Heron Lake BioEnergy (HLBYL) 10-Q 2019 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended April 30, 2019

OR

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

For the transition period from                    to                  .

COMMISSION FILE NUMBER 000-51825

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

Minnesota	41-2002393
(State or other jurisdiction of organization)	(I.R.S. Employer Identification No.)

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

(Address of principal executive offices)

(507) 793-0077

(Issuer’s telephone number)

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

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

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

Large accelerated filer  ☐	Accelerated filer  ☐
	Smaller reporting company ☐
Non-accelerated filer  ☒	Emerging growth company ☐

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

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

As of June 14, 2019, there were 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding.

INDEX

	Page No.
PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements	1
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.  Controls and Procedures	34
PART II. OTHER INFORMATION
Item 1.  Legal Proceedings	35
Item 1A. Risk Factors	35
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.  Defaults Upon Senior Securities	36
Item 4.  Mine Safety Disclosures	36
Item 5.  Other Information	36
Item 6.  Exhibits	36
SIGNATURES	37

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	April 30, 2019		October 31, 2018
	(unaudited)
ASSETS
Current Assets
Cash	$	3,178,667	$	5,995,982
Restricted cash		259,656		—
Accounts receivable		3,714,549		3,952,687
Inventory		5,579,963		6,398,686
Commodity derivative instruments		—		425,638
Prepaid expenses and other current assets		806,613		392,980
Total current assets		13,539,448		17,165,973
Property and Equipment, net		41,720,557		44,149,925
Other assets		685,884		704,958
Total Assets	$	55,945,889	$	62,020,856
LIABILITIES AND MEMBERS' EQUITY
Current Liabilities
Current maturities of long-term debt	$	309,917	$	391,934
Accounts payable		2,477,310		5,413,915
Commodity derivative instruments		67,063		25,180
Accrued expenses		652,304		843,875
Total current liabilities		3,506,594		6,674,904
Long-Term Debt, less current portion		637,383		567,267
Commitments and Contingencies
Members' Equity
Members' equity attributable to Heron Lake BioEnergy, LLC consists of 77,932,107 units issued and outstanding at both April 30, 2019 and October 31, 2018		49,916,054		53,054,846
Non-controlling interest		1,885,858		1,723,839
Total members' equity		51,801,912		54,778,685
Total Liabilities and Members' Equity	$	55,945,889	$	62,020,856

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

1

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

	Three Months Ended  April 30,				Six Months Ended April 30,
	2019		2018		2019		2018
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Revenues	$	25,494,797	$	29,880,856	$	51,192,317	$	57,853,307
Cost of Goods Sold		25,914,451		27,753,049		52,645,771		54,144,318
Gross Profit (Loss)		(419,654)		2,127,807		(1,453,454)		3,708,989
Operating Expenses		(855,755)		(841,984)		(1,775,282)		(1,707,027)
Operating Income (Loss)		(1,275,409)		1,285,823		(3,228,736)		2,001,962
Other Income (Expense):
Interest income		13,598		9,049		42,400		31,022
Interest expense		(7,416)		(9,753)		(15,330)		(28,366)
Other income, net		224,688		71,012		224,893		329,224
Total other income, net		230,870		70,308		251,963		331,880
Net Income (Loss)		(1,044,539)		1,356,131		(2,976,773)		2,333,842
Less: Net Income Attributable to Non-controlling Interest		(70,613)		(85,113)		(162,019)		(200,827)
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC	$	(1,115,152)	$	1,271,018	$	(3,138,792)	$	2,133,015
Weighted Average Units Outstanding—Basic and Diluted (Class A and B)		77,932,107		77,932,107		77,932,107		77,932,107
Net Income (Loss) Per Unit Attributable to Heron Lake BioEnergy, LLC—Basic and Diluted (Class A and B)	$	(0.01)	$	0.02	$	(0.04)	$	0.03
Distributions Per Unit (Class A and B)	$	0.00	$	0.00	$	0.00	$	0.11

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

2

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

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

			Members'
			Equity
			attributable to
			Heron Lake		Non-		Total
			BioEnergy,		controlling		Members'
	Class A Units	Class B Units	LLC		Interest		Equity
Balance—October 31, 2018	62,932,107	15,000,000	$	53,054,846	$	1,723,839	$	54,778,685
Net income attributable to non-controlling interest	—	—		—		91,406		91,406
Net loss attributable to Heron Lake BioEnergy, LLC	—	—		(2,023,640)		—		(2,023,640)
Balance—January 31, 2019	62,932,107	15,000,000	$	51,031,206	$	1,815,245	$	52,846,451
Net income attributable to non-controlling interest	—	—		—		70,613		70,613
Net loss attributable to Heron Lake BioEnergy, LLC	—	—		(1,115,152)		—		(1,115,152)
Balance—April 30, 2019	62,932,107	15,000,000	$	49,916,054	$	1,885,858	$	51,801,912
Balance—October 31, 2017	62,932,107	15,000,000	$	60,767,951	$	1,493,062	$	62,261,013
Member Distributions	—	—		(8,568,321)		(81,000)		(8,649,321)
Net income attributable to non-controlling interest	—	—		—		115,714		115,714
Net income attributable to Heron Lake BioEnergy, LLC	—	—		861,997		—		861,997
Balance—January 31, 2018	62,932,107	15,000,000	$	53,061,627	$	1,527,776	$	54,589,403
Net income attributable to non-controlling interest	—	—		—		85,113		85,113
Net income attributable to Heron Lake BioEnergy, LLC	—	—		1,271,018		—		1,271,018
Balance—April 30, 2018	62,932,107	15,000,000	$	54,332,645	$	1,612,889	$	55,945,534
Notes to Condensed Consolidated Unaudited Financial Statements are an integral part of this Statement.

3

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

		Six Months Ended April 30,
		2019		2018
		(unaudited)		(unaudited)
Cash Flow From Operating Activities:
Net income (loss)	$	(2,976,773)	$	2,333,842
Adjustments to reconcile net income (loss) to net cash provided by (used in) operations:
Depreciation and amortization		2,575,009		2,466,645
Gain on sale of asset		—		(24,815)
Change in fair value of commodity derivative instruments		(229,470)		296,887
Changes in operating assets and liabilities:
Accounts receivable		238,138		345,412
Inventory		818,723		975,169
Commodity derivative instruments		696,991		(27,887)
Prepaid expenses and other current assets		(413,633)		(117,622)
Accounts payable		(2,920,501)		(2,427,768)
Accrued expenses		(191,571)		165,532
Net cash provided by (used in) operating activities		(2,403,087)		3,985,395
Cash Flows from Investing Activities:
Capital expenditures		(142,671)		(471,059)
Proceeds from disposal of asset		—		24,815
Net cash used in investing activities		(142,671)		(446,244)
Cash Flows from Financing Activities:
Payments on long-term debt		(11,901)		(121,892)
Distributions to Heron Lake BioEnergy, LLC members		—		(8,568,321)
Distribution to non-controlling interest		—		(81,000)
Net cash used in financing activities		(11,901)		(8,771,213)
Net decrease in cash and restricted cash		(2,557,659)		(5,232,062)
Cash and Restricted Cash—Beginning of period		5,995,982		10,065,367
Cash and Restricted Cash—End of period	$	3,438,323	$	4,833,305
Reconciliation of Cash and Restricted Cash
Cash - Balance Sheet	$	3,178,667	$	4,223,469
Restricted Cash - Balance Sheet		259,656		609,836
Cash and Restricted Cash	$	3,438,323	$	4,833,305
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Interest expense	$	15,330	$	18,613
Supplemental Disclosure of Non-Cash Investing and Financing Activities
Capital expenditures included in accounts payable	$	29,464	$	—

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

4

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

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

Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), owns 73% of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC 's ethanol production facility and other customers.

Basis of Presentation and Principles of Consolidation

The condensed consolidated unaudited financial statements as of April 30, 2019 include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively the “Company”).  Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the unaudited financial statements of Agrinatural with its consolidated unaudited financial statements, with the equity and earnings (loss) attributed to the remaining 27% non-controlling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations. All significant intercompany balances and transactions are eliminated in consolidation.

The condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  These condensed consolidated unaudited financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended October 31, 2018, contained in the Company’s annual report on Form 10-K.

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

Accounting Estimates

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

5

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

Non-controlling Interest

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

Revenue Recognition

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

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

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

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

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

Inventory

Inventory is stated at the lower of cost or net realizable value. Cost for all inventories is determined using the first in first out method (FIFO). Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. Inventory consists of raw materials, work in process, finished goods, and spare parts. Corn is the primary raw material along with other raw materials. Finished goods consist of ethanol, distillers’ grains, and corn oil.

6

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

Derivative Instruments

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

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

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

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

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

Recently Adopted Accounting Pronouncements

Effective November 1, 2018, the Company adopted the amended guidance ASC Topic 606, Revenue from Contracts with Customers. Refer to Note 1 – Summary of Significant Accounting Policies and Note 3 – Revenue for further details.

In November 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-18, Restricted Cash, which amended Statement of Cash Flows (Topic 230) of the Accounting Standards Codification. The new guidance requires an entity to reconcile and explain the period-over-period change in total cash, cash equivalents, restricted cash and restricted cash equivalents within its statement of cash flows. Effective November 1, 2018, the Company adopted the new standard and has applied it retrospectively. Accordingly, the condensed consolidated statements of cash flows for the periods ended April 30, 2019 and 2018 have been adjusted from amounts previously reported.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, "Disclosure Update and Simplification," amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity

7

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

presented in the balance sheet must be provided in a note or separate statement. The analysis must present a reconciliation of the beginning balance to the ending balance for each period for which a statement of comprehensive income is required to be filed. Accordingly, the condensed consolidated statements of changes in members’ equity for the periods ended April 30, 2019 and 2018 have been presented.

Reportable Operating Segments

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

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

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

2.RISKS AND UNCERTAINTIES

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

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

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2018 and into 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. Margins improved for the second fiscal quarter of 2019.  The Company believes its cash on hand and available debt from its lender will provide sufficient liquidity to meets its anticipated working capital, debt service and other liquidity needs though the next twelve months.

8

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

3.REVENUE

Adoption of ASC Topic 606

On November 1, 2018, the Company adopted the amended guidance in ASC Topic 606, Revenue from Contracts with Customers, and all related amendments (“new revenue standard”) and applied it to all contracts using the modified retrospective transition method. The adoption of the new revenue standard did not result in any changes to the timing or amount of revenue recognized prior to November 1, 2018, but did result in expanded disclosures to our consolidated financial statements.

Revenue by Source

All revenues from contracts with customers under ASC Topic 606 are recognized at a point in time. The following table disaggregates revenue by major source for the periods ended April 30, 2019:

	Three Months Ended April 30, 2019
		Ethanol Production		Natural Gas Pipeline		Total
Ethanol	$	20,039,824	$	—	$	20,039,824
Distillers’ Grains		4,082,536		—		4,082,536
Corn Oil		725,199		—		725,199
Other		260,264		—		260,264
Natural Gas		—		386,974		386,974
Total Revenues	$	25,107,823	$	386,974	$	25,494,797
	Six Months Ended April 30, 2019
		Ethanol Production		Natural Gas Pipeline		Total
Ethanol	$	38,437,976	$	—	$	38,437,976
Distillers’ Grains		9,567,891		—		9,567,891
Corn Oil		1,689,610		—		1,689,610
Other		524,567		—		524,567
Natural Gas		—		972,273		972,273
Total Revenues	$	50,220,044	$	972,273	$	51,192,317

Payment Terms

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

Shipping and Handling Costs

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

9

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

4.INVENTORY

Inventory consisted of the following:

	April 30, 2019		October 31, 2018
	(unaudited)
Raw materials	$	867,175	$	1,215,640
Work in process		813,150		571,228
Finished goods		2,650,584		3,436,175
Supplies		1,249,054		1,175,643
Totals	$	5,579,963	$	6,398,686

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol.  Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $555,000 and $50,000 for the six months ended April 30, 2019 and 2018, respectively. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on corn inventories, as a component of cost of goods sold, of approximately $58,000 for the six months ended April 30, 2019.

5.DERIVATIVE INSTRUMENTS

As of April 30, 2019, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,360,000 bushels, comprised of short corn futures positions on 610,000 bushels that were entered into to hedge forecasted corn purchases through December 2020. Additionally, there are corn options positions of 4,750,000 bushels through July 2019. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

As of April 30, 2019, the Company had approximately $260,000 of cash collateral (restricted cash) related to derivatives held by a broker.

The following table provides detail regarding the Company’s derivative instruments at April 30, 2019, none of which are designated as hedging instruments:

	Consolidated Balance Sheet Location	Assets		Liabilities
Corn contracts	Commodity derivative instruments	$	—	$	67,063
Totals		$	—	$	67,063

As of October 31, 2018, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 2,685,000 bushels, comprised of long corn positions on 510,000 bushels that were entered into to hedge forecasted ethanol sales through July 2019, and short corn positions on 2,175,000 bushels that were entered into to hedge forecasted corn purchases through March 2020.   There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding. 

As of October 31, 2018, the Company had no cash collateral (restricted cash) related to derivatives held by a broker.

10

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2018, none of which were designated as hedging instruments:

	Consolidated Balance Sheet Location	Assets		Liabilities
Corn contracts	Commodity derivative instruments	$	425,638	$	25,180
Totals		$	425,638	$	25,180

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

	Consolidated Statement of	Three Months Ended  April 30,				Six Months Ended  April 30,
	Operations Location	2019		2018		2019		2018
Corn contracts	Cost of goods sold	$	135,178	$	(339,007)	$	229,470	$	(491,661)
Ethanol contracts	Revenues		—		111,123		—		196,372
Natural gas contracts	Cost of goods sold		—		(13,936)		—		(1,598)
Total gain (loss)		$	135,178	$	(241,820)	$	229,470	$	(296,887)

6.FAIR VALUE

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at April 30, 2019:

					Fair Value Measurement Using
	Carrying Amount in				Quoted Prices		Significant Other		Significant
	Consolidated				in Active Markets		Observable Inputs		Unobservable Inputs
Financial Liabilities:	Balance Sheet		Fair Value		(Level 1)		(Level 2)		(Level 3)
Commodity Derivative instruments - Corn	$	67,063	$	67,063	$	67,063	$	—	$	—

The following table sets forth, by level, the Company assets and liabilities that were accounted for at fair value on a recurring basis at October 31, 2018:

					Fair Value Measurement Using
	Carrying Amount in				Quoted Prices in		Significant Other		Significant
	Consolidated				Active Markets		Observable Inputs		Unobservable Inputs
Financial Assets:	Balance Sheet		Fair Value		(Level 1)		(Level 2)		(Level 3)
Commodity Derivative instruments - Corn	$	425,638	$	425,638	$	425,638	$	—	$	—
Financial Liabilities:
Commodity Derivative instruments - Corn	$	25,180	$	25,180	$	—	$	25,180	$

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

11

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

7.DEBT FINANCING

Long-term debt consists of the following:

	April 30, 2019		October 31, 2018
	(unaudited)
Amended revolving term note payable to lending institution, see terms below.	$	—	$	—
Seasonal line of credit payable to lending institution, see terms below.		—		—
Assessment payable as part of water treatment agreement, due in semi-annual installments of $189,393 with interest at 6.55%, enforceable by statutory lien, with the final payment due in 2021. The Company made deposits for one years' worth of debt service payments of approximately $364,000, which is included with other assets that are held on deposit to be applied with the final payments of the assessment.		947,300		947,300
Assessment payable as part of water supply agreement, due in monthly installments of $3,942 with interest at 8.73%, enforceable by statutory lien, with the final payment made in February 2019.		—		11,901
Totals		947,300		959,201
Less amounts due within one year		309,917		391,934
Net long-term debt	$	637,383	$	567,267

Amended Credit Facility

The amended credit facility represents the credit arrangement the Company entered into as of April 6, 2018, with an effective date of March 29, 2018, which replaced a prior revolving term note. The amended credit facility includes an amended and restated revolving term loan with a $4,000,000 principal commitment and a revolving seasonal line of credit with a $4,000,000 principal commitment. The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee. The amended credit facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties. In October 2018, The Company had an event of non-compliance related to the debt service coverage ratio as defined in the amended credit facility. In December 2018, The Company received a waiver from its lender waiving this event of noncompliance.

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

Amended Revolving Term Note

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000. Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021. Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 5.58% at April 30, 2019. 

The Company also agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.50% per annum, payable monthly in arrears.

The aggregate principal amount available to the Company for borrowing under the revolving term loan at April 30, 2019 and October 31, 2018 was $4,000,000.

12

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

Seasonal Revolving Loan

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000 until its maturing on May 1, 2020. Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.85% above the rate quoted by LIBOR Index rate, which was 5.33% at April 30, 2019. The aggregate principal amount available under the seasonal revolving loan was $4,000,000 at April 30, 2019 and $4,000,000 at October 31, 2018.

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

Estimated annual maturities of long-term debt at April 30, 2019 are as follows based on the most recent debt agreements:

2020	$	309,917
2021		333,977
2022		303,406
Total debt	$	947,300

8.COMMITMENTS AND CONTINGENCIES

Corn Forward Contracts

At April 30, 2019, the Company had cash and basis contracts for forward corn purchase commitments for approximately 1,435,000 bushels for various delivery periods through October 2020.

Given the uncertainty of future ethanol and corn prices, the Company could incur a loss on the outstanding corn purchase contracts in future periods. Management has evaluated these forward contracts and its inventories using the lower of cost or net realizable value evaluation, similar to the method used on its inventory, and has determined that an impairment loss existed of approximately $179,000 at April 30, 2019. The impairment expense is recorded as a component of cost of goods sold.

Ethanol Forward Contracts

At April 30, 2019, the Company had fixed and basis contracts to sell approximately $11,279,000 of ethanol for various delivery periods through June 2019, which approximates 83% of its anticipated ethanol sales for that period.

Distillers’ Grains Forward Contracts

At April 30, 2019, the Company had forward contracts to sell approximately $505,000 of distillers’ grains for delivery through May 2019, which approximates 30% of its anticipated distillers’ grain sales during that period.

Corn Oil Forward Contracts

At April 30, 2019, the Company had forward contracts to sell approximately $515,000 of corn oil for delivery periods through June 2019, which approximates 75% of its anticipated corn oil sales for that period.

Railcar Leases

In accordance with certain railcar lease agreements, at expiration, the Company is required to return the railcars in good condition, less normal wear and tear.  Primarily due to the ongoing maintenance and repair activities performed on its railcars, the Company has determined that no accrual for leased railcar damages is necessary and an estimate of the possible range of loss cannot be made.

13

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

9.MEMBERS’ EQUITY

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

Heron Lake BioEnergy, LLC has a total of 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding, for an aggregate total of 77,932,107 units issued and outstanding at April 30, 2019 and October 31, 2018.

On December 21, 2017, Heron Lake BioEnergy, LLC’s Board of Governors declared a cash distribution of $0.11 per unit, or approximately $8,573,000, for unit holders of record as of December 21, 2017.  The distribution was paid in January 2018.

10.RELATED PARTY TRANSACTIONS

Granite Falls Energy, LLC

The Company has a management services agreement with GFE. Under the terms of the management services agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses, and other expenses and costs incurred by GFE for the three management positions. The management services agreement automatically renews for successive one-year terms unless and until the Company or GFE gives the other party 90-days written notice of termination prior to expiration of the then current term. The management services agreement may also be terminated by either party for cause under certain circumstances. Total expenses under this agreement were approximately $99,000 and $101,000 for the three months ended April 30, 2019 and 2018, respectively, and approximately $221,000 and $238,000 for the six months ended April 30, 2019 and 2018, respectively.

Corn Purchases - Members

The Company purchased corn from board members of approximately $2,636,000 and $2,642,000 for the three months ended April 30, 2019 and 2018, respectively, and approximately $4,585,000 and $7,097,000 for the six months ended April 30, 2019 and 2018, respectively.

Swan Engineering

Agrinatural has a management and operating agreement with Swan Engineering, Inc. (“SEI”).  SEI is an affiliate of Rural Energy Solutions, LLC (“RES”), the 27% minority owner of Agrinatural.  A controlling interest of RES is owned by the principal of SEI.

Under the management and operating agreement, SEI provides Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business.  In exchange for these services, Agrinatural pays SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500.  The Company paid monthly base fee and variable customer management fee of approximately $52,000 and $49,000 for the three months ended April 30, 2019 and 2018, respectively, and approximately $104,000 and $97,000 for the six months ended April 30, 2019 and 2018, respectively. The management and operating agreement with SEI expires July 1, 2019, unless earlier terminated for cause as defined in the agreement.

14

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2019

Agrinatural also has a project management agreement with SEI.  Pursuant to the project management agreement, SEI supervises all Agrinatural's pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the project management agreement, Agrinatural pays SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural's board of managers, excluding capitalized marketing costs. The Company recorded project management fees and capital work of approximately $22,000 and $8,000 for the three months ended April 30, 2019 and 2018, respectively, and approximately $31,000 and $15,000 for the six months ended April 30, 2019 and 2018, respectively. The project management with SEI expires June 30, 2019, unless earlier terminated for cause as defined in the agreement.

11.BUSINESS SEGMENTS

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

Ethanol Production	Ethanol and co-product production and sales
Natural gas pipeline	Ownership and operations of natural gas pipeline

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

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

	Three Months Ended				Six Months Ended
	April 30, 2019		April 30, 2018		April 30, 2019		April 30, 2018
Revenue:	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Ethanol production	$	25,107,823	$	29,466,184	$	50,220,044	$	56,744,277
Natural gas pipeline		818,007		858,660		1,857,632		2,014,934
Eliminations		(431,033)		(443,988)		(885,359)		(905,904)
Total Revenue	$	25,494,797	$	29,880,856	$	51,192,317	$	57,853,307

	Three Months Ended				Six Months Ended
	April 30, 2019		April 30, 2018		April 30, 2019		April 30, 2018
Operating Income (Loss):	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Ethanol production	$	(1,584,041)	$	910,536	$	(3,929,344)	$	1,134,975
Natural gas pipeline		471,249		568,652		1,034,522		1,256,780
Eliminations		(162,617)		(193,365)		(333,914)		(389,793)
Operating Income (Loss):	$	(1,275,409)	$	1,285,823	$	(3,228,736)	$	2,001,962

	April 30, 2019		October 31, 2018
Assets:	(unaudited)
Ethanol production	$	43,291,530	$	49,540,279
Natural gas pipeline		12,654,359		12,480,577
Total Assets	$	55,945,889	$	62,020,856

15

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

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the three and six months ended April 30, 2019 and 2018.  This section should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in PART I - Item 1 of this report and the information contained in the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2018.

Disclosure Regarding Forward-Looking Statements

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

Forward-looking statements are subject to a number of known and unknown risks, uncertainties, and other factors, many of which may be beyond our control, and may cause actual results, performance, or achievements to differ materially from those projected in, expressed or implied by forward-looking statements.  While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us are described more particularly in the “Risk Factors” section of our annual report on Form 10-K for the year ended October 31, 2018 as supplemented by the risk factors disclosed in Item 1A of this report on Form 10-Q.  These risks and uncertainties include, but are not limited to, the following:

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

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

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

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

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

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

· Overcapacity and oversupply in the ethanol industry;

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

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

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

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

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

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

· Competition from alternative fuels and alternative fuel additives;

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

· Our reliance on key management personnel.

16

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

Industry and Market Data

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

Available Information

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

Overview

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

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

Reportable Operating Segments

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  Based on the nature of the products, services and operations and the expected financial results, we review our operations within the following two separate operating segments: (1) ethanol production; and (2) natural gas pipeline operations.  We currently do not have or anticipate we will have any other lines of business or other significant sources of revenue other than the sale of ethanol, distillers’ grains, corn oil and natural gas transportation.  Refer to Note 11, “Business Segments,” of the notes to the condensed consolidated unaudited financial statements for financial information about our financial reporting segments.

Ethanol Production

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

17

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

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

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

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

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

Natural Gas Pipeline

We own a controlling 73% interest in Agrinatural, a natural gas distribution and sales company located in Heron Lake, Minnesota.  Agrinatural owns approximately 190 miles of natural gas pipeline and provides natural gas to the Company’s ethanol plant and other commercial, agricultural, and residential customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company.  Agrinatural's revenues are generated through natural gas distribution fees and sales.  The operations of Agrinatural's natural gas pipeline are aggregated into a separate financial reporting segment.

The Company has two intercompany credit facilities with Agrinatural: a July 2014 credit facility, as amended (the “Original Credit Facility”) and a March 2015 credit facility, as amended (the “Additional Credit Facility”).  Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural.  Details of these credit facilities to Agrinatural are provided below in the section below entitled “PART I - Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness.”

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

Plan of Operations for the Next Twelve Months

Over the next twelve months we will continue our focus on operational improvements at our plant.  These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output

18

at our plant, continued emphasis on safety and environmental regulation, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies.

We expect to have sufficient cash generated by continuing operations and availability on our credit facility to fund our operations.  However, should we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating our plant, we may need to seek additional funding.

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

Trends and Uncertainties Impacting Our Operations

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains, and natural gas.  As a result, our operating results can fluctuate substantially due to volatility in these commodity markets.  Governmental programs designed to create incentives for the use of corn-based ethanol also have a significant impact on market prices for ethanol.  Other factors that may affect our future results of operation include those risks discussed below and in “PART II - Item 1A. Risk Factors” of this report, “PART II - Item 1A. Risk Factors” of our quarterly report on Form 10-Q for the three months ended January 31, 2019, and “PART I - Item 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2018.

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

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

Management currently believes that our margins will remain negative during the remainder of the fiscal year 2019. Continued large corn supplies and ethanol production capacity increases could have a negative impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline.  Recent US Energy Information Administration (“EIA”) reports indicate that ethanol stocks remain high and that ethanol production remains steady since the conclusion of fiscal year 2018. In addition, management believes that increased waivers of small refiner renewable volume obligations (“RVOs”) by the US Environmental Protection Agency (“EPA”), as well as uncertainty regarding the potential Renewable Fuels Standard (“RFS”) reset, will contribute to the projected tight margins.

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

In recent years, ethanol demand growth has resulted largely from increased exports.  However, export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility. Global demand for US ethanol, as reported by the EIA, continues to increase with increased exports to various foreign markets, including Brazil, Canada, India, Peru, Philippines, and Switzerland, in response to higher blending mandates and octane demand within the foreign countries and lower domestic ethanol prices.  In April 2018, in response to the tariffs imposed by the

19

Trump administration, China announced an additional retaliatory tariff on ethanol imports of 15%, bringing the total tariff to 45%. Subsequently, in July 2018, China announced an additional tariff on ethanol imports, bringing the total tariff to 70%. As a result, recent exports to China have been negligible. Brazilian demand for US ethanol has remained relatively steady, despite a tariff imposed in 2017. Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or foreign markets are developed.

Our margins have been negatively impacted during the three months ended April 30, 2019 by the lower prices received for our distillers’ grains. During our second fiscal quarter of 2019, distillers’ grains prices fell, due to lower export demand and decreased production. In addition to being an animal feed substitute for corn, distillers’ grains are increasingly considered a protein feed substitute for soybean meal. Management currently believes that the impact of the current Chinese imposition of antidumping and countervailing duties on distillers’ grains produced in the U.S. has been absorbed into the market. However, recent trade disputes with China, Mexico and Canada could result in the imposition of additional tariffs on distillers’ grains produced in the United States, which could lead to an oversupply of distillers’ grains domestically and negatively impact distillers’ grains prices. Additionally, domestic feeding margins in cattle and hogs in particular could have a negative impact on total domestic distillers’ grains demand.

Corn oil prices have been positively impacted during the three months ended April 30, 2019 by steady demand. However, from a historic perspective, corn oil prices over the past few years have been impacted by oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production, in addition to increased corn oil production. The impact of lower soybean oil prices and the market’s increase in corn oil production during the last few years will likely continue to impact corn oil prices.

In February 2018, legislation was signed extending the $1.00-per-gallon biodiesel blender tax credit retroactively to January 1, 2017. In February 2019, the Tax Extender and Disaster Relief Act of 2019 was introduced, which would reinstate the $1.00-per-gallon biodiesel blender tax credit retroactively from January 1, 2018 through December 31, 2019. This legislation has not yet been approved, and, therefore, the tax credit has not yet been renewed. Management cannot predict whether this legislation or other legislation extending the biodiesel tax credit will be passed by Congress.  Corn oil prices may decrease if biodiesel producers reduce production and/or demand for corn oil is reduced without extension of the biodiesel blenders tax credit.

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

Government Supports and Regulation

The Renewable Fuels Standard

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

Under the provisions of the RFS, the EPA must publish an annual rule that establishes the number of gallons of different types of renewable fuels, including corn-based ethanol, that must be blended with gasoline in the U.S. by refineries, blenders, distributors, and importers, which affects the domestic market for ethanol.  In November 2018, the EPA released the final renewable volume obligations (“RVOs”), which included an overall blending requirement of 19.92 billion gallons for 2019, a slight increase from 2018 mandates. Conventional corn-based ethanol levels were left at 15.0 billion gallons, excluding any waivers granted by the EPA to small refiners for “hardship.”

Current US ethanol production capacity exceeds the EPA’s 2018 and 2019 RVOs that can be satisfied by corn-based ethanol. Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” As a result, the EPA is proposing a rulemaking that proposes modifying the applicable volumes targets for cellulosic biofuel, advanced biofuel, and total renewable fuels for the years 2020-2022. The rulemaking was scheduled to be proposed in January 2019, but was delayed, likely due to the partial government shutdown in January 2019. However, in May 2019, the EPA delivered

20

the proposed rule to the White House Office of Management and Budget for its review. If the statutory RVOs are reduced as a result of reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

There is growing availability of E85 for use in flexible fuel vehicles; however, it is limited due to lacking infrastructure. In addition, the industry has been working to introduce E15 to the retail market since the EPA approved its use in vehicles model year 2001 and newer. Widespread adoption of E15 has been hampered by regulatory and infrastructure hurdles in many states, as well as consumer acceptance. Additionally, sales of E15 may have been limited because (i) it is not approved for use in all vehicles, (ii) the EPA requires a label that management believes may discourage consumers from using E15, and (iii) retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This may have prevented E15 from being used during certain times of the year in various states. In October 2018, President Trump directed the EPA to promulgate regulations making E15 available year-round. On March 4, 2019, the EPA sent a proposed rule to the Office of Management and Budget for its review. The proposed rule was published on March 12, 2019. On May 30, 2019, the EPA finalized the rule to allow E15 to be sold year-round. It is important to note that the oil industry is expected to challenge the final rule, and, in the event of such a challenge, there is no guarantee that the final rule will be upheld. The threat of a legal challenge itself could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.

The EPA assigns individual refiners, blenders, and importers the RVOs they are obligated to use based on their percentage of total fuel sales.  Obligated parties use RINs to show compliance with RVOs.  RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market.  The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties. Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. The EPA has recently granted a number of these exemptions, whereby such refiners were alleviated of their responsibility to supply RINS for their obligated volumes based upon the grounds of economic hardship.  As of May 2019, the EPA reported that it had received 37 petitions for hardship waivers for the 2017 compliance year. Thirty-five of such petitions have been approved, exempting approximately 1.82 billion RINs, which is approximately 17.05 billion gallons of gasoline and diesel, from meeting the RFS blending targets for the 2017 compliance year. Additionally, there is one petition pending for the 2017 compliance year. As of May 2019, 40 petitions for waivers have been received by the EPA for compliance year 2018. Thirty-nine of such petitions are currently pending.  

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

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

Additionally, on May 29, 2018, the National Corn Growers Association, National Farmers Union, and the Renewable Fuels Association (“RFA”) filed a petition with the U.S. Court of Appeals for the 10th Circuit challenging the EPA’s grant of waivers to three specific refineries.  The petitioners are asking the U.S. Court of Appeals for the 10th Circuit to reject the waivers granted to three refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross, Utah as an abuse of EPA authority.  These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate RVOs under the RFS. If the specific waivers granted by the EPA and/or its lower criteria for granting small refinery waivers under the RFS are allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

21

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

Further, on August 30, 2018, the RFA and Growth Energy filed a lawsuit in federal district court, alleging that the EPA and U.S. Department of Energy have improperly denied agency records requested by RFA, Growth Energy, and others under the Freedom of Information Act. The requested documents relate to exemptions from Renewable Fuel Standard compliance obligations granted by EPA.

Additionally, on February 4, 2019, Growth Energy filed a lawsuit in the Court of Appeals for the District of Columbia against the EPA, challenging the EPA’s “failure” to address small refinery exemptions in its 2019 RVO rulemaking. 

Although the maintenance of the 15.0 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the 2019 final rule, in addition to the year-round E15 rule, signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal, or otherwise invalidate the RFS.  Any such reform could adversely affect the demand and price for ethanol and the Company’s profitability.

Tax Cuts and Jobs Act

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

Results of Operations for the Three Months Ended April 30, 2019 and 2018

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the three months ended April 30, 2019 and 2018 (amounts in thousands).

	Three Months Ended April 30,
	2019				2018
		(unaudited)				(unaudited)
Statement of Operations Data			%				%
Revenues	$	25,495	100.0	%	$	29,881	100.0	%
Cost of Goods Sold		25,914	101.6	%		27,753	92.9	%
Gross Profit (Loss)		(419)	(1.6)	%		2,128	7.1	%
Operating Expenses		(856)	(3.4)	%		(842)	(2.8)	%
Operating Income (Loss)		(1,275)	(5.0)	%		1,286	4.3	%
Other Income, net		231	0.9	%		70	0.2	%
Net Income (Loss)		(1,044)	(4.1)	%		1,356	4.5	%
Less: Net Income Attributable to Non-controlling Interest		(71)	(0.3)	%		(85)	(0.3)	%
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC	$	(1,115)	(4.4)	%	$	1,271	4.2	%

22

Revenues

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists primarily of sales of our three principal products: ethanol, distillers’ grains, and corn oil, as well as incidental sales of corn syrup.  Revenues from our ethanol production segment represented approximately 98.4% of our total revenues for the three months ended April 30, 2019 and approximately 98.6% of our total revenues for the three months ended April, 2018.  Our remaining consolidated revenues are attributable to Agrinatural revenues, net of eliminations for distribution fees paid by HLBE to Agrinatural for natural gas transportation services.  The revenues attributable to our natural gas pipeline segment represented approximately 1.6% of our consolidated revenues for the three months ended April 30, 2019 and 1.4% of our consolidated revenues for the three months ended April 30, 2018.

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations the three months ended April 30, 2019:

	Three Months Ended April 30, 2019
	Sales Revenue		% of Total Revenues
	(in thousands)
Ethanol sales	$	20,040	78.6	%
Distillers' grains sales		4,079	16.0	%
Corn oil sales		725	2.8	%
Corn syrup sales		260	1.0	%
Agrinatural revenues (net of intercompany eliminations)		391	1.6	%
Total Revenues	$	25,495	100.0	%

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended April 30, 2018:

	Three Months Ended April 30, 2018
	Sales Revenue		% of Total Revenues
	(in thousands)
Ethanol sales	$	22,933	76.7	%
Distillers' grains sales		5,417	18.1	%
Corn oil sales		973	3.3	%
Corn syrup sales		143	0.5	%
Agrinatural revenues (net of intercompany eliminations)		415	1.4	%
Total Revenues	$	29,881	100.0	%

Our total consolidated revenues decreased by approximately 14.7% for the three months ended April 30, 2019, as compared to the three months ended April 30, 2018, due to decreases in the average price received for our ethanol and distillers’ grains, in addition to decreases in volumes sold of our ethanol, distillers’ grains and corn oil, which was partially offset by an increase in the average price received for our corn oil.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended April 30, 2019 and 2018:

	Three Months Ended April 30, 2019			Three Months Ended April 30, 2018
	Quantity Sold	Avg. Net Price		Quantity Sold	Avg. Net Price
Product	(in thousands)			(in thousands)
Ethanol (gallons)	16,390	$	1.22	17,952	$	1.28
Distillers' grains (tons)	32	$	129.24	38	$	142.15
Corn oil (pounds)	2,942	$	0.25	4,301	$	0.23

23

Ethanol

Total revenues from sales of ethanol decreased by approximately 12.7% for the three months ended April 30, 2019, compared to the same period of 2018 due to an approximately 4.4% decrease in the average price per gallon we received for our ethanol as compared to the same period in 2018, coupled with an approximately 8.7% decrease in the volume of ethanol sold from period to period.  The decrease in ethanol prices was due to increased production industry-wide which resulted in higher inventories. Additionally, concerns related to ongoing trade disputes and RVO waivers granted by the EPA exempting certain refiners from compliance with the RFS negatively impacted ethanol prices.

We sold fewer gallons of ethanol during the three months ended April 30, 2019 as compared to the same period of 2018 primarily due to lower production in the 2019 period. However, the amount of ethanol we produced per bushel of corn we ground was slightly more for the three months ended April 30, 2019 compared to the same period of 2018, which slightly offset the impact on our profitability.

From time to time, we engage in hedging activities with respect to our ethanol sales. At April 30, 2019, we had fixed and basis contracts for forward ethanol sales for various delivery periods through June 2019 valued at approximately $11.3 million.  Separately, ethanol derivative instruments resulted in no gain or loss for the three months ended April 30, 2019. In comparison, we had a gain on ethanol derivative instruments of approximately $111,000 for the three months ended April 30, 2018.

Distillers’ Grains

Total revenues from sales of distillers’ grains decreased by approximately 24.7% for the three months ended April 30, 2019 compared to the same period of 2018.  This decrease was due to an approximately 9.1% decrease in the average price per ton we received for our distillers’ grainsfor the three months ended April 30, 2019 compared to the same period of 2018, coupled with an approximately 17.2% decrease in the volumes of distillers’ grains sold from period to period.  The decrease in distillers’ grains prices was due to lessened export demand. We sold fewer tons of distillers’ grains in the three months ended April 30, 2019 as compared to the same period in 2018 due to overall decreased production at the ethanol plant.

At April 30, 2019, we had forward distillers’ grains sales contracts valued at approximately $505,000 for various delivery periods through May 2019.

Corn Oil

Total revenues from sales of corn oil decreased by approximately 25.4% for the three months ended April 30, 2019 compared to the same period of 2018, due to an approximately 31.6% decrease in pounds sold, which was partially offset by an increase of approximately 9.0% in the average price per pound we received for our corn oil from period to period. We sold fewer pounds of corn oil during the three months ended April 30, 2019 as compared to the same period in 2018 due to reduced ethanol production and decreased oil extraction rates per bushel of corn for the three months ended April 30, 2019 compared to the same period of 2018. Management expects our corn oil production will be relatively stable going forward.

Management attributes the decrease in corn oil prices to lower prices for soybean oil, which may be substituted for corn oil in certain circumstances and is frequently a competing raw material to corn oil for biodiesel production. Management expects corn oil prices will remain relatively steady in the near term.  However, we may experience lower demand for corn oil from the biodiesel industry as the 2019 RVOs for biodiesel were only up slightly from the 2018 levels, which may result in lower biodiesel production unless the biodiesel tax credit is further extended by Congress. However, lower soybean oil prices and the current oversupply of corn oil due to the substantial increase in corn oil production during the last few years will likely continue to negatively impact corn oil prices.

At April 30, 2019, we had forward corn oil sales contracts valued at approximately $515,000 for various delivery periods through June 2019.

24

Cost of Goods Sold

Our cost of goods sold decreased by approximately 6.6% for the three months ended April 30, 2019, compared to the three months ended April 30, 2018. Additionally, as a percentage of revenues, our cost of goods sold increased to approximately 101.6% for the three months ended April 30, 2019 compared to 92.9% for the same period of 2018.  Approximately 90% of our total costs of goods sold is attributable to our ethanol production segment.  As a result, the cost of goods sold per gallon of ethanol sold for the three months ended April 30, 2019 and 2018 was approximately $1.42 and $1.39 per gallon, respectively.

The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, electricity, and wages, salaries and benefits of production personnel, and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended April 30, 2019:

	Three Months Ended April 30, 2019
	Amount		% of
	(in thousands)		Cost of Goods Sold
Corn costs	$	17,615	68.0	%
Natural gas costs		1,766	6.8	%
All other components of costs of goods sold		6,533	25.2	%
Total Cost of Goods Sold	$	25,914	100.0	%

The following table shows the costs of corn, natural gas, and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended April 30, 2018:

	Three Months Ended April 30, 2018
	Amount		% of
	(in thousands)		Cost of Goods Sold
Corn costs	$	19,524	70.3	%
Natural gas costs		1,751	6.3	%
All other components of costs of goods sold		6,478	23.4	%
Total Cost of Goods Sold	$	27,753	100.0	%

Corn

Our cost of goods sold related to corn was approximately 9.8% less for the three months ended April 30, 2019 compared to the same period of 2018.  The decrease resulted from an approximately 12.5% decrease in the number of bushels of corn processed from period to period, which was partially offset by an approximately 4.4% increase in the average price per bushel paid for corn from period to period. Management attributes the increase in corn prices primarily to weather conditions. Management anticipates that corn prices will remain higher and are likely to continue to increase depending on the actual number of bushels of corn harvested in the fall of 2019.

The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for the three months ended April 30, 2019 was approximately $0.11 lower than the corn-ethanol price spread we experienced for same period of 2018.

From time to time we enter into forward purchase contracts for our commodity purchases and sales. At April 30, 2019 we had approximately 1.4 million bushels of cash and basis contracts for forward corn purchase commitments for various delivery periods through October 2020. 

Our corn derivative positions resulted in a gain of approximately $135,000 for the three months ended April 30, 2019 and a loss of approximately $339,000 for the three months ended April 30, 2018. We recognize the gains or losses that result from the changes in the value of our derivative instruments from corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments is impacted, which affects our financial performance.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged.

25

Natural Gas

Our cost of goods sold related to natural gas costs increased approximately 0.8% for the three months ended April 30, 2019 compared to the same period of 2018.  Management attributes this increase in cost of natural gas from period to period to increased demand and lower natural gas inventories.

We had no gain or loss on natural gas derivative instruments for the three months ended April 30, 2019. In comparison, we had a loss on natural gas derivative instruments of approximately $14,000 for the three months ended April 30, 2018.We recognize the gains or losses that result from the changes in the value of our derivative instruments from natural gas in cost of goods sold as the changes occur.

Operating Expenses

Operating expenses include wages, salaries, and benefits of administrative employees at the plant, insurance, professional fees, property taxes, and similar costs.  Operating expenses for the three months ended April 30, 2019 increased approximately 1.6% compared to the three months ended April 30, 2018. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Income (Loss)

Our income from operations for the three months ended April 30, 2019 decreased by approximately $2.6 million compared to the same period of 2018.  This decrease resulted largely from declines in prices for our ethanol and distillers’ grains as well reduced sales and production during the 2019 period.

Other Income, Net

We had net other income of approximately $231,000 during the three months April 30, 2019 compared to net other income of approximately $70,000 for the same period of 2018.  We had more other income the three months ended April 30, 2019 compared to the same period of 2018 due primarily to the timing of payments and patronage/dividend amounts received in the 2019 period.

Results of Operations for the Six Months Ended April 30, 2019 and 2018

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the six months ended April 30, 2019 and 2018 (amounts in thousands).

	Six Months Ended April 30,
	2019				2018
Statement of Operations Data	(unaudited)		%		(unaudited)		%
Revenues	$	51,192	100.0	%	$	57,853	100.0	%
Cost of Goods Sold		52,646	102.8	%		54,144	93.6	%
Gross Profit (Loss)		(1,453)	(2.8)	%		3,709	6.4	%
Operating Expenses		(1,776)	(3.5)	%		(1,707)	(3.0)	%
Operating Income (Loss)		(3,229)	(6.3)	%		2,002	3.4	%
Other Income, net		252	0.5	%		332	0.6	%
Net Income (Loss)		(2,977)	(5.8)	%		2,334	4.0	%
Less: Net Income Attributable to Non-controlling Interest		(162)	(0.3)	%		(201)	(0.3)	%
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC	$	(3,139)	(6.1)	%	$	2,133	3.7	%

26

Revenues

Revenues from our three primary products: ethanol, distillers’ grains and corn oil, as well as incidental sales of corn syrup, represented approximately 98.1% and 98.1% of our total consolidated revenues for the six months ended April 30, 2019 and 2018, respectively. Miscellaneous other revenues are attributable to Agrinatural revenues (net of eliminations) represented 1.9% and 1.9% of our consolidated revenues for the six months ended April 30, 2019 and 2018, respectively.

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the six months ended April 30, 2019:

	Six Months Ended April 30, 2019
	Sales Revenue		% of Total Revenues
	(in thousands)
Ethanol sales	$	38,438	75.1	%
Distillers' grains sales		9,568	18.7	%
Corn oil sales		1,689	3.3	%
Corn syrup sales		525	1.0	%
Agrinatural revenues (net of intercompany eliminations)		972	1.9	%
Total Revenues	$	51,192	100.0	%

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the six months ended April 30, 2018:

	Six Months Ended April 30, 2018
	Sales Revenue		% of Total Revenues
	(in thousands)
Ethanol sales	$	43,630	75.5	%
Distillers' grains sales		10,553	18.2	%
Corn oil sales		2,256	3.9	%
Corn syrup sales		305	0.5	%
Agrinatural revenues (net of intercompany eliminations)		1,109	1.9	%
Total Revenues	$	57,853	100.0	%

Our total consolidated revenues decreased by approximately 11.5% for the six months ended April 30, 2019, as compared to the same period of 2018, due to a decrease in the average price received for our ethanol and decreased sales of our products, which was partially offset by an increase in the average price received for our distillers’ grains and corn oil.  The following table reflects quantities of our three primary products sold and the average net prices received for the six months ended April 30, 2019 and 2018:

	Six Months Ended April 30, 2019			Six Months Ended April 30, 2018
	Quantity Sold	Avg. Selling Price		Quantity Sold	Avg. Selling Price
Product	(in thousands)			(in thousands)
Ethanol (gallons)	33,018	$	1.16	35,258	$	1.24
Distillers' grains (tons)	71	$	135.55	82	$	129.43
Corn oil (pounds)	6,807	$	0.25	9,245	$	0.24

Ethanol

Total revenues from sales of ethanol decreased by approximately 11.9% for the six months ended April 30, 2019 compared to the same period of 2018 due to an approximately 6.4%  decrease in the volume sold due to decreased production during the 2019 period, in addition to an approximately 5.9%  decrease in average price per gallon we received for our ethanol from period to period. The decrease in ethanol prices resulted principally from increased production industry-wide, which exceeded demand, resulting in higher inventories that pushed ethanol prices downward.

27

Our ethanol derivative instruments resulted in no gain or loss for the six months ended April 30, 2019.  In comparison, we had a gain on ethanol derivative instruments of approximately $196,000 during the six months ended April 30, 2018.  Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $555,000 and $50,000 for the six months ended April 30, 2019 and 2018, respectively.

Distillers' Grains

Total revenues from sales of distillers’ grains decreased by approximately 9.3% for the six months ended April 30, 2019 compared to the same period of 2018.  This decrease is due to an approximately 13.4% decrease in the volume sold, which was partially offset by an approximately 4.7% increase in the average price per ton received for our distillers’ grains from period to period. This increase in the market price of distillers’ grains is due to a stronger domestic market due to increases in prices of soybean meal and increased export demand. We produced and sold fewer total tons of distillers’ grains during the six months ended April 30, 2019 compared to the six months ended April 30, 2018 due to decreased ethanol production in the 2019 period.

Corn Oil

Total revenues from sales of corn oil decreased by approximately 25.1% for the six months ended April 30, 2019 compared to the six months ended April 30, 2018 due primarily to an approximately 26.4% decrease in pounds sold, which was partially offset by an approximately 1.7%  increase in the average price per pound we received for our corn oil from period to period. The decrease in volume sold for the six months ended April 30, 2019 compared to the same period of 2018 is attributable to decreased ethanol production during the six months ended April 30, 2018.

Cost of Goods Sold

Our cost of goods sold decreased by approximately 2.8% for the six months ended April 30, 2019, as compared to the six months ended April 30, 2018.  As a percentage of revenues, however, our cost of goods sold increased to approximately 102.8% for the six months ended April 30, 2019, as compared to approximately 93.6% for the same period in 2018 due to the narrower margin between the price of ethanol and the price of corn from period to period.  The cost of goods sold per gallon of ethanol produced for the six months ended April 30, 2019 and 2018 was approximately $1.43 and $1.38 per gallon of ethanol, respectively. 

The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, electricity, and wages, salaries and benefits of production personnel, and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the six months ended April 30, 2019:

	Six Months Ended April 30, 2019
	Amount		% of
	(in thousands)		Cost of Goods Sold
Corn costs	$	37,833	71.9	%
Natural gas costs		4,001	7.6	%
All other components of costs of goods sold		10,812	20.5	%
Total Cost of Goods Sold	$	52,646	100.0	%

The following table shows the costs of corn, natural gas, and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the six months ended April 30, 2018:

	Six Months Ended April 30, 2018
	Amount		% of
	(in thousands)		Cost of Goods Sold
Corn costs	$	38,963	72.0	%
Natural gas costs		3,590	6.6	%
All other components of costs of goods sold		11,591	21.4	%
Total Cost of Goods Sold	$	54,144	100.0	%

28

Corn

Our cost of goods sold related to corn was approximately 2.9% less for the six months ended April 30, 2019 compared to the same period of 2018, due primarily to an approximately 7.9% decrease in the number of bushels of corn processed, which was partially offset by an approximately 5.4% increase in the average price per bushel paid for corn from period to period.  For the six months ended April 30, 2019 and 2018, we processed approximately 10.9 million and 11.8 million bushels of corn, respectively.  The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) for the six months ended April 30, 2019, was approximately $0.14 lower than the corn-ethanol price spread we experienced for same period of 2018. 

We had a gain related to corn derivative instruments of approximately $229,000 for the six months ended April 30, 2019, which decreased our costs of goods sold.  Comparatively, we had losses related to corn derivative instruments of approximately $492,000 for the six months ended April 30, 2018, which increased our cost of goods sold. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on corn inventories, as a component of cost of goods sold, of approximately $58,000 for the six months ended April 30, 2019. Management has evaluated the outstanding corn forward purchase contracts and its inventories using the lower of cost or net realizable value evaluation, similar to the method used on its inventory, and has determined that an impairment loss existed of approximately $179,000 at April 30, 2019. The impairment expense is recorded as a component of cost of goods sold.

Natural Gas

Natural gas costs increased 11.4% for the six months ended April 30, 2019 as compared to the six months ended April 30, 2018. The increase in natural gas costs was primarily due to higher production levels and colder weather during the 2019 period.   

We had no gain or loss on natural gas derivative positions during the six months ended April 30, 2019. Comparatively, our natural gas derivative positions resulted in a loss of approximately $2,000 during the six months ended April 30, 2018, which increased our cost of goods sold.

Operating Expenses

Operating expenses for the six months ended April 30, 2019 increased by approximately 4.0% compared to the six months ended April 30, 2018. 

Operating Income (Loss)

Our income from operations for the six months ended April 30, 2019 was approximately $5.2 million less compared to the same period of 2018.  This decrease resulted largely from increased prices for our corn relative to the price of ethanol and narrowed operating margin.

Other Income, Net

We had net other income of approximately $252,000 and $332,000 during the six months ended April 30, 2019 and 2018, respectively.  We had less other income primarily due to the timing of payments and less patronage amounts received during the 2018 period.

29

Changes in Financial Condition at April 30, 2019 and October 31, 2018

The following table highlights our financial condition at April 30, 2019 and October 31, 2018 (amounts in thousands):

	April 30, 2019		October 31, 2018
Current Assets	$	13,539	$	17,166
Total Assets	$	55,946	$	62,021
Current Liabilities	$	3,507	$	6,675
Long-Term Debt, less current portion	$	637	$	567
Members' Equity attributable to Heron Lake BioEnergy, LLC	$	49,916	$	53,055
Non-Controlling Interest	$	1,886	$	1,724

The decrease in total current assets is attributable to a decrease in cash on hand of approximately $2.8 million at April 30, 2019 compared to October 31, 2018.  The decrease in cash was due primarily to approximately $2.4 million net cash used in operating activities for the six months ended April 30, 2019.  Additionally, we had decreases in the value of our commodity derivative instruments of approximately $426,000 at April 30, 2019 compared to October 31, 2018. Offsetting these decreases was an increase in prepaid expenses and other current assets of approximately $414,000 at April 30, 2019 compared to October 31, 2018.  Also contributing to the decrease in total assets was an approximately $2.4 million decrease in property and equipment primarily due to depreciation expense during the 2019 period.

Our current liabilities decreased approximately $3.2 million at April 30, 2019 compared to October 31, 2018, due to decreases of approximately $3.0 million in accounts payable and approximately $125,000 in accrued expenses. Our accounts payable were less at April 30, 2019 compared to October 31, 2018 due to the timing of payments to vendors during the six months ended April 30, 2019.

Members’ equity attributable to Heron Lake BioEnergy, LLC decreased by approximately $3.1 million at April 30, 2019 compared to October 31, 2018.  The decrease was related to the net loss attributable to HLBE during the six months ended April 30, 2019.

Non-controlling interest totaled approximately $1.9 million and $1.7 million at April 30, 2019 and October 31, 2018. This is directly related to recognition of the 27% non-controlling interest in Agrinatural at April 30, 2019 and October 31, 2018.

Liquidity and Capital Resources

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

Cash Flows

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

	Six Months Ended April 30,
	2019		2018
	(unaudited)		(unaudited)
Net cash provided by (used in) operating activities	$	(2,403)	$	3,985
Net cash used in investing activities	$	(143)	$	(446)
Net cash used in financing activities	$	(12)	$	(8,771)
Net decrease in cash and restricted cash	$	(2,558)	$	(5,232)

30

Operating Cash Flows

During the three months ended April 30, 2019, we used more cash in operating activities compared to the same period of 2018primarily due to net loss in the 2019 period.  Additionally, changes in various working capital components, including inventory, prepaid expenses, accrued expenses and accounts payable also contributed to the increase in cash used during the 2019 period.

Investing Cash Flows

We used less cash for investing activities for the three months ended April 30, 2019 compared to the same period of 2018 due to a decrease in capital expenditures for general plant improvements, which was partially offset by proceeds from disposals of property and equipment received in the 2018 period. 

Financing Cash Flows

During the three months ended April 30, 2019, we used cash to make payments of approximately $12,000 on our long-term debt.  Comparatively, during the same period of 2018, we used cash to make payments of approximately $122,000 on our long-term debt, approximately $8.6 million in distributions to our unit holders, and approximately $81,000 in distributions to non-controlling interests.

Indebtedness

Compeer Credit Facility

We have a comprehensive credit facility with Compeer Financial, FLCA and Compeer Financial, PCA, collectively formerly known as AgStar Financial Services, FLCA (“Compeer”) for which CoBank, ACP (“CoBank”) serves as the administrative agent.  This credit facility includes an amended and restated revolving term loan with a $4.0 million principal commitment and a revolving seasonal line of credit with a $4.0 million principal commitment. In exchange for the loans, we granted liens on all property (real and personal, tangible, and intangible) which include, among other things, a mortgage on the property, a security interest on commodity trading accounts, and assignment of material contracts. Please refer toItem 1 - Financial Statements, Note 7 - Debt Financing for additional details. As of April 30, 2019 and October 31, 2018, there were no amounts outstanding under our credit facility with Compeer and the aggregate principal amount available to the Company for borrowing under each of the amended revolving term loan and seasonal revolving loan was $4.0 million.

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

At April 30, 2019, the Company was in compliance with these loan covenants. However, if market conditions deteriorate in the future, circumstances may develop which could result in the Company violating the financial covenants or other terms of its amended credit facility.  If we fail to comply with the terms of our amended credit facility with Compeer, and Compeer refuses to waive the non-compliance, Compeer could terminate the credit facility and any commitment to loan funds to the Company.

Other Credit Arrangements

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

31

In October 2003, we entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors.  In consideration of this agreement, the Company and Minnesota Soybean Processors are allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that were to mature in February 2019.  The parties have agreed that prior to the scheduled expiration of the agreement, they will negotiate in good faith to replace the agreement with a further agreement regarding the wells and related facilities. The agreement has been extended by mutual agreement of the parties. The Company is currently in discussions with the City of Heron Lake to facilitate the Company’s purchase of such wells and related facilities, provided that the Company will, pursuant to a successful purchase, provide water service to at least one identified industrial customer. In the event that the purchase is not consummated, the City of Heron Lake and the Company will continue to extend the current agreement in substantially the form as currently operating.

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

There was a total of approximately $947,000 and $959,000 in outstanding water revenue bonds at April 30, 2019 and October 31, 2018, respectively. We classify our obligations under these bonds as assessments payable.  The interest rates on the bonds range from 6.55% to 8.73%.

Loans to Agrinatural

Original Agrinatural Credit Facility

In July 2014, the Company extended a five-year term loan to Agrinatural in the aggregate principal amount of approximately $3.05 million (the “Original Agrinatural Credit Facility”).  The Original Agrinatural Credit Facility requires monthly principal payments of $36,000, plus accrued interest.  Interest on the Original Agrinatural Credit Facility accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Final payment of amounts borrowed under Original Agrinatural Credit Facility is due and payable in full on May 1, 2019.

The Original Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.  The Original Agrinatural Credit Facility is secured by all of Agrinatural’s equipment and assets and a collateral assignment assigning the Company all of Agrinatural’s interests in its contracts, leases, easements, and other agreements.  In addition, Rural Energy Solutions, LLC, the minority owner of Agrinatural (“RES”), executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to the Company.

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Original Agrinatural Credit Facility. As noted, the Company has a security interest in all of Agrinatural’s assets. The Company expects to be fully paid with regard to the Original Agrinatural Credit Facility. The Company expects no interruption in the service of natural gas to its ethanol production facility. The balance of this loan was approximately $1.4 million and $1.5 million at April 30, 2019 and October 31, 2018, respectively.

Additional Agrinatural Credit Facility

In March 2015, the Company made a four-year term loan in the principal amount of $3.5 million to Agrinatural (the “Additional Agrinatural Credit Facility”). In May 2016, the Company and Agrinatural amended the Additional Agrinatural Credit Facility (the “Amendment”). Under the terms of the Additional Agrinatural Credit Facility and the Amendment, for each of calendar years, 2017, 2018 and 2019, Agrinatural may not, without consent of the Company, proceed with and pay for capital expenditures in an amount in excess of $100,000 plus the amount of contributions in aid of construction received by Agrinatural from customers for capital improvements (“CIAC”), less a reserve for distribution to the Agrinatural members to cover the income or other taxes imposed as a result of receipt of CIAC in an amount equal to 40% of CIAC.  Prior to the Amendment, Agrinatural’s capital expenditures were restricted to $100,000 per year.

32

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

The Additional Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size, including a covenant restricting capital expenditures by Agrinatural.  The Additional Agrinatural Credit Facility is secured by all of Agrinatural’s equipment and assets and a collateral assignment assigning the Company all of Agrinatural’s interests in its contracts, leases, easements, and other agreements.  In addition, RES executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to the Company.

Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Additional Agrinatural Credit Facility. As noted, the Company has a security interest in all of Agrinatural’s assets. The Company expects to be fully paid with regard to the Additional Agrinatural Credit Facility. The Company expects no interruption in the service of natural gas to its ethanol production facility. The balance of this loan was approximately $1.9 million at April 30, 2019 and $2.0 million at October 31, 2018.

Critical Accounting Estimates

Management uses estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  We believe that of our significant accounting policies summarized in Note 1 to our condensed consolidated unaudited financial statements included with this periodic report on Form 10-Q.

At April 30, 2019, our critical accounting estimates continue to include those described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2018.  Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles in the United States of America. 

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below.  We have no exposure to foreign currency risk as all our business is conducted in U.S. Dollars.  We use derivative financial instruments as part of an overall strategy to manage market risk.  We use cash, futures, and option contracts to hedge changes to the commodity prices of corn, ethanol, and natural gas.  We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes pursuant to the requirements of Generally Accepted Accounting Principles (“GAAP”).

Interest Rate Risk

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

As of April 30, 2019, we had no exposure to interest rate risk as we had no amounts outstanding under our loans with Compeer.

33

Commodity Price Risk

We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers’ grains, through the use of hedging instruments.  In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate.  Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged.  We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues.  The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from period to period due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

As of April 30, 2019, we had price protection in place for approximately 21%  of our anticipated corn and natural gas needs for the next 12 months and approximately 14%, 5%, and 12.5% of our anticipated ethanol, distillers’ grains, and corn oil sales for the next 12 twelve months, respectively.  Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations.  As input prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments.  Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term growth for us.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, corn, and natural gas price risk.  Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the fair value of our corn and natural gas prices and average ethanol price as of April 30, 2019, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements.  The volumes are based on our expected use and sale of these commodities for a one year period from April 30, 2019.

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

	Estimated Volume Requirements		Hypothetical Adverse	Approximate
	for the next 12 months	Unit of	Change in Price as of	Adverse
	(net of forward and futures contracts)	Measure	April 30, 2019	Change to Income
Ethanol	58,500,000	Gallons	10.0%	$	7,020,000
Corn	22,700,000	Bushels	10.0%	$	7,786,000
Natural Gas	1,320,000	MMBTU	10.0%	$	442,000

Item 4.  Controls and Procedures

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

Effectiveness of Disclosure Controls and Procedures

Our management, including our Chief Executive Officer (the principal executive officer), Steve Christensen, along with our Chief Financial Officer (the principal financial officer), Stacie Schuler, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as April 30, 2019.  Based upon this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

34

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended April 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.  Legal Proceedings

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

Item 1A. Risk Factors

The risk factors below should be read in conjunction with the risk factors previously discussed in Item 1A of our Form 10-K for the fiscal year ended October 31, 2018. Additional risks and uncertainties, including risks and uncertainties not presently known to us, or that we currently deem immaterial, could also have an adverse effect on our business, financial condition and/or results of operations.

Government policies and regulations, particularly those affecting the agricultural sector and related industries, could adversely affect our operations and profitability. 

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

We may experience negative impacts of higher ethanol tariffs and other disruptions to international agricultural trade related to current trade actions announced by the Trump administration and responsive actions announced by trading partners, including by China. For example, in April 2018, the Chinese government increased the tariff on U.S. ethanol imports into China from 30% to 45%, and increased such tariff again in July 2018 from 45% to 70%.  We cannot estimate the exact effect this tariff increase will have on the overall domestic ethanol market, as exports continued to China through March 2018. Since March 2018, however, exports to China have been negligible.  The increased tariff is expected to reduce overall U.S. ethanol export demand, which could have a negative effect on U.S. domestic ethanol prices.

Hardship waivers granted to “small refineries” negatively impact domestic demand, which could adversely affect our operations and profitability.

Domestic demand for ethanol is driven largely by the RFS, which requires the EPA to annually establish renewable volume obligations, or RVOs, which set forth the number of gallons of different types of renewable fuels that must be used in the U.S. by refineries, blenders, distributors and importers. RVOs for both 2018 and 2019 have been set at 15.0 billion gallons for conventional ethanol. To comply with the RVOs, obligated parties use RINs, which are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market. Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate disproportionate economic hardship. As of May 2019, the EPA reported that approximately 1.82 billion RINs, which is approximately 17.05 billion gallons of gasoline and diesel, have been exempted from meeting the RVOs for the 2017 compliance year. Petitions for waivers for the 2018 compliance year, as well as a remaining petition for the 2017 compliance year, are currently pending. If similar waivers continue to be approved, then domestic demand for our ethanol could decrease, which negatively impacts ethanol prices and our profitability.

35

The prices of ethanol and distillers’ grains may decline because of trade barriers imposed by foreign countries with respect to ethanol and distillers’ grains originating in the U.S., thereby negatively affect our profitability.

An increasing amount of our industry’s products are being exported, and U.S. production has grown to supply the foreign marketplace. However, the volume of ethanol and distillers’ grains exports may decline. If producers and exporters of ethanol and distillers’ grains are subjected to increased trade barriers when selling products to foreign customers, like the various tariffs currently in effect, then the supply of the products to the domestic market may increase, and there may be a reduction in the value of these products to producers like us in the United States.  Declines in the price we receive for our products will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably.

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

None.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

None.

Item 5.  Other Information

None.

Item 6.  Exhibits

The following exhibits are included in this report:

Exhibit No.		Exhibit
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange Act.*
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Exchange Act.*
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.*
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.*
101.1	The following materials from Heron Lake BioEnergy’s Quarterly Report on Form 10-Q for the three and six months ended April 30, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at April 30, 2019 and October 31, 2018; (ii) the Condensed Consolidated Statements of Operations for the three and six months ended April 30, 2019 and 2018; (iii) the Condensed Consolidated Statements of Members’ Equity for the three and six months ended April 30, 2019 and 2018; (iv) the Condensed Consolidated Statements of Cash Flows for the six months ended April 30, 2019 and 2018; and (v) Notes to Condensed Consolidated Unaudited Financial Statements.*

*Filed electronically herewith.

36

SIGNATURES

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

	HERON LAKE BIOENERGY, LLC
Date: June 14, 2019	/s/ Steve Christensen
	Steve Christensen
	Chief Executive Officer
Date: June 14, 2019	/s/ Stacie Schuler
	Stacie Schuler
	Chief Financial Officer

37