UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. |
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| FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005 |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| FOR THE TRANSITION PERIOD FROM TO |
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| COMMISSION FILE NUMBER: 333-50568 |
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BADGER STATE ETHANOL, LLC
(Exact name of registrant as specified in its charter)
WISCONSIN | | 39-1996522 |
(State or other jurisdiction | | (IRS Employer |
of incorporation or organization) | | Identification No.) |
820 West 17th Street
Monroe, Wisconsin 53566
(Address of principal executive offices)
(608) 329-3900
(Registrant’s telephone number, including area code)
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of November 14, 2005, the Company has issued 19,774 Class A member units.
BADGER STATE ETHANOL, LLC
FORM 10-Q QUARTERLY REPORT FOR THE QUARTER ENDED
September 30, 2005
TABLE OF CONTENTS
Part I – Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
BADGER STATE ETHANOL, LLC
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
| | September 30, 2005 | | December 31, 2004 | |
ASSETS | | | | | |
CURRENT ASSETS | | | | | |
Cash and cash equivalents | | $ | 149,611 | | $ | 3,807,383 | |
Accounts receivable: | | | | | |
Trade | | 6,250,887 | | 5,896,669 | |
Government incentive payments | | - | | 100,000 | |
Inventories | | 3,191,357 | | 2,513,357 | |
Margin deposits | | 271,297 | | 2,191,259 | |
Derivative contracts | | 74,070 | | - | |
Other assets | | 68,516 | | 189,615 | |
| | | | | |
Total current assets | | 10,005,738 | | 14,698,283 | |
| | | | | |
PROPERTY AND EQUIPMENT, at cost | | | | | |
Plant buildings and equipment | | 50,769,905 | | 47,880,729 | |
Land improvements | | 1,609,737 | | 1,398,917 | |
Office buildings and equipment | | 499,467 | | 476,467 | |
| | 52,879,109 | | 49,756,113 | |
Less accumulated depreciation and amortization | | 6,540,182 | | 4,780,896 | |
| | 46,338,927 | | 44,975,217 | |
Construction in progress | | 3,141,532 | | - | |
| | 49,480,459 | | 44,975,217 | |
OTHER ASSETS | | | | | |
Intangible assets | | 248,000 | | - | |
Other | | 237,320 | | 528,106 | |
| | 485,320 | | 528,106 | |
| | | | | |
TOTAL ASSETS | | $ | 59,971,517 | | $ | 60,201,606 | |
| | | | | |
LIABILITIES AND MEMBERS’ EQUITY | | | | | |
| | | | | |
CURRENT LIABILITIES | | | | | |
Current maturities of long-term debt | | $ | 1,497,751 | | $ | 3,409,246 | |
Accounts payable | | 2,581,992 | | 1,700,616 | |
Accrued liabilities | | 659,584 | | 1,064,232 | |
Derivative contracts | | - | | 1,989,565 | |
Deferred revenue | | 550,480 | | 329,569 | |
| | | | | |
Total current liabilities | | 5,539,807 | | 8,493,228 | |
| | | | | |
LONG-TERM DEBT, less current maturities | | 18,521,298 | | 17,635,157 | |
| | | | | |
COMMITMENTS | | - | | - | |
| | | | | |
MEMBERS’ EQUITY | | | | | |
Members’ contributions | | 17,859,787 | | 17,859,787 | |
Retained earnings | | 18,300,625 | | 16,213,434 | |
| | 36,160,412 | | 34,073,221 | |
| | | | | |
TOTAL LIABILITIES AND MEMBERS’ EQUITY | | $ | 59,971,517 | | $ | 60,201,606 | |
The accompanying notes are an integral part of these condensed consolidated statements.
1
BADGER STATE ETHANOL, LLC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| | Three months ended | | Nine months ended | |
| | September
30, 2005 | | September 30,
2004 | | September 30,
2005 | | September 30,
2004 | |
| | | | | | | | | |
Sales and revenues | | $ | 24,792,787 | | $ | 24,032,104 | | $ | 72,105,489 | | $ | 69,782,375 | |
Cost of sales | | 20,187,188 | | 22,686,205 | | 58,755,031 | | 58,089,853 | |
Gross margin | | 4,605,599 | | 1,345,899 | | 13,350,458 | | 11,692,522 | |
| | | | | | | | | |
Selling, general and administrative expenses | | 767,769 | | 724,494 | | 2,389,902 | | 2,218,552 | |
| | | | | | | | | |
Operating income | | 3,837,830 | | 621,405 | | 10,960,556 | | 9,473,970 | |
| | | | | | | | | |
Interest expense | | (315,889 | ) | (313,036 | ) | (1,224,407 | ) | (1,007,783 | ) |
Interest income | | 5,457 | | 3,826 | | 23,354 | | 11,231 | |
| | | | | | | | | |
Net income | | $ | 3,527,398 | | $ | 312,195 | | $ | 9,759,503 | | $ | 8,477,418 | |
| | | | | | | | | |
Net income per unit – basic and diluted | | $ | 178.39 | | $ | 15.79 | | $ | 493.55 | | $ | 428.72 | |
| | | | | | | | | |
Weighted average units outstanding – basic and diluted | | 19,774 | | 19,774 | | 19,774 | | 19,774 | |
The accompanying notes are an integral part of these condensed consolidated statements.
2
BADGER STATE ETHANOL, LLC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | Nine months ended
September 30, 2005 | | Nine months ended
September 30, 2004 | |
| | | | | |
Cash flows from operating activities | | | | | |
Net income | | $ | 9,759,503 | | $ | 8,477,418 | |
Adjustments to reconcile net income to net cash provided by operating activities | | | | | |
Depreciation and amortization | | 1,130,994 | | 1,824,382 | |
Changes in operating assets and liabilities: | | | | | |
Trade accounts receivable | | (354,218 | ) | (1,613,177 | ) |
Government incentive payments receivable | | 100,000 | | 812,426 | |
Inventories | | (678,000 | ) | 757,869 | |
Margin deposits | | 1,919,962 | | (1,378,259 | ) |
Other assets | | 121,099 | | 458,690 | |
Derivative contracts | | (2,063,635 | ) | 2,036,061 | |
Accounts payable | | 881,376 | | 351,223 | |
Accrued liabilities | | (404,648 | ) | (428,191 | ) |
Deferred revenue | | 220,911 | | - | |
Net cash provided by operating activities | | 10,633,344 | | 11,298,442 | |
| | | | | |
Cash flows used in investing activities | | | | | |
Cost of property and equipment | | (5,095,640 | ) | (1,203,200 | ) |
Payments for intangible assets | | (248,000 | ) | - | |
Net cash used in investing activities | | (5,343,640 | ) | (1,203,200 | ) |
| | | | | |
Cash flows from financing activities | | | | | |
Payments of financing fees | | (249,810 | ) | - | |
Proceeds from long-term debt financing | | 17,487,216 | | - | |
Payment of dividends | | (7,672,312 | ) | (4,943,500 | ) |
Payments on long-term debt financing | | (18,512,570 | ) | (5,223,077 | ) |
| | | | | |
Net cash used in financing activities | | (8,947,476 | ) | (10,166,577 | ) |
| | | | | |
NET DECREASE IN CASH AND CASH EQUIVALENTS | | (3,657,772 | ) | (71,335 | ) |
| | | | | |
Cash and cash equivalents at beginning of period | | 3,807,383 | | 1,810,490 | |
| | | | | |
Cash and cash equivalents at end of period | | $ | 149,611 | | $ | 1,739,155 | |
| | | | | |
Supplemental disclosure of cash flow information: | | | | | |
Interest paid | | $ | 1,063,005 | | $ | 1,083,224 | |
The accompanying notes are an integral part of these condensed consolidated statements.
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BADGER STATE ETHANOL, LLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Badger State Ethanol, LLC (the “Company”) operates an ethanol plant in Wisconsin that began operations in October 2002. The Company sells its production of ethanol and related products domestically and operates in one business segment.
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. These financial statements and related notes should be read in conjunction the Company’s audited financial statements for the year ended December 31, 2004, contained in the Company’s annual report on Form 10-KSB for 2004.
In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods indicated. The results of operations for the three and nine months ended September 30, 2005 are not necessarily indicative of the results expected for the full year.
NOTE B – ACQUISITION
On August 4, 2005, the Company loaned approximately $2,585,000 (the “Loan”) to Spring Valley Ventures, LLC, a Wisconsin limited liability company (“Spring Valley Ventures”). On August 5, 2005, the Company acquired all of the capital interests of Spring Valley Ventures for approximately $103,000 and converted the Loan into equity interests in Spring Valley Ventures, which is now a wholly-owned subsidiary of the Company. The Company acquired Spring Valley Ventures in order to provide additional corn storage and direct access to corn supply for the Company’s ethanol plant. The acquisition price has been allocated to land and building equipment on the balance sheet.
NOTE C - INVENTORIES
Inventories consist of the following:
| | September 30, 2005 | | December 31, 2004 | |
Raw materials | | $ | 1,762,683 | | $ | 1,244,352 | |
Work-in-process | | 391,389 | | 355,202 | |
Finished goods | | 1,037,285 | | 913,803 | |
| | | | | |
Total inventories | | $ | 3,191,357 | | $ | 2,513,357 | |
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NOTE D – DERIVATIVE INSTRUMENTS
The Company enters into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn purchases, forward corn purchase contracts and forecasted ethanol sales. The Company does not typically enter into derivative instruments other than for hedging purposes. All derivative contracts at September 30, 2005 and December 31, 2004 are recognized in the balance sheets at their fair market value.
On the date the derivative instrument is entered into, the Company will designate the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a “fair value hedge”), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a “cash flow hedge”) or (3) will not designate the derivative as a hedge. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Changes in the fair value of a derivative that is not designated as a hedge are recorded in current period earnings.
At September 30, 2005 and December 31, 2004 no derivative contracts were designated as hedges and all changes in market value have been recognized through cost of sales. The amount recorded for derivative contracts at September 30, 2005 was an asset of $74,070 and at December 31, 2004 was a liability of $1,989,565. The Company recorded a decrease to cost of sales of $71,545 and an increase to cost of sales of $857,579 related to derivative contracts for the three and nine months ended September 30, 2005. The Company recorded an increase to cost of sales of $3,009,002 and $1,797,353 related to derivative contracts for the three and nine months ended September 30, 2004.
NOTE E – GOVERNMENT INCENTIVE PAYMENTS
The Company recognizes revenue from federal and state incentive payments when all requirements of the program have been met and payments are assured. The Company recorded no revenue and $633,333 related to incentive payments under the State of Wisconsin Producer Subsidy Payment program for the three and nine months ended September 30, 2005. The Company recorded no revenue and $333 related to incentive payments under the State of Wisconsin Producer Subsidy Payment program for the three and nine months ended September 30, 2004.
The Company recorded revenue of $67,246 and $143,227 related to incentive payments under the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program (the “US CCC Program”) for the three and nine months ended September 30, 2005. The Company recorded revenue of $358,020 and $1,815,114 related to incentive payments under the US CCC Program for the three and nine months ended September 30, 2004.
5
NOTE F – COMMITMENTS
The Company had forward contracts to purchase approximately 3,200,000 and 3,280,000 bushels of corn at various prices at September 30, 2005 and December 31, 2004.
On June 29, 2005, the Company entered into various agreements to construct an approximately $25,000,000 (subject to customary adjustments) addition to the Company’s ethanol plant for the production of corn protein concentrate and corn germ. The Company expects commercial production to begin July 2006. In addition, the Company entered into two marketing agreements with a third party: one for the sale of all corn protein concentrate produced by the Company and the other for the sale of all corn germ produced by the Company. These agreements expire on the fifth anniversary of the date of first commercial production. As of September 30, 2005, $3,141,352 of the total commitment is included in construction in progress.
In addition, the Company executed a License Agreement dated as of June 23, 2005 with a third-party (the “License Agreement”), which was entered into on June 29, 2005. Pursuant to the License Agreement, the Company will license certain technologies to use in the construction and operation of the addition to the Company’s plant. The license provided under the License Agreement is irrevocable and perpetual.
NOTE G - RELATED PARTIES
The Company’s sole ethanol marketing company is a member of and has a representative on the Company’s Board of Directors. Sales for the three and nine months ended September 30, 2005 to the ethanol marketing company were $19,503,997 and $55,930,485. Sales for the three and nine months ended September 30, 2004 to the ethanol marketing company were $18,683,742 and $53,733,876. Trade accounts receivable from the ethanol marketing company at September 30, 2005 and December 31, 2004 were $5,658,084 and $5,545,505.
In connection with the sales activities of the ethanol marketing company, the Company paid expenses to the ethanol marketing company of $1,041,281 and $3,442,483 for the three and nine months ended September 30, 2005. Expenses paid to the ethanol marketing company were $1,121,098 and $3,493,007 for the three and nine months ended September 30, 2004.
NOTE H – LONG-TERM DEBT
The Company executed a credit facility (the “Credit Facility”) with Agstar Financial Services, PCA (“Agstar”) dated June 22, 2005, which was held in escrow pursuant to an agreement between the parties and entered into on June 29, 2005. The Credit Facility is structured as two term loans in the aggregate amount of $15,491,087 (the “Term Loan”), a convertible loan in the amount of $20,000,000 (the “Convertible Loan”), and a revolving loan in the amount of $9,000,000 (the “Revolving Loan”). The Credit Facility replaces the Company’s prior credit facility (the “Prior Facility”), and allows the Company to pay costs expected to be incurred under various agreements to construct an addition to the plant to produce corn protein concentrate and corn germ (see note F) and to provide for operating capital.
The Term Loan is structured as two Promissory Notes in the original principal amounts of $5,891,087 (“Note #1”) and $9,600,000 (“Note #2”). Note #1 and Note #2 bear interest at a variable rate equal to 3.25% above the LIBOR rate. The Convertible Loan and the Revolving Loan bear interest at a variable rate equal to 3% above the LIBOR
6
rate. The Company has the option to convert Note #1, Note #2 and the Convertible Loan to fixed rate loans under certain conditions, and the interest rates for Note #1, Note #2, the Convertible Loan and the Revolving Loan are subject to adjustment based on certain capital conditions of the Company.
Borrowings under the Credit Facility are secured by substantially all of the assets of the Company. The Credit Facility contains customary financial and other covenants, and includes customary restrictions on certain activities of the Company, such as incurring additional debt. If an event of default, such as failure to make required payments or a failure to comply with covenants after any applicable grace period, were to occur under the Credit Facility, “Agstar” would be entitled to, among other remedies, declare all amounts outstanding under the facility immediately due and payable, and to enforce its security interest and mortgage on the assets of the Company. The Company was in compliance with these covenants at September 30, 2005.
At September 30, 2005, the Company has $15,311,271 outstanding under the Term Loan, $1,746,129 under the Convertible Loan and $250,000 outstanding under the Revolving Loan. At December 31, 2004 the balance outstanding under the Prior Facility was $18,037,219.
NOTE I – RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the current period’s presentation. These reclassifications had no effect on previously recorded net income or members’ equity.
7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Except for the historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties, including those risks described in this section. Actual results may differ substantially from those described below. Our discussion and analysis of financial condition and results of operations of the Company should be read in conjunction with the financial statements and related notes.
Application of Critical Accounting Policies
Accounting policies, methods and estimates are an integral part of our financial statements and are based upon management’s current judgments. Certain accounting policies, methods and estimates are particularly important because of their significance to the financial statements. Note A of the Notes to Financial Statements included in the Annual Report on Form 10-KSB includes a summary of the significant accounting policies and methods we use. The following is a discussion of what we believe to be the most critical of these policies and methods.
Revenue Recognition
We recognize revenue from federal and state incentive payments when all the requirements of the program have been met and payments are assured. The payments to be received by us may change due to a variety of factors, including legislative changes and the amount of ethanol produced by us and in the marketplace.
Inventories
Inventories are stated at the lower of cost or net realizable value. Costs are determined using the first-in, first-out method.
Derivatives
We enter into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn purchases, forward corn purchase contracts and forecasted ethanol sales. We do not typically enter into derivative instruments other than for hedging purposes. All derivative contracts at September 30, 2005 and December 31, 2004 are recognized in the balance sheet at their fair market value.
On the date the derivative instrument is entered into, we will designate the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a “fair value hedge”), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a “cash flow hedge”) or (3) will not designate the derivative as a hedge. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Changes in the fair value of a derivative that is not designated as a hedge are recorded in current period earnings.
At September 30, 2005 and December 31, 2004 no derivative contracts were designated as hedges and all changes in market value have been recognized through cost of sales. We have recorded a decrease to cost of sales of $71,545 and an increase to cost of sales of $857,579 related to derivative contracts for the three and nine months ended September 30, 2005. We recorded an increase to cost of sales of $3,009,002 and $1,797,353 related to derivative contracts for the three and nine months ended September 30, 2004.
Summary
We are primarily engaged in the production and sale of fuel grade ethanol. We have an annual capacity to process between approximately 18 to 19 million bushels of corn into between approximately 50 to 52 million gallons of ethanol. In addition, we sell distillers grains, a principal by-product of the ethanol-production process,
8
which we sell as distillers modified wet grains and distillers dried grains. We also sell carbon dioxide to third parties. Also, as of October, 2005, we completed construction of our Smart Station retail fuel station and began selling ethanol based fuel (both 10% ethanol and 85% ethanol) to retail consumers.
Facility Addition
On August 30, 2005, we submitted an Air Pollution Control Construction Permit application to the Wisconsin Department of Natural Resources (“WDNR”) to authorize changes to our facility to implement the construction of the facility addition. We received our Air Pollution Control Construction Permit from the WDNR on November 1, 2005. We are required to conduct air emissions testing on our facility once the construction is complete to demonstrate compliance with the emission limitations on the Construction Permit. Following successful completion of this air emissions testing we will be issued an Air Pollution Operation Permit.
On November 2, 2005 we began the construction of our facility addition. We anticipate that the construction of the facility addition will be completed by approximately July, 2006. We estimate capital expenditures for the construction of the addition to our facility will be approximately $25,000,000.
Smart Station
The Company, in October, 2005, completed construction of an ethanol retail fuel station at the Company’s location in Monroe, Wisconsin at a cost of approximately $425,000. We had previously estimated our budget for this project at $350,000. The fuel station sells fuel to the public in either 10% ethanol or 85% ethanol blends (with the balance made up of gasoline).
Results of Operations for the Three Months Ended September 30, 2005 and 2004
The following table shows the results of our operations and the percentages of sales and revenues, cost of sales, operating expenses and other items to total sales and revenues in our statements of operations for the three months ended September 30, 2005 and 2004:
| | September 30, 2005 | | September 30, 2004 | |
| | Amount | | % | | Amount | | % | |
Sales and revenues | | $ | 24,792,787 | | 100.0 | | $ | 24,032,104 | | 100.0 | |
Cost of sales | | 20,187,188 | | 81.4 | | 22,686,205 | | 94.4 | |
Gross margin | | 4,605,599 | | 18.6 | | 1,345,899 | | 5.6 | |
| | | | | | | | | |
Selling, general and administrative expenses | | 767,769 | | 3.1 | | 724,494 | | 3.0 | |
| | | | | | | | | |
Operating income | | 3,837,830 | | 15.5 | | 621,405 | | 2.6 | |
| | | | | | | | | |
Interest expense | | (315,889 | ) | (1.3 | ) | (313,036 | ) | (1.3 | ) |
Interest income | | 5,457 | | 0.0 | | 3,826 | | 0.0 | |
| | | | | | | | | |
Net income | | $ | 3,527,398 | | 14.2 | | $ | 312,195 | | 1.3 | |
Sales and Revenues
Our sales and revenues are divided into five categories based upon the source from which they are derived: sales of ethanol, sales of distillers grains, marketing corn, sales of carbon dioxide and ethanol incentive payments. For the quarters ended September 30, 2005 and 2004, we derived approximately 78.7% and 77.7% of our sales and revenues from the sale of ethanol. Approximately 12.7% and 17.4% of our sales and revenues were derived from the sale of distillers grains for the three months ended September 30, 2005 and 2004. The decrease in revenue from distillers grains is caused by a reduction in the retail price due to an over abundance of supplies and the low cost of corn, a substitute feed. The marketing of corn accounted for approximately 7.5% and 2.9% of our sales and revenues for the three months ended September 30, 2005 and 2004. The increase in revenue from corn is
9
caused by the over abundance of corn in the immediate area of our plant, allowing us to economically sell corn by rail to markets without the same supply abundance. Sales of carbon dioxide accounted for .8% and .5% of sales for the quarters ended September 30, 2005 and 2004. Ethanol support payments from the federal and state governments accounted for .3% and 1.5% of sales and revenues for the three months ended September 30, 2005 and 2004. The ethanol support revenue amounted to $67,246 and $358,020 for the three months ended September 30, 2005 and 2004. The federal support payment is based on increases in the production of ethanol over the same prior year period. The state support payment is based on the production of ethanol within the State of Wisconsin. We expect to maintain production at approximately current levels for the remainder of the year.
Cost of Sales
Our cost of sales as a percentage of sales and revenues decreased to 81.4% for the three months ended September 30, 2005 from 94.4% for the three months ended September 30, 2004. The decrease in cost of sales for the three months ended September 30, 2005 is primarily due to fluctuations in price in the underlying input commodities.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses as a percentage of sales and revenues were 3.1% and 3.0% for the three months ended September 30, 2005 and 2004. We expect our selling, general and administrative expenses to remain constant and keep pace with production and sales.
Interest Expense and Income
Our interest expense as a percentage of sales and revenues were 1.3% and 1.3% for the three months ended September 30, 2005 and 2004. Our interest expense has remained unchanged as our debt is comparable.
Results of Operations for the Nine Months Ended September 30, 2005 and 2004
The following table shows the results of our operations and the percentages of sales and revenues, cost of sales, operating expenses and other items to total sales and revenues in our statements of operations for the nine months ended September 30, 2005 and 2004:
| | September 30, 2005 | | September 30, 2004 | |
| | Amount | | % | | Amount | | % | |
Sales and revenues | | $ | 72,105,489 | | 100.0 | | $ | 69,782,375 | | 100.0 | |
Cost of sales | | 58,755,031 | | 81.5 | | 58,089,853 | | 83.2 | |
Gross margin | | 13,350,458 | | 18.5 | | 11,692,522 | | 16.8 | |
| | | | | | | | | |
Selling, general and administrative expenses | | 2,389,902 | | 3.3 | | 2,218,552 | | 3.2 | |
| | | | | | | | | |
Operating income | | 10,960,556 | | 15.2 | | 9,473,970 | | 13.6 | |
| | | | | | | | | |
Interest expense | | (1,224,407 | ) | (1.7 | ) | (1,007,783 | ) | (1.4 | ) |
Interest income | | 23,354 | | 0.0 | | 11,231 | | 0.0 | |
| | | | | | | | | |
Net income | | $ | 9,759,503 | | 13.5 | | $ | 8,477,418 | | 12.2 | |
Sales and Revenues
Our sales and revenues are divided into five categories based upon the source from which they are derived: sales of ethanol, sales of distillers grains, marketing corn, sales of carbon dioxide and ethanol incentive payments. For the nine months ended September 30, 2005 and 2004, we derived approximately 77.6% and 77.0% of our sales and revenues from the sale of ethanol. Approximately 12.7% and 17.8% of our sales and revenues were
10
derived from the sale of distillers grains for the nine months ended September 30, 2005 and 2004. The decrease in revenue from distillers grains is cause by a reduction in the retail price due to an over abundance of supplies and the low cost of corn, a substitute feed. The marketing of corn accounted for approximately 7.9% and 2.4% of our sales and revenues for the nine months ended September 30, 2005 and 2004. The increase in revenue from corn is caused by the over abundance of corn in the immediate area of our plant, allowing us to economically sell corn to markets without the same supply abundance. Sales of carbon dioxide accounted for .7% and .2% of sales and revenues for the nine months ended September 30, 2005 and 2004. Ethanol support payments from the federal and state governments accounted for 1.1% and 2.6% of sales and revenues for the nine months ended September 30, 2005 and 2004. The ethanol support revenue amounted to $776,560 and $1,815,447 for the nine months ended September 30, 2005 and 2004. The federal support payment is based on increases in the production of ethanol over the same prior year period. The state support payment is based on the production of ethanol within the State of Wisconsin. We expect to maintain production at approximately current levels for the remainder of the year.
Cost of Sales
Our cost of sales as a percentage of sales and revenues decreased to 81.5% for the nine months ended September 30, 2005 from 83.2% for the nine months ended September 30, 2004. Cost of sales increased by $665,178 for the nine months ended September 30, 2005, compared to the same time period in 2004, due to an increase in production.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses as a percentage of sales and revenues were 3.3% and 3.2% for the nine months ended September 30, 2005 and 2004. We expect our selling, general and administrative expenses to remain constant and keep pace with production and sales.
Interest Expense and Income
Our interest expense as a percentage of sales and revenues were 1.7% and 1.4% for the nine months ended September 30, 2005 and 2004. The increase in our interest expense is due primarily to a one-time write-off of the original plant construction financing costs when we refinanced our existing debt and financed the plant. Our interest expense is expected to decrease in the near future as our debt has been paid down.
Liquidity and Capital Resources
As of September 30, 2005, we had cash and cash equivalents of $149,611, current assets of $10,005,738 and available unused revolving loan of $8,750,000. For the nine months ended September 30, 2005, cash provided by operating activities was $10,633,344, cash paid for property, equipment and intangible assets was $5,343,640 and cash used in financing activities was $8,947,476.
On June 29, 2005, the Company entered into the Credit Facility with AgStar. The Credit Facility is structured as two term loans in the aggregate amount of $15,491,087 (the “Term Loan”), a convertible loan in the amount of $20,000,000 (the “Convertible Loan”), and a revolving loan in the amount of $9,000,000 (the “Revolving Loan”). The Credit Facility replaces the Company’s prior credit facility (the “Prior Facility”), and allows the Company to pay costs expected to be incurred by the Company under the Design-Build Agreement (as defined below) and related agreements, and to provide for operating capital.
The Term Loan is structured as two Promissory Notes in the original principal amounts of $5,891,087 (“Note #1”) and $9,600,000 (“Note #2”). Note #1 and Note #2 bear interest at a variable rate equal to 3.25% above the LIBOR rate. The Convertible Loan and the Revolving Loan bear interest at a variable rate equal to 3% above the LIBOR rate. The Company has the option to convert Note #1, Note #2 and the Convertible Loan to fixed rate loans under certain conditions, and the interest rates for Note #1, Note #2, the Convertible Loan and the Revolving Loan are subject to adjustment based on certain capital conditions of the Company.
Borrowings under the Credit Facility are secured by substantially all of the assets of the Company. The Credit Facility contains customary financial and other covenants, and includes customary restrictions on certain
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activities of the Company, such as incurring additional debt. If an event of default, such as failure to make required payments or a failure to comply with covenants after any applicable grace period, were to occur under the Credit Facility, Agstar would be entitled to, among other remedies, declare all amounts outstanding under the facility immediately due and payable, and to enforce its security interest and mortgage on the assets of the Company.
We anticipate that capital expenditures for the construction of the build-out of our facility will be approximately $25,000,000. The costs of the construction of the E85 Fuel Station, which was completed in October, 2005, was approximately $425,000.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. In addition, we may make forward-looking statements orally in the future by or on behalf of the Company. We undertake no responsibility to update any forward-looking statement. When used, the words “believe,” “expect,” “will,” “can,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. Readers should not place undue reliance on any forward-looking statements and recognize that the statements are not predictions of actual future results. Actual results could and likely will differ materially from those anticipated in the forward-looking statements due to risks and uncertainties. These risks and uncertainties include, without limitation, the following and those business risks and factors described elsewhere in this report and our other Securities and Exchange Commission filings, our assumptions concerning financing requirements and future operations, changes in state and federal ethanol subsidies, our need for additional capital, our ability to manufacture our products on a commercial scale and in compliance with regulatory requirements, increased competition, and changes in government regulation.
• We have incurred substantial debt and debt service requirements.
• To service our debt, we will require a significant amount of cash and our ability to generate cash depends on many factors.
• Our debt financing contains numerous covenants, a breach of any of which may result in default.
• Our agreements or understandings with our plant general contractor, subcontractor and our sole ethanol marketing company were not negotiated at arm’s length, we may not have obtained terms as favorable to us as those we could have obtained from third parties, and any claims that we may have against them may be difficult for us to enforce.
• The ethanol industry is increasingly competitive, with additional plants in operation, under construction and in the planning stages. With additional plants coming on line in the near future, the supply of ethanol will increase which, if the demand does not grow accordingly or is unaided by government policies and programs, could adversely impact the price of ethanol and our operating results.
• The ethanol industry and our business are sensitive to corn and natural gas prices. When corn and natural gas prices increase our operating results may suffer. When corn and natural gas prices fluctuate significantly, our cost of revenues and operating results may be adversely affected by the use of derivative instruments under our risk management program.
• Federal regulations and tax incentives concerning ethanol could expire or change, which could harm our business.
• Wisconsin state producer incentive payment may not be available or could be modified which could harm our business.
• Operating our ethanol plant may require additional capital.
• To produce ethanol we intend to purchase significant amounts of corn that is subject to disease and other risks.
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• We are subject to extensive environmental regulation.
• Ethanol production is energy intensive, and we will need significant amounts of electricity and natural gas.
• Our business is not diversified.
• We established an output contract with only one distributor who will purchase all of the ethanol we produce and have contracted with only one company for the marketing and distribution of our distillers grains.
As a result of these factors, and other described risk factors, our operating results may not be indicative of future operating results and you should not rely on them as indications of our future performance.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results from holding our credit agreements. The specifics of each credit agreement are discussed in greater detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations. A hypothetical 1% increase in interest rates applied to exposed liabilities as of September 30, 2005 would result in additional interest expense of approximately $46,000 for the remainder of 2005.
Commodity Price Risk
We are also exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process, and the sale of ethanol. We seek to minimize the risks from fluctuations in the prices of corn 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, they do not qualify for 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 gains and losses are immediately recognized in our cost of sales. For example, we would generally expect that a 10% increase in the cash price of corn would produce a $100,000 increase in the fair value of our derivative instruments based on our positions at September 30, 2005. Whereas a 10% decrease in the cash price of corn would produce a $46,000 decrease in the fair value of our derivative instruments based on our positions at September 30, 2005.
The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged. As of September 30, 2005, the fair value of our derivative instruments for corn and ethanol was an asset of $74,070. There are several variables that could affect the extent to which our derivative instruments are impacted by price fluctuations in the cost of corn or ethanol. However, it is likely that commodity cash prices will have the greatest impact on the derivatives instruments with delivery dates nearest the current cash price.
To manage our corn price risk, our hedging strategy is designed to establish a price ceiling for our corn purchases. We have taken a net long position on our exchange traded futures and options contracts, which allows us to offset increases or decreases in the market price of corn. The upper limit of loss on our futures contracts is the difference between the futures price and the cash market price of corn at the time of the execution of the contract. The upper limit of loss on our exchange traded and over-the-counter option contracts is limited to the amount of the premium we paid for the option.
We estimate that our expected corn usage is approximately 18.5 million bushels per year for the production of 50 million gallons of ethanol. As of September 30, 2005, we have cash, futures, and option contract price protection in place for 20% of our expected corn usage through June, 2006. We have 18% of our expected corn
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usage protected by cash purchase contracts through June, 2006. As we move forward, additional protection may be necessary. As corn prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects but are expected to produce long-term positive growth for the Company. Our current corn hedge position is based upon the amount of ethanol that we have currently sold for future delivery. This protects us against an increase in the variable price of our corn purchased against a fixed sales price of our ethanol sold. We intend to continue our hedging strategy based upon ethanol sales and market conditions.
To manage our ethanol price risk, our hedging strategy is designed to establish a price floor for our ethanol sales. We are not offsetting ethanol sales with unleaded hedges at the current time. At present, the price of ethanol has increased. In the future, we may not be able to sell ethanol at a favorable price relative to gasoline prices, we also may not be able to sell ethanol at prices equal to or more than our current price. This would limit our ability to offset our costs of production. Currently, we are attempting to lock in favorable prices through forward contracting.
As of September 30, 2005, we have forward cash contract price protection in place for 41% of our expected ethanol production through June, 2006. As we move forward, additional protection may be necessary. As ethanol 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. As we move forward into summer, additional price protection may be required. Depending on energy market movements, crop prospects and weather, these price protection positions may cause short-term adverse effects but are expected to produce long-term positive growth for the Company.
To manage our natural gas price risk, we entered into a natural gas purchase agreement with our supplier to supply us with natural gas, fixing the price at which we purchase natural gas. The price of natural gas has risen substantially over the last several months and our strategy has been to purchase natural gas as needed and as the opportunities arise. However, we believe that the price of natural gas could drop in the future and are waiting to take advantage of such lower prices before making substantial new purchases of natural gas.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of September 30, 2005 (the “Evaluation Date”), have concluded that our disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that we file with the Securities and Exchange Commission.
Changes in Internal Controls
There have been no changes in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. | Exhibits |
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| 31.1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934). |
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| 31.2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934). |
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| 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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| 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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b. | Reports on Form 8-K. |
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| Current report on Form 8-K, dated July 21, 2005, containing a copy of the Company’s newsletter. |
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| BADGER STATE ETHANOL, LLC |
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Date: November 11, 2005 | | By: | /s/ Gary L. Kramer | |
| | Gary L. Kramer |
| | President and General Manager |
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