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EX-31.2 - CERTIFICATION - HIGHWATER ETHANOL LLCa312-certification43012.htm
EX-31.1 - CERTIFICATION - HIGHWATER ETHANOL LLCa311-certification43012.htm
EX-32.1 - CERTIFICATION - HIGHWATER ETHANOL LLCa321-certification43012.htm
EX-32.2 - CERTIFICATION - HIGHWATER ETHANOL LLCa322-certification43012.htm
EX-10.1 - AGREEMENT - HIGHWATER ETHANOL LLCa101-fifthamendedrestatedr.htm
EX-10.2 - AGREEMENT - HIGHWATER ETHANOL LLCa102-fifthamendedrestatedr.htm
EX-10.3 - AGREEMENT - HIGHWATER ETHANOL LLCa103-sixthamendmentofconst.htm
EXCEL - IDEA: XBRL DOCUMENT - HIGHWATER ETHANOL LLCFinancial_Report.xls
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the quarterly period ended April 30, 2012
 
 
 
OR
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the transition period from               to               .
 
 
 
COMMISSION FILE NUMBER 000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota
 
20-4798531
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
24500 US Highway 14, Lamberton, MN 56152
(Address of principal executive offices)
 
(507) 752-6160
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes     o No

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large Accelerated Filer o
Accelerated Filer  o
Non-Accelerated Filer x
Smaller Reporting Company o

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of June 12, 2012, there were 4,953 membership units outstanding.

1


INDEX



2




PART I    FINANCIAL INFORMATION

Item 1. Financial Statements

HIGHWATER ETHANOL, LLC
Condensed Balance Sheets

 ASSETS
 
April 30, 2012
 
October 31, 2011

 
 (Unaudited)
 

Current Assets
 

 

Cash and equivalents
 
$
4,689,266

 
$
3,427,683

Restricted cash
 
34,213

 
465,720

Restricted marketable securities
 
42,081

 
66,319

Accounts receivable
 
3,604,328

 
7,493,851

Inventories
 
4,135,991

 
4,167,870

Prepaids and other
 
95,406

 
73,737

Total current assets
 
12,601,285

 
15,695,180


 

 

Property and Equipment
 

 

Land and land improvements
 
6,820,842

 
6,813,722

Buildings
 
37,997,211

 
37,965,861

Office equipment
 
349,729

 
346,259

Equipment
 
60,697,581

 
60,209,552

Vehicles
 
41,994

 
41,994

Construction in progress
 
113,951

 
138,714


 
106,021,308

 
105,516,102

Less accumulated depreciation
 
(16,833,918
)
 
(13,704,182
)
Net property and equipment
 
89,187,390

 
91,811,920


 

 

Other Assets
 

 

Investments in RPMG
 
605,000

 
605,000

Restricted marketable securities
 
1,518,000

 
1,518,000

Debt issuance costs, net
 
961,914

 
1,103,740

Deposits
 
195,727

 
195,547

Total other assets
 
3,280,641

 
3,422,287


 

 

Total Assets
 
$
105,069,316

 
$
110,929,387

 
 
 
 
 


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


3




HIGHWATER ETHANOL, LLC
Condensed Balance Sheets

LIABILITIES AND MEMBERS' EQUITY
 
April 30, 2012
 
October 31, 2011

 
 (Unaudited)
 

Current Liabilities
 

 

Accounts payable
 
$
1,449,039

 
$
2,489,769

Accrued expenses
 
730,109

 
511,933

Deferred revenue
 
141,139

 

Derivative instruments
 
797,333

 
1,020,599

Current maturities of long-term debt
 
2,056,106

 
3,719,499

Total current liabilities
 
5,173,726

 
7,741,800


 

 

Long-Term Debt
 
49,936,371

 
50,997,079


 

 

Derivative Instrument
 
775,959

 
1,118,709


 

 

Commitments and Contingencies
 

 


 

 

Members' Equity
 

 

Members' equity, 4,953 units outstanding
 
49,183,260

 
51,071,799

Total Liabilities and Members’ Equity
 
$
105,069,316

 
$
110,929,387

 
 
 
 
 

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


4


HIGHWATER ETHANOL, LLC
Condensed Statements of Operations


Three Months Ended
 
Three Months Ended
 
Six Months Ended
 
Six Months Ended

April 30, 2012
 
April 30, 2011
 
April 30, 2012
 
April 30, 2011

(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
 
 
 
 
 
 
 
Revenues
$
33,771,321

 
$
37,394,958

 
$
73,598,897

 
$
73,664,456



 

 

 

Cost of Goods Sold
34,752,072

 
34,960,815

 
72,241,801

 
69,146,241



 

 

 

Gross Profit (Loss)
(980,751
)
 
2,434,143

 
1,357,096

 
4,518,215



 

 

 

Operating Expenses
486,777

 
471,601

 
1,001,892

 
908,893



 

 

 

Operating Profit (Loss)
(1,467,528
)
 
1,962,542

 
355,204

 
3,609,322



 

 

 

Other Income (Expense)

 

 

 

Interest income
1,346

 
710

 
36,856

 
37,898

Other income
75

 
50,566

 
50,164

 
50,566

Interest expense
(1,070,314
)
 
(1,287,161
)
 
(2,171,728
)
 
(2,452,242
)
Gain (loss) on derivative instrument
206,145

 
110,820

 
365,203

 
636,580

Total other expense, net
(862,748
)
 
(1,125,065
)
 
(1,719,505
)
 
(1,727,198
)


 

 

 

Net Income (Loss)
$
(2,330,276
)
 
$
837,477

 
$
(1,364,301
)
 
$
1,882,124

 
 
 
 
 

 

Weighted Average Units Outstanding
4,953

 
4,953

 
4,953

 
4,953

Net Income (Loss) Per Unit
$
(470.48
)
 
$
169.08

 
$
(275.45
)
 
$
380.00

Distributions Per Unit
$
100.95

 
$

 
$
100.95

 
$







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

5


HIGHWATER ETHANOL, LLC
Condensed Statements of Comprehensive Income (Loss)


 Six Months Ended

 Six Months Ended

April 30, 2012

April 30, 2011

 (Unaudited)

 (Unaudited)




 Net Income (Loss)
$
(1,364,301
)

$
1,882,124

 Other Comprehensive Income



Unrealized gains (losses) on restricted marketable securities
(24,238
)

(37,741
)
 Comprehensive Income (Loss)
$
(1,388,539
)

$
1,844,383



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


6


HIGHWATER ETHANOL, LLC
Condensed Statements of Cash Flows

Six Months Ended
 
Six Months Ended

April 30, 2012
 
April 30, 2011


 

Cash Flows from Operating Activities

 

Net income (loss)
$
(1,364,301
)
 
$
1,882,124

Adjustments to reconcile net income to net cash provided by operations

 

Depreciation and amortization
3,271,562

 
3,277,377

Interest payments made from restricted cash
67,276

 
11,220

Change in fair value of derivative instruments
(114,065
)
 
(113,314
)
Increase in restricted cash from net interest earned
(67,276
)
 
(33,638
)
Change in assets and liabilities

 

Restricted cash
431,507

 
(114,450
)
Accounts receivable, including members
3,889,523

 
1,760,962

Inventories
31,879

 
(56,171
)
Derivative instruments
(451,951
)
 
(492,516
)
Prepaids and other
(21,849
)
 
383,138

Deferred revenue
141,139

 

Accounts payable, including members
(848,699
)
 
(94,229
)
Accrued expenses
218,176

 
(50,027
)
Net cash provided by operating activities
5,182,921

 
6,360,476



 

Cash Flows from Investing Activities

 

Capital expenditures
(515,984
)
 
(425,581
)
Investment in RPMG
(181,253
)
 
(206,972
)
   Net cash used in investing activities
(697,237
)
 
(632,553
)


 

Cash Flows from Financing Activities

 

Payments on long-term debt
(2,724,101
)
 
(5,015,231
)
Member distributions
(500,000
)
 

Net cash used in financing activities
(3,224,101
)
 
(5,015,231
)


 

Net Increase (Decrease) in Cash
1,261,583

 
712,692



 

Cash – Beginning of Period
3,427,683

 
3,856,173



 

Cash – End of Period
$
4,689,266

 
$
4,568,865

 
 
 
 
Supplemental Cash Flow Information

 

Cash paid for interest expense
$
1,968,783

 
$
2,129,360



 

Supplemental Disclosure of Noncash Financing and Investing Activities

 

Unrealized gains (losses) on restricted marketable securities
$
(24,238
)
 
$
(37,741
)
Capital expenditures included in accounts payable
$
1,613

 
$
93,886

Investment in RPMG included in accounts payable
$

 
$
398,028


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

7

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  These financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company's audited financial statements for the year ended October 31, 2011, contained in the Company's Form 10-K.
 
In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for fair presentation of the Company's financial position as of April 30, 2012 and the results of operations and cash flows for all periods presented.

Nature of Business

Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) operates a 50 million gallon per year ethanol plant in Lamberton, Minnesota. The Company produces and sells fuel ethanol and distillers grains, a co-product of the fuel ethanol production process, in the continental United States, Mexico and Canada.

Accounting Estimates

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

Revenue Recognition

The Company generally sells ethanol and related products pursuant to marketing agreements. The Company's products are shipped FOB shipping point. Revenues are recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales, title transfers when loaded into the rail car and for distiller's grains when the loaded rail cars leave the plant facility.

In accordance with the Company's agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.

Derivative Instruments

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

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

8

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012

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

In order to reduce the risk caused by interest rate fluctuations, the Company entered into an interest rate swap agreement. This contract is used with the intention to limit exposure to increased interest rates. The fair value of this contract is based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The fair value of the derivative is continually subject to change due to changing market conditions. Although this serves as an economic hedge, the Company does not formally designate this instrument as a hedge and, therefore, records in earnings adjustments caused from marking the instrument to market on a monthly basis.

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

Fair Value of Financial Instruments

The carrying value of cash, accounts receivable, and accounts payable, and other working capital items approximate fair value at April 30, 2012 due to the short maturity nature of these instruments.

The carrying value of restricted cash and restricted marketable securities approximate their fair value based on quoted market prices at year end. The Company believes the carrying value of the derivative instruments approximates fair value based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs.

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

Investments

The Company entered into a capital contribution agreement with their ethanol marketer for $605,000 and became a minority owner in February 2011, which is being accounted for using the cost method.

2. UNCERTAINTIES

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


3. FAIR VALUE MEASUREMENTS

The following table provides information on those assets measured at fair value on a recurring basis.

 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
April 30, 2012
 
Level 1
 
Level 2
 
Level 3
Restricted marketable securities - current
 
$
42,081

 
$
42,081

 
$

 
$

Restricted marketable securities - long-term
 
$
1,518,000

 
$
1,518,000

 
$

 
$

Derivative instrument - interest rate swap
 
$
(1,573,292
)
 
$

 
$
(1,573,292
)
 
$


9

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012


 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
October 31, 2011
 
Level 1
 
Level 2
 
Level 3
Restricted marketable securities - current
 
$
66,319

 
$
66,319

 
$

 
$

Restricted marketable securities - long-term
 
$
1,518,000

 
$
1,518,000

 
$

 
$

Derivative instrument - interest rate swap
 
$
(1,938,496
)
 
$

 
$
(1,938,496
)
 
$

Derivative instrument - corn contracts
 
$
(200,812
)
 
$
(200,812
)
 
$

 
$


The fair value of restricted marketable securities, which is a municipal debt obligation, is based on quoted market prices in an active market. The Company determined the fair value of the interest rate swap by using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each instrument and observable market-based inputs. The analysis reflects the contractual terms of the swap agreement, including the period to maturity and uses observable market-based inputs and uses the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The Company determines the fair value of the corn contracts by obtaining the fair value measurements from an independent pricing service based on dealer quotes and live trading levels from the Chicago Board of Trade.

4. RESTRICTED MARKETABLE SECURITIES
         
The cost and fair value of the Company's restricted marketable securities consist of the following at April 30, 2012:
 
Amortized Cost
Gross
Unrealized
Gains
Fair Value
 
 
 
 
Restricted marketable securities - Current
 
 
 
   municipal obligations
$
42,081

$

$
42,081

 
 
 
 
Restricted marketable securities - Long-term
   municipal obligations
1,467,036

50,963

1,518,000

 
 
 
 
Total restricted marketable securities
$
1,509,117

$
50,963

$
1,560,081


The long-term restricted marketable securities relate to the debt service reserve fund required by the capital lease agreement. The Company had unrealized gains of $50,963 and $75,202 included in accumulated other comprehensive income at April 30, 2012 and October 31, 2011, respectively.

Shown below are the contractual maturities of marketable securities with fixed maturities at April 30, 2012. Actual maturities may differ from contractual maturities because certain securities may contain early call or prepayment rights.

Due within 1 year
 
$

Due in 1 to 3 years
 
1,560,081

     Total
 
$
1,560,081



10

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012

5. INVENTORIES

Inventories consisted of the following at:

 
 
April 30, 2012
 
October 31, 2011*
 
 
 
 
 
Raw materials
 
$
1,111,189

 
$
1,957,121

Spare parts and supplies
 
716,429

 
487,128

Work in process
 
1,202,185

 
1,139,783

Finished goods
 
1,106,188

 
583,838

 Total
 
$
4,135,991

 
$
4,167,870

         
*Derived from Audited financial statements

6. DERIVATIVE INSTRUMENTS

As of April 30, 2012, the Company had entered into corn and natural gas derivative instruments and an interest rate swap agreement, which are required to be recorded as either assets or liabilities at fair value in the statement of financial position. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company must designate the hedging instruments based upon the exposure being hedged as a fair value hedge, a cash flow hedge or a hedge against foreign currency exposure. The Company had no corn or natural gas derivative instruments outstanding at April 30, 2012.

Interest Rate Swap

At April 30, 2012, the Company had a notional amount of approximately $19,896,000 outstanding in the swap agreement that fixes the interest rate at 7.6% until June 2014.

Corn and Natural Gas Contracts

As of April 30, 2012, the Company has no open positions for corn or natural gas.

The following tables provide details regarding the Company's derivative instruments at April 30, 2012:

          Instrument
Balance Sheet location
 
Assets
Liabilities
 
 
 
 
 
Interest rate swap
Derivative instruments
 
$

$
1,573,292


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

 
 
Statement of
 
Three Months Ended April 30,
 
 
Operations location
 
2012
2011
Interest rate swap
 
Other income (expense)
 
$
206,145

$
110,820

Corn contracts
 
Cost of goods sold
 
122,905

555,817

Natural gas contracts
 
Cost of goods sold
 
(190,412
)

 
 
 
 
 
 
 
 
Statement of
 
Six Months Ended April 30,
 
 
Operations location
 
2012
2011
Interest rate swap
 
Other income (expense)
 
$
365,203

$
636,580

Corn contracts
 
Cost of goods sold
 
129,431

612,273

Natural gas contracts
 
Cost of goods sold
 
(418,016
)


11

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012

7. DEBT FINANCING

Long-term debt consists of the following at:
 
April 30,
 
October 31,*
 
2011
 
2011
Fixed rate note payable, see terms below
$
21,245,714

 
$
22,209,080

 
 
 
 
Variable rate note payable, see terms below
15,566,763

 
17,327,498

 
 
 
 
Capital lease
15,180,000

 
15,180,000

 
 
 
 
Total
51,992,477

 
54,716,578

 
 
 
 
Less amounts due within one year
2,056,106

 
3,719,499

 
 
 
 
Net long-term debt
$
49,936,371

 
$
50,997,079

*Derived from Audited financial statements

Bank Financing

The Company has two promissory notes including a $25,200,000 Fixed Rate Note and a $20,200,000 Variable Rate Note. The Company also had a $5,000,000 Long-Term Revolving Note which was paid in full in 2011. The promissory notes are described in the credit agreement and below. The credit agreement also provided a revolving loan for $5,000,000 and supports the issuance of letters of credit up to $5,600,000, all of which are secured by substantially all assets.

Fixed Rate Note

The Fixed Rate Note was initially $25,200,000 and has a variable interest rate that is fixed with an interest rate swap. The Company makes monthly principal payments on the Fixed Rate Note of approximately $157,000 plus accrued interest. Interest accrues on the Fixed Rate Note at the greater of the one-month LIBOR rate plus 300 basis points or 4%, which was 4% at April 30, 2012. A final balloon payment on the Fixed Rate Note of approximately $15,196,000 will be due February 26, 2015.

Variable Rate Note

The Variable Rate Note was initially $20,200,000. The Company makes monthly payments of interest only. Interest accrues on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%, which was 5% at April 30, 2012. The Company also makes quarterly 50% excess cash flow payments which are first applied to interest and then to principal on the Variable Rate Note with a minimum annual principal reduction of $750,000 which has been made at the time of this filing. A final balloon payment of approximately $12,567,000 will be due February 26, 2015.

Long-term Revolving Note

The Long-Term Revolving Note was initially $5,000,000 and was reduced to $4,500,000 pursuant to the terms of the third amendment to the loan documents with FNBO. The amount available on the Long-Term Revolving Note was set to decline annually by the greater of $125,000 or 50% of the excess cash flow, as defined by the third amendment. The Company was also required to make a $750,000 principal repayment on the Long-Term Revolving Note prior to February 2012 and reduce the outstanding principal balance to zero as of February 1, 2013. The payments to reduce the Long-Term Revolving Note balance to zero as required by February 1, 2013 were made in September 2011. The Long-Term Revolving Note accrues interest monthly at the greater of the one-month LIBOR plus 350 basis points or 4%.

Line of Credit

The Company's Line of Credit accrues interest at the 90 day LIBOR plus 350 basis points which was 3.97% at April 30, 2012. The line of credit requires monthly interest payments. In April 2012, the Company extended the line of credit to April 2013. At

12

HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
April 30, 2012

April 30, 2012, there are no borrowings outstanding and the maximum availability was $5,000,000.

As of April 30, 2012, the Company has letters of credit outstanding of $3,500,000. The Company pays interest at a rate of 1.75% on amounts outstanding and the letters of credit are valid until August 2012.

The estimated maturities of the long-term debt at April 30, 2012 are as follows:
 
2013
$
2,056,106

2014
3,555,143

2015
33,234,561

2016
1,574,167

2017 and thereafter
11,572,500

 
 
     Long-term debt
$
51,992,477


8. COMMITMENTS AND CONTINGENCIES

Marketing Agreements

The Company entered into an ethanol marketing agreement with their current marketer to purchase, market, and distribute all the ethanol produced by the Company. The Company also entered into a member control agreement with the marketer whereby the Company made capital contributions and became a minority owner. The buy-in commitment was $605,000 and as of April 30, 2012, the Company has paid this commitment in full.  The member control agreement became effective on February 1, 2011 and provided the Company a membership interest with voting rights. The marketing agreement would terminate if the Company ceases to be a member.  The Company would assume certain of the member's rail car leases if the agreement is terminated.

Regulatory Agencies

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

Construction in Progress

The Company had construction in progress of approximately $114,000 at April 30, 2012 for the maintenance and lime cake buildings. The additions are expected to amount to $350,000.

Forward Contracts

The Company has forward contracts in place for natural gas purchases for approximately $2,405,000 through March 2013, which represents approximately 48.81% of the Company's projected usage for the corresponding time period. In addition, the Company has forward corn contracts in place for approximately 290,000 bushels through June 2012.


13


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

We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations for the three and six month periods ended April 30, 2012, compared to the same periods of the prior fiscal year. This discussion should be read in conjunction with the condensed financial statements and notes and the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 2011.

Cautionary Statements Regarding Forward-Looking Statements

This report contains forward-looking statements that involve future events, our future performance and our expected future operations and actions.  In some cases you can identify forward-looking statements by the use of words such as “will,” “may,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to:

Changes in our business strategy, capital improvements or development plans;
Volatile commodity and financial markets;
Changes in the availability and price of corn and natural gas;
Our ability to comply with the financial covenants contained in our credit agreements with our lender;
Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw materials costs;
Our ability to generate free cash flow to invest in our business and service our debt;
The results of our hedging transactions and other risk management strategies;
Changes in the environmental regulations or in our ability to comply with such regulations;
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Changes in or elimination of federal and/or state laws or policies impacting the ethanol industry (including the elimination of any federal and/or state ethanol tax incentives);
Ethanol and distillers grains supply exceeding demand and corresponding price reductions;
Changes in plant production capacity or technical difficulties in operating the plant;
Changes and advances in ethanol production technology;
Our ability to retain key employees and maintain labor relations;
Changes in our ability to secure credit or obtain additional debt or equity financing, if we so require;
Lack of transport, storage and blending infrastructure;
Competition from alternative fuel additives; and
Limitations and restrictions contained in the instruments and agreements governing our indebtedness.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We are not under any duty to update the forward-looking statements contained in this report. Furthermore, we cannot guarantee future results, levels of activity, performance or achievements. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.

Available Information

Our website address is www.highwaterethanol.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), are available, free of charge, on our website at www.highwaterethanol.com under the link “SEC Compliance,” as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Quarterly Report on Form 10-Q.

Overview

Highwater Ethanol, LLC (“we,” “our,” “Highwater” or the “Company”) is a Minnesota limited liability company formed

14


on May 2, 2006. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the ethanol plant. Our plant has nameplate capacity of 50 million gallons of undenatured ethanol per year. However, modifications to our air emissions permit approved by Minnesota Pollution Control Agency in February 2012 allow us to produce 58 million gallons per year of undenatured ethanol per year. Our plant is currently operating at a rate of 55 million gallons per year and management anticipates it will continue to do so in the future.
    
Our operating results are largely driven by the prices at which we sell our ethanol and distillers grains as well as the other costs related to production. The price of ethanol has historically fluctuated with the price of petroleum-based products such as unleaded gasoline, heating oil and crude oil. The price of distillers grains has historically been influenced by the price of corn as a substitute livestock feed. We expect these price relationships to continue for the foreseeable future, although recent volatility in the commodities markets makes historical pricing relationships less reliable. Our largest costs of production are corn, natural gas, depreciation and manufacturing chemicals. The cost of corn is largely impacted by geopolitical supply and demand factors and the outcome of our risk management strategies. Prices for natural gas, manufacturing chemicals and denaturant are tied directly to the overall energy sector, crude oil and unleaded gasoline. We market and sell our products primarily in the continental United States using third party marketers. Renewable Products Marketing Group, LLC markets our ethanol. CHS, Inc. markets our dried distillers grains. Meadowland Farmers Co-op supplies our corn.

Effective April 1, 2012, we entered into a the Sixth Amendment of Construction Loan Agreement and the Fifth Amended and Restated Promissory Notes which amended our Construction Loan Agreement originally dated April 24, 2008 with First National Bank of Omaha, as administrative agent and collateral agent (collectively referred to as "FNBO"), and the Fourth Amended and Restated Promissory Notes executed on August 26, 2011. These amendments extend our line of credit until April 1, 2013 and modify the interest rate thereon to the three (3) month LIBOR rate plus 350 basis points with no minimum interest rate.

In November 2011, we signed a non-binding letter of intent with Butamax Advanced Biofuels for the purpose of discussing the possible implementation of biobutanol technology and commercial-scale production of biobutanol at our facility. Management is currently performing its due diligence and working with Butamax Advanced Biofuels to develop a scope of definitive agreements. Management expects to continue to work towards these definitive agreements for approximately the next 3 to 6 months. However, there is no guarantee that definitive agreements to implement biobutanol technology will be executed. If we decide to proceed with biobutanol technology, there is no assurance that there will be a market for biobutanol, that the biobutanol technology as developed by Butamax Advanced Biofuels will be effective or that our Company will be profitable.
    
There have been some recent developments in legislation that impact the ethanol industry. One such development concerns the Volumetric Ethanol Excise Tax Credit ("VEETC"). VEETC provided a volumetric ethanol excise tax credit of 4.5 cents per gallon of gasoline that contains at least 10% ethanol (total credit of 45 cents per gallon of ethanol blended which is 4.5 divided by the 10% blend). VEETC expired on December 31, 2011. In addition to the expiration of the tax incentives, a 54 cent per gallon tariff imposed on ethanol imported into the United States also expired on December 31, 2011. Management believes that the expiration of VEETC will not have a significant effect on ethanol demand provided gasoline prices remain high and the renewable fuels use requirement of the Federal Renewable Fuels Standard ("RFS") is maintained. The RFS requires that a certain amount of renewable fuels must be used in the United States each year. However, if the RFS is repealed, ethanol demand may be significantly impacted. Recently, there have been proposals in Congress to reduce or eliminate the RFS. Management does not believe that these proposals will be adopted in the near future. However, if the RFS is reduced or eliminated, the market price and demand for ethanol will likely decrease which could negatively impact our financial performance.

Many in the ethanol industry believe that it will be difficult to meet the RFS requirement in future years without an increase in the percentage of ethanol that can be blended with gasoline for use in standard (non-flex fuel) vehicles. Most ethanol that is used in the United States is sold in a blend called E10. E10 is a blend of 10% ethanol and 90% gasoline. E10 is approved for use in all standard vehicles. The United States Environmental Protection Agency (the "EPA") has approved the use of E15, gasoline which is blended at a rate of 15% ethanol and 85% gasoline, in vehicles manufactured in the model year 2001 and later. However, there were still significant federal and state regulatory hurdles that needed to be addressed. The EPA has made recent gains towards clearing those federal regulatory hurdles. In February 2012, the EPA approved health effects and emissions testing on E15 which was required by the Clean Air Act before E15 can be sold into the market. In March 2012, the EPA approved a model Misfueling Mitigation Plan and fuel survey which must be submitted by applicants before E15 registrations can be approved. Finally, in April 2012, the EPA approved the first E15 registrations approving twenty producers who have successfully registered their product to be used as E15. Although management believes that these developments are significant steps towards introduction of E15 in the marketplace, there are still obstacles to meaningful market penetration by E15. Many states still have regulatory issues that prevent the sale of E15. In addition, sales of E15 may be limited because it is not approved for use in all vehicles, the EPA requires a label that management believes may discourage consumers from using E15, and retailers may choose not to sell E15 due to concerns regarding liability. As a result, management believes that E15 may not have an immediate impact on ethanol demand in the United States.

15



The State of Minnesota recently passed the 2012 Omnibus Agriculture Policy bill which extends the start of a mandate for all gasoline blends sold in Minnesota to contain at least 20% ethanol by volume, or the maximum percentage of ethanol by volume allowed by the EPA, to August 30, 2015. The bill also requires certain state agencies to develop recommendations for incorporating biofuels other than ethanol into the mandate.

In late 2009, California passed a Low Carbon Fuels Standard ("LCFS"). The California LCFS requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which is measured using a lifecycle analysis, similar to the RFS. On December 29, 2011, a federal court in California ruled that the California LCFS was unconstitutional which halted implementation of the California LCFS. However, the California Air Resources Board ("CARB") appealed this court ruling and on April 23, 2012, a federal appellate court in California granted a request to temporarily reinstate the LCFS while the case is on appeal. This decision will allow the CARB to continue implementation of the LCFS which could negatively impact demand for corn-based ethanol and result in decreased ethanol prices.

We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities. However, based on volatility in the cost of corn and potentially tight or even negative margins throughout the period, we may need to seek additional funding.

Results of Operations for the Three Months Ended April 30, 2012 and 2011
 
The following table shows the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the three months ended April 30, 2012 and 2011:
 
2012
 
2011
Income Statement Data
Amount
 
%
 
Amount
 
%
 
(unaudited)
 
 
 
(unaudited)
 
 
Revenue
$
33,771,321

 
100.00
 %
 
$
37,394,958

 
100.00
 %
Cost of Goods Sold
34,752,072

 
102.90
 %
 
34,960,815

 
93.49
 %
Gross Profit (Loss)
(980,751
)
 
(2.90
)%
 
2,434,143

 
6.51
 %
Operating Expenses
486,777

 
1.44
 %
 
471,601

 
1.26
 %
Operating Profit (Loss)
(1,467,528
)
 
(4.35
)%
 
1,962,542

 
5.25
 %
Other Expense
(862,748
)
 
(2.55
)%
 
(1,125,065
)
 
(3.01
)%
Net Income (Loss)
$
(2,330,276
)
 
(6.90
)%
 
$
837,477

 
2.24
 %


Our revenues are derived from the sale of our ethanol and distillers grains.

The following table shows the sources of our revenue for the three months ended April 30, 2012.
Revenue Sources
 
Amount
(Unaudited)
 
Percentage of
Total Revenues
(Unaudited)
 
 
 
 
 
Ethanol Sales
 
$
27,023,106

 
80.02
%
Modified Distillers grains sales
 
1,644,606

 
4.87
%
Dried Distillers grains sales
 
5,103,609

 
15.11
%
Total Revenues
 
$
33,771,321

 
100.00
%


16


The following table shows the sources of our revenue for the three months ended April 30, 2011.
Revenue Sources
 
Amount
(Unaudited)
 
Percentage of
Total Revenues
(Unaudited)
 
 
 
 
 
Ethanol Sales
 
$
31,610,932

 
84.53
%
Modified Distillers grains sales
 
103,457

 
0.28
%
Dried Distillers grains sales
 
5,680,569

 
15.19
%
Total Revenues
 
$
37,394,958

 
100.00
%

Our total revenues were lower for the three month period ended April 30, 2012 compared to the same period in 2011, primarily due to lower prices we received for ethanol.
We experienced a slight decrease in the gallons of ethanol sold in the three month period ended April 30, 2012 as compared to the three month period ended April 30, 2011. The gallons of ethanol we sold during the three month period ended April 30, 2012 decreased by approximately 0.04% as compared to the number of gallons of ethanol we sold for the three months ended April 30, 2011. The average ethanol sales price per gallon we received for the three month period ended April 30, 2012 was approximately 14.46% lower than the average price we received for the same period of 2011.
    
Management attributes this decrease in the average price we received for our ethanol due to decreased gasoline demand which negatively impacted ethanol demand since ethanol is typically blended with gasoline. In addition, higher ethanol reserves resulted in excess ethanol supply. Management anticipates we will continue to see decreased ethanol prices and volatility throughout our 2012 fiscal year.

Distillers grains represent a larger portion of our revenues during the three months ended April 30, 2012 compared to the same period of 2011. Management believes that this is a result of the higher modified and dried distillers grains prices we received during our second fiscal quarter of 2012 compared to the same period of 2011. For the three months ended April 30, 2012, the average price per ton that we received for our modified distillers grains was approximately 63.47% higher than during the three months ended April 30, 2011. For the three months ended April 30, 2012, the average price per ton that we received for our dried distillers grains was approximately 9.23% higher than the average price we received during the three months ended April 30, 2011. The Company also experienced an increase in the number of tons of modified distillers grains sold of approximately 19,000 tons and a decrease in the number of tons of dried distillers grains sold of approximately 6,000 tons in the first fiscal quarter of 2012 as compared to the same time period of 2011.

Management attributes these higher sales prices it received for its dried distillers grains and its modified distillers grains with higher corn prices which positively impact the market price of distillers grains. Decreased demand from China due to the anti-dumping investigation has not impacted the distillers grains market as much as initially expected due to higher corn prices and increased demand from domestic consumers as well as exports to Mexico. Management anticipates that distillers grains prices will continue to follow corn prices during our 2012 fiscal year, with distillers grains trading closer to the price of corn during the winter months and selling at a greater discount compared to corn during the summer months.

Operating margins were negative during our second fiscal quarter. Management anticipates that our results of operations for our 2012 fiscal year may continue to be affected by volatility in the commodity markets and that negative margins could continue. If plant operating margins remain low or even negative for an extended period of time, management anticipates that this could significantly impact our liquidity, especially if our raw material costs increase. Management believes the industry will need to continue to grow demand and further develop an ethanol distribution system to facilitate additional blending of ethanol and gasoline to offset the increased supply brought to the marketplace by additional production. Management is optimistic that ethanol demand and distribution will expand so long as positive blend economics exist for gasoline refiners and blenders.

Cost of Goods Sold

Our two largest costs of production are corn (83.88% of cost of goods sold for the three months ended April 30, 2012) and natural gas (4.82% of cost of goods sold for the three months ended April 30, 2012).

Our average price per bushel corn for the three months ended April 30, 2012 increased by approximately 1.96% per bushel compared to the same period in 2011. We used 4,539,570 bushels of corn in the three month period ended April 30, 2012 as compared to 4,449,173 bushels for the same period in 2011.

17



Management expects that corn prices will remain volatile through the 2012 fiscal year as a result of an increase in demand for corn and limited supply. There is considerable uncertainty regarding corn prices as they can be dramatically affected by many variables such as the weather. High corn prices may have a negative effect on our operating margins unless the price of ethanol and distillers grains outpaces rising corn prices.

In the ordinary course of business, we entered into forward purchase contracts for our commodity purchases. At April 30, 2012, we have forward corn purchase contracts for various delivery periods through June 2012 for approximately 290,000 bushels. We had gains related to corn derivative instruments of approximately $123,000 for the three months ended April 30, 2012, which decreased cost of sales. We had gains related to corn derivative instruments of approximately $556,000 for the three months ended April 30, 2011.

For the three month period ended April 30, 2012, we purchased approximately 315,700 MMBTU's compared to 331,031 MMBTU's for the same period of 2011. Our average price per MMBTU of natural gas was $5.30 for the three month period ended April 30, 2012 compared to $5.17 for the same period of 2011. Management anticipates that natural gas prices will continue at their current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand during our 2012 fiscal year.

At April 30, 2012, we have forward natural gas purchase contracts for various delivery periods through March 2013 for approximately $2,405,000. We had losses related to natural gas based derivative instruments of approximately $190,000 for the three months ended April 30, 2012, with no corresponding gains or losses in the same period of 2011.

Operating Expense

We had operating expenses for the three months ended April 30, 2012 of $486,777 as compared to operating expenses of $471,601 for the same period of 2011. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Profit (Loss)

We had a loss from operations for the three months ended April 30, 2012 of $1,467,528 which is approximately (4.35)% of our revenues compared to a profit of $1,962,542 which was approximately 5.25% of our revenues for the three months ended April 30, 2011. This decrease in our operating income is primarily due to a decrease in the prices we received for our ethanol.

Other Expense

We had total other expense for the three months ended April 30, 2012 of $862,748 compared to other expense of $1,125,065 for the three months ended April 30, 2011. Our other expense for the three months ended April 30, 2012 consisted primarily of interest expense. The net decrease in other expense is due to a decrease in interest expense resulting from our continuing scheduled payments on our debt and an increase in the gain on derivative instrument for the three months ended April 30, 2012 compared to the same period of 2011.

Results of Operations for the Six Months Ended April 30, 2012 and 2011
 
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 statement of operations for the six months ended April 30, 2012 and 2011:


18


 
2012
 
2011
Income Statement Data
Amount
 
%
 
Amount
 
%
 
(unaudited)
 
 
 
(unaudited)
 
 
Revenue
$
73,598,897

 
100.00
 %
 
$
73,664,456

 
100.00
 %
Cost of Goods Sold
72,241,801

 
98.16
 %
 
69,146,241

 
93.87
 %
Gross Profit
1,357,096

 
1.84
 %
 
4,518,215

 
6.13
 %
Operating Expenses
1,001,892

 
1.36
 %
 
908,893

 
1.23
 %
Operating Profit
355,204

 
0.48
 %
 
3,609,322

 
4.90
 %
Other Expense
(1,719,505
)
 
(2.34
)%
 
(1,727,198
)
 
(2.34
)%
Net Income (Loss)
$
(1,364,301
)
 
(1.85
)%
 
$
1,882,124

 
1.13
 %

The following table shows the sources of our revenue for the six months ended April 30, 2012.
Revenue Sources
 
Amount
(Unaudited)
 
Percentage of
Total Revenues
(Unaudited)
 
 
 
 
 
Ethanol Sales
 
$
59,592,275

 
80.97
%
Modified Distillers grains sales
 
2,780,374

 
3.78
%
Dried Distillers grains sales
 
11,226,248

 
15.25
%
Total Revenues
 
$
73,598,897

 
100.00
%

The following table shows the sources of our revenue for the six months ended April 30, 2011.
Revenue Sources
 
Amount
(Unaudited)
 
Percentage of
Total Revenues
(Unaudited)
 
 
 
 
 
Ethanol Sales
 
$
62,580,646

 
84.95
%
Modified Distillers grains sales
 
212,249

 
0.29
%
Dried Distillers grains sales
 
10,871,561

 
14.76
%
Total Revenues
 
$
73,664,456

 
100.00
%

Our total revenues were lower for the six month period ending April 30, 2012 compared to the same period of 2011 primarily due to the lower prices we received for our ethanol.

We experienced a slight decrease in the gallons of ethanol sold in the six month period ended April 30, 2012 as compared to the six month period ended April 30, 2011. The gallons of ethanol we sold during the six month period ended April 30, 2012 decreased by approximately .78% as compared to the number of gallons of ethanol we sold for the six months ended April 30, 2011. The average per gallon ethanol sales price we received for the six month period ended April 30, 2012 was approximately 3.98% lower than the average price we received for the same period of 2011.

Distillers grains represent a larger portion of our revenues during the six months ended April 30, 2012 compared to the same period of 2011. For the six months ended April 30, 2012, the average price per ton that we received for our modified distillers grains was approximately 65.16% higher than during the six months ended April 30, 2011. For the six months ended April 30, 2012, the average price per ton that we received for our dried distillers grains was approximately 21.64% higher than during the six months ended April 30, 2011. The Company also experienced an increase in the number of tons of modified distillers grains sold of approximately 26,547 tons and a decrease in the number of tons of dried distillers grains sold of approximately 10,000 tons in the six months ended April 30, 2012 as compared to the same time period of 2011.

Cost of Goods Sold

Our costs of goods sold as a percentage of revenues were a 98.16% for the six months ended April 30, 2012 compared to 93.87% for the six months ended April 30, 2011. Our two largest costs of production are corn (82.19% of cost of goods sold for the six months ended April 30, 2012) and natural gas (5.18% of cost of goods sold for the six months ended April 30, 2012).

    

19


Our average cost per bushel of corn was approximately 4.98% lower during the first six months of our 2012 fiscal year compared to the same period of 2011. During the six month period ended April 30, 2012, we used approximately 9,533,504 bushels of corn to produce our ethanol and distillers grains as compared to approximately 9,407,010 bushels for the same period in 2011.

We had gains related to corn derivative instruments of approximately $129,000 for the six months ended April 30, 2012, which decreased cost of sales. We had gains related to corn derivative instruments of approximately $612,000 for the six months ended April 30, 2011.

For the six month period ended April 30, 2012, we purchased 664,829 MMBTU's compared to 695,392 MMBTU's for the same period of 2011. Our average price per MMBTU of natural gas was $5.63 for the six month period ended April 30, 2012 compared to $5.36 for the same period of 2011. We had losses related to natural gas based derivative instruments of approximately $418,000 for the six months ended April 30, 2012, with no corresponding gains or losses in the same period of 2011.

Operating Expense

We had operating expense for the six months ended April 30, 2012 of $1,001,892 compared to operating expense of $908,893 for the same period of 2011. We experienced an increase of approximately $93,000 in our operating expenses for the six months ended April 30, 2012, compared to the same period of 2011. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Profit

We had operating income for the six months ended April 30, 2012 of $355,204 compared to operating income of $3,609,322 for the same period of 2011. Our income from operations for the six months ended April 30, 2012, was 0.48% of our revenues compared to 4.90% for the same period of 2011. Our operating profit for the six months ended April 30, 2012, was lower due primarily to due to the decrease in the price we received for our ethanol.

Other Expense
    
We had total other expense (net) for the six months ended April 30, 2012 of $1,719,505 compared to other expense (net) of $1,727,198 for the same period of 2011. Our other expense for the six months ended April 30, 2012, consisted primarily of interest expense offset by derivative instrument gains.

Changes in Financial Condition for the Six Months Ended April 30, 2012

The following table highlights the changes in our financial condition for the six months ended April 30, 2012 from our previous fiscal year ended October 31, 2011:

 
April 30, 2012
(Unaudited)
 
October 31, 2011*
Current Assets
$
12,601,285

 
$
15,695,180

Current Liabilities
$
5,173,726

 
$
7,741,800

Long-Term Debt and Liabilities
$
49,936,371

 
$
50,997,079

Members' Equity
$
49,183,260

 
$
51,071,799

* Derived from audited financial statements

Current Assets. The decrease in current assets was primarily the result of a decrease in our accounts receivables of $3,889,523 which was offset partially by an increase of $1,261,583 in cash and cash equivalents on April 30, 2012 as compared to October 31, 2011.
    
Current Liabilities. The decrease was due primarily to a decrease in our accounts payable at April 30, 2012 as compared to October 31, 2011 and a decrease in our current maturities of long-term debt as a result of our making payments against the outstanding principal balance of our loans with FNBO.


20


Long-term Debt and Liabilities. Long-term debt decreased from $50,997,079 at October 31, 2011 to $49,936,371 at April 30, 2012, primarily because we continue to pay down our loans with FNBO.

Liquidity and Capital Resources

Based on financial forecasts performed by our management, we anticipate that we will have sufficient cash from our current credit facilities and cash from our operations to continue to operate the ethanol plant at capacity for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term. However, operating margins have narrowed and are expected to remain tight or non-existent through the end of our fiscal year. Should we experience unfavorable operating conditions in the future, we may have to secure additional debt or equity financing for working capital or other purposes.

We completed upgrades to the Company's Reverse Osmosis (RO) equipment and system during our second fiscal quarter. The cost for upgrading the RO system was approximately $267,000 and was funded from our operations. We also have construction in progress of approximately $114,000 at April 30, 2012 for maintenance and lime cake buildings which is expected to amount to approximately $350,000 and will be funded from operations. We do not currently anticipate any significant purchases of property and equipment that would require us to secure additional capital resources in the next 12 months.

The following table shows cash flows for the six months ended April 30, 2012 and 2011:
 
Six Months Ended April 30
 
2012
2011
 
(unaudited)
(unaudited)
Net cash provided by operating activities
$5,182,921
$6,360,476
Net cash used in investing activities
(697,237)
(632,553)
Net cash used in financing activities
(3,224,101)
(5,015,231)

Cash Flow From Operations

We experienced a decrease of approximately $1,178,000 in our cash provided by operating activities for the six month period ended April 30, 2012, compared to the same period in 2011. This decrease was due to a net loss primarily driven by decreased prices for ethanol during the 2012 period. During the six months ended April 30, 2012, our capital needs were being adequately met through cash from our operating activities and our credit facilities.

Cash Flow From Investing Activities

We used approximately $65,000 more net cash for investing activities for the six month period ended April 30, 2012, as compared to the same period in 2011. This increase was primarily due to an increase in capital expenditures during the six months ended April 30, 2012.

Cash Flow From Financing Activities

We used approximately $1,791,000 less net cash for financing activities during the six months ended April 30, 2012 as compared to the same period in 2011. This decrease was primarily a result of a decrease in the amount we paid to FNBO towards the principal balance on our loans during the six months ended April 30, 2012 as compared to the same period in 2011. In addition, we paid a distribution in the amount of $500,000 to our members during the six months ended April 30, 2012.

Short-Term and Long-Term Debt Sources

On April 24, 2008, we entered into a Construction Loan Agreement (the “Agreement”) with FNBO for the purpose of funding a portion of the cost of the ethanol plant. With construction complete and the ethanol plant commencing operations, the construction loan converted to a $25,200,000 Fixed Rate Note, a $20,200,000 Variable Rate Note, a $5,000,000 Long-Term Revolving Note, a $5,000,000 line of credit and $5,600,000 to support the issuance of letters of credit by FNBO. As of April 30, 2012, the Company had $3,500,000 in letters of credit outstanding.

Fixed Rate Note

The Fixed Rate Note was initially for $25,200,000 with a variable interest rate that is fixed with an interest rate swap. We make monthly principal payments on the Fixed Rate Note for approximately $157,000 plus accrued interest. Interest will

21


accrue on the Fixed Rate Note at the greater of the one-month LIBOR Rate, in effect from time to time, plus 300 basis points or 4%. The applicable interest rate was 4% at April 30, 2012. However, the Company entered into an interest rate swap agreement with FNBO, which fixes the interest rate on the Fixed Rate Note at 7.6% until June 2014. The outstanding balance on this note was approximately $21,246,000 and $22,209,000 at April 30, 2012 and October 31, 2011, respectively. A final balloon payment on the Fixed Rate Note of approximately $15,196,000 will be due February 26, 2015.

Variable Rate Note

The Variable Rate Note was initially for $20,200,000. We make monthly interest only payments and we will remit quarterly excess cash flow payments to FNBO which will be applied first to interest and then to principal on the Variable Rate Note with a minimum annual principal reduction of $750,000. The minimum annual principal reduction of $750,000 has already been paid at the time of filing. The outstanding balance on this note was approximately $15,567,000 and $17,327,000 at April 30, 2012 and October 31, 2011, respectively.

Interest will accrue on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%. The applicable interest rate at April 30, 2012, was 5%. A final balloon payment of approximately $12,567,000 will be due February 26, 2015.

Long-term Revolving Note

The Long-term Revolving Note was initially $5,000,000. The Company was required to make a $750,000 principal repayment on the Long-term Revolving Note prior to February 2012 and reduce the outstanding principal balance to zero as pf February 2013. FNBO has no obligation to advance any additional funds and will only advance such sums as approved in its sole discretion. The Long-term Revolving Note accrues interest monthly at the greater of the one-month LIBOR plus 350 basis points, or 4%. The applicable interest rate at April 30, 2012 was 4%. The payment to reduce the balance to zero was made in September 2011. The outstanding balance on this note was $0 at April 30, 2012 and October 31, 2011, respectively.

Line of Credit

The Company has a line of credit available equal to the amount of the Company's Borrowing Base, with a maximum limit of $5,000,000. The Company's Borrowing Base will vary and may at times be less than $5,000,000. Effective April 1, 2012, we entered into the Sixth Amendment of Construction Loan Agreement and the Fifth Amended and Restated Promissory Notes which extended our line of credit until April 1, 2013 and modified the interest rate thereon to the three (3) month LIBOR rate plus 350 basis points with no minimum interest rate, which was 3.97% at April 30, 2012. The line of credit requires monthly interest payments. As of April 30, 2012, the Company had not drawn on the line of credit and the Company had maximum availability of $5,000,000 under the line of credit at April 30, 2012.

Covenants and other Miscellaneous Financing Agreement Terms

The loan agreements are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements. We are currently in compliance with our loan covenants and anticipate being in compliance with these covenants through April 30, 2013. Additionally, we are limited to annual capital expenditures of $1,000,000 without prior approval of FNBO. We will also be prohibited from making distributions to our members without the prior approval of FNBO. In connection with the bank financing agreement, we executed a mortgage in favor of FNBO creating a first lien on our real estate and plant and a security interest in all personal property located on the property and assigned in favor of FNBO, all rents and leases to our property, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.

We will continue to work with our lenders to try to ensure that the terms of our loan agreements are met going forward. However, we cannot provide any assurance that our actions will result in sustained profitable operations or that we will not be in violation of our loan covenants or in default on our principal payments in the future. Presently, we are meeting our liquidity needs and complying with our financial covenants and the other terms of our loan agreements as modified. Should unfavorable market conditions result in our violation of the terms or covenants of our loan and we fail to obtain a waiver of any such term or covenant, our primary lender could deem us in default of our loans and require us to immediately repay a significant portion or possibly the entire outstanding balance of our loans. In the event of a default, our lender could also elect to proceed with a foreclosure action on our plant.


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Capital Lease

On April 24, 2008, we entered into certain financing and credit arrangements with U.S. Bank National Association, as trustee (the “Trustee”) and the City of Lamberton, Minnesota (the “City”) in order to secure the proceeds from the sale of the solid waste facilities revenue bonds, Series 2008A (the “Bonds”) issued by the City in the aggregate principal amount of $15,180,000 pursuant to a trust indenture between the City and the Trustee (“Trust Indenture”). The City has undertaken the issuance of the Bonds to finance the acquisition and installation of certain solid waste facilities in connection with our ethanol plant to be located near Lamberton, Minnesota. Highwater received proceeds of approximately $14,876,000, after financing costs of approximately $304,000. The remaining proceeds were held as restricted cash or marketable securities based on anticipated use and are split between a project fund of approximately $11,527,000, a capitalized interest fund of approximately $1,831,000, and a debt service reserve fund of approximately $1,518,000. The Bonds mature on December 1, 2022 and bear interest at a rate of 8.5%.

Under this equipment lease agreement with the City, we started making interest payments on November 25, 2008 and monthly thereafter at an implicit interest rate of 8.5%. The monthly capital lease interest payments correspond to 1/6 the semi-annual interest payments due on the Bonds on the next interest payment date. Monthly capital lease payments for principal were originally scheduled to begin on November 25, 2009; however, the City amended the agreement in September 2008 which adjusted the start date for principal payments to begin on November 25, 2014. These payments will equal 1/12 the annual principal payments scheduled to become due on the corresponding bonds on the next principal payment date.
    
The Company has guaranteed that if such assessed lease payments are not sufficient for the required bond payments, the Company will provide such funds as are needed to fund the shortfall. The lease agreement is secured by substantially all business assets of the Company and is also subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working-capital requirements.

Compliance with Environmental Law

We are subject to extensive air, water and other environmental regulations and we were required to obtain a number of environmental permits to construct and operate the plant. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations. Additionally, any changes that are made to the ethanol plant or its operations must be reviewed to determine if amended permits need to be obtained in order to implement these changes.

The National Pollutant Discharge Elimination System/State Disposal System (NPDES/SDS) permit, which regulates the water treatment, water disposal and stormwater systems at the facility, requires renewal every five years. We submitted a renewal application to the Minnesota Pollution Control Agency (“MPCA”) in 2011 and the NPDES/SDS permit was approved and signed by MPCA on November 9, 2011. Our NPDES/SDS permit is valid until October 31, 2016. The air emissions permit was approved by MPCA on February 14, 2012. The updated air emissions permit allows us to produce 58 million gallons per year of undenatured ethanol or 59.5 million gallons per year denatured ethanol.

Contracting Activity

Renewable Products Marketing Group, LLC markets our ethanol. Meadowland Farmers Co-op supplies our corn. CHS, Inc. markets our dried distillers grains. Each of these contracts is critical to our success and we are very dependent on each of these companies. Accordingly, the financial stability of these partners is critical to the successful operation of our business.

Butamax Advanced Biofuels

In November 2011, we signed a non-binding letter of intent with Butamax Advanced Biofuels for the purpose of discussing the possible implementation of biobutanol technology and commercial-scale production of biobutanol at our facility. Management is currently performing its due diligence and working with Butamax Advanced Biofuels to develop a scope of definitive agreements. However, there is no guarantee that definitive agreements to implement biobutanol technology will be executed.

Distribution

On March 1, 2012, the board of governors approved a distribution of $100.95 per unit for members of record as of that date. The distribution was paid in March 2012.


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Critical Accounting Estimates

Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Our most critical accounting estimates, which require the greatest use of judgment by management, are designated as critical accounting estimates and include policies related to the carrying value of long-lived assets, inventory valuation and derivatives. An in-depth description of these can be found in our Annual Report on Form 10-K for the fiscal year ended October 31, 2011. Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed financial statements in accordance with generally accepted accounting principles. There have been no changes in the policies for our accounting estimates for the quarter ended April 30, 2012.

We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below. We use derivative financial instruments as part of an overall strategy to attempt to manage market risk.

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from holding a revolving line of credit and term loans which bear variable interest rates. We manage our floating rate debt using an interest rate swap. We entered into a fixed rate swap to alter our exposure to the impact of changing interest rates on our results of operations and future cash outflows for interest. We use the interest rate swap contract to separate interest rate risk management from the debt funding decision. As of April 30, 2012, our interest rate swap had a liability fair value of $1,573,292.
    
We expect to be exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn in the ethanol production process and the sale of ethanol. 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. 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.

For the three and six months ended April 30, 2012, we recorded a loss due to the change in fair value of our outstanding natural gas derivative positions of approximately $190,000 and $418,000, respectively. We recorded gains due to changes in the fair value of our outstanding corn derivative positions for the three and six months ended April 30, 2012 of approximately $123,000 and $129,000, respectively. We also recorded gains due to changes in the fair value of our interest rate swap for the three and six months ended April 30, 2012 of approximately $206,000 and $365,000, respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Pursuant to the Instructions to Item 305(c) of Regulation S-K we are not required to provide information under this item.

Item 4.  Controls and Procedures
 
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosures.

Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Mark Peterson, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of April 30, 2012. Based upon this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including

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our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

Our management, including our principal executive officer and principal financial officer, have reviewed and evaluated any changes in our internal control over financial reporting that occurred during the quarter ended April 30, 2012 and there has been no change that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

There have been no material changes in the risks that we face since the date when we filed our Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information

None.


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Item 6. Exhibits.

(a)
The following exhibits are filed as part of this report.
Exhibit No.
 
Exhibit
10.1

 
Fifth Amended and Restated Revolving Promissory Note between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012.
10.2

 
Fifth Amended and Restated Revolving Promissory Note between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012.
10.3

 
Sixth Amendment of Construction Loan Agreement between First National Bank of Omaha and Highwater Ethanol, LLC dated April 1, 2012.
31.1

 
Certificate Pursuant to 17 CFR 240.13a-14(a)*
31.2

 
Certificate Pursuant to 17 CFR 240.13a-14(a)*
32.1

 
Certificate Pursuant to 18 U.S.C. Section 1350*
32.2

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

 
The following financial information from Highwater Ethanol, LLC's Quarterly Report on Form 10-Q for the quarter ended April 30, 2012, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of April 30, 2012 and October 31, 2011, (ii) Condensed Statements of Operations for the three and six months ended April 30, 2012 and 2011, (iii) Condensed Statements of Cash Flows for the six months ended April 30, 2012 and 2011, and (iv) the Notes to Condensed Financial Statements.**

* Filed herewith.
** Furnished herewith.


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
HIGHWATER ETHANOL, LLC
 
 
 
 
Date:
June 12, 2012
 
/s/ Brian Kletscher
 
 
 
Brian Kletscher
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
June 12, 2012
 
/s/ Mark Peterson
 
 
 
Mark Peterson
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
    

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