WESTERN PLAINS ENERGY, LLC
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
(UNAUDITED)
(1) Basis of Presentation
The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and Article 10 of Regulation S-X. They do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included.
The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full fiscal year. For further information, refer to the financial statements of the Company as of and for the year ended September 30, 2006, including notes thereto, included in the Company’s Form 10-K.
Certain amounts from the December 31, 2005 financial statements have been reclassified to conform to current period presentation.
(2) Inventory
Inventory is stated at the lower of cost, determined on a first in, first out basis, or market value. Inventory consists principally of raw material, work-in-process and finished goods. The following information summarizes inventory at December 31, 2006 and September 30, 2006:
| | December 31, 2006 | | September 30, 2006 | |
Raw materials | | $ | 1,986,843 | | $ | 462,133 | |
Work-in-process | | 967,946 | | 719,689 | |
Finished goods | | 600,617 | | 274,642 | |
| | $ | 3,555,406 | | $ | 1,456,464 | |
(3) Investments
Commodities trading accounts — futures and options contracts
The Company attempts to minimize the effects of changes in the price of agricultural commodities by using exchange-traded futures and options contracts to minimize net positions in these contracts. The Company accounts for changes in market value on exchange-traded futures and option contracts at exchange values and accounts for changes in value of forward purchase and sales contracts at local market prices determined by grain terminals in the area. Changes in the market value of all these contracts are recognized in operations as a component of cost of revenues. Unrealized losses in open contracts are recognized as a component of comprehensive income. In the period ended December 31, 2006, unrealized losses increased $17,088 to $112,380 at December 31, 2006.
4
(4) Sale/Leaseback Transaction
On October 3, 2003, the Company completed an industrial revenue bond financing with Gove County, Kansas that will provide property tax savings for 10 years on the plant site. The principal amount of the bonds is $32,000,000. The Company, as holder of the industrial revenue bonds, is due interest at 3.5% per annum with interest payable semi-annually on March 1st and September 1st. This interest income is directly offset by the lease payments on the plant. The Company and Gove County have agreed to waive the payment of both the lease payments and the interest amounts since they offset; however, they are recorded for accounting purposes. Both the bond and the corresponding lease have terms of 30 years. The lease qualifies as a capital lease. Interest income recognized on the Industrial Revenue Bonds for the three month period ended December 31, 2006 was $280,000. This amount is equal to the lease expense of the plant.
(5) Related Party Transactions
During the period ended December 31, 2006, ICM, Inc., the general contractor for the plant and an entity controlled by a former member of the Board of Managers, submitted pay applications totaling $140,608 in connection with maintenance performed during the Company’s routine shut-down and premium associated with a safety and loss program. During the same period in fiscal 2006, ICM, Inc. submitted pay applications totaling $274,261 for the replacement of the burner for the dryer unit, parts and repairs of the ethanol plant, and premium for a safety and loss program. ICM, Inc. received payments relating to these items of $108,608 in the period ended December 31, 2006, and $45,241 in the period ended December 31, 2005. Effective in March 2006, the term of the individual affiliated with the general contractor on the Company’s Board of Managers expired and he did not stand for reelection.
(6) Distribution to Members
During the period ended December 31, 2006, the Company made cash distributions to its members aggregating $16,320,000 in accordance with the terms of its Operating Agreement.
(7) Land Acquisition
On December 22, 2005, the Company purchased 80 acres of land, 95 acre feet of water rights and a railroad lease with Union Pacific Railroad, all located adjacent to its plant site. The terms of the purchase agreement were $24,000 down and three equal annual payments of $24,000 payable January 2006, 2007, and 2008 with interest accruing at the rate of 6% per annum commencing January 31, 2006. The down payment of $24,000 was paid December 22, 2005, the first installment of $24,000 was paid January 26, 2006, and the second scheduled payment of $24,000 plus $3,088 in accrued interest was paid in January 2007.
(8) Plant and Equipment
On October 10, 2006, the Company purchased a 1,000,000 bushel grain storage facility located on land adjacent to the Company’s plant for $1,200,000. The storage facility is situated on land owned by Union Pacific Railroad, consequently the Company assumed the existing 20 year lease with UP for the balance of the term of the lease. The lease expires in 2020 and may be renewed upon agreement of the parties.
In September 2006, the Company entered into a contract to construct two 250,000 bushel grain bins, two hammer mills, and all the required conveyance equipment to connect the new storage facility purchased to the ethanol plant. The contract price was $2,961,105 of which $975,000 was paid prior to September 30,
5
2006. During the three months ended December 31, 2006, the Company received pay applications totaling $1,191,474 which includes change orders totaling $226,474 and paid $476,474 during the period. The Company also purchased spare parts totaling $143,924, manufacturing equipment for $21,510, a truck for $8,500 and made improvements in the amount of $12,156 during the period.
The project is expected to be completed in late spring of 2007.
(9) Loan Modification
The Fourth Amendment to the Credit Agreement dated July 29, 2003 between the Company and AgCountry Farm Credit Services, was entered into on October 2, 2006 reducing the variable interest rate applicable to the “Revolving Loan” to LIBOR plus 2.50%. In addition, the annual administration fee was suspended and the quarterly “Unused commitment fee” was reduced from 0.5% to 0.25% of the unused portion of the Revolving Loan Commitment during the quarter. The Capital Expenditure Section was deleted and replaced with a requirement for pre-approval of capital expenditures in excess of $2,500,000 for any fiscal year. Written approval is required for capital expenditures which exceeds this limit.
(10) Subsequent Events
Based on the Company’s financial results for the quarter ended December 31, 2006, the Board of Managers declared a Member distribution equal to $1,000 per share totaling $4,080,000. This distribution was paid January 17, 2007. This required the Company to draw $1,900,000 on the “Revolving Loan” with AgCountry Farm Services.
On February 6, 2007, the Company entered into an agreement to purchase water rights from an individual who owns property adjacent to one of the Company’s parcels. The total purchase price was $340,000 which included 340 acre/feet of water rights per year.
6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
Introduction
The following narrative describes the financial condition of Western Plains Energy, L.L.C. (“we” or the “Company”) at December 31, 2006 and compares it to our financial condition at fiscal year end September 30, 2006. It also discusses our results of operations for the three month period ended December 31, 2006 and compares those results to the comparable period ended December 31, 2005. This discussion and analysis should be read in conjunction with the information contained in our annual report on Form 10-K for the fiscal year ended September 30, 2006, including the audited financial statements and notes included therein.
Results of Operations
Overview. The following table highlights certain of our operating results for the three month periods ended December 31, 2006 and 2005:
| | Three Months Ended December 31, | |
| | 2006 | | 2005 | |
Revenue | | $ | 27,311,254 | | $ | 21,020,943 | |
Income from operations | | 6,047,637 | | 5,779,893 | |
Other income (expense) | | (51,185 | ) | (61,172 | ) |
Net income | | 5,996,452 | | 5,718,721 | |
Comprehensive income | | 5,979,364 | | 6,096,096 | |
Net comprehensive income per unit | | 1,466 | | 1,494 | |
| | | | | | | |
Our operating results improved slightly for the first quarter of fiscal 2007 compared to the first quarter of fiscal 2006, primarily as result of the favorable ethanol prices prevailing during the period. For the three months ended December 31, 2006, we reported net income of $5,996,452 and revenue of $27,311,254 compared to net income of $5,718,721 and revenue of $21,020,943 for the same period in fiscal 2006. Gross profit for the three months ended December 31, 2006 was $8,545,289 compared to $7,592,456 for the same period in fiscal 2006. Gross profit was 31.3% of revenue for the three months ended December 31, 2006 compared to 36.1% for the same period in fiscal 2006.
Net income. Net income for the three months ended December 31, 2006 increased $277,731, or 4.9%, from the comparable period of fiscal 2006. We attribute this increase to favorable ethanol and distillers grain prices and increased production for this period. The favorable prices for ethanol and distillers grains helped offset the increased cost of sales which resulted from a significantly higher price for grain used in the production process when compared to the same period of fiscal 2006. Operating income, which excludes the effect of other income or expense, rose 4.6% from the first quarter of fiscal 2006 to the same period this year.
Revenue. Revenue for the first quarter of fiscal 2007 increased 29.9% from the comparable period of fiscal 2006. This increase is attributable to an increase in the price of our distillers grains, favorable ethanol prices and increased ethanol production. We sold 8.75% more ethanol in the first quarter of fiscal 2007 than the comparable period of 2006. However, since our plant was operating at
7
capacity during all of 2006, we do not expect to be able to increase production any more unless we decide to expand our plant.
We continued to enjoy favorable ethanol prices during the first quarter of fiscal 2007. The average price that we received for our ethanol during the three months ended December 31, 2006 increased 17.3% when compared to the same period of fiscal 2006. We believe the favorable prices resulted from voluntary blending and the growing recognition of ethanol as an alternative energy source. Based on existing market conditions and the fact that 96% of our ethanol expected to be produced in the second quarter of fiscal 2007 is price protected, we expect revenue from sales of ethanol to remain generally consistent through the first half of fiscal 2007. Historically, we, like other ethanol producers, have experienced a decline in ethanol prices during the spring and summer months, when mandatory blending ceases. An excessive supply of ethanol in the market may also add downward pressure to ethanol prices. For these reasons, we expect the price we receive for ethanol will decrease in the second half of fiscal 2007, consistent with the decrease in spot prices when our price protection expires.
Cost of Goods Sold. Our cost of goods sold as a percentage of revenue during for the three months ended December 31, 2006 totaled 68.7%. This compares to cost of goods sold during the same period of fiscal 2006 of 63.8%. We believe the price of grain and related hedge activities accounted for the increase in cost of goods sold. Increased demand for grain, in part from the expanding ethanol industry, has caused grain prices to increase. During the first quarter of fiscal 2007, corn prices were at or near 10 year highs. We intend to continue our hedging efforts to try and protect against increasing grain prices.
General and Administrative Expenses. General and administrative expenses for the first quarter of fiscal 2007 increased 153.3% from the comparable period of fiscal 2006. This difference is primarily attributable to legal and other professional fees associated with a potential sale of our company. However, as of the date of this report, we are no longer involved in negotiations for the sale of our company or any other similar transactions.
Depreciation. Depreciation during the first quarter of fiscal 2007 increased 4.6% from the comparable period of fiscal 2006, reflecting the increased asset base resulting from the purchase of the grain storage facility.
Overall, total expenses increased 37.8% from the first quarter of fiscal 2006 to the comparable period of 2007, which is primarily due to the increase in general and administrative expenses.
Other Income (Expense). Other expenses decreased by 16.3% during the three months ended December 31, 2006 when compared to the same period of fiscal 2006. Interest expense decreased by 90.8% during the three months ended December 31, 2006 when compared to the same period of fiscal 2006 as we paid off substantially all of our debt. Interest income increased by 71.7% during the three months ended December 31, 2006 compared to the same period of fiscal 2006 reflecting more cash invested on a temporary basis.
We recorded other expense of $83,503 for the first quarter of fiscal 2007, reflecting property taxes related to our plant expansion completed in June 2005, compared to other expense of $96,718 during the first quarter of 2006, which was primarily comprised of expenses related to plant improvements.
During the first quarter of fiscal 2007, we reported $17,088 of unrealized losses on hedging contracts compared to an unrealized gain of $377,375 during the first quarter of fiscal 2006. Comprehensive income for the first three months of fiscal 2007 decreased slightly from the first quarter of fiscal 2006 as a result of the unrealized loss on hedging contracts.
8
Liquidity and Capital Resources
Overview. The following table highlights certain information relating to our liquidity and capital resources at December 31 and September 30, 2006:
| | December 31, 2006 | | September 30, 2006 | |
Working Capital | | $ | 8,680,258 | | $ | 20,127,553 | |
Current Assets | | 12,074,794 | | 22,543,455 | |
Current Liabilities | | 3,394,536 | | 2,415,902 | |
Long-term Debt | | 41,140 | | 42,944 | |
Members’ Equity | | 37,504,784 | | 47,845,419 | |
| | | | | | | |
Our working capital at December 31, 2006 decreased 56.9% from year-end September 30, 2006. This decrease is almost entirely attributable to the cash distribution paid to our members in October 2006 in the amount of $16,320,000. Notwithstanding the reduction in working capital, however, we believe we have sufficient liquidity for the foreseeable future. Our operations continue to generate significant cash, providing more than sufficient resources for our investing and financing activities. Our current ratio, representing current assets divided by current liabilities, was 3.56:1 at December 31, 2006.
Working Capital. Current assets decreased 46.4% from fiscal year end September 30, 2006 to December 31, 2006. Cash decreased in excess of $13,000,000, comprising the largest component of the decrease in current assets, due to the significant distribution made to members in October 2006. Subsequent to December 31, 2006, our Board declared an additional cash distribution to members in the amount of $1,000 per unit for a total of $4,080,000. This distribution was paid on January 16, 2007 and further reduced our working capital; however, we believe we will generate sufficient cash from operations to meet our current needs. Current liabilities increased 40.5% from fiscal year end to December 31, 2006. The increase is primarily attributable to $715,000 in progress payments due to our general contractor in connection with the construction of two grain bins and related equipment at our plant site.
We maintain a line of credit to finance short-term working capital requirements. Following completion of the 2006 fiscal year, the amount of the line was reduced from $4,500,000 to $4,000,000 in accordance with our lending agreement. Our long-term debt at December 31, 2006 represents the long-term portion of notes payable for purchase of a tract of land and a vehicle. We believe our existing capital structure is adequate for the foreseeable future.
Cash Flow. Cash generated from operating activities during the three months ended December 31, 2006 was $5,883,688, a decrease of 21.8% from the first quarter of fiscal 2006. The decrease is primarily due to an increase in our inventory levels as compared to the first quarter of fiscal 2006. Our inventory increased 144% from September 30, 2006 to December 31, 2006, reflecting substantially higher grain prices and increased grain on hand due to additional storage provided by the grain storage facility we purchased. The amount of cash used in investing activities increased significantly during the three months ended December 31, 2006 compared to the same period of fiscal 2006, primarily due to the purchase of a grain elevator adjacent to our plant in the amount of $1,200,000, and work in progress for the grain bins and related infrastructure in the amount of $1,200,000, both of which took place during the first fiscal quarter 2007. However, we expect these investments will help us manage costs of grain better in the future.
Cash used in financing activities increased significantly during the three months ended December 31, 2006 compared to the same period of fiscal 2006. The largest increase was the distributions to our members, which increased approximately $9,700,000 when compared to the same period of fiscal 2006. Although not required to do so, the Board has declared cash distributions to members each quarter since
9
the first quarter of fiscal 2005. The increased use of cash during the first quarter of fiscal 2007 was also partially offset by a $1,826,196 net decrease in debt payments compared to the same period 2006.
Forward-Looking Statements
This Form 10-Q contains or incorporates by reference “forward-looking statements,” as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others:
· statements concerning the benefits that we expect will result from our business activities and certain transactions that we have completed, such as increased revenues, decreased expenses and avoided expenses and expenditures; and
· statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts.
These statements may be made expressly in this document or may be incorporated by reference to other documents that we will file with the SEC. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates” or similar expressions used in this report or incorporated by reference in this report.
These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. Because the statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied. We caution you not to put undue reliance on these statements, which speak only as of the date of this report. Further, the information contained in this document or incorporated herein by reference is a statement of our present intention and based on present facts and assumptions and may change at any time and without notice based on changes in such facts or assumptions.
A few of the uncertainties that could affect the accuracy of forward-looking statements, in addition to the specific “Risk Factors” identified in this report and our annual report on Form 10-K, include:
a. The state of the United States economy and how it affects the desire for automobile travel;
b. The relative price of gasoline and other competing fuels;
c. Changes in government regulations for air and water quality or subsidies for production of ethanol and other fossil fuel alternatives;
d. Technological advances in the process for producing ethanol;
e. Drought and other environmental conditions; and
f. Changes in our business plan.
10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars.
We use derivative financial instruments as part of an overall strategy to manage market risk. We use cash, futures and option contracts to hedge changes in the commodity prices of grain 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 SFAS 133, Accounting for Derivative Instruments and Hedging Activities.
Interest Rate Risk
We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results from holding a revolving promissory note which bears a variable interest rate. Although there was no outstanding balance at December 31, 2006, we utilized this revolving promissory note subsequent to the end of the period and may continue to do so in the future. Any outstanding balance on the revolving promissory note will be subject to variable interest rates.
We have not entered into any hedging transactions in connection with our note, although we may consider such an arrangement in the future if appropriate.
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 grain and natural gas in the ethanol production process and our dependence on the sale of ethanol for a majority of our revenue. We seek to minimize the risks from fluctuations in the prices of grain and natural gas through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as we believe appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases, they are not designated as such for hedge accounting purposes, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are marking to market 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 goods sold. For example, it is likely and we would generally expect that a 10% increase in the cash price of grain would produce an increase in the fair value of our derivative instruments equal to approximately $24,962 based on our positions at December 31, 2006.
The immediate recognition of hedging gains and losses can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged. As of December 31, 2006, the fair value of our derivative instruments for grain is an asset in the amount of $249,619. There are several variables that could affect the extent to which our derivative instruments are impacted by price fluctuations in the cost of grain or natural gas. 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 grain price risk, our hedging strategy is designed to establish a price ceiling and floor for our 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 grain. The upper limit of loss on our futures contracts is the difference between the contract price and the cash market price of grain 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.
11
We estimate that our expected grain usage is approximately 16,800,000 bushels per year for the production of 45,000,000 gallons of ethanol. We have price protection for approximately 50% of our expected grain usage for fiscal year ended September 30, 2007 using CBOT futures and options. As we move forward, additional protection may be necessary. As grain 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. Additional price protection may be required to solidify our margins through fiscal year 2007. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.
To manage our natural gas price risk, we entered into a natural gas purchase agreement with our supplier to supply us with natural gas. This purchase agreement fixes the price at which we purchase natural gas. We estimate that we have forward contracts in place for approximately 73% of our natural gas needs through April 2007. The forward contracts provide for approximately 34.7% lower gas prices for the first quarter of fiscal 2007 than for the first quarter of fiscal 2006. We may also purchase natural gas requirements for the summer and fall months of calendar 2007 as we attempt to further reduce our susceptibility to price increases.
A sensitivity analysis has been prepared to estimate our exposure to grain and natural gas price risk. The table presents the fair value of our derivative instruments as of December 31, 2006 and December 31, 2005 and the potential loss in fair value resulting from a hypothetical 10% adverse change in such prices. The fair value of the positions is a summation of the fair values calculated by valuing each net position at quoted market prices as of the applicable date. The results of this analysis, which may differ from actual results, are as follows:
Period Ended | | Fair Value | | Effect of Hypothetical Adverse
Change — Market Risk | |
December 31, 2006 | | $ | 249,619 | | $ | 24,962 | |
December 31, 2005 | | 352,137 | | 35,214 | |
| | | | | | | |
We are also exposed to market risk from changes in ethanol prices. These price fluctuations are minimized in part by advanced contract pricing of our ethanol, which is designed to establish a price floor for our ethanol sales. Currently, we have entered into priced contracts for 10% of our anticipated ethanol production through the remainder of our fiscal year ending September 30, 2007, and 5% of our anticipated production for the first quarter of fiscal 2008. We may continue to advance contract for ethanol sales to attempt to further reduce our risk related to price decreases. While this strategy minimizes the risk associated with downward price fluctuations of ethanol, it may also prevent us from realizing the full benefit of upward price movements. Although using priced contracts makes our revenue more predictable, we cannot predict the extent to which other factors such as inflation, government regulation or changing prices may affect our financial performance.
Item 4. Controls and Procedures
(a) We maintain a system of controls and procedures designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including the Principal Executive Officer and Principal Financial Officer to allow timely decisions regarding required disclosure. As of December 31, 2006, under the supervision and with the participation of our Chief Executive Officer and Principal Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and the Principal Financial Officer concluded that our disclosure controls and procedures were effective.
(b) There were no changes in our internal controls over financial reporting during the quarter ended December 31, 2006 that materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
12
