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Table of Contents

 

 

 

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 July 31, 2012

 

OR

 

o         Transition report under Section 13 or 15(d) of the Exchange Act.

 

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

 

41-2002393

(State or other jurisdiction of organization)

 

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

 

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

(Address of principal executive offices)

 

(507) 793-0077

(Issuer’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

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

 

As of September 14, 2012, there were 38,622,107 Class A units issued and outstanding.

 

 

 




Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Condensed Consolidated Balance Sheets

 

 

 

July 31,

 

October 31,

 

 

 

2012

 

2011*

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and equivalents

 

$

1,683,127

 

$

7,140,573

 

Restricted cash

 

152,956

 

367,012

 

Restricted certificates of deposit

 

650,000

 

650,000

 

Accounts receivable

 

859,061

 

1,378,220

 

Inventory

 

2,781,102

 

3,764,616

 

Prepaid expenses

 

690,736

 

937,521

 

Total current assets

 

6,816,982

 

14,237,942

 

 

 

 

 

 

 

Property, Plant, and Equipment

 

 

 

 

 

Land and improvements

 

12,252,091

 

12,265,434

 

Plant buildings and equipment

 

100,536,472

 

94,509,719

 

Vehicles and other equipment

 

637,619

 

635,054

 

Office buildings and equipment

 

621,721

 

615,298

 

Construction in progress

 

 

4,132,965

 

 

 

114,047,903

 

112,158,470

 

Less accumulated depreciation

 

(27,816,137

)

(23,565,525

)

 

 

86,231,766

 

88,592,945

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Restricted cash

 

 

59,574

 

Other intangible assets, net

 

388,001

 

415,276

 

Debt service deposits and other assets

 

686,438

 

828,187

 

Total other assets

 

1,074,439

 

1,303,037

 

 

 

 

 

 

 

Total Assets

 

$

94,123,187

 

$

104,133,924

 

 

See Notes to Condensed Consolidated Financial Statements

 


* Derived from audited financial statements

 

1



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Condensed Consolidated Balance Sheets

 

 

 

July 31,

 

October 31,

 

 

 

2012

 

2011*

 

 

 

(Unaudited)

 

 

 

LIABILITIES AND MEMBERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current maturities of long-term debt

 

$

4,531,844

 

$

4,572,613

 

Accounts payable:

 

 

 

 

 

Trade accounts payable

 

803,026

 

2,704,707

 

Trade accounts payable — related party

 

 

109,101

 

Accrued expenses

 

394,853

 

421,306

 

Total current liabilities

 

5,729,723

 

7,807,727

 

 

 

 

 

 

 

Long-Term Debt, net of current maturities

 

41,335,321

 

46,844,912

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Members’ Equity

 

 

 

 

 

Controlling interest in equity:

 

 

 

 

 

38,622,107 and 37,208,074 Class A units issued and outstanding at July 31, 2012 and October 31, 2011, respectively

 

46,911,196

 

49,508,123

 

Noncontrolling interest

 

146,947

 

(26,838

)

Total members’ equity

 

47,058,143

 

49,481,285

 

 

 

 

 

 

 

Total Liabilities and Members’ Equity

 

$

94,123,187

 

$

104,133,924

 

 

See Notes to Condensed Consolidated Financial Statements

 


*        Derived from audited financial statements

 

2



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Condensed Consolidated Statements of Operations

 

 

 

Three Months
Ended July 31,

 

Three Months
Ended July 31,

 

 

 

2012

 

2011

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Revenues

 

$

40,971,734

 

$

43,013,930

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

 

 

 

Cost of goods sold

 

39,987,071

 

41,199,270

 

Lower of cost or market adjustment

 

 

1,125,780

 

Total Cost of Goods Sold

 

39,987,071

 

42,325,050

 

 

 

 

 

 

 

Gross Profit

 

984,663

 

688,880

 

 

 

 

 

 

 

Selling, General, and Administrative Expenses

 

714,906

 

871,355

 

 

 

 

 

 

 

Operating Income (Loss)

 

269,757

 

(182,475

)

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

Interest income

 

2,441

 

6,530

 

Interest expense

 

(653,663

)

(567,529

)

Other income

 

2,182

 

737

 

Total other expense, net

 

(649,040

)

(560,262

)

 

 

 

 

 

 

Net Loss

 

(379,283

)

(742,737

)

 

 

 

 

 

 

Net Income Attributable to Noncontrolling Interest

 

(87,289

)

17,847

 

 

 

 

 

 

 

Net Loss Attributable to Heron Lake BioEnergy, LLC

 

$

(466,572

)

$

(724,890

)

 

 

 

 

 

 

Net Loss Per Unit - Basic and Diluted

 

$

(0.01

)

$

(0.02

)

 

 

 

 

 

 

Weighted Average Units Outstanding - Basic and Diluted

 

38,622,107

 

35,838,509

 

 

See Notes to Condensed Consolidated Financial Statements

 

3



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Condensed Consolidated Statements of Operations

 

 

 

Nine Months
Ended July 31,

 

Nine Months
Ended July 31,

 

 

 

2012

 

2011

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Revenues

 

$

121,019,764

 

$

120,235,922

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

 

 

 

Cost of goods sold

 

118,668,185

 

112,888,521

 

Lower of cost or market adjustment

 

 

1,591,810

 

Total Cost of Goods Sold

 

118,668,185

 

114,480,331

 

 

 

 

 

 

 

Gross Profit

 

2,351,579

 

5,755,591

 

 

 

 

 

 

 

Selling, General, and Administrative Expenses

 

2,428,646

 

2,335,890

 

 

 

 

 

 

 

Settlement Expense

 

900,000

 

 

 

 

 

 

 

 

Operating Income (Loss)

 

(977,067

)

3,419,701

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

Interest income

 

9,299

 

32,076

 

Interest expense

 

(1,943,578

)

(2,109,462

)

Other income, net

 

34,136

 

30,545

 

Total other expense, net

 

(1,900,143

)

(2,046,841

)

 

 

 

 

 

 

Net Income (Loss)

 

(2,877,210

)

1,372,860

 

 

 

 

 

 

 

Net (Income) Loss Attributable to Noncontrolling Interest

 

(258,520

)

17,847

 

 

 

 

 

 

 

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

 

$

(3,135,730

)

$

1,390,707

 

 

 

 

 

 

 

Net Income (Loss) Per Unit - Basic and Diluted

 

$

(0.08

)

$

0.04

 

 

 

 

 

 

 

Weighted Average Units Outstanding - Basic and Diluted

 

38,472,447

 

32,105,510

 

 

See Notes to Condensed Consolidated Financial Statements

 

4



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Condensed Consolidated Statements of Cash Flows

 

 

 

Nine Months
Ended July 31,

 

Nine Months
Ended July 31,

 

 

 

2012

 

2011

 

 

 

(Unaudited)

 

(Unaudited)

 

Operating Activities

 

 

 

 

 

Net income (loss)

 

$

(2,877,210

)

$

1,372,860

 

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

 

 

 

 

 

Depreciation and amortization

 

4,277,887

 

4,118,312

 

Lower of cost or market adjustments

 

 

1,591,810

 

Change in fair value of derivative instruments

 

 

2,200

 

Change in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

16,000

 

(369,255

)

Accounts receivable

 

1,073,736

 

(1,494,116

)

Inventory

 

983,514

 

1,017,717

 

Derivative instruments

 

 

(153,838

)

Prepaid expenses and other assets

 

223,489

 

(271,953

)

Accounts payable

 

(2,010,782

)

(1,058,350

)

Accrued expenses

 

(38,260

)

(485,219

)

Accrued loss on forward contracts

 

 

(1,193,654

)

Net cash provided by operating activities

 

1,648,374

 

3,076,514

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Capital expenditures

 

(2,444,010

)

(2,578,383

)

Net cash used in investing activities

 

(2,444,010

)

(2,578,383

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Checks written in excess of bank balance

 

 

(913,492

)

Proceeds from line of credit, net

 

 

2,500,000

 

Payments of long-term debt

 

(5,550,360

)

(2,880,708

)

Release of restricted cash

 

257,630

 

251,049

 

Member contributions

 

707,017

 

3,500,000

 

Cost of raising capital

 

(3,169

)

 

 

Distributions to Noncontrolling Interest

 

(72,928

)

 

Noncontrolling interest investment

 

 

1,000

 

Net cash provided by (used) in financing activities

 

(4,661,810

)

2,457,849

 

 

 

 

 

 

 

Net increase (decrease) in cash and equivalents

 

(5,457,446

)

2,955,980

 

 

 

 

 

 

 

Cash and Equivalents — Beginning of Period

 

7,140,573

 

1,523,318

 

 

 

 

 

 

 

Cash and Equivalents — End of Period

 

$

1,683,127

 

$

4,479,298

 

Supplemental Cash Flow Information

 

 

 

 

 

Total interest paid

 

$

1,933,499

 

$

2,594,217

 

 

 

 

 

 

 

Cost of raising capital offset against member contributions

 

$

165,045

 

$

 

 

 

 

 

 

 

Capital expenditures financed with note payable

 

$

1,325,000

 

$

 

 

 

 

 

 

 

Energy efficiency rebate receivable

 

$

554,577

 

$

 

 

 

 

 

 

 

Distribution to noncontrolling interest in accrued expenses

 

$

11,807

 

$

 

 

Notes to Condensed Consolidated Financial Statements are an integral part of these Statements.

 

5



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

1.                                      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited condensed consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. These financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended October 31, 2011, contained in the Company’s annual report on Form 10-K.

 

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

 

Nature of Business

 

The Company owns and operates a 50 million gallon ethanol plant near Heron Lake, Minnesota.  In addition, the Company produces and sells distillers grains with solubles and corn oil as co-products of ethanol production.

 

Principles of Consolidation

 

The financial statements include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiaries, Lakefield Farmers Elevator, LLC and HLBE Pipeline Company, LLC, collectively, the “Company.”  HLBE Pipeline Company, LLC owns 73% of Agrinatural Gas, LLC (“Agrinatural”).  The remaining 27% is included in the consolidated financial statements as a noncontrolling interest.  All significant intercompany balances and transactions are eliminated in consolidation.

 

Noncontrolling Interest

 

Amounts recorded as noncontrolling interest on the balance sheet 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. Agrinatural will provide natural gas to the plant with a specified price per MMBTU for an initial term of 10 years, with two renewal options for five year periods.

 

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 including, among others, the analysis of impairment of long-lived assets, and valuation of forward purchase contract commitments and inventory.  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.

 

6



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

Long-Lived Assets

 

The Company reviews property, plant and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the assets; and current expectation that the asset will more likely than not be sold or disposed significantly before the end of its estimated useful life.  If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

 

The Company’s ethanol production plant has a stated capacity of 50 million gallons per year.  The carrying value of the Company’s facilities at July 31, 2012 and October 31, 2011 was approximately $86.2 million and $88.6 million, respectively. In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, management has evaluated the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. Management has determined that the projected future undiscounted cash flows from operations of these facilities exceed their carrying value at July 31, 2012 and October 31, 2011; therefore, no impairment loss was indicated or recognized. In determining the projected future undiscounted cash flows, the Company has made significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity.  Given the uncertainties in the ethanol industry, should management be required to adjust the carrying value of the facilities at some future point in time, the adjustment could be significant and could significantly impact the Company’s financial position and results of operations.  No adjustment has been made to these financial statements for this uncertainty.

 

Fair Value of Financial Instruments

 

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 periods ended July 31, 2012 or October 31, 2011 that required adjustment to the recognized balances of assets or liabilities, which are recorded at fair value on a nonrecurring basis.

 

The carrying value of cash and equivalents, restricted certificates of deposit, marketable securities, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short maturity of these instruments. The fair value of long-term 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 fair value of a company’s debt is a measure of its current value under present market conditions. It does not impact the financial statements under current accounting rules. The Company believes the carrying amount of the revolving term loan and line of credit approximates the fair value.

 

The Company estimates the fair value of debt based on the difference between the market interest rate and the stated interest rate of the debt.  The carrying amount and the fair value of long-term debt are as follows:

 

 

 

Carrying Amount

 

Fair Value

 

 

 

 

 

 

 

Long-term debt at July 31, 2012

 

$

45,867,165

 

$

45,867,165

 

Long-term debt at October 31, 2011

 

$

51,417,525

 

$

51,417,525

 

 

7



Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

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 that could result from such events.  Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.

 

2.                                  GOING CONCERN

 

The financial statements have been prepared on a going-concern basis, which contemplates the recoverability of assets and the satisfaction of liabilities in the normal course of business.  The Company has previously disclosed losses related to operations related to difficult market conditions and operating performance.  The Company has had instances of unwaived debt covenant violations and had been operating under forbearance agreements with AgStar Financial Services, PCA (“AgStar”) and anticipate that we may violate covenants within the next year.  In addition, the Company’s working capital was at a lower level than desired.  These conditions contributed to the long-term debt with AgStar being classified as current in previously filed financial statements.  These factors and the continued volatile commodity prices raise substantial doubt about the Company’s ability to continue as a going concern.

 

The Company has continued to make changes to operations of the plant, renegotiated with AgStar, and enhanced working capital.  To this end, the Company began converting the plant from a coal-fired ethanol plant to a natural gas plant in October 2011.  This conversion was completed in November 2011.  The Company believes the conversion will reduce production and operating costs, reduce interest costs, and improve operating profitability.  In May 2011, the Company raised an additional $3.5 million from Project Viking, LLC (“Project Viking”) to help finance the natural gas conversion and to improve working capital.  The Company closed on approximately $707,000 of additional equity from existing members in November 2011.

 

In September 2011, the Company entered into a restructured loan agreement with AgStar that superseded and replaced past loan agreements with AgStar including the forbearance agreements.  This restructured loan agreement extends the maturity date of the Company’s long-term debt, maintains and extends the existing available balance on the revolving portion of the long-term debt, and allowed the Company to reclassify the debt to long-term.  As part of this restructured loan agreement, the Company repaid the revolving line of credit with AgStar in September 2011.  The repayment of the revolving line of credit was done as part of the change in ethanol and distillers marketers to Gavilon, LLC (“Gavilon”) in September 2011.  In addition to assuming responsibility for marketing the ethanol and distillers products for the Company, Gavilon assists the Company with certain risk management activities.

 

While the Company believes these changes will improve the operating performance of the plant, provide additional working capital, and reduce the effects on our plant of volatility in the industry, it is not yet certain as to whether these efforts and changes will be successful.

 

3.                                  UNCERTAINTIES

 

The Company has certain risks and uncertainties that it experienced during volatile market conditions such as what the Company experienced during fiscal year 2011 and the first three quarters of fiscal year 2012.  These volatilities can have a severe impact on operations. The Company’s revenues are derived from the sale and distribution of ethanol and distillers grains 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 75% - 85% of cost of goods sold.

 

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Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol and the net expense of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, 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.

 

4.                                      FAIR VALUE MEASUREMENTS

 

The fair value of derivative instruments is based on quoted market prices in active markets.  The Company had no assets or liabilities measured at fair value on a recurring or nonrecurring basis at July 31, 2012 and October 31, 2011.

 

5.                                      CONCENTRATIONS

 

The Company sells all of the ethanol and dry distiller grains produced to one customer under marketing agreements at July 31, 2012.

 

6.                                      INVENTORY

 

Inventory consisted of the following at July 31, 2012 and October 31, 2011:

 

 

 

July 31,

 

October 31,

 

 

 

2012

 

2011 *

 

Raw materials

 

$

520,629

 

$

593,761

 

Work in process

 

1,342,337

 

978,967

 

Supplies

 

834,277

 

840,756

 

Other grains

 

83,859

 

1,351,132

 

Total

 

$

2,781,102

 

$

3,764,616

 

 


*    Derived from audited financial statements

 

The Company recorded no losses related to inventory for the three and nine months ended July 31, 2012.  The Company recorded losses of approximately $15,000 for both the three and nine months ended July 31, 2011.  For the three and nine months ended July 31, 2011, the Company recorded losses related to forward purchase contracts, where the market value was less than the cost basis, attributable primarily to decreases in market prices of corn and ethanol, the loss was recorded with the lower of cost or market adjustment in the statement of operations. In addition, the Company stored grain inventory for farmers.  The value of these inventories owned by others is approximately $13,000 and $105,000 based on market prices at July 31, 2012 and October 31, 2011, respectively, and is not included in the amounts above.

 

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Table of Contents

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

7.                                      DERIVATIVE INSTRUMENTS

 

As of July 31, 2012, the Company has no derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the Condensed Consolidated Balance Sheet. 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 and when the Company formally documents, designates, and assesses the effectiveness of transactions that receive hedge accounting initially and on an on-going basis. The Company must designate the hedging instruments based upon the exposure being hedged as a fair value hedge or a cash flow hedge. The Company does not enter into derivative transactions for trading purposes.

 

The Company, from time to time, 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 and natural gas 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.  The Company had no derivative instruments as of July 31, 2012 and October 31, 2011.

 

The following tables provide details regarding the gains (losses) from the Company’s derivative instruments included in the Condensed Consolidated Statements of Operations, none of which are designated as hedging instruments:

 

 

 

Statement of

 

Three-Months Ended July 31,

 

 

 

Operations location

 

2012

 

2011

 

Corn contracts

 

Cost of goods sold

 

$

862,000

 

$

(448,000

)

 

 

 

 

 

 

 

 

Ethanol contracts

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Natural gas contracts

 

Cost of goods sold

 

119,000

 

 

Totals

 

 

 

$

981,000

 

$

(448,000

)

 

 

 

Statement of

 

Nine-Months Ended July 31,

 

 

 

Operations location

 

2012

 

2011

 

Corn contracts

 

Cost of goods sold

 

$

1,088,000

 

$

256,000

 

 

 

 

 

 

 

 

 

Ethanol contracts

 

Revenues

 

 

(24,000

)

 

 

 

 

 

 

 

 

Natural gas contracts

 

Cost of goods sold

 

(446,000

)

 

Totals

 

 

 

$

642,000

 

$

232,000

 

 

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

8.                                      DEBT FINANCING

 

Debt financing consists of the following:

 

 

 

July 31,

 

October 31,

 

 

 

2012

 

2011*

 

Term note payable to lending institution, see terms below

 

$

37,423,535

 

$

39,747,497

 

 

 

 

 

 

 

Revolving term note to lending institution, see terms below

 

2,764,561

 

6,864,561

 

 

 

 

 

 

 

Assessments payable

 

3,040,501

 

3,170,517

 

 

 

 

 

 

 

Notes payable to electrical company

 

564,325

 

883,340

 

 

 

 

 

 

 

Equipment note

 

 

13,860

 

 

 

 

 

 

 

Equipment note, see terms below

 

1,176,514

 

 

 

 

 

 

 

 

Construction note payable

 

897,729

 

737,750

 

 

 

 

 

 

 

Total

 

45,867,165

 

51,417,525

 

 

 

 

 

 

 

Less amounts due on demand or within one year

 

4,531,844

 

4,572,613

 

 

 

 

 

 

 

Net long term debt

 

$

41,335,321

 

$

46,844,912

 

 


*    Derived from audited financial statements

 

Term Note

 

The Company has a five-year term loan initially amounting to $40,000,000, comprised of two tranches of $20,000,000 each, with the first tranche bearing interest at a variable rate equal to the greater of LIBOR plus 3.50% or 5.0%, and the second tranche bearing interest at 5.75%.  The Company must make equal monthly payments of principal and interest on the term loan based on a ten-year amortization, provided the entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on the maturity date of September 1, 2016.  In addition, the Company is required to make additional payments annually on debt for up to 25% of the excess cash flow, as defined by the agreement, up to $2 million per year.  As part of the agreement, the premium above LIBOR on the loans may be reduced based on a financial ratio.  The loan agreements are secured by substantially all business assets and are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements.  The Company was in compliance with the covenants of its master loan agreement with AgStar at July 31, 2012.  We anticipate that one or more of our covenants under the master loan agreement with AgStar will not be met during fiscal year 2012, without an amendment to the covenants, improved financial performance, or the addition of significant working capital.

 

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

Revolving Term Note

 

The Company has obtained a five-year term revolving loan commitment in the amount of $8,008,689 until September 1, 2016.  Amounts borrowed by the Company under the term revolving loan and repaid or prepaid may be re-borrowed at any time prior to maturity date of the term revolving loan, provided that outstanding advances may not exceed the amount of the term revolving loan commitment.  Amounts outstanding on the term revolving loan bear interest at a variable rate equal to the greater of a LIBOR rate plus 3.50% or 5.0%, payable monthly.  The Company also pays an unused commitment fee on the unused portion of the term revolving loan commitment at the rate of 0.35% per annum, payable in arrears in quarterly installments during the term of the term revolving loan.  Under the terms of the agreement, the term revolving loan commitment is scheduled to decline by $500,000 annually, beginning on September 1, 2012 and each anniversary date thereafter.  The maturity date of the term revolving loan is September 1, 2016.  The Company has a $600,000 outstanding standby letter of credit at July 31, 2012, which reduces the amounts available.

 

Construction Note Payable

 

The Company has a construction note payable to a financial institution, through its ownership in Agrinatural, in the amount of $1,000,000. This note was converted to a three year term loan in March 2012 with monthly payment of approximately $30,000 including interest at 5.29% until maturity in April 2015.  The note is secured by assets of Agrinatural.

 

Equipment Note Payable

 

The Company has a note payable from a vendor related its recent addition of corn oil separation equipment in the amount of $1,325,000. The Company pays approximately $40,000 per month conditioned upon revenue generated from the corn oil equipment as noted in the agreement.  The monthly payment includes implicit interest of 5.57% until maturity in May 2015. The note is secured by the equipment.

 

Estimated maturities of long-term debt at July 31, 2012 are as follows based on the most recent debt agreement:

 

2012

 

$

4,531,844

 

2013

 

4,494,854

 

2014

 

5,035,405

 

2015

 

4,715,634

 

2016

 

25,480,478

 

After 2016

 

1,608,950

 

 

 

 

 

Total long-term debt

 

$

45,867,165

 

 

9.                                      LEASES

 

The Company leases equipment, primarily rail cars, under operating leases through 2017.  Rent expense for the nine months ended July 31, 2012 and 2011 was approximately $1,600,000 and $1,400,000, respectively.

 

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

At July 31, 2012, the Company had the following minimum future lease payments, which at inception had non-cancelable terms of more than one year:

 

2012

 

$

1,589,842

 

2013

 

1,412,842

 

2014

 

847,014

 

2015

 

833,140

 

2016

 

831,600

 

Thereafter

 

69,300

 

 

 

 

 

Total lease commitments

 

$

5,583,738

 

 

10.                               COMMITMENTS AND CONTINGENCIES

 

Legal Proceedings

 

Permit Matters

 

The Company completed the conversion to natural gas from coal in November 2011.  The Company also completed an amendment to the existing air emissions permit allowing the conversion from coal to natural gas. The Company is now seeking the final amendments to its air emissions permit related to the natural gas conversion pending regulatory approvals in form acceptable to the Company, and may incur additional costs in connection with the permit amendment, as well as improvements to its plant as part of the natural gas conversion and to ensure compliance with its permit and planned amendments.

 

On December 16, 2010, the Company entered into a stipulation agreement with the Minnesota Pollution Control Agency (“MPCA”) to resolve a notice of violation issued by the MPCA in March 2008 that alleged violations of certain rules, statutes, and permit conditions, including emission violations and reporting violations.  Under the stipulation agreement, the Company agreed to pay a civil penalty and complete other corrective actions.  On April 12, 2012, the Company received a letter from the MPCA acknowledging that the Company had completed all the corrective action requirements described in the stipulation agreement and the stipulation agreement was therefore terminated effective as of the date of the letter.

 

Coal Contract Termination Dispute and Settlement

 

Following conversion by the Company from coal to natural gas as its primary fuel, and specifically in late October 2011, the Company received correspondence from its coal supplier, Cloud Peak Energy Logistics LLC, formerly known as Northern Coal Transportation Company (“Cloud Peak”), claiming that there was a “shortfall” in the Company’s coal purchases.

 

On April 30, 2012, after a series of negotiations, the Company and Cloud Peak entered into a Confidential Settlement Agreement and Mutual Release (“Settlement Agreement”) to resolve all claims related to the coal contract dispute.  Under the terms of the Settlement Agreement, the Company made a one-time cash payment to Cloud Peak in the amount of $900,000 (the “Settlement Payment”), which was received by Cloud Peak on May 2, 2012.  The Settlement Agreement also contained a 91-day delay period beginning on May 2, 2012 and ending on August 1, 2012 (the “Delay Period”).  If neither the Company or Cloud Peak filed a voluntary petition in bankruptcy or has an involuntary bankruptcy petition filed against it during the Delay Period, the Master Coal Purchase and Sales Agreement between the parties would be terminated effective as of August 1, 2012 and both parties would file an appropriate dismissal with prejudice of the pending legal actions related to the dispute within five business days following expiration of the Delay Period.  There was no bankruptcy event during the Delay Period.  Accordingly, the Company and Cloud Peak filed a joint stipulation of dismissal with prejudice with the respective courts and the respective courts have issued an order of dismissal.

 

In general, the parties agreed that the terms and conditions of the Settlement Agreement are confidential, subject to public reporting company obligations and applicable accounting rules and principles.  Accordingly, no party (including board members, officers or other representatives of the parties with knowledge of the terms of the Settlement Agreement) is permitted to discuss or otherwise disclose such confidential information, except as required by law or pursuant to such public reporting company obligations and applicable accounting rules and principles.

 

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

July 31, 2012 (Unaudited)

 

Forward Contracts

 

The Company has natural gas agreements with a minimum commitment of approximately 1.9 million MMBTU per year until October 31, 2014.

 

11.                               MEMBERS’ EQUITY

 

On August 30, 2011, the Company commenced a subscription rights offering to holders of its Class A units who are residents of the State of Minnesota for an aggregate of 16,500,000 Class A units at a purchase price of $0.50 per unit.  No eligible Class A unit holder could purchase more than 77.73% of the Units currently held by such unit holder as of August 30, 2011.  In addition, purchasers of units were required to deposit $.125 per unit into an escrow account that was to be held to guarantee a portion of the debt of Agrinatural.  Amounts collected related to this guarantee were subsequently returned.  The offering period expired on October 15, 2011.  The Company closed on the offering in November 2011 having sold 1,414,033 Class A units for approximately $707,000.

 

12.                               RELATED PARTY TRANSACTIONS

 

The Company did not purchase any corn directly from members during the three and nine months ended July 31, 2012.  The Company’s purchases of corn from members totaled approximately $22.7 and $47.5 million during the three and nine months ended July 31, 2011.

 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains, in addition to historical information, forward-looking statements that are based on our expectations, beliefs, intentions or future strategies. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements because of certain factors, including those set forth under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended October 31, 2011, as well as in other filings we make with the Securities and Exchange Commission. All forward-looking statements included herein are based on information available to us as of the date hereof, and we undertake no obligation to update any such forward-looking statements.

 

The following is a discussion and analysis of Heron Lake BioEnergy’s financial condition and results of operations as of and for the three month and nine month periods ended July 31, 2012 and 2011. This section should be read in conjunction with the condensed consolidated financial statements and related notes in Item 1 of this report and the Company’s Annual Report on Form 10-K for the year ended October 31, 2011.

 

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 nine months ended July 31, 2012.

 

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. The plant has a stated capacity to produce 50 million gallons of denatured fuel grade ethanol and 160,000 tons of dried distillers’ grains (DDGS) per year. Our revenues are derived from the sale and distribution of our ethanol throughout the continental United States and in the sale and distribution of our distillers’ grains (DGS) locally, and throughout the continental United States. Our subsidiary, Lakefield Farmers Elevator, LLC, has grain facilities at Lakefield and Wilder, Minnesota.  Our subsidiary, HLBE Pipeline Company, LLC, owns 73% of Agrinatural Gas, LLC, the pipeline company formed to construct, own, and operate a natural gas pipeline that provides natural gas to the Company’s ethanol production facility through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota.

 

Our operating results are largely driven by the prices at which we sell ethanol and distillers grains and the costs related to their production, particularly the cost of corn. Historically, the price of ethanol tended to fluctuate in the same direction as the price of unleaded gasoline and other petroleum products. However, during fiscal 2011 and continuing into fiscal 2012, ethanol prices tended to move up and down proportionately with changes in corn prices. The price of ethanol can also be influenced by factors such as general economic conditions, concerns over blending capacities, and government policies and programs. The price of distillers grains is generally influenced by supply and demand, the price of substitute livestock feed, such as corn and soybean meal, and other animal feed proteins. Our largest component of and cost of production is corn. The cost of corn is affected primarily by factors over which we lack any control such as crop production, carryout, exports, government policies and programs, and weather. The growth of the ethanol industry has increased the demand for corn. We believe that continuing increases in global demand combined with a decreased supply due to drought conditions throughout most of the United States, will result in corn prices above historic averages.  During the third quarter of fiscal year 2012 ended July 31, 2012, the price of ethanol on the Chicago Board of Trade fluctuated from $1.97 to $2.76 per gallon; our average sales price was $2.12 per gallon, with basis.  During the same period, the price of corn on the Chicago Board of Trade fluctuated from a low of $5.51 to a high of $8.28 per bushel; our average purchase price was $6.81 per bushel, with basis.

 

Trends and Uncertainties Impacting Our Operations

 

Our current and future results of operation are affected and will continue to be affected by factors such as (a) volatile and uncertain pricing of ethanol and corn; (b) availability of corn that is, in turn, affected by trends such as corn acreage, weather conditions, and yields on existing and new acreage diverted from other crops; and (c) the supply and demand for ethanol, which is affected by acceptance of ethanol as a substitute for fuel, public perception of the ethanol industry, government incentives and regulation, and competition from new and existing construction, among other things. Other factors that may affect our future results of operation include those factors discussed in “Item 1. Business” of our Annual Report on Form 10-K for the year ended October 31, 2011 and “Part II, Item 1A Risk Factors” of this Form 10-Q.

 

Critical Accounting Estimates

 

A description of our critical accounting estimates was provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended October 31, 2011. At July 31, 2012, our critical accounting estimates continue to include those described in our Annual Report on Form 10-K. In addition, our analysis of future projections, resolution of debt terms and other assumptions in consideration of continuing as a going concern include critical accounting estimates.

 

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Table of Contents

 

Results of Operations for the Three Months Ended July 31, 2012 and 2011

 

The following table shows summary information from our Condensed Consolidated Statements of Operations for the three months ended July 31, 2012 and 2011.

 

 

 

Three Months Ended
July 31, 2012

 

Three Months Ended
July 31, 2011

 

Income Statement Data

 

Amount

 

%

 

Amount

 

%

 

Revenues

 

$

40,971,734

 

100.0

 

$

43,013,930

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

39,987,071

 

97.6

 

41,199,270

 

95.8

 

Lower of cost or market adjustment

 

 

0.0

 

1,125,780

 

2.6

 

Total Cost of Goods Sold

 

39,987,071

 

97.6

 

42,325,050

 

98.4

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

984,663

 

2.4

 

688,880

 

1.6

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

(714,906

)

(1.7

)

(871,355

)

(2.0

)

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss)

 

269,757

 

0.7

 

(182,475

)

(0.4

)

 

 

 

 

 

 

 

 

 

 

Other Expense, net

 

(649,040

)

(1.6

)

(560,262

)

(1.3

)

 

 

 

 

 

 

 

 

 

 

Net Loss

 

(379,283

)

(0.9

)

(742,737

)

(1.7

)

 

 

 

 

 

 

 

 

 

 

Net Income Attributable to Noncontrolling Interest

 

(87,289

)

(0.2

)

17,847

 

0.0

 

 

 

 

 

 

 

 

 

 

 

Net Loss Attributable to Heron Lake BioEnergy, LLC

 

$

(466,572

)

(1.1

)

$

(724,890

)

(1.7

)

 

Revenues

 

Revenues decreased 5% for the quarter ended July 31, 2012 as compared to the quarter ended July 31, 2011. Net ethanol revenues during the quarter ended July 31, 2012, were approximately $31.0 million, representing 76% of our sales, compared to approximately $35.3 million during the quarter ended July 31, 2011, representing approximately 82% of our sales. The decrease in ethanol revenue was primarily a result of an 18% decrease in the average price per gallon sold in the quarter ended July 31, 2012, as compared to the quarter ended July 31, 2011, which more than offset the 7% increase in the gallons of ethanol sold during the quarter ended July 31, 2012.  There were no ethanol derivative gains or losses during the quarters ended July 31, 2012 and 2011.

 

Total sales of DGS during the quarter ended July 31, 2012 were approximately $8.1 million comprising 20% of our revenues. DGS sales during the quarter ended July 31, 2011 were $6.8 million or 16% of revenues. The average DGS price increased 19% for the quarter ended July 31, 2012 as compared to the quarter ended July 31, 2011.  The remaining percentage of revenues is made up of incidental other sales.

 

Cost of Goods Sold

 

Our costs of sales include, among other things, the cost of corn used in ethanol and DGS production (which is the largest component of costs of sales); coal and natural gas, processing ingredients, electricity, and wages, salaries and benefits of production personnel. We use approximately 1.5 million bushels of corn per month at the plant.

 

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Table of Contents

 

The per bushel cost of corn, including lower of cost or market adjustments, decreased approximately 5% in the quarter ended July 31, 2012 as compared to the quarter ended July 31, 2011.  Cost of goods sold includes lower of cost or market adjustments of approximately $1,126,000 for the three months ended July 31, 2011, which related to forward purchase contracts where the fixed price was more than the estimated realizable value.  We had a gain related to corn derivative instruments of approximately $862,000 and a loss of approximately $448,000 for the quarters ended July 31, 2012 and 2011, respectively.  We had a gain related to natural gas derivative instruments of approximately $119,000 for the quarter ended July 31, 2012.  We had a decreased gross margin in the third quarter of fiscal 2012 as compared to third quarter of fiscal 2011 due primarily to the increased corn derivative gains in 2012 and the lower of cost or market adjustments incurred in 2011.

 

The cost of corn fluctuates based on supply and demand, which, in turn, is affected by a number of factors which are beyond our control. We expect our gross margin to fluctuate in the future based on the relative prices of corn and fuel ethanol. We may use futures and option contracts to minimize our exposure to movements in corn prices, but there is no assurance that these hedging strategies will be effective. During the quarter ended July 31, 2012, none of our contracts were designated as hedges and, as a result, changes to the market value of these contracts were recognized as a gain or loss. As a result, gains or losses on derivative instruments do not necessarily coincide with the related commodity purchases. This may cause fluctuations in our statement of operations. While we do not use hedge accounting to match gains or losses on derivative instruments, we believe the derivative instruments provide an economic hedge.

 

Operating Expenses

 

Operating expenses consist of selling, general and administrative expense and include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs. These expenses generally do not vary with the level of production at the plant.

 

Other Expense, Net

 

Other expenses consisted primarily of interest expense. Interest expense consists primarily of interest payments on our credit facilities described below. Interest expense, which was up approximately 15% for the three months ended July 31, 2012 as compared to the three months ended July 31, 2011, is dependent on the balances outstanding and on interest rates.  The interest rate on loans with AgStar were higher in 2012 than in 2011 after the changes made in September 2011.

 

Results of Operations for the Nine Months Ended July 31, 2012 and 2011

 

The following table shows summary information from our Statement of Operations for the nine months ended July 31, 2012 and 2011.

 

 

 

Nine Months Ended
July 31, 2012

 

Nine Months Ended
July 31, 2011

 

Income Statement Data

 

Amount

 

%

 

Amount

 

%

 

Revenues

 

$

121,019,764

 

100.0

 

$

120,235,922

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

118,668,185

 

98.1

 

112,888,521

 

93.9

 

Lower of cost or market adjustment

 

 

0.0

 

1,591,810

 

1.3

 

Total Cost of Goods Sold

 

118,668,185

 

98.1

 

114,480,331

 

95.2

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

2,351,579

 

1.9

 

5,755,591

 

4.8

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

(2,428,646

)

(2.0

)

(2,335,890

)

(1.9

)

 

 

 

 

 

 

 

 

 

 

Settlement Expense

 

(900,000

)

(0.7

)

 

0.0

 

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss)

 

(977,067

)

(0.8

)

3,419,701

 

2.9

 

 

 

 

 

 

 

 

 

 

 

Other Expense, net

 

(1,900,143

)

(1.6

)

(2,046,841

)

(1.7

)

 

 

 

 

 

 

 

 

 

 

Net Income (Loss)

 

(2,877,210

)

(2.4

)

1,372,860

 

1.2

 

 

 

 

 

 

 

 

 

 

 

Net Income Attributable to Noncontrolling Interest

 

(258,520

)

(0.2

)

17,847

 

0.0

 

 

 

 

 

 

 

 

 

 

 

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

 

$

(3,135,730

)

(2.6

)

$

1,390,707

 

1.2

 

 

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Table of Contents

 

Revenues

 

Revenues increased 1% for the nine months ended July 31, 2012 as compared to the nine months ended July 31, 2011. Net ethanol revenues during the nine months ended July 31, 2012 were approximately $94.1 million, representing 78% of our sales, compared to approximately $98.1 million during the nine months ended July 31, 2011, representing 82% of our sales. The decrease in ethanol revenue was a result of a 10% decrease in the average price per gallon of ethanol period to period, which was not offset enough by a 7% increase in the gallons of ethanol sold.  There were no ethanol derivative gains or losses during the nine months ended July 31, 2012.  We had losses of approximately $24,000 related to ethanol derivatives for the nine months ended July 31, 2011.

 

Total sales of DGS during the nine months ended July 31, 2012 were approximately $22.3 million comprising 18% of our sales. DGS sales during the nine months ended July 31, 2011 were $18.2 million or 15% of sales. The average DGS price increased 17% for the nine months ended July 31, 2012 as compared to the nine months ended July 31, 2011. DDGS tonnage sales increased by 4% for the nine months ended July 31, 2012 as compared to the nine months ended July 31, 2011 due to a decrease in modified DGS produced.  The remaining percent of revenues is made up of incidental sales.

 

Cost of Goods Sold

 

Our costs of goods sold includes, among other things, the cost of corn used in ethanol and DGS production (which is the largest component of costs of sales); coal, processing ingredients, electricity, and wages, salaries and benefits of production personnel. We use approximately 1.5 million bushels of corn per month at the plant. We contract with local farmers and elevators for our corn supply.

 

Our cost of goods sold (including lower of cost or market adjustments) as a percentage of revenues were 98.1% and 95.2% for the nine months ended July 31, 2012 and July 31, 2011, respectively. The per bushel cost of corn, including lower of cost or market adjustments, increased approximately 4% in the nine months ended July 31, 2012 as compared to the nine months ended July 31, 2011. This increase caused the increase in the cost of goods sold as a percent of revenues. Cost of goods sold also includes lower of cost or market adjustments of approximately $1,592,000 for the nine months ended July 31, 2011, which related to forward purchase contracts and inventory where the fixed price was more than the estimated realizable value.  We had a gains related to corn derivative instruments of approximately $1,088,000 and $256,000 for the nine months ended July 31, 2012 and 2011, respectively. We had losses related to natural gas derivative instruments of approximately $446,000 for the nine months ended July 31, 2012.  Our gross profit margin for the nine months ended July 31, 2012 decreased to 1.9% from 4.8% for the nine months ended July 31, 2011. We had a lower gross margin in the first three quarters of fiscal 2012 as compared to the first three quarters of fiscal 2011 because the 10% decrease in ethanol prices along with the 4% increase in cost of corn, including lower of cost or market adjustments.

 

The cost of corn fluctuates based on supply and demand, which, in turn, is affected by a number of factors which are beyond our control. We expect our gross margin to fluctuate in the future based on the relative prices of corn and fuel ethanol. We use futures and option contracts to minimize our exposure to movements in corn and ethanol prices, but there is no assurance that these hedging strategies will be effective. During the nine months ended July 31, 2012, none of our contracts were designated as hedges and, as a result, changes to the market value of these contracts were recognized as an increase or decrease to our revenue and costs of goods sold. As a result, gains or losses on derivative instruments do not necessarily coincide with the related corn purchases. This may cause fluctuations in our statement of operations. While we do not use hedge accounting to match gains or losses on derivative instruments, we believe the derivative instruments provide an economic hedge.

 

Operating Expenses

 

Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs. These expenses represented 2.7% of total revenues for the nine months ended July 31, 2012 and 1.9% of total revenues for the nine months ended July 31, 2011.  These expenses generally do not vary with the level of production at the plant.  The increase in the current period included additional costs related to settlement of our coal contract dispute of approximately $900,000.

 

The conversion of the plant to a natural gas fired plant is believed to produce cost savings and improved efficiencies for the Company in a number of ways.  We believe the operating costs of a coal fired plant are higher than a natural gas fired plant for items such as chemical costs and supplies, repairs and maintenance, and permitting costs.  We experienced more down time related to maintenance work that we believe will be reduced by using natural gas.  While coal power provided a cost advantage when we initially made the decision to build the plant, we believe current low natural gas prices will provide a more competitive fuel source in the future and will provide operating efficiencies and cost savings going forward.

 

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Other Expense, Net

 

Other expenses consisted primarily of interest expense. Interest expense consists primarily of interest payments on our credit facilities described below. Interest expense, which was down for the nine months ended July 31, 2012 approximately 8% as compared to the nine months ended July 31, 2011, is dependent on the balances outstanding and on interest rate fluctuations.  For the nine months ended July 31, 2012, debt balances were down approximately 12% as compared to the nine months ended July 31, 2011.  The decrease was offset by increased interest rates on AgStar loans after changes made in September 2011.

 

Liquidity and Capital Resources

 

As of July 31, 2012, we had cash and cash equivalents (other than restricted cash) of approximately $1.7 million, current assets of approximately $6.9 million and total assets of approximately $94.1 million.

 

Our principal sources of liquidity consist of cash provided by operations, cash and cash equivalents on hand, and available borrowings under our master loan agreement with AgStar. Under the master loan agreement, we have two forms of debt: a term note and a revolving term note.  The total indebtedness to AgStar at July 31, 2012 was $40.2 million, consisting of $37.4 million under the term note and $2.8 million under the revolving term note.  Our revolving term note allows borrowing up to $8.0 million subject to letters of credit outstanding.  Among other provisions, our master loan agreement contains covenants requiring us to maintain various financial ratios and tangible net worth. It also limits our annual capital expenditures and membership distributions. All of our assets and real property are subject to security interests and mortgages in favor of AgStar as security for the obligations of the master loan agreement.  We were in compliance with the covenants of our master loan agreement with AgStar at July 31, 2012.  We anticipate that one or more of our covenants under the master loan agreement with AgStar will not be met during fiscal year 2012, without an amendment to the covenants, improved financial performance, or the addition of significant working capital.

 

The Company’s failure to comply with the covenants of the master loan agreement would result in an event of default under the master loan agreement, entitling AgStar to accelerate and declare due all amounts outstanding under the master loan agreement.  If AgStar accelerated and declared due all amounts outstanding under the master loan agreement, the Company would not have adequate cash to repay the amounts due, resulting in a loss of control of our business or bankruptcy.

 

We raised $3.5 million in equity in fiscal 2011 and approximately another $700,000 in November 2011.  On August 30, 2011, the Company commenced a subscription rights offering to holders of its Class A units who were residents of the State of Minnesota for an aggregate of 16,500,000 Class A units at a purchase price of $0.50 per unit.  No eligible Class A unit holder could purchase more than 77.73% of the Units currently held by such unit holder as of August 30, 2011.  In addition, purchasers of units were also required to deposit $.125 per unit into an escrow account that was held to guarantee any potential debt of Agrinatural, but was subsequently returned after the construction was complete.  The offering period expired on October 15, 2011.  The Company closed on the offering in November 2011 having sold 1,414,033 Class A units for approximately $707,000.  The Company also collected approximately $177,000 related to the debt guarantee of the Agrinatural debt.  The purchase price, percentage limitation and offering period were determined to comply with the terms of the May 2011 Subscription Agreement between the Company and Project Viking.  At that time, Project Viking invested $3.5 million in the Company for 7,000,000 Class B units.  These units sold to Project Viking were subsequently converted to Class A units.  Project Viking agreed to guarantee up to $1 million of Agrinatural’s debt as part of its investment.

 

There is no assurance that our cash, cash generated from operations and, if necessary, available borrowing under our agreement with AgStar, will be sufficient to fund our anticipated capital needs and operating expenses, particularly if the sale of ethanol and DGS does not produce revenues in the amounts currently anticipated or if our operating costs, including specifically the cost of corn, natural gas and other inputs, are greater than anticipated.  Due to current volatility in the ethanol and corn markets, our future profit margins might be tight or not exist at all.

 

Our principal uses of cash are to pay operating expenses of the plant and to make debt service payments on our long-term debt. During the nine months ended July 31, 2012, the Company paid long term debt of approximately $5.6 million as described below.

 

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The following table summarizes our sources and uses of cash and equivalents from our condensed consolidated statements of cash flows for the periods presented:

 

 

 

Nine Months Ended
July 31

 

 

 

2012

 

2011

 

Net cash provided by operating activities

 

$

1,648,374

 

$

3,076,514

 

Net cash used in investing activities

 

(2,444,010

)

(2,578,383

)

Net cash provided by (used) in financing activities

 

(4,661,810

)

2,457,849

 

Net increase (decrease) in cash and equivalents

 

$

(5,457,446

)

$

2,955,980

 

 

During the nine months ended July 31, 2012, we provided approximately $1.7 million in cash from operating activities. This consists primarily of the net loss of $2.3 million plus non-cash expenses including depreciation and amortization of $4.3 million, decreasing inventory by $1.0 million, partially offset by a decrease in accounts payable by $1.9 million.  The additional costs related to settlement of our coal contract dispute of approximately $900,000.

 

During the nine months ended July 31, 2011, we provided $3.1 million in cash from operating activities. This consists primarily of generating net income of $1.4 million plus non-cash expenses including depreciation and amortization of $4.1 million and lower of cost or market adjustments of $1.6 million offset by decreasing accounts payables by $1.1 million and increasing accounts receivable by $1.5 million. The changes in our working capital occurred due to the timing of payments to our vendors for corn, as well as depending on the size and timing of shipments of ethanol and distiller grain as the load out can be sizable.

 

During the nine months ended July 31, 2012, we used approximately $2.4 million for investing activities to pay for capital expenditures.  This consists primarily of costs associated with the conversion of our plant to natural gas and the installation of the natural gas pipeline. During the nine months ended July 31, 2012, we used approximately $4.7 million from financing activities consisting primarily of payments on long-term debt.  We also raised an additional $707,000 of equity.

 

During the nine months ended July 31, 2011, we used approximately $2.6 million for investing activities to pay for capital expenditures.  This consists primarily of costs associated with the conversion of our plant to natural gas and the installation of the natural gas pipeline. During the nine months ended July 31, 2011, we provided $2.5 million from financing activities consisting primarily of proceeds from the sale of the Company’s units of $3.5 million.

 

Outlook

 

Ethanol prices have been very volatile over the past nine months, and we expect to see that continue throughout 2012.  There are many factors that will continue to impact volatility of prices through 2012, including the amount of domestic ethanol production, the amount of ethanol exports and domestic usage, petroleum and gasoline prices, and the development of other alternative fuels.  As of July 27, 2012, the EIA reported that ethanol production for the week was 237.8 million gallons, or a 12.4 billion gallon annualized rate.  Current ethanol inventory stocks are at 815 million gallons.

 

Prices for DGS are also affected by a number of factors beyond our control such as the supply of and demand for DGS as animal feed, prices of competing feeds, and perceptions of nutritional value of DGS as compared to those of competing feeds. We believe that current market prices for DGS can be sustained long-term as long as the prices of competing animal feeds remain steady or increase, livestock feeders continue to create demand for alternative feed sources such as distillers’ grains, and the supply of distillers’ grains remains relatively stable. On the other hand, if competing commodity price values retreat and DGS supplies increase due to growth in the ethanol industry, DGS prices may decline.

 

Corn prices have been volatile for the past year due in part to higher demand from the renewable fuels industry. The expansion of ethanol productive capacity has brought about a substantial increase in demand for corn and thus corn prices.  The volatility is also a result of less than trend line yields in the U.S. the last two years, thus impacting the corn supply.  Due to increased exposure of ethanol, corn is now being viewed as an “energy commodity” as opposed to strictly a “grain commodity,” contributing to the upward pressure on corn prices.  The USDA’s August 10, 2012 Feed Outlook Report projects U.S. corn prices to average between $7.50 and $8.90 per bushel for the 2012-2013 crop year.  They estimated that 96.4 million acres of corn was planted in 2012 with an estimated yield of 123.4 bushels per acre.

 

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Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

We are subject to market risks concerning our debt financing and future prices of corn, natural gas, ethanol and distillers grains.  We consider market risk to be the impact of adverse changes in market prices on our results of operations.  In general, ethanol prices are affected by the supply and demand for ethanol, the cost of ethanol production, the availability of other fuel oxygenates, the regulatory climate and the cost of alternative fuels such as gasoline. The price of corn is affected by weather conditions and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors.  From time to time, we may purchase corn futures and options to hedge a portion of the corn we anticipate we will need. In addition, we may contract for future physical delivery of corn. We are exposed to the full impact of market fluctuations associated with interest rates and commodity prices.

 

We are also subject to market risk on the selling prices of our distillers’ grains. These prices fluctuate seasonally when the price of corn or other cattle feed alternatives fluctuate in price.

 

As an example of our potential sensitivity to price changes, if the price of ethanol rises or falls $0.10 per gallon, our annual revenues may increase or decrease accordingly by approximately $5.0 million, assuming no other changes in our business. Additionally, if the price of corn rises or falls $0.25 per bushel, our annual cost of goods sold may increase or decrease by $5.0 million, again assuming no other changes in our business.  During the third quarter of fiscal year 2012 ended July 31, 2012, the price of ethanol on the Chicago Board of Trade fluctuated from $1.97 to $2.76 per gallon; our average sales price was $2.12 per gallon, with basis.  During the same period, the price of corn on the Chicago Board of Trade fluctuated from a low of $5.51 to a high of $8.28 per bushel; our average purchase price was $6.81 per bushel, with basis.  Our future earnings may be affected by changes in interest rates due to the impact those changes have on our interest expense on borrowings under our credit facilities. As of July 31, 2012, we had $21.5 million of outstanding borrowings with variable interest rates. With each 1% change in interest rates our annual interest expense would change by $215,000.

 

Item 4. Controls and Procedures

 

Effectiveness of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred in the fiscal quarter ended July 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Discussions of legal matters are incorporated by reference from Part I, Item 1, Note 10 “Commitments and Contingencies — Legal Proceedings” of this Form 10-Q, and should be considered an integral part of Part II, Item 1, “Legal Proceedings”.

 

Item 1A. Risk Factors

 

The most significant risk factors applicable to the Company are described in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended October 31, 2011.  In addition to the risk factors previously disclosed in our Annual Report on Form 10-K, the following risks, if they actually occur, could negatively impact our results of operations, cash flows and the value of our units.

 

Risks Related to Our Financial Condition

 

We anticipate that one or more of our covenants under the master loan agreement with AgStar will not be met during fiscal year 2012, without an amendment to the covenants, improved financial performance, or the addition of significant working capital.

 

Under our master loan agreement with AgStar, we have two forms of debt: a term note and a revolving term note.  The total indebtedness to AgStar at July 31, 2012 was $40.2 million, consisting of $37.4 million under the term note and $2.8 million under the revolving term note.  Among other provisions, our master loan agreement contains covenants requiring us to maintain various financial ratios and tangible net worth.  It also limits our annual capital expenditures and membership distributions. All of our assets and real property are subject to security interests and mortgages in favor of AgStar as security for the obligations of the master loan agreement.

 

We were in compliance with the covenants of our master loan agreement with AgStar at July 31, 2012.  We are attempting to improve various aspects of our business in order to avoid any future covenant violations and events of default. There can be no assurance that our business and financial performance will improve, that any improvements will be sustained or that any improvements will result in our compliance with covenants. Further, there is no assurance that we will be able to obtain any additional working capital on terms favorable to us, if at all. Even if we obtain additional capital, the amounts we raise may not be sufficient to avoid future covenant violations and events of default.

 

Our failure to comply with covenants of the master loan agreement would result event of default under the master loan agreement, entitling AgStar to accelerate and declare due all amounts outstanding under the master loan agreement.

 

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

 

On August 30, 2011, the Company commenced a subscription rights offering to holders of its Class A units who are residents of the State of Minnesota for an aggregate of 16,500,000 Class A units at a purchase price of $0.50 per unit.  The offering period expired on October 15, 2011.  The Company closed on the offering in November 2011 having sold 1,414,033 Class A units for approximately $707,000.  Discussion of the subscription rights offering is incorporated by reference from Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” of this Form 10-Q.

 

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

 

The following exhibits are included in this report:

 

Exhibit
No.

 

Exhibit

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act.

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act.

 

 

 

32

 

Certification pursuant to 18 U.S.C. § 1350.

 

 

 

101.1

 

The following materials from Heron Lake BioEnergy’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text.

 

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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.

 

 

HERON LAKE BIOENERGY, LLC

 

 

Date: September 14, 2012

/s/ Robert J. Ferguson

 

Robert J. Ferguson

 

President and Chief Executive Officer

 

(Principal Executive Officer)

 

 

 

 

Date: September 14, 2012

/s/ Lucas G. Schneider

 

Lucas G. Schneider

 

Chief Financial Officer

 

(Principal Accounting and Financial Officer)

 

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