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Granite Falls Energy, LLC - Quarter Report: 2018 January (Form 10-Q)

Table of Contents

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 January 31, 2018

 

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)

 

 

 

 

Minnesota

 

41-1997390

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

15045 Highway 23 SE, Granite Falls, MN 56241-0216

(Address of principal executive offices)

 

(320) 564-3100

(Registrant's telephone number, including area code)

 

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

☒Yes    No

 

Indicate by checkmark 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, a smaller reporting company, or an 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 

Non-Accelerated Filer

Accelerated Filer

Smaller Reporting Company

 

 

Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 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 March 19, 2018, there were 30,606 membership units outstanding.

 

 

 

 


 

Table of Contents

 

INDEX

 

 

 

 

Page Number

PART I. FINANCIAL INFORMATION 

3

 

 

Item 1. Financial Statements 

3

 

 

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

16

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk 

32

 

 

Item 4. Controls and Procedures 

34

 

 

PART II. OTHER INFORMATION 

34

 

 

Item 1. Legal Proceedings 

34

 

 

Item 1A. Risk Factors 

35

 

 

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

35

 

 

Item 3. Defaults Upon Senior Securities 

35

 

 

Item 4. Mine Safety Disclosures 

35

 

 

Item 5. Other Information 

36

 

 

Item 6. Exhibits 

36

 

 

SIGNATURES 

36

 

 

 

2

 


 

Table of Contents

 

PART IFINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

    

January 31, 2018

    

October 31, 2017

 

 ASSETS

    

(unaudited)

    

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

6,638,645

 

$

21,658,422

 

Restricted cash

 

 

547,132

 

 

75,189

 

Accounts receivable

 

 

7,442,899

 

 

7,622,601

 

Inventory

 

 

15,736,482

 

 

15,241,092

 

Commodity derivative instruments

 

 

36,525

 

 

244,294

 

Prepaid expenses and other current assets

 

 

702,650

 

 

361,340

 

Total current assets

 

 

31,104,333

 

 

45,202,938

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

70,414,786

 

 

72,271,013

 

 

 

 

 

 

 

 

 

Goodwill

 

 

1,372,473

 

 

1,372,473

 

 

 

 

 

 

 

 

 

Investment

 

 

7,500,000

 

 

7,500,000

 

 

 

 

 

 

 

 

 

Other Assets

 

 

733,569

 

 

743,106

 

 

 

 

 

 

 

 

 

Total Assets

 

$

111,125,161

 

$

127,089,530

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

333,015

 

$

432,183

 

Checks drawn in excess of bank balance

 

 

1,151,278

 

 

 —

 

Accounts payable

 

 

4,833,477

 

 

7,535,468

 

Commodity derivative instruments

 

 

76,264

 

 

40,379

 

Accrued expenses

 

 

1,198,817

 

 

972,043

 

Total current liabilities

 

 

7,592,851

 

 

8,980,073

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

8,453,826

 

 

8,465,502

 

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Members' Equity

 

 

 

 

 

 

 

Members' equity attributable to Granite Falls Energy, LLC consists of 30,606 units authorized,  issued, and outstanding at both January 31, 2018 and October 31, 2017

 

 

73,271,176

 

 

83,998,672

 

Non-controlling interest

 

 

21,807,308

 

 

25,645,283

 

Total members' equity

 

 

95,078,484

 

 

109,643,955

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

111,125,161

 

$

127,089,530

 

 

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

 

3


 

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GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 

 

 

 

2018

 

2017

 

 

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

 

 

Revenues

 

$

52,993,499

 

$

54,576,064

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

49,988,507

 

 

47,731,157

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

3,004,992

 

 

6,844,907

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

1,680,143

 

 

1,607,221

 

 

 

 

 

 

 

 

 

Operating Income

 

 

1,324,849

 

 

5,237,686

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

Other income, net

 

 

259,256

 

 

392,265

 

Interest income

 

 

46,473

 

 

454

 

Interest expense

 

 

(105,755)

 

 

(41,609)

 

Total other income, net

 

 

199,974

 

 

351,110

 

 

 

 

 

 

 

 

 

Net Income

 

$

1,524,823

 

$

5,588,796

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(473,217)

 

 

(1,429,005)

 

 

 

 

 

 

 

 

 

Net Income Attributable to Granite Falls Energy, LLC

 

$

1,051,606

 

$

4,159,791

 

 

 

 

 

 

 

 

 

Weighted Average Units Outstanding - Basic and Diluted

 

 

30,606

 

 

30,606

 

 

 

 

 

 

 

 

 

Amounts attributable to Granite Falls Energy, LLC:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income Per Unit - Basic and Diluted

 

$

34.36

 

$

135.91

 

 

 

 

 

 

 

 

 

Distributions Per Unit

 

$

385.00

 

$

365.00

 

 

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

 

 

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GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended January 31, 

 

 

 

2018

 

2017

 

 

 

(unaudited)

 

(unaudited)

 

Cash Flows from Operating Activities:

 

 

 

 

 

 

 

Net income

 

$

1,524,823

 

$

5,588,796

 

Adjustments to reconcile net income to net cash provided by operations:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

2,284,340

 

 

2,492,791

 

Change in fair value of commodity derivative instruments

 

 

113,233

 

 

(383,860)

 

Gain on sale of assets

 

 

(24,815)

 

 

(45,000)

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

(471,943)

 

 

 —

 

Commodity derivative instruments

 

 

130,421

 

 

842,875

 

Accounts recievable

 

 

179,702

 

 

2,302,376

 

Inventory

 

 

(495,390)

 

 

(271,086)

 

Prepaid expenses and other current assets

 

 

(341,310)

 

 

(71,998)

 

Accounts payable

 

 

(2,550,585)

 

 

(7,605,717)

 

Accrued expenses

 

 

226,774

 

 

164,537

 

Net Cash Provided by Operating Activities

 

 

575,250

 

 

3,013,714

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Payment for investment

 

 

 —

 

 

(750,000)

 

Payments for capital expenditures

 

 

(569,982)

 

 

(385,554)

 

Proceeds from disposal of assets

 

 

24,815

 

 

45,000

 

Net Cash Used in Investing Activities

 

 

(545,167)

 

 

(1,090,554)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Payments on long-term debt

 

 

(110,844)

 

 

(128,887)

 

Checks drawn in excess of bank balance

 

 

1,151,278

 

 

(1,230,005)

 

Distributions to non-controlling interests

 

 

(4,311,192)

 

 

 —

 

Member distributions paid

 

 

(11,779,102)

 

 

(11,171,190)

 

Net Cash Used in Financing Activities

 

 

(15,049,860)

 

 

(12,530,082)

 

 

 

 

 

 

 

 

 

Net Decrease in Cash

 

 

(15,019,777)

 

 

(10,606,922)

 

 

 

 

 

 

 

 

 

Cash - Beginning of Period

 

 

21,658,422

 

 

13,797,857

 

 

 

 

 

 

 

 

 

Cash - End of Period

 

$

6,638,645

 

$

3,190,935

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

105,755

 

$

41,609

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Noncash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures and construction in process included in accounts payable

 

$

63,829

 

$

175,891

 

 

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

5


 

Table of Contents

 

Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

Granite Falls Energy, LLC (“GFE”) 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.

 

Additionally, GFE owns a majority interest in Heron Lake BioEnergy, LLC (“HLBE”). 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. HLBE owns a majority interest in Agrinatural Gas, LLC (“Agrinatural”), which operates a natural gas pipeline that provides natural gas to HLBE's ethanol production facility and other customers.

 

All references to “we”, “us”, “our”, and the “Company” collectively refer to GFE and its wholly-owned and majority-owned subsidiaries.

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated unaudited financial statements as of January 31, 2018 consolidate the operating results and financial position of GFE, and its approximately 50.7% 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 49.3% 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 approximately 73% of 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 approximately 27% noncontrolling interest. All significant intercompany balances and transactions are eliminated in consolidation.

 

The accompanying condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). 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, 2017, 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.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

Reportable Operating Segments

 

Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Therefore, in applying the criteria set forth in ASC 280, the Company determined that based on the nature of the products and production process and the expected financial results, the Company’s operations at GFE’s ethanol plant and HLBE’s plant, including the production and sale of ethanol and its co-products, are aggregated into one reporting segment.

 

Additionally, the Company also realizes relatively immaterial revenue from natural gas pipeline operations at Agrinatural, HLBE’s majority owned subsidiary. Before and after accounting for intercompany eliminations, these revenues from Agrinatural’s represent less than less than 1% of our consolidated revenues and have little to no impact on the overall performance of the Company.  Therefore, the Company does not separately review Agrinatural’s revenues, cost of sales or other operating performance information.  Rather, the Company reviews Agrinatural’s natural gas pipeline financial data on a consolidated basis with the Company’s ethanol production operating segment. The Company 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 consolidated financial statements and would not achieve the basic principles and objectives of ASC 280.

 

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 and equipment, valuation of commodity derivatives, inventory, inventory purchase and sale commitments, evaluation of railcar damages contingency, and the assumptions used in the impairment analysis of long-lived assets, which includes 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.

 

Agrinatural recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee for the arrangement is fixed or determinable and collectability is reasonably assured.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value. Cost for all inventories is determined using the first in first out method (“FIFO”).  Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation.  Inventory consists of raw materials, work in process, finished goods, and 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.

 

Investment 

   

On November 1, 2016, GFE subscribed to purchase 1,500 capital units of Ringneck Energy & Feed, LLC (“Ringneck”) at a price of $5,000 per unit for a total of $7,500,000.  Ringneck is a South Dakota limited liability company that is currently constructing an 80 million gallon per year ethanol manufacturing plant in outside of Onida, South Dakota in Sully County. GFE’s investment is sufficient to secure the Company the right to appoint one director to the board of directors of Ringneck. GFE has appointed Steve Christensen, its CEO, to serve as its appointed director.

 

GFE paid a down payment of $750,000 in connection with the subscription, and signed a promissory note for $6,750,000 for the remaining balance of the subscription. On August 2, 2017, following notice from Ringneck accepting GFE’s subscription and that payment of the balance of GFE’s subscription and promissory note was due, GFE borrowed $7.5 million under its credit facility with Project Hawkeye, LLC (“Project Hawkeye”) and paid $6,750,000 to Ringneck as payment for the remaining balance of GFE’s subscription.  Project Hawkeye is an affiliate of Fagen, Inc., which is a member of GFE.  See Note 6 below for the terms of GFE’s credit facility with Project Hawkeye.

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

The investment will be accounted for by the equity method, under which the Company’s share of the net income of the investee is recognized as income in the Company’s Condensed Consolidated Statements of Operations and added to the investment account, and distributions received from the affiliates are treated as a reduction of the investment.

 

 

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% - 90% 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. The Company’s largest cost of production is corn.  The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and a risk management program used to protect against the price volatility of these commodities. Market fluctuations in the price of and demand for these products may have a significant adverse effect on the Company’s operations, profitability and the availability and adequacy of cash flow to meet the Company’s working capital requirements. 

 

 

3.   INVENTORY

 

Inventories consist of the following:

 

 

 

 

 

 

 

 

 

 

    

January 31,  2018

    

October 31,  2017

 

 

 

(unaudited)

 

 

 

Raw materials

 

$

4,524,471

 

$

4,488,923

 

Supplies

 

 

2,913,151

 

 

2,929,385

 

Work in process

 

 

1,318,638

 

 

1,281,292

 

Finished goods

 

 

6,980,222

 

 

6,541,492

 

Totals

 

$

15,736,482

 

$

15,241,092

 

 

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the net realizable 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, as a component of cost of goods sold, the Company recorded a loss on ethanol inventories of approximately $377,000 and $207,000 for the three months ended January 31, 2018 and 2017, respectively.

 

 

4.   DERIVATIVE INSTRUMENTS

 

As of January 31, 2018, the total notional amount of GFE’s outstanding corn derivative instruments was approximately 7,090,000 bushels, comprised of long corn positions on 2,070,000 bushels that were entered into to hedge forecasted ethanol sales through March 2018, and short corn positions on 5,020,000 bushels that were entered into to hedge forecasted corn purchases through December 2021. 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.

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

As of January 31, 2018, the total notional amount of HLBE’s outstanding corn derivative instruments was approximately 5,635,000 bushels, comprised of long corn positions on 1,995,000 bushels that were entered into to hedge forecasted ethanol sales through March 2018, and short corn positions on 3,640,000 bushels that were entered into to hedge forecasted corn purchases through December 2019. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of January 31, 2018, HLBE had outstanding natural gas derivative instruments totaling approximately 40,000 MMBTUs entered into to hedge forecasted ethanol sales through February 2018.

 

As of January 31, 2018, GFE had approximately $386,000 of cash collateral (restricted cash) related to derivatives held by a broker.

 

As of January 31, 2018, HLBE had approximately $161,000 of cash collateral (restricted cash) related to derivatives held by a broker.

 

The following tables provide details regarding the Company's derivative instruments at January 31, 2018, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet location

    

Assets

    

Liabilities

 

Corn contracts - GFE

 

Commodity derivative instruments

 

$

 —

 

$

70,000

 

Corn contracts - HLBE

 

Commodity derivative instruments

 

 

5,025

 

 

 —

 

Ethanol contracts - HLBE

 

Commodity derivative instruments

 

 

31,500

 

 

 —

 

Natural gas contracts - HLBE

 

Commodity derivative instruments

 

 

 —

 

 

6,264

 

Totals

 

 

 

$

36,525

 

$

76,264

 

 

As of October 31, 2017, the total notional amount of GFE’s outstanding corn derivative instruments was approximately 1,495,000 bushels, comprised of long corn positions on 200,000 bushels that were entered into to hedge forecasted ethanol sales through December 2017, and short corn positions on 1,295,000 bushels that were entered into to hedge forecasted corn purchases through December 2018. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of October 31, 2017, the total notional amount of GFE’s outstanding ethanol derivative instruments was approximately 420,000 gallons that were entered into to hedge forecasted ethanol sales through November 2017.

 

As of October 31, 2017, GFE had approximately $75,000 cash collateral (restricted cash) and approximately $12,000 due to broker related to derivatives held by a broker, recorded as a component of accounts payable.

 

As of October 31, 2017, the total notional amount of HLBE’s outstanding corn derivative instruments was approximately 1,120,000 bushels, comprised of long corn positions on 215,000 bushels that were entered into to hedge forecasted ethanol sales through December 2017, and short corn positions on 905,000 bushels that were entered into to hedge forecasted corn purchases through July 2018. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of October 31, 2017, HLBE had outstanding natural gas derivative instruments totaling 120,000 MMBTU entered into hedge forecasted natural gas purchases through February 2018.

 

As of October 31, 2017, the total notional amount of HLBE’s outstanding ethanol derivative instruments was approximately 420,000 gallons that were entered into to hedge forecasted ethanol sales through November 2017

 

As of October 31, 2017, HLBE did not have any cash collateral (restricted cash) and approximately $12,000 due to broker related to derivatives held by a broker, recorded as a component of accounts payable.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

The following tables provide details regarding the Company's derivative instruments at October 31, 2017, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet location

    

Assets

    

Liabilities

 

Corn contracts - GFE

 

Commodity derivative instruments

 

$

102,650

 

$

 —

 

Corn contracts - HLBE

 

Commodity derivative instruments

 

 

141,644

 

 

 —

 

Ethanol contracts - GFE

 

Commodity derivative instruments

 

 

 —

 

 

12,749

 

Ethanol contracts - HLBE

 

Commodity derivative instruments

 

 

 —

 

 

12,249

 

Natural gas contracts - HLBE

 

Commodity derivative instruments

 

 

 —

 

 

15,381

 

Totals

 

 

 

$

244,294

 

$

40,379

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statement

 

Three Months Ended  January 31, 

 

 

    

 of Operations Location

    

2018

    

2017

 

Corn contracts

 

Cost of Goods Sold

 

$

(265,068)

 

$

(33,137)

 

Ethanol contracts

 

Revenues

 

 

139,497

 

 

416,997

 

Natural gas contracts

 

Cost of Goods Sold

 

 

12,338

 

 

 —

 

Total gain (loss)

 

 

 

$

(113,233)

 

$

383,860

 

 

 

 

 

5.   FAIR VALUE

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at January 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

 

 

 

 

 

Quoted Prices

 

Significant Other

 

Significant

 

 

 

Carrying Amount in

 

 

 

 

in Active Markets

 

Observable Inputs

 

Unobservable Inputs

 

Financial Asset:

 

Consolidated Balance Sheet

 

Fair Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Commodity Derivative Instruments - Corn

 

$

5,025

 

$

5,025

 

$

5,025

 

$

 —

 

$

 —

 

Commodity Derivative Instruments - Ethanol

 

$

31,500

 

$

31,500

 

$

31,500

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative Instruments - Corn

 

$

70,000

 

$

70,000

 

$

70,000

 

$

 —

 

$

 —

 

Commodity Derivative Instruments - Natural Gas

 

$

6,264

 

$

6,264

 

$

 —

 

$

6,264

 

$

 —

 

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

 

 

 

 

 

Quoted Prices

 

Significant Other

 

Significant

 

 

 

Carrying Amount in

 

 

 

 

in Active Markets

 

Observable Inputs

 

Unobservable Inputs

 

Financial Asset:

 

Consolidated Balance Sheet

 

Fair Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Commodity Derivative Instruments - Corn

 

$

244,294

 

$

244,294

 

$

244,294

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative Instruments - Ethanol

 

$

24,998

 

$

24,998

 

$

36,500

 

$

(11,502)

 

$

 —

 

Commodity Derivative Instruments - Natural Gas

 

$

15,381

 

$

15,381

 

$

 —

 

$

15,381

 

$

 —

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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. We determine the fair value of ethanol and natural gas Level 2 instruments by model-based techniques in which all significant inputs are observable in the markets noted above.

 

 

6.  DEBT FACILITIES

 

Debt financing consists of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2018

 

October 31, 2017

 

 

 

(unaudited)

 

 

 

 

GRANITE FALLS ENERGY:

 

 

 

 

 

 

 

Seasonal loan, see terms below.

 

$

 —

 

$

 —

 

Term note payable to Project Hawkeye, see terms below.

 

 

7,500,000

 

 

7,500,000

 

 

 

 

 

 

 

 

 

HERON LAKE BIOENERGY:

 

 

 

 

 

 

 

Revolving term loan, see terms below.

 

 

 —

 

 

 

Assessment payable as part of water treatment agreement, due in semi-annual installments of $189,393 with interest at 6.55%, enforceable by statutory lien, with the final payment due in 2021. HLBE made deposits for one years' worth of debt service payments of approximately $364,000, which is included with other assets that are held on deposit to be applied with the final payments of the assessment.

 

 

1,241,171

 

 

1,241,171

 

Assessment payable as part of water supply agreement, due in monthly installments of $3,942 with interest at 8.73%, enforceable by statutory lien, with the final payment due in 2019.

 

 

45,670

 

 

56,514

 

Note payable to non-controlling interest member of Agrinatural.  Interest is at One Month LIBOR plus 4.0%, which was approximately 5.58% and 5.24% at January 31, 2018 and October 31, 2017, respectively. The note was paid in full in January 2018.

 

 

 —

 

 

100,000

 

Totals

 

 

8,786,841

 

 

8,897,685

 

Less: amounts due within one year

 

 

333,015

 

 

432,183

 

Net long-term debt

 

$

8,453,826

 

$

8,465,502

 

 

Granite Falls Energy

 

Seasonal Revolving Loan

 

GFE has a credit facility with a lender that includes a seasonal revolving loan, under which GFE may borrow, repay, and re-borrow up to the aggregate principal commitment of $6,000,000 until maturity.  The seasonal revolving loan matures on October 1, 2018 unless a later date is agreed to by the administrative agent for the facility.  There was no outstanding balance on the seasonal revolving loan at January 31, 2018 and October 31, 2017. Therefore, the aggregate principal amount available for borrowing by GFE under this seasonal revolving loan at January 31, 2018 and October 31, 2017 was $6,000,000.

 

The interest rate on the seasonal revolving loan is based on the bank's One Month London Interbank Offered Rate (“LIBOR”) Index Rate, plus 2.75%, which equated to 4.33% and 3.99% at January 31, 2018 and October 31, 2017, respectively.

 

The credit facility also requires GFE to comply with certain financial covenants, at various times calculated monthly, quarterly, or annually, including maintenance of certain financial ratios including minimum working capital, a debt service coverage ratio as defined by the credit facility, as well as a restriction of the payment of distributions.    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.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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

 

Project Hawkeye Loan

 

On August 2, 2017, GFE entered into a credit facility with Project Hawkeye to finance its investment in Ringneck. Pursuant to this credit facility, GFE borrowed $7.5 million from Project Hawkeye using the Ringneck investment as collateral.  The Project Hawkeye loan bears interest from date funds are first advanced on the loan through maturity, at a rate per annum equal to the sum of the One Month LIBOR Index Rate plus 3.05% per annum, with an interest rate floor of 3.55%,  which equated to 4.63% and 4.29% at January 31, 2018 and October 31, 2017 respectively.

 

The Project Hawkeye loan requires annual interest payments only for the first two years of the loan and monthly principal and interest payments for years three through nine based on a seven-year amortization period.  The monthly amortized payments will be re-amortized following any change in interest rate. The entire outstanding principal balance of the loan, plus any accrued and unpaid interest thereon, is due and payable in full on August 2, 2026. GFE is permitted to voluntarily prepay all or any portion of the outstanding balance of this loan at any time without premium or penalty.

 

Pursuant to a pledge agreement entered into in connection with the Project Hawkeye loan, GFE’s obligations are secured by all of its right, title, and interest in its investment in Ringneck, including the 1,500 units subscribed for by GFE. The loan is non-recourse to all of GFE’s other assets, meaning that in the event of default, the only remedy available to Project Hawkeye will be to foreclose and seize all of GFE’s right, title and interest in its investment in Ringneck.    

 

Heron Lake BioEnergy

 

Revolving Term Loan

 

HLBE has a revolving term note payable with a lender under which HLBE can borrow, repay and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022.  The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity. In December 2017, HLBE and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000. HLBE had no outstanding balance on the revolving term loan at January 1, 2018 and October 31, 2017. Therefore, the aggregate principal amount available to HLBE for borrowing at January 31, 2018 and October 31, 2017 was $8,000,000 and $17,500,000, respectively.

 

In connection with the reduction in the aggregate principal commitment, the interest rate on the revolving term loan was reduced from 3.25% above the One-Month LIBOR Index rate to 2.85% above the One-Month LIBOR Index rate.  The interest rate on this facility was 4.42% and 4.49% at January 31, 2018, and October 31, 2017, respectively. 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.

 

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 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, including restriction of the payment of dividends, restrictions on loans and advances to Agrinatural and the 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 part of the credit facility closing, HLBE entered into an Administrative Agency Agreement with CoBank, ACP (“CoBank”).  CoBank purchased a participation interest in the revolving term loan and was appointed the administrative agent for the purpose of servicing the loan.  As a result, CoBank will act as the agent for lender with respect to the credit facility. HLBE agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

Estimated annual maturities of debt at January 31, 2018, are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2019

    

$

333,015

 

2020

 

 

842,921

 

2021

 

 

1,389,227

 

2022

 

 

1,391,250

 

2023

 

 

1,071,428

 

Thereafter

 

 

3,759,000

 

Total debt

 

$

8,786,841

 

 

 

 

7.   MEMBERS' EQUITY

 

Granite Falls Energy

 

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 January 31, 2018 and October 31, 2017, GFE had 30,606 membership units authorized, issued, and outstanding.

 

In December 2017, the Board of Governors of GFE declared a cash distribution of $385 per unit or approximately $11,783,000, for unit holders of record as of December 21, 2017.  The distribution was paid in January 2018.

 

In December 2016, the Board of Governors of GFE declared a cash distribution of $365 per unit or approximately $11,171,000, for unit holders of record as of December 22, 2016.  The distribution was paid in January 2017.

 

Heron Lake BioEnergy

 

In December 2017, the Board of Governors of HLBE declared a cash distribution of $0.11 per unit, or approximately $8,573,000,  for unit holders of record as of December 21, 2017. The distribution was paid in January 2018.

 

At December 21, 2017, GFE owned 24,475,824 Class A membership units and 15,000,000 Class B units of HLBE, and received an aggregate distribution from HLBE of approximately $4,342,000.  The remaining $4,231,000 was distributed by HLBE to the non-controlling interest.

 

 

8.    COMMITMENTS AND CONTINGENCIES

 

Corn Purchase Commitments

 

At January 31, 2018, GFE had cash and basis contracts for forward corn contracts for approximately 4,096,000 bushels for delivery periods through February 2019.

 

At January 31, 2018,  HLBE had cash and basis contracts for forward corn purchase commitments for approximately 3,392,000 bushels for delivery periods through January 2019.

 

Corn Purchases - Members

GFE purchased corn from board members of approximately $437,000 and $0 for the three months ended January 31, 2018 and 2017, respectively.

 

HLBE purchased corn from board members of approximately $4,455,000 and $3,025,000 for the three months ended January 31, 2018 and 2017, respectively.

 

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Granite Falls Energy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

Ethanol Contracts

 

At January 31, 2018, GFE had fixed and basis contracts to sell approximately $11,710,000 of ethanol for various delivery periods through March 2018.  

 

At January 31, 2018, HLBE had fixed and basis contracts to sell approximately $14,003,000 of ethanol for various delivery periods through March 2018.  

 

Distillers' Grain Contracts

 

At January 31, 2018, GFE had forward contracts to sell approximately $993,000 of distillers' grain for various delivery periods through February 2018.

 

At January 31, 2018, HLBE had forward contracts to sell approximately $1,640,000 of distillers' grains for delivery periods through March 2018.

 

Corn Oil

 

At January 31, 2018, GFE had forward contracts to sell approximately $260,000 of corn oil for various delivery periods through February 2018.

 

At January 31, 2018, HLBE had forward contracts to sell approximately $466,000 of corn oil for various delivery periods through February 2018.

 

Railcar Damages

 

In accordance with certain railcar lease agreements, at expiration, the Company is required to return the railcars in good condition, less normal wear and tear.  Primarily due to the ongoing maintenance and repair activities performed on its railcars, the Company has determined that no accrual for leased railcars is necessary and an estimate of the possible range of loss cannot be made.

 

 

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Table of Contents

 

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 months ended January 31, 2018 and 2017. 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, 2017.

 

Disclosure Regarding Forward-Looking Statements

 

The Securities and Exchange Commission (“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, 2017 and this report on Form 10-Q. These risks and uncertainties include, but are not limited to, the following:

·

Fluctuations in the price of ethanol as a result of a number of factors, including: the price and availability of competing fuels; the overall supply and demand for ethanol and corn; the price of gasoline, crude oil and corn; and government policies;

·

Fluctuations in the price of crude oil and gasoline and the impact of lower oil and gasoline prices on ethanol prices and demand;

·

Fluctuations in the availability and price of corn, resulting from factors such as domestic stocks, demand from corn-consuming industries, such as the ethanol industry, prices for alternative crops, increasing input costs, changes in government policies, shifts in global markets or damaging growing conditions, such as plant disease or adverse weather, including drought;

·

Fluctuations in the availability and price of natural gas, which is may be affected by by factors such as weather, drilling economics, overall economic conditions and government regulations;

·

Negative operating margins which may result from lower ethanol and/or high corn prices;

·

Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;

·

Overcapacity and oversupply in the ethanol industry;

·

Ethanol may trading at a premium to gasoline at times, resulting in a disincentive for discretionary blending of ethanol beyond the requirements of the Renewable Fuels Standard (“RFS”) and consequently negatively impacting ethanol prices and demand;

·

Changes in federal and/or state laws and environmental regulations including elimination, waiver or reduction of the corn-based ethanol use requirement in the RFS and legislative acts taken by state governments such as California related to low-carbon fuels, may have an adverse effect on our business; 

·

Any impairment of the transportation, storage and blending infrastructure that prevents ethanol from reaching markets;

·

Any effect on prices and demand for our products resulting from actions in international markets, particularly imposition of tariffs on ethanol imported to Brazil and/or increased tariffs on ethanol exported to China and anti-dumping and countervailing duties on U.S. distillers’ grains exported to China;

·

Changes in our business strategy, capital improvements or development plans;

·

Effect of our risk mitigation strategies and hedging activities on our financial performance and cash flows;

·

Competition from alternative fuels and alternative fuel additives;

·

Changes or advances in plant production capacity or technical difficulties in operating the plant; and

·

Our reliance on key management personnel.

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Table of Contents

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 (“Granite Falls Energy” or “GFE”) is a Minnesota limited liability company that owns and operates a dry mill cornbased, natural gas fired ethanol plant in Granite Falls, Minnesota.  Additionally, through Project Viking, L.L.C., a wholly owned subsidiary (“Project Viking”), GFE owns an approximately 50.7% controlling interest of Heron Lake BioEnergy, LLC (“Heron Lake BioEnergy” or “HLBE”).  HLBE is a Minnesota limited liability company that owns and operates a dry mill cornbased, natural gas fired ethanol plant near Heron Lake, Minnesota.    Additionally, through its a wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), HLBE owns a 73% controlling interest of Agrinatural Gas, LLC (“Agrinatural”), which operates a natural gas pipeline. 

 

When we use the terms “Heron Lake BioEnergy”, “Heron Lake”, or “HLBE” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its majority-owned subsidiary Agrinatural. When we use the terms “Granite Falls Energy” or “GFE” or similar words, unless the context otherwise requires, we are referring to Granite Falls Energy, LLC and our operations at our ethanol production facility located in Granite Falls, Minnesota. When we use the terms the “Company”, “we”, “us”, “our” or similar, unless the context otherwise requires, we are referring to Granite Falls Energy, LLC and our consolidated wholly- and majority owned subsidiaries. 

 

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 GFE’s ethanol plant located in Granite Falls, Minnesota and at HLBE’s ethanol plant near Heron Lake, Minnesota.    

 

The GFE ethanol plant has an approximate annual production capacity of 60 million gallons of denatured ethanol, but has obtained EPA pathway approval and permits from the Minnesota Pollution Control Authority (“MPCA”) to increase our production capacity to approximately 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 has obtained EPA pathway approval and permits from the MPCA to increase its production capacity to approximately 72 million gallons of undenatured ethanol on a twelve month rolling sum basis.  We intend to continue working toward increasing production at plants to take advantage of the additional production allowed pursuant to their respective permits so long as we believe it is profitable to do so.

 

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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.

 

We do not have any long-term, fixed price exclusive supply contracts for the purchase of corn for either the GFE or HLBE plants.  Both GFE and HLBE purchase the corn necessary for operating directly from grain elevators, farmers, and local dealers within approximately 80 miles of their respective plants. Neither GFE’s nor HLBE’s members are obligated to deliver corn to our plants.

 

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 management services agreement automatically renews 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, which is a natural gas distribution and sales company located in Heron Lake, Minnesota that owns approximately 190 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.

 

On November 1, 2016, we subscribed to purchase 1,500 capital units of Ringneck Energy & Feed, LLC (“Ringneck”) at a price of $5,000 per unit for a total of $7,500,000.  By letter dated July 12, 2017, GFE was notified of Ringneck’s acceptance of GFE’s subscription and that payment of the balance of GFE’s subscription due under the promissory note was due not later than August 2, 2017. On August 2, 2017, GFE borrowed $7.5 million under its credit facility with Project Hawkeye, LLC (“Project Hawkeye”), an affiliate of Fagen, Inc., which is a member of GFE, and paid $6,750,000 to Ringneck as payment of the remaining balance of GFE’s subscription and promissory note.  Details regarding our investment in Ringneck are provided below in the section below titled “Investments.”  Details of the Project Hawkeye credit facility are provided below in the section below entitled “Indebtedness - Granite Falls Energy - GFE’s Other Credit Arrangement”.

 

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.

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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 plants. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plants to take full advantage of our permitted production capacities, 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.

 

Additionally, we expect to continue to conduct routine maintenance and repair activities at our ethanol plants to maintain current plant infrastructure, as well as small capital projects to improve operating efficiency. We anticipate using cash we generate from our operations and our revolving term loan 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 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2017.

 

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.

 

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 may be tightly compressed or negative. If the corn-ethanol spread is compressed or negative for sustained period, it is possible that our operating margins will decline or become negative and our plants may not generate adequate cash flow for operations. In such cases, we may reduce or cease production at our plants to minimize our variable costs and optimize cash flow.

 

 

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Management currently believes that our margins will remain modest during the remainder of the fiscal year 2018.  However, continued large corn supplies and ethanol production capacity increases could have a negative impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline. The ethanol industry is currently experiencing growth in production capacity principally through plant optimization and some new construction. The EIA has reported that during 2017, increasing ethanol production rates have outpaced domestic E10 gasoline demand and export growth, leading to elevated ethanol inventory levels. 

 

In recent years, the ethanol industry in the U.S. has increased exports of ethanol and distillers’ grains. However, export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility.  During 2017, China and Brazil instituted tariffs on ethanol produced in the U.S., which are expected to continue to negatively impact U.S. exports. In September 2017, China’s National Development and Reform Commission, the National Energy Board and 15 other state departments issued a joint plan to expand the use and production of biofuels containing up to 10% ethanol by 2020. China, the number three importer of U.S. ethanol in 2016, imported negligible volumes during calendar year 2017 due to a 30% tariff imposed on imports of U.S. and Brazil fuel ethanol, which took effect in January 2017. There is no assurance that the recently issued joint plan will lead to increased imports of U.S. ethanol by China but any increase in exports to China could have a positive impact on the ethanol market.

 

While Chinese export demand has fallen off since imposition of its tariffs, Brazilian demand from the U.S. has remained relatively steady. Additionally, given the ethanol supply struggles Brazil is currently facing, the government of Brazil has indicated that it is contemplating reversing the tariff. As a result, management anticipates exports to Brazil will remain steady in the near term despite the tariff because of market conditions in Brazil. Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or foreign markets are developed.

 

Our margins have also been, and could continue to be, negatively impacted due to lower market prices for distillers’ grains due to lower export demand, largely due to Chinese tariffs, and oversupply in the domestic market, along with increased corn and soybean availability. However, during the three months ended January 31, 2018, distillers’ grains prices were somewhat buoyed by improved domestic demand in response to the continued rise in soybean meal price and improved export demand from southeast Asia, particularly Vietnam. Exports of U.S. distillers’ grains to Vietnam had halted completely due to Vietnam’s imposition of stricter regulations on fumigation in December 2016. However, in a statement issued September 1, 2017, the U.S. Grains Council announced that Vietnam is lifting its suspension of U.S. distillers’ grains imports and easing fumigation requirements.  Since the lifting of Vietnam’s suspension, exports to Vietnam have resumed, although there is no guarantee that they will reach pre-suspension levels. 

 

Demand and prices for distillers’ grains have experienced significant decline due to decreased exports to China as a result of the substantial tariffs and duties imposed on imports into China of distillers’ grains produced in the U.S. imposed in January 2017. China had historically been one of the largest importers of domestically produced distillers’ grains.  However, in November 2017, the Chinese foreign ministry announced that it would be removing the 11% value-added tax on U.S. produced dried distillers’ grains but no timeline for removal has been established. While the anti-subsidy tariffs may be removed, the more substantial anti-dumping duties remain.  As a result, we cannot forecast how much demand from China will come back into the marketplace and distillers’ grains prices could remain low unless additional demand can be created from other foreign markets or domestically.

 

Corn oil prices have been adversely impacted by oversupply of corn oil due to the substantial increase in ethanol production during the last few years. Additionally, corn oil prices have been impacted by oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production. The impact of lower soybean oil prices and the current oversupply of corn oil due to the substantial increase in corn oil production during the last few years will likely continue to impact corn oil prices.

 

In February 2018, legislation was signed retroactively extending the $1.00-per-gallon biodiesel blender tax credit retroactively to January 1, 2017.  Any extension of the biodiesel blenders tax credit beyond December 31, 2017 could increase demand for corn oil and soybean oil and positively impact the price of corn oil. However, due to the recent uncertainty in Congress, management cannot predict whether additional legislation further extending the biodiesel tax credit will be passed by Congress. 

 

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Given the inherent volatility in ethanol, distillers’ grains, non-food grade corn oil, grain and natural gas prices, we cannot predict the likelihood that the spread between ethanol, distillers’ grains, non-food grade corn oil and grain prices in future periods will be consistent compared to historical periods.

 

Government Supports and Regulation

 

The Renewable Fuels Standard

 

The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which is the federal Renewable Fuels Standard (the “RFS”). The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage. Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on short-term ethanol prices and our financial performance in the future.

 

Under the provisions of the RFS, the Environmental Protection Agency (“EPA”) must publish an annual rule that establishes the number of gallons of different types of renewable fuels, including corn-based ethanol, that must be blended with gasoline in the U.S. by refineries, blenders, distributors and importers, which affects the domestic market for ethanol.  In November 2017, the EPA announced it would maintain the 15 billion gallon mandate for conventional ethanol in 2018. 

 

According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. Although the EPA maintained the RVO for conventional ethanol at 15 billion gallons, 2018 is the first year the total proposed RVOs are more than 20% below statutory volumes levels.  Thus, the EPA Administrator Pruitt directed his staff to initiate the required technical analysis to perform any future reset consistent with the reset rules. The reset will be triggered if the 2019 RVOs continue to be more than 20% below the statutory levels.  If the reset is triggered, the EPA will be required to modify statutory volumes through 2022 within one year of the trigger event, based on the same factors used to set the RVOs post-2022. Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on short-term ethanol prices and our financial performance in the future.

 

The EPA assigns individual refiners, blenders and importers the renewable volume obligations (“RVOs”) they are obligated to use based on their percentage of total fuel sales. However, the EPA has the authority to waive the mandates in whole or in part if there is inadequate domestic renewable fuel supply or the requirement severely harms the economy or environment.  Obligated parties use RINs to show compliance with RFS-mandated volumes. RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market. The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties. In November 2017, the EPA denied a petition to change the point of obligation under RFS to the parties that own the gasoline before it is sold.

 

On October 19, 2017, the EPA Administrator Pruitt reiterated his commitment to the text and spirit of the RFS. In a letter to seven senators from the Midwestern states, he stated the EPA is actively exploring its authority to issue an RVP waiver and will not pursue action on RINs involving ethanol exports. Moreover, on November 22, 2017, the EPA issued a Notice of Denial of Petitions for rulemaking to change the RFS point of obligation, confirming the point of obligation will not change. The point of obligation does not directly impact ethanol producers; however, moving the point of obligation could indirectly affect ethanol producers.

 

Valero Energy and refining trade group American Fuel and Petrochemical Manufacturers (AFPM) have challenged the EPA’s handling of the U.S. biofuel mandate in separate actions on January 26, 2018. AFPM is asking the D.C. U.S. Court of Appeals to review the EPA’s November 2017 decision to reject proposed changes to the structure of the RFS, including moving the point of obligation from refiners and importers of fuel to fuel blenders. Valero filed two petitions with the same court, one seeking review of the annual Renewable Volume Obligation (RVO) rule set by EPA’s for 2018 and 2019, which dictates the volumes of renewable fuels to be blended in the coming years, and a second arguing against the EPA’s December 2017 assertion that the agency has fulfilled its duty to periodically review the RFS as directed by statute.

 

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Although the maintenance of the 15 billion gallon RVO for corn-based ethanol, the October 2017 letter issued by EPA Administrator Pruitt, and the resulting actions taken by the EPA consistent with EPA Administrator Pruitt’s letter signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal or otherwise invalidate the RFS.  At the end of February 2018 and continuing into March, several discussions regarding the RFS were held between the Trump administration and congressional and petroleum and ethanol industry leaders.  A variety of proposals to modify obligations under the RFS have surfaced in recent months, including application of the various waiver authorities under the RFS, expanding the number of small refinery exemptions, and a $0.10 per gallon cap on the price of the RIN credits used to comply with the RFS. There has also been discussion of granting an RVP waiver for E15 gasoline blends to remove barriers to the year-rounds use of E15 and other mid-level ethanol blends.  However, it is unclear what regulatory changes, if any, will emerge from these discussions. Any changes to the RFS which could significantly affect the market price of RINs or reduce RVOs could adversely affect the demand and price for ethanol and the Company's profitability.

 

Tax Cuts and Job Act

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Reform Act”) was signed into law. The Tax Reform Act includes significant changes to the taxation of partnership entities. Included in those changes were changes U.S. federal tax rates,  significant limitations on the deductibility of interest, and allowances for the expensing of capital expendituresThe Company is currently evaluating the impact of the Tax Reform Act, as well as potential future regulations implementing the new tax law and interpretations of the new tax law with its professional advisors. The full impact of the Tax Reform Act on the Company in future periods cannot be predicted at this time

 

The Tax Reform Act also included an unintended consequence under section 199A benefitting producers of agricultural products that sell their products through cooperatives.  Currently, sales to non-cooperative grain buyers, like the Company, do not qualify for the same benefit.  This may provide cooperatives with a potential marketplace advantage over us as we compete to purchase corn for our plant due to how sales from farmers to such entities are treated for income tax purposes.  Any increase in the price we must pay for the corn to effectively compete with cooperatives would result in lower profit margins and adversely affect our financial performance.  According recent industry new reports, draft legislation has been proposed to address the marketplace imbalance created by section 199A retroactive to January 1, 2018 for inclusion in the pending 2018 omnibus spending bill.  While we believe that Congress intends to correct these provisions favoring cooperatives, there is no assurance that Congress will act to resolve this issue or that if such changes are approved that they will be retroactively applied.

 

Results of Operations for the Three Months Ended January 31, 2018 and 2017

 

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 January 31, 2018 and 2017 (amounts in thousands).  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 

 

 

2018

 

2017

 

 

 

(unaudited)

 

(unaudited)

 

Statement of Operations Data

 

Amount

    

%  

 

Amount

    

%  

 

Revenues

 

$

52,993

 

100.0

%

 

$

54,576

 

100.0

%

 

Cost of Goods Sold

 

 

49,989

 

94.3

%

 

 

47,731

 

87.5

%

 

Gross Profit

 

 

3,004

 

5.7

%

 

 

6,845

 

12.5

%

 

Operating Expenses

 

 

1,680

 

3.2

%

 

 

1,607

 

2.9

%

 

Operating Income

 

 

1,324

 

2.5

%

 

 

5,238

 

9.6

%

 

Other Income, net

 

 

200

 

0.4

%

 

 

351

 

0.6

%

 

Net Income

 

 

1,524

 

2.9

%

 

 

5,589

 

10.2

%

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(473)

 

(0.9)

%

 

 

(1,429)

 

(2.6)

%

 

Net Income Attributable to Granite Falls Energy, LLC

 

$

1,051

 

2.0

%

 

$

4,160

 

7.6

%

 

 

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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 98.4%  and 98.9% of our total revenues for the three months ended January 31, 2018 and 2017, respectively.  The remaining approximately 1.6%  and 1.1% attributable to miscellaneous other revenue for the three months ended January 31, 2018 and 2017, respectively,  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 January 31, 2018:

 

 

 

 

 

 

 

 

 

    

Three Months Ended  January 31, 2018

 

 

Sales Revenue

    

% of Total Revenues

Revenue Sources

 

(in thousands)

 

 

 

Ethanol sales

 

$

39,863

 

75.2

%

Distillers' grains sales

 

 

9,927

 

18.8

%

Corn oil sales

 

 

2,347

 

4.4

%

Miscellaneous other

 

 

856

 

1.6

%

Total Revenues

 

$

52,993

 

100.0

%

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our condensed consolidated unaudited statements of operations for the three months ended January 31, 2017:

 

 

 

 

 

 

 

 

 

    

Three Months Ended  January 31, 2017

 

 

Sales Revenue

    

% of Total Revenues

Revenue Sources

 

(in thousands)

 

 

 

Ethanol sales

 

$

43,921

 

80.5

%

Distillers' grains sales

 

 

7,648

 

14.0

%

Corn oil sales

 

 

2,419

 

4.4

%

Miscellaneous other

 

 

588

 

1.1

%

Total Revenues

 

$

54,576

 

100.0

%

 

Our total consolidated revenues decreased by approximately 2.9% for the three months ended January 31, 2018, as compared to the three months ended January 31, 2017 due primarily to the decrease in the average price received for our ethanol and corn oil, which was partially mitigated by the increase in the average price received for our distillers’ grains.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended January 31, 2018 and 2017: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2018

 

Three Months Ended  January 31, 2017

 

 

Quantity Sold

 

Avg. Net Price

 

Quantity Sold

 

Avg. Net Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

33,193

 

$

1.20

 

30,828

 

$

1.42

Distillers' grains (tons)

 

82

 

$

121.22

 

80

 

$

95.89

Corn oil (pounds)

 

9,204

 

$

0.25

 

8,889

 

$

0.27

 

Ethanol

 

Total revenues from sales of ethanol decreased by approximately 9.2% for the three months ended January 31, 2018 compared to the same period of 2017 due to a decrease of approximately 15.7% in the average price per gallon we received for our ethanol, partially offset by a 7.7% increase in volume sold. This aggregate increase in the number of gallons sold is attributable to an approximately 2.4% and 13.0% increase in the number of gallons sold at the GFE and HLBE plants, respectively, during the three months ended January 31, 2018.  We sold more ethanol at our plants as a result of increased ethanol production at the HLBE during the 2018 period and the timing of shipments at the GFE plant. We are currently operating our plants above their nameplate capacities. Management anticipates relatively stable ethanol production and sales during our 2018 fiscal year.

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The decrease in average market price for the three months ended January 31, 2018 compared to the same period of 2017 is due to lower market corn prices and increased ethanol supply in the market. Management anticipates that ethanol prices may continue lower during our 2018 fiscal year due to a several factors, including anticipated increases in U.S. ethanol production from plant expansions coming online, along with lower export demand from Brazil and China. Domestic production expansion, coupled with the Chinese and Brazilian ethanol tariffs, have increased domestic stocks of ethanol, pushing ethanol prices downward. Management anticipates that this excess ethanol supply may continue unless new export markets for ethanol are developed or domestic demand for ethanol increases.  While ethanol exports to Brazil continue, if ethanol prices increase, these exports to Brazil may cease. Further, ethanol exports could potentially be higher without the Chinese and Brazilian tariffs. Additionally, if domestic use increases as a result of the traditional summer driving season, ethanol prices may increase.  

 

From time to time, we engage in hedging activities with respect to our ethanol sales. At January 31, 2018, GFE had fixed and basis contracts for forward ethanol sales for various delivery periods through March 2018 valued at approximately $11.7 million. At January 31, 2018, HLBE had fixed and basis contracts for forward ethanol sales for various delivery periods through March 2018 valued at approximately $14.0 million.  Separately, ethanol derivative instruments resulted in gains of approximately $139,000 and $417,000 during the three months ended January 31, 2018, and January 31, 2017, respectively. 

 

Distillers' Grains

 

Total revenues from sales of distillers’ grains increased by approximately 29.8% for the three months ended January 31, 2018 compared to the same period of 2017.  This increase was due to an approximately 26.4%  increase in the average price per ton we received for our distillers’ grains, coupled with an approximately 2.7% increase in the volumes sold from period to period. The increase in total tons of distillers’ grains sold during the three months ended January 31, 2018 compared to the same period of 2017 was due to an approximately 11.6% increase in distillers’ grains produced at HLBE’s plant, offset by an approximately 5.2% decrease in distillers’ grain production at the GFE plant. The decrease in tons produced at the GFE plant was due primarily to decreased ethanol production. The increase in tons produced at the HLBE plant was due primarily to an increase in ethanol production from period to period, which resulted in increased distillers’ grains production.

 

Management attributes the increase in the market price of distillers’ grains to increased export demand from southeast Asia, particularly Vietnam, as well as increased prices for soybean meal.  Management anticipates distillers’ grains prices will remain steady during our 2018 fiscal year, unless China reduces or eliminates its tariffs or additional domestic demand and/ or other foreign markets develop. Domestic demand for distillers’ grains could decline if corn or soybean meal prices weaken and end-users switch to lower priced alternatives. Domestic demand for distillers’ grains may also decrease due to over-supply resulting from expansion of production capacity in the ethanol industry.

 

At January 31, 2018, GFE had forward distillers’ grains sales contracts valued at approximately $993,000 for various delivery periods through February 2018 and HLBE had forward distillers’ grains sales contracts valued at approximately $1.6 million for various delivery periods through March 2018.

 

Corn Oil

 

Total revenues from sales of corn oil decreased by approximately 3.0% for the three months ended January 31, 2018 compared to the same period of 2017 due to an approximately 6.3% decrease in the average price per pound received for our corn oil, which was offset by an approximately 3.5% increase in pounds sold from period to period.

 

Management attributes the decrease in corn oil prices to decreased demand from the biodiesel industry and from the feed market. Management expects corn oil prices will remain relatively steady in the near term. However, we may experierence lower demand for corn oil from the biodiesel industry since the proposed volume obligations in the 2018 RFS for biodiesel are lower than statutory levels unless the biodiesel blenders tax credit is extended beyond December 31, 2017. Additionally, the production capacity increase that is occurring throughout the ethanol industry may also result in oversupply that may negatively affecting prices unless plants curtail corn oil production or additional demand can be created.

 

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The increase in pounds sold from period to period was attributable to an approximately 14.6%  increase in the volume sold at the HLBE plant for the three months ended January 31, 2018 compared to the same period of 2017, offset by a 6.9% decrease in the volume sold at the GFE plant. The decrease in pounds sold at the GFE plant was due primarily to due to decreased ethanol production and decreased oil extraction rates per bushel of corn during the 2018 period. The increase in pounds sold at the HLBE plant was due primarily to increased ethanol production and improved oil extraction rates per bushel of corn from period to period.  Management anticipates that the corn oil production our ethanol plants will be relatively stable going forward.

 

At January 31, 2018, GFE had forward corn oil sales contracts valued at approximately $260,000 for various delivery periods through February 2018. At January 31, 2018, HLBE had forward corn oil sales contracts valued at approximately $466,000 for various delivery periods through February 2018.

 

Cost of Goods Sold

 

Our cost of goods sold increased by approximately 4.7% for the three months ended January 31, 2018, as compared to the three months ended January 31, 2017.  As a percentage of revenues, our cost of goods sold increased to approximately 94.3% for the three months ended January 31, 2018, as compared to approximately 87.5% for the same period in 2017 due primarily to the decline in the price of ethanol and corn oil which exceeded the decline in the price of corn from period to period.  Approximately 90% of our total costs of goods sold is attributable to our ethanol production segment. Therefore, the cost of goods sold per gallon of ethanol sold for the three months ended January 31, 2018 was approximately $1.36 per gallon of ethanol sold compared to approximately $1.39 per gallon of ethanol sold three months ended January 31, 2017. 

 

The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, electricity, and wages, salaries and benefits of production personnel, and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2018:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2018

 

 

Cost

    

% of Cost of Goods Sold

 

 

(in thousands)

 

 

 

Corn costs

 

$

36,000

 

72.0

%

Natural gas costs

 

 

3,492

 

7.0

%

All other components of costs of goods sold

 

 

10,497

 

21.0

%

Total Cost of Goods Sold

 

$

49,989

 

100.0

%

 

The following table shows the costs of corn, natural gas and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2017:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2017

 

 

Cost

    

% of Cost of Goods Sold

 

 

(in thousands)

 

 

 

Corn costs

 

$

35,816

 

75.0

%

Natural gas costs

 

 

3,433

 

7.2

%

All other components of costs of goods sold

 

 

8,482

 

17.8

%

Total Cost of Goods Sold

 

$

47,731

 

100.0

%

 

Corn

 

Our aggregate cost of corn was approximately 0.5%  more for the three months ended January 31, 2018 compared to the same period of 2017, due to an approximately a  3.5% increase in the number of bushels of corn processed, partially offset by 2.9% decrease in the average price per bushel paid for corn from period to period.  The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for the three months ended January 31, 2018 was approximately $0.19 lower than the corn-ethanol price spread we experienced for same period of 2017. 

 

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The decrease in corn prices was primarily due to lower market prices as a result of the strong 2017 harvest and ample market supplies of corn pushing prices down. Management anticipates that corn prices will remain relatively lower through the first half of 2018 fiscal year. However, we may still experience short term volatility due to weather conditions, domestic and world supply and demand, current and anticipated stocks, agricultural policy, and other factors, and could significantly impact our costs of production. If corn prices rise, it will have a negative effect on our operating margins unless the price of ethanol and distillers’ grains out paces rising corn prices.

 

From time to time we enter into forward purchase contracts for our commodity purchases and sales. At January 31, 2018, GFE had approximately 4.1 million bushels of cash and basis contracts for forward corn purchase commitments for delivery periods through February 2019. At January 31, 2018, HLBE had approximately 3.4 million bushels of cash and basis contracts for forward corn purchase commitments for delivery periods through January 2019.  

 

Our corn derivative positions resulted in losses of approximately $265,000 and $33,000 for the three months ended January 31, 2018 and 2017, respectively, which increased cost of goods. We recognize the gains or losses that result from the changes in the value of our derivative instruments from corn in cost of goods sold as the changes occur. As corn prices fluctuate, the value of our derivative instruments is impacted, which affects our financial performance. We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged.

 

Natural Gas

 

Our cost of goods sold related to natural gas costs increased approximately 1.7% for the three months ended January 31, 2018, as compared to the three months ended January 31, 2017.  Management attributes this increase in cost of natural gas from period to period to the colder weather during November and December 2017, which led to a spike in natural gas prices along with higher energy prices generally during the three months ended January 31, 2018. We expect continued higher natural gas prices during winter months of our 2018 fiscal year due to continued colder weather. Further, if we experience a supply disruption during our 2018 fiscal year, it may lead to significantly higher natural gas costs. 

 

From time to time we enter into forward purchase contracts for our natural gas purchases. Our natural gas derivative positions resulted in a gain of approximately $12,000 for the three months ended January 31, 2018, which decreased cost of goods sold. Comparatively, we had no gain or loss on natural gas derivative instruments for the three months ended January 31, 2017. We recognize the gains or losses that result from the changes in the value of our derivative instruments from natural gas in cost of goods sold as the changes occur.

 

Operating Expenses

 

Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees, property taxes, and similar costs. Our operating expenses increased by approximately 4.5% for the three months ended January 31, 2018 compared to the same period ended 2017.  This increase is due primarily to fixed production expenses that were higher compared to fiscal year 2018. Our efforts to optimize efficiencies and maximize production may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses generally do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady throughout the remainder of the 2018 fiscal year.

 

Operating Income

 

Our income from operations for the three months ended January 31, 2018 decreased by approximately $3.9 million compared to the same period of 2017.  This decrease resulted largely from decreased prices received for our ethanol and corn oil at our plants and the narrowing of our net operating margin. 

 

Other Income, Net

 

We had net other income of approximately $200,000 during the three months ended January 31, 2018 compared to net other income of approximately $351,000 for the same period of 2017.  We had less other income during the three months ended January 31, 2018 compared to the same period of 2017 due to increased interest expense and decreased other income from patronage income for the 2018 period.

 

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Investment

 

On November 1, 2016, we subscribed to purchase 1,500 capital units of Ringneck at a price of $5,000 per unit for a total of $7.5 million.  We paid a down payment of $750,000 in connection with our subscription, and signed a promissory note for the remaining balance of the subscription.  On August 2, 2017, following notice from Ringneck accepting GFE’s subscription and that payment of the balance of GFE’s subscription and promissory note was due, GFE borrowed $7.5 million under its credit facility with Project Hawkeye and paid $6.75 million to Ringneck for the remaining balance of GFE’s subscription.  Details of the Project Hawkeye credit facility are provided below in the section below entitled “Indebtedness - GFE’s Other Credit Arrangement”.

 

Ringneck is a South Dakota limited liability company that is constructing an 80 million gallon per year ethanol manufacturing plant in outside of Onida, South Dakota in Sully County. GFE’s investment is sufficient to the right to appoint one director to the board of directors of Ringneck and GFE has appointed Steve Christensen, its CEO, to fill this seat. The units we acquired in Ringneck are subject to restrictions on transfer, therefore, this should not be considered a liquid investment.  It may take a significant amount of time before we realize a return on our investment, if we realize a return on the investment at all.

 

Because Ringneck is not subject to SEC registration and reporting requirements, we do not expect that information about Ringneck will be available via the SEC’s EDGAR filing system. Therefore, it may be difficult for our investors to obtain information about Ringneck. 

 

Changes in Financial Condition at January 31, 2018 and October 31, 2017

 

The following table highlights our financial condition at January 31, 2018 and October 31, 2017 (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

    

January 31, 2018

    

October 31, 2017

 

 

 

(unaudited)

 

 

 

Current Assets

 

$

31,104

 

$

45,203

 

Total Assets

 

$

111,125

 

$

127,090

 

Current Liabilities

 

$

7,593

 

$

8,980

 

Long-Term Debt, less currrent portion

 

$

8,454

 

$

8,466

 

Members' Equity attributable to Granite Falls Energy, LLC

 

$

73,271

 

$

83,999

 

Non-controlling Interest

 

$

21,807

 

$

25,645

 

 

The decrease in total assets is due to a decrease in current assets which is primarily attributable to a decrease in cash on hand of approximately $15.0 million at January 31, 2018 compared to October 31, 2017, due primarily to payment of distributions of approximately $16.1 million to members and non-controlling interests in January 2018.  Also contributing to the decrease in current assets was a decrease in accounts receivable of $180,000 and the value of commodity derivative instruments of approximately $208,000. Offsetting these decreases were increases in restricted cash of approximately $472,000, inventory of approximately $495,000, and prepaid expenses and other current assets of approximately $341,000 at January 31, 2018 compared to October 31, 2017. Property and equipment also decreased by approximately $1.9 million primarily due to depreciation expense during the 2018 period.

 

Total current liabilities decreased by approximately $1.4 million at January 31, 2018 compared to October 31, 2017.  This decrease was due to decreases of approximately $2.7 million in accounts payable, and approximately $99,000  in the current portion of our long-term debt at January 31, 2018 compared to October 31, 2017.  These decreases were partially offset by increases of approximately $1.2 million in checks drawn in excess of bank balance and approximately $227,000 in accrued expenses. The decrease in our accounts payable is due to the timing of payments to vendors and lower corn prices during the three months ended January 31, 2018 which reduced the amount of corn payable at January 31, 2018. 

 

Our long-term debt decreased approximately $12,000 at January 31, 2018 compared to October 31, 2017.  The decrease is mostly due to assessments paid under HLBE’s industrial water supply treatment agreement with the City of Heron Lake and Jackson County.

 

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Members’ equity attributable to Granite Falls Energy, LLC at January 31, 2018 compared to October 31, 2017 decreased by approximately $10.7 million. The decrease was related to the distribution to our members of approximately $11.8 million during January 2018, offset by our approximately $1.1 million of net income attributable to GFE during the three months ended January 31, 2018. 

 

Non-controlling interest totaled approximately $21.8 million and $25.6 million at January 31, 2018 and October 31, 2017, respectively.  This is directly related to recognition of the 49.3% noncontrolling interest in HLBE.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity consist of cash provided by operations, cash and equivalents on hand, and available borrowings under our credit facilities. Based on management’s financial forecasts, we expect to have sufficient cash generated by continuing operations and revolving term loan to fund our operations for the next twelve months.  However, should we experience unfavorable operating conditions in the future, we may have to secure additional debt or equity sources for working capital or other purposes.

 

Cash Flows

 

The following table shows our cash flows for the nine months ended January 31, 2018 and 2017 (amounts in thousands): 

 

 

 

 

 

 

 

 

 

 

    

2018

 

2017

 

 

 

(unaudited)

 

(unaudited)

 

Net cash provided by operating activities

 

$

575

 

$

3,014

 

Net cash used in investing activities

 

$

(545)

 

$

(1,091)

 

Net cash used in financing activities

 

$

(15,050)

 

$

(12,530)

 

Net decrease in cash

 

$

(15,020)

 

$

(10,607)

 

 

Operating Cash Flows

 

During the three months ended January 31, 2018,  operations provided less cash compared to the same period of 2017 primarily due to lower net income in 2018 and changes in various working capital components, including accounts receivable, restricted cash, inventory, prepaid expenses, and accounts payable.

 

Investing Cash Flows

 

Cash used in investing activities was approximately $545,000 less for the three months ended January 31, 2018, compared to the three months ended January 31, 2017. During the three months ended January 31, 2018, we used cash for capital expenditures for general plant improvements, which was partially offset by proceeds from disposal of property and equipment. Comparatively, during the three months ended January 31, 2017, we used approximately  $386,000 of cash for capital expenditures and GFE used $750,000 for its initial payment on our subscription for its Ringneck investment.

 

Financing Cash Flows

 

During the three months ended January 31, 2018, we used cash to make payments of approximately $111,000 on our long-term debt and make payments of approximately $11.8 million in distributions to our unit holders and approximately $4.3 million to non-controlling interests, offset by approximately $1.2 million from checks in excess of bank balance.  Comparatively, during the same period of 2017, we made payments of approximately $11.2 million in distributions to our unit holders, approximately $1.2 million reduction in checks drawn in excess of bank balance, and principal payments of approximately $129,000 on HLBE’s long-term debt.

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Indebtedness

 

GFE’s Seasonal Revolving Loan

 

GFE has a credit facility with AgCountry Farm Credit Services, PCA, formerly known as United FCS (“AgCounty”), for which CoBank serves as the administrative agent.  The credit facility consists of a seasonal revolving loan. Under the seasonal revolving loan, GFE may borrow, repay, and re-borrow up to the aggregate principal commitment of $6.0 million until its maturity on October 1, 2018, unless a later date is agreed to by CoBank.  The outstanding balance on the seasonal revolving loan totaled $0 at January 31, 2018 and October 31, 2017.  Therefore, the aggregate principal amount available to GFE for additional borrowing was $6.0 million at January 31, 2018 and October 31, 2017.

 

The seasonal revolving loan bears interest from date funds are first advanced on the loan through maturity, at a rate per annum equal to the sum of the One Month LIBOR Index Rate plus 2.75% per annum, which equated to 4.33% and 3.99% at January 31, 2018 and October 31, 2017, respectively. GFE pays an unused commitment fee on the unused portion of the seasonal revolving loan commitment at the rate of 0.250% per annum. The credit facility with AgCounty is secured by substantially all of GFE’s assets.

 

Under the United FSC credit facility,  GFE is subject to certain financial and non-financial covenants that limit GFE distributions and debt and require minimum working capital, and debt service coverage ratio.  GFE agreed to a debt service coverage ratio of 1.5 to 1.0 and to maintain minimum working capital of $10.0 million.  GFE are permitted to pay distributions to its members up to 75% of its net income for the year in which the distributions are paid provided that immediately prior to the distribution and after giving effect to the distribution, no default exists and GFE is in compliance with all of its loan covenants including compliance with the financial covenants.  Further, GFE agreed not create or incur any indebtedness except for debt to AgCounty, accounts payable to trade creditors, subordinated debt owed to Project Hawkeye, or debt to other lenders in an aggregate amount not exceed $750,000 or make loans or advances or invest in any entity, other than its investments in HLBE and Ringneck, without the consent of CoBank or AgCounty.

 

As of January 31, 2018, GFE was in compliance with these financial covenants. However, if market conditions deteriorate in the future, circumstances may develop which could result in GFE violating the financial covenants or other terms of its credit facility. If GFE fails to comply with the terms of its credit agreement with AgCounty, and AgCounty refuses to waive the non-compliance, AgCounty could terminate the credit facility and any commitment to loan funds to GFE.

 

GFE’s Other Credit Arrangement

 

On August 2, 2017, GFE entered into a credit facility with Project Hawkeye for a variable-rate, amortizing non-recourse loan to finance the balance of its subscription in Ringneck.  Pursuant to this credit facility, GFE borrowed $7.5 million from Project Hawkeye using the Ringneck investment as collateral.  The Project Hawkeye loan bears interest from date funds are first advanced on the loan through maturity, at a rate per annum equal to the sum of the One Month LIBOR Index Rate plus 3.05% per annum, with an interest rate floor of 3.55%. 

 

The Project Hawkeye loan requires annual interest payments only for the first two years of the loan and monthly principal and interest payments for years three through nine based on a seven-year amortization period.  The monthly amortized payments will be re-amortized following any change in interest rate. The entire outstanding principal balance of the loan, plus any accrued and unpaid interest thereon, is due and payable in full on August 2, 2026. GFE is permitted to voluntarily prepay all or any portion of the outstanding balance of this loan at any time without premium or penalty.

 

Pursuant to a pledge agreement entered into in connection with the Project Hawkeye loan, GFE’s obligations are secured by all of its right, title, and interest in its investment in Ringneck, including the 1,500 units subscribed for by GFE. The loan is non-recourse to all of GFE’s other assets, meaning that in the event of default, the only remedy available to Project Hawkeye will be to foreclose and seize all of GFE’s right, title and interest in its investment in Ringneck.   

 

As of January 31, 2018 and October 31, 2017, there was $7.5 million outstanding under the Project Hawkeye credit facility. 

 

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HLBE’s Compeer Credit Facility

 

HLBE has a comprehensive credit facility with Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”), which consists of a revolving term loan with a maturity date of March 1, 2022.  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 Compeer loans and was appointed the administrative agent for the purpose of servicing the loans. 

 

Under the Compeer revolving term note, HLBE can borrow, repay and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022.  The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity. In December 2017, HLBE and its lender agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000. HLBE had no outstanding balance on the revolving term loan at January 1, 2018 and October 31, 2017. Therefore, the aggregate principal amount available to HLBE for borrowing at January 31, 2018 and October 31, 2017 was $8,000,000 and $17,500,000, respectively.

 

In connection with the reduction in the aggregate principal commitment, the interest rate on the revolving term loan was reduced from 3.25% above the One-Month LIBOR Index rate to 2.85% above the One-Month LIBOR Index rate.  The interest rate on this facility was 4.42% and 4.49% at January 31, 2018 and October 31, 2017, respectively.  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.

 

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 loan is secured by substantially all of HLBE's assets including a subsidiary guarantee.

 

Under the credit facility, HLBE is subject to certain financial and non-financial covenants that limit the Company’s distributions and debt and require minimum working capital, minimum local net worth, and debt service coverage ratio.  HLBE agreed to a debt service coverage ratio of 1.5 to 1.0 and to maintain minimum working capital and net worth of $8.0 million and $32.0 million, respectively.  HLBE is permitted to pay distributions to its members up to 65% of its net income for the year in which the distributions are paid provided that immediately prior to the distribution and after giving effect to the distribution, no default exists and HLBE is in compliance with all of its loan covenants including compliance with the financial covenants.  Further, HLBE agreed not to make loans or advances to Agrinatural that exceed an aggregate principal amount of approximately $3.1 million without the consent of Compeer.

 

As of January 31, 2018, HLBE was in compliance with these loan covenants. However, if market conditions deteriorate in the future, circumstances may develop which could result in HLBE violating the financial covenants or other terms of its Compeer credit facility. If HLBE fails to comply with the terms of its credit agreement with Compeer, and Compeer refuses to waive the non-compliance, Compeer could terminate the credit facility and any commitment to loan funds to HLBE.

 

HLBE’s Other Credit Arrangements

 

In addition to HLBE's primary credit arrangement with Compeer, HLBE has other material credit arrangements and debt obligations.

 

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.

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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.

 

There was a total of approximately $1.3 million in outstanding water revenue bonds at January 31, 2018 and October 31, 2017. HLBE classifies its obligations under these bonds as assessments payable. The interest rates on the bonds range from 6.55% to 8.73%.

 

HLBE also had a note payable to the noncontrolling owner of Agrinatural, which accrued interest at a rate equal to the One-Month LIBOR rate plus 4.0%. Payment of the note is due on demand at the discretion of the board of managers of Agrinatural.  The interest rate on this note payable was 4.78% and 4.53% at January 31, 2018 and October 31, 2017, respectively. There was a total of $100,000 outstanding on this note at October 31, 2017.  In January 2018, HLBE paid this note in full.

 

Agrinatural Credit Facilities

 

On July 29, 2014, HLBE has entered into an intercompany loan agreement, promissory note and related loan documents with Agrinatural, its majority owned subsidiary (collectively, the “Original Agrinatural Credit Facility”). Under the Original Agrinatural Credit Facility, the Company agreed to make a five-year term loan in the principal amount of $3.05 million to Agrinatural for use by Agrinatural to repay approximately $1.4 million of its outstanding debt and provide approximately $1.6 million of working capital to Agrinatural. The Original Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.

 

Interest on the Original Agrinatural Credit Facility accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Accrued interest is due and payable monthly.

 

On March 30, 2015, HLBE entered into an allonge to the July 29, 2014 note with Agrinatural. Under the terms of the allonge, HLBE and Agrinatural agreed to increase the principal amount of the Original Agrinatural Credit Facility to approximately $3.06 million, defer commencement of repayment of principal until May 1, 2015, decrease the monthly principal payment to $36,000 per month and shorten maturity of the Original Agrinatural Credit Facility to May 1, 2019. Except as otherwise provided in the allonge, all of the terms and conditions contained in the Original Agrinatural Credit Facility remain in full force and effect.

 

In exchange for the Original Agrinatural Credit Facility, Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural's equipment and assets and a collateral assignment assigning HLBE all of Agrinatural's interests in its contracts, leases, easements and other agreements. In addition, Rural Energy Solutions, LLC, the noncontrolling owner of Agrinatural (“RES”), executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural's obligations to HLBE.

 

The balance of this loan was approximately $1.9 million at January 31, 2018 and $2.0 million at October 31, 2017.

 

On March 30, 2015, HLBE entered into a second intercompany loan agreement, promissory note and related loan documents (collectively, the “Additional Agrinatural Credit Facility”) with Agrinatural. Under the Additional Agrinatural Credit Facility, HLBE agreed to make a four-year term loan in the principal amount of $3.5 million to Agrinatural for use by Agrinatural to repay its outstanding trade debt and provide working capital. The Additional Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size, including a covenant restricting capital expenditures by Agrinatural.

 

Interest on the additional term loan accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Prior to May 1, 2015, Agrinatural is required to pay only monthly interest on the term loan.  Commencing May 1, 2015, Agrinatural is required to make monthly installments of principal plus accrued interest. The entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on May 1, 2019.

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On May 19, 2016, HLBE and Agrinatural amended the Additional Agrinatural Credit Facility, entering into amendment to the loan agreement dated March 30, 2015 to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility.  HLBE and Agrinatural also executed an allonge to the negotiable promissory note dated March 30, 2015 to defer a portion of the principal payments required for 2016, which such deferred principal payments continue to accrue interest at the rate set forth in the note and become a part of the balloon payment due at maturity.

 

As provided in the Amendment, for calendar years 2017, 2018 and 2019, Agrinatural may, without consent of HLBE, proceed with and pay for capital expenditures in an amount up to $100,000 plus the amount of contributions in aid of construction received by Agrinatural from customers for capital improvements (“CIAC”), less a reserve for distribution to the Agrinatural members to cover the income or other taxes imposed as a result of receipt of CIAC in an amount equal to 40% of CIAC. Prior to the amendment, Agrinatural’s capital expenditures were restricted to $100,000 per year.

 

In exchange for the Additional Agrinatural Credit Facility, Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural's equipment and assets and a collateral assignment assigning HLBE all of Agrinatural's interests in its contracts, leases, easements and other agreements. In addition, RES executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural's obligations to HLBE under the Additional Agrinatural Credit Facility.

 

The balance of this loan was approximately $2.4 million at January 31, 2018 and $2.5 million at October 31, 2017.

 

Critical Accounting Policies and Estimates

 

Management uses 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.  We believe that of our significant accounting policies summarized in Note 1 to our condensed consolidated unaudited financial statements included with this Form 10-Q. 

 

At January 31, 2018, our critical accounting estimates continue to include those described in our annual report on Form 10-K for the fiscal year ended October 31, 2017. Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles in the United States of America.

 

Off-Balance Sheet Arrangements

 

We currently have no 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 use cash, futures and option contracts to hedge changes to the commodity prices of corn, ethanol and natural gas. We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes pursuant to the requirements of U.S. Generally Accepted Accounting Principles.

 

Interest Rate Risk

 

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our credit facilities with AgCounty, HLBE's credit facilities with Compeer and HLBE’s note payable to the minority owner of Agrinatural. The specifics of these credit facilities are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Indebtedness.”

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At January 31, 2018, there were no amounts outstanding under GFE’s credit facility with AgCounty or HLBE’s credit facility with Compeer.  Therefore, at January 31, 2018, we had exposure to interest rate risk only from the amounts outstanding under GFE’s credit facility with Project Hawkeye. Below is a sensitivity analysis .  Below is a sensitivity analysis we prepared regarding GFE’s income exposure to changes in interest rates.

 

The sensitivity analysis below shows the anticipated effect on our income from a 10% adverse change in interest rates for a one-year period.

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding Variable

 

 

 

 

 

 

 

 

 

 

Rate Debt at

 

Interest Rate at

 

Interest Rate Following 10%

 

Approximate Adverse

 

January 31, 2018

 

January 31, 2018

 

Adverse Change

 

Change to Income

 

$

7,500,000

 

4.63

%  

 

5.10

%  

 

$

34,000

 

 

Commodity Price Risk

 

We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers' grains, through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues. The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from period to period 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 January 31, 2018, GFE had price protection in place for approximately 14.0% and 33.0% of its anticipated corn and natural gas needs, respectively, and approximately 22.0%, 5.0%, and 6.0%  of its ethanol, distillers’ grains, and corn oil sales, respectively, for the next 12 months. As of January 31, 2018,  HLBE had price protection in place for approximately 17.0% and 5.0% of its anticipated corn and natural gas needs, respectively and approximately 25.0%, 6.0%, and 10.0% of its ethanol, distillers’ grains, and corn oil sales, respectively, for the next 12 months. Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations. As input prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

 

A sensitivity analysis has been prepared to estimate our exposure to ethanol, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the fair value of our corn and natural gas prices and average ethanol price as of January 31, 2018, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for both of the GFE and HLBE plants for a one year period from January 31, 2018.  

 

The results of this sensitivity analysis, which may differ from actual results, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Volume Requirements

 

 

 

Hypothetical Adverse

 

 

 

 

 

 

for the next 12 months

 

Unit of

 

Change in Price as of

 

Approximate Adverse

 

 

 

(net of forward and futures contracts)

 

Measure

 

January 31, 2018

 

Change to Income

 

Ethanol

 

120,000,000

 

Gallons

 

10

%

 

$

14,685,000

 

Corn

 

34,135,000

 

Bushels

 

10

%

 

$

10,939,000

 

Natural Gas

 

2,550,000

 

MMBTU

 

10

%

 

$

819,000

 

 

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Participation in Captive Reinsurance Company

 

We participate in a captive reinsurance company (“Captive”). The Captive reinsures losses related to workman's compensation, commercial property and general liability. Premiums are accrued by a charge to income for the period to which the premium relates and is remitted by our insurer to the captive reinsurer. The Captive reinsures losses in excess of a predetermined amount. The Captive insurer has estimated and collected a premium amount in excess of expected losses but less than the aggregate loss limits reinsured by the Captive. We have contributed limited capital surplus to the Captive that is available to fund losses should the actual losses sustained exceed premium funding. So long as the Captive is fully-funded through premiums and capital contributions to the aggregate loss limits reinsured, and the fronting insurers are financially strong, we cannot be assessed over the amount of our current contributions.

 

 

Item 4.   Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosures.

 

Effectiveness of Disclosure Controls and Procedures

 

Our management, including our Chief Executive Officer and General Manager (the principal executive officer), Steve Christensen, along with our Chief Financial Officer (the principal financial officer), Stacie Schuler, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of January 31, 2018. Based upon 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 controls over financial reporting during our most recently completed reporting period  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

 

From time to time in the ordinary course of business, Granite Falls Energy, LLC and Heron Lake BioEnergy, LLC may be named as a defendant in legal proceedings related to various issues, including workers' compensation claims, tort claims, or contractual disputes. We are not currently involved in any material legal proceedings.

 

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Item 1A.   Risk Factors

 

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

 

Tax reform may affect the Company and its members.

 

Congress recently passed the Tax Reform Act, which makes significant changes to the taxation of business entities. The Tax Reform Act, among other things, includes changes to U.S. federal tax rates, imposes significant additional limitations on the deductibility of interest and allows for the expensing of capital expenditures. We continue to assess the impact of the Tax Reform Act, as well as any future regulations implementing the new tax law and any interpretations of the new tax law may have on our business. The impact of this tax reform on the Company and its members is uncertain but the effect of the Tax Reform Act and any implementing regulations and interpretations could adversely affect our business and financial condition.

 

The price we pay for agricultural commodities may increase as a result of the Tax Cuts and Jobs Act which gives a benefit to agricultural producers to sell their products through cooperatives.  

 

Congress recently passed the Tax Reform Act, which includes a provision that gives a benefit to producers of agricultural products to sell their products through cooperatives.  Currently sales to non-cooperative grain buyers like the Company do not qualify for the same benefit.  This may put us at a significant disadvantage when competing with cooperatives to purchase corn for our plant.  Any increase in the price we must pay for the corn in order to compete with cooperatives would result in lower profit margins and negatively affect our financial performance.  While we believe that Congress intends to correct these provisions, there is no assurance that Congress will enact changes that will resolve this issue or that if such changes are approved that they will be retroactively applied. 

 

If the U.S. were to withdraw from or materially modify NAFTA or certain other international trade agreements, our business, financial condition and results of operations could be materially adversely affected.

 

We expect a majority of our ethanol, distillers’ grains and corn oil to continue to be marketed and sold domestically. However, as domestic production of ethanol and its co-products continues to expand, we anticipate increased international sales, including sales to Canada, Mexico and other countries with trade agreements with the U.S.  The Trump administration has expressed aversion towards certain existing international trade agreements, including the North American Free Trade Agreement (“NAFTA”), and made comments suggesting that they support significantly increasing tariffs on goods imported into the U.S., which in turn may lead to retaliatory actions on U.S. exports.  As of the date of this report, it remains unclear what the outcomes may be of NAFTA trade regulations, other international trade agreements, and tariffs on various goods imported into the U.S. If the U.S. were to withdraw from or materially modify NAFTA or other international trade agreements to which it is a party, or if tariffs were raised on the foreign-sourced goods that lead to retaliatory actions, it could have material adverse effect on our business, financial condition and results of operations.

 

 

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

 

None.

 

 

Item 3.   Defaults Upon Senior Securities

 

None.

 

Item 4.   Mine Safety Disclosures

 

None.

 

 

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Table of Contents

Item 5.   Other Information

 

None.

 

Item 6.   Exhibits.

 

(a)

The following exhibits are included in this report.

 

 

 

 

 

Exhibit No.

  

Exhibit

31.1

 

Certification of Chief Executive Officer pursuant to 17 CFR 240.13a-14(a)*

 

 

 

31.2

 

Certification of Chief Financial Officer pursuant to 17 CFR 240.13a-14(a)*

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350*

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350*

 

 

 

101

 

The following financial information from Granite Falls Ethanol, LLC's Quarterly Report on Form 10-Q for the three months ended January 31, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at January 31, 2018 and October 31, 2017; (ii) the Condensed Consolidated Statements of Operations for the three months ended January 31, 2018 and 2017; (iii) the Condensed Consolidated Statements of Cash Flows for the three months ended January 31, 2018 and 2017; and (iv) Notes to Condensed Consolidated Unaudited Financial Statements.*


*   Filed herewith.

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

GRANITE FALLS ENERGY, LLC

 

 

 

Date:   March 19, 2018

/s/ Steve Christensen

 

 

Steve Christensen

 

 

Chief Executive Officer

 

 

 

 

 

/s/ Stacie Schuler

Date:   March 19, 2018

Stacie Schuler

 

 

Chief Financial Officer

 

 

 

 

 

 

 

36