We prepared the following discussion and analysis to help readers better
understand our financial condition, changes in our financial condition, and
results of operations for the three and six months ended
Disclosure Regarding Forward-Looking Statements
The
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
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 Renewable Fuel Standard ("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
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;
? Our reliance on key management personnel;
A slowdown in global and regional economic activity, demand for our products ? and the potential for labor shortages and shipping disruptions resulting from
COVID-19. 19
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Our CEO and General Manager retired effective
may adversely affect our business; and
The election of President
adversely affect our business.
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
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
Overview
We have a management services agreement with
Ethanol Production
Our primary line of business is the Company's operation of its ethanol plant, including the production and sale of ethanol and its co-products (distillers' grains, non-edible corn oil and corn syrup). These operations are aggregated into one financial reporting segment.
Our ethanol plant has a nameplate capacity of 50 million gallons per year. We
have received
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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 on an annualized basis and intend to continue to do so into
the future, dependent on industry conditions and plant profitability. In
response to repeated malfunctions with our boiler, we installed a new boiler at
our plant in
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
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
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. In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure.
While the Company believes the replacement of the boiler has improved the operating performance of the plant, and led to lower operating costs, market conditions have resulted in tight margins and may resulted in future losses.
Proposed Merger with
During the three months ended
GFE currently owns approximately 50.7% of the Company's units. Pursuant to the
Merger Agreement, GFE will acquire the remainder of the units (the "Minority
Ownership Interest"). The purchase price for the entire Minority Ownership
Interest is
The units of Company held by GFE immediately prior closing of Merger shall be cancelled with no consideration issued to GFE. GFE will emerge from the transaction as the sole owner of the Company. At the time the Merger becomes effective, 100 percent of the membership interest in the Merger Sub shall be converted into and become 100 percent of the membership interests in the Company, as the surviving company in the Merger.
The Merger is subject to approval by the Minority Ownership Interest. We intend to convene a special meeting of the members of the Company to vote on the proposed Merger (the "Special Meeting") in the summer of 2021. The Merger is also conditioned on regulatory approval, the consent the Company's lender, and GFE's ability to obtain financing for the transaction. If such approvals and consents are obtained, the Merger is expected to close following the Special Meeting.
Upon closing of the Merger, the Company intends to file a Certification and
Notice of Termination of Registration with the
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Company's
A complete description of the Merger and the Merger Agreement is available in
the Company's preliminary proxy statement filed with the
Effect if the Merger is Not Completed
If the Merger is not completed, the Company's unitholders will not receive the Merger Consideration or any other payment for their units of the Company. Instead, Company will remain a majority-owned subsidiary of GFE.
Further, the Company has experienced significant net losses due to several
factors, including elevated corn prices, the breakdown of our ethanol plant's
boiler, and reduced demand for ethanol due to several factors, including the
COVID-19 pandemic. Due to these net losses, the Company has violated certain
loan covenants during the past fiscal year related to working capital and net
worth ratio, for which the Company has obtained waivers from its lender. The
Company was in compliance with its debt covenants on
While the Company believes the replacement of the boiler has improved the operating performance of the plant, and led to lower operating costs, market conditions have resulted in losses. If the Merger is not completed, the Company intends to source other capital sources, which may include re-negotiating their debt agreements and terms or seek potential equity solutions. At this time, there are no commitments to do so and we may not be successful in doing so.
Appointment of
GFE appointed
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, "PART II - Item 1A. Risk Factors" of our
quarterly report on Form 10-Q for the three months ended
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
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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, which can cause our operating margins to 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 believes that the ethanol outlook in the fiscal year 2021 will remain
relatively consistent with this quarter. The widespread distribution of COVID-19
vaccines and the subsequent reopening of many business have improved the overall
economic outlook and the demand for fuel, including the ethanol we produce.
However, lingering effects of the COVID-19 pandemic and other factors could
continue to negatively affect our profitability. Additionally, continued large
corn supplies and increases in ethanol production capacity could negatively
affect our profitability. This negative impact could worsen if domestic ethanol
inventories increase, or if
Ethanol production largely rebounded and remained steady in late 2020 after
briefly and significantly declining during the second fiscal quarter of 2020 at
the onset of the COVID-19 pandemic. In the three months ended
Additionally, a decrease in exports could reduce demand for biofuel including
the ethanol we produce. Annual
Further, management believes that waivers of small refiner renewable volume
obligations ("RVOs") by the
Changes 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
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
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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.
Impact of COVID-19 on the Company
Operations
The Company, and the ethanol industry as a whole, experienced significant
adverse conditions throughout 2020, and into 2021 as the COVID-19 pandemic
greatly reduced travel and thus reduced demand for fuel, including the ethanol
we produce. Reduced demand and high industry inventory levels resulted in record
low ethanol prices in the spring of 2020. As a result, we experienced negative
operating margins, significantly lower cash flow from operations and substantial
net losses. In response to these adverse market conditions, the Company idled
its ethanol production from on or about
Employees
The Company has enacted appropriate safety measures to protect the health and safety of our employees, customers, partners and suppliers, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, partners and suppliers.
Management believes that various factors, including unemployment benefits offered in response to the COVID-19 pandemic, have exacerbated an ongoing labor shortage. While we currently have sufficient employees to operate our production facility, it is possible that the current shortage of qualified, available workers could result in higher labor costs and could negatively affect our ability to efficiently operate our production facility.
Supply and Demand
Although we continue to regularly monitor the financial health of companies in our supply chain, financial hardship on our suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to produce our products, adversely affecting our operations. Various factors, including disruptions caused by the COVID-19 pandemic, have resulted in significant increases in the costs of raw materials, including the corn and natural gas we rely on to produce ethanol. Additionally, restrictions or disruptions of transportation, such as reduced availability of truck, rail or air transport, port closures and increased border controls or closures, may result in higher costs and delays, both with respect to obtaining raw materials and shipping finished products to customers, which could harm our profitability, make our products less competitive, or cause our customers to seek alternative suppliers. Additionally, the COVID-19 pandemic has significantly increased economic and demand uncertainty. The pandemic has caused a global economic slowdown, and it is possible that it could cause a global recession. In the event of a recession, demand for our products would decline further and our business would be further adversely affected.
PPP Loans
On
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The adverse conditions created by the COVID-19 pandemic caused the Company to
experience negative operating margins, significantly lower cash flow from
operations and substantial net losses. As a result, we have experienced
instances of noncompliance with certain loan covenants related to our working
capital and net worth ratio, for which the Company has received waivers from its
lender. We were in compliance with our financial covenants as of
While the lifting of restrictions related to COVID-19 has improved the overall economic outlook, the pandemic is ongoing, and its dynamic nature makes it difficult to forecast the long-term effects on our industry as a whole and our Company specifically. It is possible that even as the pandemic subsides, there will be permanent changes to social and economic patterns that will reduce demand for ethanol, such as reduced travel due to an increase in remote working.
Despite the economic uncertainty resulting from the COVID-19 pandemic, we intend to continue to focus on strategic initiatives designed to improve on our operational efficiencies, which is critical in order to drive positive results in a low-margin environment.
We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of the COVID-19 pandemic on our financial condition, results of operations or cash flows in the future.
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 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.
However, President
Additional legal actions related to the RFS are underway. These include lawsuits
challenging fuel volume waivers based on "inadequate domestic supply,"
challenging the
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The prices of renewable identification number ("RIN") credits - the compliance
mechanisms for the RFS program administered by the
COVID-19 Legislation
In response to the COVID-19 pandemic,
The CARES Act also provided for the
On
On
Results of Operations for the Three Months Ended
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
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condensed consolidated statements of operations for the three months ended
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