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HERON LAKE BIOENERGY LLC : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

03/17/2021 | 01:55pm EDT

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the three months ended January 31, 2021 and 2020.

This section should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in PART I - Item 1 of this report and the information contained in the Company's annual report on Form 10-K for the fiscal year ended October 31, 2020.

Disclosure Regarding Forward-Looking Statements

The SEC encourages companies to disclose forward-looking information so investors can better understand future prospects and make informed investment decisions. As such, we have historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance, and prospects in this report. All statements that are not historical or current facts are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would," and similar expressions.

Forward-looking statements are subject to a number of known and unknown risks, uncertainties, and other factors, many of which may be beyond our control, and may cause actual results, performance, or achievements to differ materially from those projected in, expressed or implied by forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us are described more particularly in the "Risk Factors" section of our annual report on Form 10-K for the year ended October 31, 2020 as supplemented by the risk factors disclosed in Item 1A of this report on Form 10-Q. These risks and uncertainties include, but are not limited to, the following:

Management has determined there is substantial doubt that we will be able to ? continue in business over the next year because we have debts that may come due

as a result of our failure to comply with certain loan covenants.

Fluctuations in the price of ethanol, which is affected by various factors ? including: the overall supply and demand for ethanol and corn; the price of

gasoline, crude oil and corn, government policies, the price and availability

of competing fuels;

? Fluctuations in the price of crude oil and gasoline and the impact of lower oil

and gasoline prices on ethanol prices and demand;

Fluctuations in the availability and price of corn, which is affected by

various factors including: domestic stocks, demand from corn-consuming ? industries, such as the ethanol industry, 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, including drought;

Fluctuations in the availability and price of natural gas, which may be ? affected by factors such as weather, drilling economics, overall economic

conditions, and government regulations;

? Negative operating margins which may result from lower ethanol and/or high corn


? Changes in general economic conditions or the occurrence of certain events

causing an economic impact in the agriculture, oil, or automobile industries;

? Overcapacity and oversupply in the ethanol industry;

Ethanol may trade at a premium to gasoline at times, resulting in a ? disincentive for discretionary blending of ethanol beyond the requirements of

the RFS and consequently negatively impacting ethanol prices and demand;

Changes in federal and/or state laws and environmental regulations including ? elimination, waiver, or reduction of the corn-based ethanol use requirement in

the RFS and legislative acts taken by state governments such as California

related to low-carbon fuels, may have an adverse effect on our business;

? Any impairment of the transportation, storage and blending infrastructure that

prevents ethanol from reaching markets;

? Any effect on prices and demand for our products resulting from actions in

international markets, particularly imposition of tariffs;

? Changes in our business strategy, capital improvements or development plans;

? Effect of our risk mitigation strategies and hedging activities on our

financial performance and cash flows;

? Competition from alternative fuels and alternative fuel additives;

? Changes or advances in plant production capacity or technical difficulties in

operating the plant;

? Our reliance on key management personnel; and



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A slowdown in global and regional economic activity, demand for our products ? and the potential for labor shortages and shipping disruptions resulting from


We believe our expectations regarding future events are based on reasonable assumptions; however, these assumptions may not be accurate or account for all risks and uncertainties. Consequently, forward-looking statements are not guaranteed. Actual results may vary materially from those expressed or implied in our forward-looking statements. In addition, we are not obligated and do not intend to update our forward-looking statements because of new information unless it is required by applicable securities laws. We caution investors not to place undue reliance on forward-looking statements, which represent management's views as of the date of this report. We qualify all of our forward-looking statements by these cautionary statements.

Industry and Market Data

Much of the information in this report regarding the ethanol industry, including government regulation relevant to the industry is from information published by the Renewable Fuels Association ("RFA"), a national trade association for the United States ("U.S.") ethanol industry, and information about the market for our products and competition is derived from publicly available information from governmental agencies or publications and other published independent sources.

Although we believe our third-party sources are reliable, we have not independently verified the information.

Available Information

Our website address is www.heronlakebioenergy.com. Our annual report on Form 10-K, periodic 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 Securities Exchange Act of 1934, are available, free of charge, on our website under the link "SEC Filings," as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this report on Form 10-Q.


Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota. Our business consists of the production and sale of our ethanol throughout the continental U.S. and sale of its co-products (wet, modified wet and dried distillers' grains, corn oil, and corn syrup) locally, and throughout the continental U.S. Additionally, through a wholly owned subsidiary, HLBE Pipeline Company, LLC ("HLBE Pipeline Company"), we are the sole owner of Agrinatural Gas, LLC ("Agrinatural"). Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC's ethanol production facility and other customers. When we use the terms "Heron Lake BioEnergy," "Heron Lake," or "HLBE" or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our operations at our ethanol production facility located near Heron Lake, Minnesota. When we use the terms the "Company," "we," "us," "our" or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its wholly owned subsidiary Agrinatural.

We have a management services agreement with Granite Falls Energy, LLC, a Minnesota limited liability company that operates an ethanol plant located in Granite Falls, Minnesota ("GFE"). GFE owns approximately 50.7% of our outstanding membership units. Pursuant to the management services agreement, GFE provides its chief executive officer, chief financial officer, and commodity risk manager to act in those positions as our part-time officers. Steve Christensen currently serves as our CEO and general manager, pursuant to the terms of the management services agreement. In February 2021, Granite Falls Energy executed a separation agreement with Mr. Christensen, who intends to retire by the end of 2021. Mr. Christensen is expected to continue in his role until a successor is hired and a transition period is complete.

Ethanol Production

Our primary line of business is the Company's operation of its ethanol plant, including the production and sale of ethanol and its co-products (distillers' grains, non-edible corn oil and corn syrup). These operations are aggregated into one financial reporting segment.



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Our ethanol plant has a nameplate capacity of 50 million gallons per year. We have received EPA pathway approval and have obtained permits from the Minnesota Pollution Control Authority to increase our production capacity to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis. We are currently operating above our stated nameplate capacity on an annualized basis and intend to continue to do so into the future, dependent on industry conditions and plant profitability.

In July 2020, the Company experienced major issues with its boiler, which negatively impacted production. The Company operated with temporary boilers from August 2020 through part of January 2021. The Company determined that the purchase and installation of a new boiler would be more economical and efficient than attempted repairs to the failing boiler. On September 2, 2020, the Company received notice of approval of the new boiler from the Minnesota Pollution Control Agency. As a result, the Company abandoned the failing boiler at that time. The Company recorded the loss on disposal as a component of operating expenses during the fourth fiscal quarter of the fiscal year ended October 31, 2020 of approximately $1.8 million. The new boiler was placed in service in January 2021 at an estimated cost of approximately $5.3 million.

We market and sell our products primarily using third party marketers. The markets in which our products are sold may be local, regional, national, and international and depend primarily upon the efforts of third party marketers.

We have contracted with Eco-Energy, LLC to market all of our ethanol, Gavilon Ingredients, LLC to market our distillers' grains, and RPMG, Inc. to market our corn oil. We also occasionally independently market and sell excess corn syrup from the distillation process to local livestock feeders.

Our cost of our goods sold consists primarily of costs relating to the corn and natural gas supplies necessary to produce ethanol and distillers' grains for sale at our ethanol plant. We generally do not have long-term, fixed price contracts for the purchase of corn. Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota.

Plan of Operations for the Next Twelve Months

The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2020 and so far in 2021 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels, exacerbated by the COVID-19 pandemic. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. Due to these losses, the Company has failed to comply with certain debt covenants, and the Company has forecast that is probably there will be future instances of noncompliance with the debt covenants in 2021. These conditions result in the classification of all debt with our lender as current as of January 31, 2021. The Company has insufficient cash on hand and additional borrowing capacity, and current forecasts indicate insufficient cash flows from operations, to repay the debt if it were to come due as a result of covenant noncompliance. These factors raise substantial doubt about the Company's ability to continue as a going concern.

While the Company believes the replacement of the boiler has improved the operating performance of the plant, and led to lower operating costs, market conditions have resulted in losses. The Company intends to seek other capital sources, which may include re-negotiating its debt agreements and terms. At this time, there are no commitments to do so and we may not be successful in doing so.

Over the next twelve months we will continue our focus on operational improvements at our plant. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plant, continued emphasis on safety and environmental regulation, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies. In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure.

Trends and Uncertainties Impacting Our Operations

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers' grains, and natural gas. As a result, our operating results can fluctuate substantially due to volatility in these commodity markets. Governmental programs designed to create incentives for the use of corn-based ethanol also have a significant impact on market prices for ethanol. Other factors that may affect our future results of operation include those risks discussed below and in "PART II - Item 1A. Risk Factors" of this report, and "PART I - Item 1A. Risk Factors" of our annual report on Form 10-K for the fiscal year ended October 31, 2020.



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The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy, and foreign trade. Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer, and fall. Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons.

Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels.

Distillers' grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production.

Because the market price of ethanol is not always directly related to corn, at times ethanol prices may lag price movements in corn prices and corn-ethanol price spread may be tightly compressed or negative, which can cause our operating margins to decline or become negative and our ethanol plant may not generate adequate cash flow for operations. In such cases, we may reduce or cease production at our ethanol plant to minimize our variable costs and optimize cash flow.

Management believes that the ethanol outlook in the fiscal year 2021 will remain relatively consistent with this quarter and our margins will remain tight due to higher corn prices and depressed gasoline demand. While vaccinations and increasing immunity to COVID-19, and business re-openings have improved the overall economic outlook , the negative market effects of the COVID-19 pandemic will likely continue to negatively impact our profitability. Additionally, continued large corn supplies and ethanol production capacity increases could have a negative impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline. Further, while ethanol production briefly significantly declined during the second fiscal quarter of 2020, ethanol production has mostly rebounded and remained steady in the three months ending January 31, 2021. In addition, management believes that increased waivers of small refiner renewable volume obligations ("RVOs") by the U.S. Environmental Protection Agency ("EPA"), as well as uncertainty regarding the Renewable Fuels Standard ("RFS") reset, could contribute to the projected negative or low margins.

Additionally, while ethanol continues trading at a significant discount to gasoline, which has improved export demand somewhat, increased waivers of small refiner RVOs by the EPA has contributed to management's expectation regarding margins. Prices for renewable identification numbers ("RINs") for corn-based ethanol increased slightly in the three months ending January 31, 2021. However, previously issued small refiner waivers and the reductions in Chinese imports continue to have a negative impact on prices RINs, thereby diminishing a blending incentive from the ethanol marketplace.

Changes in the price for crude oil and unleaded gasoline could have a negative impact on the demand for gasoline and impact the market price of ethanol, which could adversely impact our profitability. According to the EIA February 2021 Short Term Energy Outlook, EIA estimates that U.S. gasoline consumption will average 8.5 million barrels per day from February to June, compared with an estimated 7.8 million barrels per day in January. U.S. regular gasoline retail prices averaged $2.33 per gallon in January 2021, compared with an average of $2.20 per gallon in December 2020 and $2.55 per gallon in January 2020. EIA forecasts gasoline prices to average $2.44 gallon in 2021 and $2.46 gallon in 2022. In addition, EIA forecasts relatively stable prices for crude oil, projecting Brent crude oil prices to average $56 per barrel in the first quarter of 21 and $52 per barrel for the remainder of the year. EIA expects lower oil prices later in 2021 as a result of rising oil supply. Significant decreases in the price for crude oil have a negative impact on the demand for ethanol.

Continued ethanol production capacity increases could also have a negative impact on the market price of ethanol, which could be further exacerbated if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline. Throughout 2019 and 2020, some U.S. ethanol plants temporarily suspended production due to negative margins, largely resulting from the COVID-19 pandemic, and stagnant export projections caused by trade barriers and decreased global demand in connection with the COVID-19 pandemic.

Corn oil prices increased during the three months ending January 31, 2021. One factor in higher corn oil prices is 2019 legislation extending the $1.00 per-gallon biodiesel blender tax credit through December 31, 2022. However, corn oil prices may decrease if biodiesel producers reduce production and/or demand for corn oil is reduced without extension of the biodiesel blenders tax credit.



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Given the inherent volatility in ethanol, distillers' grains, non-food grade corn oil, grain and natural gas prices, we cannot predict the likelihood that the spread between ethanol, distillers' grains, non-food grade corn oil, and grain prices in future periods will be consistent compared to historical periods.

Impact of COVID-19 on the Company


The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout 2020, as the COVID-19 pandemic greatly reduced travel and thus reduced demand for fuel, including the ethanol we produce. Reduced demand and high industry inventory levels resulted in record low ethanol prices in the spring of 2020. As a result, we experienced negative operating margins, significantly lower cash flow from operations and substantial net losses. In response to these adverse market conditions, the Company idled its ethanol production from on or about March 30, 2020 through approximately May 31, 2020. Fuel prices generally, and ethanol prices specifically, stabilized in the three months ending January 31, 2021, and management believes there is potential for fuel demand to increase as more individuals obtain COVID-19 vaccinations and resume traveling. However, it is possible that ongoing pandemic or other factors will cause fuel demand and ethanol prices to remain flat or decrease, thus negatively affecting our business. The Company continues to monitor COVID-19 developments to determine if adjustments to production are warranted.


The Company has enacted appropriate safety measures to protect the health and safety of our employees, customers, partners and suppliers, 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

Although we continue to regularly monitor the financial health of companies in our supply chain, financial hardship on our 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 with respect to 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. Additionally, the COVID-19 pandemic has significantly increased economic and demand uncertainty. The pandemic has caused 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 further and our business would be further adversely affected.

PPP Loans

On April 18, 2020, the Company received $595,693 under the Paycheck Protection Program legislation passed in response to the economic downturn triggered by COVID-19. This note was forgiven in March 2021. The Company received a second Paycheck Protection Program loan in February 2021 in the amount of $595,693. Management expects the entire loan will be used for payroll, utilities and interest; therefore, management anticipates that the loan will be substantially forgiven. To the extent it is not forgiven, the Company would be required to repay that portion at an interest rate of 1% with principal repayment installments beginning in February 2022 with a final installment in February 2026.


The adverse conditions created by the COVID-19 pandemic caused the Company to experience negative operating margins, significantly lower cash flow from operations and substantial net losses. As a result, we have experienced instances of noncompliance with certain loan covenants related to our working capital and net worth ratio, and we are projected to experience additional instances of noncompliance with these loan covenants in the next twelve months. These factors raise substantial doubt about the Company's ability to continue as a going concern.



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While vaccinations and increasing community immunity to COVID-19 have improved the overall economic outlook, the pandemic is ongoing, and its dynamic nature makes it difficult to forecast the long-term effects on our industry as a whole and our Company specifically. New variants of the virus that causes COVID-19 may prolong the pandemic, create additional waves of infections, or impose other challenges. It is possible that even after the pandemic has subsided, there will be permanent changes to social and economic patterns that will reduce demand for ethanol, such as reduced travel due to increased use of video-teleconferencing technology and remote working.

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, which is critical in order to drive positive results in a low-margin environment.

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 the COVID-19 pandemic on our financial condition, results of operations or cash flows in the future.

Government Supports and Regulation

The Renewable Fuels Standard

The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which is the federal Renewable Fuels Standard ("RFS"). The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage. Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on ethanol prices and our financial performance in the future.

However, President Joe Biden's administration, which took office in January 2021, has indicated support for RFS blending rules and energy policies that could be beneficial to the ethanol industry and our business. Specifically, the EPA under the Biden administration has announced it supports the interpretation of the RFS's small-refinery provisions made by U.S. Court of Appeals for the Tenth Circuit in a 2020 decision. In the case, Renewable Fuels Association et al. v. EPA, various agriculture and biofuel groups challenged the EPA's grant of waivers to three specific refineries. The waived gallons were not redistributed to obligated parties, and thus reduced the aggregate RVOs under the RFS. In January 2020, the court struck down the exemptions as improperly issued by the EPA. The court interpreted the RFS statute to require that any exemption granted to a small refinery after 2010 must take the form of an "extension." The U.S. Supreme Court has agreed to hear the case. In February 2021, the EPA announced it supported the 10th Circuit's interpretation of the RFS, reversing the position the EPA took under the previous administration. Nonetheless, it is uncertain whether the 10th Circuit's interpretation will be upheld or whether the Biden administration will continue to support energy policies that benefit the ethanol industry and our business.

Additional legal actions related to the RFS are underway. These include lawsuits challenging fuel volume waivers based on "inadequate domestic supply," challenging the EPA's lower threshold for granting small refinery exemptions, seeking broader, forward-looking remedy to account for the collective lost volumes caused by recent small refinery exemptions, alleging that the EPA and U.S. Department of Energy have improperly denied access to public records request by RFA, and challenging the Final 2019 Rule over the EPA's failure to address small refinery exemptions in the rulemaking. If these legal actions, which general seek to require the EPA to enforce the renewable fuel blending requirements of the RFS, are unsuccessful, there may negative impacts on the ethanol industry and our financial performance.

COVID-19 Legislation

In response to the COVID-19 pandemic, Congress passed the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") in March 2020 in an attempt to offset some of the economic damage arising from the COVID-19 pandemic. The CARES Act created and funded multiple programs that have impacted or could impact our industry. The USDA was given additional resources for the Commodity Credit Corporation (CCC), which it is using 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.



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The CARES Act also provided for the Small Business Administration 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.

On December 27, 2020, the federal government enacted Consolidated Appropriations Act, 2021, a second COVID-19 relief package. Among other things, the legislation authorized additional PPP loans. In February 2021, the Company received a second Paycheck Protection Program loan in the amount of $595,693. Management expects the entire loan will be used for payroll, utilities and interest; therefore, management anticipates that the loan will be substantially forgiven.

Results of Operations for the Three Months Ended January 31, 2021 and 2020

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2021 and 2020 (amounts in thousands).

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