Cardinal Ethanol LLC - FORM 10-Q - August 2, 2018

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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 June 30, 2018.
 
 
 
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 000-53036
 
CARDINAL ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Indiana
 
20-2327916
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1554 N. County Road 600 E., Union City, IN 47390
(Address of principal executive offices)
 
(765) 964-3137
(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
 
Emerging Growth Company o
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. 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 August 2, 2018, there were 14,606 membership units outstanding.

1

INDEX



2

PART I        FINANCIAL INFORMATION

Item 1. Financial Statements

CARDINAL ETHANOL, LLC
Condensed Balance Sheets
 ASSETS
June 30, 2018
 
September 30, 2017

 (Unaudited)
 

Current Assets

 

Cash
$
10,138,977

 
$
18,995,755

Restricted cash
263,578

 
401,406

Trade accounts receivable
16,211,221

 
15,006,093

Miscellaneous receivables
309,885

 
384,508

Inventories
22,576,144

 
14,604,975

Prepaid and other current assets
277,566

 
253,791

Commodity derivative instruments
2,195,419

 
492,842

Total current assets
51,972,790

 
50,139,370


 
 

Property, plant, and equipment, net
99,778,992

 
107,936,389


 
 

Other Assets
 
 

Investment
1,295,192

 
1,096,237

Total other assets
1,295,192

 
1,096,237


 
 

Total Assets
$
153,046,974

 
$
159,171,996

LIABILITIES AND MEMBERS' EQUITY
 
 
 

 
 

Current Liabilities

 

Advances from customers
375,543

 
—

Accounts payable
2,950,085

 
3,983,923

Accounts payable-grain
6,599,526

 
8,378,095

Accrued expenses
1,103,290

 
1,381,734

Commodity derivative instruments
2,047,139

 
513,829

Current maturities of long-term debt
4,390,373

 
3,749,826

Total current liabilities
17,465,956

 
18,007,407



 

Long-Term Debt, net of current maturities
14,355,344

 
14,581,758



 

Commitments and Contingencies

 



 

Members’ Equity

 

Members' contributions, net of cost of raising capital, 14,606 units authorized, issued and outstanding
70,912,213

 
70,912,213

Retained earnings
50,313,461

 
55,670,618

Total members' equity
121,225,674

 
126,582,831



 

Total Liabilities and Members’ Equity
$
153,046,974

 
$
159,171,996


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


3

CARDINAL ETHANOL, LLC
Condensed Statements of Operations (Unaudited)


Three Months Ended
 
Nine Months Ended

June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
 

 

 

 

Revenues
$
71,197,328

 
$
50,900,700

 
$
192,765,153

 
$
168,428,966


 
 

 

 
 
Cost of Goods Sold
67,084,985

 
50,647,521

 
182,108,709

 
155,115,697


 
 

 

 
 
Gross Profit
4,112,343

 
253,179

 
10,656,444

 
13,313,269



 

 

 
 
Operating Expenses
1,866,720

 
1,511,346

 
5,192,734

 
4,132,967


 
 

 
 
 
 
Operating Income (Loss)
2,245,623

 
(1,258,167
)
 
5,463,710

 
9,180,302


 
 

 
 
 
 
Other Income (Expense)
 
 

 
 
 
 
Interest expense
(246,388
)
 
—

 
(671,881
)
 
(270,467
)
Miscellaneous income
14,433

 
20,576

 
75,214

 
51,911

Total
(231,955
)
 
20,576

 
(596,667
)
 
(218,556
)

 
 

 
 
 
 
Net Income (Loss)
$
2,013,668

 
$
(1,237,591
)
 
$
4,867,043

 
$
8,961,746

 
 
 
 
 
 
 
 
Weight Average Units Outstanding - basic and diluted
14,606

 
14,606

 
14,606

 
14,606



 

 
 
 
 
Net Income (Loss) Per Unit - basic and diluted
$
138

 
$
(85
)
 
$
333

 
$
614

 
 
 
 
 
 
 
 
Distributions Per Unit
$
100

 
$
275

 
$
700

 
$
1,075

 
 
 
 
 
 
 
 

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





4

CARDINAL ETHANOL, LLC
Condensed Statements of Cash Flows (Unaudited)

Nine Months Ended
 
Nine Months Ended

June 30, 2018
 
June 30, 2017
 

 

Cash Flows from Operating Activities
 
 
 
Net income
$
4,867,043

 
$
8,961,746

Adjustments to reconcile net income to net cash provided by operations:

 

Depreciation
8,707,377

 
7,711,431

Change in fair value of commodity derivative instruments
(169,266
)
 
97,075

Gain on sale of equipment
(9,561
)
 
—

Non-cash dividend income
(198,955
)
 
(157,986
)
Change in operating assets and liabilities:
 
 

Trade accounts receivables
(1,205,128
)
 
(2,217,551
)
Miscellaneous receivable
74,623

 
(84,601
)
Inventories
(7,971,169
)
 
(2,328,951
)
Prepaid and other current assets
(23,775
)
 
(144,184
)
Advances from customers
375,543

 
—

Accounts payable
(1,033,838
)
 
1,002,947

Accounts payable-grain
(1,778,569
)
 
(1,655,494
)
Accrued expenses
1,150,576

 
(853,442
)
Net cash provided by operating activities
2,784,901

 
10,330,990


 
 

Cash Flows from Investing Activities
 
 

Capital expenditures
(118,953
)
 
(4,948,318
)
Payments for construction in progress
(1,860,488
)
 
(5,784,595
)
Proceeds from sale of equipment
10,000

 
—

   Net cash used for investing activities
(1,969,441
)
 
(10,732,913
)

 
 

Cash Flows from Financing Activities
 
 

Distributions paid
(10,224,200
)
 
(15,701,450
)
Proceeds from revolving credit loan
10,349,708

 
—

Payments against revolving credit loan
(10,349,708
)
 
—

Proceeds from long-term debt
3,524,049

 
4,404,149

Payments on long-term debt
(3,109,915
)
 
(2,183,812
)
Net cash used for financing activities
(9,810,066
)
 
(13,481,113
)

 
 

Net Decrease in Cash and Restricted Cash
(8,994,606
)
 
(13,883,036
)


 

Cash and Restricted Cash – Beginning of Period
19,397,161

 
24,462,911



 

Cash and Restricted Cash – End of Period
$
10,402,555

 
$
10,579,875


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


5


CARDINAL ETHANOL, LLC
Condensed Statements of Cash Flows (Unaudited)

Nine Months Ended
 
Nine Months Ended

June 30, 2018
 
June 30, 2017
Reconciliation of Cash and Restricted Cash
 
 
 
Cash - Balance Sheet
$
10,138,977

 
$
9,687,682

Restricted Cash - Balance Sheet
263,578

 
892,193

Cash and Restricted Cash
10,402,555


10,579,875

 
 
 
 
Supplemental Cash Flow Information
 
 

Interest paid
$
651,915

 
$
402,194


 
 

Supplemental Disclosure of Non-cash Investing and Financing Activities
 
 

     Construction in process included in accrued expenses and accounts payable
$
32,259

 
$
1,104,190


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


6

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed 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 September 30, 2017, contained in the Company's annual report on Form 10-K.

In the opinion of management, the interim condensed financial statements reflect all adjustments considered necessary for fair presentation.

Nature of Business

Cardinal Ethanol, LLC, (the “Company”) is an Indiana limited liability company currently producing fuel-grade ethanol, distillers grains, corn oil and carbon dioxide near Union City, Indiana and sells these products throughout the continental United States. During the nine months ended June 30, 2018 and 2017, the Company produced approximately 95,662,000 and 92,758,000 gallons of ethanol, respectively.

The company began procuring, holding, transporting and selling agricultural grain commodities during the fourth fiscal quarter of 2017.

Reportable 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 are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.   Based on the related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.

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

•
Trading Division. During 2017, the Company constructed a grain loading facility within our single site to buy, hold and sell inventories of agricultural grains, primarily soybeans. We perform no additional processing of these grains, unlike the corn inventory we hold and use in ethanol production. The activities of buying, selling and holding of grains other than for ethanol and co-product production comprise this financial reporting segment.

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 the following significant matters, among others; the useful lives of fixed assets, the valuation of basis and delay price contracts on corn purchases, derivatives, inventory, patronage dividends, long-lived assets and inventory purchase commitments. Actual results may differ from previously estimated amounts, 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.

Restricted Cash

As a part of its commodities hedging activities, the Company is required to maintain cash balances with our commodities trading companies for initial and maintenance margins on a per futures contract basis. Changes in the market value of contracts may increase these requirements. As the futures contracts expire, the margin requirements also expire. Accordingly, we record the

7

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


cash maintained with the traders in the margin accounts as restricted cash. Since this cash is immediately available to us upon request when there is a margin excess, we consider this restricted cash to be a current asset.

Trade Accounts Receivable

Credit terms are extended to customers in the normal course of business. The Company performs ongoing credit evaluations of
its customers' financial condition and, generally, requires no collateral. Accounts receivable are recorded at their estimated net
realizable value. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company's
credit terms. Amounts considered uncollectible are written off. The Company's estimate of the allowance for doubtful accounts
is based on historical experience, its evaluation of the current status of receivables, and unusual circumstances, if any. At June 30, 2018 and September 30, 2017, the Company determined that an allowance for doubtful accounts was not necessary.

Inventories

Ethanol production division (see Reportable Segments) inventories consist of raw materials, work in process, finished goods and parts. Corn is the primary raw material. Finished goods consist of ethanol, dried distiller grains and corn oil. Inventories are stated at the lower of weighted average cost or net realizable value. Net realizable value is the estimated selling prices in the normal course of business, less reasonably predictable selling costs.

Trading division (see Reportable Segments) inventories consist of grain. Soybeans were the only grains held and traded at June 30, 2018. These inventories are stated at market value, which may include reductions for quality.

Property, Plant and Equipment

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

Long-Lived Assets

The Company reviews its long-lived assets, such as property, plant and equipment and financing costs, subject to depreciation and amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

Investments

Investments consist of the capital stock and patron equities of the Company's distillers grains marketer. The investments are stated at the lower of cost or fair value and adjusted for non cash patronage equities received. Patronage dividends are recognized when received and included within revenue in the condensed statements of operations.

Revenue Recognition

The Ethanol Division 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. The Company may sell a portion of its ethanol to its marketer at an interim or provisional price. The marketer takes title to the ethanol, but by contract, the final price risk remains with the Company. The Company's products are sold Free on Board (FOB) shipping point.

In accordance with the Company's agreements for the marketing and sale of ethanol and related products, marketing fees, commissions and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded

8

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


net of these commissions and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.

The Trading Division buys, holds and sells inventories of agricultural grains, primarily soybeans, under contracts with other grain dealers or processors. Revenue is recognized when transportation and delivery has occurred under the terms of the sales agreement, the final price for the contract is fixed or determinable and collectability is reasonably assured.

Derivative Instruments

From time to time the Company enters into derivative transactions to hedge its exposures to commodity price fluctuations. The Company is required to record these derivatives in the balance sheet 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 the statement of operations, depending on the item being hedged.

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 financial statements.

The Company has elected for its Ethanol Division to apply the normal purchase normal sale exemption to all forward commodity contracts. For the Trading Division, the Company has elected not to apply the normal purchase normal sale exemption to its forward purchase and sales contracts and therefore marks these derivative instruments to market.

Net Income per Unit

Basic net income per unit is computed by dividing net income by the weighted average number of members' units outstanding during the period. Diluted net income per unit is computed by dividing net income by the weighted average number of members' units and members' unit equivalents outstanding during the period. There were no member unit equivalents outstanding during the periods presented; accordingly, the Company's basic and diluted net income per unit are the same.

Recently Issued or Adopted Accounting Pronouncements

Accounting for Leases (Evaluating)

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), which provides guidance for accounting for leases. The new guidance requires companies to recognize the assets and liabilities for the rights and obligations created by leased assets, initially measured at the present value of the lease payments. The accounting guidance for lessors is largely unchanged. The ASU is effective for the Company beginning in October 2019. It is to be adopted using a modified retrospective approach. The Company is currently evaluating the impact that the adoption of this guidance will have on the Company’s financial statements and anticipates the new guidance will significantly impact its financial statements given the Company has leased a significant number of rail cars for transporting Dried Distillers' Grains with Solubles (DDGS) to its ultimate customers.


9

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


Revenue Recognition (Evaluated)

In May 2014, and amended in August 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09 which amended the Revenue from Contracts with Customers (Topic 606) of the Accounting Standards
Codification. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and
services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company beginning in October 2018. We have evaluated the impact of the standard on the financial statements
and believe there will be no material effect except for additional disclosure.

2. CONCENTRATIONS

Two major customers accounted for approximately 95% of the outstanding accounts receivable balance at June 30, 2018 and 95% at September 30, 2017. These same two customers accounted for approximately 79% and 82% of revenue for the three and nine month periods ended June 30, 2018 and 96% of revenue for the three and nine month periods ended June 30, 2017.

3.  INVENTORIES

Inventories consist of the following as of:

 
June 30, 2018 (Unaudited)
 
September 30, 2017
Ethanol Division:
 
 
 
 Raw materials
$
7,170,056

 
$
5,754,084

 Work in progress
1,228,171

 
1,354,346

 Finished goods
2,110,499

 
2,722,869

 Spare parts
2,837,969

 
2,633,371

Ethanol Division Subtotal
$
13,346,695

 
$
12,464,670

Trading Division:
 
 
 
Grain inventory
$
9,229,449

 
$
2,140,305

Trading Division Subtotal
$
9,229,449

 
$
2,140,305

Total Inventories
$
22,576,144

 
$
14,604,975


In the ordinary course of business, the Company enters into forward purchase contracts for its commodity purchases and sales. Certain contracts that literally meet the definition of a derivative may be exempted from derivative accounting as normal purchases or normal sales. At June 30, 2018, the Company had forward corn purchase contracts at various fixed prices for various delivery periods through March 2020 for approximately 5.6% of expected production needs for the next 21 months. Approximately 5.5% of the forward corn purchases were with related parties. Given the uncertainty of future ethanol and corn prices, the Company could incur a loss on the outstanding corn purchase contracts in future periods. Management has evaluated these forward contracts using a methodology similar to that used in the lower of cost or net realizable value evaluation with respect to inventory valuation, and has determined that no impairment existed at June 30, 2018 or September 30, 2017. The Company has elected not to apply the normal purchase and sale exemption to its forward soybean contracts and therefore treats them as derivative instruments.

At June 30, 2018, the Ethanol Division had forward dried distiller grains sales contracts for approximately 41.6% of expected production for the next 3 months at various fixed prices for delivery periods through September 2018. At June 30, 2018, the Company had forward corn oil contracts at various prices for delivery through July 2018, which approximates just part of that month's production. Also, at June 30, 2018, the Company had forward natural gas contracts for approximately 34.5% of expected purchases for the next 16 months at various prices for various delivery periods through October 2019. Additionally, at June 30, 2018, the Trading Division had forward soybean purchase contracts for various delivery periods through July 2018 (See Note 4). Approximately 3.2% of the forward soybean purchases were with related parties.



10

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


4. DERIVATIVE INSTRUMENTS

The Company enters into corn, ethanol, natural gas and soybean derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company must designate the hedging instruments based upon the exposure being hedged as a fair value hedge, a cash flow hedge or a hedge against foreign currency exposure. The Company formally documents, designates, and assesses the effectiveness of transactions that receive hedge accounting initially and on an on-going basis.

Commodity Contracts

The Company enters into commodity-based derivatives, for corn, ethanol, natural gas and soybeans in order to protect cash flows from fluctuations caused by volatility in commodity prices. This is also done to protect gross profit margins from potentially adverse effects of market and price volatility on commodity based purchase commitments where the prices are set at a future date. 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. The changes in the fair market value of ethanol derivative instruments are included as a component of revenue.  The changes in the fair market value of corn, natural gas, and soybean derivative instruments are included as a component of cost of goods sold.

At June 30, 2018, the Ethanol Division had a net short (selling) position of 5,207,715 bushels of corn under derivative contracts used to hedge its forward corn contracts, corn inventory and ethanol sales. These corn derivatives are traded on the Chicago Board of Trade as of June 30, 2018 and are forecasted to settle for various delivery periods through December 2019. At June 30, 2018, the Company had a net long (buying) position of 1,680,000 gallons of ethanol under derivative contracts used to hedge its future ethanol sales. These ethanol derivatives are traded on the New York Mercantile Exchange and are forecasted to settle for various delivery periods through July 2018. At June 30, 2018, the Trading Division also had a net short (selling) position of 2,155,000 bushels of soybeans under derivative contracts used to hedge its forward soybean contract purchases. These soybean derivatives are traded on the Chicago Board of Trade and are, as of June 30, 2018, forecasted to settle for various delivery periods through July 2019. These derivatives have not been designated as effective hedges for accounting purposes.

The following table provides balance sheet details regarding the Company's derivative financial instruments at June 30, 2018:

Instrument
Balance Sheet Location
 
Assets
 
Liabilities
Ethanol Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
—

 
$
189,525

Corn Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
764,098

 
$
—

Soybean Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
1,379,469

 
$
—

Soybean Forward Purchase Contracts
Commodity Derivative Instruments - Current
 
$
51,852

 
$
1,857,614

Totals
Commodity Derivative Instruments - Current
 
$
2,195,419

 
$
2,047,139


As of June 30, 2018, the Company had approximately $264,000 cash collateral (restricted cash) related to ethanol, corn, natural gas and soybean derivatives held by three brokers.

The following table provides balance sheet details regarding the Company's futures and options derivative financial instruments at September 30, 2017:

11

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


Instrument
Balance Sheet Location
 
Assets
 
Liabilities
Ethanol Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
—

 
$
89,019

Corn Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
489,531

 
$
—

Soybean Futures and Options Contracts
Commodity Derivative Instruments - Current
 
$
—

 
$
175,338

Soybean Forward Purchase Contracts
Commodity Derivative Instruments - Current
 
$
3,311

 
$
249,472

Totals
Commodity Derivative Instruments - Current
 
$
492,842

 
$
513,829


As of September 30, 2017, the Company had approximately $401,000 of cash collateral (restricted cash) related to ethanol and corn derivatives held by three brokers.

The following table provides details regarding the gains and (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments for the three months and nine months ended June 30, 2017 and June 30, 2018:
Instrument
Statement of Operations Location
 Three Months 6/30/2017
 
Nine Months 6/30/2017
 
Three Months 6/30/2018
 
Nine Months 6/30/2018
Corn Futures and Options Contracts
Cost of Goods Sold
$
(113,169
)
 
$
443,427

 
$
1,464,076

 
$
1,282,687

Ethanol Futures and Options Contracts
Revenues
13,855

 
1,360,415

 
(142,568
)
 
(467,644
)
Natural Gas Futures and Options Contracts
Cost of Goods Sold
25,018

 
158,848

 
8,577

 
165,590

Soybean Futures and Options Contracts
Cost of Good Sold
14,564

 
12,356

 
4,149,333

 
3,219,346

Soybean Forward Purchase Contracts
Cost of Goods Sold
—

 
—

 
(3,963,696
)
 
(3,031,969
)
Totals
 
$
(59,732
)
 
$
1,975,046

 
$
1,515,722

 
$
1,168,010



5. FAIR VALUE MEASUREMENTS
 
The following table provides information on those assets and liabilities measured at fair value on a recurring basis as of June 30, 2018:

Instruments
Carrying Amount
Fair Value
Level 1
Level 2
Level 3
Corn Futures and Options Contracts
$
764,098

$
764,098

$
720,519

$
43,579

$
—

Ethanol Futures and Options Contracts
$
(189,525
)
$
(189,525
)
$
(189,525
)
$
—

$
—

Soybean Futures and Options Contracts
$
1,379,469

$
1,379,469

$
1,379,469

$
—

$
—

Soybean Forward Purchase Asset
$
51,852

$
51,852

$
—

$
51,852

$
—

Soybean Forward Purchase Liability
$
(1,857,614
)
$
(1,857,614
)
$
—

$
(1,857,614
)
$
—

Soybean Inventory
$
—

$
9,229,449

$
—

$
9,229,449

$
—


The following table provides information on those assets and liabilities measured at fair value on a recurring basis as of September 30, 2017:

12

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


Instruments

Carrying Amount
Fair Value
Level 1
Level 2
Level 3
Corn Futures and Options Contracts
$
489,351

$
489,351

$
489,351

$
—

$
—

Ethanol Futures and Options Contracts
$
(89,019
)
$
(89,019
)
$
(89,019
)
$
—

$
—

Soybean Futures and Options Contracts
$
(175,338
)
$
(175,338
)
$
(175,338
)
$
—

$
—

Soybean Forward Purchase
$
(246,162
)
$
(246,162
)
$
—

$
(246,162
)
$
—

Soybean Inventory
$
2,140,305

$
2,140,305

$
—

$
2,140,305

$
—


We determine the fair value of commodity futures derivative instruments utilizing Level 1 inputs 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. Soybean forward purchase contracts are reported at fair value utilizing Level 2 inputs from current contract prices that are being issued by the Company. Estimated fair values for inventories carried at market are based on exchange-quoted prices, adjusted for differences in local markets and quality.

6.  BANK FINANCING

The Company has a loan agreement consisting of four loans, the Term Loan, Declining Revolving Loan (Declining Loan), the Revolving Credit Loan and the Grain Loadout Facility Loan (formerly the Construction Loan) in exchange for liens on all property (real and personal, tangible and intangible) which include, among other things, a mortgage on the property, a security interest on commodity trading accounts and assignment of material contracts. The loan agreement assigns an interest rate of LIBOR plus 290 basis points (2.9%) to each of the individual loans. The Revolving Credit Loan is assigned the one month LIBOR rate which changes on the first day of every month. The Term Loan, the Revolving Loan and the Grain Loadout Facility Loan each have interest charged based on the ninety day (three month) LIBOR rate. The interest rate is assigned at the beginning of the ninety day period and not all of the loans have the same interest rate beginning and ending dates.
During the term of the loans, the Company will be subject to certain financial covenants. The minimum working capital is $15,000,000, which is calculated as current assets plus the amount available for drawing under the long term revolving note, less current liabilities. The minimum fixed charge coverage ratio is no less than 1.15:1.0 measured on a rolling four quarter average basis. However, for any reporting period, if the Company's working capital is equal to or more than $25,000,000, the Company will be subject to maintaining a debt service charge coverage ratio of no less than 1.15:1.0 in lieu of the fixed charge coverage ratio.

Term Loan

The interest rate on the Term Loan at June 30, 2018 was 5.21% and at September 30, 2017 was 4.20%. There were borrowings in the amount of approximately $9,498,000 outstanding on the Term Loan at June 30, 2018 and approximately $11,856,000 outstanding at September 30, 2017. The Term Loan requires monthly installment payments of principal and interest of approximately $282,700, with a final maturity date of February 28, 2021.

Declining Note

The maximum availability of the Declining Loan is $5,000,000 with such amount to be available for working capital purposes. The interest rate on the Declining Loan at June 30, 2018 was 5.21% and at September 30, 2017 was 4.20%. There were no borrowings outstanding on the Declining Loan at June 30, 2018 or at September 30, 2017.

Revolving Credit Loan

The Revolving Credit Loan has a limit of $15,000,000 supported by a borrowing base made up of the Company's corn, ethanol, dried distillers grain, corn oil and soybean inventories reduced by accounts payable associated with those inventories having a priority. It is also supported by the eligible accounts receivable and commodity trading account excess margin funds.The interest

13

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


rate at June 30, 2018 was 4.89% and at September 30, 2017 was 4.14%. There were no borrowings outstanding on the Revolving Credit Loan at June 30, 2018 or at September 30, 2017.

Grain Loadout Facility Loan

The Grain Loadout Facility Loan (formerly Construction Loan) had a limit of $10,000,000. The interest rateat June 30, 2018 was 5.21% and at September 30, 2017 was 4.22%. There were borrowings in the amount of approximately $9,248,000 and $6,476,000 outstanding on the Grain Loadout Facility Loan at June 30, 2018 and September 30, 2017, respectively. The principal balance on the Construction Loan of $10,000,000 was converted to term debt effective December 31, 2017. The Grain Loadout Facility Loan requires monthly installment payments of principal of approximately $119,000 plus interest accrued in arrears from the date of the last payment, such payments commenced on February 1, 2018, with a final maturity date of February 28, 2023.

Long-term debt, as discussed above, consists of the following at June 30, 2018:
Term note
$
9,497,849

Grain Loadout facility loan
9,247,868

Less amounts due within one year
(4,390,373
)
       Net long-term debt
$
14,355,344


The estimated maturities of long-term debt at June 30, 2018 are as follows:
July 1, 2018 to June 30, 2019
$
4,390,373

July 1, 2019 to June 30, 2020
4,550,014

July 1, 2020 to June 30, 2021
4,843,177

July 1, 2021 to June 30, 2022
1,428,571

July 1, 2022 to June 30, 2023
3,533,582

Total long-term debt
$
18,745,717


7. LEASES

At June 30, 2018, the Company had the following operating lease minimum commitments for payments of rentals under leases which at inception had a non-cancellable term of more than one year:
 
Total
July 1, 2018 to June 30, 2019
$
1,022,047

July 1, 2019 to June 30, 2020
918,000

July 1, 2020 to June 30, 2021
918,000

July 1, 2021 to June 30, 2022
382,500

Total minimum lease commitments
$
3,240,547


8. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

Patent Infringement

In February 2010, a lawsuit against the Company was filed by an unrelated party claiming the Company's operation of the oil separation system in a patent infringement. In connection with the lawsuit, in February 2010, the agreement for the construction and installation of the tricanter oil separation system was amended. In this amendment the manufacturer and installer of the tricanter oil separation system indemnifies the Company against all claims of infringement of patents, copyrights or other intellectual property rights from the Company's purchase and use of the tricanter oil system and agrees to defend the Company in the lawsuit filed at no expense to the Company. On October 23, 2014, the court granted summary judgment finding that all of the patents claimed were invalid and that the Company had not infringed. In addition, on September 15, 2016, the United States District

14

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


Court granted summary judgment finding that the patents were invalid due to inequitable conduct before the US Patent and Trademark Office by the inventors and their attorneys. The Company has since settled with the attorneys for the inventors. A motion to reconsider the decision regarding inequitable conduct is pending. In addition, an appeal regarding the current ruling on inequitable conduct has been filed. The manufacturer has, and the Company expects it will continue, to vigorously defend itself and the Company in these lawsuits and in any appeal filed.

If the ruling was to be successfully appealed, the Company estimates that damages sought in this litigation if awarded would be
based on a reasonable royalty to, or lost profits of, the plaintiff. If the court deems the case exceptional, attorney's fees may be awarded and are likely to be $1,000,000 or more. The manufacturer has also agreed to indemnify the Company for these fees. However, in the event that damages are awarded, if the manufacturer is unable to fully indemnify the Company for any reason, the Company could be liable. In addition, the Company may need to cease use of its current oil separation process and seek out a replacement or cease oil production altogether.

Air Permit

On January 4, 2018, the Company received a letter from the Indiana Department of Environmental Management, Office of Air Quality (“IDEM”) alleging violations of the Company's air permit.  While the Company believes it has certain defenses to these allegations, it is currently unable to determine with any certainty the outcome of this matter including the extent of any potential monetary sanctions that may result.

9. UNCERTAINTIES IMPACTING THE ETHANOL INDUSTRY AND OUR FUTURE OPERATIONS

The Company has certain risks and uncertainties that it experiences during volatile market conditions, which can have a severe impact on operations. The Company's revenues are primarily derived from the sale and distribution of ethanol, distillers grains and corn oil to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers and from purchases on the open market. Ethanol sales average approximately 79% of total revenues and corn costs average 63% of total cost of goods sold.

The Company's operating and financial performance is largely driven by prices at which the Company sells ethanol, distillers grains and corn oil, and the related cost of corn. The price of ethanol is influenced by factors such as supply and demand, weather, government policies and programs, and the unleaded gasoline and the petroleum markets, although, since 2005, the prices of ethanol and gasoline began a divergence with ethanol selling for less than gasoline at the wholesale level. 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, weather, government policies and programs. The Company's risk management program is used to protect against the price volatility of these commodities.

10. BUSINESS SEGMENTS

Based on the growth of the Company's Trading Division during the first quarter of fiscal 2018 and operations in fiscal 2018, the Company has determined it now has two reportable operating 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, gross profit, grain inventories, operating income, and total assets:
 

15

CARDINAL ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
June 30, 2018


 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Revenue:
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Ethanol production
$
57,912,534

 
$
50,900,700

 
$
164,337,421

 
$
168,428,966

Grain trading
$
13,284,794

 
$
—

 
$
28,427,732

 
$
—

Total Revenue
$
71,197,328

 
$
50,900,700

 
$
192,765,153

 
$
168,428,966

 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Gross Profit:
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Ethanol production
$
3,427,027

 
$
253,179

 
$
9,646,359

 
$
13,313,269

Grain trading
$
685,316

 
$
—

 
$
1,010,085

 
$
—

Total Gross Profit
$
4,112,343

 
$
253,179

 
$
10,656,444

 
$
13,313,269

 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Operating Income (Loss):
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Ethanol production
$
1,756,168

 
$
(1,258,167
)
 
$
5,029,913

 
$
9,180,302

Grain trading
$
489,455

 
$
—

 
$
433,797

 
$
—

Total Operating Income (Loss)
$
2,245,623

 
$
(1,258,167
)
 
$
5,463,710

 
$
9,180,302

 
June 30, 2018
 
September 30, 2017
Grain Inventories:
(unaudited)
 

Ethanol production
$
7,170,056

 
$
5,754,084

Grain trading
$
9,229,449

 
$
2,140,305

Total Grain Inventories
$
16,399,505

 
$
7,894,389

 
 
 
 
 
June 30, 2018
 
September 30, 2017
Total Assets:
(unaudited)
 

Ethanol production
$
131,974,040

 
$
156,548,789

Grain trading
$
21,072,934

 
$
2,623,207

Total Assets
$
153,046,974

 
$
159,171,996




16

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 June 30, 2018, 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 September 30, 2017.

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 "may," "will," "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, including, but not limited to those listed below and those business risks and factors described elsewhere in this report and our other Securities and Exchange Commission filings. 

•
Reduction, delay, or elimination of the Renewable Fuel Standard;
•
Changes in the availability and price of corn, natural gas and other grains;
•
Our inability to secure credit or obtain additional equity financing we may require in the future to continue our operations;
•
Decreases in the price we receive for our ethanol, distiller grains,corn oil and other grains;
•
Our ability to satisfy the financial covenants contained in our credit agreements with our senior lender;
•
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;
•
Negative impacts that our hedging activities may have on our operations;
•
Ethanol and distiller grains supply exceeding demand and corresponding price reductions;
•
Our ability to generate free cash flow to invest in our business and service our debt;
•
Changes in the environmental regulations that apply to our plant operations;
•
Changes in our business strategy, capital improvements or development plans;
•
Changes in plant production capacity or technical difficulties in operating the plant;
•
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
•
Lack of transport, storage and blending infrastructure preventing our products from reaching high demand markets;
•
Changes in federal and/or state laws;
•
Changes and advances in ethanol production technology;
•
Competition from alternative fuel additives;
•
Changes in interest rates or the lack of credit availability;
•
Changes in legislation benefiting renewable fuels;
•
Our ability to retain key employees and maintain labor relations;
•
Volatile commodity and financial markets;
•
Limitations and restrictions contained in the instruments and agreements governing our indebtedness; and
•
Decreases in export demand due to the imposition of tariffs by foreign governments on ethanol and distillers grains produced in the United States.

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 undertake no duty to update these forward-looking statements even though our situation may change in the future.  We cannot guarantee future results, levels of activity, performance or achievements.  We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report.  You should read this report and the documents that we reference in this report and have filed as exhibits, completely and with the understanding that our actual future results may be materially different from what we currently expect.  We qualify all of our forward-looking statements with these cautionary statements.

Overview

Cardinal Ethanol, LLC is an Indiana limited liability company operating an ethanol plant in east central Indiana near Union City, Indiana. We began producing ethanol, distillers grains and corn oil at the plant in November 2008. In addition, we recently added a facility to allow us to procure, transport and sell grain commodities through our new grain operations (the "Trading Division").


17

On May 15, 2018, the board of directors declared a cash distribution. The dates and amounts are listed in the table below:
Date Declared
 
Distribution Declared Per Unit
 
Total Distribution Amount
 
Month Distribution Paid
May 15, 2018
 
$
100

 
$
1,460,600

 
May 2018

We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities as amended. However, should we experience unfavorable operating conditions, we may need to seek additional funding.

Reportable Operating Segments
 
Operating segments are defined as components of an enterprise for which separate financial information is available that are 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 through our Ethanol Division; and (2) trading of agricultural grains through our Trading Division. 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 and the trading of agricultural grains.  Refer to Note 10, “Business Segments”, of the notes to the condensed unaudited financial statements for financial information about our financial reporting segments.

Ethanol Division

In August 2010, we obtained a new Title V air permit allowing us to increase our annual ethanol production to 140 million gallons compared to 110 million gallons under our previous permit. Our annual ethanol production for the fiscal year ended September 30, 2017 increased to approximately 125 million gallons. We expect ethanol production for the fiscal year ended September 30, 2018 to increase to approximately 135 million gallons due to the completion of certain projects which added storage capacity, improved process efficiencies, and added an additional cooling tower cell and a beer-degasser.

Our revenues are primarily derived from the sale of our ethanol, distillers grains and corn oil. We market and sell ethanol and its co-products (distillers grains and corn oil) primarily in the continental United States using third party marketers. Murex, LLC markets all of our ethanol. Our distillers grains are marketed by CHS, Inc. We market and distribute all of the corn oil we produce directly to end users and third party brokers.    
    
Trading Division

We procure, transport and sell grain commodities through our grain operations. We have and expect to continue to buy primarily soybeans and corn from producers relying principally on forward purchase contracts to ensure an adequate supply of grain. However, we may also purchase grain the day of delivery. Grain prices will typically be comprised of futures prices on the Chicago Mercantile Exchange ("CME") and local basis adjustments. We intend to manage the futures price risk of changing commodity prices by entering into exchange traded futures contracts with the CME. Grain shipments will be made by rail and truck. We anticipate that sales will be made to grain processors and export markets in the southeastern United States and will generally be made by contract for delivery in a future period. Income is expected to be earned on grain bought and sold, the appreciation or depreciation in the basis value of the grain held and the appreciation or depreciation between the futures contract months. The Trading Division began operations at the end of our fourth fiscal quarter of 2017.

To provide funding for the construction of the grain loadout facility, we obtained a construction loan in the amount of $10,000,000 which converted to term debt effective December 31, 2017 (the "Grain Loadout Facility Loan"). Please refer to Item 1- Financial Statements, Note 6 - Bank Financing for additional details.

Results of Operations for the Three Months Ended June 30, 2018 and 2017

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our statement of operations for the three months ended June 30, 2018 and 2017:


18

 
2018
 
2017
Statement of Operations Data
Amount
 
%
 
Amount
 
%
Revenue
$
71,197,328

 
100.0

 
$
50,900,700

 
100.0

Cost of Goods Sold
67,084,985

 
94.2

 
50,647,521

 
99.5

Gross Profit
4,112,343

 
5.8

 
253,179

 
0.5

Operating Expenses
1,866,720

 
2.6

 
1,511,346

 
3.0

Operating Income (Loss)
2,245,623

 
3.2

 
(1,258,167
)
 
(2.5
)
Other Income (Expense), Net
(231,955
)
 
(0.4
)
 
20,576

 
0.1

Net Income (Loss)
$
2,013,668

 
2.8

 
$
(1,237,591
)
 
(2.4
)

Revenues

We have two reportable segments-the Ethanol Division and the Trading Division. Our revenues from operations from our Ethanol Division come from three primary sources: sales of fuel ethanol, distillers grains and corn oil. Revenues from operations of our Trading Division are derived from procuring, transporting and selling grain commodities. Revenues in each division also include net gains or losses from derivatives related to products sold.

The following table shows the sources of our total revenue from the two segments and the approximate percentage of revenues to total revenues in our unaudited condensed consolidated statements of operations for the three months ended June 30, 2018 and 2017:
 
2018
 
2017
Revenue:
Amount
% of Total Revenues
 
Amount
% of Total Revenues
Ethanol production
$
57,912,534

81.3
%
 
50,900,700

100.0
%
Grain trading
13,284,794

18.7

 
—

—

Total Revenue
$
71,197,328

100.0
%
 
$
50,900,700

100.0
%

Ethanol Division

The following table shows the sources of our revenues from our Ethanol Division for the three months ended June 30, 2018 and 2017:

 
2018
 
2017
Revenue Source
Amount
% of Revenues
 
Amount
% of Revenues
Ethanol Sales
$
44,624,976

77.1
%
 
$
41,833,898

82.2
%
Distillers Grains Sales
11,348,365

19.6

 
7,083,349

13.9

Corn Oil Sales
1,802,185

3.1

 
1,860,078

3.7

Carbon Dioxide Sales
124,358

0.2

 
123,375

0.2

Other Revenue
12,650

—

 
—

—

Total Revenues
$
57,912,534

100.0
%
 
$
50,900,700

100.0
%

Ethanol
    
Our revenues from ethanol increased in the three months ended June 30, 2018 as compared the to the same period in 2017.

We experienced an increase in ethanol gallons sold of approximately 12.53% for the three months ended June 30, 2018 as compared to the same period in 2017 resulting primarily from increased ethanol production rates and ethanol yields. We are currently operating at approximately 38% above our nameplate capacity. Management anticipates that going forward our plant will produce approximately 135 million gallons annually due to completion of various projects increasing our production capacity.

The average price per gallon of ethanol sold for the three months ended June 30, 2018 was approximately 5.52% lower than our average price per gallon of ethanol sold for the same period in 2017. This decrease in average market price for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017 is due to concerns related to recent trade

19

disputes with countries such as China, Mexico and the European Union and the potential for the imposition of tariffs on products produced in the United States. In addition, ethanol prices may have been negatively impacted by waivers granted by the EPA exempting certain refiners from compliance with the RFS.

Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices. If corn, crude oil and gasoline prices decrease, that could have a significant negative impact on the market price of ethanol and our profitability, particularly should ethanol stocks increase due to increased production in the industry. A decline in ethanol exports due to trade disputes resulting in tariffs imposed on ethanol produced in the United States would also likely contribute to higher ethanol stocks unless additional demand could be created domestically through the use of higher blends. Finally, the granting of additional EPA waivers to refiners would have a negative effect on ethanol prices.

Distillers Grains

Our revenues from distillers grains increased in the three months ended June 30, 2018 as compared to the same period in 2017. This increase in revenues is the result of an increase in the average market price per ton of distillers grains sold for the period ended June 30, 2018 as compared to the same period in 2017.

The average price per ton of distillers grains sold for the three months ended June 30, 2018 was approximately 71.14% higher than the average price per ton of distillers grains sold for the same period in 2017. This increase in the market price of distillers grains is due to higher corn prices and strong export demand from foreign markets during the three months ended June 30, 2018 as compared to the same period in 2017, which has resulted in an increase in the price of distillers grains as a percentage of corn values.

China has been a significant consumer of exported distillers grains. However, an anti-dumping investigation beginning in January of 2016 into distillers grains produced in the United States led to the imposition by China of preliminary anti-dumping and anti-subsidy duties on imports of ethanol produced in the United States in the fall of 2016 and a final ruling imposing even higher duties in January 2017. The investigation and imposition of these duties resulted in a decline in demand from China. Recent trade disputes with countries such as China, Mexico and the European Union have created additional uncertainty as to future export demand. If export demand suffers, this could lead to lower distillers grains prices unless additional demand can be sustained from domestic or other foreign markets.

Domestic demand for distillers grains may be negatively affected by a seasonal decline during the summer months. In addition, lower corn prices and growing conditions in a particular season’s harvest resulting in poor corn quality could lead to lower distillers grains prices.  In addition, increased production of distillers grains by the ethanol industry would have a negative effect of prices.
   
We sold approximately 6.38% less tons of distillers grains in the three months ended June 30, 2018 as compared to the same period in 2017 due primarily to yield improvement in our ethanol production which reduces the output of distillers grains. Management expects distillers grains production will be relatively comparable going forward to levels of production for the three months ended June 30, 2018.

Corn Oil

Our revenues from corn oil sales decreased in the three months ended June 30, 2018 as compared to the same period in 2017 which was mainly the result of lower corn oil prices. The average price per pound of corn oil was approximately 17.24% lower for the three months ended June 30, 2018 as compared to the same period in 2017 due primarily to uncertainty of biodiesel demand. We sold approximately 19.54% more tons of corn oil in the three months ended June 30, 2018 as compared to the same period in 2017 due to increased yield per bushel and higher production rates correlating to higher ethanol production rates.
    
Management expects corn oil prices will remain relatively steady in the near term. However, corn oil prices may be negatively affected if the renewable volume obligations for biodiesel are reduced by the EPA or if the biodiesel tax credit which was retroactively extended for 2017 is not further extended by Congress. Corn oil prices may also decrease if biodiesel plants switch to lower priced alternatives such as soybean oil. In addition, recent trade disputes have created additional uncertainty which could have a negative affect on corn oil prices. Management expects corn oil production will be relatively comparable going forward to levels of production for the three months ended June 30, 2018.


20

Trading Division

The following table shows the sources of our revenues from our Trading Division for the three months ended June 30, 2018 and 2017:
 
2018
 
2017
Revenue Source
Amount
% of Revenues
 
Amount
% of Revenues
Soybean Sales
$
13,275,694

99.9
%
 
$
—

—
%
Other Revenue
9,100

0.1

 
 
 
Total Revenues
$
13,284,794

100.0
%
 
$
—

—
%

Soybeans

We began operating the Trading Division in late September 2017. During the three months ended June 30, 2018 our revenues were derived primarily from transporting and selling soybeans.

Cost of Goods Sold

Ethanol Division

Our cost of goods sold as a percentage of revenues was approximately 81.2% for the three months ended June 30, 2018 as compared to approximately 99.5% for the same period in 2017. This decrease in cost of goods sold as a percentage of revenues was the result of distillers grains revenue being 65% higher while corn prices were 4% higher for the three months ended June 30, 2018 as compared to the same period in 2017. Our two largest costs of production are corn and natural gas. Cost of goods sold also includes net gains or losses from derivatives related to our commodities purchases.

Corn

Our largest cost associated with the production of ethanol, distillers grains and corn oil is corn cost. During the three months ended June 30, 2018, we used approximately 2.48% more bushels of corn to produce our ethanol, distillers grain and corn oil as compared to the same period in 2017 because our plant was running at a higher production rate. During the three months ended June 30, 2018, our average price paid per bushel of corn was approximately 2.09% higher as compared to the same period in 2017. Increased volatility in corn prices during the three months ended June 30, 2018, was primarily due to concerns related to planting conditions and domestic corn stocks. Corn supplies have been sufficient locally and we have had no difficulty sourcing corn during our third fiscal quarter.
 
Weather, world supply and demand, current and anticipated stocks, agricultural policy and other factors can contribute to volatility in corn prices. If corn prices rise, it will have a negative effect on our operating margins unless the price of ethanol and distillers grains out paces rising corn prices. Volatility in the price of corn could significantly impact our cost of goods sold.

Natural Gas

Our natural gas cost after hedging was lower during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. This decrease in cost of natural gas for the three months ended June 30, 2018 as compared to the same period in 2017 was primarily the result of a decrease of approximately 13.74% in the average price per MMBTU of natural gas due to increased natural gas stocks. We also used approximately 4.23% more natural gas for the three months ended June 30, 2018 as compared to the same period in 2017, mostly because of higher ethanol production levels for the period.

Natural gas prices are expected to increase in the future due to producers shutting down wells resulting in lower natural gas production and to the conversion of power plants across the U.S. from coal to natural gas. Natural gas prices will also be dependent upon the severity of the coming winter weather. If the nation were to experience a catastrophic weather event causing problems related to the supply of natural gas, this could result in higher natural gas prices.

Trading Division

The following table shows the costs incurred to procure various agricultural commodities for our Trading Division for the three months ended June 30, 2018 and 2017:

21

 
2018
 
2017
 
Amount
% of Revenues
 
Amount
% of Revenues
Soybeans
$
12,599,478

100.0
%
 
$
—

—
%
Total Cost of Goods Sold
$
12,599,478

100.0
%
 
$
—

—
%

We began operating the Trading Division in late September 2017. During the three months ended June 30, 2018 our cost was primarily the procurement of soybeans for sale.

Derivatives

We enter into hedging instruments to minimize price fluctuations in the prices of our finished products and inputs. As the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our revenues and our cost of goods sold. These commodity-based derivatives are not designated as effective hedges for accounting purposes. Please refer to Item 3 - Quantitative and Qualitative Disclosures About Market Risk-Commodity Price Risk for information on our derivatives.

Operating Expense

Our operating expenses as a percentage of revenues were approximately 2.6% for the three months ended June 30, 2018 as compared to operating expenses of approximately 3.0% of revenues for the same period in 2017. Operating expenses include salaries and benefits of administrative employees, insurance, taxes, professional fees and other general administrative costs. Our efforts to optimize efficiencies and maximize production may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses generally do not vary with the level of production at the plant, we expect our operating expenses to remain steady into and throughout our 2018 fiscal year.

Operating Income

Our income from operations for the three months ended June 30, 2018 was approximately 3.2% of our revenues as compared to operating loss of approximately 2.5% of revenues for the same period in 2017. The increase in operating income for the three months ended June 30, 2018 was primarily the result of higher distillers grain prices as discussed above.

Other Expense

Our other expense for the three months ended June 30, 2018 and our other income for the same period in 2017 was minimal. Our other expense for the three months ended June 30, 2018 consisted primarily of interest expense.

Results of Operations for the Nine Months Ended June 30, 2018 and 2017

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our statement of operations for the nine months ended June 30, 2018 and 2017:

 
2018
 
2017
Statement of Operations Data
Amount
 
%
 
Amount
 
%
Revenue
$
192,765,153

 
100.0

 
$
168,428,966

 
100.0

Cost of Goods Sold
182,108,709

 
94.5

 
155,115,697

 
92.1

Gross Profit
10,656,444

 
5.5

 
13,313,269

 
7.9

Operating Expenses
5,192,734

 
2.7

 
4,132,967

 
2.5

Operating Income
5,463,710

 
2.8

 
9,180,302

 
5.4

Other Expense, Net
(596,667
)
 
(0.3
)
 
(218,556
)
 
(0.1
)
Net Income
$
4,867,043

 
2.5

 
$
8,961,746

 
5.3


Revenues

We have two reportable segments--the Ethanol Division and the Trading Division. Our revenues from operations from our Ethanol Division come from three primary sources: sales of fuel ethanol, distillers grains and corn oil. Revenues from operations

22

of our Trading Division are derived from procuring, transporting and selling grain commodities. Revenues in each division also include net gains or losses from derivatives related to products sold.

The following table shows the sources of our total revenue from the two segments and the approximate percentage of revenues to total revenues in our unaudited condensed consolidated statements of operations for the nine months ended June 30, 2018 and 2017.
 
2018
 
2017
Revenue:
Amount
% of Total Revenues
 
Amount
% of Total Revenues
Ethanol production
$
164,337,421

85.3
%
 
$
168,428,966

100.0
%
Grain trading
28,427,732

14.7

 
—

—

Total Revenue
$
192,765,153

100.0
%
 
$
168,428,966

100.00
%

Ethanol Division

The following table shows the sources of our revenues from our Ethanol Division for the nine months ended June 30, 2018 and 2017:

 
2018
 
2017
Revenue Source
Amount
% of Revenues
 
Amount
% of Revenues
Ethanol Sales
$
127,131,852

77.4
%
 
$
139,639,375

82.9
%
Distillers Grains Sales
30,733,044

18.7

 
22,276,935

13.2

Corn Oil Sales
5,858,735

3.6

 
5,916,563

3.5

Carbon Dioxide Sales
371,106

0.2

 
358,525

0.2

Other Revenue
242,684

0.1

 
237,568

0.2

Total Revenues
$
164,337,421

100.0
%
 
$
168,428,966

100.0
%

Ethanol
    
Our revenues from ethanol decreased in the nine months ended June 30, 2018 as compared the to the same period in 2017.

The average price per gallon of ethanol sold for the nine months ended June 30, 2018 was approximately 15.92% lower than our average price per gallon of ethanol sold for the same period in 2017. This decrease in average market price for the nine months ended June 30, 2018 as compared to the nine months ended June 30, 2017 is due to increased industry-wide production which was in excess of demand. In addition, concerns related to recent trade disputes and waivers granted by the EPA exempting certain refiners from compliance with the RFS negatively impacted ethanol prices.

We experienced an increase in ethanol gallons sold of approximately 3.46% for the nine months ended June 30, 2018 as compared to the same period in 2017 resulting primarily from normal fluctuations in when our customers order and when those orders are filled by shipments. We are currently operating at approximately 38% above our nameplate capacity. Management anticipates that going forward our plant will produce approximately 135 million gallons annually due to completion of various projects increasing our production capacity.
    
Distillers Grains

Our revenues from distillers grains increased in the nine months ended June 30, 2018 as compared to the same period in 2017. This increase in revenues is the result of an increase in the average market price per ton of distillers grains sold for the period ended June 30, 2018 as compared to the same period in 2017.

The average price per ton of distillers grains sold for the nine months ended June 30, 2018 was approximately 46.53% higher than the average price per ton of distillers grains sold for the same period in 2017. This increase in the market price of distillers grains is due to higher export demand during the nine months ended June 30, 2018 as compared to the same period in 2017, which has resulted in an increase in the price of distillers grains as a percentage of corn values.


23

We sold approximately 5.43% less tons of distillers grains in the nine months ended June 30, 2018 as compared to the same period in 2017 due primarily to yield improvement in our ethanol production which reduces the output of distillers grains. Management expects distillers grains production will be relatively comparable going forward to levels of production for the nine months ended June 30, 2018.

Corn Oil

Our revenues from corn oil sales was comparable in the nine months ended June 30, 2018 as compared to the same period in 2017. The average price per pound of corn oil was lower for the nine months ended June 30, 2018 as compared to the same period in 2017. We sold more tons of corn oil in the nine months ended June 30, 2018 as compared to the same period in 2017 due to increased yield per bushel.
    
Trading Division

The following table shows the sources of our revenues from our Trading Division for the nine months ended June 30, 2018 and 2017:
 
2018
 
2017
Revenue Source
Amount
% of Revenues
 
Amount
% of Revenues
Soybean Sales
$
28,409,832

99.9
%
 
$
—

—
%
Other Revenue
17,900

0.1

 
—

 
Total Revenues
$
28,427,732

100.0
%
 
$
—

—
%

Soybeans

We began operating the Trading Division in late September 2017. During the nine months ended June 30, 2018 our revenues were derived primarily from transporting and selling soybeans.

Cost of Goods Sold

Ethanol Division

Our cost of goods sold as a percentage of revenues was approximately 94.5%for the nine months ended June 30, 2018 as compared to approximately 92.1% for the same period in 2017. This increase in cost of goods sold as a percentage of revenues was the result of the narrowing of the margin between ethanol prices relative to the cost of corn for the nine months ended June 30, 2018 as compared to the same period in 2017. Our two largest costs of production are corn and natural gas. Cost of goods sold also includes net gains or losses from derivatives related to our commodities purchases.

Corn

Our largest cost associated with the production of ethanol, distillers grains and corn oil is corn cost. During the nine months ended June 30, 2018, we used approximately 6.62% more bushels of corn to produce our ethanol, distillers grain and corn oil as compared to the same period in 2017 because we produced 1.65% more gallons of denatured ethanol and improved yield per bushel by 2.20%. During the nine months ended June 30, 2018, our average price paid per bushel of corn was approximately 2.13% lower as compared to the same period in 2017. Corn prices have trended lower due to the plentiful 2017 harvest. Corn supplies have been sufficient locally and we have had no difficulty sourcing corn during our third fiscal quarter.
 
Natural Gas

Our natural gas cost after hedging was lower during the nine months ended June 30, 2018 as compared to the nine months ended June 30, 2017. This decrease in cost of natural gas for the nine months ended June 30, 2018 as compared to the same period in 2017 was primarily the result of an decrease of approximately 4.47% in the average price per MMBTU of natural gas due to increased natural gas stocks. We also used approximately 1.92% more natural gas for the nine months ended June 30, 2018 as compared to the same period in 2017 because of higher ethanol production levels for the period.


24

Trading Division

The following table shows the costs incurred to procure various agricultural commodities for our Trading Division for the nine months ended June 30, 2018 and 2017:
 
2018
 
2017
 
Amount
% of Revenues
 
Amount
% of Revenues
Soybeans
$
27,417,647

100.00
%
 
$
—

—
%
Total Cost of Goods Sold
$
27,417,647

100.00
%
 
$
—

—
%

We began operating the Trading Division in late September 2017. During the nine months ended June 30, 2018 our cost was primarily the procurement of soybeans for sale.

Derivatives

We enter into hedging instruments to minimize price fluctuations in the prices of our finished products and inputs. As the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our revenues and our cost of goods sold. These commodity-based derivatives are not designated as effective hedges for accounting purposes. Please refer to Item 3 - Quantitative and Qualitative Disclosures About Market Risk-Commodity Price Risk for information on our derivatives.

Operating Expense

Our operating expenses as a percentage of revenues were approximately 2.7% for the nine months ended June 30, 2018 as compared to operating expenses of approximately 2.5% of revenues for the same period in 2017. Operating expenses include salaries and benefits of administrative employees, insurance, taxes, professional fees and other general administrative costs. Our efforts to optimize efficiencies and maximize production may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses generally do not vary with the level of production at the plant, we expect our operating expenses to remain steady into and throughout our 2018 fiscal year.

Operating Income

Our income from operations for the nine months ended June 30, 2018 was approximately 2.8% of our revenues as compared to operating income of approximately 5.4% of revenues for the same period in 2017. The decrease in operating income for the nine months ended June 30, 2018 was primarily the result of increased corn prices relative to the price of ethanol.

Other Expense

Our other expense for the nine months ended June 30, 2018 and for the same period in 2017 was minimal. Our other expense for the nine months ended June 30, 2018 and June 30, 2017 consisted primarily of interest expense.

Changes in Financial Condition for the Nine Months Ended June 30, 2018

The following table highlights the changes in our financial condition:

 
June 30, 2018
(Unaudited)
 
September 30, 2017
Current Assets
$
51,972,790

 
$
50,139,370

Current Liabilities
$
17,465,956

 
$
18,007,407

Long-Term Liabilities
$
14,355,344

 
$
14,581,758

Member's Equity
$
121,225,674

 
$
126,582,831


We experienced an increase in our current assets at June 30, 2018 as compared to September 30, 2017. This increase was primarily driven by an increase in our grain inventories at June 30, 2018 as compared to September 30, 2017 due to operations of our Trading Division. We also experienced an increase in our commodity derivative instruments due to relatively stable grain prices during the period. The value of our derivative instruments are most affected by movements in market prices. We also

25

experienced an increase in our trade accounts receivable due to the normal ebbs and flows of our operating cycle. These increases were partially offset by a decrease in our cash due to payments for grain inventories.

We experienced a decrease in our total current liabilities at June 30, 2018 as compared to September 30, 2017. This decrease was primarily due to a decrease in grain accounts payable due to disbursements to producers for deferred payments in early January 2018 and a decrease in trade accounts payable due to payments on capital projects in the first and second quarters of our 2018 fiscal year. These decreases were partially offset by an increase in current maturities of long term debt due to recording monthly payments due on the Grain Loadout Facility Loan over the next twelve months as a current liability. The loan converted to a term loan in December 2017.

We experienced a decrease in our long-term liabilities as of June 30, 2018 as compared to September 30, 2017. At June 30, 2018, we had $14,355,344 of outstanding borrowings due in greater than one year from the balance sheet date as compared to $14,581,758 at September 30, 2017 because of the additional debt incurred in the first quarter of fiscal year 2018 for construction of the grain receiving and loading facility for our Trading Division.

Liquidity and Capital Resources
    
Based on financial forecasts performed by our management, we anticipate that we will have sufficient cash from our current credit facilities and cash from our operations to continue to operate the ethanol plant for the next 12 months. We do not anticipate seeking additional equity financing during our 2018 fiscal year. However, should 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 may need to rely on our revolving lines of credit for operations.
        
The following table shows cash flows for the nine months ended June 30, 2018 and 2017:
 
 
2018
 
2017
Net cash provided by operating activities
 
$
2,784,901

 
$
10,330,990

Net cash used for investing activities
 
$
(1,969,441
)
 
$
(10,732,913
)
Net cash used for financing activities
 
$
(9,810,066
)
 
$
(13,481,113
)
Net decrease in Cash and Restricted cash
 
$
(8,994,606
)
 
$
(13,883,036
)
Cash and Restricted cash, beginning of period
 
$
19,397,161

 
$
24,462,911

Cash and Restricted cash, end of period
 
$
10,402,555

 
$
10,579,875


Cash Flow from and used in Operations

We experienced a decrease in our cash flow from operations for the nine months ended June 30, 2018 as compared to the same period in 2017. This was primarily the result of decreased net income as a result of decreased ethanol prices relative to the cost of corn and cash used on inventory and other working capital components for the nine months ended June 30, 2018 compared with the same period in 2017.

Cash Flow used for Investing Activities

We used less cash in investing activities for the nine months ended June 30, 2018 as compared to the same period in 2017. Cash used in investing activities was used for payments for construction in progress and capital expenditures due to our capital projects which were substantially completed and paid by December 31, 2017.
    
Cash Flow used for Financing Activities

We used less cash in financing activities for the nine months ended June 30, 2018 as compared to the same period in 2017. This decrease was mainly the result less cash paid for distributions, and less net proceeds on long term debt during the nine months ended June 30, 2018 compared with the same period in 2017.

Our liquidity, results of operations and financial performance will be impacted by many variables, including the market price for commodities such as, but not limited to, corn, ethanol and other energy commodities, as well as the market price for any co-products generated by the facility and the cost of labor and other operating costs.  Assuming future relative price levels for corn, ethanol and distillers grains remain consistent with the relative price levels as of June 30, 2018, we expect operations to generate adequate cash flows to maintain operations.

26

Short and Long Term Debt Sources

We have a loan agreement consisting of four loans, the Term Loan, the Declining Revolving Loan ("Declining Loan"), the Revolving Credit Loan and a Grain Loadout Facility Loan (formerly the Construction Loan). In exchange for these loans, we granted liens on all property (real and personal, tangible and intangible) which include, among other things, a mortgage on the property, a security interest on commodity trading accounts, and assignment of material contracts. Please refer to Item 1 - Financial Statements, Note 6 - Bank Financing for additional details.
Term Loan
    
The interest rate on the Term Loan is based on the 3-month London Interbank Offered Rate ("LIBOR") plus two hundred ninety basis points. The interest rate at June 30, 2018 was 5.21%. The Term Loan requires monthly installment payments of approximately $282,700 commencing on September 1, 2016, with a final maturity date of February 28, 2021. There was approximately $9,498,000 outstanding on the Term Loan at June 30, 2018 and approximately $11,856,000 outstanding on the Term Loan at September 30, 2017.

Declining Loan

The maximum availability of the Declining Loan is $5,000,000 with such amount to be available for working capital purposes. The interest rate on the Declining Loan is based on the 3-month LIBOR plus two hundred ninety basis points. The interest rate at June 30, 2018 was 5.21%. There was no borrowings outstanding on the Declining Loan at June 30, 2018 or September 30, 2017.
    
Revolving Credit Loan

The Revolving Credit Loan has a limit of $15,000,000 supported by a borrowing base made up of our corn, ethanol, dried distillers grain, corn oil and soybean inventories reduced by accounts payable associated with those inventories having a priority. It is also supported by the eligible accounts receivable and commodity trading account excess margin funds. The interest rate on the Revolving Credit Loan is based on the 1-month LIBOR plus two hundred ninety basis points. The interest rate at June 30, 2018 was 4.89%. There were no borrowings outstanding on the Revolving Credit Note at June 30, 2018 or September 30, 2017.
    
Grain Loadout Facility Loan

The Grain Loadout Facility Loan (formerly construction loan) has a limit of $10,000,000. The interest rate on the Grain Loadout Facility Loan is based on the 3-month LIBOR plus two hundred ninety basis points and at June 30, 2018 was 5.21%. There were borrowings in the amount of approximately $9,248,000 outstanding on the Grain Loadout Facility Loan at June 30, 2018. There were borrowings of $6,476,000 on the Grain Loadout Facility Loan at September 30, 2017. The principal balance on the Construction Loan of $10,000,000 was converted to term debt effective December 31, 2017. The Grain Loadout Facility Loan requires monthly installment payments of principal of approximately $119,000 plus interest accrued in arrears from the date of the last payment, such payments commenced on February 1, 2018, with a final maturity date of February 28, 2023.
    
Covenants

During the term of the loans, we will be subject to certain financial covenants. Our minimum working capital is $15,000,000, which is calculated as our current assets plus the amount available for drawing under our long term revolving note, less current liabilities. Our minimum fixed charge coverage ratio is no less than 1.15:1.0 measured on a rolling four quarter average basis. However, for any reporting period, if our working capital is equal to or more than $25,000,000, we will be subject to maintaining a debt service charge coverage ratio of no less than 1.15:1.0 in lieu of the fixed charge coverage ratio.

Our loan agreement also requires us to obtain prior approval from our lender before making, or committing to make, capital expenditures exceeding an aggregate amount of $5,000,000.

We are meeting our liquidity needs and complying with our financial covenants and the other terms of our loan agreements at June 30, 2018. Based on current management projections, we anticipate that future operations will be sufficient to generate enough cash flow to maintain operations, service any new debt and comply with our financial covenants and other terms of our loan agreements through June 30, 2019. Should market conditions deteriorate in the future, circumstances may develop which could result in us violating the financial covenants or other terms of our loan agreements. Should we violate the terms or covenants of our loan or fail to obtain a waiver of any such term or covenant, our primary lender could deem us in default of our loans and

27

require us to immediately repay a significant portion or possibly the entire outstanding balance of our loans if we have a balance outstanding. In that event, our lender could also elect to proceed with a foreclosure action on our plant.
Development Agreement

In September 2007, the Company entered into a development agreement with Randolph County Redevelopment Commission (“the Commission”) to promote economic development in the area. Under the terms of this agreement, beginning in January 2008 through December 2028, the money the Company pays toward property tax expense is allocated to an expense and an acquisition account. The funds in the acquisition account can be used by the Commission to purchase equipment, at the Company's direction, for the plant. The Company does not have title to or control over the funds in the acquisition account, no amounts have been recorded in the balance sheet relating to this account.

Tax Abatement

In October 2006, the real estate that our plant was constructed on was determined to be an economic revitalization area, which qualified us for tax abatement. The abatement period is for a ten year term, with an effective date beginning calendar year end 2009 for the property taxes payable in calendar year 2010. The program allows for 100% abatement of property taxes beginning in year 1, and then decreases on a ratable scale so that in year 11 the full amount of property taxes are due and payable. We must apply annually and meet specified criteria to qualify for the abatement program.

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 useful lives of fixed assets; allowance for doubtful accounts; the valuation of basis and delay price contracts on corn purchases; derivatives; inventory; patronage dividends, long-lived assets and inventory purchase commitments.  An in-depth description of these can be found in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017.  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 nine months ended June 30, 2018.
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 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.

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our Term Loan, Declining Loan, Revolving Credit Loan and Grain Loadout Facility Loan (formerly Construction Loan) which bear variable interest rates.  The interest rate for the Term Loan is the 3-month LIBOR rate plus 290 basis points with no minimum. There were borrowings in the amount of approximately $9,498,000 outstanding on the Term Loan and the applicable interest rate was 5.21% at June 30, 2018. The interest rate on the Declining Loan is the 3-month LIBOR plus 290 basis points with no minimum. There were no borrowings outstanding on the Declining Loan and the applicable interest rate was 5.21% at June 30, 2018. The interest rate for the Revolving Credit Note is the 1-month LIBOR rate plus 290 basis points with no minimum. There were no outstanding balances on the Revolving Credit Note at June 30, 2018 and the applicable interest rate was 4.89%. The interest rate on the Grain Loadout Facility Loan is the 3-month LIBOR plus 290 basis points with no minimum. There were borrowings in the amount of approximately $9,248,000 outstanding on the Grain Loadout Facility Loan and the applicable interest rate was 5.21% at June 30, 2018. The specifics of the Term Loan, Declining Loan, the Revolving Credit Loan and the Grain Loadout Facility Loan are discussed in greater detail above. If we were to experience a 10% adverse change in LIBOR, the annual effect

28

such change would have on our statement of operations, based on the amount we had outstanding on our variable interest rate loans at June 30, 2018, would be approximately $98,000.

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 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 distiller's grains, through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues. The immediate recognition of hedging gains and losses 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.

We enter into forward contracts for our commodity purchases and sales on a regular basis.  It is our intent that, as we enter in to these contracts, we will use various hedging instruments to maintain a near even market position.  For example, if we have 1 million bushels of corn under fixed price contracts we would generally expect to enter into a short hedge position to offset our price risk relative to those bushels we have under fixed price contracts.  Because our ethanol marketing company is selling substantially all of the gallons it markets on a spot basis we also include the corn bushel equivalent of the ethanol we have produced that is inventory but not yet priced as bushels that need to be hedged.

The following table provides details regarding the gains and (losses) from our derivative instruments in the statements of operations, none of which are designated as hedging instruments, for the three and nine months ended June 30, 2018 and 2017:
 
Three Months Ended
Three Months Ended
Nine Months Ended
Nine Months Ended
 
June 30, 2018
June 30, 2017
June 30, 2018
June 30, 2017
Corn Futures and Options Contracts
$
1,464,076

$
(113,169
)
$
1,282,687

$
443,427

Ethanol Futures and Options Contracts
(142,568
)
13,855

(467,644
)
1,360,415

Natural Gas Futures and Options Contracts
8,577

25,018

165,590

158,848

Soybean Futures and Options Contracts
4,149,333

14,564

3,219,346

12,356

Soybean Forward Contracts
(3,963,696
)
—

(3,031,969
)
—

Totals
$
1,515,722

$
(59,732
)
$
1,168,010

$
1,975,046


These soybean contracts will be marked to market as the contract periods expire. This means that any gains or losses realized will be recognized in our gross margin at each month end until they are delivered upon.  Due to the volatility and risk involved in the commodities market, we cannot be certain that these gains or losses will be realized. 

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.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn oil, 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 and average ethanol, distillers grains and corn oil prices as of June 30, 2018 net of the forward and future contracts used to hedge our market risk. The volumes are based on our expected use and sale of these commodities for a one year period from June 30, 2018. The results of this analysis, which may differ from actual results, are approximately as follows:


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Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)
Unit of Measure
Hypothetical Adverse Change in Price as of June 30, 2018
Approximate Adverse Change to Income
Natural Gas
3,300,000

MMBTU
10%

$
502,672

Ethanol
128,203,880

Gallons
10%

$
17,948,543

Corn
43,170,488

Bushels
10%

$
14,257,425

DDGs
324,000

Tons
10%

$
4,002,621

Corn Oil
31,500,000

Pounds
10%

$
683,970

Soybeans
5,000,000

Bushels
10%

$
1,373,787


Liability Risk

We participate in a captive reinsurance company (the “Captive”).  The Captive re-insures losses related to worker's compensation, commercial property and general liability.  Premiums are accrued by a charge to income for the period to which the premium relates and is remitted by our insurer to the captive re-insurer.  The Captive re-insures catastrophic losses in excess of a predetermined amount.  Our premiums are structured such that we have made a prepaid collateral deposit estimated for losses related to the above coverage.  The Captive insurer has estimated and collected an amount in excess of the estimated losses but less than the catastrophic loss limit insured by the Captive. We cannot be assessed in excess of the amount in the collateral fund.

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), Jeff Painter, along with our Chief Financial Officer (the principal financial officer), William Dartt, 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 June 30, 2018.  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 our third quarter of our 2018 fiscal year that have materially affected, or are likely to materially affect, our internal control over financial reporting.

PART II.     OTHER INFORMATION

Item 1. Legal Proceedings

Patent Infringement

On June 27, 2008, we entered into a Tricanter Purchase and Installation Agreement with ICM, Inc. for the construction and installation of a Tricanter Oil Separation System. On February 12, 2010, GS CleanTech Corporation ("GS CleanTech") filed a lawsuit in the United States District Court for the Southern District of Indiana, claiming that the Company's operation of the oil recovery system manufactured and installed by ICM, Inc. infringes a patent claimed by GS CleanTech. GS CleanTech sought royalties and damages associated with the alleged infringement, as well as attorney's fees from the Company. GS CleanTech subsequently filed actions against at least fourteen other ethanol producing companies for infringement of its patent rights, adding

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several additional patents. GS CleanTech successfully petitioned for the cases to be joined in a multi-district litigation ("MDL") which was assigned to the United States District Court for the Southern District of Indiana (Case No. 1:10-ml-02181). We subsequently answered and counterclaimed that the patent claims at issue are invalid and that the Company is not infringing.

Motions for summary judgment were filed by the defendants, including the Company, and GS CleanTech. Meanwhile, GS CleanTech filed suit against another group of defendants which were joined with the MDL. On October 23, 2014, the United States District Court granted summary judgment finding that all of the patents claimed by GS CleanTech were invalid and that the Company had not infringed. In addition, on September 15, 2016, the United States District Court granted summary judgment finding that the patents were invalid due to inequitable conduct before the US Patent and Trademark Office by the inventors and their attorneys. GS CleanTech has asked the United States District Court to reconsider its decision regarding inequitable conduct. In addition, GS CleanTech and its attorneys filed a Notice of Appeal. The defendants have since settled with the attorneys for GS CleanTech.

On February 16, 2010, ICM, Inc. agreed to indemnify the Company from and against all claims, demands, liabilities, actions, litigations, losses, damages, costs and expenses, including reasonable attorney's fees arising out of any claim of infringement of patents, copyrights or other intellectual property rights by reason of our purchase and use of the oil recovery system and agrees to defend the Company. Several of the other defendants also use equipment and processes provided by ICM, Inc. ICM, Inc. has, and we expect it will continue, to vigorously defend itself and the Company in this lawsuit and in any appeal filed by GS CleanTech. If GS CleanTech were to be successful in any appeal filed and allowed to continue to pursue its claims, we estimate that damages, if awarded, would be based on a reasonable royalty to, or lost profits of, GS CleanTech. Because of its rulings, it seems unlikely that the District Court would deem the case exceptional. However, in the event it would be deemed to be exceptional, attorney's fees may be awarded and are likely to be $1,000,000 or more. ICM, Inc. has also agreed to indemnify us. However, in the event that damages were to be awarded, if ICM, Inc. does not fully indemnify us for any reason, we could be liable and could also be required to cease use of our oil separation process and seek out a replacement or cease oil production altogether.

Air Permit

On January 4, 2018, we received a letter from the Indiana Department of Environmental Management, Office of Air Quality (“IDEM”) alleging violations of our air permit.  IDEM alleges that we (i) constructed and operated a fermenter without previous construction or operational approval; (ii) constructed and operated emission units (conveyors and legs) without the appropriate emission controls (two baghouses instead of one larger baghouse); (iii) constructed and operated emission units (steel bins) without emission controls; and (iv) operated emission units above the emission limits.  IDEM indicates that it intends to refer this matter for formal enforcement action.  We are currently reviewing the allegations and have provided IDEM with additional information.  While we believe that we have certain defenses to these allegations, we are currently unable to determine with any certainty the outcome of this matter including the extent of any potential monetary sanctions that may result.

Item 1A.    Risk Factors
    
The following risk factors are provided due to material changes from the risk factors previously disclosed in our annual report on Form 10-K. The risk factors set forth below should be read in conjunction with the risk factors section and the Management's Discussion and Analysis section for the fiscal year ended September 30, 2017, included in our annual report on Form 10-K.

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

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A cyber attack or other information security breach could have a material adverse effect on our operations and result in financial losses. We are regularly the target of attempted cyber and other security threats and must continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact.  If we are unable to prevent cyber attacks and other information security breaches, we may encounter significant disruptions in our operations which could adversely impact our business, financial condition and results of operations or result in the unauthorized disclosure of confidential information. Such breaches may also harm our reputation, result in financial losses or subject us to litigation or other costs or penalties.

Government policies and regulations, particularly those affecting the agricultural sector and related industries, could adversely affect our operations and profitability.  Agricultural commodity production and trade flows are significantly affected by government policies and regulations.  Governmental policies affecting the agricultural industry, such as taxes, trade tariffs, duties, subsidies, import and export restrictions on commodities and commodity products, can influence industry profitability, the planting of certain crops, the location and size of crop production, whether unprocessed or processed commodity products are traded, and the volume and types of imports and exports.  In addition, international trade disputes can adversely affect trade flows by limiting or disrupting trade between countries or regions. Future governmental policies, regulations or actions affecting our industry may adversely affect the supply of, demand for and prices of our products, restrict our ability to do business and cause our financial results to suffer.
 
We may experience negative impacts of higher ethanol tariffs and other disruptions to international agricultural trade related to current trade actions announced by the Trump administration and responsive actions announced by trading partners, including by China. On April 2, 2018, the Chinese government increased the tariff on U.S. ethanol imports into China from 30% to 45%.  We cannot estimate the exact effect this tariff increase will have on the overall domestic ethanol market.  However, the increased tariff may reduce overall U.S. ethanol export demand, which could have a negative effect on U.S. domestic ethanol prices.

Our Trading Division business is affected by the supply and demand of commodities, and is sensitive to factors outside of our control. Adverse price movements could negatively affect our profitability and results of operations.  Our Trading Division buys, sells and holds inventories of agricultural commodities, some of which are readily traded on commodity futures exchanges. Unfavorable weather conditions, both local and worldwide, as well as other factors beyond our control, can affect the supply and demand of these commodities and expose us to liquidity pressures to finance hedges in the grain business in rapidly rising markets. Increased costs of inventory and prices of raw material would decrease our profit margins and adversely affect our results of operations. While we attempt to manage the risk associated with commodity price changes for our grain inventory positions with derivative instruments, including purchase and sale contracts, we are unable to offset 100% of the price risk of each transaction due to timing, availability of futures and options contracts and third-party credit risk. Furthermore, there is a risk that the derivatives we employ will not be effective in offsetting all of the risks that we are trying to manage. This can happen when the derivative and the underlying value of grain inventories and purchase and sale contracts are not perfectly matched. Our grain derivatives, for example, do not perfectly correlate with the basis component of our grain inventory and contracts. (Basis is defined as the difference between the local cash price of a commodity and the corresponding exchange-traded futures price.) Differences can reflect time periods, locations or product forms. Although the basis component is smaller and generally less volatile than the futures component of our grain market price, basis moves on a large grain position can significantly impact the profitability of the Trading Division. Our futures, options and over-the-counter contracts are subject to margin calls. If there are large movements in the commodities market, we could be required to post significant levels of margin, which would impact our liquidity. There is no assurance that the efforts we have taken to mitigate the impact of the volatility of the prices of commodities upon which we rely will be successful and any sudden change in the price of these commodities could have an adverse effect on our business and results of operations.

We face intense competition in our Trading Division. We face significant competition in our Trading Division and we have numerous competitors, some of which are larger and have greater financial resources than we have. Competition could cause us to lose market share and talented employees, exit certain lines of business, increase marketing or other expenditures or reduce pricing, each of which could have an adverse effect on our business and profitability.

Government policies and regulations, particularly those affecting the agricultural sector and related industries, could adversely affect our operations and profitability.  Agricultural commodity production and trade flows are significantly affected by government policies and regulations. Governmental policies affecting the agricultural industry, such as taxes, tariffs, duties, subsidies, import and export restrictions on agricultural commodities and commodity products can influence industry profitability, the planting of certain crops versus other uses of agricultural resources, the location and size of crop production, whether unprocessed or processed commodity products are traded and the volume and types of imports and exports. In addition, international trade disputes can adversely affect agricultural commodity trade flows by limiting or disrupting trade between countries or regions. Future governmental policies, regulations or actions affecting our industry may adversely affect the supply of, demand for and prices of our products, restrict our ability to do business and cause our financial results to suffer.

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Our Trading Division uses derivative contracts to reduce volatility in the commodity markets. Non-performance by the counter-parties to those contracts could adversely affect our future results of operations and financial position. A significant amount of our commodity purchases and sales are done through forward contracting. In addition, we use exchange traded and to a lesser degree over-the-counter contracts to reduce volatility in changing commodity prices. A significant adverse change in commodity prices could cause a counter-party to one or more of our derivative contracts to not perform on their obligation.
If a substantial portion of our inventory becomes damaged or obsolete, its value would decrease and our profit margins would suffer. We may carry significant amounts of inventory in our Trading Division. The value of our inventories could decrease due to deterioration in the quality of our grain inventory due to damage, moisture, insects, disease or foreign material. If the quality of our grain were to deteriorate below an acceptable level, the value of our inventory could decrease significantly.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits.

(a)
The following exhibits are filed as part of this report.
Exhibit No.
 
Exhibit
31.1

 
31.2

 
32.1

 
32.2

 
101

 
The following financial information from Cardinal Ethanol, LLC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of June 30, 2018 and September 30, 2017, (ii) Condensed Statements of Operations for the three and nine months ended June 30, 2018 and 2017, (iii) Condensed Statements of Cash Flows for the nine months ended June 30, 2018 and 2017, and (iv) the Notes to Condensed Unaudited 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.

33

 
 
 
CARDINAL ETHANOL, LLC
 
 
 
 
Date:
August 2, 2018
 
/s/ Jeffrey Painter
 
 
 
Jeffrey Painter
 
 
 
President and Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
August 2, 2018
 
/s/ William Dartt
 
 
 
William Dartt
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
    

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Cardinal Ethanol LLC Reports