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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 |
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| Form 10-K |
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| ý | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| | For the fiscal year ended September 30, 2020 |
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| o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| | For the transition period from _________ to __________ |
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| Commission file number | 000-53041 |
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| SOUTHWEST IOWA RENEWABLE ENERGY, LLC |
| (Exact name of registrant as specified in its charter) |
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| Iowa | 20-2735046 |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
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| 10868 189th Street, Council Bluffs, Iowa | 51503 |
| (Address of principal executive offices) | (Zip Code) |
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| Registrant’s telephone number (712) 366-0392 |
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| Securities registered under Section 12(b) of the Exchange Act: | None. |
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| Title of each class | Name of each exchange on which registered |
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| Securities registered under Section 12(g) of the Exchange Act: | |
| Series A Membership Units |
| (Title of class) |
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x |
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No x |
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Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o |
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Indicate by check mark whether the registrant has submitted electronically on its corporate Website every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o |
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Indicate by check mark if disclosure of delinquent filers in response 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. Yes o No x |
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| 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. | |
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| Large accelerated filer | ☐ | Accelerated filer | ☐ |
| Non-accelerated filer | ☐ | Emerging growth company | ☐ |
| Smaller reporting company | ☒ | | |
| If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. | ☐ |
| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). | |
| Yes | ☐ | No | ☒ |
| Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. | ☐ |
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As of March 31, 2020, the aggregate market value of the Membership Units held by non-affiliates (computed by reference to the last price at which the Membership Units were sold) was $38,592,500.
As of September 30, 2020, the Company had 8,975 Series A Membership Units outstanding.
DOCUMENTS INCORPORATED BY REFERENCE—Portions of the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission with respect to the 2021 annual meeting of the members of the registrant are incorporated by reference into Part III of this Form 10-K.
PART I
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K of Southwest Iowa Renewable Energy, LLC (the “Company,” “we,” or “us”) contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to future events, our future financial performance, or our expected future operations and actions. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “future,” “intend,” “could,” “hope,” “predict,” “target,” “potential,” or “continue” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions based on current information and involve numerous assumptions, risks and uncertainties. Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the reasons described in this report. 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 the availability and price of corn, natural gas, and steam;
•Negative impacts resulting from the reduction in the renewable fuel volume requirements under the Renewable Fuel Standard issued by the Environmental Protection Agency;
•Our inability to comply with our credit agreements required to continue our operations;
•Negative impacts that our hedging activities may have on our operations;
•Decreases in the market prices of ethanol and distillers grains;
•Ethanol supply exceeding demand and corresponding ethanol price reductions;
•Changes in the environmental regulations that apply to our plant operations;
•Changes in plant production capacity or technical difficulties in operating the plant;
•Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
•Changes in other federal or state laws and regulations relating to the production and use of ethanol;
•Changes and advances in ethanol production technology;
•Competition from larger producers as well as competition from alternative fuel additives;
•Changes in interest rates and lending conditions of our loan covenants;
•Volatile commodity and financial markets;
•Decreases in export demand due to the imposition of duties and tariffs by foreign governments on ethanol and distillers grains produced in the United States;
•Disruptions, failures or security breaches relating to our information technology infrastructure;
•Trade actions by the Trump Administration, particularly those affecting the biofuels and agriculture sectors and related industries; and
•Disruptions caused by health epidemics, such as novel strain of the coronavirus, and the adverse impact of such epidemics on global economic and business conditions.
These forward-looking statements are based on management’s estimates, projections and assumptions as of the date hereof and include various assumptions that underlie such statements. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed below and in the section titled "Risk Factors." Other risks and uncertainties are disclosed in our prior Securities and Exchange Commission ("SEC") filings. These and many other factors could affect our future financial condition and operating results and could cause actual results to differ materially from expectations set forth in the forward-looking statements made in this document or elsewhere by Company or on its behalf. We undertake no obligation to revise or update any forward-looking statements. The forward-looking statements contained in this Form 10-K are included in the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Item 1. Business.
The Company is an Iowa limited liability company located in Council Bluffs, Iowa, formed in March, 2005. The Company is permitted to produce 140 million gallons of ethanol. We began producing ethanol in February, 2009 and sell our ethanol, distillers grains and corn oil in the United States, Mexico and the Pacific Rim.
Our production facility (the “Facility”) is located in Pottawattamie County in southwestern Iowa, south of Council Bluffs. It is near two major interstate highways, I-29 and I-80, within a mile of the Missouri River and has access to five major rail carriers. This location is in close proximity to a significant amount of corn and has convenient product market access. The Facility receives corn and chemical deliveries primarily by truck and is able to utilize rail delivery if necessary. Finished products are shipped by rail and truck. The site has access to water from ground wells and from the Missouri River. Additionally, in close proximity to the Facility’s primary energy source (steam), there are two natural gas providers available, both with infrastructure immediately accessible to the Facility.
Financial Information
Please refer to “Item 7-Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information about our revenue, profit and loss measurements and total assets and liabilities, and “Item 8 – Financial Statements and Supplementary Data” for our financial statements and supplementary data.
Impact of COVID-19 on our Business
A novel strain of coronavirus (“COVID-19”) was first identified in Wuhan, China in December 2019 and on March 11, 2020, the World Health Organization characterized the spread of COVID-19 as a pandemic. Since then, several world governments, including the United States and many individual states and municipalities, have imposed lock-downs, self-quarantine requirements, and travel restrictions on their citizens. These actions have dramatically decreased the demand for and price of blended gasoline across the globe and in the United States. Because the United States requires ethanol to be blended into the nation’s fuel supplies, gasoline consumption and demand plays a key role in the demand for and price of ethanol.
Operations
Throughout most of 2018 and 2019 as well as early 2020, the Company, and the ethanol industry as a whole, experienced significant adverse conditions as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors, which have been compounded by the impact of COVID-19 in 2020, resulted and continue to result in lower operating margins, lower cash flow from operations and net losses. In response to these adverse market conditions, commencing in the middle of March 2020, we elected to reduce ethanol production at our plant by approximately fifty percent in the month of April. During May and June 2020, we also operated our plant at lower than normal ethanol production levels. However, we ramped up production from June through September and began operating at normal levels compared to early 2020. Management believes that this reduction was warranted due to negative margins in the ethanol industry resulting in part from a slowdown in global and regional economic activity and decreased ethanol demand due to the COVID-19 pandemic. Limiting ethanol production also resulted in a corresponding decrease in distillers grains and corn oil production. The Company will continue to monitor COVID-19 developments and the effect on fuel demand and terminal capacity in order to determine whether further adjustments to production will be necessary.
In response to the COVID-19 pandemic and pursuant to temporary regulatory relief issued by the U.S. Food and Drug Administration (“FDA”), several ethanol plants and industrial chemical companies have found ways to process ethanol into hand sanitizer for medical and consumer applications. During our period of reduced production, the Company found several customers seeking ethanol in bulk for use in hand sanitizers. The Company also bottled "SIREtizer" hand sanitizer for local distribution. Given the economic conditions and the unprecedented decrease in the price and demand for blended gasoline, the Company was able to command a higher margin supplying ethanol for use in hand sanitizer products than for its conventional ethanol product. The Company produced and sold ethanol based hand sanitizer as a new line of business in the months of April and May. However, in June 2020, the FDA tightened the temporary regulatory language such that certain ethanol plants, including the Company, halted production and cancelled supply agreements for ethanol used in hand sanitizer.
Employee Health and Safety
From the earliest signs of the outbreak, we have taken proactive action to protect the health and safety of our employees, customers, partners and suppliers. We enacted appropriate safety measures, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present at the plant, and staggering schedules and shifts for those that must be on-site to perform their work, and frequently disinfecting our workspaces and requiring employees who must be physically present at the plant to wear masks. The Company also suspended all plant tours, and instituted a policy for contractor/vendors to answer a health questionnaire and provide information about the work environment where they have been for the past fourteen days. We expect to continue to implement these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further
actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, partners and suppliers.
Supply and Demand Impact
Although we continue to regularly monitor the financial health of companies in our supply chain, financial hardship on our suppliers or sub-suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to produce our products, adversely affecting our operations, even when operating at reduced production levels. Additionally, restrictions or disruptions of transportation, such as reduced availability of truck, rail or air transport, port closures and increased border controls or closures, may result in higher costs and delays, both on obtaining raw materials and shipping finished products to customers, which could harm our profitability, make our products less competitive, or cause our customers to seek alternative suppliers.
The COVID-19 outbreak has significantly increased economic and demand uncertainty. We anticipate that the current outbreak or continued spread of COVID-19 will cause a global economic slowdown, and it is possible that it could cause a global recession. In the event of a recession, demand for our products would decline and our business would be adversely effected.
Paycheck Protection Program Loan
On April 15, 2020, the Company received $1.1 million under the new Paycheck Protection Program ("PPP Loan") legislation passed in response to the economic downturn triggered by COVID-19. Our PPP Loan may be forgiven based upon various factors, including, without limitation, our payroll cost over an eight to twenty-four week period starting upon our receipt of the funds. Expenses for approved payroll costs, lease payments on agreements before February 15, 2020 and utility payments under agreements before February 1, 2020 and certain other specified costs can be paid with these funds and eligible for payment forgiveness by the federal government. At least 60% of the proceeds must be used for approved payroll costs, and no more than 40% on non-payroll expenses. Management believes that our use of our PPP Loan proceeds for the approved expense categories will be fully forgiven..
Outlook
Although there is uncertainty related to the anticipated impact of the recent COVID-19 outbreak on our future results, we believe our current cash reserves, cash generated from our operations, our PPP Loan and the available cash under our revolving term loan leave us well-positioned to manage our business through this crisis as it continues to unfold. However, the impacts of the COVID-19 pandemic are broad-reaching and the financial impacts associated with the COVID-19 pandemic include, but are not limited to, reduced production levels, lower net sales and potential incremental costs associated with mitigating the effects of the pandemic, including storage and logistics costs and other expenses. As a result, although we were in compliance with our financial covenants set forth in our loan agreements (the "FCSA Credit Facility") with Farm Credit Services of America, FLCA (“FCSA”) and CoBank, ACB (“CoBank”) as of September 30, 2020, the impact the COVID-19 pandemic could have an adverse impact on our operating results which could result in our inability to comply with certain of these financial covenants and require our lenders to waive compliance with, or agree to amend, any such covenant to avoid a default. However, based on our current forecast of market conditions and our financial performance, we expect that we will be in a position to satisfy all of the financial covenants in our FCSA Credit Facility for the next twelve months.
The COVID-19 pandemic is ongoing, and its dynamic nature, including uncertainties relating to the ultimate geographic spread of the virus, the severity of the disease, the duration of the pandemic, and actions that would be taken by governmental authorities to contain the pandemic or to treat its impact, makes it difficult to forecast any effects on our fiscal year ending September 30, 2021 ("Fiscal 2021") results, including our results for the first quarter of Fiscal 2021. However, the challenges posed by the COVID-19 pandemic on the global economy increased significantly as the fourth quarter of Fiscal 2020 progressed in response to the global resurgence of COVID-19 and the extension of, enhancement of, or imposition of new, government measures aimed at curbing the pandemic including lock-downs, self-quarantine requirements, and travel restrictions. As of the date of this filing, management does not anticipate material improvement in the macroeconomic environment during the first or second quarter of Fiscal 2021 and, as a result our results for Fiscal 2021 may also be affected.
Despite the economic uncertainty resulting from the COVID-19 pandemic, we intend to continue to focus on strategic initiatives designed to improve on our operational efficiencies and diversify our products which is critical in order to drive positive results in a low margin environment. Our management team is currently in the process of implementing several projects to enhance our plant's operational efficiencies and we also continue to evaluate opportunities to add value to our
production process by diversifying into high protein feed along with measures to reduce the carbon index ("CI") of the ethanol we produce.
In addition, we are also continuing with our efforts to de-bottleneck the production process. In September 2019, we placed into service a membrane dehydration technology that allows for an increase in dehydration capacity and a reduction in our CI score.
Also, we believe that consolidation within the ethanol industry, coupled with our location, good operating efficiencies and our solid team may provide new opportunities for our plant.
We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of COVID-19 on our financial condition, results of operations or cash flows in the future.
Rail Access
We own a six mile loop railroad track for rail service to our Facility, which accommodates several unit trains. We are party to an Industrial Track Agreement with CBEC Railway, Inc. (the “Track Agreement “), which governs our use of the loop railroad and requires, among other things, that we maintain the loop track.
On March 24, 2019 the Company entered into an amendment to the Amended and Restated Railcar Lease Agreement (“Railcar Agreement”) with Bunge North America, Inc. (“Bunge”), for the lease of 323 ethanol cars and 111 hopper cars which are used for the delivery and marketing of our ethanol and distillers grains. Bunge was a related party until December 31, 2019. Pursuant to the terms of the Membership Interest Purchase Agreement (the "Bunge Repurchase Agreement") effective December 31, 2019, the Company repurchased the 3,334 Series B membership units owned by Bunge.
The Railcar Agreement was amended to 110 hopper cars effective November 2019 and effective July 17, 2020, Bunge sold their tankers to Trinity Leasing. Trinity Leasing entered into a lease agreement with the Company which incorporates the terms of the original Bunge Railcar Agreement but reduced the ethanol car level to 320 ethanol cars. Under the Railcar Agreement, the original DOT111 tank cars are leased over a four year term from March 24, 2019 to April 30, 2023, with the ability to start returning cars after January 1, 2023 to conform to the requirement for DOT117 tank cars with enhanced safety specifications which is scheduled to be effective in May 2023. The 110 hopper cars are leased over a three year term running from March 24, 2019 to March 31, 2022 which term will continue on a month-to-month basis thereafter. The amendments to the Railcar Agreement lowered the cost for the leases by approximately 20% as compared to the prior lease terms. Pursuant to the terms of a side letter to the Railcar Agreement, we sublease cars to other companies from time to time when the cars are not needed in our operations. We work with the lessor to determine the most economic use of the available ethanol and hopper cars in light of then current market conditions. In February 2019, we entered into a second 36 month lease for an additional 30 tank cars from an unrelated third party leasing company (this was in addition to the 30 non-insulated tank cars leased from that company signed December 2015). This agreement expired in June of 2020, and was converted to a month-to-month basis. These 30 tank cars will be returned during the first quarter of Fiscal 2021.
Employees
We had 60 full time employees, as of September 30, 2020. We are not subject to any collective bargaining agreements and we have not experienced any work stoppages. Our management considers our employee relationships to be favorable.
Principal Products
The principal products we produce are ethanol, distillers grains, corn oil, and carbon dioxide ("CO2").
Ethanol
Our primary product is ethanol. Ethanol is ethyl alcohol, a fuel component made primarily from corn and various other grains, which can be used as: (i) an octane enhancer in fuels; (ii) an oxygenated fuel additive for the purpose of reducing ozone and carbon monoxide vehicle emissions; and (iii) a non-petroleum-based gasoline substitute. More than 99% of all ethanol produced in the United States is used in its primary form for blending with unleaded gasoline and other fuel products. The principal purchasers of ethanol are generally wholesale gasoline marketers or blenders. Ethanol is shipped by truck in the local markets, and by rail in the regional, national and international markets.
We produced 117.8 million and 129.3 million gallons of ethanol for the fiscal years ended September 30, 2020 ("Fiscal 2020") and September 30, 2019 (“Fiscal 2019”), respectively, and approximately 74.3% and 75.4% of our revenue was derived from the sale of ethanol in Fiscal 2020 and Fiscal 2019, respectively. The decrease in gallons produced and our revenues from ethanol sales during Fiscal 2020 resulted principally from our strategic reductions in production levels in response to unfavorable operating conditions in the ethanol industry and the COVID-19 pandemic.
Distillers Grain
The principal co-product of the ethanol production process is distillers grains, a high protein, high-energy animal feed marketed primarily to the beef and dairy industries. Distillers grains contain by-pass protein that is superior to other protein supplements such as cottonseed meal and soybean meal. We produce two forms of distillers grains: wet distillers grains with solubles (“WDGS”) and dried distillers grains with solubles (“DDGS”). WDGS are processed corn mash that has been dried to approximately 50% to 65% moisture. WDGS have a shelf life of approximately seven days and are sold to local markets. DDGS are processed corn mash that has been dried to approximately 10% to 12% moisture. It has a longer shelf life and may be sold and shipped to any market.
In Fiscal 2020, we sold 5.7% fewer tons of distillers grains compared to Fiscal 2019. Approximately 20.0% and 19.0% of our revenue was derived from the sale of distillers grains in Fiscal 2020 and Fiscal 2019, respectively. The decrease in distillers grains produced and sold during Fiscal 2020 resulted principally from our strategic reductions in production levels in response to unfavorable operating conditions in the ethanol industry and the COVID-19 pandemic.
Corn Oil
Our system separates corn oil from the post-fermentation syrup stream as it leaves the evaporators of the ethanol plant. The corn oil is then routed to storage tanks, and the remaining concentrated syrup is routed to the plant’s syrup tank. Corn oil can be marketed as either a feed additive or a biodiesel feedstock. We sold 9.8% fewer tons of corn oil in Fiscal 2020 than in Fiscal 2019, with approximately 5.0% and 5.1% of our revenue generated from corn oil sales, respectively.
Carbon Dioxide
In April 2013, we entered into a Carbon Dioxide Purchase and Sale Agreement (the “CO2 Agreement”) with Air Products and Chemicals, Inc., formerly known as EPCO Carbon Dioxide Products, Inc. ("Air Products") under which we agreed to supply, and Air Products agreed to purchase, a portion of raw CO2 gas produced by our facility. In addition, we entered into a Non-Exclusive CO2 Facility Site Lease Agreement under which we granted Air Products a non-exclusive right of entry and license to construct, maintain and operate a carbon dioxide liquefaction plant (the “CO2 Plant”) on a site near our facility. The term of the CO2 Agreement runs for ten (10) years from the startup of the CO2 Plant (the “Initial Term”) and then renews automatically for two (2) additional five (5) year periods thereafter, unless written notice of termination is submitted within six (6) months prior to the end of the then current term.
Air Products pays us a base price per ton, which acts as a floor price, Air Products will pay us an additional amount based on Air Products profits above a minimum targeted margin. The CO2 Agreement also contains a take or pay obligation pursuant to which Air Products agrees to pay us for a minimum number of tons each year. CO2 was 0.4% of our revenue for Fiscal 2020 and 0.3% in Fiscal 2019.
Principal Product Markets
As described below in “Distribution Methods,” we market and distribute all of our ethanol through Bunge pursuant to the terms of the Restated Ethanol Agreement effective Jauary 1, 2020. Distiller grains were handled through Bunge during the first half of our fiscal year pursuant to the terms of the Amended and Restated Distiller’s Grain Purchase Agreement dated December 5, 2014 (the "DG Purchase Agreement"). The DG Purchase Agreement expired December 31, 20219; however, as part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities under the original DG Purchase Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge under the DG Purchase Agreement.
Our ethanol, distillers grains and corn oil are primarily sold in the domestic market; however, as markets allow, our products can be, and have been, sold in the export markets. We explore all markets for our distillers grains and corn oil products, and we expect Bunge to explore all markets for our ethanol, including export markets. We believe that there is some potential for increased international sales of our products; however, due to high transportation costs, and the fact that we are not located near a major international shipping port, we expect a majority of our products to continue to be marketed and sold domestically.
According to the U.S. Energy Information Administration (the "EIA"), in the first eight months of 2020, ethanol exports decreased 10% as compared to the first eight months of 2019. Canada has moved to the top spot as the country that imports the largest percentage of ethanol produced in the United States. Brazil moved back to second place, as tariffs implemented by Brazil on U.S. ethanol imports have significantly reduced Brazilian demand. India remains the third largest destination of U.S. ethanol exports. Exports of U.S. ethanol to these three countries constitute almost 58% of all U.S. ethanol exports. South Korea and Mexico represent the remaining countries in the top 5 for destinations for U.S. ethanol exports in the first eight months of 2020.
Brazilian demand fell from 31% of U.S. ethanol exports in 2019 to 20% in 2020. Ethanol exports to Brazil continue to be impacted by the tariff on U.S. ethanol imports. The effect of the tariff has been mitigated somewhat by the adoption of a rate tariff quota that allows 750 million liters of ethanol annually to be shipped into Brazil before the tariff applies. However, this rate tariff quota currently is set to expire in December 2020 (extended 90 days from the original expiration on August 30, 2020). The Brazilian Chamber of Foreign Trade ("CAMEX") extended the free quota in anticipation of potential trade talks with the U.S .to negotiate import/export issues which are expected to commence in the fourth calendar quarter of 2020. There is no guarantee that the trade talks will result in a further extension of the rate tariff quota and the impact of the tariff should the rate tariff quota be allowed to expire could be significant and may result in further decreases in exports of U.S. ethanol to Brazil.
Similar to Brazil, tariffs implemented by China on U.S. ethanol have essentially eliminated China as an export market for U.S. ethanol. China was included in the top export markets during the first half of 2018; however, approximately 99% of the exports to China occurred in the first three months of 2018 and since then, U.S. ethanol exports to China have been reduced to almost nothing due to increased tariffs. On December 13, 2019, the U.S. and China announced an agreement to the first phase of a trade deal (the "Phase One Agreement") where China agreed to purchase billions of dollars in agricultural products in exchange for the U.S. agreeing not to pursue a new round of tariffs starting January 2020. After the pandemic hit the U.S,, relations between the two countries have been strained, and the impact on the ethanol market cannot be determined at this time. However, according to the Peterson Institute for International Economics, through October 2020 China has only purchased approximately 56% of its year-to-date commitments under the Phase One Agreement, and there can be no certainty at this time of whether its buying will improve.
Ethanol export demand is more unpredictable than domestic demand, and tends to fluctuate over time as it is subject to monetary and political forces in other nations. For instance, a strong U.S. Dollar is an example of a force that may negatively impact ethanol exports from the United States. In addition, the Chinese and Brazil tariffs have had, and likely will continue to have, a negative impact on the export market demand and prices for ethanol produced in the United States. There is also potential for the imposition of tariffs by other countries in addition to Brazil and China due to trade disputes with the United States which could reduce the overall export demand and therefore could have a negative impact on ethanol prices.
Distillers grains have become more accepted as animal feed throughout the world and therefore, distillers grains exports have increased and may continue to increase as worldwide acceptance grows. However, according to the U.S. Grains Council (the "USGC"), U.S. distillers grains annual exports through July 31, 2020 were approximately 3% lower than distillers grains exports for the same seven month period last year. The decrease experienced during the first seven months of 2020 is even greater when taking into consideration the fact that 2019 had 5% fewer distillers grains exports than 2018. Mexico, South Korea, Vietnam, Indonesia, and Canada remain the top destinations for U.S. distillers grains exports.
Historically, the United States ethanol industry exported a significant amount of distillers grains to China; however, exports to China have significantly decreased as a result of the Chinese anti-dumping and countervailing investigations and the implementation of significant duties on importing into China distillers grains produced in the United States. The imposition of these duties resulted in materially decreased demand from China requiring U.S. producers to seek out alternative export markets, including Mexico, Canada and Vietnam In addition, recent trade disputes with other countries have created additional uncertainty as to future export demand for U.S. distillers grains.
We market and distribute all of the corn oil we produce directly to end users or middlemen within the domestic market. Corn oil can be used as the feedstock to produce biodiesel, as a feed ingredient and has other industrial uses.
We sell carbon dioxide directly to Air Products.
Distribution Methods
On December 5, 2014, the Company entered into an Amended and Restated Ethanol Purchase Agreement with Bunge which was further amended and restated on October 23, 2017 to include specific provisions for loading and shipment of ethanol
by truck (the “Ethanol Agreement”). Under the Ethanol Agreement, the Company agreed to sell Bunge all of the ethanol produced by the Company, and Bunge agreed to purchase the same. The Company paid Bunge a percentage fee for ethanol sold by Bunge, subject to a minimum and maximum annual fee. The initial term of the Ethanol Agreement expired on December 31, 2019. As part of the Bunge Membership Interest Purchase Agreement (the "Bunge Repurchase Agreement"), the parties entered into a restated Ethanol Agreement effective January 1, 2020 (the "Restated Ethanol Agreement") which provides that the Company will pay Bunge a flat monthly marketing fee. The term of the Restated Ethanol Agreement expires on December 31, 2026.
We were a party to a Distillers Grain Purchase Agreement, as amended (“DG Agreement”) with Bunge, under which Bunge was obligated to purchase from us and we were obligated to sell to Bunge all distillers grains produced at our Facility. Under the DG Agreement, Bunge paid us a purchase price equal to the sales price minus the marketing fee and transportation costs. The sales price was the price received by Bunge in a contract consistent with the DG Marketing Policy or the spot price agreed to between Bunge and the Company. Bunge received a marketing fee consisting of a percentage of the net sales price, subject to a minimum and maximum amount. Net sales price is the sales price less the transportation costs and rail lease charges. The transportation costs were all freight charges, fuel surcharges, and other access charges applicable to delivery of distillers grains. The initial term of the DG Agreement expired on December 31, 2019; however, as part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities of the DG Purchase Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge under the DG Purchase Agreement.
Rail lease charges are the monthly lease payment for rail cars along with all administrative and tax filing fees for such leased rail cars.
We market and distribute all of the corn oil we produce directly to buyers within the domestic market.
Raw Materials
Corn Requirements
The principal raw material necessary to produce ethanol, distillers grain and corn oil is corn. We are significantly dependent on the availability and price of corn which are affected by supply and demand factors such as crop production, carryout, exports, government policies and programs, risk management and weather. With the volatility of the weather and commodity markets, we cannot predict the future price of corn. Because the market price of ethanol is not directly related to corn prices, we, like most ethanol producers, are not able to compensate for increases in the cost of corn through adjustments in our prices for our ethanol although we do see increases in the prices of our distillers grain during times of higher corn prices. However, given that ethanol sales comprise a majority of our revenues, our inability to adjust our ethanol prices can result in a negative impact on our profitability during periods of high corn prices.
High corn prices have a negative effect on our operating margins unless the price of ethanol and distillers grains out paces rising corn prices. During Fiscal 2020, corn prices were lower compared to Fiscal 2019 due primarily to a slowdown in the domestic and worldwide economy due to the pandemic. Total use was down 3% for the year, as industrial use, ethanol use and exports were all lower than originally forecasted. In November 2020, the United States Department of Agriculture (the “USDA”) revised their estimates for the 2020/2021 corn production to decrease its forecast to 14.7 billion bushels which is down approximately 1.2% from the October forecast. Based on November 1 conditions, the USDA left forecasts of average corn yields unchanged at 178 bushels per acre. The USDA forecast for area harvested for corn reduced the area harvested to 82.5 million acres which is down 1.0 million acres from the prior months' forecast.
Our management expects that corn prices will remain steady or move slightly higher through the first two quarters of Fiscal 2021 as a result of the lower levels of production and yield forecasted by the USDA, as well as carryover levels from the prior year. However, if corn prices rise more than expected, it will have an adverse impact on our operating margins unless the prices we receive for our ethanol and distillers grains are able to outpace the rising corn prices. Management continually monitors corn prices and the availability of corn near the Facility and also continually attempts to minimize the effects of the volatility of corn costs on profitability through its risk management strategies, including hedging positions taken in the corn market.
Our Facility would need approximately 48.3 million bushels of corn annually, to produce 140 million gallons of ethanol, or approximately 132,300 bushels per day. During Fiscal 2020 we purchased 9.5% less corn compared to Fiscal 2019, which was obtained entirely from local markets. The Company and Bunge were also parties to an Amended and Restated Grain Feedstock Agency Agreement (the “Agency Agreement”). The Agency Agreement provided that Bunge procure corn for the Company and the Company pay Bunge a per bushel fee, subject to a minimum and maximum annual fee. The initial term of
the Agency Agreement expired on December 31, 2019; however, as part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities of the Agency Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge under the Agency Agreement.
Starting with the 2015 crop year, the Company began using corn containing Syngenta Seeds, Inc.’s proprietary Enogen® technology (“Enogen Corn”) for a portion of its ethanol production needs. The Company contracted directly with growers to produce Enogen Corn for sale to the Company. Bunge and the Company were also parties to a Services Agreement regarding corn purchases (the “Services Agreement ”) under which we originated all Enogen Corn contracts for our Facility and Bunge assisted us with certain administrative matters related to Enogen Corn, including facilitating delivery to our Facility. The initial term of the Services Agreement expired on December 31, 2019, and the Company notified Bunge of its election not to extend the Services Agreement, but to allow corn planted this fiscal year to be planted and harvested under the terms of the Services Agreement. Expenses under the Services Agreement were included as part of the Amended and Restated Grain Feedstock Agency Agreement discussed above.
Energy Requirements
The production of ethanol is an energy intensive process which uses significant amounts of electricity and steam or natural gas as a heat source. Presently, about 24,000 MMBTUs of energy are required to produce a gallon of ethanol. It is our goal to operate the plant as safely and profitably as possible, optimizing the amount of energy consumed per gallon of ethanol produced, balanced with the relative values of WDGS as compared to DDGS.
In September 2019, the Company went on line with the Whitefox Integrated Cartridge Efficiency (ICE) system to push towards more efficient operations in our plant. This technology benefits the plant through energy reduction, purity flexibility and debottlenecking of the distillation and dehydration processes. Energy efficiency improved by approximately 1,000 BTU's per gallon of ethanol produced, which results in steam savings and carbon emission reductions In April 2020, the Company implemented Bioleap's Dryer Exhaust Energy Recovers ("DEER"). The DEER system reduces the steam load on the boilers, providing immediate energy savings and freeing up capacity on the current boiler system. The change in the source blend for steam from approximately 50% natural gas and 50% steam in Fiscal 2019 to 95% natural gas and 5% steam in Fiscal 2020 impacted the energy costs for the Company due to the lower cost of natural gas as compared to steam which benefits were partially offset as the natural gas boilers are less efficient than the steam line.
Steam
Unlike most ethanol producers in the United States which use natural gas as their primary energy source, we have access to steam as a one of our energy sources in addition to natural gas. Historically, we have changed between steam and natural gas depending on energy costs and other factors. We believe our ability to utilize steam makes us more competitive, as under certain energy market conditions our energy costs will be lower than natural gas fired plants. We have entered into a Steam Service Contract (“Steam Contract”) with MidAmerican Energy Company (“MidAm”), under which MidAm provides us the steam required by us, up to 475,000 pounds per hour. The Steam Contract links our net energy rates and charges for steam to certain specified energy indexes, subject to certain minimum and maximum rates, so that our steam costs remain competitive with the general energy market. The Steam Contract expires in November 2024. During Fiscal 2020, we purchased approximately 90.9% less steam compared to Fiscal 2019. The decrease in Fiscal 2020 was due to a contractual obligation specified in our contract with MidAm and their plant availability. The price for steam decreased 5.6% in Fiscal 2020 as compared to Fiscal 2019. Steam availability from MidAm continues to be volatile as a result of MidAm’s increased utilization of wind energy, rather than coal, since Fiscal 2017.
Natural Gas
Although steam has traditionally been considered our primary energy source, natural gas accounted for approximately 93.2% of our energy usage in Fiscal 2020, compared to 50.6% in Fiscal 2019. The increase in our natural gas usage was due to decreased steam availability and obligations specified in our contract with MidAm, and a reduction in natural gas prices of over 18% when comparing Fiscal 2020 with Fiscal 2019. We have two natural gas boilers for use when our steam service is temporarily unavailable. Natural gas is also needed for incidental purposes. We entered into a natural gas supply agreement with Encore Energy in April of 2012 to fulfill our natural gas needs at the Gas Daily Midpoint pricing.
Electricity
Our Facility requires a large continuous supply of electrical energy. In Fiscal 2020 we used approximately 7.3% less electricity compared to Fiscal 2019. This was primarily due to lower production levels during Fiscal 2020 as compared to Fiscal 2019.
Water
We require a supply of water typical for the industry for our production process. Our primary water source comes from the underground Missouri River aquifer via our three onsite wells. The majority of the water used in an ethanol plant is recycled back into the plant. All our ground water is treated through our onsite water oxidation system. This filtered water is used throughout our process. We do treat (polish) some of this filtered water for boiler and cooling tower make-up with our Reverse Osmosis (RO) system to minimize any elements that will harm the boiler and steam systems as permitted. We send some of our non-process contact water back to the Missouri River. The makeup water requirements for the cooling tower are primarily a result of evaporation and cooling. We also evaporate much of our water through our dryer system for dried corn distillers grains. The rest of our process water is recycled back into the plant, which minimizes waste of our water supply.
Patents, Trademarks, Licenses, Franchises and Concessions
SIRE® and our SIRE® logo are registered trademarks of the Company in the United States. Other trademarks, service marks and trade names used in this report constitute common law trademarks and/or service marks of the Company. Other parties’ marks referred to in this report are the property of their respective owners. We were granted a perpetual license by ICM, Inc. (“ICM”) to use certain ethanol production technology necessary to operate our Facility. There is no ongoing fee or definitive calendar term for this license.
Seasonality of Sales
We experience some seasonality of demand for our ethanol. Since ethanol is predominantly blended with conventional gasoline for use in automobiles, ethanol demand tends to shift in relation to gasoline demand. As a result, we experience some seasonality of demand for ethanol in the summer months related to increased driving. In addition, we experience some increased ethanol demand during holiday seasons related to increased gasoline demand.
Risk Management and Hedging Transactions
The profitability of our operations is highly dependent on the impact of market fluctuations associated with commodity prices. We use various derivative instruments as part of an overall strategy to manage market risk and to reduce the risk that our ethanol production will become unprofitable when market prices among our principal commodities and products do not correlate. In order to mitigate our commodity and product price risks, we enter into hedging transactions, including forward corn, ethanol, distillers grain and natural gas contracts, in an attempt to partially offset the effects of price volatility for corn and ethanol. We also enter into over-the-counter and exchange-traded futures and option contracts for corn, ethanol and distillers grains, designed to limit our exposure to increases in the price of corn and manage ethanol price fluctuations. Although we believe that our hedging strategies can reduce the risk of price fluctuations, the financial statement impact of these activities depends upon, among other things, the prices involved and our ability to physically receive or deliver the commodities involved. Our hedging activities could cause net income to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged. As corn and ethanol prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments.
Hedging arrangements expose us to the risk of financial loss in situations where the counterparty to the hedging contract defaults or, in the case of exchange-traded contracts, where there is a change in the expected differential between the price of the commodity underlying the hedging agreement and the actual prices paid or received by us for the physical commodity bought or sold. There are also situations where the hedging transactions themselves may result in losses, as when a position is purchased in a declining market or a position is sold in a rising market. Hedging losses may be offset by a decreased cash price for corn and natural gas and an increased cash price for ethanol and distillers grains.
We continually monitor and manage our commodity risk exposure and our hedging transactions as part of our overall risk management policy. As a result, we may vary the amount of hedging or other risk mitigation strategies we undertake, and we may choose not to engage in hedging transactions. Our ability to hedge is always subject to our liquidity and available capital.
Dependence on One or a Few Major Customers
As discussed above, we have marketing and agency agreements with Bunge for the purpose of marketing and distributing our ethanol product. Currently, we do not have the ability to market our ethanol internally should Bunge be unable or refuse to market our ethanol at acceptable prices. However, we anticipate that we would be able to very quickly secure competitive marketers should we need to replace Bunge for any reason.
We previously relied on Bunge for the sale and distribution of our distillers grains. However, our DG Purchase Agreement with Bunge expired on December 31, 2019. Pursuant to the Bunge Repurchase Agreement, Bunge provided transition services until March 31, 2020 for all duties and responsibilities previously performed by Bunge under the DG Purchase Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge under the DG Purchase Agreement.
In Fiscal 2020, Bunge constituted 83% of total revenues, compared to almost 95% of revenue in Fiscal 2019.
Competition
Domestic Ethanol Competitors
The ethanol we produce is similar to ethanol produced by other domestic plants. At the end of 2019, the Renewable Fuels Association ("RFA") estimated that there were 203 installed ethanol production facilities in the United States with a total capacity of 16.6 billion gallons based on nameplate capacity and seven additional plants under expansion or construction with capacity to produce an additional 270 million gallons. The ethanol industry is experiencing the lowest margin environment seen in the past nine to ten years principally due to the fact that the supply of ethanol is outstripping demand and markets are reacting accordingly by disincentivizing production. Commencing in March 2020, the COVID-19 virus impact upon the economy drove the price of gasoline downwards, and the price of ethanol plummeted to or below production costs. In response, many plants in the U.S. shut down production or cut production levels. According to the RFA, since March 1, 2020, 69 ethanol plants with annual production capacity of nearly 6 billing gallons have been fully idled, 64 plants have reduced production levels from 10% to 50% representing an additional 1.7 billion gallons of reduced ethanol production. Although there has been a steady recovery of production levels from late April 2020 through June 2020 there are still about two dozen plants idled and a majority of facilities running slightly below normal production levels. With most plants running at about 10% of pre COVID-19 production levels since June 2020, the RFA estimates that currently total idled capacity represents about 2.5 billion gallons of annual production. Adding to the supply/demand imbalance is the stance taken by the EPA under the Trump Administration with regard to the issuance of “hardship waivers” to so-called small refineries. In our fiscal fourth quarter, some plants started to increase production and bring plants back on board, but industry information has not quantified the recent buildup.
Since ethanol is a commodity product, competition in the industry is predominately based on price. The top five producers account for almost half of domestic production. We are in direct competition with many of these top five producers as well as other national producers, many of whom have greater resources and experience than we have and each of which is producing significantly more ethanol than we produce. In addition, we believe that the ethanol industry will continue to consolidate leading to a market where a small number of large ethanol producers with substantial production capacities will control an even larger portion of the U.S. ethanol production. In recent years, the ethanol industry has also seen increased competition from oil companies who have purchased ethanol production facilities. These oil companies are required to blend a certain amount of ethanol each year.
We may be at a competitive disadvantage compared to our larger competitors and the oil companies who are capable of producing a significantly greater amount of ethanol, have multiple ethanol plants that may help them achieve certain efficiencies and other benefits that we cannot achieve with one ethanol plant or are able to operate at times when it is unprofitable for us to operate. For instance, ethanol producers that own multiple plants may be able to compete in the marketplace more effectively, especially during periods when operating margins are unfavorable, because they have the flexibility to run certain production facilities while reducing production or shutting down production at other facilities. These large producers may also be able to realize economies of scale which we are unable to realize or they may have better negotiating positions with purchasers. Further, new products or methods of ethanol production developed by larger and better-financed competitors could create competitive advantages over us.
Foreign Ethanol Competitors
In recent years, the ethanol industry has experienced increased competition from international suppliers of ethanol and although ethanol imports have decreased during the past few years, if competition from ethanol imports were to increase again, such increased imports could negatively impact demand for domestic ethanol which could adversely impact our financial
results. Large international companies with much greater resources than ours have developed, or are developing, increased foreign ethanol production capacities.
Many international suppliers produce ethanol primarily from inputs other than corn, such as sugarcane, and have cost structures that may be substantially lower than U.S. based ethanol producers including us. Many of these international suppliers are companies with much greater resources than us with greater production capacities.
Brazil is the world’s second largest ethanol producer. Brazil makes ethanol primarily from sugarcane as opposed to corn, and depending on feedstock prices, may be less expensive to produce. Several large companies produce ethanol in Brazil, including affiliates of Bunge. Brazilian imports account for less than 1% of U.S. ethanol consumed. Many in the ethanol industry are concerned that certain provisions of the Renewable Fuel Standard (the "RFS") as adopted may disproportionately benefit ethanol produced from sugarcane. This could make sugarcane based ethanol, which is primarily produced in Brazil, more competitive in the United States ethanol market. If this were to occur, it could reduce demand for the ethanol that we produce. In recent years, sugarcane ethanol imported from Brazil has been one of the most economical means for certain obligated parties to comply with the RFS requirement to blend 5 billion gallons of advanced biofuels.
In order to address supply issues after the sugarcane harvest, some Brazilian ethanol plants have become "flex plants" enabling them to process year round with local corn as well as sugarcane. Two new processing plants finished construction which will substantially increase Brazilian ethanol production and thereby increase the inventory available for U.S. ethanol imports. During 2020, Brazilian annual corn harvest has seen encouraging expansion, resulting in corn-based ethanol production almost doubling since last year. Any additional increase in ethanol imports from Brazil will further increase domestic ethanol supplies in the United States and may result in ethanol price decreases.
Based on the current strength of the United States Dollar compared to the Brazilian Reis along with very favorable prices for sugarcane based ethanol in the United States, specifically in California, it is possible that U.S. ethanol imports from Brazil could increase in Fiscal 2021 which would further impact the level of ethanol supplies in the United States and may result in ethanol price decreases.
Depending on feedstock prices, ethanol imported from foreign countries, including Brazil, may be less expensive than domestically-produced ethanol. However, foreign demand, transportation costs and infrastructure constraints may temper the market impact on the United States.
Local Ethanol Production
Because we are located on the border of Iowa and Nebraska, and because ethanol producers generally compete primarily with local and regional producers, the ethanol producers located in Iowa and Nebraska presently constitute our primary competition. According to the Renewable Fuels Association, 2020 Ethanol Outlook, Iowa had 43 operating ethanol refineries in production, with a combined nameplate capacity to produce 4.5 billion gallons of ethanol. For Nebraska, the RFA reports there are currently 26 existing ethanol plants in production in Nebraska, with a combined ethanol nameplate production capacity of approximately 2.3 billion gallons. As previously discussed, in response to the COVID-19pandemic and the impact to the economy, many plants in Iowa and Nebraska have shut down production or cut production. A local competitor idled one plant in Iowa, and one in Nebraska in April of 2020, and recently announced they will continue to keep them idle through the winter.
Competition from Alternative Renewable Fuels
Many of the current ethanol production incentives are designed to encourage the production of renewable fuels using raw materials other than corn, including cellulose. Cellulose is the main component of plant cell walls and is the most common organic compound on earth. Cellulose is found in wood chips, corn stalks, rice straw, amongst other common plants. Cellulosic ethanol is ethanol produced from cellulose. Research continues regarding cellulosic ethanol, and various companies are in various stages of developing and constructing some of the first generation cellulosic plants. Several companies have commenced pilot projects to study the feasibility of commercially producing cellulosic ethanol and are producing cellulosic ethanol on a small scale and, at a few companies in the United States have begun producing on a commercial scale. Additional commercial scale cellulosic ethanol plants could be completed in the near future, although these cellulosic ethanol plants have continued to face financial and technological issues. If this technology can be profitably employed on a commercial scale, it could potentially lead to ethanol that is less expensive to produce than corn based ethanol. Cellulosic ethanol may also capture more government subsidies and assistance than corn based ethanol. This could decrease demand for our product or result in competitive disadvantages for our ethanol production process.
Because our Facility is designed as a single-feedstock facility, we have limited ability to adapt the plant to a different feedstock or process system without additional capital investment and retooling.
A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Like ethanol, the emerging fuel cell and electric-powered vehicle industries offer technological options to address worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to decrease fuel costs, lessen dependence on crude oil and reduce harmful emissions. The same can be said of electric-powered vehicles. If the fuel cell industry continues to expand and gain broad acceptance and becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. Likewise, participants in the emerging electric-powered vehicle industry are currently targeting the transportation market to decrease dependence on crude oil and reduce harmful emissions. If the electric-powered vehicle industry continues to expand and gain broad acceptance, the ethanol and larger gasoline industry may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our profitability
.
Distillers Grain Competition
Ethanol plants in the Midwest produce the majority of distillers grains and primarily compete with other ethanol producers in the production and sales of distillers grains. According to the RFA 2020 Ethanol Outlook (the "RFA 2020 Outlook"), ethanol plants produced almost 39.6 million metric tons of distillers grains and other animal feed in 2019. We compete with other producers of distillers grains products both locally and nationally.
The primary customers of distillers grains are dairy and beef cattle, according to the RFA 2020 Outlook, which comprises 74% of distiller grains consumption. In recent years, an increasing amount of distillers grains have been used in the swine, poultry and fish markets. Numerous feeding trials show advantages in milk production, growth, rumen health, and palatability over other dairy cattle feeds. With the advancement of research into the feeding rations of poultry and swine, we expect these markets 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 from such expansion.
The market for distillers grains is generally confined to locations where freight costs allow it to be competitively priced against other feed ingredients. Distillers grains compete with three other feed formulations: corn gluten feed, dry brewers grain and mill feeds. The primary value of these products as animal feed is their protein content. Dry brewers grain and distillers grains have about the same protein content, and corn gluten feed and mill feeds have slightly lower protein contents. Distillers grains contain nutrients, fat content, and fiber that we believe will differentiate our distillers grains products from other feed formulations. However, producers of other forms of animal feed may also have greater experience and resources than we do and their products may have greater acceptance among producers of beef and dairy cattle, poultry and hogs.
Principal Supply & Demand Factors
Ethanol
Ethanol prices fluctated wildly during Fiscal 2020 as the impact on gasoline demand caused by an economic slowdown due to the pandemic caused price of ethanol to be reduced 30% between April and June 2020. Capacity was impacted as numerous plants reduced or ceased production to adjust to the changing conditions. The industry never saw the benefit of implementing the year-round use of E15 ethanol signed in May 2019, as the economy stalled as a result of the COVID-19 pandemic and many local and state governments implemented stay at home orders, lockdowns and other quarantine requirements which adversely impact gasoline consumption in general.
Management currently expects ethanol prices will continue to adjust to the supply and demand factors of ethanol and oil and will generally fluctuate with, but not be directly correlated to, the price of corn.
Management believes the industry will need to align the retail product delivery infrastructure and demand for ethanol in order to increase production margins in the near and long term. The supply and demand in the industry remain in relative balance at current production values.
Management also believes it is important that ethanol blending capabilities of the gasoline market be expanded to increase demand for ethanol. Recently, there has been increased awareness of the need to expand retail ethanol distribution and blending infrastructure, which would allow the ethanol industry to supply ethanol to markets in the United States that are not currently selling significant amounts of ethanol. On June 1, 2019, President Trump initiated rulemaking to expand fuel waivers
for E15 to allow year round sale of fuel blends containing gasoline up to a 15% blend of ethanol. Although there have been significant developments towards the availability of E15 in the marketplace and the recent EPA final rule allowing the year-round sale of E15, there are still obstacles that could inhibit meaningful market penetration by E15.
Distillers Grains
Distillers grains compete with other protein-based animal feed products. In North America, over 80% of distillers grains are used in ruminant animal diets, with the balance to poultry and swine. Every bushel of corn used in the dry grind ethanol process yields approximately 17 pounds of dry matter distillers grains, which is an excellent source of energy and protein for livestock and poultry. The price of distillers grains may decrease when the prices of competing feed products decrease. The prices of competing animal feed products are based in part on the prices of the commodities from which these products are derived. Downward pressure on commodity prices, such as soybeans and corn, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers grains.
Historically, sales prices for distillers grains have correlated with prices of corn. However, there have been occasions when the price increase for this co-product has not been directly correlated to changes in corn prices. In addition, our distillers grains compete with products made from other feedstocks, the cost of which may not rise when corn prices rise. Consequently, the price we may receive for distillers grains may not rise as corn prices rise, thereby lowering our cost recovery percentage relative to corn.
Management expects that distillers grain prices will continue to generally follow the price of corn during Fiscal 2021.
Competition for Supply of Corn
During crop year 2019/20, according to the USDA October 2020 report, 81.3 million acres of corn were harvested, which was down slightly from 2018/19. Although there were more acres planted, the expected yield is 167.5 bushels per acre, which is down 5% compared to 2019's results. A contributing factor to the shortfall was a intense storm in August 2020 that impacted 550 thousand acres of corn and caused extensive property damage to grain elevators. For the crop year 2020/21, current projections are 82.5 million acres of corn to be harvested, and the yield per acre is projected to approach recent levels of 178.4 bushels per acre. Prices for corn are expected to continue to increase slightly as a result of the replacement of lower beginning stocks, higher total domestic use and increased exports as forecasted by the USDA.
Competition for corn supply from other ethanol plants and other corn consumers exists around our Facility. According to RFA 2020 Ethanol Industry Outlook, there were 43 operational ethanol plants in Iowa. The plants are concentrated, for the most part, in the northern and central regions of the state where a majority of the corn is produced.
We compete with other users of corn, including ethanol producers regionally and nationally, producers of food and food ingredients for human consumption (such as high fructose corn syrup, starches, and sweeteners), producers of animal feed and industrial users. According to the USDA, for 2018/2019, 5.4 billion bushels of U.S. corn were used in ethanol production, with 6.8 billion bushels being used in food and other industrial uses, and 2.1 billion bushels used for export. For the crop year 2019/20, bushels of U.S. corn for ethanol production fell to 4.9 billion bushels used in ethanol production, with 6.3 billion bushels being used in food and other industrial uses, and 1.8 billion bushels used for export. As of October 2020, the USDA has forecast the amount of corn to be used for ethanol production during the current marketing year to increase slightly to 5.1 billion bushels with 6.5 billion bushels being used in food and other industrial uses, and 2.3 billion bushels used for exports.
Federal Ethanol Support and Governmental Regulations
RFS and Related Federal Legislation
The ethanol industry receives support through the Federal Renewable Fuels Standard (the “RFS”) which has been, and will continue to be, a driving factor in the growth of ethanol usage. The RFS requires that each year a certain amount of renewable fuels must be used in the United States. The RFS is a national program that allows refiners to use renewable fuel blends in those areas of the country where it is most cost-effective. The EPA is responsible for revising and implementing regulations to ensure that transportation fuel sold in the United States contains a minimum volume of renewable fuel.
The RFS original statutory volume requirements increased incrementally each year through 2022 when the mandate requires that the United States use 36 billion gallons of renewable fuels. Starting in 2009, the RFS required that a portion of the RFS must be met by certain “advanced” renewable fuels. These advanced renewable fuels include ethanol that is not made from corn, such as cellulosic ethanol and biomass based biodiesel. The use of these advanced renewable fuels increases each year as a percentage of the total renewable fuels required to be used in the United States.
Annually, the EPA is supposed to pass a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligation. On November 30, 2018, the EPA issued the final rule that set the 2019 annual volume requirements for renewable fuel at 19.92 billion gallons of renewable fuels per year (the "Final 2019 Rule"). On July 5, 2019, the EPA issued a proposed rule for 2020 which set the annual volume requirements renewable fuel at 19.92 billion gallons of renewable fuel (the "Proposed 2020 Rule"). Both the Final 2019 Rule and the Proposed 2020 Rule maintained the number of gallons that may be met by conventional renewable fuels such as corn based ethanol at 15.0 billion gallons. A public hearing on the Proposed 2020 Rule was held in July and the public comment period expired on August 30, 2019. The final rule was originally expected to be issued in November 2019.
However, on October 15, 2019, the EPA released a supplemental notice seeking additional comments on a proposed rule on adjustments to the way that annual renewable fuel percentages are calculated. The supplemental notice was issued in response to an announcement on October 4, 2019, by President Trump of a proposed plan to require refiners not exempt from the rules to blend additional gallons of ethanol to make up for the gallons exempted by the EPA's expanded use of waivers to small refineries. The effect of these waivers is that the refinery is no longer required to earn or purchase blending credits, known as Renewable Identification Numbers or "RINs", negatively affecting ethanol demand and resulting in lower ethanol prices. The proposed plan was expected to calculate the volume that refiners were required to blend by using a three-year average of exempted gallons. However, the EPA proposed to use a three-year average to account for the reduction in demand resulting from the waivers using the number of gallons of relief recommended by the United States Department of Energy. A public hearing on the proposed rule was held October 30 and the public comment period expired on November 30, 2019. On December 19, 2019, the EPA issued the final rule that set out the 2020 annual volume requirements (the "Final 2020 Rule") at 20.09 billion gallons up from the 19.92 billion gallons for 2019. Similar to the Final 2019 Rule, the Final 2020 Rule included 15.0 billion gallons of conventional corn-based ethanol.
The EPA has not yet released the proposed rule to set the renewable volume obligation for 2021.
Although the volume requirements set forth in the Final 2019 Rule are slightly higher than the final 2018 volume requirements (the "Final 2018 Rule") and the Final 2020 Rule volume requirements are slightly higher than those set forth in the Final 2019 Rule, the volume requirements under the Final 2018 Rule, the Final 2019 Rule and the Final 2020 Rule are all still significantly below the statutory mandates of 26 billion gallons, 28 billion gallons and 30 billion gallons, respectively, with significant reductions in the volume requirements for advanced biofuels as well.
Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. The Final 2018 Rule represented the first year the total proposed volume requirements were more than 20% below statutory levels. In response, the EPA Administrator directed his staff to initiate the required technical analysis to perform any future reset consistent with the reset rules. The Final 2019 Rule is approximately 29% below the statutory levels representing the second consecutive year of reductions of more than 20% below the statutory mandates therefore triggering the mandatory reset under the RFS. The Final 2020 Rule is approximately 34% below the statutory targets, which represents the third consecutive year of reductions of more than 20% below the statutory mandates. After the issuance of the Final 2019 Rule, the EPA became statutorily required to modify the statutory volumes through 2022 within one year of the trigger event, based on the same factors used to set the volume requirements post-2022. These factors include environmental impact, domestic energy security, expected production, infrastructure impact, consumer costs, job creation, price of agricultural commodities, food prices, and rural economic development.
In October 2018, the Trump administration released timelines for certain EPA rulemaking initiatives relating to the RFS including the “reset” of the statutory blending targets. The EPA is expected to propose rules modifying the applicable statutory volume targets for cellulosic biofuel, advanced biofuel, and total renewable fuel for the years 2020-2022. The proposed rules are also expected to include proposed diesel renewable volume obligations for 2021 and 2022.
Federal mandates supporting the use of renewable fuels like the RFS are a significant driver of ethanol demand in the U.S. Ethanol policies are influenced by environmental concerns, diversifying our fuel supply, and an interest in reducing the country’s dependence on foreign oil. Consumer acceptance of flex-fuel vehicles and higher ethanol blends of ethanol in non-flex-fuel vehicles may be necessary before ethanol can achieve significant growth in U.S. market share. Another important factor is a waiver in the Clean Air Act, known as the "One-Pound Waiver", which allows E10 to be sold year-round, even though it exceeds the RVP ("Reid Vapor Pressure", a common measure of gasoline volatility) limitation of nine pounds per square inch. At the end of May 2019, the EPA finalized a rule which extended the One-Pound Waiver to E15 so its sale can expand beyond flex-fuel vehicles during the June 1 to September 15 summer driving season. Although this rule is being challenged in court, the One-Pound Waiver is in effect and E15 can be sold year round. However, with respect to the 2019 summer driving season, because the rule was not finalized until the end of May, the ethanol industry was unable to fully
capitalize on increased E15 sales during the 2019 peak summer driving season. The EIA first quarter estimate, which did not take into account the impact of COVID-19 on the U.S. economy, had gasoline consumption for 2020 flat with last year, with gasoline prices being 18% lower than in 2019. The EIA forecast for summer driving put consumption down 23% as compared to the same period in 2019, as a result of travel restrictions and reduced economic activity related to COVID-19. The COVID-19 pandemic has had, and will likely continue to have, a significant impact on the U.S. and worldwide economy over the next few months.
Despite the recent actions by the Trump administration relating to E15, there continues to be uncertainty regarding the future of the RFS as a result of the significant number of small refinery waivers granted. Under the RFS, the EPA assigns individual refiners, blenders, and importers the volume of renewable fuels they are obligated to use based on their percentage of total domestic transportation fuel sales. The mechanism that provides accountability in RFS compliance is the Renewable Identification Number (RIN). RIN’s are a tradeable commodity given that if refiners (obligated parties) need additional RIN’s to be compliant, they have to purchase them from those that have excess. Thus, there is an economic incentive to use renewable fuels like ethanol, or in the alternative, buy RIN’s. Obligated parties use RINs to show compliance with RFS-mandated volumes. RINs are attached to renewable fuels by ethanol producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market. The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties.
On April 15, 2020, five Governors sent a letter to the EPA requesting a general waiver from the RFS due to the drop in demand caused by COVID-19 travel restrictions. They contend that the compliance costs (i.e. cost to purchase RINs) is onerous and could put some refineries out of business. In June 2020, the Attorneys General of seven states joined in the request made to waive the 2020 RFS compliance burdens. The EPA has 90 days to respond, and as of the date of this filing, had indicated only that they are “watching the situation closely, and reviewing the governors’ letter.”
Although the Final 2018 Rule, the Final 2019 Rule, and the Final 2020 Rule maintain the number of gallons which may be met by conventional renewable fuels such as corn-based ethanol at 15.0 billion gallons this number does not take into account waivers granted by the EPA to small refiners for "hardship." The EPA can, in consultation with the Department of Energy, waive the obligation for individual smaller refineries that are suffering “disproportionate economic hardship” due to compliance with the RFS. To qualify, for this “small refinery waiver,” the refineries must be under total throughput of 75,000 barrels per day and state their case for an exemption in an application to the EPA each year.
As of June 2020, the EPA has approved 85 exemptions for compliance years 2016 to 2018, freeing refineries from using 4 billion gallons of renewable fuel. This effectively reduces the annual renewable volume obligation for each year by that amount as the waivers exempt the obligating parties from meeting the RFS blending targets and the waived gallons are not reallocated to other obligated parties at this time. As discussed above, the mechanism that provides accountability in RFS compliance is the Renewable Identification Number ("RIN"). RINs are a tradeable commodity given that if refiners (obligated parties) need additional RINs to be compliant, they have to purchase them from those that have excess. Thus, there is an economic incentive to use renewable fuels like ethanol, or in the alternative, buy RINs. Granting these small refinery waivers effectively reduces the annual renewable volume obligation for each year by that amount as the waivers exempt the obligating parties from meeting the RFS blending targets and the waived gallons are not reallocated to other obligated parties at this time. The resulting surplus of RINs in the market has brought values down significantly to under $0.20. In late 2017 D6 RIN prices were about $0.75 per gallon, averaged $0.30 in 2018, and less than $0.20 in 2019. Since higher RIN values help to make higher blends of ethanol more cost competitive, lower RIN values could hinder or at least slow retailer and consumer adoption of E15 and higher blends. As discussed further below, the Tenth Circuit Court of Appeals ruled that multiple small refinery exemptions were improperly extended by the EPA which caused D6 RIN trading prices to increase to approximately $0.24 per gallon in January 2020. Recently RIN values have increased to near $0.60 based on lower ethanol production levels in response to the COVID-19 pandemic.
As of June 30, 2020, the EPA has received 52 requests for small refinery waivers that will be up for consideration during 2020. If the EPA approves all 52 of the pending applications, the ethanol market would suffer another loss of 2 billion gallons of biofuel blending requirements which will adversely impact RIN prices and the ethanol market. These waiver requests represent an effort by refineries to bypass the ruling of the Tenth Circuit and establish a continuous chain of exemptions. If the EPA continues to grant discretionary waivers and RIN prices continue to fall, it could negatively affect ethanol prices.
The Trump Administration has not announced a plan to reallocate ethanol gallons lost to exemptions in the current year and therefore, the continued granting of waivers and the failure of the Trump Administration to take any action to reallocate the lost exemptions will continue to negatively impact ethanol demand and RIN and ethanol prices
Biofuels groups have filed a lawsuit in the U.S. Federal District Court for the D.C. Circuit, challenging the Final 2019 Rule over the EPA’s failure to address small refinery exemptions in the rulemaking. This is the first RFS rulemaking since the
expanded use of the exemptions came to light, however the EPA has refused to cap the number of waivers it grants or how it accounts for the retroactive waivers in its percentage standard calculations. The EPA has a statutory mandate to ensure the volume requirements are met, which are achieved by setting the percentage standards for obligated parties. The EPA's current approach runs counter to this statutory mandate and undermines Congressional intent. Biofuels groups argue the EPA must therefore adjust its percentage standard calculations to make up for past retroactive waivers and adjust the standards to account for any waivers it reasonably expects to grant in the future.
In a supplemental rulemaking to the Proposed 2020 Rule, the EPA changed their approach, and for the first time accounted for the gallons that they anticipate they will be waiving from the blending requirements due to small refinery exemptions. To accomplish this, they are adding in the trailing three year average of gallons the Department of Energy (the "DOE") recommended be waived, in effect raising the blending volumes across the board in anticipation of waiving the obligations in whole or in part for certain refineries that qualify for the exemptions. Although in past years the EPA has disregarded recommendations from the Department of Energy in the rule the DOE stated its intent to adhere to these recommendations going forward, including granting partial waivers rather than an all or nothing approach. The EPA will be adjudicating the 2020 compliance year small refinery exemption applications in early 2021, but have indicated they will adhere to DOE recommendations for the 2019 compliance year applications as well, which should be adjudicated in 2020.
If the EPA’s decisions to reduce the volume requirements under the RFS statutory mandates is allowed to stand, if the volume requirements are further reduced or if the EPA continues to grant waivers to small refineries, the market price and demand for ethanol would be adversely affected which would negatively impact our financial performance. The EPA based the projected volume of gasoline and diesel that was exempt in 2020 on utilizing the three year rolling average of relief recommended by the Department of Energy, rather than the three year rolling level of actual exemptions advocated by agricultural interests.
On May 29, 2018, the National Corn Growers Association, National Farmers Union, and the Renewable Fuels Association filed a petition challenging the EPA’s grant of waivers to three specific refineries seeking that the court reject the waivers granted to the three as an abuse of EPA authority. These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate Renewable Volume Obligations ("RVOs") under the RFS. If the specific waivers granted by the EPA and/or its lower criteria for granting small refinery waivers under the RFS are allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance. On January 24, 2020, the U.S. Court of Appeals for the Tenth Circuit announced that the three exemptions were improperly issued by the EPA. The Court held that the EPA cannot "extend" exemptions to any small refineries whose earlier, temporary exemptions had lapsed. The Court concluded that the EPA exceeded its statutory authority in granting these petitions because there was nothing for the agency to "extend". Utilizing this criteria, there would have been a maximum of seven small refineries that could have received continuous extensions, yet the EPA has granted thirty five exemptions in a single year. The Court also found the EPA had abused their discretion in failing to explain how the EPA could maintain that such refineries would incur an economic hardship while continuing to claim that the costs of RIN compliance are passed through and recovered by those same refineries.
On January 24, 2020, the U.S. Court of Appeals for the Tenth Circuit announced that the three exemptions were improperly issued by the EPA. The Court held that the EPA cannot "extend" exemptions to any small refineries whose earlier, temporary exemptions had lapsed; rather, that small refinery exemptions may only be granted to refineries that had secured them continuously each year since 2010. The Court concluded that the EPA exceeded its statutory authority in granting these petitions because there was nothing for the agency to "extend". Utilizing this criteria, there would have been a maximum of seven small refineries that could have received continuous extensions, yet the EPA has granted thirty five exemptions in a single year. The Court also found the EPA had abused their discretion in failing to explain how the EPA could maintain that such refineries would incur an economic hardship while continuing to claim that the costs of RIN compliance are passed through and recovered by those same refineries. Consistent with this ruling, in September 2020, the EPA denied certain small refinery exemption petitions filed by oil refineries in 2020 seeking retroactive relief from their ethanol use requirements for prior years. There are currently still some petitions for waivers pending before the EPA for 2019 and 2020 compliance years
Related to the recent lawsuits, the Renewable Fuels Association, American Coalition for Ethanol, Growth Energy, National Biodiesel Board, National Corn Growers Association, Biotechnology Industry Organization, and National Farmers Union petitioned the EPA on June 4, 2018 to change its regulations to account for lost volumes of renewable fuel resulting from the retroactive small refinery exemptions. This petition to the EPA seeks a broader, forward-looking remedy to account for the collective lost volumes caused by the recent increase in retroactive small refinery RVO exemptions. The EPA has not reallocated volume exemptions in prior years, and continued to approve 31 new requests in 2019. On October 29, 2019, the U.S. House of Representatives Committee on Energy and Commerce met to examine the effects of the small refinery
exemptions on biofuels and agriculture since 2016. Several companies have petitioned the EPA to make available more information on refinery exemptions.
On February 4, 2019, Growth Energy filed a lawsuit in the Court of Appeals for the District of Columbia against the EPA challenging the EPA’s failure to address small refinery exemptions in the Final 2019 Rule. An administrative stay has been granted to research the contents of the lawsuit.
Although the maintenance of the 15 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the Final 2019 Rule and the Final 2020 Rule together with the application of the One-Pound Waiver to E15 permitting the year round sale of E15 signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal or otherwise invalidate the RFS and it is unclear what regulatory framework and renewable volume requirements, if any, will emerge as a result of any such reforms; however, any such reform could adversely affect the demand and price for ethanol and the Company's profitability.
On September 24, 2020, Representative Cheri Bustos of Illinois introduced the Next Generation Fuels Act, which establishes a minimum octane standard for gasoline and requires sources of added octane value to reduce carbon emissions by at least 30% when compared to baseline gasoline. The legislation would require the EPA to create a 98 research octane number ("RON") standard, limit reliance on toxic aromatic hydrocarbons, and update fuel and infrastructure regulations to expand the availability of mid-level ethanol blends. The bill would ensure parity in the regulation of gasoline volatility, correct the R-factor used in fuel economy testing, provide for an E30 fuel waiver, replace the EPS's flawed MOVES model, and restore meaningful credit toward compliance with fuel economy and emission standards for the production of flex field vehicles. Another provision is to enable the sale of E15 fuel using E10 pumps, subject to state regulations.
On October 28, 2020, Growth Energy and the Renewable Fuels Association, after the failure of the EPA to respond to several Freedom of Information Act requests regarding the small refinery exemption ("SRE") program and the escalation by the EPA of the granting SRE's in the past three years, filed a partial summary judgement in the District Court of the District of Columbia. The petition asserts that EPA's granting of SREs has allowed numerous refineries to avoid their RFS compliance obligations at the expense of renewable fuel producers and supporters, including American farmers. The two organizations have asked the court to order the following: 1) the EPA should not withhold the name of the company submitting the application or the name and location of the refinery for which relief is sought; 2) the EPA should immediately produce the information withheld for the Renewable Fuel Standard compliance years 2015 through 2017; and 3) the EPA should not withhold any of the five data elements identified in the Renewables Enhancement and Growth Support ("REGS") rule.
COVID-19 Legislation
In response to the COVID-19 pandemic, Congress passed the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") in late March 2020 in an attempt to offset the subsequent economic damage. The CARES Act created and funded multiple programs that have impacted or could impact our industry. The United States Department of Agriculture ("USDA") was given additional resources for the Commodity Credit Corporation (CCC) and they are using those funds to provide direct payments to farmers, including corn farmers from whom we purchase most of our feedstock for ethanol production. Similar to the trade aid payments made by the USDA over the past two years, this cash injection for farmers could cause them to delay marketing decisions and increase the price we have to pay to purchase the corn. The USDA did not include any CCC funds for ethanol plants as of this filing.
The CARES Act also provided for the Small Business Administration (the "SBA") to assist companies that constitute small business and keep them from laying off workers. The Paycheck Protection Program (the "PPP") was created and quickly paid out all of the funds appropriated, including some to farmers and to ethanol plants. Although we received our PPP Loan under the CARES Act, as discussed above, the receipt of PPP funds by farmers could, like the CCC funds, incentivize them to delay marketing corn which could increase the price of corn.
Ethanol is the primary ingredient in hand sanitizer. The CARES Act provided a tax exclusion on the shipment of undenatured ethanol for use in manufacturing hand sanitizer. The FDA has provided expanded guidance to allow for more denaturants to be used in ethanol intended for hand sanitizer production, and has expanded the grades of ethanol allowed for the duration of the public health crisis. In June 2020, the FDA tightened the temporary regulatory language such that certain ethanol plants, including the Company, halted production and cancelled supply agreements for ethanol used in hand sanitizer.
There is potential for financial relief to the biofuel sector in the next government spending program. On October 2, 2020, the U.S. House of Representatives passed another COVID-19 economic relief package, the HEROES Act II, which provides for $2.2 billion in relief and includes provisions for the renewable fuels industry. U.S. Senate confirmation is
required, but as of the date of this filing, the U.S. Senate has not passed the HEROES Act II. If the HEROES Act II were to become law, it could provide a 45 cent per gallon payment for qualified fuel produced from January 1, 2020 to May 1, 2020. The Company received $0.7 million from the State of Iowa in the fourth quarter of Fiscal 2020, from an allocation given to individual states via the first government spending program. This was classified as other operating income. There is no guarantee that the HEROES Act II will be enacted or if enacted, will include any provisions for the benefit of the renewable fuels industry or that if included, we would receive any such benefits.
State Initiatives and Mandates
In 2006, Iowa passed legislation promoting the use of renewable fuels in Iowa. One of the most significant provisions of the Iowa renewable fuels legislation was a renewable fuels targeted set of tax credits encouraging an escalating percentage of the gasoline sold in Iowa to consist of, be blended with, or be replaced by, renewable fuels. To receive the tax credit, retailers of gasoline are required to reach escalating annual targets of the percentage of their gasoline sales that consist of, are blended with, or are replaced by, renewable fuels. This renewable fuel tax credit originally required 10% of the gasoline that retailers sold to fall within the renewable fuels definitions to receive the credit and has increased incrementally to 25% as of January 1, 2020. This tax credit will automatically sunset for tax years beginning on or after January 1, 2021 unless legislative action is taken.
E85
Demand for ethanol has been affected by moderately increased consumption of E85 fuel, a blend of 85% ethanol and 15% gasoline, which is available for use in flex fuel vehicles. There are more than 21 million flex fuel vehicles on the road today, or approximately 8% of all vehicles, representing more vehicles than require premium gasoline today. In addition to use as a fuel in flexible fuel vehicles, E85 can be used as an aviation fuel, as reported by the National Corn Growers Association, and as a hydrogen source for fuel cells. According to the U.S. Department of Energy, there are currently more than 21 million flexible fuel vehicles capable of operating on E85 in the United States and nearly all of the major automakers have available flexible fuel modes and have indicated plans to produce several million more flexible fuel vehicles per year. The U.S. Department of Energy reports that there are more than 3,500 retail gasoline stations supplying E85 or other ethanol flex fuel blends. While the number of retail E85 suppliers has increased each year, this remains a relatively small percentage of the total number of U.S. retail gasoline stations, which is approximately 168,000. In order for E85 fuel to increase demand for ethanol, it must be available for consumers to purchase it. As public awareness of ethanol and E85 increases along with E85’s increased availability, management anticipates some growth in demand for ethanol associated with increased E85 consumption. The USDA provides financial assistance to help implement “blender pumps” in the United States in order to increase demand for ethanol and to help offset the cost of introducing mid-level ethanol blends into the United States retail gasoline market. A blender pump is a gasoline pump that can dispense a variety of different ethanol/gasoline blends. Blender pumps typically can dispense E10, E20, E30, E40, E50 and E85. These blender pumps accomplish these different ethanol/gasoline blends by internally mixing ethanol and gasoline which are held in separate tanks at the retail gas stations. Many in the ethanol industry believe that increased use of blender pumps will increase demand for ethanol by allowing gasoline retailers to provide various mid-level ethanol blends in a cost effective manner and allowing consumers with flex-fuel vehicles to purchase more ethanol through these mid-level blends.
Changes in Corporate Average Fuel Economy (“CAFE”) standards have also benefited the ethanol industry by encouraging use of E85 fuel products. CAFE provides an effective 54% efficiency bonus to flexible-fuel vehicles running on E85. This variance encourages auto manufacturers to build more flexible-fuel models, particularly in trucks and sport utility vehicles that are otherwise unlikely to meet CAFE standards.
E15
E15 is a blend of higher octane gasoline and up to 15% ethanol. E15 was approved for use in model year 2001 and newer cars, light-duty trucks, medium-duty passenger vehicles (SUVs) and all flex-fuel vehicles by the U.S. Environmental Protection Agency in 2012, This approved group of vehicles includes 90% of the cars, trucks and SUVs on the road today According to the Renewable Fuel Association. This higher octane fuel is available in 30 states at retail fueling stations. Sheetz, Kum & Go, Murphy USA, MAPCO Express, Protec Fuel, Minnoco, Thornton's, Hy-Vee, Growmark and Casey's all offer E15 to 2001 and newer vehicles today at several stations. One of the historic challenges with the growth of the E15 market is the fact that, the waiver in the Clean Air Act, known as the One-Pound Waiver, which allows E10 to be sold year-round, does not apply to E15 or higher blends, even though it has similar physical properties to E10. On March 12, 2019, the EPA proposed regulatory changes to allow E15 to take advantage of the One-Pound Waiver and authorized the sale of E15 during the summer
months even though it exceeds the Reid Vapor Pressure limitation. At the end of May 2019, the EPA finalized the rule extending the One-Pound Waiver to E15 so its sale can expand beyond flex-fuel vehicles during the June 1 to September 15 summer driving season. This rule is being challenged in an action filed in Federal District Court for the D.C. Circuit.
In May 2020, the USDA announced the Higher Blends Infrastructure Incentive Program which consists of up to $100 million in funding for grants to be use to increase the availability of higher blends of ethanol and biodiesel fuels and to help increase the implementation of “blender pumps” in the United States. Funds may be awarded to retailers such as fueling stations and convenience stores to assist in the cost of installation or upgrading of fuel pumps and other infrastructure which helps offset the cost of introducing higher level ethanol blends into the United States retail gasoline market. A blender pump is a gasoline pump that can dispense a variety of different ethanol/gasoline blends. Blender pumps typically can dispense E10, E15, E20, E30, E40, E50 and E85. These blender pumps accomplish these different ethanol/gasoline blends by internally mixing ethanol and gasoline which are held in separate tanks at the retail gas stations. Many in the ethanol industry believe that increased use of blender pumps will increase demand for ethanol by allowing gasoline retailers to provide various mid-level ethanol blends in a cost effective manner and allowing consumers with flex-fuel vehicles to purchase more ethanol through these mid-level blends. However, the expense of blender pumps has delayed their availability in the retail gasoline market. In October 2020, the USDA announced the grant of $22 million of awards to the first round of recipients.
The program's predecessory, the Biofuels Infrastructure Partnership ("BIP"), was implemented by the USDA in May 2015 to increase the availability of higher blends and to fund the installation of new ethanol infrastructure. The USDA reports that to date, 20 states have received BIP federal funding in an aggregate amount of $100 million covering nearly 1,500 stations with almost 5,000 proposed pumps.
Cellulosic Ethanol
The Energy Independence and Security Act provided numerous funding opportunities in support of cellulosic ethanol. In addition, RFS2 mandates an increasing level of production of biofuels which are not derived from corn. These policies suggest an increasing policy preference away from corn ethanol and toward cellulosic ethanol.
Environmental and Other Regulations and Permits
Ethanol production involves the emission of various airborne pollutants, including particulate matters, carbon monoxide, oxides of nitrogen, volatile organic compounds and sulfur dioxide. Ethanol production also requires the use of significant volumes of water, a portion of which is treated and discharged into the environment. We are required to maintain various environmental and operating permits. Even though we have successfully acquired the permits necessary for our operations, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources on complying with such regulations. In addition, if we sought to expand the Facility’s capacity in the future, above our current 140 million gallons, we would likely be required to acquire additional regulatory permits and could also be required to install additional pollution control equipment. Our failure to obtain and maintain any environmental and/or operating permits currently required or which may be required in the future could force us to make material changes to our Facility or to shut down altogether.
The U.S. Supreme Court has classified carbon dioxide as an air pollutant under the Clean Air Act in a case seeking to require the EPA to regulate carbon dioxide in vehicle emissions. As stated above, we believe the final RFS2 regulations grandfather our plant at its current operating capacity, though expansion of our plant will need to meet a threshold of a 20% reduction in greenhouse gas (“GHG”) emissions from a baseline measurement to produce ethanol eligible for the RFS2 mandate. In order to expand capacity at our plant above our current permitted 140 million gallons, we will be required to obtain additional permits and install improved technology.
Separately, the California Air Resources Board ("CARB") has adopted a Low Carbon Fuel Standard (the "LCFS") requiring a 10% reduction in GHG emissions from transportation fuels by 2020 using a lifecycle GHG emissions calculation. On December 29, 2011, a federal district court in California ruled that the California LCFS was unconstitutional which halted implementation of the California LCFS. CARB appealed this court ruling and on September 18, 2013, the federal appellate court reversed the federal district court finding the LCFS constitutional and remanding the case back to federal district court to determine whether the LCFS imposes a burden on interstate commerce that is excessive in light of the local benefits. On June 30, 2014, the United States Supreme Court declined to hear the appeal of the federal appellate court ruling and CARB recently re-adopted the LCFS with some slight modifications. The LCFS could have a negative impact on the overall market demand for corn-based ethanol and result in decreased ethanol prices.
Part of our business is regulated by environmental laws and regulations governing the labeling, use, storage, discharge and disposal of hazardous materials. Other examples of government policies that can have an impact on our business include tariffs, duties, subsidies, import and export restrictions and outright embargos.
We also employ maintenance and operations personnel at our Facility. In addition to the attention that we place on the health and safety of our employees, the operations at our Facility are governed by the regulations of the Occupational Safety and Health Administration, or OSHA.
We have obtained all of the necessary permits to operate the plant. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations.
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our website at www.sireethanol.com as soon as reasonably practicable after we file or furnish such information electronically with the SEC. The information found on our website is not incorporated by reference into this report or any other report we file with or furnish to the SEC.
The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
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 Associated With Our Capital Structure
Our units have no public trading market and are subject to significant transfer restrictions which could make it difficult to sell units and could reduce the value of the units.
There is not an active trading market for our membership units. To maintain our partnership tax status, our units may not be publicly traded. Within applicable tax regulations, we utilize a qualified matching service (“QMS”) to provide a limited market to our members, but we have not and will not apply for listing of the units on any stock exchange. Finally, applicable securities laws may also restrict the transfer of our units. As a result, while a limited market for our units may develop through the QMS, members may not sell units readily, and use of the QMS is subject to a variety of conditions and limitations. The transfer of our units is also restricted by our Fourth Amended and Restated Operating Agreement dated March 21, 2015 (the “Operating Agreement”) unless the Board of Directors (the “Board” or “Board of Directors”) approves such a transfer. Furthermore, the Board will not approve transfer requests which would cause the Company to be characterized as a publicly traded partnership under the regulations adopted under the Internal Revenue Code of 1986, as amended (the “Code”). The value of our units will likely be lower because they are illiquid. Members are required to bear the economic risks associated with an investment in us for an indefinite period of time.
Our current indebtedness requires us to comply with certain restrictive loan covenants which may limit our ability to operate our business.
Under the terms of our Credit Agreement, we have made certain customary representations and we are subject to customary affirmative and negative covenants, including restrictions on our ability to incur additional debt that is not subordinated, create additional liens, transfer or dispose of assets, make distributions, consolidate, dissolve or merge, and customary events of default (including payment defaults, covenant defaults, cross defaults and bankruptcy defaults). The Credit Agreement also contains financial covenants including a minimum working capital amount, minimum local net worth (as defined) and a minimum debt service coverage ratio. We can provide no assurance that, if we are unable to comply with these covenants in the future, we will be able to obtain the necessary waivers or amend our loan agreements to prevent a default.
A breach of any of these covenants or requirements could result in a default under our Credit Agreement. If we default under our Credit Agreement and we are unable to cure the default or obtain a waiver, we will not be able to access the credit available under our Credit Agreement and there can be no assurance that we would be able to obtain alternative financing. Our Credit Agreement also includes customary default provisions that entitle our lenders to take various actions in the event of a default, including, but not limited to, demanding payment for all amounts outstanding. If this occurs, we may not be able to repay such indebtedness or borrow sufficient funds to refinance. Even if new financing is available, it may not be on terms that are acceptable to us. No assurance can be given that our future operating results will be sufficient to achieve compliance with the covenants and requirements of our Credit Agreement.
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Risks Associated With Operations
The COVID-19 pandemic may negatively affect our operations, financial condition, and demand for our products depending on the severity and longevity of the pandemic and its effects.
The COVID-19 pandemic is currently impacting countries, communities, supply chains and commodities markets, in addition to the global financial markets. This pandemic has resulted in social distancing, travel bans, governmental stay-at-home orders, and quarantines, and these may limit access to our facilities, customers, suppliers, management, support staff and professional advisors. At this time it is not possible to fully assess the impact of the COVID-19 pandemic on the Company’s operations and capital requirements, but the aforementioned factors, among other things, may impact our operations, financial condition and demand for our products, as well as our overall ability to react timely and mitigate the impact of this event. Furthermore, the aforementioned factors may hamper efforts to comply with our filing obligations with the Securities and Exchange Commission. Depending on its severity and longevity, the COVID-19 pandemic may have a material adverse effect on our business, customers, and members.
The impact of adverse economic conditions on gasoline could have a material adverse impact on the price and demand for ethanol and our financial performance.
The demand for gasoline correlates closely with general economic growth rates. The occurrence of recessions or other periods of low or negative economic growth will typically have a direct adverse impact on gasoline prices. Other factors that affect general economic conditions in the world or in a major region, such as changes in population growth rates, periods of civil unrest, pandemics (e.g. COVID-19), government austerity programs, or currency exchange rate fluctuations, can also impact the demand for gasoline. Sovereign debt downgrades, defaults, inability to access debt markets due to credit or legal constraints, liquidity crises, the breakup or restructuring of fiscal, monetary, or political systems such as the European Union, and other events or conditions (e.g. pandemics such as COVID-19), that impair the functioning of financial markets and institutions also may adversely impact the demand for gasoline. Reduced demand for gasoline may impair demand for ethanol, harm our operations and negatively impact our financial condition.
Decreasing oil and gasoline prices resulting in ethanol trading at a premium to gasoline could negatively impact our ability to operate profitably.
Ethanol has historically traded at a discount to gasoline; however, with the recent fluctuations in gasoline prices, at times ethanol may trade at a premium to gasoline, causing a financial disincentive for discretionary blending of ethanol beyond the rates required to comply with the RFS. Discretionary blending is an important secondary market which is often determined by the price of ethanol versus the price of gasoline. In periods when discretionary blending is financially unattractive, the demand for ethanol may be reduced. In recent years, the price of ethanol has been less than the price of gasoline which increased demand for ethanol from fuel blenders. However, recently, low oil prices have driven down the price of gasoline which has reduced the spread between the price of gasoline and the price of ethanol which could discourage discretionary blending, dampen the export market and result in a downward market adjustment in the price of ethanol. Any extended period where oil and gasoline prices remain lower than ethanol prices for a significant period of time could have a material adverse effect on our business, results of operation and financial condition which could decrease the value of our units.
Declines in the price of ethanol or distillers grain would significantly reduce our revenues.
The sales prices of ethanol and distillers grains can be volatile as a result of a number of factors such as overall supply and demand, the price of gasoline and corn, levels of government support, and the availability and price of competing products. We are dependent on a favorable spread between the price we receive for our ethanol and distillers grains and the price we pay for corn and natural gas. Any lowering of ethanol and distillers grains prices, especially if it is associated with increases in corn
and natural gas prices, may affect our ability to operate profitably. We anticipate the price of ethanol and distillers grains to continue to be volatile in the next fiscal year as a result of the net effect of changes in the price of gasoline and corn and increased ethanol supply. Declines in the prices we receive for our ethanol and distillers grains will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably for an extended period of time which could decrease the value of our units.
One of the most significant factors influencing the price of ethanol has been the substantial increase in ethanol production in recent years. According to the Renewable Fuels Association 2020 Ethanol Outlook, domestic ethanol production capacity increased from an annualized rate of 1.5 billion gallons per year in 1999 to a record 16.9 billion gallons in 2019 with an additional 183 billion gallons under construction. Although many plants are operating at reduced production levels in response to the COVID-19 pandemic, if ethanol production margins improve, owners of ethanol production facilities may increase production levels to pre-pandemic levels or to even greater production levels, resulting in further increases in domestic ethanol inventories. Any increase in the supply of ethanol may not be commensurate with increases in the demand for ethanol, thus leading to lower ethanol prices. Also, demand for ethanol could be impaired due to a number of other factors, including regulatory developments and reduced United States gasoline consumption. Reduced gasoline consumption has occurred in the past and could occur in the future as a result of increased gasoline or oil prices or other factors such as increased automobile fuel efficiency. Any of these outcomes could have a material adverse effect on our results of operations, cash flows and financial condition.
Increased demand for ethanol may require an increase in higher percentage blends for conventional automobiles.
Currently, ethanol is blended with conventional gasoline for use in standard (non-flex fuel) vehicles to create a blend which is 10% ethanol and 90% conventional gasoline. In order to expand demand for ethanol, higher percentage blends of ethanol must be utilized in conventional automobiles. Such higher percentage blends of ethanol have become a contentious issue with automobile manufacturers and environmental groups having fought against higher percentage ethanol blends. E15 is a blend which is 15% ethanol and 85% conventional gasoline. Although there have been significant developments towards the availability of E15 in the marketplace and the EPA recently issued a final rule allowing the year-round sale of E15, there are still obstacles to meaningful market penetration by E15. As a result, the approval of E15 may not significantly increase demand for ethanol.
Reduced ethanol exports to Brazil could have a negative impact on ethanol prices.
Brazil has historically been a top destination for ethanol produced in the United States. However, Brazil has imposed a tariff on ethanol which is produced in the United States and exported to Brazil. This tariff has resulted in a decline in demand for ethanol from Brazil and could negatively impact the market price of ethanol in the United States and our ability to profitably operate the ethanol plant.
Our business is not diversified.
Our success depends largely on our ability to profitably operate our ethanol plant. We do not have any other lines of business or other sources of revenue if we are unable to operate our ethanol plant and manufacture ethanol, distillers grains, corn oil and carbon dioxide. If economic or political factors adversely affect the market for ethanol, distillers grains, corn oil or carbon dioxide, we have no other line of business to fall back on. Our business would also be significantly harmed if the ethanol plant could not operate at full capacity for any extended period of time.
We are dependent on MidAm for our steam supply and any failure by it may result in a decrease in our profits or our inability to operate.
Under the Steam Contract, MidAm provides us with steam to operate our Facility. We expect to face periodic interruptions in our steam supply under the Steam Contract. For this reason, we installed boilers at the Facility to provide a backup natural gas energy source. We also have entered into a natural gas supply agreement with Encore Energy for our long term natural gas needs, but this does not assure availability at all times. In addition, our current environmental permits limit the annual amount of natural gas that we may use in operating our gas-fired boiler.
As with natural gas and other energy sources, our steam supply can be subject to immediate interruption by weather, strikes, transportation, conversion to wind turbines and production problems that can cause supply interruptions or shortages. While we anticipate utilizing natural gas as a temporary heat source in the event of MidAm’s plant outages, an
extended interruption in the supply of both steam and natural gas backup could cause us to halt or discontinue our production of ethanol, which would damage our ability to generate revenues.
Any site near a major waterway system presents potential for flooding risk.
While our site is located in an area designated as above the 100-year flood plain, it does exist within an area at risk of a "500-year flood". Even though our site is protected by levee systems, its existence next to a major river and major creeks present a risk that flooding could occur at some point in the future. During the last half of our fiscal year ended September 30, 2011, the Missouri River experienced significant flooding, as a result of unprecedented amounts of rain and snow in the Missouri River basin. This produced a sustained flood lasting many weeks at a "500-year flood" level (a level which has a 0.2 percent chance of occurring). While there were levee failures elsewhere, the levees held around our facility. We did experience minimal rail disruption due to flooding in the surrounding areas to the north and south of the Facility, but our operations were not significantly impacted.
We have procured flood insurance as a means of risk mitigation; however, there is a chance that such insurance will not cover certain costs in excess of our insurance associated with flood damage or loss of income during a flood period. Our current insurance may not be adequate to cover the losses that could be incurred in a flood of a 500-year magnitude.
We may experience delays or disruption in the operation of our rail line and loop track, which may lead to decreased revenues.
We have entered into the Track Agreement to service our track and railroad cars. There may be times when we have to slow production at our ethanol plant due to our inability to ship all of the ethanol and distillers grains we produce, or getting rail cars returned on a timely basis. Due to increased rail traffic nationally because of shipments of crude oil, rail shipment delays have been experienced from time to time, especially during severe winter conditions. If we cannot operate our plant at full capacity, we may experience decreased revenues which may affect the profitability of the Facility.
Hedging transactions, which are primarily intended to stabilize our corn costs, may be ineffective and involve risks and costs that could reduce our profitability and have an adverse impact on our liquidity.
We are exposed to market risk from changes in commodity prices. Exposure to commodity price risk results principally from our dependence on corn in the ethanol production process. In an attempt to minimize the effects of the volatility of corn costs on our operating profits, we enter into forward corn, ethanol, and distillers grain contracts and engage in other hedging transactions involving over-the-counter and exchange-traded futures and option contracts for corn; provided, we have sufficient working capital to support such hedging transactions. Hedging is an attempt to protect the price at which we buy corn and the price at which we will sell our products in the future and to reduce profitability and operational risks caused by price fluctuation. The effectiveness of our hedging strategies, and the associated financial impact, depends upon, among other things, the cost of corn and our ability to sell sufficient amounts of ethanol and distillers grains to utilize all of the corn subject to our futures contracts. Our hedging activities may not successfully reduce the risk caused by price fluctuations which may leave us vulnerable to high corn prices. We have experienced hedging losses in the past and we may experience hedging losses again in the future. We may vary the amount of hedging or other price mitigation strategies we undertake, or we may choose not to engage in hedging transactions in the future and our operations and financial conditions may be adversely affected during periods in which corn prices increase.
Hedging arrangements also expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or, in the case of over-the-counter or exchange-traded contracts, where there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices paid or received by us.
Our attempts to reduce market risk associated with fluctuations in commodity prices through the use of over-the-counter or exchange-traded futures results in additional costs, such as brokers’ commissions, and may require cash deposits with brokers or margin calls. Utilizing cash for these costs and to cover margin calls has an impact on the cash we have available for our operations which could result in liquidity problems during times when corn prices fall significantly. Depending on our open derivative positions, we may require additional liquidity with little advance notice to meet margin calls. We have had to in the past, and in the future will likely be required to, cover margin calls. While we continuously monitor our exposure to margin calls, we cannot guarantee that we will be able to maintain adequate liquidity to cover margin calls in the future.
Ethanol production is energy intensive and interruptions in our supply of energy, or volatility in energy prices, could have a material adverse impact on our business.
Ethanol production requires a constant and consistent supply of energy. If our production is halted for any extended period of time, it will have a material adverse effect on our business. If we were to suffer interruptions in our energy supply, our business would be harmed. We have entered into the Steam Contract for our primary energy source. We also are able to operate at full capacity using natural gas-fired boilers, which mitigates the risk of disruption in steam supply. However, the amount of natural gas we are permitted to use for this purpose is currently limited and the price of natural gas may be significantly higher than our steam price. In addition, natural gas and electricity prices have historically fluctuated significantly. Increases in the price of steam, natural gas or electricity would harm our business by increasing our energy costs. The prices which we will be required to pay for these energy sources will have a direct impact on our costs of producing ethanol and our financial results.
Our ability to successfully operate depends on the availability of water.
To produce ethanol, we need a significant supply of water, and water supply and quality are important requirements to operate an ethanol plant. Our water requirements are supplied by our wells, but there are no assurances that we will continue to have a sufficient supply of water to sustain the Facility in the future, or that we can obtain the necessary permits to obtain water directly from the Missouri River as an alternative to our wells.
We have executed an output contract for the purchase of all of the ethanol we produce, which may result in lower revenues because of decreased marketing flexibility and inability to capitalize on temporary or regional price disparities.
Bunge is the exclusive purchaser of our ethanol and markets our ethanol in national, regional and local markets. We do not plan to build our own sales force or sales organization to support the sale of ethanol. As a result, we are dependent on Bunge to sell our principal product. When there are temporary or regional disparities in ethanol market prices, it could be more financially advantageous to have the flexibility to sell ethanol ourselves through our own sales force. We have decided not to pursue this route.
We are increasingly dependent on information technology and disruptions, failures or security breaches of our information technology infrastructure could have a material adverse effect on our operations.
Information technology is critically important to our business operations. We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic and financial information, to manage a variety of business processes and activities, including production, manufacturing, financial, logistics, sales, marketing and administrative functions. We depend on our information technology infrastructure to communicate internally and externally with employees, customers, suppliers and others. We also use information technology networks and systems to comply with regulatory, legal and tax requirements. These information technology systems, many of which are managed by third parties or used in connection with shared service centers, may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, computer viruses, attacks by computer hackers or other cybersecurity risks, telecommunication failures, user errors, natural disasters, terrorist attacks or other catastrophic events. If any of our significant information technology systems suffer severe damage, disruption or shutdown, and our disaster recovery and business continuity plans do not effectively resolve the issues in a timely manner, our product sales, financial condition and results of operations may be materially and adversely affected, and we could experience delays in reporting our financial results.
In addition, if we are unable to prevent physical and electronic break-ins, cyber-attacks and other information security breaches, we may encounter significant disruptions in our operations including our production and manufacturing processes, which can cause us to suffer financial and reputational damage, be subject to litigation or incur remediation costs or penalties. Any such disruption could materially and adversely impact our reputation, business, financial condition and results of operations.
Such breaches may also result in the unauthorized disclosure of confidential information belonging to us or to our partners, customers, suppliers or employees which could further harm our reputation or cause us to suffer financial losses or be subject to litigation or other costs or penalties. The mishandling or inappropriate disclosure of non-public sensitive or protected information could lead to the loss of intellectual property, negatively impact planned corporate transactions or damage our reputation and brand image. Misuse, leakage or falsification of legally protected information could also result in a violation of data privacy laws and regulations and have a negative impact on our reputation, business, financial condition and results of operations.
A reduction in ethanol exports to China due to the imposition of a tariff on U.S. ethanol could have a negative impact on ethanol prices.
China has imposed a tariff on ethanol which is produced in the United States and exported to China which has negatively impacted exports of ethanol to China. The decrease has negatively impacted the market price of ethanol in the United States and could adversely impact our ability to profitably operate the Company. On December 13, 2019, the U.S. and China announced an agreement to the first phase of a trade deal (the "Phase One Agreement") where China agreed to purchase billions of dollars in agricultural products in exchange for the U.S. agreeing not to pursue a new round of tariffs starting January 2020. The impact on the ethanol market cannot be determined at this time. According to the Peterson Institute for International Economics, through October 2020 China has only purchased approximately 56% of its year-to-date purchase commitments under the Phase One Agreement, and there can be no certainty at this time of whether its purchasing will improve.
Decreases in exports of distillers grains to China have had, and could continue to have, a negative effect on the price of distillers grains in the U.S. and negatively affect our profitability.
Historically, the United States ethanol industry exported a significant amount of distillers grains to China. However, the Chinese government began an antidumping and countervailing duty investigation related to distillers grains imported from the United States and announced a final ruling in 2017 which imposed substantial duties on US distillers grains. The imposition of these duties resulted in plummeting demand from this top importer requiring United States producers to seek out alternatives markets, most notably in Mexico and Canada. The imposition of these duties created significant trade barriers and have significantly decreased demand from China and the prices for distiller’s grains produced in the United States. Although the market has substantially adjusted to the loss of this key market, if alternative markets are not found and maintained, the failure of China to return as a significant export market for U.S. distillers grains combined with lower domestic corn prices could negatively impact the price of distillers grains and the profitability of the Company. On December 13, 2019, the U.S. and China announced the Phase One Agreement where China agreed to purchase billions of dollars in agricultural products in exchange for the U.S. agreeing not to pursue a new round of tariffs starting January 2020. The impact on the distillers grain market cannot be determined at this time; however, as noted above, through October 2020 China has only purchased approximately 56% of its year-to-date purchase commitments under the Phase One Agreement, and there can be no certainty at this time of whether its purchasing will improve.
Trade actions by the Trump Administration, particularly those affecting the agriculture sector and related industries, could adversely affect our operations and profitability.
Government policies and regulations significantly impact domestic agricultural commodity production and trade flows and governmental policies affecting the agricultural industry, such as taxes, trade tariffs, duties, subsidies, import and export restrictions on commodities and commodity products, can influence industry profitability, the planting of certain crops, the location and size of crop production, whether unprocessed or processed commodity products are traded, and the volume and types of imports and exports. International trade disputes can also adversely affect trade flows by limiting or disrupting trade between countries or regions. Future governmental policies, regulations or actions affecting our industry may adversely affect the supply of, demand for and prices of our products, restrict our ability to do business and cause our financial results to suffer.
As a result of trade actions announced by the Trump administration and responsive actions announced by our trading partners, including by China, we may experience negative impacts of higher ethanol tariffs and other disruptions to international agricultural trade. In 2018, the Chinese government increased the tariffs on U.S. ethanol imports into China to 70% which tariffs were then lowered to 45% in 2020 as a result of the Phase One Agreement. These tariffs are expected to reduce overall U.S. ethanol export demand, which could have a negative effect on U.S. domestic ethanol prices, especially given the current oversupply in domestic ethanol inventories. Despite the recent announcement of the Phase One Agreement, there is no guarantee that such trade deal will increase U.S. exports of ethanol or distillers grains to China or have a positive impact on the ethanol market or the distillers grain market. However, as noted above, through October 2020 China has only purchased approximately 56% of its year-to-date purchase commitments under the Phase One Agreement, and there can be no certainty at this time of whether its purchasing will improve.
Continued price volatility and fluctuations in the price of corn may adversely impact our operating results and profitability.
Our operating results and financial condition are significantly affected by the price and supply of corn. Because ethanol competes with non-corn derived fuels, we generally are unable to readily pass along increases in corn costs to our customers. At certain levels, corn prices may make the production of ethanol uneconomical. There is significant price pressure on local corn markets caused by nearby ethanol plants, livestock industries and other corn consuming enterprises. Additionally, local corn supplies and prices could be adversely affected by rising prices for alternative crops, increasing input costs, changes
in government policies, shifts in global markets, or damaging growing conditions such as plant disease or adverse weather conditions, including but not limited to drought.
Declines in the price of ethanol or distillers grain would significantly reduce our revenues.
The sales prices of ethanol and distillers grains can be volatile as a result of a number of factors such as overall supply and demand, the price of gasoline and corn, levels of government support, and the availability and price of competing products. We are dependent on a favorable spread between the price we receive for our ethanol and distillers grains and the price we pay for corn and natural gas. Any lowering of ethanol and distillers grains prices, especially if it is associated with increases in corn and natural gas prices, may affect our ability to operate profitably. We anticipate the price of ethanol and distillers grains to continue to be volatile in during our 2021 fiscal year as a result of the net effect of changes in the price of gasoline and corn and increased ethanol supply offset by increased export demand and the continuing impact of the COVID-19 pandemic. In addition, growing conditions in a particular season’s harvest may cause the corn crop to be of poor quality resulting in corn shortages and a decrease in distillers grains prices. Declines in the prices we receive for our ethanol and distillers grains will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably for an extended period of time.
We compete with larger, better financed entities, which could negatively impact our ability to operate profitably.
There is significant competition among ethanol producers with numerous producers and privately-owned ethanol plants planned and operating throughout the Midwest and elsewhere in the United States. Our business faces a competitive challenge from larger plants, from plants that can produce a wider range of products than we can, and from other plants similar to ours. Large ethanol producers such as Archer Daniels Midland, Flint Hills Resources LP, Green Plains Inc., Valero Renewable Fuels and POET Biorefining, among others, are capable of producing a significantly greater amount of ethanol than we produce. Further, many believe that there will be further consolidation occurring in the ethanol industry in the near future which will likely lead to a few companies who control a significant portion of the ethanol production market. We may not be able to compete with these larger entities. These larger ethanol producers may be able to affect the ethanol market in ways that are not beneficial to us which could affect our financial performance.
Increased ethanol industry penetration by oil companies may adversely impact our margins.
The ethanol industry is a highly competitive environment and it is principally comprised of smaller entities that engage exclusively in ethanol production and large integrated grain companies that produce ethanol along with their base grain businesses. We have historically always faced competition with other small independent producers as well as larger, better financed producers for capital, labor, corn and other resources. Until recently, oil companies, petrochemical refiners and gasoline retailers have not been engaged in ethanol production to a large extent. These companies, however, form the primary distribution networks for marketing ethanol through blended gasoline. During the past few years, several large oil companies have begun to penetrate the ethanol production market. If these companies increase their ethanol plant ownership or other oil companies seek to engage in direct ethanol production, there may be a decrease in the demand for ethanol from smaller independent ethanol producers like us which could result in an adverse effect on our operations, cash flows and financial condition.
Changes and advances in ethanol production technology could require us to incur costs to update our Facility 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 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 remains competitive. Alternatively, we may be required to seek third-party licenses, which could also result in significant expenditures. We cannot guarantee or assure that third-party licenses will be available or, once obtained, will 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.
Competition from the advancement of alternative fuels may decrease the demand for ethanol and negatively impact our profitability.
Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells or clean burning gaseous fuels. Like ethanol, the emerging fuel cell and electric-powered vehicle industries offer a technological options to address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to lower fuel costs, decrease dependence on crude oil and reduce harmful emissions. The same can largely be said of electric-powered vehicles. If the fuel cell and hydrogen industries continue to expand and gain broad acceptance, and hydrogen becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. Likewise, participants in the emerging electric-powered vehicle industry are currently targeting the transportation market to decrease dependence on crude oil and reduce harmful emissions. If the electric-powered vehicle industry continues to expand and gain broad acceptance, the ethanol and larger gasoline industry may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our profitability.
Corn-based ethanol may compete with cellulose-based ethanol in the future, which could make it more difficult for us to produce ethanol on a cost-effective basis.
Most ethanol produced in the U.S. is currently produced from corn and other raw grains, such as milo or sorghum - especially in the Midwest. 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. The Energy Independence and Security Act of 2007 and the 2008 Farm Bill offer a very strong incentive to develop commercial scale cellulosic ethanol. The statutory volume requirement in the RFS requires that 16 billion gallons per year of advanced bio-fuels be consumed in the United States by 2022. Additionally, state and federal grants have been awarded to several companies who are seeking to develop commercial-scale cellulosic ethanol plants. As a result, at least three companies have reportedly already begun producing on a commercial scale and a handful of other companies have begun construction on commercial scale cellulosic ethanol plants some of which may be completed in the near future. If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively. It may not be practical or cost-effective to convert our Facility into a plant which will use cellulose-based biomass to produce ethanol. If we are unable to produce ethanol as cost-effectively as cellulose-based producers, our ability to generate revenue will be negatively impacted.
Depending on commodity prices, foreign producers may produce ethanol at a lower cost than we can, which may result in lower ethanol prices which would adversely affect our financial results.
We face competition from foreign ethanol producers with Brazil currently the second largest ethanol producer in the world. Brazil’s ethanol production is sugarcane based, as opposed to corn based, and, depending on feedstock prices, may be less expensive to produce. Under the RFS, certain parties are obligated to meet an advanced biofuel standard and sugarcane ethanol imported from Brazil has historically been one of the most economical means for obligated parties to meet this standard. Other foreign producers may be able to produce ethanol at lower input costs, including costs of feedstock, facilities and personnel, than we can. While foreign demand, transportation costs and infrastructure constraints may temper the market impact throughout the United States, competition from imported ethanol may affect our ability to sell our ethanol profitably, which may have an adverse effect on our operations, cash flows and financial position. If significant additional foreign ethanol production capacity is created, such facilities could create excess supplies of ethanol on world markets, which may result in lower prices of ethanol throughout the world, including the United States. Such foreign competition is a risk to our business. Any penetration of ethanol imports into the domestic market may have a material adverse effect on our operations, cash flows and financial position.
Risks Associated With Government Regulation and Subsidization
The ethanol industry is highly dependent on government mandates relating to the production and use of ethanol and changes to such mandates and related regulations could adversely affect the market for ethanol and our results of operations.
The domestic market for ethanol is largely dictated by federal mandates for blending ethanol with gasoline. Future demand for ethanol will be largely dependent upon the economic incentives to blend based upon the relative value of gasoline versus ethanol, taking into consideration the relative octane value of ethanol, environmental requirements and the RFS mandate. The RFS mandate helps support a market for ethanol that might disappear without this incentive.
Annually, the EPA is supposed to pass a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligations. In the past, the EPA has set the renewable volume obligations below the statutory volume requirements. The EPA issued the final rule for 2020 which set the annual volume requirements for renewable fuel at 20.09 billion gallons of renewable fuel (the "Final 2020 Rule"). Both the final 2019 volume requirements (the "Final 2019 Rule") and the Final 2020 Rule maintained the number of gallons that may be met by conventional renewable fuels such as corn based ethanol at 15.0 billion gallons. Although the volume requirements set forth in the Final 2019 Rule are slightly higher than the final 2018 volume requirements (the "Final 2018 Rule") and the Final 2020 Rule volume requirements are slightly higher than those set forth in the Final 2019 Rule, the volume requirements under the Final 2018 Rule, the Final 2019 Rule and the Final 2020 Rule are all still significantly below the 26 billion gallons, 28 billion gallons and 30 billion gallons, respectively, statutory mandates, with significant reductions in the volume requirements for advanced biofuels as well.. The EPA had not issued proposed 2021 volume requirements as of the date of this filing.
Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. The Final 2018 Rule represented the first year the total proposed volume requirements were more than 20% below statutory levels and the Final 2019 Rule is approximately 29% below the statutory levels representing the second consecutive year of reductions of more than 20% below the statutory mandates and therefore, triggering the mandatory reset under the RFS. The Final 2020 Rule is approximately 23% below the statutory levels, which makes 2020 the third year in a row which could cause a reset. The EPA is now statutorily required to modify the statutory volumes through 2022 within one year of the trigger event, based on the same factors used to set the volume requirements post-2022. These factors include environmental impact, domestic energy security, expected production, infrastructure impact, consumer costs, job creation, price of agricultural commodities, food prices, and rural economic development. If the EPA were to significantly reduce the statutory volume requirements under the RFS or if the RFS were to be otherwise reduced or eliminated by the exercise of the EPA waiver authority or by Congress, the market price and demand for ethanol could decrease which will negatively impact our financial performance.
The EPA has recently expanded its use of waivers to small refineries. The effect of these waivers is that the refinery is no longer required to earn or purchase blending credits, known as RINs, negatively affecting ethanol demand and resulting in lower ethanol prices. On October 15, 2019, the EPA released a supplemental notice seeking additional comment on a proposed rule on adjustments to the way that annual renewable fuel percentages are calculated. The supplemental notice was issued in response to an announcement by President Trump of a proposed plan to require refiners not exempt from the rules to blend additional gallons of ethanol to make up for the gallons exempted by the EPA's expanded use of waivers to small refineries. The proposed plan was expected to calculate the volume that refiners were required to blend by using a three-year average of exempted gallons. However, the EPA proposed to use a three-year average to account for the reduction in demand resulting from the waivers using an the number of gallons of relief recommended by the United States Department of Energy. If the EPA continues to grant waivers to smaller refineries and the Trump Administration fails to take any action to reallocate ethanol gallons lost to such waivers, the market price and demand for ethanol would be adversely affected which would negatively impact our financial performance.
The compliance mechanism for RFS is the generation of renewable identification numbers, or RINs, which are generated and attached to renewable fuels such as the ethanol we produce and detached when the renewable fuel is blended into the transportation fuel supply. Detached RINs may be retired by obligated parties to demonstrate compliance with RFS or may be separately traded in the market. The market price of detached RINs may affect the price of ethanol in certain U.S. markets as obligated parties may factor these costs into their purchasing decisions. Moreover, at certain price levels for various types of RINs, it becomes more economical to import foreign sugarcane ethanol. If changes to RFS2 result in significant changes in the price of various types of RINs, it could negatively affect the price of ethanol, and our operations could be adversely impacted.
Federal law mandates the use of oxygenated gasoline in the winter in areas that do not meet Clean Air Act standards for carbon monoxide. If these mandates are repealed, the market for domestic ethanol could be significantly reduced. Additionally, flexible-fuel vehicles receive preferential treatment in meeting corporate average fuel economy, or CAFE, standards. However, high blend ethanol fuels such as E85 result in lower fuel efficiencies. Absent the CAFE preferences, it may be unlikely that auto manufacturers would build flexible-fuel vehicles. Any change in these CAFE preferences could reduce the growth of E85 markets and result in lower ethanol prices, which could adversely impact our operating results.
To the extent that such federal or state laws or regulations are modified, the demand for ethanol may be reduced, which could negatively and materially affect our ability to operate profitably.
We are subject to extensive environmental regulation and operational safety regulations that impact our expenses and could reduce our profitability.
Ethanol production involves the emission of various airborne pollutants, including particulate matters, carbon monoxide, oxides of nitrogen, volatile organic compounds and sulfur dioxide. We are subject to regulations on emissions from the EPA and the IDNR (Iowa Department of Natural Resources). The EPA’s and IDNR’s environmental regulations are subject to change and often such changes are not favorable to industry. Consequently, even if we have the proper permits now, we may be required to invest or spend considerable resources to comply with future environmental regulations.
Our failure to comply or the need to respond to threatened actions involving environmental laws and regulations may adversely affect our business, operating results or financial condition. We must follow procedures for the proper handling, storage, and transportation of finished products and materials used in the production process and for the disposal of waste products. In addition, state or local requirements also restrict our production and distribution operations. We could incur significant costs to comply with applicable laws and regulations. Changes to current environmental rules for the protection of the environment may require us to incur additional expenditures for equipment or processes.
We could be subject to environmental nuisance or related claims by employees, property owners or residents near the Facility arising from air or water discharges. Ethanol production has been known to produce an odor to which surrounding residents could object. We believe our plant design mitigates most odor objections. However, if odors become a problem, we may be subject to fines and could be forced to take costly curative measures. Environmental litigation or increased environmental compliance costs could significantly increase our operating costs.
We are subject to federal and state laws regarding operational safety. Risks of substantial compliance costs and liabilities are inherent in ethanol production. Costs and liabilities related to worker safety may be incurred. Possible future developments-including stricter safety laws for workers or others, regulations and enforcement policies and claims for personal or property damages resulting from our operation could result in substantial costs and liabilities that could reduce the amount of cash that we would otherwise have to distribute to members or use to further enhance our business.
Carbon dioxide may be regulated by the EPA in the future as an air pollutant, requiring us to obtain additional permits and install additional environmental mitigation equipment, which may adversely affect our financial performance.
Our Facility emits carbon dioxide as a by-product of the ethanol production process and we sell a portion of our carbon dioxide by-product to Air Products and Chemicals, Inc. pursuant to a Carbon Dioxide Purchase and Sale Agreement. The United States Supreme Court has classified carbon dioxide as an air pollutant under the Clean Air Act in a case seeking to require the EPA to regulate carbon dioxide in vehicle emissions. 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. While there are currently no regulations applicable to us concerning carbon dioxide, if Iowa or the federal government, or any appropriate agency, decides 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 steps unknown to us at this time in order to comply with such law or regulation. Compliance with future regulation of carbon dioxide, if it occurs, could be costly and may prevent us from operating the Facility profitably.
The California Low Carbon Fuel Standard may decrease demand for corn based ethanol which could negatively impact our profitability.
California passed a Low Carbon Fuels Standard ("LCFS") which requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which reductions are measured using a lifecycle analysis. The California LCFS and other state regulations aimed at reducing greenhouse gas emissions could preclude corn-based ethanol produced in the Midwest from being used in California. California represents a significant ethanol demand market and therefore, if we are unable to supply corn-based ethanol to California, this could negatively impact our ability to profitably operate the ethanol plant.
Our site borders nesting areas used by endangered bird species, which could impact our ability to successfully maintain or renew operating permits. The presence of these species, or future shifts in its nesting areas, could adversely impact future operating performance.
The Piping Plover ( Charadrius melodus ) and Least Tern ( Sterna antillarum ) use the fly ash ponds of the existing MidAm power plant for their nesting grounds. The birds are listed on the state and federal threatened and endangered species lists. The IDNR determined that our rail operation, within specified but acceptable limits, does not interfere with the birds’ nesting patterns and behaviors. However, it was necessary for us to modify our construction schedules, plant site design and track maintenance schedule to accommodate the birds’ patterns. We cannot foresee or predict the birds’ future behaviors or
status. As such, we cannot say with certainty that endangered species related issues will not arise in the future that could negatively affect the plant’s operations.
Item 2. Properties.
We own the Facility site located near Council Bluffs, Iowa, which consists of three parcels totaling nearly 275 acres. This property is encumbered under the mortgage agreement with our Lender. We lease 45 acres on the south end of the property to an unrelated third party for farming, and we custom farm for our own use on ten acres.
Item 3. Legal Proceedings.
On August 25, 2010, the Company entered into a Tricanter Purchase and Installation Agreement (the “Tricanter Agreement”) with ICM, pursuant to which ICM sold the Company a tricanter corn oil separation system (the “Tricanter Equipment”). Under the Tricanter Agreement, ICM has agreed to indemnify the Company from any and all lawsuit and damages with respect to the Company's installation and use of the Tricanter Equipment.
On August 5, 2013, GS Cleantech Corporation (“GS Cleantech”) filed a suit in United States District Court for the Southern District of Iowa, Western Division (Case No. 2:13-CV-00021-JAJ-CFB), naming the Company as a defendant (the “Lawsuit”). The Lawsuit alleges infringement of patents assigned to GS Cleantech with respect to the corn oil separation technology used in the Tricanter Equipment. The Lawsuit seeks preliminary and permanent injunctions against the Company to prevent future infringement on the patents owned by GS CleanTech and damages in an unspecified amount adequate to compensate GS CleanTech for the alleged patent infringement, plus attorney's fees. The Lawsuit became part of multidistrict litigation against numerous parties and was transferred to the Federal District Court for the Southern District of Indiana (the “Court”).
On October 23, 2014, the patents owned by GS CleanTech in the Lawsuit were found to be invalid by the SD of Indiana District Court. On January 15, 2015, the Company received a partial summary judgment finding in the Lawsuit by the SD of Indiana District Court consistent with the October 23, 2014 ruling. In September 2016, the Court issued an opinion rendering the CleanTech patents unenforceable due to inequitable conduct. This ruling is in addition to the prior favorable court decisions on non-infringement. GS CleanTech and its attorneys filed a Notice of Appeal appealing the rulings of the September 2016 decision. On March 2, 2020, the rulings were affirmed on appeal by the Court of Appeals for the Federal Circuit and a petition for a rehearing of the appeal en banc was subsequently denied. The time to seek further appeal of the rulings has since expired and the judgment may be considered final. Under the Tricanter Agreement, ICM was obligated to, and did retain counsel at its expense to defend the Company in this Lawsuit.
From time to time, the Company may be subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters, if any, are currently not determinable, we do not expect that the ultimate costs to resolve these matters, if any, would have a material adverse effect on the Company consolidated financial position, results of operations, or cash flows.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Member Matters, and Issuer Purchases of Equity Securities.
As of September 30, 2020, we had 8,975 Series A Units issued and outstanding held by 840 persons. We do not have any established trading market for our units, nor is one contemplated. However, we do provide access to a Qualified Matching Service for our members, which provides a system for limited transfers of our units.
In connection with the payoff of subordinated debt held by ICM Investments, LLC (“ICM”), we entered into the SIRE ICM Unit Agreement dated December 17, 2014 (the “Unit Agreement”). Under the Unit Agreement, we granted ICM the right to sell to us ICM’s 1,000 Series C and 18 Series A Membership Units (the “ICM Units”) commencing anytime during the earliest of several alternative dates and events at the greater of $10,897 per unit or the fair market value (as defined in the agreement) on the date of exercise (the “Put Right”).
On August 16, 2019, we received notice of the exercise by ICM of its Put Right, applicable for all of the Series C and Series A Units held by ICM. In its notice, ICM waived its right to a determination of fair market value and ICM agreed to accept the total of Eleven Million Ninety-Three Thousand One Hundred and Forty Six Dollars ($11,093,146), which is the purchase price of Ten Thousand Eight Hundred Ninety-Seven Dollars ($10,897) per unit stated in the Unit Agreement, multiplied by 1,000 Series C Units and 18 Series A Membership Units. On November 15, 2019, we closed the repurchase transaction and paid ICM $11.1 million for the 1,000 Series C Units and 18 Series A Units.
On December 31, 2019, the Company entered into a purchase agreement for all of the 3,334 Series B membership units held by Bunge. On December 31, 2019, the Company paid Bunge $18.0 million for the 3,334 Series B shares.
To date, we have made distributions totaling $28.9 million to our members, with no distributions made during Fiscal 2020 or Fiscal 2019. We cannot be certain if or when we will be able to make additional distributions. Further, our ability to make distributions is restricted under the terms of the Credit Agreement.
Item 6. Selected Financial Data.
The following table presents selected financial and operating data as of the dates and for the periods indicated. The selected balance sheet financial data for the years ended September 30, 2020 and 2019 and the selected income statement data and other financial data for such years have been derived from the audited financial statements included elsewhere in this Form 10-K. You should read the following table in conjunction with "Item 7- Management Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and the accompanying notes included elsewhere in this Form 10-K. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following financial data.
| | | | | | | | | | | |
| | September 30, 2020 | | September 30, 2019 |
| | Amounts | | Amounts |
| | in 000's | | in 000's |
| Balance Sheet Data | | | |
| Cash and cash equivalents | $ | 1,116 | | | $ | 1,075 | |
| Total current assets | 24,102 | | | 27,967 | |
| Total assets | $ | 140,826 | | | $ | 140,863 | |
| Total current liabilities | $ | 18,623 | | | $ | 21,854 | |
| Total long term liabilities | 56,399 | | | 29,704 | |
| Total liabilities | 75,022 | | | 51,558 | |
| Total members' equity | 65,804 | | | 89,305 | |
| Total liabilities and members' equity | $ | 140,826 | | | $ | 140,863 | |
| | | | | | | | | | | |
| | Fiscal 2020 | | Fiscal 2019 |
| | Amounts | | Amounts |
| | in 000's | | in 000's |
| Income Statement | | | |
| Revenues | $ | 198,614 | | | $ | 216,993 | |
| Cost of Goods Sold | 192,889 | | | 219,017 | |
| Gross Margin (Loss) | 5,725 | | | (2,024) | |
| General and Administrative Expenses | 5,169 | | | 4,837 | |
| | | |
| Interest expense and other income, net | 998 | | | 999 | |
| Change in fair value of put option liability | — | | | 637 | |
| | | |
| Net (Loss) | $ | (442) | | | $ | (8,497) | |
| (Loss) per Unit: | | | |
| | | |
| | | |
| (Loss) per unit -basic | $ | (44.65) | | | $ | (637.58) | |
| (Loss) per unit -diluted | $ | (44.65) | | | $ | (637.58) | |
Modified EBITDA
Modified EBITDA is defined as net income (loss) plus interest expense net of interest income, plus depreciation and amortization, or EBITDA, then adjusted for unrealized hedging losses, and other non-cash credits and charges to net income. Modified EBITDA is not required by or presented in accordance with generally accepted accounting principles in the United States of America (“GAAP”), and should not be considered as an alternative to net income, operating income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities or as a measure of our liquidity.
We present Modified EBITDA because we consider it to be an important supplemental measure of our operating performance and it is considered by our management and Board of Directors as an important operating metric in their assessment of our performance.
We believe Modified EBITDA allows us to better compare our current operating results with corresponding historical periods and with the operational performance of other companies in our industry because it does not give effect to potential differences caused by variations in capital structures (affecting relative interest expense, including the impact of write-offs of deferred financing costs when companies refinance their indebtedness), the amortization of intangibles (affecting relative amortization expense), unrealized hedging losses and other items that are unrelated to underlying operating performance. We also present Modified EBITDA because we believe it is frequently used by securities analysts and investors as a measure of performance. There are a number of material limitations to the use of Modified EBITDA as an analytical tool, including the following:
•Modified EBITDA does not reflect our interest expense or the cash requirements to pay our interest. Because we have borrowed money to finance our operations, interest expense is a necessary element of our costs and our ability to generate profits and cash flows. Therefore, any measure that excludes interest expense may have material limitations.
•Although depreciation and amortization are non-cash expenses in the period recorded, the assets being depreciated and amortized may have to be replaced in the future, and Modified EBITDA does not reflect the cash requirements for such replacement. Because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate profits. Therefore, any measure that excludes depreciation and amortization expense may have material limitations.
We compensate for these limitations by relying primarily on our GAAP financial measures and by using Modified EBITDA only as supplemental information. We believe that consideration of Modified EBITDA, together with a careful review of our GAAP financial measures, is the most informed method of analyzing our operations. Because Modified EBITDA is not a measurement determined in accordance with GAAP and is susceptible to varying calculations, Modified EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. The following table provides a reconciliation of Modified EBITDA to net income (loss):
| | | | | | | | | | | |
| | Fiscal 2020 | | Fiscal 2019 |
| | Amounts | | Amounts |
| | in 000's (except per unit) | | in 000's (except per unit) |
| | | |
| Net (Loss) | $ | (442) | | | $ | (8,497) | |
| Interest Expense, Net | 2,085 | | | 1,069 | |
| Depreciation | 10,694 | | | 10,230 | |
| EBITDA | 12,337 | | | 2,802 | |
| | | |
| Unrealized hedging (gain) | (995) | | | (473) | |
| | | |
| Change in fair value of put option liability | — | | | 637 | |
| | | |
| | | |
| Modified EBITDA | $ | 11,342 | | | $ | 2,966 | |
| | | |
| | | |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
General Overview and Recent Developments
The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our financial condition and results of operations. This discussion should be read in conjunction with the financial statements included herewith and notes to the financial statements thereto and the risk factors contained herein.
The Company is an Iowa limited liability company located in Council Bluffs, Iowa, formed in March, 2005. The Company is permitted to produce 140 million gallons of ethanol. We began producing ethanol in February, 2009 and sell our ethanol, distillers grains, and corn oil in the United States, Mexico and the Pacific Rim.
On November 26, 2019, the EPA approved the Company's petition as an "Efficient Producer" to increase the D-6 RINs generated for up to 147 million gallons of ethanol produced annually, provided the non-grandfathered ethanol produced satisfies the 20% lifecycle GHG ("Greenhouse gas" impacts) reduction requirements specified in the Clean Air Act for renewable fuel. The Company must comply with all registration provisions in order to register for the production of non-grandfathered ethanol, and the registration application must be accepted by the EPA before the facility is eligible to generate RIN's for non-grandfathered ethanol produced. The Company anticipates completing the registration process by the end of the second quarter in the fiscal year ending September 30, 2021 ("Fiscal 2021").
Industry Factors Affecting our Results of Operations
For the fiscal year ended September 30, 2020 ("Fiscal 2020") compared to the fiscal year ended September 30, 2019 (
"Fiscal 2019"), the average price per gallon of ethanol sold did not change. There has been a decrease in the supply of ethanol, which has largely followed trends in motor fuel gasoline. There has been decreased prices for crude oil and gasoline in Fiscal 2020 compared to Fiscal 2019 due to reduced economic activity and stay-at-home orders aimed at slowing the spread of COVID-19. This pandemic also had a big impact on consumption, as gasoline consumption declined 12% in Fiscal 2020 as compared to Fiscal 2019.
Corn prices decreased during Fiscal 2020 due to the impact of COVID-19 on local, national and global economies . At times during this fiscal year, corn prices were 80-85% of Fiscal 2019 delivered cost prices. Motor fuel consumption was down 12% in Fiscal 2020 compared to Fiscal 2019, and with it, the demand for corn remained lower in Fiscal 2020. With a worldwide pandemic, exports of corn also decreased as countries waited to make purchase commitments, Prices for corn are expected to remain flat or increase sightly in 2020/21 as production builds back up from COVID-19 levels. Acres harvested and yields per acre are forecast by the USDA World Agricultural Supply and Demand Estimates ("WASDE") report to result in production levels over 9% greater in 2021, but they are only forecasting a 5% increase in corn used for ethanol production. Weather, world supply and demand, current and anticipated stocks, agricultural policy and other factors can contribute to volatility in corn prices. If corn prices should rise, it will have a negative effect on our operating margins unless the price of ethanol and distillers grains out paces rising corn prices.
Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices. If corn, crude oil and gasoline prices remain low or further decrease, that could have a significant negative impact on the market price of ethanol and our profitability particularly should ethanol stocks remain high. A decline in U.S. ethanol exports due to the premium on the price of ethanol as compared to unleaded gasoline, or other factors may contribute to higher ethanol stocks unless additional demand can be created from other foreign markets or domestically. There is currently a possibility of higher exports in Fiscal 2021; however, countries may remain cautious in light of the impact of COVID-19 on domestic and worldwide demand which could further decrease U.S. ethanol exports in Fiscal 2021.
In addition, market forces may continue to have a negative impact on distiller grain prices including lower export demand as a result the impact of COVID-19 on the worldwide economy. Overall, distiller grain exports were down 5% compared to Fiscal 2019, with a four fold increase in China exports offset by lower demand in other countries. The top 5 export locations in Fiscal 2019 averaged lower demand in Fiscal 2020 for distiller grains by almost 12% . We cannot forecast how much demand from these top 5 countries will come back into the marketplace, or if China will sustain the levels reached in Fiscal 2020. Distiller grains prices could remain low unless additional demand can be created from other foreign markets or domestically. Domestic demand for distillers grains could also remain low if corn prices decline and end-users switch to lower priced alternatives.
Results of Operations
The following table shows our results of operations, stated as a percentage of revenue for Fiscal 2020 and 2019.
| | | | | | | | | | | | | | | | | | | | | | | |
| Fiscal 2020 | | Fiscal 2019 |
| | Amounts | | % of Revenues | | Amounts | | % of Revenues |
| | in 000's | | | | in 000's | | |
| Income Statement Data | | | | | | | |
| Revenues | $ | 198,614 | | | 100.0 | % | | $ | 216,993 | | | 100.0 | % |
| Cost of Goods Sold | | | | | | | |
| Material Costs | 142,477 | | | 71.7 | % | | 161,715 | | | 74.5 | % |
| Variable Production Expense | 24,367 | | | 12.3 | % | | 31,498 | | | 14.5 | % |
| Fixed Production Expense | 26,045 | | | 13.1 | % | | 25,804 | | | 11.9 | % |
| Gross Margin (Loss) | 5,725 | | | 2.9 | % | | (2,024) | | | (0.9) | % |
| General and Administrative Expenses | 5,169 | | | 2.6 | % | | 4,837 | | | 2.2 | % |
| | | | | | | |
| Other Expenses | 998 | | | 0.5 | % | | 1,636 | | | 0.8 | % |
| Net (Loss) | $ | (442) | | | (0.2) | % | | $ | (8,497) | | | (3.9) | % |
Revenues
Our revenue from operations is derived from three primary sources: sales of ethanol, distillers grains, and corn oil. The chart below displays statistical information regarding our revenues. The decrease in revenue from Fiscal 2020 compared to Fiscal 2019 was due to the impact of the worldwide pandemic on domestic and international demand for our products. For our main product ethanol, there was no change in the average price per gallon of ethanol in Fiscal 2020 as compared to Fiscal 2019. However, there was a 10.1% decrease in the volume of ethanol sold during Fiscal 2020 compared to Fiscal 2019 due the impact of the COVID-19 pandemic on domestic production levels and upon transportation both domestically and internationally due to work from home government mandates and layoffs in many industries. Due to the slower economy and the reduced production levels at many plants, there was also a decrease of 5.7% in the volume of distillers grains sold which was somewhat offset by an increase in the average price per ton of distillers grains of approximately 2.5%. Corn oil revenue also decreased 11.1% in Fiscal 2020 compared to Fiscal 2019 due to a decrease of 9.8% in tons sold in Fiscal 2020 as compared to Fiscal 2019, along with a decrease of 1.4% in the price of corn oil.
The market experienced lower domestic demand in response to the COVID-19 pandemic which caused consumer driving to decrease approximately 12% as compared to last year due to work from home mandates coupled with massive layoffs in particular industries. In addition, the market experienced weak export demand as a result of the impact of the pandemic on the worldwide economy All of these factors resulted in an extremely tight year for the ethanol industry. Ethanol prices are typically directionally consistent with changes in corn and energy prices, but in Fiscal 2020, ethanol prices trended wildly lower in our third quarter of Fiscal 2020, as much as 38%, while corn prices fluctuated lower by only 10% . The decrease in the price of ethanol due to lower industry production because of small refiner waivers granted by the EPA without requiring these gallons to be reallocated to other larger users also had an effect upon the ethanol industry which was further compounded by decreased production in response to COVID-19.
The 2.5% increase in the average price of distillers grains was offset by a 6% decrease in tonnage sold resulting in a 3% reduction in this revenue category. The decrease in tonnage sold resulted from lower domestic demand due to the slower pandemic economy.
During Fiscal 2020, corn oil prices decreased 1.4% compared to Fiscal 2019, as a result of lower cost of corn offset by lower corn oil yield as the plant operated at reduced rates in response to the COVID-19 pandemic. The price decrease was compounded by a 9.8% decrease in tons sold due to the slowdown to the economy. Although management believes that corn oil prices will remain relatively steady at the current price levels, prices may decrease further if there is an oversupply of corn oil production resulting from increased production rates or if biodiesel producers begin to utilize lower-priced alternatives such as soybean oil unless an alternative demand for corn oil can be found.
| | | | | | | | | | | | | | | | | | | | | | | |
| Fiscal 2020 | | Fiscal 2019 |
| | Amounts in 000's | | % of Revenues | | Amounts in 000's | | % of Revenues |
| Product Revenue Information | | | | | | | |
| Ethanol | $ | 147,605 | | | 74.3 | % | | $ | 163,533 | | | 75.4 | % |
| Distiller's Grains | 39,781 | | | 20.0 | % | | 41,154 | | | 19.0 | % |
| Corn Oil | 9,886 | | | 5.0 | % | | 11,116 | | | 5.1 | % |
| Other | 1,342 | | | 0.7 | % | | 1,190 | | | 0.5 | % |
Cost of Goods Sold
Our cost of goods sold as a percentage of our revenues was 97.1% and 100.9% for Fiscal 2020 and 2019, respectively, and decreased due to lower production volume in response to the COVID-19 pandemic, which resulted in less corn purchased, and also due to lower corn prices in Fiscal 2020 as compared to Fiscal 2019. Our two primary costs of producing ethanol and distillers grains are corn and energy, with steam and natural gas as our primary energy sources. Cost of goods sold also includes net (gains) or losses from derivatives and hedging relating to corn. Material costs decreased as a result of the average price of corn used in ethanol production per bushel decreasing by 8.2% in Fiscal 2020 from Fiscal 2019 on an 11% decrease in ethanol production in Fiscal 2020 compared to Fiscal 2019.
Realized and unrealized (gains) or losses related to our derivatives and hedging related to corn resulted in a decrease of $2.6 million in our cost of goods sold for Fiscal 2020, compared to a decrease of $2.8 million in our cost of goods sold for Fiscal 2019. We recognize the gains or losses that result from the changes in the value of our derivative instruments related to corn in cost of goods sold as the changes occur. As corn prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance. We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged.
Our average steam and natural gas energy cost decreased 25.8% per MMBTU comparing Fiscal 2020 to Fiscal 2019. Variable production expenses decreased when comparing Fiscal 2020 to Fiscal 2019 due to lower energy costs resulting from lower volume and low natural gas prices as we moved away from steam, lower cost of chemicals and reduced marketing fees as a result of the expiration of certain agreements with Bunge for the purchase and sale of our distiller grains and the procurement of our corn supply. Fixed production expenses were unchanged when comparing Fiscal 2020 to Fiscal 2019 due to lower lease expenses due to resigning the railcar agreement, lower repairs and maintenance basically offset by higher depreciation expenses for projects brought on board and higher insurance premiums.
General & Administrative Expense
Our general and administrative expenses as a percentage of revenues were 2.6% for Fiscal 2020 and 2.2% for Fiscal 2019. General and administrative expenses include salaries and benefits of administrative employees, professional fees and other general administrative costs. Our general and administrative expenses for Fiscal 2020 increased 6.9% compared to Fiscal 2019. The increase in general and administrative expenses from Fiscal 2019 to Fiscal 2020 is due mainly to higher legal and professional fees.
Other Expense
Our other expenses were approximately $1.0 million and $1.6 million for Fiscal 2020 and 2019, respectively, and were approximately 0.5% and 0.8% of our revenues for Fiscal 2020 and 2019, respectively. The majority of this decrease in other expenses was a result of funds received for the Iowa Biofuels grant and patronage dividends offset by higher interest costs in Fiscal 2020. In fiscal 2019 there was a true up of the ICM put option for $0.6 million, with no activity in Fiscal 2020 due to the put option settlement.
Paycheck Protection Program Loan
On April 15, 2020, the Company received $1.1 million under the new Paycheck Protection Program ("PPP Loan") legislation passed in response to the economic downturn triggered by COVID-19. Our PPP Loan may be forgiven based upon various factors, including, without limitation, our payroll cost over an eight to twenty-four week period starting upon our
receipt of the funds. Expenses for approved payroll costs, lease payments on agreements before February 15, 2020 and utility payments under agreements before February 1, 2020 and certain other specified costs can be paid with these funds and eligible for payment forgiveness by the federal government. At least 60% of the proceeds must be used for approved payroll costs, and no more than 40% on non-payroll expenses. Management believes that our use of our PPP Loan proceeds for the approved expense categories will generally be fully forgiven if we satisfy certain employee headcount and compensation conditions.
Liquidity and Capital Resources
As of September 30, 2020, we had a cash balance of $1.1 million, $13.2 million available under the term revolver and working capital of $5.5 million.
In June 2014, the Company entered into a $66.0 million Senior Credit Agreement (the “Credit Agreement”) with Farm Credit Services of America, FLCA (“FCSA”) and CoBank, ACB, as cash management provider and agent (“CoBank”). The proceeds of the Credit Agreement were used to refinance senior bank debt previously outstanding and scheduled to mature in August 2014. The Credit Agreement provided us with a term loan of $30 million, that matured in 2019, and a revolving term loan of $36 million, due in 2023. The interest rate on the Credit Agreement was LIBOR plus 3.35%. The Credit Agreement resulted in a significantly lower interest rate than under the prior credit facility. The Company’s term loan and revolving term loan requires it to comply with specified financial covenants related to minimum local net worth, minimum current working capital, a minimum debt service coverage ratio and limitation on unit holder distributions.
Effective November 8, 2019, we entered into Amendment No. 4 to the Credit Agreement (the “Fourth Amendment”). The following are the key modifications made by the Fourth Amendment:
•The existing term note is replaced by an Amended and Restated Term Note with a maximum principal amount of $30.0 million, a maturity date of November 15, 2024, two principal payments of $3.75 million (March 1 and September 1) per year and an interest rate of LIBOR + 340 basis points.
•The limitation on distributions to members has been modified to permit distributions to members under two sets of conditions: (i) provided certain conditions are met, we may distribute up to 50% of net income to members with respect to any fiscal year; and (ii) subject to certain conditions, we may make a distribution to members if there was at least $1 of net income in the most recently-completed fiscal year, positive net income is reasonably projected for the year of distribution, and we have working capital of at least $30.0 million before and after the distribution.
•Under the Fourth Amendment, there are two financial covenants: (i) we must maintain working capital of not less than $20,000,000 at the end of each month, (which allows the unadvanced portion of the revolving term loan to be included in the calculation); and (ii) our debt service coverage ratio (net income divided by the mandatory annual principal payment of $7,500,000 on the Amended and Restated Term Note) at the end of each fiscal year must be at least 1.20 to 1.
The Fourth Amendment also expressly authorized the Company to repurchase the Class C Units and Class A Units of the Company owned by ICM for a purchase price equal to $11.1 million which repurchase was completed on November 15, 2019. Class B units were purchased by the Company December 31, 2019 from Bunge for $18.0 million.
We expect the prices of our primary input (corn) to increase slightly and our principal product prices (ethanol and distillers grains) to remain stable in the first quarter of Fiscal 2021, given the relative prices of these commodities and the operations of our risk management program in the quarter. We therefore currently believe that our operating margins in the first quarter of Fiscal 2021 will be similar to our operating margins in the fourth quarter of Fiscal 2020. We expect that in the last three quarters of Fiscal 2021 our margins will be steady if ethanol and corn prices maintain their stability.
Primary Working Capital Needs
Cash provided by operations for Fiscal 2020 and 2019 was $7.1 million and $5.0 million, respectively. This change is primarily a result of improved net loss of $8.3 million partially offset by an decrease in accrued expenses to settle the ICM put option.. For Fiscal 2020 and 2019, net cash (used in) investing activities was $(8.2) million and $(9.8) million, respectively, primarily for fixed asset additions. For Fiscal 2020 and 2019, net cash flows provided by financing activities was $1.1 million and $4.4 million, respectively due to increased revolver loan borrowings, primarily for the purchase of capital units.
We believe that our existing sources of liquidity, including cash on hand, available revolving credit and cash provided by operating activities, will satisfy our projected liquidity requirements, which primarily consists of working capital requirements, for the next twelve months. However, in the event that the market experiences significant price volatility and negative crush margins at or in excess of the levels experienced in previous years, we may be required to explore alternative methods to meet our short-term liquidity needs including temporary shutdowns of operations, temporary reductions in our production levels, or negotiating short-term concessions from our lenders.
Commodity Price Risk
Our operations are highly dependent on commodity prices, especially prices for corn, ethanol and distillers grains and the spread between them ( the "crush margin"). As a result of price volatility for these commodities, our operating results may fluctuate substantially. The price and availability of corn are subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, weather, governmental programs and foreign purchases. We may experience increasing costs for corn and natural gas and decreasing prices for ethanol and distillers grains which could significantly impact our operating results. Because the market price of ethanol is not directly related to corn prices, ethanol producers are generally not able to compensate for increases in the cost of corn through adjustments in prices for ethanol. We continue to monitor corn and ethanol prices and manage the "crush margin" to affect our longer-term profitability.
We enter into various derivative contracts with the primary objective of managing our exposure to adverse price movements in the commodities used for, and produced in, our business operations and, to the extent we have working capital available and available market conditions are appropriate, we engage in hedging transactions which involve risks that could harm our business. We measure and review our net commodity positions on a daily basis. Our daily net agricultural commodity position consists of inventory, forward purchase and sale contracts, over-the-counter and exchange traded derivative instruments. The effectiveness of our hedging strategies is dependent upon the cost of commodities and our ability to sell sufficient products to use all of the commodities for which we have futures contracts. Although we actively manage our risk and adjust hedging strategies as appropriate, there is no assurance that our hedging activities will successfully reduce the risk caused by market volatility which may leave us vulnerable to high commodity prices. Alternatively, we may choose not to engage in hedging transactions in the future. As a result, our future results of operations and financial conditions may also be adversely affected during periods in which price changes in corn, ethanol and distillers grain to not work in our favor.
In addition, as described above, hedging transactions expose us to the risk of counterparty non-performance where the counterparty to the hedging contract defaults on its contract or, in the case of over-the-counter or exchange-traded contracts, where there is a change in the expected differential between the price of the commodity underlying the hedging agreement and the actual prices paid or received by us for the physical commodity bought or sold. We have, from time to time, experienced instances of counterparty non-performance but losses incurred in these situations were not significant.
Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match any gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in the current period (commonly referred to as the “mark to market” method). The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged. As corn prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, our hedging strategies may cause immediate adverse effects, but are expected to produce long-term positive impact.
In the event we do not have sufficient working capital to enter into hedging strategies to manage our commodities price risk, we may be forced to purchase our corn and market our ethanol at spot prices and as a result, we could be further exposed to market volatility and risk. However, during the past year, the spot market has been advantageous.
Credit and Counterparty Risks
Through our normal business activities, we are subject to significant credit and counterparty risks that arise through normal commercial sales and purchases, including forward commitments to buy and sell, and through various other over-the-counter (OTC) derivative instruments that we utilize to manage risks inherent in our business activities. We define credit and counterparty risk as a potential financial loss due to the failure of a counterparty to honor its obligations. The exposure is measured based upon several factors, including unpaid accounts receivable from counterparties and unrealized gains (losses)
from OTC derivative instruments (including forward purchase and sale contracts). We actively monitor credit and counterparty risk through credit analysis (by our marketing agent).
Impact of Hedging Transactions on Liquidity
Our operations and cash flows are highly impacted by commodity prices, including prices for corn, ethanol, distillers grains and natural gas. We attempt to reduce the market risk associated with fluctuations in commodity prices through the use of derivative instruments, including forward corn contracts and over-the-counter exchange-traded futures and option contracts. Our liquidity position may be positively or negatively affected by changes in the underlying value of our derivative instruments. When the value of our open derivative positions decrease, we may be required to post margin deposits with our brokers to cover a portion of the decrease or we may require significant liquidity with little advanced notice to meet margin calls. Conversely, when the value of our open derivative positions increase, our brokers may be required to deliver margin deposits to us for a portion of the increase. We continuously monitor and manage our derivative instruments portfolio and our exposure to margin calls and while we believe we will continue to maintain adequate liquidity to cover such margin calls from operating results and borrowings, we cannot estimate the actual availability of funds from operations or borrowings for hedging transactions in the future.
The effects, positive or negative, on liquidity resulting from our hedging activities tend to be mitigated by offsetting changes in cash prices in our business. For example, in a period of rising corn prices, gains resulting from long grain derivative positions would generally be offset by higher cash prices paid to farmers and other suppliers in local corn markets. These offsetting changes do not always occur, however, in the same amounts or in the same period.
We expect that a $1.00 per bushel fluctuation in market prices for corn would impact our cost of goods sold by approximately $48 million, or $0.34 per gallon, assuming our plant operates at 100% of our capacity assuming no increase in the price of ethanol. We expect the annual impact to our results of operations due to a $0.50 decrease in ethanol prices will result in approximately a $70 million decrease in revenue.
Summary of Critical Accounting Policies and Estimates
Note 2 to our financial statements contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. Accounting estimates are an integral part of the preparation of financial statements and are based upon management’s current judgment. We used our knowledge and experience about past events and certain future assumptions to make estimates and judgments involving matters that are inherently uncertain and that affect the carrying value of our assets and liabilities. We believe that of our significant accounting policies, the following are noteworthy because changes in these estimates or assumptions could materially affect our financial position and results of operations:
•Revenue Recognition
The Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) on October 1, 2018. Under the ASU, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the considerations the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from the contracts with customers. The Company applied the five-step method outlined in the ASU to all contracts with customers, and elected the modified retrospective implementation method. The new revenue standard did not have an impact on the Company's financial statements.
The Company sells ethanol and related products pursuant to marketing agreements. Revenues are recognized when the risk of loss has been transferred to the end customer and the end customer has taken title to the product, prices are fixed or determinable and collectability is reasonably assured.
The Company’s products are generally shipped FOB loading point, and recorded as a sale upon delivery of the applicable bill of lading and transfer of risk of loss. The Company’s ethanol sales are handled through an ethanol purchase agreement (the “Ethanol Agreement”) with Bunge North America, Inc. (“Bunge”) which was restated effective January 1, 2020 in connection with the Company's repurchase of the Series B Units from Bunge under the Bunge Membership Interest Purchase Agreement (the "Bunge Repurchase Agreement"). Syrup and distillers grains (co-products) were sold through a distillers grains agreement (the “DG Agreement”) with Bunge, based on market prices. As discussed in Note 6, the initial term of this DG Agreement expired December 31, 2019, and as set forth in the Bunge Repurchase Agreement, Bunge provided transition services for all duties and responsibilities of the original DG Agreement through March 31, 2020. In April 1, 2020, the Company assumed responsibility for these functions. The Company markets and distributes all of the corn oil it produces directly to end users at market prices. Carbon dioxide is sold through a Carbon Dioxide Purchase and Sale Agreement (the
“CO2 Agreement”) with Air Products and Chemicals, Inc. Shipping and handling costs are booked as a direct offset to revenue. Marketing fees, agency fees, and commissions due to the marketer are calculated separately from the settlement for the sale of the ethanol products and co-products and are included as a component of cost of goods sold.
•Investment in Commodities Contracts, Derivative Instruments and Hedging Activities
The Company’s operations and cash flows are subject to fluctuations due to changes in commodity prices. The Company is subject to market risk with respect to the price and availability of corn, the principal raw material used to produce ethanol and ethanol by-products. Exposure to commodity price risk results from its dependence on corn in the ethanol production process. In general, rising corn prices result in lower profit margins and, therefore, represent unfavorable market conditions. This is especially true when market conditions do not allow the Company to pass along increased corn costs to customers. The availability and price of corn is subject to wide fluctuations due to unpredictable factors such as weather conditions, farmer planting decisions, governmental policies with respect to agriculture and international trade and global demand and supply.
To minimize the risk and the volatility of commodity prices, primarily related to corn and ethanol, the Company uses various derivative instruments, including forward corn, ethanol and distillers grains purchase and sales contracts, over-the-counter and exchange-trade futures and option contracts. When the Company has sufficient working capital available, it enters into derivative contracts to hedge its exposure to price risk related to forecasted corn needs and forward corn purchase contracts.
Management has evaluated the Company’s contracts to determine whether the contracts are derivative instruments. Certain contracts that literally meet the definition of a derivative may be exempted from derivative accounting 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. Gains and losses on contracts that are designated as normal purchases or normal sales contracts are not recognized until quantities are delivered or utilized in production.
The Company applies the normal purchase and sale exemption to forward contracts relating to ethanol and distillers grains and solubles and therefore these forward contracts are not marked to market. As of September 30, 2020, the Company had 7.7 million gallons in open contracts for ethanol, 86 thousand tons of open contracts on dried distillers grains , 89 thousand tons of wet distillers grains, and 8.9 million pounds of corn oil on open contracts.
Corn purchase contracts are treated as derivative financial instruments. Changes in fair value of forward corn contracts, which are marked to market each period, are included in costs of goods sold. As of September 30, 2020, the Company was committed to purchasing 2.2 million bushels of corn on a forward contract basis resulting in a total commitment of $7.5 million. In addition the Company was committed to purchasing 759 thousand bushels of corn using basis contracts.
In addition, the Company enters into short-term cash, options and futures contracts as a means of managing exposure to changes in commodity prices. The Company enters into derivative contracts to hedge the exposure to volatile commodity price fluctuations. The Company maintains a risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by market volatility. The Company’s specific goal is to protect itself from large moves in commodity costs. All derivatives are designated as non-hedge derivatives and the contracts will be accounted for at fair value. Although the contracts will be effective economic hedges of specified risks, they are not designated as and accounted for as hedging instruments.
•Inventory
Inventory is valued at the lower of weighted average cost or net realizable value. In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation.
•Put Option liability.
The put option liability consisted of an agreement between the Company and ICM, Inc. ("ICM") that contained a conditional obligation to repurchase feature. Under the Unit Agreement between the Company and ICM dated December 17, 2014 (the "Unit Agreement"), the Company granted ICM the right to sell to the Company its 1,000 Series C and 18 Series A
Membership Units (the "ICM Units") commencing anytime during the earliest of several alternative dates and events at a price equal to the greater of $10,987 per unit or the fair market value (as defined in the Unit Agreement) on the date of exercise (the "Put Option"). On August 16, 2019, ICM notified the Company of its intent to exercise the Put Option and waived its right to determine the fair market value for the ICM Units. On November 15, 2019, the Company repurchased the ICM Units for $11.1 million in accordance with the terms of the Put Option set forth in the Unit Agreement. The effective date of the Company's repurchase of the ICM Units was October 31, 2019.
Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Members and Board of Directors of Southwest Iowa Renewable Energy, LLC
Opinion on the Financial Statements
We have audited the accompanying balance sheets of Southwest Iowa Renewable Energy, LLC (the Company) as of September 30, 2020 and 2019, the related statements of operations, members’ equity and cash flows for each of the years then ended, and the related notes to the financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have Served as the Company's auditor since 2008.
Des Moines, Iowa
December 11, 2020
| | | | | | | | | | | |
| SOUTHWEST IOWA RENEWABLE ENERGY, LLC | | | |
| Balance Sheets | | | |
| (Dollars in thousands) | | | |
| | | | |
| | September 30, 2020 | | September 30, 2019 |
| ASSETS | | | |
| Current Assets | | | |
| Cash and cash equivalents | $ | 1,116 | | | $ | 1,075 | |
| | | |
| Accounts receivable, net of allowance for doubtful accounts | 8,488 | | | 1,431 | |
| Accounts receivable, related party | 0 | | | 7,885 | |
| Derivative financial instruments | 705 | | | 78 | |
| Inventory | 13,369 | | | 17,167 | |
| Prepaid expenses and other | 424 | | | 331 | |
| Total current assets | 24,102 | | | 27,967 | |
| Property, Plant and Equipment | | | |
| Land | 2,064 | | | 2,064 | |
| Plant, building and equipment | 247,462 | | | 239,446 | |
| Office and other equipment | 1,803 | | | 1,803 | |
| | 251,329 | | | 243,313 | |
| Accumulated depreciation | (142,444) | | | (131,864) | |
| Net property, plant and equipment | 108,885 | | | 111,449 | |
| | | |
| Right of use asset operating leases, net | 6,667 | | | 0 | |
| Other Assets | 1,172 | | | 1,447 | |
| | | |
| Total Assets | $ | 140,826 | | | $ | 140,863 | |
| | | |
| LIABILITIES AND MEMBERS' EQUITY | | | |
| Current Liabilities | | | |
| Accounts payable | $ | 3,204 | | | $ | 4,151 | |
| Accounts payable, related parties | 0 | | | 2 | |
| Derivative financial instruments | 0 | | | 597 | |
| Accrued expenses | 4,176 | | | 9,906 | |
| Accrued expenses, related parties | 0 | | | 581 | |
| Accrued put option liability, related party | 0 | | | 6,037 | |
| Current maturities of notes payable | 8,191 | | | 580 | |
| Current portion of operating lease liability | 3,052 | | | 0 | |
| Total current liabilities | 18,623 | | | 21,854 | |
| Long Term Liabilities | | | |
| Notes payable, less current maturities | 48,529 | | | 25,832 | |
| Other long-term liabilities | 4,255 | | | 3,872 | |
| Operating lease liability, less current maturities | 3,615 | | | 0 | |
| Total long term liabilities | 56,399 | | | 29,704 | |
| | | |
| Members' Equity | | | |
| Members' capital | | | |
| 8,975 and 13,327 units issued and outstanding as of September 30, 2020 and 2019, respectively | 64,106 | | | 87,165 | |
| Retained earnings | 1,698 | | | 2,140 | |
| Total members' equity | 65,804 | | | 89,305 | |
| Total Liabilities and Members' Equity | $ | 140,826 | | | $ | 140,863 | |
| See Notes to Financial Statements | | | |
| | | | | | | | | | | |
| SOUTHWEST IOWA RENEWABLE ENERGY, LLC | | | |
| Statements of Operations | | | |
| (Dollars in thousands, except per unit data) | | | |
| | Year Ended | | Year Ended |
| | September 30, 2020 | | September 30, 2019 |
| Revenues | $ | 198,614 | | | $ | 216,993 | |
| Cost of Goods Sold | | | |
| Cost of goods sold-non hedging | 195,488 | | | 221,842 | |
| Realized & unrealized hedging (gains) losses | (2,599) | | | (2,825) | |
| | 192,889 | | | 219,017 | |
| | | |
| Gross Margin (Loss) | 5,725 | | | (2,024) | |
| | | |
| General and administrative expenses | 5,169 | | | 4,837 | |
| | | |
| | | |
| Operating Income (Loss) | 556 | | | (6,861) | |
| | | |
| Other Expense | | | |
| | | |
| | | |
| | | |
| Interest expense and other income, net | 998 | | | 999 | |
| Change in fair value of put option liability | 0 | | | 637 | |
| | | |
| | 998 | | | 1,636 | |
| | | |
| Net (Loss) | $ | (442) | | | $ | (8,497) | |
| | | |
| Weighted Average Units Outstanding -basic | 9,899 | | | 13,327 | |
| Weighted Average Units Outstanding -diluted | 9,899 | | | 13,327 | |
| (Loss) per unit -basic | $ | (44.65) | | | $ | (637.58) | |
| (Loss) per unit -diluted | $ | (44.65) | | | $ | (637.58) | |
| | | |
| | | |
| See Notes to Financial Statements | | | |
| | | | | | | | | | | | | | | | | |
| SOUTHWEST IOWA RENEWABLE ENERGY, LLC | | | | | |
| Statements of Members' Equity | | | | | |
| (Dollars in thousands) | | | | | |
| | Members' Capital | | Retained Earnings | | Total |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| Balance, September 30, 2018 | $ | 87,165 | | | $ | 10,637 | | | $ | 97,802 | |
| Net (Loss) | 0 | | | (8,497) | | | (8,497) | |
| | | | | |
| | | | | |
| Balance, September 30, 2019 | $ | 87,165 | | | $ | 2,140 | | | $ | 89,305 | |
| Repurchase of Membership Units | (23,059) | | | 0 | | | (23,059) | |
| Net (Loss) | 0 | | | (442) | | | (442) | |
| | | | | |
| Balance, September 30, 2020 | $ | 64,106 | | | $ | 1,698 | | | $ | 65,804 | |
| See Notes to Financial Statements | | | | | |
| | | | | | | | | | | |
| SOUTHWEST IOWA RENEWABLE ENERGY, LLC | | | |
| Statements of Cash Flows | | | |
| (Dollars in thousands) | | | |
| | Year Ended | | Year Ended |
| | September 30, 2020 | | September 30, 2019 |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | |
| Net (Loss) | $ | (442) | | | $ | (8,497) | |
| Adjustments to reconcile net (loss) to net cash provided by operating activities: | | | |
| Depreciation | 10,694 | | | 10,230 | |
| Amortization | 100 | | | 71 | |
| Loss on disposal of property and equipment | 85 | | | 0 | |
| Change in other assets, net | 275 | | | 291 | |
| | | |
| Change in fair value of put option liability | 0 | | | 637 | |
| Bad Debt Expense | 128 | | | 0 | |
| (Increase) decrease in current assets: | | | |
| Accounts receivable | 700 | | | 3,356 | |
| Inventory | 3,798 | | | (3,641) | |
| Prepaid expenses and other | (93) | | | 10 | |
| | | |
| Derivative financial instruments | (627) | | | 968 | |
| Increase (decrease) in other long-term liabilities | 383 | | | (1,517) | |
| Increase (decrease) in current liabilities: | | | |
| Accounts payable | (949) | | | 952 | |
| Derivative financial instruments | (597) | | | (970) | |
| Accrued expenses | (6,311) | | | 3,108 | |
| Net cash provided by operating activities | 7,144 | | | 4,998 | |
| | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | | |
| Purchase of property and equipment | (8,342) | | | (9,811) | |
| | | |
| | | |
| Proceeds from sale of property and equipment | 127 | | | 0 | |
| | | |
| | | |
| Net cash (used in) investing activities | (8,215) | | | (9,811) | |
| | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | |
| | | |
| Payments for financing costs | (223) | | | 0 | |
| Settlement of put option liability | (6,037) | | | 0 | |
| | | |
| Proceeds from notes payable | 223,736 | | | 193,041 | |
| Payments of notes payable | (193,305) | | | (188,593) | |
| Repurchase of membership units | (23,059) | | | 0 | |
| Net cash provided by financing activities | 1,112 | | | 4,448 | |
| | | |
| Net increase (decrease) in cash and cash equivalents | 41 | | | (365) | |
| | | |
| CASH AND CASH EQUIVALENTS | | | |
| Beginning | 1,075 | | | 1,440 | |
| Ending | $ | 1,116 | | | $ | 1,075 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| SUPPLEMENTAL CASH FLOW INFORMATION | | | |
| Cash paid for interest | $ | 1,927 | | | $ | 980 | |
| | | |
| SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES | | | |
| Establishment of lease liability and right-of-use asset | $ | 9,684 | | | $ | 0 | |
| See Notes to Financial Statements | | | |
| | |
| |
SOUTHWEST IOWA RENEWABLE ENERGY, LLC Notes to Financial Statements September 30, 2020 |
Note 1: Nature of Business
Southwest Iowa Renewable Energy, LLC (the “Company”), located in Council Bluffs, Iowa, was formed in March 2005, operates a 140 million gallon capacity ethanol plant and began producing ethanol in February 2009. The Company sold 115.0 million gallons and 128.0 million gallons of ethanol in Fiscal 2020 and Fiscal 2019, respectively. The Company sells its ethanol, distillers grains, corn syrup, and corn oil in the continental United States, Mexico and the Pacific Rim.
Note 2: Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with a maturity of three months or less when purchased to be cash equivalents.
Concentration of Credit Risk
The Company’s cash balances are maintained in bank deposit accounts which at times may exceed federally-insured limits. The Company has not experienced any losses in such accounts.
Revenue Recognition
The Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) on October 1, 2018. Under the ASU, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the considerations the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from the contracts with customers. The Company applied the five-step method outlined in the ASU to all contracts with customers, and elected the modified retrospective implementation method. The new revenue standard did not have an impact on the Company's financial statements.
The Company sells ethanol and related products pursuant to marketing agreements. Revenues are recognized when the risk of loss has been transferred to the marketing company and the marketing company has taken title to the product, prices are fixed or determinable and collectability is reasonably assured.
The Company’s products are generally shipped Free on Board ("FOB") shipping point, and recorded as a sale upon delivery of the applicable bill of lading and transfer of risk of loss. The Company’s ethanol sales are handled through an ethanol purchase agreement (the “Ethanol Agreement”) with Bunge North America, Inc. (“Bunge”) which was restated effective January 1, 2020 in connection with the Company's repurchase of the Series B Units from Bunge under the Bunge Membership Interest Purchase Agreement (the "Bunge Repurchase Agreement"). Syrup and distillers grains (co-products) were sold through a distillers grains agreement (the “DG Agreement”) with Bunge, based on market prices. As discussed in Note 6, the initial term of this DG Agreement expired December 31, 2019, and as set forth in the Bunge Repurchase Agreement, Bunge provided transition services for all duties and responsibilities of the original DG Agreement through March 31, 2020. The Company is now responsible for all of these functions. The Company markets and distributes all of the corn oil it produces directly to end users at market prices. Carbon dioxide is sold through a Carbon Dioxide Purchase and Sale Agreement (the “CO2 Agreement”) with Air Products and Chemicals, Inc. Shipping and handling costs are booked as a direct offset to revenue. Marketing fees, agency fees, and commissions due to the marketer are calculated separately from the settlement for the sale of the ethanol products and co-products and are included as a component of cost of goods sold.
Accounts Receivable
Accounts receivable are recorded at original invoice amounts less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering customers’ financial condition, credit history and current economic conditions. As of September 30, 2020 and 2019, management had determined an allowance of $128 thousand and $0 was necessary, respectively. Receivables are written off when deemed uncollectible, and recoveries of receivables written off are recorded when received.
Risks and Uncertainties
The Company's operating and financial performance is largely driven by the prices at which ethanol is sold and the net expense of corn. The price of ethanol is influenced by factors such as supply and demand, weather, government policies and programs, and unleaded gasoline and the petroleum markets with ethanol selling, in general, for less than gasoline at the wholesale level. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The Company's largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, weather, government policies and programs. The Company's risk management program is used to protect against the price volatility of these commodities.
Investment in Commodities Contracts, Derivative Instruments and Hedging Activities
The Company’s operations and cash flows are subject to fluctuations due to changes in commodity prices. The Company is subject to market risk with respect to the price and availability of corn, the principal raw material used to produce ethanol and ethanol by-products. Exposure to commodity price risk results from its dependence on corn in the ethanol production process. In general, rising corn prices result in lower profit margins and, therefore, represent unfavorable market conditions. This is especially true when market conditions do not allow the Company to pass along increased corn costs to customers. The availability and price of corn is subject to wide fluctuations due to unpredictable factors such as weather conditions, farmer planting decisions, governmental policies with respect to agriculture and international trade and global demand and supply.
To minimize the risk and the volatility of commodity prices, primarily related to corn and ethanol, the Company uses various derivative instruments, including forward corn, ethanol and distillers grains purchase and sales contracts, over-the-counter and exchange-trade futures and option contracts. When the Company has sufficient working capital available, it enters into derivative contracts to hedge its exposure to price risk related to forecasted corn needs and forward corn purchase contracts.
Management has evaluated the Company’s contracts to determine whether the contracts are derivative instruments. Certain contracts that literally meet the definition of a derivative may be exempted from derivative accounting 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. Gains and losses on contracts that are designated as normal purchases or normal sales contracts are not recognized until quantities are delivered or utilized in production.
The Company applies the normal sale exemption to forward contracts relating to ethanol, distillers grains, and corn oil and therefore these forward contracts are not marked to market. As of September 30, 2020, the Company had commitments to sell 7.7 million gallons of ethanol, 86 thousand tons of dried distillers grains, 89 thousand tons of wet distillers grains and 8.9 million pounds of corn oil.
Corn purchase contracts are treated as derivative financial instruments. Changes in fair value of forward corn contracts, which are marked to market each period, are included in costs of goods sold. As of September 30, 2020, the Company was committed to purchasing 2.2 million bushels of corn on a forward contract basis resulting in a total commitment of $7.5 million. In addition the Company was committed to purchasing 759 thousand bushels of corn using basis contracts.
In addition, the Company enters into short-term cash, options and futures contracts as a means of managing exposure to changes in commodity prices. The Company enters into derivative contracts to hedge the exposure to volatile commodity price fluctuations. The Company maintains a risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by market volatility. The Company’s specific goal is to protect itself from large moves in commodity costs. All derivatives are designated as non-hedge derivatives and the contracts will be
accounted for at fair value. Although the contracts are considered effective economic hedges of specified risks, they are not designated as or accounted for as hedging instruments.
Derivatives not designated as hedging instruments along with cash due to brokers at September 30, 2020 and 2019 are as follows:
| | | | | | | | | | | | | | |
| | Balance Sheet Classification | September 30, 2020 | | September 30, 2019 |
| | in 000's | | in 000's |
| Futures and option contracts | | | | |
| In gain position | | $ | 590 | | | $ | 368 | |
| In loss position | | (592) | | | (364) | |
| Cash held by broker | | $ | 304 | | | $ | 74 | |
| Forward contracts, corn | | 403 | | | 0 | |
| | Current asset | 705 | | | 78 | |
| | | | | |
| | | | |
| Forward contracts, corn | Current liability | 0 | | | 597 | |
| | | | |
| | | | |
| Net futures, options, and forward contracts | | $ | 705 | | | $ | (519) | |
The net realized and unrealized gains and losses on the Company’s derivative contracts for the years ended September 30, 2020 and 2019 consist of the following:
| | | | | | | | | | | | | | |
| Statement of Operations Classification | September 30, 2020 | | September 30, 2019 |
| Net realized and unrealized (gains) losses related to: | (in 000's) | | (in 000's) |
| | | | |
| Forward purchase contracts (corn) | Cost of Goods Sold | $ | 67 | | | $ | (1,530) | |
| Futures and option contracts (corn) | Cost of Goods Sold | (2,666) | | | (1,295) | |
| | | | |
Inventory
Inventory is stated at the lower of average cost or net realizable value. In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation. At both September 30, 2020 and 2019, there was no lower of cost or market adjustment.
Leases
In February 2016, FASB issued ASU 2016-02 "Leases” ("ASU 2016-02"). ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for all leases greater than one year in duration and classified as operating leases under previous GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and for interim periods within that fiscal year. Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted cash flow basis; and 2) a "right to use" asset, which is an asset that represents the lessee's right to use the specified asset for the lease term. The Company adopted this accounting standard effective October 1, 2019, the start of our fiscal year. Upon adoption, the Company elected a practical expedient which allows existing leases to retain their classification as operating leases. The Company has elected to account for lease and related non-lease components as a single lease component. See Note 11 for more detailed information regarding leases.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives:
| | | | | |
| Buildings | 40 years |
| Process Equipment | 10 - 20 Years |
| Office Equipment | 3-7 Years |
Maintenance and repairs are charged to expense as incurred; major improvements are capitalized.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows from operations are less than the carrying value of the asset group. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. Management has determined there were no events or changes in circumstances that required an impairment evaluation during Fiscal 2020 or Fiscal 2019.
Income Taxes
The Company has elected to be treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, the Company’s earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements.
Management has evaluated the Company’s tax positions under the Financial Accounting Standards Board issued guidance on accounting for uncertainty in income taxes and concluded that the Company has taken no uncertain tax positions that require adjustment to the financial statements to comply with the provisions of this guidance.
Put Option Liability
The put option liability consisted of an agreement between the Company and ICM, Inc. ("ICM") that contained a conditional obligation to repurchase feature. Under the Unit Agreement between the Company and ICM dated December 17, 2014 (the "Unit Agreement"), the Company granted ICM the right to sell to the Company its 1,000 Series C and 18 Series A Membership Units (the "ICM Units") commencing anytime during the earliest of several alternative dates and events at a price equal to the greater of $10,987 per unit or the fair market value (as defined in the Unit Agreement) on the date of exercise (the "Put Option"). On August 16, 2019, ICM notified the Company of its intent to exercise the Put Option and waived its right to determine the fair market value for the ICM Units. On November 15, 2019, the Company repurchased the ICM Units for $11.1 million in accordance with the terms of the Put Option set forth in the Unit Agreement. The effective date of the Company's repurchase of the ICM Units was October 31, 2019.
Income Per Unit
Basic income per unit is calculated by dividing net income by the weighted average units outstanding for each period. Basic earnings and diluted per unit data were computed as follows (in thousands except per unit data):
| | | | | | | | | | | |
| Twelve Months Ended |
| September 30, 2020 | | September 30, 2019 |
| Numerator: | | | |
| Net (loss) for basic earnings per unit | $ | (442) | | | $ | (8,497) | |
| | | |
| Change in fair value of put option liability | $ | 0 | | | $ | 637 | |
| Net (loss) for diluted earnings per unit | $ | (442) | | | $ | (7,860) | |
| | | |
| Denominator: | | | |
| Weighted average units outstanding - basic | 9,899 | | | 13,327 | |
| Weighted average units outstanding - diluted | 9,899 | | | 13,327 | |
| (Loss) per unit - basic | $ | (44.65) | | | $ | (637.58) | |
| (Loss) per unit - diluted | $ | (44.65) | | | $ | (637.58) | |
Note 3: Inventory
Inventory is comprised of the following at:
| | | | | | | | | | | |
| | September 30, 2020 | | September 30, 2019 |
| | (in 000's) | | (in 000's) |
| Raw Materials - corn | $ | 1,663 | | | $ | 4,270 | |
| Supplies and Chemicals | 4,906 | | | 5,063 | |
| Work in Process | 1,667 | | | 1,724 | |
| Finished Goods | 5,133 | | | 6,110 | |
| Total | $ | 13,369 | | | $ | 17,167 | |
Note 4: Members’ Equity
At September 30, 2020 and 2019 outstanding member units were:
| | | | | | | | | | | | | | |
| | September 30, 2020 | | September 30, 2019 |
| A Units | | 8,975 | | | 8,993 | |
| B Units | | 0 | | | 3,334 | |
| C Units | | 0 | | | 1,000 | |
| | 8,975 | | | 13,327 | |
The Series A, B and C unit holders all vote on certain matters with equal rights. Prior to the repurchase of all of the Series C Units in November 2019, the Series C unit holders as a group elected one Board member. The Series B unit holders as a group have the right to elect the number of Board members which bears the same proportion to the total number of Directors in relation to Series B outstanding units to total outstanding units. Based on this calculation, the Series B unit holders elected two Board members up to December 31, 2019, when the Company purchased the shares from Bunge. Series A unit holders now elect all of the Directors.
Note 5: Revolving Loan/Credit Agreements
FCSA/CoBank
During Fiscal 2014, the Company entered into a credit agreement with Farm Credit Services of America, FLCA (“FCSA”) and CoBank, ACB, as cash management provider and agent (“CoBank”) which provides the Company with a term loan in the amount of $30.0 million (the “Term Loan”) and a revolving term loan in the amount of up to $36.0 million (the “Revolving Term Loan", and together with the Term Loan, the “FCSA Credit Facility”). The FCSA Credit Facility is secured by a security interest on all of the Company’s assets.
The Term Loan provides for payments by the Company to FCSA of quarterly installments of $1.5 million, which began on December 20, 2014 and matured September 20, 2019. The Revolving Term Loan has a maturity date of June 1, 2023 and requires annual reductions in principal availability of $6.0 million commencing on June 1, 2020. Under the FCSA Credit Facility, the Company has the right to select from the several LIBOR based interest rate options with respect to each of the Term Loan and the Revolving Term Loan.
On November 8, 2019 the Company amended the credit agreement with Farm Credit Services of America, FLCA (“FCSA”) and CoBank, ACB, as cash management provider and agent (“CoBank”) which provides the Company with a term loan in the amount of $30.0 million (the “Term Loan”) and a revolving term loan in the amount of up to $40.0 million (the “Revolving Term Loan”), together with the Term Loan, the “ FCSA Credit Facility ”). The FCSA Credit Facility is secured by a security interest on all of the Company’s assets.
The Term Loan provides for semi-annual payments by the Company to FCSA of $3.75 million beginning September 1, 2020 and a maturity date of November 15, 2024. The Revolving Term Loan also has a maturity date of November 15, 2024. Under the FCSA Credit Facility, the Company has the right to select from several LIBOR based interest rate options with respect to each of the loans, with a LIBOR spread of 3.4% per annum.
As of September 30, 2020, there was $53.1 million outstanding under the FCSA Credit Facility, with $13.2 million available under the Revolving Term Loan.
Financing costs associated with the Credit Agreement Facility are recorded at cost and include expenditures directly related to securing debt financing. The Company amortizes financing costs using the effective interest method over the term of the related debt.
Paycheck Protection Program Loan
On April 14, 2020, the Company received 1.1 million under the new Paycheck Protection Program Loan ("PPP loan") legislation passed by Congress and signed by President Trump. The PPP loan may be forgiven based upon various factors, including, without limitation, the borrower's payroll cost over an eight to twenty-four week period starting upon the receipt of the funds. Expenses for approved payroll costs, lease payments on agreements before February 15, 2020 and utility payments under agreements before February 1, 2020 and certain other specified costs can be paid with these funds and eligible for payment forgiveness by the federal government. At least 60% of the proceeds must be used for approved payroll costs, and no more than 40% for non payroll expenses. PPP loan proceeds used by a borrower for the approved expense categories will generally be fully forgiven by the lender if the borrower satisfies certain employee headcount and compensation requirements .
Note 6: Notes Payable
| | | | | | | | | | | |
| Notes payable consists of the following (in 000's): | | | |
| | | |
| | September 30, 2020 | | September 30, 2019 |
| Term loan bearing interest at LIBOR plus 3.40% (3.55% at September 30, 2020) | $ | 26,250 | | | $ | 0 | |
| Note payable, PPP Loan bearing interest at 1.00%, maturing April 28, 2022 | 1,063 | | | 0 | |
| Revolving term loan bearing interest at LIBOR plus 3.40% (3.55% at September 30, 2020) | 26,828 | | | 23,902 | |
| | | |
| | | |
| Other with interest rates from 3.50% to 4.15% and maturities through 2027 | 2,761 | | | 2,569 | |
| | 56,902 | | | 26,471 | |
| Less Current Maturities | 8,191 | | | 580 | |
| Less Financing Costs, net of amortization | 182 | | | 59 | |
| Total Long Term Debt | 48,529 | | | 25,832 | |
Approximate aggregate maturities of notes payable as of September 30, 2020 are as follows (in 000's):
| | | | | |
| 2021 | $ | 8,191 | |
| | |
| 2022 | 10,069 | |
| | |
| 2023 | 7,609 | |
| | |
| 2024 | 3,863 | |
| |
| 2025 | 26,944 | |
| |
| 2026 and thereafter | 226 | |
| |
| Total | $ | 56,902 | |
Note 7: Fair Value Measurement
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company used various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observable inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy.
The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 - Valuations for assets and liabilities traded in active markets from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities.
Level 3 - Valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
A description of the valuation methodologies used for instruments measured at fair value, including the general classifications of such instruments pursuant to the valuation hierarchy, is set below.
Put Option liability. The put option liability consisted of a Unit Agreement between the Company and ICM that contains a conditional obligation to repurchase feature. Under the Unit Agreement, the Company granted ICM the right to sell to the Company its 1,000 Series C Units and 18 Series A Membership Units (the "ICM Units") commencing anytime during the earliest of several alternative dates and events at the price equal to the greater of $10,987 per unit or the fair market value (as defined in the agreement) on the date of exercise (the "Put Option"). On August 16, 2019, ICM notified the Company of its intent to exercise the Put Option and waived its right to determine the fair market value for the ICM Units. On November 15, 2019, the Company repurchased the ICM Units for $11.1 million in settlement of the Put Option consistent with the terms of the Unit Agreement. The Company's repurchase of the ICM Units was effective October 31, 2019.
Derivative financial statements. Commodity futures and exchange traded options are reported at fair value utilizing Level 1 inputs. For these contracts, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the Chicago Mercantile Exchange (“CME”) market. Ethanol contracts are reported at fair value utilizing Level 2 inputs from third-party pricing services. Forward purchase contracts are reported at fair value utilizing Level 2 inputs. For these contracts, the Company obtains fair value measurements from local grain terminal values. The fair value measurements consider observable data that may include live trading bids from local elevators and processing plants which are based off the CME market.
The following table summarizes financial instruments measured at fair value on a recurring basis as of September 30, 2020 and 2019, categorized by the level of the valuation inputs within the fair value hierarchy: (dollars in '000s)
| | | | | | | | | | | | | | | | | |
| | September 30, 2020 |
| | Level 1 | | Level 2 | | Level 3 |
| Assets: | | | | | |
| Derivative financial instruments | $ | 590 | | | $ | 403 | | | $ | 0 | |
| | | | | |
| Liabilities: | | | | | |
| Derivative financial instruments | $ | 592 | | | 0 | | | 0 | |
| | | | | |
| | | | | |
| | |
| | September 30, 2019 |
| | Level 1 | | Level 2 | | Level 3 |
| Assets: | | | | | |
| Derivative financial instruments | $ | 368 | | | $ | 0 | | | $ | 0 | |
| | | | | |
| Liabilities: | | | | | |
| Derivative financial instruments | 364 | | | 597 | | | 0 | |
| Put Option Liability | 0 | | | 0 | | | 6,037 | |
The following table summarizes the assumptions used in computing the fair value of the put option subject to fair value:
| | | | | | | | | |
| | | September 30, 2019 |
| | | |
| Risk-free interest rate | | | 0 | % |
| Expected volatility | | | 0 | % |
| Expected life (years) | | | 0.25 | |
| Exercise unit price | | | $ | 10,897 | |
| Company unit price | | | $ | 4,967 | |
The following table reflects the activity for liabilities measured at fair value using Level 3 inputs as of September 30, 2020 and September 30, 2019:
| | | | | | | | | | | |
| | | |
| September 30, 2020 | | September 30, 2019 |
| Beginning Balance | $ | 6,037 | | | $ | 5,400 | |
| | | |
| Put Option (Redeemed) | (6,037) | | | 0 | |
| Change in Value | 0 | | | 637 | |
| Ending Balance | $ | 0 | | | $ | 6,037 | |
Note 8: Incentive Compensation
The Company has an equity incentive plan which provides that the Board of Directors may make awards of equity appreciation units (“EAU”) and equity participation units (“EPU”) to employees from time to time, subject to vesting provisions as determined for each award. There are no EAUs outstanding. The EPUs are valued in accordance with the agreement which is based on the book value per unit of the Company. The Company had 63.9 unvested EPUs outstanding under this plan as of September 30, 2020, which will vest three years from the dates of the awards.
During the Fiscal 2020 and 2019, the Company recorded compensation expense related to this plan of approximately $172,000 and $164,000, respectively. As of September 30, 2020 and 2019, the Company had a liability of approximately $344,000 and $908,000, respectively, recorded within accrued expenses on the balance sheet. The incentive compensation expense is recognized over three years from the date of the awards. The amounts to be recognized over future periods at September 30, 2020 and 2019 was $221,000 and $232,000, respectively.
Note 9: Related Party Transactions and Major Customers
Related Party Transactions
On November 15, 2019, the Company repurchased all of the ICM Units, which repurchase had an effective date of October 31, 2019. On December 31, 2019, the effective date, the Company repurchased the 3,334 Series B membership units owned by Bunge. Effective as of the date of the respective repurchase of the ICM Units and the Series B Units from Bunge, ICM and Bunge no longer constituted related parties. However, the activities discussed below reflect related party activity during the quarter ended December 31, 2019 up to and through the date of the respective repurchase, and historical expenses incurred in Fiscal 2019 for comparable periods.
Bunge
On December 5, 2014, the Company entered into an Amended and Restated Ethanol Purchase Agreement with Bunge which was further amended and restated on October 23, 2017 to include specific provisions for loading and shipment of ethanol by truck (the “Ethanol Agreement”). Under the Ethanol Agreement, the Company agreed to sell Bunge all of the ethanol produced by the Company, and Bunge agreed to purchase the same. The Company paid Bunge a percentage marketing fee for ethanol sold by Bunge, subject to a minimum and maximum annual fee. The initial term of the Ethanol Agreement expired on December 31, 2019. As part of the Bunge Membership Interest Purchase Agreement (the "Bunge Repurchase Agreement"), the parties entered into a restated Ethanol Agreement effective January 1, 2020 (the "Restated Ethanol Agreement") which provides that the Company will pay Bunge a flat monthly marketing fee. The term of the Restated Ethanol Agreement expires on December 31, 2026. The Company incurred related party ethanol marketing expenses of $0.4 million in Fiscal 2020 and $1.5 million Fiscal 2019, under the Ethanol Agreements. The decrease in the related party ethanol marketing expenses is due to the fact that Bunge ceased to be a related party effective as of January 1, 2020.
On June 26, 2009, the Company executed a Railcar Agreement with Bunge for the lease of 325 ethanol cars and 300 hopper cars which are used for the delivery and marketing of ethanol and distillers grains. In November 2016, The Company reduced the number of leased ethanol cars to 323 and in both November 2013 and January 2015. The Company reduced the number of hopper cars by 1 for a total of 298 leased hopper cars. Under the Railcar Agreement, the Company leases railcars for terms lasting 120 months and continuing on a month to month basis thereafter. The Railcar Agreement will terminate upon the expiration of all railcar leases. In November 2016, the Company entered into a sublease for 96 hoppers with Bunge that expired on March 24, 2019. The Company had subleased another 92 hopper cars to unrelated third parties, which also expired March 25, 2019. In June 2018, one of the third party customers entered into an assignment agreement for their 52 hopper cars with the Company and Bunge.
The Company entered into a agreement effective March 24, 2019 extending the original Railcar Agreement with Bunge for the lease of 323 ethanol cars and 111 hopper cars which will be used for the delivery and marketing of ethanol and distiller grains. This was later amended to 110 hopper cars effective November 2019. Effective August 2020, the ethanol car level was amended to 320, and the lease was assigned to Trinity Leasing company. Under the Railcar Agreement, the original DOT111 tank cars are leased over a four year term from March 24, 2019 to April 30, 2023, with the ability to start returning cars after January 1, 2023 to conform to the requirement for DOT117 tank cars with enhanced safety specifications which is scheduled to be effective in May 2023. The 110 hopper cars are leased over a three year term running from March 24, 2019 to March 31, 2022 which term will continue on a month-to-month basis thereafter. The amendments to the Railcar Agreement lowered the cost for the leases by approximately 20% as compared to the prior lease terms. Pursuant to the terms of a side letter to the Railcar Agreement, we sublease cars back to other companies from time to time when the cars are not in use in our operations. We work with the lessor to determine the most economic use of the available ethanol and hopper cars in light of current market conditions. In February 2019, we entered into a second 36 month lease for an additional 30 tank cars from an unrelated third party leasing company (this was in addition to the 30 non-insulated tank cars leased from that company signed December 2015. This agreement expired in June of 2020, and was converted to a month-to-month basis. The 30 tank cars will be returned during the First Quarter of Fiscal 2021). Related party expenses under this agreement were $0.8 million and $3.5 million for Fiscal 2020 and 2019, respectively, net of subleases and accretion.
The Company continues to work with the lessors to determine the need for ethanol and hopper cars in light of current market conditions, and the expected conditions in 2020 and beyond. The Company believes we will be able to fully utilize our fleet of hopper cars in the future, to allow us to cost-effectively ship distillers grains to distant markets, primarily the export markets.
On December 5, 2014, the Company and Bunge entered into an Amended and Restated Distiller’s Grain Purchase Agreement (the “ DG Purchase Agreement ”). Under the DG Purchase Agreement, Bunge will purchase all distiller’s grains produced by the Company, and will receive a marketing fee based on the net sale price of distillers grains, subject to a minimum and maximum annual fee. The initial term of the DG Purchase Agreement expired on December 31, 2019. As part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities of the original DG Purchase Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge. The Company has incurred related party distillers grains marketing expenses of $0.3 million and $1.3 million during Fiscal 2020 and 2019, respectively.
The Company and Bunge also entered into an Amended and Restated Grain Feedstock Agency Agreement on December 5, 2014 (the “ Agency Agreement ”). The Agency Agreement provides that Bunge will procure corn for the Company, the Company will pay Bunge a per bushel fee, subject to a minimum and maximum annual fee. The initial term of the Agency Agreement expired on December 31, 2019. As part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities of the original Agency Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge. Related party expenses for corn procurement by Bunge were $0.2 million and $0.7 million during Fiscal 2020 and 2019, respectively.
Since the 2015 crop year, the Company has been using corn containing Syngenta Seeds, Inc.’s proprietary Enogen® technology (“ Enogen Corn ”) for a portion of its ethanol production needs. The Company contracts directly with growers to produce Enogen Corn for sale to the Company. Concurrent with the Agency Agreement, the Company and Bunge entered into a Services Agreement regarding corn purchases (the “ Services Agreement ”). Under this agreement, the Company originates all Enogen Corn contracts for its facility and Bunge assists the Company with certain administrative matters related to Enogen Corn, including facilitating delivery to the facility. The Company pays Bunge a per bushel service fee. The initial term of the Services Agreement expires on December 31, 2019 and the Company notified Bunge of its election not to extend the Services Agreement, but to allow corn planted this fiscal year to be planted and harvested under the terms of the Services Agreement.. Expenses under the Services Agreement are included as part of the Amended and Restated Grain Feedstock Agency Agreement discussed above.
ICM
In connection with the payoff of the ICM subordinated debt, the Company entered into the SIRE ICM Unit Agreement dated December 17, 2014 (the “ Unit Agreement ”). Under the Unit Agreement, the Company granted ICM the right to sell to the Company its 1,000 Series C and 18 Series A Membership Units (the “ ICM Units ”) commencing anytime during the earliest of several alternative dates and events at the greater of $10,897 per unit or the fair market value (as defined in the agreement) on the date of exercise. On August 16, 2019, ICM notified the Company of its intent to exercise the Put Option and waived its right to determine the fair market value for the ICM Units. On November 15, 2019, the Company repurchased the ICM Units for $11.1 million in settlement of the Put Option consistent with the terms of the Unit Agreement. The effective date of the Company's repurchase of the ICM Units was October 31, 2019. The Company had increased expense in Fiscal 2019 by $637 thousand.
Major Customers
The Company was party to an Ethanol Agreement and a Distillers Grain Purchase Agreement with Bunge for the exclusive marketing, selling, and distributing of all of the ethanol and distillers grains produced by the Company through December 31, 2019. In connection with the Bunge Repurchase Agreement, the Company and Bunge entered into a Restated Ethanol Agreement effective January 1, 2020 pursuant to which Bunge continues to purchase and market all of the ethanol produced by the Company. The Distillers Grain Purchase Agreement expired on December 31, 2019; however, as part of the Bunge Repurchase Agreement, Bunge agreed to provide transition services until March 31, 2020 for all duties and responsibilities of the Distillers Grain Purchase Agreement. The Company is now responsible for all duties and responsibilities previously performed by Bunge under the Distillers Grain Purchase Agreement. The Company has expensed $0.7 million and $2.8 million in marketing fees under these agreements for Fiscal 2020 and 2019, respectively. Revenues with this customer were $165.1 million and $205.1 million, respectively, for Fiscal 2020 and 2019. Trade accounts receivable due from Bunge were $4.6 million and $7.9 million as of September 30, 2020 and 2019, respectively.
Note 10: Commitments
The Company has entered into a steam contract with an unrelated party under which the vendor agreed to provide the steam required by the Company, up to 475,000 pounds per hour. The Company agreed to pay a net energy rate for all steam
provided under the contract as well as a monthly demand charge. The net energy rate is set for the first three years then adjusted each year beginning on the third anniversary date. The steam contract was renewed effective January 1, 2013, and will remain in effect until November 30, 2024. Expenses under this agreement for the years ended September 30, 2020 and 2019 were $0.5 million and $5.7 million, respectively.
Note 11: Lease Obligations
Effective October 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). The Company elected the option to apply the transition provisions at the adoption date instead of the earliest comparative period presented in the financial statements. By making this election, the Company has not applied retrospective reporting for the year ended September 30, 2019. The Company elected the short-term lease exception provided for in the standard and therefore only recognized right-of-use assets and lease liabilities for leases with a term greater than one year. The Company elected the package of practical expedients to not re-evaluate existing contracts as containing a lease or the lease classification unless it was not previously assessed against the lease criteria. In addition, the Company did not reassess initial direct costs for any existing leases.
A lease exists when a contract conveys to a party the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. The Company recognized a lease liability at the lease commencement date, as the present value of future lease payments, using an estimated rate of interest that the Company would pay to borrow equivalent funds on a collateralized basis. A lease asset is recognized based on the lease liability value and adjusted for any prepaid lease payments, initial direct costs, or lease incentive amounts. The lease term at the commencement date includes any renewal options or termination options when it is reasonably certain that the Company will exercise or not exercise those options, respectively.
The Company leases rail cars and rail moving equipment with original terms up to 3 years for hopper cars and 4 years for tanker cars from Bunge. This lease was assigned to Trinity Leasing effective July 17, 2020. An additional 60 cars are leased from a third party under two separate leases for 3 years for half and 4 years for the second half. The Company is obligated to pay costs of insurance, taxes, repairs and maintenance pursuant to the terms of the leases. These costs are in addition to regular lease payments and are not included in lease expense. The Company subleased 50 tanker cars to two unrelated third parties. The leases expire December 31, 2020 and January 31, 2021. The Company subleased 60 hopper cars to an unrelated third party starting in May 2020, and the third party returned 15 hopper cars in September 2020. The lease expired in August 2020, but the remaining 45 hopper cars remain on a month-to-month rent basis. Expense incurred for the operating leases were $2.4 million for the year ended September 30, 2020. The lease agreements have maturity dates ranging from January 2022 to May 2023. The average remaining life of the lease term for these leases was 2.93 years as of September 30, 2020.
The discount rate used in determining the lease liability for each individual lease was the Company's estimated incremental borrowing rate of 3.55% . The right-of-use asset operating lease, is included in the other asset grouping, and operating lease liability, included in current and long term liabilities was $6.7 million as of September 30, 2020.
The Company's aggregate minimum rental commitments under non-cancellable operating leases as of September 30, 2020 are as follows (in 000's):
| | | | | |
| 2021 | $ | 3,106 | |
| |
| 2022 | 2,574 | |
| |
| 2023 | 1,225 | |
| |
| Total | 6,905 | |
| |
| Undiscounted future payments | 6,905 | |
| |
| Discount effect | (238) | |
| |
| Present value | $ | 6,667 | |
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
There are no items to report.
Item 9A. Controls and Procedures.
The Company’s management, including its President and Chief Executive Officer (our principal executive officer), Michael D. Jerke, along with its Chief Financial Officer (our principal financial officer), Brett L. Frevert, have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended, the “Exchange Act”), as of September 30, 2020. The Company’s 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 the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Based upon this review and evaluation, these officers believe that the Company's disclosure controls and procedures are presently effective in ensuring that material information related to us is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission (the "SEC").
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2020. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (the 2013 Framework). Based on this assessment, the Company’s management concluded that, as of September 30, 2020, the Company’s integrated controls over financial reporting were effective.
This annual report does not include an attestation report on internal controls by the company’s registered public accounting firm pursuant to the exemption under Section 989G of the Dodd-Frank Act of 2010.
Item 9B. Other Information.
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The Information required by this Item is incorporated by reference from the definitive proxy statement for the Company’s 2021 Annual Meeting of Members (the “2021 Proxy Statement”) to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended September 30, 2020.
Item 11. Executive Compensation.
The Information required by this Item is incorporated by reference in the 2021 Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Member Matters.
The Information required by this Item is incorporated by reference in the 2021 Proxy Statement.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The Information required by this Item is incorporated by reference in the 2021 Proxy Statement.
Item 14. Principal Accountant Fees and Services.
The Information required by this Item is incorporated by reference in the 2021 Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a)Documents filed as part of this Report.
Balance Sheets
Statements of Operations
Statements of Members’ Equity
Statements of Cash Flows
Notes to Financial Statements
(b)The following exhibits are filed herewith or incorporated by reference as set forth below:
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| 2 | Omitted - Inapplicable. |
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| Articles of Organization, as filed with the Iowa Secretary of State on March 28, 2005 (incorporated by reference to Exhibit 3(i) of Registration Statement on Form 10 filed by the Company on January 28, 2008). |
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| Fifth Amended and Restated Operating Agreement dated June 19, 2020 (incorporated by reference to Exhibit 3.2.1 on Form 8-K filed by the Company on June 23, 2020. |
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| Unit Transfer Policy, including QMS Manual attached thereto as Appendix 1 (incorporated by reference to Exhibit 4(ii) on Form 10-Q filed by the Company on February 7, 2020). |
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| 9 | Omitted - Inapplicable. |
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| Electric Service Contract dated December 15, 2006 with MidAmerican Energy Company (incorporated by reference to Exhibit 10.6 of Registration Statement on Form 10 filed by the Company on January 28, 2008). |
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| License Agreement dated September 25, 2006 between the Company and ICM, Inc. (incorporated by reference to Exhibit 10.10 on Form S-1/A filed by the Company on February 24, 2011). Portions of the Agreement have been omitted pursuant to a request for confidential treatment. |
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| Steam Service Contract dated January 22, 2007 between the Company and MidAmerican Energy Company, as amended October 3, 2008, January 1, 2009, January 1, 2009, December 1, 2009, January 1, 2013, and August 20, 2015 (filed herewith). Portions of the Agreement and amendments thereto have been omitted pursuant to Item 601(b)(10)(iv) of Regulation S-K (17 CFR § 229.601(b)(10)(iv)) because such information is both not material and would likely cause competitive harm to the company if publicly disclosed |
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| Amended and Restated Railcar Sublease Agreement dated March 25, 2009 with Bunge North America, Inc. (filed herewith). Portions of the Agreement have been omitted pursuant to Item 601(b)(10)(iv) of Regulation S-K (17 CFR § 229.601(b)(10)(iv)) because such information is both not material and would likely cause competitive harm to the company if publicly disclosed. |
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| ICM, Inc. Agreement - Equity Matters, by and between ICM, Inc. and the Company, dated as of June 17, 2010 (incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Company on June 23, 2010). |
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| Bunge Agreement - Equity Matters by and between the Company and Bunge N.A. Holdings, Inc. dated effective August 26, 2009. (incorporated by reference to Exhibit 10.72 of Form S-1/A filed by the Company on February 24, 2011) |
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| First Amendment to Bunge Agreement - Equity Matters, by and between Bunge N.A. Holdings, Inc. and the Company, dated as of June 17, 2010 (incorporated by reference to Exhibit 10.5 of Form 8-K filed by the Company on June 23, 2010). |
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| Southwest Iowa Renewable Energy Equity Incentive Plan (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company of July 6, 2010). |
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| Joint Defense Agreement between ICM, Inc. and the Company dated July 13, 2010 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on July 16, 2010). |
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| Tricanter Purchase and Installation Agreement by and between ICM, Inc. and the Company dated August 25, 2010 (incorporated by reference to Exhibit 10.1 of Form 8-K/A filed by the Company on January 12, 2011). Portions of the Agreement have been omitted pursuant to a request for confidential treatment. |
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| Employment Agreement dated effective January 1, 2012 by and between the Company and Brian T. Cahill. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on January 5, 2012). |
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| First Amendment to Promissory Note dated February 29, 2012 by and between the Company and Bunge N.A. Holdings, Inc. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on March 6, 2012) |
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| Base Contract for Sale and Purchase of Natural Gas between Encore Energy Services, Inc. and the Company effective April 1, 2012. Portions of this Agreement have been omitted pursuant to a request for confidential treatment (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on May 1, 2012). |
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| Confirming Order between Encore Energy Services, Inc. and the Company dated April 25, 2012. Portions of the Agreement have been omitted pursuant to a request for confidential treatment. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on May 1, 2012). |
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| Letter Agreement by and between the Company and CFO Systems, LLC dated June 21, 2012. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on June 22, 2012). |
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| Notice of Assignment of Interests from Bunge N.A. Holdings, Inc. to Bunge North America, Inc. dated September 24, 2012. (incorporated by reference of Exhibit 10 of Form 10-K filed by Company on December 19, 2012). |
| Carbon Dioxide Purchase and Sale Agreement by and among the Company and EPCO Carbon Dioxide Products, Inc. named therein dated effective as of April 2, 2013 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on April 11, 2013). |
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| Non-Exclusive CO2 Facility Site Lease Agreement by and among the Company and EPCO Carbon Dioxide Products, Inc. named therein dated effective April 2, 2013 (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company of April 11, 2013). |
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| Credit Agreement by and between the Company, Farm Credit Services of America, FLCA, as Lender and CoBank, ACB as cash management provider and agent dated as of June 24, 2014 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on June 30, 2014). |
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| Term Note by and between the Company and Farm Credit Services of America, FLCA dated June 24, 2014 (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on June 30, 2014). |
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| Revolving Term Note by and between the Company and Farm Credit Services of America, FLCA dated as of June 24, 2014 (incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Company on June 30, 2014). |
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| Amendment No. 1 to Ethanol Purchase Agreement by and between the Company, as Producer, Bunge North America, Inc., as Bunge dated August 29, 2014 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on September 5, 2014). |
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| Amendment No. 2 to Ethanol Purchase Agreement by and between the Company, as Producer, Bunge North America, Inc., as Bunge dated October 31, 2014 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on October 31, 2014). |
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| Amended and Restated Ethanol Purchase Agreement dated effective December 5, 2014 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on December 11, 2014). Portions of the Ethanol Purchase Agreement have been omitted pursuant to a request for confidential treatment. |
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| Second Amended and Restated Ethanol Purchase Agreement effective as of January 1, 2020 by and among the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Company on January 2, 2020). |
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| Amended and Restated Grain Feedstock Agency Agreement dated effective December 5, 2014 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on December 11, 2014). Portions of the Grain Feedstock Agency Agreement have been omitted pursuant to a request for confidential treatment. |
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| Amended and Restated Distiller’s Grain Purchase Agreement dated effective December 5, 2014 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Company on December 11, 2014). Portions of the Distiller’s Grain Purchase Agreement have been omitted pursuant to a request for confidential treatment. |
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| Services Agreement Regarding Corn Purchases dated effective December 5, 2014 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.4 of Form 8-K filed by the Company on December 11, 2014). Portions of the Services Agreement have been omitted pursuant to a request for confidential treatment. |
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| Letter Agreement dated effective December 5, 2014 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.5 of Form 8-K filed by the Company on December 11, 2014). |
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| SIRE ICM Unit Agreement by and between the Company and ICM Investments, LLC dated effective as of December 17, 2014 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on December 23, 2014). |
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| Employment Agreement between the Company and Michael D. Jerke effective October 22, 2018 (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on September 28, 2018). |
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| Amendment No. 4 to Credit Agreement dated November 8, 2019 by and among Southwest Iowa Renewable Energy, LLC, Farm Credit Services of American, FLCA and CoBank, ACB (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on November 14, 2019). |
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| Amended and Restated Term Note by and between the Company and Farm Credit Services of America, FLCA dated November 8, 2019 (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on November 14, 2019). |
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| Amended and Restated Revolving Term Note by and between the Company and Farm Credit Services of America, FLCA dated November 8, 2019 (incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Company on November 14, 2019). |
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| Amended and Restated Ethanol Purchase Agreement dated effective October 23, 2017 by and between the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on October 26, 2017). Portions of the Ethanol Purchase Agreement have been omitted pursuant to a request for confidential treatment. |
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| Bunge Membership Interest Purchase Agreement dated December 31, 2019 by and among the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Company on January 2, 2020. |
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| Termination Agreement dated December 31, 2019 by and among the Company and Bunge North America, Inc. (incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Company on January 2, 2020). |
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| 11 | Omitted - Inapplicable. |
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| 12 | Omitted - Inapplicable. |
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| 13 | Omitted - Inapplicable. |
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| 14 | Omitted - Inapplicable. |
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| 15 | Omitted - Inapplicable. |
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| 16 | Omitted - Inapplicable. |
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| 17 | Omitted - Inapplicable. |
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| 18 | Omitted - Inapplicable. |
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| 19 | Omitted - Inapplicable. |
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| 20 | Omitted - Inapplicable. |
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| Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002) executed by the Principal Executive Officer. (filed herewith) |
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| Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002) executed by the Principal Financial Officer. (filed herewith) |
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| Rule 15d-14(b) Certifications (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) executed by the Principal Executive Officer. (furnished herewith) |
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| Rule 15d-14(b) Certifications (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) executed by the Principal Financial Officer. (furnished herewith) |
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| 101.XMLXBRL | | Instance Document |
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| 101.XSDXBRL | | Taxonomy Schema |
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| 101.CALXBRL | | Taxonomy Calculation Database |
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| 101.LABXBRL | | Taxonomy Label Linkbase |
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| 101.PREXBRL | | Taxonomy Presentation Linkbase |
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| 101.DEFXBRL | | Taxonomy Definition Linkbase |
________________________
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| * | Denotes exhibit that constitutes a management contract, or compensatory plan or arrangement |
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| ** | This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference |
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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| | SOUTHWEST IOWA RENEWABLE ENERGY, LLC |
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| Date: | December 11, 2020 | /s/ Michael D. Jerke |
| | Michael D. Jerke, President and Chief Executive Officer |
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| Date: | December 11, 2020 | /s/ Brett L. Frevert |
| | Brett L. Frevert, CFO and Principal Financial Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
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| Signature | Date |
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/s/ Karol D. King | December 11, 2020 |
| Karol D. King, Chairman of the Board | |
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/s/ Theodore V. Bauer | December 11, 2020 |
| Theodore V. Bauer, Director | |
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/s/ Michael K. Guttau | December 11, 2020 |
| Michael K. Guttau, Director | |
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/s/ Jill E. Euken | December 11, 2020 |
| Jill E. Euken, Director | |
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