UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended April 30, 2018 

OR

For the transition period from                    to                  .

COMMISSION FILE NUMBER 000-51825

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

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.  ☒  Yes  ☐  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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ☒  Yes  ☐  No

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

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

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

As of June 14, 2018, there were 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding.

INDEX

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

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

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

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

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

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

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

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

Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), owns 73% of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC 's ethanol production facility and other customers.

Basis of Presentation and Principles of Consolidation

The condensed consolidated unaudited financial statements as of April  30, 2018 include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively the “Company”).  Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the unaudited financial statements of Agrinatural with its consolidated unaudited financial statements, with the equity and earnings (loss) attributed to the remaining 27% non-controlling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations.  All significant intercompany balances and transactions are eliminated in consolidation.

The condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  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 condensed consolidated unaudited financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended October 31, 2017, contained in the Company’s annual report on Form 10-K.

In the opinion of management, the condensed consolidated unaudited financial statements reflect all adjustments consisting of normal recurring accruals 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 unaudited financial statements should not be regarded as necessarily indicative of results that may be expected for any other fiscal period or for the fiscal year.

Accounting Estimates

Management uses estimates and assumptions in preparing these condensed consolidated unaudited 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 economic lives of property and equipment, the analysis of impairment of long-lived assets, valuation of commodity derivative instruments, inventory, inventory purchase and sales commitments, and evaluation of railcar damages contingency. The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made.  Actual results could differ from those estimates.

Non-controlling Interest

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

Revenue Recognition

The Company generally sells ethanol and related products pursuant to marketing agreements.  Revenues from the production of ethanol and the related products are recorded when the customer has taken title and assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured.  Title is generally assumed by the buyer at the Company’s shipping point.

In accordance with the Company's agreements for the marketing and sale of ethanol and related products, marketing fees and commissions due to the marketers are deducted from the gross sales price as earned.  These fees and commissions are recorded net of revenues as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.  Shipping costs incurred by the Company in the sale of ethanol are not specifically identifiable and as a result, are recorded based on the net selling price reported to the Company from the marketer.  Shipping costs incurred by the Company in the sale of ethanol related products are included in cost of goods sold.

Agrinatural recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee for the arrangement is fixed or determinable and collectability is reasonably assured.

Inventory

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

Derivative Instruments

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

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

Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives.  Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”.  Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.  Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our condensed consolidated unaudited financial statements.

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

The Company has adopted authoritative guidance related to “Derivatives and Hedging”, and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  See further discussion in Note 4.

Reportable Operating Segments

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

2.RISKS AND UNCERTAINTIES

The Company has certain risks and uncertainties that it experiences during volatile market conditions.  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 70% to 90% of total revenues and corn costs average 70% to 90% of cost of goods sold.

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

3.INVENTORY

Inventory consisted of the following:

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol.  Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $50,000 and $0 for the six months ended April  30, 2018 and 2017, respectively.

4.DERIVATIVE INSTRUMENTS

As of April 30, 2018, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,015,000 bushels, comprised of long corn positions on 700,000 bushels that were entered into to hedge forecasted ethanol sales through July 2018, and short corn positions on 4,315,000 bushels that were entered into to hedge forecasted corn purchases through December 2019.  There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding. 

As of April  30, 2018, the Company had approximately $610,000 of cash collateral (restricted cash) and approximately $3,000 due to a broker related to derivatives held by a broker, recorded as a component of accounts payable. 

The following tables provide details regarding the Company’s derivative instruments at April  30, 2018, none of which are designated as hedging instruments:

As of October 31, 2017, the total notional amount of the Company's outstanding corn derivative instruments was approximately 1,120,000 bushels, comprised of long corn positions on 215,000 bushels that were entered into to hedge forecasted ethanol sales through December 2017, and short corn positions on 905,000 bushels that were entered into to hedge forecasted corn purchases through July 2018.     There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding. 

As of October 31, 2017, the Company had outstanding natural gas derivative instruments totaling 120,000 MMBTU entered into to hedge forecasted natural gas purchases through February 2018.

As of October 31, 2017, the total notional amount of the Company’s outstanding ethanol derivative instruments was approximately 420,000 gallons that were entered into to hedge forecasted ethanol sales through November 2017.

As of October 31, 2017, the Company had no cash collateral (restricted cash) and approximately $12,000 due to broker related to derivatives held by a broker, recorded as a component of accounts payable.

The following tables provide details regarding the Company’s derivative instruments at October 31, 2017, none of which were designated as hedging instruments:

The following tables provide detail regarding the gains (losses) from Company’s derivative financial instruments in its condensed consolidated unaudited statements of operations, none of which are designated as hedging instruments:

5.FAIR VALUE

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at April 30, 2018:

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2017:

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

6.DEBT FINANCING

Long-term debt consists of the following:

Revolving Term Note

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

Amended Credit Facility

The amended credit facility includes an amended and restated revolving term loan with a $4,000,000 principal commitment and a revolving seasonal line of credit with a $4,000,000 principal commitment.  The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee.  The amended credit facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

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

Amended Revolving Term Note

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021.  Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 5.01% at April 30, 2018.    

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

The aggregate principal amount available to the Company for borrowing under the revolving term loan at October 31, 2017 was $17,500,000, and under the amended revolving term loan at April 30, 2018 was $4,000,000.

Seasonal Revolving Loan

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000 until its maturing on February 1, 2019.  Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.850% above the rate quoted by LIBOR Index rate, which was 4.76% at April 30, 2018.  

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

Estimated annual maturities of long-term debt at April  30, 2018 are as follows based on the most recent debt agreements:

7.COMMITMENTS AND CONTINGENCIES

Corn Forward Contracts

At April  30, 2018, the Company had cash and basis contracts for forward corn purchase commitments totaling approximately 7,495,000 bushels for various delivery periods through April 2019.

Ethanol Forward Contracts

At April  30, 2018,  the Company had fixed and basis contracts to sell approximately $12,431,000 of ethanol for various delivery periods through June 2018.   

Distillers’ Grains Forward Contracts

At April  30, 2018, the Company had forward contracts to sell approximately $1,324,000 of distillers’ grains for various delivery periods through June 2018.

Corn Oil Forward Contracts

At April  30, 2018, the Company had forward contracts to sell approximately $1,225,000 of corn oil for various delivery periods through December 2018.

Railcar Damages 

In accordance with certain railcar lease agreements, at expiration, the Company is required to return the railcars in good condition, less normal wear, and tear.  Primarily due to the ongoing maintenance and repair activities performed on its railcars, the Company has determined that no accrual for leased railcar damages is necessary and an estimate of the possible range of loss cannot be made.

8.MEMBERS’ EQUITY

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

Heron Lake BioEnergy, LLC has a total of 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding, for an aggregate total of 77,932,107 units issued and outstanding at April  30, 2018 and October 31, 2017. 

On December 21, 2017,  Heron Lake BioEnergy, LLC’s Board of Governors declared a cash distribution of $0.11 per unit, or approximately $8,573,000, for unit holders of record as of December 21, 2017.  The distribution was paid in January 2018.  

9.RELATED PARTY TRANSACTIONS

Granite Falls Energy, LLC

The Company has a management services agreement with GFE. Under the terms of the management services agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses, and other expenses and costs incurred by GFE for the three management positions.  The management services agreement automatically renews for successive one-year terms unless and until the Company or GFE gives the other party 90-days written notice of termination prior to expiration of then current term.  The management services agreement may also be terminated by either party for cause under certain circumstances. Total expenses under this agreement were approximately $101,000 and $91,000 for the three months ended April  30, 2018 and 2017,  respectively, and approximately $238,000 and $199,000 for the six months ended April 30, 2018 and 2017, respectively.

Corn Purchases - Members

The Company purchased corn from board members of approximately $2,642,000 and $2,569,000 for the three months ended April  30, 2018 and 2017, respectively, and approximately $7,097,000 and $5,594,000 for the six months ended April  30, 2018 and 2017, respectively. Of this total, approximately $67,000 and $607,000 was included in accounts payable at April 30, 2018 and October 31, 2017, respectively.

Agrinatural

During 2013, the Company borrowed $300,000 from the non-controlling interest member of Agrinatural.  This note was paid in full in January 2018.  Total interest paid in relation to this note payable amounted to approximately $0 and $1,000 for the three months ended April  30, 2018 and 2017, respectively, and approximately $1,000 and $3,000 for the six months ended April  30, 2018 and 2017, respectively.

Swan Engineering

Agrinatural has a management and operating agreement with Swan Engineering, Inc. (“SEI”).  SEI is an affiliate of Rural Energy Solutions, LLC (“RES”), the 27% minority owner of Agrinatural.  A controlling interest of RES is owned by the principal of SEI.

Under the management and operating agreement, SEI provides Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business.  In exchange for these services, Agrinatural pays SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500.  The Company paid monthly base fee and variable customer management fee of approximately $49,000 and $48,000 for the three months ended April  30, 2018 and 2017, respectively, and approximately $97,000 for the six months ended April  30, 2018 and 2017.  The management and operating agreement with SEI expires July 1, 2019, unless earlier terminated for cause as defined in the agreement.

Agrinatural also has a project management agreement with SEI.  Pursuant to the project management agreement, SEI supervises all Agrinatural's pipeline construction projects.  These projects are constructed by unrelated third-party pipeline construction companies.  Under the project management agreement, Agrinatural pays SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural's board of managers, excluding capitalized marketing costs.  The Company recorded project management fees and capital work of approximately $8,000 and $2,000 for the three months ended April  30, 2018 and 2017, respectively, and approximately $15,000 and $12,000 for the six months ended April  30, 2018 and 2017, respectively.  The project management with SEI expires June 30, 2019, unless earlier terminated for cause as defined in the agreement.

10.BUSINESS SEGMENTS

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

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

The following tables summarize financial information by segment and provide a reconciliation of segment revenue, contribution to operating income, and total assets:

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

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 three and six months ended April  30, 2018 and 2017.  This section should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in PART I - Item 1 of this report and the information contained in the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2017.

Disclosure Regarding Forward-Looking Statements

The SEC encourages companies to disclose forward-looking information so investors can better understand future prospects and make informed investment decisions.  As such, we have historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance, and prospects in this report.  All statements that are not historical or current facts are forward-looking statements.  In some cases, you can identify forward-looking statements by terms such as “anticipates”, “believes”, “could”, “estimates”, “expects”, “intends”, “may”, “plans”, “potential”, “predicts”, “projects”, “should”, “will”, “would”, and similar expressions. 

Forward-looking statements are subject to a number of known and unknown risks, uncertainties, and other factors, many of which may be beyond our control, and may cause actual results, performance, or achievements to differ materially from those projected in, expressed or implied by 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 are described more particularly in the “Risk Factors” section of our annual report on Form 10-K for the year ended October 31, 2017  as supplemented by the risk factors disclosed in Item 1A of this report on Form 10-Q.  These risks and uncertainties include, but are not limited to, the following:

We believe our expectations regarding future events are based on reasonable assumptions; however, these assumptions may not be accurate or account for all risks and uncertainties.  Consequently, forward-looking statements are not guaranteed.  Actual results may vary materially from those expressed or implied in our forward-looking statements.  In addition, we are not obligated and do not intend to update our forward-looking statements because of new information unless it is required by applicable securities laws.  We caution investors not to place undue reliance on forward-looking statements, which represent management’s views as of the date of this report.    We qualify all of our forward-looking statements by these cautionary statements.

Industry and Market Data

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

Available Information

Our website address is www.heronlakebioenergy.com.  Our annual report on Form 10-K, periodic 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, are available, free of charge, on our website under the link “SEC Filings”, 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 report on Form 10-Q.

Overview

Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota.  Our business consists of the production and sale of our ethanol throughout the continental U.S. and sale of its co-products (wet, modified wet and dried distillers’ grains, corn oil, and corn syrup) locally, and throughout the continental U.S. Additionally, through a wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), we own a  73% controlling interest of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC 's ethanol production facility and other customers. 

When we use the terms “Heron Lake BioEnergy”, “Heron Lake”, or “HLBE” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our operations at our ethanol production facility located near Heron Lake, Minnesota.  When we use the terms the “Company”, “we”, “us”, “our” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its majority-owned subsidiary Agrinatural.

Reportable Operating Segments

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  Based on the nature of the products, services and operations and the expected financial results, we review our operations within the following two separate operating segments: (1) ethanol production; and (2) natural gas pipeline operations.  We currently do not have or anticipate we will have any other lines of business or other significant sources of revenue other than the sale of ethanol, distillers’ grains, corn oil and natural gas transportation.  Refer to Note 10, “Business Segments”, of the notes to the condensed consolidated unaudited financial statements for financial information about our financial reporting segments.

Ethanol Production

Our primary line of business is the Company’s operation of its ethanol plant, including the production and sale of ethanol and its co-products (distillers’ grains, non-edible corn oil and corn syrup).  These operations are aggregated into one financial reporting segment. 

Our ethanol plant has a nameplate capacity of 50 million gallons per year.  We have received EPA pathway approval and have obtained permits from the Minnesota Pollution Control Authority to increase our production capacity to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis.  We are currently operating above our stated nameplate capacity and intend to continue to do into the near future, dependent on industry conditions and plant profitability.

We have a management services agreement with Granite Falls Energy, LLC, a Minnesota limited liability company that operates an ethanol plant located in Granite Falls, Minnesota (“GFE”).  GFE owns approximately 50.7% of our outstanding membership units.    Pursuant to the management services agreement, GFE provides its chief executive officer, chief financial officer, and commodity risk manager to act in those positions as our part-time officers.  The management services automatically renews for successive one-year terms until either party gives the other party written notice of termination prior to expiration of the then current term.  The management services agreement may also be terminated by either party for cause under certain circumstances.

We market and sell our products primarily using third party marketers.    The markets in which our products are sold may be local, regional, national, and international and depend primarily upon the efforts of third party marketers.  We have contracted with Eco-Energy, LLC to market all of our ethanol, Gavilon Ingredients, LLC to market our distillers’ grains, and Renewable Products Marketing Group, LLC to market our corn oil.  We also occasionally independently market and sell excess corn syrup from the distillation process to local livestock feeders. 

Our cost of our goods sold consists primarily of costs relating to the corn and natural gas supplies necessary to produce ethanol and distillers’ grains for sale at our ethanol plant.  We generally do not have long-term, fixed price contracts for the purchase of corn.  Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota.

We have a facilities agreement with Northern Border Pipeline Company, which allows us access to an existing interstate natural gas pipeline located approximately 16 miles north from our plant.  We have entered into a firm natural gas transportation agreement with Agrinatural, our majority-owned subsidiary.  We also have an agreement with Constellation New Energy—Gas Division, LLC to supply the natural gas necessary to operate our plant.

Natural Gas Pipeline

We own a controlling 73% interest in Agrinatural, a natural gas distribution and sales company located in Heron Lake, Minnesota.  Agrinatural owns approximately 190 miles of natural gas pipeline and provides natural gas to the Company's ethanol plant and other commercial, agricultural, and residential customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company.  Agrinatural's revenues are generated through natural gas distribution fees and sales.  The operations of Agrinatural's natural gas pipeline are aggregated into a separate financial reporting segment.

The Company has entered into two intercompany credit facilities with Agrinatural: the July 2014 credit facility, as amended (the “Original Credit Facility”) and the March 2015 credit facility, as amended (the “Additional Credit Facility”).  Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural.  Details of these credit facilities to Agrinatural are provided below in the section below entitled “PART I - Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness”.

During the normal course of business, the Company enters into transactions between its two operating segments as a result of HLBE’s firm natural gas transportation agreement with Agrinatural.  These intersegment activities are recorded by each segment at prices approximating market and treated as if they are third-party transactions.  Consequently, these transactions impact segment performance.  However, the revenues and corresponding costs are eliminated in consolidation and do not impact the Company’s unaudited condensed consolidated results.

Plan of Operations for the Next Twelve Months

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

We expect to have sufficient cash generated by continuing operations and availability on our credit facility to fund our operations.  However, should we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating our plant, we may need to seek additional funding.