HIGHWATER ETHANOL LLC - FORM 10-Q - September 9, 2013

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EX-32.2 - CERTIFICATION - HIGHWATER ETHANOL LLCa322-certification73113.htm
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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, 2013
 
 
 
OR
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the transition period from               to               .
 
 
 
COMMISSION FILE NUMBER 000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota
 
20-4798531
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
24500 US Highway 14, Lamberton, MN 56152
(Address of principal executive offices)
 
(507) 752-6160
(Registrant's telephone number, including area code)
 
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 September 9, 2013 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
 
July 31, 2013
 
October 31, 2012

 
 (Unaudited)
 

Current Assets
 

 

Cash and equivalents
 
$
2,969,010

 
$
1,431,996

Deposits with broker
 
218,414

 
600,192

Restricted short-term investments
 
—

 
14,841

Accounts receivable
 
4,087,436

 
4,927,791

Inventories
 
4,735,152

 
4,146,426

Prepaids and other
 
107,136

 
64,362

Total current assets
 
12,117,148

 
11,185,608


 

 

Property and Equipment
 

 

Land and land improvements
 
6,853,912

 
6,847,696

Buildings
 
38,450,065

 
38,368,076

Office equipment
 
363,487

 
353,657

Equipment
 
60,907,569

 
60,803,735

Vehicles
 
41,994

 
41,994

Construction in progress
 
19,103

 
27,529


 
106,636,130

 
106,442,687

Less accumulated depreciation
 
(24,723,777
)
 
(19,983,052
)
Net property and equipment
 
81,912,353

 
86,459,635


 

 

Other Assets
 

 

Investments in RPMG
 
1,512,475

 
1,512,475

Restricted marketable securities
 
1,557,718

 
1,518,000

Debt issuance costs, net
 
632,741

 
825,988

Deposits
 
194,457

 
195,727

Total other assets
 
3,897,391

 
4,052,190


 

 

Total Assets
 
$
97,926,892

 
$
101,697,433

 
 
 
 
 


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


3



HIGHWATER ETHANOL, LLC
Condensed Balance Sheets

LIABILITIES AND MEMBERS' EQUITY
July 31, 2013
 
October 31, 2012

 (Unaudited)
 

Current Liabilities

 

Accounts payable
$
1,673,927

 
$
2,016,384

Accrued expenses
686,683

 
631,109

Derivative instruments
741,112

 
1,113,554

Current maturities of long-term debt
2,925,490

 
2,901,330

Total current liabilities
6,027,212

 
6,662,377



 

Long-Term Debt
44,809,761

 
47,857,262



 

Other Liabilities
—

 
222,652

 
 
 
 
Derivative Instruments
—

 
422,937



 

Commitments and Contingencies

 



 

Members' Equity

 

Members' equity, 4,953 units outstanding
47,089,919

 
46,532,205

 
 
 
 
Total Liabilities and Members’ Equity
$
97,926,892

 
$
101,697,433

 
 
 
 

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
 
Nine Months Ended
 
Nine Months Ended

July 31, 2013
 
July 31, 2012
 
July 31, 2013
 
July 31, 2012

(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
 
 
 
 
 
 
 
Revenues
$
44,801,707

 
$
39,240,928

 
$
130,642,134

 
$
112,839,825



 

 

 

Cost of Goods Sold
42,189,942

 
39,055,338

 
126,573,119

 
111,297,139



 

 
.
 

Gross Profit
2,611,765

 
185,590

 
4,069,015

 
1,542,686



 

 

 

Operating Expenses
400,257

 
389,093

 
1,365,715

 
1,390,985



 

 

 

Operating Profit (Loss)
2,211,508

 
(203,503
)
 
2,703,300

 
151,701



 

 

 

Other Income (Expense)

 

 

 

Interest income
33,674

 
33,972

 
67,364

 
70,828

Other income
1,523

 
2,196

 
3,961

 
52,361

Interest expense
(989,466
)
 
(1,070,170
)
 
(3,085,830
)
 
(3,241,897
)
Gain on interest rate swap
196,808

 
168,653

 
585,682

 
533,856

Income from equity in investment
111,551

 
—

 
315,015

 
—

Total other expense, net
(645,910
)
 
(865,349
)
 
(2,113,808
)
 
(2,584,852
)


 

 

 

Net Income (Loss)
$
1,565,598

 
$
(1,068,852
)
 
$
589,492

 
$
(2,433,151
)
 
 
 
 
 

 

Weighted Average Units Outstanding
4,953

 
4,953

 
4,953

 
4,953

Net Income (Loss) Per Unit
$
316.09

 
$
(215.80
)
 
$
119.02

 
$
(491.25
)
Distributions Per Unit
$
—

 
$
—

 
$
—

 
$
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)


Three Months Ended
 
Three Months Ended
 
Nine Months Ended

Nine Months Ended

July 31, 2013
 
July 31, 2012
 
July 31, 2013

July 31, 2012

 (Unaudited)
 
 (Unaudited)
 
 (Unaudited)

 (Unaudited)

 
 
 
 



 Net Income (Loss)
$
1,565,598

 
$
(1,068,852
)
 
$
589,492


$
(2,433,151
)
 Other Comprehensive Income
 
 
 
 



Unrealized loss on restricted marketable securities
(6,615
)
 
(14,253
)
 
(31,778
)

(38,491
)
 Comprehensive Income (Loss)
$
1,558,983

 
$
(1,083,105
)
 
$
557,714


$
(2,471,642
)


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


6

HIGHWATER ETHANOL, LLC
Condensed Statements of Cash Flows

Nine Months Ended
 
Nine Months Ended

July 31, 2013
 
July 31, 2012

(Unaudited)
 
(Unaudited)
Cash Flows from Operating Activities

 

Net income (loss)
$
589,492

 
$
(2,433,151
)
Adjustments to reconcile net income (loss) to net cash provided by operations

 

Depreciation and amortization
4,933,972

 
4,911,352

Equity in earnings in RPMG used to settle liability
(315,015
)
 
—

Interest payments made from restricted cash
—

 
67,276

Change in fair value of derivative instruments
(226,921
)
 
139,221

Increase in restricted cash from net interest earned
(67,296
)
 
(67,276
)
Change in assets and liabilities

 

Restricted short term investments
(56,655
)
 
107,595

Deposits with broker
449,074

 
—

Accounts receivable
840,355

 
300,174

Inventories
(588,726
)
 
(626,782
)
Derivative instruments
(568,459
)
 
(669,360
)
Prepaids and other
(41,504
)
 
51,991

Accounts payable
(32,191
)
 
(603,536
)
Accrued expenses
55,574

 
225,501

Net cash provided by operating activities
4,971,700

 
1,403,005



 

Cash Flows from Investing Activities

 

Capital expenditures
(193,443
)
 
(793,863
)
Investment in RPMG
—

 
(181,253
)
   Net cash used in investing activities
(193,443
)
 
(975,116
)


 

Cash Flows from Financing Activities

 

Payments on long-term debt
(3,023,341
)
 
(3,230,114
)
Investment in RPMG utilized to settle liability
(217,902
)
 
—

Member distributions
—

 
(500,000
)
Net cash used in financing activities
(3,241,243
)
 
(3,730,114
)


 

Net Increase (Decrease) in Cash and Equivalents
1,537,014

 
(3,302,225
)


 

Cash and equivalents – Beginning of Period
1,431,996

 
3,427,683



 

Cash and equivalents – End of Period
$
2,969,010

 
$
125,458

 
 
 
 
Supplemental Cash Flow Information

 

Cash paid for interest expense
$
3,099,042

 
$
1,968,783



 

Supplemental Disclosure of Noncash Financing and Investing Activities

 

Unrealized loss on restricted marketable securities
$
(31,778
)
 
$
(38,491
)
Capital expenditures included in accounts payable
$
—

 
$
22,826


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

7
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

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, 2012, 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 July 31, 2013 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 is 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
July 31, 2013

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

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

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

Fair Value of Financial Instruments

The carrying value of cash, accounts receivable, accounts payable and other working capital items approximate fair value at July 31, 2013 due to the short maturity nature of these instruments.

The carrying value of restricted marketable securities approximate their fair value based on quoted market prices at quarter 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 containing variable interest rates and this rate is a market interest rate for these borrowings.

Investments

The Company has an investment interest in an unlisted company, Renewable Fuels Marketing Group, LLC (RPMG), who markets the Company's ethanol. This investment is a flow-through entity and is being accounted for by the equity method of accounting under which the Company's share of net income is recognized as income in the Company's income statement and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company has a 7% interest in RPMG. The Company consistently follows the practice of recognizing the net income based on the most recent reliable data. Therefore, the net income which is reported in the Company's income statement for the quarter ended July 31, 2013 is based on the investee's results of operations for the nine month period ended June 30, 2013.

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.



9
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

3. FAIR VALUE MEASUREMENTS

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

 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
July 31, 2013
 
Level 1
 
Level 2
 
Level 3
Restricted marketable securities - long-term
 
$
1,557,718

 
$
1,557,718

 
$
—

 
$
—

Derivative instrument - interest rate swap
 
$
(611,334
)
 
$
—

 
$
(611,334
)
 
$
—

Derivative instrument - commodities
 
$
(129,778
)
 
$
(129,778
)
 
$
—

 
$
—


 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
October 31, 2012
 
Level 1
 
Level 2
 
Level 3
Restricted marketable securities - current
 
$
14,841

 
$
14,841

 
$
—

 
$
—

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

 
$
1,518,000

 
$
—

 
$
—

Derivative instrument - interest rate swap
 
$
(1,197,016
)
 
$
—

 
$
(1,197,016
)
 
$
—

Derivative instrument - commodities
 
$
(339,475
)
 
$
(339,475
)
 
$
—

 
$
—


The fair value of restricted marketable securities is based on quoted market prices in an active market. The Company determined 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 values 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 July 31, 2013:
 
Amortized Cost
Gross
Unrealized
Losses
Fair Value
 
 
 
 
 
 
 
 
Restricted marketable securities - Long-term
   municipal obligations
$
1,565,772

$
8,054

$
1,557,718


The long-term restricted marketable securities relate to the debt service reserve fund required by the capital lease agreement. The Company had an unrealized loss of $8,054 and a gain of $23,724 included in accumulated other comprehensive income at July 31, 2013 and October 31, 2012, respectively.

Shown below are the contractual maturities of marketable securities with fixed maturities at July 31, 2013. Actual maturities may differ from contractual maturities because certain securities may contain early call or prepayment rights.

Due within 1 year
 
$
1,557,718

 
 


     Total
 
$
1,557,718



10
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

5. INVENTORIES

Inventories consisted of the following at:

 
 
July 31, 2013
 
October 31, 2012*
 
 
 
 
 
Raw materials
 
$
1,688,665

 
$
1,219,867

Spare parts and supplies
 
1,188,859

 
959,482

Work in process
 
1,224,129

 
1,362,851

Finished goods
 
633,499

 
604,226

 Total
 
$
4,735,152

 
$
4,146,426

         
*Derived from Audited financial statements

6. DERIVATIVE INSTRUMENTS

As of July 31, 2013, the Company had entered into corn and natural gas derivative instruments and an interest rate swap agreement, which are required to be recorded as either assets or liabilities at fair value in the 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 derivative instruments outstanding at July 31, 2013 are not designated as effective hedges for accounting purposes.

Interest Rate Swap

At July 31, 2013, the Company had a notional amount of approximately $17,172,000 outstanding in the swap agreement that fixes the interest rate at 7.6% until June 2014.

Corn and Natural Gas Contracts

As of July 31, 2013, the Company has open positions for 45,000 bushels of corn. Management expects all open positions outstanding as of July 31, 2013 to be realized within the next twelve months.

The following tables provide details regarding the Company's derivative instruments at July 31, 2013:

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

$
611,334

Commodities
Derivative instruments
 
$
—

$
129,778


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:


11
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

 
 
Statement of
 
Three Months Ended July 31,
 
 
Operations location
 
2013
2012
Interest rate swap
 
Other income (expense)
 
$
196,808

$
168,653

Corn contracts
 
Cost of goods sold
 
(194,003
)
149,915

Natural gas contracts
 
Cost of goods sold
 
(21,418
)
(1,005
)
 
 
 
 
 
 
 
 
Statement of
 
Nine Months Ended July 31,
 
 
Operations location
 
2013
2012
Interest rate swap
 
Other income (expense)
 
$
585,682

$
533,856

Corn contracts
 
Cost of goods sold
 
(24,909
)
279,346

Natural gas contracts
 
Cost of goods sold
 
(51,096
)
(419,021
)

7. DEBT FINANCING

Long-term debt consists of the following at:
 
July 31, 2013
 
October 31, 2012*
Fixed rate note payable, see terms below
$
18,646,314

 
$
20,233,688

 
 
 
 
Variable rate note payable, see terms below
13,908,937

 
15,344,904

 
 
 
 
Capital lease
15,180,000

 
15,180,000

 
 
 
 
Total
47,735,251

 
50,758,592

 
 
 
 
Less amounts due within one year
(2,925,490
)
 
(2,901,330
)
 
 
 
 
Net long-term debt
$
44,809,761

 
$
47,857,262

*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 line of credit for $5,000,000 and supports the issuance of letters of credit up to $5,600,000, all of which are secured by substantially all assets.

In March, 2013, the Company entered into an amendment which extended the line of credit until April 2014. In addition, the Company agreed to terminate the Long-Term Revolving Note and the minimum working capital requirement was amended to $1,500,000, to be measured on a quarterly basis at the end of each fiscal quarter.

The financing agreement with FNBO is subject to various financial and non-financial covenants that limit distributions and debt and require minimum net worth, fixed charge coverage ratio, working capital requirements, and a maximum leverage ratio. The Company is currently meeting all FNBO covenants. However, if the Company fails to comply with the loan covenants the Company may be forced to accelerate payment of the outstanding principal balances on the Loans or be subject to other remedies.

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 $168,000 plus accrued interest. Interest accrues on the Fixed Rate Note at the greater of the one-month LIBOR rate plus 300 basis points or 4%, which was 4% at July 31, 2013. A final balloon payment on the Fixed Rate Note of approximately $15,191,000 will be due February 26, 2015.


12
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

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 July 31, 2013. The Company also makes quarterly 50% excess cash flow payments which are first applied to interest and then to principal on the Variable Rate Note with a minimum annual principal reduction of $750,000, all of which has been made at the time of this filing. A final balloon payment of approximately $12,421,000 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 First National Bank of Omaha (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 accrued interest monthly at the greater of the one-month LIBOR plus 350 basis points or 4%. As part of the amendment entered into in March 2013, the Long-Term Revolving Note was terminated.

Line of Credit

The Company's Line of Credit accrues interest at the 90 day LIBOR plus 350 basis points which was 3.77% at July 31, 2013. The line of credit requires monthly interest payments. In March 2013, the Company extended the line of credit to April 2014. At July 31, 2013, the Company had no borrowings outstanding and the maximum availability was $5,000,000.

As part of the amendment entered into in January 2011, the Company is required to make additional payments quarterly on debt for up to 50% of the excess cash flow, as defined by the agreement.  As part of the bank financing 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.

As of July 31, 2013, the Company has letters of credit outstanding of $3,000,000. The Company pays interest at a rate of 1.75% on amounts outstanding and the letters of credit are valid until January 2014.

Capital Lease

The capital lease agreement with U.S. Bank National Association and the City of Lamberton is subject to various financial and non-financial covenants that limit distributions and leverage and require minimum tangible net worth, fixed charge coverage ratio, working-capital requirements, and a maximum leverage ratio. The Company is currently meeting all of these covenants. However, if the Company fails to comply with the covenants and does not obtain a waiver, the Trustee and the City could elect to exercise their available remedies, which include forcing immediate payment of outstanding balances.

The estimated maturities of the long-term debt at July 31, 2013 are as follows:
2014
$
2,925,490

2015
30,563,094

2016
1,480,000

2017
1,606,667

2018 and thereafter
11,160,000

 
 
     Long-term debt
$
47,735,251



13
HIGHWATER ETHANOL, LLC
Notes to Unaudited Condensed Financial Statements
July 31, 2013

8. COMMITMENTS AND CONTINGENCIES

Regulatory Agencies

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

Forward Contracts

The Company has forward contracts in place for natural gas purchases for approximately $1,200,000 through February, which represents approximately 27% of the Company's projected usage for the corresponding time period.

14

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 nine month periods ended July 31, 2013, 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, 2012.

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:
Ÿ
Changes in the availability and price of corn and natural gas;
Ÿ
Volatile commodity and financial markets;
Ÿ
Our ability to comply with the financial covenants contained in our credit agreements with our lenders;
Ÿ
Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw material costs;
Ÿ
Results of our hedging activities and other risk management strategies;
Ÿ
Ethanol and distillers grains supply exceeding demand and corresponding price reductions;
Ÿ
Our ability to generate cash flow to invest in our business and service our debt;
Ÿ
Changes in the environmental regulations that apply to our plant operations and changes in our ability to comply with such regulations;
Ÿ
Changes in our business strategy, capital improvements or development plans;
Ÿ
Changes in plant production capacity or technical difficulties in operating the plant;
Ÿ
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Ÿ
Lack of transportation, storage and blending infrastructure preventing ethanol from reaching high demand markets;
Ÿ
Changes in federal and/or state laws or policies impacting the ethanol industry;
Ÿ
Changes and advances in ethanol production technology and the development of alternative fuels and energy sources and advanced biofuels;
Ÿ
Competition from alternative fuel additives;
Ÿ
Changes in interest rates and lending conditions;
Ÿ
Decreases in the price we receive for our ethanol and distillers grains;
Ÿ
Changes in legislation including the Renewable Fuel Standard;
Ÿ
Our inability to secure credit or obtain additional equity financing we may require in the future; and
Ÿ
Our ability to retain key employees and maintain labor relations.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or 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.


15

Overview

Highwater Ethanol, LLC (“we,” “our,” “Highwater” or the “Company”) is a Minnesota limited liability company formed 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 allow us to produce 58 million gallons per year of undenatured ethanol per year. Our plant is currently operating above nameplate capacity 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 corn. The price of distillers grains has also 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. RPMG, Inc. ("RPMG") markets our ethanol. CHS, Inc. markets our dried distillers grains. Meadowland Farmers Co-op supplies our corn.
On March 29, 2013, we entered into an Eighth Amendment of Construction Loan Agreement with First National Bank of Omaha ("FNBO") which extended our line of credit until April 1, 2014. In addition, we agreed to terminate our Long-term Revolving Note and reduce our minimum working capital requirement to $1,500,000, to be measured on a quarterly basis at the end of each fiscal quarter, to correspond with the termination of the Long-term Revolving Note.

On December 31, 2011, the Volumetric Ethanol Excise Tax Credit ("VEETC") expired. 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). 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. In 2012, the ethanol industry in the United States experienced increased competition from ethanol produced outside the United States which may have been due in part to the elimination of the tariff on foreign ethanol. Management believes that competition from ethanol imports will likely remain strong in 2013 and may affect our ability to sell our ethanol profitably. Management believes that the expiration of VEETC has had some impact on the amount of discretionary blending and may result in a decrease in domestic ethanol demand in the future.

The RFS requires that a certain amount of renewable fuels must be used in the United States each year. In February 2010, the EPA issued new regulations governing the RFS. These new regulations have been called RFS2. Recently, there have been proposals for legislation in Congress to reduce or eliminate the RFS. In addition, the American Petroleum Institute and the American Fuel &Petrochemical Manufacturers filed petitions with the United States Environmental Protection Agency (the "EPA") requesting partial waivers of the requirements of the RFS. If Congress were to pass legislation to reduce or eliminate the RFS or if waivers were to be granted or the RFS were to be otherwise reduced, eliminated or modified, the market price and demand for ethanol will likely decrease which could have a significant negative impact on 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 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. In April 2012, the EPA approved the first E15 registrations approving twenty producers who have successfully registered their product to be used as E15. Finally, in June 2012, the EPA gave the final approval to allow the sale of E15. Although management believes that these developments are significant steps towards introduction of E15 in the marketplace, there are still obstacles to meaningful market penetration by E15. Many states still have regulatory issues that prevent the sale of E15. Sales of E15 may be limited because it is not approved for use in all vehicles, the EPA requires a label that management believes may discourage consumers from using E15, and retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may be required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This may prevent E15 from being used during

16

certain times of the year in various states. As a result, management believes that E15 may not have an immediate impact on ethanol demand in the United States.

The European Union recently concluded an anti-dumping investigation related to ethanol produced in the United States and exported to Europe. As a result of this investigation, the European Union has imposed a tariff on ethanol which is produced in the United States and exported to Europe. This tariff could result in a decrease of exports of ethanol to Europe which could negatively impact the market price of ethanol in the United States.

In late 2009, California passed a Low Carbon Fuels Standard ("LCFS"). The California LCFS requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which is measured using a lifecycle analysis, similar to the RFS. On December 29, 2011, a federal 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 which allowed CARB to continue implementation of the LCFS. A decision on the appeal is expected in the near future. In addition, a state court in California recently required CARB to take certain corrective actions regarding the approval of the LCFS regulations while allowing the LCFS regulations to remain in effect during this process. If federal and state challenges to the LCFS are ultimately unsuccessful, the LCFS could have a negative impact on demand for corn-based ethanol and result in decreased ethanol prices.    

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 July 31, 2013 and 2012
 
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 July 31, 2013 and 2012:
 
2013
 
2012
Income Statement Data
Amount
 
%
 
Amount
 
%
 
(unaudited)
 
 
 
(unaudited)
 
 
Revenue
$
44,801,707

 
100.00
 %
 
$
39,240,928

 
100.00
 %
Cost of Goods Sold
42,189,942

 
94.17
 %
 
39,055,338

 
99.53
 %
Gross Profit (Loss)
2,611,765

 
5.83
 %
 
185,590

 
0.47
 %
Operating Expenses
400,257

 
0.89
 %
 
389,093

 
0.99
 %
Operating Profit (Loss)
2,211,508

 
4.94
 %
 
(203,503
)
 
(0.52
)%
Other Expense
(645,910
)
 
(1.44
)%
 
(865,349
)
 
(2.21
)%
Net Income (Loss)
$
1,565,598

 
3.49
 %
 
$
(1,068,852
)
 
(2.72
)%

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 July 31, 2013 and 2012.
 
 
2013
 
2012
Revenue Sources
 
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
 
Ethanol Sales
 
$
35,285,743

 
78.76
%
 
$
30,816,693

 
78.53
%
Modified Distillers grains sales
 
1,438,472

 
3.21
%
 
2,450,688

 
6.25
%
Dried Distillers grains sales
 
8,077,492

 
18.03
%
 
5,973,547

 
15.22
%
Total Revenues
 
$
44,801,707

 
100.00
%
 
$
39,240,928

 
100.00
%




17

Our total revenues were higher for the three month period ended July 31, 2013 compared to the same period in 2012. Revenue from ethanol sales increased by approximately 14.5% during the three months ended July 31, 2013 compared to the same period of 2012 primarily due to higher ethanol prices. The average ethanol sales price per gallon we received for the three month period ended July 31, 2013 was approximately 13.4% higher than the average price we received for the same period of 2012. In addition, we experienced a slight increase in the gallons of ethanol sold in the three month period ended July 31, 2013 as compared to the three month period ended July 31, 2012. The gallons of ethanol we sold during the three month period ended July 31, 2013 increased by approximately 1% as compared to the number of gallons of ethanol we sold for the three months ended July 31, 2012.
Management attributes this increase in the average price we received for our ethanol for the three month period ended July 31, 2013 compared to the same period of 2012 to a higher corn prices as compared to the same period of 2012. Although ethanol prices have declined somewhat over our third fiscal quarter, that decline in ethanol prices has tracked a corresponding decline in corn prices resulting in continued positive operating margins. Management is optimistic that the current positive operating environment will continue and expects that ethanol prices will change in relation to corn and energy prices. However, the results of the 2013 corn harvest are dependent on a number of variables and are expected to have a significant impact on corn prices during our fourth fiscal quarter.

Revenue from distillers grains increased by approximately 13% during the three months ended July 31, 2013 compared to the same period of 2012. Management believes that this is primarily a result of the higher modified distillers grains prices we received and the increase in the number of tons of dried distillers grains sold during our third fiscal quarter of 2013 compared to the same period of 2012. For the three months ended July 31, 2013, the average price per ton that we received for our modified distillers grains was approximately 19.8% higher than during the three months ended July 31, 2012. For the three months ended July 31, 2013, the average price per ton that we received for our dried distillers grains was comparable to the average price we received during the three months ended July 31, 2012. The tons of dried distillers grains we sold during the three months ended July 31, 2013, increased by approximately 35.9% as compared to the tons of dried distillers grains we sold for the three months ended July 31, 2012. The tons of modified distillers grains we sold during the three months ended July 31, 2013, decreased by approximately 51% as compared to the same period of 2012.

Management attributes the increase in the average price we received for our modified distillers grains and strong distillers grains prices overall to higher corn prices and low corn stocks and a limited supply of modified distillers grains. Management anticipates that distillers grains prices will remain strong and continue to follow corn prices until at least the 2013 corn harvest.

Cost of Goods Sold

Our two largest costs of production are corn (83.4% of cost of goods sold for the three months ended July 31, 2013) and natural gas (3.8% of cost of goods sold for the three months ended July 31, 2013). Our total cost of goods sold was approximately 8% more during the three months ended July 31, 2013 compared to the same period of 2012.
    
Our average price per bushel corn for the three months ended July 31, 2013 increased by approximately 7.7% per bushel compared to the same period in 2012 due to higher corn prices. We used approximately 1.5% more bushels of corn in the three month period ended July 31, 2013 as compared to the same period in 2012.

Management attributes higher corn prices to increased market prices in response to drought conditions in the United States in 2012 which resulted in a drop in yields for the 2012 corn crop and a limited supply. However, corn prices have decreased during our third fiscal quarter in response to recent reports projecting an increased corn supply for the 2013 harvest. Management believes that an adequate corn supply will be available in our area to operate the ethanol plant. However, corn prices will also likely continue to remain relatively high and remain volatile at least until the 2013 crop is harvested and perhaps beyond depending on weather conditions and other factors. If we experience unfavorable operating conditions that prevent us from profitably operating the ethanol plant, we may need to reduce or halt production at our plant.

In the ordinary course of business, we enter into forward purchase contracts for our commodity purchases. At July 31, 2013, we have no forward corn purchase contracts. We had losses related to corn derivative instruments of approximately $194,000 for the three months ended July 31, 2013, which increased cost of sales. We had gains related to corn derivative instruments of approximately $150,000 for the three months ended July 31, 2012.

For the three month period ended July 31, 2013, we purchased approximately 7.5% more natural gas as compared to the same period of 2012. This increase in natural gas usage is primarily due to an increase in production of dried distiller's grains. Our average price per MMBTU of natural gas was 8% higher for the three month period ended July 31, 2013 compared to the same period of 2012. Management anticipates that natural gas prices will continue at their current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

18


At July 31, 2013, we have forward natural gas purchase contracts for various delivery periods through February 2014 for approximately $1,200,000. We had losses related to natural gas based derivative instruments of approximately $21,000 for the three months ended July 31, 2013. We had losses related to natural gas based derivative instruments of approximately $1,000 for the three months ended July 31, 2012.

Operating Expense

We had operating expenses for the three months ended July 31, 2013 of $400,257 as compared to operating expenses of $389,093 for the same period of 2012. Management attributes this increase in operating expenses primarily to an increase in professional fees, license and permits for the three months ended July 31, 2013 as compared to the same period of 2012. 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 profit from operations for the three months ended July 31, 2013 of $2,211,508 which is approximately 4.94% of our revenues compared to a loss of $203,503 which was approximately 0.52% of our revenues for the three months ended July 31, 2012. This increase in our operating income is primarily due to an increase in the price we received for our ethanol relative to the price we paid for corn.

Other Expense

We had total other expense for the three months ended July 31, 2013 of $645,910 compared to other expense of $865,349 for the three months ended July 31, 2012. Our other expense for the three months ended July 31, 2013 consisted primarily of interest expense offset by gain on interest rate swap and income from equity in investment.

Results of Operations for the Nine Months Ended July 31, 2013 and 2012
 
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 nine months ended July 31, 2013 and 2012:

 
2013
 
2012
Income Statement Data
Amount
 
%
 
Amount
 
%
 
(unaudited)
 
 
 
(unaudited)
 
 
Revenue
$
130,642,134

 
100.00
 %
 
$
112,839,825

 
100.00
 %
Cost of Goods Sold
126,573,119

 
96.89
 %
 
111,297,139

 
98.63
 %
Gross Profit
4,069,015

 
3.11
 %
 
1,542,686

 
1.37
 %
Operating Expenses
1,365,715

 
1.05
 %
 
1,390,985

 
1.23
 %
Operating Profit
2,703,300

 
2.07
 %
 
151,701

 
0.13
 %
Other Expense
(2,113,808
)
 
(1.62
)%
 
(2,584,852
)
 
(2.29
)%
Net Income (Loss)
$
589,492

 
0.45
 %
 
$
(2,433,151
)
 
(2.16
)%

The following table shows the sources of our revenue for the nine months ended July 31, 2013 and 2012.
 
 
2013
 
2012
Revenue Sources
 
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
 
Ethanol Sales
 
$
100,883,770

 
77.22
%
 
$
90,408,968

 
80.12
%
Modified Distillers grains sales
 
7,458,942

 
5.71
%
 
5,231,063

 
4.64
%
Dried Distillers grains sales
 
22,299,422

 
17.07
%
 
17,199,794

 
15.24
%
Total Revenues
 
$
130,642,134

 
100.00
%
 
$
112,839,825

 
100.00
%
    
Our total revenues were higher for the nine month period ending July 31, 2013 compared to the same period of 2012.

19


Revenue from ethanol sales increased by approximately 11.6% during the nine months ended July 31, 2013 compared to the same period of 2012 primarily due to higher ethanol prices. The average ethanol sales price per gallon we received for the nine month period ended July 31, 2013 was approximately 7.9% higher than the average price we received for the same period of 2012. In addition, we experienced an increase in the gallons of ethanol sold in the nine month period ended July 31, 2013 as compared to the nine month period ended July 31, 2012. The gallons of ethanol we sold during the nine month period ended July 31, 2013 increased by approximately 3.3% as compared to the number of gallons of ethanol we sold for the nine months ended July 31, 2012.

Revenue from distillers grains increased by approximately 32.7% during the nine months ended July 31, 2013 compared to the same period of 2012. For the nine months ended July 31, 2013, the average price per ton that we received for our modified distillers grains was approximately 39% higher than during the nine months ended July 31, 2012. For the nine months ended July 31, 2013, the average price per ton that we received for our dried distillers grains was approximately 18.5% higher than during the nine months ended July 31, 2012. The tons of dried distillers grains sold during the nine months ended July 31, 2013, increased by approximately 9.4% as compared to the tons of dried distillers grains we sold for the three months ended July 31, 2012. The tons of modified distillers grains we sold during the nine months ended July 31, 2013, increased by approximately 2.5% as compared to the same period of 2012.

Cost of Goods Sold

Our total cost of goods sold was approximately 13.7% more during the nine months ended July 31, 2013 compared to the nine months ended July 31, 2012. Our two largest costs of production are corn (84.5% of cost of goods sold for the nine months ended July 31, 2013) and natural gas (3.8% of cost of goods sold for the nine months ended July 31, 2013).     

Our average price per bushel of corn for the nine months ended July 31, 2013 increased by approximately 12.9% per bushel compared to the same period in 2012. During the nine month period ended July 31, 2013, we used approximately 3.6% more corn as compared to the same period in 2012.

We had losses related to corn derivative instruments of approximately $25,000 for the nine months ended July 31, 2013, which increased cost of sales. We had gains related to corn derivative instruments of approximately $279,000 for the nine months ended July 31, 2012.

For the nine month period ended July 31, 2013, we purchased approximately 6.6% more natural gas as compared to the same period in 2012. This increase in natural gas usage is primarily due to an increase in production of dried distiller's grains. Our average price per MMBTU of natural gas was 12.6% lower for the nine month period ended July 31, 2013 compared to the same period in 2012. We had losses related to natural gas based derivative instruments of approximately $51,000 for the nine months ended July 31, 2013. We had losses related to natural gas based derivative instruments of approximately $419,000 for the nine months ended July 31, 2012.

Operating Expense

We had operating expense for the nine months ended July 31, 2013 of $1,365,715 compared to operating expense of $1,390,985 for the same period of 2012. Management attributes this decrease in operating expenses primarily to a decrease in professional fees and insurance for the nine months ended July 31, 2013 as compared to the same period of 2012. 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 profit for the nine months ended July 31, 2013 of $2,703,300 compared to operating profit of $151,701 for the same period of 2012. Our income from operations for the nine months ended July 31, 2013, was 2.07% of our revenues compared to 0.13% for the same period of 2012. Our operating profit for the nine months ended July 31, 2013, was higher primarily due to an increase in the price we received for our ethanol relative to the price we paid for corn.


20

Other Expense
    
We had total other expense for the nine months ended July 31, 2013 of $2,113,808 compared to other expense of $2,584,852 for the same period of 2012. Our other expense for the nine months ended July 31, 2013 consisted primarily of interest expense offset by gain on interest rate swap and income from equity in investment.

Changes in Financial Condition for the Nine Months Ended July 31, 2013

The following table highlights the changes in our financial condition for the nine months ended July 31, 2013 from our previous fiscal year ended October 31, 2012:

 
July 31, 2013
(Unaudited)
 
October 31, 2012
Current Assets
$
12,117,148

 
$
11,185,608

Current Liabilities
$
6,027,212

 
$
6,662,377

Long-Term Debt and Liabilities
$
44,809,761

 
$
48,502,851

    
Current Assets. The increase in current assets was primarily the result of an increase in cash and inventories, which were offset partially by a decrease in accounts receivable at July 31, 2013 as compared to October 31, 2012.
    
Current Liabilities. The decrease in current liabilities was due primarily to a decrease in accounts payable and derivative instruments at July 31, 2013 as compared to October 31, 2012.

Long-term Debt and Liabilities. Long-term debt decreased from $48,502,851 at October 31, 2012 to $44,809,761 at July 31, 2013 primarily due to scheduled principal repayments on our loans with FNBO. The other liability amounts include the long-term portion for the interest rate swap.

Liquidity and Capital Resources

Based on financial forecasts performed by our management, we anticipate that we will have sufficient cash on hand, 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, high corn prices significantly increase our cost of goods sold. If increases in cost of goods sold are not offset by corresponding increases in the prices we receive from the sale of our products, these increases in cost of goods sold can have a significant negative impact on our financial performance. If we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating the ethanol plant, we could have difficulty maintaining our liquidity and we may have to secure additional debt or equity financing for working capital or other purposes.

We are currently exploring the installation of corn oil extraction technology at our plant. If we decide to proceed, we anticipate we would need to secure additional external financing by the end of the calendar year to provide the capital resources to do so. We do not yet know what amount of financing would be needed or upon what terms we would be able to secure such financing.

The following table shows cash flows for the nine months ended July 31, 2013 and 2012:
 
Nine Months Ended July 31,
 
2013
2012
 
(unaudited)
(unaudited)
Net cash provided by operating activities
$4,971,700
$1,403,005
Net cash used in investing activities
(193,443)
(975,116)
Net cash used in financing activities
(3,241,243)
(3,730,114)

Cash Flow From Operations

We experienced an increase in our cash provided by operating activities for the nine month period ended July 31, 2013 as compared to the same period in 2012. This increase was primarily due to an increase in our net income during the period ended

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July 31, 2013 compared to the same period in 2012. During the nine months ended July 31, 2013, our capital needs were being adequately met through cash from our operating activities and our credit facilities.

Cash Flow From Investing Activities

We used less net cash for investing activities for the nine month period ended July 31, 2013 as compared to the same period in 2012. This decrease was primarily due to a decrease in capital expenditures during the nine months ended July 31, 2013.

Cash Flow From Financing Activities

We used less net cash for financing activities during the nine months ended July 31, 2013 as compared to the same period in 2012. This decrease was primarily a result of our making a member distribution during the nine months ended July 31, 2012.

Short-Term and Long-Term Debt Sources with FNBO

On April 24, 2008, we entered into a Construction Loan Agreement (the “Agreement”) with 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 July 31, 2013, we have $3,000,000 in letters of credit outstanding.
    
On March 29, 2013, we entered into an Eighth Amendment of Construction Loan Agreement which extended our line of credit until April 1, 2014. In addition, we agreed to terminate our Long-term Revolving Note which had a $0 balance and under which advances of additional funds had been in FNBO's sole discretion. FNBO also reduced our minimum working capital requirement to $1,500,000, to be measured on a quarterly basis at the end of each fiscal quarter.

Fixed Rate Note

The Fixed Rate Note was initially for $25,200,000 with a variable interest rate that is fixed with an interest rate swap. We make monthly principal payments on the Fixed Rate Note for approximately $168,000 plus accrued interest. Interest accrues 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 July 31, 2013. However, we entered into an interest rate swap agreement with FNBO, which fixes the interest rate on the Fixed Rate Note at 7.6% until June 2014. The outstanding balance on this note was approximately $18,646,000 and $20,234,000 at July 31, 2013 and October 31, 2012, respectively. A final balloon payment on the Fixed Rate Note of approximately $15,191,000 will be due February 26, 2015. We expect to refinance our debt facility prior to this date.

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 outstanding balance on this note was approximately $13,909,000 and $15,345,000 at July 31, 2013 and October 31, 2012, respectively.    Interest accrues 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 July 31, 2013, was 5%. A final balloon payment of approximately $12,421,000 will be due February 26, 2015. We expect to refinance our debt facility prior to this date.
 
Long-term Revolving Note

The Long-term Revolving Note was initially $5,000,000. The Long-term Revolving Note accrued interest monthly at the greater of the one-month LIBOR plus 350 basis points, or 4%. We were 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 2013. The payment to reduce the balance to zero was made in September 2011. Pursuant to the Eighth Amendment of Construction Loan Agreement, we agreed to terminate our Long-term Revolving Note. Prior to its termination, FNBO had no obligation to advance any additional funds and would only advance such sums as approved in its sole discretion.

Line of Credit

We have a line of credit available equal to the amount of the Borrowing Base, with a maximum limit of $5,000,000. The Borrowing Base will vary and may at times be less than $5,000,000. The line of credit is set to expire on April 1, 2014. The line

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of credit accrues interest at the three-month LIBOR rate plus 350 basis points with no minimum interest rate, which was 3.77% at July 31, 2013 and requires monthly interest payments. The outstanding balance on this note was $0 as of July 31, 2013.

Covenants and other Miscellaneous Financing Agreement Terms
    
As part of the amendment entered into in January 2011, we are required to make additional payments quarterly on debt for up to 50% of the excess cash flow, as defined by the agreement.  As part of the financing agreement, the premium above LIBOR on the loans may be reduced based on a financial ratio.  The agreement is secured by substantially all business assets and is subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements. FNBO amended the calculation of the covenant measuring the fixed charge coverage ratio for six quarters beginning November 1, 2012 through April 30, 2014 as follows: 0.65:1.00 at January 31, 2013 and April 30, 2013, 0.80:1.00 at July 31, 2013 and October 31, 2013 and 1.05:1.00 at January 31, 2014 and April 30, 2014. The fixed charge coverage ratio shall revert to 1.10:1.00 at July 31, 2014 and at the end of each fiscal quarter thereafter. The net worth calculation is amended as of November 1, 2012 to $41,250,000 to be measured quarterly. The minimum working capital requirement was amended to $1,500,000, as of March 29, 2013 to be measured quarterly.

Additionally, we are limited to annual capital expenditures of $1,000,000 without prior approval of FNBO. We are also prohibited from making distributions to our members without the prior approval of FNBO. In connection with the financing agreement, we executed a mortgage in favor of FNBO creating a first lien on our real estate and plant and a security interest in all personal property located on the property and assigned in favor of FNBO, all rents and leases to our property, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.

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

Capital 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 undertook the issuance of the Bonds to finance the acquisition and installation of certain solid waste facilities in connection with our ethanol plant near Lamberton, Minnesota. We received proceeds of approximately $14,876,000, after deducting financing costs of approximately $304,000. The remaining proceeds were held as restricted cash or marketable securities based on anticipated use and are split between a project fund of approximately $11,527,000, a capitalized interest fund of approximately $1,831,000, and a debt service reserve fund of approximately $1,518,000. The Bonds mature on December 1, 2022 and bear interest at a rate of 8.5%.

Under the capital lease agreement with the City, we started making interest payments on November 25, 2008 and monthly thereafter at an implicit interest rate of 8.5%. The monthly capital lease interest payments correspond to 1/6 the semi-annual interest payments due on the Bonds on the next interest payment date. Monthly capital lease payments of principal were originally scheduled to begin on November 25, 2009; however, the City amended the agreement in September 2008 which adjusted the start date for principal payments to begin on November 25, 2014. These payments will equal 1/12 the annual principal payments scheduled to become due on the corresponding bonds on the next principal payment date.
    
We have guaranteed that if such assessed capital lease payments are not sufficient for the required bond payments, we will provide such funds as are needed to fund the shortfall. The capital lease agreement is secured by substantially all business assets of the Company and is also subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working-capital requirements. Presently, we are complying with our financial covenants and the other terms of our capital lease. We will continue to work with the Trustee to try to ensure that the terms of our capital lease are met going forward. Should unfavorable market conditions result in our violation of the terms or covenants of our capital lease and we fail to obtain a waiver of any such term or covenant, the Trustee and the City could deem us to be in default and elect to exercise their available remedies which could include requiring us to immediately repay the outstanding balance.

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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.

Contracting Activity

RPMG, Inc. 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.

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, 2012. 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 July 31, 2013.

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 July 31, 2013, our interest rate swap had a liability fair value of approximately $611,000.

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 nine months ended July 31, 2013, we recorded losses due to the change in fair value of our outstanding natural gas derivative positions of approximately $21,000 and $51,000, respectively. We recorded losses due to changes in the fair value of our outstanding corn derivative positions for the three and nine months ended July 31, 2013 of approximately $194,000 and $25,000, respectively. We also recorded gains due to changes in the fair value of our interest rate swap for the three and nine months ended July 31, 2013 of approximately $197,000 and $586,000, respectively.


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

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from a term loan (the "Variable Rate Note") and a line of credit bearing a variable interest rate.  As of July 31, 2013, we had $13,908,937 outstanding on our Variable Rate Note. Interest will accrue on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 5%. The applicable interest rate at July 31, 2013 was 5%. If we were to experience a 10% adverse change in LIBOR, the annual effect such change would have on our income statement, based on the amount we had outstanding on our Variable Rate Note of July 31, 2013, would be approximately $69,545. At July 31, 2013, we had $0 outstanding on our line of credit.

The specifics of each note are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

In order to reduce the risk caused by interest rate fluctuations, we entered into an interest rate swap agreement. We use the interest rate swap agreement to limit exposure to increased interest rates. The fair value of this interest rate swap agreement is based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The fair value of the derivative is continually subject to change due to changing market conditions. Although the interest rate swap held by us as of July 31, 2013 serves as an economic hedge, we do not formally designate this instrument as a hedge and, therefore, record in earnings adjustments caused from marking the instrument to market on a monthly basis. As of July 31, 2013, our interest rate swap had a liability fair value of approximately $611,000.

Commodity Price Risk

We expect to be exposed to market risk from changes in commodity prices.  Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process and the sale of ethanol and distillers grains. We may seek to minimize the risks from fluctuations in the prices of raw material inputs through the use of corn commodity-based and natural gas derivatives. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.

In the ordinary course of business, we entered into forward purchase contracts for our natural gas purchases. At July 31, 2013, we have natural gas forward contracts for delivery periods through February 2014 for a total commitment of approximately $1,200,000. At July 31, 2013, we have open positions for 45,000 bushels of corn on the Chicago Board of Trade and 20,000 dekatherms of natural gas on the New York Mercantile Exchange. These derivatives have not been designated as an effective hedge for accounting purposes and are forecasted to settle within the next 12 months. For the three and nine months ended July 31, 2013, we recorded losses due to the change in fair value of our outstanding natural gas derivative positions of approximately $21,000 and $51,000, respectively. We recorded losses due to changes in the fair value of our outstanding corn derivative positions for the three and nine months ended July 31, 2013 of approximately $194,000 and $25,000, respectively.

As corn prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.


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A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of July 31, 2013 of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from July 31, 2013. The results of this analysis, which may differ from actual results, are approximately as follows:

 
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)
Unit of Measure
Hypothetical Adverse Change in Price as of
July 31, 2013
Approximate Adverse Change to Income
Natural Gas
1,406,214

MMBTU
10
%
 
$
476,707

Ethanol
57,999,900

Gallons
10
%
 
$
12,759,978

Corn
19,999,966

Bushels
10
%
 
$
11,459,981

DDGs
157,457

Tons
10
%
 
$
3,432,563


Item 4.  Controls and Procedures
 
Disclosure Controls and Procedures

Our management is responsible for maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In addition, the disclosure controls and procedures must ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial and other required disclosures.

Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Lucas Schneider, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of July 31, 2013.  Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the nine months ended July 31, 2013, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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.

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Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits.

(a)
The following exhibits are filed as part of this report.
Exhibit No.
 
Exhibit
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 July 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of July 31, 2013 and October 31, 2012, (ii) Condensed Statements of Operations for the three and nine months ended July 31, 2013 and 2012, (iii) Condensed Statements of Comprehensive Income (Loss) for the three and nine months ended July 31, 2013 and 2012, (iv) Statements of Cash Flows for the nine months ended July 31, 2013 and 2012, and (v) 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:
September 9, 2013
 
/s/ Brian Kletscher
 
 
 
Brian Kletscher
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
September 9, 2013
 
/s/ Lucas Schneider
 
 
 
Lucas Schneider
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
 
 
 
 


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HIGHWATER ETHANOL LLC Reports

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