UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the quarterly period ended | June 30, 2020 |
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: On August 7, 2020 the total number of units outstanding was 105,122 units made up of 42,049 Common Units, 56,086 Class A Units and 6,987 Class B Units.
LINCOLNWAY ENERGY, LLC
FORM 10-Q
For the Quarter Ended June 30, 2020
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 | 14 | |
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
June 30, 2020 | September 30, 2019 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
CURRENT ASSETS | |||||||
Cash and cash equivalents | $ | 4,772,643 | $ | 260,858 | |||
Derivative financial instruments (Note 9 and 10) | 56,402 | 188,694 | |||||
Trade and other accounts receivable (Note 8) | 3,472,836 | 3,259,768 | |||||
Inventories (Note 3) | 7,313,399 | 6,440,716 | |||||
Prepaid expenses and other | 695,693 | 308,184 | |||||
Total current assets | 16,310,973 | 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 | 86,513,186 | 86,110,958 | |||||
Office furniture and equipment | 447,130 | 455,129 | |||||
Construction in progress | 6,796,507 | 6,806,549 | |||||
108,472,148 | 108,077,409 | ||||||
Accumulated depreciation | (69,291,129 | ) | (65,685,719 | ) | |||
Total property and equipment | 39,181,019 | 42,391,690 | |||||
OTHER ASSETS | |||||||
Right of use asset operating lease, net of accumulated amortization (Note 8) | 5,711,404 | — | |||||
Other | 1,102,769 | 864,082 | |||||
Total other assets | 6,814,173 | 864,082 | |||||
Total assets | $ | 62,306,165 | $ | 53,713,992 |
See Notes to Unaudited Financial Statements.
2
Lincolnway Energy, LLC
Balance Sheets (continued)
June 30, 2020 | September 30, 2019 | ||||||
(Unaudited) | |||||||
LIABILITIES AND MEMBERS' EQUITY | |||||||
CURRENT LIABILITIES | |||||||
Accounts payable | $1,216,572 | $1,794,431 | |||||
Accounts payable, related party (Note 7) | 629,033 | 375,394 | |||||
Accrued loss on firm purchase commitments | — | 67,591 | |||||
Accrued expenses | 917,969 | 776,385 | |||||
Current maturities of long-term debt (Note 5 & 6) | 505,700 | 25,000,000 | |||||
Revolving credit loan (Note 4) | — | 300,000 | |||||
Current portion of operating lease liability (Note 8) | 1,811,934 | — | |||||
Total current liabilities | 5,081,208 | 28,313,801 | |||||
NONCURRENT LIABILITIES | |||||||
Long-term debt, less current maturities (Note 5) | 23,200,000 | — | |||||
Operating lease liability (Note 8) | 3,899,470 | — | |||||
Other | 725,763 | 649,799 | |||||
Total noncurrent liabilities | 27,825,233 | 649,799 | |||||
COMMITMENTS AND CONTINGENCY (Note 8 and 9) | — | — | |||||
MEMBERS' EQUITY | |||||||
Member contributions, 105,122 and 42,049 units issued and outstanding as of June 30, 2020 and September 30, 2019, respectively | 46,490,105 | 38,990,105 | |||||
Retained (deficit) | (17,090,381 | ) | (14,239,713 | ) | |||
Total members' equity | 29,399,724 | 24,750,392 | |||||
Total liabilities and members' equity | $ | 62,306,165 | $ | 53,713,992 |
3
Lincolnway Energy, LLC
Statements of Operations
Three Months Ended | Nine Months Ended | ||||||||||||||
June 30, 2020 | June 30, 2019 | June 30, 2020 | June 30, 2019 | ||||||||||||
(Unaudited) | |||||||||||||||
Revenues (Notes 2 and 8) | $ | 20,136,749 | $ | 26,488,313 | $ | 73,516,378 | $ | 71,193,326 | |||||||
Cost of goods sold (Note 7 and 8) | 18,816,144 | 28,137,492 | 73,173,710 | 77,337,800 | |||||||||||
Gross profit (loss) | 1,320,605 | (1,649,179 | ) | 342,668 | (6,144,474 | ) | |||||||||
General and administrative expenses | 766,079 | 1,028,108 | 2,531,239 | 2,773,045 | |||||||||||
Bad debt expense | — | 4,385,009 | — | 4,385,009 | |||||||||||
Operating income (loss) | 554,526 | (7,062,296 | ) | (2,188,571 | ) | (13,302,528 | ) | ||||||||
Other income (expense): | |||||||||||||||
Interest income | 2,959 | (30,990 | ) | 9,180 | 7,701 | ||||||||||
Interest expense | (254,237 | ) | (342,335 | ) | (897,949 | ) | (446,723 | ) | |||||||
Other income | — | 40,779 | 226,672 | 3,079,940 | |||||||||||
(251,278 | ) | (332,546 | ) | (662,097 | ) | 2,640,918 | |||||||||
Net income (loss) | $ | 303,248 | $ | (7,394,842 | ) | $ | (2,850,668 | ) | $ | (10,661,610 | ) | ||||
Weighted average units outstanding | 91,953 | 42,049 | 58,776 | 42,049 | |||||||||||
Net income (loss) per unit - basic and diluted | $ | 3.30 | $ | (175.87 | ) | $ | (48.50 | ) | $ | (253.55 | ) | ||||
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 | ||||
Issuance of 42,049 membership units | 5,000,000 | — | 5,000,000 | ||||||||
Net (loss) | — | (3,129,698 | ) | (3,129,698 | ) | ||||||
Balance, March 31, 2020 | $ | 43,990,105 | $ | (17,393,629 | ) | $ | 26,596,476 | ||||
Issuance of 21,024 membership units | 2,500,000 | 0 | 2,500,000 | ||||||||
Net income | 0 | 303,248 | 303,248 | ||||||||
Balance, June 30, 2020 | $ | 46,490,105 | $ | (17,090,381 | ) | $ | 29,399,724 |
Member Contributions | Retained (Deficit) | Total | |||||||||
Balance, September 30, 2018 | $ | 38,990,105 | $ | (990,907 | ) | $ | 37,999,198 | ||||
Net (loss) | — | (1,836,126 | ) | (1,836,126 | ) | ||||||
Balance, December 31, 2018 | $ | 38,990,105 | $ | (2,827,033 | ) | $ | 36,163,072 | ||||
Net (loss) | — | (1,430,642 | ) | (1,430,642 | ) | ||||||
Balance, March 31, 2019 | $ | 38,990,105 | (4,257,675 | ) | $ | 34,732,430 | |||||
Net (loss) | — | (7,394,842 | ) | (7,394,842 | ) | ||||||
Balance, June 30, 2019 | $ | 38,990,105 | (11,652,517 | ) | $ | 27,337,588 |
See Notes to Unaudited Financial Statements.
5
Lincolnway Energy, LLC | Nine Months Ended | Nine Months Ended | |||||
Statements of Cash Flows | June 30, 2020 | June 30, 2019 | |||||
(Unaudited) | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
Net (loss) | $ | (2,850,668 | ) | $ | (10,661,610 | ) | |
Adjustments to reconcile net (loss) to net cash (used in) operating activities: | |||||||
Depreciation and amortization | 3,614,282 | 4,105,400 | |||||
Loss on disposal of property and equipment | — | 228,475 | |||||
Accrued loss on firm purchase commitments | (67,591 | ) | 181,078 | ||||
Bad debt expense | — | 4,385,009 | |||||
Changes in working capital components: | |||||||
Trade and other accounts receivable | (213,068 | ) | (341,979 | ) | |||
Inventories | (872,683 | ) | (958,478 | ) | |||
Prepaid expenses and other | (550,232 | ) | (24,956 | ) | |||
Accounts payable | (540,251 | ) | (489,825 | ) | |||
Accounts payable, related party | 253,639 | (491,985 | ) | ||||
Accrued expenses | 141,584 | (352,436 | ) | ||||
Derivative financial instruments | 132,292 | (545,062 | ) | ||||
Net cash (used in) operating activities | (952,696 | ) | (4,966,369 | ) | |||
CASH FLOWS FROM INVESTING ACTIVITIES | |||||||
Purchase of property and equipment | (441,219 | ) | (2,930,185 | ) | |||
Proceeds from sale of property and equipment | — | 15,000 | |||||
Net cash (used in) investing activities | (441,219 | ) | (2,915,185 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES | |||||||
Proceeds from operating line of credit | 10,467,500 | — | |||||
Payments on operating line of credit | (10,767,500 | ) | — | ||||
Proceeds from long-term borrowings | 27,505,700 | 50,050,000 | |||||
Payments on long-term borrowings | (28,800,000 | ) | (42,650,000 | ) | |||
Proceeds from issuance of membership units | 7,500,000 | — | |||||
Net cash provided by financing activities | 5,905,700 | 7,400,000 | |||||
Net increase (decrease) in cash and cash equivalents | 4,511,785 | (481,554 | ) | ||||
CASH AND CASH EQUIVALENTS | |||||||
Beginning | 260,858 | 668,456 | |||||
Ending | $ | 4,772,643 | $ | 186,902 | |||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW | |||||||
INFORMATION, cash paid for interest, including capitalized interest for 2020 of $0 and 2019 of $304,947 | 979,929 | 839,649 | |||||
SUPPLEMENTAL DISCLOSURES OF NONCASH | |||||||
INVESTING AND FINANCING ACTIVITIES | |||||||
Construction in progress included in accounts payable | 23,365 | 26,907 | |||||
Construction in progress converted to note receivable | — | 4,080,000 | |||||
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 June 30, 2020 and for the nine months ended June 30, 2020 and 2019 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.
Risks and Uncertainties: The COVID-19 pandemic is currently impacting countries, communities, supply chains and commodities markets, in addition to the global financial markets. This pandemic has resulted in social distancing, travel bans, governmental stay-at-home orders, and quarantines, and these may limit access to our facilities, customers, suppliers, management, support staff and professional advisors. At this time it is not possible to fully assess the impact of the COVID-19 pandemic on the Company’s operations and capital requirements, but the aforementioned factors, among other things, may impact our operations, financial condition and demand for our products, as well as our overall ability to react timely and mitigate the impact of this event. Depending on its severity and longevity, the COVID-19 pandemic may have a material adverse effect on our business, customers, and members.
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 June 30, 2020 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 June 30, 2020 and September 30, 2019, the Company recognized a reserve and resulting loss of approximately $0 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
7
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
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 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 $0 and $68,000 as of June 30, 2020 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. On March 31, 2020, 42,049 new Class A Units were issued which Class A Units are a separate class of unit than the units issued to existing members which have been renamed “Common Units”. On May
8
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
28, 2020, the Company issued an additional 14,037 Class A Units and 6,987 new Class B Units. The combined issuance of Class A Units is 56,086 units and the total issuance of Class B Units is 6,987 units. There are also 42,049 Common Units outstanding for an aggregate number of 105,122 units outstanding comprised of Class A Units, Class B Units and Common Units. The weighted average number of units is based on days outstanding for the reporting period. The Class A Units and Class B Units have a liquidation preference which provides that in the event of a liquidation or deemed liquidation, the Class A and Class B members will receive the return of their capital contributions, reduced by the amount of distributions received, prior to the holders of Common Units receiving any proceeds.
Recently Issued Accounting Pronouncements: In February 2016, Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) No. 2016-02 "Leases" (Topic 842) ("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 Generally Accepted Accounting Principles ("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 are 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 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 | Nine Months Ended | ||||||||||||||
June 30, 2020 | June 30, 2019 | June 30, 2020 | June 30, 2019 | ||||||||||||
Ethanol, net of hedging gain (loss) | $ | 14,025,039 | $ | 21,006,222 | $ | 55,182,772 | $ | 54,649,341 | |||||||
Distillers Grains | 4,360,153 | 3,761,379 | 13,715,936 | 11,253,448 | |||||||||||
Other | 1,751,557 | 1,720,712 | 4,617,670 | 5,290,537 | |||||||||||
Total | $ | 20,136,749 | $ | 26,488,313 | $ | 73,516,378 | $ | 71,193,326 |
Note 3. Inventories
Inventories consist of the following:
June 30, 2020 | September 30, 2019 | ||||||
Raw materials, including corn, chemicals, parts and supplies | $ | 4,051,295 | $ | 4,902,526 | |||
Work in process | 743,619 | 900,459 | |||||
Ethanol and distillers grains | 2,518,485 | 637,731 | |||||
Total | $ | 7,313,399 | $ | 6,440,716 |
Note 4. Revolving Credit Loan
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
9
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
maturity date to June 1, 2020. Effective as of May 29, 2020, the Company and the bank amended the revolving credit loan to extend the maturity date of the revolving credit loan until January 1, 2021. Interest accrues at a variable interest rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate plus 3.75% (3.93% as of June 30, 2020). The Company also pays a commitment fee on the average daily unused portion of the loan at the rate of 0.25% 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 credit agreement. There was an outstanding balance of $0 and $300,000 on the revolving credit loan as of June 30, 2020 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. Effective May 29, 2020, the Company and the bank amended the revolving term loan to modify the step-down reduction of available borrowing capacity to defer the initial step-down reduction of $5,000,000 originally scheduled for October 20, 2020 to October 20, 2021. As amended, the Company’s borrowing capacity under the revolving term loan will reduce by $5,000,000 every year starting October 20, 2021 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% (3.93% as of June 30, 2020). The Company also pays a commitment fee on the average daily unused portion of the loan at the rate of 0.50% 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 agreement. At June 30, 2020 and September 30, 2019, the outstanding balance on the revolving term loan was $23,200,000 and $25,000,000, respectively.
As noted above, the Company and the bank amended the revolving term loan to defer the initial step-down reduction of available borrowing capacity so that the new maximum commitment amount reduction schedule is as follows:
Maximum Commitment Amount | From | Up to and Including |
$20,000,000 | October 20, 2021 | October 19, 2022 |
$15,000,000 | October 20, 2022 | October 19, 2023 |
$10,000,000 | October 20, 2023 | October 1, 2024 |
In connection with the revolving term loan, the Company entered into an Amended and Restated Letter of Credit Promissory Note. The maximum letter of credit commitment of $1,307,525. As of June 30, 2020, the outstanding amount payable by the Company under the letter of credit was $1,307,525.
On April 13, 2020, the Company received a loan in the amount of $505,700 under the new Paycheck Protection Program (the “PPP Loan”) legislation administered by the U.S. Small Business Administration. The PPP Loan may be forgiven based upon various factors, including, without limitation, our payroll cost and certain other approved expenses over an eight to twenty-four week period starting upon our receipt of the funds. Expenses for payroll costs, lease payments on agreements before February 15, 2020, utility payments under agreements before February 1, 2020 and certain other specified costs can be utilized from these funds and eligible for payment forgiveness by the federal government. At least 60% of the proceeds must be used for approved payroll costs, and no more than 40% on non-payroll expenses. Management believes our use of our PPP Loan proceeds for the approved expense categories will generally be fully forgiven if we satisfy certain employee headcount and compensation conditions. The PPP loan has a maturity date April 13, 2022 and management currently believes this loan will be forgiven before maturity. The stated interest rate on this loan is 1% if not forgiven.
Note 6. Liquidity and Management Plans
The Company’s financial statements for the fiscal year ended September 30, 2019 were prepared assuming that the Company would continue as a going concern. However, the Company has experienced an extended period of depressed margins which has resulted in a significant decrease in working capital and cash over those periods and resulted in the Company’s failure to satisfy its financial covenants under its master credit agreement. As detailed in the Company’s Form 10-K for the fiscal year September 30, 2019 (the “2019 Form 10-K”), the Company was not in compliance with certain financial covenants under its master credit agreement as of September 30, 2019. As a result, the Report of Independent Registered Public Accounting Firm included in the Company’s 2019 Form 10-K included an explanatory paragraph regarding the Company’s ability to continue as a going concern. Management also disclosed a going concern uncertainty in the Company’s financial statements included in the Company’s Form
10
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
10-Q for the fiscal quarter ended December 31, 2019 filed with the SEC on February 14, 2020 (the “Q1 2020 Form 10-Q”). During the fiscal second quarter and thereafter, management determined that the previous going concern uncertainty has now been mitigated based on the following:
• | On March 31, 2020, the Company received $5,000,000 million in cash in connection with the issuance of 42,049 new Class A Units. |
• | On April 13, 2020, the Company received $505,700 cash proceeds under the Paycheck Protection Program administered by the U.S. Small Business Administration which is discussed further in Note 5. |
• | On May 28, 2020, the Company received an additional $2.5 million in cash in connection with the issuance of an additional 14,037 Class A Units and 6,987 new Class B Units. |
• | Effective May 29, 2020, the Company and the bank entered into certain amendments to the master credit agreement and loan documents governing the revolving credit loan and the revolving term loan to (i) extend the maturity of the revolving credit loan until January 1, 2021; (ii) defer the initial $5,000,000 step-down reduction in borrowing capacity under the revolving term loan until October 20, 2021 instead of October 20, 2020, (iii) eliminate the application of the debt service |
coverage ratio financial covenant for the fiscal year ending September 30, 2020, (iv) reduce the minimum net worth required in the financial covenants from $25,000,000 to $24,000,000 and increase the minimum working capital required in the financial covenants from $7,500,000 to $10,000,000.
• | The bank provided the Company with a letter waiving past violations resulting from non-compliance with the working capital, net worth and debt service coverage ratio financial covenants from June 30, 2019 through April 30, 2020. |
Based upon the completion of the transactions described above together with the continued effects of our recent capital issuances and our improved liquidity, management believes the previously reported going concern uncertainty has been mitigated.
Note 7. Related-Party Transactions
The Company had the following related-party activity with members during the nine months ended June 30, 2020 and 2019:
Corn Commitment: | |||||||||
June 30, 2020 | |||||||||
Corn Forward Purchase Commitment | Basis Corn Commitment (Bushels) | Commitment Through | Amount Due | ||||||
Related Parties | $ | 1,548,363 | 300,000 | January 2021 | $ | 629,033 |
Corn Purchased: | ||||||
Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Nine Months Ended June 30, 2020 | Nine Months Ended June 30, 2019 | |||
Related Parties | $12,512,644 | $ | 8,781,404 | $41,335,537 | $30,992,085 |
On January 15, 2020, the Company entered into a Management Services Agreement with Husker Ag, LLC (“Husker Ag”) for management services pertaining to the Company’s ethanol facility. Effective April 1, 2020, the Company entered into an Amended and Restated Management Services Agreement (the “Management Agreement”) with HALE, LLC, an affiliate of Husker Ag (“HALE”), which replaced and superseded the original Management Services Agreement between the Company and Husker Ag. Pursuant to the terms of the Management Agreement, HALE now provides management services to the Company’s ethanol facility, including providing the Company with individuals to (a) serve as General Manager, Environmental and Safety Manager, Commodity Risk Manager, and to fill such other positions as may be necessary from time to time; and (b) perform the respective management services for each such position. For three month and nine month period ended June 30, 2020, Lincolnway Energy incurred expenses $242,096 and $389,849 due to Husker Ag LLC for services and out-of-pocket travel expenses. At June 30, 2020 $60,900 was included in accrued expenses on the balance sheet.
Effective March 31, 2020, the Company and HALE entered into a Preferred Membership Unit Purchase Agreement (the “MUPA”) pursuant to which HALE purchased 42,049 new Class A Units of the Company for an aggregate price of $5,000,000. Effective on May 28, 2020, in accordance with the terms of the MUPA, HALE purchased an additional14,037 Class A Units for an aggregate price of $1,669,176. As a result, HALE holds a total of 56,086 new Class A Units. In connection with the investment by HALE
11
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
in the Company and pursuant to the terms of the MUPA and the Company’s current operating agreement, HALE has the right to appoint four of the Company’s seven directors (the “Class A Directors”). The Class A Directors serve until they resign or HALE removes them. The remaining three directors are elected by the members holding Common Units and Class B Units.
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 $14,025,039 and $55,182,772, respectively, for the three and nine months ended June 30, 2020. Revenues with this entity were $21,006,221and $54,627,815, respectively for the three and nine months ended June 30, 2019. Trade accounts receivable of $2,400,244 were due from this entity as of June 30, 2020. As of June 30, 2020, the Company had ethanol unpriced sales commitments with this entity of approximately 14.1 million gallons through September 2020.
The Company has an agreement with an unrelated entity for marketing, selling and distributing all the distillers grains produced by the Company. Revenues from this entity including both distillers grains and corn oil were $4,473,741 and $14,226,207, respectively, for the three and nine months ended June 30, 2020. The revenues from this entity were $3,761,379 and $11,253,448, respectively, for the three and nine months ended June 30, 2019. 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 $758,047 were due from this entity as of June 30, 2020. The Company had distillers grain sales commitments with this entity of approximately 25,430 tons, for a total sales commitment of approximately $3.1 million.
As of June 30, 2020, the Company had purchase commitments for corn forward contracts with various unrelated parties, totaling approximately $397,592. These contracts matured on July 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 June 30, 2020, the remaining commitment was approximately $1.3 million.
As of June 30, 2020, the Company had purchase commitments for natural gas basis contracts with an unrelated party totaling 395,313 MMBtu's maturing at various dates through October 2020.
Effective October 1, 2019, the Company adopted ASU 2016-02 regarding Leases. 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 June 30, 2020 and 2019 was approximately $470,000 and $497,000, respectively. Rent expense for the operating leased during the nine months ended June 30, 2020 and 2019 was approximately $1,489,000 and $1,540,000, respectively. The lease agreements have maturity dates ranging from June 2021 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 June 30, 2020 is $5,711,404.
12
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
_____________________________________________________________________________________________________
At June 30, 2020, the Company had the following approximate future minimum rental commitments through September 30 of each year:
2020 | $ | 466,125 | |
2021 | 1,853,440 | ||
2022 | 1,581,044 | ||
2023 | 1,286,169 | ||
2024 | 982,275 | ||
Thereafter | 513,450 | ||
Total | $6,682,503 |
A reconciliation of the undiscounted future payments in the schedule above and the lease liability recognized in the balance sheet as of June 30, 2020 is shown below:
Undiscounted future payments | $ | 6,682,503 | |
Discount effect | 1,045,542 | ||
$ | 5,636,961 |
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:
June 30, 2020 | September 30, 2019 | ||||||
Derivative assets - corn contracts | $ | 43,300 | $ | 531,875 | |||
Derivative liabilities - corn contracts | (121,687 | ) | (93,650 | ) | |||
Cash due from (due to) broker | 134,789 | (249,531 | ) | ||||
Total | $ | 56,402 | $ | 188,694 |
13
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
The effects on operating income from derivative activities are as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||
June 30, 2020 | June 30, 2019 | June 30, 2020 | June 30, 2019 | ||||||||||||
Gains in revenues due to derivatives related to ethanol sales: | |||||||||||||||
Realized gain | $ | — | $ | — | $ | — | $ | 21,525 | |||||||
Total effect on revenues | — | — | — | 21,525 | |||||||||||
Gains (losses) in cost of goods sold due to derivatives related to corn costs: | |||||||||||||||
Realized gain (loss) | 601,750 | (444,267 | ) | 1,635,018 | 327,033 | ||||||||||
Unrealized (loss) | (430,088 | ) | (561,425 | ) | (713,738 | ) | (971,738 | ) | |||||||
Total effect on corn cost | 171,662 | (1,005,692 | ) | 921,280 | (644,705 | ) | |||||||||
Gains in cost of goods sold due to derivatives related to natural gas costs: | |||||||||||||||
Realized gain | — | — | — | 13,660 | |||||||||||
Unrealized gain | — | — | — | 3,460 | |||||||||||
Total effect on natural gas cost | — | — | — | 17,120 | |||||||||||
Total effect on cost of goods sold | 171,662 | (1,005,692 | ) | 921,280 | (627,585 | ) | |||||||||
Total gain due to derivative activities | $ | 171,662 | $ | (1,005,692 | ) | $ | 921,280 | $ | (606,060 | ) |
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.
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 the Company's financial assets and financial liabilities carried at fair value.
14
Lincolnway Energy, LLC
Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Derivative financial instruments: Commodity futures and exchange-traded commodity options contracts are reported at fair value utilizing Level 1 inputs. For these contracts, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the CME and NYMEX markets. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the over-the-counter markets.
The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2020 and September 30, 2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
June 30, 2020 | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets, derivative financial instruments | $ | 43,300 | $ | 43,300 | $ | — | $ | — | ||||||||
Liabilities, derivative financial instruments | $ | 121,687 | $ | 121,687 | — | — | ||||||||||
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 | $ | — | $ | — |
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
15
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; |
• | 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; Trade actions by the Trump Administration, particularly those affecting the agriculture sector and related industries; and |
• | Disruption caused by health epidemics, such as the novel strain of the coronavirus, and the adverse impact of such epidemics on global economic and business conditions. |
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
16
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.
Impact of COVID-19 on our Business
A novel strain of coronavirus (“COVID-19”) was first identified in Wuhan, China in December 2019 and on March 11, 2020, the World Health Organization characterized the spread of COVID-19 as a pandemic. Since then, several world governments, including the United States and many individual states and municipalities, have imposed lock downs, self-quarantine requirements, and travel restrictions on their citizens. These actions have dramatically decreased the demand for and price of blended gasoline across the globe and in the United States. Because the United States requires ethanol to be blended into the nation’s fuel supplies, gasoline consumption and demand plays a key role in the demand for and price of ethanol.
Operations
In April, at the beginning of this quarter, we conducted our annual maintenance shutdown as planned. Because of COVID-19 we elected to extend the shutdown an additional five days. As a result of health concerns associated with bringing vendors and service providers to our plant, our maintenance and plant staff performed the maintenance. When the plant started back up, production levels increased, energy consumption was reduced and plant operational performance showed increased efficiencies. By the end of the third quarter, the plant was operating at an annualized production rate of 80 million gallons a year, our natural gas consumption rate decreased to an estimated 23,000 BTUs per gallon and our electricity usage dropped to a half a kilowatt per gallon.
We have also been working to improve our dry distiller grains product over the past months. Instead of producing and shipping a 92-ton product in a single rail car, we improved the weight of the product to nearly 105 tons in that same single rail car. In addition, during the COVID-19 pandemic, we have continued to produce CO2 which was needed by municipalities and food processing plants.
The global COVID-19 pandemic has resulted in a materially increased demand for hand sanitizer and a shortage in inventory. As a result, pursuant to temporary regulatory relief issued by the U.S. Food and Drug Administration (“FDA”) in light of the COVID-19 pandemic inventory shortage, several ethanol plants and industrial chemical companies implemented a process to turn ethanol into hand sanitizer for medical and consumer applications. However, in June 2020, the FDA prohibited certain ethanol plants without specialized purification processes in place from producing and distributing hand sanitizer by limiting chemicals permitted in the finished product and as a result forced such ethanol plants to halt production and cancel supply agreements. We will continue to monitor the demand for hand sanitizer and both the applicable FDA and EPA regulations that could potentially create opportunities for the Company in the future.
During the last several years, the Company, along with the ethanol industry as a whole, have experienced significant adverse conditions as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels which
17
negative market conditions have been compounded by the impact of COVID-19. Despite the increased plant efficiencies we have achieved during the global pandemic, the long-term impact of the pandemic on the Company and the ethanol industry is uncertain and therefore, management plans to continue to monitor COVID-19 developments and economic conditions within the market and make adjustments accordingly.
Employee Health and Safety
From the earliest signs of the outbreak, we have taken proactive, aggressive action to protect the health and safety of our employees, customers, partners and suppliers. We enacted appropriate safety measures based on guidance from the Iowa governor’s office, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present at the plant, staggering schedules and shifts for those that must be on-site to perform their work, extensively and frequently disinfecting our workspaces. We expect to continue to implement these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, partners and suppliers.
Supply and Demand Impact
Although we continue to regularly monitor the financial health of companies in our supply chain, financial hardship on our suppliers or sub-suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to produce our products, adversely affecting our operations, even when operating at reduced production levels. Additionally, restrictions or disruptions of transportation, such as reduced availability of truck, rail or air transport, port closures and increased border controls or closures, may result in higher costs and delays, both on obtaining raw materials and shipping finished products to customers, which could harm our profitability, make our products less competitive, or cause our customers to seek alternative suppliers.
The COVID-19 outbreak has significantly increased economic and demand uncertainty. We anticipate that the current outbreak or continued spread of COVID-19 will cause a global economic slowdown, and it is possible that it could cause a global recession. In the event of a recession, demand for our products would decline and our business would be adversely affected.
Paycheck Protection Program Loan
On April 13, 2020, the Company received a loan in the amount of $505,700 under the new Paycheck Protection Program ("PPP Loan") legislation passed in response to the economic downturn triggered by COVID-19 and administered by the U.S. Small Business Administration. Our PPP Loan may be forgiven based upon various factors, including, without limitation, our payroll cost and certain other approved expenses over an eight to twenty-four week period starting upon our receipt of the funds. Expenses for payroll costs, lease payments on agreements before February 15, 2020, utility payments under agreements before February 1, 2020 and certain other specified costs can be utilized from these funds and eligible for payment forgiveness by the federal government. At least 60% of the proceeds must be used for approved payroll costs, and no more than 40% on non-payroll expenses. Management believes our use of our PPP Loan proceeds for the approved expense categories will generally be fully forgiven if we satisfy certain employee headcount and compensation conditions.
Outlook
Although there is uncertainty related to the anticipated impact of the recent COVID-19 outbreak on our future results, we believe our current cash reserves, cash generated from our operations, cash generated from the issuance of new Class A Units and new Class B Units, our PPP Loan and the available cash under our amended revolving credit loan and our amended revolving term loan leave us well-positioned to manage our business through this crisis as it continues to unfold. However, the impacts of the COVID-19 pandemic are broad-reaching and the financial impacts associated with the COVID-19 pandemic include, but are not limited to, reduced production levels, lower net sales and potential incremental costs associated with mitigating the effects of the pandemic, including storage and logistics costs and other expenses. As a result, although we were in compliance with our financial covenants set forth in our amended master credit agreement (the "Credit Agreement") with Farm Credit Services of America, FLCA, Farm Credit Services of America, PCA and CoBank, ACB as of June 30, 2020, the impact the COVID-19 pandemic could have an adverse impact on our operating results which could result in our inability to comply with certain of these financial covenants and require our lenders to waive compliance with, or agree to amend, any such covenant to avoid a default. However, based on our current forecast of market conditions and our financial performance together with the amended financial covenants set forth in our Credit Agreement effective as of June 30, 2020, we expect that we will be in a position to satisfy all of the financial covenants in our Credit Agreement for the next twelve months.
18
The COVID-19 pandemic is ongoing, and its dynamic nature, including uncertainties relating to the ultimate geographic spread of the virus, the severity of the disease, the duration of the pandemic, and actions that would be taken by governmental authorities to contain the pandemic or to treat its impact, makes it difficult to forecast any effects on our results for the fiscal year ended September 30, 2020 (“Fiscal 2020”). Despite the positive financial performance achieved by the Company during the third quarter of Fiscal 2020, the challenges posed by the COVID-19 pandemic on the ethanol industry and the global economy continued throughout the third quarter of Fiscal 2020 and as of the date of this filing, management does not anticipate material improvement in the macroeconomic environment and, as a result our results for Fiscal 2020 may be significantly affected.
Despite the economic uncertainty resulting from the COVID-19 pandemic, we intend to continue to focus on strategic initiatives designed to improve on our operational efficiencies and diversify our products which is critical in order to drive positive results in a negative margin environment. We believe that consolidation within the ethanol industry, coupled with our location, good operating efficiencies and our solid team may provide new opportunities for our plant.
We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of COVID-19 on our financial condition, results of operations or cash flows in the future.
Recent Events
Preferred Membership Unit Purchase Agreement
Effective March 31, 2020, we entered into a Preferred Membership Unit Purchase Agreement (the “MUPA”) with HALE, LLC (“HALE”), an affiliate of Husker Ag, LLC (“Husker Ag”). Under the MUPA, HALE purchased 42,049 new Class A Units of the Company for an aggregate price of $5,000,000, or $118.91 per Class A Unit. Pursuant to the terms of those Class A Units, HALE, and by affiliation Husker Ag, has the right to approve certain actions customary for holders of senior equity, more specifically set forth in the Fourth Amended and Restated Operating Agreement (as defined below). The Class A Units have equal rights to distributions as other units of the Company, but, for distributions as a result of a liquidation (and deemed liquidation) holders of Class A Units will first receive the amount of their capital contributions (reduced by the amount of distributions received) prior to any other unit holders receiving any proceeds. Additionally, the Class A Unit holders are entitled to appoint four of the seven directors on the Company’s board of directors. As a condition to HALE’s obligations under the MUPA, the Company and HALE executed the Management Agreement (defined below), and the Company entered into the Fourth Amended and Restated Operating Agreement (defined below).
Amended and Restated Management Services Agreement
On January 15, 2020, we entered into a Management Services Agreement with Husker Ag for management services pertaining to our ethanol facility. Effective April 1, 2020 and pursuant to the terms of the MUPA, we entered into an Amended and Restated Management Services Agreement (the “Management Agreement”) with HALE which replaced and superseded the original Management Services Agreement. Pursuant to the terms of the Management Agreement, HALE now provides management services to our ethanol facility, including providing us with individuals to (a) serve as General Manager, Environmental and Safety Manager, Commodity Risk Manager, and to fill such other positions as may be necessary from time to time; and (b) perform the respective management services for each such position.
The initial term of the Management Agreement is twelve months from the Effective Date. 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 days prior to the expiration of the then-current term. 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 HALE or Husker Ag acquires control of the Company, either party has the right to terminate the Management Agreement upon ninety days written notice. During the initial term of the Management Agreement, we will pay HALE 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, we will pay HALE, on a monthly basis, an amount equal to 50% of the total salary, bonuses, benefits, expenses and costs incurred by the HALE and 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 HALE fiscal year.
Third Amended and Restated Operating Agreement of Lincolnway Energy, LLC
19
Effective as of March 30, 2020, the Company entered into the Third Amended and Restated Operating Agreement of the Company (the “Third Amended and Restated Operating Agreement”). The material terms of and changes made in the Third Amended and Restated Operating Agreement were previously disclosed to the members of the Company in the “PROPOSALS TO AMEND OUR OPERATING AGREEMENT” section of the Company’s 2020 Proxy Statement, filed with the SEC on February 28, 2020. These changes were approved by the members of the Company at the Special Meeting of the members on March 23, 2020.
Fourth Amended and Restated Operating Agreement of Lincolnway Energy, LLC
Effective as of April 1, 2020 the Company entered into the Fourth Amended and Restated Operating Agreement of the Company (the “Fourth Amended and Restated Operating Agreement”). The adoption of the Fourth Amended and Restated Operating Agreement was a condition precedent to HALE’s obligations under the MUPA. The Fourth Amended and Restated Operating Agreement contains material changes from the Third Amended and Restated Operating Agreement, including the following:
• | The Fourth Amended and Restated Operating Agreement provides for two new classes of units in the Company: Class A Units and Class B Units. HALE holds all Class A Units and is the sole Class A Member. The holders of the Class A Units and the Class B Units, the Class A Member and Class B Members, respectively, will share in operating distributions of the Company on the same basis as other members and will have the same number of votes as other members on issues presented to all members. The Class A Member and Class B Members, however, have certain rights that are not shared by the holders of the Company’s preexisting units-now called “Common Units.” These rights include, among other things, the following: |
◦ | a liquidation preference pursuant to which in the event of a liquidation (or Deemed Liquidation) the Class A Member and Class B Members will receive the return of their capital contributions, reduced by the amount of distributions received, prior to the Common Members receiving any proceeds. A “Deemed Liquidation” as defined in the Fourth Amended and Restated Operating Agreement includes a sale of all or substantially all of the Company’s assets in a single transaction or a series of transactions or a merger or consolidation of the Company with any other company or other transaction in which the holders of the Company's voting power prior to the transaction will hold less than 50% of the voting power of the surviving entity; and |
◦ | a class voting provision, providing that the Company cannot alter any provision of the Certificate of Organization or then current operating agreement if it would adversely alter the rights, preferences, privileges or powers of or restrictions on the Class A Units or Class B Units without the majority vote of the outstanding units affected thereby. |
• | The Class A Member has special approval rights, meaning that the Company cannot take any of the following actions without the approval of the majority of the outstanding Class A Units, which include the following: |
◦ | create or authorize the creation of or issue any other security convertible into or exercisable for any equity security, having rights, preferences or privileges senior to or on parity with the Class A Units, or increase the authorized number of Class A Units; |
◦ | approve any merger, sale of assets or other reorganization or acquisition; |
◦ | approve the purchase, redemption or other acquisition of any Common Units of the Company, other than repurchases pursuant to unit restriction agreements approved by the Company’s board of directors upon termination of a consultant, director or employee; |
◦ | declare or pay any distribution with respect to any capital units prior to the Class A Units (except as otherwise provided in the Fourth Amended and Restated Operating Agreement); |
◦ | incur or guaranty indebtedness for borrowed money in excess of $25,000,000; |
◦ | create or hold capital units in any subsidiary that is not a wholly-owned subsidiary or dispose of any subsidiary units or all or substantially all of any subsidiary assets; |
◦ | increase or decrease the size of the Company’s board of directors; |
◦ | make any material change to the Company's business, or |
◦ | approve the liquidation or dissolution of the Company. |
• | The Class A Member has certain preemptive rights, including the right to acquire its pro rata portion of any future issuances of units in the Company meaning that the Class A Member is protected from dilution of its interest by the issuance of additional units so long as it elects to exercise the preemptive right. However, this preemptive right did not apply to the private offering and resulting issuance of Class B Units discussed below under the section entitled “Additional Equity Issuances” and discussed further below in “Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds”. |
• | The Company’s board of directors has been substantially restructured. Previously the Company’s board of directors had nine members split into three separate classes, each elected for staggered three-year terms. As of March 31, 2020, the |
20
Company had eight directors in office, and one vacancy. Now the Company’s board of directors is composed of seven directors, four of whom are appointed solely by the Class A Member and are called “Class A Directors”, and three of whom are nominated and elected by the Common Members and Class B Members collectively and are called “Elected Directors”. The Class A Directors serve until they resign, or the Class A Member removes them. The Elected Directors, other than those presently in office as of the date the Fourth Amended and Restated Operating Agreement was entered into, will generally be arranged into three classes, with one director in each class, each elected for staggered three-year terms.
◦ | The four new Class A Directors appointed to the Company’s board of directors by the Class A Member, HALE, effective April 1, 2020, were are Robert Brummels, Dan Heard, James Krause, and Marvin Stech. All these individuals are also directors of HALE and Husker Ag. |
◦ | The Elected Directors are three persons who were already members of the Company’s board of directors. They are Jeff Taylor, Bill Couser, and Rick Vaughan. Jeff Taylor will continue serving as an Elected Director until the 2022 annual meeting of the members, at which time he will be eligible for election to a three-year term expiring in 2025. Bill Couser will continue serving as an Elected Director until the 2022 annual meeting of the members, at which time he will be eligible for election to a two-year term expiring in 2024, with three-year terms available thereafter. Rick Vaughan will continue serving as an Elected Director until the 2023 annual meeting of the members, at which time he will be eligible for election to a three-year term expiring in 2026. |
• | The quorum requirements for meetings of the Company’s members have been changed such that members represented in person or by proxy or written ballot at any meeting of the members holding at least twenty-five percent of the outstanding units (which shall include Members holding at least twenty-five percent of the outstanding Common Units and Class B Units, in the aggregate and, with respect to any matter upon which the Class A Units are entitled to vote, shall include Members holding at least twenty-five percent of the outstanding Class A Units) shall constitute a quorum. |
• | The Fourth Amended and Restated Operating Agreement contains modifications to various provisions to expressly authorize and provide for “virtual” meetings of the members to take place by means of remote communications. |
Resignation of Five Existing Directors
In connection with the restructuring of the Company’s board of directors pursuant to the Fourth Amended and Restated Operating Agreement, five of the Company’s directors resigned, effective April 1, 2020. These directors were Douglas Moore, James Dickson, Brian Conrad, Timothy Fevold, and Kurt Olson. These resignations were not the result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices.
Change of Control of the Company
On April 1, 2020, upon the Company’s entry into the Fourth Amended and Restated Operating Agreement and issuance of the Class A Units to HALE pursuant to the terms of the MUPA, and in connection with the execution of the Management Agreement, a change of control occurred in the Company. Upon the occurrence of those events, HALE obtained control of the Company, which control was assumed from the Common Members of the Company who previously controlled it. Pursuant to the issuance of the Class A Units in accordance with the MUPA, the terms of Management Agreement, and the terms of the Fourth Amended and Restated Operating Agreement, HALE’s basis of control is that it presently (a) owns all of the outstanding Class A Units; (b) owns fifty percent of the Company’s outstanding equity securities; (c) has the right, as the sole Class A Member, to unilaterally elect a majority of the Company’s board of directors; (d) has the right to approve or prevent certain corporate actions as discussed above; and (e) will appoint persons to act as the Company’s General Manager, Environmental and Safety Manager, Commodity Risk Manager, and to fill such other positions as may be necessary from time to time.
HALE obtained control of the Company in consideration of the $5,000,000 investment that it made pursuant to the MUPA in exchange for 42,049 Class A Units, at a per unit price of $118.91.
Additional Equity Issuances
On May 28, 2020, the Company closed its previously announced private offering of up to $2,500,000 of Class B Units to its existing members who are “accredited investors” (such members “Existing Accredited Members”), as such term is defined in Rule 501 of Regulation D, promulgated by the SEC (the “Class B Offering”). In connection with the Class B Offering, the Company sold 6,822 Class B Units to Existing Accredited Members for an aggregate purchase price of $811,204, at a per unit price of
21
$118.91. In addition, on May 28, 2020, the Company also agreed to sell, and subsequently sold, 165 Class B Units to LKPK Holdings, LLC, a Nebraska limited liability company, for a purchase price of $19,620, at a per unit price of $118.91.
Pursuant to the terms of the MUPA, HALE agreed to make an additional equity investment in the Company to offset any shortfall from the $2,500,000 in the Class B Offering. Under the MUPA, HALE agreed to contribute cash to the Company in exchange for additional Class A Units in an amount equal to any shortfall in the $2,500,000 that the Company sought to raise in the Class B Offering discussed above which guaranteed that the Company would receive a cumulative total capital infusion of $7,500,000 from the MUPA and the Class B Offering transactions. In accordance with the terms of the MUPA, on May 28, 2020, the Company sold an additional 14,037 Class B Units to HALE for a purchase price of $1,669,176, at a per unit price of $118.91.
The table below sets forth the equity ownership in the Company by class of units outstanding upon the completion of the restructuring and equity issuances discussed above under the section entitled “Recent Events:”
Class of Units | Total Units Outstanding | Percentage Ownership |
Common Units | 42,049 | 40% |
Class A Units | 56,086 | 53% |
Class B Units | 6,987 | 7% |
TOTAL | 105,122 | 100% |
Ethanol Supply and Demand
The ethanol industry has been dramatically affected by COVID-19 from the middle of January 2020 through April of 2020. The ethanol industry is still responding to the uncertainty of consumer driving patterns with the stay at home orders enacted by federal, state and local government authorities as well as the stay at home policies maintained by corporate entities. During the first of half of calendar year 2020, many plants in the U.S. have shut down production or cut production levels. According to the Renewable Fuels Association ("RFA"), 75 ethanol plants have been idled, 79 plants are operating at reduced levels and 50 plants are operating near normal capacity. This means 50% of the industry's production capacity is off-line. Adding to the supply/demand imbalance is the stance taken by the Environmental Protection Agency (the "EPA") under the Trump Administration with regard to the issuance of “hardship waivers” to so-called small refineries which is discussed further in the section below entitled "Renewable Fuel Standard".
Domestic ethanol use peaked the week ended of March 6, 2020 at around 14 billion gallons per year as reported by the Energy Information Agency (“EIA”). Domestic ethanol plant production peaked the week ended January 10, 2020 near 16.7 billion annualized as reported by EIA. The industry currently has capacity to produce over 17 billion gallons with approximately 10% of such capacity currently in a long-term idled state. The COVID-19 pandemic became a mainstream news topic during the week ended January 10, 2020. On January 13, 2020 sources such as Apple Mobility started using this date as the base line in tracking consumer mileage patterns. The week ended April 24, 2020, the EIA reported ethanol plant production for 2020 dropped to 49.04% from production as of January 10, 2020. The EIA reported consumption of ethanol dropped to 7.6 billion gallons for the week ended April 3, 2020 which was the first week of the calendar quarter for this reporting period. This low consumption week came four weeks after the EIA reported peak consumption near 14 billion annualized ended March 6, 2020. During this time period several states implemented stay at home restrictions with California restrictions effective March 19, 2020 and states such as Illinois, New Jersey and New York effective shortly thereafter. These restrictions adversely impacted driving habits and gasoline consumption and therefore reduced consumption of ethanol. Additionally, during the week ended April 3, 2020, the domestic inventory level according to the EIA data was near 54 days on hand. This amount is 25 to 30 days higher than historical typical domestic inventory days on hand and highlights the domestic oversupply within the ethanol industry which has been exacerbated by the COVID-19 pandemic.
As we ended the quarter for the week ended July 3, 2020, ethanol production improved to almost 14 billion gallons as reported by the EIA or 83.47% off the peak production week ended January 10, 2020 while consumption improved to 12.9 billion gallons or a 69% consumption increase since the first week of this calendar quarter. Despite the increase in consumption, a significant disparity between domestic production and inventories as compared to domestic consumption remains which could have an adverse impact on market demand and prices. Moreover, the continued impact of the COVID-19 pandemic on the industry, including enhanced or additional stay at home restrictions, could further negatively impact domestic consumption and the demand for, and prices of, ethanol which could adversely impact our financial performance.
Ethanol prices as reported on the Chicago Board of Trade (CBOT) nearby Platts ethanol settlement was $0.81 a gallon on April 1, 2020. This is the lowest price reported in the ethanol industry in at least 20 years. Since April 1, ethanol price has rallied to a
22
nearby close Platts settlement of $1.28 on June 16, 2020. As a second wave of COVID-19 has developed, Platts ethanol nearby settlement has dropped to the $1.20 to $1.25 range.
Even prior to the rise of the COVID-19 pandemic, exports played a critical role in keeping the United States from being awash in production and the critical nature of the export market has intensified as a result of the impact of COVID-19 and the actions of government authorities and corporate businesses. If U.S. exports of ethanol remain low or decline further or unless additional demand can be found in foreign or domestic markets, a continued level of current ethanol stocks or any increase in domestic ethanol supply could further adversely impact the price of ethanol.
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 the country where it is most cost-effective. 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 Renewable Identification Numbers or 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
23
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 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. Although this rule is being challenged in court, 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. On March 11, 2020, the EIA had gasoline consumption for 2020 flat with last year with gasoline prices being 18% lower than in 2019; however, this forecast did not take into account the COVID-19 virus impact on the U.S. economy. The COVID-19 virus will have a significant impact on the U.S. and worldwide economy over the next few months, all unchartered territory that makes forecasting near impossible.
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. 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. 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.
On April 15, 2020, five Governors sent a letter to the EPA requesting a general waiver from the RFS due to the drop in demand caused by COVID-19 travel restrictions. They contend that the compliance costs (i.e. cost to purchase RINs) is onerous and could put some refineries out of business. In June 2020, the Attorneys General of seven sates joined in the request made to waive the 2020 RFS compliance mandate. The EPA has 90 days to respond, and as of this filing had indicated only that they are “watching the situation closely and reviewing the governors’ letter.”
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 June 2020, 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.
24
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. As discussed further below, the Tenth Circuit Court of Appeals ruled that multiple small refinery exemptions were improperly extended by the EPA which caused D6 RIN trading prices to increase to approximately $0.24 per gallon in January 2020. As of June 30, 2020, the EPA has received 52 requests for small refinery waivers that will be up for consideration during 2020. If the EPA approves all 52 of the pending applications, the ethanol market would suffer another loss of 2 billion gallons of biofuel blending requirements which will adversely impact RIN prices and the ethanol market. These waiver requests represent an effort by refineries to bypass the ruling of the Tenth Circuit and establish a continuous chain of exemptions. If the EPA continues to grant discretionary waivers and RIN prices continue to fall, it could negatively affect ethanol prices.
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.
In a supplemental rulemaking to the Proposed 2020 Rule, the EPA changed their approach, and for the first time accounted for the gallons that they anticipate they will be waiving from the blending requirements due to small refinery exemptions. To accomplish this, they are adding in the trailing three year average of gallons the Department of Energy (the "DOE") recommended be waived, in effect raising the blending volumes across the board in anticipation of waiving the obligations in whole or in part for certain refineries that qualify for the exemptions. Although in past years the EPA has disregarded recommendations from the Department of Energy in the rule the DOE stated its intent to adhere to these recommendations going forward, including granting partial waivers rather than an all or nothing approach. The EPA will be adjudicating the 2020 compliance year small refinery exemption applications in early 2021, but have indicated they will adhere to DOE recommendations for the 2019 compliance year applications as well, which should be adjudicated in 2020
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.
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
25
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.
COVID-19 Legislation
In response to the COVID-19 pandemic, Congress passed the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") in late March 2020 in an attempt to offset the subsequent economic damage. The CARES Act created and funded multiple programs that have impacted or could impact our industry. The United States Department of Agriculture ("USDA") was given additional resources for the Commodity Credit Corporation ("CCC") and they are using those funds to provide direct payments to farmers, including corn farmers from whom we purchase most of our feedstock for ethanol production. Similar to the trade aid payments made by the USDA over the past two years, this cash injection for farmers could cause them to delay marketing decisions and increase the price we have to pay to purchase the corn. The USDA did not include any CCC funds for ethanol plants as of this filing.
The CARES Act also provided for the Small Business Administration (the "SBA") to assist companies that constitute small business and keep them from laying off workers. The Paycheck Protection Program (the "PPP") was created and quickly paid out all of the funds appropriated, including some to farmers and to ethanol plants. Although we received our PPP Loan under the CARES Act, as discussed above, the receipt of PPP funds by farmers could, like the CCC funds, incentivize them to delay marketing corn which could increase the price of corn.
Ethanol is the primary ingredient in hand sanitizer. The CARES Act provided a tax exclusion on the shipment of undenatured ethanol for use in manufacturing hand sanitizer. The FDA originally provided expanded guidance to allow for more denaturants to be used in ethanol intended for hand sanitizer production, and expanded the grades of ethanol allowed for the duration of the public health crisis. However, in June 2020, the FDA prohibited certain ethanol plants without specialized purification processes in place from producing and distributing hand sanitizer by limiting chemicals permitted in the finished product and as a result forced such ethanol plants to halt production and cancel supply agreements.
Executive Summary
Highlights for the three months ended June 30, 2020, are as follows:
•Total revenues decreased $6.4 million compared to the 2019 comparable period.
•Total cost of goods sold decreased $9.3 million, compared to the 2019 comparable period.
•Net income was $303,248, which represents an increase in net income of $7.1 million when compared to the net loss of $7.4 million for the 2019 comparable period.
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 through three months and nine months ended June 30, 2020 and 2019 (dollars in thousands):
26
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||
Income Statement Data | 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||||||
Revenue | $20,136 | 100.0 | % | $26,488 | 100.0 | % | $73,516 | 100.0 | % | $71,193 | 100.0 | % | ||||||||||||||||
Cost of goods sold | 18,816 | 93.4 | % | 28,137 | 106.2 | % | 73,173 | 99.5 | % | 77,337 | 108.6 | % | ||||||||||||||||
Gross profit (loss) | 1,320 | 6.6 | % | (1,649 | ) | (6.2 | )% | 343 | 0.5 | % | (6,144 | ) | (8.6 | )% | ||||||||||||||
General and administrative expenses | 766 | 3.8 | % | 1,028 | 3.9 | % | 2,531 | 3.4 | % | 2,773 | 3.9 | % | ||||||||||||||||
Bad debt expense | — | — | % | 4,385 | 17.0 | % | — | — | % | 4,385 | 6.2 | % | ||||||||||||||||
Operating income (loss) | 554 | 2.8 | % | (7,062 | ) | (26.6 | )% | (2,188 | ) | (2.9 | )% | (13,302 | ) | (18.7 | )% | |||||||||||||
Other income (expense), net | (251 | ) | (1.2 | )% | (333 | ) | (1.3 | )% | (662 | ) | (0.9 | )% | 2,640 | 3.7 | % | |||||||||||||
Net income (loss) | $ | 303 | 1.6 | % | $ | (7,395 | ) | (27.9 | )% | $ | (2,850 | ) | (3.8 | )% | $ | (10,662 | ) | (15.0 | )% |
Results of Operations for the Three Months Ended June 30, 2020 as Compared to the Three Months Ended June 30, 2019.
Revenues. Total revenues decreased for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. For the three months ended June 30, 2020 ethanol sales decreased by 33% and sales from co-products increased by 10.5%. The change in ethanol revenue was a result of a decrease in the price per gallon driven by the impact of the COVID-19 pandemic and a reduction in ethanol gallons sold due to decreased demand also principally driven by the impact of the COVID-19 pandemic. The Company sold 18% fewer gallons of ethanol during the three months ended June 30, 2020, when compared to the three months ended June 30, 2019. The COVID-19 pandemic significantly and adversely impacted the price of ethanol during March, April and May of 2020.
Sales from co-products increased by 10.5% for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. 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 and carbon dioxide revenue. Distillers grain revenue increased as market prices increased due to reduced supply as a result of idled ethanol plant production capacity due to COVID-19. The additional increase in distillers grains revenue related to improvement in plant production efficiencies resulting in premium rail market sales due to 105 ton railcars being delivered instead of low 90 ton rail cars which previously resulted in a discounted price per ton as compared to premium rail market sales.
Cost of goods sold. Cost of goods sold decreased by 33%, or approximately $ 9.3 million, for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. The decrease was due to lower corn costs, lower ingredient usage, reduced energy related costs, lower repair and maintenance costs, and reduced labor expense. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas costs, electricity, production labor, repairs and maintenance, and depreciation.
Corn costs, including hedging, decreased $5.6 million, or 27.9%, for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The decrease resulted from a 13.8% decrease in the price of corn. For the three months ended June 30, 2020 corn costs included a derivatives gain of $0.172 million compared to a $1 million net loss for derivatives relating to corn costs in the same quarter for the prior year. Corn costs represented 78.8% of cost of goods sold for the three months ended June 30, 2020 compared to 73.7% for the three months ended June 30, 2019.
Repairs and maintenance decreased approximately 45%, or $.411 million for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. The decrease was due an increased effort from internal maintenance staff completing required maintenance services instead of paying contractors to perform such services.
Depreciation expense remained flat for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. The stabilized depreciation during the third quarter of Fiscal 2020 can be attributed to minimal capital improvement spent on the plant.
General and administrative costs decreased by $262,000, or 25%, for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. The decrease is due to a combination of costs savings measured by management during the three months ended June 30, 2020.
27
Results of Operations for the Nine Months Ended June 30, 2020 as Compared to the Nine Months Ended June 30, 2019
Revenues. Revenues increased by $2.1 million, or 3.3%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. Ethanol sales increased $.555 million, or 1%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The change in ethanol revenue was a result of a $0.01 decrease in the price per gallon received as well as a 1.9% increase in sales volume for the nine months ended June 30, 2020 when compared to the nine months ended June 30, 2019. Sales volume increased 1.9% as production run rates improved due to conversion yields and efficiencies resulting from measures implemented during the winter of 2019. During the nine months ended June 30, 2020 there were no derivatives related to ethanol sales, compared to a $21,525 net gain in the prior period.
Sales from co-products increased by 14%, or $2.2 million for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. Co-product revenue increased primarily due to a 28.2% increase in dried distillers grains revenue for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The additional increase in distillers grains revenue related to improvement in plant production resulting in premium rail market sales due to 105 ton railcars being delivered instead of low 90 ton rail cars which previously resulted in a discounted price per ton as compared to premium rail market sales.
Cost of goods sold. Cost of goods sold decreased $4.2 million for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The decrease was primarily due to decrease in corn costs ingredients, energy related expenses, repairs and maintenance, and labor. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas, electricity, production labor, repairs and maintenance, and depreciation.
Corn costs, including hedging, decreased by $5.2 million, or 9.6%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. During the nine months ending June 30, 2020 corn bushels consumed increased because of increasing the plants run rates and higher ethanol production in the amount of 855 thousand bushels. This increased in bushel increased corn cost $3 million or 5.7%. For the nine months ended June 30, 2020, corn costs included a $56,000 net gain for derivatives relating to future contracts, compared to a $0.6 million loss for the nine months ended June 30, 2019. The additional factor in the increased corn cost was a $0.1 per bushel increase price paid for the nine months ended June 30, 2020 compared to the comparable period ending 2019. Corn costs represented 67% of cost of goods sold for the nine months ended June 30, 2020, compared to 70.2% for the nine months ended June 30, 2019.
Repairs and maintenance decreased by $1.6 million, or 30.7%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The decrease was due the utilization of Company maintenance staff to perform the necessary maintenance work instead of hiring outside contractors as part of managements increased focus on cost control.
Depreciation expense decreased approximately $0.5 million, or 88%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. Depreciation decrease is based on the normal useful life and not adding new capital projects.
General and administrative costs decreased by $242,000, or 8.7%, for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The decrease is due to a combination of costs savings measures by management during over the past six months for the quarter ending June 30, 2020.
Other income decreased $3 million for the nine months ended June 30, 2020 as compared to the nine months ended June 30, 2019. The decrease is due to approximately $3 million one time settlement payment received in exchange for the early termination of a contract.
Industry Factors that May Affect Future Operating Results
During the three months ended June 30, 2020, the economic uncertainty relating to the COVID-19 pandemic continues to impact the ethanol industry resulting in decreased prices for production output due to uncertain demand. Likewise, corn feedstock price has also decreased when compared to corn prices over the last few years however since demand for ethanol is uncertain, Management continues to believe that buying corn from month to month is the best strategy in case the market experiences further decreased in and resulting production decreases over those we have experienced over the past five months.
As the COVID-19 pandemic continues to spread throughout the United States and worldwide, in an effort to contain the spread of this virus, there have been various government mandated restrictions, in addition to voluntary privately implemented restrictions, including limiting public gatherings, retail store closures, restrictions on employees working and the quarantining of people who may have been exposed to the virus. The duration of the resulting downturn in economic activity is unknown both on a macro and a micro level and has
28
led to historically low ethanol pricing such that it is currently unprofitable to operate our ethanol plants at such levels. Consequently, we reduced our plants operating production capacity before and after our planned maintenance shutdown which we extended to 10 days from the normal five days and completed using internal staff rather than third parties. The impacts of COVID-19 on our business operations, including the duration and impact on ethanol demand cannot be reasonably estimated at this time, although a prolonged reduction in production or potential stoppage at our plant would have a material adverse impact on our results of operations, financial condition and cash flows in Fiscal 2020. Management will continue to support efforts to contain the spread of the virus and evaluate and implement strategies relating to staffing, production and operations as it deems appropriate.
During the quarter ended June 30, 2020, corn pricing averaged $3.23 at the nearby daily settlement on CBOT with the max settled price on the nearby contract was $3.39 and the minimum was $3.03 The 2020 planting season provided ideal weather for corn compared to the challenging weather conditions experienced during past five years. The June 11, 2020 USDA report increased the ending 2019 corn inventory by 2.1 billion bushels and also projects the 2020 corn inventory at 3.3 billion bushels. These increases, coupled with potentially less consumption by ethanol plants, decreased world exports along with decreased demand for corn as feed for livestock and poultry, is driving corn prices lower on the CBOT. Cash basis levels moved in favor of the ethanol plant as farm selling occurred so corn did not go out of condition in the grain bin plus the uncertainty of future corn pricing due to COVID-19. The Company is expecting corn origination to remain steady or improve since USDA is projecting a larger than normal corn inventory supply. The Company plans to monitor the weather over the next three months and will adjust its corn buying strategy as corn production becomes better known.
The forward environment for the U.S. ethanol industry is still very much in question as the Company enters the final half of Fiscal 2020 because of COVID-19. If the pandemic continues or we experience a second wave and stay at home restrictions are not re-implemented by government authorities and/or are not rescinded by domestic businesses, the demand for ethanol will continue to be materially adversely effected. During the past six months, management has improved the production process of ethanol by lowering our costs and operating more efficiently. These operating process improvements have increased production capacity as well allowing for production rates of 6.7 million gallons a month compared to year ago when the plant was producing between 5 to 5.2 million gallons per month. Despite these substantial improvements in production efficiencies, if COVID-19 continues to adversely impact the demand and price for ethanol, our financial performance will also be adversely impacted. 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. Despite the potential positive impact of E15 sales in the future, management 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.
The EPA continues to grant extensive small refinery exemptions which has an immediate impact on ethanol demand and demonstrates the ongoing support of the current administration for the fossil fuel industry and continuing hostility towards the ethanol industry. Management currently believes that our margins will remain tight to negative in light of mixed signals on support for the RFS and the continued granting of small refinery waivers by the EPA. In addition, the continued effect of the COVID-19 pandemic on the economy is expected to have a substantial negative impact on demand, which could adversely impact our profitability during the balance of Fiscal 2020. Tightening of corn supplies and continued over production of domestic ethanol may also impact operating margins and our profitability. This negative impact could worsen in the event that domestic ethanol inventories remain high, or if U.S. exports of ethanol remain low or decline further. Unless additional demand can be found in foreign or domestic markets, a continued level of current ethanol stocks or any increase in domestic ethanol supply could further adversely impact the price of ethanol.
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.
Corn oil prices started to recover during the beginning of the 2020 and the price received remains higher than the previous year. 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, the reinstated Blenders
29
Tax Credit of $1.00 per gallon may 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
Credit Agreement Amendments
Effective May 29, 2020 (the “Effective Date”) the Company entered into an amendment (the “Amendment”) to its Credit Agreement with Farm Credit Services of America, FLCA and Farm Credit Services of America, PCA (collectively, the “Lender”) dated July 3, 2017, as previously amended February 23, 2018 (the “Credit Agreement”). CoBank, ACB (“CoBank”) continues to have a participation interest in the underlying loans issued under the Credit Agreement and continues to serve as administrative agent for the Credit Agreement. The Amendment modifies the working capital, net worth and debt service coverage ratio financial covenants in the Credit Agreement as follows:
• | Working Capital. The working capital financial covenant is modified to increase the minimum working capital the Company is required to have at the end of each financial statement period. Pursuant to the Amendment the Company must have an excess of current assets over current liabilities of not less than $10,000,000 (“Working Capital Amount”); except that in determining (a) current assets, any amount available under any revolving term promissory note with Lender under the Credit Agreement may be included, and (b) current liabilities, any amount of revolving promissory note with Lender under the Credit Agreement considered a non-current liability and any amount of previous operating lease(s) now reflected as a current liability may be excluded (all as determined in accordance with the Accounting Standards (as defined in the “Credit Agreement”)). The Working Capital Amount was previously $7,500,000. |
• | Net Worth. The net worth financial covenant is modified to reduce the net worth amount the Company is required to have at the end of each financial statement period. Pursuant to the Amendment, the Company must have an excess of total assets over total liabilities of not less than $24,000,000 (all as determined in accordance with the Accounting Standards) (the “Net Worth Amount”), and a specified receivable is excluded. The Net Worth Amount was previously $25,000,000. |
• | Debt Service Coverage Ratio. The language of this financial covenant is modified to provide that the application of this covenant to the Company does not commence until the fiscal year ending September 30, 2021 and to provide that commencing with the fiscal year ending September 30, 2021, the Company shall not have a Debt Service Coverage Ratio of less than 1.50 to 1.00. Under the Amendment, the definition of Debt Service Coverage Ratio is modified to mean: (a) net income (after taxes), plus depreciation and amortization, minus non-cash income from patronage/investments, minus extraordinary gains (plus losses), minus gains (plus losses) on asset sale; divided by (b) $5,000,000 (all as determined in accordance with the Accounting Standards). |
In addition, the Amendment modified the dividend and distributions negative covenant set forth in the Credit Agreement to provide increased financial limitations on the ability of the Company to declare or pay dividends or distributions to its members. Under the Amendment, the Company may not declare or pay any dividends or purchase, redeem, retire or otherwise acquire for value any of its capital stock, or allocate or otherwise set apart any sum for any of the foregoing, except that beginning with fiscal year ending September 30, 2022 and each fiscal year thereafter, the Company may pay dividends in an amount up to 40.00% of its net income for the prior fiscal year assuming there no Event of Default or Potential Default has occurred and continues or would result therefrom. Notwithstanding the foregoing, the Company may pay dividends of up to 75% of net income for the prior fiscal year,
30
provided that the Company’s working capital, pre and post distribution, remains above $15,000,000 million and assuming there no Event of Default or Potential Default has occurred and continues or would result therefrom.
In connection with the execution of the Amendment, the Company and Lender entered into an Amended and Restated Revolving Term Promissory Note dated May 29, 2020 (the “Restated Revolving Term Note”) which amended, restated and superseded the Amended and Restated Revolving Term Promissory Note dated December 28, 2018 (the “Prior Revolving Term Note”). The Restated Revolving Term Note amends the Prior Revolving Term Note to delay the commencement of the maximum commitment amount reduction schedule for a year so that the new maximum commitment amount reduction schedule is as follows:
Maximum Commitment Amount | From | Up to and Including |
$20,000,000 | October 20, 2021 | October 19, 2022 |
$15,000,000 | October 20, 2022 | October 19, 2023 |
$10,000,000 | October 20, 2023 | October 1, 2024 |
In connection with the execution of the Amendment, the Company and the Lender entered into an Amended and Restated Revolving Credit Promissory Note dated May 29, 2020 (the “Restated Revolving Credit Note”) which amended, restated and superseded the Revolving Credit Promissory Note dated June 28, 2019 to extend the maturity date to January 1, 2021, subject to an annual renewal.
In connection with the execution of the Credit Agreement, the Company and the Lender also entered into an Amended and Restated Letter of Credit Promissory Note dated May 29, 2020 (the “Restated Letter of Credit Note”) which amended, restated and superseded the Revolving Letter of Credit Promissory Note dated June 28, 2019. The maximum amount of the letter of credit commitment was changed to $1,307,525.
In addition, the Lender provided the Company with a letter dated May 28, 2020 waiving past violations resulting from non-compliance with the working capital, net worth and debt service coverage ratio financial covenants from June 30, 2019 through April 30, 2020.
Cash Injections and Mitigation of Previous Going Concern Uncertainty
Recently, the Company has completed several transactions that has resulted in the Company’s receipt of the following injections of cash:
• | On March 31, 2020, the Company received $5,000,000 million in cash in connection with the issuance of 42,049 new Class A Units. |
• | On April 13, 2020, the Company received $505,700 under the Paycheck Protection Program administered by the U.S. Small Business Administration. |
• | On May 28, 2020, the Company received an additional $2,500,000 in cash in connection with the issuance of an additional 14,037 Class A Units and 6,987 new Class B Units. |
As discussed above, the Report of Independent Registered Public Accounting Firm included in the Company’s 2019 Form 10-K included an explanatory paragraph expressing doubt regarding the Company’s ability to continue as a going concern. Management also disclosed a going concern uncertainty in the Company’s financial statements included in the Q1 2020 Form 10-Q. Based on the completion of the transactions described above together with the continued effects of our recent capital issuances and our improved liquidity, management believes the previously reported going concern uncertainty has been mitigated.
Although there is uncertainty related to the anticipated impact of the recent COVID-19 outbreak on our future results, we believe our current cash reserves, the cash received from our recent equity issuances, our PPP Loan, and the available cash under our revolving term loan and our revolving credit loan leave us well-positioned to manage our business through this crisis as it continues to unfold. However, the impacts of the COVID-19 pandemic are broad-reaching and the financial impacts associated with the COVID-19 pandemic include, but are not limited to, reduced production levels, lower net sales and potential incremental costs associated with mitigating the effects of the pandemic, including storage and logistics costs and other expenses. As a result, although we were in compliance with our financial covenants set forth in our Credit Agreement as of May 29, 2020, the impact the COVID-19 pandemic could adversely impact our operating results which could result in our inability to comply with certain of these financial covenants and require our lenders to waive compliance with, or agree to amend, any such covenant to avoid a default. However, based on our current forecast of market conditions and our financial performance, we expect that we will be in a position to satisfy all of the financial covenants in our Credit Agreement for the next twelve months.
31
Despite the uncertainty related to the impact of the COVID-19 pandemic on our future results, management expects to have sufficient cash available to fund operations for the next twelve months generated by cash from our continuing operations, available cash reserves and available cash under our revolving term loan and our revolving credit loan.
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:
Nine Months Ended June 30, | ||||||||
(Unaudited) | ||||||||
Cash Flow Data: | 2020 | 2019 | ||||||
Net cash (used in) operating activities | $ | (952,696 | ) | $ | (4,966,369 | ) | ||
Net cash (used in) investing activities | (441,219 | ) | (2,915,185 | ) | ||||
Net cash provided by financing activities | 5,905,700 | 7,400,000 | ||||||
Net increase (decrease) in cash and cash equivalents | $ | 4,511,785 | $ | (481,554 | ) |
Cash Flow Used in Operations
For the nine months ended June 30, 2020, net cash used in operating activities improved by $1.4 million when compared to net cash provided by operating activities for the nine- months ended June 30, 2019. The improvement in cash provided by operating activities is due to the reduction of operating expenses, improvements in inventory controls, improved production efficiencies and timing of working capital cycles.
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 $1.6 million for the nine month ended June 30, 2020 compared to the nine months ended June 30, 2019. The decrease was due to less capitalized expenses and improvements to the facility as the plant has implemented a preventive maintenance plan.
Cash Flow Provided by Financing Activities
Cash flows from financing activities include transactions and events whereby cash is obtained from, or paid to, depositors, creditors or investors. Net cash provided by financing activities decreased by $2.7 million for the nine months ended June 30, 2020 compared to the nine months ended June 30, 2019. The decrease was due to less borrowing along with proceeds received by the Company from issuance of membership units.
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
32
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.
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 June 30, 2020 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 nine months ended June 30, 2020 and 2019, the Company had a lower of cost or net realizable value inventory adjustment of $0.00 and $180,000 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
33
We currently do not have any off-balance sheet arrangements.
34
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.
We may from time to time take various cash, futures, options or other positions in an attempt to minimize or reduce our price risks related to corn and ethanol. The extent to which we enter into such positions may vary substantially from time to time and based on various factors, including seasonal factors and our views as to future market trends. Those activities are, however, also subject to various material risks, including that price movements in the cash and futures corn and ethanol markets are highly volatile and are influenced by many factors and occurrences that are beyond our control. We could incur substantial losses on our cash, futures, options or other positions.
Although we intend our futures and option positions to accomplish an economic hedge against our future purchases of corn or 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 June 30, 2020 was $171,662 as opposed to a net gain of $1,005,692 for the three months ended June 30, 2019.
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
35
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 March 31, 2020 represented approximately 5.86% 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.
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.
Item 1A. Risk Factors.
Members should carefully consider the discussion of risks and the other information in our annual report on Form 10-K for the year ended September 30, 2019, in Part I, Item 1A, “Risk Factors,” the disclosures of risks in Part II, Item 1.A in our quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2020 along with the discussion of risks and other information in Part
36
I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under “Cautionary Information Regarding Forward-Looking Statements,” of this report. Although we have attempted to discuss key factors, our members need to be aware that other risks may prove to be important in the future. New risks may emerge at any time and we cannot predict such risks or estimate the extent to which they may affect our financial performance.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
As previously disclosed in the Company's Current Report on Form 8-K filed with the SEC on June 3, 2020 and its Quarterly Report on Form 10-Q filed with the SEC on June 19, 2020, on May 28, 2020 (the “Closing Date”), the Company closed its previously announced private offering of new Class B Units (the “Class B Offering”) to its existing members who are “accredited investors” (such members “Existing Accredited Members”), as such term is defined in Rule 501 of Regulation D, promulgated by the SEC under the Securities Act of 1933, as amended (the “Securities Act”). Pursuant to subscription agreements between the Company and certain Existing Accredited Investors entered into as part of the Class B Offering, the Company sold 6,822 new Class B Units for an aggregate price of $811,204, or $118.91 per unit.
Also effective as of the Closing Date (a) pursuant to the Preferred Membership Unit Purchase Agreement between the Company and HALE, LLC, an Iowa limited liability company (“HALE”) dated as of March 31, 2020 (a copy of which was previously filed with the SEC as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed April 3, 2020) incorporated herein by reference (the “MUPA”) the Company sold an additional 14,037 Class A Units to HALE for $1,669,176, or $118.91 per unit, and (b) pursuant to a separate subscription agreement between the Company and LKPK Holdings, LLC, a Nebraska limited liability company (“LKPK”), the Company agreed to sell and subsequently sold 165 Class B Units to LKPK for $19,620, or $118.91 per unit. The aggregate price for the sale of these Class A Units and Class B Units was $2,500,000, or $118.91 per unit. These securities were sold for cash consideration, and there were no underwriting discounts, sales commissions, or brokerage fees applied or paid in the transaction.
These sales were consummated in reliance on the exemption from registration found in Rule 506(b) of Regulation D, promulgated by the SEC under the Securities Act. The facts relied upon to make the exemption available are that (a) the securities were offered and sold exclusively to accredited investors, as such term is defined in Rule 501 of Regulation D; (b) no general solicitations were made in connection with the offer or sale of the securities; (c) the securities bear the required statutory legend prescribing the restrictions on transfer and resale applicable to the securities as required by Section 502 of Regulation D; (d) none of the “bad actor” disqualification events contained in Rule 506(d) of Regulation D apply to any pertinent person or entity in the offering; and (e) the Company filed the Form D notice, and all other necessary notices, in a timely manner with all applicable securities regulators, both state and federal.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
37
Item 6. Exhibits.
The following exhibits are filed as part of this quarterly report.
Description of Exhibit | Page | ||||
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) | ||||
† 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. |
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
LINCOLNWAY ENERGY, LLC | ||
August 14, 2020 | By: | /s/ Seth Harder |
Name: Seth Harder | ||
Title: General Manager, President and Chief Executive Officer | ||
August 14, 2020 | By: | /s/ Jeff Kistner |
Name: Jeff Kistner | ||
Title: Interim Chief Financial Officer |
39