UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

☒     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended October 31, 2019.

Or

☐     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the transition period from                    to                    .

 

Commission File Number 000-51825

Heron Lake BioEnergy, LLC

(Exact name of registrant as specified in its charter)

 

 

 

Minnesota

(State or other jurisdiction of

incorporation or organization)

    

41-2002393

(IRS Employer

Identification No.)

 

91246 390th Avenue, Heron Lake, MN 56137-1375

(Address of principal executive offices)

Registrant’s telephone number, including area code: (507) 793-0077

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

    

Securities registered pursuant to Section 12(g) of the Act:

None

 

Class A Units

Name of Exchange on which registered: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes ☐    No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: Yes ☐    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. Yes ☒    No ☐

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

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

 

 

 

 

 

 

 

Large Accelerated Filer ☐

 

 

 

 

 

Accelerated Filer ☐

Non-Accelerated Filer ☒

 

 

 

Smaller Reporting Company ☐

Emerging Growth Company ☐

 

 

 

 

 

 

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 126-2 of the Act) Yes ☐    No ☒

As of April 30, 2019, the aggregate market value of the 32,199,012 Class A units held by non-affiliates (computed by reference to the most recent offering price of Class A membership units) was approximately $9,659,704.  The units are not listed on an exchange or otherwise publicly traded. Additionally, the membership units are subject to significant restrictions on transfer under the registrant’s operating and member control agreement. In determining this value, the registrant has assumed that all of its governors, chief executive officer, chief financial officer, Granite Falls Energy, LLC and beneficial owners of 5% or more of its outstanding membership units are affiliates, but this assumption shall not apply to or be conclusive for any other purpose.

As of April 30, 2019, all of the 15,000,000 Class B units were held by an affiliate of the Company.

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 29, 2020, there were 62,932,107 Class A units and 15,000,000 Class B units outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s definitive Proxy Statement for the registrant’s 2020 Annual Meeting of Members are incorporated by reference into Part III.

 

1

 

 

INDEX

 

 

 

 

PART I 

 

 

 

 

 

Item 1. 

Business

4

Item 1A. 

Risk Factors

19

Item 1B. 

Unresolved Staff Comments

34

Item 2. 

Properties

34

Item 3. 

Legal Proceedings

34

Item 4. 

Mine Safety Disclosures

34

 

 

 

PART II 

 

 

 

 

 

Item 5. 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

34

Item 6. 

Selected Financial Data

38

Item 7. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

39

Item 7A. 

Quantitative and Qualitative Disclosures about Market Risk

56

Item 8. 

Financial Statements and Supplementary Data

58

Item 9. 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

81

Item 9A. 

Controls and Procedures

81

Item 9B. 

Other Information

82

 

 

 

PART III 

 

 

 

 

 

Item 10. 

Directors, Executive Officers and Corporate Governance

82

Item 11. 

Executive Compensation

82

Item 12. 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

82

Item 13. 

Certain Relationships and Related Transactions, and Director Independence

82

Item 14. 

Principal Accounting Fees and Services

82

 

 

 

PART IV 

 

 

 

 

 

Item 15. 

Exhibits, Financial Statement Schedules

83

 

 

 

SIGNATURES 

87

 

 

2

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report contains historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance and prospects. All statements that are not historical or current facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and relate to future events, our future financial performance, or 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 the following:

 

·

Fluctuations in the prices of grain, utilities and ethanol, which are affected by various factors including weather, production levels, supply, demand, and availability of production inputs;

·

Changes in the availability and price of corn and natural gas;

·

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

·

Fluctuations in the price of crude oil and gasoline;

·

Ethanol may trade at a premium to gasoline at times, causing a disincentive for discretionary blending of ethanol beyond the requirements of the federal Renewable Fuels Standard (“RFS”) and resulting in a negative impact on ethanol prices and demand;

·

Changes in federal and/or state laws and environmental regulations including elimination, waiver or reduction of the Renewable Fuels Standard, may have an adverse effect on our business;

·

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

·

Any effect on prices of distillers’ grains resulting from actions in international markets;

·

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

·

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

·

Alternative fuel additives may be developed that are superior to, or cheaper than ethanol;

·

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

·

Our ability to profitably operate the ethanol plant and maintain positive margins and generate free cash flow, which may impact our ability to meet current obligations, invest in our business, service our debt and satisfy the financial covenants contained in our credit agreement with our lender;

·

Changes in interest rates or the lack of credit availability;

·

Our ability to make distributions in light of financial covenants in our credit facility;

·

Our ability to retain key employees and maintain labor relations;

·

The supply of ethanol rail cars in the market has fluctuated in recent years and may affect our ability to obtain new tanker cars or negotiate new leases at a reasonable fee when our current leases expire;

·

Any delays in shipping our products by rail and corresponding decreases in our sales or production as a result of shipping delay and ethanol storage constraints;

·

Our units are subject to a number of transfer restrictions, no public market exists for our units, and we do not expect one to develop.

 

Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the reasons described in Part I, Item 1A. “Risk Factors” of this Form 10-K.  We undertake no duty to update these forward-looking statements, even though our situation may change in the future.  We cannot guarantee future results, levels of activity, performance or achievements.  We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report.  You should read this report and the documents that we reference in this report and have filed as exhibits, completely and with the understanding that our actual future results may be materially different from what we currently expect.  We qualify all of our forward-looking statements with these cautionary statements. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended October 31 and the associated quarters of those fiscal years.

3

 

INDUSTRY AND MARKET DATA

 

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

 

 

AVAILABLE INFORMATION

 

Our principal executive offices are located at 91246 390th Avenue, Heron Lake, Minnesota 56137, and our telephone number is 507-793-0077.  We make available free of charge on or through our Internet website, www.heronlakebioenergy.com, all of our reports and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).  The SEC also maintains an internet site (http://www.sec.gov) through which the public can access our reports.  We will provide electronic or paper copies of these documents free of charge upon request.

 

 

PART I

 

When we use the terms “Heron Lake BioEnergy,” “Heron Lake,” or “HLBE” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our operations at our ethanol production facility located near Heron Lake, Minnesota. When we use the terms the “Company,” “we,” “us,” “our” or similar words in this Annual Report on Form 10-K, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, through which, beginning as of December 11, 2019, HLBE holds a 100% interest in Agrinatural Gas, LLC (“Agrinatural”). At October 31, 2019, HLBE held a 73% interest in Agrinatural. Please refer to “ITEM 8 - FOOTNOTE 18 - SUBSEQUENT EVENT” for additional information. 

 

Additionally, when we refer to “units” in this Annual Report on Form 10-K, unless the context otherwise requires, we are referring to the Class A units of Heron Lake BioEnergy.

 

 

ITEM 1.    BUSINESS

 

Overview

 

Heron Lake BioEnergy, LLC was organized as a Minnesota limited liability company on April 12, 2001 under the name “Generation II, LLC.”  In June 2004, we changed our name to Heron Lake BioEnergy, LLC. 

 

In July 2013, Granite Falls Energy, LLC (“Granite Falls” or “GFE”) acquired a controlling interest in the Company from Project Viking, L.L.C. GFE, now a related party, owns an ethanol plant located in Granite Falls, Minnesota. As of January 29, 2019, GFE owns approximately 31.4% of our outstanding Class A membership units and 100.0% of our outstanding Class B Units, for total ownership of approximately 50.7%.  As a result of its majority ownership, GFE has the right to appoint five (5) of the nine (9) governors to our board of governors under our member control agreement.

 

We operate a dry mill fuel-grade ethanol plant in Heron Lake, Minnesota.  Since beginning operation of our ethanol plant on September 21, 2007, our primary business has been the production and sale of ethanol and co-products, including dried distillers’ grains and since February 2012, non-edible corn oil. Our plant was originally constructed as a coal fired plant but was converted to natural gas in November 2011. 

 

Our ethanol plant has a nameplate capacity of 50 million gallons per year.  On July 10, 2015, the Minnesota Pollution Control Agency approved a major amendment to our air emission permit which increased our permitted production capacity from 59.9 million gallons to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis.  We are currently operating above our stated nameplate capacity at an annual rate

4

 

of approximately 65 million gallons and intend to continue to take advantage of the additional production allowed pursuant to our permit as long as we believe it is profitable to do so.

 

In fiscal years 2019, 2018, and 2017, we sold approximately 65.5 million gallons, 66.9 million gallons, and 64.0 million gallons of ethanol, respectively.

 

Our wholly owned subsidiary, HLBE Pipeline Company, LLC, is the sole owner of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural is a natural gas pipeline company that was formed to construct, own, and operate the natural gas pipeline that provides natural gas to the Company’s ethanol production facility and other customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota. On October 18, 2019, HLBE Pipeline Company, LLC entered into an agreement to purchase RES’s 27% non-controlling interest in Agrinatural, which became effective on December 11, 2019. Prior to December 11, 2019, Rural Energy Solutions, LLC (“RES”) owned a 27% non-controlling interest in Agrinatural.

 

Reportable Operating Segments

 

Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.   Based on the related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.

 

·

Ethanol Production.   Based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant, including the production and sale of ethanol and its co-products, are aggregated into one financial reporting segment.

 

·

Natural Gas Pipeline. The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment.

 

Before intercompany eliminations, revenues from our natural gas pipeline segment represented 3.0%, 3.2%, and 2.7% of our total consolidated revenues in the years ended October 31, 2019, 2018, and 2017, respectively.  After accounting for intercompany eliminations for fees paid by the Company to Agrinatural for natural gas transportation services pursuant to our natural gas transportation agreement, Agrinatural’s revenues represented 1.3%, 1.5%, and 1.1% of our consolidated revenues for the fiscal years ended October 31, 2019, 2018, and 2017, respectively, and have little to no impact on the overall performance of the Company.

 

We currently do not have or anticipate we will have any other lines of business or other significant sources of revenue other than the sale of ethanol, distillers’ grains, corn oil and natural gas transportation.  Refer to Note 16, “Business Segments,” of the notes to audited consolidated financial statements for financial information about our financial reporting segments.

 

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 consolidated financial statements and supplementary data.

 

Ethanol Production Segment

 

Revenues from our ethanol production segment have represented 98.7%, 98.5%, and 98.9% of our revenues in the years ended October 31, 2019, 2018, and 2017, respectively. 

5

 

Principal Products

 

The principal products from our ethanol production are fuel-grade ethanol, distillers’ grains, non-edible corn oil and miscellaneous sales of distillers’ syrup, a by-product of the ethanol production process.  We did not introduce any new products or services as part of our ethanol production segment during our fiscal year ended October 31, 2019. 

 

The table below shows the approximate percentage of our total revenue which is attributable to each of our principal products for each of the last three fiscal years.

 

 

 

 

 

 

 

 

 

    

Fiscal Year 2019

    

Fiscal Year 2018

    

Fiscal Year 2017

Ethanol

 

77.3%

 

75.7%

 

80.3%

Distillers' Grains

 

17.1%

 

18.5%

 

13.6%

Corn Oil

 

3.3%

 

3.7%

 

4.5%

Misc. Syrup Sales

 

1.0%

 

0.6%

 

0.5%

 

Ethanol

 

Ethanol is a type of alcohol produced in the U.S. principally from corn.  Ethanol is ethyl alcohol, a fuel component made primarily from corn in the U.S. but can also be produced from various other grains. Ethanol is primarily used as:

 

·

an octane enhancer in fuels;

·

an oxygenated fuel additive that can reduce ozone and carbon monoxide vehicle emissions;

·

a non-petroleum-based gasoline substitute; and

·

as a renewable fuel to displace consumption of imported oil.

 

Ethanol produced in the U.S. is primarily used for blending with unleaded gasoline and other fuel products as an octane enhancer or fuel additive.  Ethanol is most commonly sold as E10 (10% ethanol and 90% gasoline), which is the blend of ethanol approved by the U.S. Environmental Protection Agency (“EPA”) for use in all American automobiles. Increasingly, ethanol is also available as E85, a higher percentage ethanol blend (85% ethanol and 15% gasoline) approved by the EPA for use in flexible fuel vehicles. Additionally, ethanol is available as E15 (15% ethanol and 85% gasoline), which is approved by the EPA for use in model year 2001 and newer cars, light-duty trucks, medium-duty passenger vehicles, and all flex-fuel vehicles.

 

Distillers’ Grains

 

The principal co-product of the ethanol production process is distillers’ grains, a high protein and high-energy animal feed ingredient primarily marketed to the dairy and beef industries.  Dry mill ethanol processing creates three primary forms of distillers’ grains: wet distillers’ grains, modified wet distillers’ grains, and dried distillers’ grains with solubles.  Most of the distillers’ grains that we sell are in the form of dried distillers’ grains and modified/wet distillers’ grains.  Modified/wet distillers’ grains are processed corn mash that has been dried to approximately 50% moisture and has a shelf life of approximately 7 days.  Modified/wet distillers’ grains are often sold to nearby markets.  Dried distillers’ grains with solubles are corn mash that has been dried to approximately 10% to 12% moisture.  It has an almost indefinite shelf life and may be sold and shipped to any market and fed to almost all types of livestock.

 

Corn Oil

 

We also extract a portion of the crude corn oil contained in our distillers’ grains which we market separately from our distillers’ grains.  The corn oil that we produce is not food grade corn oil and therefore cannot be used for human consumption. Corn oil is used primarily as a biodiesel feedstock and as a supplement for animal feed.

 

Corn Syrup

 

We also occasionally sell excess corn syrup in liquid syrup form to livestock feeders.  The excess syrup results from a plant upset, or when the amount of syrup produced during the drying process exceeds our distillers’ grains’ dryer capacity. Corn syrup is used primarily as a feed additive to moisten dry feed stuffs such as hay.

6

 

Principal Product Markets

 

As described below in “Distribution of Principal Products”, we market and distribute all of our ethanol, distillers’ grains and corn oil through professional third party marketers. Our marketers make all decisions with regard to where our products are marketed and we have little control over the marketing decisions they make.

 

Our ethanol, distillers’ grains and corn oil are primarily sold in the domestic market; however, as markets allow, our products can be, and have been, sold in the export markets. We expect our marketers to explore all markets for our products, including export markets. We believe that there is some potential for increased international sales of our products. Nevertheless, due to high transportation costs, and the fact that we are not located near a major international shipping port, we expect our products to continue to be marketed primarily domestically. 

 

Ethanol Markets

 

The markets in which our ethanol is sold will depend primarily upon the efforts of Eco-Energy, Inc. (“Eco-Energy”), which buys and markets our ethanol. There are local, regional, national, and international markets for ethanol.  The principal markets for our ethanol are petroleum terminals in the continental U.S.  The principal purchasers of ethanol are generally wholesale gasoline distributors or blenders.

 

We believe that local markets will be limited and must typically be evaluated on a case-by-case basis.  Although local markets may be the easiest to service, they may be oversold because of the number of ethanol producers near our plant, which may depress the price of ethanol in those markets.

 

Typically, a regional market is one that is outside of the local market, yet within the neighboring states.  Some regional markets include large cities that are subject to anti-smog measures in either carbon monoxide or ozone non-attainment areas, or that have implemented oxygenated gasoline programs, such as Chicago, St. Louis, Denver, and Minneapolis.  We consider our primary regional market to be large cities within a 450-mile radius of our ethanol plant.  In the national ethanol market, the highest demand by volume is primarily in the southern U.S. and the east and west coast regions.

 

We expect a majority of our ethanol to continue to be marketed and sold domestically. Over our past fiscal year, exports of ethanol have decreased, with Brazil receiving the largest percentage of ethanol produced in the United States and Canada in second place. India, South Korea, Philippines, Colombia, Peru, United Arab Emirates have also been top destinations.  Ethanol export demand is more unpredictable than domestic demand and tends to fluctuate over time as it is subject to monetary and political forces in other nations. For example, a strong US Dollar is a force that may negatively impact ethanol exports from the United States.  Additionally, the imposition of tariffs and duties on ethanol imported from the U.S., as well as increased production of ethanol and similar fuels in other countries, can also negatively impact domestic export demand.

 

Exports to China have been negligible during fiscal year 2019. Additionally, although exports to China increased during 2018 over 2017, China imported comparatively negligible volumes during both 2017 and 2018 to the volumes imported prior to 2017. This reduction is due to China’s increase of the tariff on ethanol imported from the U.S. to 45% as of April 2, 2018, compared to the previous 30% tariff imposed in 2017, and the subsequent increase of the 45% tariff to 70% as of July 6, 2018. It is unclear whether the tariffs will be reduced, if ever, and therefore, this tariff is likely to continue to have a negative impact on the export market demand and prices for ethanol produced in the United States. 

 

On January 15, 2020, President Trump signed a “phase one” trade agreement with China, which is to take effect within 30 days of its signing. The agreement includes a commitment by China to purchase agricultural products over the next two years, including ethanol. While this agreement appears positive for the industry, there is no guarantee that the agreement will be fully implemented, nor is there a guarantee that exports to China return to pre-tariff levels.

 

During 2017, Brazil also adopted import quotas on imported ethanol, which negatively impacted U.S. exports to Brazil. The import quota imposed a 20% tariff on U.S. ethanol imports in excess of 150 million liters, or 39.6 million gallons per quarter. The tariff was valid for two years, and expired in September 2019. In September 2019, Brazil raised the import quota to 187.5 million liters, or 49.5 million gallons, per quarter, before the imports become subject to the 20% tariff. U.S. exports to Brazil have decreased from our 2018 fiscal year to our 2019 fiscal year. The import quota and

7

 

tariff may continue to have a negative impact on the export market demand and prices for ethanol produced in the United States.

 

We transport our ethanol primarily by rail.  In addition to rail, we service certain regional markets by truck from time to time.  We believe that regional pricing tends to follow national pricing less the freight difference.

 

Distillers’ Grains Markets

 

We sell distillers’ grains as animal feed for beef and dairy cattle, poultry, and hogs. Most of the distillers’ grains that we sell are in the form of dried distillers’ grains.  Currently, the U.S. ethanol industry exports a significant amount of dried distillers’ grains, which may increase as worldwide acceptance grows. According to the U.S. Grains Council, total U.S. distiller’s grains exports through October 2019 decreased significantly compared to distiller’s grains exports for the same period last year. Top export markets include Mexico, Japan, Canada, Colombia, China, and South Korea.

 

Historically, the United States ethanol industry exported a significant amount of distillers’ grains to China and Vietnam. However, during 2016, China began an anti-dumping and countervailing duty investigation related to distillers’ grains imported from the U.S. which contributed to a decline in distillers’ grains shipped to China during 2016. In January 2017, China issued final tariffs on U.S. distillers’ grains. The Chinese distillers’ grains anti-dumping tariffs range from 42.2% to 53.7% and the anti-subsidy tariffs range from 11.2% to 12%. The imposition of these duties has resulted in a significant decline in demand from this top importer requiring U.S. producers to seek out alternative markets.  Exports to China are substantially below the pre-tariff export levels. There is no guarantee that distillers’ grains exports to China will return to pre-tariff levels.

 

On January 15, 2020, President Trump signed a “phase one” trade agreement with China, which is to take effect within 30 days of its signing. The agreement includes a commitment by China to purchase agricultural products over the next two years, including distillers’ grains. The agreement will also provide U.S. manufacturers of DDGS with a streamlined process for registration and licensing in order to facilitate U.S. exports to China. While this agreement appears positive for the industry, there is no guarantee that the agreement will be fully implemented, nor is there a guarantee that exports to China return to pre-tariff levels.

 

We also sell modified wet distillers’ grains, which typically have a shelf life of a maximum of 7 days.  This provides for a much smaller, more local market and makes the timing of its sale critical. Further, because of its moisture content, the modified wet distillers’ grains are heavier and more difficult to handle. The customer must be close enough to justify the additional handling and shipping costs. As a result, modified wet distillers’ grains are principally sold only to local feedlots and livestock operations.

 

Various factors affect the price of distillers’ grains, including, among others, the price of corn, soybean meal and other alternative feed products, the performance or value of distillers’ grains in a particular feed market, and the supply and demand within the market.  Like other commodities, the price of distillers’ grains can fluctuate significantly.

 

Corn Oil Markets

 

Our corn oil is primarily sold to biodiesel manufacturers and, to a lesser extent, feed lot and poultry markets. We generally transport our corn oil by truck to users located primarily in the upper Midwest.

 

Distribution of Principal Products

 

Our ethanol plant is located in Heron Lake, Minnesota in Jackson County. We selected the plant site because of its accessibility to road and rail transportation and its proximity to grain supplies.  The ethanol plant has the facilities necessary to load ethanol and distillers’ grains onto trucks and rail cars.  It is served by the Union Pacific Railroad. Our site is in close proximity to major highways that connect to major population centers such as Minneapolis, Minnesota; Chicago, Illinois; and Detroit, Michigan.

 

Ethanol Distribution

 

Eco-Energy is our ethanol marketer.  Pursuant to our marketing agreement with Eco-Energy, it has agreed to purchase and market the entire ethanol output of our ethanol plant.  Additionally, Eco-Energy arranges for the

8

 

transportation of our ethanol.  We pay Eco-Energy a marketing fee based on a percentage of the applicable sales price per gallon of ethanol sold, as well as a fixed lease fee for rail cars leased from Eco-Energy. The marketing fee was negotiated based on prevailing market-rate conditions for comparable ethanol marketing services.

 

The term of our agreement with Eco-Energy expires on December 31, 2020.  However, the agreement provides for automatic renewals for additional consecutive terms of one year unless either party provides written notice to the other at least 90 days prior to the end of the then-current term.    

 

Distillers’ Grains Distribution

 

Gavilon Ingredients, LLC (“Gavilon”) serves as the distillers’ grains marketer for our plant pursuant to a distillers’ grains off-take agreement.  Pursuant to our agreement with Gavilon, Gavilon purchases all of the distillers’ grains produced at our ethanol plant.  We pay Gavilon a service fee for its services under this agreement. The contract commenced on November 1, 2013 with an initial term of six months, and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 60 days to the other party.

 

Corn Oil Distribution

 

RPMG, Inc. (“RPMG”) markets the corn oil produced at our ethanol plant pursuant to a corn oil marketing agreement.  We pay RPMG a commission based on each pound of corn oil sold by RPMG under the agreement.

 

We independently market and sell the excess corn syrup occasionally produced from the distillation process at our plant to local livestock feeders.

 

Dependence on One or a Few Major Customers

 

As discussed above, we have exclusive ethanol marketing agreements with Eco-Energy. Additionally, we have agreements with Gavilon and RPMG to market all of the distillers’ grains and corn oil, respectively, produced at the plant. We rely on Eco-Energy, RPMG and Gavilon for the sale and distribution of all of our products, therefore, we are highly dependent on Eco-Energy, RPMG and Gavilon for the successful marketing of our products. Any loss of these companies as our marketing agents for our ethanol, distillers’ grains, or corn oil could have a negative impact on our revenues.

 

Seasonality of Ethanol Sales

 

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.

 

Pricing of Corn and Ethanol

 

We expect that ethanol sales will represent our primary revenue source and corn will represent our primary component of cost of goods sold.  Therefore, changes in the price at which we can sell the ethanol we produce and the price at which we buy corn for our ethanol plant present significant operational risks inherent in our business. Trends in ethanol prices and corn prices are subject to a number of factors and are difficult to predict.

 

The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy and foreign trade. With the volatility of the weather and commodity markets, we cannot predict the future price of corn. Historically, ethanol prices have tended to correlate with corn prices, as well as wholesale gasoline prices; with demand for and the price of ethanol increasing as supplies of petroleum decreased or appeared to be threatened, crude oil prices increased and wholesale gasoline prices increased. However, the prices of both ethanol and corn do not always follow historical trends. 

 

9

 

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 plants.  Because the market price of ethanol is not directly related to corn prices, we, like most ethanol producers, are not able to compensate for increases in the cost of corn through adjustments in our prices for our ethanol, although we do tend to see increases in the prices of our distillers’ grains during times of higher corn prices. Given that ethanol sales comprise a majority of our revenues, our inability to adjust our ethanol prices can result in a negative impact on our profitability during periods of high corn prices.

 

Ethanol prices were slightly higher during fiscal year 2019 compared to fiscal year 2018.  Ethanol prices were higher during the fiscal year ended October 31, 2019 due to decreased ethanol stocks compared to the fiscal year ended October 31, 2018.  Management expects additional volatility for the price of ethanol in 2020.  According to EIA forecasts, ethanol production is projected to increase slightly in 2020, and demand is expected to remain steady. However, there is no guarantee that either of these forecasts will occur.  Due to tariffs and international competition, exports fell in 2019, and it appears unlikely that the export market will improve in 2020.  U.S. gas demand decreased slightly year over year in 2019, while ethanol as a percentage of the fuel supply remained steady. Ethanol consumption is projected to remain flat in 2020; however, there is no guarantee that this projection will be accurate.  A decrease in demand for either gasoline or ethanol blends would adversely impact the price of ethanol, which could result in a material adverse effect on our business, results of operations and financial condition

 

Sources and Availability of Raw Materials

 

The primary raw materials used in the production of ethanol at our plant are corn and natural gas.  Our ethanol plant also requires significant and uninterrupted amounts of electricity and water.  We have entered into agreements for our supply of electricity, natural gas, and water.

 

Corn Procurement

 

Ethanol production requires substantial amounts of corn. The cost of corn represented approximately 74.0%, 71.8%, and 72.9% of our cost of sales for the years ended October 31, 2019, 2018, and 2017, respectively.  At our current production rate of approximately 65 million gallons of ethanol per year, we need to consume approximately 22.5 million bushels of corn per year for our dry mill ethanol process.  We believe our facility has sufficient corn storage capacity, with the capability to store approximately 8 days of corn supply.

 

We generally purchase corn through spot cash, fixed-price forward, basis only, and futures only contracts. Our fixed-price forward contracts specify the amount of corn, the price and the time period over which the corn is to be delivered.  These forward contracts are at fixed prices indexed to Chicago Board of Trade (“CBOT”) prices. Our corn requirements can be contracted in advance under fixed-price forward contracts or options. The parameters of these contracts are based on the local supply and demand situation and the seasonality of the price. For delayed pricing contracts, producers will deliver corn to us, but the pricing for that corn and the related payment will occur at a later date. We may also purchase a portion of our corn on a spot basis. For our spot purchases, we post daily corn bids so that corn producers can sell to us on a spot basis.

 

Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota. We compete with ethanol producers in close proximity for the supplies of corn we will require to operate our plant.  There are 8 ethanol plants within an approximate 50 mile radius of our plant. The existence of other ethanol plants, particularly those in close proximity to our plant, increase the demand for corn and may result in higher costs for supplies of corn. We also compete with other users of corn, including ethanol producers regionally and nationally, producers of food and food ingredients for human consumption (such as high fructose corn syrup, starches, and sweeteners), producers of animal feed and industrial users.

 

Since corn is the primary raw material we use to produce our products, the availability and cost of corn can have a significant impact on the profitability of our operations. Corn prices were higher during our 2019 fiscal year due to adverse weather conditions, which led to less supply. If we continue to experience unfavorable weather conditions during our 2020 fiscal year, the price we pay for corn and the availability of corn near our plant could be negatively impacted. If we experience a localized shortage of corn, we may be forced to purchase corn from producers who are farther away from our ethanol plant which can increase our transportation costs.

 

10

 

Natural Gas Procurement

 

The primary source of energy in our manufacturing process is natural gas.  The cost of natural gas represented approximately 6.3%, 6.4%, and 6.7% of our cost of sales for the years ended October 31, 2019, 2018, and 2017, respectively. 

 

We do not anticipate any problems securing the natural gas we require to continue to operate our plant at capacity during our 2020 fiscal year or beyond.  We have a facilities agreement with Northern Border Pipeline Company, which allows us to access an existing interstate natural gas pipeline located approximately 16 miles north from our plant. We also have entered into a firm natural gas transportation agreement with our indirectly wholly owned subsidiary, Agrinatural.  Under the terms of the firm natural gas transportation agreement, Agrinatural will provide natural gas to the plant with a specified price per MMBTU for a term ending on October 31, 2021, with one automatic renewal option to extend the term an additional five years. 

 

We also have a base agreement for the sale and purchase of natural gas with Constellation NewEnergy—Gas Division, LLC.  We buy all of our natural gas from Constellation, and this agreement runs until March 31, 2022.

 

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, dried 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.

 

Electricity

 

Our plant requires a continuous supply of electricity. We have an agreement in place to supply electricity to our plant. Our plant obtains its electricity from Federal Rural Electric. We do not anticipate any problems securing the electricity that we require to continue to operate our plant at capacity during our 2020 fiscal year or beyond.

 

Water

 

Our plant also requires a continuous supply of water, which we obtain pursuant to an industrial water supply agreement with the City of Heron Lake and Jackson County, Minnesota. We do not anticipate any problems securing the water that we require to continue to operate our plant at capacity during our 2020 fiscal year or beyond.

 

Risk Management and Hedging

 

The profitability of our operations is highly dependent on the impact of market fluctuations associated with commodity prices.  We use various derivative instruments as part of an overall strategy to manage market risk and to reduce the risk that our ethanol production will become unprofitable when market prices among our principal commodities and products do not correlate.  

 

In order to mitigate our commodity and product price risks, we enter into hedging transactions, including forward corn, ethanol, distillers’ grains and natural gas contracts, in an attempt to partially offset the effects of price volatility for corn and ethanol.  However, we are not always presented with an opportunity to lock in a favorable margin and our plant’s profitability may be negatively impacted during periods of high grain prices. We also enter into over-the-counter and exchange-traded futures, swaps and option contracts for corn, ethanol and distillers’ grains, designed to limit our exposure to increases in the price of corn and manage ethanol price fluctuations.  

 

Although we believe that our hedging strategies can reduce the risk of price fluctuations, the financial statement impact of these activities depends upon, among other things, the prices involved and our ability to physically receive or deliver the commodities involved.  Our hedging activities could cause net income 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 corn and ethanol prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments.

11

 

 

Hedging arrangements expose us to the risk of financial loss in situations where the counterparty to the hedging contract defaults or, in the case of exchange-traded contracts, where there is a change in the expected differential between the price of the commodity underlying the hedging agreement and the actual prices paid or received by us for the physical commodity bought or sold.  There are also situations where the hedging transactions themselves may result in losses, as when a position is purchased in a declining market or a position is sold in a rising market. Hedging losses may be offset by a decreased cash price for corn and natural gas and an increased cash price for ethanol and distillers’ grains.

 

We have established a risk management committee which assists the board and our risk management manager to, among other things, establish appropriate policies and strategies for hedging and enterprise risk. We continually monitor and manage our commodity risk exposure and our hedging transactions as part of our overall risk management policy.  As a result, we may vary the amount of hedging or other risk mitigation strategies we undertake, and we may choose not to engage in hedging transactions.  Our ability to hedge is always subject to our liquidity and available capital.

 

Process Improvement

 

We are continually working to develop new methods of operating the ethanol plant more efficiently.  We continue to conduct process improvement activities in order to realize these efficiency improvements.

 

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 was included in the amount we paid to Fagen, Inc. to design and build our ethanol plant.

 

Competition

 

Ethanol Competition

 

We sell our ethanol in a highly competitive market.  Ethanol is a commodity product where competition in the industry is predominantly based on price. On a national scale, we are in direct competition with numerous other ethanol producers.  According to the Renewable Fuels Association (the “RFA”), there are approximately 199 biorefineries with a total nameplate capacity of approximately 16.9 billion gallons of ethanol per year, with an additional four plants under expansion or construction with capacity to produce an additional 183 million gallons.  However, the RFA estimates that approximately 5.4% of the ethanol production capacity in the U.S. was not operating as of its latest available data. 

 

The following table identifies the top five largest ethanol producers in the U.S. along with their production capacities.

 

 

 

 

 

    

Nameplate Capacity

 

Company

 

(mmgy)

 

Valero Renewable Fuels

 

1,730

 

Archer Daniels Midland

 

1,716

 

Green Plains, Inc.

 

1,128

 

POET Biorefining

 

970

 

Flint Hills Resources LP

 

840

 

Source: Renewable Fuels Association

 

 

 

 

Each of the large ethanol producers above are capable of producing significantly more ethanol than we produce. These producers and other large producers are, among other things, capable of producing a significantly greater amount of ethanol or have multiple ethanol plants that may help them achieve certain benefits that we could not achieve with one ethanol plant. This could put us at a competitive disadvantage to other ethanol producers.

 

Larger ethanol producers may have an advantage over us from economies of scale and stronger negotiating positions with purchasers.  Large producers own multiple ethanol plants and may have flexibility to run certain facilities while shutting or slowing down production at their other facilities. This added flexibility may allow these producers to compete more effectively, especially during periods when operating margins are unfavorable in the ethanol industry.

 

12

 

Some large producers own ethanol plants in geographically diverse areas of the U.S. and as result, may be able to more effectively spread the risk they encounter related to feedstock prices. Some of our competitors are owned subsidiaries of larger oil companies, such as Valero Renewable Fuels and Flint Hills Resources. Because their parent oil companies are required to blend a certain amount of ethanol each year, these competitors may be able to operate their ethanol production facilities at times when it is unprofitable for us to operate our ethanol plant. Further, new products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages over us and harm our business.

 

A majority of the U.S. ethanol plants, and therefore, the greatest number of gallons of ethanol production capacity, are concentrated in the corn-producing states of Iowa, Nebraska, Illinois, Indiana, Minnesota, South Dakota, Ohio, Wisconsin, Kansas, and North Dakota.  According to the RFA, Minnesota is one of the top producers of ethanol in the U.S. with 18 ethanol plants producing an aggregate of approximately 1.2 billion gallons of ethanol per year. Therefore, we face increased regional and local competition because of the location of our ethanol plant. 

 

Eco-Energy markets our ethanol primarily on a regional and national basis.  We compete with other ethanol producers both for markets in Minnesota and markets in other states. We believe that we are able to reach the best available markets through the use of our experienced marketer and by the rail delivery methods we use. We believe that we can compete favorably with other ethanol producers due to our proximity to ample grain, natural gas, electricity and water supplies at favorable prices.

 

In addition to intense competition with domestic producers of ethanol, we have faced increased competition from ethanol produced in foreign countries. Depending on feedstock prices, ethanol imported from foreign countries may be less expensive than domestically-produced ethanol.  However, foreign demand, transportation costs and infrastructure constraints may temper the market impact on the United States. Ethanol imports have been lower in recent years. However, if demand for imported ethanol were to increase again, demand for domestic ethanol may be reduced, which could lead to lower domestic prices and lower operating margins. Large international companies with much greater resources than ours have developed, or are developing, increased foreign ethanol production capacities. Many international suppliers produce ethanol primarily from inputs other than corn, such as sugar cane, and have cost structures that may be substantially lower than U.S. based ethanol producers including us. Many of these international suppliers are companies with much greater resources than us with greater production capacities.

 

Competition from Alternative Fuels and Other Fuel Additives

 

Alternative fuels and alternative ethanol production methods are continually under development. New ethanol products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages over us and harm our business.

 

We 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 that is being explored is cellulose. Cellulose is found in wood chips, corn stalks and rice straw, amongst other common plants. Several companies and researchers have commenced pilot projects to study the feasibility of commercially producing cellulosic ethanol. Additionally, a few companies have begun construction or completed commercial scale cellulosic ethanol plants. 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. 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.

 

In addition to competing with ethanol producers, we also compete with producers of other gasoline oxygenates.  Many gasoline oxygenates are produced by other companies, including oil companies.  The major oil companies have significantly greater resources than we have to develop alternative products and to influence legislation and public perception of ethanol. Historically, as a gasoline oxygenate, ethanol primarily competed with two gasoline oxygenates, both of which are ether-based: MTBE (methyl tertiary butyl ether) and ETBE (ethyl tertiary butyl ether).  While ethanol has displaced these two gasoline oxygenates, the development of ethers intended for use as oxygenates is continuing and we will compete with producers of any future ethers used as oxygenates.

 

A number of automotive, industrial and power generation manufacturers are developing alternative fuels and clean power systems using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Electric car

13

 

technology has recently grown in popularity, especially in urban areas. While there are currently a limited number of vehicle recharging stations, there has been increased focus on developing these recharging stations to make electric car technology more feasible and widely available in the future. Additional competition from these other sources of alternative energy, particularly in the automobile market, could reduce the demand for ethanol, which would negatively impact our profitability.

 

Distillers’ Grains Competition

 

The amount of distillers’ grains produced annually in North America has increased significantly as the number of ethanol plants has increased.  We compete with other producers of distillers’ grains products both locally and nationally, with more intense competition for sales of distillers’ grains among ethanol producers in close proximity to our ethanol plant.  These competitors may be more likely to sell to the same markets that we target for our distillers’ grains.

 

Distillers’ grains are primarily used as an animal feed, competing with other feed formulations using corn and soybean meal. As a result, we believe that distillers’ grains prices are positively impacted by increases in corn and soybean prices. In recent years, the U.S. ethanol industry increased exports of distillers’ grains. However, exports of distillers’ grains fell in 2019 as compared to 2018, due partially to currency devaluation and related issues in Turkey, in addition to Chinese import duties on U.S. distillers’ grains. The decline in exports increases the domestic supply of distillers’ grains, which has a corresponding negative impact on the price of distillers’ grains as compared to a comparable volume of corn. Continued decreases in distillers’ grains exports could result in increased competition among ethanol producers for sales of distillers’ grains and could negatively impact distillers’ grains prices in the U.S.

 

Corn Oil Competition

 

We compete with many ethanol producers for the sale of corn oil. Many ethanol producers have installed the equipment necessary to separate corn oil from the distillers’ grains they produce which has increased competition for corn oil sales and has resulted in lower market corn oil prices.

 

Government Ethanol Supports

 

The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which is the federal Renewable Fuels Standard (the “RFS”). The RFS 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 has been, and we expect will continue to be, a significant factor impacting ethanol usage.

 

Under the RFS, the EPA is required to pass an annual rule that establishes the number of gallons of different types of renewable fuels that must be used in the U.S. by refineries, blenders, distributors and importers, which are known as renewable volume obligations (“RVOs”). The EPA has the authority to waive the mandates in whole or in part if one of two conditions have been met: 1) there is inadequate domestic renewable fuel supply, or 2) implementation of the mandate requirement would severely harm the economy or environment of a state, region or the United States.

 

The RFS sets the statutory RVO for corn-based ethanol at 15 billion gallons beginning in 2016 and each year thereafter through 2022. On December 19, 2019, the EPA announced the final 2020 RVOs, setting the RVOs for conventional ethanol at 15.0 billion gallons, advanced biofuels at 5.09 billion gallons and cellulosic ethanol at 0.59 billion gallons, for overall RVOs of 20.09 billion gallons for 2020.  Although this final rule achieves the statutory RVO for conventional corn-based ethanol, it reduces the overall RVOs below the overall statutory level of 30 billion gallons. 

 

On November 30, 2018, the EPA announced the final rule for 2019 RVOs, which was set at 15.0 billion gallons for corn-based ethanol. The 2019 final rule also set advanced biofuels at 4.92 billion gallons and cellulosic ethanol at 0.42 billion gallons, for overall RVOs of 19.92 billion gallons for 2019. While the 2019 final rule met the statutory RVO for conventional corn-based ethanol originally set by Congress, it fell substantially below the statutory RVO overall level of 28 billion gallons.  

14

 

The following chart illustrates the potential U.S. ethanol demand based on the schedule of minimum usage established by the RFS program through the year 2022 (in billions of gallons):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maximum Amount of Corn-based

 

 

 

 

Total Renewable

 

Cellulosic

 

Biodiesel

 

Advanced Biofuel

 

 Ethanol That Can Be Used to 

Year

    

RVO Source

    

Fuel RVO

    

Ethanol RVO

 

RVO

    

RVO

    

Satisfy Total Renewable Fuel RVO

2017

 

RFS Statute

 

24.00

 

5.50

 

 -

 

9.00

 

15.00

 

 

EPA Final Rule(1)

 

19.28

 

0.31

 

2.00

 

4.28

 

15.00

2018

 

RFS Statute

 

26.00

 

7.00

 

 -

 

11.00

 

15.00

 

 

EPA Final Rule(2)

 

19.29

 

0.29

 

2.10

 

4.29

 

15.00

2019

 

RFS Statute

 

28.00

 

8.50

 

 -

 

13.00

 

15.00

 

 

EPA Final Rule(3)

 

19.92

 

0.42

 

2.10

 

4.92

 

15.00

2020

 

RFS Statute

 

30.00

 

10.50

 

 -

 

15.00

 

15.00

 

 

EPA Final Rule(4)

 

20.09

 

0.59

 

2.43

 

5.09

 

15.00

2021

 

RFS Statute

 

33.00

 

13.50

 

 -

 

18.00

 

15.00

2022

 

RFS Statute

 

36.00

 

16.00

 

 -

 

21.00

 

15.00

(1)Final EPA RFS RVOs for 2017 issued November 2016.

(2)Final EPA RFS RVOs for 2018 issued November 2017.

(3)Final EPA RFS RVOs for 2019 issued November 2018.

(4)Final EPA RFS RVOs for 2020 issued December 2019.

 

Ethanol production capacity exceeded the EPA’s 2018 and 2019 RVOs that could be satisfied by corn-based ethanol.  Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered a proposed RFS “reset” rule to the Office of Management and Budget. If the statutory RVOs are reduced as a result of such reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

Beginning in January 2016, various ethanol and agricultural industry groups petitioned a federal appeals court to hear a legal challenge to of the EPA’s decision to reduce the total renewable fuel volume requirements for 2014-2016 through use of its “inadequate domestic supply” waiver authority.  On July 28, 2017, the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the petitioners, concluding that the EPA erred in its exercise of “inadequate domestic supply” waiver authority by considering demand-side constraints. As a result, the Court vacated the EPA’s decision to reduce the total renewable fuel volume requirements for 2016, and remanded to the EPA to address the 2016 total renewable fuels volume requirements. In December 2019, the EPA announced that it is deferring action on this issue until an anticipated date in early 2020. While management believes the decision should benefit the ethanol industry overall by clarifying the EPA's waiver analysis is limited to consideration of supply-side factors only, no direct impact on the Company is expected from the decision.

 

Management anticipates that there will be further legal challenges to the EPA's reduction in the volume requirements, including the final rules for 2018, 2019, and 2020. However, if the EPA's decision to reduce the volume requirements under the RFS is allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance. 

 

Beyond the federal mandates, there are limited domestic markets for ethanol.  Further, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress.  If such efforts are successful in further reducing or repealing the blending requirements of the RFS, a significant decrease in ethanol demand may result and could have a material adverse effect on our results of operations, cash flows and financial condition, unless additional demand from exports or discretionary or E85 blending develops.

 

Most ethanol that is used in the U.S. 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 U.S. is approximately 143 billion gallons per year. Assuming that all gasoline in the U.S. is blended at a rate of 10% ethanol and 90% gasoline, the maximum demand for ethanol is 14.3 billion gallons per year.  This is commonly referred to as the “blend 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

15

 

gasoline that is being used in the U.S. and it discounts the possibility of additional ethanol used in higher percentage blends such as E15 and E85. These higher percentage blends may lead to additional ethanol demand if they become more widely available and accepted by the market.

 

There is growing availability of E85 for use in flexible fuel vehicles, however it is limited due to lacking infrastructure. In addition, the industry has been working to introduce E15 to the retail market since the EPA approved its use in vehicles model year 2001 and newer. However, widespread adoption of E15 is hampered by regulatory and infrastructure hurdles in many states, as well as consumer acceptance. Additionally, sales of E15 may be limited because: (i) it is not approved for use in all vehicles; (ii) the EPA requires a label that management believes may discourage consumers from using E15; and (iii) retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This prevented E15 from being used during certain times of the year in various states. However, on May 30, 2019, the EPA issued a final rule which allows E15 to be sold year-round. In June 2019, the American Fuel and Petrochemical Manufacturers association filed a lawsuit in the U.S. Court of Appeals for the District of Columbia challenging the final rule. Additionally, in August 2019, the Small Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the District of Columbia seeking review of the final rule. There is no guarantee that the final rule will be upheld. Legal challenges could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.

 

Obligated parties use renewable identification numbers (“RINs”) to show compliance with RFS-mandated volumes. RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market. The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties. Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. On December 19, 2019, the EPA released data on the number of waivers filed, which indicated that, as of December 19, 2019, 16 petitions for waivers for the 2019 compliance year have been received. For the 2018 compliance year, 42 petitions have been received. To date, the EPA has approved 31 petitions and denied 6 petitions, and 5 petitions have been declared ineligible or withdrawn. The 31 approved petitions have exempted approximately 1.43 billion RINs, which is approximately 13.42 billion gallons of gasoline and diesel, from meeting the RFS blending targets. The 35 approved petitions for compliance year 2017 exempted approximately 1.82 billion RINs, which is approximately 17.05 billion gallons of gasoline and diesel, from meeting the RFS blending targets. It is expected that additional petitions for waivers for the 2019 compliance year will be received by the EPA. It is also expected that the EPA will approve a significant number of these waiver petitions, thereby exempting a substantial number of gallons of gasoline and diesel from meeting the RFS blending targets. These exemptions decrease demand for our products, which negatively impacts ethanol prices and our profitability.

 

A proposed rule released by the EPA in October 2019 proposed changes intended to project the exempted volume of gasoline and diesel due to small refinery exemptions, regardless of whether such exemptions were actually granted after the annual rulemaking. However, the final rule released by the EPA in December 2019 provides that EPA will project exempt volumes based on a three-year average of the relief recommended by the Department of Energy (“DOE”) for years 2016-2018, rather than based on actual exemptions granted. For the 2016 compliance year, the EPA said the DOE’s recommended relief was approximately 440 million RINs. The EPA, however, actually granted waivers for approximately 790 million RINs. Similarly, the DOE’s 2017 compliance year recommendation was 1.02 billion RINs, as compared to the approximately 1.82 billion RINs granted waivers by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs granted waivers by the EPA. The EPA’s final rule also announced its general policy approach with respect to small refinery waivers on a go-forward basis as consistent with DOE’s recommendations, where appropriate. The final rule fell short of the relief that was urged by ethanol producers. As a result, management expects that small refinery exemptions will continue to have a negative effect on demand for our products, ethanol prices, and our profitability. 

 

Compliance with Environmental Laws and Other Regulatory Matters

 

Our business subjects us to various federal, state, and local environmental laws and regulations, including: those relating to discharges into the air, water, and ground; the generation, storage, handling, use, transportation, and disposal of hazardous materials; and the health and safety of our employees. These laws and regulations require us to obtain and comply with numerous permits to construct and operate our ethanol plant, including water, air, and other

16

 

environmental permits.  The costs associated with obtaining these permits and meeting the conditions of these permits have increased our costs of construction and production.  Additionally, compliance with environmental laws and permit conditions in the future could require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment, as well as significant management time and expense.  A violation of these laws, regulations or permit conditions can result in substantial fines, natural resource damage, criminal sanctions, permit revocations, and/or plant shutdown, any of which could have a material adverse effect on our operations.  Although violations and environmental non-compliance still remain a possibility following our conversion from coal to natural gas combustion, the exposure to the company has been greatly reduced.

 

Our air permit requires certain on-going performance testing to be completed periodically to ensure compliance with minor source emission limits. On May 12, 2017, we submitted a letter to the Minnesota Pollution Control Agency (“MPCA”) regarding the certain non-compliant results from on-going performance testing required under our air permit. Since reporting to MPCA, The Company cooperated with MPCA’s review of the non-compliant tests and maintained open communication with MPCA staff to resolve the matter.  On October 17, 2017, we entered into a stipulation agreement with MPCA relating to the non-compliant test results.  Under the stipulation agreement, we agreed to pay a civil penalty of $63,500, which was paid in October 2017.

 

For the fiscal year ended October 31, 2017, we incurred costs and expenses of approximately $265,000 complying with environmental laws, including civil penalties for non-compliance.  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. For the fiscal year ended October 31, 2018, we incurred costs and expenses of approximately $133,000 complying with environmental laws. For the fiscal year ended October 31, 2019, we incurred costs and expenses of approximately $88,000 complying with environmental laws.

 

On January 13, 2015, we submitted an efficient producer petition to the EPA which was approved by the EPA on March 12, 2015.  In the approval determination, the EPA’s analysis indicated that we achieved at least a 20.1% reduction in greenhouse gas (“GHG”) emissions for their non-grandfathered volumes compared to the baseline lifecycle GHG emissions. Pursuant to the award approval, we are only authorized to generate RINs for our plant’s non-grandfathered volumes if we can demonstrate that all ethanol produced at the plant during an averaging period (defined as the prior 365 days or the number of days since the date of the EPA efficient producer pathway approval) meets the 20% GHG reduction requirement. To make this demonstration, we must comply with the compliance plan we developed and keep certain records as specified in the EPA’s approval.  Additionally, we must register with the EPA as a renewable fuel producer for the non-grandfathered volumes.  Although we believe we will be able to maintain continuous compliance with the 20% reduction in GHG emissions requirement, there is no guarantee that we will do so.  If we do not maintain continuous compliance with the 20% reduction in GHG emissions requirement, we will not be able issue RINs for the non-grandfathered volumes of ethanol produced at our plant.  As a result, we may be forced to rely on export sales for these non-grandfathered volumes of ethanol, which could adversely affect our operating margins, which, in turn could adversely affect our results of operations, cash flows and financial condition.

 

The California Air Resources Board, or CARB, has adopted a Low Carbon Fuel Standard, or LCFS, requiring a 10% reduction in average carbon intensity of gasoline and diesel transportation fuels from 2010 to 2020.  After a series of rulings that temporarily prevented CARB from enforcing these regulations, 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. On June 30, 2014, the U.S. Supreme Court declined to hear the appeal of the federal appellate court ruling and CARB recently re-adopted the LCFS with some slight modifications. The LCFS could have a negative impact on demand for corn-based ethanol and result in decreased ethanol prices affecting our ability to operate profitably. 

 

Exports to China have been negligible since the imposition of a 70% tariff in July 2018. It is unclear when the tariffs will be reduced, if ever, and therefore, this tariff is likely to continue to have a negative impact on the export market demand and prices for ethanol produced in the United States. Additionally, in September 2019, Brazil set its import quota at 187.5 million liters, or 49.5 million gallons, per quarter, before the imports become subject to the 20% tariff. This quota has resulted in decreases of ethanol exported to Brazil. The import quota and tariff may continue to have a negative impact on the export market demand and prices for ethanol produced in the United States.

 

17

 

Employees

 

We compete with ethanol producers in close proximity of our facility for the personnel required to operate our plant.  The existence and development of other ethanol plants will increase competition for qualified managers, engineers, operators and other personnel.  We also compete for personnel with businesses other than ethanol producers and with businesses located outside the community of Heron Lake, Minnesota.

 

As of the date of this report, we have 40 full time employees, of which 7 employees are involved primarily in management and administration and the remaining employees are involved primarily in plant operations.  We do not currently anticipate any significant change in the number of employees at our plant.

 

We have entered into a management services agreement with Granite Falls Energy.  Pursuant to the management services agreement, GFE provides its chief executive officer, chief financial officer, and commodity risk manager to act in those positions as part-time officers and managers of the Company.  Each person providing management services to the Company under the management services agreement is subject to oversight by our board of governors.  However, the chief executive officer is solely responsible for hiring and firing persons providing management services under the management services agreement.

 

The initial term of the management services agreement automatically renews for successive one-year terms until either party gives the other party written notice of termination prior to expiration of the then current term. The management services agreement may also be terminated by either party for cause under certain circumstances.

 

GFE is responsible for and agreed to directly pay salary, wages, and/or benefits to the persons providing management services under the management services agreement.  Under the terms of the management services agreement, the Company pays GFE 50% of the estimated total salary, bonuses and other expenses and costs (including all benefits and tax contributions) incurred by GFE for the three management positions on a monthly basis with a “true-up” following the close of GFE’s fiscal year.

 

Natural Gas Pipeline Segment

 

Through our wholly owned subsidiary, HLBE Pipeline Company, we indirectly own 100% of Agrinatural Gas, LLC, a Delaware limited liability company (“Agrinatural”). On October 18, 2019, HLBE Pipeline Company entered into an agreement to purchase RES’s 27% non-controlling interest in Agrinatural, which became effective on December 11, 2019. Prior to December 11, 2019, Rural Energy Solutions, LLC (“RES”) owned a 27% non-controlling interest in Agrinatural.

 

Agrinatural is governed by a 3-member board of managers.  As the sole member of the sole member of Agrinatural, we have the right to appoint all of the managers of Agrinatural.

 

Agrinatural is a natural gas distribution and sales company located in Heron Lake, Minnesota.  Agrinatural’s natural gas pipeline originates from an interconnection with the natural gas transmission pipeline of Northern Border Pipeline Company approximately seven miles southwest of Jeffers, Minnesota in Cottonwood County. Agrinatural currently owns and operates approximately 190 miles of pipeline, including 164 miles of distribution mains and 26 miles of service lines. The Agrinatural pipeline was initially installed in 2011 to serve the Company.  Since the initial installation of the pipeline, Agrinatural has added several other commercial, agricultural and residential customers in the communities and surrounding areas of Heron Lake, Jeffers, Delft, Dundee, Storden, and Okabena, Minnesota. 

 

Prior to July 1, 2019, Agrinatural had a management and operating agreement with Swan Engineering, Inc. (“SEI”), an affiliate of RES, whereby SEI provided Agrinatural with day-to-day management and operation of Agrinatural’s pipeline distribution business.  In exchange for these services, Agrinatural paid SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500. For the fiscal year ended October 31, 2019, the Company paid SEI approximately $28,000 of monthly base fees and approximately $111,000 of variable customer management fees. The management and operating agreement with SEI expired July 1, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.

 

18

 

Prior to July 1, 2019, Agrinatural also had a project management agreement with SEI, whereby SEI supervised all of Agrinatural’s pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the project management agreement, Agrinatural paid SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural’s board of managers, excluding capitalized marketing costs. For the fiscal year ended October 31, 2019, the Company paid SEI approximately $45,000 for project management and capital work fees. The project management agreement with SEI expired June 30, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.

 

The Company has two intercompany credit facilities with Agrinatural: a July 2014 credit facility (the “Original Credit Facility”) and a March 2015 credit facility (the “Additional Credit Facility”). Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural. Subsequent to the closing of the Company’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Original Agrinatural Credit Facility.

 

On May 19, 2016, the Company amended the Additional Credit Facility, entering into an amendment to the loan agreement dated March 30, 2015 and an allonge to the negotiable promissory note dated March 30, 2015 issued by Agrinatural to the Company. Under the terms of the amendment and allonge, the Company agreed to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility and defer a portion of the principal payments required for 2016 and capitalize the deferred principal to the balloon payment due at maturity. Subsequent to the closing of the Company’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Additional Agrinatural Credit Facility.

 

Details of the Agrinatural credit facilities are provided below in the section below entitled “PART II - ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Credit Arrangements”.

 

Assets from our natural gas pipeline segment have represented 22.1%, 20.1%, and 18.1% of our consolidated total assets in the years ended October 31, 2019, 2018, and 2017, respectively.  Agrinatural’s assets consist of distribution main pipelines and service pipelines, together with the associated easement and land rights, a town border station, meters and regulators, office and other equipment and construction in process.

 

Agrinatural’s revenues are generated through natural gas distribution fees and sales, including distribution fees paid by the Company pursuant to our firm natural gas transportation agreement with Agrinatural.  Before intercompany eliminations, revenues from our natural gas pipeline segment represented 3.0%, 3.2%, and 2.7% of our total consolidated revenues in the years ended October 31, 2019, 2018, and 2017, respectively.  After accounting for intercompany eliminations for fees from the Company for natural gas transportation services, Agrinatural’s revenues represented 1.3%, 1.5%, and 1.1% of our consolidated revenues for the fiscal years ended October 31, 2019, 2018, and 2017, respectively, and have little to no impact on the overall performance of the Company.

 

Financial Information about Geographic Areas

 

All of our operations are domiciled in the U.S., including those of Agrinatural, our majority owned subsidiary.  All of the products sold to our customers for the fiscal years ended October 31, 2019, 2018, and 2017 were produced in the United States, and all of our long-lived assets are domiciled in the United States.

 

For the principal products of our ethanol production segment, we have engaged third party professional marketers who decide where our products are marketed, and we have no 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 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 may face.  The following risks, together with additional risks and uncertainties not currently known to us or that we currently deem immaterial could

19

 

impair our financial condition and results of operation.  If any of the following risks actually occur, our results of operations, cash flows and the value of our units could be negatively impacted.

 

Risks Relating to Our Ethanol Production Operations

 

Because we are primarily dependent upon one product of our ethanol production segment, our business is not significantly diversified, and we may not be able to adapt to changing market conditions or endure any decline in the ethanol industry.

 

Our success depends on our ability to efficiently produce and sell ethanol, and, to a lesser extent, distillers’ grains and corn oil.  Although we operate a natural gas pipeline through our majority owned subsidiary, it does not produce significant revenue to rely upon if we are unable to produce and sell ethanol, distillers’ grains and corn oil, or if the market for those products decline. Our lack of diversification means that we may not be able to adapt to changing market conditions, changes in regulation, increased competition or any significant decline in the ethanol industry.

 

Our profitability depends upon purchasing corn at lower prices and selling ethanol at higher prices and because the difference between ethanol and corn prices can vary significantly, our financial results may also fluctuate significantly.

 

The results of our ethanol production business are highly impacted by commodity prices.  The substantial majority of our revenues are derived from the sale of ethanol. Our gross profit relating to the sale of ethanol is principally dependent on the difference between the price we receive for the ethanol we produce and the cost of corn and natural gas that we must purchase.  Changes in the prices and supplies of corn and natural gas are subject to and determined by market forces over which we have no control, such as weather, domestic and global demand, shortages, export prices, and various governmental policies in the U.S. and around the world. As a result of price volatility for these commodities, our operating results may fluctuate substantially. Increases in corn or natural gas prices or decreases in ethanol, distillers’ grains and corn oil prices may make it unprofitable to operate our plant. No assurance can be given that we will be able to purchase corn and natural gas at, or near, current prices and that we will be able to sell ethanol, distillers’ grains and corn oil at, or near, current prices. Consequently, our results of operations and financial position may be adversely affected by increases in the price of corn or natural gas or decreases in the price of ethanol, distillers’ grains and corn oil.

 

We seek to minimize the risks from fluctuations in the prices of corn and natural gas through the use of hedging instruments.  However, these hedging transactions also involve risks to our business.  If we were to experience relatively higher corn and natural gas costs compared to the selling prices of our products for an extended period of time, the value of our units may be reduced.

 

Sustained negative operating margins may require some ethanol producers to temporarily limit or cease production.

 

Our ability and the ability of other ethanol producers to operate profitably is largely determined by the spread between the price paid for corn and the price received for ethanol.  If this spread is narrow or is negative for a sustained period, some ethanol producers may elect to temporarily limit or cease production until their possibility for profitability returns.  Although we currently have no plans to limit or cease ethanol production, we may be required to do so if we experience a period of sustained negative operating margins.  In such an event, we would still incur certain fixed costs, which would impact our financial performance.

 

Volatility in oil and gas prices may materially affect ethanol pricing and demand.

 

Ethanol has historically traded at a discount to gasoline.  When ethanol trades at a discount to gasoline it encourages discretionary blending, thereby increasing the demand for ethanol beyond required blending rates. Conversely, when ethanol trades at a premium to gasoline, there is a disincentive for discretionary blending and ethanol demand is negatively impacted.  Consequently, ethanol pricing and demand may also be volatile, which makes it difficult to manage profit margins and which could result in a material adverse effect on our business, results of operations and financial condition.

 

20

 

If the supply of ethanol exceeds the demand for ethanol, the price we receive for our ethanol and distillers’ grains may decrease.

 

Domestic ethanol production capacity has increased substantially over the past decade.  However, demand for ethanol may not increase as quickly as expected or to a level that exceeds supply, or at all.

 

Excess ethanol production capacity may result from decreases in the demand for ethanol or increased domestic production or imported supply. There are many factors affecting demand for ethanol, including regulatory developments and reduced gasoline consumption as a result of increased prices for gasoline or crude oil. Higher gasoline prices could cause businesses and consumers to reduce driving or acquire vehicles with more favorable gasoline mileage, or higher prices could spur technological advances, such as the commercialization of engines utilizing hydrogen fuel-cells, which could supplant gasoline-powered engines. There are a number of governmental initiatives designed to reduce gasoline consumption, including tax credits for hybrid vehicles and consumer education programs.

 

Because ethanol production produces distillers’ grains as a co-product, increased ethanol production will also lead to increased production of distillers’ grains. An increase in the supply of distillers’ grains, without corresponding increases in demand, could lead to lower prices or an inability to sell our distillers’ grains production. A decline in the price of distillers’ grains or the distillers’ grains market generally could have a material adverse effect on our business, results of operations and financial condition.

 

Management expects additional volatility for the price of ethanol in 2020.  Ethanol production is expected to increase slightly in 2020, and demand is expected to remain steady in 2020, which may lead to market imbalances. Due to tariffs and international competition, exports fell in 2019, and it appears unlikely that the export market will improve in 2020. U.S. gas demand decreased slightly year over year in 2019, while ethanol as a percentage of the fuel supply remained steady. A decrease in demand for either gasoline or ethanol blends would adversely impact the price of ethanol, which could result in a material adverse effect on our business, results of operations and financial condition.

 

The price of distillers’ grains is affected by the price of other commodity products, such as soybeans, and decreases in the price of these commodities could decrease the price of distillers’ grains.

 

Distillers’ grains compete with other protein-based animal feed products. The price of distillers’ grains may decrease when the price of competing feed products decrease. The prices of competing animal feed products are based in part on the prices of the commodities from which they are derived. Downward pressure on commodity prices, such as soybeans, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers’ grains. The price of distillers’ grains is not tied to production costs. However, decreases in the price of distillers’ grains would result in less revenue from the sale of distillers’ grains and could result in lower profit margins.

 

Historically, sales prices for distillers’ grains have been correlated with prices of corn. However, recently, the price increase for this co-product has lagged behind increases in corn prices. In addition, our distillers’ grains co-product competes with products made from other feedstocks, the cost of which may not have risen as corn prices have risen. Consequently, the price we may receive for distillers grains may not rise as corn prices rise, thereby lowering our cost recovery percentage relative to corn.

 

The prices of ethanol and distillers’ grains may decline as a result of trade barriers imposed by foreign countries with respect to ethanol and distillers’ grains originating in the U.S. and negatively affect our profitability.

 

An increasing amount of our industry’s products are being exported.  The U.S. ethanol industry was bolstered during our 2019 fiscal year with exports of ethanol which increased demand for our ethanol. However, these ethanol exports may not continue. If producers and exporters of ethanol and distillers’ grains are subjected to trade barriers when selling products to foreign customers, such as the tariffs and quotas currently in effect, there may be a reduction in the price of these products in the U.S.  Declines in the price we receive for our products will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably.

 

If U.S. producers can not satisfy import requirements imposed by countries importing distillers’ grains, export demand could be significantly reduced as a result. If export demand of distillers’ grains is significantly reduced as a

21

 

result, the price of distillers’ grains in the U.S. would likely continue to decline which would have a negative effect on our revenue and could impact our ability to profitably operate which could in turn reduce the value of our units.

 

We face intense competition that may result in reductions in the price we receive for our ethanol, increases in the prices we pay for our corn, or lower gross profits.

 

Competition in the ethanol industry is intense. We face formidable competition in every aspect of our business from both larger and smaller producers of ethanol and distillers’ grains. Some larger producers of ethanol, such as Archer Daniels Midland, POET Biorefining, Cargill, Inc., Valero Energy Corporation, and Green Plains, Inc. have substantially greater financial, operational, procurement, marketing, distribution and technical resources than we have. We may not be able to compete with these larger entities. These larger ethanol producers may be able to affect the ethanol market in ways that are not beneficial to us which could affect our financial performance. 

 

Additionally, smaller competitors, such as farmer-owned cooperatives and independent companies owned by farmers and investors, have business advantages, such as the ability to more favorably procure corn by operating smaller plants that may not affect the local price of corn as much as a larger-scale plant like ours or requiring their farmer-owners to sell them corn as a requirement of ownership. Because Minnesota is one of the top producers of ethanol in the U.S., we face increased competition because of the location of our ethanol plants. Competing ethanol producers may introduce competitive pricing pressures that may adversely affect our sales levels and margins or our ability to procure corn at favorable prices. As a result, we cannot assure you that we will be able to compete successfully with existing or new competitors.

 

Until recently, oil companies, petrochemical refiners and gasoline retailers have not been engaged in ethanol production to a large extent. These companies, however, form the primary distribution networks for marketing ethanol through blended gasoline. During the past few years, several large oil companies have begun to penetrate the ethanol production market. If these companies increase their ethanol plant ownership or other oil companies seek to engage in direct ethanol production, such as Valero Renewable Fuels and Flint Hills Resources which are subsidiaries of larger oil companies, there may be a decrease in the demand for ethanol from smaller independent ethanol producers like us which could result in an adverse effect on our operations, cash flows and financial condition.

 

We also face increasing competition from international ethanol suppliers. Most international ethanol producers have cost structures that can be substantially lower than ours and therefore can sell their ethanol for substantially less than we can.

 

Competing ethanol producers may introduce competitive pricing pressures that may adversely affect our sales levels and margins or our ability to procure corn at favorable prices. As a result, we cannot assure you that we will be able to compete successfully with existing or new competitors.

 

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.  We seek to minimize the risks from fluctuations in the prices of corn, natural gas and ethanol through the use of hedging instruments.  The effectiveness of our hedging strategies is dependent on the price of corn, natural gas and ethanol and our ability to sell sufficient products to use all of the corn and natural gas 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 corn and natural gas prices, as well as low ethanol prices.

 

22

 

Operational difficulties at our plant could negatively impact our sales volumes and could cause us to incur substantial losses.

 

We have experienced operational difficulties at our plant in the past that have resulted in scheduled and unscheduled downtime or reductions in the number of gallons of ethanol we produce. Some of the difficulties we have experienced relate to production problems, repairs required to our plant equipment and equipment maintenance, the installation of new equipment and related testing, and our efforts to improve and test our air emissions. Our revenues are driven in large part by the number of gallons of ethanol and the number of tons of distillers’ grains we produce. If our ethanol plant does not efficiently produce our products in high volumes, our business, results of operations, and financial condition may be materially adversely affected.

 

Our operations are also subject to operational hazards inherent in our industry and to manufacturing in general, such as equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. The occurrence of any of these operational hazards may materially adversely affect our business, results of operations and financial condition. Further, our insurance may not be adequate to fully cover the potential operational hazards described above or we may not be able to renew this insurance on commercially reasonable terms or at all.

 

Our operations and financial performance could be adversely affected by infrastructure disruptions and lack of adequate transportation and storage infrastructure in certain areas.

 

We ship our ethanol to our customers primarily by the railroad adjacent to our site. We also have the potential to receive inbound corn via the railroad. Our customers require appropriate transportation and storage capacity to take delivery of the products we produce. We also receive our natural gas through a pipeline that is approximately 16 miles in length. Without the appropriate flow of natural gas through the pipeline our plant may not be able to run at desired production levels or at all. Therefore, our business is dependent on the continuing availability of rail, highway and related infrastructure.

 

Any disruptions in our infrastructure network, whether caused by labor difficulties, earthquakes, storms, other natural disasters, human error or malfeasance or other reasons, could have a material adverse effect on our business. We rely upon third-parties to maintain the rail lines from our plant to the national rail network, and any failure on their part to maintain the lines could impede our delivery of products, impose additional costs on us and could have a material adverse effect on our business, results of operations and financial condition.

 

In addition, lack of this infrastructure prevents the use of ethanol in certain areas where there might otherwise be demand and results in excess ethanol supply in areas with more established ethanol infrastructure, depressing ethanol prices in those areas. In order for the ethanol industry to grow and expand into additional markets and for our ethanol to be sold in these new markets, there must be substantial development of infrastructure including:

 

·

additional rail capacity;

·

additional storage facilities for ethanol;

·

increases in truck fleets capable of transporting ethanol within localized markets;

·

expansion of refining and blending facilities to handle ethanol; and

·

growth in service stations equipped to handle ethanol fuels.

 

The substantial investments that will be required for these infrastructure changes and expansions may not be made on a timely basis, if at all, and decisions regarding these infrastructure improvements are outside of our control. Significant delay or failure to improve the infrastructure that facilitates the distribution could curtail more widespread ethanol demand or reduce prices for our products in certain areas, which would have a material adverse effect on our business, results of operations or financial condition.

 

23

 

Rail logistical problems may result in delays in shipments of our products which could negatively impact our financial performance.

 

There has been an increase in rail traffic congestion throughout the U.S. primarily due to the increase in cargo trains carrying shale oil. From time to time, periodic high demand and unusually adverse weather conditions may cause rail congestion resulting in rail delays and rail logistical problems. Although we have not been materially affected by prior rail congestion period, future periods of congestion may affect our ability to operate our plant at full capacity due to ethanol storage capacity constraints, which in turn could have a negative effect on our financial performance.

 

We depend on our management and key employees, and the loss of these relationships could negatively impact our ability to operate profitably.

 

Our success depends in part on our ability to attract and retain competent personnel. For our ethanol plant, we must hire qualified managers, operations personnel, accounting staff and others, which can be challenging in a rural community.   Further, our current employees may decide to end their employment with us.  Competition for employees in the ethanol industry is intense, and we may not be able to attract and retain qualified personnel. 

 

Part of our management team is provided by Granite Falls Energy pursuant to the management services agreement.  The management services agreement provides that it can be terminated on thirty days’ notice in certain circumstances. If the management services agreement is terminated or one or more of our employees terminate their employment, either with us or Granite Falls Energy, we may not be able to replace these individuals.  Any loss of these managers or key employees may prevent us from operating the ethanol plant efficiently and comply with our other obligations.

 

Technology in our industry evolves rapidly, potentially causing our plant to become obsolete, and we must continue to enhance the technology of our plant or our business may suffer.

 

We expect that technological advances in the processes and procedures for processing ethanol will continue to occur. It is possible that those advances could make the processes and procedures that we utilize at our ethanol plant less efficient or obsolete. These advances could also allow our competitors to produce ethanol at a lower cost 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 those of our competitors, which could cause our ethanol plant to become uncompetitive.

 

Failures of our information technology infrastructure could have a material adverse effect on operations. 

 

We utilize various software applications and other information technology that are critically important to our business operations. We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic and financial information, to manage a variety of business processes and activities, including production, manufacturing, financial, logistics, sales, marketing and administrative functions. We depend on our information technology infrastructure to communicate internally and externally with employees, customers, suppliers and others. We also use information technology networks and systems to comply with regulatory, legal and tax requirements. These information technology systems, some of which are managed by third parties, may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, computer viruses, attacks by computer hackers or other cybersecurity risks, telecommunication failures, user errors, natural disasters, terrorist attacks or other catastrophic events. If any of our significant information technology systems suffer severe damage, disruption or shutdown, and our disaster recovery and business continuity plans do not effectively resolve the issues in a timely manner, our product sales, financial condition and results of operations may be materially and adversely affected.    

     

A cyber-attack or other information security breach could have a material adverse effect on our operations and result in financial losses. 

 

We are regularly the target of attempted cyber and other security threats and must continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact.  If we are unable to prevent cyber-attacks and other information security breaches, we may encounter significant disruptions in our operations which could adversely impact our business, financial condition and results of operations or result in the

24

 

unauthorized disclosure of confidential information. Such breaches may also harm our reputation, result in financial losses or subject us to litigation or other costs or penalties.

 

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 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 results of operations and financial condition.

 

Our sales will decline, and our business will be materially harmed if our third party marketers do not effectively market or sell the ethanol, distillers’ grains and corn oil we produce or if there is a significant reduction or delay in orders from our marketers.

 

We have entered into agreements with third parties to market our supply of ethanol, distillers’ grains and corn oil. Our marketers are independent businesses that we do not control. We cannot be certain that our marketers will market or sell our ethanol, distillers’ grains and corn oil effectively. Our agreements with our marketers do not contain requirements that a certain percentage of sales are of our products, nor do the agreements restrict the marketer’s ability to choose alternative sources for ethanol, distillers’ grains or corn oil.

 

Our success in achieving revenue from the sale of ethanol, distillers’ grains and corn oil will depend upon the continued viability and financial stability of our marketers. Our marketers may choose to devote their efforts to other producers or reduce or fail to devote the necessary resources to provide effective sales and marketing support of our products. We believe that our financial success will continue to depend in large part upon the success of our marketers in operating their businesses.

 

If our marketers breach their contracts or do not have the ability, for financial or other reasons, to market all of the ethanol we produce or to market the co-products produced at our plant, we may not have any readily available alternative means to sell our products. Our lack of a sales force and reliance on these third parties to sell and market most of our products may place us at a competitive disadvantage. Our failure to sell all of our ethanol and co-products may result in lower revenues and reduced profitability.

 

We are exposed to credit risk resulting from non-payment by significant customers.

 

We have a concentration of credit risk because we sell our primary product, ethanol, and its co-products, distillers’ grains and corn oil to three customers. Although we typically receive payments timely and within the terms of our marketing agreements with these customers, we continually monitor this credit risk exposure. These customers accounted for approximately 97.5%, 98.3%, and 99.5% of revenue for the years ended October 31, 2019, 2018, and 2017, respectively, and approximately 98.1% and 95.6% of the outstanding accounts receivable balance at October 31, 2019 and 2018, respectively.  The inability of a third party to pay our accounts receivable may cause us to experience losses and may adversely affect our liquidity and our ability to make our payments when due.

 

Consumer resistance to the use of ethanol based on the belief that ethanol is expensive, 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 at the pump. Some also believe that ethanol adds to air pollution and harms car and truck 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 widespread and may be increasing as a result of recent efforts to increase the allowable percentage of ethanol that may be blended for use in conventional automobiles.  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 and financial condition.

 

25

 

Risks Related to Regulation and Government Action

 

Our failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.

 

We are subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground. Certain aspects of our operations require environmental permits and controls to prevent and reduce air and water pollution, and these permits are subject to modification, renewal and revocation by issuing authorities including the Minnesota Pollution Control Agency. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions and third-party claims for property damage and personal injury as a result of violations of or liabilities under environmental laws or non-compliance with environmental permits. We could also incur substantial costs and experience increased operating expenses as a result of operational changes to comply with environmental laws, regulations and permits. We have previously incurred substantial costs relating to our air emissions permit and expect additional costs relating to this permit in the future.

 

Our air permit requires certain on-going performance testing to be completed periodically to ensure compliance with minor source emission limits. On May 12, 2017, we submitted a letter to the MPCA regarding the results of certain non-compliant tests. On October 17, 2017, we entered into a stipulation agreement with the MPCA relating to these non-compliant tests.  Under the stipulation agreement, we agreed to pay a civil penalty of $63,500, which was paid in October 2017.  

 

Environmental laws and regulations are subject to substantial change. We cannot predict what material impact, if any, these changes in laws or regulations might have on our business. The MPCA’s approval of our amendment, as well as future changes in regulations or enforcement policies could impose more stringent requirements on us, compliance with which could require additional capital expenditures, increase our operating costs or otherwise adversely affect our business. These changes may also relax requirements that could prove beneficial to our competitors and thus adversely affect our business. Further, regulations of the EPA and the MPCA depend heavily on administrative interpretations. We cannot assure you that future interpretations made by regulatory authorities, with possible retroactive effect, will not adversely affect our business, financial condition and results of operations. Failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.

 

Because federal and state regulation heavily influence the supply of and demand for ethanol, changes in government regulation that adversely affect demand or supply will have a material adverse effect on our business.

 

Various federal and state laws, regulations and programs impact the supply of and demand for ethanol.  We believe the most important of these is the RFS, which sets minimum national volume standards for use of cellulosic, biomass-based diesel and total advanced renewable fuels.  The RFS helps support a market for ethanol that might disappear without this incentive. In the case of the RFS, while it creates a demand for ethanol, the existence of specific categories of renewable fuels also creates a demand for these types of renewable fuels and will likely provide an incentive for companies to further develop these products to capitalize on that demand. In these circumstances, the RFS may also reduce demand for ethanol in favor of the renewable fuels for which specific categories exist.

 

By statute, the RFS requires that 16.55 billion gallons be sold or dispensed in 2013, increasing to 36.0 billion gallons by 2022, but caps the amount of corn-based ethanol that can be used to meet the renewable fuels blending requirements at 15.0 billion gallons for 2015 and thereafter. On December 19, 2019, the EPA announced final RVO requirements for the RFS for calendar year 2020. The corn-based biofuel requirement was set at 15.0 billion gallons, equating to the statutory requirement level as originally set by Congress when the RFS was enacted. However, the overall RVOs were set at 20.09 billion gallons for 2020, more than 20% below the overall statutory level of 30 billion gallons, due to decreases in the RVOs for cellulosic ethanol and advanced biofuels.  The 2019 and 2018 standards were also more than 20% below the overall statutory level.

 

According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered a proposed RFS “reset” rule to the Office of Management and Budget. If the statutory RVOs are reduced as a result of reset, it could have an adverse effect on the market price and demand for

26

 

ethanol which would negatively impact our financial performance. Current ethanol production capacity exceeds the 2020 RVO standard which can be satisfied by corn-based ethanol. Reduction of blending requirements could reduce the demand for and price of ethanol. If demand for ethanol decreases, it could materially adversely affect our business, results of operations and financial condition.

 

Additionally, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. Successful reduction or repeal of the blending requirements of the RFS could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. On December 19, 2019, the EPA released data on the number of waivers filed, which indicated that, as of December 19, 2019, 16 petitions for waivers for the 2019 compliance year have been received. For the 2018 compliance year, 42 petitions have been received. To date, the EPA has approved 31 petitions and denied 6 petitions, and 5 petitions have been declared ineligible or withdrawn. The 31 approved petitions have exempted approximately 1.43 billion RINs, which is approximately 13.42 billion gallons of gasoline and diesel, from meeting the RFS blending targets. The 35 approved petitions for compliance year 2017 exempted approximately 1.82 billion RINs, which is approximately 17.05 billion gallons of gasoline and diesel, from meeting the RFS blending targets. It is expected that additional petitions for waivers for the 2019 compliance year will be received by the EPA. It is also expected that the EPA will approve a significant number of these waiver petitions, thereby exempting a substantial number of gallons of gasoline and diesel from meeting the RFS blending targets. These exemptions decrease demand for our products, which negatively impacts ethanol prices and our profitability.

 

A proposed rule released by the EPA in October 2019 proposed changes intended to project the exempted volume of gasoline and diesel due to small refinery exemptions, regardless of whether such exemptions were actually granted after the annual rulemaking. However, the final rule released by the EPA in December 2019 provides that EPA will project exempt volumes based on a three-year average of the relief recommended by the Department of Energy (“DOE”) for years 2016-2018, rather than based on actual exemptions granted. For the 2016 compliance year, the EPA said the DOE’s recommended relief was approximately 440 million RINs. The EPA, however, actually granted waivers for approximately 790 million RINs. Similarly, the DOE’s 2017 compliance year recommendation was 1.02 billion RINs, as compared to the approximately 1.82 billion RINs granted waivers by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs granted waivers by the EPA. The EPA’s final rule also announced its general policy approach with respect to small refinery waivers on a go-forward basis as consistent with DOE’s recommendations, where appropriate. The final rule fell short of the relief that was urged by ethanol producers. It is likely that the EPA’s continued granting of small refinery exemptions will continue to have a negative effect on demand for our products, ethanol prices, and our profitability. 

 

The EPA imposed E10 “blend wall” if not overcome will have an adverse effect on demand for ethanol.

 

We believe that the E10 “blend wall” is one of the most critical governmental policies currently facing the ethanol industry. The “blend wall” issue arises because of several conflicting requirements. First, the renewable fuels standards dictate a continuing increase in the amount of ethanol blended into the national gasoline supply. Second, the EPA mandates a limit of 10% ethanol inclusion in non-flex fuel vehicles, and the E85 vehicle marketplace is struggling to grow due to lacking infrastructure. The EPA policy of 10% and the RFS increasing blend rate are at odds, which is sometimes referred to as the “blend wall.”

 

While the issue is being considered by the EPA, there have been no regulatory changes that would reconcile the conflicting requirements. In 2011, the EPA allowed 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. Management believes that many gasoline retailers will refuse to provide E15 due to the fact that not all standard vehicles will be allowed to use E15 and due to the labeling requirements the EPA may impose. As a result, the approval of E15 may not significantly increase demand for ethanol.

 

In addition, different gasoline blendstocks may have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This prevented E15 from being used during certain times of the year in various states. However, on May 30, 2019, the EPA issued a final rule which allows E15 to be sold

27

 

year-round. In June 2019, the American Fuel and Petrochemical Manufacturers association filed a lawsuit in the U.S. Court of Appeals for the District of Columbia challenging the final rule. Additionally, in August 2019, the Small Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the District of Columbia seeking review of the final rule. There is no guarantee that the final rule will be upheld. Legal challenges could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.

 

The California Low Carbon Fuel Standard may decrease demand for corn based ethanol which could negatively impact our profitability.

 

California passed a Low Carbon Fuels Standard (“LCFS”) which requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which reductions are measured using a lifecycle analysis. Management believes that these regulations could preclude corn based ethanol produced in the Midwest from being used in California. California represents a significant ethanol demand market. If the ethanol industry is unable to supply corn based ethanol to California, it could significantly reduce demand for the ethanol we produce. This could result in a reduction of our revenues and negatively impact our ability to profitably operate the ethanol plant.

 

Meeting the requirements of evolving environmental, health and safety laws and regulations, and in particular those related to climate change, could adversely affect our financial performance.

 

When the EPA released its final regulations on RFS, these regulations grandfathered our plant at its current production capacity for the generation of RINs for compliance with RFS.  Any expansion of our plant beyond the grandfathered volumes must meet a threshold of a 20% reduction in GHG emissions from a 2005 baseline measurement for the ethanol to be eligible to generate RINS for compliance with the RFS II mandate.

 

In 2015, our plant was awarded “efficient producer” status under the pathway petition program for the non-grandfathered volumes of ethanol produced at our plant. Pursuant to the award approval, we are only authorized to generate RINs for our non-grandfathered volume if we can demonstrate that all ethanol produced at the plant during an averaging period (defined as the prior 365 days or the number of days since the date EPA efficient producer pathway approval) meets the 20% GHG reduction requirement.

 

Although we believe our plant will be able to maintain continuous compliance with the 20% reduction in GHG emissions requirement as presently operated, there is no guarantee that we will not have to install carbon dioxide mitigation equipment or take other steps unknown to us at this time in order to comply with the efficient producer requirements or other future law or regulation.  Continued compliance with the efficient producer GHG reduction requirements or compliance with future law or regulation of carbon dioxide, could be costly and may prevent us from operating our plant as profitably, which may have an adverse impact on our operations, cash flows and financial position.

 

If we fail to comply with the 20% reduction in GHG emissions requirement, we will not be able to generate RINs for our non-grandfathered volumes of ethanol, which could adversely affect our operating margins.

 

We expect that nearly all of the anticipated demand for our ethanol production will be by customers obligated to comply with the RFS. The EPA’s approval of our efficient producer petitions requires that the plant demonstrates continuous compliance with the 20% reduction in GHG emissions for all volumes of ethanol produced, not just non-grandfathered volumes of ethanol. If we cannot show continuous compliance with the requirement for all volumes of ethanol, we will not be able issue RINs for the non-grandfathered volumes of ethanol produced. If our ethanol production does not meet the requirements for RIN generation as administered by the EPA, we may be required to sell those gallons of ethanol without RINs at lower prices in the domestic market to compensate for the lack of RINs or sell these gallons of ethanol in the export market where RINs are not required, which could adversely affect our results of operations, cash flows and financial condition.

 

28

 

Risks Related to Agrinatural and Natural Gas Pipeline Operations

 

The expansion of Agrinatural’s existing assets and construction of new assets is subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our results of operations and financial condition, and require additional capital contributions or loans from us.

 

One of the ways Agrinatural intends to grow its business is through the expansion of its existing assets and construction of new energy infrastructure assets. The construction of additions or modifications to Agrinatural’s existing pipelines, and the construction of other new energy infrastructure assets, involve numerous regulatory, environmental, political and legal uncertainties beyond Agrinatural’s control and may require the expenditure of significant capital.  Therefore, as the majority-owner of Agrinatural, we may be required to make additional capital contributions, loans and/or guaranty loans to Agrinatural in order to fund such expansion projects.  If Agrinatural undertakes these projects they may not be completed on schedule, at the budgeted cost or at all. Moreover, Agrinatural’s revenues may not increase immediately upon the expenditure of funds on a particular project. For instance, if it expands or adds a new pipeline, the construction may occur over an extended period of time, and we will not receive any material increases in revenues until the project is completed.

 

Agrinatural may also construct facilities to capture anticipated future growth in production or demand, which may not materialize or where contracts are later canceled. As a result, new pipelines may not be able to attract enough throughput volume to achieve our expected investment return, which could adversely affect our results of operations and financial condition. The construction of new pipelines may also require Agrinatural to obtain new rights-of-way, and it may become more expensive for Agrinatural to obtain these new rights-of-way or to renew existing rights-of-way. If the cost of renewing or obtaining new rights-of-way increases, Agrinatural’s cash flows could be adversely affected.

 

Transporting natural gas involves inherent risks that could cause Agrinatural, and therefore the Company as its majority owner, to incur significant financial losses.

 

There are inherent hazards and operation risks in gas distribution activities, such as leaks, accidental explosions and mechanical problems that could cause the loss of human life, significant damage to property, environmental pollution, impairment of operations and substantial losses to Agrinatural. The location of pipelines near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. These activities may subject us to litigation and administrative proceedings that could result in substantial monetary judgments, fines or penalties against us. To the extent that the occurrence of any of these events is not fully covered by insurance, they could adversely affect Agrinatural’s earnings and cash flow.

 

Volatility in the price of natural gas could result in customers switching to alternative energy sources which could reduce Agrinatural’s revenues, earnings and cash flow.

 

The market price of alternative energy sources such as coal, electricity, propane, oil and steam is a competitive factor affecting the demand for Agrinatural’s gas distribution services. Its customers may have or may acquire the capacity to use one or more of the alternative energy sources if the price of natural gas and Agrinatural’s distribution services increase significantly. Natural gas has typically been less expensive than these alternative energy sources. However, if natural gas prices increase significantly, some of these alternative energy sources may become more economical or more attractive than natural gas, which could reduce our earnings and cash flow.

 

Agrinatural’s natural gas pipeline operations are subject to significant governmental and private sector regulations.

 

Agrinatural’s natural gas pipeline operations are subject to government regulation, including the Federal Energy Regulatory Commission and Minnesota Office of Pipeline Safety, compliance with which can impose significant costs on Agrinatural’s natural gas distribution business. Failure to comply with such regulations can result in additional costs, fines or criminal action.

 

29

 

Risks Related to the Units

 

Granite Falls Energy owns a large percentage of our units, which allows it to control or heavily influence matters requiring member approval, and has additional board rights under our member control agreement.

 

As of January 29, 2020, Granite Falls Energy, LLC, through its wholly owned subsidiary, Project Viking, L.L.C., owns approximately 50.7% of our outstanding units.  As a result, Granite Falls Energy can significantly influence our management and affairs and all matters requiring member approval, including the approval of significant corporate transactions.

 

Our member control agreement gives members who hold significant amounts of equity in us the right to designate governors to serve on our board of governors. Therefore, Granite Falls Energy has the right to appoint five persons to our nine-person board pursuant to this provision. With the right to designate a majority of our board, Granite Falls Energy can significantly influence the outcome of any actions taken by our board of governors and our business. 

 

In addition, given the large ownership of Granite Falls Energy, they can significantly influence other actions, such as amendments to our operating agreement, mergers, going private transactions, and other extraordinary transactions, and any decisions concerning the terms of any of these transactions. The ownership and voting positions of Granite Falls Energy may have the effect of delaying, deterring, or preventing a change in control or a change in the composition of our board of directors.

 

Further, the interests of Granite Falls Energy may not coincide with our interests or the interests of our other members. For example, Granite Falls Energy owns and operates an ethanol production facility that could be considered our competitor. Granite Falls Energy may also use its rights under the member control agreement and their large ownership position to address their own interests, which may be different from those of our other members.

 

There is no public market for our units and no public market is expected to develop.

 

There is no established public trading market for our units, and we do not expect one to develop in the foreseeable future.  We have established a Unit Trading Bulletin Board through FNC Ag Stock, LLC, in order to facilitate trading among our members.  The Unit Trading Bulletin Board is a private online matching service that has been designed to comply with federal tax laws and IRS regulations establishing a “qualified matching service,” as well as state and federal securities laws.  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. 

 

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 result, units held by our members may not be easily resold and members may be required to hold their units indefinitely. Even if members are able to resell our units, the price may be less than the members’ investment in the units or may otherwise be unattractive to the member.

 

There are significant restrictions on the transfer of our units.

 

To protect our status as a partnership for tax purposes and to assure that no public trading market in our units develops, our units are subject to significant restrictions on transfer and transfers are subject to approval by our board of governors. All transfers of units must comply with the transfer provisions of our member control agreement and the unit transfer policy adopted by our board of governors. Our board of governors will not approve transfers which could cause us to lose our tax status or violate federal or state securities laws. As a result of the provisions of our member control agreement, members may not be able to transfer their units and may be required to assume the risks of the investment for an indefinite period of time.

 

30

 

There is no assurance that we will be able to make distributions to our unit holders, which means that holders could receive little or no return on their investment.

 

Distributions of our net cash flow may be made at the sole discretion of our board of governors, subject to the provisions of the Minnesota Limited Liability Company Act, our member control agreement and restrictions imposed by Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”) under our credit facility. Our credit facility with Compeer currently limits our ability to make distributions to our members. If our financial performance and loan covenants permit, we expect to make cash distributions at times and in amounts that will permit our members to make income tax payments, along with distributions in excess of these amounts. However, our board may elect to retain cash for operating purposes, debt retirement, plant improvements or expansion. Although we have declared distributions that were paid to members in January 2016 and 2018, there is no guarantee that we will be in a financial position to pay distributions in the future, that the terms of our credit facility will allow us to make distributions to our members, or that distributions, if any, will be at times or in amounts to permit our members to make income tax payments. Consequently, members may receive little or no return on their investment in the units.

 

We may authorize and issue units of new classes which could be superior to or adversely affect holders of our outstanding units.

 

Our board of governors, upon the approval of a majority in interest of our members, has the power to authorize and issue units of classes which have voting powers, designations, preferences, limitations and special rights, including preferred distribution rights, conversion rights, redemption rights and liquidation rights, different from or superior to those of our present units. New units may be issued at a price and on terms determined by our board of governors. The terms of the units and the terms of issuance of the units could have an adverse impact on your voting rights and could dilute your financial interest in us.

 

Our use of a staggered board of governors and allocation of governor appointment rights may reduce the ability of members to affect the composition of the board.

 

We are managed by a board of governors, currently consisting of four (4) elected governors and five (5) appointed governors. The seats on the board that are not subject to a right of appointment will be elected by the members without appointment rights. An appointed governor serves indefinitely at the pleasure of the member appointing him or her (so long as such member and its affiliates continue to hold a sufficient number of units to maintain the applicable appointment right) until a successor is appointed, or until the earlier death, resignation or removal of the appointed governor.

 

Under our member control agreement, non-appointed governors are divided into three classes, with the term of one class expiring each year. As the term of each class expires, the successors to the governors in that class will be elected for a term of three years. As a result, members elect only approximately one-third of the non-appointed governors each year.

 

The effect of these provisions may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, control of us and may discourage attempts to change our management, even if an acquisition or these changes would be beneficial to our members.

 

Our units represent both financial and governance rights, and loss of status as a member would result in the loss of the holder’s voting and other rights and would allow us to redeem such holder’s units.

 

Holders of units are entitled to certain financial rights, such as the right to any distributions, and to governance rights, such as the right to vote as a member. If a unit holder does not continue to qualify as a member or such holder’s member status is terminated, the holder would lose certain rights, such as voting rights, and we could redeem such holder’s units. The minimum number of units presently required for membership is 2,500 units. In addition, holders of units may be terminated as a member if the holder dies or ceases to exist, violates our member control agreement or takes actions contrary to our interests, and for other reasons. Although our member control agreement does not define what actions might be contrary to our interests, and our board of governors has not adopted a policy on the subject, such actions might include providing confidential information about us to a competitor, taking a board or management position with a competitor or taking action which results in significant financial harm to us in the marketplace. If a holder of units is terminated as a member, our board of governors will have no obligation to redeem such holder’s units.

31

 

 

Voting rights of members are not necessarily equal and are subject to certain limitations.

 

Members of our company are holders of units who have been admitted as members upon their investment in our units and who are admitted as members by our board of governors. The minimum number of units required to retain membership is 2,500 units. Any holder of units who is not a member will not have voting rights. Transferees of units must be approved by our board of governors to become members. Members who are holders of our present units are entitled to one vote for each unit held. The provisions of our member control agreement relating to voting rights applicable to any class of units will apply equally to all units of that class.

 

However, our member control agreement gives members who hold significant amounts of equity in us the right to designate governors to serve on our board of governors. For every 9% of our units held, the member has the right to appoint one person to our board. Granite Falls has the right to appoint five persons to our board pursuant to this provision and has currently appointed five persons. If units of any other class are issued in the future, holders of units of that other class will have the voting rights that are established for that class by our board of governors with the approval of our members. Consequently, the voting rights of members may not be necessarily proportional to the number of units held.

 

Further, cumulative voting for governors is not allowed, which makes it substantially less likely that a minority of members could elect a member to the board of governors. Members do not have dissenter’s rights. This means that they will not have the right to dissent and seek payment for their units in the event we merge, consolidate, exchange or otherwise dispose of all or substantially all of our property. Holders of units who are not members have no voting rights. These provisions may limit the ability of members to change the governance and policies of our company.

 

All members will be bound by actions taken by members holding a majority of our units, and because of the restrictions on transfer and lack of dissenters’ rights, members could be forced to hold a substantially changed investment.

 

We cannot engage in certain transactions, such as a merger, consolidation, dissolution or sale of all or substantially all of our assets, without the approval of our members. However, if holders of a majority of our units approve a transaction, then all members will also be bound to that transaction regardless of whether that member agrees with or voted in favor of the transaction. Under our member control agreement, members will not have any dissenters’ rights to seek appraisal or payment of the fair value of their units. Consequently, because there is no public market for the units, members may be forced to hold a substantially changed investment.

 

Risks Related to Tax Issues in a Limited Liability Company

 

EACH UNIT HOLDER SHOULD CONSULT THE INVESTOR’S OWN TAX ADVISOR WITH RESPECT TO THE FEDERAL AND STATE TAX CONSEQUENCES OF AN INVESTMENT IN HERON LAKE BIOENERGY, LLC AND ITS IMPACT ON THE INVESTOR’S TAX REPORTING OBLIGATIONS AND LIABILITY.

 

If we are not taxed as a partnership, we will pay taxes on all of our net income and you will be taxed on any earnings we distribute, and this will reduce the amount of cash available for distributions to holders of our units.

 

We consider Heron Lake BioEnergy, LLC to be a partnership for federal income tax purposes. This means that we will not pay any federal income tax, and our members will pay tax on their share of our net income. If we are unable to maintain our partnership tax treatment or qualify for partnership taxation for whatever reason, then we may be taxed as a corporation. We cannot assure you that we will be able to maintain our partnership tax classification. For example, there might be changes in the law or our company that would cause us to be reclassified as a corporation. As a corporation, we would be taxed on our taxable income at rates of up to 35% for federal income tax purposes (21% beginning after December 31, 2017). Further, distributions would be treated as ordinary dividend income to our unit holders to the extent of our earnings and profits. These distributions would not be deductible by us, thus resulting in double taxation of our earnings and profits. This would also reduce the amount of cash we may have available for distributions.

 

32

 

Your tax liability from your allocated share of our taxable income may exceed any cash distributions you receive, which means that you may have to satisfy this tax liability with your personal funds.

 

As a partnership for federal income tax purposes, all of our profits and losses “pass-through” to our unit holders. You must pay tax on your allocated share of our taxable income every year. You may incur tax liabilities from allocations of taxable income for a particular year or in the aggregate that exceed any cash distributions you receive in that year or in the aggregate. This may occur because of various factors, including but not limited to, accounting methodology, the specific tax rates you face, and payment obligations and other debt covenants that restrict our ability to pay cash distributions. If this occurs, you may have to pay income tax on your allocated share of our taxable income with your own personal funds.

 

You may not be able to fully deduct your share of our losses or your interest expense.

 

It is likely that your interest in us will be treated as a “passive activity” for federal income tax purposes. In the case of unit holders who are individuals or personal services corporations, this means that a unit holder’s share of any loss incurred by us will be deductible only against the holder’s income or gains from other passive activities, e.g., S corporations and partnerships that conduct a business in which the holder is not a material participant. Some closely held C corporations have more favorable passive loss limitations. Passive activity losses that are disallowed in any taxable year are suspended and may be carried forward and used as an offset against passive activity income in future years. Upon disposition of a taxpayer’s entire interest in a passive activity to an unrelated person in a taxable transaction, suspended losses with respect to that activity may then be deducted.

 

Interest paid on any borrowings incurred to purchase units may not be deductible in whole or in part because the interest must be aggregated with other items of income and loss that the unit holder has independently experienced from passive activities and subjected to limitations on passive activity losses.

 

Deductibility of capital losses that we incur and pass through to you or that you incur upon disposition of units may be limited. Capital losses are deductible only to the extent of capital gains plus, in the case of non-corporate taxpayers, the excess may be used to offset up to $3,000 of ordinary income. If a non-corporate taxpayer cannot fully utilize a capital loss because of this limitation, the unused loss may be carried forward and used in future years subject to the same limitations in the future years.

 

Although we expect that a number of our members may qualify for the Qualified Business Income Deduction (“QBID”), you may not qualify for the QBID.

 

Your ownership of our units may qualify you for the QBID. Pursuant to the Tax Cuts and Jobs Act of 2017, the QBID allows for a deduction of up to 20% of the qualified business income (“QBI”) of an owner of a pass-through entity. QBI generally includes the net amount of qualified income, gain, deduction, and loss from a domestic trade or business in which the taxpayer is an owner. The calculation of the QBID depends on a variety of factors, with the most significant factor being the taxpayer’s taxable income. For married persons filing jointly with taxable income equal to or less than the threshold amount, which is subject to adjustment for inflation, of $315,000 ($157,500 for taxpayers filing single), a taxpayer’s QBID is the lesser of: (1) 20% of the taxpayer’s QBI, or (2) 20% of the taxpayer’s taxable income less their net capital gains. For married persons filing jointly with taxable income exceeding the above-referenced threshold amounts, the QBID is subject to further limitations, such as limitations based on the amount of W-2 wages paid with respect to that entity or business, the unadjusted basis of qualified property in the business, and the type of trade or business. Because the impact of this deduction is dependent upon your particular tax situation, you should consult your own tax advisor as to your eligibility for the QBID. There is no guarantee that you will qualify for the QBID.

 

Preparation of your tax returns may be complicated and expensive.

 

The tax treatment of limited liability companies and the rules regarding partnership allocations are complex. We will file a partnership income tax return and will furnish each unit holder with a Schedule K-1 that sets forth our determination of that unit holder’s allocable share of income, gains, losses and deductions. In addition to U.S. federal income taxes, unit holders will likely be subject to other taxes, such as state and local taxes, that are imposed by various jurisdictions. It is the responsibility of each unit holder to file all applicable federal, state and local tax returns and pay all applicable taxes. You may wish to engage a tax professional to assist you in preparing your tax returns and this could be costly to you.

 

33

 

Any audit of our tax returns resulting in adjustments could result in additional tax liability to you.

 

The IRS may audit our tax returns and may disagree with the positions that we take on our returns or any Schedule K-1. If any of the information on our partnership tax return or a Schedule K-1 is successfully challenged by the IRS, the character and amount of items of income, gains, losses, deductions or credits in a manner allocable to some or all our unit holders may change in a manner that adversely affects those unit holders. This could result in adjustments on unit holders’ tax returns and in additional tax liabilities, penalties and interest to you. An audit of our tax returns could lead to separate audits of your personal tax returns, especially if adjustments are required.

 

 

ITEM 1B.    UNRESOLVED STAFF COMMENTS

 

None.

 

 

ITEM 2.    PROPERTIES

 

We own approximately 216 acres of land located near Heron Lake, Minnesota on which we have constructed and operate our ethanol plant, which also includes corn, ethanol, distillers’ grains and corn oil storage and handling facilities.  Located on these 216 acres is an approximately 7,320 square foot building that serves as our headquarters.  Our address is 91246 390th Avenue, Heron Lake, Minnesota 56137-3175.

 

All of our real property is subject to mortgages in favor of Compeer as security for loan obligations.

 

Our indirectly wholly owned subsidiary’s, Agrinatural, property consists of 190 miles of distribution main pipelines and service pipelines, together with the associated easement and land rights, a town border station, meters and regulators, office and other equipment and construction in process.  Agrinatural’s assets have represented 22.1%, 20.1%, and 18.1%, of our consolidated total assets in the years ended October 31, 2019, 2018, and 2017, respectively.  All of Agrinatural’s real property and assets are subject to mortgages in favor of HLBE as security for loan obligations.

 

Our and Agrinatural’s credit facilities are discussed in more detail under “ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Credit Arrangements.”

 

ITEM 3.    LEGAL PROCEEDINGS

 

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

 

 

ITEM 4.    MINE SAFETY DISCLOSURES

 

None.

 

 

PART II

 

 

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

There is no public trading market for our Class A or Class B units.

 

34

 

However, we have established an online unit trading bulletin board (“QMS”) through FNC Ag Stock, LLC, in order to facilitate trading in our units. The QMS has been designed to comply with federal tax laws and IRS regulations establishing a “qualified matching service,” as well as state and federal securities laws. Our QMS 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 QMS 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 QMS 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 QMS. We do not receive any compensation for creating or maintaining the QMS. In advertising our QMS, we do not characterize Heron Lake BioEnergy, LLC as being a broker or dealer or an exchange. We do not use the QMS to offer to buy or sell securities other than in compliance with securities laws, including any applicable registration requirements.

 

There are detailed timelines that must be followed under the QMS rules and procedures with respect to offers and sales of membership units. All transactions must comply with the QMS rules and procedures, our member control agreement, and are subject to approval by our board of governors.

 

So long as we remain a publicly reporting company, information about the Company will be publicly available through the SEC’s filing system. However, if at any time we cease to be a publicly reporting company, we anticipate continuing to make information about the Company publicly available on our website in order to continue operating the QMS.

 

The following table contains historical information by fiscal quarter for the past two fiscal years regarding the actual unit transactions that were completed by our unit-holders during the periods specified. We believe the following table 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 Per Unit Price

    

High Per Unit Price

    

Total Units Traded

 

2018 1st

 

N/A

 

N/A

 

 —

 

2018 2nd

 

$ 0.80

 

$ 0.85

 

164,750

 

2018 3rd

 

$ 0.80

 

$ 0.85

 

111,000

 

2018 4th

 

$ 0.77

 

$ 0.80

 

48,438

 

2019 1st

 

$ 0.80

 

$ 0.80

 

16,250

 

2019 2nd

 

$ 0.80

 

$ 0.80

 

11,000

 

2019 3rd

 

$ 0.50

 

$ 0.60

 

55,000

 

2019 4th

 

$ 0.70

 

$ 0.75

 

22,000

 

 

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 Heron Lake BioEnergy to be deemed a publicly traded partnership.

 

Issuer Repurchases of Equity Securities

 

We did not make any repurchases of our Class A or Class B units during fiscal 2019.

 

Holders of Record

 

As of January 29, 2020, there were 62,932,107 Class A units outstanding held of record by 1,185 unit holders, and 15,000,000 Class B units outstanding held of record by one unit holder. There are no other classes of units outstanding.  The determination of the number of members is based upon the number of record holders of the units as reflected in the Company’s internal unit records.

 

35

 

As of January 29, 2020, Granite Falls Energy, LLC owns an approximately 50.7% controlling interest in the Company through its wholly owned subsidiary, Project Viking, L.L.C. GFE is a related party by virtue of its ownership interest in us.  As a result of its majority ownership, GFE has the right to appoint five (5) of the nine (9) governors to our board of governors under our member control agreement.

 

As of October 31, 2019, and January 29, 2020, there were no outstanding options or warrants to purchase, or securities convertible for or into, our units.

 

Distributions

 

Distributions by the Company to our unit holders are in proportion to the number of units held by each unit holder. A unit holder’s distribution is determined by multiplying the number of units by distribution per unit declared. Our board of governors has complete discretion over the timing and amount of distributions to our unit holders.

 

Distributions are restricted by certain loan covenants in our comprehensive credit facility with Compeer. We may only make distributions to our members in an amount that does not exceed 65% of our net profit (determined according to GAAP) for such fiscal year; provided that the we are and will remain in compliance with all of the covenants, terms and conditions of the comprehensive credit facility. If our financial performance and loan covenants permit, we expect to make future cash distributions at times and in amounts that will permit our members to make income tax payments, along with distributions in excess of these amounts. Cash distributions are not assured, however, and we may never be in a position to make distributions. Under Minnesota law, we cannot make a distribution to a member if, after the distribution, we would not be able to pay our debts as they become due or our liabilities, excluding liabilities to our members on account of their capital contributions, would exceed our assets.

 

We did not make any distributions to our members during fiscal year 2017.

 

On December 21, 2017, our board of governors declared a distribution of $0.11 per membership unit for a total of approximately $8.6 million to be paid to members of record as of December 21, 2017. The distribution was paid on January 29, 2018. 

 

No additional distributions were either declared or paid in 2018 or 2019.

 

Our board of directors has complete discretion over the timing and amount of distributions to our members. 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.

 

Unregistered Sales of Equity Securities

 

The Company had no unregistered sales of securities in fiscal year 2019.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

As of the date of this annual report, we had no “equity compensation plans” (including individual equity compensation arrangements) under which any of our equity securities are authorized for issuance.

 

Performance Graph

 

The following graph shows a comparison of cumulative total member return since October 31, 2014, 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 code as the Company (the “SIC Code Index”). The graph assumes $100 was invested in each of the Company’s units, the NASDAQ, and the Industry Index on October 31, 2014. Data points on the graph are semi-annual. Note that historic stock price performance is not necessarily indicative of future unit price performance.

 

36

 

PICTURE 1

 

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 a filing.

37

 

 

ITEM 6.    SELECTED FINANCIAL DATA

 

The following table presents selected consolidated financial and operating data as of the dates and for the periods indicated. The selected financial data for the consolidated balance sheets as of October 31, 2019 and 2018 and the consolidated statements of operations data for the years ended October 31, 2019, 2018, and 2017 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected financial data for the consolidated balance sheets as of October 31, 2016 and 2015 and the consolidated statements of operations data for the years ended October 31, 2016 and 2015 were derived from audited consolidated financial statements filed previously. This selected consolidated financial data should be read in conjunction with “ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” and the consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following consolidated financial data (amounts in thousands, except per unit data and unless context otherwise requires).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Fiscal Years Ended October, 31,

 

Statement of Operations

    

2019

    

2018

    

2017

    

2016

    

2015

 

Revenues

 

$

106,827

 

$

108,472

 

$

109,918

 

$

109,606

 

$

115,660

 

Cost of Goods Sold

 

 

108,812

 

 

104,380

 

 

99,488

 

 

101,112

 

 

105,248

 

Gross Profit (Loss)

 

 

(1,985)

 

 

4,092

 

 

10,430

 

 

8,494

 

 

10,412

 

Operating Expenses

 

 

(3,398)

 

 

(3,198)

 

 

(3,125)

 

 

(2,999)

 

 

(3,001)

 

Operating Income (Loss)

 

 

(5,383)

 

 

894

 

 

7,305

 

 

5,495

 

 

7,411

 

Other Income (Expense)

 

 

205

 

 

273

 

 

211

 

 

(300)

 

 

(432)

 

Net Income (Loss)

 

 

(5,178)

 

 

1,167

 

 

7,516

 

 

5,195

 

 

6,979

 

Less: Net Income Attributable to Non­controlling Interest

 

 

(278)

 

 

(312)

 

 

(248)

 

 

(245)

 

 

(228)

 

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC

 

$

(5,456)

 

$

855

 

$

7,268

 

$

4,950

 

$

6,751

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Units Outstanding—Basic and Diluted (Class A and B)

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

Net Income (Loss) Per Unit Attributed to Heron Lake BioEnergy, LLC—Basic and Diluted (Class A and B)

 

$

(0.07)

 

$

0.01

 

$

0.09

 

$

0.06

 

$

0.09

 

Distributions Per Unit (Class A and B)

 

$

 —

 

$

0.11

 

$

 —

 

$

0.05

 

$

0.12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data at October 31,

    

2019

    

2018

    

2017

    

2016

    

2015

 

Current assets

 

$

16,266

 

$

17,166

 

$

21,562

 

$

12,614

 

$

12,892

 

Property and equipment, net

 

 

39,408

 

 

44,150

 

 

46,567

 

 

50,376

 

 

52,985

 

Other assets

 

 

922

 

 

705

 

 

744

 

 

781

 

 

819

 

Total assets

 

$

56,596

 

$

62,021

 

$

68,873

 

$

63,771

 

$

66,696

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

6,144

 

$

6,675

 

$

5,646

 

$

7,632

 

$

6,456

 

Long-term debt, less current portion

 

 

300

 

 

567

 

 

966

 

 

1,394

 

 

6,712

 

Other long-term liabilities

 

 

551

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Members' equity attributable to Heron Lake BioEnergy, LLC

 

 

47,599

 

 

53,055

 

 

60,768

 

 

53,500

 

 

52,446

 

Non-controlling interest

 

 

2,002

 

 

1,724

 

 

1,493

 

 

1,245

 

 

1,082

 

Total liabilities and members' equity

 

$

56,596

 

$

62,021

 

$

68,873

 

$

63,771

 

$

66,696

 

 

 

 

38

 

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

General

 

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the fiscal year ended October 31, 2019.  This discussion should be read in conjunction with the consolidated financial statements included herewith and notes to the consolidated financial statements thereto and the risk factors contained herein.

 

Overview

 

Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota.

 

Our revenues are derived from the sale and distribution of our ethanol throughout the continental U.S. and in the sale and distribution of our distillers’ grains (DGS) locally, and throughout the continental U.S.

 

Based on the criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes: (1) production of ethanol and related distillers’ grains, corn oil and syrup collectively referred to as ethanol production; and (2) natural gas pipeline distribution and services from the Company’s majority owned subsidiary, Agrinatural.

 

Before intercompany eliminations, revenues from our natural gas pipeline segment represented 3.0%, 3.2%, and 2.7% of our total consolidated revenues in the years ended October 31, 2019, 2018, and 2017, respectively.  After accounting for intercompany eliminations for fees paid by the Company for natural gas transportation services pursuant to our natural gas transportation agreement with Agrinatural, Agrinatural’s revenues represented 1.3%, 1.5%, and 1.1% of our consolidated revenues for the fiscal years ended October 31, 2019, 2018, and 2017 respectively, and have little to no impact on the overall performance of the Company.

 

Plan of Operations For the Next Twelve Months

 

Over the next twelve months we will continue our focus on operational improvements at our plant. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plant, continued emphasis on safety and environmental regulation, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies.

 

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2018 and into 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. We expect to have sufficient cash generated by continuing operations and availability on our credit facility to fund our operations.  However, should we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating our plant, we may need to seek additional funding.

 

In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure, as well as small capital projects to improve operating efficiency. We anticipate using cash we generate from our operations and our revolving term loan to finance these plant upgrade projects.

 

Trends and Uncertainties Impacting Our Operations

 

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains and natural gas, as well as governmental programs designed to create incentives for the use of corn-based ethanol.  Other factors that may affect our future results of operation include those risks and factors discussed in this report at “PART I - ITEM 1. BUSINESS” and “PART I - ITEM 1A. RISK FACTORS”.

 

39

 

Our operations are highly dependent on commodity prices, especially prices for corn, ethanol, distillers’ grains and natural gas. As a result, our operating results can fluctuate substantially due to volatility in these commodity markets. The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy and foreign trade. Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer and fall. Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons. Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels. Distillers’ grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production.

 

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

 

For the fiscal year ended October 31, 2019 compared to fiscal year ended October 31, 2018, our average price per gallon of ethanol sold increased approximately 2.4%. However, the average price per gallon of ethanol sold for the fiscal year ended October 31, 2019 was approximately 8.7% lower than the average price per gallon of ethanol sold for the fiscal year ended October 31, 2017. There has been decreased production of ethanol and gasoline demand has been flat. Additionally, the increase in approved economic hardship exemptions from the RVOs has recently effectively lowered the RVOs by a significant number of gallons of domestic demand. If this trend continues, it may continue to negatively impact the U.S. ethanol market. Management believes that the ethanol outlook moving into fiscal year 2020 will remain relatively flat and our margins will remain tight due to higher corn prices and relatively flat gasoline demand.  

 

In recent years, exports of ethanol have been increasing; however, exports fell slightly during the 2019 fiscal year compared to the 2018 fiscal year. Export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility. During 2017, Brazil and China adopted import quotas and/or tariffs on the importation of ethanol, which are expected to continue to negatively impact U.S. exports. China, the number three importer of U.S. ethanol in 2016, has imported negligible volumes since imposing a 70% tariff in 2018. On September 1, 2017, Brazil’s Chamber of Foreign Trade imposed a 20% tariff on U.S. ethanol imports in excess of 150 million liters, or 39.6 million gallons, per quarter. The tariff was renewed in September 2019, but the import quota was raised to 187.5 million liters, or 49.5 million gallons, per quarter. U.S. exports to Brazil have decreased from our 2018 fiscal year to our 2019 fiscal year. This tariff may continue to have a negative impact on the export market demand and prices for ethanol produced in the United States. Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or foreign markets are developed.

 

Corn prices trended upward during fiscal year 2019, but began trending slightly downward during the fourth quarter of fiscal year 2019. The latest estimates of supply and demand provided by the U.S. Department of Agriculture (“USDA”) estimate the 2018-19 ending corn stocks at approximately 2.1 billion bushels, and project the 2019-2020 corn supply at approximately 15.8 billion bushels, which is less than the 2018-2019 supply, with corn consumption for ethanol and co-products steady at approximately 5.3 billion bushels, suggesting higher corn prices into the first half of fiscal 2020. 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, it will have a negative effect on our operating margins unless the price of ethanol and distillers’ grains outpaces rising corn prices.

 

Distillers’ grains prices increased in 2019 over 2018 due to decreased supply as a result of decreased production. Top export markets include Mexico, Japan, Canada, Colombia, China, and South Korea. Of note, however, is that export demand from China, historically one of the largest importers of U.S. produced distillers grains, has significantly declined. In 2017, China imposed significant anti-dumping and anti-subsidy tariffs on distillers’ grains imported from the U.S., which resulted in significant declines in exports of U.S. distillers’ grains to China. The anti-dumping tariffs range from 42.2% to 53.7% and the anti-subsidy tariffs range from 11.2% to 12%. The imposition of

40

 

these duties has resulted in a significant decline in demand from this top importer requiring U.S. producers to seek out alternative markets.  Exports to China are substantially below the pre-tariff export levels. There is no guarantee that distillers’ grains exports to China will return to pre-tariff levels.

 

Management anticipates distillers’ grains prices will remain steady during our 2020 fiscal year, unless additional domestic demand or other foreign markets develop. Domestic demand for distillers’ grains could be negatively affected if corn prices decline and end-users switch to lower priced alternatives.  

 

Although our corn oil prices improved slightly year over year, corn oil prices as a whole have been adversely impacted during the last few years by oversupply of corn oil due to the substantial increase in corn oil production. Additionally, corn oil prices have been impacted by the oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production. In December 2019, legislation was signed extending the $1.00 per-gallon biodiesel blender tax credit retroactively to January 1, 2018, and through December 31, 2022.

 

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

  

Results of Operations for the Fiscal Years Ended October 31, 2019 and 2018

 

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our audited consolidated statements of operations for the fiscal years ended October 31, 2019 and 2018 (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

Statement of Operations Data

 

 

 

%

 

 

 

%

Revenues

 

$

106,827

 

100.0

%  

 

$

108,472

 

100.0

%

Cost of Goods Sold

 

 

108,812

 

101.9

%  

 

 

104,380

 

96.2

%

Gross Profit (Loss)

 

 

(1,985)

 

(1.9)

%  

 

 

4,092

 

3.8

%

Operating Expenses

 

 

(3,398)

 

(3.2)

%  

 

 

(3,198)

 

(2.9)

%

Operating Income (Loss)

 

 

(5,383)

 

(5.1)

%  

 

 

894

 

0.9

%

Other Income, net

 

 

205

 

0.2

%  

 

 

273

 

0.3

%

Net Income (Loss)

 

 

(5,178)

 

(4.9)

%  

 

 

1,167

 

1.2

%

Less: Net Income Attributable to Non-controlling Interest

 

 

(278)

 

(0.3)

%  

 

 

(312)

 

(0.3)

%

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC

 

$

(5,456)

 

(5.2)

%  

 

$

855

 

0.9

%

 

Revenues

 

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists of sales of our three primary products: ethanol, distillers’ grains and corn oil. Our remaining consolidated revenues are attributable to incidental sales of corn syrup and Agrinatural revenues, net of eliminations for distribution fees paid by the Company to Agrinatural for natural gas transportation services.

 

41

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our audited consolidated statements of operations for the fiscal year ended October 31, 2019:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2019

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

82,544

 

77.3

%

Distillers' grains sales

 

 

18,214

 

17.1

%

Corn oil sales

 

 

3,514

 

3.3

%

Corn syrup sales

 

 

1,123

 

1.0

%

Agrinatural revenues (net of intercompany eliminations)

 

 

1,432

 

1.3

%

Total Revenues

 

$

106,827

 

100.0

%

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our consolidated statements of operations for the fiscal year ended October 31, 2018:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2018

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

82,136

 

75.7

%

Distillers' grains sales

 

 

20,041

 

18.5

%

Corn oil sales

 

 

4,028

 

3.7

%

Corn syrup sales

 

 

607

 

0.6

%

Agrinatural revenues (net of intercompany eliminations)

 

 

1,660

 

1.5

%

Total Revenues

 

$

108,472

 

100.0

%

 

Our total consolidated revenues decreased by approximately 1.5% for the fiscal year ended October 31, 2019, as compared to the fiscal year 2018 primarily due to decreases in production of ethanol, distillers’ grains, and corn oil, which were partially mitigated by increases in average prices realized for our ethanol, distillers’ grains, and corn oil. The following table reflects quantities of our three primary products sold and the average net prices received for the fiscal years ended October 31, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2019

 

Year Ended October 31, 2018

 

 

Quantity Sold

 

Avg. Selling Price

 

Quantity Sold

 

Avg. Selling Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

65,512

 

$

1.26

 

66,889

 

$

1.23

Distillers' grains (tons)

 

143

 

$

127.32

 

160

 

$

125.34

Corn oil (pounds)

 

14,251

 

$

0.25

 

16,657

 

$

0.24

 

Ethanol

 

Total revenues from sales of ethanol increased by approximately 0.5% for fiscal year 2019 compared to the fiscal year 2018 due primarily to an approximately 2.4% increase in the average price per gallon we received for our ethanol, offset by an approximate 2.1% decrease in the volumes sold from period to period. We sold fewer ethanol gallons during fiscal year 2019 as compared to fiscal year 2018 primarily due to a decrease in ethanol production. Ethanol production was lower at our plant compared to the prior year as a result of slight production slowdowns due to lower corn supply availability. We are currently operating above our nameplate capacity. Management anticipates relatively stable ethanol production and sales during our 2020 fiscal year.

 

The increase in the price of ethanol was due to decreased ethanol stocks compared to the fiscal year ended October 31, 2018. In addition, because ethanol prices are typically directionally consistent with changes in corn prices, higher corn prices pushed the price of ethanol slightly higher.

 

We occasionally engage in hedging activities with respect to our ethanol sales. We recognize the gains or losses that result from the changes in the value of these derivative instruments in revenues as the changes occur. At October 31, 2019, we had fixed and basis contracts for forward ethanol sales for various delivery periods through December 2019

42

 

valued at approximately $13.5 million. Separately, ethanol derivative instruments resulted in a gain of approximately $25,000 for the fiscal year ended October 31, 2019 and a gain of approximately $54,000 for the fiscal year ended October 31, 2018.

 

Distillers’ Grains

 

Total revenues from sales of distillers’ grains for our 2019 fiscal year decreased approximately 9.1% compared to fiscal year 2018.  The decrease in distillers’ grains revenues is primarily attributable to an approximately 10.6% decrease in the tons of distillers’ grains sold from period to period, which was partially offset by an approximately 1.6% increase in the average price per ton we received for our distillers’ grains sold during fiscal year 2019 compared to fiscal year 2018.

 

The increase in the market price of distillers’ grains is primarily due to decreased supply as a result of decreased production. Management anticipates that distillers’ grains prices will remain steady during our 2020 fiscal year unless export markets continue to shrink or production increases.

 

We sold fewer tons of distillers’ grains during fiscal year 2019 as compared to 2018 due primarily to decreased production at the plant. Management anticipates relatively stable distillers’ grains production going forward. 

 

At October 31, 2019, we had forward contracts to sell approximately $1.3 million of distillers’ grains for delivery through January 2020.

 

Corn Oil

 

Separating the corn oil from our distillers’ grains decreases the total tons of distillers’ grains that we sell; however, our corn oil has a higher per ton value than our distillers’ grains. Total revenues from sales of corn oil decreased by approximately 12.8% for fiscal year 2019 compared to the fiscal year 2018.  This decrease is attributable to an approximately 14.4% decrease in the number of pounds of corn oil sold from period to period, which was slightly offset by an approximately 4.2% increase in the average price we received per pound of corn oil sold during fiscal year 2019 compared to fiscal year 2018. 

 

Management attributes the decrease in corn oil sales during fiscal year 2019 as compared to 2018 primarily to decreased production at the plant. Management expects our corn oil production will be relatively stable going forward.

 

Although management believes that corn oil prices will remain relatively steady, prices may decrease if there is an oversupply of corn oil production resulting from increased production rates at ethanol plants or if biodiesel producers begin to utilize lower-priced alternatives such as soybean oil or if the biodiesel blenders’ tax credit is not renewed and biodiesel production declines.

 

At October 31, 2019, we had forward corn oil sales contracts to sell approximately $468,000 for delivery through December 2019.

 

Cost of Goods Sold

 

Our cost of goods sold increased by approximately 4.2% for the fiscal year ended October 31, 2019, as compared to the fiscal year ended October 31, 2018. Cost of goods sold, as a percentage of revenues, also increased to approximately 101.9% for the fiscal year ended October 31, 2019, as compared to approximately 96.2% for the 2018 fiscal year due to a narrower margin between the price of ethanol and the price of corn.  Approximately 90% of our total costs of goods sold is attributable to ethanol production. As a result, the cost of goods sold per gallon of ethanol produced for the fiscal year ended October 31, 2019 was approximately $1.49 per gallon of ethanol sold compared to approximately $1.40 per gallon of ethanol produced for the fiscal year ended October 31, 2018.

 

43

 

The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, electricity, and wages, salaries and benefits of production personnel, and the approximate percentage of costs of those components to total costs of goods sold in our audited consolidated statements of operations for the fiscal year ended October 31, 2019:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2019

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

80,504

 

74.0

%

Natural gas costs

 

 

6,818

 

6.3

%

All other components of costs of goods sold

 

 

21,490

 

19.7

%

Total Cost of Goods Sold

 

$

108,812

 

100.0

%

 

 

The following table shows the costs of corn, natural gas and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our audited consolidated statements of operations for the fiscal year ended October 31, 2018:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2018

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

74,887

 

71.7

%

Natural gas costs

 

 

6,660

 

6.4

%

All other components of costs of goods sold

 

 

22,833

 

21.9

%

Total Cost of Goods Sold

 

$

104,380

 

100.0

%

 

Corn Costs

 

Our cost of goods sold related to corn increased approximately 7.5% for our 2019 fiscal year compared to our 2018 fiscal year, due to an approximately 12.5% increase in the average price per bushel paid for corn from period to period, which was partially offset by an approximately 4.9% decrease in the number of bushels of corn processed from period to period.  The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for our 2019 fiscal year was approximately $0.10 less than the corn-ethanol price spread we experienced for fiscal year 2018.

 

The increase in our cost per bushel of corn was primarily related to higher market corn prices due to adverse weather conditions and strong demand. Due to projected decreased corn stocks and strong demand, management anticipates that corn prices will remain steady during our first half of 2020 fiscal year.

 

For our fiscal years ended October 31, 2019 and 2018, we processed approximately 21.9 million and 23.0 million bushels of corn, respectively.  Our corn conversion efficiency decreased slightly during our 2019 fiscal year compared to 2018. Management anticipates consistent corn consumption during our 2020 fiscal year provided that we can achieve positive operating margins that allow us to continue to operate the ethanol plant at capacity.

 

From time to time we enter into forward purchase contracts for our corn purchases. At October 31, 2019, we had forward corn purchase contracts for approximately 740,000 bushels for deliveries through December 2021. Comparatively, at October 31, 2018, we had forward corn purchase contracts for approximately 2.3 million bushels for various delivery periods through October 2019.

 

Our corn derivative positions resulted in gains of approximately $351,000 and $1.2 million for the fiscal years ended October 31, 2019 and 2018, respectively, which decreased cost of goods sold. We recognize the gains or losses that result from the changes in the value of our derivative instruments from corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance. We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged. 

 

44

 

Natural Gas Costs

 

For our 2019 fiscal year, we experienced an increase of approximately 2.4% in our overall natural gas costs compared to our 2018 fiscal year.  During the past two fiscal years, there has been an increase in cost of natural gas, primarily as a result of an increase in the average price per MMBTU of natural gas due to increased domestic and export demand. Management also anticipates higher natural gas prices as we move through the winter months due to the typical seasonal natural gas cost increases experienced during the winter months.

 

From time to time we enter into forward purchase contracts for our natural gas purchases. Our natural gas derivative positions resulted in no gain or loss for the fiscal year ended October 31, 2019, which had no effect on cost of goods sold, and a loss of approximately $1,600 for the fiscal year ended October 31, 2018, which increased cost of goods sold. We recognize the gains or losses that result from the changes in the value of our derivative instruments from natural gas in cost of goods sold as the changes occur.

 

Operating Expense

 

Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees, property taxes and similar costs.  Operating expenses as a percentage of revenues rose slightly to 3.2% of revenues for our fiscal year ended October 31, 2019, compared to 2.9% of revenues for our fiscal year ended October 31, 2018.  This increase is due primarily to lower revenues and increased industry association costs. 

 

Our efforts to optimize efficiencies and maximize production may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses generally do not vary with the level of production at the plant, we expect our operating expenses to remain steady into and throughout our 2020 fiscal year.

 

Operating Income (Loss)

 

For our fiscal year ended October 31, 2019, we reported operating loss of approximately $5.4 million, compared to operating income of approximately $894,000 for our fiscal year ended October 31, 2018.  This decrease resulted largely from increased prices for corn and the narrowing of margins of our ethanol production segment.

 

Other Income, Net

 

We had net other income of approximately $205,000 during fiscal year 2019, compared to net other income of approximately $273,000 for fiscal year 2018.  We had less other income during fiscal year 2019 compared to fiscal year 2018 primarily due to less patronage amounts received during the 2019 period.

 

Results of Operations for the Fiscal Years Ended October 31, 2018 and 2017

 

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our audited consolidated statements of operations for the fiscal years ended October 31, 2018 and 2017 (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

Statement of Operations Data

 

 

 

%

 

 

 

%

Revenues

 

$

108,472

 

100.0

%  

 

$

109,918

 

100.0

%

Cost of Goods Sold

 

 

104,380

 

96.2

%  

 

 

99,488

 

90.5

%

Gross Profit

 

 

4,092

 

3.8

%  

 

 

10,430

 

9.5

%

Operating Expenses

 

 

(3,198)

 

(2.9)

%  

 

 

(3,125)

 

(2.8)

%

Operating Income

 

 

894

 

0.9

%  

 

 

7,305

 

6.7

%

Other Income, net

 

 

273

 

0.3

%  

 

 

211

 

0.2

%

Net Income

 

 

1,167

 

1.2

%  

 

 

7,516

 

6.9

%

Less: Net Income Attributable to Non-controlling Interest

 

 

(312)

 

(0.3)

%  

 

 

(248)

 

(0.2)

%

Net Income Attributable to Heron Lake BioEnergy, LLC

 

$

855

 

0.9

%  

 

$

7,268

 

6.7

%

 

 

45

 

Revenues

 

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists of sales of our three primary products: ethanol, distillers’ grains and corn oil. Our remaining consolidated revenues are attributable to incidental sales of corn syrup and Agrinatural revenues, net of eliminations for distribution fees paid by the Company to Agrinatural for natural gas transportation services.

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our audited consolidated statements of operations for the fiscal year ended October 31, 2018:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2018

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

82,136

 

75.7

%

Distillers' grains sales

 

 

20,041

 

18.5

%

Corn oil sales

 

 

4,028

 

3.7

%

Corn syrup sales

 

 

607

 

0.6

%

Agrinatural revenues (net of intercompany eliminations)

 

 

1,660

 

1.5

%

Total Revenues

 

$

108,472

 

100.0

%

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our consolidated statements of operations for the fiscal year ended October 31, 2017:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2017

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

88,231

 

80.3

%

Distillers' grains sales

 

 

15,002

 

13.6

%

Corn oil sales

 

 

4,915

 

4.5

%

Corn syrup sales

 

 

562

 

0.5

%

Agrinatural revenues (net of intercompany eliminations)

 

 

1,208

 

1.1

%

Total Revenues

 

$

109,918

 

100.0

%

 

Our total consolidated revenues decreased by approximately 1.3% for the fiscal year ended October 31, 2018, as compared to the fiscal year 2017 primarily due to decreases in the average price realized for our ethanol and corn oil which were partially mitigated by an increase in average price realized for our distillers’ grains.  The following table reflects quantities of our three primary products sold and the average net prices received for the fiscal years ended October 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2018

 

Year Ended October 31, 2017

 

 

Quantity Sold

 

Avg. Net Price

 

Quantity Sold

 

Avg. Net Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

66,889

 

$

1.23

 

64,030

 

$

1.38

Distillers' grains (tons)

 

160

 

$

125.34

 

156

 

$

96.44

Corn oil (pounds)

 

16,657

 

$

0.24

 

17,755

 

$

0.28

 

Ethanol

 

Total revenues from sales of ethanol decreased by approximately 6.9% for fiscal year 2018 compared to the fiscal year 2017 due primarily to an approximately 10.9% decrease in the average price per gallon we received for our ethanol, offset by an approximate 4.5% increase in the volumes sold from period to period. We  sold more ethanol gallons during fiscal year 2018 as compared to fiscal year 2017 primarily due to the timing of ethanol shipments and an increase in ethanol production. Ethanol production was higher at our plant in fiscal year 2018 compared to the prior year due to capital improvements we made at our plant designed to increase ethanol production and improve efficiency. The decrease in the price of ethanol was due to excess supply of ethanol, in addition to lessened demand due to the increase

46

 

in the approval of small refinery hardship waivers. In addition, because ethanol prices are typically directionally consistent with changes in corn prices, lower corn prices kept the price of ethanol lower.

 

Ethanol derivative instruments resulted in a gain of approximately $54,000 during the fiscal year ended October 31, 2018 and a loss of approximately $219,000 for the fiscal year ended October 31, 2017.

 

Distillers’ Grains

 

Total revenues from sales of distillers’ grains for our 2018 fiscal year increased approximately 33.6% less compared to fiscal year 2017.  The increase in distillers’ grains revenues is primarily attributable to an approximately 30.0% increase in the average price per ton we received for our distillers’ grains from period to period, coupled with an approximately 2.8% increase in the tons of distillers’ grains sold during fiscal year 2018 compared to fiscal year 2017. The increase in the market price of distillers’ grains is due to higher demand, particularly from Vietnam, the European Union, Thailand, and South Korea. We sold more total tons of distillers’ grains during our 2018 fiscal year compared to the same period of 2017 due to an increase in distillers’ grains yield at the plant. 

 

Corn Oil

 

Total revenues from sales of corn oil decreased by approximately 18.0% for fiscal year 2018 compared to the fiscal year 2017.  This decrease was attributable to an approximately 12.7% decrease in the average price we received per pound of corn oil sold, coupled with an approximately 6.2% decrease in the number of pounds sold during fiscal year 2018 compared to fiscal year 2017.

 

Cost of Goods Sold

 

Our cost of goods sold increased by approximately 4.9% for the fiscal year ended October 31, 2018, as compared to the fiscal year ended October 31, 2017. Cost of goods sold, as a percentage of revenues, also increased to approximately 96.2% for the fiscal year ended October 31, 2018, as compared to approximately 90.5% for the 2017 fiscal year due to a narrower margin between the price of ethanol and the price of corn.  Approximately 90% of our total costs of goods sold is attributable to ethanol production. As a result, the cost of goods sold per gallon of ethanol produced for the fiscal year ended October 31, 2018 was approximately $1.40 per gallon of ethanol sold compared to approximately $1.38 per gallon of ethanol produced for the fiscal year ended October 31, 2017. 

 

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

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2018

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

74,887

 

71.7

%

Natural gas costs

 

 

6,660

 

6.4

%

All other components of costs of goods sold

 

 

22,833

 

21.9

%

Total Cost of Goods Sold

 

$

104,380

 

100.0

%

 

The following table shows the costs of corn, natural gas and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our audited consolidated statements of operations for the fiscal year ended October 31, 2017:

 

 

 

 

 

 

 

 

 

 

Year Ended October 31, 2017

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

72,523

 

72.9

%

Natural gas costs

 

 

6,645

 

6.7

%

All other components of costs of goods sold

 

 

20,320

 

20.4

%

Total Cost of Goods Sold

 

$

99,488

 

100.0

%

 

47

 

Corn Costs

 

Our cost of goods sold related to corn increased approximately 3.3% for our 2018 fiscal year compared to our 2017 fiscal year.  This increase was due primarily to an approximately 2.3% increase in the number of bushels of corn processed and an approximately 0.9% increase in the average price per bushel paid for corn from period to period. The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for our 2018 fiscal year was approximately $0.16 less than the corn-ethanol price spread we experienced for our 2017 fiscal year.  The increase in our cost per bushel of corn was primarily related to higher market corn prices due to strong demand and weather threats.

 

For our fiscal years ended October 31, 2018 and 2017, we processed approximately 23.0 million and 22.5 million bushels of corn, respectively. We improved our corn conversion efficiency slightly during our 2018 fiscal year compared to 2017 .  

 

At October 31, 2018, we had forward corn purchase contracts for approximately 2.3 million bushels for various delivery periods through October 2019. Comparatively, at October 31, 2017, we had forward corn purchase contracts for approximately 1.8 million bushels for various delivery periods through October 2018.

 

Our corn derivative positions resulted in gains of approximately $1.2 million and $962,000 for the fiscal years ended October 31, 2018 and 2017, respectively, which decreased cost of goods sold. 

 

Natural Gas Costs

 

For our 2018 fiscal year, we experienced an increase of approximately 0.2% in our overall natural gas costs compared to our 2017 fiscal year.  The increase in cost of natural gas from period to period was primarily the result of an increase in the average price per MMBTU of natural gas due to increased domestic and export demand and lower production.

 

Our natural gas derivative positions resulted in a loss of approximately $1,600 for the fiscal year ended October 31, 2018, which increased cost of goods sold. Comparatively, our natural gas derivate positions resulted in a loss of approximately $15,000 for the fiscal year ended October 31, 2017, which increased cost of goods sold.

 

Operating Expense

 

Operating expenses as a percentage of revenues rose slightly to 2.9% of revenues for our fiscal year ended October 31, 2018 compared to 2.8% of revenues for our fiscal year ended October 31, 2017.  This increase is due primarily to fixed production expenses that were higher compared to fiscal year 2017.

 

Operating Income

 

For our fiscal year ended October 31, 2018, we reported operating income of approximately $894,000 and for our fiscal year ended October 31, 2017, we had operating income of approximately $7.3 million.  This decrease resulted largely from decreased prices for our ethanol, relative to the price of corn, and the narrowing of margins of our ethanol production segment.

 

Other Income, Net

 

We had net other income for our fiscal year ended October 31, 2018 of approximately $273,000 compared to net other income of approximately $211,000 for our fiscal year ended October 31, 2017.  This increase in other income is due to patronage income and decreased interest expense during our fiscal year ended October 31, 2018 compared to the same period of 2017 as a result of fewer borrowings under our credit facilities during the 2018 fiscal year.

 

48

 

Changes in Financial Condition at October 31, 2019 and 2018

 

The following table highlights the changes in our financial condition from our audited consolidated balance sheet for the periods presented (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

    

October 31, 2019

    

October 31, 2018

 

Current Assets

 

$

16,626

 

$

17,166

 

Total Assets

 

$

56,596

 

$

62,021

 

Current Liabilities

 

$

6,144

 

$

6,675

 

Long-Term Debt, less current portion

 

$

300

 

$

567

 

Other Long-Term Liabilities

 

$

551

 

$

 —

 

Members' Equity attributable to Heron Lake BioEnergy, LLC

 

$

47,599

 

$

53,055

 

Non-Controlling Interest

 

$

2,002

 

$

1,724

 

 

The $5.4 million decrease in total assets was primarily driven by the decrease of current assets of approximately $900,000 and our property and equipment of approximately $4.7 million. The decrease in current assets was primarily driven by a decrease in our cash and commodity derivative instruments of approximately $1.8 million, partially offset by an increase in accounts receivable of approximately $939,000 due to timing of rail shipments of ethanol.

 

Current liabilities at October 31, 2019 decreased by approximately $531,000 compared to October 31, 2018. This decrease was primarily due to decreases of accrued expenses by approximately $421,000, current maturities of long-term debt by approximately $58,000, accounts payable of approximately $27,000 at October 31, 2019 compared to October 31, 2018.

 

Our long-term debt decreased by approximately $267,000 at October 31, 2019 compared to October 31, 2018. The decrease is due to payments on the note payable to the electric company and assessments paid under industrial water supply treatment agreement with the City of Heron Lake and Jackson County.

 

Our other long-term liabilities increased by approximately $551,000 at October 31, 2019 compared to October 31, 2018. The increase is due to rail car rehabilitation costs recorded for fiscal year 2019.

 

Members’ equity attributable to Heron Lake BioEnergy, LLC decreased approximately $5.5 million at October 31, 2019 compared to October 31, 2018. This decrease was due to approximately $5.5 million in net loss attributable to HLBE. Non-controlling interest totaled approximately $2.0 million at October 31, 2019 compared to approximately $1.7 million at October 31, 2018. This is directly related to recognition of the 27.0% non-controlling interest in Agrinatural, LLC.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity consist of cash provided by operations, cash on hand, and available borrowings under our credit facility with Compeer.  Our principal uses of cash are to pay operating expenses of the plant, to make debt service payments on our long-term debt, and to make distribution payments to our members.  We expect to have sufficient cash generated by continuing operations and current lines of credit to fund our operations for the next twelve months.

 

We do not currently anticipate any significant purchases of property and equipment that would require us to secure additional capital in the next twelve months. For our 2020 fiscal year, we anticipate completion of several small capital projects and to maintain current plant infrastructure and improve operating efficiency. We expect to have sufficient cash generated by continuing operations and current lines of credit to fund our operations and complete our capital expenditures during our 2020 fiscal year and beyond. 

 

Management continues to evaluate conditions in the ethanol industry and explore opportunities to improve the efficiency and profitability of our operations which may require additional capital to supplement cash generated from operations and available for borrowing under our revolving term loan.

 

49

 

Year Ended October 31, 2019 Compared to Year Ended October 31, 2018

 

The following table summarizes our sources and uses of cash from our audited consolidated statements of cash flows for the periods presented (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

Net cash provided by (used in) operating activities

    

$

(420)

    

$

7,527

 

Net cash used in investing activities

 

$

(657)

 

$

(2,509)

 

Net cash used in financing activities

 

$

(325)

 

$

(9,088)

 

Net decrease in cash and restricted cash

 

$

(1,402)

 

$

(4,070)

 

 

Operating Cash Flows

 

During the fiscal year ended October 31, 2019, net cash provided by (used in) operating activities decreased by approximately $7.9 million compared to the fiscal year ended October 31, 2018. The decrease resulted largely from an approximately $6.3 million decrease in our net income in the current year, coupled with decreases of approximately $1.6 million from period to period in various working capital items.  Net income decreased for fiscal year 2019 due to decreased revenues and higher costs of goods sold.

 

Investing Cash Flows

 

During the fiscal year ended October 31, 2019, net cash used in investing activities decreased by approximately $1.9 million due primarily to decreased capital expenditures compared to the fiscal year ended October 31, 2018.

 

Financing Cash Flows

 

We used approximately $8.8 million less for financing activities for the fiscal year ended October 31, 2019 compared to the fiscal year ended October 31, 2018.  During the fiscal year ended October 31, 2019, we used cash to make payments of approximately $325,000 on our long-term debt. For the same period of 2018, we used cash to make payments of approximately $438,000 on our long-term debt and made distributions to Heron Lake BioEnergy members of approximately $8.6 million and to non-controlling interests of approximately $81,000.

 

Year Ended October 31, 2018 Compared to Year Ended October 31, 2017

 

The following table summarizes our sources and uses of cash from our audited consolidated statements of cash flows for the periods presented (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended October 31,

 

 

 

2018

 

2017

 

Net cash provided by operating activities

    

$

7,527

    

$

12,250

 

Net cash used in investing activities

 

$

(2,509)

 

$

(1,129)

 

Net cash used in financing activities

 

$

(9,088)

 

$

(2,353)

 

Net increase (decrease) in cash and restricted cash

 

$

(4,070)

 

$

8,768

 

 

Operating Cash Flows

 

During the fiscal year ended October 31, 2018, net cash provided by operating activities decreased by approximately $4.7 million compared to the fiscal year ended October 31, 2017. The decrease resulted largely from an approximately $6.3 million decrease in our net income in fiscal year 2018, offset by increases of approximately $1.6 million from period to period in various working capital items. Net income decreased for fiscal year 2018 due to decreased revenues and higher costs of goods sold.

 

Investing Cash Flows

 

During the fiscal year ended October 31, 2018, net cash used in investing activities increased by approximately $1.4 million due to increased capital expenditures compared to the fiscal year ended October 31, 2017.

 

50

 

Financing Cash Flows

 

We used approximately $6.7 million more for financing activities for the fiscal year ended October 31, 2018 compared to the fiscal year ended October 31, 2017.  During fiscal year 2018, we used cash to make payments of approximately $438,000 on our long-term debt and made distributions to Heron Lake BioEnergy members of approximately $8.6 million and to non-controlling interests of approximately $81,000.

 

For the same period of 2017, we used cash to make payments of approximately $486,000 on our long-term debt and decreased approximately $1.9 million on checks drawn in excess of bank balance.

 

Contractual Obligations

 

The following table provides information regarding the consolidated contractual obligations of the Company as of October 31, 2019 (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

   

Less than

   

One to

   

Four to

   

Greater Than

 

 

 

Total

 

One Year

 

Three Years

 

Five Years

 

Five Years

 

Long-term debt obligations(1)

 

$

752

 

$

379

 

$

373

 

$

 —

 

$

 —

 

Operating lease obligations(2)

 

 

12,550

 

 

1,767

 

 

3,534

 

 

3,437

 

 

3,812

 

Purchase obligations(3)

 

 

3,018

 

 

2,628

 

 

390

 

 

 

 

 

Total contractual obligations

 

$

16,320

 

$

4,774

 

$

4,297

 

$

3,437

 

$

3,812

 

 

 

(1)

Long-term debt obligations include principal and estimated interest under our credit facilities based on the interest rates in effect as of October 31, 2019, assuming contractual maturities.

(2)

The operating lease obligations in the table above include our rail car leases.

(3)

Purchase obligations consist of forward contracted corn deliveries.  The amounts were determined assuming prices, including freight costs, at current market prices as of October 31, 2019 for basis contracts that had not yet been fixed.

 

Credit Arrangements

 

Revolving Term Note

 

We had a revolving term note payable to Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”) under which we could borrow, repay, and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022.  The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity.  In December 2017, the Company and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000.  On April 6, 2018, the Company finalized loan agreements with an effective date of March 29, 2018 for an amended credit facility with Compeer (the “2018 Credit Facility”). On January 7, 2020, the Company finalized loan agreements for an amended credit facility with its lender (the “2020 Credit Facility”).

 

2018 Credit Facility with Compeer

 

We had a comprehensive credit facility with Compeer for which CoBank, ACP (“CoBank”) served as the administrative agent.  This credit facility originally consisted of a revolving term loan with a maturity date of March 1, 2022.   However, on April 6, 2018, we entered into an amended credit facility with Compeer (the “2018 Credit Facility”).  The 2018 Credit Facility includes an amended and restated revolving term loan with a $4.0 million principal commitment and a revolving seasonal line of credit with a $4.0 million principal commitment.  CoBank will continue to act as Compeer's administrative agent with respect to our 2018 Credit Facility and has a participation interest in the loans. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021.  Interest on the amended revolving term loan accrues at a variable weekly rate equal

51

 

to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 4.87% at October 31, 2019.   

 

We agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

 

The aggregate principal amount available to the Company for borrowing under the revolving term loan at October 31, 2019 and 2018 was $4.0 million.

 

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million until its maturing on May 1, 2020.  Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.85% above the LIBOR Index rate, which was 4.62% at October 31, 2019.

 

The Company also agreed to pay an unused commitment fee on the unused portion of the seasonal revolving loan commitment at the rate of 0.250% per annum.

 

The aggregate principal amount available to the Company for borrowing under the seasonal revolving loan at October 31, 2019 and 2018 was $4.0 million.

 

The 2018 Credit Facility is secured by substantially all of our assets, including a subsidiary guarantee.

 

Under the 2018 Credit Facility, the Company is subject to certain financial and non-financial covenants that limit the Company’s distributions and debt and require minimum working capital, minimum local net worth, and debt service coverage ratio.  We agreed to a debt service coverage ratio of 1.15 to 1.0, to maintain minimum working capital $8.0 million through September 30, 2018 and $10.0 million thereafter, and to maintain net worth of $32.0 million.  We are permitted to pay distributions to our members up to 75% of our net income for the year in which the distributions are paid provided that immediately prior to the distribution and after giving effect to the distribution, no default exists and we are in compliance with all of our loan covenants.  Further, we agreed not to make loans or advances to Agrinatural that exceed an aggregate principal amount of approximately $6.6 million without the consent of Compeer.

 

In October 2018, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2018, the Company received a waiver from its lender waiving this event of noncompliance. In October 2019, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2019, the Company received a waiver from its lender waiving this event of noncompliance. If market conditions deteriorate in the future, circumstances may develop which could result in the Company violating the financial covenants or other terms of its 2018 Credit Facility. Should unfavorable market conditions result in our violation of the terms or covenants of the 2018 Credit Facility and we fail to obtain a waiver of any such term or covenant, Compeer could deem the Company in default, impose fees, charges and penalties, terminate any commitment to loan funds and require the Company to immediately repay a significant portion or possibly the entire outstanding balance of the revolving term loan. In the event of a default, Compeer could also elect to proceed with a foreclosure action on our plant.

 

2020 Credit Facility with Compeer

 

The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment.  The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

 

Under the terms of the amended and restated revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $8.0 million.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2022. Interest on the amended and restated revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate,

52

 

which was 4.87% at October 31, 2019.  We agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

 

As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank.  As a result, CoBank will continue act as the agent for the lender with respect to the 2020 Credit Facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Other Credit Arrangements

 

In addition to our primary credit arrangement with Compeer, we have other material credit arrangements and debt obligations.

 

In October 2003, we entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors, an unrelated company. In consideration of this agreement, we and Minnesota Soybean Processors were allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. On September 30, 2019, we finalized a new industrial water supply development and distribution agreement with the City of Heron Lake, effective as of February 1, 2019. Under this agreement, we pay flow charges and fixed monthly charges to the City of Heron Lake, in addition to certain excess maintenance costs. The term of this agreement expires February 1, 2029.

 

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

 

As of October 31, 2019 and 2018, there was a total of approximately $634,000 and $947,000 in outstanding water revenue bonds, respectively. We classify our obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.

 

To fund the purchase of the distribution system and substation for the plant, we entered into a loan agreement with Federated Rural Electric Association pursuant to which we borrowed $600,000 under a secured promissory note secured by the distribution system and substation for the plant. Under the note we were required to make monthly payments to Federated Rural Electric Association of $6,250 consisting of principal and an annual maintenance fee of 1% beginning on October 10, 2009. We paid the balance of this loan in full in September 2017.

 

We also had a note payable to the minority owner of Agrinatural Gas, LLC in the amount of $100,000 at October 31, 2017.  We paid the balance of this loan in full in January 2018.  

 

Loans to Agrinatural

 

Original Agrinatural Credit Facility

 

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

 

On March 30, 2015, HLBE entered into an allonge (the “Allonge”) to the July 29, 2014 note with Agrinatural. Under the terms of the Allonge, HLBE and Agrinatural agreed to increase the principal amount of the Original Agrinatural Credit Facility to approximately $3.06 million, defer commencement of repayment of principal until May 1, 2015, decrease the monthly principal payment to $36,000 per month and shorten maturity of the Original Agrinatural Credit Facility to May 1, 2019.

 

53

 

Interest on the Original Agrinatural Credit Facility was not amended and accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Accrued interest is due and payable on a monthly basis. Except as otherwise provided in the Allonge, all of the terms and conditions contained in the Original Agrinatural Credit Facility remain in full force and effect.

 

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

 

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Original Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was approximately $1.1 million and $1.5 million at October 31, 2019 and October 31, 2018, respectively. Subsequent to the closing of HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Original Agrinatural Credit Facility.

 

Additional Agrinatural Credit Facility

 

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

 

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

 

On May 19, 2016, HLBE and Agrinatural amended the Additional Agrinatural Credit Facility, entering into amendment to the loan agreement dated March 30, 2015 (the “Amendment”).  Additionally, HLBE and Agrinatural entered into an allonge to the negotiable promissory note dated March 30, 2015 issued by Agrinatural to HLBE (the “Additional Allonge”) to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility and deferred a portion of the principal payments required for 2016. 

 

The Amendment provides that the portion of principal payments deferred in calendar year 2016 to continue to accrue interest at the rate set forth in the Note and become a part of the balloon payment due at maturity.  Additionally, for calendar years, 2017, 2018 and 2019, the Amendment provides that Agrinatural may, without consent of HLBE, proceed with and pay for capital expenditures in an amount up to $100,000 plus the amount of contributions in aid of construction received by Agrinatural from customers for capital improvements (“CIAC”), less a reserve for distribution to the Agrinatural members to cover the income or other taxes imposed as a result of receipt of CIAC in an amount equal to 40% of CIAC. Prior to the Amendment, Agrinatural’s capital expenditures were restricted to $100,000 per year.

 

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

 

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Additional Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was approximately $1.5 million at October 31, 2019 and $2.0 million at October 31, 2018. Subsequent to the closing of

54

 

HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Additional Agrinatural Credit Facility.

 

Off Balance-Sheet Arrangements

 

We have no off balance-sheet arrangements.

 

Critical Accounting Estimates

 

Note 1 to our consolidated financial statements contains a summary of our significant accounting policies, many of which require management to use estimates and assumptions. Accounting estimates are an integral part of the preparation of financial statements and are based upon management’s current judgment. We use our knowledge and experience about past events and certain future assumptions to make estimates and judgments involving matters that are inherently uncertain and that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. We believe that of our significant accounting policies, the following are most noteworthy because changes in these estimates or assumptions could materially affect our financial position and results of operations:

 

Revenue Recognition

 

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Our contracts primarily consist of agreements with marketing companies and other customers as described below. Our performance obligations consist of the delivery of ethanol, distillers' grains, and corn oil to our customers. Our customers primarily consist of three distinct marketing companies as discussed below. The consideration we receive for these products is fixed or determinable based on current observable market prices at the Chicago Mercantile Exchange, generally, and adjusted for local market differentials. Our contracts have specific delivery modes, rail or truck, and dates. Revenue is recognized when the Company delivers the products to the mode of transportation specified in the contract, at the transaction price established in the contract, net of commissions, fees, and freight.

 

Agrinatural recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration Agrinatural expects to receive in exchange for those products or services.

 

Derivative Instruments

 

From time to time, we enter into forward sales contracts for ethanol, distillers and corn oil, and purchase contracts for corn and natural gas to hedge our exposure to commodity price fluctuations.  These contracts 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. Accordingly, we classify these sales and purchase contracts as normal sales and purchase contracts and as a result, these contracts are not marked to market in our consolidated financial statements.

 

On occasion, in order to reduce the risks caused by market fluctuations, the Company hedges its anticipated corn, natural gas, and denaturant purchases and ethanol sales by entering into options and futures contracts. These contracts are used with the intention to fix the purchase price of anticipated requirements for corn in the Company’s ethanol production activities and the related sales price of ethanol. The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions.

 

Although the Company believes its commodity derivative positions are economic hedges, none have been formally designated as a hedge for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value recognized in current period earnings or losses. The Company does not enter into financial instruments for trading or speculative purposes.

 

55

 

Inventory

 

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

 

Property and Equipment

 

Management’s estimate of the depreciable lives of property and equipment is based on the estimated useful lives. 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. The Company tests for impairment at the asset group level, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. 

 

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 future corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our derivative instruments and forward contracts. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the assessment of impairment of our long-lived assets to be a critical accounting estimate.

 

Rail Car Rehabilitation Costs

 

The Company leases 50 hopper rail cars under a multi-year agreement which ends in May 2027. Under the agreement, the Company is required to pay to rehabilitate each car for “damage” that is considered to be other than normal wear and tear upon turn in of the car(s) at the termination of the lease. Prior to the year ending October 31, 2019, the Company believed ongoing repairs resulted in an insignificant future rehabilitation expense. During the year ending October 31, 2019, based on new information, we re-evaluated our assumptions and believe that it is probable that we may be assessed for damages incurred. Company management has estimated total costs to rehabilitate the cars at October 31, 2019 to be approximately $551,000. During the year ended October 31, 2019, the Company has recorded an expense in cost of goods and a corresponding estimated long-term liability totaling $551,000. The Company accrues the estimated cost of railcar damages over the term of the lease as the damages are incurred. It is reasonably possible that there will be a change in estimate in the future.

 

 

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to the impact of market fluctuations associated commodity prices as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. We use cash, futures and option contracts to hedge changes to the commodity prices of corn, ethanol, and natural gas. We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes pursuant to the requirements of FASB ASC 815, Derivatives and Hedging.

 

Interest Rate Risk

 

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our credit facilities with Compeer. The specifics of these credit facilities are discussed in greater detail in “PART II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness”.

 

56

 

The interest rate on the revolving term loan is equal to 3.10% above the One-Month LIBOR, which was 4.87% at October 31, 2019. The interest rate on the seasonal revolving loan is equal to 2.85% above the One-Month LIBOR, which was 4.62% at October 31, 2019. There were no borrowings on either the revolving term loan or the seasonal revolving loan at October 31, 2019. However, if there were borrowings on either or both loan, and we were to experience a 10% adverse change in interest rates, the effect of such change could be substantial and material.

 

Commodity Price Risk

 

We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers’ grains, through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues. The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from 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, 2019, we had price protection in place for approximately 3% and 36% of our anticipated corn and natural gas needs, respectively, and 16%, 5% and 13% of our ethanol, distillers’ grains and corn oil sales, respectively, for the next 12 months.  Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations. As input prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

 

A sensitivity analysis has been prepared to estimate our exposure to ethanol, corn, and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average ethanol price and the fair value of our corn and natural gas prices as of October 31, 2019, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from October 31, 2019. The results of this analysis, which may differ from actual results, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Volume Requirements 

 

 

 

Hypothetical Adverse

 

Approximate

 

 

for the next 12 months

 

Unit of

 

Change in Price as of

 

Adverse

 

    

(net of forward and futures contracts)

    

Measure

    

October 31, 2019

    

Change to Income

Ethanol

 

54,850,000

 

Gallons

 

10.0%

 

$

7,775,000

 

Corn

 

20,800,000

 

Bushels

 

10.0%

 

$

8,174,000

 

Natural Gas

 

1,100,000

 

MMBTU

 

10.0%

 

$

400,000

 

 

 

57

 

 

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

PICTURE 3

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Governors and Members of

Heron Lake BioEnergy, LLC and Subsidiaries

Heron Lake, Minnesota

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Heron Lake BioEnergy, LLC and Subsidiaries (the Company) as of October 31, 2019 and 2018, and the related consolidated statements of operations, changes in members’ equity, and cash flows for each of the years in the three-year period ended October 31, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended October 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, 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.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

/s/ Boulay PLLP

 

We have served as the Company’s auditor since 2005.

 

Minneapolis, Minnesota

January 29, 2020

 

 

58

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

    

October 31, 2019

    

October 31, 2018

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

4,541,295

 

$

5,995,982

 

Restricted cash

 

 

52,516

 

 

 —

 

Accounts receivable

 

 

4,891,249

 

 

3,952,687

 

Inventory

 

 

6,276,258

 

 

6,398,686

 

Commodity derivative instruments

 

 

95,823

 

 

425,638

 

Prepaid expenses and other current assets

 

 

408,325

 

 

392,980

 

Total current assets

 

 

16,265,466

 

 

17,165,973

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

39,408,195

 

 

44,149,925

 

 

 

 

 

 

 

 

 

Other assets

 

 

922,254

 

 

704,958

 

 

 

 

 

 

 

 

 

Total Assets

 

$

56,595,915

 

$

62,020,856

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

333,977

 

$

391,934

 

Accounts payable

 

 

5,386,618

 

 

5,413,915

 

Commodity derivative instruments

 

 

 —

 

 

25,180

 

Accrued expenses

 

 

423,266

 

 

843,875

 

Total current liabilities

 

 

6,143,861

 

 

6,674,904

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

300,203

 

 

567,267

 

 

 

 

 

 

 

 

 

Other Long-Term Liabilities

 

 

551,000

 

 

 —

 

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Members' Equity

 

 

 

 

 

 

 

Members' equity attributable to Heron Lake BioEnergy, LLC consists of 77,932,107 units issued and outstanding at October 31, 2019 and 2018

 

 

47,599,276

 

 

53,054,846

 

Non-controlling interest

 

 

2,001,575

 

 

1,723,839

 

Total members' equity

 

 

49,600,851

 

 

54,778,685

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

56,595,915

 

$

62,020,856

 

 

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

59

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Consolidated Statements of Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended October 31,

 

 

2019

 

2018

 

2017

Revenues

 

$

106,827,445

 

$

108,472,054

 

$

109,917,652

 

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

108,812,379

 

 

104,379,759

 

 

99,488,370

 

 

 

 

 

 

 

 

 

 

Gross Profit (Loss)

 

 

(1,984,934)

 

 

4,092,295

 

 

10,429,282

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

(3,397,611)

 

 

(3,198,740)

 

 

(3,124,687)

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss)

 

 

(5,382,545)

 

 

893,555

 

 

7,304,595

 

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

Interest income

 

 

77,654

 

 

75,558

 

 

24,668

Interest expense

 

 

(98,815)

 

 

(132,036)

 

 

(212,491)

Other income, net

 

 

225,872

 

 

329,916

 

 

399,221

Total other income, net

 

 

204,711

 

 

273,438

 

 

211,398

 

 

 

 

 

 

 

 

 

 

Net Income (Loss)

 

 

(5,177,834)

 

 

1,166,993

 

 

7,515,993

 

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(277,736)

 

 

(311,777)

 

 

(247,638)

 

 

 

 

 

 

 

 

 

 

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC

 

$

(5,455,570)

 

$

855,216

 

$

7,268,355

 

 

 

 

 

 

 

 

 

 

Weighted Average Units Outstanding—Basic and Diluted (Class A and B)

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

 

 

 

 

 

 

 

 

 

Net Income (Loss) Per Unit Attributable to Heron Lake BioEnergy, LLC—Basic and Diluted (Class A and B)

 

$

(0.07)

 

$

0.01

 

$

0.09

 

 

 

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

 —

 

$

0.11

 

$

 —

 

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

 

60

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Consolidated Statements of Changes in Members’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

Members'

    

 

 

    

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 

Heron Lake

 

Non-

 

Total

 

 

 

 

 

 

 

BioEnergy,

 

controlling 

 

Members'

 

 

 

Class A Units

 

Class B Units

 

LLC

 

Interest

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2016

 

62,932,107

 

15,000,000

 

$

53,499,596

 

$

1,245,424

 

$

54,745,020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to non-controlling interest

 

 —

 

 —

 

 

 —

 

 

247,638

 

 

247,638

 

Net income attributable to Heron Lake BioEnergy, LLC

 

 —

 

 —

 

 

7,268,355

 

 

 —

 

 

7,268,355

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2017

 

62,932,107

 

15,000,000

 

 

60,767,951

 

 

1,493,062

 

 

62,261,013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Member Distributions

 

 —

 

 —

 

 

(8,568,321)

 

 

(81,000)

 

 

(8,649,321)

 

Net income attributable to non-controlling interest

 

 —

 

 —

 

 

 —

 

 

311,777

 

 

311,777

 

Net income attributable to Heron Lake BioEnergy, LLC

 

 —

 

 —

 

 

855,216

 

 

 —

 

 

855,216

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2018

 

62,932,107

 

15,000,000

 

 

53,054,846

 

 

1,723,839

 

 

54,778,685

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to non-controlling interest

 

 —

 

 —

 

 

 —

 

 

277,736

 

 

277,736

 

Net loss attributable to Heron Lake BioEnergy, LLC

 

 —

 

 —

 

 

(5,455,570)

 

 

 —

 

 

(5,455,570)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2019

 

62,932,107

 

15,000,000

 

$

47,599,276

 

$

2,001,575

 

$

49,600,851

 

 

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

61

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

    

Fiscal Year Ended October 31,

 

 

2019

 

2018

 

2017

Cash Flow From Operating Activities:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(5,177,834)

 

$

1,166,993

 

$

7,515,993

Adjustments to reconcile net income (loss) to net cash provided by (used in) operations:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

5,253,479

 

 

5,037,645

 

 

5,021,798

(Gain) loss on sale of asset

 

 

4,864

 

 

(24,815)

 

 

(45,000)

Change in fair value of commodity derivative instruments

 

 

(375,216)

 

 

(1,240,386)

 

 

(728,073)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(938,562)

 

 

79,290

 

 

575,225

Inventory

 

 

122,428

 

 

665,658

 

 

(1,199,799)

Commodity derivative instruments

 

 

679,851

 

 

953,942

 

 

1,276,397

Prepaid expenses and other current assets

 

 

(15,345)

 

 

(133,874)

 

 

(77,253)

Accounts payable

 

 

(103,915)

 

 

594,150

 

 

(107,013)

Accrued expenses

 

 

(420,609)

 

 

428,769

 

 

17,699

Accrued railcar rehabilitation costs

 

 

551,000

 

 

 —

 

 

 —

Net cash provided by (used in) operating activities

 

 

(419,859)

 

 

7,527,372

 

 

12,249,974

 

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(432,291)

 

 

(2,533,767)

 

 

(1,174,527)

Acquisition of non-controlling interest

 

 

(225,000)

 

 

 —

 

 

 —

Proceeds from disposal of asset

 

 

 —

 

 

24,815

 

 

45,000

Net cash used in investing activities

 

 

(657,291)

 

 

(2,508,952)

 

 

(1,129,527)

 

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

 

 

Checks drawn in excess of bank balance

 

 

 —

 

 

 —

 

 

(1,866,683)

Payments on long-term debt

 

 

(325,021)

 

 

(438,484)

 

 

(486,041)

Distributions to Heron Lake BioEnergy, LLC members

 

 

 —

 

 

(8,568,321)

 

 

 —

Distribution to non-controlling interest

 

 

 —

 

 

(81,000)

 

 

 —

Net cash used in financing activities

 

 

(325,021)

 

 

(9,087,805)

 

 

(2,352,724)

 

 

 

 

 

 

 

 

 

 

Net increase (Decrease) in Cash and Restricted Cash

 

 

(1,402,171)

 

 

(4,069,385)

 

 

8,767,723

 

 

 

 

 

 

 

 

 

 

Cash and Restricted Cash—Beginning of Period

 

 

5,995,982

 

 

10,065,367

 

 

1,297,644

 

 

 

 

 

 

 

 

 

 

Cash and Restricted Cash—End of Period

 

$

4,593,811

 

$

5,995,982

 

$

10,065,367

 

 

 

 

 

 

 

 

 

 

Reconciliation of Cash and Restricted Cash

 

 

 

 

 

 

 

 

 

Cash - Balance Sheet

 

$

4,541,295

 

$

5,995,982

 

$

10,065,367

Restricted Cash - Balance Sheet

 

 

52,516

 

 

 —

 

 

 —

Cash and Restricted Cash

 

$

4,593,811

 

$

5,995,982

 

$

10,065,367

 

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

 

 

Interest expense

 

$

98,815

 

$

132,036

 

$

212,491

 

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

 

 

 

 

Capital expenditures included in accounts payable

 

$

125,186

 

$

48,568

 

$

 —

 

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

 

 

 

 

62

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

Heron Lake BioEnergy, LLC owns and operates an ethanol plant near Heron Lake, Minnesota with a permitted capacity of approximately 72.3 million gallons per year of undenatured ethanol on a twelve-month rolling sum basis.  In addition, Heron Lake BioEnergy, LLC produces and sells distillers’ grains with solubles and corn oil as co-products of ethanol production. 

   

Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), owns 100% of Agrinatural Gas, LLC (“Agrinatural”), beginning as of December 11, 2019. At October 31, 2019, HLBE held a 73% interest in Agrinatural. Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC’s ethanol production facility and other customers.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively, “the Company”). Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the financial statements of Agrinatural with its consolidated financial statements, with the equity and earnings (loss) attributed to the remaining 27% non-controlling interest identified separately in the accompanying consolidated balance sheets and statements of operations. All significant intercompany balances and transactions are eliminated in consolidation. See Note 18 for a subsequent event regarding the acquisition of non-controlling interest.

 

Fiscal Reporting Period

 

The Company’s fiscal year end for reporting financial operations is October 31.

 

Accounting Estimates

 

Management uses estimates and assumptions in preparing these consolidated financial statements in accordance with U.S. 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 including, among others, the economic lives of property and equipment, valuation of commodity derivative instruments and inventory, evaluation of rail car rehabilitation costs, the assumptions used in the impairment analysis of long-lived assets, and inventory purchase and sale commitments.  The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.

 

Non-controlling Interest

 

Amounts recorded as non-controlling interest relate to the net investment by an unrelated party in Agrinatural. Income and losses are allocated to the members of Agrinatural based on their respective percentage of membership units held. Pursuant to the firm natural gas transportation agreement with Agrinatural, Agrinatural will provide natural gas to Heron Lake BioEnergy’s plant with a specified price per MMBTU with a term ending on October 31, 2021, with one automatic renewal option to extend the term for an additional five years period.

   

Revenue Recognition

 

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Our contracts primarily consist of agreements with marketing companies and other customers as described below. Our performance obligations consist of the delivery of ethanol, distillers’ grains, and corn oil to our customers. Our customers primarily consist of three distinct marketing companies as discussed below. The consideration we receive for these products is fixed or determinable based on current observable market prices at the Chicago Mercantile Exchange, generally, and adjusted for local market differentials. Our contracts have specific delivery modes, rail or truck, and dates. Revenue is recognized when the Company delivers the products to the mode of transportation specified in the contract, at the transaction price established

63

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

in the contract, net of commissions, fees, and freight. We sell each of the products via different marketing channels as described below.

 

·

Ethanol. The Company sells its ethanol via a marketing agreement with Eco-Energy, Inc. Eco-Energy sells one hundred percent of the Company’s ethanol production based on agreements with end users at prices agreed upon mutually among the end user, Eco-Energy and the Company. Our performance obligations consist of our obligation to deliver ethanol to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. The marketing agreement calls for control and title to pass to Eco-Energy once a rail car is released to the railroad or a truck is released from the Company’s scales. Revenue is recognized then at the price in the agreement with the end user, net of commissions, freight, and fees.

 

·

Distillers grains. The Company engages another third-party marketing company, Gavilon, Inc, to sell one hundred percent of the distillers grains it produces at the plant. Gavilon takes title and control once a rail car is released to the railroad or a truck is released from the Company’s scales. Prices are agreed upon between Gavilon and the Company.  Our performance obligations consist of our obligation to deliver distillers grains to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees.

 

·

Distillers corn oil (corn oil). The Company sells one hundred percent of its corn oil production to RPMG, Inc.  The process for selling corn oil is the same as our distillers’ grains.  RPMG takes title and control once a rail car is released to the railroad or a truck is released from the Company's scales. Prices are agreed upon between RPMG and the Company.  Our performance obligations consist of our obligation to deliver corn oil to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees.

 

·

Agrinatural generates revenue from the transportation of natural gas to residential and commercial customers. Revenue is recognized at the point when natural gas is delivered at the transaction price established in the contract.

 

Cost of Goods Sold

 

The primary components of cost of goods sold for the production of ethanol and related co-products are corn, energy, raw materials, overhead, depreciation, railcar rehabilitation costs, and direct labor.

 

Operating Expenses

 

The primary components of operating expenses are salaries and expenses for administrative employees, professional fees, board of governor expenses and property taxes.

 

Cash

 

The Company maintains its accounts at multiple financial institutions. At times throughout the year, the Company’s cash balances may exceed amounts insured by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation. The Company does not believe it is exposed to any significant credit risk on its cash balances.

 

Restricted Cash

 

The Company is periodically required to maintain cash balances at its broker related to derivative instrument positions as discussed in Note 7.

 

Accounts Receivable

 

Credit terms are extended to customers in the normal course of business. The Company performs ongoing credit evaluations of its customers’ financial condition and, 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

64

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

written off. The Company follows a policy of providing an allowance for doubtful accounts; however, based on historical experience, and its evaluation of the current status of receivables, the Company is of the belief that such accounts will be collectible in all material respects and thus an allowance was not necessary at October 31, 2019 or 2018.  It is at least possible this estimate will change in the future.

   

Inventory

 

Inventory is stated at the lower of cost or net realizable value. Cost for all inventories is determined using the first in first out method (FIFO).  Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation.  Inventory consists of raw materials, work in process, finished goods, and supplies.  Corn is the primary raw material along with other raw materials.  Finished goods consist of ethanol, distillers’ grains, and corn oil.

   

Derivative Instruments

 

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

   

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

   

Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.

   

Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our consolidated financial statements.

   

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

   

The Company has adopted authoritative guidance related to “Derivatives and Hedging,” and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. See further discussion in Note 7.

 

Other Intangibles

 

Other intangibles are stated at cost and include road improvements located near the plant in which the Company has a beneficial interest in but does not own the road. The Company amortizes the assets over the economic useful life. The Company recorded amortization expense in the amount of approximately $7,700 for the fiscal year ended October 31, 2019, and approximately $38,000 for each of the fiscal years ended October 31, 2018 and 2017. 

 

65

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

Property and Equipment

 

Property and equipment are recorded at cost. Depreciation is provided over an estimated useful life by use of the straight-line deprecation method. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. Construction in progress expenditures will be depreciated using the straight-line method over their estimated useful lives once the assets are placed into service.

 

Depreciable useful lives are as follows:

 

 

 

 

Land improvements

    

15 Years

 

Plant building and equipment

 

7-40 Years

 

Vehicles and other equipment

 

5-7 Years

 

Office buildings and equipment

 

3-40 Years

 

 

Long-Lived Assets

 

Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  When determining impairment losses, a long lived asset should be grouped with other assets or liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or liabilities.  If circumstances require a long-lived asset to 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, but not limited to, discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.  No impairment expense was recorded during fiscal 2019, 2018, and 2017.

 

Fair Value of Financial Instruments

 

The Company follows guidance for accounting for fair value measurements of financial assets and liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring and nonrecurring basis. The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements).

 

The three levels of the fair value hierarchy are as follows:

 

·

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

·

Level 2 inputs include:

1.

Quoted prices in active markets for similar assets or liabilities.

2.

Quoted prices in markets that are observable for the asset or liability either directly or indirectly, for substantially the full term of the asset or liability.

3.

Inputs that derived primarily from or corroborated by observable market date by correlation or other means.

 

·

Level 3 inputs are unobservable inputs for the asset or liability.

 

The level in the fair value hierarchy within which a fair measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

 

Except for those assets and liabilities which are required by authoritative accounting guidance to be recorded at fair value in our balance sheets, the Company has elected not to record any other assets or liabilities at fair value.  No events occurred during the fiscal years ended October 31, 2019, 2018, and 2017 that required adjustment to the recognized balances of assets or liabilities, which are recorded at fair value on a nonrecurring basis.

 

66

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short maturity of these instruments. The fair value of debt has been estimated using discounted cash flow analysis based upon the Company’s current incremental borrowing rates for similar types of financing arrangements. The fair value of outstanding debt will fluctuate with changes in applicable interest rates. Fair value will exceed carrying value when the current market interest rate is lower than the interest rate at which the debt was originally issued. The Company believes the carrying amount of its debt facilities approximates the fair value.

 

Income Taxes

 

The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, its earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements. Differences between financial statement basis of assets and tax basis of assets is related to capitalization and amortization of organization and start-up costs for tax purposes, whereas these costs are expensed for financial statement purposes. In addition, the Company uses the alternative depreciation system (ADS) for tax depreciation instead of the straight-line method that is used for book depreciation, which also causes temporary differences. The Company’s tax year end is December 31.

   

The Company had no significant uncertain tax positions as of October 31, 2019 or 2018 that would require disclosure, primarily due to the partnership tax status. 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%. Primarily due to the Company’s tax status as a partnership, the adoption of this guidance had no material impact on the Company’s financial condition or results of operations.

   

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 2016.

 

Net Income per Unit

 

Basic net income per unit is computed by dividing net income by the weighted average number of members’ units outstanding during the period. Diluted net income or loss per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period.

 

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.

 

Reportable Operating Segments

 

Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.   Based on the related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.

 

·

Ethanol Production.   Based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant, including the production and sale of ethanol and its co-products, are aggregated into one financial reporting segment.

 

67

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

·

Natural Gas Pipeline. The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment.

 

Recently Adopted Accounting Pronouncements

 

Effective November 1, 2018, the Company adopted the amended guidance ASC Topic 606, Revenue from Contracts with Customers. Refer to Note 1 – Summary of Significant Accounting Policies and Note 3 – Revenue for further details.

   

In November 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-18, Restricted Cash, which amended Statement of Cash Flows (Topic 230) of the Accounting Standards Codification. The new guidance requires an entity to reconcile and explain the period-over-period change in total cash, cash equivalents, restricted cash and restricted cash equivalents within its statement of cash flows. Effective November 1, 2018, the Company adopted the new standard and has applied it retrospectively. Accordingly, the consolidated statements of cash flows for the periods ended October 31, 2019, 2018, and 2017 have been adjusted from amounts previously reported.

 

Recently Issued Accounting Pronouncements

 

Leases (Evaluating)

 

In February 2016, the FASB adopted ASU No. 2016-02, Leases (Topic 842), which provides guidance for accounting for leases. The new guidance requires companies to recognize the assets and liabilities for the rights and obligations created by leased assets, initially measured at the present value of the lease payments. The accounting guidance for lessors is largely unchanged. The guidance will be effective for the Company beginning November 1, 2019. It is to be adopted using a modified retrospective approach. The Company is evaluating the impact that the adoption of this guidance will have on the Company’s consolidated financial statements and anticipates the new guidance will significantly impact its consolidated financial statements given the Company leases a significant number of rail cars for transporting ethanol and dried distillers grains with solubles to its end customers.

 

2. RISKS AND UNCERTAINTIES

 

The Company has certain risks and uncertainties that it experienced during volatile market conditions. These volatilities can have a severe impact on operations. The Company’s revenues are primarily derived from the sale and distribution of ethanol, distillers’ grains and corn oil to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers. Ethanol sales average 75%-85% of total revenues and corn costs average 70%-90% of cost of goods sold.

   

The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol, distillers’ grains and corn oil, and the related costs of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, unleaded gasoline prices and the petroleum markets as a whole. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and a risk management program used to protect against the price volatility of these commodities. Market fluctuations in the price of and demand for these products may have a significant adverse effect on the Company’s operations, profitability and the availability and adequacy of cash flow to meet the Company’s working capital requirements. The Company’s risk management program is used to protect against the price volatility of these commodities.

   

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2018 and into 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. The Company believes its cash on hand and available debt from its lender will provide sufficient liquidity to meets its anticipated working capital, debt service and other liquidity needs through the next twelve months.

 

Additionally, supply and demand for ethanol are impacted by federal and state legislation and regulation, most significantly the Renewable Fuels Standard (“RFS”), and any changes in legislation or regulation could cause the

68

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

demand for ethanol to decline or its supply to increase, which could have a material adverse effect on our business, results of operations and financial condition, and the ability to operate at a profit. On December 19, 2019, the EPA announced the final 2020 renewable volume requirements (“RVOs”), setting the RVOs for conventional ethanol at 15.0 billion gallons, advanced biofuels at 5.09 billion gallons and cellulosic ethanol at 0.59 billion gallons, for overall RVOs of 20.09 billion gallons for 2020.  Although this final rule achieves the statutory RVO for conventional corn-based ethanol originally set by Congress when the RFS was enacted, it reduces the overall RVOs below the overall statutory level of 30 billion gallons. 

 

Current ethanol production capacity exceeds the EPA’s 2019 and 2020 RVOs that can be satisfied by corn-based ethanol.  According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered a proposed RFS “reset” rule to the White House Office of Management and Budget. If the statutory RVOs are reduced as a result of such reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

Additionally, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. Successful reduction or repeal of the blending requirements of the RFS could result in a significant decrease in ethanol demand.

 

3. REVENUE

 

Adoption of ASC Topic 606

   

On November 1, 2018, the Company adopted the amended guidance in ASC Topic 606, Revenue from Contracts with Customers, and all related amendments (“new revenue standard”) and applied it to all contracts using the modified retrospective transition method. The adoption of the new revenue standard did not result in any changes to the timing or amount of revenue recognized prior to November 1, 2018, but did result in expanded disclosures to our consolidated financial statements.

 

Revenue by Source

   

All revenues from contracts with customers under ASC Topic 606 are recognized at a point in time. The following table disaggregates revenue by major source for the fiscal year ended October 31, 2019:  

 

 

 

 

 

 

 

 

 

 

 

 

Ethanol Production

 

 

Natural Gas Pipeline

 

 

Total

Ethanol

$

82,544,145

 

$

 

$

82,544,145

Distillers’ Grains

 

18,214,512

 

 

 

 

18,214,512

Corn Oil

 

3,513,679

 

 

 

 

3,513,679

Other

 

1,123,217

 

 

 

 

1,123,217

Natural Gas

 

 

 

1,431,892

 

 

1,431,892

Total Revenues

$

105,395,553

 

$

1,431,892

 

$

106,827,445

69

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

Payment Terms

   

The Company has contractual payment terms with each respective marketer that sells ethanol, distillers’ grains and corn oil.  These terms are 10 calendar days after the transfer of control date. The Company has contractual payment terms with the natural gas customers of 20 days.

 

Shipping and Handling Costs

   

Shipping and handling costs related to contracts with customers for sale of goods are accounted for as a fulfillment activity and are included in cost of goods sold. Accordingly, amounts billed to customers for such costs are included as a component of revenue.

 

4. FAIR VALUE MEASUREMENTS

 

The Company follows accounting guidance related to fair value disclosures.  For the Company, this guidance applies to certain derivative investments.  The authoritative guidance also clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair measurements.

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices

 

Significant Other

 

Significant

 

 

 

Consolidated Balance Sheet

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable inputs

 

Financial Assets

    

 

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

20,060

 

$

20,060

 

$

20,060

 

$

 —

 

$

 —

 

Commodity Derivative instruments - Ethanol

 

$

75,763

 

$

75,763

 

$

75,763

 

$

 

 

$

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

 

 

Consolidated

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable Inputs

 

Financial Assets:

    

Balance Sheet

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

425,638

 

$

425,638

 

$

425,638

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative instruments - Corn

 

$

25,180

 

$

25,180

 

$

 —

 

$

25,180

 

$

 

 

 

We determine the fair value of commodity derivative instruments by obtaining fair value measurements from an independent pricing service.  The fair value measurements consider observable data that may include dealer quotes and live trading levels from the Chicago Board of Trade market and New York Mercantile Exchange. We determine the fair value of corn Level 2 instruments by model-based techniques in which all significant inputs are observable in the markets noted above.

 

5. CONCENTRATIONS

 

The Company sold all of the ethanol, distillers’ grains, and corn oil produced at its plant to three customers under marketing agreements during the fiscal years ended October 31, 2019, 2018, and 2017.

   

70

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

The percentage of total revenues attributable to each of the Company’s three major customers for the fiscal years ended October 31, 2019, 2018, and 2017 were as follows: 

 

 

 

 

 

 

 

 

 

 

 

October 31, 2019

 

October 31, 2018

 

October 31, 2017

 

Eco-Energy, Inc. - Ethanol

 

77.3%

 

76.3%

 

81.3%

 

Gavilon Ingredients, LLC - Distillers' Grains

 

16.9%

 

18.3%

 

13.7%

 

RPMG, Inc. - Corn Oil

 

3.3%

 

3.7%

 

4.5%

 

 

The percentage of total accounts receivable attributable to each of the Company’s three major customers at October 31, 2019 and 2018 were as follows:

 

 

 

 

 

 

 

 

 

October 31, 2019

 

October 31, 2018

 

Eco-Energy, Inc. - Ethanol

 

80.0%

 

77.6%

 

Gavilon Ingredients, LLC - Distillers' Grains

 

15.3%

 

15.4%

 

RPMG, Inc. - Corn Oil

 

2.8%

 

2.6%

 

 

 

6. INVENTORY

 

Inventory consists of the following at October 31:

 

 

 

 

 

 

 

 

 

 

    

2019

    

2018

 

Raw materials

 

$

932,503

 

$

1,215,640

 

Work in process

 

 

732,243

 

 

571,228

 

Finished goods

 

 

3,157,429

 

 

3,436,175

 

Supplies

 

 

1,454,083

 

 

1,175,643

 

Totals

 

$

6,276,258

 

$

6,398,686

 

 

The Company performs a lower cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol.  Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol and corn inventories, as a component of cost of goods sold, of approximately $537,000 and $47,000 for the fiscal year ended October 31, 2019, respectively. The Company recorded a loss on ethanol and corn inventories, as a component of cost of goods sold, of approximately $669,000 and $101,000 for the fiscal year ended October 31, 2018, respectively.

 

 

 

7. DERIVATIVE INSTRUMENTS

 

The Company enters into corn, ethanol, and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices for periods up to 24 months. These derivatives are put in place to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sales and corn purchase commitments where the prices are set at a future date. Although these derivative instruments serve the Company’s purpose as an economic hedge, they 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.

 

As of October 31, 2019, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,398,000 bushels, comprised of long corn futures positions on 2,131,000 bushels that were entered into to hedge forecasted ethanol sales through July 2020, and short corn futures positions on 3,267,000 bushels that were entered into to hedge forecasted corn purchases through December 2021. Additionally, there are corn options positions of 4,000,000 bushels through March 2020. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of October 31, 2019, the Company had approximately $52,000 in cash collateral (restricted cash) related to derivates held by a broker.

 

71

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2019, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

20,060

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

75,763

 

 

 —

 

Totals

 

 

 

$

95,823

 

$

 —

 

 

As of October 31, 2018, the Company had no cash collateral (restricted cash) related to derivatives held by a broker.

 

The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2018, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

425,638

 

$

25,180

 

Totals

 

 

 

$

425,638

 

$

25,180

 

 

As of October 31, 2018, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 2,685,000 bushels, comprised of long corn positions on 510,000 bushels that were entered into to hedge forecasted ethanol sales through July 2019, and short corn positions on 2,175,000 bushels that were entered into to hedge forecasted corn purchases through March 2020.  There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

The following table provides details regarding the gains (losses) from the Company’s derivative instruments in its consolidated statements of operations, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Statement of

 

Fiscal Year Ended  October 31,

 

 

    

Operations Location

 

2019

    

2018

    

2017

 

Corn contracts

 

Cost of goods sold

 

$

350,624

 

$

1,188,237

 

$

962,256

 

Ethanol contracts

 

Revenues

 

 

24,592

 

 

53,747

 

 

(218,802)

 

Natural gas contracts

 

Cost of goods sold

 

 

 —

 

 

(1,598)

 

 

(15,381)

 

Total gain

 

 

 

$

375,216

 

$

1,240,386

 

$

728,073

 

 

 

8. PROPERTY AND EQUIPMENT

 

A summary of property and equipment is as follows:

 

 

 

 

 

 

 

 

 

 

    

October 31, 2019

    

October 31, 2018

 

Land and improvements

 

$

9,111,838

 

$

9,111,838

 

Plant buildings and equipment

 

 

88,708,522

 

 

87,940,264

 

Vehicles

 

 

700,959

 

 

700,959

 

Office buildings

 

 

735,864

 

 

738,073

 

Construction in progress

 

 

58,319

 

 

375,245

 

 

 

 

99,315,502

 

 

98,866,379

 

Less: accumulated depreciation

 

 

(59,907,307)

 

 

(54,716,454)

 

Net property and equipment

 

$

39,408,195

 

$

44,149,925

 

 

Depreciation expense totaled approximately $5,246,000, $4,999,000 and $4,984,000 during the fiscal years ended October 31, 2019, 2018, and 2017, respectively. 

72

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

9. DEBT FACILITIES

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

 

October 31, 2019

 

October 31, 2018

 

Amended revolving term note payable to lending institution, see terms below.

 

$

 —

 

$

 —

 

Seasonal line of credit payable to lending institution, see terms below.

 

 

 —

 

 

 —

 

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

 

 

634,180

 

 

947,300

 

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

 

 

 —

 

 

11,901

 

Totals

 

 

634,180

 

 

959,201

 

Less amounts due within one year

 

 

333,977

 

 

391,934

 

Net long-term debt

 

$

300,203

 

$

567,267

 

 

Revolving Term Note

 

The Company had a revolving term note payable under which the Company could borrow, repay, and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022. The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity. In December 2017, the Company and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000.  On April 6, 2018, the Company finalized loan agreements with an effective date of March 29, 2018 for an amended credit facility with its lender (the “2018 Credit Facility”). On January 7, 2020, the Company finalized loan agreements for an amended credit facility with its lender (the “2020 Credit Facility”).

 

2020 Credit Facility 

   

The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment. This loan replaces the amended revolving term note and seasonal revolving loan made under the 2018 Credit Facility. The loan is secured by substantially all of the Company’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

 

As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank, ACP (“CoBank”).  As a result, CoBank will continue act as the agent for the lender with respect to the 2020 Credit Facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

   

Amended Revolving Term Note 

   

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $8,000,000.  Final payment of amounts borrowed under the amended revolving term loan is due December 1, 2022.  Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate.      

    

The Company also agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

   

73

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

2018 Credit Facility

 

The 2018 Credit Facility includes an amended and restated revolving term loan with a $4,000,000 principal commitment and a revolving seasonal line of credit with a $4,000,000 principal commitment.  The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee.  The 2018 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties. In October 2018, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2018, the Company received a waiver from its lender waiving this event of noncompliance. In October 2019, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2019, the Company received a waiver from its lender waiving this event of noncompliance.

 

As part of the 2018 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank, ACP (“CoBank”).  As a result, CoBank will continue act as the agent for the lender with respect to the 2018 Credit Facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

   

Amended Revolving Term Note

   

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021.  Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 4.87% at October 31, 2019.     

 

The Company also agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

   

The aggregate principal amount available to the Company for borrowing under the amended revolving term loan at October 31, 2019 and 2018 was $4,000,000.

   

Seasonal Revolving Loan

   

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000 until its maturing on May 1, 2020.  Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.85% above the rate quoted by LIBOR Index rate, which was 4.62% at October 31, 2019.  The aggregate principal amount available under the seasonal revolving loan was $4,000,000 at October 31, 2019 and 2018.

   

The Company also agreed to pay an unused commitment fee on the unused portion of the seasonal revolving loan commitment at the rate of 0.250% per annum.

 

Estimated annual maturities of long-term debt at October 31, 2019 are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2020

    

$

333,977

 

2021

 

 

300,203

 

Total debt

 

$

634,180

 

 

 

10. MEMBERS’ EQUITY

 

The Company is authorized to issue 80,000,000 capital units, of which 65,000,000 have been designated Class A units and 15,000,000 have been designated as Class B units. Members of the Company are holders of units who have been admitted as members and who hold at least 2,500 units. Any holder of units who is not a member will not have voting rights. Transferees of units must be approved by our board of governors to become members. Members are entitled to one vote for each unit held. Subject to the Member Control Agreement, all units share equally in the profits and losses and distributions of assets on a per unit basis.

74

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

On December 21, 2017, the Company’s board of governors declared a distribution of $0.11 per membership unit for a total of approximately $8,573,000 to be paid to members of record as of December 21, 2017.  The distribution was paid in January 2018.  Based on the covenants contained in the Company’s lender credit facilities, the foregoing distribution was approved by its lender prior to distribution.

 

11. LEASES

 

The Company has lease agreements with leasing companies for 138 rail cars for the transportation of the Company’s ethanol with various maturity dates through January 2027. The rail car lease payments are due monthly in the aggregate amount of approximately $122,000. 

 

The Company has lease agreements with leasing companies for 110 hopper cars to assist in with the transport of the distillers’ grains by rail with various maturity dates through May 2027.  The rail car lease payments are due monthly in the amount of approximately $64,000.

 

Rent expense for the Company’s leases was approximately $2,374,000, $2,339,000 and $2,170,000 for the fiscal years ended October 31, 2019, 2018, and 2017, respectively.

 

At October 31, 2019, the Company had the following minimum future lease payments, which at inception had non‑cancelable terms of more than one year:

 

 

 

 

 

 

November 1, 2019 to October 31, 2020

 

$

1,767,000

 

November 1, 2020 to October 31, 2021

 

 

1,767,000

 

November 1, 2021 to October 31, 2022

 

 

1,767,000

 

November 1, 2022 to October 31, 2023

 

 

1,767,000

 

November 1, 2023 to October 31, 2024

 

 

1,670,000

 

Thereafter

 

 

3,812,000

 

Total minimum lease commitments

 

$

12,550,000

 

 

 

12. INCOME TAXES

 

The differences between consolidated financial statement basis and tax basis of assets and liabilities are estimated as follows at October 31:

 

 

 

 

 

 

 

 

 

    

2019

    

2018

Consolidated financial statement basis of assets

 

$

56,595,915

 

$

62,020,856

Plus: Organization and start-up costs capitalized for tax purposes, net

 

 

502,566

 

 

617,833

Less: Unrealized gains on commodity derivative instruments

 

 

(95,823)

 

 

(425,638)

Less: Accumulated tax depreciation and amortization greater than financial statement basis

 

 

(56,386,730)

 

 

(56,330,302)

Plus: Impairment charge

 

 

27,844,579

 

 

27,844,579

Income tax basis of assets

 

$

28,460,507

 

$

33,727,328

 

    

 

    

 

Financial Statement basis of liabilities

 

$

6,995,064

 

 

 

Accrued Rail Car Maintenance

 

 

(551,000)

 

 

 

Other Accruals

 

 

(183,891)

 

 

 

Income tax basis of liabilities

 

$

6,260,174

 

 

 

 

There were no significant differences between the consolidated financial statement basis of liabilities and the income tax basis of liabilities at 2018.

 

13. EMPLOYEE BENEFIT PLANS

 

The Company has a defined contribution plan available to all of its qualified employees. The Company contributes a match of 50% of the participant’s salary deferral up to a maximum of 4% of the employee’s salary.  The Company

75

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

contributions totaled approximately $92,000, $98,000, and $90,000 for the fiscal years ended October 31, 2019, 2018, and 2017, respectively.

 

14. RELATED PARTY TRANSACTIONS

 

Granite Falls Energy, LLC

 

The Company has a management services agreement with Granite Falls Energy, LLC (“GFE”), a related party.  Under the terms of the agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses and other expenses and costs for the three management positions.  The management services agreement automatically renews for successive one-year terms unless the Company or GFE gives the other party 90-day written notice of termination prior to expiration of the then-current term.  The management services agreement may also be terminated by either party for cause under certain circumstances.

 

Total expenses under this agreement were $438,000, $449,000 and $406,000 for fiscal years ended October 31, 2019, 2018, and 2017, respectively.

 

Corn Purchase - Members

 

The Company purchased corn from members of its Board of Governors of approximately $11,478,000 in fiscal year 2019,  of which approximately $470,000 is included in accounts payable at October 31, 2019, $14,483,000 in fiscal year 2018, of which approximately $348,000 is included in accounts payable at October 31, 2018, and $9,811,000 in fiscal year 2017  of which approximately $602,000 is included in accounts payable at October 31, 2017.

 

Swan Engineering

 

Agrinatural had a management and operating agreement with Swan Engineering, Inc. (“SEI”). SEI, together with an unrelated third party owns Rural Energy Solutions, LLC (“RES”), the 27% minority owner of Agrinatural. Under the management and operating agreement, SEI provided Agrinatural with day-to-day management and operation of Agrinatural’s pipeline distribution business. In exchange for these services, Agrinatural paid SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500. For the year ended October 31, 2019, the Company paid approximately $28,000 and $111,000 for the monthly base fee and variable customer management fee, respectively. For the year ended October 31, 2018, the Company paid approximately $38,000 and $161,000 for the monthly base fee and variable customer management fee, respectively.  For the year ended October 31, 2017, the Company paid approximately $36,000 and $157,000 for the monthly base fee and variable customer management fee, respectively. The management and operating agreement with SEI expired July 1, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.

 

Agrinatural also had a project management agreement with SEI. Pursuant to the project management agreement, SEI supervised all of Agrinatural’s pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the project management agreement, Agrinatural paid SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural’s Board of Directors, excluding capitalized marketing costs. For the year ended October 31, 2019, the Company incurred approximately $45,000 for project management and capital work fees. For the year ended October 31, 2018, the Company incurred approximately $77,000 for project management and capital work fees. For the year ended October 31, 2017, the Company incurred approximately $44,000 for project management and capital work fees. The project management with SEI expired June 30, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.

 

15. COMMITMENTS AND CONTINGENCIES

 

Water Agreements

 

In September 2019, the Company entered into an industrial water supply development and distribution agreement, effective as of February 1, 2019, with the City of Heron Lake for 10 years.  The Company has the exclusive rights to the

76

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

first 600 gallons per minute of capacity that is available from the well.  In consideration, the Company will pay flow charges at a rate of $0.60 cents per thousand gallons of water, in addition to a fixed monthly charge of $1,500 per month.  The flow charges are placed into a dedicated fund for operation and maintenance of the well, and are capped at $300,000 at the end of each year. The Company is also responsible for paying 55% of operation and maintenance costs in excess of the $300,000 cap, in the first two years of the agreement. Thereafter, the percentage payable by the Company is determined based on a two-year average of the Company’s usage compared to the total amount of industrial water supplied to the Company and a third-party customer of the City of Heron Lake.

 

Under the previous industrial water supply development and distribution agreement with the City of Heron Lake, the Company paid one half of the City of Heron Lake’s water well bond payments of $735,000, plus a 5% administrative fee, totaling approximately $594,000, and operating costs, relative to the Company’s water usage, plus a 10% profit. The Company recorded an assessment of approximately $367,000 with long-term debt as described in Note 9.  The Company paid operating and administrative expenses of approximately $12,000 per year.

 

In May 2006, the Company entered into a water treatment agreement with the City of Heron Lake and Jackson County for 30 years. The Company will pay for operating and maintenance costs of the plant in exchange for receiving treated water.  In addition, the Company agreed to an assessment for a portion of the capital costs of the water treatment plant. 

 

The Company recorded assessments with long-term debt of $500,000 and $3,550,000 in fiscal 2007 and 2006, respectively, as described in Note 9.  The Company paid operating and maintenance expenses of approximately $52,000, $92,000, and $24,000 in fiscal 2019, 2018, and 2017, respectively.

 

Ethanol Marketing Agreement

 

The Company has a marketing agreement (“Eco Agreement”) with Eco-Energy, Inc., an unrelated party (“Eco-Energy”) for the sale of ethanol.  Under this ethanol agreement, Eco-Energy purchases, markets and resells 100% of the ethanol produced at the Company’s ethanol production facility and arranges for the transportation of ethanol.  The Company pays Eco-Energy a marketing fee per gallon of ethanol sold in consideration of Eco-Energy’s services, as well as a fixed lease fee for rail cars leased from Eco-Energy to the Company. The marketing fee was negotiated based on prevailing market-rate conditions for comparable ethanol marketing services.

 

The initial term of Eco Agreement continued through December 31, 2016, with automatic renewals for additional three terms of three year periods unless terminated by either party by providing written notice to the other party at least 3 months prior to the end of the then current term. During the third fiscal quarter of 2016, the Company amended the Eco Agreement. In October 2019, the Company amended the Eco Agreement, which provides an extension of the term of the agreement through December 31, 2020, with automatic renewals for additional consecutive terms of one year unless either party provides written notice to the other at least 90 days prior to the end of the then-current term. Additionally, the amended Eco Agreement provides for certain negotiated changes to the marketing fees payable to Eco-Energy and payment terms based on prevailing market-rate conditions for comparable ethanol marketed services.

 

Ethanol marketing fees and commissions totaled approximately $635,000, $604,000, and $587,000 for the fiscal years ended October 31, 2019, 2018, and 2017.

 

Ethanol Forward Contracts

 

At October 31, 2019, the Company had fixed and basis contracts to sell approximately $13,490,000 of ethanol for various delivery periods through December 2019, which approximates 92% of its anticipated ethanol sales for that period.

 

Distillers’ Grains Marketing Agreement

 

Gavilon Ingredients, LLC, an unrelated party (“Gavilon”), serves as the distillers’ grains marketer for our plant pursuant to a distillers’ grains off-take agreement.  Pursuant to our agreement with Gavilon, Gavilon purchases all of the distillers’ grains produced at our ethanol plant.  We pay Gavilon a service fee for its services under this agreement. The contract commenced on November 1, 2013 with an initial term of six months, and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 60 days to the other party.

 

77

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

Distillers’ grains commissions totaled approximately $287,000, $252,000, and $268,000 for the fiscal years ended October 31, 2019, 2018 and 2017.

 

Distillers’ Grains Forward Contracts

 

At October 31, 2019, the Company had forward contracts to sell approximately $1,275,000 of distillers’ grains for delivery through January 2020, which approximates 21% of its anticipated distillers’ grains sales during that period.

 

Corn Oil Marketing Agreement

 

RPMG, Inc., an unrelated party, markets the corn oil produced at our ethanol plant pursuant to a corn oil marketing agreement.  We pay RPMG a commission based on each pound of corn oil sold by RPMG under the agreement. The contract commenced on November 1, 2013 with an initial term of one year and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 90 days to the other party.

 

Corn oil commissions totaled approximately $71,000, $83,000, and $89,000 for the fiscal years ended October 31, 2019, 2018, and 2017.

 

Corn Oil Forward Contracts

 

At October 31, 2019, the Company had forward contracts to sell approximately $468,000 of corn oil for delivery through December 2019, which approximates 75% of its anticipated corn oil sales for that period.

 

Contract for Natural Gas Pipeline to Plant

 

The Company has a facilities agreement with Northern Border Pipeline Company which allows us access to an existing interstate natural gas pipeline located approximately 16 miles north from the plant. Agrinatural was formed to own and operate the pipeline and transports gas to the Company pursuant to a transportation agreement.

 

The Company also has a base agreement for the sale and purchase of natural gas with Constellation NewEnergy-Gas Division, LLC (“Constellation”), pursuant to which it buys all of its natural gas from Constellation.  This agreement runs until March 31, 2022.

 

Corn Forward Contracts

 

At October 31, 2019, the Company had cash and basis contracts for forward corn purchase commitments for approximately 740,000 bushels for deliveries through December 2021.

 

Given the uncertainty of future ethanol and corn prices, the Company could incur a loss on the outstanding corn purchase contracts in future periods. Management has evaluated these forward contracts and its inventories using the lower of cost or net realizable value evaluation, similar to the method used on its inventory, and has determined that no impairment loss existed at October 31, 2019 and 2017, and an impairment loss existed of approximately $323,000 at October 31, 2018. The impairment expense is recorded as a component of cost of goods sold.

 

Rail Car Rehabilitation Costs 

 

The Company leases 50 hopper rail cars under a multi-year agreement which ends in May 2027. Under the agreement, the Company is required to pay to rehabilitate each car for “damage” that is considered to be other than normal wear and tear upon turn in of the car(s) at the termination of the lease. Prior to the year ending October 31, 2019, the Company believed ongoing repairs resulted in an insignificant future rehabilitation expense. During the year ending October 31, 2019, based on new information, we re-evaluated our assumptions and believe that it is probable that we may be assessed for damages incurred. Company management has estimated total costs to rehabilitate the cars at October 31, 2019 to be approximately $551,000. During the year ended October 31, 2019, the Company has recorded an expense in cost of goods and a corresponding estimated long-term liability totaling $551,000. The Company accrues the estimated cost of railcar damages over the term of the lease as the damages are incurred.

 

78

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

16. BUSINESS SEGMENTS

 

The Company groups its operations into the following two business segments:

 

 

 

 

Ethanol Production:

    

Ethanol and co-product production and sales

Natural gas pipeline:

 

Ownership and operations of natural gas pipeline

 

Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses.   The accounting policies for each segment are the same as those described in the summary of significant accounting policies in Note 1. Segment income or loss does not include any allocation of shared-service costs.  Segment assets are those that are directly used in or identified with segment operations. Inter-segment balances and transactions have been eliminated.

 

The following tables summarize financial information by segment and provide a reconciliation of segment revenue, contribution to operating income and total assets for the fiscal years ended October 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended  October 31,

 

Revenue:

 

2019

 

2018

 

2017

 

Ethanol production

 

$

105,395,553

 

$

106,811,761

 

$

108,709,255

 

Natural gas pipeline

 

 

3,182,958

 

 

3,436,880

 

 

2,946,438

 

Eliminations

 

 

(1,751,066)

 

 

(1,776,587)

 

 

(1,738,041)

 

Total Revenue

 

$

106,827,445

 

$

108,472,054

 

$

109,917,652

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended  October 31,

 

Operating Income (Loss):

 

2019

 

2018

 

2017

 

Ethanol production

    

$

(6,594,653)

    

$

(501,475)

 

$

6,821,779

 

Natural gas pipeline

 

 

1,878,935

 

 

2,116,147

 

 

1,177,251

 

Eliminations

 

 

(666,827)

 

 

(721,117)

 

 

(694,435)

 

Operating Income (Loss):

 

$

(5,382,545)

 

$

893,555

 

$

7,304,595

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended October 31,

 

Assets:

 

2019

 

2018

 

Ethanol production

 

$

44,097,379

 

$

49,540,279

 

Natural gas pipeline

 

 

12,498,536

 

 

12,480,577

 

Total Assets

 

$

56,595,915

 

$

62,020,856

 

 

 

79

 

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

17. QUARTERLY FINANCIAL DATA (UNAUDITED)

 

Summary quarterly results are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

First

    

Second

    

Third

    

Fourth

 

Fiscal year ended October 31, 2019

 

Quarter

 

Quarter

 

Quarter

 

Quarter

 

Revenues

 

$

25,697,520

 

$

25,494,797

 

$

27,367,787

 

$

28,267,341

 

Gross profit (loss)

 

 

(1,033,800)

 

 

(419,654)

 

 

1,248,103

 

 

(1,779,583)

 

Operating income (loss)

 

 

(1,953,327)

 

 

(1,275,409)

 

 

381,693

 

 

(2,535,502)

 

Net income (loss) attributable to Heron Lake BioEnergy, LLC

 

 

(2,023,640)

 

 

(1,115,152)

 

 

326,579

 

 

(2,643,357)

 

Basic and diluted earnings (loss) per unit attributable to Heron Lake BioEnergy, LLC (Class A and B)

 

$

(0.03)

 

$

(0.01)

 

$

 —

 

$

(0.03)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

First

    

Second

    

Third

    

Fourth

 

Fiscal year ended October 31, 2018

 

Quarter

 

Quarter

 

Quarter

 

Quarter

 

Revenues

 

$

27,972,451

 

$

29,880,856

 

$

26,252,916

 

$

24,365,831

 

Gross profit (loss)

 

 

1,581,182

 

 

2,127,807

 

 

1,092,414

 

 

(709,108)

 

Operating income (loss)

 

 

716,139

 

 

1,285,823

 

 

373,043

 

 

(1,481,450)

 

Net income (loss) attributable to Heron Lake BioEnergy, LLC

 

 

861,997

 

 

1,271,018

 

 

302,686

 

 

(1,580,485)

 

Basic and diluted earnings (loss) per unit attributable to Heron Lake BioEnergy, LLC (Class A and B)

 

$

0.01

 

$

0.02

 

$

 —

 

$

(0.02)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

First

    

Second

    

Third

    

Fourth

 

Fiscal year ended October 31, 2017

 

Quarter

 

Quarter

 

Quarter

 

Quarter

 

Revenues

 

$

27,390,074

 

$

25,990,784

 

$

28,541,889

 

$

27,994,905

 

Gross profit

 

 

3,414,231

 

 

1,850,266

 

 

2,251,294

 

 

2,913,491

 

Operating income

 

 

2,567,534

 

 

1,080,594

 

 

1,518,888

 

 

2,137,579

 

Net income attributable to Heron Lake BioEnergy, LLC

 

 

2,832,416

 

 

1,019,120

 

 

1,414,752

 

 

2,002,070

 

Basic and diluted earnings per unit attributable to Heron Lake BioEnergy, LLC (Class A and B)

 

$

0.04

 

$

0.01

 

$

0.02

 

$

0.02

 

 

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.

 

18. SUBSEQUENT EVENT

 

On December 11, 2019, HLBE Pipeline Company, LLC, which is a wholly owned subsidiary of Heron Lake BioEnergy, acquired the remaining non-controlling interest of Agrinatural for a total price of $2.225 million. A deposit of $225,000 was paid in October 2019 and recorded within other assets at October 31, 2019. The change of interest will be recorded as an equity transaction in accordance with ASC 805 during fiscal year 2020.

 

 

 

 

80

 

 

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

 

ITEM 9A.    CONTROLS AND PROCEDURES

 

(a) Disclosure Controls and Procedures

 

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

 

Our management, including our Chief Executive Officer and General Manager (the principal executive officer), Steve Christensen, along with our Chief Financial Officer (the principal financial officer), Stacie Schuler, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of October 31, 2019. Based upon this review and evaluation, these officers have concluded that our consolidated disclosure controls and procedures are effective as of October 31, 2019.

 

(b) Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a15-(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s 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 the assets of the Company;

 

(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 receipts and expenditures of the Company are being made only in accordance with authorizations of management and governors of the Company; and

 

(iii)  provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of October 31, 2019.

 

An attestation report from our accounting firm on our internal control over financial reporting is not included in this annual report because an attestation report is only required under the regulations of the Securities and Exchange Commission for accelerated filers and large accelerated filers.

81

 

(c) Changes in Internal Controls Over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fourth fiscal quarter ended October 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B.    OTHER INFORMATION

 

None.

 

 

PART III

 

Pursuant to General Instruction G(3), we omit Part III, Items 10, 11, 12, 13 and 14 and incorporate such items by reference to an amendment to this Annual Report on Form 10-K or to a definitive proxy statement (the “2020 Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year (October 31, 2019) covered by this Annual Report.

 

 

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The Information required by this Item is incorporated by reference to the 2020 Proxy Statement.

 

 

ITEM 11.    EXECUTIVE COMPENSATION

 

The Information required by this Item is incorporated by reference to the 2020 Proxy Statement.

 

 

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The Information required by this Item is incorporated by reference to the 2020 Proxy Statement.

 

 

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The Information required by this Item is incorporated by reference to the 2020 Proxy Statement.

 

 

ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

 

The Information required by this Item is incorporated by reference to the 2020 Proxy Statement.

 

82

 

 

PART IV

 

 

ITEM 15.    EXHIBITS, FINANCIAL STATEMENTS SCHEDULES

 

The following exhibits and financial statements are filed as part of, or are incorporated by reference into, this report:

 

(a)Financial Statements

 

The consolidated financial statements appear beginning at page 58 of this report.

 

(b)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.

 

(c)Exhibits

 

 

 

 

 

 

Exhibit
Number

    

Exhibit Title

    

Incorporated by Reference To:

3.1

 

First Amended and Restated Articles of Organization of Heron Lake BioEnergy, LLC, as amended effective August 30, 2011

 

Exhibit 3.1 to Current Report on Form 8-K dated September 2, 2011.

3.2

 

Member Control Agreement of Heron Lake BioEnergy, LLC, as amended through August 30, 2011

 

Exhibit 3.2 to Current Report on Form 8-K dated September 2, 2011.

3.2.1

 

First Amendment to the Member Control Agreement

 

Exhibit 3.1 to Current Report on Form 8-K dated March 24, 2014.

3.2.2

 

Second Amendment to the Member Control Agreement

 

Exhibit 3.1 to Current Report on Form 8-K/A dated March 29, 2017.

4.1

 

Form of Class A Unit Certificate

 

Exhibit 4.1 of the Company’s Registration Statement on Form 10 (File No. 000-51825) filed on August 22, 2008 (the “2008 Registration Statement”).

4.2

 

Unit Transfer Policy adopted November 5, 2008

 

Exhibit 4.1 of the Company’s Current Report on Form 8-K dated November 5, 2008.

10.1

 

Industrial Water Supply Development and Distribution Agreement dated October 27, 2003 among Heron Lake BioEnergy, LLC (f/k/a Generation II Ethanol, LLC), City of Heron Lake, Jackson County, and Minnesota Soybean Processors

 

Exhibit 10.10 of the Company’s 2008 Registration Statement.

10.2

 

Industrial Water Supply Treatment Agreement dated May 23, 2006 among Heron Lake BioEnergy, LLC, City of Heron Lake and County of Jackson

 

Exhibit 10.11 of the Company’s 2008 Registration Statement.

10.3

 

Loan Agreement dated December 28, 2007 by and between Federated Rural Electric Association and Heron Lake BioEnergy, LLC

 

Exhibit 10.19 of the Company’s 2008 Registration Statement.

10.4

 

Secured Promissory Note issued December 28, 2007 by Heron Lake BioEnergy, LLC as borrower to Federated Rural Electric Association as lender in principal amount of $600,000

 

Exhibit 10.20 of the Company’s 2008 Registration Statement.

10.5

 

Security Agreement dated December 28, 2007 by Heron Lake BioEnergy, LLC in favor of Federated Rural Electric Association

 

Exhibit 10.21 of the Company’s 2008 Registration Statement.

83

 

 

10.6

 

Electric Service Agreement dated October 17, 2007 by and between Interstate Power and Light Company and Heron Lake BioEnergy, LLC

 

Exhibit 10.22 of the Company’s 2008 Registration Statement.

 

 

 

 

 

Exhibit
Number

    

Exhibit Title

    

Incorporated by Reference To:

10.7

 

Shared Savings Contract dated November 16, 2007 by and between Interstate Power and Light Company and Heron Lake BioEnergy, LLC

 

Exhibit 10.23 of the Company’s 2008 Registration Statement.

10.8

 

Escrow Agreement dated November 16, 2007 by and between Heron Lake BioEnergy, LLC, Farmers State Bank of Hartland for the benefit of Interstate Power and Light Company

 

Exhibit 10.24 of the Company’s 2008 Registration Statement.

10.9

 

Management Services Agreement effective as of July 31, 2013 between Granite Falls Energy, LLC and Heron Lake BioEnergy, LLC*

 

Exhibit 10.4 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2013.

10.10

 

Corn Oil Marketing Agreement dated September 4, 2013 by and among Heron Lake BioEnergy, LLC and RPMG, Inc. †

 

Exhibit 10.76 to Annual Report on Form 10-K/A for the year ended October 31, 2013.

10.11

 

Ethanol Marketing Agreement dated September 17, 2013 by and among Heron Lake BioEnergy, LLC and Eco-Energy, LLC †

 

Exhibit 10.77 to Annual Report on Form 10-K for the year ended October 31, 2013.

10.12

 

Distillers’ Grains Off-Take Agreement dated September 24, 2013 by and among Heron Lake BioEnergy, LLC and Gavilon Ingredients, LLC †

 

Exhibit 10.78 to Annual Report on Form 10-K/A for the year ended October 31, 2013.

10.13

 

Loan Agreement dated July 29, 2014 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.14

 

Promissory Note dated July 29, 2014 between Heron Lake BioEnergy, LLC, as Holder, and Agrinatural Gas, LLC, as Borrower

 

Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.15

 

Security Agreement dated July 29, 2014 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.3 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.16

 

Collateral Assignment dated July 29, 2014 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.4 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.17

 

Guaranty dated July 29, 2014 by Rural Energy Solutions, LLC, guarantor, in favor of Heron Lake BioEnergy, LLC

 

Exhibit 10.5 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.18

 

Master Loan Agreement dated July 29, 2014 by and between AgStar Financial Services, FLCA and Heron Lake BioEnergy, LLC

 

Exhibit 10.6 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.19

 

$28,000,000 Revolving Term Loan Supplement dated July 29, 2014 by and between AgStar Financial Services, FLCA and Heron Lake BioEnergy, LLC

 

Exhibit 10.7 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.20

 

Security Agreement dated July 29, 2014 between Heron Lake BioEnergy, LLC and AgStar Financial Services, FLCA and CoBank, ACB

 

Exhibit 10.8 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.21

 

Real Estate Mortgage, Assignment of Rents and Profits and Fixture Financing Statement dated July 29, 2014 by and between AgStar Financial Services, FLCA, CoBank, ACB and Heron Lake BioEnergy, LLC

 

Exhibit 10.9 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.22

 

Guaranty dated July 29, 2014 by HLBE Pipeline Company, LLC in favor of AgStar Financial Services, FLCA

 

Exhibit 10.10 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

10.23

 

Security Agreement dated July 29, 2014 between HLBE Pipeline Company, LLC and AgStar Financial Services, FLCA and CoBank, ACB

 

Exhibit 10.11 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2014.

84

 

 

10.24

 

Allonge Agreement dated March 30, 2015 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.1 to Current Report on Form 8-K for the quarter ended March 31, 2015.

 

 

 

 

 

 

Exhibit
Number

    

Exhibit Title

    

Incorporated by Reference To:

10.25

 

Loan Agreement dated March 30, 2015 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.2 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.26

 

Promissory Note dated March 30, 2015 between Heron Lake BioEnergy, LLC, as Holder, and Agrinatural Gas, LLC, as Borrower

 

Exhibit 10.3 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.27

 

Security Agreement dated March 30, 2015 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.4 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.28

 

Collateral Assignment dated March 30, 2015 by and between Agrinatural Gas, LLC, and Heron Lake BioEnergy, LLC

 

Exhibit 10.5 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.29

 

Guaranty dated March 30, 2015 by Rural Energy Solutions, LLC, guarantor, in favor of Heron Lake BioEnergy, LLC

 

Exhibit 10.6 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.30

 

Restructure Agreement dated March 30, 2015 by and between Agrinatural Gas, LLC and Swan Engineering, Inc.

 

Exhibit 10.7 to Current Report on Form 8-K for the quarter ended March 31, 2015.

10.31

 

Amendment No. 1 dated July  22, 2016 to the Ethanol Marketing Agreement dated September 17, 2013 by and among Heron Lake BioEnergy, LLC and Eco-Energy, LLC †

 

Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended July 31, 2016.

10.32

 

Industrial Water Supply and Distribution Agreement dated September 25, 2019 by and among Heron Lake BioEnergy, LLC (f/k/a Generation II Ethanol, LLC) and City of Heron Lake, Minnesota

 

Filed herewith.

10.33

 

Membership Interest Purchase Agreement dated October 18, 2019 by and among Rural Energy Solutions, LLC, HLBE Pipeline Company, LLC, Swan Engineering, Inc., Mychael Swan, and Agrinatural Gas, LLC

 

Filed herewith.

10.34

 

Amendment No. 2 dated October 28, 2019 to the Ethanol Marketing Agreement dated September 17, 2018 by and among Heron Lake BioEnergy, LLC and Eco-Energy, LLC ɷ

 

Filed herewith.

21.10

 

Subsidiaries of the Registrant

 

Exhibit 21.1 to Annual Report on Form 10-K for the year ended October 31, 2011.

31.1

 

Certification of Chief Executive Officer (principal executive officer) pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act.

 

Attached hereto.

31.2

 

Certifications of Chief Financial Officer (principal financial officer) pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act.

 

Attached hereto.

32.1

 

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

 

Attached hereto.

32.2

 

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

 

Attached hereto.

85

 

 

101.1

 

The following materials from Heron Lake BioEnergy, LLC’s Annual Report on Form 10-K for the fiscal year ended October 31, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets as of October 31, 2019 and October 31, 2018, (ii) the Consolidated Statements of Operations for the fiscal years ended October 31, 2019, 2018, and 2017, (iii) the Consolidated Statements of Changes in Members’ Equity for the fiscal years ended October 31, 2019, 2018, and 2017, (iv) the Consolidated Statements of Cash Flows for the fiscal years ended October 31, 2019, 2018, and 2017, and (v) the Notes to Consolidated Financial Statements.


*   Indicates compensatory agreement.

†   Certain portions of this exhibit have been redacted and filed on a confidential basis with the Commission pursuant to a request for confidential treatment under Rule 24b-2 of under the Exchange Act. Spaces corresponding to the deleted portions are represented by brackets with asterisks [* * *].

ɷ  Certain portions of this exhibit have been redacted pursuant to Item 601(b)(10)(iv) as they are both not material and would likely cause competitive harm to the Company if publicly disclosed. Spaces corresponding to the deleted portions are represented by brackets with [* * *].

 

 

86

 

 

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.

 

 

 

 

 

 

HERON LAKE BIOENERGY, LLC

 

 

 

Date:

January 29, 2020

/s/ Steve Christensen

 

 

Steve Christensen

 

 

Chief Executive Officer

 

 

 

Date:

January 29, 2020

/s/ Stacie Schuler

 

 

Stacie Schuler

 

 

Chief Financial Officer

 

 

 

 

87

 

 

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 29, 2020

 

/s/ Steve Christensen

 

 

 

Steve Christensen, Chief Executive Officer and General Manager

 

 

 

(Principal Executive Officer)

 

 

 

 

Date:

January 29, 2020

 

/s/ Stacie Schuler

 

 

 

Stacie Schuler, Chief Financial Officer

 

 

 

(Principal Financial and Accounting Officer)

 

 

 

 

Date:

January 29, 2020

 

/s/ Paul Enstad

 

 

 

Paul Enstad, Governor and Chairman

 

 

 

 

Date:

January 29, 2020

 

/s/ Rodney R. Wilkison

 

 

 

Rodney R. Wilkison, Governor and Vice Chairman

 

 

 

 

Date:

January 29, 2020

 

/s/ Michael Kunerth

 

 

 

Michael Kunerth, Governor and Secretary

 

 

 

 

Date:

January 29, 2020

 

/s/ Dean Buesing

 

 

 

Dean Buesing, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Robert Ferguson

 

 

 

Robert Ferguson, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Marten Goulet

 

 

 

Marten Goulet, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Kenton Johnson

 

 

 

Kenton Johnson, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Doug Schmitz

 

 

 

Doug Schmitz, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ David Woestehoff

 

 

 

David Woestehoff, Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Jeremy Janssen

 

 

 

Jeremy Janssen, Alternate Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Sherry Jean Larson

 

 

 

Sherry Jean Larson, Alternate Governor

 

 

 

 

Date:

January 29, 2020

 

/s/ Bruce LaVigne

 

 

 

Bruce LaVigne, Alternate Governor

 

88

 

INDUSTRIAL WATER SUPPLY

AND DISTRIBUTION AGREEMENT

 

This Industrial Water Supply and Distribution Agreement is made this 25th day of September, 2019, by and among the City of Heron Lake, Minnesota, a Minnesota Municipal Corporation, (the "City") and Heron Lake BioEnergy, LLC, a Minnesota limited liability company (“BioEnergy''), formerly known as Generation II Ethanol, LLC, and collectively known as the ''Parties":

 

WITNESSETH:

 

A.

WHEREAS, the original INDUSTRIAL WATER SUPPLY DEVELOPMENT AND DIS1RIBUTION AGREEMENT, dated October 27, 2003, by and between the Parties and Minnesota Soybean Processors, a Minnesota cooperative corporation ("MnSP") and the County of Jackson ("County") sets forth that BioEnergy will require untreated industrial water and that the City agrees to supply the untreated industrial water to BioEnergy upon terms and conditions set forth in the original agreement; and

 

B.

WHEREAS, the INDUSTRIAL WATER SUPPLY DEVELOPMENT AND DISTRIBUTION AGREEMENT terminated on February 1, 2019, pursuant to paragraph 20.1 of said agreement; and

 

C.

WHEREAS, City and BioEnergy wish to enter into an amended agreement so that the City can continue to supply industrial water to BioEnergy for a certain flow charge fee and fixed charge fee; and

 

D.

WHEREAS, all parties have approved this Agreement pursuant to separate resolutions approved for signature by their governing council or boards.

 

NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, the receipt of which is hereby acknowledged, the City and BioEnergy hereby agree as follows:

 

1. The City shall provide the first 600 gpm of capacity available from the City Well Facilities (described in the original Industrial Water Supply Development and Distribution Agreement dated October 27, 2003) to BioEnergy.

 

2. The flow charges payable to the City by BioEnergy shall be at the rate of $0.60 per thousand gallons of water supplied to BioEnergy. In addition, there shall be a fixed monthly charge payable to the City by BioEnergy in the amount of $1,500.00 per month. The flow charges and fixed charge invoice shall be provided to BioEnergy at the beginning of each month with payment due to the City by the 15th day of each month. Each payment shall be mailed to the City of Heron Lake, PO Box 315, Heron Lake, MN 56137.

 

3. When the fixed charge of $1,500.00 per month is collected by the City, the City will deposit the fixed charge into its municipal water fund or any other fund as determined solely by the City Council of Heron Lake, Minnesota. The flow charge of $0.60 per thousand gallons of water supplied to BioEnergy that is paid by BioEnergy to the City will be placed into a dedicated fund for the operation and maintenance of the City wellfield, well facilities and related distribution infrastructure retained by the City. The dedicated account for the operation and maintenance of the City wellfield, well facilities and related distribution infrastructure retained by the City shall be capped at $300,000.00 at the end of

each calendar year. If the dedicated account exceeds $300,000.00 after the December flow charge is received and all expenses are paid, the City will return BioEnergy's share of the amount over $300,000.00 on the last business day of December unless extraordinary operational and maintenance expenses are planned or known by the City. If extraordinary operational and maintenance expenses are planned or known by the City, the City shall have the right to retain the flow charge paid by BioEnergy and place the amount in the dedicated account until such time as the extraordinary operational and maintenance expenses are paid for and completed.

 

4. In the event the maintenance costs home by the City for the wellfield, well facilities, and related distribution infrastructure retained by the City exceed funds held in the dedicated account for operation and maintenance, then in the first two years of this agreement, BioEnergy will receive a City invoice for an amount which equals fifty-five (55) percent of the maintenance costs which exceed the funds held in the dedicated account. For example, if the maintenance costs exceed the amount held in the dedicated account by $50,000.00 during the first two years of this agreement, BioEnergy will receive an invoice  from the  City  in  the  amount of  $27,500.00 and BioEnergy will be required to pay that amount.   If this agreement has been in place for at least two years, then BioEnergy shall pay a percentage of the maintenance costs that exceed the amount held in the dedicated fund. The percent that BioEnergy pays will be determined using a two year average of the amount of industrial water used by BioEnergy as compared to the total amount of industrial water supplied to both MnSP and BioEnergy during the two year period. For example, if a total of 100 units of industrial water are supplied to MnSP and BioEnergy over a two year period, and BioEnergy was supplied 60 of the 100 units, then BioEnergy will be responsible for paying sixty (60) percent of the maintenance costs that exceed the funds held in the dedicated account.

 

5. Unless this agreement is renewed by both parties, upon completion of this agreement, all dedicated account funds shall be distributed to MnSP and BioEnergy within a reasonable amount of time and in proportion to the amount each entity contributed to the dedicated account. For example, if BioEnergy contributed forty (40%) percent of the funds held in the dedicated account, then BioEnergy shall be distributed forty (40%) percent of the dedicated fund amount upon completion of this agreement.

 

6. The City shall continue to own and operate the Well Facilities described and set forth in that agreement dated October 27, 2003.

 

7. This Amended Agreement shall have a term often (10) years beginning February 1, 2019.

 

8. The parties all acknowledge and represent to each other that they have been represented by legal counsel of their own choosing in connection with their consideration and execution of this Agreement. The parties acknowledge and represent to each other that in executing this Agreement, they have relied solely upon their own independent judgment, belief and knowledge, and upon the advice of their own chosen legal counsel. The normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Agreement.

 

9. This Agreement shall be governed by, construed and enforced in accordance with the laws of the State of Minnesota.

 

10. This Agreement may be executed in counterparts, each of which shall be deemed to be one and the same instrument. The parties hereto shall exchange among themselves original signed counterparts.

 

11. The City fees and expenses associated with this Agreement shall be considered operation expenses and the City shall have the right to use dedicated account funds to pay these City fees and expenses, including attorney fees.

 

12. In the event BioEnergy is sold or no longer in business and this agreement terminates, BioEnergy will be refunded its share of excess funds after wells are updated and in good standing.

 

IN WITNESS WHEREOF, the parties have executed this Amendment to Industrial Water Supply and Distribution Agreement as of the day and year first above-written.

 

 

CITY OF HERON LAKE, MINNESOTA,

A Minnesota Municipal Corporation

 

By /s/ Jason Freking

          Jason Freking, its Mayor

 

 

By /s/ Stacy J. Grube

          Stacy J. Grube, its Clerk

 

 

 

 

 

HERON LAKE BIOENERGY, LLC, a Minnesota Limited Liability Company

 

By /s/ Steve A. Christensen CEO/GM

 

its President

 

 

 

Membership Interest Purchase Agreement

 

This Membership Interest Purchase Agreement ("Agreement"), dated as of the Effective Date (as defined below), is by and between Rural Energy Solutions, LLC, a Minnesota limited liability company ("Seller"), HLBE Pipeline Company, LLC, a Minnesota limited liability company ("Buyer"), Swan Engineering, Inc., a Minnesota corporation ("Swan Engineering") and Mychael Swan, individually (collectively with Swan Engineering, "Swan"), and Agrinatural Gas, LLC, a Delaware limited liability company ("Agrinatural"). "Effective Date" means the date this Agreement is fully executed by the parties.

 

In consideration of the mutual covenants contained herein, the parties hereto agree as follows:

 

Article 1

Purchase of Membership Interest

 

1.1 Sale of Membership Interest - Seller hereby agrees to sell, transfer, convey and deliver to Buyer at closing, and Buyer hereby agrees to purchase from Seller at closing, all of Seller's limited liability company membership interest(s) in Agrinatural, free and clear of all liens and encumbrances (collectively, the "Interest"), for the Purchase Price set forth in Article 2.

 

1.2 This is a sale by Seller of a membership interest in Agrinatural, and this Agreement is joined by the parties described herein to the extent said parties make representations, warranties and agree to certain terms and conditions.

 

1.3 No Assumption of Liabilities - Buyer shall not assume any liabilities, obligations or undertakings of Seller of any kind or nature whatsoever, whether fixed or contingent, known or unknown, determined or determinable, due or not yet due, except as specifically provided herein and except obligations or liabilities incurred solely as a member of Agrinatural because of becoming the owner of the Interest.

 

Article 2

Purchase Price

2.1 Purchase Price - Buyer hereby agrees to pay Seller Two Million Two Hundred Twenty-five Thousand and no/100 Dollars ($2,225,000.00) (the "Purchase Price") for the Interest as follows:

a.

Two Hundred Twenty-five Thousand and no/100 Dollars ($225,000.00) paid upon the execution hereof. Such shall be paid by cashier's check or bank money order or wire transfer. Such will be paid to and held in the Maslon LLP client trust account and shall only be released at the Closing.

 

b.

$2 million in cash by cashier's check, bank money order or wire transfer at Closing.

 

Article 3

Representations and Warranties Regarding Seller

 

Seller makes the following representations and warranties to Buyer, with the intention that Buyer may rely upon the same and that said representations shall  be true and correct  as of the date of Closing; provided, however,  that the sole and exclusive  remedy available to Buyer with respect  to any breach of the representations or  warranties  set forth in  this Article 3 shall be the option not  to complete the Closing,

except that the representations and warranties of Swan as contained in Article 15 shall remain in effect and survive the Closing.

 

2.1 Authority - Subject in each case to the requirement of Seller to receive consent from its limited liability company members ("Member Consent"): (a) Seller has all requisite power and authority to execute, perform and carry out the provisions of this Agreement; and (b) Seller has taken all requisite action authorizing and empowering it to enter into this Agreement and to consummate the transactions contemplated in this Agreement.

 

2.2 Breaches of Contracts; Required Consents - Subject in each case to the requirement of Seller to receive Member Consent, neither the execution and delivery of this Agreement by Seller, nor compliance by it with the terms and provisions of this Agreement, will: (a) conflict with or result in a breach of (i) any of the terms, conditions or provisions of the Articles of Organization or other governing instruments of Seller, (ii) any judgment, order, decree or ruling to which Seller is a party, or (iii) any injunction of any court or governmental authority to which Seller is subject; or (b) other than Member Consent require the affirmative consent or approval of any third party (or such consent or approval of any required third party will be obtained by the Closing Date).

 

2.3 Binding Obligation - Subject in each case to the requirement of Seller to receive Member Consent: (a) this Agreement constitutes the legal, valid and binding obligation of Seller in accordance with the terms hereof, and (b) Seller is not subject to any charter, mortgage, lien, lease, agreement, contract, instrument, law, rule, regulation, order, judgment or decree, or any other restriction of any kind or character, which would prevent the consummation of the transactions contemplated in this Agreement.

 

2.4 Representations - The representations, warranties and agreements of Seller contained herein shall be true and correct on and as of the date of Closing, with the same force and effect as though such representations and warranties have been made on and of the Closing Date.

 

Article 4

Closing

 

4.1 Closing - The closing of the transaction contemplated by this  Agreement ("Closing") shall occur as soon as reasonably possible, but no later than thirty (30) days after the Effective Date (as applicable, the "Closing Date"), subject to the requirement of Seller obtaining Member Consent or Seller's option (in its sole discretion) to seek a Court Order as contemplated by Section (8.lj). If such Member Consent or Court Order has not been obtained within thirty (30) days from the Effective Date, the Closing Date shall be extended to no later than five (5) business days after receipt by Seller of a Court Order but not later than December 31, 2019. If at said time the Member Consent or Court Order is not obtained, this Agreement shall terminate with no liability to either party.

 

Article 5

Post-Closing Obligations

 

5.1  Further  Documents  and  Assurances  -   At any time and  from time to time after the Closing Date, each party shall, upon request of another party, execute, acknowledge and deliver all such further and other assurances and documents, and will take such action consistent with the terms of this Agreement, as may be reasonably requested to carry out the transactions contemplated herein and to permit each party to enjoy its rights and benefits hereunder.

 

Article 6

Arbitration

 

6.1 Arbitration - Any dispute arising out of  or  relating  to this  Agreement  or the alleged breach of it shall be discussed between the disputing parties in a good faith effort to arrive at a mutual settlement of any such controversy. If, notwithstanding, such dispute cannot be resolved, such dispute shall be settled by binding arbitration. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. Arbitration will be conducted pursuant to the provisions of this Agreement, and the commercial arbitration rules of the American Arbitration Association, unless such rules are inconsistent with the provisions of this Agreement, without submission of the dispute to such Association. Unless the arbitrator determines otherwise, limited civil discovery shall be permitted for the production of documents and taking of depositions. Unresolved discovery disputes may be brought to the attention of the arbitrator who may dispose of such dispute. The arbitrator shall have the authority to award any remedy or relief that a court of this state could order or grant. The arbitrator may award to the prevailing party, if any, as determined by the arbitrator, all of its costs and fees, including reasonable attorneys' fees. Unless otherwise agreed by the parties, the place of any arbitration proceedings shall be Hennepin, Minnesota. The parties shall jointly choose the arbitrator. If the parties are not able to agree on an arbitrator, then a Court of competent jurisdiction can be petitioned to appoint the arbitrator.

 

Article 7

General

 

2.1 Modifications - This Agreement may not be changed or terminated orally. No modification, termination or attempted waiver of any of its provisions shall be valid unless in writing signed by the party against whom the same is sought to be enforced.

 

2.2 Notices -Any notice or other communication required or permitted hereunder shall be in writing and shall be deemed to have been given when received, if personally delivered, and when deposited, if placed in the U.S. mail for delivery by registered or certified mail, return receipt requested, postage prepaid, addressed at the addresses set forth below. Addresses may be changed by written notice given pursuant to this Section; provided, however, any such notice for the purpose of changing an address shall not be effective, if mailed, until three (3) working days after depositing in the U.S. mail or when actually received, whichever occurs first.

 

Notices to Seller shall be delivered to:

 

Rural Energy Solutions, LLC

c/o John Sprangers

PLANERGY ACQUISITION CORP.

Suite 270

680 Commerce Drive

Woodbury, MN 55125

Email: jsprangers680@gmail.com

With a copy to:

Maslon LLP

90 South Seventh Street, Suite 3300

Minneapolis, MN 55402

Attn: Barry Gersick

Email: barry.gersick@maslon.com

Notices to Buyer shall be delivered to:

HLBE Pipeline Company, LLC

c/o Steve Christensen

Heron Lake BioEnergy, LLC

91246 390th Avenue

Heron Lake, MN 56137-3175

Email: schristensen@granitefallsenergy.com

With a copy to:

Stoneberg, Giles & Stroup, P.A.

300 South O'Connell Street

Marshall, MN 56258-2638

Attn: Kevin K. Stroup

kevin@sgslawyers.com 

Notices to Swan shall be delivered to:

Swan Engineering, Inc.

Attn: Mychael Swan

mychael.swan@gmail.com 

 

With a copy to:

 

Maslon LLP

90 South Seventh Street, Suite 3300

Minneapolis, MN 55402

Attn: Barry Gersick

Email: barry.gersick@maslon.com

 

2.3 Counterparts - This Agreement may be executed in counterparts and by different parties on different counterparts with the same effect as if the signatures thereto were on the same instrument. Facsimile or signatures sent electronically shall be deemed original signatures for all purposes.

 

2.4 Headings - The descriptive headings of the several Articles and Sections of this Agreement are inserted for convenience only and do not constitute a part of this Agreement.

 

2.5 Expenses - Except as otherwise provided herein, each party hereto shall each bear and pay for its own costs and expenses incurred by it or on its behalf in connection with the transactions contemplated hereby, including, without limitation, all fees and disbursements of brokers, lawyers, accountants and financial consultants incurred through the Closing Date.

 

2.6 Entire Agreement; Modification and Waiver - This Agreement,  together  with the Exhibits and any related written agreements specifically referred to herein, represents the only agreement among the parties concerning the subject matter hereof and supersedes all prior agreements whether written or oral, relating thereto. Any waiver shall be limited to the provision hereof and the circumstance or event

specifically made subject thereto and shall not be deemed a waiver of any other term hereof or of the same circumstance or event upon any recurrence thereof.

 

2.7 Binding Effect - This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs and successors in interest.

 

2.8 Governing Law - This Agreement and the legal relations between the parties shall be governed by and construed in accordance with the laws of the State of Minnesota, without regard to its conflicts-of-law principles.

 

2.9 No Third Partv Benefits - Nothing in this Agreement, expressed or implied, is intended to confer on any person other than the parties to this Agreement or their respective successors or assigns, any rights, remedies, obligations or liabilities under or by reason of this Agreement.

 

Article 8

Buyer's Contingencies

 

8.1 Contingencies - Buyer's obligation to purchase  the  Interest  is  subject  to  the Buyer's satisfaction, in its reasonable discretion, of all the following conditions prior to the Closing, unless waived by Buyer:

 

a.

Buyer shall have received all documents reasonably necessary to show that Seller and all other parties hereto have complied with all representations, warranties and agreements of Seller herein.

 

b.

Seller shall have delivered to Buyer a bill of sale validly transferring marketable, free and clear title and any other documents required by this Agreement (the effectiveness of which, however, shall be subject to Seller's receipt of the Purchase Price in full).

 

c.

Seller and Swan shall have delivered to Buyer a certificate of an officer of Seller and of Swan dated as of the Closing Date and in a form acceptable to Buyer, certifying in such detail as Buyer may reasonably request to the fulfillment of the conditions specified in this Agreement.

 

d.

The financial statements and reports provided by Agrinatural to Buyer shall have been prepared in accordance with generally accepted accounting principles consistently followed throughout the periods indicated, fairly presenting the financial condition and assets and liabilities (whether accrued, absolute, contingent or otherwise) of Agrinatural as of the dates indicated, and the results of operations of Agrinatural for the periods then ended.

 

e.

There shall have been no developments in the business of Agrinatural, or in the Interest, between the date of May 1, 2019 and the Closing Date which would have a materially adverse effect on the business and operations of Agrinatural.

 

f.

Between May 1, 2019 and the Closing Date, Agrinatural shall not have:

 

(i)

incurred any material liabilities or obligations (absolute or contingent), except for liabilities and obligations disclosed to Buyer in writing prior to

Closing or otherwise known by Buyer, or in the Exhibits annexed hereto, and except for such liabilities and obligations as have arisen in the ordinary course of business of Agrinatural since May 1, 2019, none of which newly arisen liabilities and obligations shall have had a material adverse effect upon Agrinatural, the Interest, Agrinatural's business (the "Business"), or Agrinatural's organization, properties, or financial condition;

 

(ii)

mortgaged, pledged or subjected to any lien, charge or other encumbrance, Agrinatural' s assets;

 

(iii)

sold or transferred any assets, other than sales of inventory or utilization of supplies in the ordinary course of business;

 

(iv)

sold, assigned or transferred any intellectual property, or other intangible assets of Agrinatural or relating to the Business;

 

(v)

suffered any extraordinary losses or waived any rights of substantial value relating to the Business;

 

(vi)

suffered any material damage, destruction or loss to any of Agrinatural' s material assets, whether or not covered by insurance;

 

(vii)

entered into any transaction involving or relating to the Business other than in the ordinary course of business;

 

(viii)

increased the compensation payable, or to become payable by Agrinatural to any of its employees including, but not limited to, any bonus payment or deferred compensation;

 

(ix)

increased any benefits to employees of Agrinatural under pension, insurance or other employee benefit programs;

 

(x)

changed its methods of accounting in any respect;

 

(xi)

acquired a significant portion of the assets or stock of any person or business entity; or

 

(xii)

suffered a termination of, or amendment to any material license or permit;

(xiii)

began any new construction or projects regarding or on behalf of Agrinatural other than as approved by board resolutions of Agrinatural.

 

g.

All licenses, permits, franchises, approvals and governmental authorizations required for Agrinatural, the Business or their operations shall have been obtained and be in good standing. No other licenses, permits, franchises, approvals or other governmental authorizations shall be required for Agrinatural, the Business or their operations as heretofore conducted by Agrinatural. True, current, correct and complete copies of such licenses, permits, franchises, approvals, and governmental authorizations shall have been delivered by Agrinatural to Buyer. Agrinatural shall have performed in all material respects all obligations required to be performed by it to date under, and is not in default under, any such licenses, permits, franchises,

approvals, or governmental authorizations or the laws, regulations and requirements of the licensing and permit authorities. All such licenses, permits, franchises, approvals, and governmental authorizations shall be in full force and effect.

 

h.

On the Closing Date there shall not have been any actions, suits or proceedings pending or threatened against or affecting Seller at law or in equity, that, if adversely determined, would materially and adversely affect the Interest or the transactions contemplated by this Agreement.

 

i.

Seller shall not have received any distributions or payments from Agrinatural other than distributions (if any) provided to all similarly situated limited liability company members of Agrinatural.

 

j.

Seller shall have obtained either (i) the Member  Consent or (ii) if such is not obtained, a court order or other valid determination of a court of competent jurisdiction approving the sale contemplated herein ("Court Order"); provided, that Seller has no obligation whatsoever to seek a Court Order.

 

k.

All reasonably necessary operational information related to the operations of Agrinatural, in whatever form (electronic, paper copies, or otherwise), including but not limited to all construction plans and diagrams possessed by Swan or Swan Engineering, shall have been turned over to Agrinatural prior to or at closing. All reasonably necessary operational information and operational documents, in whatever form and of whatever type and nature of Agrinatural or of Swan Engineering that are used in the operations of Agrinatural shall have been delivered to Buyer or Agrinatural as a part of this transaction without further charge or cost; provided, if there is a specific fee to transfer or cost of copying (such as from any computer system or making copies of hard documents), such reasonable fees and costs shall be paid by Buyer, and Buyer shall be informed of such fees and costs prior to their being incurred.

 

l.

The rights and obligations of the Released Parties (as defined below) under the Related Agreements (as defined below) shall have been terminated, to the extent the Related Agreements have not otherwise been terminated or expired by their terms. "Released Parties" means Heron Lake BioEnergy, LLC ("Heron"), Agrinatural, Rural Energy Solutions, LLC, Swan Engineering, Wildwood Technology, LLC, Woodbury Consulting, LLC, Mychael Swan, John Sprangers and Ann Tessier. "Related Agreements" means the following agreements between or among, as applicable, certain of the Released Parties and the parties identified below:

 

(i)

NaturalGas Local Distribution Company Management and Operating Agreement between Agrinatural and Swan Engineering;

 

(ii)

Project Management Agreement between Agrinatural and Swan Engineering;

 

(iii)

Professional Services Agreement - Capital Work between Agrinatural and Swan Engineering;

 

(iv)

Professional Services Agreement between Agrinatural and Wildwood Technology, LLC for Ann Tessier consulting services;

 

(v)

Professional Services Agreement between Agrinatural and Woodbury Consulting LLC for John Sprangers consulting services;

 

(vi)

Loan Agreement dated July 29, 2014 by and between Agrinatural and Heron and related Negotiable Promissory Note and Guaranty thereof by Rural Energy Solutions, LLC; except that the obligations of said documents shall remain obligations of Agrinatural to Heron Lake BioEnergy;

 

(vii)

Loan Agreement dated March 30, 2015 by and between Agrinatural and Heron and related Allonge, Negotiable Promissory Note and Guaranty thereof by Rural Energy Solutions, LLC; except that the obligations of said documents shall remain obligations of Agrinatural to Heron Lake BioEnergy;

 

(viii)

The Agrinatural Gas LLC Amended and Restated Limited Liability Company Agreement dated May 13, 2011, as further amended, shall remain in effect as the Agrinatural Limited Liability Company Agreement, with the sole member being HLBE Pipeline Company;

 

(ix)

All rights and interests of Swan in and to the Agreements with Liesenfeld and Legacy shall be conveyed and assigned to Agrinatural by Swan at Closing. There shall be no payment to Swan for the conveyance of all rights and interests in said Agreements to Agrinatural;

 

(x)

Leisenfeld and Legacy selling and conveying all of their rights and interests in and to the natural gas lines under said Agreements to Agrinatural on terms satisfactory to Agrinatural - such to occur as a part of Closing; and

 

(xi)

Buyer, Agrinatural and Heron Lake BioEnergy shall have received releases, in form and content satisfactory to said parties, of all claims that the following described parties may have against said released parties, officers thereof and Boards thereof.

Specifically, Seller, Swan Engineering, Wildwood Technology, Woodbury Consulting, Mychael Swan, John Sprangers, Ann Tessier, Ken Morris and Mike Driscoll (such constituting all of the companies on the other side and all the individuals that are owners or part of those companies) shall release Agrinatural, HLBE Pipeline Company and Heron Lake BioEnergy (all as entities) and all individuals associated with such released parties (meaning Board of Directors, Management, etc.).

 

Article 9

Seller's Conditions to Close

 

9.1Seller's obligation to consummate the transactions contemplated herein is subject to the following conditions, unless waived by Seller:

 

a.

Seller shall have obtained either (i) the Member Consent or (ii) a Court Order; provided, that Seller shall be under no obligation to seek a Court Order;

 

b.

Buyer shall have complied with all of its obligations under this Agreement;

 

c.

Seller shall have received releases, in form and content satisfactory to Seller, of all claims that any party to the Related Agreements have or may have against Seller arising on or prior to the Closing Date;

 

d.

All outstanding obligations of the Released Parties under the Related Agreements shall have been terminated, to the extent the Related Agreements have not otherwise been terminated or expired by their terms, except as stated in Article 8.1;

 

e.

All Related Agreements shall have been terminated or shall have expired by their terms, except as stated in Article 8.1;

 

f.

Seller shall have received releases, in form and content satisfactory to Seller, of all claims that Agrinatural, Buyer and Swan have or may have against the limited liability company members of Seller (and each of them individually);

 

g.

Seller shall have received a release, in form and content satisfactory to Seller, of all claims that Heron has or may have against Seller or its limited liability company members (and each of them individually) related to Agrinatural's indebtedness to Heron Lake BioEnergy, LLC, including, without limitation, a release of all related guaranties and pledges; and

 

h.

Seller shall have received satisfactory evidence that Agrinatural' s D&O policy will continue in full force and effect (or that Buyer or Agrinatural has otherwise procured substantially equivalent coverage), and that the same shall apply to John Sprangers, Mychael Swan, Ken Morris and Mike Driscoll, for as long as such individuals may be exposed to any claims whatsoever related to Agrinatural (Claims Period), and such policy shall provide that the same may not be terminated or materially revised without the written consent of Seller and each such individual.

 

Article 10

Representations and Warranties Regarding Buyer

 

Buyer makes the following representations and warranties to Seller, with the intention that Seller may rely upon the same and that said representations shall be true and correct as of the Closing Date.

 

8.1 Organization -Buyer has all requisite power and authority, to own its properties and assets and conduct its business as presently conducted. Buyer is qualified to do business and in good standing in all states in which qualification is required by the nature of the Business.

 

8.2 Authority - Buyer has all requisite power and authority to execute, perform and carry out the provisions of this Agreement. Buyer has taken all requisite action authorizing and empowering it to enter into this Agreement and to consummate the transactions contemplated in by this Agreement. Buyer has all requisite power and authority (without consent or approval of any other person) to enter into and carry out their obligations under this Agreement.

 

8.3 Breaches of Contracts: Required Consents - Neither the execution and delivery of this Agreement by Buyer or Buyer's limited liability company members, nor compliance by it with the terms and provisions of this Agreement will: (a) conflict with or result in a breach of (i) any of the terms, conditions or provisions of the Articles of Organization or other governing instruments of Buyer, (ii) any judgment, order, decree or ruling to which Buyer is a party, (iii) any injunction of any court or governmental authority to which Buyer is subject, or (iv) any agreement, contract or commitment which is material to the Business or to Buyer's financial condition; or (b) require the affirmative consent or approval of any third party (or such consent or approval of any required third party will be obtained by the Closing Date).

 

8.4 Binding Obligation - This Agreement constitutes the legal, valid and binding obligation of Buyer in accordance with the terms hereof. Buyer is not subject to any charter, mortgage, lien, lease, agreement, contract, instrument, law, rule, regulation, order, judgment or decree, or any other restriction of any kind or character, which would prevent the consummation of the transactions contemplated in this Agreement.

 

Article 11

Other Matters

 

8.1 Excluded Assets - Only the Interest is being sold. No other assets or rights of Seller are sold or conveyed hereby.

8.2 Member Consent or Court Order - Seller will use reasonable business efforts to obtain the Member Consent prior to the Closing Date. Seller may, but is not obligated to, elect to seek a Court Order, in its sole and absolute discretion.

 

8.3 Swan Severance - Mychael Swan agrees that there is no severance payment  due to Mychael Swan from Agrinatural.

 

8.4 Access to Books and Records - Buyer agrees to give Swan, Mike Driscoll and John Sprangers, and each of their representatives and designees, full and complete access to the books and records of Agrinatural (including, without limitation, officers' records) for purposes of preparation of expert reports and company valuation in connection with any actual or potential claims or litigation in which such matters are reasonably material.

 

8.5 D&O Policy - Beginning on the Effective Date, Buyer shall ensure that Agrinatural' s D&O policy will continue in full force and effect (or that Buyer or Agrinatural otherwise procures and maintains substantially equivalent coverage), and that the same shall apply to John Sprangers, Mychael Swan, Ken Morris and Mike Driscoll, for as long as such individuals may be exposed to any claims whatsoever related to Agrinatural (the "Claims Period"), and such policy shall provide that the same may not be terminated or materially revised without the written consent of Seller and each such individual. This Section 11.5 will survive until the end of the Claims Period.

 

 

Article12

Representations and Warranties, Survival

 

12.1 All statements contained in any documents, certificates or other instruments delivered by or on behalf of Seller, Swan or Buyer pursuant to this Agreement or in connection with the transactions contemplated hereby shall be deemed representations and warranties by Seller, Swan or Buyer hereunder. All representations and warranties and agreements made by Seller, Swan or Buyer in this Agreement or in any documents, certificates, or other instruments delivered pursuant hereto that, by their nature or their express terms, were intended to survive the Closing shall so survive the Closing hereunder (and any investigation at any time made by or on behalf of Seller, Swan or Buyer).

 

Article13

Event of Default

 

13.1 It shall be an event of default under this Agreement ("Event of Default") if Buyer, Seller or Swan fail to comply with or to perform any term, obligation, covenant or condition contained in this Agreement. If an Event of Default occurs under this Agreement, at any time, the non-defaulting party shall have all the rights and remedies set forth in this Agreement, and at law and equity, and except as may be prohibited by applicable law, all of the non-defaulting party's rights and remedies, whether evidenced by this Agreement or pursuant to law, shall be cumulative and may be exercised singularly or concurrently. Election by the non-defaulting party to pursue any remedy shall not exclude pursuit of any other remedy. The non-defaulting party's failure to perform shall not affect its right to declare a default and exercise its remedies.

 

Article14

Warranty by Swan

 

8.1 Swan represents and warrants that there are no outstanding agreements affecting Agrinatural, directly or indirectly, except as specifically contained in the records of Agrinatural and the Leisenfeld and Legacy Agreements. Swan specifically represents that there are no further additional agreements between Swan or any other parties regarding or related to Agrinatural, including but not limited to, any rights to connect to Agrinatural lines, use Agrinatural lines or rights to any rebates, discounts or payments related to Agrinatural. That there are no rights by any party to purchase any lines or equipment that is connected to the Agrinatural operating system as it currently exists and no rights or obligations of Swan Engineering or Agrinatural to purchase lines or equipment from any party, except for the construction underway to correct gas line pressure regarding the Liesenfeld and Legacy lines.

 

8.2 Any and all rights of access to the border station and any and all rights to purchase natural gas from the main distribution line and rights to attach to said main distribution line are held solely by Agrinatural and Swan represents and warrants he has no interest or claims in or to said rights.

 

8.3 Swan Engineering and Swan, jointly and severally, state, represent and warrant that there are no undisclosed agreements that have been entered into that may affect, in any fashion whatsoever, ownership and operation of the Agrinatural assets. Specifically, that there are no undisclosed agreements regarding ownership or repurchases of any natural gas lines or any assets that are hooked to, attached to or otherwise could be deemed to affect operations of the Agrinatural system.

 

Moreover, at closing, Swan Engineering and Swan, jointly and severally, shall execute documents as reasonably requested by Buyer to transfer all purchase rights and other rights and obligations in and to the Agreement for Swan to Install and Operate a Customer Fuel Line for Legacy Farms; for Liesenfeld

Farms, consisting of three pages, dated December 29, 2017 and any other agreements that may be disclosed to Buyer prior to closing.

 

Buyer's obligation to close is subject to Buyer, in its sole discretion, being reasonably assured that all such agreements have been disclosed to Buyer and that all such agreements are, in Buyer's sole discretion, acceptable to Buyer.

 

8.4 The terms of this Article 14 shall survive Closing and any breach shall entitle Buyer to bring a claim for damages solely against Swan and/or Swan Engineering caused by any such breach. Any releases granted pursuant to the terms of this Agreement shall not release any liabilities that may accrue pursuant to any breach of this Article 14.

 

Article 15

Income Tax Allocation

 

15.1 Buyer, Seller and Agrinatural agree that there shall be no distribution of cash to Seller from Agrinatural and that for tax purposes all income, loss deductions and credits for calendar year 2019 shall be allocated to Buyer. All cash, receivables and income of Agrinatural allocated to the Interest shall remain with Buyer and Buyer shall report all income on its tax returns and no such income shall be reported to Seller. Seller agrees to report the sale of the Interest on its income tax returns.

 

Article16

Compliance with Laws

 

16.1 To the best of Seller's knowledge, Agrinatural, the business of Agrinatural, and the assets of Agrinatural, comply with all applicable laws, regulations and orders applicable to Agrinatural, the Business, and the Purchased Assets, including without limitation CERCLA, RCRA, MERLA, EPCRA, FIFRA, the Occupational Safety & Health Act, the Clean Air Act, the Clean Water Act, the Atomic Energy Act, the Toxic Substances Control Act, the Safe Drinking Water Act, and the Refuse Act, and the present uses by Agrinatural of its assets do not violate any laws, regulations and orders.

 

Article 17

Intellectual Property

 

17.1 To the knowledge of Seller, (a) Agrinatural owns or is licensed to use all Intellectual Property used by it in the conduct of its business as currently conducted. The use by Agrinatural of any such Intellectual Property, and the conduct by Agrinatural of the Business, does not infringe on the rights of any third party, and no claim has been asserted to such effect or otherwise affecting any Intellectual Property of Agrinatural; and (b) no third party is infringing and upon the Intellectual Property of Agrinatural.

 

Article 18

Cooperation on Transfer/Turnover and No Severance Payment Due

 

8.1 Swan Engineering and Swan, jointly and severally, agree that any and all operational information, in whatever form (electronic, paper copies, or otherwise), including but not limited to all construction plans, diagrams and operational manuals relating to Agrinatural in their possession have been or shall be turned over to Buyer or Agrinatural prior to or at closing.

 

8.2 It is agreed that the full ownership of the membership interests in Agrinatural by Buyer and

corresponding operation of Agrinatural by new Management shall happen as seamlessly as possible and that accordingly all operational information and all operational documents, in whatever form and of whatever type and nature of Agrinatural or of Swan Engineering that are related to or used in the operations of Agrinatural have been or shall be delivered to Buyer or Agrinatural as a part of this transaction without further charge or cost. If there is a specific fee to transfer or cost of copying (such as from any computer system or making copies of hard documents), such reasonable fees and costs shall be paid by Buyer. Buyer shall be informed of such fees and costs prior to their being incurred.

 

8.3 Swan agrees that there is no severance payment due to Swan from Agrinatural.

 

IN WITNESS WHEREOF, each of the parties hereto has caused this Membership Interest Purchase Agreement to be executed by a duly authorized representative on the day and year indicated above.

 

 

 

Seller:RURAL ENERGY SOLUTIONS, LLC

 

Dated: OCTOBER 18, 2019By: /s/ Michael L. Swan

           Its: CEO MEMBER

 

 

 

Buyer:HLBE PIPELINE COMPANY, LLC, INC.

 

Dated: 10/18/2019By: /s/ Steve A. Christensen

           Its: CEO

 

 

 

Swan Engineering:SWAN ENGINEERING, INC.

 

Dated: OCTOBER 18, 2019By: /s/ Michael L. Swan

           Its: CEO/OWNER

 

 

 

Mychael Swan:

 

Dated: OCTOBER 18, 2019/s/ Michael L. Swan

Mychael Swan, Personally

 

 

 

AGRINATURAL GAS, LLC

Solely with respect to the provisions of Section

15.1 hereof

 

Dated: 10/17/2019By: /s/ John Sprangers

           Its: CEO

 

 

 

 

CERTAIN INFORMATION IDENTIFIED BY [***] HAS BEEN OMITTED FROM THIS EXHIBIT BECAUSE IT IS BOTH (I) NOT MATERIAL AND (II) WOULD LIKELY CAUSE COMPETITIVE HARM TO THE COMPANY IF PUBLICLY DISCLOSED.

 

AMENDMENT NO. 2

ETHANOL MARKETING AGREEMENT

 

THIS Amendment No. 2 ("Amendment 2"), dated October 28, 2019, is entered into by and between Eco-Energy, LLC, a Tennessee Limited Liability Corporation with its registered office at 6100 Tower Circle, Suite 500, Franklin, Tennessee 37067 ("Eco"), and Heron Lake Bio Energy, LLC ("HLBE''), a Minnesota Limited Liability Corporation with its  main office at 91246 390th Avenue, Heron Lake, Minnesota.  Eco and Heron are hereinafter also referred to collectively as the "Parties."

 

RECITALS

 

A. The Parties previously entered an Ethanol Marketing Agreement ("Agreement"), executed September 17, 2013, where the Parties established certain terms and conditions relating to Eco 's rights and obligations regarding the purchase of HLBE's entire ethanol output. The Agreement established a  term which commenced on November 1, 2013 and continued until December 31, 2016.  A copy of  the Agreement—including Exhibit A and Exhibit B of the Agreement—is attached hereto as Appendix 1.

 

B. On July 22, 2016, the Parties entered into Amendment No. 1 to the Agreement (attached hereto as Appendix 2), which modified  the  Agreement  as follows:  (i)  adjusted  the Purchase  Price and  Fees  section  of the Agreement by changing the fee that HLBE pays Eco for Marketing  Fees  to  [***],  (ii) required Eco to make payment to HLBE  every  Friday  for  the  previous  week's  ethanol  shipments,  (iii) [***], and (iv) extended the expiration date of the Agreement until December 31, 2019.

 

C.

The Parties now desire to amend the Agreement in order to memorialize the modifications recently agreed upon by the Parties as well as incorporate such modifications into the Agreement.

 

NOW, THEREFORE, the written signatures of the Parties integrate this Amendment No. 2 into the Agreement making it a binding, and legally enforceable, portion of such.  For good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Eco and HLBE agree as follows:

 

I.

EFFECTIVE DATE: The modifications specified in Paragraph II of this Amendment No. 2 shall become effective on October 1, 2019.

 

II.

MODIFICATIONS:

 

1) Section 4 of the Agreement is hereby deleted in its entirety and replaced with the following:

 

4.

Purchase Price and Fees.

 

(a) The amount Payable by Eco to HLBE for ethanol that is purchased by Eco pursuant to this Agreement shall be [***].

 

(b) The amount Payable by HLBE to Eco for services to be provided  by Eco  under  this Agreement (the "Marketing Fee'') shall be equal to [***].

 

(c)  [***].

 

2)The first two sentences of Section 21(a) are hereby deleted in their entirety and replaced with the following:

 

21. Term and Termination:

 

(a) The term of this agreement shall continue until December 31, 2020 (the "Term"). Upon the expiration of the Term, this Agreement will automatically renew for additional consecutive terms of one (1) year each unless either party hereto gives written notice to the other at least ninety (90) days prior to the end of the Term or the then current renewal term, in which case this Agreement shall terminate at the end of the Term or such then current renewal term.

 

III.

EFFECT OF AMENDMENT No. 2: Except as expressly modified in Section II of this Amendment No. 2 the Agreement remains unchanged and in full force and effect.

 

IV.

ENTIRETIES: This Amendment No. 2 represents the final agreement between the parties regarding the subject matter hereof and may not be contradicted by evidence or prior, contemporaneous, or subsequent oral agreements of the parties. There are no unwritten oral agreements between the parties.

 

 

ECO ENERGY, LLCHERON LAKE BIOENERGY, LLC

 

By: /s/ Josh BaileyBy: /s/ Steve A. Christensen

 

Name: Josh BaileyName: Steve A. Christensen

 

Title: CEOTitle: CEO

 

Date: 10/28/19Date: 10/28/19

 

EXHIBIT 31.1

 

CERTIFICATIONS

 

I, Steve Christensen, certify that:

 

1.I have reviewed this annual report on Form 10-K of Heron Lake BioEnergy, LLC;

 

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

 

d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

/s/

 

 

 

Date:

January 29,  2020

 

/s/ Steve A. Christensen

 

 

 

Steve A. Christensen

 

 

 

Chief Executive Officer

 

 

 

(principal executive officer)

 

EXHIBIT 31.2

 

CERTIFICATIONS

 

I, Stacie Schuler, certify that:

 

1.I have reviewed this annual report on Form 10-K of Heron Lake BioEnergy, LLC;

 

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

 

d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

/s/

 

 

 

Date:

January 29, 2020

 

/s/ Stacie Schuler

 

 

 

Stacie Schuler

 

 

 

Chief Financial Officer

 

 

 

(principal financial officer)

 

EXHIBIT 32.1

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

 

In connection with the annual report on Form 10-K of Heron Lake BioEnergy, LLC (the “Company”) for the fiscal year ended October 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steve Christensen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

8

 

 

 

Date:

January 29, 2020

 

/s/ Steve A. Christensen

 

 

 

Steve A. Christensen

 

 

 

Chief Executive Officer

 

 

 

(principal executive officer)

 

 

EXHIBIT 32.2

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

 

In connection with the annual report on Form 10-K of Heron Lake BioEnergy, LLC (the “Company”) for the fiscal year ended October 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stacie Schuler, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

 

 

 

Date:

January 29, 2020

 

/s/ Stacie Schuler

 

 

 

Stacie Schuler

 

 

 

Chief Financial Officer

 

 

 

(principal financial officer)