UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the quarterly period ended | June 30, 2019 |
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______________________ to _______________________ |
Commission File Number: 000-51764
LINCOLNWAY ENERGY, LLC
Exact name of registrant as specified in its charter)
Iowa | 20-1118105 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
59511 W. Lincoln Highway, Nevada, Iowa | 50201 |
(Address of principal executive offices) | (Zip Code) |
515-232-1010
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Membership units | N/A | N/A |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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).
þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth 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 o | Accelerated filer o | |
Non-accelerated filer þ | Smaller reporting company o | |
Emerging growth company o | ||
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. o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 42,049 membership units outstanding at August 1, 2019.
LINCOLNWAY ENERGY, LLC
FORM 10-Q
For the Quarter Ended June 30, 2019
INDEX
Page | |||
Part I. | Financial Information | ||
Item 1. | Unaudited Financial Statements | ||
Balance Sheets | |||
Statements of Operations | |||
Statements of Members' Equity | |||
Statements of Cash Flows | |||
Notes to Unaudited Financial Statements | |||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | ||
Item 4. | Controls and Procedures | ||
Part II. | Other Information | ||
Item 1. | Legal Proceedings | ||
Item 1A. | Risk Factors | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | ||
Item 3. | Defaults Upon Senior Securities | ||
Item 4. | Mine Safety Disclosures | ||
Item 5. | Other Information | ||
Item 6. | Exhibits | ||
Signatures | |||
Exhibits Filed With This Report | |||
Rule 13a-14(a) Certification of President and Chief Executive Officer | E-1 | ||
Rule 13a-14(a) Certification of Chief Financial Officer | E-2 | ||
Section 1350 Certification of President and Chief Executive Officer | E-3 | ||
Section 1350 Certification of Chief Financial Officer | E-4 | ||
Interactive Data Files (filed electronically herewith) |
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements.
Lincolnway Energy, LLC
Balance Sheets
June 30, 2019 | September 30, 2018 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
CURRENT ASSETS | |||||||
Cash and cash equivalents | $ | 186,902 | $ | 668,456 | |||
Derivative financial instruments (Note 8 and 9) | 1,100,189 | 555,127 | |||||
Trade and other accounts receivable (Note 7) | 2,823,468 | 2,786,498 | |||||
Inventories (Note 3) | 5,515,181 | 4,556,703 | |||||
Prepaid expenses and other | 299,831 | 291,036 | |||||
Total current assets | 9,925,571 | 8,857,820 | |||||
PROPERTY AND EQUIPMENT | |||||||
Land and land improvements | 7,156,465 | 7,148,360 | |||||
Buildings and improvements | 7,548,308 | 6,019,001 | |||||
Plant and process equipment | 85,927,383 | 85,732,218 | |||||
Office furniture and equipment | 479,812 | 478,173 | |||||
Construction in progress | 6,764,863 | 11,610,970 | |||||
107,876,831 | 110,988,722 | ||||||
Accumulated depreciation | (64,719,722 | ) | (62,272,902 | ) | |||
Total property and equipment | 43,157,109 | 48,715,820 | |||||
OTHER ASSETS | 862,520 | 829,832 | |||||
Total assets | $ | 53,945,200 | $ | 58,403,472 |
See Notes to Unaudited Financial Statements.
2
Lincolnway Energy, LLC
Balance Sheets (continued)
June 30, 2019 | September 30, 2018 | ||||||
(Unaudited) | |||||||
LIABILITIES AND MEMBERS' EQUITY | |||||||
CURRENT LIABILITIES | |||||||
Accounts payable | $1,829,075 | $2,378,921 | |||||
Accounts payable, related party (Note 7) | 165,148 | 657,133 | |||||
Current maturities of long-term debt (Note 5 and 6) | 22,600,000 | — | |||||
Accrued loss on firm purchase commitments | 547,246 | 366,168 | |||||
Accrued expenses | 916,027 | 972,167 | |||||
Total current liabilities | 26,057,496 | 4,374,389 | |||||
NONCURRENT LIABILITIES | |||||||
Long-term debt, less current maturities (Note 5) | — | 15,200,000 | |||||
Deferred revenue | — | 296,296 | |||||
Other | 550,116 | 533,589 | |||||
Total noncurrent liabilities | 550,116 | 16,029,885 | |||||
COMMITMENTS AND CONTINGENCIES (Note 8) | |||||||
MEMBERS' EQUITY | |||||||
Member contributions, 42,049 units issued and outstanding | 38,990,105 | 38,990,105 | |||||
Retained (deficit) | (11,652,517 | ) | (990,907 | ) | |||
Total members' equity | 27,337,588 | 37,999,198 | |||||
Total liabilities and members' equity | $ | 53,945,200 | $ | 58,403,472 |
3
Lincolnway Energy, LLC
Statements of Operations
Three Months Ended | Nine Months Ended | ||||||||||||||
June 30, 2019 | June 30, 2018 | June 30, 2019 | June 30, 2018 | ||||||||||||
(Unaudited) | (Unaudited) | ||||||||||||||
Revenues (Notes 2 and 6) | $ | 26,488,313 | $ | 27,100,886 | $ | 71,193,326 | $ | 76,359,668 | |||||||
Cost of goods sold (Note 6) | 28,137,492 | 26,233,030 | 77,337,800 | 75,505,673 | |||||||||||
Gross profit (loss) | (1,649,179 | ) | 867,856 | (6,144,474 | ) | 853,995 | |||||||||
General and administrative expenses | 1,028,108 | 735,719 | 2,773,045 | 2,465,237 | |||||||||||
Bad debt expense | 4,385,009 | — | 4,385,009 | — | |||||||||||
Operating profit (loss) | (7,062,296 | ) | 132,137 | (13,302,528 | ) | (1,611,242 | ) | ||||||||
Other income (expense): | |||||||||||||||
Interest income | (30,990 | ) | 19,516 | 7,701 | 41,447 | ||||||||||
Interest expense | (342,335 | ) | (28,675 | ) | (446,723 | ) | (28,675 | ) | |||||||
Other income | 40,779 | 199,526 | 3,079,940 | 580,784 | |||||||||||
(332,546 | ) | 190,367 | 2,640,918 | 593,556 | |||||||||||
Net profit (loss) | $ | (7,394,842 | ) | $ | 322,504 | $ | (10,661,610 | ) | $ | (1,017,686 | ) | ||||
Weighted average units outstanding | 42,049 | 42,049 | 42,049 | 42,049 | |||||||||||
Net profit (loss) per unit - basic and diluted | $ | (175.87 | ) | $ | 7.67 | $ | (253.55 | ) | $ | (24.20 | ) | ||||
Distributions per unit - basic and diluted | $ | — | $ | — | $ | — | $ | 25.00 |
See Notes to Unaudited Financial Statements.
4
Lincolnway Energy, LLC
Statements of Members' Equity
Member Contributions | Retained (Deficit) | Total | |||||||||
Balance, September 30, 2018 | $ | 38,990,105 | $ | (990,907 | ) | $ | 37,999,198 | ||||
Net (loss) | — | (1,836,126 | ) | (1,836,126 | ) | ||||||
Balance, December 31, 2018 | 38,990,105 | (2,827,033 | ) | 36,163,072 | |||||||
Net (loss) | — | (1,430,642 | ) | (1,430,642 | ) | ||||||
Balance, March 31, 2019 | $ | 38,990,105 | $ | (4,257,675 | ) | $ | 34,732,430 | ||||
Net (loss) | — | (7,394,842 | ) | (7,394,842 | ) | ||||||
Balance, June 30, 2019 | $ | 38,990,105 | $ | (11,652,517 | ) | $ | 27,337,588 |
Member Contributions | Retained Equity | Total | |||||||||
Balance, September 30, 2017 | $ | 38,990,105 | $ | 3,007,533 | $ | 41,997,638 | |||||
Net (loss) | — | (947,021 | ) | (947,021 | ) | ||||||
Distributions ($25 per unit) | — | (1,051,225 | ) | (1,051,225 | ) | ||||||
Balance, December 31, 2017 | 38,990,105 | 1,009,287 | 39,999,392 | ||||||||
Net (loss) | — | (393,169 | ) | (393,169 | ) | ||||||
Balance, March 31, 2018 | $ | 38,990,105 | $ | 616,118 | $ | 39,606,223 | |||||
Net income | — | 322,504 | 322,504 | ||||||||
Balance, June 30, 2018 | $ | 38,990,105 | $ | 938,622 | $ | 39,928,727 |
See Notes to Unaudited Financial Statements.
5
Lincolnway Energy, LLC Statements of Cash Flows | |||||||
Nine Months Ended | Nine Months Ended | ||||||
June 30, 2019 | June 30, 2018 | ||||||
(Unaudited) | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
Net (loss) | $ | (10,661,610 | ) | $ | (1,017,686 | ) | |
Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities: | |||||||
Depreciation and amortization | 4,105,400 | 3,139,546 | |||||
Loss on disposal of property and equipment | 228,475 | 36,123 | |||||
Gain on equity dividend | — | (7,518 | ) | ||||
Accrued loss on firm purchase commitments | 181,078 | — | |||||
Bad debt expense | 4,385,009 | — | |||||
Changes in working capital components: | |||||||
Trade and other accounts receivable | (341,979 | ) | 158,730 | ||||
Inventories | (958,478 | ) | 718,805 | ||||
Prepaid expenses and other | (24,956 | ) | 102,251 | ||||
Accounts payable | (489,825 | ) | (1,461,294 | ) | |||
Accounts payable, related party | (491,985 | ) | (297,295 | ) | |||
Accrued expenses and deferred revenue | (352,436 | ) | 178,829 | ||||
Derivative financial instruments | (545,062 | ) | 68,149 | ||||
Net cash provided by (used in) operating activities | (4,966,369 | ) | 1,618,640 | ||||
CASH FLOWS FROM INVESTING ACTIVITIES | |||||||
Purchase of property and equipment | (2,930,185 | ) | (11,711,269 | ) | |||
Proceeds from sale of property and equipment | 15,000 | — | |||||
Net cash (used in) investing activities | (2,915,185 | ) | (11,711,269 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES | |||||||
Proceeds from long-term borrowings | 50,050,000 | 53,800,000 | |||||
Payments on long-term borrowings | (42,650,000 | ) | (42,900,000 | ) | |||
Member distributions | — | (1,051,225 | ) | ||||
Net cash provided by financing activities | 7,400,000 | 9,848,775 | |||||
Net (decrease) in cash and cash equivalents | (481,554 | ) | (243,854 | ) | |||
CASH AND CASH EQUIVALENTS | |||||||
Beginning | 668,456 | 690,513 | |||||
Ending | $ | 186,902 | $ | 446,659 | |||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW | |||||||
INFORMATION, cash paid for interest, including capitalized interest for 2019 of $304,947 and 2018 of $360,117 | $ | 839,649 | $ | 312,488 | |||
SUPPLEMENTAL DISCLOSURES OF NONCASH | |||||||
INVESTING AND FINANCING ACTIVITIES | |||||||
Construction in progress included in accounts payable | $ | 26,907 | $ | 308,020 | |||
Construction in progress included in accrued expenses | $ | — | 40,439 | ||||
Construction in progress converted to note receivable | $ | 4,080,000 | $ | — |
See Notes to Unaudited Financial Statements.
6
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
_____________________________________________________________________________________________________
Note 1. Nature of Business and Significant Accounting Policies
Principal business activity: Lincolnway Energy, LLC (the "Company"), located in Nevada, Iowa, was formed in May 2004 to build and operate a 50 million gallon annual production dry mill corn-based ethanol plant. The Company began making sales on May 30, 2006 and became operational during the quarter ended June 30, 2006. The Company is directly influenced by commodity markets and the agricultural and energy industries and, accordingly, its results of operations and financial condition may be significantly affected by cyclical market trends and the regulatory, political and economic conditions in these industries.
Basis of presentation and other information: The balance sheet as of September 30, 2018 was derived from the Company's audited balance sheet as of that date. The accompanying financial statements as of June 30, 2019 and for the three and nine months ended June 30, 2019 and 2018 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods. These unaudited financial statements and notes should be read in conjunction with the audited financial statements and notes thereto, for the year ended September 30, 2018 contained in the Company's Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire year.
Use of estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Although the Company maintains its cash accounts in one bank, the Company believes it is not exposed to any significant credit risk on cash and cash equivalents.
Trade accounts receivable: Trade accounts receivable are recorded at original invoice amounts less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering customers financial condition, credit history and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of receivables written off are recorded when received. A receivable is considered past due if any portion of the receivable is outstanding more than 90 days. There was no allowance for doubtful accounts balance as of June 30, 2019 and September 30, 2018.
Note receivable: On March 28, 2019, the Company recorded a note receivable totaling $4,080,000 for a component of the construction in progress (the dryer) that failed to meet required specifications. The vendor issued a promissory note to the Company, which is personally guaranteed by principals of the vendor. The full amount of the note receivable plus interest is currently due and payable. During the three months ended June 30, 2019 management determined based on communication from the vendor and lack of payment that the note receivable, including interest of $60,809, should be fully reserved at June 30, 2019. Bad debt expense of $4,385,009 and none was recorded during the three and nine months ended June 30, 2019 and 2018, respectively.
Inventories: Inventories are stated at the lower of net realizable value or actual cost using the first-in, first-out method. In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation. As of June 30, 2019 and September 30, 2018, the Company recognized a reserve and resulting loss of approximately $180,000 and $280,000 respectively, for a lower of net realizable value or cost inventory adjustment due to low market prices for ethanol.
Derivative financial instruments: The Company periodically enters into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. The Company does not typically enter into derivative instruments other than for hedging purposes. All the derivative contracts are recognized on the balance sheet at their fair market value. Although the Company believes its derivative positions are economic hedges, none have been designated as a hedge for accounting purposes. Accordingly, any realized or unrealized gain or loss related to corn and natural gas derivatives is recorded in the statement of operations as a component of cost of goods sold. Any realized or unrealized gain or loss related to ethanol derivative instruments is recorded in the statement of operations as a component of revenue. The Company reports all contracts with the same counter party on a net basis on the balance sheet. Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales”, and therefore are not marked to market in the Company’s financial statements. Forward contracts with delivery dates with 30 days that can be reasonably estimated are subject
7
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
to a lower of cost or net realizable value assessment. The Company recognized a reserve and resulting accrued loss on purchase commitments of approximately $547,000 and $366,000 as of June 30, 2019 and September 30, 2018, respectively.
Revenue recognition: The Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), in the first quarter of fiscal year 2019, using the modified retrospective method. Topic 606 requires the Company to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company generally recognizes revenue at a point and time. The implementation of the new standard did not result in any changes to the measurement or recognition of revenue for prior periods, however additional disclosures have been added in accordance with the ASU.
The following is a description of principal activities from which we generate revenue. Revenues from contracts with customers are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those goods or services.
• | sales of ethanol |
• | sales of distillers grains |
• | sales of corn oil |
Shipping costs incurred by the Company in the sale of ethanol, distiller grains and corn oil are not specifically identifiable and as a result, are recorded based on the net selling price. Railcar lease costs incurred by the Company in the sale of its products are included in the cost of goods sold.
Deferred revenue: Deferred revenue represents fees received under a service agreement in advance of services being performed. The related revenue was deferred and recognized as the services are performed over the 10 year agreement. On December 17, 2018, the Company entered into a settlement agreement in connection with the early termination of the contract. The settlement totaled approximately $3,000,000 and is included in other income and the remaining deferred revenue of approximately $420,000 was recognized during the nine months ended June 30, 2019.
Income taxes: The Company is organized as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, the Company’s earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements.
Earnings per unit: Basic and diluted net income (loss) per unit have been computed on the basis of the weighted average number of units outstanding during each period presented.
Recently Issued Accounting Pronouncements: In February 2016, FASB issued ASU No. 2016-2 "Leases" ("ASU 2016-02"). ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for all leases greater than one year in duration and classified as operating leases under previous GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and for interim periods within that fiscal year. Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): (1) a lease liability, which is a lessee's obligation to make lease payments arising from the lease, measured on a discounted cash flow basis; and (2) a "right of use" asset, which is an asset that represents the lessee's right to use the specified asset for the lease term. The Company will not implement ASU 2016-02 until October 2019, when fiscal year 2020 starts. The Company is evaluating the impact of the new standard on the financial statements but expects that upon adoption of this accounting standard, right of use assets and lease obligations recognized on the balance sheet will be material.
8
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Note 2. Revenues
Components of revenues are as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||
June 30, 2019 | June 30, 2018 | June 30, 2019 | June 30, 2018 | ||||||||||||
Ethanol, net of hedging gain (loss) | $ | 21,006,222 | $ | 20,779,432 | $ | 54,649,341 | $ | 57,905,465 | |||||||
Distillers Grains | 3,761,379 | 4,424,605 | 11,253,448 | 12,859,885 | |||||||||||
Other | 1,720,712 | 1,896,849 | 5,290,537 | 5,594,318 | |||||||||||
Total | $ | 26,488,313 | $ | 27,100,886 | $ | 71,193,326 | $ | 76,359,668 |
Note 3. Inventories
Inventories consist of the following:
June 30, 2019 | September 30, 2018 | ||||||
Raw materials, including corn, chemicals and supplies | $ | 3,726,953 | $ | 3,297,104 | |||
Work in process | 978,972 | 794,844 | |||||
Ethanol and distillers grains | 809,256 | 464,755 | |||||
Total | $ | 5,515,181 | $ | 4,556,703 |
Note 4. Revolving Credit Loan
The Company entered into a Revolving Credit Promissory Note dated June 23, 2019 which provides for loans of not to exceed $4,000,000 at any time outstanding through January 1, 2020, subject to annual renewal. Interest will accrue at a variable interest rate (adjusting on a weekly basis) based upon the one-month LIBOR index rate plus 3.75% (2.40% as of June 30, 2019).
The Company will also pay a commitment fee on the average daily unused portion of the loan at the rate of .25% per annum, payable monthly. The loan is secured by substantially all assets of the Company and subject to certain financial and nonfinancial covenants as defined in the master loan agreement. There was no outstanding balance on the revolving credit loan as of June 30, 2019 and September 30, 2018.
Note 5. Long-Term Debt
The Company has a revolving term loan, with a bank, available for up to $25,000,000. Borrowings will be reduced by $5,000,000 every year starting October 20, 2020 until October 1, 2024 when the loan expires. The Company will pay interest on the unpaid balance at a variable interest rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate (2.40% as of June 30, 2019) plus 3.75%. The Company also pays a commitment fee on the average daily unused portion of the loan at the rate of .50% annum, payable monthly. The loan is secured by substantially all assets of the Company and subject to certain financial and nonfinancial covenants as defined in the master agreement. There were outstanding borrowings of $22,600,000 and $15,200,000, respectively, on the revolving term loan at June 30, 2019 and September 30, 2018. Aggregate maturities of long term debt as of June 30, 2019 are as follows:
9
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Fiscal Year | Amount Due | ||
2019 | $ | 22,600,000 | |
2020 | $0 | ||
2021 | $0 | ||
2022 | $0 | ||
2023 | $0 | ||
Thereafter | $0 | ||
Total | $22,600,000 |
In connection with the revolving term loan, the Company entered into an Amended and Restated Letter of Credit Promissory Note. The maximum amount of the letter of credit commitment is $1,588,275. As of June 30, 2019, the outstanding amount payable by the Company under the Restated Letter of Credit Note was $1,588,275.
Note 6. Liquidity and Going Concern Analysis
The Company has experienced an extended period of depressed margins which has resulted in a significant decrease in working capital and cash over the past several months. In September 2018, the Company was able to obtain covenant waivers from its lender related to covenant compliance and to modify future covenant requirements to allow it to remain in compliance until the margin environment improved. The margin environment did not improve in the ensuing months. As a result, the Company entered into an additional line of credit and amended its covenants in June, 2019. These factors have raised substantial doubt as to the Company’s ability to continue as a going concern for the next 12 months. Management believed these factors to be significant due to a lack of liquidity and uncertainty regarding the Company’s ability to meet its financial obligations without additional financing or equity infusion. Based on this evaluation, the Company has determined compliance over the next 12 month period is not reasonably possible and, as a result, has recognized all debt as current on its financial statements. The Company believes it will be able to work with the bank on future covenant waivers if needed, or get additional equity/financing, however these results cannot be assured.
Note 7. Related-Party Transactions
The Company had the following related-party activity with members during the three and nine months ended June 30, 2019 and 2018:
Corn Commitment: | |||||||||
June 30, 2019 | |||||||||
Corn Forward Purchase Commitment | Basis Corn Commitment (Bushels) | Commitment Through | Amount Due | ||||||
Related Parties | $ | 3,406,557 | 320,000 | April 2020 | $ | 165,148 |
Corn Purchased: | ||||||||||||
Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Nine Months Ended June 30, 2019 | Nine Months Ended June 30, 2018 | |||||||||
Related Parties | $ | 8,781,404 | $ | 11,219,193 | $ | 30,992,085 | $ | 31,140,482 |
10
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Note 8. Commitments and Major Customers
The Company has an agreement with an unrelated entity for marketing, selling and distributing all of the ethanol produced by the Company. Revenues from this entity were $21,006,221 and $54,627,815, respectively, for the three and nine months ended June 30, 2019. Revenues with this entity were $20,776,282 and $57,915,314, respectively for the three and nine months ended June 30, 2018. Trade accounts receivable of $2,266,817 were due from this entity as of June 30, 2019. As of June 30, 2019, the Company had ethanol unpriced sales commitments with this entity of approximately 16.5 million gallons through December 2019.
The Company has an agreement with an unrelated entity for marketing, selling and distributing all of the distillers grains produced by the Company. Revenues from this entity including both distillers grains and corn oil were $3,761,379 and $11,253,448, respectively, for the three and nine months ended June 30, 2019. Revenues with this entity were $4,479,177 and $12,971,145, respectively, for the three and nine months ended June 30, 2018. The Company sells corn oil to this entity as a third party broker independent of its agreement with the entity relating to distillers grain sales. Trade accounts receivable of $212,976 were due from this entity as of June 30, 2019. The Company had distillers grain sales commitments with this entity of approximately 4,600 tons, for a total sales commitment of approximately $583,250.
As of June 30, 2019, the Company had purchase commitments for corn forward contracts with various unrelated parties, totaling approximately $6.5 million. These contracts mature at various dates through June 2020. The Company also had basis contract commitments with unrelated parties to purchase 142,500 bushels of corn. These contracts mature at various dates through July 2019.
The Company has an agreement with an unrelated party for the transportation of natural gas to the Company's ethanol plant. Under the agreement, the Company is committed to future monthly usage fees totaling approximately $3.6 million over the 10 year term which commenced in November 2014. The Company assigned an irrevocable standby letter of credit to the counter-party to stand as security for the Company's obligation under the agreement maturing May 2021. The letter of credit will be reduced over time as the Company makes payments under the agreement. At June 30, 2019, the remaining commitment was approximately $1.5 million.
As of June 30, 2019, the Company had purchase commitments for natural gas basis contracts with an unrelated party totaling 312,800 MMBtu's maturing at various dates through December 2019.
Note 9. Risk Management
The Company's activities expose it to a variety of market risks, including the effects of changes in commodity prices. These financial exposures are monitored and managed by the Company as an integral part of its overall risk management program. The Company's risk management program focuses on the unpredictability of commodity markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results.
The Company maintains a risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by market fluctuations. The Company's specific goal is to protect the Company from large moves in the commodity costs.
To reduce price risk caused by market fluctuations, the Company generally follows a policy of using exchange-traded futures and options contracts to minimize its net position of merchandisable agricultural commodity inventories and forward purchase and sale contracts. Exchange traded futures and options contracts are designated as non-hedge derivatives and are valued at market price with changes in market price recorded in operating income through cost of goods sold for corn derivatives and through revenue for ethanol derivatives. The Company treats all contracts with the same counterparty on a net basis on the balance sheet.
Derivatives not designated as hedging instruments are as follows:
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Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
June 30, 2019 | September 30, 2018 | ||||||
Derivative assets - corn contracts | $ | 285,763 | $ | 819,613 | |||
Derivative assets - ethanol contracts | — | 2,640 | |||||
Derivative liabilities - corn contracts | (438,700 | ) | (813 | ) | |||
Cash held by (due to) broker | 1,253,126 | (266,313 | ) | ||||
Total | $ | 1,100,189 | $ | 555,127 |
The effects on operating income from derivative activities are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, 2019 | June 30, 2018 | June 30, 2019 | June 30, 2018 | |||||||||||||
Gains (losses) in revenues due to derivatives related to ethanol sales: | ||||||||||||||||
Realized (loss) | $ | — | $ | 11,781 | $ | 21,525 | $ | (9,849 | ) | |||||||
Unrealized (loss) | — | (8,631 | ) | — | — | |||||||||||
Total effect on revenues | — | 3,150 | 21,525 | (9,849 | ) | |||||||||||
Gains (losses) in cost of goods sold due to derivatives related to corn costs: | ||||||||||||||||
Realized gain (loss) | (444,267 | ) | 317,981 | 327,033 | 738,706 | |||||||||||
Unrealized gain (loss) | (561,425 | ) | 1,050,763 | (971,738 | ) | 404,275 | ||||||||||
Total effect on corn cost | (1,005,692 | ) | 1,368,744 | (644,705 | ) | 1,142,981 | ||||||||||
Gains (loss) in cost of goods sold due to derivatives related to natural gas costs: | ||||||||||||||||
Realized gain | — | 17,820 | 13,660 | 48,759 | ||||||||||||
Unrealized gain (loss) | — | (5,580 | ) | 3,460 | 8,710 | |||||||||||
Total effect on natural gas cost | — | 12,240 | 17,120 | 57,469 | ||||||||||||
Total effect on cost of goods sold | (1,005,692 | ) | 1,380,984 | (627,585 | ) | 1,200,450 | ||||||||||
Total gain (loss) due to derivative activities | $ | (1,005,692 | ) | $ | 1,384,134 | $ | (606,060 | ) | $ | 1,190,601 |
Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales”, and therefore are not marked to market in the Company's financial statements but are subject to a lower of cost or market assessment.
Note 10 Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according
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Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 - | Valuations for assets and liabilities traded in active markets from readily available pricing sources for market transactions involving identical assets or liabilities. |
Level 2 - | Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities. |
Level 3 - | Valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. |
A description of the valuation methodologies used for instruments measured at fair value, including the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company's financial assets and financial liabilities carried at fair value.
Derivative financial instruments: Commodity futures and exchange-traded commodity options contracts are reported at fair value utilizing Level 1 inputs. For these contracts, the Company obtains 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 CME and NYMEX markets. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the over-the-counter markets.
The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2019 and September 30, 2018, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
June 30, 2019 | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets, derivative financial instruments | $ | 285,763 | $ | 285,763 | $ | — | $ | — | ||||||||
Liabilities, derivative financial instruments | $ | 438,700 | $ | 438,700 | $ | — | $ | — | ||||||||
September 30, 2018 | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets, derivative financial instruments | $ | 822,253 | $ | 822,253 | $ | — | $ | — | ||||||||
Liabilities, derivative financial instruments | $ | 813 | $ | 813 | $ | — | $ | — |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
General
The following discussion and analysis provides information which management of Lincolnway Energy, LLC (the “Company”, “we,” “us,” and “our”) believes is relevant to an assessment and understanding of our financial condition and results of operations. This discussion should be read in conjunction with the financial statements included herewith and notes to the financial statements and our Annual Report on Form 10-K for the year ended September 30, 2018 ("Fiscal 2018") including the financial statements, accompanying notes and the risk factors contained herein.
Cautionary Statement on Forward-Looking Statements
Various discussions and statements in this quarterly report are or contain forward-looking statements that express our current beliefs, forecasts, projections and predictions about future events. All statements other than statements of historical fact are
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forward-looking statements, and include statements with respect to financial results and condition; anticipated trends in business, revenues, net income, net profits or net losses; projections concerning ethanol prices, distillers grain prices, corn prices, gas prices, operations, capital needs and cash flow; investment, business, growth, joint venture, expansion, acquisition and divestiture opportunities and strategies; management's plans or intentions for the future; competitive position or circumstances; and other forecasts, projections, predictions and statements of expectation. Words such as "expects," "anticipates," "estimates," "plans," "may," "will," "contemplates," "forecasts," "strategy," "future," "potential," "predicts," "projects," "prospects," "possible," "continue," "hopes," "intends," "believes," "seeks," "should," "could," "thinks," "objectives" and other similar expressions or variations of those words or those types of words help identify forward-looking statements.
Actual future performance, outcomes and results may differ materially from those suggested by or expressed in forward-looking statements as a result of numerous and varied factors, risks and uncertainties, some that are known and some that are not, and many of which are beyond the control of the Company and its management. We cannot guarantee our future results, performance or business conditions, and strong or undue reliance must not be placed on any forward-looking statements, which speak only as of the date of this report. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by the Company include:
• | Changes in the availability and price of corn and natural gas; |
• | Negative impacts resulting from the reduction in the renewable fuel volume requirements under the Renewable Fuel Standard issued by the Environmental Protection Agency; |
• | Changes in federal mandates relating to the blending of ethanol with gasoline, including, without limitation reductions to, or the elimination of, the Renewable Fuel Standard volume obligations; |
• | The inability to comply with the covenants and other requirements of Lincolnway Energy's various loan agreements; |
• | Negative impacts that hedging activities may have on Lincolnway Energy's operations or financial condition; |
• | Decreases in the market prices of ethanol and distillers grains; |
• | Ethanol supply exceeding demand; |
• | Changes in the environmental regulations that apply to the Lincolnway Energy plant operations; |
• | Changes in plant production capacity or technical difficulties in operating the plant; |
• | Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries; |
• | Changes in other federal or state laws and regulations relating to the production and use of ethanol; |
• | Changes and advances in ethanol production technology; |
• | Competition from larger producers as well as competition from alternative fuel additives; |
• | Changes in interest rates and lending conditions of the loan covenants in the Company loan agreements; |
• | Volatile commodity and financial markets; |
• | Decreases in export demand due to the imposition of duties and tariffs by foreign governments on ethanol and distillers grains produced in the United States; |
• | Disruptions, failures; security breaches or other cybersecurity threats relating to or impacting our information technology infrastructure; and |
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• | Trade actions by the Federal Government, particularly those affecting the agriculture sector and related industries. |
These forward-looking statements are based on management’s estimates, projections and assumptions as of the date hereof and include the assumptions that underlie such statements. Our actual results or actions could and likely will differ materially from those anticipated in the forward-looking statements for many reasons, including the reasons described in this report. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in this report and in the section titled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2018 and in our other prior Securities and Exchange Commission filings. These and many other factors could affect our future financial condition and operating results and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by the Company or on its behalf. We undertake no obligation to revise or update any forward-looking statements. The forward-looking statements contained in this report are included in the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
General Overview
Lincolnway Energy is an Iowa limited liability company that operates a dry mill, natural gas fired ethanol plant located in Nevada, Iowa. We have been processing corn into fuel grade ethanol and distillers grains at the ethanol plant since May 22, 2006. Our ethanol plant has a nameplate production capacity of 50,000,000 gallons of ethanol per year.
All of the ethanol we produce is marketed by Eco-Energy, LLC (“Eco-Energy”) and all of our distillers grains are marketed by Gavilon Ingredients, LLC (“Gavilon”). Our revenues are derived primarily from the sale of our ethanol and distillers grains.
We also extract corn oil from the syrup generated in the production of ethanol. We market and distribute all of our corn oil directly to end users and third party brokers within the domestic market.
Air Products and Chemicals, Inc., formerly known as EPCO Carbon Dioxide Products, Inc. (“Air Products”), has a plant located on the Company’s site that purchases the Company's carbon dioxide gas that is produced as part of the fermentation process and converts that raw carbon dioxide gas into liquid carbon dioxide.
We expect to fund our operations during the next twelve months using cash flows from continuing operations and the revolving term loan that is available. If the current ethanol economics continue, the Company may seek capital in form of equity or debt to meet our operating requirements.
Executive Overview of Ethanol Industry
The ethanol industry is experiencing the lowest margin environment seen in the past decade primarily due to the fact that the substantial oversupply of ethanol which is exceeding demand and markets are reacting accordingly by disincentivizing production. Although our current plant operational efficiencies are strong, in order to drive positive results in a negative margin environment, we need to continue to enhance our operational efficiencies. As a result, our management team and Board of Directors continue to explore opportunities to improve our plant's operational efficiencies. We are evaluating various opportunities to add value to our production process by diversifying into high protein feed along with measures to reduce the energy we use as part of the production process and to reduce the carbon index of the ethanol we produce.
As stated in Note 1, the Company wrote off the Dyer note receivable for approximately $4.4 million. We remain committed to the development of a new high quality species specific animal feed which we have branded as PureStream™ protein as we seek alternatives for drying this high quality feed product. We currently intend to market this new product to the growing swine and poultry markets in Iowa. When compared to traditional distillers grains, our new PureStream™ protein animal feed products are expected to be higher in crude protein and richer in the essential amino acids that drive growth in swine and poultry. We entered into agreements with third parties for the installation of a grains drying and cooling system as part of the development of the PureStream™ protein production process; however, as is common when installing new production equipment, we have faced multiple challenges with the installation and implementation of such systems. We are currently evaluating our options with respect to these agreements and potential alternatives in order to complete the development of the necessary enhancements required to produce the PureStream™ protein animal feed.
Part of the evaluation process for any of these opportunities and efficiency improvements includes a review of the relative costs and benefits of any proposed process enhancements, including any necessary capital investments in technology or equipment and the potential return on such investment. These process enhancements require significant financial investments but the goal is to
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implement processes and technologies that will provide a positive return that will improve the revenue and income prospects of the Company.
Renewable Fuel Standard
The ethanol industry is dependent on the Federal Renewable Fuels Standard (the “RFS”), a federal ethanol support and economic incentive which mandates ethanol use, and the RFS continues to be a driving factor in the growth of ethanol usage. The RFS requires that in each year a certain amount of renewable fuels must be used in the United States. The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective. The U.S. Environmental Protection Agency (the “EPA”) is responsible for revising and implementing regulations to ensure that transportation fuel sold in the United States contains a minimum volume of renewable fuel.
The RFS usage requirements increase incrementally each year through 2022 when the mandate requires that the United States use 36 billion gallons of renewable fuels. Starting in 2009, the RFS required that a portion of the RFS must be met by certain “advanced” renewable fuels. These advanced renewable fuels include ethanol that is not made from corn, such as cellulosic ethanol and biomass based biodiesel. The use of these advanced renewable fuels increases each year as a percentage of the total renewable fuels required to be used in the United States.
Annually, the EPA is required to pass a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligation. On November 30, 2018, the EPA issued the final rule for 2019 which set the annual volume requirement for renewable fuel at 19.92 billion gallons of renewable fuels per year (the "Final 2019 Rule"). On July 5, 2019, the EPA issued the proposed rule that sets the 2020 annual volume requirements for renewable fuel at 20.04 billion gallons per year and maintained the number of gallons that may be met by conventional renewable fuels such as corn based ethanol at 15.0 billion gallons (the "Proposed 2020 Rule"). Although the volume requirements set forth in the Final 2019 Rule are slightly higher than the 2018 requirements and the proposed 2019 Rule is slightly higher than the Final 2019 Rule, the volume requirements under both the Final 2019 Rule and the proposed 2020 Rule are still significantly below the 26 billion gallons and 28 billion gallons statutory mandates for 2019 and 2020, respectively, with significant reductions in the volume requirements for advanced biofuels as well. However, the Final 2019 Rule maintains the number of gallons which may be met by conventional renewable fuels such as corn-based ethanol at 15.0 billion gallons.
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. The Final 2018 Rule represented the first year the total proposed volume requirements were more than 20% below statutory levels. In response, the EPA Administrator directed his staff to initiate the required technical analysis to perform any future reset consistent with the reset rules. The Final 2019 Rule is approximately 29% below the statutory levels representing the second consecutive year of reductions of more than 20% below the statutory mandates triggering the mandatory reset under the RFS. Therefore, the EPA is now statutorily required to modify the statutory volumes through 2022 within one year of the trigger event, based on the same factors used to set the volume requirements post-2022. These factors include environmental impact, domestic energy security, expected production, infrastructure impact, consumer costs, job creation, price of agricultural commodities, food prices, and rural economic development.
In October 2018, the Trump administration released timelines for certain EPA rulemaking initiatives relating to the RFS including the “reset” of the statutory blending targets. The EPA is expected to propose rules modifying the applicable volume targets for cellulosic biofuel, advanced biofuel, and total renewable fuel for the years 2020-2022. The proposed rules are also expected to include proposed diesel renewable volume obligations for 2021 and 2022. The timetable for the consideration of the proposed rule is expected to overlap with the annual standard-setting rulemaking, therefore, it is expected that the proposed rule will also include the applicable renewable volume obligations for 2020.
Federal mandates supporting the use of renewable fuels like the RFS are a significant driver of ethanol demand in the U.S. Ethanol policies are influenced by environmental concerns, diversifying our fuel supply, and an interest in reducing the country’s dependence on foreign oil. Consumer acceptance of flex-fuel vehicles and higher ethanol blends of ethanol in non-flex-fuel vehicles may be necessary before ethanol can achieve significant growth in U.S. market share. Another important factor is a waiver in the Clean Air Act, known as the One-Pound Waiver, which allows E10 to be sold year-round, even though it exceeds the Reid Vapor Pressure limitation of nine pounds per square inch.
On April 12, 2018, as part of a series of meetings focused on RIN prices and E15 year-round sales involving President Trump, Senators, key federal agency and industry leaders, President Trump indicated that EPA would be moving forward to authorize year-round sales of E15 by rulemaking designed to remove arbitrary barriers to the year-round use of E15 that currently inhibit
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sales of E15 in certain markets during summer driving months and extend the One-Pound Waiver to E15 so that E15 may be sold throughout the year without disruption.
Despite the recent actions by the Trump administration relating to E15, there continues to be uncertainty regarding the future of the RFS as a result of the significant number of small refiner waivers granted. Under the RFS, the EPA assigns individual refiners, blenders, and importers the volume of renewable fuels they are obligated to use based on their percentage of total domestic transportation fuel sales. Obligated parties use RINs to show compliance with RFS-mandated volumes. RINs are attached to renewable fuels by ethanol 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.
The EPA can, in consultation with the Department of Energy, waive the obligation for individual smaller refineries that are suffering “disproportionate economic hardship” due to compliance with the RFS. To qualify, for this “small refinery waiver,” the refineries must be under total throughput of 75,000 barrels per day and state their case for an exemption in an application to the EPA each year. As of March 2019, the EPA reported waiving the obligation for 19 of 20 applicants for compliance year 2016, totaling 790 million gallons, and 35 of 37 for compliance year 2017 totaling 1.82 billion gallons. This effectively reduces the annual renewable volume obligation for each year by that amount as the waivers exempt the obligating parties from meeting the RFS blending targets and the waived gallons are not reallocated to other obligated parties at this time. The resulting surplus of RINs in the market has brought values down significantly, from the mid $0.80 range early in the year to under $0.20. Since the RIN value helps to make higher blends of ethanol more cost effective, lower RIN values could negatively impact retailer and consumer adoption of E15 and higher blends. As of June 30, 2019, there are approximately 40 waiver applications pending for compliance year 2018.
The joint impact of large increases in small refiner waivers granted by the EPA and the substantial reduction in U.S. ethanol exports to China has had a very negative impact on ethanol D6 RIN prices. RIN prices have fallen by over 60%, largely removing a powerful blending incentive from the ethanol marketplace. The reduction in RIN prices can also have an adverse impact on ethanol prices. If the EPA continues to grant discretionary waivers and RIN prices continue to fall, it could negatively affect ethanol prices.
Biofuels groups have filed a lawsuit in the U.S. Federal District Court for the D.C. Circuit, challenging the Final 2019 Rule over the EPA’s failure to address small refinery exemptions in the rulemaking. This is the first RFS rulemaking since the expanded use of the exemptions came to light, however the EPA has refused to cap the number of waivers it grants or how it accounts for the retroactive waivers in its percentage standard calculations. The EPA has a statutory mandate to ensure the volume requirements are met, which are achieved by setting the percentage standards for obligated parties. The current approach accomplishes the opposite. Even if all the obligated parties comply with their respective percentage obligations for 2019, the nation’s overall supply of renewable fuel will not meet the total volume requirements set by the EPA. This undermines Congressional intent of demand pressure creation and an increased consumption of renewable fuels. Biofuels groups argue the EPA must therefore adjust its percentage standard calculations to make up for past retroactive waivers and adjust the standards to account for any waivers it reasonably expects to grant in the future.
If the EPA’s decisions to reduce the volume requirements under the RFS statutory mandates are allowed to stand, if the volume requirements are further reduced or if the EPA continues to grant waivers to small refiners, the market price and demand for ethanol would be adversely effective which would negatively impact our financial performance.
On May 18, 2018, the Advanced Biofuel Association initiated a legal challenge to the EPA’s process for granting exemptions from compliance under the RFS to small refineries. In its petition, the Advanced Biofuel Association seeks judicial review of 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.
Additionally, on May 29, 2018, the National Corn Growers Association, National Farmers Union and the Renewable Fuels Association filed a petition challenging the EPA’s grant of waivers to three specific refineries seeking that the court reject the waivers granted to the three as an abuse of EPA authority. These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate renewable volume obligations (“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.
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 the EPA seeks a broader, forward-looking remedy to account for the collective
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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.
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 the Final 2019 Rule.
Although the maintenance of the 15 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the Final 2018 Rule and the Final 2019 Rule together with the recent actions by the Trump administration relating to permitting the year round sale of E15 signals support from the EPA and the Trump administration for domestic ethanol production, there is still significant uncertainty about the level of support for the RFS within the Trump administration. The Trump administration could still elect to materially modify, repeal or otherwise invalidate the RFS and it is unclear what regulatory framework and renewable volume requirements, if any, will emerge as a result of any such reforms; however, any such reform could adversely affect the demand and price for ethanol and the Company’s profitability.
Executive Summary
Highlights for the three months ended June 30, 2019, are as follows:
•Total revenues decreased 2.3%, or $612 thousand, compared to the 2018 comparable period.
•Total cost of goods sold increased 7.3%, or $1.9 million, compared to the 2018 comparable period.
• | Net (loss) was approximately ($7.4) million, which was an increase of $7.0 million when compared to the net profit of $.3 million for the 2018 comparable period. A significant component of the net loss for this period was a one-time bad debt expense of approximately $4.4 million as further described in Note 1. |
Results of Operations
The following table shows the results of operations and the percentages of revenues, cost of goods sold, operating expenses and other items to total revenues in our statement of operations for the three and nine months ended June 30, 2019 and 2018 (dollars in thousands):
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||||||||||||||
Income Statement Data | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||
Revenue | $26,488 | 100.0 | % | $27,101 | 100.0 | % | $71,193 | 100.0 | % | $76,360 | 100.0 | % | ||||||||||||||||
Cost of goods sold | 28,137 | 106.2 | % | 26,233 | 96.8 | % | 77,337 | 108.6 | % | 75,506 | 98.9 | % | ||||||||||||||||
Gross profit (loss) | (1,649 | ) | (6.2 | )% | 868 | 3.2 | % | (6,144 | ) | (8.6 | )% | 854 | 1.1 | % | ||||||||||||||
General and administrative expenses | 1,028 | 3.9 | % | 736 | 2.7 | % | 2,773 | 3.9 | % | 2,425 | 3.2 | % | ||||||||||||||||
Bad debt expense | 4,385 | 17.0 | % | — | — | % | 4,385 | 6.2 | % | — | — | % | ||||||||||||||||
Operating income (loss) | (7,062 | ) | (26.6 | )% | 132 | 0.5 | % | (13,302 | ) | (18.7 | )% | (1,611 | ) | (2.1 | )% | |||||||||||||
Other income (expense), net | (333 | ) | (1.3 | )% | 191 | 0.7 | % | 2,640 | 3.7 | % | 593 | 0.8 | % | |||||||||||||||
Net income (loss) | $ | (7,395 | ) | (27.9 | )% | $ | 323 | 1.2 | % | $ | (10,662 | ) | (15.0 | )% | $ | (1,018 | ) | (1.3 | )% |
Results of Operations for the Three Months Ended June 30, 2019 as Compared to the Three Months Ended June 30, 2018
Revenues. Total revenues decreased by 2.3% for the three months ended June 30, 2019 as compared to the three months ended June 30, 2018. Ethanol sales increased by 1.1% and sales from co-products decreased by 13.3% for the three months ended June 30, 2019 as
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compared to the three months ended June 30, 2018. The change in ethanol revenue was a result of a 1.5% decrease in the price per gallon received combined with a 2.7% increase in sales volume for the three months ended June 30, 2019, when compared to the three months ended June 30, 2018. Ethanol prices decreased due to relatively high inventories in the domestic market coupled with ongoing record domestic production of ethanol. In addition, ethanol prices have been negatively impacted by international trade disputes with foreign countries, including, China, Mexico, and the European Union, and the institution of tariffs have had an adverse effect on export demand from certain countries. Ethanol sales volume decreased as flooding issues caused bottlenecks with railcar returns, forcing the Company to build inventories instead of shipping product. Ethanol revenue for the three months ended June 30, 2019 was not impacted by derivatives compared to a $3,150 net gain for the three months ended June 30, 2018.
Sales from co-products decreased by 13.3% for the three months ended June 30, 2019 from the three months ended June 30, 2018. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. The change in co-product sales was primarily due to a $.7 million decrease in distillers grain revenue. Distillers grain sales volume decreased as problems with railcar returns forced the company to build inventories. Improvements in ethanol yields also decreased distillers grain production as more corn in the process is converted to ethanol.
Cost of goods sold. Cost of goods sold increased by 7.3% or approximately $1.9 million, for the three months ended June 30, 2019 from the three months ended June 30, 2018. The increase was primarily due to the increase in of the corn futures positions held as a hedge against the physical corn contracted to be processed. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas costs, electricity, production labor, repairs and maintenance, and depreciation.
Corn costs, including hedging, decreased $1.6 million, or 8.7%, for the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The decrease was due to hedging and reduced bushels consumed with improved production yields. For the three months ended June 30, 2019 corn costs included a $1.0 million net loss for derivatives relating to corn costs, compared to a $1.4 million net gain in the same quarter for the prior year. Corn costs represented 69.2% of cost of goods sold for the three months ended June 30, 2019, compared to 67.7% for the three months ended June 30, 2018.
General and administrative costs increased by $.3 million or 39.7% for the three months ended June 30, 2019 from the three months ended March 31, 2018. The increase is due to increased payroll and legal fees in transition of management personnel and general legal work assisting with the new company management.
Results of Operations for the Nine Months Ended June 30, 2019 as Compared to the Nine Months Ended June 30, 2018
Revenues. Revenues decreased by $5.1 million, or 6.8%, for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. Ethanol sales decreased $3.3 million, or 5.6%, for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. The change in ethanol revenue was a result of a 4.8% decrease in the price per gallon received as well as a 0.87% decrease in sales volume for the nine months ended June 30, 2019, when compared to the nine months ended June 30, 2018. Ethanol prices decreased due to relatively high inventories in the domestic market coupled with ongoing record production of ethanol. Sales volume decreased 0.87% as production run rates remained stable with stable yields, efficiencies and profitability.
Sales from co-products decreased by 10.4%, or $1.9 million, for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. Co-product revenue decreased primarily due to a 12.5% decrease in combined distillers grains revenue for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. Distillers grain revenues decreased due to relatively high inventories in the domestic market coupled with ongoing record production of ethanol.
Cost of goods sold. Cost of goods sold increased $1.8 million for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. The increase was primarily due to increased corn hedging costs and repairs and maintenance. Changes in other categories were fairly small and considered immaterial. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas, electricity, production labor, repairs and maintenance, and depreciation.
Corn costs, including hedging, increased by $2.5 million, or 4.9%, for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. The increase was due to a 5% increase in corn bushels priced while the production process decreased corn consumed by 572,541 bushels or 4%. For the nine months ended June 30, 2019, corn costs included a $.6 million net loss for derivatives relating to future contracts, compared to a $1.1 million loss for the nine months ended June 30, 2018. Corn costs represented 70.2% of cost of goods sold for the nine months ended June 30, 2019, compared to 68.7% for the nine months ended June 30, 2018.
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Repairs and maintenance decreased by $1.2 million or 32% for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. The decrease was due to an increased focus on preventative maintenance to avoid large costly repairs as well as a focus on cost control.
Depreciation expense increased approximately $.9 million, or 36.0% for the nine months ended June 30, 2019 from the nine months ended June 30, 2018. Depreciation was accelerated on the old regenerative thermal oxidizer (RTO) to adjust the asset to its revised useful life before it was replaced in December 2018 and thusly resumed to normalized depreciation rate.
General and administrative costs increased by $308 thousand or 12.5% for the nine months ended June, 2019 from the nine months ended June 30, 2018. The increase is due to additional payroll related to management transition and legal fees related to performance concerns regarding newly installed equipment.
A significant component of the net loss for this period was a one-time bad debt expense of $4,385,009 as further described in Note 1.
Industry Factors that May Affect Future Operating Results
During the three months ended June 30, 2019, the ethanol industry experienced historically poor ethanol production margins as a result of a combination of factors including the following:
• | Corn prices were very strong during the three months ended June 30, 2019. The price per bushel rallied over $1.00 per bushel in the 5-week period from May 13 to June 17. The market was reacting to the potential impact of extreme wetness during planting in the U.S. corn belt which resulted in the slowest corn planting progress in history. While the worst conditions and slowest progress were reported in the areas east of the Mississippi River, most western corn belt states were also severely impacted. At this time the market has no reliable idea of how many acres were lost as actual planting progress was so far behind on the date of the acreage survey on June 1 as to render it meaningless. In addition to how much corn was able to be planted, there is serious concern regarding how much the late planting dates will impact yield. Various industry and academic studies indicate likely yield reductions on the order of more than 5% regardless of growing season weather. USDA recognized this problem in their June supply and demand report, reducing estimated corn yield down to 166 bushels per acre from the estimate of 176 bushels per acre in the May report. |
• | Domestic ethanol usage was 1% lower than the same six months the year before and net exports for the period were 195 million gallons, or 23% lower. Industry capacity was estimated to have grown by 300-500 million gallons annualized versus the same time period a year ago. While ethanol prices rallied along with corn prices, the rally was relatively anemic due to this enlarged capacity overhang. Despite ongoing economic growth and growing unemployment levels, gasoline demand has failed to improve and ethanol capacity expansion has resulted in lower margin levels than we have experienced at similar stocks/usage levels in the past. |
• | Export sales of U.S. ethanol to foreign consumers have waned as a result of much smaller discounts of U.S. ethanol versus gasoline prices. This has reduced demand from octane buyers. In addition, the trade war has reduced exports to China to virtually nothing. Brazilian tariffs have curtailed demand from that country. And very significantly, a series of good world sugar crops have depressed sugar prices around the globe. This has turned Brazilian sugar mills to producing more ethanol and less sugar. After supplying their domestic markets, the Brazilian producers have ample quantities to move into the export markets and have taken Indian, European and South American business away from U.S. producers. Current trade estimates have U.S. exports falling more than 300 million gallons versus 2018. Additionally, imports of Brazilian ethanol into the U.S. are expected to increase from 40 million gallons to 140 million gallons. China and Brazil had been two of the top importers of U.S. ethanol but political considerations will continue to dominate for the foreseeable future. Even if tariffs were eliminated, demand for U.S. ethanol would likely not improve due to lower Brazilian prices on the international market. |
• | Ethanol no longer trades at a large discount to gasoline which had improved domestic and export demand somewhat, particularly among price opportunistic foreign buyers. As ethanol prices have been pulled up by rising corn prices, its discount to Reformulated gasoline Blend stock for Oxygen Blending (RBOB) has fallen 40 cents in the last quarter. This smaller discount and the EPA engineered reduction in ethanol RINS prices have greatly reduced the attractiveness of higher ethanol blends and have stymied the penetration of E15 blends in the domestic market. While the EPA’s approval of year around blending of E15 promises potentially significant increases in ethanol blending in the future, management believes this is positive for the industry. In the short run, the narrowed spread between ethanol and RBOB prices has greatly weakened the economics of installing blender pumps at service stations. Without significant growth in this vital link in the supply chain, ethanol blending growth will continue to disappoint. |
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• | The EPA’s maintenance in the Final 2019 Rule of the number of gallons which may be met by conventional renewable fuels such as corn-based ethanol at 15.0 billion gallons is a continuance of the status quo. Of much greater importance for domestic ethanol demand is the long awaited approval by the EPA for the sale of E15 blends year round. This theoretically raises the potential demand for ethanol by upwards of 7 billion gallons. Before any of this additional demand can be realized, significant changes must occur in the supply chain, particularly the installation of blender pumps at retail gas stations. In addition, a huge job of consumer education must be accomplished as to what the benefits of higher ethanol blends may be. Given the hostility of the oil industry toward higher ethanol blends, and their control of half of the gas stations in the U.S., this promises to be a long and arduous process. Most importantly for ethanol in the near term, EPA continues to grant extensive small refinery exemptions. Current estimates are that EPA has granted approximately 2.6 billion gallons of such waivers for 2019. This demand impact is immediate and demonstrates the ongoing support of the current administration for the fossil fuel industry and continuing hostility towards the ethanol industry. |
• | With the threats to both export and domestic demand outlined above, one important driving force moving our margins lower during the quarter was stunted demand growth. Year over year quarterly demand increased barely 1%, or 160 million gallons. Of far greater importance was the increase in production capacity. Industry sources estimate capacity expansion of 500 million gallons between debottlenecking and capacity additions at existing plants and the opening of new plants. Management believes that figure to be conservative and that potential supply expansion over the last year could be on the order of 600-700 million gallons. Regardless, the net effect has been a severe contraction of margins. |
We use futures and options strategies on the Chicago Mercantile Exchange to hedge some of the risk involved with changing corn prices, as well as the purchase and physical delivery of corn contracts from area farmers and commercial suppliers. We also incorporate risk management strategies to cover some of the risk involved with changing ethanol and distillers market prices. We continue to monitor the markets and attempt to provide for an adequate supply of corn and protection against rapid price increases for corn and price decreases for ethanol and distillers grains.
Management currently believes that our margins will continue on the defensive for the remainder of the fiscal year ending September 30, 2019 (“Fiscal 2019”). Tightening old crop corn supplies and ethanol production capacity increases should have a positive impact on the market price of corn and a lesser positive impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen in the event that domestic ethanol inventories remain historically high or grow, or if U.S. exports of ethanol decline further. The ethanol industry is currently experiencing growth in production capacity principally through plant optimization and some new construction. The EIA has reported that thus far during 2019, increasing ethanol production rates outpaced domestic E10 gasoline demand and export demand, leading to elevated ethanol inventory levels. According to the EIA, as of December 31, 2018, weekly ending stocks of ethanol were a modest 1% higher than the same time last year but 16% higher than the previous five-year average. With a decrease in net exports and a modest increase in domestic demand during the first 6 months of 2019, ending stocks of ethanol on June 30, 2019 increased to 103% of the ending stocks on June 30, 2018. Although poor corn planting conditions have provided some support for ethanol prices, with the decrease in export demand resulting from the higher domestic ethanol prices, if ethanol and corn prices increase further, this could negatively impact domestic ethanol demand also. The renewable volume obligations and small refiner waivers granted by the EPA also may result in an oversupply of renewable fuel credits which could decrease demand for corn-based ethanol despite the potential demand increase attributable to the E15 ruling. The Final 2019 Rule renewable volume requirements did not include any material growth and as a result, unless additional demand can be generated in foreign or domestic markets, a continued or growing level of current ethanol stocks could adversely impact the price of ethanol.
Our margins have been, and could continue to be, negatively impacted due to the lower prices received for our distillers grains. During the second quarter of our 2018 distillers grains prices did not improve as a result of rising U.S. corn and world soybean meal prices which management believes is attributable to the U.S. planting delays and the resulting declines in acreage and yield expectations. The U.S. is the largest corn producer in the world and a large exporter of soybean meal. In addition to being an animal feed substitute for corn, distillers grains are increasingly considered a protein feed substitute for soybean meal. In the second quarter of 2019 strong corn prices and relatively weak soybean meal prices due to a record South American soybean crop have caused distillers grains prices to fall versus corn, our basic raw material. In addition, hogs, a major demand sector for distillers grains, have experienced a significant reduction in price due to the tariff war with China. Demand and prices for distillers grains may continue to experience decreases in the near term due to lower demand as a result of these lower margins for hog growers and a lesser share of distillers grains in domestic rations. While management believes that the impact of the Chinese imposition of anti-dumping and countervailing duties on distillers grains produced in the U.S. has been largely absorbed into the current market, the softness in U.S. hog and soybean prices relative to corn prices could result in ongoing stagnation in distillers grains prices at low levels. Other countries such as Mexico, Canada and South Korea have increased their imports of distillers grains and management believes that the impact of reduced demand from China has been fully discounted in the market. But weaker U.S. feed demand is not positive for prices.
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The Final 2019 Rule raised the renewable volume requirements for advanced biofuels from the 2018 level of 4.5 billion gallons to 4.9 billion gallons and left biomass-based diesel unchanged at 2.1 billion gallons. This could positively impact the demand for corn oil. U.S. corn oil supplies are expected to grow by approximately 10%. World oilseed supplies are projected to be flat and world oilseed stocks are expected to contract. This suggests corn oil prices may fluctuate modestly. Thus far in 2019 corn oil prices have been very weak relative to corn prices and the relative contribution of corn oil to margins has fallen. Much of this price weakness is attributable to increased uncertainty regarding the biodiesel tax credit. Biodiesel producers have also experienced shrinking margins as fears grow that the tax credit may be reduced and phased out or eliminated altogether. These fears have curtailed corn oil demand. Management sees little potential for increases in corn oil prices until the status of the tax credit is clarified.
Credit and Counterparty Risks
Through our normal business activities, we are subject to significant credit and counterparty risks that arise through normal commercial sales and purchases, including forward commitments to buy and sell, and through various other over-the-counter (OTC) derivative instruments that we utilize to manage risks inherent in our business activities. We define credit and counterparty risk as a potential financial loss due to the failure of a counterparty to honor its obligations. The exposure is measured based upon several factors, including unpaid accounts receivable from counterparties and unrealized gains (losses) from OTC derivative instruments (including forward purchase and sale contracts). Part of our risk management strategy requires that we actively monitor credit and counterparty risk through credit analysis.
Liquidity and Capital Resources
Based on the financial projections prepared by management, we plan to closely monitor existing cash, our current credit facilities, and cash from operations to continue to operate the ethanol plant. The Company may seek capital in form of equity or debt due to the negative results of the ethanol margins to meet our operating requirements. Management is waiting to see how the corn crop develops with the 2019 harvest regarding the future corn supply. Corn prices may continue to increase in price with the uncertain corn production. Working capital (deficit) was approximately $(16.1) million after writing off $4.4 million related to a note receivable and converting $22.6 million of long term liabilities to current liabilities as of June 30, 2019. As referenced in Note 1, on March 28, 2019, the Company recorded a note receivable totaling $4,080,000 for a component of the construction in progress (the dryer) that failed to meet required specifications. The vendor issued a promissory note to the Company, which is personally guaranteed by principals of the vendor. The full amount of the note receivable plus interest was wrote off because there is no guarantee that we will be able to collect all, or any, of the amounts due and payable under such note receivable. The long term debt was converted to current liabilities due to the uncertainties of staying in covenant compliance for debt service coverage at year end. However, management currently projects that liquid working capital will be sufficient based on current cash balances and credit facilities available for the remainder of the fiscal year, but management will continue to monitor our liquidity position on a weekly basis.
Lincolnway is technically in default with its working capital covenant with its lender because of the reclassification of long term debt to current. In addition, based on management's financial projections it is anticipated that the Company will not be in compliance with the debt service coverage covenant at September 30, 2019, the end of our fiscal year. As such, management determined, in accordance with generally accepted accounting principles (GAAP), to reclassify long term debt as current liabilities. Management is currently discussing the working capital covenant and debt service coverage waivers with our lender.
Our financial position and liquidity are, and will continue to be, influenced by a variety of factors, including, without limitation:
• | our ability to generate cash flows from operations; |
• | our ability to meet covenants and/or successfully negotiate a reasonable solution with our current lender to find alternative financing; |
• | the level of our outstanding indebtedness and the interest we are obligated to pay; |
• | our capital expenditure requirements, which consists primarily of plant improvements to improve efficiencies and expenditures for our new PureStream™ protein process; and |
• | our margin maintenance requirements on all commodity trading accounts. |
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The following table summarizes our sources and uses of cash and cash equivalents from the unaudited statement of cash flows for the periods presented:
Nine Months Ended June 30, | ||||||||
(Unaudited) | ||||||||
Cash Flow Data: | 2019 | 2018 | ||||||
Net cash (used in) operating activities | $ | (4,966,369 | ) | $ | 1,618,640 | |||
Net cash (used in) investing activities | (2,915,185 | ) | (11,711,269 | ) | ||||
Net cash provided by financing activities | 7,400,000 | 9,848,775 | ||||||
Net (decrease) in cash and cash equivalents | $ | (481,554 | ) | $ | (243,854 | ) |
Cash Flow (Used in) Operations
For the nine months ended June 30, 2019, net cash used in operating activities increased by $6.6 million when compared to net cash provided by operating activities for the nine months ended June 30, 2018. The decrease in cash used in operating activities is due to net loss and the timing in working capital components.
Cash Flow (Used in) Investing Activities
Cash flows from investing activities reflect the impact of property and equipment acquired for the ethanol plant. Net cash used in investing activities decreased by $8.8 million for the nine months ended June 30, 2019 compared to the nine months ended June 30, 2018. The decrease is due to progress payments on the installation of a grains drying and cooling system in the previous fiscal year.
Cash Flow Provided by Financing Activities
Cash flows from financing activities include transactions and events whereby cash is obtained from, or paid to, depositors, creditors or investors. Net cash provided by financing activities decreased by $2.4 million for the nine months ended June 30, 2019 compared to the nine months ended June 30, 2018. The decrease is due to reduced borrowings on our term revolver in the nine month ended June 30, 2019 compared to borrowings in the nine months ended June 30, 2018. In addition to the distribution paid to members in fiscal year 2018.
Critical Accounting Estimates and Accounting Policies
Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.
Revenue Recognition
Revenue from the sale of our ethanol and distillers grains is recognized at the time title and all risks of ownership transfer to the marketing company. This generally occurs upon the loading of the product. For ethanol, title passes from the Company at the time the product crosses the loading flange into either a railcar or truck. For railcar shipments, this takes place when the railcar is filled and the marketer receives written notice that the railcars have been loaded and are available for billing. For distillers grains, title passes upon the loading of distillers grains into trucks. Shipping and handling costs incurred by us for the sale of ethanol and distillers grain are included in costs of goods sold.
All of our ethanol production is sold to Eco-Energy. The purchase price payable to us under our agreement with Eco-Energy is the purchase price set forth in the applicable purchase order, less a marketing fee payable to Eco-Energy.
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We have an agreement with Gavilon to purchase all of the distillers grains produced at our ethanol plant. The purchase price payable to us is the corresponding price being paid to Gavilon for the distillers grains, less certain logistics costs and a service fee.
Derivative Instruments
We enter into derivative contracts to hedge our exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. We do not typically enter into derivative instruments other than for hedging purposes. All future derivative contracts are recognized on the June 30, 2019 balance sheet at their fair value. Although we believe our derivative positions are economic hedges, none have been designated as a hedge for accounting purposes. Accordingly, any realized or unrealized gain or loss related to these derivative instruments is recorded in the statement of operations as a component of cost of goods sold for corn contracts and as a component of revenue for ethanol contracts.
Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales”, and therefore are not marked to market in our financial statements but are subject to a lower of cost or market assessment.
Inventories and Lower of Cost or Net Realizable Value
Inventories are stated at the lower of net realizable value or actual cost using the first-in, first-out method. In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation. For the nine months ended June 30, 2019 and 2018, the Company had a lower of net realizable value inventory adjustment of approximately $180,000 and $280,000 respectively, for a lower of net realizable value or cost inventory adjustment due to low market prices for ethanol.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In addition to the various risks inherent in the ethanol industry and our operations, we are exposed to various market risks. The primary market risks arise as a result of possible changes in certain commodity prices and changes in interest rates.
Commodity Price Risk
We are exposed to market risk with respect to the price of ethanol, which is our principal product, and the price and availability of corn and natural gas, which are the principal commodities we use to produce ethanol. Our other primary product is distillers grains, and we are also subject to market risk with respect to the price for distillers grains. The prices for ethanol, distillers grains, corn and natural gas are volatile, and we may experience market conditions where the prices we receive for our ethanol and distillers grains are declining, but the price we pay for our corn, natural gas and other inputs is increasing. Our results will therefore vary substantially over time, and include the possibility of losses, which could be substantial.
In general, rising ethanol and distillers grains prices result in higher profit margins, and therefore represent favorable market conditions. We are, however, subject to various material risks related to our production of ethanol and distillers grains and the price for ethanol and distillers grains. For example, ethanol and distillers grains prices are influenced by various factors beyond the control of our management, including the supply and demand for gasoline, the availability of substitutes, international trade and the effects of domestic and foreign laws, regulations and government policies.
In general, rising corn prices result in lower profit margins and, accordingly, represent unfavorable market conditions. We will generally not be able to pass along increased corn costs to our ethanol customers. We are subject to various material risks related to the availability and price of corn, many of which are beyond our control. For example, the availability and price of corn is subject to wide fluctuations due to various unpredictable factors, including weather conditions, crop yields, farmer planting decisions, governmental policies with respect to agriculture, and local, regional, national and international trade, demand and supply. If our corn costs were to increase $.10 per bushel from one year to the next, the impact on costs of goods sold would be approximately $2.3 million for the year, assuming corn use of 23 million bushels during the year.
Falling ethanol prices indicate weak market conditions and will usually negatively impact profit margins. We will typically be unable to pass through the impact of decreased ethanol revenues to its corn suppliers. We are subject to various material risks related to the demand for and price of ethanol, many of which are beyond our control. For example, the demand for and price of ethanol is subject to significant fluctuations due to various unpredictable factors which are beyond the control of management,
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including driving habits, consumer vehicle buying decisions, petroleum price movement, plant capacity utilization, and government policies with respect to biofuel use, railroad transportation requirements, national and international trade and supply and demand. If our ethanol revenue were to decrease $.05 per gallon from one year to the next, the impact on gross revenues would be approximately $3.1 million for the year.
During the quarter ended June 30, 2019, corn prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $3.43 per bushel for July 2019 delivery to a high of $4.64 per bushel for July 2019 delivery. The corn prices based on the Chicago Mercantile Exchange daily futures data during the quarter ended June 30, 2018 ranged from a low of $3.39 per bushel for July 2018 delivery to a high of $4.12 per bushel for July 2018 delivery.
The average price we received for our ethanol during the three months ended June 30, 2019 was $1.30 per gallon, as compared to $1.32 per gallon during the three months ended June 30, 2018.
During the quarter ended June 30, 2019, ethanol prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $1.28 per gallon for July 2019 delivery to a high of $1.65 per gallon for July 2019 delivery. The ethanol prices based on the Chicago Mercantile Exchange daily futures data during the three months ended June 30, 2018 ranged from a low of $1.36 per gallon for July 2018 delivery to a high of $1.54 per gallon for July 2018 delivery.
We may from time to time take various cash, futures, options or other positions in an attempt to minimize or reduce our price risks related to corn and ethanol. The extent to which we enter into such positions may vary substantially from time to time and based on various factors, including seasonal factors and our views as to future market trends. Those activities are, however, also subject to various material risks, including that price movements in the cash and futures corn and ethanol markets are highly volatile and are influenced by many factors and occurrences that are beyond our control. We could incur substantial losses on our cash, futures, options or other positions.
Although we intend our futures and option positions to accomplish an economic hedge against our future purchases of corn or future sales of ethanol, we have chosen not to use hedge accounting for those positions, which would match the gain or loss on the positions to the specific commodity purchase being hedged. To avoid the higher costs associated with hedge accounting, we are instead using fair value accounting for the positions. Generally, that means as the current market price of the positions change, the realized or unrealized gains and losses are immediately recognized in our costs of goods sold in the statement of operations for corn positions or as a component of revenue in the statement of operations for ethanol positions. The immediate recognition of gains and losses on those positions can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the positions relative to the cost and use of the commodity being hedged. For example, our net loss on corn derivative financial instruments that was included in our cost of goods sold for the three months ended June 30, 2019 was $1,005,692, as opposed to a net gain of $1, 380,984 for the three months ended June 30, 2018.
We attempt to offset or hedge some of the risk involved with changing corn prices through the trading of futures and options on the Chicago Mercantile Exchange, as well as through purchase and physical delivery contracts from suppliers. We continue to stay at a near neutral corn position due to an uptrend in ethanol sales margins. We continue to monitor and attempt to ensure adequate corn supply and protection against rapid price increases. As noted above those activities are, however, subject to various material risks, including that price movements in the cash corn and corn futures markets are highly volatile and are influenced by many factors and occurrences which are beyond our control.
Another important raw material for our production of ethanol is natural gas. Our cost per MMBTU is subject to various factors that are outside of the control of our management. The factors include changes in weather, increases in transportation costs and overall economic activity. Our natural gas costs will therefore vary, and the variations could be material. Our natural gas costs for the three months ended June 30, 2019 represented approximately 6.8% of our total cost of goods sold for that period.
Interest Rate Risk
We have various outstanding loan agreements that expose us to market risk related to changes in the interest rate imposed under the loan agreement and promissory notes.
We have entered into loan agreements, including an irrevocable letter of credit, with Farm Credit Services of America, FLCA and Farm Credit Services of America, PCA (collectively, "Farm Credit"). The interest rate on the Farm Credit revolving term loan and irrevocable letter of credit is a variable interest rate based on the one-month LIBOR index plus 3.75%. We do not anticipate any significant increase in interest rates during Fiscal 2019.
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Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based on that evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures have been effective to provide reasonable assurance that the information required to be disclosed in the reports our files or submits under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and (ii) accumulated and communicated to management, including our principal executive and principal financial officers or persons performing such functions, as appropriate, to allow timely decisions regarding disclosure. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
No Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time the Company is involved in various litigation matters arising in the ordinary course of its business. None of these matters, either individually or in the aggregate, currently is material to the Company except as reported in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2018, there were no material developments to such matters.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2018. Additional risks and uncertainties, including risk 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 results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
The following exhibits are filed as part of this quarterly report.
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Description of Exhibit | Page | |||
10 | Amendment to Credit Agreement between Lincolnway Energy, LLC and Farm Credit Services of America, FLCA and Farm Credit Services of America, PCA effective June 23, 2019 | * | ||
Revolving Credit Promissory Note between Lincolnway Energy, LLC and Farm Credit Services of America, PCA effective June 23, 2019 | ** | |||
Amended and Restated Letter of Credit Promissory Note between Lincolnway Energy, LLC and Farm Credit Services of America, PCA effective June 23, 2019 | *** | |||
31 | Rule 13a-14(a)/15d-14(a) Certifications | |||
Rule 13a-14(a) Certification of President and Chief Executive Officer | E-1 | |||
Rule 13a-14(a) Certification of Chief Financial Officer | E-2 | |||
32 | Section 1350 Certifications | |||
Section 1350 Certification of President and Chief Executive Officer | E-3 | |||
Section 1350 Certification of Chief Financial Officer | E-4 | |||
101 | Interactive Data Files (furnished electronically herewith pursuant to Rule 405 of Regulation S-T) | |||
* Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Committee on July 8, 2019. ** Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Committee on July 8, 2019. *** Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Committee on July 8, 2019. | ||||
† This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. |
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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.
LINCOLNWAY ENERGY, LLC | ||
August 19, 2019 | By: | /s/ Michael Hollenberg |
Name: Michael Hollenberg | ||
Title: President and Chief Executive Officer | ||
August 19, 2019 | By: | /s/ Jeff Kistner |
Name: Jeff Kistner | ||
Title: Interim Chief Financial Officer |
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