HIGHWATER ETHANOL LLC - Annual Report: 2013 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. |
For the fiscal year ended October 31, 2013 | |
OR | |
o | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. |
For the transition period from to . | |
COMMISSION FILE NUMBER 000-53588 | |
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
Minnesota | 20-4798531 | |||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||
24500 US Highway 14, Lamberton, MN 56152 | ||||
(Address of principal executive offices) | ||||
(507) 752-6160 | ||||
(Registrant's telephone number, including area code) | ||||
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Membership Units
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large Accelerated Filer o | Accelerated Filer o |
Non-Accelerated Filer x | Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
As of April 30, 2013, the aggregate market value of the membership units held by non-affiliates (computed by reference to the most recent offering price of such membership units of $10,000) was $39,085,000. The Company is a limited liability company whose outstanding common equity is subject to significant restrictions on transfer under its Member Control Agreement. No public market for common equity of Highwater Ethanol, LLC is established and it is unlikely in the foreseeable future that a public market for its common equity will develop.
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of January 16, 2014, there were 4,953 membership units outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Annual Report.
1
INDEX
Page Number | |
2
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that involve future events, our future financial performance and our expected future operations and actions. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “future,” “intend,” “could,” “hope,” “predict,” “target,” “potential,” or “continue” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions based on current information and involve numerous assumptions, risks and uncertainties, including, but not limited to those listed below and those business risks and factors described elsewhere in this report and our other Securities and Exchange Commission filings.
Ÿ | Changes in the availability and price of corn and natural gas; |
Ÿ | Reduction or elimination of the Renewable Fuel Standard; |
Ÿ | Our ability to comply with the financial covenants contained in our credit agreements with our lenders; |
Ÿ | Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw material costs; |
Ÿ | Results of our hedging activities and other risk management strategies; |
Ÿ | Ethanol and distillers grains supply exceeding demand and corresponding price reductions; |
Ÿ | Our ability to generate cash flow to invest in our business and service our debt; |
Ÿ | Changes in the environmental regulations that apply to our plant operations and changes in our ability to comply with such regulations; |
Ÿ | Changes in our business strategy, capital improvements or development plans; |
Ÿ | Changes in plant production capacity or technical difficulties in operating the plant; |
Ÿ | Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries; |
Ÿ | Lack of transportation, storage and blending infrastructure preventing ethanol from reaching high demand markets; |
Ÿ | Changes in federal and/or state laws or policies impacting the ethanol industry; |
Ÿ | Changes and advances in ethanol production technology and the development of alternative fuels and energy sources and advanced biofuels; |
Ÿ | Competition from alternative fuel additives; |
Ÿ | Changes in interest rates and lending conditions; |
Ÿ | Decreases in the price we receive for our ethanol and distillers grains; |
Ÿ | Volatile financial or commodity markets; |
Ÿ | Our inability to secure credit or obtain additional equity financing we may require in the future; and |
Ÿ | Our ability to retain key employees and maintain labor relations. |
The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or any persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements. We caution you not to put undue reliance on any forward-looking
3
statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits, completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.
AVAILABLE INFORMATION
Information is also available at our website at www.highwaterethanol.com, under “SEC Compliance,” which includes links to reports we have filed with the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Annual Report on Form 10-K.
PART I
ITEM 1. BUSINESS
Business Development
Highwater Ethanol, LLC (“we,” “our,” “Highwater Ethanol” or the “Company”) was formed as a Minnesota limited liability company organized on May 2, 2006, for the purpose of constructing, owning, and operating a 50 million gallon per year ethanol plant near Lamberton, Minnesota. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the plant. We have been operating at an annual rate of approximately 57.5 million gallons for the fiscal year ended 2013 and anticipate we will continue to operate in this range in the future.
On January 25, 2013, we entered into the Seventh Amendment of Construction Loan Agreement which amended our Construction Loan Agreement originally dated April 24, 2008 with First National Bank of Omaha ("FNBO"). The amendment waived our violations at October 31, 2012 of the fixed charge coverage ratio and the minimum net worth covenants. In addition, the amendment amended the calculation of the covenants measuring the fixed charge coverage ratio and the minimum net worth calculation.
On March 29, 2013, we entered into an Eighth Amendment of Construction Loan Agreement with FNBO which extended our line of credit until April 1, 2014. In addition, we agreed to terminate our Long-term Revolving Note and reduce our minimum working capital requirement to $1,500,000, to be measured on a quarterly basis at the end of each fiscal quarter, to correspond with the termination of the Long-term Revolving Note.
We entered into a series of related definitive agreements dated September 26, 2013 with Butamax Advanced Biofuels, LLC ("Butamax") which include an Easement for Construction and Process Demonstration Agreement, an Equipment Lease Agreement, a Technology License Agreement, a Technology Demonstration Risk Reduction Agreement and a Security Agreement (collectively, the "Agreements") pursuant to which Butamax has agreed to construct, install and lease its corn oil separation system and license to the Company its corn oil separation technology. Pursuant to the Agreements, we agreed to give Butamax access to our plant in order to construct, install, operate, test and commercially validate its corn oil separation system. Butamax retains ownership of the corn oil separation system and technology but agrees to lease it to the Company for a term of 120 months subject to Butamax's right to remove the system if we are in breach of the Agreements. The term of the lease may also be extended or terminated pursuant to the terms of the Agreements and we are responsible for repairs and maintenance of the system and bear the risk of loss. In return, we agree to payment of certain license fees which are subject to being reduced under the terms of the Agreements if the corn oil separation system does not meet certain performance goals. The Agreements provide that the corn oil separation system shall be conveyed to the Company at the end of the term so long as we are not in breach of the Agreements. We have granted a security interest to Butamax in the corn oil separation system to secure our obligations under the Agreements. We entered into a letter of intent to explore biobutanol production with Butamax in December 2011, and the corn oil separation system is part of a Phase 1 project working towards this intent. However, Phase 2 will be dependent on completion of separate definitive agreements for biobutanol production. If the definitive agreements for biobutanol production are not executed, either the Company or Butamax may request that the corn oil separation system be removed and the license for the technology terminated. Pursuant to the Agreements, we agreed, subject to certain obligations of confidentiality, to provide Butamax with Company information on a monthly basis including business and financial information and have granted Butamax the option to have a representative present in board and committee meetings as an observer. We also agreed to give Butamax notice in the event of an issuance or sale of membership interests or convertible debt instruments. Installation by Butamax of the corn oil separation system and technology began in September 2013 with a goal to be operational during our fiscal year. The total minimum commitment under the lease is approximately $2,500,000.
On November 21, 2013 (with an effective date of November 4, 2013), we entered into a Distillers Crude Corn Oil Marketing Agreement (the "Marketing Agreement") with CHS, Inc. ("CHS") wherein we agreed to sell to CHS, and CHS agrees
4
to purchase, all crude corn oil to be produced at the plant. CHS will pay the actual price that CHS receives from its buyers less a marketing fee, actual freight and transportation costs and certain taxes related to the purchase, delivery or sale of the corn oil. The Marketing Agreement is effective for an initial term which commences on the date on which the plant commences producing corn oil pursuant to our mutual agreement. Following expiration of the initial term, the Marketing Agreement shall automatically renew for successive terms unless terminated in accordance with its terms. As of the date of this report, we have not yet begun producing corn oil at the plant.
We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities.
Financial Information
Please refer to “ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations” for information about our revenue, profit and loss measurements and total assets and liabilities and “ITEM 8 - Financial Statements and Supplementary Data” for our financial statements and supplementary data.
Principal Products
The principal products we currently produce at the ethanol plant are fuel-grade ethanol and distillers grains. The table below shows the approximate percentage of our total revenue which is attributed to each of our primary products for each of our last three fiscal years.
Product | Fiscal Year 2013 | Fiscal Year 2012 | Fiscal Year 2011 | ||||||
Ethanol | 77 | % | 79 | % | 84 | % | |||
Distiller Grains | 23 | % | 21 | % | 16 | % | |||
Ethanol
Our primary product is ethanol. Ethanol is ethyl alcohol, a fuel component made primarily from corn and various other grains. The ethanol we produce is manufactured from corn. Although the ethanol industry continues to explore production technologies employing various feedstocks, such as biomass, corn-based production technologies remain the most practical and
provide the lowest operating risks. Corn produces large quantities of carbohydrates, which convert into glucose more easily than most other kinds of biomass. The Renewable Fuels Association estimates current capacity for domestic ethanol production at approximately 14.9 billion gallons as of November 30, 2013 with approximately 7.5% of that capacity idled.
An ethanol plant is essentially a fermentation plant. Ground corn and water are mixed with enzymes and yeast to produce a substance called “beer,” which contains about 10% alcohol and 90% water. The “beer” is boiled to separate the water, resulting in ethyl alcohol, which is then dehydrated to increase the alcohol content. This product is then mixed with a certified denaturant to make the product unfit for human consumption and commercially saleable.
Ethanol can be used as: (i) an octane enhancer in fuels; (ii) an oxygenated fuel additive for the purpose of reducing ozone and carbon monoxide emissions; and (iii) a non-petroleum-based gasoline substitute. Approximately 95% of all ethanol is used in its primary form for blending with unleaded gasoline and other fuel products. Used as a fuel oxygenate, ethanol provides a means to control carbon monoxide emissions in large metropolitan areas. The principal purchasers of ethanol are generally the wholesale gasoline marketer or blender.
Distillers Grains
The principal co-product of the ethanol production process is distillers grains, a high protein, high-energy animal feed supplement primarily marketed to the dairy, poultry, swine and beef industries. Dry mill ethanol processing creates three forms of distiller grains: Distillers Wet Grains with Solubles (“DWS”), Distillers Modified Wet Grains with Solubles (“DMWS”) and Distillers Dried Grains with Solubles (“DDGS”). DWS is processed corn mash that contains approximately 70% moisture. DWS has a shelf life of approximately three days and can be sold only to farms within the immediate vicinity of an ethanol plant. DMWS is DWS that has been dried to approximately 50% moisture. DMWS has a slightly longer shelf life of approximately ten days and is often sold to nearby markets. DDGS is DWS that has been dried to 10% to 12% moisture. DDGS has an almost indefinite shelf life and may be sold and shipped to any market regardless of its vicinity to an ethanol plant.
5
Principal Product Markets
As described below in “Distribution Methods” we market and distribute a majority of our ethanol and distillers grains through professional third party marketers. Our ethanol and distillers grains marketers make decisions with regard to where our products are marketed. Our ethanol and distillers grains are primarily sold in the domestic market, however, as domestic production of ethanol and distillers grains continue to expand, we anticipate increased international sales of ethanol and distillers grains. Currently, the United States ethanol industry exports a significant amount of distillers grains to Mexico, Canada and China. Management anticipates that demand for distillers grains in the Asian market may continue to increase in the future as distillers grains are used in animal feeding operations in China and because China terminated an 18-month anti-dumping investigation with respect to distillers grains imported from the United States. However, recently China rejected shipments of corn which contained a non-approved GMO trait. Management believes that China will reject distiller grains which contain this trait as well. If China rejects shipments of distiller grains, it may negatively impact distiller grains prices in the United States.
Over the last two years, exports of ethanol have decreased. However, exports could increase in the future if market conditions become favorable. We expect our ethanol and distillers grains marketers to explore all markets for our products, including export markets. However, due to high transportation costs, and the fact that we are not located near a major international shipping port, we expect a majority of our products to continue to be marketed and sold domestically.
Distribution Methods
Ethanol
We have an exclusive marketing agreement with RPMG, Inc. (“RPMG”) for the purposes of marketing and distributing our ethanol. Because we are an owner of Renewable Products Marketing Group, LLC (“RPMG LLC”), the parent entity of RPMG, our ethanol marketing fees are based on RPMG's cost to market our ethanol. Further, as an owner, we share in the profits and losses generated by RPMG when it markets products for other producers who are not owners of RPMG LLC. Our marketing agreement provides that we can sell our ethanol either through an index arrangement or at an agreed upon fixed price. The term of our marketing agreement is perpetual until terminated according to its terms. The primary reasons for termination would be if we cease to be an owner of RPMG LLC, if there is a breach which is not cured, or if we give advance notice to RPMG that we wish to terminate. Notwithstanding our right to terminate, we may be obligated to continue to market our ethanol through RPMG for a period of time after termination. Further, following termination, we agree to accept an assignment of certain railcar leases which RPMG has secured to service us. If the marketing agreement is terminated, it would trigger a redemption of our ownership interest in RPMG LLC.
Distillers Grains
We entered into a distillers grains marketing agreement with CHS to market all the dried distillers grains we produce at the plant. Under the agreement, CHS will charge a maximum of $2.00 per ton and a minimum of $1.50 per ton price using 2% of the FOB plant price actually received by CHS for all dried distillers grains removed by CHS from our plant. The initial term of our agreement with CHS expired in August 2010. However, the agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, CHS will be responsible for all transportation arrangements for the distribution of our dried distillers grains. We market and sell our own distillers modified wet grains with solubles.
New Products and Services
We have not introduced any new products or services during our fiscal year 2013. We expect that we will begin separating and marketing corn oil during fiscal year 2014.
Sources and Availability of Raw Materials
Corn Feedstock Supply
The major raw material required for our ethanol plant to produce ethanol and distillers grains is corn. To produce 50 million gallons of ethanol per year, our ethanol plant needs approximately 18.5 million bushels of corn per year, or approximately 50,000 bushels of corn per day, as the feedstock for its dry milling process.
We have entered into a grain procurement agreement with Meadowland Farmers Co-op (“Meadowland”). Meadowland has the exclusive right and responsibility to provide us with our daily requirements of corn meeting quality specifications set forth in the grain procurement agreement. Under the agreement, we will purchase corn at the local market price delivered to the plant
6
plus a fixed fee per bushel of corn purchased. We will provide Meadowland with an estimate of our usage at the beginning of each fiscal quarter and Meadowland agrees to at all times maintain the minimum of 7 days corn usage at our ethanol plant. The initial term of the agreement is for seven years from the time we requested our first delivery of corn, which was in July 2009.
Increases in the price of corn significantly increase our cost of goods sold. If these increases in cost of goods sold are not offset by corresponding increases in the prices we receive from the sale of our products, these increases in cost of goods sold can have a significant negative impact on our financial performance. The United States experienced severe drought conditions in 2012 which negatively impacted the amount of corn that was harvested in the fall of 2012 and resulted in a significant increase in corn prices which resulted in tighter operating margins during the first three quarters of our fiscal year. Corn prices decreased during our third and fourth quarter in response to predictions of a large 2013 corn crop.
The USDA estimates the 2013 corn crop in the United States at almost 14 billion bushels. This represents a new record production in the United States. Management expects that corn prices will remain lower through the winter of 2013 as a result of an increase in supply and a larger carryover. However, a shortage of corn could develop particularly if we were to experience poor weather conditions. Weather, world supply and demand, current and anticipated stocks, agricultural policy and other factors can contribute to volatility in corn prices. If corn prices rise again, it will have a negative effect on our operating margins unless the price of ethanol and distillers grains out paces rising corn prices. Should we experience unfavorable operating conditions that prevent us from profitably operating the ethanol plant, we may need to reduce or halt production at our plant.
Utilities
Natural Gas
Natural gas is an important input to our manufacturing process. We use natural gas to dry our distillers grains products to moisture contents at which they can be stored for longer periods. This allows the distillers grains we produce to be transported greater distances to serve broader livestock markets.
We have access to an existing Northern Natural Gas interstate natural gas pipeline located approximately one half mile from our ethanol plant. We entered into a natural gas service agreement with CenterPoint Energy Resources Corp., d.b.a. CenterPoint Energy Minnesota Gas (“CenterPoint”). CenterPoint constructed for us a pipeline from the Northern Natural Gas Company (“Northern”) Town Border Station. We purchase all of our natural gas requirements from CenterPoint's pipeline. This agreement will continue until October 31, 2019.
We also entered into an energy management agreement with U.S. Energy Services, Inc. (“US Energy”) pursuant to which US Energy is providing us with the necessary natural gas management services. Some of their services may include an economic comparison of distribution service options, negotiation and minimization of interconnect costs, submission of the necessary pipeline “tap” request, supplying the plant with and/or negotiating the procurement of natural gas, development and implementation of a price risk management plan targeted at mitigating natural gas price volatility and maintaining profitability, providing consolidated monthly invoices that reflect all natural gas costs. In addition, US Energy is responsible for reviewing and reconciling all invoices. In exchange for these services, we pay US Energy a monthly retainer fee.
We do not anticipate any problems securing the natural gas we need to operate our ethanol plant during our 2014 fiscal year.
Electricity
On June 28, 2007, we entered into an agreement for electric service with Redwood Electric Cooperative, Inc., (“Redwood”) for the purchase and delivery of electric power and energy necessary to operate our ethanol plant. In exchange for its services, we pay Redwood a monthly facilities charge of approximately $12,000 plus Redwood's standard electrical rates. In addition, we agreed that in the event our ethanol plant does not continue to be operational for the entire term of the contract, we will reimburse Redwood for its expenses related to the installation of the facilities necessary to supply our electrical needs. Upon execution of the agreement, we became a member of Redwood and are bound by its articles of incorporation and bylaws. This agreement will remain in effect for 10 years following the initial billing period. In the event we wish to continue receiving electrical service from Redwood beyond the 10 year period, we will need to enter into a new agreement with Redwood at least one year prior to the expiration of the initial 10 year period. If the agreement is terminated by either party for any reason prior to the expiration of the initial ten year period, we will be required to pay for the entire amount of the facility charge for the remainder of the initial ten year period. We do not anticipate any problems securing the electricity we need to operate our ethanol plant during our 2014 fiscal year.
7
Water
We require a significant supply of water. We obtain water from a high capacity well. We acquired all of the necessary permits required for our water usage. Much of the water used in an ethanol plant is recycled back into the process. There are, however, certain areas of production where fresh water is needed. Those areas include the boiler makeup water and cooling tower water. Boiler makeup water is treated on-site to minimize all elements that will harm the boiler and recycled water cannot be used for this process. Cooling tower water is deemed non-contact water because it does not come in contact with the mash, and, therefore, can be regenerated back into the cooling tower process. The makeup water requirements for the cooling tower are primarily a result of evaporation. Much of our water can be recycled back into the process, which minimizes the discharge water. We expect this will have the long-term effect of lowering wastewater treatment costs. We have assessed our water needs and determined we have an adequate supply.
Research and Development
We continually conduct research and development activities associated with the development of new technologies for use in producing ethanol and distillers grains and the potential for implementation of biobutanol technology and commercial-scale production of biobutanol at our facility. Our costs associated with these activities for the fiscal year ended October 31, 2013 were insignificant.
Patents, Trademarks, Licenses, Franchises and Concessions
We do not currently hold any patents, trademarks, franchises or concessions. We were granted a license by ICM, Inc. to use certain ethanol production technology necessary to operate our ethanol plant. The cost of the license granted by ICM, Inc. was included in the amount we paid to Fagen, Inc. to design and build our ethanol plant.
Seasonality Sales
We experience some seasonality of demand for our ethanol. Since ethanol is predominantly blended with conventional gasoline for use in automobiles, ethanol demand tends to shift in relation to gasoline demand. As a result, we experience some seasonality of demand for ethanol in the summer months related to increased driving. In addition, we experience some increased ethanol demand during holiday seasons related to increased gasoline demand.
Working Capital
We primarily use our working capital for purchases of raw materials necessary to operate the ethanol plant. Our primary sources of working capital are cash generated by our operations as well as our line of credit with FNBO. At October 31, 2013, we had approximately $5,000,000 available to draw on our line of credit.
Dependence on One or a Few Major Customers
As discussed above, we have a marketing agreement with RPMG for the marketing, sale and distribution of our ethanol and have engaged CHS, Inc. for marketing, selling and distributing our distillers dried grains with solubles. We expect to rely on RPMG for the sale and distribution of our ethanol and CHS for the sale and distribution of our distillers dried grains with solubles. We also expect to rely upon CHS for the sale and distribution of corn oil once we begin separating and marketing corn oil. Therefore, although there are other marketers in the industry, we are highly dependent on RPMG and CHS for the successful marketing of our products. Any loss of RPMG or CHS as our marketing agents could have a significant negative impact on our revenues. We market and sell our own distillers modified wet grains.
Federal Ethanol Supports and Governmental Regulation
Federal Ethanol Supports
The ethanol industry is dependent on several economic incentives to produce ethanol, including federal tax incentives and ethanol use mandates. One significant federal ethanol support is the Federal Renewable Fuels Standard (the “RFS”). The RFS requires that in each year, a certain amount of renewable fuels must be used in the United States. The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective. The RFS requirement increases incrementally each year until the United States is required to use 36 billion gallons of renewable fuels by 2022. Starting in 2009, the RFS required that a portion of the RFS must be met by certain “advanced” renewable fuels. These advanced renewable fuels include ethanol that is not made from
8
corn, such as cellulosic ethanol and biomass based biodiesel. The use of these advanced renewable fuels increases each year as a percentage of the total renewable fuels required to be used in the United States.
The RFS for 2013 was approximately 16.55 billion gallons, of which corn based ethanol could be used to satisfy approximately 13.8 billion gallons. The statutory volume requirement of the RFS for 2014 is approximately 18.15 billion gallons, of which corn based ethanol can be used to satisfy approximately 14.4 billion gallons. However, if the RFS were to be repealed or modified by Congress or the EPA, ethanol demand may be significantly impacted. The EPA has the authority to waive the RFS requirement, in whole or in part, provided one of the following two conditions have been met: (1) there is inadequate domestic renewable fuel supply; or (2) implementation of the requirement would severely harm the economy or environment of a state, region or the United States. Annually, the EPA passes a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligations ("RVO").
On November 15, 2013, the EPA announced a proposal to significantly reduce the levels for 2014 from the statutory volume requirement of 18.15 billion gallons to 15.21 billion gallons and reduce the RVO that can be satisfied by corn based ethanol from 14.4 billion gallons to 13 billion gallons. This proposal would result in a lowering of the 2014 numbers below the 2013 level of 13.8 billion gallons. The EPA proposal is subject to a 60-day public comment period which will end on January 28, 2014. The EPA is also seeking comment on several petitions it has received for partial waiver of the statutory volumes for 2014. Recently, there have also been proposals in Congress to reduce or eliminate the RFS. If the EPA's proposal becomes a final rule significantly reducing the RFS or if the RFS were to be otherwise reduced or eliminated by the exercise of the EPA waiver authority or by Congress, the market price and demand for ethanol will likely decrease which will negatively impact our financial performance. Current ethanol production capacity exceeds the EPA's proposed 2014 RVO which can be satisfied by corn based ethanol by approximately 1.8 billion gallons.
In February 2010, the EPA issued new regulations governing the RFS. These new regulations have been called RFS2. The most controversial part of RFS2 involves what is commonly referred to as the lifecycle analysis of greenhouse gas emissions. Specifically, the EPA adopted rules to determine which renewable fuels provided sufficient reductions in greenhouse gases, compared to conventional gasoline, to qualify under the RFS program. RFS2 establishes a tiered approach, where regular renewable fuels are required to accomplish a 20% greenhouse gas reduction compared to gasoline, advanced biofuels and biomass-based biodiesel must accomplish a 50% reduction in greenhouse gases, and cellulosic biofuels must accomplish a 60% reduction in greenhouse gases. Any fuels that fail to meet this standard cannot be used by fuel blenders to satisfy their obligations under the RFS program. The scientific method of calculating these greenhouse gas reductions has been a contentious issue. Many in the ethanol industry were concerned that corn based ethanol would not meet the 20% greenhouse gas reduction requirement based on certain parts of the environmental impact model that many in the ethanol industry believed was scientifically suspect. However, RFS2 as adopted by the EPA provides that corn-based ethanol from modern ethanol production processes does meet the definition of a renewable fuel under the RFS program. Our ethanol plant was grandfathered into the RFS due to the fact that it was constructed prior to the effective date of the lifecycle greenhouse gas requirement and is not required to prove compliance with the lifecycle greenhouse gas reductions. Many in the ethanol industry are concerned that certain provisions of RFS2 as adopted may disproportionately benefit ethanol produced from sugarcane. This could make sugarcane based ethanol, which is primarily produced in Brazil, more competitive in the United States ethanol market. If this were to occur, it could reduce demand for the ethanol that we produce.
Most ethanol that is used in the United States is sold in a blend called E10. E10 is a blend of 10% ethanol and 90% gasoline. E10 is approved for use in all standard vehicles. Estimates indicate that gasoline demand in the United States is approximately 134 billion gallons per year. Assuming that all gasoline in the United States is blended at a rate of 10% ethanol and 90% gasoline, the maximum demand for ethanol is 13.4 billion gallons per year. This is commonly referred to as the “blending wall,” which represents a theoretical limit where more ethanol cannot be blended into the national gasoline pool. This is a theoretical limit because it is believed that it would not be possible to blend ethanol into every gallon of gasoline that is being used in the United States and it discounts the possibility of additional ethanol used in higher percentage blends such as E85 used in flex fuel vehicles. The RFS for 2013 was approximately 16.55 billion gallons, of which corn based ethanol could be used to satisfy approximately 13.8 billion gallons. The RFS requires that 36 billion gallons of renewable fuels must be used each year by 2022, which equates to approximately 27% renewable fuels used per gallon of gasoline currently sold.
Many in the ethanol industry believe that it will be impossible to meet the RFS requirement in future years without an increase in the percentage of ethanol that can be blended with gasoline for use in standard (non-flex fuel) vehicles. The United States Environmental Protection Agency (the "EPA") has approved the use of E15, gasoline which is blended at a rate of 15% ethanol and 85% gasoline, in vehicles manufactured in the model year 2001 and later. However, there were still significant federal and state regulatory hurdles that needed to be addressed. The EPA has made recent gains towards clearing those federal regulatory hurdles. In February 2012, the EPA approved health effects and emissions testing on E15 which was required by the Clean Air Act before E15 can be sold into the market. In March 2012, the EPA approved a model Misfueling Mitigation Plan and fuel survey
9
which must be submitted by applicants before E15 registrations can be approved. In April 2012, the EPA approved the first E15 registrations approving twenty producers who have successfully registered their product to be used as E15. Finally, in June 2012, the EPA gave the final approval to allow the sale of E15. Although management believes that these developments are significant steps towards introduction of E15 in the marketplace, there are still obstacles to meaningful market penetration by E15. Many states still have regulatory issues that prevent the sale of E15. Sales of E15 may be limited because it is not approved for use in all vehicles, the EPA requires a label that management believes may discourage consumers from using E15, and retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may be required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This may prevent E15 from being used during certain times of the year in various states. As a result, management believes that E15 may not have an immediate impact on ethanol demand in the United States.
The Volumetric Ethanol Excise Tax Credit ("VEETC") provided a volumetric ethanol excise tax credit of 4.5 cents per gallon of gasoline that contains at least 10% ethanol (total credit of 45 cents per gallon of ethanol blended which is 4.5 divided by the 10% blend). VEETC expired on December 31, 2011. In addition to the expiration of the tax incentives, a 54 cent per gallon tariff imposed on ethanol imported into the United States also expired on December 31, 2011. The ethanol industry in the United States experienced increased competition from ethanol produced outside of the United States during 2012. These increased ethanol imports were likely at least in part due to the expiration of the tariff on imported ethanol. While imports of ethanol were lower in 2013, elimination of the tariff could lead to increased importation of foreign ethanol, especially in areas of the United States that are easily accessible by international shipping ports. Foreign ethanol may be a less expensive alternative to domestically produced ethanol and may affect our ability to sell our ethanol profitably.
The United States Department of Agriculture (“USDA”) also provides financial assistance to help implement “blender pumps” in the United States in order to increase demand for ethanol and to help offset the cost of introducing mid-level ethanol blends into the United States retail gasoline market. A blender pump is a gasoline pump that can dispense a variety of different ethanol/gasoline blends. Blender pumps typically can dispense E10, E20, E30, E40, E50 and E85. These blender pumps accomplish these different ethanol/gasoline blends by internally mixing ethanol and gasoline which are held in separate tanks at the retail gas stations. Many in the ethanol industry believe that increased use of blender pumps will increase demand for ethanol by allowing gasoline retailers to provide various mid-level ethanol blends in a cost effective manner and allowing consumers with flex-fuel vehicles to purchase more ethanol through these mid-level blends. However, blender pumps cost approximately $25,000 each, so it may take time before they become widely available in the retail gasoline market.
Effect of Governmental Regulation
The government's regulation of the environment changes constantly. We are subject to extensive air, water and other environmental regulations and we have been required to obtain a number of environmental permits to construct and operate the plant. It is possible that more stringent federal or state environmental rules or regulations could be adopted, which could increase our operating costs and expenses. It also is possible that federal or state environmental rules or regulations could be adopted that could have an adverse effect on the use of ethanol. For example, changes in the environmental regulations regarding the required oxygen content of automobile emissions could have an adverse effect on the ethanol industry. Plant operations are governed by the Occupational Safety and Health Administration (“OSHA”). OSHA regulations may change such that the costs of operating the plant may increase. Any of these regulatory factors may result in higher costs or other adverse conditions effecting our operations, cash flows and financial performance.
The European Union concluded an anti-dumping investigation related to ethanol produced in the United States and exported to Europe. As a result of this investigation, the European Union has imposed a tariff on ethanol which is produced in the United States and exported to Europe. This tariff could result in decreased exports of ethanol to Europe which could negatively impact the market price of ethanol in the United States.
In late 2009, California passed a Low Carbon Fuels Standard ("LCFS"). The California LCFS requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which is measured using a lifecycle analysis, similar to the RFS. On December 29, 2011, a federal district court in California ruled that the California LCFS was unconstitutional which halted implementation of the California LCFS. However, the California Air Resources Board ("CARB") appealed this court ruling and on September 18, 2013, the federal appellate court reversed the federal district court finding the LCFS constitutional and remanding the case back to federal district court to determine whether the LCFS imposes a burden on interstate commerce that is excessive in light of the local benefits. In addition, a state court in California recently required that CARB take certain corrective actions regarding the approval of the LCFS regulations while allowing the LCFS regulations to remain in effect during this process. If federal and state challenges to the LCFS are ultimately unsuccessful, the LCFS could have a negative impact on demand for corn-based ethanol and result in decreased ethanol prices.
10
Competition
Ethanol
We are in direct competition with numerous ethanol producers, many of whom have greater resources than we do. Following the significant growth during 2005 and 2006, the ethanol industry has grown at a much slower pace. As of December 14, 2013, the Renewable Fuels Association estimates that there are 211 ethanol production facilities in the U.S. with capacity to produce approximately 14.9 billion gallons of ethanol and another 6 plants under expansion or construction with capacity to produce an additional 165 million gallons. However, the Renewable Fuels Association estimates that approximately 8% of the ethanol production capacity in the United States is currently idled.
Since ethanol is a commodity product, competition in the industry is predominantly based on price. We have also experienced increased competition from oil companies who have started purchasing ethanol production facilities. These oil companies are required to blend a certain amount of ethanol each year. Therefore, the oil companies may be able to operate their ethanol production facilities at times when it is unprofitable for us to operate. Larger ethanol producers may be able to realize economies of scale that we are unable to realize. This could put us at a competitive disadvantage to other ethanol producers. The ethanol industry is continuing to consolidate where a few larger ethanol producers are increasing their production capacities and are controlling a larger portion of the United States ethanol production. Further, some ethanol producers own multiple ethanol plants which may allow them to compete more effectively by providing them flexibility to run certain production facilities while they have other facilities shut down. This added flexibility may allow these ethanol producers to compete more effectively, especially during periods when operation margins are unfavorable in the ethanol industry.
The largest ethanol producers include Archer Daniels Midland, Green Plains Renewable Energy, POET Biorefining and Valero Renewable Fuels, each of which are capable of producing significantly more ethanol than we produce. The following table identifies the majority of the largest ethanol producers in the United States along with their production capacities.
U.S. FUEL ETHANOL PRODUCTION CAPACITY
BY TOP PRODUCERS
Producers of Approximately 700
million gallons per year (mmgy) or more
Company | Current Capacity (mmgy) | |
Archer Daniels Midland | 1,720.0 | |
POET Biorefining | 1,629.0 | |
Valero Renewable Fuels | 1,130.0 | |
Green Plains Renewable Energy | 1,100.4 | |
Updated: December 14, 2013
The ethanol industry in the United States faces competition from ethanol produced outside of the United States. Ethanol imports were lower during our 2013 fiscal year compared to 2012 which may have positively impacted operating margins in 2013. However, we may experience increased competition from ethanol imports in the future which may negatively impact demand for ethanol produced in the United States and lead to lower prices on domestic ethanol.
We also anticipate increased competition from renewable fuels that do not use corn as the feedstock. Many of the current ethanol production incentives are designed to encourage the production of renewable fuels using raw materials other than corn. One type of ethanol production feedstock is cellulose. Cellulose is the main component of plant cell walls and is the most common organic compound on earth. Cellulose is found in wood chips, corn stalks, rice, straw, amongst other common plants. Cellulosic ethanol is ethanol produced from cellulose. Several companies and researchers have commenced pilot projects to study the feasibility of commercially producing cellulosic ethanol and are producing cellulosic ethanol on a small scale and and at least one
company has reportedly begun producing on a commercial scale. A handful of other companies have begun constructing commercial scale cellulosic ethanol plants in the United States some of which are expected to be operational in early 2014. If this technology can be profitably employed on a commercial scale, it could potentially lead to ethanol that is less expensive to produce than corn based ethanol, especially if corn prices remain high. Cellulosic ethanol may also capture more government subsidies and assistance than corn based ethanol. This could decrease demand for our product or result in competitive disadvantages for our ethanol production process.
11
A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Electric car technology has grown in popularity, especially in urban areas. While currently there are a limited number of vehicle recharging stations, making electric cars not feasible for all consumers, there has been increased focus on developing these recharging stations which may make electric car technology more widely available in the future. This additional competition from alternate sources could reduce the demand for ethanol, which would negatively impact our profitability.
Distillers Grains
Ethanol plants in the Midwest produce the majority of distillers grains and primarily compete with other ethanol producers in the production and sales of distillers grains. According to the Renewable Fuels Association's Ethanol Industry Outlook 2013, ethanol plants produced more than 35 million metric tons of distillers grains in 2011/2012 and are expected to produce an estimated 33.3 million metric tons in 2012/2013. The amount of distillers grains produced is expected to fluctuate with changes in ethanol production.
The primary consumers of distillers grains are dairy and beef cattle, according to the Renewable Fuels Association's Ethanol Industry Outlook 2013. In recent years, an increasing amount of distillers grains have been used in the swine and poultry markets. Numerous feeding trials show advantages in milk production, growth, rumen health, and palatability over other dairy cattle feeds. With the advancement of research into the feeding rations of poultry and swine, we expect these markets to expand and create additional demand for distillers grains; however, no assurance can be given that these markets will in fact expand, or if they do, that we will benefit from it. The market for distillers grains is generally confined to locations where freight costs allow it to be competitively priced against other feed ingredients. Distillers grains compete with three other feed formulations: corn gluten feed, dry brewers grain and mill feeds. The primary value of these products as animal feed is their protein content. Dry brewers grain and distillers grains have about the same protein content, and corn gluten feed and mill feeds have slightly lower protein contents.
Cost of Compliance with Environmental Laws
We are subject to extensive air, water and other environmental regulations and we were required to obtain a number of environmental permits to construct and operate the plant. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations. Additionally, any changes that are made to the ethanol plant or its operations must be reviewed to determine if amended permits need to be obtained in order to implement these changes.
During the fiscal year ended October 31, 2013, we incurred costs and expenses of approximately $160,000 complying with environmental laws.
Butamax Advanced Biofuels Letter of Intent
In November 2011, we signed a non-binding letter of intent with Butamax for the purpose of discussing the possible implementation of biobutanol technology and commercial-scale production of biobutanol at our facility. We have entered into a series of definitive agreements with Butamax pursuant to which Butamax has agreed to construct, install and lease its corn oil separation system and license to the Company its corn oil separation technology. Please refer to “ITEM 1 - Business-Business Development” and “ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.” The installation of the corn oil separation system is part of a Phase 1 project working towards the implementation of biobutanol technology at our facility. However, Phase 2 will be dependent on completion of separate definitive agreements for biobutanol production. Management expects to conduct to work with Butamax towards the execution of these definitive agreements in the future. However, there is no guarantee that definitive agreements to implement biobutanol technology will be executed.
Employees
As of October 31, 2013, we had 39 full-time employees.
Financial Information about Geographic Areas
All of our operations are domiciled in the United States. All of the products sold to our customers for fiscal years 2013, 2012 and 2011 were produced in the United States and all of our long-lived assets are domiciled in the United States. We have
12
engaged third-party professional marketers who decide where the majority of our products are marketed and we have limited control over the marketing decisions made by our third-party professional marketers. These third-party marketers may decide to sell our products in countries other than the United States. However, we anticipate that our products will primarily be marketed and sold in the United States.
ITEM 1A. RISK FACTORS
You should carefully read and consider the risks and uncertainties below and the other information contained in this report. The risks and uncertainties described below are not the only ones we face. The following risks, together with additional risks and uncertainties not currently known to us or that we currently deem immaterial could impair our financial condition and results of operations.
Risks Relating to Our Business
A decrease in the spread between the price we receive for our products and the price we pay for raw materials will have an adverse effect on our profitability. Our ability to profitably operate the ethanol plant is primarily dependent on the spread between the price we pay for corn and natural gas and the price we receive for our ethanol. While the price of ethanol typically changes in relation to corn prices, this correlation has not always been reliable historically and may not always exist. In the event that the spread between the price for our products and the costs associated with our raw materials becomes negative, we may be unable to maintain our liquidity which may adversely impact our ability to profitably operate which could negatively impact the value of our units.
Declines in the price of ethanol or distillers grains would reduce our revenues. The sale prices of ethanol and distillers grains can be volatile as a result of a number of factors such as overall supply and demand, the price of gasoline and corn, levels of government support, and the availability and price of competing products. Any lowering of ethanol or distillers grains prices, especially if it is associated with increases in corn and natural gas prices, may affect our ability to operate profitably. We anticipate the price of ethanol and distillers grains to continue to be volatile in our 2014 fiscal year. Declines in the prices we receive for our ethanol and distillers grains will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably for an extended period of time which could decrease the value of our units.
Increases in the price of corn or natural gas would reduce our profitability. Our primary source of revenue is from the sale of ethanol and distillers grains. Our results of operations and financial condition are significantly affected by the cost and supply of corn and natural gas. Changes in the price and supply of corn and natural gas are subject to and determined by market forces over which we have no control including weather and general economic factors. Generally, higher corn prices will produce lower profit margins and, therefore, negatively affect our financial performance. If a period of high corn prices were to be sustained for some time, such pricing may reduce our ability to operate profitably because of the higher cost of operating our plant. We may not be able to offset any increase in the price of corn by increasing the price of our products. If we cannot offset increases in the price of corn, our financial performance may be negatively affected.
The prices for and availability of natural gas are subject to volatile market conditions. These market conditions often are affected by factors beyond our control such as higher prices as a result of colder than average weather conditions or natural disasters, overall economic conditions and foreign and domestic governmental regulations and relations. Significant disruptions in the supply of natural gas could impair our ability to manufacture ethanol and more significantly, distillers grains for our customers. Furthermore, increases in natural gas prices or changes in our natural gas costs relative to natural gas costs paid by competitors may adversely affect our results of operations and financial condition.
We engage in hedging transactions which involve risks that could harm our business. We are exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process, along with sales of ethanol and distillers grains. We seek to minimize the risks from fluctuations in the prices of corn and natural gas through the use of derivative instruments. The effectiveness of our hedging strategies is dependent on the price of corn and natural gas and our ability to sell sufficient products to use all of the products for which we have futures contracts. Our hedging activities may not successfully reduce the risk caused by price fluctuation which may leave us vulnerable to high prices. Alternatively, we may choose not to engage in hedging transactions in the future and our operations and financial conditions may be adversely affected during periods in which prices increase. Utilizing cash for margin calls has an impact on the cash we have available for operations which could result in liquidity problems. Price movements in corn contracts are highly volatile and are influenced by many factors that are beyond our control. There are several variables that could affect the extent to which our derivative instruments are impacted by price fluctuations in the cost of corn. We may incur such costs and they may be significant which could impact our ability to profitably operate the plant and may reduct the value of our units.
13
Our business is not diversified. Our success depends almost entirely on our ability to profitably operate our ethanol plant. We do not have any other lines of business or other sources of revenue if we are unable to operate our ethanol plant and manufacture ethanol and distillers grains. If economic or political factors adversely affect the market for ethanol or distillers grains, we have no other line of business to fall back on. Our business would also be significantly harmed if the ethanol plant could not operate at full capacity for any extended period of time.
We have signed a letter of intent with Butamax Advanced Biofuels, LLC for the purpose of discussing the implementation of biobutanol technology at our facility; however, we may not be able to reach definitive agreements and, in the event we proceed with biobutanol technology, there are no assurances that the technology will be effective or that there will be a market for biobutanol. We entered into a letter of intent with Butamax for the purpose of discussing the conversion of our ethanol facility to a biobutanol facility. We have entered into a series of definitive agreements regarding Phase 1 of the project with Butamax whereby Butamax has agreed to install and lease its corn oil separation system and license to the Company its corn oil separation technology. However, Phase 2 is dependent on our executing definitive agreements related to biobutanol production. We may never enter into these definitive agreements with Butamax and therefore, may never convert our ethanol facility to a biobutanol facility. In the event we do proceed with definitive agreements and convert our facility to a biobutanol facility, there are no assurances that the biobutanol technology as developed by Butamax will be effective. Even if the technology were to be effective, there is no assurance that we would be able to profitably market the biobutanol.
If RPMG, which markets all of our ethanol fails, it may negatively impact our ability to profitably operate the ethanol plant. All of our ethanol is marketed by RPMG. Therefore, nearly all of our revenue is derived from sales that are secured by RPMG. If RPMG is unable to market our ethanol, it may negatively impact our ability to profitably operate the ethanol plant. While management believes that we could secure an alternative marketer if RPMG were to fail, switching marketers may negatively impact our cash flow and our ability to continue to operate profitably, which may decrease the value of our units.
We depend on our management and key employees, and the loss of these relationships could negatively impact our ability to operate profitably. We are highly dependent on our management team to operate our ethanol plant. We may not be able to replace these individuals should they decide to cease their employment with us, or if they become unavailable for any other reason. While we seek to compensate our management and key employees in a manner that will encourage them to continue their employment with us, they may choose to seek other employment. Any loss of these executive officers and key employees may prevent us from operating the ethanol plant profitably and could decrease the value of our units.
Changes and advances in ethanol production technology could require us to incur costs to update our plant or could otherwise hinder our ability to compete in the ethanol industry or operate profitably. Advances and changes in the technology of ethanol production are expected to occur. Such advances and changes may make the ethanol production technology installed in our plant less desirable or obsolete. These advances could also allow our competitors to produce ethanol at a lower costs than we are able. If we are unable to adopt or incorporate technological advances, our ethanol production methods and processes could be less efficient than our competitors, which could cause our plant to become uncompetitive or completely obsolete. If our competitors develop, obtain or license technology that is superior to ours or that makes our technology obsolete, we may be required to incur significant costs to enhance or acquire new technology so that our ethanol production remains competitive. Alternatively, we may be required to seek third-party licenses, which could also result in significant expenditures. These third-party licenses may not be available or, once obtained, they may not continue to be available on commercially reasonable terms. These costs could negatively impact our financial performance by increasing our operating costs and reducing our net income.
Our existing debt financing agreements contain, and our future debt financing agreements may contain, restrictive covenants that limit distributions and impose restrictions on the operation of our business. The use of debt financing makes it more difficult for us to operate because we must make principal and interest payments on the indebtedness and abide by covenants contained in our debt financing agreements. Although we have significantly reduced our level of debt, the restrictive covenants contained in our financing agreements may have important implications on our operations, including, among other things: (a) limiting our ability to obtain additional debt or equity financing; (b) placing us at a competitive disadvantage because we may be more leveraged than some of our competitors; (c) subjecting all or substantially all of our assets to liens, which means that there may be no assets left for unit holders in the event of a liquidation; and (d) limiting our ability to make business and operational decisions regarding our business, including, among other things, limiting our ability to pay dividends to our unit holders, make capital improvements, sell or purchase assets or engage in transactions we deem to be appropriate and in our best interest.
We may violate the terms of our credit and capital lease agreements, including the financial covenants, which could result in our lenders demanding immediate repayment. Our credit and capital lease agreements with First National Bank of Omaha ("FNBO") and U.S. Bank National Association ("U.S. Bank") as trustee for the City of Lamberton include various financial loan covenants. We are currently in compliance with our loan covenants and management projections predict that we will be in compliance with our loan covenants for at least the next 12 months. However, unforeseen circumstances may develop which
14
could result in us violating our loan covenants. If we violate the terms of our credit agreements, including our financial loan covenants, FNBO or U.S. Bank could deem us to be in default of our loans and require us to immediately repay the entire outstanding balance of our loans. If we do not have the funds available to repay the loans or we cannot find another source of financing, we may fail which could decrease or eliminate the value of our units.
Our inability to secure credit facilities we may require in the future could negatively impact our liquidity. Due to current conditions in the credit markets, it has been difficult for businesses to secure financing. While we do not currently require more financing than we have, in the future we may need additional financing. If we require financing in the future and are unable to secure such financing, or we are unable to secure the financing we require on reasonable terms, it may have a negative impact on our liquidity which could negatively impact the value of our units.
Our operations may be negatively impacted by natural disasters, severe weather conditions, and other unforeseen plant shutdowns which can negatively impact our operations. Our operations may be negatively impacted by events outside of our control such as natural disasters, severe weather including flooding and droughts, strikes, train derailments and other unforeseen events which may negatively impact our operations. If we experience any of these unforeseen circumstances which could negatively impact our operations, it may affect our cash flow and negatively impact the value of our business.
We may incur casualty losses that are not covered by insurance which could negatively impact the value of our units. We have purchased insurance which we believe adequately covers our losses from foreseeable risks. However, there are risks that we may encounter for which there is no insurance or for which insurance is not available on terms that are acceptable to us. If we experience a loss which materially impairs our ability to operate the ethanol plant which is not covered by insurance, the value of our units could be reduced or eliminated.
Risks Related to Ethanol Industry
The ethanol industry is an industry that is changing rapidly which can result in unexpected developments that could negatively impact our operations and the value of our units. The ethanol industry has grown significantly in the last fourteen years. According to the Renewable Fuels Association, the ethanol industry has grown from approximately 1.5 billion gallons of production per year in 1999 to approximately 14.9 billion gallons of current domestic ethanol production capacity. This rapid growth has resulted in significant shifts in supply and demand of ethanol over a very short period of time. As a result, past performance by the ethanol plant or the ethanol industry generally might not be indicative of future performance. We may experience a rapid shift in the economic conditions in the ethanol industry which may make it difficult to operate the ethanol plant profitably. If changes occur in the ethanol industry that make it difficult for us to operate the ethanol plant profitably, it could result in the reduction in the value of our units.
Demand for ethanol may not continue to grow unless ethanol can be blended into gasoline in higher percentage blends for all conventional automobiles. Currently, ethanol is primarily blended with gasoline for use in standard (non-flex fuel) vehicles to create a blend which is 10% ethanol and 90% gasoline. Estimates indicate that approximately 134 billion gallons of gasoline are sold in the United States each year. Assuming that all gasoline in the United States is blended at a rate of 10% ethanol and 90% gasoline, the maximum demand for ethanol is 13.4 billion gallons. This is commonly referred to as the "blending wall," which represents a theoretical limit where more ethanol cannot be blended into the national gasoline pool. Many in the ethanol industry believe that the ethanol industry has already reached this blending wall which is shown by the EPA's recent proposed reduction to the RFS for 2014. In order to expand ethanol demand, higher percentage blends of ethanol must be utilized in standard vehicles. The EPA has approved the use of E15 for standard vehicles produced in the model year 2001 and later. However, the fact that E15 has not been approved for use in all vehicles and the labeling requirements associated with E15 may result in many gasoline retailers refusing to carry E15. In addition, different gasoline blendstocks may be required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. As a result, the approval of E15 may not significantly increase demand for ethanol.
If exports to Europe are decreased due to the imposition by the European Union of a tariff on U.S. ethanol, ethanol
prices may be negatively impacted. The European Union concluded an anti-dumping investigation related to ethanol produced in the United States and exported to Europe. As a result of this investigation, the European Union has imposed a tariff on ethanol which is produced in the United States and exported to Europe. If exports of ethanol to Europe decrease as a result of this tariff, it could negatively impact the market price of ethanol in the United States. Any decrease in ethanol prices or demand may negatively impact our ability to profitably operate the ethanol plant.
The California Low Carbon Fuel Standard may decrease demand for corn based ethanol which could negatively impact our profitability. California passed a Low Carbon Fuel Standard (LCFS) requiring that renewable fuels used in California must accomplish certain reductions in greenhouse gases which are measured using a lifecycle analysis. California represents a
15
significant ethanol market and if we are unable to supply ethanol to California, it could significantly reduce demand for the ethanol we produce. Any decrease in ethanol demand as a result of the California LCFS could negatively impact ethanol prices which could reduce our revenues and negatively impact our ability to profitably operate the ethanol plant.
Technology advances in the commercialization of cellulosic ethanol may decrease demand for corn based ethanol which may negatively affect our profitability. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, municipal solid waste and energy crops. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas which are unable to grow corn. There are several government initiatives that offer a strong incentive to develop commercial scale cellulosic ethanol. Although subject to possible reduction by the EPA, the statutory volume requirement of the RFS provides for 16 billion gallons per year of advanced bio-fuels to be consumed in the United States by 2022. Additionally, state and federal grants have been awarded to several companies who are seeking to develop commercial-scale cellulosic ethanol plants. Commercial scale cellulosic ethanol plants are currently under construction in the United States with at least one being reportedly operational and others nearing completion. If an efficient method of producing ethanol from cellulose-based biomass on a commercial scale is successful, we may not be able to compete effectively. If we are unable to produce ethanol as cost-effectively as cellulose-based producers, our ability to general revenue will be negatively impacted.
We operate in an intensely competitive industry and compete with larger, better financed companies which could impact our ability to operate profitably. There is significant competition among ethanol producers. There are numerous producer-owned and privately-owned ethanol plants planned and operating through the United States. In addition, we have seen increased competition from oil companies who have purchased ethanol production facilities. We also face competition from ethanol producers located outside the United States. The largest ethanol producers include Archer Daniels Midland, Green Plains Renewable Energy, POET, and Valero Renewable Fuels, all of which are each capable of producing significantly more ethanol than we produce. Further, many believe that there will be further consolidation occurring in the ethanol industry in the future which will likely lead to a few companies who control a significant portion of the ethanol production market. We may not be able to compete with these larger producers and our inability to compete could negatively impact our financial performance.
Competition from the advancement of alternative fuels may lessen the demand for ethanol. Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Like ethanol, these emerging technologies offer an option to address worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. If these alternative technologies continue to expand and gain broad acceptance and become readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, resulting in lower ethanol prices that might adversely affect our financial condition.
Consumer resistance to the use of ethanol based on the belief that ethanol is expensive, uses too much corn, adds to air pollution, harms engines, and/or takes more energy to produce than it contributes may affect the demand for ethanol. Certain individuals believe that the use of ethanol will have a negative impact on gasoline prices and that ethanol production uses too much of the available corn supply. Many also believe that ethanol adds to air pollution and harms vehicle engines. Still other consumers believe that the process of producing ethanol actually uses more fossil energy, such as oil and natural gas, than the amount of energy that is produced. These consumer beliefs could potentially be wide-spread. If consumers choose not to buy ethanol based on these beliefs, it would affect the demand for the ethanol we produce which could negatively affect our profitability.
Risks Related to Regulation and Governmental Action
Government incentives for ethanol production may be eliminated in the future, which could hinder our ability to operate at a profit. The ethanol industry is assisted by various federal and state ethanol production and tax incentives, including the RFS. The RFS helps to support a market for ethanol that might disappear without this incentive. Any waiver of the RFS or any modification or elimination of the RFS and the minimum levels of renewable fuels required in gasoline could negatively impact ethanol demand and prices and our results of operations. Recently, there have been proposals in Congress to reduce or eliminate the RFS. In addition, on November 15, 2013, the EPA announced a proposal to significantly reduce the RFS levels for 2014 from the statutory volume requirement of 18.15 billion gallons to 15.21 billion gallons and reduce the renewable volume obligations that can be satisfied by corn based ethanol from 14.4 billion gallons to 13 billion gallons. The EPA proposal is subject to a 60-day public comment period which will end on January 28, 2014. The EPA is also seeking comment on several petitions it has received for partial waiver of the statutory volumes for 2014. If the EPA's proposal becomes a final rule significantly reducing the RFS or if the RFS were to be otherwise reduced or eliminated by the exercise of the EPA waiver authority or by Congress, the market price and demand for ethanol will likely decrease which will negatively impact our financial performance.
16
The federal Volumetric Ethanol Excise Tax ("VEETC") and the United States tariff on foreign ethanol expired on December 31, 2011. VEETC and the secondary tariff on foreign ethanol expired on December 31, 2011. The elimination of tax incentives for gasoline refiners and blenders resulting from the expiration of VEETC may have a negative impact on demand for ethanol which may result in lower market ethanol prices. In addition, the loss of the United States' tariff on foreign ethanol could result in continued increases in importation of ethanol produced in other countries, especially in areas of the United States that are easily accessible by international shipping ports. Any increase in ethanol imports could negatively impact domestic ethanol prices and demand.
Changes in environmental regulations or violations of these regulations could be expensive and reduce our profitability. We are subject to extensive air, water and other environmental laws and regulations. In addition, some of these laws require our plant to operate under a number of environmental permits. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potentials impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, damages, criminal sanctions, permit revocations and/or plant shutdowns. In the future, we may be subject to legal actions brought by environmental advocacy groups and other parties for actual or alleged violations of environmental laws or our permits. Additionally, any changes in environmental laws and regulations could require us to spend considerable resources to comply with future environmental regulations. The expense of compliance could be significant enough to reduce our profitability and negatively affect our financial condition.
Carbon dioxide may be regulated in the future as an air pollutant requiring us to obtain additional permits or install additional environmental equipment which could adversely effect our financial performance. In 2007, the Supreme Court decided a case in which it ruled that carbon dioxide is an air pollutant under the Clean Air Act for the purposes of motor vehicle emissions. In 2011 the EPA issued a tailoring rule that deferred greenhouse gas regulations for ethanol plants until July of 2014. However, in July of 2013 the D.C. Circuit issued an opinion vacating the EPA's deferral of those regulations for biogenic sources, including ethanol plants. Our plant produces a significant amount of carbon dioxide. While there are currently no regulations restricting carbon dioxide emissions, if the EPA or the State of Minnesota were to regulate carbon dioxide emissions by plants such as ours, we may have to apply for additional permits or we may be required to install carbon dioxide mitigation equipment or take other as yet unknown steps to comply with these potential regulations. Compliance with any future regulation of carbon dioxide, if it occurs, could be costly and may prevent us from operating the ethanol plant profitably which could decrease or eliminate the value of our units.
ITEM 2. PROPERTIES
Our plant site is made up of two adjacent parcels which together total approximately 125 acres in southwest Minnesota near Lamberton. The plant's address is 24500 U.S. Highway 14, Lamberton, Minnesota 56152. We produce all of our ethanol and distillers grains at this site. Our plant is in excellent condition and is capable of functioning at over 100% of its 50 million gallons per year nameplate production capacity.
All of our tangible and intangible property, real and personal, serves as the collateral for our credit and capital lease agreements with First National Bank of Omaha ("FNBO") and U.S. Bank National Association ("U.S. Bank") as trustee for the City of Lamberton. In addition, we have begun installation of a corn oil separation system which will serve as collateral for our obligations with Butamax. Our credit facility and our capital lease and our agreements with Butamax are discussed in more detail under “ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED MEMBER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
As of January 15, 2014, we have approximately 4,953 membership units outstanding and approximately 1,441 unit holders of record. There is no public trading market for our membership units.
We have, however, established a Unit Trading Bulletin Board, a private online matching service, through Farmers National Company Agstock, LLC in order to facilitate trading among our members. The Unit Trading Bulletin Board has been designed to comply with federal tax laws and Internal Revenue Service ("IRS") regulations establishing a “qualified matching service,” as well as state and federal securities laws. Our Unit Bulletin Board consists of an electronic bulletin board that provides a list of interested buyers with a list of interested sellers, along with their non-firm price quotes. The Unit Trading Bulletin Board does not automatically affect matches between potential sellers and buyers and it is the sole responsibility of sellers and buyers to contact each other to make a determination as to whether an agreement to transfer units may be reached. We do not become involved in any purchase or sale negotiations arising from our Unit Trading Bulletin Board and have no role in effecting the transactions beyond approval, as required under our member control agreement, and the issuance of new certificates. We do not give advice regarding the merits or shortcomings of any particular transaction. We do not receive, transfer or hold funds or securities as an incident of operating the Unit Trading Bulletin Board. We do not receive any compensation for creating or maintaining the Unit Trading Bulletin Board. In advertising our Unit Trading Bulletin Board, we do not characterize Highwater Ethanol as being a broker or dealer or an exchange. We do not use the Unit Trading Bulletin Board to offer to buy or sell securities other than in compliance with the securities laws, including any applicable registration requirements.
There are detailed timelines that must be followed under the Unit Trading Bulletin Board Rules and Procedures with respect to offers and sales of membership units. All transactions must comply with the Unit Trading Bulletin Board Rules, our member control agreement, and are subject to approval by our board of governors.
As a limited liability company, we are required to restrict the transfers of our membership units in order to preserve our partnership tax status. Our membership units may not be traded on any established securities market or readily traded on a secondary market (or the substantial equivalent thereof). All transfers are subject to a determination that the transfer will not cause Highwater Ethanol to be deemed a publicly traded partnership.
The following table contains historical information by fiscal quarter for the fiscal years ended October 31, 2013 and 2012 regarding the actual unit transactions that were completed by our unit-holders during the periods specified. We believe this most accurately represents the current trading value of the Company's units. The information was compiled by reviewing the completed unit transfers that occurred on our qualified matching service bulletin board during the quarters indicated.
Quarter | Low Price | High Price | Average Price | # of Units Traded | ||||||
2012 1st | $ | 5,100 | $ | 5,550 | $ | 5,233 | 9 | |||
2012 2nd | $ | 6,000 | $ | 6,000 | $ | 6,000 | 2 | |||
2012 3rd | $ | — | $ | — | $ | — | — | |||
2012 4th | $ | — | $ | — | $ | — | — | |||
2013 1st | $ | 5,000 | $ | 5,000 | $ | 5,000 | 1 | |||
2013 2nd | $ | — | $ | — | $ | — | — | |||
2013 3rd | $ | 5,000 | $ | 5,000 | $ | 5,000 | 4 | |||
2013 4th | $ | 5,000 | $ | 5,000 | $ | 5,000 | 1 | |||
The following table contains the asked prices that were posted on the Company's alternative trading service bulletin board and includes some transactions that were not completed. The Company believes the table above more accurately describes the trading value of its units as the asked prices below include some offers that never resulted in completed transactions. The information was compiled by reviewing postings that were made on the Company's alternative trading service bulletin board.
18
Sellers Quarter | Low Price | High Price | Average Price | # of Units Listed | ||||||
2012 1st | $ | 5,000 | $ | 6,000 | $ | 5,500 | 3 | |||
2012 2nd | $ | 6,000 | $ | 7,250 | $ | 6,625 | 3 | |||
2012 3rd | $ | 5,000 | $ | 7,200 | $ | 6,171 | 7 | |||
2012 4th | $ | 5,000 | $ | 5,000 | $ | 5,000 | 1 | |||
2013 1st | $ | 5,000 | $ | 7,200 | $ | 6,340 | 4 | |||
2013 2nd | $ | 5,000 | $ | 8,500 | $ | 6,500 | 3 | |||
2013 3rd | $ | 5,000 | $ | 8,500 | $ | 6,875 | 4 | |||
2013 4th | $ | 5,000 | $ | 10,000 | $ | 7,250 | 4 | |||
Distributions
We did not make any distributions to our members during our fiscal year ended October 31, 2013. We paid distributions of $100.95 per unit to our members during our fiscal year ended October 31, 2012. Our board of governors has discretion over the timing and amount of distributions to our unit holders, subject to certain restrictions in our credit agreements.
Our expectations with respect to our ability to make future distributions are discussed in greater detail in “ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations” In addition, distributions are restricted by certain loan covenants in our construction term loan and revolving credit financing agreements. These loan covenants and restrictions are described in greater detail under “ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
Performance Graph
The following graph shows a comparison of cumulative total member return since October 31, 2008, calculated on a dividend reinvested basis, for the Company, the NASDAQ Composite Index (the "NASDAQ") and an index of other companies that have the same SIC codes as the Company (the "Industry Index"). The graph assumes $100 was invested in each of our units, the NASDAQ, and the Industry Index on October 31, 2008. Note that historic stock price performance is not necessarily indicative of future unit price performance.
19
Pursuant to the rules and regulations of the Securities and Exchange Commission, the performance graph and the information set forth therein shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed to be incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial and operating data as of the dates and for the periods indicated. The selected balance sheet financial data as of October 31, 2011, 2010 and 2009 and the selected statements of operations data and other financial data for the years ended October 31, 2010 and 2009 have been derived from our audited financial statements that are not included in this Form 10-K. The selected balance sheet financial data as of October 31, 2013 and 2012 and the selected statements of operations data and other financial data for each of the years in the three year period ended October 31, 2013 have been derived from the audited financial statements included elsewhere in this Form 10-K. You should read the following table in conjunction with "ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and the accompanying notes included elsewhere in this Form 10-K. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following financial data.
20
Statement of Operations Data: | 2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||||||
Revenues | $ | 168,682,409 | $ | 156,648,625 | $ | 160,374,033 | $ | 104,849,565 | $ | 18,983,802 | ||||||||||
Cost of Goods Sold | 159,305,976 | 155,785,481 | 149,540,234 | 94,993,137 | 16,064,288 | |||||||||||||||
Gross Profit | 9,376,433 | 863,144 | 10,833,799 | 9,856,428 | 2,919,514 | |||||||||||||||
Operating Expenses | 1,819,444 | 1,804,031 | 1,762,414 | 1,850,905 | 1,882,608 | |||||||||||||||
Operating Income (Loss) | 7,556,989 | (940,887 | ) | 9,071,385 | 8,005,523 | 1,036,906 | ||||||||||||||
Other Expense | (2,732,930 | ) | (3,184,001 | ) | (3,928,028 | ) | (5,253,117 | ) | (2,528,312 | ) | ||||||||||
Net Income (Loss) | $ | 4,824,059 | $ | (4,124,888 | ) | $ | 5,143,357 | $ | 2,752,406 | $ | (1,491,406 | ) | ||||||||
Weighted Average Units Outstanding | 4,953 | 4,953 | 4,953 | 4,953 | 4,953 | |||||||||||||||
Basic and Diluted Net Income (Loss) Per Unit | $ | 973.97 | $ | (832.81 | ) | $ | 1,038.43 | $ | 555.70 | $ | (301.11 | ) | ||||||||
Cash Distributions Per Unit | $ | — | $ | 100.95 | $ | — | $ | — | $ | — | ||||||||||
Balance Sheet Data: | 2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||||||
Current Assets | $ | 15,905,435 | $ | 11,185,608 | $ | 15,695,180 | $ | 13,745,241 | $ | 8,956,961 | ||||||||||
Net Property and Equipment | 80,312,341 | 86,459,635 | 91,811,920 | 97,558,718 | 103,052,684 | |||||||||||||||
Other Assets | 4,048,812 | 4,052,190 | 3,422,287 | 3,147,298 | 3,278,767 | |||||||||||||||
Total Assets | $ | 100,266,588 | $ | 101,697,433 | $ | 110,929,387 | $ | 114,451,257 | $ | 115,288,412 | ||||||||||
Current Liabilities | $ | 7,711,996 | $ | 6,662,377 | $ | 7,741,800 | $ | 10,252,887 | $ | 7,818,927 | ||||||||||
Long-Term Debt | 41,231,727 | 47,857,262 | 50,997,079 | 56,439,317 | 62,712,332 | |||||||||||||||
Other Liabilities | — | 645,589 | 1,118,709 | 1,787,375 | 1,563,985 | |||||||||||||||
Members' Equity | 51,322,865 | 46,532,205 | 51,071,799 | 45,971,678 | 43,193,168 | |||||||||||||||
Total Liabilities & Members' Equity | $ | 100,266,588 | $ | 101,697,433 | $ | 110,929,387 | $ | 114,451,257 | $ | 115,288,412 | ||||||||||
See "ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" for further discussion of our financial results.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations for the Fiscal Years Ended October 31, 2013 and 2012
The following table shows the results of our operations and the percentage of revenues, cost of goods sold, gross profit, operating expenses, operating profit (loss) and other items to total revenues in our statements of operations for the fiscal years ended October 31, 2013 and 2012:
21
2013 | 2012 | ||||||||||||
Statements of Operations Data | Amount | % | Amount | % | |||||||||
Revenues | $ | 168,682,409 | 100.00 | % | $ | 156,648,625 | 100.00 | % | |||||
Cost of Goods Sold | 159,305,976 | 94.44 | % | 155,785,481 | 99.45 | % | |||||||
Gross Profit | 9,376,433 | 5.56 | % | 863,144 | 0.55 | % | |||||||
Operating Expenses | 1,819,444 | 1.08 | % | 1,804,031 | 1.15 | % | |||||||
Operating Profit (Loss) | 7,556,989 | 4.48 | % | (940,887 | ) | (0.60 | )% | ||||||
Other Expense, Net | (2,732,930 | ) | (1.62 | )% | (3,184,001 | ) | (2.03 | )% | |||||
Net Income (Loss) | $ | 4,824,059 | 2.86 | % | $ | (4,124,888 | ) | (2.63 | )% | ||||
The following table shows the sources of our revenues for the fiscal years ended October 31, 2013 and 2012.
2013 | 2012 | |||||||||||||
Revenue Sources | Amount | Percentage of Total Revenues | Amount | Percentage of Total Revenues | ||||||||||
Ethanol Sales | $ | 130,623,053 | 77.44 | % | $ | 123,398,657 | 78.78 | % | ||||||
Modified Wet Distillers Grains Sales | 8,460,200 | 5.02 | % | 7,742,353 | 4.94 | % | ||||||||
Dried Distillers Grains Sales | 29,599,156 | 17.54 | % | 25,507,615 | 16.28 | % | ||||||||
Total Revenues | $ | 168,682,409 | 100.00 | % | $ | 156,648,625 | 100.00 | % | ||||||
Our total revenues were higher for the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. Revenue from ethanol sales increased by approximately 5.9% during the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012 primarily due to higher ethanol prices. The average per gallon ethanol sales price we received for the fiscal year ended October 31, 2013 was approximately 3.7% higher than the average price we received for the fiscal year ended October 31, 2012. In addition, we experienced an increase in the gallons of ethanol sold in the fiscal year ended October 31, 2013 as compared to the fiscal year ended October 31, 2012. The gallons of ethanol we sold during the fiscal year ended October 31, 2013 increased by approximately 2.2% as compared to the number of gallons of ethanol we sold for the fiscal year ended October 31, 2012. In the ordinary course of business, we enter into forward contracts for our commodity purchases and sales. At October 31, 2013, we have forward ethanol sales contracts of approximately 2,100,000 gallons for various delivery periods through December 2013.
Management attributes this increase in the average price we received for our ethanol for the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012 to a lower national supply of ethanol and a decrease in ethanol imports. Although ethanol prices declined somewhat late in our fiscal year, that decline in ethanol prices has been less than the corresponding decline in corn prices resulting in an improvement in operating margins. Management is optimistic that the current positive operating environment will continue and expects that changes in ethanol prices will generally be directionally consistent with changes in corn and energy prices. However, ethanol prices could face downward pressure if ethanol imports increase or if domestic demand decreases. In addition, ethanol prices could be negatively impacted if the use requirements mandated by the RFS are significantly reduced or eliminated.
Revenue from distillers grains increased by approximately 14.5% during the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. Management believes that this is primarily a result of higher distillers grains prices and an increase in the number of tons of dried distillers grains sold during our fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. For the fiscal year ended October 31, 2013, the average price per ton that we received for our dried distillers grains was approximately 5.2% higher than during the fiscal year ended October 31, 2012. For the fiscal year ended October 31, 2013, the average price per ton that we received for our modified distillers grains was approximately 21.1% higher than during the fiscal year ended October 31, 2012. Conversely, the tons of dried distillers grains we sold during the fiscal year ended October 31, 2013, increased by approximately 10.8% as compared to the tons of dried distillers grains we sold for the fiscal year ended October 31, 2012. The tons of modified distillers grains we sold during the fiscal year ended October 31, 2013, decreased by approximately 9.8% as compared to the fiscal year ended October 31, 2012. However, this was offset by increased price per ton received. As of October 31, 2013, we have forward dried distiller grains sales contracts of approximately 11,475 tons at various fixed prices for various delivery periods through February 2014.
22
Distillers grains prices typically change in proportion to corn prices and availability of corn. Management attributes the increase in the average price we received for dried distillers grains and modified distillers grains to the high corn prices and lower corn supply we experienced during much of the fiscal year ended October 31, 2013. Corn prices decreased during our third and fourth fiscal quarter due to predictions of a large corn crop which resulted in lower distillers grains prices. However, distillers grains prices have remained strong in relation to corn prices. Management anticipates that distillers grains prices will continue to follow corn prices and change in relation to the availability of corn throughout our fiscal year.
Cost of Goods Sold
Our two largest costs of production are corn (83.1% of cost of goods sold for the fiscal year ended October 31, 2013) and natural gas (4.0% of cost of goods sold for the fiscal year ended October 31, 2013). Our total cost of goods sold was approximately 2.3% more during the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. Our average price per bushel of corn for the fiscal year ended October 31, 2013 was approximately the same as compared to the fiscal year ended October 31, 2012. We used approximately 2.9% more bushels of corn in the fiscal year ended October 31, 2013 as compared to the fiscal year ended October 31, 2012.
We experienced high corn prices for the first half of our fiscal year resulting from poor weather conditions in the United States in 2012 which resulted in a limited supply and low corn carryover. However, corn prices decreased during our third fiscal quarter and fourth fiscal quarters in response to reports projecting a record 2013 corn crop. These decreased prices have continued through harvest and subsequent to our 2013 fiscal year end. Management believes that an adequate corn supply will be available in our area to operate the ethanol plant and that prices during our 2014 fiscal year will be lower due to plentiful supply. However, corn prices will likely remain volatile in the future depending on weather conditions and other factors.
In the ordinary course of business, we enter into forward purchase contracts for our commodity purchases. At October 31, 2013, we have no forward corn purchase contracts. We had gains related to corn derivative instruments of approximately $331,000 for the fiscal year ended October 31, 2013, which decreased cost of sales. We had gains related to corn derivative instruments of approximately $481,000 for the fiscal year ended October 31, 2012.
For the fiscal year ended October 31, 2013, we purchased approximately 5.9% more natural gas as compared to the same period of 2012. This increase in natural gas usage is primarily due to an increase in production of ethanol and dried distillers grains. Our average price per MMBTU of natural gas was 6.7% lower for the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. Management anticipates that natural gas prices will continue at their current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand due to unseasonably cold winter weather conditions.
In the ordinary course of business, we entered into forward purchase contracts for our natural gas purchases. At October 31, 2013, we have natural gas forward contracts for delivery periods through February 2014 for a total commitment of approximately $849,000. We had gains related to natural gas based derivative instruments of approximately $41,000 for the fiscal year ended October 31, 2013. We had losses related to natural gas based derivative instruments of approximately $419,000 for the fiscal year ended October 31, 2012.
Operating Expense
We had operating expense for the fiscal year ended October 31, 2013 of $1,819,444 compared to operating expense of $1,804,031 for the fiscal year ended October 31, 2012. Management attributes this increase in operating expense to increased costs related to our business and property insurance, property taxes and safety supplies. We continue to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.
Operating Profit (Loss)
We had operating profit for the fiscal year ended October 31, 2013 of $7,556,989 compared to operating loss of $940,887 for the fiscal year ended October 31, 2012. Our income from operations for the fiscal year ended October 31, 2013, was 4.5% of our revenues. This increase in our profitability for the fiscal year ended October 31, 2013, was due primarily to an increase in the price we received for our ethanol which contributed to positive operating margins during the last three quarters of our fiscal year.
23
Other Expense, Net
We had total other expense for the fiscal year ended October 31, 2013 of $2,732,930 compared to other expense of $3,184,001 for the fiscal year ended October 31, 2012. Our other expense for the fiscal year ended October 31, 2013 consisted primarily of interest expense offset in part by interest rate swap gains and investment income. Management attributes this decrease in other expense primarily to a decrease in interest expense due to our having a lower outstanding balance on our loans.
Results of Operations for the Fiscal Years Ended October 31, 2012 and 2011
The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses, operating profit and other items to total revenues in our statements of operations for the fiscal years ended October 31, 2012 and 2011:
2012 | 2011 | ||||||||||||
Statements of Operations Data | Amount | % | Amount | % | |||||||||
Revenues | $ | 156,648,625 | 100.00 | % | $ | 160,374,033 | 100.00 | % | |||||
Cost of Goods Sold | 155,785,481 | 99.45 | % | 149,540,234 | 93.24 | % | |||||||
Gross Profit | 863,144 | 0.55 | % | 10,833,799 | 6.76 | % | |||||||
Operating Expenses | 1,804,031 | 1.15 | % | 1,762,414 | 1.10 | % | |||||||
Operating Profit (Loss) | (940,887 | ) | (0.60 | )% | 9,071,385 | 5.66 | % | ||||||
Other Expense | (3,184,001 | ) | (2.03 | )% | (3,928,028 | ) | (2.45 | )% | |||||
Net Income (Loss) | $ | (4,124,888 | ) | (2.63 | )% | $ | 5,143,357 | 3.21 | % | ||||
Revenues
The following table shows the sources of our revenues for the fiscal years ended October 31, 2012 and 2011.
2012 | 2011 | |||||||||||||
Revenue Sources | Amount | Percentage of Total Revenues | Amount | Percentage of Total Revenues | ||||||||||
Ethanol Sales | $ | 123,398,657 | 78.77 | % | $ | 135,149,520 | 84.27 | % | ||||||
Modified Wet Distillers Grains Sales | 7,742,353 | 4.94 | % | 884,950 | 0.55 | % | ||||||||
Dried Distillers Grains Sales | 25,507,615 | 16.29 | % | 24,339,563 | 15.18 | % | ||||||||
Total Revenues | $ | 156,648,625 | 100.00 | % | $ | 160,374,033 | 100.00 | % | ||||||
Our total revenues were lower for the fiscal year ended October 31, 2012 compared to the fiscal year ended October 31, 2011. Revenue from ethanol sales decreased by approximately 8.6% during the fiscal year ended October 31, 2012 compared to the fiscal year ended October 31, 2011 primarily due to lower ethanol prices. The average ethanol sales price per gallon we received for the fiscal year ended October 31, 2012 was approximately 10.2% lower than the average price we received for the fiscal year ended October 31, 2011. We experienced a slight increase in the gallons of ethanol sold in the fiscal year ended October 31, 2012 as compared to the fiscal year ended October 31, 2011. The gallons of ethanol we sold during the fiscal year ended October 31, 2012 increased by approximately 1.9% as compared to the number of gallons of ethanol we sold for the fiscal year ended October 31, 2011.
Revenue from distillers grains increased by approximately 31.8% during fiscal year ended October 31, 2012 compared to the fiscal year ended October 31, 2011. Management believes that this is primarily a result of the higher distillers grains prices we received and the increase in the number of tons of distillers grains sold during our fiscal year ended October 31, 2012 compared to the fiscal year ended October 31, 2011. For the fiscal year ended October 31, 2012, the average price per ton that we received for our modified distillers grains was approximately 45.2% higher than during the fiscal year ended October 31, 2011. For the fiscal year ended October 31, 2012, the average price per ton that we received for our dried distillers grains was approximately 27.6% higher than during the fiscal year ended October 31, 2011. The tons of dried distillers grains we sold during the fiscal year ended October 31, 2012, decreased by approximately 17.9% as compared to the tons of dried distillers grains we sold for the fiscal
24
year ended October 31, 2011. The tons of modified distillers grains we sold during the fiscal year ended October 31, 2012, increased by approximately 602.5% as compared to the fiscal year ended October 31, 2011.
Cost of Goods Sold
Our two largest costs of production are corn (85.81% of cost of goods sold for the fiscal year ended October 31, 2012) and natural gas (4.27% of cost of goods sold for the fiscal year ended October 31, 2012). Our total cost of goods sold was approximately 4.2% more during the fiscal year ended October 31, 2012 compared to the fiscal year ended October 31, 2011. Our average price per bushel of corn during our 2012 fiscal year increased by approximately 16.6% per bushel compared to the fiscal year ended October 31, 2011 due to market price adjustments. We used approximately 2.8% more bushels of corn in the fiscal year ended October 31, 2012 as compared to the fiscal year ended October 31, 2011. We had gains related to corn derivative instruments of approximately $481,000 for the fiscal year ended October 31, 2012, which decreased cost of sales. We had gains related to corn derivative instruments of approximately $494,000 for the fiscal year ended October 31, 2011.
For the fiscal year ended October 31, 2012, we purchased approximately 3.3% less natural gas as compared to the fiscal year ended October 31, 2011. This decrease in natural gas usage is primarily due to a decrease in production of dried distillers grains. Our average price per MMBTU of natural gas was 7.2% lower during our 2012 fiscal year compared to the fiscal year ended October 31, 2011. We had losses related to natural gas based derivative instruments of approximately $419,000 for the fiscal year ended October 31, 2012. We had no gains or losses related to natural gas based derivative instruments for the fiscal year ended October 31, 2011.
Operating Expense
We had operating expense for the fiscal year ended October 31, 2012 of $1,804,031 compared to operating expense of $1,762,414 for the fiscal year ended October 31, 2011. Management attributes this increase in operating expense to increased costs related to our business and property insurance, property taxes and safety supplies.
Operating Profit (Loss)
We had operating loss for the fiscal year ended October 31, 2012 of $940,887 compared to operating income of $9,071,385 for the fiscal year ended October 31, 2011. Our operating loss for the fiscal year ended October 31, 2012, was (0.60)% of our revenues compared to 5.66% for the fiscal year ended October 31, 2011. Our operating loss for the fiscal year ended October 31, 2012, was due primarily to due to a decrease in the price we received for our ethanol and an increase in the price of corn which resulted in negative operating margins in the second half of our fiscal year.
Other Expense, Net
We had total other expense for the fiscal year ended October 31, 2012 of $3,184,001 compared to other expense of $3,928,028 for the fiscal year ended October 31, 2011. Our other expense for the fiscal year ended October 31, 2012, consisted primarily of interest expense offset in part by interest rate swap gains and investment income.
Changes in Financial Condition for the Fiscal Year Ended October 31, 2013 and 2012
The following table highlights the changes in our financial condition for the fiscal year ended October 31, 2013 from our previous fiscal year ended October 31, 2012:
October 31, 2013 | October 31, 2012 | ||||||
Current Assets | $ | 15,905,435 | $ | 11,185,608 | |||
Current Liabilities | 7,711,996 | 6,662,377 | |||||
Long-Term Liabilities | 41,231,727 | 48,502,851 | |||||
Current Assets. The increase in current assets was primarily the result of an increase in our cash and cash equivalents due to positive operating margins during our last three fiscal quarters which was partially offset by a decrease in accounts receivable and inventories at October 31, 2013 as compared to October 31, 2012. Our primary use of cash was to pay down debt.
Current Liabilities. The increase in current liabilities at October 31, 2013 as compared to October 31, 2012 was due primarily to an increase in current maturities of long-term debt due to required excess cash flow payments.
25
Long-Term Liabilities. Long-term debt decreased at October 31, 2013 as compared to October 31, 2012 primarily due to scheduled principal repayments on our loans with FNBO. The other liability amounts in 2012 include the long-term portion for the interest rate swap.
Liquidity and Capital Resources
Our primary sources of liquidity are our line of credit and cash generated from operations. Based on financial forecasts performed by our management, we anticipate that we will have sufficient cash from our current credit facilities and cash from our operations to continue to operate the ethanol plant at capacity for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term. However, higher corn prices would significantly increase our cost of goods sold. If increases in cost of goods sold can not be offset by corresponding increases in the prices we receive from the sale of our products, these increases in cost of goods sold can have a significant negative impact on our financial performance. If we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating the ethanol plant, we could have difficulty maintaining our liquidity and we may have to secure additional debt or equity financing for working capital or other purposes.
We have entered into a series of definitive agreements with Butamax pursuant to which Butamax has agreed to install and lease its corn oil separation system and license to the Company its corn oil separation technology. Please refer to “ITEM 1 - Business-Business Development” and below for more detail regarding this arrangement. However, because we anticipate that we will pay Butamax monthly license fees, we do not currently anticipate that we will need to secure additional capital resources in order to install or implement the corn oil separation system. We do not currently anticipate that we will need to secure additional capital resources for any other significant purchases of property and equipment in the next 12 months.
The following table shows cash flows for the fiscal years ended October 31, 2013 and 2012:
October 31, 2013 | October 31, 2012 | |||||
Net cash provided by operating activities | $ | 11,876,872 | $ | 3,855,584 | ||
Net cash used in investing activities | (440,225 | ) | (1,393,285 | ) | ||
Net cash used in financing activities | (4,999,455 | ) | (4,457,986 | ) | ||
Cash Flow From Operations
We experienced an increase in our cash provided by operating activities for the fiscal year ended October 31, 2013 compared to the fiscal year ended October 31, 2012. This increase was due to an increase in our net income due to positive operating margins during the last three fiscal quarters of the fiscal year ended October 31, 2013. During the fiscal year ended October 31, 2013, our capital needs were being adequately met through cash from our operating activities and our credit facilities.
Cash Flow From Investing Activities
We used less cash for investing activities for the fiscal year ended October 31, 2013, as compared to the fiscal year ended October 31, 2012. This decrease was primarily due to a decrease in capital expenditures and a decrease in our investment in RPMG LLC during the fiscal year ended October 31, 2013.
Cash Flow From Financing Activities
We used more cash from financing activities during the fiscal year ended October 31, 2013 as compared to the fiscal year ended October 31, 2012. This increase was primarily a result of an increase in the amount we paid to FNBO towards the principal balance on our loans during the fiscal year ended October 31, 2013 as compared to the fiscal year ended October 31, 2012. However, we paid a distribution in the amount of $500,000 to our members during the fiscal year ended October 31, 2012.
The following table shows cash flows for the fiscal years ended October 31, 2012 and 2011:
26
October 31, 2012 | October 31, 2011 | |
Net cash provided by operating activities | $3,855,584 | $9,354,989 |
Net cash used in investing activities | (1,393,285) | (1,259,365) |
Net cash used in financing activities | (4,457,986) | (8,524,114) |
Cash Flow From Operations
We experienced a decrease in our cash provided by operating activities for the fiscal year period ended October 31, 2012 compared to the fiscal year ended October 31, 2011. This decrease was due to a net loss primarily driven by decreased prices for ethanol during the fiscal year ended October 31, 2012. During the fiscal year ended October 31, 2012, our capital needs were being adequately met through cash from our operating activities and our credit facilities.
Cash Flow From Investing Activities
We used more cash for investing activities for the fiscal year ended October 31, 2012, as compared to the fiscal year ended October 31, 2011. This increase was primarily due to an increase in capital expenditures and an increase in our investment in RPMG LLC during the fiscal year ended October 31, 2012.
Cash Flow From Financing Activities
We used less cash for financing activities during the fiscal year ended October 31, 2012 as compared to the fiscal year ended October 31, 2011. This decrease was primarily a result of a decrease in the amount we paid to FNBO towards the principal balance on our loans during the fiscal year ended October 31, 2012 as compared to the fiscal year ended October 31, 2011. However, we paid a distribution in the amount of $500,000 to our members during the fiscal year ended October 31, 2012.
Short-Term and Long-Term Debt Sources with FNBO
On April 24, 2008, we entered into a Construction Loan Agreement (the “Agreement”) with FNBO for the purpose of funding a portion of the cost of the ethanol plant. With construction complete and the ethanol plant commencing operations, the construction loan converted to a $25,200,000 Fixed Rate Note, a $20,200,000 Variable Rate Note, a $5,000,000 Long-Term Revolving Note, a $5,000,000 line of credit and $5,600,000 to support the issuance of letters of credit by FNBO. As of October 31, 2013, we have $2,500,000 in letters of credit outstanding. We pay interest at a rate of 1.75% on amounts outstanding and the letters of credit are valid until October 2014.
On January 25, 2013, we entered into the Seventh Amendment of Construction Loan Agreement which amended our Agreement with FNBO. The amendment waived our violations at October 31, 2012 of the fixed charge coverage ratio and the minimum net worth covenants. In addition, the amendment amended the calculation of the covenants measuring the fixed charge coverage ratio and the minimum net worth calculation.
On March 29, 2013, we entered into an Eighth Amendment of Construction Loan Agreement which extended our line of credit until April 1, 2014. In addition, we agreed to terminate our Long-term Revolving Note which had a $0 balance and under which advances of additional funds had been in FNBO's sole discretion. FNBO also reduced our minimum working capital requirement to $1,500,000, to be measured on a quarterly basis at the end of each fiscal quarter.
Fixed Rate Note
The Fixed Rate Note was initially for $25,200,000 with a variable interest rate that is fixed with an interest rate swap. We make monthly principal payments on the Fixed Rate Note for approximately $168,000 plus accrued interest. Interest will accrue on the Fixed Rate Note at the greater of the one-month LIBOR Rate, in effect from time to time, plus 300 basis points or 4%. The applicable interest rate was 4% at October 31, 2013. However, we entered into an interest rate swap agreement with FNBO, which fixes the interest rate on the Fixed Rate Note at 7.6% until June 2014. The outstanding balance on this note was approximately $18,099,000 and $20,234,000 at October 31, 2013 and October 31, 2012, respectively. A final balloon payment on the Fixed Rate Note of approximately $15,191,000 will be due February 26, 2015.
27
Variable Rate Note
The Variable Rate Note was initially for $20,200,000. We make monthly interest only payments and we will remit quarterly excess cash flow payments to FNBO which will be applied first to interest and then to principal on the Variable Rate Note with a minimum annual principal reduction of $750,000. The minimum annual principal reduction of $750,000 has already been paid at the time of filing. The outstanding balance on this note was approximately $12,480,000 and $15,345,000 at October 31, 2013 and October 31, 2012, respectively.
Interest will accrue on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%. The applicable interest rate at October 31, 2013, was 5%. A final balloon payment of approximately $11,729,000 will be due February 26, 2015.
Line of Credit
We have a line of credit available equal to the amount of the Borrowing Base, with a maximum limit of $5,000,000. The Borrowing Base will vary and may at times be less than $5,000,000. Our line of credit expires on April 1, 2014 and accrues interest at the three-month LIBOR rate plus 350 basis points with no minimum interest rate, which was 3.74% at October 31, 2013. The line of credit requires monthly interest payments. As of October 31, 2013, we had not drawn on the line of credit and have a maximum availability of $5,000,000.
Covenants and other Miscellaneous Financing Agreement Terms
As part of the amendment entered into in January 2011, we are required to make additional payments quarterly on debt for up to 50% of the excess cash flow, as defined by the agreement. As part of the financing agreement, the premium above LIBOR on the loans may be reduced based on a financial ratio. The agreement is secured by substantially all business assets and is subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements. FNBO amended the calculation of the covenant measuring the fixed charge coverage ratio for six quarters beginning November 1, 2012 through April 30, 2014 as follows: 0.65:1.00 at January 31, 2013 and April 30, 2013, 0.80:1.00 at July 31, 2013 and October 31, 2013 and 1.05:1.00 at January 31, 2014 and April 30, 2014. The fixed charge coverage ratio will revert to 1.10:1.00 at July 31, 2014 and at the end of each fiscal quarter thereafter. The net worth calculation is amended as of November 1, 2012 to $41,250,000 to be measured quarterly. The minimum working capital requirement was amended to $1,500,000, as of March 29, 2013 to be measured quarterly.
Additionally, we are limited to annual capital expenditures of $1,000,000 without prior approval of FNBO. We are also prohibited from making distributions to our members without the prior approval of FNBO. In connection with the financing agreement, we executed a mortgage in favor of FNBO creating a first lien on our real estate and plant and a security interest in all personal property located on the property and assigned in favor of FNBO, all rents and leases to our property, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.
Presently, we are meeting our liquidity needs and complying with our financial covenants and the other terms of our loan agreements with FNBO. We will continue to work with FNBO to try to ensure that the terms of our loan agreements are met going forward. However, we cannot provide any assurance that our actions will result in sustained profitable operations or that we will not be in violation of our loan covenants or in default on our principal payments in the future. Should unfavorable market conditions result in our violation of the terms or covenants of our loan and we fail to obtain a waiver of any such term or covenant, FNBO could deem us in default of our loans and require us to immediately repay a significant portion or possibly the entire outstanding balance of our loans. In the event of a default, FNBO could also elect to proceed with a foreclosure action on our plant.
Capital Leases
City of Lamberton, Minnesota
On April 24, 2008, we entered into certain financing and credit arrangements with U.S. Bank National Association, as trustee (the “Trustee”) and the City of Lamberton, Minnesota (the “City”) in order to secure the proceeds from the sale of the solid waste facilities revenue bonds, Series 2008A (the “Bonds”) issued by the City in the aggregate principal amount of $15,180,000 pursuant to a trust indenture between the City and the Trustee (“Trust Indenture”). The City undertook the issuance of the Bonds to finance the acquisition and installation of certain solid waste facilities in connection with our ethanol plant near Lamberton, Minnesota. We received proceeds of approximately $14,876,000, after deducting financing costs of approximately $304,000. The remaining proceeds were held as restricted cash or marketable securities based on anticipated use and are split between a project
28
fund of approximately $11,527,000, a capitalized interest fund of approximately $1,831,000, and a debt service reserve fund of approximately $1,518,000. The Bonds mature on December 1, 2022 and bear interest at a rate of 8.5%.
Under the capital lease agreement with the City, we started making interest payments on November 25, 2008 and monthly thereafter at an implicit interest rate of 8.5%. The monthly capital lease interest payments correspond to 1/6 the semi-annual interest payments due on the Bonds on the next interest payment date. Monthly capital lease payments of principal were originally scheduled to begin on November 25, 2009; however, the City amended the agreement in September 2008 which adjusted the start date for principal payments to begin on November 25, 2014. These payments will equal 1/12 the annual principal payments scheduled to become due on the corresponding bonds on the next principal payment date.
We have guaranteed that if such assessed capital lease payments are not sufficient for the required bond payments, we will provide such funds as are needed to fund the shortfall. The capital lease agreement is secured by substantially all business assets of the Company and is also subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working-capital requirements. Presently, we are complying with our financial covenants and the other terms of our capital lease. We will continue to work with the Trustee to try to ensure that the terms of our capital lease are met going forward. Should unfavorable market conditions result in our violation of the terms or covenants of our capital lease and we fail to obtain a waiver of any such term or covenant, the Trustee and the City could deem us to be in default and elect to exercise their available remedies which could include requiring us to immediately repay the outstanding balance.
Butamax
We entered into a series of related definitive agreements dated September 26, 2013 with Butamax which include an Easement for Construction and Process Demonstration Agreement, an Equipment Lease Agreement, a Technology License Agreement, a Technology Demonstration Risk Reduction Agreement and a Security Agreement (collectively, the "Agreements") pursuant to which Butamax has agreed to construct, install and lease its corn oil separation system and license to the Company its proprietary, patent-protected corn oil separation technology. Pursuant to the Agreements, we agreed to give Butamax access to our plant in order to construct, install, operate, test and commercially validate its corn oil separation system. Butamax retains ownership of the corn oil separation system and technology but agrees to lease it to the Company for a term of 120 months subject to Butamax's right to remove the system if we are in breach of the Agreements. The term of the lease may also be extended or terminated pursuant to the terms of the Agreements and we are responsible for repairs and maintenance of the system and bear the risk of loss. In return, we agree to payment of certain license fees which are subject to being reduced under the terms of the Agreements if the corn oil separation system does not meet certain performance goals. The Agreements provide that the corn oil separation system shall be conveyed to the Company at the end of the term so long as we are not in breach of the Agreements. We have granted a security interest to Butamax in the corn oil separation system to secure our obligations under the Agreements. Pursuant to the Agreements, we agreed, subject to certain obligations of confidentiality, to provide Butamax with Company information on a monthly basis including business and financial information and have granted Butamax the option to have a representative present in board and committee meetings as an observer. We also agreed to give Butamax notice in the event of an issuance or sale of membership interests or convertible debt instruments. We plan to record this as a capital lease, beginning at the time of "start up" as defined in the Agreements. The total minimum commitment under the lease is approximately $2,500,000.
Contractual Cash Obligations
In addition to our long-term debt obligations, we have certain other contractual cash obligations and commitments. The following tables provide information regarding our contractual obligations and approximate commitments as of October 31, 2013:
Payment Due by Period | |||||||||||||||
Total | Less than One Year | One to Three Years | Three to Five Years | After Five Years | |||||||||||
Long-Term Debt Obligations | $ | 32,672,683 | $ | 6,220,160 | $ | 26,452,523 | $ | — | $ | — | |||||
Capital Lease Obligations | 25,433,275 | 1,776,411 | 6,931,516 | 5,731,127 | 10,994,221 | ||||||||||
Operating Lease Obligations | 122,400 | 122,400 | — | — | — | ||||||||||
Purchase Obligations | 848,880 | 848,880 | — | — | — | ||||||||||
Total Contractual Obligations | $ | 59,077,238 | $ | 8,967,851 | $ | 33,384,039 | $ | 5,731,127 | $ | 10,994,221 | |||||
29
The long-term debt obligations in the table above include both principal and interest payments, and payments on the interest rate swap agreement at the interest rates applicable to the obligations as of October 31, 2013.
Critical Accounting Estimates
Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:
Long-Lived Assets
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment testing for assets requires various estimates and assumptions, including an allocation of cash flows to those assets and, if required, an estimate of the fair value of those assets. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions, which do not reflect unanticipated events and circumstances that may occur. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the assessment of carrying value of property and equipment to be a critical accounting estimate.
Inventory Valuation
We value our inventory at lower of cost or market. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions which do not reflect unanticipated events and circumstances that may occur. In our analysis, we consider corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our derivative instruments. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the valuation of the lower of cost or market on inventory to be a critical accounting estimate.
Derivatives
We are exposed to market risks from changes in interest rates, corn, natural gas, and ethanol prices. We may seek to minimize these commodity price fluctuation risks through the use of derivative instruments. In the event we utilize derivative instruments, we will attempt to link these instruments to financing plans, sales plans, market developments, and pricing activities. Such instruments in and of themselves can result in additional costs due to unexpected directional price movements.
In April 2008, we entered into an interest fixed rate swap agreement, which is a derivative instrument, in order to manage our exposure to the impact of changing interest rates. The initial notional amount of the swap was $23,305,000. The interest rate swap pays a fixed interest rate on the notional amount at 7.6% until June 2014, and receives a variable interest rate. The changes in the fair value of the interest rate swap are recorded currently in operations. As of October 31, 2013, we had a notional amount of approximately $16,582,000 outstanding in the swap agreement. We do not use hedge accounting which would match the gain or loss on our hedge positions to the interest rate swap being hedged. Instead, we use fair value accounting for our hedge positions, which means that as the current market price of our hedge position changes, the gains and losses are immediately recognized in other income (expense).
We have entered into corn commodity-based derivatives and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices. In practice, as markets move, we actively attempt to manage our risk and adjust hedging strategies as appropriate. We do not use hedge accounting which would match the gain or loss on our hedge positions to the specific commodity contracts being hedged. Instead, we use fair value accounting for our hedge positions, which means that as the current market price of our hedge position changes, the gains and losses are immediately recognized in our cost of goods sold. The immediate recognition of hedging gains and losses under fair value accounting can cause net income (loss) to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.
As of October 31, 2013, the fair values of our corn derivative instruments are reflected as a liability of approximately $467,000. As the prices of the hedged commodity moves in reaction to market trends and information, our statement of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on
30
market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to protect the Company over the term of the contracts for the hedged amounts.
We enter into forward purchase contracts for our natural gas purchases. At October 31, 2013, we have natural gas forward contracts for delivery periods through February 2014 for a total commitment of approximately $849,000.
Subsequent Events
On November 21, 2013 (with an effective date of November 4, 2013), we entered into a Distillers Crude Corn Oil Marketing Agreement (the "Marketing Agreement") with CHS wherein we agreed to sell to CHS, and CHS agrees to purchase, all crude corn oil to be produced at the plant. CHS will pay the actual price that CHS receives from its buyers less a marketing fee, actual freight and transportation costs and certain taxes related to the purchase, delivery or sale of the corn oil. The Marketing Agreement is effective for an initial term which commences on the date on which the plant commences producing corn oil pursuant to our mutual agreement. Following expiration of the initial term, the Marketing Agreement shall automatically renew for successive terms unless terminated in accordance with its terms.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. We may use cash, futures and option contracts to hedge changes to the commodity prices of corn and natural gas. We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes. We use derivative financial instruments to alter our exposure to interest rate risk. We entered into a interest rate swap agreement that we did not designate as a hedge for accounting purposes.
Interest Rate Risk
We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from a term loan (the "Variable Rate Note") and a line of credit bearing a variable interest rate. As of October 31, 2013, we had $12,480,437 outstanding on our Variable Rate Note. Interest will accrue on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%. The applicable interest rate at October 31, 2013, was 5%. If we were to experience a 1% adverse change in our interest rate, the annual effect such change would have on our statement of operations, based on the amount we had outstanding on our variable interest rate loans as of October 31, 2013, would be approximately $125,000. At October 31, 2013, we did not have any amounts outstanding on our line of credit.
The specifics of each note are discussed in greater detail in “Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
In order to reduce the risk caused by interest rate fluctuations, we entered into an interest rate swap agreement. We use the interest rate swap agreement to limit exposure to increased interest rates. The fair value of this interest rate swap agreement is based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The fair value of the derivative is continually subject to change due to changing market conditions. Although the interest rate swap held by us as of October 31, 2013 serves as an economic hedge, we do not formally designate this instrument as a hedge and, therefore, we record adjustments caused from marking the instrument to market on a monthly basis in other income (expense) on the statements of operations. As of October 31, 2013 and 2012, our interest rate swap's fair value of approximately ($427,000) and ($1,197,000) was included in derivative instruments on the balance sheets.
Commodity Price Risk
We expect to be exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process and the sale of ethanol and distillers grains. We may seek to minimize the risks from fluctuations in the prices of raw material inputs through the use of corn commodity-based and natural gas derivatives. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is
31
recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.
In the ordinary course of business, we enter into forward purchase contracts for our natural gas purchases. At October 31, 2013, we have natural gas forward contracts for delivery periods through February 2014 for a total commitment of approximately $849,000. At October 31, 2013, we have open positions for 2,075,000 bushels of corn on the Chicago Board of Trade and 220,000 dekatherms of natural gas on the New York Mercantile Exchange. These derivatives have not been designated as an effective hedge for accounting purposes. Corn and natural gas derivatives are forecasted to settle through October 2014. For the fiscal year ended October 31, 2013, we recorded a gain due to the change in fair value of our outstanding corn derivative positions and our outstanding natural gas derivative positions of approximately $331,000 and $41,000, respectively.
As corn prices move in reaction to market trends and information, our statements of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.
A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of October 31, 2013 of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from October 31, 2013. The results of this analysis, which may differ from actual results, are approximately as follows:
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts) | Unit of Measure | Hypothetical Adverse Change in Price as of 10/31/13 | Approximate Adverse Change to Income | ||||||
Natural Gas | 1,419,392 | MMBTU | 10 | % | $ | 634,042 | |||
Ethanol | 57,999,999 | Gallons | 10 | % | $ | 10,324,000 | |||
Corn | 19,999,966 | Bushels | 10 | % | $ | 8,459,986 | |||
DDGs | 157,457 | Tons | 10 | % | $ | 3,023,174 | |||
For comparison purposes, the results of our sensitivity analysis for October 31, 2012 were as follows:
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts) | Unit of Measure | Hypothetical Adverse Change in Price as of 10/31/12 | Approximate Adverse Change to Income | ||||||
Natural Gas | 1,362,998 | MMBTU | 10 | % | $ | 538,384 | |||
Ethanol | 57,999,900 | Gallons | 10 | % | $ | 13,049,977 | |||
Corn | 19,931,237 | Bushels | 10 | % | $ | 14,505,940 | |||
DDGs | 157,457 | Tons | 10 | % | $ | 4,034,993 | |||
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Governors and Members
Highwater Ethanol, LLC
We have audited the accompanying balance sheet of Highwater Ethanol, LLC (the Company) as of October 31, 2013, and the related statements of operations, comprehensive income (loss), changes in members’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2013 financial statements referred to above present fairly, in all material respects, the financial position of the Company as of October 31, 2013, and the results of its operations and its cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey LLP
Sioux Falls, South Dakota
January 16, 2014
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Governors
Highwater Ethanol, LLC
Lamberton, Minnesota
We have audited the accompanying balance sheet of Highwater Ethanol, LLC (the Company) as of October 31, 2012, and the related statements of operations, comprehensive income (loss), and changes in members' equity, and cash flows for each of the years in the two year period ended October 31, 2012. Highwater Ethanol, LLC's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Highwater Ethanol, LLC as of October 31, 2012, and the results of its operations and its cash flows for each of the years in the two year period ended October 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ Boulay, Heutmaker, Zibell & Co., P.L.L.P
Certified Public Accountants
Minneapolis, Minnesota
January 29, 2013
34
HIGHWATER ETHANOL, LLC
Balance Sheets
ASSETS | October 31, 2013 | October 31, 2012 | ||||||
Current Assets | ||||||||
Cash and cash equivalents | $ | 7,869,188 | $ | 1,431,996 | ||||
Deposits with broker | 1,025,324 | 600,192 | ||||||
Restricted short-term investments | — | 14,841 | ||||||
Accounts receivable | 3,271,738 | 4,927,791 | ||||||
Inventories | 3,595,878 | 4,146,426 | ||||||
Prepaids and other | 143,307 | 64,362 | ||||||
Total current assets | 15,905,435 | 11,185,608 | ||||||
Property and Equipment | ||||||||
Land and land improvements | 6,853,912 | 6,847,696 | ||||||
Buildings | 38,450,065 | 38,368,076 | ||||||
Office equipment | 367,508 | 353,657 | ||||||
Plant and process equipment | 60,890,831 | 60,803,735 | ||||||
Vehicles | 41,994 | 41,994 | ||||||
Construction in progress | 5,672 | 27,529 | ||||||
106,609,982 | 106,442,687 | |||||||
Less accumulated depreciation | (26,297,641 | ) | (19,983,052 | ) | ||||
Net property and equipment | 80,312,341 | 86,459,635 | ||||||
Other Assets | ||||||||
Investment in RPMG | 1,730,626 | 1,512,475 | ||||||
Restricted marketable securities | 1,556,139 | 1,518,000 | ||||||
Debt issuance costs, net | 570,590 | 825,988 | ||||||
Deposits | 191,457 | 195,727 | ||||||
Total other assets | 4,048,812 | 4,052,190 | ||||||
Total Assets | $ | 100,266,588 | $ | 101,697,433 | ||||
Notes to Financial Statements are an integral part of this Statement.
35
HIGHWATER ETHANOL, LLC
Balance Sheets
LIABILITIES AND MEMBERS' EQUITY | October 31, 2013 | October 31, 2012 | ||||||
Current Liabilities | ||||||||
Accounts payable | $ | 1,714,221 | $ | 2,016,384 | ||||
Accrued expenses | 553,942 | 631,109 | ||||||
Deferred revenue | 22,317 | — | ||||||
Derivative instruments | 894,106 | 1,113,554 | ||||||
Current maturities of long-term debt | 4,527,410 | 2,901,330 | ||||||
Total current liabilities | 7,711,996 | 6,662,377 | ||||||
Long-Term Debt | 41,231,727 | 47,857,262 | ||||||
Other Liabilities | — | 222,652 | ||||||
Derivative Instruments | — | 422,937 | ||||||
Commitments and Contingencies | ||||||||
Members' Equity | ||||||||
Members' equity, 4,953 units issued, authorized and outstanding | 51,322,865 | 46,532,205 | ||||||
Total Liabilities and Members’ Equity | $ | 100,266,588 | $ | 101,697,433 | ||||
Notes to Financial Statements are an integral part of this Statement.
36
HIGHWATER ETHANOL, LLC
Statements of Operations
Fiscal Year Ended | Fiscal Year Ended | Fiscal Year Ended | |||||||||
October 31, 2013 | October 31, 2012 | October 31, 2011 | |||||||||
Revenues | $ | 168,682,409 | $ | 156,648,625 | $ | 160,374,033 | |||||
Cost of Goods Sold | 159,305,976 | 155,785,481 | 149,540,234 | ||||||||
Gross Profit | 9,376,433 | 863,144 | 10,833,799 | ||||||||
Operating Expenses | 1,819,444 | 1,804,031 | 1,762,414 | ||||||||
Operating Profit (Loss) | 7,556,989 | (940,887 | ) | 9,071,385 | |||||||
Other Income (Expense) | |||||||||||
Interest income | 68,009 | 70,859 | 73,309 | ||||||||
Other income | 23,930 | 67,757 | 52,870 | ||||||||
Interest expense | (4,048,031 | ) | (4,282,900 | ) | (4,743,553 | ) | |||||
Gain on interest rate swap | 769,925 | 741,480 | 689,346 | ||||||||
Income from equity investment | 453,237 | 218,803 | — | ||||||||
Total other expense, net | (2,732,930 | ) | (3,184,001 | ) | (3,928,028 | ) | |||||
Net Income (Loss) | $ | 4,824,059 | $ | (4,124,888 | ) | $ | 5,143,357 | ||||
Weighted Average Units Outstanding | 4,953 | 4,953 | 4,953 | ||||||||
Basic and Diluted Net Income (Loss) Per Unit | $ | 973.97 | $ | (832.81 | ) | $ | 1,038.43 | ||||
Distributions Per Unit | $ | — | $ | 100.95 | $ | — | |||||
Notes to Financial Statements are an integral part of this Statement.
37
HIGHWATER ETHANOL, LLC
Statements of Comprehensive Income (Loss)
Year Ended | Year Ended | Year Ended | |||||||||
October 31, 2013 | October 31, 2012 | October 31, 2011 | |||||||||
Net Income (Loss) | $ | 4,824,059 | $ | (4,124,888 | ) | $ | 5,143,357 | ||||
Other Comprehensive Income (Loss) | |||||||||||
Unrealized losses on restricted marketable securities | (33,399 | ) | (51,478 | ) | (43,236 | ) | |||||
Comprehensive Income (Loss) | $ | 4,790,660 | $ | (4,176,366 | ) | $ | 5,100,121 | ||||
Notes to Financial Statements are an integral part of this Statement.
38
HIGHWATER ETHANOL, LLC
Statement of Changes in Members' Equity
Members' Equity | Accumulated Other Comprehensive Income (Loss) | Total | |||||||||
Balance - October 31, 2010 | $ | 45,853,240 | $ | 118,438 | $ | 45,971,678 | |||||
Net income | 5,143,357 | — | 5,143,357 | ||||||||
Unrealized loss on restricted marketable securities | — | (43,236 | ) | (43,236 | ) | ||||||
Balance - October 31, 2011 | 50,996,597 | 75,202 | 51,071,799 | ||||||||
Net loss | (4,124,888 | ) | — | (4,124,888 | ) | ||||||
Member distributions | (500,000 | ) | — | (500,000 | ) | ||||||
Equity adjustment in investee | 136,772 | — | 136,772 | ||||||||
Unrealized loss on restricted marketable securities | — | (51,478 | ) | (51,478 | ) | ||||||
Balance - October 31, 2012 | 46,508,481 | 23,724 | 46,532,205 | ||||||||
Net income | 4,824,059 | — | 4,824,059 | ||||||||
Unrealized loss on restricted marketable securities | — | (33,399 | ) | (33,399 | ) | ||||||
Balance - October 31, 2013 | $ | 51,332,540 | $ | (9,675 | ) | $ | 51,322,865 | ||||
Notes to Financial Statements are an integral part of this Statement.
39
HIGHWATER ETHANOL, LLC
Statements of Cash Flows
Fiscal Year Ended | Fiscal Year Ended | Fiscal Year Ended | |||||||||
October 31, 2013 | October 31, 2012 | October 31, 2011 | |||||||||
Cash Flows from Operating Activities | |||||||||||
Net income (loss) | $ | 4,824,059 | $ | (4,124,888 | ) | $ | 5,143,357 | ||||
Adjustments to reconcile net income (loss) to net cash provided by operations | |||||||||||
Depreciation and amortization | 6,580,350 | 6,556,622 | 6,558,855 | ||||||||
Equity in earnings in RPMG used to settle liability | (453,237 | ) | — | — | |||||||
Interest payments made from restricted cash | — | 67,276 | 67,281 | ||||||||
Change in fair value of derivative instruments | — | 138,662 | 267,129 | ||||||||
Increase in restricted short-term investments from net interest earned | — | (67,276 | ) | (67,275 | ) | ||||||
Change in assets and liabilities | |||||||||||
Restricted marketable securities | (56,697 | ) | (134,472 | ) | (397,869 | ) | |||||
Deposits with broker | (425,132 | ) | — | — | |||||||
Accounts receivable, including members | 1,656,053 | 2,566,060 | (2,729,263 | ) | |||||||
Inventories | 550,548 | 21,444 | 269,802 | ||||||||
Derivative instruments | (642,385 | ) | (741,479 | ) | (755,663 | ) | |||||
Prepaids and other | (74,675 | ) | 9,195 | 435,659 | |||||||
Deferred revenue | 22,317 | — | — | ||||||||
Accounts payable | (27,162 | ) | (554,736 | ) | 691,869 | ||||||
Accrued expenses | (77,167 | ) | 119,176 | (128,893 | ) | ||||||
Net cash provided by operating activities | 11,876,872 | 3,855,584 | 9,354,989 | ||||||||
Cash Flows from Investing Activities | |||||||||||
Acquisitions of property and equipment | (206,159 | ) | (938,976 | ) | (835,623 | ) | |||||
Proceeds from sale of property and equipment | 28,500 | — | — | ||||||||
Investment in RPMG | (262,566 | ) | (454,309 | ) | (423,742 | ) | |||||
Net cash used in investing activities | (440,225 | ) | (1,393,285 | ) | (1,259,365 | ) | |||||
Cash Flows from Financing Activities | |||||||||||
Payments on long-term debt | (4,999,455 | ) | (3,957,986 | ) | (8,524,114 | ) | |||||
Member distributions | — | (500,000 | ) | — | |||||||
Net cash used in financing activities | (4,999,455 | ) | (4,457,986 | ) | (8,524,114 | ) | |||||
Net Increase (Decrease) in Cash and Cash Equivalents | 6,437,192 | (1,995,687 | ) | (428,490 | ) | ||||||
Cash and cash equivalents – Beginning of Period | 1,431,996 | 3,427,683 | 3,856,173 | ||||||||
Cash and cash equivalents – End of Period | $ | 7,869,188 | $ | 1,431,996 | $ | 3,427,683 | |||||
Supplemental Cash Flow Information | |||||||||||
Cash paid for interest expense | $ | 3,635,989 | $ | 3,871,613 | $ | 4,200,379 | |||||
Supplemental Disclosure of Noncash Financing and Investing Activities | |||||||||||
Unrealized loss on restricted marketable securities | $ | (33,399 | ) | $ | (51,478 | ) | $ | (43,236 | ) | ||
Capital expenditures included in accounts payable | $ | — | $ | — | $ | 12,391 | |||||
Investment in RPMG included in accounts payable | $ | — | $ | 275,000 | $ | 181,258 | |||||
Investment in RPMG included in long-term liabilities | $ | — | $ | 222,652 | $ | — | |||||
Equity adjustment in investee | $ | — | $ | 136,772 | $ | — | |||||
Notes to Financial Statements are an integral part of this Statement.
40
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) operates a 50 million gallon per year ethanol plant in Lamberton, Minnesota. The Company produces and sells fuel ethanol and distillers grains, a co-product of the fuel ethanol production process, in the continental United States, Mexico and Canada.
Accounting Estimates
Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters, among others, the carrying value of property and equipment and related impairment testing, inventory valuation, and derivative instruments. Actual results could differ from those estimates and such differences may be material to the financial statements. The Company periodically reviews estimates and assumptions and the effects of revisions are reflected in the period in which the revision is made.
Revenue Recognition
The Company generally sells ethanol and related products pursuant to marketing agreements. The Company’s products are shipped FOB shipping point. Revenues are recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales, title transfers when loaded into the rail car and for distiller’s grains when the loaded rail cars leave the plant facility.
In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.
Cash and Cash Equivalents
The Company maintains its accounts primarily at one financial institution. At times throughout the year, the cash balances may exceed amounts insured by the Federal Deposit Insurance Corporation. The Company does not believe it is exposed to any significant credit risk on cash and cash equivalent balances.
Deposits with Broker
The Company maintains deposits with broker as part of the derivative instruments described in Note 7. Deposits with broker consist of cash balances which are recorded at cost and adjusted for any uncollectability.
Restricted Short-Term Investments
The Company maintains restricted short-term investments as part of the capital lease financing agreement. The restricted short-term investments include money market accounts and similar debt instruments. The Company does not believe it is exposed to any significant credit risk on these balances.
Restricted Marketable Securities
The Company maintains restricted marketable securities in debt securities as part of the capital lease financing agreements described in Note 9. The restricted marketable securities consist primarily of municipal obligations, U.S. treasury government obligations, and corporate obligations. Restricted marketable securities are classified as “available-for-sale” and are carried at their estimated fair market value based on quoted market prices at year end.
41
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
Accounts Receivable
Credit terms are extended to customers in the normal course of business. The Company routinely monitors accounts receivable and customer balances are generally kept current at 30 days or less. The Company generally requires no collateral.
Accounts receivable are recorded at their estimated net realizable value. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms. Accounts considered uncollectible are written off. The Company’s estimate of the allowance for doubtful accounts is based on historical experience, its evaluation of the current status of receivables, and unusual circumstances, if any. At October 31, 2013 and 2012, the Company believed that such amounts would be collectible and an allowance was not considered necessary.
Inventories
Inventory consists of raw materials, supplies, work in process and finished goods. Raw materials and supplies are stated at the lower of cost (first-in, first-out method) or market. Work in process and finished goods are stated at the lower of average cost or market.
Property and Equipment
Property and equipment is stated at cost. Depreciation is provided over an estimated useful life by use of the straight line method. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. The present value of capital lease obligations is classified as long-term debt and the related assets will be included with property and equipment. Amortization of property and equipment under capital lease is included with depreciation expense.
Depreciation is computed using the straight-line method over the following estimated useful lives:
Minimum Years | Maximum Years | |
Land improvements | 15 | 20 |
Buildings | 10 | 20 |
Office equipment | 5 | 5 |
Plant and process equipment | 10 | 20 |
Vehicles | 7 | 7 |
Carrying Value of Long-Lived Assets
Long-lived assets, such as property and equipment, and other long-lived assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
In August 2009, the Company completed construction of its ethanol production facilities with installed capacity of 50 million gallons per year. The carrying value of these facilities at October 31, 2013 was approximately $80.3 million. In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, management evaluates the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. In determining the projected future undiscounted cash flows, the Company makes significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. The Company has not recorded any impairment as of October 31, 2013 and 2012.
42
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
Derivative Instruments
Derivatives are recognized in the balance sheets and the measurement of these instruments are at fair value. In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.
Contracts are evaluated to determine whether the contracts are derivatives. Certain contracts that 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 as derivatives, therefore, are not marked to market in our financial statements.
In order to reduce the risk caused by interest rate fluctuations, the Company entered into an interest rate swap agreement. This contract is used with the intention to limit exposure to increased interest rates. The fair value of this contract is based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The fair value of the derivative is continually subject to change due to changing market conditions. Although this serves as an economic hedge, the Company does not formally designate this instrument as a hedge and, therefore, records in earnings adjustments caused from marking the instrument to market on a monthly basis as a gain (loss) on interest rate swap. Net cash settlements on the interest rate swap are recognized as interest expense.
The Company entered into corn commodity-based and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in prices. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, restricted short-term investments, accounts receivable, and accounts payable, and other working capital items approximate fair value at October 31, 2013 and 2012 due to the short maturity nature of these instruments.
The carrying value of restricted marketable securities approximate their fair value based on quoted market prices at year end. The carrying value of derivative instruments approximates fair value based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs.
The Company believes the carrying amount of the long-term debt approximates the fair value due to a significant portion of total indebtedness containing variable interest rates and this rate is a market interest rate for these borrowings. The Company determined it is not practicable to estimate the fair value of the capital lease debt since the agreement contains unique terms, conditions and restrictions which are negotiated at arms length and there was no readily determinable similar instrument on which to base an estimate of fair value.
Investments
The Company has an investment interest in an unlisted company, Renewable Fuels Marketing Group, LLC (RPMG), who markets the Company’s ethanol. This investment is a flow-through entity and is being accounted for by the equity method of accounting under which the Company’s share of RPMG net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company has a 7% interest in RPMG. The Company consistently follows the practice of recognizing the net income based on a one month lag. Therefore, the net income which is reported in the Company’s statements of operations for the years
43
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
ended October 31, 2013 and 2012 is based on the investee’s results of operations for the twelve month periods ended September 30, 2013 and 2012.
Debt Issuance Costs
Costs associated with the issuance of debt are recorded as debt issuance costs and are amortized over the term of the related debt by use of the effective interest method.
Net Income (Loss) per Unit
Basic net income (loss) per unit is computed by dividing net income (loss) by the weighted average number of members’ units outstanding during the period. Diluted net income per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period. There were no member unit equivalents outstanding during the periods presented; accordingly, for all periods presented, the Company’s basic and diluted net income (loss) per unit are the same.
Income Taxes
The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, their income or losses are included in the income tax returns of the members and partners. Accordingly, no provision or liability for federal or state income taxes has been included in these financial statements.
The Company recognizes and measures tax benefits when realization of the benefits is uncertain under a two-step approach. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. The Company has not recognized any liability for unrecognized tax benefits and has not identified any uncertain tax positions.
The Company files income tax returns in the U.S. federal and Minnesota state jurisdictions. The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2009.
Environmental Liabilities
The Company’s operations are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which it operates. These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its location. Accordingly, the Company has adopted policies, practices, and procedures in the areas of pollution control, occupational health, and the production, handling, storage, and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability, which could result from such events. Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.
Segment Reporting
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker or decision making group in deciding how to allocate resources and in assessing performance. The Company has determined that it has one reportable business segment, the manufacture and marketing of fuel-grade ethanol and the co-products of the ethanol production process. The Company's chief operating decision maker reviews financial information of the Company as a whole for purposes of assessing financial performance and making operating decisions. Accordingly, the Company considers itself to be operating in a single industry segment.
2. UNCERTAINTIES
The Company derives substantially all of its revenues from the sale of ethanol and distillers grains. These products are commodities and the market prices for these products display substantial volatility and are subject to a number of factors which are beyond the control of the Company. The Company’s most significant manufacturing inputs are corn and natural gas. The price of these commodities is also subject to substantial volatility and uncontrollable market factors. In addition, these input costs do not necessarily fluctuate with the market prices for ethanol and distillers grains. As a result, the Company is subject to significant
44
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
risk that its operating margins can be reduced or eliminated due to the relative movements in the market prices of its products and major manufacturing inputs. As a result, market fluctuations in the price of or demand for these commodities can have a significant adverse effect on the Company’s operations, profitability, and availability of cash flows to make loan payments and maintain compliance with the loan agreement.
3. CONCENTRATIONS
The Company has identified certain concentrations that are present in their business operations. The Company’s revenue from ethanol sales and distiller sales are derived from a single customer under an ethanol marketing agreement and a distillers marketing agreement as described in Note 13.
The Company purchases all corn from a single supplier, a related party, under a grain procurement agreement described in Note 13.
The Company sold all ethanol produced to a related party under an ethanol marketing agreement described in Note 13. Total sales for the years ended October 31, 2013, 2012 and 2011 were $130,869,245, $122,718,876, and $135,443,140, respectively. Accounts receivable as of October 3, 2013 and 2012 were $2,312,825 and and $2,325,490, respectively.
4. FAIR VALUE MEASUREMENTS
Various inputs are considered when determining the value of financial instruments. The inputs or methodologies used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these instruments. These inputs are summarized in the three broad levels listed below:
• | Level 1 inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. |
• | Level 2 inputs include the following: |
◦ | Quoted prices in active markets for similar assets or liabilities. |
◦ | Quoted prices in markets that are not active for identical or similar assets or liabilities. |
◦ | Inputs other than quoted prices that are observable for the asset or liability. |
◦ | Inputs that are derived primarily from or corroborated by observable market data by correlation or other means. |
• | Level 3 inputs are unobservable inputs for the asset or liability. |
The following table provides information on those assets measured at fair value on a recurring basis.
Fair Value as of | Fair Value Measurement Using | |||||||||||||||
October 31, 2013 | Level 1 | Level 2 | Level 3 | |||||||||||||
Restricted marketable securities | $ | 1,556,139 | $ | 1,556,139 | $ | — | $ | — | ||||||||
Derivative instrument - interest rate swap | $ | (427,091 | ) | $ | — | $ | (427,091 | ) | $ | — | ||||||
Derivative instrument - commodities | $ | (467,015 | ) | $ | (467,015 | ) | $ | — | $ | — | ||||||
Fair Value as of | Fair Value Measurement Using | |||||||||||||||
October 31, 2012 | Level 1 | Level 2 | Level 3 | |||||||||||||
Restricted marketable securities - current | $ | 14,841 | $ | 14,841 | $ | — | $ | — | ||||||||
Restricted marketable securities - long-term | $ | 1,518,000 | $ | 1,518,000 | $ | — | $ | — | ||||||||
Derivative instrument - interest rate swap | $ | (1,197,016 | ) | $ | — | $ | (1,197,016 | ) | $ | — | ||||||
Derivative instrument - commodities | $ | (339,475 | ) | $ | (339,475 | ) | $ | — | $ | — | ||||||
The fair value of restricted marketable securities is based on quoted market prices in an active market. The Company determined
45
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
the fair value of the interest rate swap by using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each instrument and observable market-based inputs. The analysis reflects the contractual terms of the swap agreement, including the period to maturity and uses observable market-based inputs and uses the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The Company determines the fair value of the corn contracts by obtaining the fair value measurements from an independent pricing service based on dealer quotes and live trading levels from the Chicago Board of Trade.
5. RESTRICTED MARKETABLE SECURITIES
The cost and fair value of the Company's restricted marketable securities consist of the following at October 31, 2013:
Amortized Cost | Gross Unrealized Losses | Fair Value | |||||||
Restricted marketable securities - Long-term municipal obligations | $ | 1,565,814 | $ | (9,675 | ) | $ | 1,556,139 | ||
The cost and fair value of the Company's restricted marketable securities consist of the following at October 31, 2012:
Amortized Cost | Gross Unrealized Gains | Fair Value | |||||||
Restricted marketable securities - Current municipal obligations | $ | 14,612 | $ | 229 | $ | 14,841 | |||
Restricted marketable securities - Long-term municipal obligations | 1,494,505 | 23,495 | 1,518,000 | ||||||
Total restricted marketable securities | $ | 1,509,117 | $ | 23,724 | $ | 1,532,841 | |||
The long-term restricted marketable securities relate to the debt service reserve fund required by the capital lease agreement. The Company had unrealized loss of $9,675 and unrealized gains of $23,724, and $75,202 included in accumulated other comprehensive income at October 31, 2013, October 31, 2012 and October 31, 2011, respectively.
Shown below are the contractual maturities of marketable securities with fixed maturities at October 31, 2013. Actual maturities may differ from contractual maturities because certain securities may contain early call or prepayment rights. Although these are due within one year they are classified as long-term since they are held in the debt service reserve fund, for long-term debt and are reinvested when due.
Due within 1 year | $ | 1,556,139 | ||
Total | $ | 1,556,139 | ||
46
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
6. INVENTORIES
Inventories consisted of the following at:
October 31, 2013 | October 31, 2012 | |||||||
Raw materials | $ | 986,199 | $ | 1,219,867 | ||||
Spare parts and supplies | 1,241,515 | 959,482 | ||||||
Work in process | 883,278 | 1,362,851 | ||||||
Finished goods | 484,886 | 604,226 | ||||||
Total | $ | 3,595,878 | $ | 4,146,426 | ||||
7. DERIVATIVE INSTRUMENTS
As of October 31, 2013, the Company had entered into corn and natural gas derivative instruments and an interest rate swap agreement, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. They are not used for speculative purposes. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge, a cash flow hedge or a hedge against foreign currency exposure. The derivative instruments outstanding at October 31, 2013 and 2012 are not designated as effective hedges for accounting purposes.
Interest Rate Swap
At October 31, 2013 and 2012, the interest rate swap had a notional amount of approximately $16,582,000 and $18,829,000, respectively, that pays a fixed rate and receives a variable rate, that effectively fixes the interest rate on the Fixed Rate Note referred to in Note 9 at 7.6% until June 2014.
Corn and Natural Gas Contracts
As of October 31, 2013, the Company has open positions for 2,075,000 bushels of corn and 220,000 dekatherms of natural gas. Management expects all open positions outstanding as of October 31, 2013 to be realized within the next twelve months.
The following tables provide details regarding the Company's derivative instruments at October 31:
Instrument | Balance Sheet location | Liabilities | ||||||
2013 | 2012 | |||||||
Interest rate swap | Derivative instruments | $ | 427,091 | $ | 1,197,016 | |||
Commodities | Derivative instruments | $ | 467,015 | $ | 339,475 | |||
The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments:
Statement of | Year Ended October 31 | |||||||||||
Operations location | 2013 | 2012 | 2011 | |||||||||
Interest rate swap | Other income (expense) | $ | 769,925 | $ | 741,480 | $ | 689,346 | |||||
Corn contracts | Cost of goods sold | 331,488 | 481,013 | 493,632 | ||||||||
Natural gas contracts | Cost of goods sold | 41,198 | (419,021 | ) | — | |||||||
47
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
8. INVESTMENT IN RPMG
The financial statements of RPMG are summarized as of and for the years ended September 30 as follows:
September 30, 2013 | September 30, 2012 | |||||
Current assets | $ | 138,356,633 | $ | 154,285,332 | ||
Other assets | 688,613 | 644,431 | ||||
Current liabilities | 104,550,866 | 129,832,966 | ||||
Long-term liabilities | — | 136,000 | ||||
Members' equity | 34,494,380 | 24,960,797 | ||||
Revenue | 4,107,686,492 | 3,773,258,524 | ||||
Net income | 5,879,093 | 2,399,699 | ||||
9. DEBT FINANCING
Long-term debt consists of the following at:
October 31, 2013 | October 31, 2012 | ||||||
Fixed rate note payable, see terms below | $ | 18,098,700 | $ | 20,233,688 | |||
Variable rate note payable, see terms below | 12,480,437 | 15,344,904 | |||||
Capital lease | 15,180,000 | 15,180,000 | |||||
Total | 45,759,137 | 50,758,592 | |||||
Less amounts due within one year | 4,527,410 | 2,901,330 | |||||
Net long-term debt | $ | 41,231,727 | $ | 47,857,262 | |||
Bank Financing
The Company has two promissory notes including a $25,200,000 Fixed Rate Note and a $20,200,000 Variable Rate Note. The promissory notes are described in the credit agreement and below. The credit agreement also provides a revolving line of credit for $5,000,000 and supports the issuance of letters of credit up to $5,600,000, all of which are secured by substantially all assets.
Fixed Rate Note
The Fixed Rate Note was initially $25,200,000 and has a variable interest rate that is fixed with an interest rate swap through June 2014. The Company makes monthly principal payments on the Fixed Rate Note of approximately $168,000 plus accrued interest. Interest accrues on the Fixed Rate Note at the greater of the one-month LIBOR rate plus 300 basis points or 4%, which was 4% at October 31, 2013. A final balloon payment on the Fixed Rate Note of approximately $15,191,000 will be due February 26, 2015.
Variable Rate Note
The Variable Rate Note was initially $20,200,000. The Company makes monthly payments of interest only. Interest accrues on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%, which was 5% at October 31, 2013. The Company also makes quarterly 50% excess cash flow payments which are first applied to interest and then to principal on the Variable Rate Note with a minimum annual principal reduction of $750,000 which has been made at the time of this filing. A final balloon payment of approximately $11,729,000 will be due February 26, 2015.
48
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
Line of Credit
The Company's Line of Credit accrues interest at the 90 day LIBOR plus 350 basis points which was 3.74% at October 31, 2013. The line of credit requires monthly interest payments. In March 2013, the Company extended the line of credit to April 2014. At October 31, 2013 and 2012, there are no borrowings outstanding and the maximum availability was $5,000,000.
The loan agreements are secured by substantially all business assets and are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements.
As of October 31, 2013, the Company has letters of credit outstanding of $2,500,000. The Company pays interest at a rate of 1.75% on amounts outstanding and the letters of credit expire in October 2014.
Capital Lease
In April 2008, the Company entered into a lease agreement with the City of Lamberton, Minnesota, (the City) in order to finance equipment for the plant. The lease has a term from April 1, 2008 through April 1, 2028 unless terminated earlier. The City financed the purchase of equipment through Solid Waste Facilities Revenue Bonds Series 2008A totaling $15,180,000.
Under the equipment lease agreement with the City, the Company started making interest payments on November 25, 2008 and monthly thereafter at an implicit interest rate of 8.5%. The monthly capital lease interest payments correspond to 1/6 the semi-annual interest payments due on the Bonds on the next interest payment date. Monthly capital lease payments for principal are scheduled to begin on November 25, 2014. These payments will equal 1/12 the annual principal payments scheduled to become due on the corresponding bonds on the next principal payment date.
The Company has guaranteed that if such assessed lease payments are not sufficient for the required Bond payments, the Company will provide such funds as are needed to fund the shortfall. The lease agreement is secured by substantially all business assets and is subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working capital requirements, and are secured by all business assets. The Company is currently meeting all of these covenants. However, if the Company fails to comply with the covenants and does not obtain a waiver, the Trustee and the City could elect to exercise their available remedies, which include forcing immediate payment of outstanding balances.
The capital lease includes an option to purchase the equipment at fair market value at the end of the lease term. Under the capital lease agreement, the proceeds are for project costs and the establishment of a capitalized interest fund and a debt service reserve fund. The Company received proceeds of approximately $14,876,000, after financing costs of approximately $304,000.
The estimated maturities of the long-term debt at October 31, 2013 are as follows:
2014 | $ | 4,527,410 | |
2015 | 27,335,060 | ||
2016 | 1,510,000 | ||
2017 | 1,639,167 | ||
2018 | 1,778,333 | ||
2019 and thereafter | 8,969,167 | ||
Long-term debt | $ | 45,759,137 | |
10. LEASES
The Company leases rail cars and equipment under operating and capital leases. Rail car leases include additional payments for usage beyond specified levels. Total lease expense for the years ending October 31, 2013, 2012 and 2011 was approximately $240,000, $222,000, and $193,000 respectively.
Future minimum lease payments under the capital leases are as follows at October 31, 2013:
49
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
Operating | Capital | |||||
2014 | $ | 122,400 | $ | 1,290,300 | ||
2015 | — | 2,573,633 | ||||
2016 | — | 2,691,217 | ||||
2017 | — | 2,692,033 | ||||
2018 | — | 2,691,871 | ||||
After 2018 | — | 10,994,221 | ||||
Total | $ | 122,400 | 22,933,275 | |||
Less amount representing interest | 7,753,275 | |||||
Present value of minimum lease payments | 15,180,000 | |||||
Less current maturities | — | |||||
Long-term debt | $ | 15,180,000 | ||||
11. MEMBERS' EQUITY
The Company has one class of membership units, which include certain transfer restrictions as specified in the operating agreement and pursuant to applicable tax and securities law, with each unit representing a pro rata ownership in the Company’s capital, profits, losses and distributions. Income and losses are allocated to all members based upon their respective percentage of units held.
12. INCOME TAXES
The Company has adopted an October 31 fiscal year end, but has a tax year end of December 31. The differences between financial statement basis and tax basis of assets are estimated as follows:
October 31, 2013 | October 31, 2012 | |||||||
Financial statement basis of total assets | $ | 100,266,588 | $ | 101,697,433 | ||||
Organizational and start-up costs | 2,840,342 | 3,104,560 | ||||||
Book to tax depreciation | (27,846,650 | ) | (16,420,732 | ) | ||||
Income tax basis of total assets | $ | 75,260,280 | $ | 88,381,261 | ||||
The differences between the financial statement basis and tax basis of the Company's liabilities are estimated as follows:
October 31, 2013 | October 31, 2012 | |||||||
Financial statement basis of total liabilities | $ | 48,943,723 | $ | 55,165,228 | ||||
Less: Derivative instruments | (894,106 | ) | (1,197,016 | ) | ||||
Income tax basis of total liabilities | $ | 48,049,617 | $ | 53,968,212 | ||||
13. COMMITMENTS AND CONTINGENCIES
Marketing Agreements
The Company entered into an ethanol marketing agreement with their current marketer (RPMG) to purchase, market, and distribute all the ethanol produced by the Company. The Company also entered into a member control agreement with the marketer whereby the Company made capital contributions and became a minority owner of the marketer. The member control agreement became effective on February 1, 2011 and provides the Company a membership interest with voting rights. The marketing agreement will terminate if the Company ceases to be a member. The Company will assume certain of the member’s rail car leases if the agreement is terminated. In August 2012, the Company entered into an amended and restated marketing agreement that became effective on October 1, 2012 with the marketer. The amended and restated agreement provides that its marketer is its exclusive ethanol marketer and that the Company can sell its ethanol either through an index arrangement or at an agreed upon fixed price. The marketing agreement is perpetual until terminated according to the agreement. The Company may be obligated to continue to market its ethanol through the marketer for a period of time. The amended agreement requires minimum capital amounts invested as required under the agreement.
We entered into a distillers grains marketing agreement with a marketer to market all our dried distillers grains we produce at the plant. Under the agreement they will charge a maximum of $2.00 per ton and a minimum of $1.50 per ton price using 2% of the FOB plant price actually received by them for all dried distillers grains removed by them from our plant. The agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, they will be responsible for all transportation arrangements for the distribution of our dried distillers grains. Beginning in July 2011, we market and sell our own modified and wet distillers grains (MWDG).
Grain Procurement Contract
The Company has entered into a grain procurement agreement with a grain elevator to provide all of the corn needed for the operation of the ethanol plant. Under the agreement, the Company purchases corn at the local market price delivered to the plant plus a fixed fee per bushel of corn. The agreement expires in August 2016.
Regulatory Agencies
The Company is subject to oversight from regulatory agencies regarding environmental concerns which arise in the ordinary course of its business.
Forward Contracts
The Company has forward contracts in place for natural gas purchases for approximately $849,000 through February 2014, which represents approximately 45% of the Company's projected usage for the corresponding time period. At October 31, 2013, the Company has 2,100,000 gallons of forward, fixed price ethanol sales contracts for various delivery periods through December 2013. In addition, the Company has forward dried distiller grains sales contracts of approximately 12,000 tons at various fixed prices for various delivery periods through February 2014.
Capital Lease
The Company entered into a series of related definitive agreements dated September 26, 2013, with an unrelated party for the construction, installation and lease of a corn oil separation system and license of corn oil separation technology. The Company expects to lease the corn oil separation system and technology for a term of 120 months subject to the other party's right to remove the system upon default by the Company and subject to extension or termination pursuant to the terms of the agreements. The Company is responsible for repairs and maintenance of the system and bears the risk of loss. The Company will pay certain license fees which are subject to being reduced if the corn oil separation system does not meet certain performance goals. The corn oil separation system shall be conveyed to the Company at the end of the term so long as the Company is not in breach. The Company granted a security interest in the corn oil separation system to secure its obligations under the agreements. In addition the Company agreed, subject to certain obligations of confidentiality, to provide the other party with Company information on a monthly basis including business and financial information and granted the other party the option to have a representative present in board and committee meetings as an observer. The Company also agreed to give the other party notice in the event of an issuance or sale of Company membership interests or convertible debt instruments. The Company plans to record this as a capital lease, beginning at the time of "start up" as defined in the agreements. The total minimum commitment under the lease is approximately $2,500,000.
50
HIGHWATER ETHANOL, LLC
Notes to Financial Statements
October 31, 2013 and 2012
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||||||||||
Fiscal Year Ended October 31, 2013 | |||||||||||||||
Revenues | $ | 43,201,533 | $ | 42,638,894 | $ | 44,801,707 | $ | 38,040,275 | |||||||
Gross profit (loss) | (529,082 | ) | 1,986,332 | 2,611,765 | 5,307,418 | ||||||||||
Operating income (loss) | (1,057,604 | ) | 1,549,396 | 2,211,508 | 4,853,689 | ||||||||||
Net income (loss) | (1,746,420 | ) | 770,314 | 1,565,598 | 4,234,567 | ||||||||||
Basic and diluted earnings (loss) per unit | (352.60 | ) | 155.52 | 316.09 | 854.95 | ||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||||||||||
Fiscal Year Ended October 31, 2012 | |||||||||||||||
Revenues | $ | 39,827,576 | $ | 33,771,321 | $ | 39,240,928 | $ | 43,808,800 | |||||||
Gross profit (loss) | 2,337,847 | (980,751 | ) | 185,590 | (679,542 | ) | |||||||||
Operating income (loss) | 1,822,732 | (1,467,528 | ) | (203,503 | ) | (1,092,588 | ) | ||||||||
Net income (loss) | 965,975 | (2,330,276 | ) | (1,068,852 | ) | (1,691,735 | ) | ||||||||
Basic and diluted earnings (loss) per unit | 195.03 | (470.48 | ) | (215.80 | ) | (341.56 | ) | ||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||||||||||
Fiscal Year Ended October 31, 2011 | |||||||||||||||
Revenues | $ | 36,269,498 | $ | 37,394,958 | $ | 43,133,745 | $ | 43,575,832 | |||||||
Gross profit | 2,084,072 | 2,434,143 | 2,342,598 | 3,972,986 | |||||||||||
Operating income | 1,646,780 | 1,962,542 | 1,865,282 | 3,596,781 | |||||||||||
Net income | 1,044,647 | 837,477 | 673,093 | 2,588,140 | |||||||||||
Basic and diluted earnings per unit | 210.91 | 169.08 | 135.90 | 522.54 | |||||||||||
The above quarterly financial data is unaudited, but in the opinion of management, all adjustments necessary for a fair presentation of the selected data for these periods presented have been included.
15. SUBSEQUENT EVENT
On November 21, 2013 (with an effective date of November 4, 2013), Highwater Ethanol, LLC (the "Company") entered into a Distillers Crude Corn Oil Marketing Agreement (the "Marketing Agreement") with CHS, Inc. ("CHS") wherein the Company agrees to sell to CHS, and CHS agrees to purchase, all crude corn oil ("Oil") to be produced at the Company's ethanol plant. Under the Marketing Agreement, CHS will execute contracts with buyers after giving prior notice of the terms and conditions thereof to the Company and receiving direction from the Company to accept such contracts. For all Oil sold to CHS under the Marketing Agreement, CHS will pay to the Company the actual price that CHS receives from its buyers less a marketing fee, actual freight and transportation costs and certain taxes related to the purchase, delivery or sale of the Oil. The Company agrees to provide Oil meeting certain specifications as provided in the Marketing Agreement and the Marketing Agreement provides for a process by which CHS can reject nonconforming Oil. The Marketing Agreement is effective for an initial term which commences on the date on which the ethanol plant commences producing Oil pursuant to the mutual agreement of CHS and the Company. Following expiration of the initial term, the Marketing Agreement shall automatically renew for successive terms unless terminated by CHS or the Company in accordance with the Marketing Agreement.
51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management is responsible for maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In addition, the disclosure controls and procedures must ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial and other required disclosures.
Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Lucas Schneider, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of October 31, 2013. Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
Inherent Limitations Over Internal Controls
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management's Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control-Integrated Framework
52
issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992 (“COSO”). Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of October 31, 2013.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. As we are a non-accelerated filer, management's report is not subject to attestation by our registered public accounting firm pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002 that permit us to provide only management's report in this annual report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth quarter of our 2013 fiscal year, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference from the definitive proxy statement for our 2014 annual meeting of members to be filed with the Securities Exchange Commission within 120 days after the end of our 2013 fiscal year. This proxy statement is referred to in this report as the 2014 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the 2014 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MEMBER MATTERS
The information required by this Item is incorporated by reference from the 2014 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference from the 2014 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference from the 2014 Proxy Statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Exhibits Filed as Part of this Report and Exhibits Incorporated by Reference.
The following exhibits and financial statements are filed as part of, or are incorporated by reference into, this report:
(1) | Financial Statements |
The financial statements appear beginning at page 34 of this report.
53
(2) | Financial Statement Schedules |
All supplemental schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.
(3) | Exhibits |
Exhibit No. | Exhibit | Filed Herewith | Incorporated by Reference | ||
3.1 | Articles of Organization of the registrant. | Exhibit 3.1 to the registrant's registration statement on Form SB-2 (Commission File 333-137482). | |||
3.2 | Second Amended and Restated Member Control Agreement of the registrant. | Exhibit 3.2 to the registrant's registration Form 10-Q filed with the Commission on March 22, 2011. | |||
4.1 | Form of Membership Unit Certificate. | Exhibit 4.2 to the registrant's registration statement on Form SB-2 (Commission File 333-137482). | |||
10.1 | Grain Procurement Agreement and Amendment with Meadowland Farmers Co-op. | Exhibit 10.6 to the registrant's registration statement on Form SB-2 (Commission File 33-137482). | |||
10.2 | Energy Management Agreement dated June 8, 2006 between Highwater Ethanol, LLC and U.S. Energy Services, Inc. | Exhibit 10.9 to the registrant's registration statement on Form SB-2 (Commission File 33-137482). | |||
10.3 | Redwood Electric Service Agreement dated June 28, 2007. | Exhibit 99.1 to the registrant's Form 8-K filed with the Commission on July 3, 2007. | |||
10.4 | Distillers Grains Marketing Agreement with CHS, Inc. dated October 11, 2007. | Exhibit 10.4 to the registrant's Form 10-KSB filed with the Commission on January 29, 2008. | |||
10.5 | Lease Agreement dated April 1, 2008 with the City of Lamberton, MN. | Exhibit 10.2 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.6 | Trust Indenture dated April 1, 2008 with the City of Lamberton, MN and U.S. Bank National Association. | Exhibit 10.3 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.7 | Guaranty Agreement dated April 1, 2008 with U.S. Bank National Association. | Exhibit 10.4 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.8 | Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Financing Statement dated April 1, 2008 with U.S. Bank National Association. | Exhibit 10.6 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.9 | Security Agreement dated April 1, 2008 with U.S. Bank National Association. | Exhibit 10.7 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.10 | Intercreditor Agreement dated April 24, 2008 with First National Bank of Omaha and U.S. Bank National Association. | Exhibit 10.8 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.11 | Construction Loan Agreement dated April 24, 2008 with First National Bank of Omaha. | Exhibit 10.10 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.12 | Construction Loan Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Financing Statement dated April 24, 2008 with First National Bank of Omaha. | Exhibit 10.11 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.13 | Security Agreement dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.12 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
54
10.14 | $10,000,000 Construction Note dated April 24, 2008 with First National Bank of Omaha. | Exhibit 10.13 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.15 | $2,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.14 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.16 | $9,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.15 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.17 | $13,646,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.16 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.18 | $500,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.17 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.19 | $1,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.18 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.20 | $14,254,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. | Exhibit 10.19 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.21 | Promissory Note and Continuing Letter of Credit Agreement dated April 24, 2008 with First National Bank of Omaha. | Exhibit 10.20 to the registrant's Form 10-QSB filed with the Commission on June 13, 2008. | |||
10.22 | Centerpoint Natural Gas Agreement dated June 26, 2008. | Exhibit 10.26 to the registrant's Form 10-QSB filed with the Commission on September 15, 2008. | |||
10.23 | Trinity Industries Leasing Company Railroad Car Lease Agreement dated July 1, 2009. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on June 15, 2009. | |||
10.24 | Interest Rate Swap Agreement dated April 25, 2008. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on September 21, 2009. | |||
10.25 | First Amendment to Construction Loan Agreement dated August 11, 2009. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on September 21, 2009. | |||
10.26 | First Amendment and Restated Revolving Promissory Note dated August 11, 2009. | Exhibit 10.3 to the registrant's Form 10-Q filed with the Commission on September 21, 2009. | |||
10.27 | First Amendment and Restated Revolving Promissory Note (1 million) dated August 11, 2009. | Exhibit 10.4 to the registrant's Form 10-Q filed with the Commission on September 21, 2009. | |||
10.28 | First Amendment and Restated Revolving Promissory Note (2646 million) dated August 11, 2009. | Exhibit 10.5 to the registrant's Form 10-Q filed with the Commission on September 21, 2009. | |||
10.29 | Fixed Rate Note between First National Bank of Omaha and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.30 | Fixed Rate Note between Heritage Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.31 | Fixed Rate Note between United FCS and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.3 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.32 | Fixed Rate Note between AgStar Financial Services, PCA and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.4 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.33 | Fixed Rate Note between Deere Credit and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.5 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
55
10.34 | Fixed Rate Note between First Bank & Trust and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.6 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.35 | Fixed Rate Note between Granite Falls Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.7 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.36 | Variable Rate Note between Highwater Ethanol, LLC and First National Bank of Omaha dated February 26, 2010. | Exhibit 10.8 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.37 | Variable Rate Note between Heritage Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.9 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.38 | Variable Rate Note between United FCS and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.10 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.39 | Variable Rate Note between AgStar Financial Services, PCA and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.11 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.40 | Variable Rate Note between Deere Credit and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.12 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.41 | Variable Rate Note between First Bank & Trust and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.13 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.42 | Variable Rate Note between Granite Falls Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.14 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.43 | Long Term Revolving Note between Highwater Ethanol, LLC and First National Bank of Omaha dated February 26, 2010. | Exhibit 10.15 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.44 | Long Term Revolving Rate Note between Heritage Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.16 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.45 | Long Term Revolving Rate Note between United FCS and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.17 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.46 | Long Term Revolving Rate Note between AgStar Financial Services, PCA and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.18 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.47 | Long Term Revolving Rate Note between Deere Credit and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.19 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.48 | Long Term Revolving Rate Note between First Bank & Trust and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.20 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.49 | Long Term Revolving Rate Note between Granite Falls Bank and Highwater Ethanol, LLC dated February 26, 2010. | Exhibit 10.21 to the registrant's Form 10-Q filed with the Commission on March 17, 2010. | |||
10.50 | RPMG Ethanol Fuel Marketing Agreement dated February 1, 2011.+ | Exhibit 10.50 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.51 | Third Amendment of Construction Loan Agreement dated January 28, 2011. | Exhibit 10.51 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.52 | First Amended and Restated Variable Rate Note between Highwater Ethanol, LLC and First National Bank of Omaha dated January 31, 2011. | Exhibit 10.52 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
56
10.53 | First Amended and Restated Variable Rate Note between Heritage Bank and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.53 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.54 | First Amended and Restated Variable Rate Note between United FCS and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.54 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.55 | First Amended and Restated Variable Rate Note between AgStar Financial Services, PCA and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.55 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.56 | First Amended and Restated Variable Rate Note between Deere Credit and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.56 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.57 | First Amended and Restated Variable Rate Note between First Bank & Trust and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.57 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.58 | First Amended and Restated Variable Rate Note between Granite Falls Bank and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.58 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.59 | First Amended and Restated Long Term Revolving Note between Highwater Ethanol, LLC and First National Bank of Omaha dated January 31, 2011. | Exhibit 10.59 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.60 | First Amended and Restated Long Term Revolving Rate Note between Heritage Bank and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.60 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.61 | First Amended and Restated Long Term Revolving Rate Note between United FCS and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.61 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.62 | First Amended and Restated Long Term Revolving Rate Note between AgStar Financial Services, PCA and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.62 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.63 | First Amended and Restated Long Term Revolving Rate Note between Deere Credit and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.63 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.64 | First Amended and Restated Long Term Revolving Rate Note between First Bank & Trust and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.64 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.65 | First Amended and Restated Long Term Revolving Rate Note between Granite Falls Bank and Highwater Ethanol, LLC dated January 31, 2011. | Exhibit 10.65 to the registrant's Form 10-K filed with the Commission on February 3, 2011. | |||
10.66 | Fourth Amendment of Construction Loan Agreement between First National Bank of Omaha and Highwater Ethanol, LLC dated February 26, 2011. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on March 22, 2011. | |||
10.67 | Amended and Restated Revolving Promissory Note with Deere Credit, Inc. dated February 26, 2011. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on March 22, 2011. | |||
57
10.68 | Third Amended and Restated Revolving Promissory Note with First National Bank of Omaha dated February 26, 2011. | Exhibit 10.3 to the registrant's Form 10-Q filed with the Commission on March 22, 2011. | |||
10.69 | Third Amended and Restated Revolving Promissory Note with First Bank & Trust dated February 26, 2011. | Exhibit 10.4 to the registrant's Form 10-Q filed with the Commission on March 22, 2011. | |||
10.70 | Fifth Amendment of Construction Loan Agreement between First National Bank of Omaha and Highwater Ethanol, LLC dated August 26, 2011. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on September 12, 2011. | |||
10.71 | Fourth Amended and Restated Revolving Promissory Note between First National Bank of Omaha and Highwater Ethanol, LLC dated August 26, 2011. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on September 12, 2011. | |||
10.72 | Fourth Amended and Restated Revolving Promissory note between First National Bank of Omaha and Highwater Ethanol, LLC dated August 26, 2011. | Exhibit 10.3 to the registrant's Form 10-Q filed with the Commission on September 12, 2011. | |||
10.73 | Fifth Amended and Restated Revolving Promissory Note between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on June 12, 2012. | |||
10.74 | Fifth Amended and Restated Revolving Promissory Note between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012. | Exhibit 10.2 to the registrant's Form 10-Q filed with the Commission on June 12, 2012. | |||
10.75 | Sixth Amendment of Construction Loan Agreement between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012. | Exhibit 10.3 to the registrant's Form 10-Q filed with the Commission on June 12, 2012. | |||
10.76 | Amended and Restated Ethanol Marketing Agreement between RPMG, Inc. and Highwater Ethanol, LLC dated August 27, 2012. + | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on September 14, 2012. | |||
10.77 | Seventh Amendment of Construction Loan Agreement between First National Bank of Omaha and Highwater Ethanol, LLC dated January 25, 2013 | Exhibit 10.77 to the registrant's Form 10-K filed with the Commission on January 29, 2013. | |||
10.78 | Eighth Amendment of Construction Loan Agreement dated March 29, 2013. | Exhibit 10.1 to the registrant's Form 10-Q filed with the Commission on June 10, 2013. | |||
10.79 | Easement for Construction and Process Demonstration Agreement between Butamax Advanced Biofuels LLC and Highwater Ethanol, LLC dated September 26, 2013.+ | X | |||
10.80 | Eqiupment Lease Agreement between Butamax Advanced Biofuels LLC and Highwater Ethanol, LLC dated September 26, 2013.+ | X | |||
10.81 | Technology Demonstration Risk Reduction Agreement between Butamax Advanced Biofuels LLC and Highwater Ethanol, LLC dated September 26, 2013.+ | X | |||
10.82 | Security Agreement between Butamax Advanced Biofuels LLC and Highwater Ethanol, LLC dated September 26, 2013.+ | X | |||
58
10.83 | Technology License Agreement between Butamax Advanced Biofuels LLC and Highwater Ethanol, LLC dated September 26, 2013.+ | X | |||
10.84 | Distillers Crude Corn Oil Marketing Agreement between CHS Inc. and Highwater Ethanol, LLC dated November 4, 2013.+ | X | |||
10.85 | 2014 Bonus Plan for CEO and CFO | X | |||
14.1 | Code of Ethics of Highwater Ethanol, LLC adopted on June 26, 2008. | Exhibit 14.1 to the registrant's Form 10-K filed with the Commission on January 29, 2013. | |||
31.1 | Certificate Pursuant to 17 CFR 240.13a-14(a) | X | |||
31.2 | Certificate Pursuant to 17 CFR 240.13a-14(a) | X | |||
32.1 | Certificate Pursuant to 18 U.S.C. Section 1350 | X | |||
32.2 | Certificate Pursuant to 18 U.S.C. Section 1350 | X | |||
101 | The following financial information from Highwater Ethanol, LLC's Annual Report on Form 10-K for the fiscal year ended October 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) Balance Sheets as of October 31, 2013 and October 31, 2012, (ii) Statements of Operations for the fiscal years ended October 31, 2013, 2012 and 2011, (iii) Statement of Changes in Members' Equity and Comprehensive Income (Loss); (iv) Statements of Cash Flows for the fiscal years ended October 31, 2013, 2012 and 2011, and (v) the Notes to Financial Statements.** | ||||
(+) Confidential Treatment Requested.
(X) Filed herewith
** Furnished herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HIGHWATER ETHANOL, LLC | |||
Date: | January 15, 2014 | /s/ Brian Kletscher | |
Brian Kletscher | |||
Chief Executive Officer | |||
(Principal Executive Officer) | |||
Date: | January 15, 2014 | /s/ Lucas Schneider | |
Lucas Schneider | |||
Chief Financial Officer | |||
(Principal Financial and Accounting Officer) | |||
59
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: | January 15, 2014 | /s/ David G. Moldan | |
David G. Moldan, Chairman and Governor | |||
Date: | January 15, 2014 | /s/ Timothy J. VanDerWal | |
Timothy J. VanDerWal, Vice Chairman and Governor | |||
Date: | January 15, 2014 | /s/ Warren Walter Pankonin | |
Warren Walter Pankonin, Secretary and Governor | |||
Date: | January 15, 2014 | /s/ Luke Spalj | |
Luke Spalj, Treasurer and Governor | |||
Date: | January 15, 2014 | /s/ Scott Brittenham | |
Scott Brittenham, Governor | |||
Date: | January 15, 2014 | /s/ Russell J. Derickson | |
Russell J. Derickson, Governor | |||
Date: | January 15, 2014 | /s/ William Garth | |
William Garth, Governor | |||
Date: | January 15, 2014 | /s/ George M. Goblish | |
George M. Goblish, Governor | |||
Date: | January 15, 2014 | /s/ Ronald E. Jorgenson | |
Ronald E. Jorgenson, Governor | |||
60