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 | December 31, 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)
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 as of February 1, 2020.
LINCOLNWAY ENERGY, LLC
FORM 10-Q
For the Quarter Ended December 31, 2019
INDEX
Page | |||
Part I. | Financial Information | ||
Item 1. | Unaudited Financial Statements | ||
a) Balance Sheets | |||
b) Statements of Operations | |||
c) Statements of Members' Equity | |||
d) Statements of Cash Flows | |||
e) Notes to Unaudited Financial Statements | |||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 15 | |
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 Interim Chief Financial Officer | E-2 | ||
Section 1350 Certification of President and Chief Executive Officer | E-3 | ||
Section 1350 Certification of Interim 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
December 31, 2019 | September 30, 2019 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
CURRENT ASSETS | |||||||
Cash and cash equivalents | $ | 399,895 | $ | 260,858 | |||
Derivative financial instruments (Note 9 and 10) | 366,198 | 188,694 | |||||
Trade and other accounts receivable (Note 8) | 3,396,312 | 3,259,768 | |||||
Inventories (Note 3) | 5,250,332 | 6,440,716 | |||||
Prepaid expenses and other | 328,756 | 308,184 | |||||
Total current assets | 9,741,493 | 10,458,220 | |||||
PROPERTY AND EQUIPMENT | |||||||
Land and land improvements | 7,156,465 | 7,156,465 | |||||
Buildings and improvements | 7,558,860 | 7,548,308 | |||||
Plant and process equipment | 86,285,715 | 86,110,958 | |||||
Office furniture and equipment | 449,882 | 455,129 | |||||
Construction in progress | 6,796,507 | 6,806,549 | |||||
108,247,429 | 108,077,409 | ||||||
Accumulated depreciation | (66,895,601 | ) | (65,685,719 | ) | |||
Total property and equipment | 41,351,828 | 42,391,690 | |||||
OTHER ASSETS | |||||||
Right of use asset operating lease, net of accumulated amortization (Note 8) | 6,262,785 | — | |||||
Other | 1,056,741 | 864,082 | |||||
Total other assets | 7,319,526 | 864,082 | |||||
Total assets | $ | 58,412,847 | $ | 53,713,992 |
See Notes to Unaudited Financial Statements.
2
Lincolnway Energy, LLC
Balance Sheets (continued)
December 31, 2019 | September 30, 2019 | ||||||
(Unaudited) | |||||||
LIABILITIES AND MEMBERS' EQUITY | |||||||
CURRENT LIABILITIES | |||||||
Accounts payable | $3,317,076 | $1,794,431 | |||||
Accounts payable, related party (Note 7) | 320,285 | 375,394 | |||||
Accrued loss on firm purchase commitments | 385,028 | 67,591 | |||||
Accrued expenses | 960,406 | 776,385 | |||||
Current maturities of long-term debt (Note 5 & 6) | 21,800,000 | 25,000,000 | |||||
Revolving credit loan (Note 4) | — | 300,000 | |||||
Current portion of operating lease liability (Note 8) | 1,838,790 | — | |||||
Total current liabilities | 28,621,585 | 28,313,801 | |||||
NONCURRENT LIABILITIES | |||||||
Operating lease liability (Note 8) | 4,423,995 | — | |||||
Other | 641,093 | 649,799 | |||||
Total noncurrent liabilities | 5,065,088 | 649,799 | |||||
COMMITMENTS AND CONTINGENCY (Note 8 and 9) | — | — | |||||
MEMBERS' EQUITY (Note 11) | |||||||
Member contributions, 42,049 units issued and outstanding | 38,990,105 | 38,990,105 | |||||
Retained (deficit) | (14,263,931 | ) | (14,239,713 | ) | |||
Total members' equity | 24,726,174 | 24,750,392 | |||||
Total liabilities and members' equity | $ | 58,412,847 | $ | 53,713,992 |
3
Lincolnway Energy, LLC
Statements of Operations
Three Months Ended | |||||||
December 31, 2019 | December 31, 2018 | ||||||
(Unaudited) | |||||||
Revenues (Notes 2 and 8) | $ | 29,002,735 | $ | 20,371,692 | |||
Cost of goods sold (Note 7 and 8) | 27,893,358 | 24,295,117 | |||||
Gross profit (loss) | 1,109,377 | (3,923,425 | ) | ||||
General and administrative expenses | 810,538 | 860,983 | |||||
Operating income (loss) | 298,839 | (4,784,408 | ) | ||||
Other income (expense): | |||||||
Interest income | 3,374 | 2,089 | |||||
Interest expense | (326,431 | ) | (86,310 | ) | |||
Other income | — | 3,032,503 | |||||
(323,057 | ) | 2,948,282 | |||||
Net (loss) | $ | (24,218 | ) | $ | (1,836,126 | ) | |
Weighted average units outstanding | 42,049 | 42,049 | |||||
Net (loss) per unit - basic and diluted | $ | (0.58 | ) | $ | (43.67 | ) | |
See Notes to Unaudited Financial Statements.
4
Lincolnway Energy, LLC
Statements of Members' Equity
Member Contributions | Retained (Deficit) | Total | |||||||||
Balance, September 30, 2019 | $ | 38,990,105 | $ | (14,239,713 | ) | $ | 24,750,392 | ||||
Net (loss) | — | (24,218 | ) | (24,218 | ) | ||||||
Balance, December 31, 2019 | $ | 38,990,105 | $ | (14,263,931 | ) | $ | 24,726,174 |
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 |
See Notes to Unaudited Financial Statements.
5
xd
Lincolnway Energy, LLC | Three Months Ended | Three Months Ended | |||||
Statements of Cash Flows | December 31, 2019 | December 31, 2018 | |||||
(Unaudited) | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
Net (loss) | $ | (24,218 | ) | $ | (1,836,126 | ) | |
Adjustments to reconcile net (loss) to net cash provided by operating activities: | |||||||
Depreciation and amortization | 1,215,128 | 1,732,892 | |||||
Accrued loss on firm purchase commitments | 317,437 | 125,801 | |||||
Changes in working capital components: | |||||||
Trade and other accounts receivable | (136,544 | ) | 690,788 | ||||
Inventories | 1,190,384 | (2,704,935 | ) | ||||
Prepaid expenses and other | (221,937 | ) | (28,314 | ) | |||
Accounts payable | 1,583,618 | 1,647,880 | |||||
Accounts payable, related party | (55,109 | ) | 1,785,273 | ||||
Accrued expenses | 184,021 | (460,752 | ) | ||||
Derivative financial instruments | (177,504 | ) | 68,541 | ||||
Net cash provided by operating activities | 3,875,276 | 1,021,048 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES | |||||||
Purchase of property and equipment | (236,239 | ) | (1,325,770 | ) | |||
Net cash (used in) investing activities | (236,239 | ) | (1,325,770 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES | |||||||
Proceeds from long-term borrowings | 16,800,000 | 14,250,000 | |||||
Payments on long-term borrowings | (20,300,000 | ) | (14,050,000 | ) | |||
Net cash provided by (used in) financing activities | (3,500,000 | ) | 200,000 | ||||
Net increase (decrease) in cash and cash equivalents | 139,037 | (104,722 | ) | ||||
CASH AND CASH EQUIVALENTS | |||||||
Beginning | 260,858 | 668,456 | |||||
Ending | $ | 399,895 | $ | 563,734 | |||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW | |||||||
INFORMATION, cash paid for interest, including capitalized interest for 2019 of $0 and 2018 of $161,199 | $ | 338,140 | $ | 230,007 | |||
SUPPLEMENTAL DISCLOSURES OF NONCASH | |||||||
INVESTING AND FINANCING ACTIVITIES | |||||||
Construction in progress included in accounts payable | $ | — | $ | 121,590 | |||
Construction in progress included in accrued expenses | — | 888,629 | |||||
Establishment of lease liability and right of use asset | 6,691,675 | — |
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, 2019 was derived from the Company's audited balance sheet as of that date. The accompanying financial statements as of December 31, 2019 and for the three months ended December 31, 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, 2019 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 0 allowance for doubtful accounts balance as of December 31, 2019 and September 30, 2019.
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 December 31, 2019 and September 30, 2019, the Company recognized a reserve and resulting loss of approximately $172,000 and $76,000 respectively, for a lower of net realizable value or cost inventory adjustment due to low market prices for ethanol.
Property and equipment: Property and equipment is stated at cost. Construction in progress is comprised of costs related to the projects that are not completed. Depreciation is computed using the straight-line method over the estimated useful lives. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. When circumstances or events arise that questions an asset's usefulness, the asset is evaluated for future use and appropriate carrying value. The Company evaluates the carrying value of long-lived tangible assets when events or changes in circumstances indicate that the carrying value may not be recoverable. Such events and circumstances include, but are not limited to, significant decreases in the market value of the asset, adverse changes in the extent or manner in which the asset is being used, significant changes in the business climate, or current or projected cash flow losses associated with the use of the assets. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such assets are separately identifiable and are less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. For long-lived assets to be held for use in future operations and for fixed (tangible) assets, fair value is determined primarily using either the projected cash flows discounted at a rate commensurate with the risk involved or an appraisal. For long-lived assets to be disposed of by sale or other than sale, fair value is determined in a similar manner, except that fair values are reduced for disposal costs.
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
7
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
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 within 30 days that can be reasonably estimated are subject to a lower of cost or net realizable value assessment. The Company recognized a reserve and resulting accrued loss on purchase commitments of approximately $385,000 and $68,000 as of December 31, 2019 and September 30, 2019, 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 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.
Revenue from the sale of the Company's ethanol and distillers grains is recognized at the time title, control and all risks of ownership transfer to the marketing company. This generally occurs upon the loading of the product. For ethanol, title and control passes at the time the product crosses the loading flange in either a railcar or truck. For distillers grain, title and control passes upon the loading into trucks or railcars. Corn oil is marketed internally. Revenue is recognized when title and control of ownership transfers, upon loading. Shipping and handling costs incurred by the Company for the sale of distillers grain are included in costs of goods sold. Ethanol revenue is reported free on board (FOB) and all shipping and handling costs are incurred by the ethanol marketer. Commissions for the marketing and sale of ethanol and distiller grains are included in costs of goods sold.
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. Management has evaluated the Company's material tax positions and determined there were no uncertain tax positions that require adjustment to the financial statements. The Company does not currently anticipate significant changes in its uncertain tax positions over the next twelve months.
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 adopted this accounting standard effective October 1, 2019. Upon adoption, the Company elected a practical expedient which allows existing leases to retain their classification as
8
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
operating leases. Additionally, the Company has elected to account for lease and related non-lease components as a single lease component. The Company elected the option to apply the transition provisions at adoption date instead of the earliest comparative period presented in the financial statements. Due to this election, the Company is not required to retrospectively apply the standard to the previous periods presented. See additional disclosure in Note 8.
Note 2. Revenues
Components of revenues are as follows:
Three Months Ended | |||||||
December 31, 2019 | December 31, 2018 | ||||||
Ethanol, net of hedging gain (loss) | $ | 22,974,264 | $ | 14,651,402 | |||
Distillers Grains | 4,503,669 | 3,773,540 | |||||
Other | 1,524,802 | 1,946,750 | |||||
Total | $ | 29,002,735 | $ | 20,371,692 |
Note 3. Inventories
Inventories consist of the following:
December 31, 2019 | September 30, 2019 | ||||||
Raw materials, including corn, chemicals, parts and supplies | $ | 3,695,917 | $ | 4,902,526 | |||
Work in process | 877,565 | 900,459 | |||||
Ethanol and distillers grains | 676,850 | 637,731 | |||||
Total | $ | 5,250,332 | $ | 6,440,716 |
Note 4. Revolving Credit
The Company has a revolving credit loan with a bank which provides for loans not to exceed $4,000,000 outstanding at any time. The loan originally matured on January 1, 2020 but the Company received an extension on December 24, 2019 extending the maturity date to April 1, 2020. Interest accrues at a variable interest rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate plus 3.75% (5.5% as of December 31, 2019). The Company also pays 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. The Company is presently not in compliance with covenants, as further explained in Notes 5 and 6. There was an outstanding balance of $0 and $300,000 on the revolving credit loan as of December 31, 2019 and September 30, 2019, respectively.
Note 5. Long-Term Debt
The Company has a revolving term loan, with a bank, available for up to $25,000,000. Borrowing capacity will be reduced by $5,000,000 every year starting October 20, 2020 until October 1, 2024 when the loan expires. The Company pays interest on the unpaid balance at a variable interest rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate plus 3.75% (5.50%% as of December 31, 2019). 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. At December 31, 2019 and September 30, 2019 the outstanding balance on the revolving term loan was $21,800,000 and $25,000,000, respectively. Aggregate maturities of long
9
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
term debt as of December 31, 2019 are presented as current due to the noncompliance with financial covenants, as further explained in Note 6.
The Company also has a letter of credit with a bank that provides for a maximum letter of credit commitment of $1,448,625. As of December 31, 2019, the outstanding amount payable by the Company under the letter of credit was $1,448,625.
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 recent periods. 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 the Company 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. The Company was in noncompliance with its covenants as of September 30, 2019 and remains in noncompliance as of December 31, 2019. The covenant defaults have not presently been waived. These factors have raised substantial doubt as to the Company's ability to continue as a going concern for the next 12 months. Management believes 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 an equity infusion. Based on this evaluation, the Company has determined covenant compliance over the next 12 month period is not reasonably possible and, as a result, has presented all debt as current on its balance sheet as of December 31, 2019. The Company believes it will be able to work with the bank on future covenant waivers if needed, or get additional equity or 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 months ended December 31, 2019 and 2018:
Corn Commitment: | |||||||||
December 31, 2019 | |||||||||
Corn Forward Purchase Commitment | Basis Corn Commitment (Bushels) | Commitment Through | Amount Due | ||||||
Related Parties | $ | 2,506,999 | 130,000 | April 2020 | $ | 320,285 |
Corn Purchased: | ||||
Three Months Ended December 31, 2019 | Three Months Ended December 31, 2018 | |||
Related Parties | $10,946,803 | $ | 10,901,338 |
Note 8. Commitments, Major Customers and Lease Obligations
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 $22,974,264 and $14,652,977, respectively, for the three months ended December 31, 2019 and 2018. Trade accounts receivable of $2,249,089 were due from this entity as of December 31, 2019. As of December 31, 2019, the Company had ethanol unpriced sales commitments with this entity of approximately 13.6 million gallons through June 2020.
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 $4,667,402 and $3,773,540, respectively, for the three months ended December 31, 2019 and 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 $788,024 were due from this entity as of December 31, 2019. The Company had distillers grain sales commitments with this entity of approximately 1,735 tons, for a total sales commitment of approximately $239,000.
10
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
_____________________________________________________________________________________________________
As of December 31, 2019, the Company had purchase commitments for corn forward contracts with various unrelated parties, totaling approximately $2.6 million. These contracts mature at various dates through October 2020. The Company had no basis contract commitments with unrelated parties to purchase corn.
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 is reduced over time as the Company makes payments under the agreement. At December 31, 2019, the remaining commitment was approximately $1.4 million.
As of December 31, 2019, the Company had purchase commitments for natural gas basis contracts with an unrelated party totaling 167,555 MMBtu's maturing at various dates through January 2020.
Effective October 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). The Company elected the short-term lease exception provided for in the standard and therefore only recognized right-of-use assets and lease liabilities for leases with a term greater than one year.
A lease exists when a contract conveys to a party the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. The Company recognized a lease liability equal to the present value of future lease payments based on an estimated interest rate commensurate with the rate the Company would pay to borrow equivalent funds. A lease asset was recognized based on the lease liability value and adjusted for any prepaid lease payments or lease incentives. The lease term at the commencement date includes any renewal options or termination options when it is reasonably certain that the Company will exercise or not exercise those options, respectively.
The Company leases railcars and is obligated to pay costs of insurance, taxes, repairs and maintenance pursuant to the terms of the leases. Rent expense for the operating leases during the three months ended December 31, 2019 and 2018 was approximately $499,000 and $507,000, respectively. The lease agreements have maturity dates ranging from March 2020 to September 2025.
The discount rate used in determining the lease liability ranged from 3.68% to 6.23% and was determined by incremental borrowing rates at the time the lease commenced. The right of use asset and liability at December 31, 2019 is $6,262,785.
At December 31, 2019, the Company had the following approximate minimum rental commitments for the period ending December 31:
2020 | $ | 1,532,940 | |
2021 | 1,853,440 | ||
2022 | 1,581,044 | ||
2023 | 1,286,169 | ||
2024 | 982,275 | ||
Thereafter | 513,450 | ||
Total | $7,749,318 |
A reconciliation of the undiscounted future payments in the schedule above and the lease liability recognized in the balance sheet as of December 31, 2019 is shown below:
Undiscounted future payments | $ | 7,749,318 | |
Less: leases entered into, not yet commenced | 339,000 | ||
Discount effect | 1,147,533 | ||
$ | 6,262,785 |
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Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
_____________________________________________________________________________________________________
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:
December 31, 2019 | September 30, 2019 | ||||||
Derivative assets - corn contracts | $ | 278,900 | $ | 531,875 | |||
Derivative liabilities - corn contracts | (81,775 | ) | (93,650 | ) | |||
Cash from (due to) broker | 169,073 | (249,531 | ) | ||||
Total | $ | 366,198 | $ | 188,694 |
The effects on operating income from derivative activities are as follows:
Three Months Ended | |||||||
December 31, 2019 | December 31, 2018 | ||||||
(Losses) in revenues due to derivatives related to ethanol sales: | |||||||
Realized (loss) | $ | — | $ | (1,575 | ) | ||
Total effect on revenues | — | (1,575 | ) | ||||
Gains (losses) in cost of goods sold due to derivatives related to corn costs: | |||||||
Realized gain | 606,987 | 260,938 | |||||
Unrealized (loss) | (438,225 | ) | (324,400 | ) | |||
Total effect on corn cost | 168,762 | (63,462 | ) | ||||
Gains (losses) in cost of goods sold due to derivatives related to natural gas costs: | |||||||
Realized gain | — | 80,680 | |||||
Unrealized (loss) | — | (41,060 | ) | ||||
Total effect on natural gas cost | — | 39,620 | |||||
Total effect on cost of goods sold | 168,762 | (23,842 | ) | ||||
Total gain (loss) due to derivative activities | $ | 168,762 | $ | (25,417 | ) |
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 net realizable value assessment.
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Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
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 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 December 31, 2019 and September 30, 2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
December 31, 2019 | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets, derivative financial instruments | $ | 278,900 | $ | 278,900 | $ | — | $ | — | ||||||||
Liabilities, derivative financial instruments | $ | 81,775 | $ | 81,775 | $ | — | $ | — | ||||||||
September 30, 2019 | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets, derivative financial instruments | $ | 531,875 | $ | 531,875 | $ | — | $ | — | ||||||||
Liabilities, derivative financial instruments | $ | 93,650 | $ | 93,650 | $ | — | $ | — |
Note 11. Subsequent Event
Effective February 6, 2020, the Company entered into a non-binding term sheet for the issuance of new equity capital. Under the term sheet, $5 million of new preferred A units would be issued to a potential investor, and $2.5 million of new preferred B units would be offered to existing members. Closing is subject to member approval, completion of definitive agreements and
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Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
various customary closing conditions. The anticipated closing dates are approximately March 31, 2020 and May 1, 2020 for the class A and class B units, respectively.
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, 2019 ("Fiscal 2019") 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 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 distiller's grains; |
• | Ethanol supply exceeding demand and corresponding ethanol price reductions; |
• | 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; |
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• | 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 distiller's grains produced in the United States; |
• | Disruptions, failures; security breaches or other cybersecurity threats relating to or impacting our information technology infrastructure; and |
• | Trade actions by the Trump Administration, 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, 2019 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 collects the carbon dioxide gas that is produced as part of the fermentation process and converts that raw carbon dioxide gas into liquid carbon dioxide. Air Products also markets and sells the liquid carbon dioxide.
Going Concern
The ethanol industry has experienced an extended period of depressed margins which has impacted the Company and resulted in a significant decrease in our working capital and cash. As a result, the Company was in noncompliance with certain financial covenants in its credit agreement as of September 30, 2019 and remains in noncompliance as of December 31, 2019. Compliance with these covenants has not been waived by our lender. Our continued noncompliance has raised substantial doubt as to the
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Company's ability to continue as a going concern for the next 12 months, Management has determined that the due to the lack of liquidity and uncertainty regarding the Company's ability to meet its financial obligations without additional financing or an equity infusion, covenant compliance over the next 12 month period is not reasonably possible. As a result, the Company has presented all debt as current on its balance sheet as of December 31, 2019. The Company believes it will be able to work with its lender on future covenant waivers if needed, or get additional equity or financing, however, these results cannot be assured.
The Company experienced improved margins during the three months ended December 31, 2019 and expects to fund operations during the next 12 months using cash flow from continuing operations and the available amounts under our revolving term loan. If the Company continues to experience improved margins, our liquidity position should also improve which could lead to compliance with our financial covenants earlier than forecasted. However, the margin environment within the ethanol industry is uncertain and there is no guaranty that improved margins within the industry or at the Company will continue.
Recent Events
Management Services Agreement
On January 15, 2020, the Company entered into a Management Services Agreement (the “Management Agreement”) with Husker Ag, LLC (“Husker Ag”) for management services pertaining to the Company’s ethanol facility located in Nevada, Iowa. Pursuant to the terms of the Management Agreement, Husker Ag will provide the Company with individuals to serve as General Manager, Environmental and Safety Manager and Commodity Risk Manager and to perform the respective management services for each such position.
The initial term of the Management Agreement is four months with the initial term expiring in May 2020. Upon expiration of the initial term, the Management Agreement will automatically renew for one year periods unless either party provides notice of non-renewal at least ninety (90) days prior to the expiration of the then-current term. During the initial term of the Management Agreement, the Company will pay Husker Ag a monthly fee of $36,000 for the management services. The parties shall mutually agree upon the compensation for any renewal term prior to the expiration of the then-current term. In the event the parties are unable to agree upon compensation for any renewal term, the Company shall pay Husker Ag, on a monthly basis, an amount equal to 50% of the total salary, bonuses, benefits, expenses and costs incurred by the Husker Ag employees performing the services. The monthly payment will be paid on an estimated basis with a true up calculation and payment occurring as soon as possible at the end of the applicable Husker Ag fiscal year
The Company and Husker Ag are also in discussions regarding a potential capital transaction which may require amendments to the Company’s Operating Agreement requiring approval by the Company’s members. In the event that the parties pursue the potential transaction and the Company’s members do not vote to approve the amendments to the Operating Agreement necessary to consummate the transaction, either the Company or Husker Ag can terminate the Management Agreement upon ninety (90) days written notice. Either party may terminate the Management Agreement for cause as defined in the Management Agreement. In the event of a change of control event pursuant to which a third party other than Husker Ag acquires control of the Company, the Company has the right to terminate the Management Agreement upon ninety (90) days written notice.
Termination of Chief Executive Officer
In connection with the execution of the Management Agreement, Michael Hollenberg ceased serving as the Company’s President and Chief Executive Officer effective January 17, 2020. Mr. Hollenberg’s employment agreement with the Company (the “Hollenberg Employment Agreement”) provided that he was entitled to severance under certain circumstances in connection with a “change of control.” The Hollenberg Employment Agreement, defined a “change of control” to include any transfer to, or hiring of, an outside third party to provide operational and/or management control, via contract or similar arrangement. The execution of the Management Agreement constituted such a change of control. Mr. Hollenberg was not retained in connection with the change of control that occurred upon the execution of the Management Agreement and Mr. Hollenberg was therefore entitled to and did resign from the Company effective January 17, 2020 which triggered a severance obligation under the terms of the Hollenberg Employment Agreement.
On January 17, 2020, Mr. Hollenberg and the Company entered into a Separation Agreement (the “Separation Agreement”) which became effective January 25, 2020. Under the terms of the Separation Agreement, Mr. Hollenberg received (i) a severance payment in the amount of $100,000 less standard tax and other applicable withholdings (the “Severance Payment”) and (ii) a payment of $6,803 for accrued but unused paid time off (the “PTO Payment”). In addition, if qualified, for a period of six months or until Mr. Hollenberg begins equivalent employment, whichever is shorter, the Company agreed to provide health insurance to Mr. Hollenberg under the Company’s plan pursuant to and subject to Mr. Hollenberg’s right to COBRA continuation coverage if Mr. Hollenberg
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timely elects such coverage. The Company also agreed to pay reasonable expenses for Mr. Hollenberg’s travel, lodging and entrance fee for the 2020 National Ethanol Conference in February 2020 in Houston, Texas.
Mr. Hollenberg agreed to remain available through January 15, 2021 to consult with the Company, as reasonably requested, regarding certain matters in which Mr. Hollenberg was involved or about which he may have knowledge. The Company will pay Mr. Hollenberg for such consulting services at an hourly rate of $200 per hour plus reimbursement of out-of-pocket costs and expenses.
The Separation Agreement contained a general release and waiver of claims pursuant to which Mr. Hollenberg released the Company and certain other parties from any and all claims, charges, causes of action and damages arising on or prior to his execution of the Separation Agreement. In consideration for the general release, the Company released Mr. Hollenberg from certain non-competition restrictions set forth in his employment agreement; however, Mr. Hollenberg will continue to be bound the non-solicitation, confidentiality and other post-termination provisions set forth in the Hollenberg Employment Agreement.
Appointment of New Chief Executive Officer
In connection with the execution of the Management Agreement, the directors of the Company appointed Seth Harder as the General Manager, President and Chief Executive Officer of the Company. Seth Harder, age 41, has served as General Manager of Husker Ag, LLC for 14 years beginning in January of 2006, during which time Husker Ag has grown from its original capacity of 20 million gallons to currently producing 110 million gallons per year. Prior to his appointment as General Manager, Mr. Harder served as Husker Ag’s Plant Manager from September 2004 through December 2005. He originally joined Husker Ag in November 2002 as the Company's first Production Manager followed by a time with ICM, Inc. where he worked as an ethanol trainer and plant startup specialist. Mr. Harder is a current Board member and former executive officer of Renewal Fuels Nebraska. He is also a Board member of the Renewable Fuels Association and the American Coalition for Ethanol (ACE). In 2019, Mr. Harder was appointed by Governor Pete Ricketts to the Nebraska Environmental Quality Council.
Non-Binding Term Sheet with Husker Ag
Effective February 6, 2020 the Company entered into a non-binding Memorandum of Terms with Husker Ag for the issuance of new equity capital, among other things. Under the term sheet, $5 million of new preferred A units would be issued to a Husker Ag, and $2.5 million of new preferred B units would be offered to existing members. Husker Ag would be entitled to appoint a majority of the Company's board of directors. Closing is subject to member approval and various customary closing conditions. The anticipated closing dates are approximately March 31, 2020 and May 1, 2020 for the class A and class B units, respectively. An executed copy of the Memorandum of Terms has been filed with the SEC on Form 8-K on our about the date of this filing, and is referenced in the Exhibit Index below.
Corn Procurement Agreement
The Company entered into a Corn Procurement Agreement (the “Procurement Agreement”) with Innovative Ag Services Co. (“Seller”) for the supply of producer corn for the Company’s ethanol facility which will be effective January 24, 2020. The Procurement Agreement shall remain in effect until terminated by either party upon material breach or upon thirty (30) days’ prior written notice either with or without cause. Under the terms of the Procurement Agreement, the Company shall purchase from Seller, and Seller shall supply to the Company, all of the producer corn required for the Company to operate its ethanol facility. The Company retains the rights to arrange and source all purchases and deliveries of corn purchased through this agreement. The Company shall pay Seller for all producer corn delivered to the Facility plus a per bushel procurement fee.
Grain Procurement Agreement
Also on February 6, 2020, the Company executed a Grain Procurement Agreement (the “Grain Agreement”) with Husker Trading, Inc. (“Trading”), an affiliate of Husker Ag. Under the Grain Agreement, Trading will source the purchase of all corn required by the Company to operate its ethanol facility. During the term of the Corn Procurement Agreement, Trading will do so in coordination with the Seller under the Corn Procurement Agreement, as discussed in the prior paragraph. The term of the Grain Agreement is six months, and will terminate unless there is mutual agreement to extend the term. Trading will receive a fee of $0.01 per bushel of corn delivered to the Company.
Renewable Fuel Standard
The ethanol industry receives support through the Federal Renewable Fuels Standard (the “RFS”) which has been, and will continue to be, a driving factor in the growth of ethanol usage. The RFS requires that each year a certain amount of renewable fuels must be used in the United States. The RFS is a national program that allows refiners to use renewable fuel blends in those areas of
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the country 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 original statutory volume requirements increased 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 2019 annual volume requirements for renewable fuel at 19.92 billion gallons per year (the "Final 2019 Rule"). On July 5, 2019, the EPA issued a proposed rule for 2020 which set the annual volume requirements for renewable fuel at 19.92 billion gallons (the "Proposed 2020 Rule"). Both the Final 2019 Rule and the Proposed 2020 Rule maintained the number of gallons that may be met by conventional renewable fuels such as corn based ethanol at 15.0 billion gallons. A public hearing on the Proposed 2020 Rule was held in July and the public comment period expired on August 30, 2019. The final rule was originally expected to be issued in November 2019.
However, on October 15, 2019, the EPA released a supplemental notice seeking additional comments on a proposed rule on adjustments to the way that annual renewable fuel percentages are calculated. The supplemental notice was issued in response to an announcement on October 4, 2019, by President Trump of a proposed plan to require refiners not exempt from the rules to blend additional gallons of ethanol to make up for the gallons exempted by the EPA's expanded use of waivers to small refineries. The effect of these waivers is that the refinery is no longer required to earn or purchase blending credits, known as RINs, negatively affecting ethanol demand and resulting in lower ethanol prices. The proposed plan was expected to calculate the volume that refiners were required to blend by using a three-year average of exempted gallons. However, the EPA proposed to use a three-year average to account for the reduction in demand resulting from the waivers using the number of gallons of relief recommended by the United States Department of Energy. A public hearing on the proposed rule was held October 30 and the public comment period expired on November 30, 2019. On December 19, 2019, the EPA issued the final rule that set out the 2020 annual volume requirements (the "Final 2020 Rule") at 20.09 billion gallons up from the 19.92 billion gallons for 2019. Similar to the Final 2019 Rule, the Final 2020 Rule included 15.0 billion gallons of conventional corn-based ethanol.
Although the volume requirements set forth in the Final 2019 Rule are slightly higher than the final 2018 volume requirements (the "Final 2018 Rule") and the Final 2020 Rule volume requirements are slightly higher than those set forth in the Final 2019 Rule, the volume requirements under the Final 2018 Rule, the Final 2019 Rule and the Final 2020 Rule are all still significantly below the 26 billion gallons, 28 billion gallons and 30 billion gallons, respectively, statutory mandates, with significant reductions in the volume requirements for advanced biofuels as well.
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 therefore triggering the mandatory reset under the RFS. The Final 2020 Rule is approximately 34% below the statutory targets, which represents the third consecutive year of reductions of more than 20% below the statutory mandates. After the issuance of the Final 2019 Rule, the EPA became 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 statutory 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.
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
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Air Act, known as the "One-Pound Waiver", which allows E10 to be sold year-round, even though it exceeds the RVP limitation of nine pounds per square inch. At the end of May 2019, the EPA finalized a rule which extended the One-Pound Waiver to E15 so its sale can expand beyond flex-fuel vehicles during the June 1 to September 15 summer driving season. This rule is being challenged in court; however, the One-Pound Waiver is in effect, and E15 can be sold year round. However, with respect to the 2019 summer driving season, because the rule was not finalized until the end of May, the ethanol industry was unable to fully capitalize on increased E15 sales during the 2019 peak summer driving season.
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 refinery 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.
Although the Final 2019 Rule and the Final 2020 Rule maintain the number of gallons which may be met by conventional renewable fuels such as corn-based ethanol at 15.0 billion gallons this number does not take into account waivers granted by the EPA to small refiners for "hardship." 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 October 2019, the EPA has approved 85 exemptions for compliance years 2016 to 2018, freeing refineries from using 4 billion gallons of renewable fuel. 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. As discussed above, the mechanism that provides accountability in RFS compliance is the Renewable Identification Number (RIN). RINs are a tradeable commodity given that if refiners (obligated parties) need additional RINs to be compliant, they have to purchase them from those that have excess. Thus, there is an economic incentive to use renewable fuels like ethanol, or in the alternative, buy RINs. Granting these small refinery waivers 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 to under $0.20. In late 2017 D6 RIN prices were about $0.75 per gallon, averaged $0.30 in 2018, and less than $0.20 in 2019. Since higher RIN values help to make higher blends of ethanol more cost competitive, lower RIN values could hinder or at least slow retailer and consumer adoption of E15 and higher blends. If the EPA continues to grant discretionary waivers and RIN prices continue to fall, it could negatively affect ethanol prices.
In response to the substantially expanded granting of small refinery exemptions in 2019, over 15 plants have shut down while other plants have limited production. The RFA estimates that approximately 20 ethanol plants have been temporarily idled or permanently closed since the EPA began to expand the volume of the small refinery exemptions granted. The Trump Administration has not announced a plan to reallocate ethanol gallons lost to exemptions in the current year and therefore, the continued granting of waivers and the failure of the Trump Administration to take any action to reallocate the lost exemptions will continue to negatively impact ethanol demand and RIN and 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 EPA's current approach runs counter to this statutory mandate and undermines Congressional intent. 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 refineries, the market price and demand for ethanol would be adversely effective which would negatively impact our financial performance. The EPA's based the projected volume of gasoline and diesel that was exempt in 2020 on utilizing the three year rolling average of relief recommended by the Department of Energy, rather than the three year rolling level of actual exemptions advocated by agricultural interests.
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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. In November 2019, the Court dismissed the case because the Advanced Biofuels Association did not identify a final agency action in their original lawsuit.
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.
On January 24, 2020, the U.S. Court of Appeals for the Tenth Circuit announced that the three exemptions were improperly issued by the EPA. The Court held that the EPA cannot "extend" exemptions to any small refineries whose earlier, temporary exemptions had lapsed. The Court concluded that the EPA exceeded its statutory authority in granting these petitions because there was nothing for the agency to "extend". Utilizing this criteria, there would have been a maximum of seven small refineries that could have received continuous extensions, yet the EPA has granted thirty five exemptions in a single year. The Court also found the EPA had abused their discretion in failing to explain how the EPA could maintain that such refineries would incur an economic hardship while continuing to claim that the costs of RIN compliance are passed through and recovered by those same refineries.
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 lost volumes caused by the recent increase in retroactive small refinery RVO exemptions. The EPA has not reallocated volume exemptions in prior years, and continued to approve 31 new requests in 2019. On October 29, 2019, the U.S. House of Representatives Committee on Energy and Commerce met to examine the effects of the small refinery exemptions on biofuels and agriculture since 2016. Companies were seeking the EPA to make available more information on refinery exemptions.
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. An administrative stay has been granted to research the contents of the lawsuit.
Although the maintenance of the 15 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the Final 2019 Rule and the Final 2020 Rule together with the application of the One-Pound Waiver to E15 permitting the year round sale of E15 signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal or otherwise invalidate the RFS 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 December 31, 2019, are as follows:
•Total revenues increased 42.4%, or $8.6 million, compared to the 2018 comparable period.
•Total cost of goods sold increased 14.8%, or $3.6 million, compared to the 2018 comparable period.
•Other income decreased approximately $3.0 million from the three months ended December 31, 2018. The decrease was due to a one-time settlement payment received in exchange for the early termination of a contract in the fall of 2018.
•Net loss was approximately $24 thousand, which represents a decrease in net loss of $1.8 million when compared to the net loss of $1.8 million for the 2018 comparable period.
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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 months ended December 31, 2019 and 2018 (dollars in thousands):
Three Months Ended December 31, | |||||||||||||||
(Unaudited) | |||||||||||||||
Income Statement Data | 2019 | 2018 | |||||||||||||
Revenue | $29,002 | 100.0 | % | $20,372 | 100.0 | % | |||||||||
Cost of goods sold | 27,893 | 96.2 | % | 24,295 | 119.3 | % | |||||||||
Gross profit (loss) | 1,109 | 3.8 | % | (3,923 | ) | (19.3 | )% | ||||||||
General and administrative expenses | 810 | 2.8 | % | 861 | 4.2 | % | |||||||||
Operating income (loss) | 299 | 1.0 | % | (4,784 | ) | (23.5 | )% | ||||||||
Other income (expense), net | (323 | ) | (1.1 | )% | 2,948 | 14.5 | % | ||||||||
Net (loss) | $ | (24 | ) | (0.1 | )% | $ | (1,836 | ) | (9.0 | )% |
Results of Operations for the Three Months Ended December 31, 2019 as Compared to the Three Months Ended December 31, 2018
Revenues. Total revenues increased by 42% for the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. For the three months ended December 31, 2019 ethanol sales increased by 57%, sales from co-products increased by 5% and other income decreased 100% due to the one time termination fee due to the load out agreement during the period ended December 31, 2018. The change in ethanol revenue was a result of a 23.8%, or $0.265 per gallon, increase in the price per gallon received as well as a 26.6% increase in sales volume for the three months ended December 31, 2019, when compared to the three months ended December 31, 2018. Ethanol prices increased due to reduced inventories in the domestic market coupled with reduced domestic production of ethanol resulting from the fact that many ethanol plants have been idled or have significantly reduced production due to the recent depressed margins. Ethanol revenue for the three months ended December 31, 2019 was not impacted by ethanol derivatives, compared to a $1,575 net loss in the same quarter for the prior year.
Sales from co-products increased by 6% for the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. The change in co-product sales resulted primarily from an increase in distillers grain revenue. Distillers grain revenue increased as market prices increased as a result of steady world and U.S. protein prices along with higher corn expense being incurred as an alternative feed substitute for the U.S. meat producer.
Cost of goods sold. Cost of goods sold increased by 14.8%, or approximately $3.6 million, for the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. The increase was primarily due to increases in corn costs. 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, increased $4.1 million, or 24.5%, for the three months ended December 31, 2019 compared to the three months ended December 31, 2018. The increase resulted from a 7.7% increase in corn price, due partially to increased production resulting in increased demand for corn. For the three months ended December 31, 2019 corn costs included a $168,762 net gain for derivatives relating to corn costs compared to a $63,462 net loss in the same quarter for the prior year. Corn costs represented 74.2% of cost of goods sold for the three months ended December 31, 2019 compared to 66.6% for the three months ended December 31, 2018.
Repairs and maintenance decreased approximately 23.5%, or $.76 million, for the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. The decrease was due an increased focus on preventative maintenance to avoid larger costly repairs as well as a focus on cost control.
Depreciation expense decreased approximately $.5 million or 30% for the three months ended December 31, 2019 from the three months ended December 31, 2018. The decrease in depreciation during the first quarter of fiscal year 2020 can be attributed to the Company not adding depreciable assets to the plant and accelerated depreciation taken on the regenerative thermal oxidizer during the three month period December 31, 2018 due to its known replacement date.
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General and administrative costs decreased by $50,445, or 5.9%, for the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. The decrease is due to a combination of reduced research and development costs and reduced legal expenses in the areas of employee benefits and litigation matters during the three months ended December 31, 2019.
Other income decreased approximately $3 million from the three months ended December 31, 2019 from the three months ended December 31, 2018 as the payment was a one-time settlement payment received in exchange for the early termination of a load out agreement.
Industry Factors that May Affect Future Operating Results
During the three months ended December 31, 2019, the ethanol industry experienced moderate ethanol production margins at the beginning and ended with extremely weak ethanol production margins in December as a result of a combination of factors including the following:
Ÿ | Corn pricing stayed range bounded on the Chicago Board of Trade between $3.58 to $3.98 a bushel primarily due to late harvest and uncertain harvest yield reported from the corn belt states. The late harvest suggested that yields would fall below trend, and the United States Department of Agriculture (the "USDA") production figures to date have confirmed a yield of approximately 4-5% below trend. Although weather conditions improved as the growing season progressed crop yields remained uncertain. Cash basis levels moved slightly higher as a lack of farm selling and an extremely delayed harvest stretched available supplies to the breaking point at the end of the crop year. The resulting volatile cash prices created additional risks for the ethanol producer. Ethanol prices failed to keep pace with corn prices and as a result the industry has suffered negative margins the last half of December. Lincolnway Energy is expecting an even more challenging year in corn origination in the 2019/2020 season with a projected total corn supply reduced to closer to 16 billion bushels as compared to the 17 billion bushel supplies the industry has enjoyed over the last 3 years. The USDA currently forecasts ending stocks of 1.9 billion bushels, or 14.0% of usage, and management expects relatively stable corn futures and basis for the first quarter of calendar 2020 with the chance for more volatile markets thereafter. |
Ÿ | Ethanol continues to see significant margin weakness because of over production. Ethanol stocks built to record high levels, briefly during the summer and then dropped in September because plant production decreased significantly due to the fact that multiple plants elected to reduce production capacity or remain idle because of negative margins and limited corn supply resulting from the late harvest. Lower corn supplies are expected and the industry, particularly on a regional level, will be fighting to manage raw material availability. Ongoing capacity expansion means a fight for ethanol market share as the industry seeks to run at higher production rates despite stagnant demand. Imports from Brazil have expanded in the fourth calendar quarter of 2019 by 58 million gallons caused a further surplus in domestic inventories especially in the Midwest. |
Ÿ | Although there has been substantial growth in export demand in recent years, export ethanol produced in the U.S. declined during the fourth calendar quarter of 2019 and we currently expect that the export growth curve will continue to move downward in 2020. As a result of the current trade war, despite a long term commitment to increased ethanol blending in gasoline, Chinese demand is likely to remain near zero. With protective tariffs still in place and improved availability of sugar cane ethanol, Brazilian imports of U.S. ethanol are forecast to fall by 112 million gallons. In addition, given the current over supply in domestic ethanol inventories, the decrease in Brazilian demand caused by that country’s quota system and the attractiveness of U.S. imports from Brazil to meet advanced biofuel mandates and satisfy the California carbon intensity/low carbon fuel standard requirements, we expect foreign trade to continue to exert a negative impact on ethanol prices. |
Ÿ | The forward environment for the U.S. ethanol industry is still very much in question as the Company enters its fiscal year ending September 30, 2020 ("Fiscal 2020"). Organic capacity growth continues to weigh on a stagnant domestic demand base. Smaller corn supplies will likely cause regional dislocations, resulting in volatile corn basis swings and potentially offer opportunities for ethanol producers in “corn rich” areas such as Iowa, to capitalize with higher priced ethanol sales. But given the current high levels of ethanol stocks and a corn supply adequate to supply demand at least into mid-2020, ethanol production margins may well remain depressed for the foreseeable future. The EPA’s maintenance in the Final 2020 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 of 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, consumer education regarding the benefits of higher ethanol blends is critically important. Management believes in the next 5-10 years the adoption of E15 blends could expand domestic ethanol consumption by as much as 2 billion gallons. But progress towards that goal will likely be very modest as pump and other infrastructure requirements will occur very slowly. Any positive effect on demand and market prices will likely be realized over years not months and slow to impact the Company's operations and financial condition. 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. Despite the potential positive impact of E15 sales in the future, management |
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continues to have significant concerns about the impact of the small refiner waivers granted by the EPA (which are discussed further below) on any potential positive impacts from E15. The reduced usage requirements of the small refiners have not been passed along to large refiners and in the short run represents a greater potential hole in demand than the adoption of regulations permitting the year-round sale of E15 can fill.
Ÿ | Largely steady gasoline prices have resulted in no demand increases in the domestic market. Gasoline demand has stagnated year over year. Demographics, alternative fuel vehicles and efficiency improvements have stalled gasoline demand growth for most of the last decade. With 89% of U.S. ethanol production consumed domestically and domestic demand growth in neutral, the industry may continue to experience a weak margin environment. The stronger U.S. economy has been an important factor in the expansion of miles driven; however, it is a very modest expansion of miles driven. At multi-decade lows, unemployment rates are unlikely to move any lower, gasoline demand growth during Fiscal 2020 is unlikely, and industry capacity expansion appears to be moving beyond the gasoline market’s ability to absorb more ethanol without quicker adoption of E15 and other higher blends or a strong renewal of export growth. |
Ÿ | 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 increased in response to rising corn prices, its discount to reformulated gasoline blend stock for oxygen blending (RBOB) fell slightly during the 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 round blending of E15 promises potentially significant increases in ethanol blending in the future which management believes is a significant positive for the industry in the long run. 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. |
Ÿ | The EPA continues to grant extensive small refinery exemptions with current estimates indicating that the EPA 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. The U.S. government continues to take positions which negatively impact domestic offtake of ethanol. Exemptions for small refiner blending of ethanol have now been granted even to subsidiaries of large multinational oil companies. Under the RFS, a small refinery (a refinery that processes less than 75,000 barrels per day) can petition the EPA for a waiver of their requirement to submit RINs. The EPA, through consultation with the Department of Energy and the Department of Agriculture, can grant them a full or partial waiver, or deny it within 90 days of submittal. The EPA granted significantly more of these waivers for 2018 and 2019 than they had in the past, totaling estimated two billion gallons of waived requirements. This effectively reduced the RFS volumes for those compliance years by that amount, and has lowered RIN values significantly over the past calendar year which in turn adversely impacts the market and price for ethanol. However, on January 24, 2020, the U.S. Court of Appeals for the Tenth Circuit struck down three specific waivers which had been challenged by biofuels industry groups stating that the waivers were improperly issued by the EPA. The court also found that the EPA abused its discretion in failing to explain how the EPA could conclude that a small refinery could suffer a disproportionate economic hardship while the EPA continued to consistently claim that costs for RIN compliance are passed through to, and recovered by, the same small refineries. Although this ruling is a positive signal to the marketplace, there is no guarantee that the EPA will cease granting small refinery waivers or that courts will strike down additional waivers granted by the EPA |
Ÿ | 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 to be tight to negative for the remainder of Fiscal 2020 . Tightening corn supplies and continued over production of ethanol gallons will impact operating margins and 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.
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Corn oil prices stayed flat in the fourth quarter after falling to multi-year lows. The avalanche of soybean stocks in the U.S. resulted in high crush rates and substantial soybean oil production. Soybean oil prices increased during this quarter because of world demand. The reinstated blenders’ tax credit for biodiesel could positively impact the price and demand for corn oil as biodiesel production margins improve. Corn oil supplies in the U.S. are expected to grow due to yield improvements which could offset the impact of lower ethanol production rates.
The Final 2020 Rule raised the renewable volume requirements for advanced biofuels from the 201 level of 4.9 billion gallons to 5.09 billion gallons and increased the biomass-based diesel from 2.1 billion gallons to 2.43 billion gallons. Additionally, with the reinstated Blenders Tax Credit of $1.00 per gallon will 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.
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 currently working with a potential strategic investor to inject cash equity into the Company. Working capital (deficit) was approximately $(18.9) million after converting $21.8 million of long-term liabilities to current liabilities as a result of the violation of debt covenants. The long-term debt was converted to current liabilities due to the uncertainties of staying in covenant compliance with our lender. 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. As of December 31, 2019 Lincolnway is in default on its tangible net worth covenant. 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, 2020, 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 necessary covenants 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; |
• | the level of our outstanding indebtedness and the interest we are obligated to pay; |
• | our ability to obtain ongoing credit from our primary lender and, if needed, to obtain waivers of covenant violations; |
• | our margin maintenance requirements on all commodity trading accounts. |
The following table summarizes our sources and uses of cash and cash equivalents from the unaudited statement of cash flows for the periods presented:
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Three Months Ended December 31, | ||||||||
(Unaudited) | ||||||||
Cash Flow Data: | 2019 | 2018 | ||||||
Net cash provided by operating activities | $ | 3,875,276 | $ | 1,021,048 | ||||
Net cash (used in) investing activities | (236,239 | ) | (1,325,770 | ) | ||||
Net cash provided by (used in) financing activities | (3,500,000 | ) | 200,000 | |||||
Net increase (decrease) in cash and cash equivalents | $ | 139,037 | $ | (104,722 | ) |
Cash Flow Provided by Operations
For the three months ended December 31, 2019, net cash provided by operating activities increased by $2.8 million when compared to net cash provided by operating activities for the three months ended December 31, 2018. The increase in cash provided by operating activities due to the lower net loss and 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 $1.1 million for the three months ended December 31, 2019 compared to the three months ended December 31, 2018. The decrease was due to several large progress payments made on the installation of a grains drying and cooling system in the previous fiscal year.
Cash Flow Provided by (used in) 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 $3.7 million for the three months ended December 31, 2019 compared to the three months ended December 31, 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, control and all risks of ownership transfer to the marketing company. This generally occurs upon the loading of the product. For ethanol, title and control passes at the time the product crosses the loading flange into either a railcar or truck.For distillers grains, title and control passes upon the loading of distillers grains into trucks or railcars. Corn oil is marketed internally. Revenue is recognized when title and control of ownership transfers, upon loading. Shipping and handling costs incurred by the Company for the sale of distillers grain are included in the costs of goods sold. Ethanol revenue is reported free on board (FOB) and all shipping and handling costs are incurred by the ethanol marketer. Commissions for the marketing and sale of ethanol and distiller grains are included in the 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.
The Company has 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.
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Derivative Instruments
Lincolnway Energy periodically enters into derivative contracts to hedge our exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. Lincolnway Energy does not typically enter into derivative instruments other than for hedging purposes. All future derivative contracts are recognized on the December 31, 2019 balance sheet at their fair value. Although Lincolnway Energy believes 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 Market
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 three months ended December 31, 2019 and 2018, the Company had a lower of cost or net realizable value inventory adjustment of $172,016 and $1,082,234 respectively.
Property and Equipment
Property and equipment is stated at cost. Construction in progress is comprised of costs related to the projects that are not completed. Depreciation is computed using the straight-line method over the following estimated useful lives. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. When circumstances or events arise that questions an asset's usefulness, the asset is evaluate for future use and appropriate carrying value.
The Company evaluates the carrying value of long-lived tangible assets when events or changes in circumstances indicate that the carrying value may not be recoverable. Such events and circumstances include, but are not limited to, significant decreases in the market value of the asset, adverse changes in the extent or manner in which the asset is being used, significant changes in business climate, or current or projected cash flow losses associated with the use of the assets. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such assets are separately identifiable and are less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. For long-lived assets to be held for use in future operations and for fixed (tangible) assets, fair value is determined primarily using either the projected cash flows discounted at a rate commensurate with the risk involved or an appraisal. For long-lived assets to be disposed of by sale or other than sale, fair value is determined in a similar manner, except that fair values are reduced for disposal costs.
Off-Balance Sheet Arrangements
We currently do not have any off-balance sheet arrangements.
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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 $2.1 million for the year, assuming corn use of 21 million bushels during the year.
Falling ethanol prices indicate weak market conditions and will usually negatively impact profit margins. Lincolnway Energy will typically be unable to pass through the impact of decreased ethanol revenues to its corn suppliers. Lincolnway Energy is subject to various material risks related to the demand for and price of ethanol, many of which are beyond the control of the Company. 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 Lincolnway Energy's management, 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 Lincolnway Energy's 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 December 31, 2019, corn prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $3.58 per bushel for December 2019 delivery to a high of $3.98 per bushel for October 2019 delivery. The corn prices based on the Chicago Mercantile Exchange daily futures data during the quarter ended December 31, 2018 ranged from a low of $3.56 per bushel for November 2018 delivery to a high of $3.86 per bushel for December 2018 delivery.
The average price we received for our ethanol FOB Nevada, Ia., during the three months ended December 31, 2019 was $1.38 per gallon, as compared to $1.11 per gallon during the three months ended December 31, 2018.
During the quarter ended December 30, 2019, ethanol prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $1.32 per gallon for December 2019 delivery to a high of $1.52 per gallon for November 2019 delivery. The ethanol prices based on the Chicago Mercantile Exchange daily futures data during the three months ended December 31, 2018 ranged from a low of $1.20 per gallon for November 2018 delivery to a high of $1.32 per gallon for October 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.
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Although we intend our futures and option positions to accomplish an economic hedge against our future purchases of corn or futures 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 changes, 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 gain on corn derivative financial instruments that was included in our cost of goods sold for the three months ended December 31, 2019 was $168,762, as opposed to a net loss of $63,462 for the three months ended December 31, 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, increase in transportation costs and the 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 December 31, 2019 represented approximately 5.5% 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 2020.
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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 General Manager, President and Chief Executive Officer and our Interim Chief Financial Officer (our principal 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 General Manager, President and Chief Executive Officer and our Interim 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 management 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, 2019, there were no material developments to such matters.
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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, 2019. 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.
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Item 6. Exhibits.
The following exhibits are filed as part of this quarterly report.
Description of Exhibit | Page | |||||
10 | Management Services Agreement between Lincolnway Energy, LLC and Husker Ag, LLC dated January 1, 2020** | * | ||||
10 | Corn Procurement Agreement between Lincolnway Energy, LLC and Innovative Ag Services Co. effective January 24, 2020 | * | ||||
10 | Separation Agreement and General Release between the Lincolnway Energy, LLC and Michael Hollenberg dated January 17, 2020** | * | ||||
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 Interim Chief Financial Officer | E-2 | |||||
32 | Section 1350 Certifications | |||||
Section 1350 Certification of President and Chief Executive Officer † | E-3 | |||||
Section 1350 Certification of Interim 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 January 3, 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 | ||
February 14, 2020 | By: | /s/ Seth Harder |
Name: Seth Harder | ||
Title: General Manager, President and Chief Executive Officer | ||
February 14, 2020 | By: | /s/ Jeff Kistner |
Name: Jeff Kistner | ||
Title: Interim Chief Financial Officer |
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