UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended October 31, 2008
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 000-53588
HIGHWATER ETHANOL, LLC
(Name of registrant as specified in its charter)
Minnesota |
| 20-4798531 |
(State or other jurisdiction of |
| (I.R.S. Employer Identification No.) |
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24500 US Highway 14, Lamberton, MN |
| 56152 |
(Address of principal executive offices) |
| (Zip Code) |
(507) 752-6160
(Registrant’s telephone number, including area code)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes o No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes o No
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. x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o |
| Accelerated filer o |
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Non-accelerated filer o |
| Smaller Reporting Company x |
(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes x No
As of January 25, 2009, the aggregate market value of the membership units held by non-affiliates (computed by reference to the most recent offering price of such membership units) was $47,350,000. The Company is a limited liability company whose outstanding common equity is subject to significant restrictions on transfer under its Member Control Agreement. No public market for common equity of Highwater Ethanol, LLC is established and it is unlikely in the foreseeable future that a public market for its common equity will develop.
As of January 25, 2009, there were 4,953 membership units outstanding. As of September 25, 2009, there were 4,953 membership units outstanding.
Explanatory Note Regarding Amendment No. 1
This Amendment No. 1 to the Annual Report on Form 10-KSB of Highwater Ethanol, LLC (the “Company”) for the fiscal year ended October 31, 2008, is being filed for the purpose of amending and restating Items 1A, 6, 7, 8A(T) and 13 to correct an error that occurred with the omission of an interest rate swap agreement. The interest rate swap fixes the interest rate on a portion of the Company’s long-term debt at 7.60% for a period of five years beginning in June 2009. The Company did not previously record the interest rate swap, which is a liability due to the decline in market interest rates. As a result of this error, an interest rate swap was unrecorded at October 31, 2008. The value of the agreement was not reflected in liabilities, members’ equity and net income (loss) accounts. In accordance with Rule 12b-15 under the Securities and Exchange Act of 1934, the complete text of such Items, as amended are set forth herein. In addition to the filing of this Amendment No. 1 and pursuant to Rule 12b-15, the Company is including certain currently dated certifications. The remainder of the Company’s Form 10-KSB has not been updated to reflect events occurring subsequent to the original reporting date.
Therefore, the Company has:
· Increased liabilities by approximately $591,000, resulting in a decrease of net income of approximately $591,000 or $193.42 per weighted average unit outstanding, for the year ended October 31, 2008.
· Decreased members’ equity by approximately $591,000 as of October 31, 2008.
In addition, based on the continued assessment and evaluation of the Company’s internal control over financial reporting, the Company believes it has a material weakness due to the omission of the interest rate swap transaction and related effects on prior periods. As part of the Company’s continued evaluation of its internal controls, the Company recently hired a Chief Financial Officer in February 2009. Due to the addition of Mark Peterson as the Company’s Chief Financial Officer he is now the signatory and certifier effective March 5, 2009 of the financial statements and reports filed with the United States Securities and Exchange Commission. Prior to Mr. Peterson joining the Company, the financial statements and reports were signed and certified by Tim Van Der Wal who was the Company’s Treasurer (Principal Financial and Accounting Officer).
The information in this Amendment has been updated to give effect to the restatement. The disclosures in this Amendment supersede and replace the disclosures in the Form 10-KSB, as initially filed. However, this report speaks as of the original filing date of the Form 10-KSB, and other than providing the restated financial statements, restated financial notes and the restated portion of the relevant Management, Discussion and Analysis, the Company has not updated the disclosures contained in the Form 10-KSB to reflect any events that occurred subsequent to the original reporting date. Accordingly, in conjunction with reading this Form 10-KSB/A, you should also read all other filings that we have made with the Securities and Exchange Commission since the date of the original filings.
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Forward Looking Statements
This report contains forward-looking statements that involve future events, our future performance and our expected future operations and actions. In some cases you can identify forward-looking statements by the use of words such as “may,” “should,” “will,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. Many of these forward-looking statements are located in this report under Item 1, “Description of Business;” Item 1A, “Risk Factors,” Item 2, “Description of Property;” and Item 6, “Management’s Discussion and Analysis or Plan of Operations,” but they may appear in other sections as well.
These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties. Important factors that could significantly affect our assumptions, plans, anticipated actions and future financial and other results include, among others, those matters set forth in the section of this report in Item 1A - “Risk Factors.” You are urged to consider all of those risk factors when evaluating any forward-looking statement, and we caution you not to put undue reliance on any forward-looking statements.
You should read this report thoroughly with the understanding that our actual results may differ materially from those set forth in the forward-looking statements for many reasons, including events beyond our control and assumptions that prove to be inaccurate or unfounded. We cannot provide any assurance with respect to our future performance or results. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include
· Changes in our business strategy, capital improvements or development plans;
· Construction delays and technical difficulties in constructing the plant;
· Increases in the cost of construction;
· Changes in the environmental regulations or in our ability to comply with the environmental regulations that apply to our plant site and our anticipated operations;
· Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
· Changes in the availability and price of corn and natural gas and the market for ethanol and distillers grains;
· Our anticipated inelastic demand for corn, as it is the only available feedstock for our plant;
· Difficulties we may encounter during the construction of our plant;
· Changes in federal and/or state laws (including the elimination of any federal and/or state ethanol tax incentives);
· Changes and advances in ethanol production technology that may make it more difficult for us to compete with other ethanol plants utilizing such technology;
· Competition from alternative fuel additives;
· Our inability to secure credit that we may require in the future;
· Lack of transport, storage and blending infrastructure preventing ethanol from reaching high demand markets;
· Changes in interest rates and lending conditions;
· Volatile commodity and financial markets; and
· Ethanol supply exceeding demand and corresponding ethanol price reductions.
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The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or any persons acting on our behalf. We are not under any duty to update the forward-looking statements contained in this report. We cannot guarantee future results, levels of activity, performance or achievements. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.
ITEM 1A. RISK FACTORS.
You should carefully read and consider the risks and uncertainties below and the other information contained in this report. The risks and uncertainties described below are not the only ones we may face. The following risks, together with additional risks and uncertainties not currently known to us or that we currently deem immaterial could impair our financial condition and results of operation.
Risks Related to Highwater Ethanol as a Development-Stage Company
Highwater Ethanol has no operating history, which could result in errors in management and operations causing a reduction in the value of your investment. We have no history of operations. We may not manage start-up effectively or properly staff operations, and any failure to manage our start-up effectively could delay the commencement of plant operations. A delay in start-up operations is likely to further delay our ability to generate revenue and satisfy our debt obligations. We anticipate a period of significant growth, involving the construction and start-up of operations of the plant. This period of growth and the start-up of the plant are likely to be a substantial challenge to us. If we fail to manage start-up effectively, we may not be able to operate our plant profitably or at all.
We have little to no experience in the ethanol industry and our governors do not dedicate their efforts to our project on a full time basis, which may affect our ability to build and operate the ethanol plant. We are presently dependent upon our initial governors. Most of these individuals are experienced in business generally but have very little or no experience in organizing and building an ethanol plant, and governing and operating a public company. Our governors also have little to no expertise in the ethanol industry. In addition, certain governors on our board are presently engaged in business and other activities which impose substantial demand on the time and attention of such governors. Our governors do not dedicate their efforts to our project on a full time basis which may affect our ability to build and develop our ethanol plant. Our member control agreement provides that the initial board of governors will serve until the first annual or special meeting of the members following commencement of substantial operations of the ethanol plant. If our project suffers delays due to financing or construction, our initial board of governors could serve for an extended period of time. In that event, our only recourse to replace these governors would be through an amendment to our operating agreement which could be difficult to accomplish.
We will depend on Fagen, Inc. for expertise in beginning operations in the ethanol industry and any loss of this relationship could cause us delay and added expense, placing us at a competitive disadvantage. We are dependent on our relationship with Fagen, Inc. and its employees. Any loss of this relationship with Fagen, Inc., particularly during the construction and start-up period of the plant may prevent us from commencing operations and result in the failure of our business. The time and expense of locating new consultants and contractors would result in unforeseen expenses and delays which may reduce our ability to generate revenue and operate profitability and significantly damage our competitive position in the ethanol industry.
Our business is not diversified. We expect our business to solely consist of ethanol and distillers grains production and sales. We do not have any other lines of business or other sources of revenue if we are unable to complete the construction and operation of the plant or if we are unable to operate our plant and generate ethanol and distillers grains. If we are unable to generate revenues by the production and sales of ethanol and distillers grains our business may fail since we do not expect to have any other lines of business or alternative revenue sources.
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We have a history of losses and may not ever operate profitably. We have incurred and may continue to incur significant losses until we successfully complete construction and commence operations of the plant. Through October 31, 2008, we generated losses and have a deficit in working capital. There is no assurance that we will be successful in our efforts to build and operate an ethanol plant. Even if we successfully begin operations at the ethanol plant, there is no assurance that we will be able to operate profitably.
Risks Related to Construction of the Ethanol Plant
We may need to increase cost estimates for construction of the ethanol plant, and such increase could result in devaluation of our units if ethanol plant construction requires additional capital. We anticipate that Fagen, Inc. will construct the plant for a contract price, based on the plans and specifications in the design-build agreement. We have based our capital needs on a design for the plant that will cost approximately $69,950,000 with additional start-up and development costs of approximately $43,630,000 for a total project completion cost of approximately $113,580,000. The final cost of the plant may be higher.
Defects in plant construction could result in delays in our ability to generate revenues if our plant does not produce ethanol or its co-products as anticipated. Defects in materials and/or workmanship in the plant may occur. Under the terms of the design-build agreement with Fagen, Inc., Fagen, Inc. will warrant that the material and equipment furnished to build the plant will be new, of good quality, and free from material defects in material or workmanship at the time of delivery. Though the design-build agreement requires Fagen, Inc. to correct all defects in material or workmanship for a period of one year after substantial completion of the plant, material defects in material or workmanship may still occur. Such defects could delay the commencement of operations of the plant, or, if such defects are discovered after operations have commenced, could cause us to halt or discontinue the plant’s operation. Halting or discontinuing plant operations could delay our ability to generate revenues.
The plant site may have unknown environmental problems that could be expensive and time consuming to correct, which may delay or halt plant construction and delay our ability to generate revenue. Our plant site is located in Redwood County, Minnesota, near the City of Lamberton, Minnesota. We may encounter hazardous environmental conditions that may delay the construction of the plant. We do not anticipate Fagen, Inc. will be responsible for any hazardous environmental conditions encountered at the plant site. Upon encountering a hazardous environmental condition, Fagen, Inc. may suspend work in the affected area. If we receive notice of a hazardous environmental condition, we may be required to correct the condition prior to continuing construction. The presence of a hazardous environmental condition will likely delay construction of the plant and may require significant expenditure of our resources to correct the condition. In addition, Fagen, Inc. will be entitled to an adjustment in price and time of performance if it has been adversely affected by the hazardous environmental condition. If we encounter any hazardous environmental conditions during construction that require time or money to correct, such event could delay our ability to generate revenues.
Risks Relating to Our Business
We have a significant amount of debt, and our existing debt financing agreements contain, and our future debt financing agreements may contain, restrictive covenants that limit distributions and impose restrictions on the operation of our business. The use of debt financing makes it more difficult for us to operate because we must make principal and interest payments on the indebtedness and abide by covenants contained in our debt financing agreements. The level of our debt may have important implications on our operations, including, among other things: (a) limiting our ability to obtain additional debt or equity financing; (b) making us vulnerable to increases in prevailing interest rates; (c) placing us at a competitive disadvantage because we may be substantially more leveraged than some of our competitors; (d) subjecting all or substantially all of our assets to liens, which means that there may be no assets left for shareholders in the event of a liquidation; and (e) limiting our ability to make business and operational decisions regarding our business, including, among other things, limiting our ability to pay dividends to our unit holders, make capital improvements, sell or purchase assets or engage in transactions we deem to be appropriate and in our best interest.
Our inability to secure credit facilities we may require in the future may negatively impact our liquidity. Due to current conditions in the credit markets, it has been increasingly difficult for businesses to secure financing. While we do not currently require more financing than we have, in the future we may need additional financing. If
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we require financing in the future and we are unable to secure such financing, it may have a negative impact on our liquidity. This could negatively impact the value of our units.
We have no operating history and our business may not be as successful as we anticipate. We have not yet begun plant operations. Accordingly, we have no operating history from which you can evaluate our business and prospects. Our operating results could fluctuate significantly in the future as a result of a variety of factors, including those discussed throughout these risk factors. Many of these factors are outside our control. As a result of these factors, our operating results may not be indicative of future operating results and you should not rely on them as indications of our future performance.
We expect to be heavily dependent on rail as our primary mode of transporting our product to distribution terminals. Most ethanol producers ship ethanol by rail to distribution terminals, which then send the ethanol on a barge or truck to blenders. Increased production of ethanol has created a bottleneck between producers and blenders, and the rail system’s capacity is strained to meet demand. In addition, railroads are also facing pressure from increased corn production, and have found it difficult to meet the demand to transport the grain to storage facilities. If the nation’s rail system cannot keep pace with the production of ethanol and corn, we may be forced to pay higher prices for rail cars in order to compete with other plants for access to transportation. This could lead to a decrease in our profitability and you could lose some or all of your investment.
The expansion of domestic ethanol production in combination with state bans on Methyl Tertiary Butyl Ether (MTBE) and/or state renewable fuels standards may place strains on destination terminal and blender infrastructure such that our ethanol cannot be marketed and shipped to the blending terminals that would otherwise provide us the best cost advantages. If the volume of ethanol shipments continues to increase with the nation’s increased production capacity and blenders switch from MTBE to ethanol, there may be weaknesses in infrastructure and its capacity to transport ethanol such that our product cannot reach its target markets. In addition, ethanol destination terminals may not have adequate capacity to handle the supply of ethanol, and will have to quickly adapt by building more tanks to hold increased inventory before shipping ethanol to the blenders. Many blending terminals may need to make infrastructure changes to blend ethanol instead of MTBE and to blend the quantities of ethanol that are being produced. Refineries may be unwilling to spend large amounts of capital to expand infrastructure, or may be disinclined to blend ethanol absent a legislative mandate to increase blending. If the blending terminals do not have sufficient capacity or the necessary infrastructure to make this switch, or are reluctant to make such large capital expenditures to blend ethanol, there may be an oversupply of ethanol on the market, which could depress ethanol prices and negatively impact our financial performance.
Our financial performance will be significantly dependent on corn prices and generally we will not be able to pass on increases in input prices to our customers. Our results of operations and financial condition are significantly affected by the cost and supply of corn and natural gas. Changes in the price and supply of corn and natural gas are subject to and determined by market forces over which we have no control.
Ethanol production requires substantial amounts of corn. Corn, as with most other crops, is affected by weather, disease and other environmental conditions. The price of corn is also influenced by general economic, market and government factors. These factors include farmer planting decisions, domestic and foreign government farm programs and policies, global demand and supply and quality. Changes in the price of corn can significantly affect our business. Generally, higher corn prices will produce lower profit margins and, therefore, represent unfavorable market conditions. This is especially true if market conditions do not allow us to pass along increased corn costs to our customers. The price of corn has fluctuated significantly in the past and may fluctuate significantly in the future. Over the course of the last year, the price of corn has exceeded historical averages. If a period of high corn prices were to be sustained for some time, such pricing may reduce our ability to generate revenues because of the higher cost of operating and may make ethanol uneconomical to use in fuel markets. We cannot offer any assurance that we will be able to offset any increase in the price of corn by increasing the price of our products. If we cannot offset increases in the price of corn, our financial performance may be materially and adversely affected.
The spread between ethanol and corn prices can vary significantly and we do not expect the spread to remain at the high levels recently experienced by the ethanol industry. Our gross margins will depend principally on the spread between ethanol and corn prices. The spread between the price of a gallon of ethanol and the cost of the amount of corn required to produce a gallon of ethanol will likely continue to fluctuate. Any further reduction in
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the spread between ethanol and corn prices, whether a result of an increase in corn prices or a reduction in ethanol prices, would adversely affect our future results of operations and financial condition.
Our revenues will be greatly affected by the price at which we can sell our ethanol and distillers grains. These prices can be volatile as a result of a number of factors. These factors include the overall supply and demand, the price of gasoline, level of government support, and the availability and price of competing products. For instance, the price of ethanol tends to increase as the price of gasoline increases, and the price of ethanol tends to decrease as the price of gasoline decreases. Any lowering of gasoline prices will likely also lead to lower prices for ethanol, which may decrease our ethanol sales and reduce revenues, causing a reduction in the value of your investment
We expect to sell all of the ethanol we produce to RPMG in accordance with an exclusive ethanol marketing agreement. We have engaged RPMG as our exclusive marketing agent for all of the ethanol we produce at the plant. We will rely heavily on its marketing efforts to successfully sell our product. Because RPMG sells ethanol for itself and a number of other producers, we expect to have limited control over its sales efforts. Our financial performance may be dependent upon the financial health of RPMG as a significant portion of our accounts receivable are expected to be attributable to RPMG and its customers. If RPMG fails to competitively market our ethanol or breaches the ethanol marketing agreement, we could experience a material loss and we may not have any readily available means to sell our ethanol.
We expect to engage in hedging transactions which involve risks that can harm our business. We will be exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process. We will seek to minimize the risks from fluctuations in the prices of corn and natural gas through the use of hedging instruments. The effectiveness of our hedging strategies is dependent upon the cost of corn and natural gas and our ability to sell sufficient products to use all of the corn and natural gas for which we have futures contracts. There is no assurance that our hedging activities will successfully reduce the risk caused by price fluctuation which may leave us vulnerable to high corn and natural gas prices. Alternatively, we may choose not to engage in hedging transactions. As a result, our future results of operations and financial conditions may also be adversely affected during periods in which corn and/or natural gas prices increase.
Changes and advances in ethanol production technology could require us to incur costs to update our plant or could otherwise hinder our ability to compete in the ethanol industry or operate profitably. Advances and changes in the technology of ethanol production are expected to occur. Such advances and changes may make the ethanol production technology we installed in our plant less desirable or obsolete. These advances could also allow our competitors to produce ethanol at a lower cost than us. If we are unable to adopt or incorporate technological advances, our ethanol production methods and processes could be less efficient than our competitors, which could cause our plant to become uncompetitive or completely obsolete. If our competitors develop, obtain or license technology that is superior to ours or that makes our technology obsolete, we may be required to incur significant costs to enhance or acquire new technology so that our ethanol production process remains competitive. Alternatively, we may be required to seek third-party licenses, which could also result in significant expenditures. Third-party licenses may not be available or, once obtained, may not continue to be available on commercially reasonable terms, if at all. These costs could negatively impact our financial performance by increasing our operating costs and reducing our net income.
Risks Related to Ethanol Industry
Overcapacity within the ethanol industry could cause an oversupply of ethanol and a decline in ethanol prices. Excess capacity in the ethanol industry would have an adverse impact on our results of operations, cash flows and general financial condition. Excess capacity may also result or intensify from increases in production capacity coupled with insufficient demand. If the demand for ethanol does not grow at the same pace as increases in supply, we would expect the price for ethanol to decline. If excess capacity in the ethanol industry occurs, the market price of ethanol may decline to a level that is inadequate to generate sufficient cash flow to cover our costs.
We expect to operate in a competitive industry and compete with larger, better financed entities which could impact our ability to operate profitably. There is significant competition among ethanol producers with
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numerous producer and privately owned ethanol plants planned and operating throughout the United States. The largest ethanol producers include POET, VeraSun Energy Corporation, Archer Daniels Midland, and Hawkeye Renewables, LLC, all of which are each capable of producing more ethanol than we expect to produce. A number of our competitors are divisions of substantially larger enterprises and have substantially greater financial resources than we do. If the demand for ethanol does not grow at the same pace as increases in supply, we expect that lower prices for ethanol may result which may adversely affect our ability to generate profits and our financial condition.
Risks Related to Regulation and Governmental Action
Government incentives for ethanol production, including federal tax incentives, may be eliminated in the future, which could hinder our ability to operate at a profit.
Renewable Fuels Standard. The ethanol industry is assisted by various federal ethanol production and tax incentives, including the RFS set forth in the Energy Independence and Security Act of 2007. The RFS helps support a market for ethanol that might disappear without this incentive; as such, waiver of RFS minimum levels of renewable fuels included in gasoline could negatively impact our results of operations.
In addition, the elimination or reduction of tax incentives to the ethanol industry, such as the Volume Ethanol Excise Tax Credit (VEETC) available to gasoline refiners and blenders, could also reduce the market demand for ethanol, which could reduce prices and our revenues by making it more costly or difficult for us to produce and sell ethanol. If the federal tax incentives are eliminated or sharply curtailed, we believe that decreased demand for ethanol will result, which could negatively impact our ability to operate profitably.
Changes in environmental regulations or violations of the regulations could be expensive and reduce our profitability. We are subject to extensive air, water and other environmental laws and regulations. In addition, some of these laws require our plant to operate under a number of environmental permits. These laws, regulations and permits can often require expensive pollution control equipment or operation changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, damages, criminal sanctions, permit revocations and/or plant shutdowns. In the future, we may be subject to legal actions brought by environmental advocacy groups and other parties for actual or alleged violations of environmental laws or our permits. Additionally, any changes in environmental laws and regulations, both at the federal and state level, could require us to spend considerable resources in order to comply with future environmental regulations. The expense of compliance could be significant enough to reduce our profitability and negatively affect our financial condition.
Carbon dioxide may be regulated in the future by the EPA as an air pollutant requiring us to obtain additional permits and install additional environmental mitigation equipment, which could adversely affect our financial performance. In 2007, the Supreme Court decided a case in which it ruled that carbon dioxide is an air pollutant under the Clean Air Act for the purposes of motor vehicle emissions. The Supreme Court directed the EPA to regulate carbon dioxide from vehicle emissions as a pollutant under the Clean Air Act. Similar lawsuits have been filed seeking to require the EPA to regulate carbon dioxide emissions from stationary sources such as our ethanol plant under the Clean Air Act. Our plant may produce a significant amount of carbon dioxide that we will vent into the atmosphere; however, we intend to capture a small portion of our carbon dioxide emissions through our water treatment system. While there are currently no regulations applicable to us concerning carbon dioxide, if the EPA or the State of Minnesota were to regulate carbon dioxide emissions by plants such as ours, we may have to apply for additional permits or we may be required to install carbon dioxide mitigation equipment or take other as yet unknown steps to comply with these potential regulations. Compliance with any future regulation of carbon dioxide, if it occurs, could be costly and may prevent us from operating the ethanol plant profitably which could decrease or eliminate the value of our units.
ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
This report contains forward-looking statements that involve significant risks and uncertainties. The following discussion, which focuses on our plan of operation through the commencement of operations of the plant, consists almost entirely of forward-looking information and statements. Actual events or results may differ
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materially from those indicated or anticipated, as discussed in the section entitled “Forward Looking Statements.” This may occur as a result of many factors, including those set forth in Item 1A, “Risk Factors.” The following discussion of our financial condition and plan of operation should also be read in conjunction with our financial statements and notes to financial statements contained in this report.
Overview
Highwater Ethanol, LLC is a development-stage Minnesota limited liability company. It was formed on May 2, 2006 for the purpose of developing, constructing, owning and operating a 50 million gallon per year ethanol plant near Lamberton, Minnesota. We have not yet engaged in the production of ethanol and distillers grains. Based upon engineering specifications from Fagen, Inc., we expect the ethanol plant, once built, will process approximately 18.5 million bushels of corn per year into 50 million gallons of denatured fuel grade ethanol and 160,000 tons of dried distillers grains with solubles. Plant construction is progressing on schedule. We anticipate that our plant will be operational in May 2009.
We anticipate the total project costs to be approximately $113,580,000 which includes construction of our ethanol plant and start-up of operations. We are financing the construction and start-up of the ethanol plant with a combination of equity and debt.
Since we have not yet become operational as of the end of our fiscal year, we do not have comparable income, production or sales data.
Plan of Operations for the Next 12 Months
We expect to spend the next 12 months focused on completing plant construction and commencing start-up operations. As a result of our successful completion of the registered offering and the related debt financing, we expect to have sufficient cash on hand to cover all costs associated with construction of the project. We estimate that we will need approximately $113,580,000 to complete plant construction and begin start-up operations.
Project Capitalization
We issued 150 units to our founding members, for an aggregate of $500,000. In addition, we issued 236 units to our seed capital members in exchange for aggregate proceeds of approximately $1,180,000. We received total proceeds from our private placements of $1,680,000.
We filed a registration statement on Form SB-2 with the Securities and Exchange Commission (“SEC”) which became effective on April 5, 2007. We closed the offering on April 5, 2008 having raised proceeds of approximately $45,670,000 were transferred to our account at First National Bank of Omaha. We then issued 4,567 registered units to our members which supplemented the 386 units issued in our private placement offerings to our founders and our seed capital investors.
On April 24, 2008, we entered into a Construction Loan Agreement (the “Agreement”) with First National Bank of Omaha of Omaha, Nebraska (“FNBO”) for the purpose of funding a portion of the cost of the ethanol plant. Under the Agreement, FNBO has agreed to loan us up to $61,000,000, consisting of a $50,400,000 Construction Loan, together with a $5,000,000 Revolving Loan, and $5,600,000 to support the issuance of letters of credit by FNBO. We have issued letters of credit to Redwood Electric Cooperative, Inc. and Northern Natural Gas Company for the amount of $700,000 and $4,000,000 respectively. The details of the letters of credit are described below in
Plant Construction and Start-Up of Plant Operations.
During the construction period, interest on the Construction Loan will be payable on a monthly basis on the outstanding principal amount at a variable rate equal to the one month LIBOR Rate, in effect from time to time, plus 350 basis points prior to maturity. On the Construction Loan Termination Date, the Construction Loan will be converted into a Fixed Rate Note for the maximum amount of $25,200,000, a Variable Rate Note for the maximum amount of $20,200,000 and a Long term Revolving Note for the maximum amount of $5,000,000.
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We will make monthly principal payments on the Fixed Rate Note ranging from approximately $145,000 to $197,000 plus accrued interest on the eighth day of every month commencing one month immediately following the Construction Loan Termination Date. A final balloon payment of approximately $15,184,000 will be due on the termination date of the Fixed Rate Note. We will make monthly payments ranging from approximately $147,000 to $211,000 on the eighth day of every month commencing one month immediately following the Construction Loan Termination Date which shall be allocated as follows: (i) first to accrued and unpaid interest on the Long Term Revolving Note, (ii) next to accrued and unpaid interest on the Variable Rate Note, and (iii) next to principal on the Variable Rate Note. In connection with the Construction Loan Agreement, the Company entered into an interest rate swap which fixes the interest rate on the Fixed Rate Note at 7.6% for five years beginning in June 2009.
In connection with the Construction Loan Agreement, we executed a mortgage in favor of FNBO creating a first lien on our real estate and plant and a security interest in all personal property located on the property. In addition, we assigned in favor of FNBO, all rents and leases to our property, the design/build contract, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.
In addition, during the term of the loans, we will be subject to certain financial covenants consisting of minimum working capital, minimum net worth, and maximum debt service coverage ratios. After our construction phase we will be limited to annual capital expenditures of $1,000,000 without prior approval of the Banks. We will also be prohibited from making distributions to our members of greater than 45% of our net income during any fiscal year if our debt leverage ratio (combined total liabilities to net worth) is greater than or equal to 1.0:1.0. Our failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the term notes and revolving note and/or the imposition of fees, charges or penalties. Any acceleration of the debt financing or imposition of the significant fees, charges or penalties may restrict or limit our access to the capital resources necessary to continue plant construction or operations. The lease agreement is secured by substantially all business assets and is subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working capital requirements.
Also on April 24, 2008, we entered into certain financing and credit arrangements with U.S. Bank National Association, as trustee (the “Trustee”) and the City of Lamberton, Minnesota (the “City”) in order to secure the proceeds from the sale of the solid waste facilities revenue bonds, Series 2008A (the “Bonds”) issued by the City in the aggregate principal amount of $15,180,000 pursuant to a trust indenture between the City and the Trustee (“Trust Indenture”). The City has undertaken the issuance of the Bonds to finance the acquisition and installation of certain solid waste facilities in connection with our ethanol plant to be located near Lamberton, Minnesota. Highwater received proceeds of approximately $14,876,000, after financing costs of approximately $304,000. The remaining proceeds are held as restricted cash or marketable securities based on anticipated use and are split between a project fund of approximately $11,564,000, a capitalized interest fund of approximately $1,818,000, and a debt service reserve fund of approximately $1,501,000. The Bonds mature on December 1, 2022 and bear interest at a rate of 8.5%.
We may apply for grants from the USDA and other sources. Although we may apply under several programs simultaneously and may be awarded grants or other benefits from more than one program, it must be noted that some combinations of programs are mutually exclusive. Under some state and federal programs, awards are not made to applicants in cases where construction on the project has started prior to the award date. There is no guarantee that applications will result in awards of grants or loans.
Plant construction and start-up of plant operations
Construction of the project is expected to take 16 to 18 months from the date construction commenced. We anticipate completion of plant construction in approximately May 2009. We anticipate that our total project cost will be approximately $113,580,000. We expect to have sufficient cash on hand through our equity and debt financing to complete construction and start-up operations. However, any significant changes to our estimated budget may result in our need for additional equity or debt financing. Once we are operational, we expect to begin generating cash flow.
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On September 28, 2006, we entered into a design-build contract with Fagen, Inc. for the design and construction of our ethanol plant for a total price of $69,950,000. If Fagen, Inc. is required to employ union labor, excluding union labor for the grain system and energy center, the contract price will be increased to include any increased costs associated with the use of union labor. We paid a mobilization fee of $5,000,000 to Fagen, Inc. when we issued our notice to proceed with construction in April 2008 pursuant to the terms of the design-build contract.
We have executed a Phase I and Phase II Engineering Services Agreement with Fagen Engineering, LLC, an entity related to our design-builder Fagen, Inc., for the performance of certain engineering and design work. Fagen Engineering, LLC performs the engineering services for projects constructed by Fagen, Inc. In exchange for certain engineering and design services, we have agreed to pay Fagen Engineering, LLC a lump-sum fixed fee, which will be credited against the total design-build costs.
We also entered into a license agreement with ICM, Inc. for limited use of ICM, Inc.’s proprietary technology and information to assist us in operating, maintaining, and repairing the ethanol production facility. We are not obligated to pay a fee to ICM, Inc. for use of the proprietary information and technology because our payment to Fagen, Inc. for the construction of the plant under our design-build agreement is inclusive of these costs. Under the license agreement, ICM, Inc. retains the exclusive right and interest in the proprietary information and technology and the goodwill associated with that information. ICM, Inc. may terminate the agreement upon written notice if we improperly use or disclose the proprietary information or technology at which point all proprietary property must be returned to ICM, Inc.
On November 28, 2007 we executed a Phase 1 Mass Grading and Drainage Agreement with R and G Construction Co. for certain improvements to the project site which involves mass grading and drainage activities. We agreed to pay a monthly fee of 90% of the value based on the amount of work completed with the remaining 10% held as retainage. As of October 31, 2008, we incurred approximately $2,113,000 for R and G’s services under this agreement. In August 2008, we entered into an additional contract with R and G for rail system drainage for an amount of approximately $1,214,000. We agreed to pay a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. As of October 31, 2008, we had incurred approximately $1,190,000 in costs under these agreements and the work has been completed.
In December 2007, we entered into an agreement with Rice Lake Construction for construction of a water treatment facility, well drilling and installation of the fire loop for approximately $15,995,000. We agreed to make monthly payments based on the amount of work completed, with 5% retainage held on the last two payments. As of October 31, 2008, we had incurred approximately $6,178,000 in costs under this agreement.
In July 2008, we entered into an agreement with L.A. Colo., LLC for rail work in the amount of approximately $4,361,000. We agreed to pay a monthly fee of 90% of the value on the amount of work completed with the remaining 10% held as retainage. The project is scheduled to be completed in early 2009 as we have approximately 200 feet left to be installed. As of October 31, 2008, we had incurred approximately $3,700,000 in costs under this agreement.
Also, in July 2008, we entered into an agreement with McCormick Construction Company for the installation of auger cast pilings for support of grain silos for approximately $428,000. We paid a 10% down payment of approximately $43,000 upon execution of the documents, and made monthly progress payments during the construction. As of October 31, 2008, we had incurred $424,000 in costs under this agreement and construction has been completed.
In August 2008, we entered into an agreement with Lamberton Construction for the construction of an administration building for approximately $278,000. Pursuant to the terms of the agreement we are paying a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. As of October 31, 2008, we had incurred approximately $50,000 in costs under this agreement.
Plant construction is progressing on schedule. We commenced site work at the plant in November 2007. We provided Fagen, Inc. with notice to proceed with construction, which was executed on April 7, 2008. Status to date on the construction is as follows:
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· Administration Building—Construction of the administration building is approximately 70% complete with interior cabinetry, trim and flooring remaining to be installed. The exterior walls need siding. We expect to occupy this building by the end of February 2009.
· DDG Storage Building—The construction of the distillers dried grain storage building is complete.
· Process Building Area—All field fabricated tanks (fermenters, beer well, stilage alley tanks) have been completed. All distillation vessels (columns and molecular sieves) have been set in place. All process tanks (evaporators, slurry, CIP and enzyme) inside the Process Building are installed. Process piping and pumps are being hooked up to the tanks. All stillage alley tanks are insulated and many exterior pipelines are now insulated as well. The electrical hook up from the Motor Control Center (MCC) room to the equipment has been started and is progressing.
· Energy Center—The centrifuges, dryers, dust collectors, conveyors, screws and ductwork are all in place. The thermal oxidizer stack was installed in December and is awaiting the arrival of the thermal oxidizer and the boiler with both expected to arrive in early February. Electrical wiring from the MCC room to the equipment has been started in this building as well and is also progressing.
· Cooling Tower/Water Treatment—Cooling tower construction has been completed. The cooling water header lines to the process building are being connected to the tower pumps. The Cold Lime Softening water treatment building was erected in November and concrete floor slabs are currently being installed and the water treatment storage tanks are being constructed. Some water treatment equipment is beginning to arrive on site. We expect a late March or early April 2009 completion timeline.
· Tank Farm—All tank farm storage vessels are built, painted and rigged with floating roofs. The outside accessories are currently being attached to the tanks.
· Grain Receiving Area—The concrete grain storage silos were poured in October. The grain receiving building basement is complete with equipment, including the rail scale. The building is now ready for the concrete floor and then wall erection. The grain legs are currently being attached to the silos. Also underway is the electrical insulation of switch gear in the MCC room.
Infrastructure Status:
· Natural Gas—Centerpoint Energy installed the natural gas pipeline into the Company’s site. In addition, our natural gas contractor installed the natural gas lines connecting Centerpoint Energy’s main regular distribution line to the energy center, load out flare and administration building.
· Rail Siding and Spurs—Rail siding and spurs are approximately 98% complete. The siding is connected via mainline switches to the DM&E Railroad system. Approximately 200 feet of the total 28,000 foot track is left to install into the grain receiving building once that building is complete.
· Electrical Substation—Redwood Electric and Great River Energy have finished the electrical sub-station construction. Permanent electrical power distribution network has been installed on the site and is now supplying electrical power to several areas of the site.
· Phase 1—All dirt work associated with the phase 1 portion of construction was substantially complete by mid-November. The installation of approximately 100 feet of drain culvert, grass seeding and the final grading of site roads is all that remains and we expect this to be completed in the spring.
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· Phase 2—All off-site and on-site process water supply pipelines, the entire fire loop system, the on-site sanitary sewer and potable water supply lines are complete. The production well pumps and pitless adapters are ready to install in the wells. The electrical service to the well sites is complete.
We estimate that we will need approximately $69,950,000 to construct the plant and a total of approximately $43,630,000 to cover all other expenditures necessary to complete the project, commence plant operations and produce revenue.
Marketing and Grain Procurement Agreements
We have entered into an ethanol marketing agreement with Renewable Products Marketing Group, LLC (“RPMG”) pursuant to which RPMG will be our exclusive ethanol marketer. RPMG will use its best efforts to market and obtain the best price for the ethanol we expect to produce in exchange for a percentage of the price we receive for each gallon of ethanol sold. The initial term of the RPMG agreement is for 24 months and shall be automatically extended for 12 months unless either party gives the other prior written notice. The RPMG agreement can be terminated for any uncured breach of the terms of the agreement. In the event the agreement is not renewed, Highwater may assume certain rail car leases currently controlled by RPMG.
On October 11, 2007, we entered into a Distillers Grains Marketing Agreement with CHS, Inc. CHS, Inc. is a diversified energy, grains and foods company owned by farmers, ranchers and cooperatives. CHS, Inc. provides products and services ranging from grain marketing to food processing to meet the needs of its customers around the world. CHS, Inc. will market our distillers grains and we receive a percentage of the selling price actually received by CHS, Inc. in marketing our distillers grains to its customers. Under the agreement, CHS,��Inc. will pay to us a price equal to 98% of the FOB plant price actually received by CHS, Inc. for all dried distillers grains removed by CHS, Inc. from our plant and a price equal to 96% of the FOB plant price actually received by CHS, Inc. for all our wet distillers grains. The term of our agreement with CHS, Inc. is for one year commencing as of the completion and start-up of the plant. Thereafter, the agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, CHS, Inc. will be responsible for all transportation arrangements for the distribution of our distillers grains.
We have entered into a grain procurement agreement with Meadowland Farmers Co-op (“Meadowland”). Meadowland has the exclusive right and responsibility to provide us with our daily requirements of corn meeting quality specifications set forth in the grain procurement agreement. Under the agreement, we will purchase corn at the local market price delivered to the ethanol plant plus a fixed fee per bushel of corn purchased. We will provide Meadowland with an estimate of our usage at the beginning of each fiscal quarter and Meadowland agrees to at all times maintain a minimum of 7 days corn usage at our plant. The initial term of the agreement is 7 years from the time we request our first delivery of corn.
Other Consultants
Agreement for Electric Service
On June 28, 2007 we entered into an Agreement for Electric Service with Redwood Electric Cooperative, Inc. for the sale and delivery of electric power and energy necessary to operate our ethanol plant. In exchange for its services, we agreed to pay Redwood Electric Cooperative, Inc. a monthly facilities charge of approximately $12,000 plus the Cooperative’s standard electrical rates. Pursuant to the agreement the contract rate will be guaranteed for up to five years. Upon execution of the agreement, we became a member of the Cooperative and are bound by its articles of incorporation and bylaws. This agreement will remain in effect for ten years following the initial billing period. In the event we wish to continue receiving electrical service from the Cooperative beyond the ten year period, we will need to enter into a new agreement with the Cooperative at least one year prior to the expiration of the initial ten year period. If the agreement is terminated by either party for any reason prior to the expiration of the initial ten year period, we will be required to pay for the entire amount of the facility charge for the remainder of the initial ten year period. Also, pursuant to this agreement, Highwater provided the Cooperative with a Letter of Credit in the amount of $700,000 at the expense of Highwater for the entire period of construction and continuing for a period of one year of commercial operation. The Cooperative agrees to release the Letter of Credit requirement after
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one full year of commercial operation upon a showing by Highwater that it is solvent. In the event that Highwater is not solvent after one year of commercial operation, the Letter of Credit will remain in effect; provided, however, the Cooperative agrees to review Highwater’s financial situation after each subsequent one year period has passed and if Highwater establishes that it is solvent at any of those review dates, the letter of credit will be released. In June 2008, there was a verbal agreement to suspend the $12,000 monthly fee until operations commence.
Energy Management Agreement
We have entered into an energy management agreement with U.S. Energy Services, Inc. pursuant to which U.S. Energy will provide us with the necessary natural gas management services. Some of their services may include an economic comparison of distribution service options, negotiation and minimization of interconnect costs, submission of the necessary pipeline “tap” request, supplying the plant with and/or negotiating the procurement of natural gas, development and implementation of a price risk management plan targeted at mitigating natural gas price volatility and maintaining profitability, providing consolidated monthly invoices that reflect all natural gas costs, and U.S. Energy will be responsible for reviewing and reconciling all invoices. In exchange for these services, we will pay U.S. Energy a monthly retainer fee of $3,050 for an initial contract term of 12 months. If we decide to utilize U.S. Energy’s hedging service we will have to pay an additional $.01 per MMBTu administrative fee for physical or financial natural gas hedging. Additional fees may apply for additional services and for time and travel.
Construction Consulting Agreement
On May 27, 2008 we entered into an Agreement for Consulting Services with Granite Falls Energy, LLC (“Granite Falls”) to assist us in monitoring the construction and reviewing project plans and documents. Some of their services may include reviewing project budget and timeline, reviewing contracts, weekly on-site inspections, obtaining competitive bids and executing contracts for services not currently under contract and providing recommendation and analysis of change order requests. In exchange for these services, we will pay Granite Falls a Consultant fee of $10,250 per month for its consulting services. Additional services will be billed to Highwater in accordance with a set fee schedule. The agreement commenced May 1, 2008 and will continue unless terminated by either party, by providing the other with a 30 day advance written notice of termination.
Natural Gas Service Agreement
On July 1, 2008, we entered into a natural gas service agreement with CenterPoint Energy Resources Corp., d.b.a. CenterPoint Energy Minnesota Gas (“CenterPoint Energy”). CenterPoint Energy has constructed a pipeline from the Northern Natural Gas Company (“Northern”) Town Border Station for Highwater (Highwater TBS”) terminating at Highwater’s selected location. Construction shall be completed by the later of April 1, 2009 or within 15 days of Northern’s completion of the Highwater TBS. Additionally, Highwater agrees to purchase all of its natural gas requirements from CenterPoint Energy’s pipeline. This Agreement will continue until October 31, 2019. Also, pursuant to this agreement, Highwater has provided Northern with a letter of credit for $4,000,000. Northern may draw on the letter of credit only if (1) Highwater is in default of its obligations under this agreement and all applicable notice and cure periods have expired or (2) Northern’s contractual obligations with Highwater extend beyond the expiration date of the Letter of Credit and either Highwater or the Issuing Bank has provided notice to Northern that the Letter of Credit will not be extended beyond its currently effective expiration period. Pursuant to the terms of the agreement we provided a security deposit of $500,000, which was returned to the Company with the release of the capacity agreement in December 2008.
Permitting and Regulatory Activities
We are subject to extensive air, water and other environmental regulations. We have obtained the required air and construction permits necessary to begin construction of the plant and are in the process of obtaining any additional permits necessary to operate the plant. Fagen, Inc. and Earth Tec Consulting, Inc. are coordinating and assisting us with obtaining certain environmental permits, and advising us on general environmental compliance. In addition, we will retain consultants with expertise specific to the permits being pursued to ensure all permits are acquired in a cost efficient and timely manner.
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We have received our Air Emissions Permit, a Stormwater permit, a Discharge for Stormwater During Construction Acitivities Permit, Groundwater Permit and an Above Ground Storage Tank Permit. Additionally, we have received the water appropriation permits from the Minnesota Department of Natural Resources as well as Notice from the Redwood Conservation District approving an exemption to place force mains through a wetland area. We have also received the necessary permits from Minnesota Pollution Control Agency (MPCA) for treatment of our wasteater.
The remaining permits will be required shortly before or shortly after we begin to operate the plant. If for any reason any of these permits are not granted, construction costs for the plant may increase, or the plant may not be constructed at all. Currently, we do not anticipate problems in obtaining the required permits; however, such problems may arise in which case our plant may not be allowed to operate.
Trends and Uncertainties Impacting the Ethanol Industry and Our Future Operations
We are subject to industry-wide factors, trends and uncertainties that affect our operating and financial performance. These factors include, but are not limited to, the available supply and cost of corn from which our ethanol and distillers grains are processed; the cost of natural gas, which we use in the production process; new technology developments in the industry; dependence on our ethanol marketer and distillers grains marketer to market and distribute our products; the intensely competitive nature of the ethanol industry; and possible changes in legislation/regulations at the federal, state and/or local level. These factors as well as other trends and uncertainties are described in more detail below.
We have no operating history and our business may not be as successful as we anticipate. As of the end of the fiscal year we had not yet completed construction of the plant. Accordingly, we have no operating history from which you can evaluate our business and prospects. Our operating results could fluctuate significantly in the future as a result of a variety of factors. Many of these factors are outside our control. In addition, our prospects must be considered in light of the normal risks and uncertainties encountered by an early stage company in a rapidly growing industry where supply, demand and pricing may change substantially in a short amount of time.
Economic Downturn
The U.S. stock markets tumbled in September and October 2008 upon the collapse of multiple major financial institutions, the federal government’s takeover of two major mortgage companies, Freddie Mac and Fannie Mae, and the President’s enactment of a $700 billion bailout plan pursuant to which the federal government will directly invest in troubled financial institutions. Financial institutions across the country have lost billions of dollars due to the extension of credit for the purchase and refinance of over-valued real property. The U.S. economy is in the midst of a recession, with increasing unemployment rates and decreasing retail sales. Other large corporate giants, such as the big three auto makers, have also been seeking government bailout money and may be facing bankruptcy. These factors have caused significant economic stress and upheaval in the financial and credit markets in the United States, as well as abroad. Credit markets have tightened and lending requirements have become more stringent. Oil prices have dropped rapidly as demand for fuel has decreased. We believe that these factors have contributed to a decrease in the prices at which we may be able to sell our ethanol in the future which may persist throughout all or parts of fiscal year 2009. It is uncertain how long and to what extent these economic troubles may negatively affect ethanol prices in the future.
Corn Prices
Our cost of goods sold will consist primarily of costs relating to the corn and natural gas supplies necessary to produce ethanol and distillers grains for sale. On December 11, 2008, the USDA released its Crop Production report, which estimated the 2008 grain corn crop at approximately 12 billion bushels, approximately 8% below the USDA’s estimate of the 2007 corn crop of 13.07 billion bushels. Corn prices reached historical highs in June 2008, but have come down sharply since that time as stronger than expected corn yields materialized and the global financial crisis brought down the prices of most commodities generally. We expect continued volatility in the price of corn, which could significantly impact our cost of goods sold. The growing number of operating ethanol plants nationwide is also expected to increase the demand for corn. This increase will likely drive the price of corn upwards in our market which will impact our ability to operate profitably.
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There is no assurance that a corn shortage will not develop, particularly if there is an extended drought or other production problems in the 2009 crop year. We anticipate that our plant’s profitability will be negatively impacted during periods of high corn prices. Although we expect the negative impact on profitability resulting from high corn prices to be mitigated, in part, by the increased value of the distillers grains we intend to market (as the price of corn and the price of distillers grains tend to fluctuate in tandem), we still may be unable to operate profitably if high corn prices are sustained for a significant period of time.
Natural Gas
Natural gas is also an important input commodity to our manufacturing process. We estimate that our natural gas usage will be approximately 10% to 15% of our annual total production cost. We use natural gas to dry our distillers grain products to a moisture content at which they can be stored for long periods of time, and can be transported greater distances. Any sustained increase in the price level of natural gas will increase our cost of production and will negatively impact our future profit margins.
Ethanol Supply and Demand
The number of ethanol plants being developed and constructed in the United States continues to increase. If the demand for ethanol does not grow at the same pace as increases in supply, we expect the price for ethanol to further decline. The prices of crude oil and refined gasoline decreased significantly in the second half of 2008, which has in turn placed downward pressure on the price of ethanol. Declining ethanol prices will result in lower future revenues and may reduce or eliminate profits.
While we believe that the nationally mandated usage of renewable fuels has largely driven demand in the past, we believe that an increase in voluntary usage will be necessary for the industry to continue its growth trend. In addition, a higher RFS standard may be necessary to encourage blenders to utilize ethanol. We expect that voluntary usage by blenders will occur only if the price of ethanol makes increased blending economical. In addition, we believe that heightened consumer awareness and consumer demand for ethanol-blended gasoline may play an important role in growing overall ethanol demand and voluntary usage by blenders. If blenders do not voluntarily increase the amount of ethanol blended into gasoline and consumer awareness does not increase, it is possible that additional ethanol supply will continue to outpace demand and further depress ethanol prices.
Ethanol Industry Competition
We operate in a competitive industry and compete with larger, better financed entities which could impact our ability to operate profitably. There is significant competition among ethanol producers with numerous producer and privately owned ethanol plants planned and operating throughout the United States. In addition, we are beginning to see consolidation in the industry. Archer Daniels Midland Company, POET, LLC, Hawkeye Renewables, LLC, Aventine Renewable Energy Holdings, Inc., VeraSun Energy Corp. and Cargill Incorporated control a significant portion of the ethanol market, producing an aggregate of over 4.6 billion gallons of ethanol annually. However, in November 2008 VeraSun Energy Corp. announced it had filed for Chapter 11 bankruptcy protection thereby calling into question its ability to maintain its level of ethanol production.
Derivatives
We are exposed to market risks from changes in corn, natural gas, and ethanol prices. We may seek to minimize these commodity price fluctuation risks through the use of derivative instruments. Although we will attempt to link these instruments to sales plans, market developments, and pricing activities, such instruments in and of themselves can result in additional costs due to unexpected directional price movements. We may incur such costs and they may be significant.
In April 2008, we entered into an interest rate swap agreement in order to manage our exposure to the impact of changing interest rates. As of October 31, 2008, we had recorded a liability for a derivative instrument of approximately $591,000 related to the interest rate swap. This derivative instrument was not designated as a cash
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flow hedge. The Company has recognized a loss on the interest rate swap of approximately $591,000 included in other income and expense for the year ended October 31, 2008.
Distillers Grains Marketing
With the advancement of research into the feeding rations of poultry and swine, we anticipate these markets will continue to expand and create additional demand for distillers grains; however, no assurance can be given that these markets will in fact expand, or if they do that we will benefit.
Technology Developments
The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, municipal solid waste, and energy crops. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas which are unable to grow corn. Although current technology is not sufficiently efficient to be competitive, the United States Congress is consistently increasing the availability of incentives to promote the development of commercially viable cellulose based ethanol production technology.
Advances and changes in the technology used to produce ethanol may make the technology we are installing in our plant less desirable or obsolete. These advances could also allow our competitors to produce ethanol at a lower cost than us. If we are unable to adopt or incorporate technological advances, our ethanol production methods and processes could be less efficient than our competitors, which could cause our plant to become uncompetitive or completely obsolete.
Government Legislation and Regulations
The ethanol industry and our business are assisted by various federal ethanol supports and tax incentives, including those included in the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007. Government incentives for ethanol production, including federal tax incentives, may be reduced or eliminated in the future, which could hinder our ability to operate at a profit. Federal ethanol supports, such as the renewable fuels standard (“RFS”), help support a market for ethanol that might disappear without this incentive; as such, a waiver of minimum levels of renewable fuels included in gasoline could have a material adverse effect on our results of operations. The elimination or reduction of tax incentives to the ethanol industry, such as the VEETC available to gasoline refiners and blenders, could reduce the market for ethanol, causing prices, revenues, and profitability to decrease.
Liquidity and Capital Resources
Estimated Sources of Funds
The following schedule sets forth estimated sources of funds to build our ethanol plant near Lamberton, Minnesota. This schedule could change in the future depending on the level of equity and debt financing we receive and the amount of grants, if any we are able to obtain.
Sources of |
|
|
| Percent |
| |
Offering Proceeds (2) |
| $ | 45,710,000 |
| 40.24 | % |
Seed Capital Proceeds (3) |
| $ | 1,680,000 |
| 1.48 | % |
Senior and Subordinated Debt Financing (4) |
| $ | 51,314,000 |
| 45.18 | % |
Bond Financing (5) |
| $ | 14,876,000 |
| 13.10 | % |
Total Sources of Funds |
| $ | 113,580,000 |
| 100.00 | % |
(1) The amount of estimated offering proceeds and senior debt financing may be adjusted depending on the amount of grants we are able to obtain.
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(2) We received proceeds for approximately $45,670,000 in our registered offering and issued 4,567 registered units to our investors. We also received $40,000 of investor deposits that were forfeited and are included with these offering proceeds.
(3) We issued a total of 386 units to our seed capital investors in exchange for proceeds of $1,680,000. We issued a total of 236 units to our seed capital investors at a price of $5,000 per unit. In addition, we issued 150 units to our founders at a price of $3,333.33 per unit.
(4) We have a definitive loan agreement with FNBO for debt financing in the amount up to $61,000,000, consisting of up to $50,400,000 for a Construction Loan, together with up to $5,000,000 Revolving Loan and up to $5,600,000 to support the issuance of letters of credit by FNBO. We have issued letters of credit to Redwood Electric Cooperative, Inc. and Northern Natural Gas Company for the amount of $700,000 and $4,000,000 respectfully. The details of the letters of credit are described above in Plant Construction and Start-Up of Plant Operations. The Company also entered into an interest rate swap agreement which fixes the interest rate on the Fixed Rate Note at 7.6% for five years beginning in June 2009.
(5) We have entered into a long term lease agreement with the City of Lamberton, Minnesota in order to finance equipment for the plant. The City financed the purchase of equipment through Solid Waste Facilities Revenue Bonds Series 2008A totaling $15,180,000. We received proceeds of approximately $14,876,000, after financing costs of approximately $304,000. The remaining proceeds are held as restricted cash and marketable securities based on anticipated use and are split between a project fund of approximately $11,564,000, a capitalized interest fund of approximately $1,818,000, and a debt service reserve fund of approximately $1,501,000.
We expect to have sufficient cash on hand through our equity and debt financing to cover all costs associated with construction of the project, including, but not limited to, site development, utilities, construction and equipment acquisition.
Estimated Uses of Proceeds
The following table reflects our estimate of costs and expenditures for the ethanol plant to be built near Lamberton, Minnesota. These estimates are based on discussions with Fagen, Inc., our design-builder. The following figures are intended to be estimates only, and the actual use of funds may vary significantly from the descriptions given below due to a variety of factors described elsewhere in this report.
Estimate of Costs as of the Date of this Report.
Use of Proceeds |
| Amount |
| Percent of Total |
| |
|
|
|
|
|
| |
Plant construction |
| $ | 69,950,000 |
| 61.59 | % |
Land cost |
| 1,098,000 |
| 0.97 | % | |
Site development costs |
| 13,647,300 |
| 12.02 | % | |
Construction contingency |
| 1,000,000 |
| 0.88 | % | |
Construction performance bond |
| 350,000 |
| 0.31 | % | |
Construction insurance costs |
| 160,000 |
| 0.14 | % | |
Administrative building |
| 300,000 |
| 0.26 | % | |
Office equipment |
| 44,500 |
| 0.04 | % | |
Computers, Software, Network |
| 193,000 |
| 0.17 | % | |
Railroad |
| 5,879,615 |
| 5.18 | % | |
Rolling stock |
| 560,000 |
| 0.49 | % | |
Fire Protection and water supply |
| 6,005,835 |
| 5.29 | % | |
Construction Manager Fees |
| 100,000 |
| 0.09 | % | |
Capitalized interest |
| 1,818,000 |
| 1.60 | % | |
Start up costs: |
|
|
|
|
| |
Financing costs |
| 1,981,000 |
| 1.74 | % | |
Cost of Raising Capital |
| 736,000 |
| 0.65 | % | |
Organization costs |
| 935,000 |
| 0.82 | % | |
Pre-production period costs |
| 1,170,750 |
| 1.03 | % | |
Debt Service Reserve |
| 1,501,000 |
| 1.32 | % | |
Working capital |
| 2,000,000 |
| 1.76 | % | |
Inventory - corn |
| 1,375,000 |
| 1.21 | % | |
Inventory - chemicals and ingredients |
| 600,000 |
| 0.53 | % | |
Inventory - Ethanol |
| 1,500,000 |
| 1.32 | % | |
Inventory - DDGS |
| 500,000 |
| 0.44 | % | |
Spare parts - process equipment |
| 175,000 |
| 0.15 | % | |
Total |
| $ | 113,580,000 |
| 100.00 | % |
18
We expect the total funding required for the plant to be approximately $113,580,000, which includes $69,950,000 to build the plant and approximately $43,630,000 for other project development costs including land, site development, utilities, start-up costs, capitalized fees and interest, inventories and working capital. In addition, our use of proceeds budget was previously increased due to increases in the budgeted amounts for the CCI contingency, site development costs, construction performance bond, railroad costs, fire protection and water supply, and financing costs. Our use of proceeds is measured from date of inception and we have already incurred some of the related expenditures.
Financial Results
As of October 31, 2008, we had cash of approximately $1,356,000 and total assets of approximately $77,798,000, which includes approximately $62,948,000 in construction in progress and approximately $6,842,000 in restricted marketable securities. As of October 31, 2008, we had current liabilities of approximately $17,556,000 consisting mainly of accrued expenses in the amount of approximately $669,000 and construction payable in the amount of approximately $16,764,000. In addition, we have long term debt of approximately $15,180,000 and long-term derivative instrument of approximately $530,000. Total members’ equity as of October 31, 2008, was approximately $44,532,000. Since inception, we have generated no revenue from operations, and as of October 31, 2008, have accumulated net losses of approximately $2,061,000 and accumulated other comprehensive loss of approximately $60,000.
At October 31, 2008, we had recorded a liability for a derivative instrument of approximately $591,000 related to the interest rate swap. The Company has recognized a loss on the interest rate swap of approximately $591,000 included in other income and expense for the year ended October 31, 2008.
We raised $1,680,000 in seed capital through previous private placements. We received proceeds for approximately 4,567 units through our registered offering for aggregate proceeds of approximately $45,670,000. We closed the offering on April 5, 2008 and released funds from escrow on April 7, 2008.
Critical Accounting Estimates
Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment testing for assets requires various estimates and assumptions,
19
including an allocation of cash flows to those assets and, if required, an estimate of the fair value of those assets. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management’s assumptions, which do not reflect unanticipated events and circumstances that may occur.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Employees
We currently have three part-time employees, a Plant Manager and a General Manager/Chief Executive Officer. Our Grain Merchandiser and Maintenance Technician are expected to start working for the Company in February and our Operations Manager is expected to start work in early March. See “DESCRIPTION OF BUSINESS — Employees.”
20
ITEM 7. FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Governors
Highwater Ethanol, LLC
Lamberton, Minnesota
We have audited the accompanying balance sheets of Highwater Ethanol, LLC (a development stage company) as of October 31, 2008 and 2007, and the related statements of operations, changes in members’ equity and comprehensive loss, and cash flows for the years then ended and the period from inception (May 2, 2006) to October 31, 2008. Highwater Ethanol, LLC’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Highwater Ethanol, LLC (a development stage company) as of October 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended and for the period from inception (May 2, 2006) to October 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
| /s/ Boulay, Heutmaker, Zibell & Co., P.L.L.P |
|
|
| Certified Public Accountants |
|
|
Minneapolis, Minnesota |
|
January 29, 2009, except as to Notes 1, 5, 7, 9 and 11 |
|
which are as of September 29, 2009 |
|
21
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Balance Sheets
|
| October 31, |
| October 31, |
| ||
ASSETS |
| 2008 |
| 2007 |
| ||
|
| (Restated) |
|
|
| ||
Current Assets |
|
|
|
|
| ||
Cash |
| $ | 1,355,827 |
| $ | 98,697 |
|
Restricted cash |
| 2,916,825 |
| 56,254 |
| ||
Restricted marketable securities |
| 5,380,199 |
| — |
| ||
Prepaids and other |
| 540,190 |
| 35,353 |
| ||
Total current assets |
| 10,193,041 |
| 190,304 |
| ||
|
|
|
|
|
| ||
Property and Equipment |
|
|
|
|
| ||
Land and land improvements |
| 1,250,621 |
| 1,018,252 |
| ||
Construction in progress |
| 62,948,311 |
| 20,854 |
| ||
Office equipment |
| 19,137 |
| 17,283 |
| ||
Accumulated depreciation |
| (5,949 | ) | (2,386 | ) | ||
Total property and equipment |
| 64,212,120 |
| 1,054,003 |
| ||
|
|
|
|
|
| ||
Other Assets |
|
|
|
|
| ||
Restricted cash |
| 56,565 |
| — |
| ||
Restricted marketable securities |
| 1,461,435 |
| — |
| ||
Deferred offering costs |
| — |
| 717,363 |
| ||
Debt issuance costs, net |
| 1,874,782 |
| 2,209 |
| ||
Land options |
| — |
| 2,000 |
| ||
Total other assets |
| 3,392,782 |
| 721,572 |
| ||
|
|
|
|
|
| ||
Total Assets |
| $ | 77,797,943 |
| $ | 1,965,879 |
|
|
|
|
|
|
| ||
|
| October 31, |
| October 31, |
| ||
LIABILITIES AND EQUITY |
| 2008 |
| 2007 |
| ||
|
| (Restated) |
|
|
| ||
Current Liabilities |
|
|
|
|
| ||
Note payable |
| $ | — |
| $ | 1,100,000 |
|
Accounts payable |
| 54,833 |
| 577,231 |
| ||
Accounts payable - members |
| 7,014 |
| 125,589 |
| ||
Construction payable |
| 1,620,712 |
| — |
| ||
Construction payable - members |
| 15,143,048 |
| — |
| ||
Accrued expenses |
| 669,126 |
| 13,956 |
| ||
Derivative instrument |
| 60,996 |
| — |
| ||
Total current liabilities |
| 17,555,729 |
| 1,816,776 |
| ||
|
|
|
|
|
| ||
Long-Term Debt |
| 15,180,000 |
| — |
| ||
|
|
|
|
|
| ||
Derivative Instrument |
| 530,078 |
| — |
| ||
|
|
|
|
|
| ||
Commitments and Contingencies |
|
|
|
|
| ||
|
|
|
|
|
| ||
Members’ Equity |
|
|
|
|
| ||
Member contributions, net of costs related to capital contributions, 4,953 and 386 units outstanding at October 31, 2008 and 2007, respectively |
| 46,653,590 |
| 1,680,000 |
| ||
Deficit accumulated during development stage |
| (2,061,350 | ) | (1,530,897 | ) | ||
Accumulated other comprehensive loss |
| (60,104 | ) | — |
| ||
Total members’ equity |
| 44,532,136 |
| 149,103 |
| ||
|
|
|
|
|
| ||
Total Liabilities and Members’ Equity |
| $ | 77,797,943 |
| $ | 1,965,879 |
|
Notes to Financial Statements are an integral part of this Statement.
22
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Statements of Operations
|
|
|
|
|
| From Inception |
| |||
|
| Year Ended |
| Year Ended |
| (May 2, 2006) |
| |||
|
| October 31, 2008 |
| October 31, 2007 |
| to October 31, 2008 |
| |||
|
| (Restated) |
|
|
| (Restated) |
| |||
|
|
|
|
|
|
|
| |||
Revenues |
| $ | — |
| $ | — |
| $ | — |
|
|
|
|
|
|
|
|
| |||
Operating Expenses |
|
|
|
|
|
|
| |||
Professional fees |
| 710,218 |
| 990,707 |
| 2,042,272 |
| |||
General and administrative |
| 300,512 |
| 199,720 |
| 527,193 |
| |||
Total operating expenses |
| 1,010,730 |
| 1,190,427 |
| 2,569,465 |
| |||
|
|
|
|
|
|
|
| |||
Operating Loss |
| (1,010,730 | ) | (1,190,427 | ) | (2,569,465 | ) | |||
|
|
|
|
|
|
|
| |||
Other Income (Expense) |
|
|
|
|
|
|
| |||
Interest income |
| 1,060,630 |
| 30,507 |
| 1,110,785 |
| |||
Other income |
| 10,721 |
| 3,225 |
| 13,946 |
| |||
Interest expense |
| — |
| (25,542 | ) | (25,542 | ) | |||
Loss on derivative instrument |
| (591,074 | ) | — |
| (591,074 | ) | |||
Total other income, net |
| 480,277 |
| 8,190 |
| 508,115 |
| |||
|
|
|
|
|
|
|
| |||
Net Loss |
| $ | (530,453 | ) | $ | (1,182,237 | ) | $ | (2,061,350 | ) |
|
|
|
|
|
|
|
| |||
Weighted Average Units Outstanding |
| 3,056 |
| 386 |
| 1,440 |
| |||
|
|
|
|
|
|
|
| |||
Net Loss Per Unit |
| $ | (173.58 | ) | $ | (3,062.79 | ) | $ | (1,431.49 | ) |
Notes to Financial Statements are an integral part of this Statement.
23
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Statement of Changes in Members’ Equity and Comprehensive Loss
|
|
|
|
|
|
|
|
|
| ||||
|
|
|
| Deficit Accumulated |
| Accumulated Other |
|
|
| ||||
|
| Member |
| During |
| Comprehensive |
|
|
| ||||
|
| Contributions |
| Development Stage |
| Loss |
| Total |
| ||||
|
|
|
|
|
|
|
| (Restated) |
| ||||
Balance - May 2, 2006, Inception |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
|
|
|
|
|
|
|
|
|
|
| ||||
Membership units - 150 units at $3,333 per unit, May 2006 |
| 500,000 |
| — |
| — |
| 500,000 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Membership units - 236 units at $5,000 per unit, June 2006 |
| 1,180,000 |
| — |
| — |
| 1,180,000 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net loss |
| — |
| (348,660 | ) | — |
| (348,660 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance - October 31, 2006 |
| 1,680,000 |
| (348,660 | ) | — |
| 1,331,340 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net loss |
| — |
| (1,182,237 | ) | — |
| (1,182,237 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance - October 31, 2007 |
| 1,680,000 |
| (1,530,897 | ) | — |
| 149,103 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Membership units - 4,567 units at $10,000 per unit, April 2008 |
| 45,670,000 |
| — |
| — |
| 45,670,000 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Additional paid in capital - forfeited units |
| 40,000 |
| — |
| — |
| 40,000 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs of raising capital |
| (736,410 | ) | — |
| — |
| (736,410 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive loss |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net loss |
| — |
| (530,453 | ) | — |
| (530,453 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Unrealized loss on restricted marketable securities |
| — |
| — |
| (60,104 | ) | (60,104 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Total comprehensive loss |
| — |
| — |
| — |
| (590,557 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance - October 31, 2008 |
| $ | 46,653,590 |
| $ | (2,061,350 | ) | $ | (60,104 | ) | $ | 44,532,136 |
|
Notes to Financial Statements are an integral part of this Statement.
24
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Statement of Cash Flows
|
|
|
|
|
| From Inception |
| |||
|
| Year Ended |
| Year Ended |
| (May 2, 2006) |
| |||
|
| October 31, 2008 |
| October 31, 2007 |
| to October 31, 2008 |
| |||
|
| (Restated) |
|
|
| (Restated) |
| |||
Cash Flows from Operating Activities |
|
|
|
|
|
|
| |||
Net loss |
| $ | (530,453 | ) | $ | (1,182,237 | ) | $ | (2,061,350 | ) |
Adjustments to reconcile net loss to net cash from operations |
|
|
|
|
|
|
| |||
Depreciation and amortization |
| 3,563 |
| 6,179 |
| 9,801 |
| |||
Change in fair value of derivative instrument |
| 591,074 |
| — |
| 591,074 |
| |||
Other |
| 1,624 |
| — |
| 370 |
| |||
Change in assets and liabilities |
|
|
|
|
|
|
| |||
Prepaids and other |
| (504,837 | ) | (20,080 | ) | (540,190 | ) | |||
Accounts payable, including members |
| (411,737 | ) | 283,896 |
| 61,847 |
| |||
Accrued expenses |
| (11,485 | ) | 13,956 |
| 2,471 |
| |||
Net cash used in operating activities |
| (862,251 | ) | (898,286 | ) | (1,935,977 | ) | |||
|
|
|
|
|
|
|
| |||
Cash Flows from Investing Activities |
|
|
|
|
|
|
| |||
Capital expenditures |
| (232,223 | ) | (874,415 | ) | (1,227,758 | ) | |||
Construction in progress |
| (40,327,504 | ) | (20,854 | ) | (40,348,358 | ) | |||
Payments for land options |
| — |
| (30,000 | ) | (42,000 | ) | |||
Net cash used in investing activities |
| (40,559,727 | ) | (925,269 | ) | (41,618,116 | ) | |||
|
|
|
|
|
|
|
| |||
Cash Flows from Financing Activities |
|
|
|
|
|
|
| |||
Proceeds from note payable |
| — |
| 1,038,939 |
| 1,038,939 |
| |||
Payments on notes payable |
| (1,100,000 | ) | — |
| (1,100,000 | ) | |||
Funds received from restricted cash |
| 36,721 |
| — |
| 36,721 |
| |||
Increase in restricted cash from net interest earned |
| (119,604 | ) | — |
| (119,604 | ) | |||
Member contributions |
| 45,670,000 |
| — |
| 47,350,000 |
| |||
Forfeited investor deposits |
| 40,000 |
| — |
| 40,000 |
| |||
Payments for deferred offering costs |
| (248,283 | ) | (381,058 | ) | (736,410 | ) | |||
Payments for debt issuance costs |
| (1,599,726 | ) | — |
| (1,599,726 | ) | |||
Net cash provided by financing activities |
| 42,679,108 |
| 657,881 |
| 44,909,920 |
| |||
|
|
|
|
|
|
|
| |||
Net Increase (Decrease) in Cash |
| 1,257,130 |
| (1,165,674 | ) | 1,355,827 |
| |||
|
|
|
|
|
|
|
| |||
Cash - Beginning of period |
| 98,697 |
| 1,264,371 |
| — |
| |||
|
|
|
|
|
|
|
| |||
Cash - End of period |
| $ | 1,355,827 |
| $ | 98,697 |
| $ | 1,355,827 |
|
|
|
|
|
|
|
|
| |||
Supplemental Cash Flow Information |
|
|
|
|
|
|
| |||
Cash paid for interest expense |
| $ | — |
| $ | 25,542 |
| $ | 25,542 |
|
Cash paid for interest capitalized |
| $ | 66,895 |
| $ | 8,154 |
| $ | 76,895 |
|
Total |
| $ | 66,895 |
| $ | 33,696 |
| $ | 102,437 |
|
|
|
|
|
|
|
|
| |||
Supplemental Disclosure of Noncash Financing and Investing Activities |
|
|
|
|
|
|
| |||
Unrealized losses on restricted marketable securities |
| $ | 60,104 |
| $ | — |
| $ | 60,104 |
|
Restricted cash received as part of capital lease |
| $ | 14,876,400 |
| $ | — |
| $ | 14,876,400 |
|
Restricted cash received as part of note payable |
| $ | — |
| $ | 55,000 |
| $ | 55,000 |
|
Purchase of restricted marketable securities with restricted cash |
| $ | 6,903,362 |
| $ | — |
| $ | 6,903,362 |
|
Capital expenditures included in construction payable |
| $ | 16,763,760 |
| $ | — |
| $ | 16,763,760 |
|
Capital expenditures included in accounts payable |
| $ | — |
| $ | 119,704 |
| $ | — |
|
Construction in progress paid from restricted cash |
| $ | 5,138,785 |
| $ | — |
| $ | 5,138,785 |
|
Accrued interest capitalized in construction in progress |
| $ | 666,655 |
| $ | — |
| $ | 666,655 |
|
Loan costs capitalized with construction in progress |
| $ | 30,753 |
| $ | — |
| $ | 30,753 |
|
Deferred offering costs included in accounts payable |
| $ | — |
| $ | 229,236 |
| $ | — |
|
Debt issuance costs financed through capital lease |
| $ | 303,600 |
| $ | — |
| $ | 303,600 |
|
Debt issuance costs financed with note payable |
| $ | — |
| $ | 6,061 |
| $ | 6,061 |
|
Costs of raising capital offset against equity raised |
| $ | 736,410 |
| $ | — |
| $ | 736,410 |
|
Land options exercised for land purchase |
| $ | 2,000 |
| $ | 40,000 |
| $ | 42,000 |
|
Notes to Financial Statements are an integral part of this Statement.
25
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) was organized with the intentions of developing, owning and operating a 50 million gallon dry mill corn-processing ethanol plant near Lamberton, Minnesota. The Company was formed on May 2, 2006 to have a perpetual life. As of October 31, 2008, the Company is in the development stage with its efforts being principally devoted to organizational activities and construction of the plant. The Company anticipates completion of the plant in May 2009.
Fiscal Reporting Period
The Company has adopted a fiscal year ending October 31 for reporting financial operations.
Accounting Estimates
Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ from those estimates.
Cash
The Company maintains its accounts primarily at one financial institution. At times throughout the year, the cash balances may exceed amounts insured by the Federal Deposit Insurance Corporation. The Company does not believe it is exposed to any significant credit risk on cash balances.
Restricted Cash
The Company maintains restricted cash balances as part of the capital lease financing agreement described in Note 9. The restricted cash balances include money market accounts and similar debt instruments which currently exceed amounts insured by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation. The Company does not believe it is exposed to any significant credit risk on cash balances.
Restricted Marketable Securities
The Company maintains restricted marketable securities in debt securities as part of the capital lease financing agreement described in Note 9. The restricted marketable securities consist primarily of municipal obligations, U.S. treasury government obligations, and corporate obligations. Restricted marketable securities are classified as “available-for-sale” and are carried at their estimated fair market value based on quoted market prices at year end.
Realized gains and losses, determined using the specific identification method, are included in earnings; unrealized holding gains and losses on available-for-sale securities are reported as a separate component of members’ equity in accumulated other comprehensive income or loss and excluded from earnings until realized.
Property and Equipment
Property and equipment is stated at cost. Depreciation is provided over an estimated useful life by use of the straight line method. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. The present value of capital lease obligations is classified as long-term debt and the related assets will be included with property and equipment. Amortization of property and equipment under capital lease will be included with depreciation expense.
26
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
The Company incurred substantial consulting, permitting, and other pre-construction services related to building its plant facilities prior to receiving project funding. These costs were expensed prior to obtaining project debt and equity financing. Once this funding was received, these costs as they related to project construction have been capitalized with construction in progress.
The Company capitalizes construction costs and construction period interest as construction in progress until the assets are placed in service. As of October 31, 2008, the Company had construction in progress of approximately $62,950,000, which includes approximately $774,000 of capitalized interest, including amounts accrued, and approximately $92,000 of insurance costs. As of October 31, 2007, the Company had construction in progress of approximately $21,000, all consisting of capitalized interest, including amounts accrued.
Carrying Value of Long-Lived Assets
Long-lived assets, such as property, plant, and equipment, and other long-lived assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
Deferred Offering Costs
The Company defers the costs incurred to raise equity financing until that financing occurs. At such time that the issuance of new equity occurs, these costs will be netted against the proceeds received. In April 2008, the issuance of new equity occurred and approximately $736,000 of offering costs were netted against the proceeds received.
Debt Issuance Costs
Costs associated with the issuance of debt are recorded as debt issuance costs and are amortized over the term of the related debt by use of the effective interest method.
Net Income (Loss) per Unit
Basic net income (loss) per unit is computed by dividing net income by the weighted average number of members’ units outstanding during the period. Diluted net income per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period. There were no member unit equivalents outstanding during the periods presented; accordingly, for all periods presented, the Company’s basic and diluted net income per unit are the same.
Income Taxes
The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, their income or losses are included in the income tax returns of the members and partners. Accordingly, no provision or liability for federal or state income taxes has been included in these financial statements.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the requirements of SFAS 109, Accounting for Income Taxes, relating to the recognition of income tax benefits. FIN 48 provides a two-step approach to recognizing and measuring tax benefits when realization of the
27
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
benefits is uncertain. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. Primarily due to the Company’s tax status as a partnership, the adoption of FIN 48 on November 1, 2008, had no material impact on the Company’s financial condition or results of operations.
Fair Value of Financial Instruments
The carrying value of cash, restricted cash, and restricted marketable securities approximates their fair value based on quoted market prices at year end. The Company believes the carrying value of the derivative instrument approximates fair value based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The Company believes the carrying amount of the long-term debt approximates the fair value due to the terms of the debt and the current interest rate environment.
Derivative Instrument
The Company accounts for derivative instruments in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133 requires the recognition of derivative instruments in the balance sheet and the measurement of these instruments at fair value.
In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Changes in the fair value of undesignated derivatives are recorded in the statement of operations along with items being hedged. The Statement of Cash Flows includes the non-cash effects of changes in the interest rate swap as a change in fair value of derivative instrument.
Additionally, SFAS No. 133 requires a company to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal are documented as normal and exempted from the accounting and reporting requirements of SFAS No. 133, and therefore, are not marked to market in our financial statements.
In order to reduce the risk caused by interest rate fluctuations, the Company entered into an interest rate swap agreement. This contract is used with the intention to limit exposure to increased interest rates. The fair value of this contract is based on widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs. The fair value of the derivative is continually subject to change due to changing market conditions. The Company does not formally designate this instrument as a hedge and, therefore, records in earnings adjustments caused from marking instrument to market on a monthly basis.
Recently Issued Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157 (SFAS 157), Fair Value Measurements, SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.
The statement is effective for (1) financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years and (2) certain non-financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2008, and interim periods
28
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
within those fiscal years. The Company is evaluating the effect, if any, that the adoption of SFAS 157 will have on its results of operations, financial position, and the related disclosures.
In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 159, (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (Accounting for Certain Investments in Debt and Equity Securities). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. The Company is evaluating the effect, if any, that the adoption of SFAS 159 will have on its results of operations, financial position, and the related disclosures.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. SFAS 161 applies to all derivative instruments and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42 of SFAS 133 and related hedged items accounted for under SFAS 133. SFAS 161 requires entities to provide greater transparency through additional disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. SFAS 161 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2008. The Company currently plans to adopt SFAS 161 during its 2010 fiscal year.
2. UNCERTAINTIES
The Company will derive substantially all of its revenues from the sale of ethanol and distillers grains once operations commence. These products are commodities and the market prices for these products recently display substantial volatility and are subject to a number of factors which are beyond the control of the Company. The Company’s most significant manufacturing inputs will be corn and natural gas. The price of these commodities is also subject to substantial volatility and uncontrollable market factors. In addition, these input costs do not necessarily fluctuate with the market prices for ethanol and distillers grains.
As a result, the Company is subject to significant risk that its operating margins can be reduced or eliminated due to the relative movements in the market prices of its products and major manufacturing inputs. As a result, market fluctuations in the price of or demand for these commodities can have a significant adverse effect on the Company’s operations and profitability.
29
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
3. RESTRICTED MARKETABLE SECURITIES
The cost and fair value of the Company’s restricted marketable securities consist of the following at October 31, 2008:
|
| Amortized |
| Gross |
| Fair Value |
| |||
|
|
|
|
|
|
|
| |||
Restricted marketable securities - Current |
|
|
|
|
|
|
| |||
Municipal obligations |
| $ | 430,210 |
| $ | (3,977 | ) | $ | 426,233 |
|
U.S. treasury government obligations |
| 639,791 |
| (8,283 | ) | 631,508 |
| |||
Corporate obligations |
| 4,322,620 |
| (162 | ) | 4,322,458 |
| |||
Total restricted marketable securities |
| 5,392,621 |
| (12,422 | ) | 5,380,199 |
| |||
|
|
|
|
|
|
|
| |||
Restricted marketable securities — Long-term |
|
|
|
|
|
|
| |||
Municipal obligations |
| 1,509,117 |
| (47,682 | ) | 1,461,435 |
| |||
|
|
|
|
|
|
|
| |||
Total restricted marketable securities |
| $ | 6,901,738 |
| $ | (60,104 | ) | $ | 6,841,634 |
|
The long-term restricted marketable securities relate to the debt service reserve fund noted in Note 9. Other comprehensive income is income of approximately $500 for the year ended October 31, 2008.
Shown below are the contractual maturities of marketable securities with fixed maturities at October 31, 2008. Actual maturities may differ from contractual maturities because certain securities may contain early call or prepayment rights.
Due within 1 year |
| $ | 5,380,199 |
|
Due in 1 to 3 years |
| — |
| |
Due in 3 to 5 years |
| 1,237,815 |
| |
Due in more than 5 years |
| 223,620 |
| |
Total |
| $ | 6,841,634 |
|
4. INTERIM FINANCING
The Company had a note payable for $800,000 from a bank to finance a land purchase. The note carried annual interest at 7.50% and was repaid in April 2008.
In July 2007, the Company obtained an unsecured note payable for $300,000 from the general contractor. The note carried interest at 7.50% and was payable in full at the earlier of financial close or January 2, 2008. In January 2008, the Company executed an extension agreement for the note to be payable in full at the earlier of financial close or April 15, 2008. In April 2008, the Company paid all principal and interest due on this note.
5. DERIVATIVE INSTRUMENT
At October 31, 2008, the Company recorded a liability for a derivative instrument of approximately $591,000 related to the interest rate swap described in Note 9. This derivative instrument was not designated as a cash flow hedge. The Company has recognized a loss on the interest rate swap of approximately $591,000 included in other income and expense for the year ended October 31, 2008.
30
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
6. MEMBERS’ EQUITY
The Company has one class of membership units, which include certain transfer restrictions as specified in the operating agreement and pursuant to applicable tax and securities law, with each unit representing a pro rata ownership in the Company’s capital, profits, losses and distributions. Income and losses are allocated to all members based upon their respective percentage of units held.
The Company was initially capitalized by 13 members, contributing an aggregate of $500,000 for 150 units. The Company was further capitalized by 117 additional members contributing an aggregate of $1,180,000 in exchange for 236 units.
The Company filed a Form SB-2 Registration Statement with the Securities and Exchange Commission (SEC) for a minimum of 4,500 and up to 6,000 membership units for sale at $10,000 per unit. The Registration Statement was declared effective on April 5, 2007. Offering proceeds were held in escrow until April 2008. The total number of units accepted was 4,567 with proceeds totaling $45,670,000. The Company received approximately $40,000 of investor deposits that were forfeited and are included with member contributions. These funds will be used to provide financing to complete the Company’s ethanol facility in Lamberton, Minnesota.
7. INCOME TAXES
The Company has adopted an October 31 fiscal year end, but has a tax year end of December 31. The differences between financial statement basis and tax basis of assets are estimated as follows:
|
| October 31, |
| October 31, |
| ||
|
| 2008 |
| 2007 |
| ||
|
|
|
|
|
| ||
Financial statement basis of total assets |
| $ | 77,797,943 |
| $ | 1,965,879 |
|
|
|
|
|
|
| ||
Organizational and start-up costs expensed for financial reporting purposes |
| 2,542,960 |
| 1,544,339 |
| ||
|
|
|
|
|
| ||
Income tax basis of total assets |
| $ | 80,340,903 |
| $ | 3,510,218 |
|
The differences between the financial statement basis and tax basis of the Company’s liabilities are estimated as follows:
|
| October 31, |
| October 31, |
| ||
|
| 2008 |
| 2007 |
| ||
|
|
|
|
|
| ||
Financial statement basis of liabilities |
| $ | 33,265,807 |
| $ | 1,816,776 |
|
|
|
|
|
|
| ||
Less: unrealized loss on derivative instrument |
| (591,074 | ) | — |
| ||
|
|
|
|
|
| ||
Income tax basis of liabilities |
| $ | 32,674,733 |
| $ | 1,816,776 |
|
31
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
8. RELATED PARTY TRANSACTIONS
A member is providing legal services to the Company. The Company has incurred approximately $123,000 for the year ended October 31, 2008 related to these services.
In September 2006, the Company entered into an agreement with a general contractor, a member, to design and build the ethanol plant. As of October 31, 2008, the Company has incurred approximately $47,747,000 for these services.
In December 2007, the Company entered into an agreement with a related party through common ownership for the construction of a water treatment facility, well drilling, and installation of the fire loop. As of October 31, 2008, the Company has incurred approximately $6,178,272 under this agreement.
In June 2007, the Company entered into an agreement with a related party to be the exclusive provider of electricity for the plant. As of October 31, 2008, the monthly fee of approximately $12,000 had been suspended until operations begin.
In August 2008, the Company entered into an agreement with a related party through common ownership for the construction of an administration building. As of October 31, 2008, the Company has incurred approximately $50,000.
9. DEBT FINANCING
Bank Financing
In April 2008, the Company entered into a credit agreement with a financial institution for the purpose of funding a portion of the cost of the ethanol plant. Under the credit agreement, the lender will provide a construction loan of $50,400,000, a construction revolving loan for $5,000,000 and will support the issuance of letters of credit up to $5,600,000, all of which are secured by substantially all assets. At October 31, 2008, the Company had issued $4,700,000 in letters of credit. The Company will make monthly interest payments for all amounts owed during the construction phase at the greater of LIBOR plus 350 basis points or 4%. No amounts have been drawn on this financing at October 31, 2008. Upon the completion of construction, a maximum of $25,200,000 of the construction loan will convert into a Fixed Rate Note, a maximum of $20,200,000 will convert into a Variable Rate Note, and a maximum of $5,000,000 will convert into a Long-term Revolving Note, as described in the credit agreement and further below.
Fixed Rate Note
The Fixed Rate Note is for up to $25,200,000 with a variable interest rate that is fixed with an interest rate swap. The Company will make 59 monthly principal payments on the Fixed Rate Note initially for approximately $145,000 plus accrued interest commencing one month immediately following the construction loan termination date. Interest will accrue on the Fixed Rate Note at the greater of the one-month LIBOR rate plus 300 basis points or 4%. A final balloon payment on the Fixed Rate Note of approximately $15,184,000 will be due five years following the construction loan termination date. The Company entered into an interest rate swap which fixes the interest rate on the Fixed Rate Note at 7.6% for five years beginning in June 2009.
Variable Rate Note
The Variable Rate Note is for up to $20,200,000. For the Variable Rate Note, the Company will make 59 monthly payments initially for approximately $147,000 plus accrued interest commencing one month immediately following the construction loan termination date for the Variable Rate Note. Interest will accrue on the Variable Rate Note at the greater of the one-month LIBOR rate plus 350 basis points or 4%. A final balloon payment of approximately $14,807,000 will be due five years following the construction loan termination date.
Long-term Revolving Note
The Long-term Revolving Note is for up to $5,000,000 initially. The amount available on the Long-term Revolving Note will decline annually by the greater of $125,000 or 50% of the excess cash flow, as defined by the agreement. The Long-term Revolving Note will accrue interest monthly at the greater of the one-month LIBOR plus 350 basis points, or 4% until maturity will be due five years following the construction loan termination date.
32
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
Line of Credit
The construction revolving loan is the Company’s line of credit and accrues interest at the greater of the one-month LIBOR plus 350 basis points or 4%. The line of credit requires monthly interest payments and is payable in full in April 2009.
The Company is required to make additional payments annually on debt for up to 50% of the excess cash flow, as defined by the agreement. As part of the bank financing agreement, the premium above LIBOR on the loans may be reduced based on a financial ratio. The loan agreements are secured by substantially all business assets and are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements.
As of October 31, 2008, the Company has letters of credit outstanding of $4,700,000 as mentioned previously. The Company pays interest at a rate of 3% on amounts outstanding and the letters of credit are valid until July 2009. One of the letters of credit will automatically renew for an additional one year period in the amount of $4,000,000.
Capital Lease
In April 2008, the Company entered into a lease agreement with the City of Lamberton, Minnesota, (the City) in order to finance equipment for the plant. The lease has a term from April 1, 2008 through April 1, 2028 or until earlier terminated. The City financed the purchase of equipment through Solid Waste Facilities Revenue Bonds Series 2008A totaling $15,180,000.
Under the equipment lease agreement with the City, the Company will start making interest payments on November 25, 2008 and monthly thereafter at an implicit interest rate of 8.5%. The monthly capital lease interest payments correspond to 1/6 the semi-annual interest payments due on the Bonds on the next interest payment date. Monthly capital lease payments for principal were originally scheduled to begin on November 25, 2009, however, the City amended the agreement in September 2008 which adjusted the start date for principal payments to begin on November 25, 2014. These payments will equal 1/12 the annual principal payments scheduled to become due on the corresponding bonds on the next principal payment date. The Company has guaranteed that if such assessed lease payments are not sufficient for the required bond payments, the Company will provide such funds as are needed to fund the shortfall. The lease agreement is secured by substantially all business assets and is subject to various financial and non-financial covenants that limit distributions and leverage and require minimum debt service coverage, net worth, and working capital requirements, and are secured by all business assets.
The capital lease includes an option to purchase the equipment at fair market value at the end of the lease term. Under the capital lease agreement, the proceeds are for project costs and the establishment of a capitalized interest fund and a debt service reserve fund. The Company received proceeds of approximately $14,876,000, after financing costs of approximately $304,000. At close when the funds were distributed, the remaining proceeds were held as restricted cash based on anticipated use and were split between a project fund of approximately $11,527,000, a capitalized interest fund of approximately $1,831,000, and a debt service reserve fund of approximately $1,518,000.
Estimated principal payments on long-term debt are as follows at October 31, 2008:
2009 |
| $ | — |
|
2010 |
| — |
| |
2011 |
| — |
| |
2012 |
| — |
| |
2013 |
| — |
| |
After 2013 |
| 15,180,000 |
| |
Total |
| $ | 15,180,000 |
|
33
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
Future minimum lease payments under the capital lease are as follows at October 31, 2008:
2009 |
| $ | 1,956,955 |
|
2010 |
| 1,290,300 |
| |
2011 |
| 1,290,300 |
| |
2012 |
| 1,290,300 |
| |
2013 |
| 1,290,300 |
| |
After 2013 |
| 22,933,275 |
| |
Total |
| 30,051,430 |
| |
Less amount representing interest |
| 14,871,430 |
| |
Present value of minimum lease payments |
| 15,180,000 |
| |
Less current maturities |
| — |
| |
Long-term debt |
| $ | 15,180,000 |
|
10. COMMITMENTS AND CONTINGENCIES
Construction Contracts
The total cost of the project, including the construction of the ethanol plant and start-up expenses, is expected to approximate $113,580,000. The Company signed an agreement in September 2006 with a general contractor, a related party, to design and build the ethanol plant at a total contract price of approximately $66,026,000. The design-build agreement provided for an upward adjust of the construction price over the construction cost index (CCI) published in January 2006 of 7660.29. As the notice to proceed was executed in April 2008, the contract price increased, with change orders, to approximately $69,950,000.
Monthly applications are submitted for work performed in the previous period. Final payment will be due when final completion has been achieved. As of October 31, 2008, the Company has incurred approximately $47,747,000 for these services.
Site Improvement Contracts
In November 2007, the Company entered into an agreement with an unrelated party for dirt work related to the construction of the plant for an amount of approximately $1,761,000. As of October 31, 2008 the company has approved change orders totaling approximately $395,000. The Company shall pay a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. As of October 31, 2008, the Company has incurred approximately $2,113,000 under this agreement. In August 2008, the Company entered into an additional contract with the same party for rail system drainage for an amount of approximately $1,214,000. The Company shall pay a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. As of October 31, 2008, the Company has incurred approximately $1,190,000 under this agreement.
In December 2007, the Company entered into an agreement with a related party for construction of a water treatment facility, well drilling, and installation of the fire loop for approximately $15,995,000. The company shall make monthly payments based on the amount of work completed, with 5% retainage held on the last two payments. As of October 31, 2008, the Company has incurred approximately $6,178,000 under this agreement.
In July 2008, the Company entered into an agreement with an unrelated party for rail work for approximately $4,361,000. The Company shall pay a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. The contractor began work on August 15, 2008, and must complete the project by January 15, 2009. The contractor shall pay the Company $750 for damages each day that work extends
34
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
beyond January 15, 2009. As of October 31, 2008, the Company has incurred approximately $3,700,000 under this agreement.
In July 2008, the Company entered into an agreement with an unrelated party for the installation of piling for support of grain silos for approximately $428,000. The contract required a 10% down payment of approximately $43,000 upon signing. As of October 31, 2008, the Company has incurred approximately $424,000 under this contract.
In August 2008, the Company entered into an agreement with a related party for the construction of an administration building for approximately $278,000. The Company shall pay a monthly fee of 90% of the value based on the amount of work completed, with the remaining 10% held as retainage. As of October 31, 2008, the Company has incurred approximately $50,000.
Consulting Contracts
In June 2007, the Company entered into an agreement with a related party to be the exclusive provider of electricity for the plant. The agreement is to commence the earlier of the first day of the month in which the plant begins operations or June 1, 2008. The agreement is to remain in effect for a period of ten years following commencement. The rates for these services will be a fixed charge of $12,000 per month along with monthly electric usage based on rates listed in the agreement. The rates for the first five years of the agreement are guaranteed. The estimated construction cost of the electrical infrastructure is $1,300,000. If the plant is not completed as planned or if the plant does not continue in operations for the entire term of the contract, the Company is liable for incurred project costs to date minus any salvage value. The agreement required the Company to provide a letter of credit upon request in the amount of $700,000, which was issued in July 2008, for the period of the construction and continuing for one year after commercial operation. In June 2008, there was a verbal agreement to suspend the $12,000 monthly fee until operations begin.
In May 2008, the Company entered into an agreement with an unrelated party to provide construction management services. The agreement will remain in effect until terminated. The fees for these services are $10,250 per month plus expense reimbursement. As of October 31, 2008, the Company has incurred approximately $69,000 under this agreement.
In June 2008, the Company entered into an agreement with an unrelated party for construction of a natural gas pipeline, which is expected to be in April 2009, and to be the exclusive provider of natural gas for the plant. The agreement commences upon completion of the pipeline and will remain in effect for ten years. The rates for these services will be based on the agreed upon minimum usage at rates listed in the agreement. The estimated construction cost of the pipeline is $4,000,000. The agreement requires a cash deposit or letter of credit of $4,000,000 plus three months of capacity payments payable in installments determined by the unrelated party before construction begins. The agreement also required the Company to provide a security deposit of $500,000, which will be returned to the Company over the term of the agreement. The Company made the security deposit payment of $500,000 in June 2008, and secured a $4,000,000 letter of credit in July 2008.
Marketing Agreements
In September 2006, the Company entered into a marketing agreement with an unrelated party to purchase, market, and distribute all the ethanol produced by the Company. The Company will pay the buyer one percent of the net sales price for certain marketing costs. The initial term is for two years beginning in the month when ethanol production begins with a one year renewal option. The Company would assume certain rail car leases if the agreement is not renewed.
In October 2007, the Company entered into a marketing agreement with an unrelated party to purchase all of the distiller’s dried grains with solubles (DDGS), wet distillers grains (WDG), and solubles the Company is expected to
35
HIGHWATER ETHANOL, LLC
(A Development Stage Company)
Notes to Financial Statements
October 31, 2008 and 2007
produce. The buyer agrees to pay the Company 98% of the selling price for DDGS and 96% of the selling price for WDG and a fee of $2 per ton for solubles, with a minimum fee of $1.50 per ton for sales of DDGS and WDG. The agreement commences on completion and start-up of operations of the plant and continues for one year. The agreement will remain in effect thereafter unless a 120 day advance written notice of termination is provided by either party.
Grain Procurement Contract
In July 2006, the Company entered into a grain procurement agreement with an unrelated party to provide all of the corn needed for the operation of the ethanol plant. Under the agreement, the Company will purchase corn at the local market price delivered to the plant plus a fixed fee per bushel of corn. The agreement begins when operations commence and continues for seven years.
11. RESTATEMENT
On September 8, 2009, the Company’s Audit Committee, upon management’s recommendation, determined that its financial statements as of October 31, 2008 as reported on Form 10-KSB should not be relied upon due to an error that occurred in the recording of an interest rate swap agreement. The Company had not recorded the interest rate swap entered into in April 2008. The effects of this error on the financial statements were as follows:
Balance Sheet |
| October 31, 2008 |
| October 31, 2008 |
| ||
|
| (As previously reported) |
| (As restated) |
| ||
|
|
|
|
|
| ||
Derivative instrument liability |
| $ | — |
| $ | 591,074 |
|
Deficit accumulated during the development stage |
| $ | (1,470,276 | ) | $ | (2,061,350 | ) |
Statement of Operations |
| Year Ended |
| Year Ended |
| ||
|
| (As previously reported) |
| (As restated) |
| ||
|
|
|
|
|
| ||
Loss on derivative instrument |
| $ | — |
| $ | (591,074 | ) |
Net Income (Loss) |
| $ | 60,621 |
| $ | (530,453 | ) |
Net Income (Loss) Per Unit |
| $ | 19.84 |
| $ | (173.58 | ) |
36
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
Item 8A(T). CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
Management of Highwater is responsible for maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. In addition, the disclosure controls and procedures must ensure that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial and other required disclosures.
At the end of the period covered by this report, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the supervision and with the participation of our Principal Executive Officer, Brian Kletscher, and our Principal Financial Officer, Mark Peterson. Based on their evaluation of our disclosure controls and procedures, they have concluded that during the period covered by this report, such disclosure controls and procedures were not effective to detect the inappropriate application of US GAAP standards.
Prior to this most recent evaluation of the effectiveness of our disclosure controls and procedures covering the period ended October 31, 2008 in which our controls and procedures were deemed to be not effective, our Company had disclosed material weaknesses. Our management is working diligently to remediate the material weaknesses and will continue our efforts to remediate these material weaknesses through ongoing process improvements and the implementation of enhanced policies and improving standards. We are in the process of strengthening internal controls including enhancing our internal control systems and procedures to assure that these weaknesses are corrected and remediated. No material weaknesses will be considered remediated until the remedial procedures have operated for an appropriate period, have been tested, and management has concluded that they are operating effectively.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance to our management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; (iii) provide reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and (iv) provide reasonable assurance that unauthorized acquisition, use or disposition of company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because changes in conditions may occur or the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of October 31, 2008. This assessment is based on the criteria for effective internal control described in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based
37
on its assessment, management concluded that the Company’s internal control over financial reporting was not effective as of October 31, 2008. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
This report shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liabilities of that section , and is not incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Changes in Internal Control over Financial Reporting
Our management, including our principal executive officer and principal financial officer, have reviewed and evaluated any changes in our internal control over financial reporting that occurred as of October 31, 2008 and there has been no change that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
PART III.
ITEM 13. EXHIBITS.
The following exhibits are filed as part of, or are incorporated by reference into, this report:
Exhibit |
| Description |
| Method of |
10.1 |
| Fifth Amendment to Lump Sum Design-Build Agreement between Highwater Ethanol, LLC and Fagen, Inc. |
| 1 |
|
|
|
|
|
10.2 |
| Lease Agreement dated April 1, 2008 with the City of Lamberton, MN |
| 2 |
|
|
|
|
|
10.3 |
| Trust Indenture dated April 1, 2008 with the City of Lamberton, MN and U.S. Bank National Association |
| 2 |
|
|
|
|
|
10.4 |
| Guaranty Agreement dated April 1, 2008 with U.S. Bank National Association |
| 2 |
|
|
|
|
|
10.5 |
| Bill of Sale dated April 25, 2008 from Highwater Ethanol, LLC to City of Lamberton, MN |
| 2 |
|
|
|
|
|
10.6 |
| Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Financing Statement dated April 1, 2008 with U.S. Bank National Association |
| 2 |
|
|
|
|
|
10.7 |
| Security Agreement dated April 1, 2008 with U.S. Bank National Association |
| 2 |
|
|
|
|
|
10.8 |
| Intercreditor Agreement dated April 24, 2008 with First National Bank of Omaha and U.S. Bank National Association. |
| 2 |
|
|
|
|
|
10.9 |
| Disbursing Agreement dated April 24, 2008 with First National Bank of Omaha, Homestead Escrow and Exchange Company and Dakota Homestead Title Insurance Company. |
| 2 |
|
|
|
|
|
10.10 |
| Construction Loan Agreement dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.11 |
| Construction Loan Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Financing Statement dated April 24, 2008 with First National Bank of |
| 2 |
38
|
| Omaha. |
|
|
|
|
|
|
|
10.12 |
| Security Agreement dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.13 |
| $10,000,000 Construction Note dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.14 |
| $2,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.15 |
| $9,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.16 |
| $13,646,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.17 |
| $500,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.18 |
| $1,000,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.19 |
| $14,254,000 Construction Note dated April 25, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.20 |
| Promissory Note and Continuing Letter of Credit Agreement dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.21 |
| $1,000,000 Revolving Promissory Note dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.22 |
| $1,354,000 Revolving Promissory Note dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.23 |
| $2,646,000 Revolving Promissory Note dated April 24, 2008 with First National Bank of Omaha. |
| 2 |
|
|
|
|
|
10.24 |
| Consulting Agreement dated May 27, 2008 with Granite Falls Energy, LLC. |
| 2 |
|
|
|
|
|
10.25 |
| Private Placement Agreement dated March 27, 2008 with City of Lamberton, MN and Northland Securities, Inc. |
| 3 |
|
|
|
|
|
10.26 |
| Natural Gas Service Agreement dated June 26, 2008 with CenterPoint Energy Resources Corp.+ |
| 4 |
|
|
|
|
|
10.27 |
| General Contract dated July 30, 2008 with L.A. Colo, LLC |
| 4 |
|
|
|
|
|
10.28 |
| Grain Silo Support Construction Contract dated July 24, 2008 with McC, Inc. |
| 4 |
|
|
|
|
|
14.1 |
| Code of Ethics of Highwater Ethanol, LLC as adopted in June 2008. |
| 5 |
|
|
|
|
|
31.1 |
| Certificate Pursuant to 17 CFR 240.13a-14(a) |
| * |
|
|
|
|
|
31.2 |
| Certificate Pursuant to 17 CFR 240.13a-14(a) |
| * |
|
|
|
|
|
32.1 |
| Certificate Pursuant to 18 U.S.C. § 1350 |
| * |
|
|
|
|
|
39
32.2 |
| Certificate Pursuant to 18 U.S.C. § 1350. |
| * |
(*) | Filed herewith. |
|
|
(1) | Incorporated by reference to the exhibit of the same number in Form 10-QSB filed with the Securities and Exchange Commission on March 17, 2008. |
|
|
(2) | Incorporated by reference to the exhibit of the same number in Form 10-QSB filed with the Securities and Exchange Commission on June 13, 2008. |
|
|
(3) | Incorporated by reference to Exhibit 99.1 on Form 8-K filed with the Securities and Exchange Commission on April 1, 2008. |
|
|
(4) | Incorporated by reference to the exhibit of the same number in Form 10-QSB filed with the Securities and Exchange Commission on September 15, 2008. |
|
|
(5) | Incorporated by reference to the exhibit of the same number in Form 10-KSB for the fiscal year ended October 31, 2008 and filed with the Securities and Exchange Commission on January 29, 2009. |
|
|
(+) | Material has been omitted pursuant to a request for confidential treatment and such materials have been filed separately with the Securities and Exchange Commission. |
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
|
| HIGHWATER ETHANOL, LLC |
|
|
|
|
|
|
|
|
Date: | September 28, 2009 |
| /s/ Brian Kletscher |
|
|
| Brian Kletscher |
|
|
| Principal Executive Officer |
|
|
|
|
|
|
|
|
Date: | September 28, 2009 |
| /s/ Mark Peterson |
|
|
| Mark Peterson |
|
|
| Principal Financial Officer |
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: | September 28, 2009 |
| /s/ Brian Kletscher |
|
|
| Brian Kletscher |
|
|
| Principal Executive Officer |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Mark Peterson |
|
|
| Mark Peterson |
|
|
| Principal Financial Officer |
|
|
|
|
Date: | September 28, 2009 |
| /s/ David G. Moldan |
|
|
| David G. Moldan |
|
|
| President and Governor |
40
Date: | September 28, 2009 |
| /s/ John M. Schueller |
|
|
| John M. Schueller |
|
|
| Vice President and Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/Timothy J. Van Der Wal |
|
|
| Timothy J. Van Der Wal |
|
|
| Treasurer and Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/Warren Walter Pankonin |
|
|
| Warren Walter Pankonin |
|
|
| Secretary and Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Monica Rose Anderson |
|
|
| Monica Rose Anderson, Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Russell J. Derickson |
|
|
| Russell J. Derickson, Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ George M. Goblish |
|
|
| George M. Goblish, Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Ronald E. Jorgenson |
|
|
| Ronald E. Jorgenson, Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Michael J. Landuyt |
|
|
| Michael J. Landuyt, Governor |
|
|
|
|
Date: | September 28, 2009 |
| /s/ Jason R. Fink |
|
|
| Jason R. Fink, Governor |
41