Attached files

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EX-32.2 - EX-32.2 - Heron Lake BioEnergy, LLChlb-20200131ex322f91d10.htm
EX-32.1 - EX-32.1 - Heron Lake BioEnergy, LLChlb-20200131ex3219a56e2.htm
EX-31.2 - EX-31.2 - Heron Lake BioEnergy, LLChlb-20200131ex3128e6538.htm
EX-31.1 - EX-31.1 - Heron Lake BioEnergy, LLChlb-20200131ex311f257eb.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the quarterly period ended January 31, 2020

 

OR

 

 

 

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

 

For the transition period from                    to                  .

 

COMMISSION FILE NUMBER 000-51825

 

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

 

 

 

 

Minnesota

 

41-2002393

(State or other jurisdiction of organization)

 

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

 

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

(Address of principal executive offices)

 

(507) 793-0077

(Issuer’s telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

 

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

None

 

NA

 

NA

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ☒  Yes  ☐  No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ☒    Yes  ☐  No

 

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

 

 

 

 

Large accelerated filer  ☐

 

Accelerated filer  ☐

 

 

Smaller reporting company ☐

Non-accelerated filer  ☒

 

Emerging growth company ☐

 

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

 

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

 

As of March 16, 2020, there were 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding.

 

 

 

 

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

 

January 31, 2020

    

October 31, 2019

 

 

 

(unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

2,095,986

 

$

4,541,295

 

Restricted cash

 

 

42,221

 

 

52,516

 

Accounts receivable

 

 

988,463

 

 

4,891,249

 

Inventory

 

 

7,751,957

 

 

6,276,258

 

Commodity derivative instruments

 

 

144,410

 

 

95,823

 

Prepaid expenses and other current assets

 

 

641,557

 

 

408,325

 

Total current assets

 

 

11,664,594

 

 

16,265,466

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

38,175,096

 

 

39,408,195

 

 

 

 

 

 

 

 

 

Operating lease right of use assets

 

 

10,257,425

 

 

 —

 

 

 

 

 

 

 

 

 

Other assets

 

 

697,254

 

 

922,254

 

 

 

 

 

 

 

 

 

Total Assets

 

$

60,794,369

 

$

56,595,915

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

333,977

 

$

333,977

 

Checks drawn in excess of bank balances

 

 

724,292

 

 

 —

 

Accounts payable

 

 

3,124,877

 

 

5,386,618

 

Commodity derivative instruments

 

 

12,912

 

 

 —

 

Accrued expenses

 

 

380,927

 

 

423,266

 

Operating lease, current liabilities

 

 

1,296,140

 

 

 —

 

Total current liabilities

 

 

5,873,125

 

 

6,143,861

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

370,174

 

 

300,203

 

 

 

 

 

 

 

 

 

Operating Lease, long-term liabilities

 

 

8,961,285

 

 

 —

 

 

 

 

 

 

 

 

 

Other Long-Term Liabilities

 

 

562,481

 

 

551,000

 

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Members' Equity

 

 

 

 

 

 

 

Members' equity attributable to Heron Lake BioEnergy, LLC consists of 77,932,107 units issued and outstanding at January 31, 2020 and October 31, 2019

 

 

45,027,304

 

 

47,599,276

 

Non-controlling interest

 

 

 —

 

 

2,001,575

 

Total members' equity

 

 

45,027,304

 

 

49,600,851

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

60,794,369

 

$

56,595,915

 

 

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

1

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31,

 

 

 

(unaudited)

 

 

 

2020

 

2019

 

Revenues

 

$

26,680,280

 

$

25,697,520

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

28,129,771

 

 

26,731,320

 

 

 

 

 

 

 

 

 

Gross Loss

 

 

(1,449,491)

 

 

(1,033,800)

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

(899,445)

 

 

(919,527)

 

 

 

 

 

 

 

 

 

Operating Loss

 

 

(2,348,936)

 

 

(1,953,327)

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

Interest income

 

 

11,581

 

 

28,802

 

Interest expense

 

 

(11,531)

 

 

(7,914)

 

Other income, net

 

 

339

 

 

205

 

Total other income, net

 

 

389

 

 

21,093

 

 

 

 

 

 

 

 

 

Net Loss

 

 

(2,348,547)

 

 

(1,932,234)

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(67,827)

 

 

(91,406)

 

 

 

 

 

 

 

 

 

Net Loss Attributable to Heron Lake BioEnergy, LLC

 

$

(2,416,374)

 

$

(2,023,640)

 

 

 

 

 

 

 

 

 

Weighted Average Units Outstanding—Basic and Diluted (Class A and B)

 

 

77,932,107

 

 

77,932,107

 

 

 

 

 

 

 

 

 

Net Loss Per Unit Attributable to Heron Lake BioEnergy, LLC—Basic and Diluted (Class A and B)

 

$

(0.03)

 

$

(0.03)

 

 

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

 —

 

$

 —

 

 

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

 

2

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Members’ Equity (unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

Members' equity

    

 

 

    

 

 

 

 

 

 

 

 

attributable to

 

 

 

 

 

 

 

 

 

 

 

 

Heron Lake

 

Non-

 

Total

 

 

 

 

 

 

BioEnergy,

 

controlling 

 

Members'

 

 

Class A Units

 

Class B Units

 

LLC

 

Interest

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2019

 

62,932,107

 

15,000,000

 

$

47,599,276

 

$

2,001,575

 

$

49,600,851

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of non-controlling interest

 

 —

 

 —

 

 

(155,598)

 

 

(2,069,402)

 

 

(2,225,000)

Net income attributable to non-controlling interest

 

 —

 

 —

 

 

 —

 

 

67,827

 

 

67,827

Net loss attributable to Heron Lake BioEnergy, LLC

 

 —

 

 —

 

 

(2,416,374)

 

 

 —

 

 

(2,416,374)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—January 31, 2020

 

62,932,107

 

15,000,000

 

$

45,027,304

 

$

 —

 

$

45,027,304

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—October 31, 2018

 

62,932,107

 

15,000,000

 

$

53,054,846

 

$

1,723,839

 

$

54,778,685

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to non-controlling interest

 

 —

 

 —

 

 

 —

 

 

91,406

 

 

91,406

Net loss attributable to Heron Lake BioEnergy, LLC

 

 —

 

 —

 

 

(2,023,640)

 

 

 —

 

 

(2,023,640)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—January 31, 2019

 

62,932,107

 

15,000,000

 

$

51,031,206

 

$

1,815,245

 

$

52,846,451

 

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

 

3

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31,

 

 

 

 

2020

 

 

2019

 

 

    

 

(unaudited)

    

 

(unaudited)

 

Cash Flow From Operating Activities:

 

 

 

 

 

 

 

Net loss

 

$

(2,348,547)

 

$

(1,932,234)

 

Adjustments to reconcile net loss to net cash used in operations:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,316,198

 

 

1,286,722

 

Change in fair value of commodity derivative instruments

 

 

162,620

 

 

(94,292)

 

Change in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

3,902,786

 

 

2,368,689

 

Inventory

 

 

(1,475,699)

 

 

(1,040,419)

 

Commodity derivative instruments

 

 

(198,295)

 

 

391,575

 

Prepaid expenses and other current assets

 

 

(233,232)

 

 

(291,950)

 

Accounts payable

 

 

(2,136,555)

 

 

(3,098,498)

 

Accrued expenses

 

 

(42,339)

 

 

(220,187)

 

Accrued railcar rehabilitation costs

 

 

11,481

 

 

 —

 

Net cash used in operating activities

 

 

(1,041,582)

 

 

(2,630,594)

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Capital expenditures

 

 

(208,285)

 

 

(92,921)

 

Net cash used in investing activities

 

 

(208,285)

 

 

(92,921)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Checks drawn in excess of bank balance

 

 

724,292

 

 

 —

 

Proceeds from long-term debt

 

 

7,039,706

 

 

 —

 

Payments on long-term debt

 

 

(6,969,735)

 

 

(7,763)

 

Acquisition of non-controlling interest

 

 

(2,000,000)

 

 

 —

 

Net cash used in financing activities

 

 

(1,205,737)

 

 

(7,763)

 

 

 

 

 

 

 

 

 

Net decrease in Cash and Restricted Cash

 

 

(2,455,604)

 

 

(2,731,278)

 

 

 

 

 

 

 

 

 

Cash and Restricted Cash—Beginning of Period

 

 

4,593,811

 

 

5,995,982

 

 

 

 

 

 

 

 

 

Cash and Restricted Cash—End of Period

 

$

2,138,207

 

$

3,264,704

 

 

 

 

 

 

 

 

 

Reconciliation of Cash and Restricted Cash

 

 

 

 

 

 

 

Cash - Balance Sheet

 

$

2,095,986

 

$

3,125,463

 

Restricted Cash - Balance Sheet

 

 

42,221

 

 

139,241

 

Cash and Restricted Cash

 

$

2,138,207

 

$

3,264,704

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

11,531

 

$

7,914

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures included in accounts payable

 

$

 —

 

$

8,148

 

 

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

 

 

4

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

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

 

Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), is the sole owner of Agrinatural Gas, LLC (“Agrinatural”). Agrinatural is a natural gas pipeline company that was formed to construct, own, and operate the natural gas pipeline that provides natural gas to the Company’s ethanol production facility and other customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota. Beginning as of December 11, 2019, HLBE holds a 100% interest in Agrinatural. At October 31, 2019, HLBE held a 73% interest in Agrinatural. 

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated unaudited financial statements as of January 31, 2020 include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively, the “Company”).  Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the unaudited financial statements of Agrinatural with its consolidated unaudited financial statements, with the equity and earnings attributed to the remaining 27% non-controlling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations through December 11, 2019, when the remaining non-controlling interest was acquired. All significant intercompany balances and transactions are eliminated in consolidation.

 

The condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  These condensed consolidated unaudited financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended October 31, 2019, contained in the Company’s annual report on Form 10-K.

 

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

 

Accounting Estimates

 

Management uses estimates and assumptions in preparing these condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles.  Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters including, among others, the economic lives of property and equipment, the assumptions used in the analysis of impairment of long-lived assets, valuation of commodity derivative instruments, inventory, inventory purchase and sales commitments, and evaluation of railcar rehabilitation costs. The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made.  Actual results could differ from those estimates.

 

5

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

Non-controlling Interest

 

Amounts recorded as non-controlling interest on the October 31, 2019 balance sheet relates to the net investment by an unrelated party in Agrinatural through December 11, 2019 when the remaining non-controlling interest was acquired. Income and losses are allocated to the members of Agrinatural based on their respective percentage of membership units held.  Pursuant to the firm natural gas transportation agreement, Agrinatural will provide natural gas to the plant with a specified price per MMBTU for a term ending on October 31, 2021, with one automatic renewal option to extend the term for an additional five years. 

 

Revenue Recognition

 

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Our contracts primarily consist of agreements with marketing companies and other customers as described below. Our performance obligations consist of the delivery of ethanol, distillers' grains, and corn oil to our customers. Our customers primarily consist of three distinct marketing companies as discussed below. The consideration we receive for these products is fixed or determinable based on current observable market prices at the Chicago Mercantile Exchange, generally, and adjusted for local market differentials. Our contracts have specific delivery modes, rail or truck, and dates. Revenue is recognized when the Company delivers the products to the mode of transportation specified in the contract, at the transaction price established in the contract, net of commissions, fees, and freight. We sell each of the products via different marketing channels as described below.

 

·

Ethanol. The Company sells its ethanol via a marketing agreement with Eco-Energy, Inc. Eco-Energy sells one hundred percent of the Company’s ethanol production based on agreements with end users at prices agreed upon mutually among the end user, Eco-Energy and the Company. Our performance obligations consist of our obligation to deliver ethanol to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. The marketing agreement calls for control and title to pass to Eco-Energy once a rail car is released to the railroad or a truck is released from the Company’s scales. Revenue is recognized then at the price in the agreement with the end user, net of commissions, freight, and fees.

 

·

Distillers’ grains. The Company engages another third-party marketing company, Gavilon, Inc, to sell one hundred percent of the distillers grains it produces at the plant. Gavilon takes title and control once a rail car is released to the railroad or a truck is released from the Company’s scales. Prices are agreed upon between Gavilon and the Company.  Our performance obligations consist of our obligation to deliver distillers grains to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees.

 

·

Distillers’ corn oil (corn oil). The Company sells one hundred percent of its corn oil production to RPMG, Inc.  The process for selling corn oil is the same as our distillers’ grains.  RPMG takes title and control once a rail car is released to the railroad or a truck is released from the Company's scales. Prices are agreed upon between RPMG and the Company.  Our performance obligations consist of our obligation to deliver corn oil to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees.

 

·

Agrinatural generates revenue from the transportation of natural gas to residential and commercial customers. Revenue is recognized at the point when natural gas is delivered at the transaction price established in the contract.

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value. Cost for all inventories is determined using the first in first out method. Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. Inventory consists of raw materials, work in process, finished

6

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

goods, and supplies. Corn is the primary raw material along with other raw materials. Finished goods consist of ethanol, distillers’ grains, and corn oil.

 

Derivative Instruments

 

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

 

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

 

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

 

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

 

The Company has adopted authoritative guidance related to “Derivatives and Hedging,” and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  See further discussion in Note 5.

 

Recently Adopted Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (FASB) issued new guidance on accounting for leases under Accounting Standards Codification 842 (ASC 842). Under the new guidance, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted cash flow basis; and (2) a “right of use” asset, which is an asset that represents the lessee’s right to use the specified asset for the lease term. Lease expense under the new guidance is substantially the same as prior to the adoption. See Note 8 for further information. 

 

Reportable Operating Segments

 

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

7

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.

 

·

Ethanol Production.   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.

 

·

Natural Gas Pipeline.  The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment.

 

2.RISKS AND UNCERTAINTIES

 

The Company has certain risks and uncertainties that it experiences during volatile market conditions. These volatilities can have a severe impact on operations. The Company’s revenues are derived from the sale and distribution of ethanol and distillers’ grains to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers. Ethanol sales average 70% to 90% of total revenues and corn costs average 70% to 90% of cost of goods sold.

 

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

 

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2019 and into 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. The Company believes its cash on hand and available debt from its lender will provide sufficient liquidity to meets its anticipated working capital, debt service and other liquidity needs through the next twelve months.

 

8

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

3.REVENUE

 

Revenue by Source

 

All revenues from contracts with customers under ASC Topic 606 are recognized at a point in time. The following table disaggregates revenue by major source for the three months ended January 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2020

 

(unaudited)

 

 

Ethanol Production

 

 

Natural Gas Pipeline

 

 

Total

Ethanol

$

20,291,884

 

$

 

$

20,291,884

Distillers’ Grains

 

4,488,804

 

 

 

 

4,488,804

Corn Oil

 

914,398

 

 

 

 

914,398

Other

 

295,917

 

 

 

 

295,917

Natural Gas

 

0

 

 

689,277

 

 

689,277

Total Revenues

$

25,991,003

 

$

689,277

 

$

26,680,280

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2019

 

(unaudited)

 

 

Ethanol Production

 

 

Natural Gas Pipeline

 

 

Total

Ethanol

$

18,398,152

 

$

 

$

18,398,152

Distillers’ Grains

 

5,485,355

 

 

 

 

5,485,355

Corn Oil

 

964,411

 

 

 

 

964,411

Other

 

264,303

 

 

 

 

264,303

Natural Gas

 

 

 

585,299

 

 

585,299

Total Revenues

$

25,112,221

 

$

585,299

 

$

25,697,520

 

Payment Terms

 

The Company has contractual payment terms with each respective marketer that sells ethanol, distillers’ grains and corn oil.  These terms are 10 calendar days after the transfer of control date. The Company has contractual payment terms with the natural gas customers of 20 days.

 

Shipping and Handling Costs

 

Shipping and handling costs related to contracts with customers for sale of goods are accounted for as a fulfillment activity and are included in cost of goods sold. Accordingly, amounts billed to customers for such costs are included as a component of revenue.

 

9

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

4.INVENTORY

 

Inventory consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2020

 

October 31, 2019

 

 

    

(unaudited)

    

 

 

 

Raw materials

 

$

1,939,236

 

$

932,503

 

Work in process

 

 

696,617

 

 

732,243

 

Finished goods

 

 

3,673,218

 

 

3,157,429

 

Supplies

 

 

1,442,886

 

 

1,454,083

 

Totals

 

$

7,751,957

 

$

6,276,258

 

 

 

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol.  Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $877,000 and $981,000 for the three months ended January 31, 2020 and 2019, respectively. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on corn inventories, as a component of cost of goods sold, of approximately $126,000 and $24,000 for the three months ended January 31, 2020 and 2019, respectively.

 

5.DERIVATIVE INSTRUMENTS

 

As of January 31, 2020, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,528,000 bushels, comprised of long corn futures positions on 391,000 bushels that were entered into to hedge forecasted ethanol sales through July 2020 and short corn futures positions on 1,607,000 bushels that were entered into to hedge forecasted corn purchases through December 2021. Additionally, there are corn options positions of 3,530,000 bushels through July 2020. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of January 31, 2020, the Company had approximately $42,000 of cash collateral (restricted cash) related to derivatives held by a broker.

 

The following table provides detail regarding the Company’s derivative instruments at January 31, 2020, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

144,410

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

 —

 

 

12,912

 

Totals

 

 

 

$

144,410

 

$

12,912

 

 

As of October 31, 2019, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,398,000 bushels, comprised of long corn futures positions on 2,131,000 bushels that were entered into to hedge forecasted ethanol sales through July 2020, and short corn futures positions on 3,267,000 bushels that were entered into to hedge forecasted corn purchases through December 2021. Additionally, there are corn options positions of 4,000,000 bushels through March 2020. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding. 

 

As of October 31, 2019, the Company had a $52,000 in cash collateral (restricted cash) related to derivatives held by a broker.

 

10

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2019, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

20,060

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

75,763

 

 

 —

 

Totals

 

 

 

$

95,823

 

$

 —

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Statement of

    

Three Months Ended  January 31,

 

 

    

Operations Location

    

2020

    

2019

 

Corn contracts

 

Cost of goods sold

 

$

(80,768)

 

$

94,292

 

Ethanol contracts

 

Revenues

 

 

(81,852)

 

 

 —

 

Total gain (loss)

 

 

 

$

(162,620)

 

$

94,292

 

 

 

 

6.FAIR VALUE

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at January 31, 2020:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices

 

Significant Other

 

Significant

 

 

 

Consolidated Balance Sheet

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable inputs

 

Financial Assets:

    

 

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

144,410

 

$

144,410

 

$

144,410

 

$

 —

 

$

 —

 

Commodity Derivative instruments - Ethanol

 

$

12,912

 

$

12,912

 

$

12,912

 

$

 —

 

$

 —

 

 

The following table sets forth, by level, the Company assets and liabilities that were accounted for at fair value on a recurring basis at October 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

 

 

Consolidated

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable Inputs

 

Financial Assets:

    

Balance Sheet

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

20,060

 

$

20,060

 

$

20,060

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative instruments - Ethanol

 

$

75,763

 

$

75,763

 

$

75,763

 

$

 —

 

$

 —

 

 

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

 

 

11

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

7.DEBT FINANCING

 

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2020

 

October 31, 2019

 

 

 

(unaudited)

 

 

 

Amended revolving term note payable to lending institution, see terms below.

 

$

69,971

 

$

 —

 

Assessment payable as part of water treatment agreement, due in semi-annual installments of $189,393 with interest at 6.55%, enforceable by statutory lien, with the final payment due in 2021. The Company made deposits for one years' worth of debt service payments of approximately $364,000, which is included with other assets that are held on deposit to be applied with the final payments of the assessment.

 

 

634,180

 

 

634,180

 

Totals

 

 

704,151

 

 

634,180

 

Less amounts due within one year

 

 

333,977

 

 

333,977

 

Net long-term debt

 

$

370,174

 

$

300,203

 

 

Revolving Term Note

 

The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment.  This loan replaces the amended revolving term note and seasonal revolving loan made under the 2018 Credit Facility. The loan is secured by substantially all of the Company’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

 

As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank, ACP (“CoBank”).  As a result, CoBank will continue to act as the agent for the lender with respect to the 2020 Credit Facility. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $8,000,000. Final payment of amounts borrowed under the amended revolving term loan is due December 1, 2022. Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which totaled 4.76% at January 31, 2020    

 

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

 

Estimated annual maturities of long-term debt at January 31, 2020 are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2020

    

$

333,977

 

2021

 

 

300,203

 

2022

 

 

69,971

 

Total debt

 

$

704,151

 

 

8.LEASES

 

Adoption of ASC 842

 

12

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

As discussed in Note 1, on November 1, 2019, the Company adopted the provisions of ASC 842 using the modified retrospective approach, which applies the provisions of ASC 842 upon adoption, with no change to prior periods. This adoption resulted in the Company recognizing initial right of use assets and lease liabilities of approximately $10.9 million at November 1, 2019. The adoption did not have a significant impact on the Company’s statement of operations.

 

 

Upon the initial adoption of ASC 842, the Company elected the following practical expedients allowable under the guidance: not to reassess whether any expired or existing contracts are or contain leases; not to reassess the lease classification for any expired or existing leases; not to reassess initial direct costs for any existing leases. Additionally, the Company elected the short-term lease exemption policy, applying the requirements of ASC 842 to only long-term (greater than one year) leases.

 

 

The Company leases rail cars for its facility to transport ethanol and dried distillers’ grains to its end customers. Operating lease right of use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company uses its estimated incremental borrowing rate, unless an implicit rate is readily determinable, as the discount rate for each lease in determining the present value of lease payments. For the three months ended January 31, 2020, the Company’s weighted average discount rate was 4.87%.  Operating lease expense is recognized on a straight-line basis over the lease term.

 

The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s leases have remaining terms of approximately one to seven years. For the three months ended January 31, 2020, the weighted average remaining lease term was four years.

 

The Company elected to use a portfolio approach for lease classification, which allows for an entity to group together leases with similar characteristics provided that its application does not create a material difference when compared to accounting for the leases at a contract level. For railcar leases, the Company elected to combine the railcars within each rider and account for each rider as an individual lease.

 

The following table summarizes the remaining maturities of the Company’s operating lease liabilities as of January 31, 2020:

 

 

 

 

 

 

Twelve Months Ended January 31,

 

 

 

 

2021

 

$

1,767,000

 

2022

 

 

1,767,000

 

2023

 

 

1,767,000

 

2024

 

 

1,757,250

 

2025

 

 

1,650,000

 

Thereafter

 

 

3,400,000

 

Totals

 

 

12,108,250

 

Less: Amount representing interest

 

 

1,850,825

 

Lease liabilities

 

$

10,257,425

 

 

For the three months ended January 31, 2020, the Company recorded operating lease costs of approximately $575,000 in cost of goods sold in the Company’s statement of operations, which approximates the cash paid for the period.

 

9.COMMITMENTS AND CONTINGENCIES

 

Corn Forward Contracts

 

At January 31, 2020, the Company had cash and basis contracts for forward corn purchase commitments for approximately 7,966,000 bushels for deliveries through December 2021.

 

13

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

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 and its inventories using the lower of cost or net realizable value evaluation, similar to the method used on its inventory, and has determined that no impairment loss existed at January 31, 2020 or October 31, 2019.

 

Ethanol Forward Contracts

 

At January 31, 2020, the Company had fixed and basis contracts to sell approximately $11,566,000 of ethanol for various delivery periods through March 2020, which approximates 85% of its anticipated ethanol sales for that period. 

 

Distillers’ Grains Forward Contracts

 

At January 31, 2020, the Company had forward contracts to sell approximately $2,211,000 of distillers’ grains for delivery through March 2020, which approximates 55% of its anticipated distillers’ grains sales during that period.

 

Corn Oil Forward Contracts

 

At January 31, 2020, the Company had forward contracts to sell approximately $289,000 of corn oil for various delivery periods through February 2020, which approximates 75% of its anticipated corn oil sales for that period.

 

Rail Car Rehabilitation Costs

 

The Company leases 50 hopper rail cars under a multi-year agreement which ends in May 2027. Under the agreement, the Company is required to pay to rehabilitate each car for “damage” that is considered to be other than normal wear and tear upon turn in of the car(s) at the termination of the lease. Prior to the year ending October 31, 2019, the Company believed ongoing repairs resulted in an insignificant future rehabilitation expense. During the year ending October 31, 2019, based on new information, we re-evaluated our assumptions and believe that it is probable that we may be assessed for damages incurred. Company management has estimated total costs to rehabilitate the cars at January 31, 2020 to be approximately $562,000. During the quarter ended January 31, 2020, the Company has recorded an expense in cost of goods of approximately $11,000.

 

10.MEMBERS’ EQUITY

 

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

 

Heron Lake BioEnergy, LLC has a total of 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding, for an aggregate total of 77,932,107 units issued and outstanding at January 31, 2020 and October 31, 2019.

 

On December 11, 2019, HLBE Pipeline Company acquired the remaining non-controlling interest of Agrinatural for a total price of $2.225 million. A deposit of $225,000 was paid in October 2019 and recorded within other assets at October 31, 2019, and the remaining amount was paid on December 11, 2019. The change of interest is recorded as an equity transaction in accordance with ASC 805. 

 

14

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

11.RELATED PARTY TRANSACTIONS

 

Granite Falls Energy, LLC

 

The Company has a management services agreement with Granite Falls Energy, LLC (“GFE”, a related party). Under the terms of the management services agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses, and other expenses and costs incurred by GFE for the three management positions. The management services agreement automatically renews for successive one-year terms unless and until the Company or GFE gives the other party 90-days written notice of termination prior to expiration of the then current term. The management services agreement may also be terminated by either party for cause under certain circumstances. Total expenses under this agreement were approximately $123,000 and $121,000 for the three months ended January 31, 2020 and 2019, respectively.

 

Corn Purchases - Members

 

The Company purchased corn from board members of approximately $5,065,000 and $1,949,000 for the three months ended January 31, 2020 and 2019, respectively.

15

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2020

 

12.BUSINESS SEGMENTS

 

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

 

 

 

Ethanol Production

Ethanol and co-product production and sales

Natural gas pipeline

Ownership and operations of natural gas pipeline

 

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

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

January 31, 2020

 

January 31, 2019

 

 

Revenue:

    

(unaudited)

    

(unaudited)

 

 

Ethanol production

 

$

25,991,003

 

$

25,112,221

 

 

Natural gas pipeline

 

 

1,136,217

 

 

1,039,625

 

 

Eliminations

 

 

(446,940)

 

 

(454,326)

 

 

Total Revenue

 

$

26,680,280

 

$

25,697,520

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

January 31, 2020

 

January 31, 2019

 

 

Operating Income (Loss):

 

(unaudited)

    

(unaudited)

 

 

Ethanol production

    

$

(2,812,778)

    

$

(2,345,303)

 

 

Natural gas pipeline

 

 

646,298

 

 

563,273

 

 

Eliminations

 

 

(182,456)

 

 

(171,297)

 

 

Operating Loss

 

$

(2,348,936)

 

$

(1,953,327)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 31, 2020

 

October 31, 2019

 

Assets:

    

(unaudited)

 

 

 

Ethanol production

 

$

48,171,952

 

$

44,097,379

 

Natural gas pipeline

 

 

12,622,417

 

 

12,498,536

 

Total Assets

 

$

60,794,369

 

$

56,595,915

 

 

 

 

16

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

 

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the three months ended January 31, 2020 and 2019.  This section should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in PART I - Item 1 of this report and the information contained in the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2019.

 

Disclosure Regarding Forward-Looking Statements

 

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

 

Forward-looking statements are subject to a number of known and unknown risks, uncertainties, and other factors, many of which may be beyond our control, and may cause actual results, performance, or achievements to differ materially from those projected in, expressed or implied by forward-looking statements.  While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us are described more particularly in the “Risk Factors” section of our annual report on Form 10-K for the year ended October 31, 2019 as supplemented by the risk factors disclosed in Item 1A of this report on Form 10-Q.  These risks and uncertainties include, but are not limited to, the following:

 

·

Fluctuations in the price of ethanol, which is affected by various factors including: the overall supply and demand for ethanol and corn; the price of gasoline, crude oil and corn, government policies, the price and availability of competing fuels;

·

Fluctuations in the price of crude oil and gasoline and the impact of lower oil and gasoline prices on ethanol prices and demand;

·

Fluctuations in the availability and price of corn, which is affected by various factors including: domestic stocks, demand from corn-consuming industries, such as the ethanol industry, prices for alternative crops, increasing input costs, changes in government policies, shifts in global markets or damaging growing conditions, such as plant disease or adverse weather, including drought;

·

Fluctuations in the availability and price of natural gas, which may be affected by factors such as weather, drilling economics, overall economic conditions, and government regulations;

·

Negative operating margins which may result from lower ethanol and/or high corn prices;

·

Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil, or automobile industries;

·

Overcapacity and oversupply in the ethanol industry;

·

Ethanol may trade at a premium to gasoline at times, resulting in a disincentive for discretionary blending of ethanol beyond the requirements of the RFS and consequently negatively impacting ethanol prices and demand;

·

Changes in federal and/or state laws and environmental regulations including elimination, waiver, or reduction of the corn-based ethanol use requirement in the RFS and legislative acts taken by state governments such as California related to low-carbon fuels, may have an adverse effect on our business;

·

Any impairment of the transportation, storage and blending infrastructure that prevents ethanol from reaching markets;

·

Any effect on prices and demand for our products resulting from actions in international markets, particularly imposition of tariffs;

·

Changes in our business strategy, capital improvements or development plans;

·

Effect of our risk mitigation strategies and hedging activities on our financial performance and cash flows;

·

Competition from alternative fuels and alternative fuel additives;

·

Changes or advances in plant production capacity or technical difficulties in operating the plant; and

·

Our reliance on key management personnel.

17

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

 

Industry and Market Data

 

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

 

Available Information

 

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

 

Overview

 

Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota.  Our business consists of the production and sale of our ethanol throughout the continental U.S. and sale of its co-products (wet, modified wet and dried distillers’ grains, corn oil, and corn syrup) locally, and throughout the continental U.S. Additionally, through a wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), we are the sole owner of Agrinatural Gas, LLC (“Agrinatural”).  Beginning as of December 11, 2019, we hold a 100% interest in Agrinatural. At October 31, 2019, we held a 73% interest in Agrinatural. Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC’s ethanol production facility and other customers.

 

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

 

Reportable Operating Segments

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  Based on the nature of the products, services and operations and the expected financial results, we review our operations within the following two separate operating segments: (1) ethanol production; and (2) natural gas pipeline operations.  We currently do not have or anticipate we will have any other lines of business or other significant sources of revenue other than the sale of ethanol, distillers’ grains, corn oil and natural gas transportation.  Refer to Note 12, “Business Segments,” of the notes to the condensed consolidated unaudited financial statements for financial information about our financial reporting segments.

 

Ethanol Production

 

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

18

 

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

 

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

 

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

 

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

 

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

 

Natural Gas Pipeline

 

Through our wholly owned subsidiary, HLBE Pipeline Company, we indirectly own 100% of Agrinatural Gas, LLC, a Delaware limited liability company (“Agrinatural”), a natural gas distribution and sales company located in Heron Lake, Minnesota. On October 18, 2019, HLBE Pipeline Company entered into an agreement to purchase the 27% non-controlling interest in Agrinatural, which became effective on December 11, 2019. Prior to December 11, 2019, Rural Energy Solutions, LLC owned a 27% non-controlling interest in Agrinatural. Agrinatural owns approximately 190 miles of natural gas pipeline and provides natural gas to the Company’s ethanol plant and other commercial, agricultural, and residential customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company.  Agrinatural's revenues are generated through natural gas distribution fees and sales.  The operations of Agrinatural's natural gas pipeline are aggregated into a separate financial reporting segment.

 

Agrinatural has a natural gas local distribution company management agreement with GFE pursuant to which GFE’s chief executive officer and chief financial officer also hold those same offices with Agrinatural. The agreement automatically renews for successive one-year terms unless either Agrinatural or GFE gives the other party written notice of termination prior to expiration of the then current term. The agreement may also be terminated by either party for cause under certain circumstances.

 

The Company has two intercompany credit facilities with Agrinatural: a July 2014 credit facility, as amended (the “Original Credit Facility”) and a March 2015 credit facility, as amended (the “Additional Credit Facility”).  Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural.  Subsequent to the closing of the Company’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to both the Original Credit Facility and the Additional Credit Facility. Additional details are provided below in the section below entitled “PART I - Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness.

19

 

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

 

Plan of Operations for the Next Twelve Months

 

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

 

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2019 and into 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. We expect to have sufficient cash generated by continuing operations and availability on our credit facility to fund our operations.  However, should unfavorable operating conditions continue in the ethanol industry that prevent us from profitably operating our plant, we may need to seek additional funding.

 

In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure, as well as small capital projects, including the construction of additional grain storage, to improve operating efficiency. We anticipate using cash we generate from our operations and our revolving term loan to finance these plant upgrade projects.

 

Trends and Uncertainties Impacting Our Operations

 

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains, and natural gas.  As a result, our operating results can fluctuate substantially due to volatility in these commodity markets.  Governmental programs designed to create incentives for the use of corn-based ethanol also have a significant impact on market prices for ethanol.  Other factors that may affect our future results of operation include those risks discussed below and in “PART II - Item 1A. Risk Factors” of this report and “PART I - Item 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2019.

 

The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy, and foreign trade.  Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer, and fall.  Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons.  Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels.  Distillers’ grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production.

 

Because the market price of ethanol is not always directly related to corn, at times ethanol prices may lag price movements in corn prices and corn-ethanol price spread may be tightly compressed or negative.  If the corn-ethanol spread is compressed or negative for sustained period, it is possible that our operating margins will decline or become negative and our ethanol plant may not generate adequate cash flow for operations.  In such cases, we may reduce or cease production at our ethanol plant to minimize our variable costs and optimize cash flow.

 

Management currently believes that our margins will remain negative or low during the remainder of the fiscal year 2020. Continued large corn supplies and ethanol production capacity increases could have a negative impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline. Recent US Energy Information Administration (“EIA”) reports indicate that ethanol stocks remain high and that ethanol production remains steady since the conclusion of fiscal year 2019. In addition, management believes that increased waivers of small refiner renewable

20

volume obligations (“RVOs”) by the U.S. Environmental Protection Agency (“EPA”), as well as uncertainty regarding the Renewable Fuels Standard (“RFS”) reset, will contribute to the projected negative or low margins.

 

Additionally, while ethanol continues trading at a significant discount to gasoline, which has improved export demand somewhat, increased waivers of small refiner RVOs by the EPA has contributed to management’s expectation regarding margins. The impact of the increases in small refiner waivers granted by the EPA and the reductions in Chinese imports continues to have a negative impact on prices for renewable identification numbers (“RINs”) for corn-based ethanol.  As a result, RINs prices remain lower, removing a blending incentive from the ethanol marketplace.

 

Increases in the price for crude oil and unleaded gasoline could have a negative impact on the demand for gasoline and impact the market price of ethanol, which could adversely impact our profitability. According to the EIA February 2020 Short Term Energy Outlook, U.S. gasoline demand was approximately 9.3 million barrels per day in 2019 and is expected to stay at that same level in 2020. The EIA forecasts regular gasoline prices to average $2.60 per gallon in 2020 compared to the 2019 average of $2.73 per gallon. The EIA also estimates the summer peak price will gradually decrease from the peak in August at an average of $2.68 per gallon to an average $2.53 per gallon in December. Any increase in the average gallon cost to the public could have a negative impact on the EIA’s forecast.

 

In addition, crude oil prices have fallen sharply in March 2020, as a result of market reaction to the coronavirus pandemic, which has caused global demand to decline, and international price wars. Such marked decreases in crude oil prices are likely to have a negative impact on the demand for ethanol, which are likely to be exacerbated by overall lessened global energy demand as a result of the coronavirus pandemic.  

 

Continued ethanol production capacity increases could also have a negative impact on the market price of ethanol, which could be further exacerbated if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline. Throughout 2019, some U.S. ethanol plants temporarily suspended production due to negative margins and stagnant export projections caused by trade barriers.

 

In recent years, exports of ethanol have increased; however, exports fell slightly during the 2019 fiscal year compared to the 2018 fiscal year.  Export demand for ethanol is less consistent compared to domestic demand, which can lead to ethanol price volatility. During 2017, Brazil and China adopted import quotas and/or tariffs on the importation of ethanol, which are expected to continue to negatively impact U.S. exports. China, the number three importer of U.S. ethanol in 2016, has imported negligible volumes since imposing a 70% tariff in 2018. Brazilian demand for US ethanol has remained relatively steady, despite a tariff imposed in 2017 and renewed in 2019. Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or foreign markets are developed.

 

During our first fiscal quarter of 2020, distillers’ grains prices fell, due to lower export demand and weakness in corn and soybean meal prices. In addition to being an animal feed substitute for corn, distillers’ grains are increasingly considered a protein feed substitute for soybean meal. Management currently believes that the impact of the current Chinese imposition of antidumping and countervailing duties on distillers’ grains produced in the U.S. has been absorbed into the market. However, recent trade disputes with China, Mexico and Canada could result in the imposition of additional tariffs on distillers’ grains produced in the United States, which could lead to an oversupply of distillers’ grains domestically and negatively impact distillers’ grains prices. Additionally, domestic feeding margins in cattle and hogs in particular could have a negative impact on total domestic distillers’ grains demand.

 

Corn oil prices have been slightly negatively impacted during the three months ended January 31, 2020, in line with the recent historic perspective, which has seen corn oil prices over the past few years be impacted by oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production, in addition to increased corn oil production. The impact of lower soybean oil prices and the market’s increase in corn oil production during the last few years will likely continue to impact corn oil prices.

 

In December 2019, legislation was signed extending the $1.00 per-gallon biodiesel blender tax credit retroactively to January 1, 2018 through December 31, 2022. However, corn oil prices may decrease if biodiesel producers reduce production and/or demand for corn oil is reduced without extension of the biodiesel blenders tax credit.

 

Given the inherent volatility in ethanol, distillers’ grains, non-food grade corn oil, grain and natural gas prices, we cannot predict the likelihood that the spread between ethanol, distillers’ grains, non-food grade corn oil, and grain prices in future periods will be consistent compared to historical periods.

21

 

Government Supports and Regulation

 

The Renewable Fuels Standard

 

The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which is the federal Renewable Fuels Standard (“RFS”).  The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage.  Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on ethanol prices and our financial performance in the future.

 

Under the provisions of the RFS, the EPA must publish an annual rule that establishes the number of gallons of different types of renewable fuels, including corn-based ethanol, that must be blended with gasoline in the U.S. by refineries, blenders, distributors, and importers, which affects the domestic market for ethanol.  In December 2019, the EPA released the final 2020 renewable volume obligations (“RVOs”), which included an overall blending requirement of 20.09 billion gallons for 2020, a slight increase from 2019 mandates. Conventional corn-based ethanol levels were left at 15.0 billion gallons, excluding any waivers granted by the EPA to small refiners for “hardship.”

 

U.S. ethanol production capacity exceeded the EPA’s 2018 and 2019 RVOs that could be satisfied by corn-based ethanol. Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered the proposed RFS “reset” rule to the White House Office of Management and Budget for its review. If the statutory RVOs are reduced as a result of reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

There is growing availability of E85 for use in flexible fuel vehicles; however, it is limited due to lacking infrastructure. In addition, the industry has been working to introduce E15 to the retail market since the EPA approved its use in vehicles model year 2001 and newer. Widespread adoption of E15 has been hampered by regulatory and infrastructure hurdles in many states, as well as consumer acceptance. Additionally, sales of E15 may have been limited because (i) it is not approved for use in all vehicles, (ii) the EPA requires a label that management believes may discourage consumers from using E15, and (iii) retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This may have prevented E15 from being used during certain times of the year in various states. However, on May 30, 2019, the EPA issued a final rule which allows E15 to be sold year-round. In June 2019, the American Fuel and Petrochemical Manufacturers association filed a lawsuit in the U.S. Court of Appeals for the District of Columbia challenging the final rule. Additionally, in August 2019, the Small Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the District of Columbia seeking review of the final rule. There is no guarantee that the final rule will be upheld. Legal challenges could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.

 

The EPA assigns individual refiners, blenders, and importers the RVOs they are obligated to use based on their percentage of total fuel sales.  Obligated parties use RINs to show compliance with RVOs.  RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market.  The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties. Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. The EPA has recently granted a number of these exemptions, whereby such refiners were alleviated of their responsibility to supply RINS for their obligated volumes based upon the grounds of economic hardship.  On February 20, 2020, the EPA released data on the number of waivers filed, which indicated that 23 petitions for waivers for the 2019 compliance year have been received. For the 2018 compliance year, 42 petitions have been received. To date, the EPA has approved 31 petitions and denied 6 petitions, and 5 petitions have been declared ineligible or withdrawn. The 31 approved petitions have exempted approximately 1.43 billion RINs, which is approximately 13.42 billion gallons of gasoline and diesel, from meeting the RFS blending targets. The 37 approved petitions for compliance year 2017 exempted approximately 1.82 billion RINs, which is approximately 17.05 billion gallons of gasoline and diesel, from meeting the RFS blending targets. It is expected that additional petitions for waivers for the 2019 compliance year will be received by the EPA. It is also expected that the EPA will approve a significant number of these waiver petitions, thereby exempting a substantial number of gallons of

22

gasoline and diesel from meeting the RFS blending targets. These exemptions decrease demand for our products, which negatively impacts ethanol prices and our profitability.

 

A proposed rule released by the EPA in October 2019 proposed changes intended to project the exempted volume of gasoline and diesel due to small refinery exemptions, regardless of whether such exemptions were actually granted after the annual rulemaking. However, the final rule released by the EPA in December 2019 provides that EPA will project exempt volumes based on a three-year average of the relief recommended by the Department of Energy (“DOE”) for years 2016-2018, rather than based on actual exemptions granted. For the 2016 compliance year, the EPA said the DOE’s recommended relief was approximately 440 million RINs. The EPA, however, actually granted waivers for approximately 790 million RINs. Similarly, the DOE’s 2017 compliance year recommendation was 1.02 billion RINs, as compared to the approximately 1.82 billion RINs granted waivers by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs granted waivers by the EPA. The EPA’s final rule also announced its general policy approach with respect to small refinery waivers on a go-forward basis as consistent with DOE’s recommendations, where appropriate. The final rule fell short of the relief that was urged by ethanol producers. As a result, management expects that small refinery exemptions will continue to have a negative effect on demand for our products, ethanol prices, and our profitability.

 

Legal challenges are underway to the RFS, including the EPA’s recent reductions in the RFS volume requirements, the 2018 final rule, and the denial of petitions to change the RFS point of obligation. If the EPA’s decision to reduce the volume requirements under the RFS is allowed to stand, if the volume requirements are further reduced, or if the RFS point of obligation were changed, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

Beginning in January 2016, various ethanol and agricultural industry groups petitioned a federal appeals court to hear a legal challenge to of the EPA’s decision to reduce the total renewable fuel volume requirements for 2014-2016 through use of its “inadequate domestic supply” waiver authority.  On July 28, 2017, the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the petitioners, concluding that the EPA erred in its exercise of “inadequate domestic supply” waiver authority by considering demand-side constraints. As a result, the Court vacated the EPA’s decision to reduce the total renewable fuel volume requirements for 2016, and remanded to the EPA to address the 2016 total renewable fuels volume requirements. In December 2019, the EPA announced that it is deferring action on this issue until an anticipated date in early 2020. While management believes the decision should benefit the ethanol industry overall by clarifying the EPA's waiver analysis is limited to consideration of supply-side factors only, no direct impact on the Company is expected from the decision.

 

On May 1, 2018, the Advanced Biofuels Association submitted a petition with the U.S. Court of Appeals for the D.C. Circuit challenging EPA’s process for granting exemptions from compliance under the RFS to small refineries. The Advanced Biofuel Association petition asks the court to review the EPA’s decision to modify criteria to lower the threshold by which the agency determines whether to grant small refineries an exemption for the RFS for reasons of disproportionate economic hardship. In May 2019, the U.S. Court of Appeals for the D.C. Circuit denied a motion by the Advanced Biofuels Association seeking a preliminary injunction to prevent the EPA from granting any additional small refinery exemptions under the RFS until its pending lawsuit with the agency is resolved. In August 2019, the U.S. Court of Appeals for the D.C. Circuit denied the petition, upholding the EPA’s decisions. 

 

Additionally, on May 29, 2018, the National Corn Growers Association, National Farmers Union, and the Renewable Fuels Association (“RFA”) filed a petition with the U.S. Court of Appeals for the 10th Circuit challenging the EPA’s grant of waivers to three specific refineries.  The petitioners are asking the U.S. Court of Appeals for the 10th Circuit to reject the waivers granted to three refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross, Utah as an abuse of EPA authority. These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate RVOs under the RFS.  In January 2020, the court struck down the exemptions as improperly issued by the EPA. The court interpreted the RFS statute to require that any exemption granted to a small refinery after 2010 must take the form of an “extension,” which would require a small refinery exemption in prior years to prolong, enlarge or add to. The court approved a 15-day extension of the deadline to file a petition for rehearing, which sets the deadline at March 24, 2020.  If the specific waivers granted by the EPA and/or its lower criteria for granting small refinery waivers under the RFS are allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

23

Related to the recent lawsuits, the Renewable Fuels Association, American Coalition for Ethanol, Growth Energy, National Biodiesel Board, National Corn Growers Association, Biotechnology Industry Organization, and National Farmers Union petitioned the EPA on June 4, 2018 to change its regulations to account for lost volumes of renewable fuel resulting from the retroactive small refinery exemptions. This petition to EPA seeks a broader, forward-looking remedy to account for the collective lost volumes caused by the recent increase in retroactive small refinery RVO exemptions. In June 2018, the court issued a stay pending further administrative proceedings. On July 30, 2019, the groups petitioned the court to lift such stay. It is unclear what regulatory changes, if any, will emerge from the petition to the EPA.

 

Further, on July 31, 2018, Producers of Renewables United for Integrity Truth and Transparency filed a petition for review in the U.S. Court of Appeals for the D.C. Circuit, petitioning for review of final agency action by the EPA in its decision to allow the generation of RINs by obligated parties under the RFS that do not represent biofuel production in the year the RIN was generated. In May 2019, the court issued an order dismissing a portion of the lawsuit challenging the EPA’s timing, due to untimely filing. The order also transferred the RINs issues to the U.S. Court of Appeals for the 10th Circuit.

 

Also, on August 30, 2018, the RFA and Growth Energy filed a lawsuit in federal district court, alleging that the EPA and U.S. Department of Energy have improperly denied agency records requested by RFA, Growth Energy, and others under the Freedom of Information Act. The requested documents relate to exemptions from Renewable Fuel Standard compliance obligations granted by EPA. Additionally, on February 4, 2019, Growth Energy filed a lawsuit in the Court of Appeals for the District of Columbia against the EPA, challenging the EPA’s “failure” to address small refinery exemptions in its 2019 RVO rulemaking.  

 

Although the maintenance of the 15.0 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the 2020 final rule, in addition to the year-round E15 rule, signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal, or otherwise invalidate the RFS.  Any such reform could adversely affect the demand and price for ethanol and the Company’s profitability.

 

Tax Cuts and Jobs Act

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Reform Act”) was signed into law.  The Tax Reform Act includes significant changes to the taxation of partnership entities.  The Company continues to evaluate the impact of the Tax Reform Act with its professional advisors. The full impact of the Tax Reform Act on the Company in future periods cannot be predicted at this time. On March 23, 2018, Congress rescinded an unintended consequence of the Tax Reform Act under section 199A, which provided certain tax benefits to producers selling grain to cooperative associations and enabled a potential marketplace advantage over other agribusiness companies.

 

Results of Operations for the Three Months Ended January 31, 2020 and 2019

 

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2020 and 2019 (amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31,

 

 

2020

 

2019

 

 

 

(unaudited)

 

 

 

 

 

(unaudited)

 

 

 

Statement of Operations Data

 

 

 

%

 

 

 

%

Revenues

 

$

26,680

 

100.0

%  

 

$

25,697

 

100.0

%

Cost of Goods Sold

 

 

28,130

 

105.4

%  

 

 

26,731

 

104.0

%

Gross Loss

 

 

(1,450)

 

(5.4)

%  

 

 

(1,034)

 

(4.0)

%

Operating Expenses

 

 

(899)

 

(3.4)

%  

 

 

(919)

 

(3.6)

%

Operating Loss

 

 

(2,349)

 

(8.8)

%  

 

 

(1,953)

 

(7.6)

%

Other Income, net

 

 

 —

 

 —

%  

 

 

21

 

0.1

%

Net Loss

 

 

(2,349)

 

(8.8)

%  

 

 

(1,932)

 

(7.5)

%

Less: Net Income Attributable to Non-controlling Interest

 

 

(68)

 

(0.3)

%  

 

 

(92)

 

(0.4)

%

24

Net Loss Attributable to Heron Lake BioEnergy, LLC

 

$

(2,417)

 

(9.1)

%  

 

$

(2,024)

 

(7.9)

%

 

Revenues

 

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists primarily of sales of our three principal products: ethanol, distillers’ grains, and corn oil, as well as incidental sales of corn syrup.  Revenues from our ethanol production segment represented approximately 97.4% of our total revenues for the three months ended January 31, 2020 and approximately 97.7% of our total revenues for the three months ended January 31, 2019.  Our remaining consolidated revenues are attributable to Agrinatural revenues, net of eliminations for distribution fees paid by HLBE to Agrinatural for natural gas transportation services.  The revenues attributable to our natural gas pipeline segment represented approximately 2.6% of our consolidated revenues for the three months ended January 31, 2020 and approximately 2.3% of our consolidated revenues for the three months ended January 31, 2019.

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations the three months ended January 31, 2020:

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2020

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

20,292

 

76.1

%

Distillers' grains sales

 

 

4,489

 

16.8

%

Corn oil sales

 

 

914

 

3.4

%

Corn syrup sales

 

 

296

 

1.1

%

Agrinatural revenues (net of intercompany eliminations)

 

 

689

 

2.6

%

Total Revenues

 

$

26,680

 

100.0

%

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2019:

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2019

 

    

Sales Revenue

    

% of Total Revenues

 

    

(in thousands)

 

 

 

Ethanol sales

 

$

18,398

 

71.6

%

Distillers' grains sales

 

 

5,485

 

21.3

%

Corn oil sales

 

 

964

 

3.8

%

Corn syrup sales

 

 

265

 

1.0

%

Agrinatural revenues (net of intercompany eliminations)

 

 

585

 

2.3

%

Total Revenues

 

$

25,697

 

100.0

%

 

Our total consolidated revenues increased by approximately 3.8% for the three months ended January 31, 2020, as compared to the three months ended January 31, 2019, due to an increase in the average price received for our ethanol and an increase in volume sold of our corn oil, which was partially offset by a decrease in the average price received for our distillers’ grains and corn oil and decreases in volumes sold of our ethanol and distillers’ grains.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended January 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2020

 

Three Months Ended January 31, 2019

 

 

Quantity Sold

 

Avg. Net Price

 

Quantity Sold

 

Avg. Net Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

15,502

 

$

1.31

 

16,628

 

$

1.11

Distillers' grains (tons)

 

33

 

$

136.76

 

39

 

$

140.57

Corn oil (pounds)

 

4,005

 

$

0.23

 

3,865

 

$

0.25

25

 

Ethanol

 

Total revenues from sales of ethanol increased by approximately 10.3% for the three months ended January 31, 2020, compared to the same period of 2019 due to an approximately 18.0% increase in the average price per gallon we received for our ethanol as compared to the same period in 2019, which was partially offset by an approximately 6.8% decrease in the volume of ethanol sold from period to period.  The increase in ethanol prices was primarily due to the increase in corn prices.

 

From time to time, we engage in hedging activities with respect to our ethanol sales. At January 31, 2020, we had fixed and basis contracts for forward ethanol sales for various delivery periods through March 2020 valued at approximately $11.6 million.  Separately, ethanol derivative instruments resulted in a loss of approximately $82,000 for the three months ended January 31, 2020. In comparison, we had no gain or loss on ethanol derivative instruments for the three months ended January 31, 2019. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $877,000 and $981,000 for the three months ended January 31, 2020 and 2019, respectively.

 

Distillers’ Grains

 

Total revenues from sales of distillers’ grains decreased by approximately 18.2% for the three months ended January 31, 2020 compared to the same period of 2019.  This decrease was due to an approximately 15.4% decrease in the volumes of distillers’ grains sold in the three months ended January 31, 2020 compared to the same period of 2019, coupled with an approximately 2.7% decrease in the average price per ton we received for our distillers’ grains from period to period.    We sold fewer tons of distillers’ grains in the three months ended January 31, 2020 as compared to the same period in 2019 due to the timing of shipments and less production.

 

At January 31, 2020, we had forward distillers’ grains sales contracts valued at approximately $2.2 million for delivery through March 2020.

 

Corn Oil

 

Total revenues from sales of corn oil decreased by approximately 5.2% for the three months ended January 31, 2020 compared to the same period of 2019, due to an approximately 8.0% decrease in the average price per pound we received for our corn oil from period to period, which was partially offset by an increase of approximately 3.6% in pounds sold from period to period.

 

Management expects corn oil prices will remain relatively steady in the near term.  However, we may experience lower demand for corn oil from the biodiesel industry as the 2020 RVOs for biodiesel were only up slightly from the 2019 levels, which may result in lower biodiesel production. Additionally, lower soybean oil prices could negatively impact corn oil prices.

 

At January 31, 2020, we had forward corn oil sales contracts valued at approximately $289,000 for various delivery periods through February 2020.

 

Cost of Goods Sold

 

Our cost of goods sold increased by approximately 5.2% for the three months ended January 31, 2020, compared to the three months ended January 31, 2019. Additionally, as a percentage of revenues, our cost of goods sold increased to approximately 105.4% for the three months ended January 31, 2020 compared to 104.0% for the same period of 2019.  Approximately 90% of our total costs of goods sold is attributable to our ethanol production segment.  As a result, the cost of goods sold per gallon of ethanol sold for the three months ended January 31, 2020 and 2019 was approximately $1.63 and $1.45 per gallon, respectively.

 

26

The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, electricity, and wages, salaries and benefits of production personnel, inventory net realizable value losses, and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2020:

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2020

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

21,569

 

76.7

%

Natural gas costs

 

 

1,818

 

6.5

%

All other components of costs of goods sold

 

 

4,743

 

16.8

%

Total Cost of Goods Sold

 

$

28,130

 

100.0

%

 

The following table shows the costs of corn, natural gas, and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2019:

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2019

 

    

Amount

    

% of

 

 

(in thousands)

 

Cost of Goods Sold

Corn costs

 

$

20,218

 

75.6

%

Natural gas costs

 

 

2,235

 

8.4

%

All other components of costs of goods sold

 

 

4,278

 

16.0

%

Total Cost of Goods Sold

 

$

26,731

 

100.0

%

 

Corn

 

Our cost of goods sold related to corn was approximately 6.7% more for the three months ended January 31, 2020 compared to the same period of 2019.  The increase resulted from an approximately 15.2% increase in the average price per bushel paid for corn from period to period, which was partially offset by an approximately 7.5% decrease in the number of bushels of corn processed from period to period. Management attributes the increase in corn prices primarily to weather conditions. Management anticipates that corn prices will remain higher.

 

The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for the three months ended January 31, 2020 was approximately the same as the corn-ethanol price spread we experienced for same period of 2019.

 

From time to time we enter into forward purchase contracts for our commodity purchases and sales. At January 31, 2020 we had approximately 8.0 million bushels of cash and basis contracts for forward corn purchase commitments for deliveries through December 2021. 

 

Our corn derivative positions resulted in a loss of approximately $81,000 for the three months ended January 31, 2020 and a gain of approximately $94,000 for the three months ended January 31, 2019. We recognize the gains or losses that result from the changes in the value of our derivative instruments from corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments is impacted, which affects our financial performance.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on corn inventories, as a component of cost of goods sold, of approximately $126,000 and $24,000 for the three months ended January 31, 2020 and 2019, respectively.

 

Natural Gas

 

Our cost of goods sold related to natural gas costs decreased approximately 18.7% for the three months ended January 31, 2020 compared to the same period of 2019.  Management attributes this decrease in cost of natural gas from period to period to higher natural gas inventories.

 

27

We had no gain or loss on natural gas derivative instruments for the three months ended January 31, 2020 and 2019. We recognize the gains or losses that result from the changes in the value of our derivative instruments from natural gas in cost of goods sold as the changes occur.

 

Other Components of Costs of Goods Sold

 

Our costs of goods sold related to all other components increased approximately 10.9% for the three months ended January 31, 2020 compared to the same period of 2019. Management attributes this increase in costs from period to period to lower costs for repairs and maintenance in the 2019 period.

 

Operating Expenses

 

Operating expenses include wages, salaries, and benefits of administrative employees at the plant, insurance, professional fees, property taxes, and similar costs. Operating expenses for the three months ended January 31, 2020 decreased approximately 2.2% compared to the three months ended January 31, 2019. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

 

Operating Loss

 

Our operating loss for the three months ended January 31, 2020 increased by approximately $396,000 compared to the same period of 2019.  This increase resulted largely from increases in cost of goods sold related to corn and other  components during the 2020 period.

 

Other Income, Net

 

We had net other income of approximately $400 during the three months ended January 31, 2020 compared to net other income of approximately $21,000 for the same period of 2019We had less other income the three months ended January 31, 2020 compared to the same period of 2019 due primarily to less interest income during the 2020 period.

 

Changes in Financial Condition at January 31, 2020 and October 31, 2019

 

The following table highlights our financial condition at January 31, 2020 and October 31, 2019 (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

    

January 31, 2020

    

October 31, 2019

 

Current Assets

 

$

11,665

 

$

16,266

 

Total Assets

 

$

60,794

 

$

56,596

 

Current Liabilities

 

$

5,873

 

$

6,144

 

Long-Term Debt, less current portion

 

$

370

 

$

300

 

Operating Leases, long-term liabilities

 

$

8,961

 

 

 —

 

Other Long-Term Liabilities

 

$

563

 

$

551

 

Members' Equity attributable to Heron Lake BioEnergy, LLC

 

$

45,027

 

$

47,599

 

Non-Controlling Interest

 

$

 —

 

$

2,002

 

 

The decrease in total current assets is primarily attributable to a decrease in accounts receivable of approximately $3.9 million at January 31, 2020 compared to October 31, 2019. Additionally, we had decreases of approximately $2.4 million in cash on hand and approximately $10,000 in restricted cash at January 31, 2020 compared to October 31, 2019. Offsetting these decreases were increases of approximately $1.5 million in inventory, approximately $49,000 in the value of commodity derivative instruments, and approximately $233,000 in prepaid expenses and other current assets at January 31, 2020 compared to October 31, 2019.  The increase in total assets was primarily due to recognition of operating lease right of use assets of approximately $10.3 million, offset by an approximately $1.2 million decrease in property and equipment primarily due to depreciation expense during the 2020 period.

 

Our current liabilities decreased approximately $271,000 at January 31, 2020 compared to October 31, 2019, due to decreases of approximately $2.3 million in accounts payable and approximately $42,000 in accrued expenses. Offsetting

28

these decreases were increases of approximately $724,000 in checks drawn in excess of bank balance, approximately $13,000 in the value of commodity derivative instruments, and approximately $1.3 million from the current liabilities related to our operating lease. Our accounts payable were less at January 31, 2020 compared to October 31, 2019 due to the timing of payments to vendors during the three months ended January 31, 2020.

 

Members’ equity attributable to Heron Lake BioEnergy, LLC decreased by approximately $2.6 million at January 31, 2020 compared to October 31, 2019. The decrease was related to the net loss attributable to HLBE during the three months ended January 31, 2020.

 

Non-controlling interest totaled $0 and approximately $2.0 million at January 31, 2020 and October 31, 2019, respectively. This is directly related to recognition of the 27% non-controlling interest in Agrinatural at October 31, 2019.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity consist of cash provided by operations, cash, and available borrowings under our credit facility with Compeer.  Based on management’s financial forecasts, we expect to have sufficient cash generated by continuing operations and revolving term loan to fund our operations for the next twelve months.  However, should we experience unfavorable operating conditions in the future, we may have to secure additional debt or equity sources for working capital or other purposes.

 

Cash Flows

 

The following table summarizes our sources and uses of cash and restricted cash from our unaudited condensed consolidated statements of cash flows for the periods presented (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31,

 

 

 

2020

 

2019

 

 

    

(unaudited)

    

(unaudited)

 

Net cash used in operating activities

    

$

(1,042)

    

$

(2,631)

 

Net cash used in investing activities

 

$

(208)

 

$

(93)

 

Net cash used in financing activities

 

$

(1,206)

 

$

(8)

 

Net decrease in cash and restricted cash

 

$

(2,456)

 

$

(2,732)

 

 

Operating Cash Flows

 

During the three months ended January 31, 2020, we used less cash in operating activities compared to the same period of 2019 primarily due to changes in various working capital components, including accounts receivable, inventory, and accounts payable, partially offset by an increased net loss during the three months ended January 31, 2020.

 

Investing Cash Flows

 

We used more cash for investing activities for the three months ended January 31, 2020 compared to the same period of 2019 due to an increase in capital expenditures for general plant improvements.

 

Financing Cash Flows

 

During the three months ended January 31, 2020, we used cash to make payments of approximately $7.0 million on our long-term debt and approximately $2.0 million with respect to our acquisition of non-controlling interest, which were partially offset by approximately $724,000 in checks drawn in excess of bank balance and approximately $7.0 million in proceeds from long-term debt. Comparatively, during the same period of 2019, we used cash to make payments of approximately $8,000 on our long-term debt.

 

Indebtedness

 

Revolving Term Note

 

We had a revolving term note payable to Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”) under which we could borrow, repay, and re-borrow in an amount up to the original aggregate principal

29

commitment at any time prior to maturity at March 1, 2022. The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity.  In December 2017, the Company and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000.  On April 6, 2018, the Company finalized loan agreements with an effective date of March 29, 2018 for an amended credit facility with Compeer (the “2018 Credit Facility”). On January 7, 2020, the Company finalized loan agreements for an amended credit facility with its lender (the “2020 Credit Facility”).

 

 

2018 Credit Facility with Compeer

 

We had a comprehensive credit facility with Compeer for which CoBank, ACP (“CoBank”) served as the administrative agent.  This credit facility originally consisted of a revolving term loan with a maturity date of March 1, 2022.   However, on April 6, 2018, we entered into an amended credit facility with Compeer (the “2018 Credit Facility”).  The 2018 Credit Facility includes an amended and restated revolving term loan with a $4.0 million principal commitment and a revolving seasonal line of credit with a $4.0 million principal commitment.  CoBank will continue to act as Compeer's administrative agent with respect to our 2018 Credit Facility and has a participation interest in the loans. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021.  Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which totaled 4.76% at January 31, 2020.  

 

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

 

The aggregate principal amount available to the Company for borrowing under the revolving term loan at January 31, 2020 and 2019 was $4.0 million.

 

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million until its maturing on May 1, 2020.  Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.85% above the LIBOR Index rate, which was 4.51% at January 31, 2020.

 

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

 

The aggregate principal amount available to the Company for borrowing under the seasonal revolving loan at January 31, 2020 and 2019 was $4.0 million.

 

The 2018 Credit Facility is secured by substantially all of our assets, including a subsidiary guarantee.

 

Under the 2018 Credit Facility, the Company is subject to certain financial and non-financial covenants that limit the Company’s distributions and debt and require minimum working capital, minimum local net worth, and debt service coverage ratio.  We agreed to a debt service coverage ratio of 1.15 to 1.0, to maintain minimum working capital $8.0 million through September 30, 2018 and $10.0 million thereafter, and to maintain net worth of $32.0 million. We are permitted to pay distributions to our members up to 75% of our net income for the year in which the distributions are paid provided that immediately prior to the distribution and after giving effect to the distribution, no default exists and we are in compliance with all of our loan covenants.  Further, we agreed not to make loans or advances to Agrinatural that exceed an aggregate principal amount of approximately $6.6 million without the consent of Compeer.

 

In October 2018, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2018, the Company received a waiver from its lender waiving this event of noncompliance. In October 2019, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2019, the Company received a waiver from its lender waiving this event of noncompliance. If market conditions deteriorate in the future, circumstances may develop which could result

30

in the Company violating the financial covenants or other terms of its 2018 Credit Facility. Should unfavorable market conditions result in our violation of the terms or covenants of the 2018 Credit Facility and we fail to obtain a waiver of any such term or covenant, Compeer could deem the Company in default, impose fees, charges and penalties, terminate any commitment to loan funds and require the Company to immediately repay a significant portion or possibly the entire outstanding balance of the revolving term loan. In the event of a default, Compeer could also elect to proceed with a foreclosure action on our plant.

 

2020 Credit Facility with Compeer

 

The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment.  The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

 

Under the terms of the amended and restated revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $8.0 million.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2022. Interest on the amended and restated revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which totaled 4.76% at January 31, 2020.  We agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

 

As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank.  As a result, CoBank will continue act as the agent for the lender with respect to the 2020 Credit Facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Other Credit Arrangements

 

In addition to our primary credit arrangement with Compeer, we have other material credit arrangements and debt obligations.

 

In October 2003, we entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors, an unrelated company. In consideration of this agreement, we and Minnesota Soybean Processors were allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. On September 30, 2019, we finalized a new industrial water supply development and distribution agreement with the City of Heron Lake, effective as of February 1, 2019. Under this agreement, we pay flow charges and fixed monthly charges to the City of Heron Lake, in addition to certain excess maintenance costs. The term of this agreement expires February 1, 2029.

 

In May 2006, we entered into an industrial water supply treatment agreement with the City of Heron Lake and Jackson County. Under this agreement, we pay monthly installments over 24 months starting January 1, 2007 equal to one years’ debt service on approximately $3.6 million in water revenue bonds, which will be returned to us if any funds remain after final payment in full on the bonds and assuming we comply with all payment obligations under the agreement.

 

As of January 31, 2020 and 2019, there was a total of approximately $634,000 and $951,000 in outstanding water revenue bonds, respectively. We classify our obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.

 

To fund the purchase of the distribution system and substation for the plant, we entered into a loan agreement with Federated Rural Electric Association pursuant to which we borrowed $600,000 under a secured promissory note secured by the distribution system and substation for the plant. Under the note we were required to make monthly payments to Federated Rural Electric Association of $6,250 consisting of principal and an annual maintenance fee of 1% beginning on October 10, 2009. We paid the balance of this loan in full in September 2017.

 

31

We also had a note payable to the minority owner of Agrinatural Gas, LLC in the amount of $100,000 at October 31, 2017.  We paid the balance of this loan in full in January 2018. 

32

Loans to Agrinatural

 

Original Agrinatural Credit Facility

 

On July 29, 2014, HLBE entered into an intercompany loan agreement and related loan documents with Agrinatural (the “Original Agrinatural Credit Facility”). Under the Original Agrinatural Credit Facility, HLBE agreed to make a five-year term loan in the principal amount of $3.05 million to Agrinatural for use by Agrinatural to repay approximately $1.4 million of its outstanding debt and provide approximately $1.6 million of working capital to Agrinatural. The Original Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.

 

On March 30, 2015, HLBE entered into an allonge (the “Allonge”) to the July 29, 2014 note with Agrinatural. Under the terms of the Allonge, HLBE and Agrinatural agreed to increase the principal amount of the Original Agrinatural Credit Facility to approximately $3.06 million, defer commencement of repayment of principal until May 1, 2015, decrease the monthly principal payment to $36,000 per month and shorten maturity of the Original Agrinatural Credit Facility to May 1, 2019.

 

Interest on the Original Agrinatural Credit Facility was not amended and accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Accrued interest is due and payable on a monthly basis. Except as otherwise provided in the Allonge, all of the terms and conditions contained in the Original Agrinatural Credit Facility remain in full force and effect.

 

In exchange for the Loan Agreement, the Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural’s equipment and assets and a collateral assignment assigning HLBE all of Agrinatural’s interests in its contracts, leases, easements and other agreements. In addition, RES, the former minority owner of Agrinatural, executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to HLBE.

 

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Original Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was $0 at January 31, 2020 and approximately approximately $1.1 million at October 31, 2019. Subsequent to the closing of HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Original Agrinatural Credit Facility.

 

Additional Agrinatural Credit Facility

 

On March 30, 2015, HLBE entered into a second intercompany loan agreement and related loan documents (the “Additional Agrinatural Credit Facility”) with Agrinatural. Under the Additional Agrinatural Credit Facility, HLBE agreed to make a four-year term loan in the principal amount of $3.5 million to Agrinatural for use by Agrinatural to repay its outstanding trade debt and provide working capital. The Additional Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.

 

Interest on the additional term loan accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Prior to May 1, 2015, Agrinatural is required to pay only monthly interest on the term loan.  Commencing May 1, 2015, Agrinatural is required to make monthly installments of principal plus accrued interest. The entire principal balance and accrued and unpaid interest on the term loan was due and payable in full on May 1, 2019.

 

On May 19, 2016, HLBE and Agrinatural amended the Additional Agrinatural Credit Facility, entering into amendment to the loan agreement dated March 30, 2015 (the “Amendment”).  Additionally, HLBE and Agrinatural entered into an allonge to the negotiable promissory note dated March 30, 2015 issued by Agrinatural to HLBE (the “Additional Allonge”) to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility and deferred a portion of the principal payments required for 2016.

 

33

The Amendment provides that the portion of principal payments deferred in calendar year 2016 to continue to accrue interest at the rate set forth in the Note and become a part of the balloon payment due at maturity.  Additionally, for calendar years, 2017, 2018 and 2019, the Amendment provides that Agrinatural may, without consent of HLBE, proceed with and pay for capital expenditures in an amount up to $100,000 plus the amount of contributions in aid of construction received by Agrinatural from customers for capital improvements (“CIAC”), less a reserve for distribution to the Agrinatural members to cover the income or other taxes imposed as a result of receipt of CIAC in an amount equal to 40% of CIAC. Prior to the Amendment, Agrinatural’s capital expenditures were restricted to $100,000 per year.

 

In exchange for the Additional Agrinatural Credit Facility, Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural’s equipment and assets and a collateral assignment assigning HLBE all of Agrinatural’s interests in its contracts, leases, easements and other agreements. In addition, RES executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to HLBE under the Additional Agrinatural Credit Facility.

 

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Additional Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was $0 at January 31, 2020 and approximately $1.5 million at October 31, 2019. Subsequent to the closing of HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Additional Agrinatural Credit Facility.

 

Critical Accounting Estimates

 

Management uses 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.  We believe that of our significant accounting policies summarized in Note 1 to our condensed consolidated unaudited financial statements included with this periodic report on Form 10-Q.

 

At January 31, 2020, our critical accounting estimates continue to include those described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019.  Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles in the United States of America. 

 

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 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, ethanol, 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 pursuant to the requirements of Generally Accepted Accounting Principles (“GAAP”).

 

Interest Rate Risk

 

From time to time, we may be exposed to market risk from changes in interest rates.  Exposure to interest rate risk results primarily from our credit facility with Compeer.  The specifics of these credit facilities are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Indebtedness”.

 

As of January 31, 2020, we had no exposure to interest rate risk as we had no amounts outstanding under our loans with Compeer.

 

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Commodity Price Risk

 

We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers’ grains, through the use of hedging instruments.  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 under fair value accounting can cause net income to be volatile from period to period due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

 

As of January 31, 2020, we had price protection in place for approximately 35% and 30% of our anticipated corn and natural gas needs for the next 12 months, respectively, and approximately 17%, 5%, and 6% of our anticipated ethanol, distillers’ grains, and corn oil sales for the next 12 twelve months, respectively. Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations.  As input 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 growth for us.

 

A sensitivity analysis has been prepared to estimate our exposure to ethanol, 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 fair value of our corn and natural gas prices and average ethanol price as of January 31, 2020, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements.  The volumes are based on our expected use and sale of these commodities for a one year period from January 31, 2020.

 

The results of this analysis, which may differ from actual results, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Volume Requirements 

 

 

 

Hypothetical Adverse

 

Approximate

 

 

for the next 12 months

 

Unit of

 

Change in Price as of

 

Adverse

 

    

(net of forward and futures contracts)

    

Measure

    

January 31, 2020

    

Change to Income

Ethanol

 

57,500,000

 

Gallons

 

10.0%

 

$

7,130,000

 

Corn

 

15,000,000

 

Bushels

 

10.0%

 

$

5,685,000

 

Natural Gas

 

1,250,000

 

MMBTU

 

10.0%

 

$

355,000

 

 

 

 

Item 4.  Controls and Procedures

 

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

 

Effectiveness of Disclosure Controls and Procedures

 

Our management, including our Chief Executive Officer (the principal executive officer), Steve Christensen, along with our Chief Financial Officer (the principal financial officer), Stacie Schuler, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as January 31, 2020.  Based upon this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

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Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the three months ended January 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

From time to time in the ordinary course of business, the Company may be named as a defendant in legal proceedings related to various issues, including workers’ compensation claims, tort claims, or contractual disputes.  We are not currently involved in any material legal proceedings.

 

Item 1A. Risk Factors

 

The risk factors below should be read in conjunction with the risk factors previously discussed in Item 1A of our Form 10-K for the fiscal year ended October 31, 2019. Additional risks and uncertainties, including risks and uncertainties not presently known to us, or that we currently deem immaterial, could also have an adverse effect on our business, financial condition and/or results of operations.

 

Our business, and our industry as a whole, could be adversely affected by an outbreak of disease, epidemic or pandemic, such as the global coronavirus pandemic, or similar public threat, or fear of such an event. 

 

The recent global outbreak of the coronavirus pandemic could have a negative impact on our revenues and operating results. This outbreak could result in disruptions and damage to our business, caused by both the negative impact to our ability to obtain cost effective raw materials, supplies and component parts necessary to operate our ethanol, distillers’ grains, corn oil, or natural gas business and the negative impact on our ability to operate our facility should the coronavirus spread more broadly within Minnesota or the Midwest, thereby creating an increased risk of exposure to our workforce which cannot operate our facility remotely. Mitigation efforts will not completely prevent our business from being adversely affected, and the longer the pandemic impacts supply and demand and the more broadly the pandemic spreads, it is more likely that the impact on our business, revenues and operating results will become increasingly negative.

 

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

 

None.

 

Item 3.  Defaults Upon Senior Securities

 

None.

 

Item 4.  Mine Safety Disclosures

 

None.

 

Item 5.  Other Information

 

None.

 

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Item 6.  Exhibits

 

The following exhibits are included in this report:

 

 

 

 

Exhibit No.

 

Exhibit

 

 

 

31.1 

 

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

 

 

 

31.2 

 

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

 

 

 

32.1 

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.*

 

 

 

32.2 

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.*

 

 

 

101.1

 

The following materials from Heron Lake BioEnergy’s Quarterly Report on Form 10-Q for the three months ended January 31, 2020, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at January 31, 2020 and October 31, 2019; (ii) the Condensed Consolidated Statements of Operations for the three months ended January 31, 2020 and 2019; (iii) the Condensed Consolidated Statements of Members’ Equity for the three months ended January 31, 2020 and 2019; (iv) the Condensed Consolidated Statements of Cash Flows for the three months ended January 31, 2020 and 2019; and (v) Notes to Condensed Consolidated Unaudited Financial Statements.*


*Filed electronically herewith.

 

 

37

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

HERON LAKE BIOENERGY, LLC

 

 

Date: March 16, 2020

/s/ Steve Christensen

 

Steve Christensen

 

Chief Executive Officer

 

 

Date: March 16, 2020

/s/ Stacie Schuler

 

Stacie Schuler

 

Chief Financial Officer

 

38