UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended September 30, 2008 | ||
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| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
COMMISSION FILE NO. 0-50711
NORTHERN GROWERS, LLC
(Exact name of registrant as specified in its charter)
SOUTH DAKOTA |
| 77-0589881 |
(State or other jurisdiction of |
| (I.R.S. Employer |
48416 144th Street, PO Box 356, Big Stone City, SD 57216
(Address of principal executive offices)
605-862-7902
(Registrant’s telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
o Large Accelerated Filer |
| x Accelerated Filer |
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o Non-Accelerated Filer |
| o Smaller Reporting Company |
(do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
| o Yes x No |
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes o No o
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: On November 3, 2008, the issuer had 50,628,000 Class A capital units outstanding.
NORTHERN GROWERS, LLC
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CONSOLIDATED FINANCIAL STATEMENTS |
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3
NORTHERN GROWERS, LLC
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
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| September 30, |
| December 31, |
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| 2008 |
| 2007* |
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ASSETS |
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CURRENT ASSETS |
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Cash |
| $ | 9,257,451 |
| $ | 9,182,533 |
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Accounts receivable |
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Trade related party |
| 8,855,854 |
| 5,711,848 |
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Trade |
| 1,336,786 |
| 876,510 |
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Other |
| 312,803 |
| 1,005,132 |
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Inventory |
| 6,924,198 |
| 16,977,162 |
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Prepaid expenses |
| 259,328 |
| 103,678 |
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Investment in commodities contracts |
| 2,941,491 |
| 1,216,724 |
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Total current assets |
| 29,887,911 |
| 35,073,587 |
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PROPERTY AND EQUIPMENT |
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Land improvements |
| 7,107,452 |
| 7,090,574 |
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Equipment |
| 71,193,326 |
| 71,186,213 |
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Buildings |
| 15,379,448 |
| 15,379,448 |
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| 93,680,226 |
| 93,656,235 |
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Less accumulated depreciation |
| (19,343,709 | ) | (15,515,208 | ) | ||
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Net property and equipment |
| 74,336,517 |
| 78,141,027 |
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OTHER ASSETS |
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Financing costs, net of amortization of $102,450 and $51,194 as of September 30, 2008 and December 31, 2007 |
| 242,469 |
| 265,491 |
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Assets held for sale |
| 100,000 |
| 100,000 |
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Total other assets |
| 342,469 |
| 365,491 |
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| $ | 104,566,897 |
| $ | 113,580,105 |
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* Derived from audited financial statements
See Notes to Unaudited Consolidated Financial Statements
4
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| September 30, |
| December 31, |
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| 2008 |
| 2007* |
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LIABILITIES AND MEMBERS’ EQUITY |
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CURRENT LIABILITIES |
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Accounts payable - trade |
| $ | 2,379,663 |
| $ | 1,974,139 |
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Accounts payable - corn |
| 4,070,269 |
| 5,281,356 |
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Accounts payable - related party |
| 305,538 |
| 348,008 |
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Other accrued liabilities |
| 627,725 |
| 523,421 |
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Accrued interest |
| 3,688 |
| 3,750 |
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Corn purchase contracts |
| 501,022 |
| — |
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Distribution payable - Northern Growers |
| — |
| 1,518,840 |
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Notes payable |
| 5,000 |
| 5,000 |
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Current portion of notes payable |
| 5,762,047 |
| 5,695,078 |
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Total current liabilities |
| 13,654,952 |
| 15,349,592 |
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LONG-TERM LIABILITIES |
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Derivative financial instruments |
| 912,616 |
| 900,826 |
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Long-term notes payable |
| 41,572,771 |
| 45,894,139 |
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Total long-term liabilities |
| 42,485,387 |
| 46,794,965 |
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COMMITMENTS AND CONTINGENCIES (NOTE 6) |
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MINORITY INTEREST |
| 10,984,949 |
| 11,631,149 |
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MEMBERS’ EQUITY |
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Capital units, $0.25 stated value, 50,628,000 units issued and outstanding |
| 12,657,000 |
| 12,657,000 |
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Additional paid-in capital |
| 64,900 |
| 64,900 |
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Accumulated other comprehensive (loss) |
| (704,173 | ) | (695,076 | ) | ||
Retained earnings |
| 25,423,882 |
| 27,777,575 |
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Total members’ equity |
| 37,441,609 |
| 39,804,399 |
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| $ | 104,566,897 |
| $ | 113,580,105 |
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* Derived from audited financial statements
See Notes to Unaudited Consolidated Financial Statements
5
NORTHERN GROWERS, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
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| Three Months Ended September 30, |
| Nine Months Ended September 30, |
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| 2008 |
| 2007 |
| 2008 |
| 2007 |
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REVENUES |
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Sales related party |
| $ | 38,271,909 |
| $ | 34,589,824 |
| $ | 110,986,002 |
| $ | 92,116,005 |
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Sales |
| 9,255,526 |
| 5,360,277 |
| 25,546,646 |
| 14,754,732 |
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Incentive |
| 250,000 |
| 250,000 |
| 395,595 |
| 500,000 |
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Total revenues |
| 47,777,435 |
| 40,200,101 |
| 136,928,243 |
| 107,370,737 |
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COST OF REVENUES |
| 52,678,557 |
| 31,397,187 |
| 134,577,245 |
| 85,127,185 |
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GROSS PROFIT (LOSS) |
| (4,901,122 | ) | 8,802,914 |
| 2,350,998 |
| 22,243,552 |
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EXPENSES |
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General and administrative |
| 743,183 |
| 1,301,220 |
| 2,661,418 |
| 3,730,742 |
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Total operating expenses |
| 743,183 |
| 1,301,220 |
| 2,661,418 |
| 3,730,742 |
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INCOME (LOSS) FROM OPERATIONS |
| (5,644,305 | ) | 7,501,694 |
| (310,420 | ) | 18,512,810 |
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OTHER INCOME (EXPENSES) |
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Interest income |
| 18,785 |
| 118,129 |
| 47,022 |
| 345,852 |
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Interest expense |
| (860,960 | ) | (880,660 | ) | (2,721,631 | ) | (1,898,756 | ) | ||||
Other |
| 1,928 |
| 16,215 |
| (12,171 | ) | 52,674 |
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Total other income (expenses) |
| (840,247 | ) | (746,316 | ) | (2,686,780 | ) | (1,500,230 | ) | ||||
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INCOME (LOSS) BEFORE MINORITY INTEREST |
| (6,484,552 | ) | 6,755,378 |
| (2,997,200 | ) | 17,012,580 |
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MINORITY INTEREST IN SUBSIDIARY (INCOME) LOSS |
| 1,468,919 |
| (1,549,455 | ) | 643,507 |
| (3,928,290 | ) | ||||
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NET INCOME (LOSS) |
| (5,015,633 | ) | 5,205,923 |
| (2,353,693 | ) | 13,084,290 |
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OTHER COMPREHENSIVE INCOME (LOSS) |
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Cash flow hedge income (loss) |
| (55,768 | ) | (298,290 | ) | (9,097 | ) | (73,275 | ) | ||||
Total other comprehensive income (loss) |
| (55,768 | ) | (298,290 | ) | (9,097 | ) | (73,275 | ) | ||||
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COMPREHENSIVE INCOME (LOSS) |
| $ | (5,071,401 | ) | $ | 4,907,633 |
| $ | (2,362,790 | ) | $ | 13,011,015 |
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BASIC AND DILUTED EARNINGS (LOSS) PER CAPITAL UNIT |
| $ | (0.099 | ) | $ | 0.103 |
| $ | (0.046 | ) | $ | 0.258 |
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BASIC AND DILUTED WEIGHTED AVERAGE CAPITAL UNITS OUTSTANDING |
| 50,628,000 |
| 50,628,000 |
| 50,628,000 |
| 50,628,000 |
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DISTRIBUTIONS PER CAPITAL UNIT DECLARED |
| $ | — |
| $ | — |
| $ | — |
| $ | 0.208 |
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DISTRIBUTIONS PER CAPITAL UNIT PAID |
| $ | — |
| $ | 0.081 |
| $ | 0.030 |
| $ | 0.342 |
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See Notes to Unaudited Consolidated Financial Statements
6
Table of Contents
NORTHERN GROWERS, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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| Nine Months |
| Nine Months |
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| Ended |
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| September 30, |
| September 30, |
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| 2008 |
| 2007 |
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OPERATING ACTIVITIES |
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Net income (loss) |
| $ | (2,353,693 | ) | $ | 13,084,290 |
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Changes to net income not affecting cash |
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Depreciation |
| 3,828,502 |
| 3,133,976 |
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Amortization of loan fees |
| 51,256 |
| 25,925 |
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Minority interest in subsidiary’s earnings (loss) |
| (643,507 | ) | 3,928,290 |
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Decrease (increase) in current assets |
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Accounts receivable |
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Related party |
| (3,144,006 | ) | (472,751 | ) | ||
Trade |
| (460,276 | ) | 196,360 |
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Other |
| 3,006 |
| (195 | ) | ||
Inventory |
| 10,052,964 |
| 7,412,805 |
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Prepaid expenses |
| (155,650 | ) | (123,477 | ) | ||
Investment in commodity contracts |
| (1,724,767 | ) | (1,123,058 | ) | ||
Increase (decrease) in current liabilities |
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Accounts payable |
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Trade |
| 405,524 |
| 722,397 |
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Corn |
| (1,211,087 | ) | (229,461 | ) | ||
Related party |
| (42,470 | ) | (282,543 | ) | ||
Accrued liabilities |
| 104,304 |
| 44,953 |
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Accrued interest |
| (62 | ) | 15,925 |
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Corn purchase contracts |
| 501,022 |
| — |
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NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES |
| 5,211,060 |
| 26,333,436 |
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INVESTING ACTIVITIES |
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Purchase of property and equipment |
| (351,366 | ) | (17,618,867 | ) | ||
Cash paid for capitalized construction interest |
| — |
| (653,413 | ) | ||
Tax refund on construction |
| 1,016,697 |
| 302,264 |
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NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES |
| 665,331 |
| (17,970,016 | ) | ||
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FINANCING ACTIVITIES |
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Short-term notes payable issued |
| 25,000 |
| — |
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Payment on short-term notes payable |
| (25,000 | ) | — |
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Long-term notes payable issued |
| 8,000,000 |
| 14,040,126 |
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Principal paid on long-term notes payable |
| (12,254,399 | ) | (1,422,220 | ) | ||
Distributions paid - Northern Growers |
| (1,518,840 | ) | (17,321,359 | ) | ||
Distributions paid - minority member |
| — |
| (5,778,520 | ) | ||
Cash paid for financing costs |
| (28,234 | ) | (46,307 | ) | ||
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NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES |
| (5,801,473 | ) | (10,528,280 | ) | ||
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NET INCREASE (DECREASE) IN CASH |
| 74,918 |
| (2,164,860 | ) | ||
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CASH AT BEGINNING OF PERIOD |
| 9,182,533 |
| 9,925,200 |
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CASH AT END OF PERIOD |
| $ | 9,257,451 |
| $ | 7,760,340 |
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
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Cash paid for interest |
| $ | 2,721,510 |
| $ | 2,609,547 |
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SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES |
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Accounts payable incurred for construction costs |
| $ | — |
| $ | 168,632 |
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Accounts receivable for tax refund on construction |
| $ | 142,632 |
| $ | 384,920 |
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See Notes to Unaudited Consolidated Financial Statements
7
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
Principal Business Activity
Northern Growers, LLC or Northern Growers (formerly Northern Growers Cooperative or the “Cooperative”), is a South Dakota limited liability company that was organized to pool investors, provide a portion of the corn supply for an ethanol plant (“the plant”) owned by Northern Lights Ethanol, LLC (d/b/a POET™ Biorefining – Big Stone) (“POET™ Biorefining – Big Stone”), and own a 77.16% interest in POET™ Biorefining – Big Stone. For purposes of the financial statements and notes, the “Company” refers to both Northern Growers and POET™ Biorefining – Big Stone on a consolidated basis. On June 26, 2002, the Company began grinding corn and on July 5, 2002, the Company commenced its principal operations at a 40 million gallon nameplate capacity. On May 14, 2007, the Company completed its expansion to a 75 million gallon nameplate capacity. The Company sells ethanol and related products primarily in the United States.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited financial statements contained herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America.
In the opinion of management, all adjustments considered necessary for a fair presentation have been included in the accompanying financial statements. All such adjustments are of a normal, recurring nature. The results of operations for the three and nine month periods ended September 30, 2008 and 2007 are not necessarily indicative of the results to be expected for a full year.
These financial statements and notes included in this Form 10-Q report should be read in conjunction with the company’s 2007 Form 10-K report, as certain notes and other pertinent information have been abbreviated or omitted in this report.
Principles of Consolidation
The consolidated financial statements include the accounts of Northern Growers and its 77.16% owned subsidiary, POET™ Biorefining - Big Stone. All significant inter-company transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.
Environmental Liabilities
The Company’s operations are subject to environmental laws and regulations adopted by various governmental authorities in the jurisdiction in which it operates. These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its locations. Accordingly, the Company has adopted policies, practices and procedures in the areas of pollution control, occupational health, and the production, handling, storage and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability which could result from such events. Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.
(continued on next page)
8
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Cost of Revenues
The primary components of cost of revenues from the production of ethanol and related products are corn expense, energy expense (steam, natural gas and electricity), raw materials expense (chemicals and denaturant), shipping costs on sales and depreciation on process equipment.
All shipping costs incurred with regard to the sale of ethanol and related product inventory are included in the consolidated statements of operations as a component of gross revenues. Accordingly, those shipping costs are deducted and are all classified as a component of cost of revenues. Shipping costs in relation to sales are defined as the cost to transport products to customers. Other shipping costs in the cost of revenues include inbound freight charges on inventory.
General and Administrative Expenses
The primary components of general and administrative expenses are management fees, insurance expense and professional fees (legal, audit and consulting).
Investment in Commodities Contracts, Derivative Instruments and Hedging Activities
SFAS No. 133 requires a company to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted from SFAS No. 133 as normal purchases or normal sales. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal are documented as normal and exempted from the accounting and reporting requirements of SFAS No. 133.
The Company enters into short-term cash, options and futures contracts and ethanol swaps as a means of securing corn and natural gas for the ethanol plant and managing exposure to changes in commodity prices. All derivatives are designated as non-hedge derivatives. Although the contracts are effective economic hedges of specified risks, they are not designated as and accounted for as hedging instruments.
As part of its trading activity, the Company uses futures and option contracts and ethanol swaps offered through regulated commodity exchanges to reduce risk and is exposed to risk of loss in the market value of inventories. To reduce that risk, the Company generally takes positions using cash and futures contracts, ethanol swaps and options.
Unrealized gains and losses related to derivative contracts are included as a component of cost of revenues in the accompanying consolidated financial statements. Inventories are recorded at net realizable value so that gains and losses on derivative contracts are offset by gains and losses on inventories and reflected in current earnings. For the statement of cash flows, such contract transactions are classified as operating activities.
The Company has recorded a decrease to cost of revenues of $1,579,332 and $1,497,446 related to our derivative contracts for the nine months ended September 30, 2008 and 2007, respectively. These derivative contracts can be found on the Balance Sheet under “Investment in commodities contracts”.
During 2007 and 2006 the Company entered into derivative financial instruments to limit its exposure to changes in interest rates. The Company entered into two interest rate swap agreements as part of its interest rate risk management strategy and to effectively convert a portion of its variable rate debt to fixed rate debt. The swap agreements are accounted for as a cash flow hedge under SFAS No. 133, as amended.
(continued on next page)
9
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Interest Rate Swap Agreements
During 2007 and 2006 the Company entered into interest rate swap agreements as part of its interest rate risk management strategy and to effectively convert a portion of its variable rate debt to fixed rate debt. The swap agreements, which both expire August 31, 2014, are accounted for as cash flow hedges under SFAS No. 133, as amended. Under the terms of the swap agreements, the Company’s net payment is a fixed interest rate on the notional amount in exchange for receiving a variable rate based on one month LIBOR. The swap transactions qualify for the shortcut method of recognition under SFAS No. 133; therefore, no portion of the swap is treated as ineffective. The notional amount of the two interest rate swap agreements was $22,275,000 and $24,131,250 as of September 30, 2008 and December 31, 2007, respectively. A derivative liability to record the fair value of the swap of $912,616 and $900,826 has been recorded, with a corresponding entry of $9,097 and $550,734 to other comprehensive loss on the members’ equity section of the balance sheet and a decrease of $2,693 and $163,023 to minority interest for the periods ended September 30, 2008 and December 31, 2007, respectively.
Other Comprehensive Income (Loss)
The Company has adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (“SFAS 130”) that establishes standards for reporting comprehensive income. The Statement defines comprehensive income as the changes in equity of an enterprise except those resulting from stockholder transactions. As of September 30, 2008 and December 31, 2007, accumulated other comprehensive loss consists of an unrealized loss from our interest rate swap agreements designated as a cash flow hedge.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. The Company adopted SFAS 157 as of January 1, 2008 except as noted below, and it did not have a material impact on its financial position and results of operations.
Relative to SFAS 157, the FASB issued FASB Staff Positions (FSP) 157-1 and 157-2. FSP 157-1 amends SFAS 157 to exclude SFAS No. 13, “Accounting for Leases,” (SFAS 13) and its related interpretive accounting pronouncements that address leasing transactions, while FSP 157-2 delays the effective date of the application of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.
The Company adopted SFAS 157 as of January 1, 2008, with the exception of the application of the statement to non-recurring nonfinancial assets and nonfinancial liabilities. Non-recurring nonfinancial assets and nonfinancial liabilities for which the Company has not applied the provisions of SFAS 157 include assets held for sale, corn inventory, ethanol inventory and distillers grains inventory carried at net realizable value.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (Consolidated Financial Statements). SFAS 160 establishes accounting and reporting standards for a noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. In addition, SFAS 160 requires certain consolidation procedures for consistency with the requirements of SFAS 141, Business Combinations. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 with earlier adoption prohibited. The Company is evaluating the effect, if any, that the adoption of SFAS 160 will have on its results of operations, financial position, and the related disclosures.
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10
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
In December 2007, the FASB issued SFAS 141(R), Business Combinations. SFAS 141(R) expands the definition of transactions and events that qualify as business combinations; requires that the acquired assets and liabilities, including contingencies, be recorded at the fair value determined on the acquisition date and changes thereafter reflected in revenue, not goodwill; changes the recognition timing for restructuring costs; and requires acquisition costs to be expensed as incurred. Adoption of SFAS 141(R) is required for combinations after December 15, 2008. Early adoption and retroactive application of SFAS 141(R) to fiscal years preceding the effective date are not permitted. The Company is evaluating the effect, if any, that the adoption of SFAS 141(R) will have on its results of operations, financial position, and the related disclosures.
In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities, which requires enhanced disclosures about how these instruments and activities affect the entity’s financial position, financial performance and cash flows. The standard requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Because SFAS 161 requires enhanced disclosures but does not modify the accounting treatment of derivative instruments and hedging activities, the Company believes the adoption of this standard will have no impact on its financial position, results of operations or cash flows.
In May 2008, the FASB issued SFAS 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles (“GAAP”) for nongovernmental entities.
Prior to the issuance of SFAS 162, GAAP hierarchy was defined in the American Institute of Certified Public Accountants (“AICPA”) Statement on Auditing Standards (“SAS”) 69, The Meaning of Present Fairly in Conformity with Generally Accept Accounting Principles. SAS 69 is directed to the auditor rather than the entity. SFAS 162 addresses this issue by establishing that the GAAP hierarchy should be directed to entities because it is the entity (not the auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP.
This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not believe that implementation of this standard will have a material impact on its consolidated financial position, results of operations or cash flows.
NOTE 3 - FAIR VALUE MEASUREMENTS
Effective January 1, 2008, we adopted Statement of Financial Accounting Standard No. 157, “Fair Value Measurements” (SFAS 157), as it applies to our financial instruments, and Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (SFAS 159). SFAS 157 defines fair value, outlines a framework for measuring fair value, and details the required disclosures about fair value measurements. SFAS 159 permits companies to irrevocably choose to measure certain financial instruments and other items at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities.
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11
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Under SFAS 157, fair value is defined as 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 the principal or most advantageous market. SFAS 157 establishes a hierarchy in determining the fair value of an asset or liability. The fair value hierarchy has three levels of inputs, both observable and unobservable. SFAS 157 requires the utilization of the lowest possible level of input to determine fair value. Level 1 inputs include quoted market prices in an active market for identical assets or liabilities. Level 2 inputs are market data, other than Level 1, that are observable either directly or indirectly. Level 2 inputs include quoted market prices for similar assets or liabilities, quoted market prices in an inactive market, and other observable information that can be corroborated by market data. Level 3 inputs are unobservable and corroborated by little or no market data.
Except for those assets and liabilities which are required by authoritative accounting guidance to be recorded at fair value in our Consolidated Balance Sheets, we have elected not to record any other assets or liabilities at fair value, as permitted by SFAS 159. No events occurred during the first nine months of 2008 which would require adjustment to the recognized balances of assets or liabilities which are recorded at fair value on a nonrecurring basis.
The following table provides information on those assets and liabilities measured at fair value on a recurring basis.
Table:
|
| Carrying Amount |
|
|
|
|
|
|
|
|
| ||||
|
| In Consolidated |
|
|
|
|
|
|
|
|
| ||||
|
| Balance Sheet |
| Fair Value |
| Fair Value Measurement Using |
| ||||||||
|
| September 30, 2008 |
| September 30, 2008 |
| Level 1 |
| Level 2 |
| Level 3 |
| ||||
Investment in commodity contracts |
| $ | 2,941,491 |
| $ | 2,941,491 |
| $ | 2,941,491 |
|
|
|
|
| |
Corn purchase contracts |
| $ | (501,022 | ) | $ | (501,022 | ) |
|
| $ | (501,022 | ) |
|
| |
Derivative financial instruments |
| $ | (912,616 | ) | $ | (912,616 | ) |
|
| $ | (912,616 | ) |
|
| |
The Company’s corn purchase contracts consist of forward purchase commitments and are included in inventory. The fair value for these financial agreements were determined using quoted market prices from the Chicago Board of Trade (CBOT) for similar assets, and are designated as Level 2 within the valuation hierarchy. Investment in commodity contracts principally includes corn and natural gas futures and option contracts and ethanol swaps. The fair values for which are obtained from quoted market prices from the CBOT for identical assets or liabilities, and are designated as Level 1 within the valuation hierarchy. Derivative financial instruments consists of interest rate swaps at fair value using the counterparty’s marked-to-market statement, which can be validated using modeling techniques that include market inputs such as publicly available interest rate yield curves, and are designated as Level 2 within the valuation hierarchy.
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12
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - INVENTORY
Inventory consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
| 2008 |
| 2007* |
| ||
|
|
|
|
|
| ||
Finished goods |
| $ | 2,042,447 |
| $ | 1,473,720 |
|
Raw materials |
| 2,399,279 |
| 12,983,539 |
| ||
Work-in-process |
| 1,274,327 |
| 1,352,000 |
| ||
Spare parts inventory |
| 1,208,145 |
| 1,167,903 |
| ||
|
|
|
|
|
| ||
|
| $ | 6,924,198 |
| $ | 16,977,162 |
|
*Derived from audited financial statements
NOTE 5 - NOTES PAYABLE
Northern Growers received advances of $5,000 from various entities to help establish the Company. This short-term note payable is due on demand and does not bear interest. The balance of this non-interest bearing note was $5,000 at September 30, 2008 and December 31, 2007.
Northern Growers received a loan advance of $25,000 from First Bank & Trust, Milbank, SD, during the three month period ending March 31, 2008 for short-term cash needs. This short-term note payable bore interest at 5.94% and matured May 1, 2008 and was paid in full. The balance of this note was $0 at September 30, 2008 and December 31, 2007.
On August 28, 2006, POET™ Biorefining - Big Stone and US Bank National Association, Sioux Falls, South Dakota (Bank) entered into an amended and restated loan agreement for the purpose of financing the plant’s expansion and restructuring the $3.0 million and $5.0 million revolving notes into one note. On September 21, 2007, an amendment to the loan agreement became effective. The purpose of the amendment was to finance the purchase and construction of additional grain storage bins and equipment ($4,300,000) and obtain a $9,000,000 short-term revolving loan. Under the amended and restated loan agreement and the September 21, 2007 amendment, POET™ Biorefining – Big Stone is subject to six notes: Note #174, a $3.9 million variable-rate, non-revolving note; Note #158, a $15.8 million fixed-rate note; Note #91, an $8 million variable-rate, revolving long term note; Note #190, a $33 million construction note; Note #232, a $4.3 million variable-rate note; and Note #216, a $9 million variable-rate, revolving short-term note.
Note #174, the $3.9 million variable-rate, non-revolving note, bears interest at the Bank’s prime rate, or 5.0% at September 30, 2008. This note requires quarterly payments of interest and amortized principal on the basis of a ten-year term, the first payment being made on June 30, 2005. The note matures on March 31, 2012.
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13
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note #158, the $15.8 million fixed-rate note, bears an interest rate of 6.38%. This note requires quarterly payments of interest and amortized principal on the basis of a ten-year term and is subject to maturity on March 31, 2012. The first payment was made on June 30, 2005.
Note #117, the $1.2 million fixed rate note, was retired on April 30, 2007.
Note #91, the $8.0 million variable rate, revolving note, permits POET™ Biorefining - Big Stone to borrow, on a revolving basis, the difference between the unpaid principal balance and $8 million. The revolving note bears a variable-interest rate equal to the prime rate announced by the Bank from time to time, adjusted each time the Prime Rate changes (5.0% at September 30, 2008). Quarterly payments of interest on any unpaid balance are due March 31, June 30, September 30, and December 31 of each year. The total unpaid principal balance is due at maturity, or August 31, 2014. The loan is subject to a quarterly unused commitment fee of .0375% and prepayment is without penalty. The amount available on this note was $8,000,000 at September 30, 2008 and December 31, 2007.
Note #190, the construction note of $33,000,000, was converted to a term note on August 31, 2007. The notional amount ($22,275,000 as of September 30, 2008) is subject to the interest rate swap agreements discussed in Note 2 under “Interest Rate Swap Agreements”. The note is amortized over a ten-year period and is subject to a maturity of August 31, 2014. Payments of principal are due quarterly and began on November 30, 2007. Payments of interest are due monthly, subject to a variable rate of one-month LIBOR plus 2.75%, adjusted monthly (5.232% at September 30, 2008).
Note #232, the $4.3 million note, is subject to a variable rate of LIBOR plus 3.00% (5.459% at September 30, 2008), adjusted and due monthly. A principal payment of $154,000 is due quarterly, which began on October 31, 2007.
Note #216, the $9 million short-term note, which was issued on September 21, 2007, permits us to borrow, on a revolving basis, the difference of the outstanding principal amount and the lesser of the borrowing base or $9.0 million. The borrowing base is defined as 75% of the total of the fair market value of the outstanding inventory, eligible accounts receivable, and hedging accounts at fair market value. The principal purpose of this revolver is to cover the cost of purchasing corn. It bears a variable-interest rate equal to one-month LIBOR plus 3.00%, payable monthly when there is an outstanding balance (5.2369% at September 30, 2008). The loan is subject to a quarterly unused commitment fee of .0250%. The total unpaid principal balance is due at maturity, or July 30, 2008. $9,000,000 was available at September 30, 2008 and December 31, 2007.
POET™ Biorefining - Big Stone is subject to certain restrictive covenants establishing minimum reporting requirements, ratios, working capital and net worth requirements and is in compliance at September 30, 2008 with the exception of the fixed charge coverage ratio. The bank has waived the fixed charge coverage ratio for this quarter. Collateral for the notes is multiple mortgages and security agreements, multiple UCC filings on all business assets, and assignments of certain agreements related to the construction and operation of the plant.
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14
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Long-term notes payable with the Bank consisted of the following:
|
| September 30, 2008 |
| December 31, 2007* |
| ||
|
| (Unaudited) |
|
|
| ||
|
|
|
|
|
| ||
Note #174 |
| $ | 2,535,000 |
| $ | 2,827,500 |
|
Note #158 |
| 11,415,818 |
| 12,440,717 |
| ||
Note #190 |
| 29,700,000 |
| 32,175,000 |
| ||
Note #232 |
| 3,684,000 |
| 4,146,000 |
| ||
|
|
|
|
|
| ||
|
| 47,334,818 |
| 51,589,217 |
| ||
Less current portion |
| (5,762,047 | ) | (5,695,078 | ) | ||
|
|
|
|
|
| ||
|
| $ | 41,572,771 |
| $ | 45,894,139 |
|
*Derived from audited financial statements.
Minimum principal payments, through the maturity of the long-term notes, are estimated as follows:
Twelve Months Ending September 30, |
| Amount |
| |
|
|
|
| |
2009 |
| $ | 5,762,047 |
|
2010 |
| 5,857,189 |
| |
2011 |
| 5,958,548 |
| |
2012 |
| 12,037,034 |
| |
2013 |
| 3,916,000 |
| |
October 1, 2013 to August 31, 2014 |
| 13,804,000 |
| |
|
|
|
| |
|
| $ | 47,334,818 |
|
NOTE 6 - COMMITMENTS, CONTINGENCIES AND AGREEMENTS
Substantially all of the Company’s endeavors are subject to federal, state and local regulations relating to the discharge of materials into the environment. Management believes that the current practices and procedures for the control and disposition of such wastes comply with the applicable federal, state and local requirements.
Due to the name change of Broin Companies, LLC (“Broin”) to POET™, LLC in early 2007 and a corresponding change in the name of some Broin-related companies, the Company’s existing contractual arrangements and agreements for plant development, operations and marketing are now with newly named entities containing POET™. All of the newly named POET™-related entities are the same Broin-related entities that existed prior to the Broin to POET™ name change. Broin Investments I, LLC, the minority member of POET™ Biorefining – Big Stone, has not changed its name, yet is still a related party to all POET™-named companies listed here.
The Company has entered into contracts and agreements regarding the construction, operation and management of the ethanol plant. Agreements with the minority member, or parties related to the minority member through common ownership, are as follows:
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15
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Expansion Construction Agreement – The Company entered into a Design/Build Agreement with POET™ Design and Construction, Inc. (formerly known as Broin & Associates, Inc.) on October 25, 2005. The purpose of this agreement was to expand the name-plate production capacity of the plant from 40 million gallons of ethanol annually to 75 million gallons of ethanol annually, as well as to make certain capital improvements to the plant for the incorporation of new raw starch technology. The final cost of construction and improvements for both projects was $42.3 million, with all construction complete and final payments made at December 31, 2007.
Additional Corn Storage Construction Agreement – The Company entered into a Design/Build Agreement with POET™ Design and Construction, Inc. on April 3, 2007. The purpose of this agreement was to expand the corn storage capacity at the plant. The final cost of construction and improvements for this project was $4.2 million, with all construction complete and final payments made at December 31, 2007.
Ethanol Marketing Agreement – The Company renewed its agreement with Ethanol Products, LLC (d/b/a/ POET™ Ethanol Products) for the sale, marketing, billing and receipt of payment and other administrative services for all ethanol produced by the plant. The new agreement is effective July 1, 2007 and terminates on July 1, 2012, automatically renewing for a five-year term unless a notice of termination is provided by either party prior to the end of the term. The Company has sales commitments with POET™ Ethanol Products of approximately 18 million gallons over the next eleven months, of which 14 million gallons are contracted at a variable price and 4 million gallons are contracted at a fixed sales price ranging from $1.65 to $3.08 per gallon. The Company purchases all of its denaturant through POET™ Ethanol Products.
Management Agreement – On April 20, 2005, the Company renewed its agreement with POET™ Plant Management, LLC (formerly known as Broin Management, LLC) for the management and operation of the plant. The original agreement was executed on November 2, 2000 and remained in effect until July 1, 2005. The term of the new management agreement, as amended, continues through June 30, 2015. In exchange for these services, POET™ Plant Management receives an annual fee of $450,000, payable in equal monthly installments, plus an incentive bonus based on a percentage of net income, payable quarterly. The annual fee is adjusted each year on March 1st for changes in the consumer price index. The fees and bonus paid to POET™ Plant Management include the salary and benefits of the general manager and technical manager and certain other services related to operation of the plant.
Technology and Patent Rights License Agreement - On October 25, 2005, the Company entered into a Technology and Patent Rights License Agreement with POET™ Design and Construction, Inc. (formerly known as Broin and Associates, Inc.). Under this agreement, POET™ Design and Construction granted the Company a non-exclusive license to use certain technology and patents owned, developed, or obtained by POET™ Design and Construction relating to the ethanol and related product production processes. The Company is required to pay an annual licensing fee for the right to use such technology and patents. The term of this agreement continues until June 30, 2015.
Risk Management Agreement – On April 1, 2007, the Company entered into a new corn and natural gas price risk management agreement with POET™ Plant Management. The new risk management agreement became effective on July 1, 2007 and terminates on July 1, 2012, automatically renewing for a five-year term unless a notice of termination is provided by either party prior to the end of the term. In exchange for providing certain risk management services relating to corn and natural gas prices, including hedging and pooling services, the Company pays POET™ Plant Management an annual fee, payable in quarterly installments, subject to modification in the case of plant expansions or increases in corn usage.
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16
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Distillers Grains Marketing Agreement – The Company has an agreement with POET™ Nutrition, Inc. (formerly known as Dakota Gold Marketing, Inc.), to provide marketing and administrative services for the sale of distillers grains. The agreement commenced March 8, 2002, with a current expiration date of March 8, 2012, renewing for five-year terms unless terminated by either party with 90 days notice prior to expiration. The agreement provides for an agency relationship in that POET™ Nutrition does not take title to the distillers grains but acts as a broker on behalf of the Company. The Company has entered into forward contracts to sell approximately 40,150 tons of various distiller grains at an average fixed price of approximately $199 per ton as of September 30, 2008.
Agreements with unrelated parties are as follows:
Property Lease – The Company has a 99 year property lease (an operating lease) with Big Stone-Grant Industrial Development and Transportation, LLC. In 2001, rent was $2,400 annually through May 1, 2006, after which it increased by 5% through 2011. Beginning on May 1, 2006, and every five years thereafter, rent is increased 5% over the immediately preceding five-year period.
Steam – The Company has an agreement with the co-owners of the Big Stone Plant (“Big Stone Plant”), Otter Tail Corporation, Montana-Dakota Utilities Co. and Northwestern Public Service, for the use of steam in the ethanol production process. The rate for a minimum amount is set at a base rate, adjusted annually for changes in the cost of energy. As of January 17, 2008, steam volumes that exceed the contract minimums are billed on a market-based price from Big Stone Plant. The agreement commenced on June 1, 2002 and has a term of ten years, renewable for two five-year periods, after which the agreement is renewable from year to year. Either party may terminate the agreement by providing notice one year prior to a renewal or expiration date.
Minimum payments related to the above agreements are summarized in the following table:
Twelve Months Ending |
| Lease |
| Management |
| Unconditional |
|
|
| ||||
September 30, |
| Agreements |
| Agreements |
| Agreements |
| Total |
| ||||
2009 |
| $ | 2,520 |
| $ | 566,849 |
| $ | 217,080 |
| $ | 786,449 |
|
2010 |
| 2,520 |
| 566,849 |
| 217,080 |
| 786,449 |
| ||||
2011 |
| 2,573 |
| 566,849 |
| 217,080 |
| 786,502 |
| ||||
2012 |
| 2,646 |
| 528,947 |
| 144,720 |
| 676,313 |
| ||||
2013 |
| 2,646 |
| 491,045 |
| — |
| 493,691 |
| ||||
Oct 31, 2014 through 2100 |
| 363,699 |
| 859,328 |
| — |
| 1,223,027 |
| ||||
|
| $ | 376,604 |
| $ | 3,579,867 |
| $ | 795,960 |
| $ | 4,752,431 |
|
Corn Delivery – On August 9, 2005, POET™ Biorefining - Big Stone agreed to release Northern Growers and, accordingly, all of its members from delivering corn to the plant starting on January 1, 2006. Prior to January 1, 2006, Northern Growers’ members were obligated to deliver corn to the plant unless the plant released the member from the member’s corn delivery obligation. Effective January 1, 2006, however, Northern Growers’ members are no longer obligated to deliver corn to the plant. Instead, the plant purchases all of its corn from local corn producers and the open market.
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17
NORTHERN GROWERS, LLC
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Incentive Revenue - The Company receives an incentive payment from the State of South Dakota to produce ethanol. In accordance with the terms of this arrangement, revenue is recorded based on ethanol sold. The State of South Dakota has set a maximum of up to $1,000,000 per year for this program per qualifying producer. The Company has earned $250,000, $645,596 and $750,000 for the program years ended June 30, 2009, 2008 and 2007, respectively. Incentive revenue of $395,595 and $500,000 was recorded for the nine month periods ended September 30, 2008 and 2007, respectively, for this program.
Capital Unit Trading - On March 8, 2004, Northern Growers’ members and non-members began trading Northern Growers capital units on an alternative trading system operated by Alerus Securities Corporation of West Fargo, North Dakota.
Environmental Contingency - - In January 2003, the Environmental Protection Agency (EPA) issued formal information requests to, among others, plants designed, constructed, and/or managed by POET™ Design and Construction and POET™ Plant Management. By virtue of the nature and timing of these requests, the Company’s plant became subject to these requests. The requests required that the subject plants provide the EPA with certain data regarding emissions, presumably to determine whether the applicable plants were in compliance with the Clean Air Act. After this information was provided to the EPA, POET™ Design and Construction, on behalf of the Company and the subject plants managed by POET™ Plant Management, initiated discussions with the EPA regarding the application and use of testing methods for quantifying certain types of emissions emanating from these plants.
To date, no legal proceeding is pending with or threatened by the EPA nor has POET™ Design and Construction resolved with the EPA the application and use of the proper testing method for quantifying emissions. If a proceeding were initiated or settlement reached with the EPA, fines and/or other penalties against the Company could result, the nature and scope of which is uncertain. While there is a reasonable possibility of fines and/or other penalties in the event a proceeding is initiated or settlement reached, until the EPA and POET™ Design and Construction resolve the outstanding issues, the Company is unable to estimate the scope and magnitude of any possible fine or other penalty. Accordingly, the Company has not accrued any amount to its consolidated statement of operations relating to any potential claim.
NOTE 7 - DISTRIBUTIONS
During January 2007, POET™ Biorefining - Big Stone approved an $11,000,000 distribution, which it paid on January 26, 2007. Northern Growers received $8,487,600 and the minority member received $2,512,400. In conjunction with this cash distribution, on January 29, 2007, Northern Growers retained $1,699,904 by a super majority vote of the Board of Managers, and paid a distribution of $6,787,696 to its members of record as of December 31, 2006. The above distributions are recorded as a liability as of December 31, 2006.
During April 2007, POET™ Biorefining - Big Stone approved a $9,000,000 distribution, which it paid on April 24, 2007. Northern Growers received $6,944,400 and the minority member received $2,055,600. In conjunction with this cash distribution, on April 25, 2007, Northern Growers retained $499,961 by a super majority vote of the Board of Managers, and paid a distribution of $6,444,439 to its members of record as of March 31, 2007.
During July 2007, POET™ Biorefining - Big Stone approved a $5,300,000 distribution, which it paid on July 27, 2007. Northern Growers received $4,089,480 and the minority member received $1,210,520. In conjunction with this cash distribution, on August 2, 2007, Northern Growers paid a distribution of $4,089,224 to its members of record as of June 30, 2007.
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18
During January 2008, Northern Growers approved a distribution which it paid from cash reserves. On January 29, 2008, Northern Growers paid a distribution of $1,518,840 to its members of record as of December 31, 2007. The above distribution is recorded as a liability as of December 31, 2007.
NOTE 8 - CAPITAL UNITS
On June 20, 2005, Northern Growers approved a four-for-one (4-for-1) capital unit split of its Class A capital units, effective for September 1, 2005. Under the terms of the Class A capital units’ split, members of record as of September 1, 2005 received four capital units for each one capital unit held in Northern Growers.
On June 2, 2006, Northern Growers approved a two-for-one (2-for-1) capital unit split of its Class A capital units, effective for July 1, 2006. Under the terms of the Class A capital units’ split, members of record as of July 1, 2006 received two capital units for each one capital unit held in Northern Growers.
NOTE 9 - UNCERTAINTIES
The Company has certain risks and uncertainties that it experiences during volatile market conditions such as what the Company experienced during the quarter ending September 30, 2008. These volatilities can have a severe impact on operations. The Company’s revenues are derived from the sale and distribution of ethanol and distillers grains to customers primarily located in the U.S. Corn for the production process is supplied to our plant primarily from local agricultural producers and from purchases on the open market. Ethanol sales, historically, average 80% of total revenues and corn costs historically average 50 to 60% of cost of revenues.
The Company’s operating and financial performance is largely driven by the prices at which we sell ethanol and the net expense of corn. The price of ethanol is influenced by factors such as prices of supply and demand, weather, government policies and programs, and unleaded gasoline and the petroleum markets, although since 2005 the prices of ethanol and gasoline began a divergence with ethanol selling for less than gasoline at the wholesale level. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. Our 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, and our risk management program used to protect against the price volatility of these commodities.
Our net income decreased by approximately $10.2 million from the three months ended September 30, 2007 to the three months ended September 30, 2008, and by approximately $15.4 million for the nine months ended September 30, 2007 to September 30, 2008. Net income decreased between periods because of rising corn costs that were not offset by rises in ethanol prices. Corn costs were primarily affected by a 62% and 48% increase in the market price of corn between the three and nine month periods, respectively. Prices increased due to increases in demand for grain from global markets, increased speculation in the commodity markets including oil and corn, low corn carryout from 2007, and inclement spring weather. Corn costs also rose between quarters due to a change in value of our market-to-arrive contracts, which were adversely affected by the change in market price. We experienced a 16% and 3% rise in ethanol prices between the three and nine months ended, respectively, however, these increases were not enough to offset the increase in corn costs. Ethanol prices rose mainly in conjunction with the increase in the price of corn and oil.
We anticipate that our results of operations for the remainder of 2008 and into 2009 will continue to be affected by high corn prices, a surplus of ethanol, low ethanol prices, and volatility in the commodity markets. While the market price of corn has since dropped to $4.03 per bushel on October 31, 2008 as quoted on the CBOT for December 2008 futures from a peak of $7.88 per bushel in late June 2008 as quoted on the CBOT, it still remains relatively volatile. The volatility is due to various factors, including uncertainty with respect to the fall harvest and corn carryout in 2008, increased demand for grain from global and national markets, speculation in the commodity markets, and demand for corn from the ethanol industry. Concurrently, the price of ethanol ($1.75 per gallon as of October 31, 2008 on the CBOT for December 2008 futures) is expected to lag due to excess supply in the market and sluggish demand growth. Currently, 176 ethanol biorefineries in the U.S. have a capacity to produce more than 10.7 billion gallons annually. Another 27 biorefineries are under construction or expanding, which could add approximately 2.3 billion gallons of new production capacity in the next 6 to 12 months. Consequently, we expect margins to be tight or exist not at all, though not on the scale as the third quarter of 2008. There is reason for optimism, however. The ethanol supply situation, though uncertain as to exactly when, is anticipated to correct itself through the postponement and cancellation of new construction due to current market conditions and rising, albeit slow, demand growth. Moreover, corn prices have lowered considerably and a favorable fall harvest is anticipated which should facilitate this current price trend. Our liquidity position also remains strong.
19
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
The information in this quarterly report on Form 10-Q for the three and nine month period ended September 30, 2008, (including reports filed with the Securities and Exchange Commission (the “SEC” or “Commission”), contains “forward-looking statements” that deal with future results, expectations, plans and performance, and should be read in conjunction with the consolidated financial statements and Annual Report on Form 10-K for the year ended December 31, 2007. Forward-looking statements may include statements which use words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “predict,” “hope,” “will,” “should,” “could,” “may,” “future,” “potential,” or the negatives of these words, and all similar expressions. Forward-looking statements involve numerous assumptions, risks and uncertainties. Actual results or actual business or other conditions may differ materially from those contemplated by any forward-looking statements. Factors that could cause actual results to differ materially from the forward-looking statements are identified in our Form 10-K for the year ended December 31, 2007.
We are not under any duty to update the forward-looking statements contained in this report, nor do we guarantee future results or performance or what future business conditions will be like. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report.
Overview and Executive Summary
Northern Growers, LLC (“Northern Growers”) owns and manages a 77.16% interest in its subsidiary, POET™ Biorefining - Big Stone (POET™ Biorefining - Big Stone and Northern Growers are also collectively referred to as “we” “us” or “our”), an ethanol and distillers grains plant (the “plant” or “our plant”) located in Big Stone City, South Dakota.
Our revenues are derived from the sale and distribution of ethanol and distillers grains to customers primarily located in the U.S. Corn for the production process is supplied to our plant primarily from local agricultural producers and from purchases on the open market. After processing the corn, ethanol is sold to POET™ Ethanol Products, LLC, which subsequently markets and sells the ethanol to gasoline blenders and refineries located throughout the continental U.S. All of our distillers grains are sold through POET™ Nutrition, Inc., which markets and sells the product to livestock feeders primarily located in the continental U.S.
Our operating and financial performance is largely driven by the prices at which we sell ethanol and distillers grains and the costs related to production. Since 2004, federal and state government incentive programs have become an immaterial source of
20
revenue and income. The price of ethanol is influenced by factors such as price of corn, supply and demand, weather, government policies and programs, and unleaded gasoline and the petroleum markets, although since 2005 the prices of ethanol and gasoline began a divergence with ethanol selling 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 price of distillers grains is influenced by factors such as the price of corn, soybean meal and other protein-based feed products, and supply and demand. Excess grain supply in the market, in particular, puts downward pressure on the price of distiller grains. Our two largest costs of production are corn and natural gas, although our plant’s use of natural gas is offset by the use of steam supplied from the adjacent power plant, Big Stone Plant. The cost of corn and natural gas is generally impacted by factors such as supply and demand, weather, government policies and programs, and our risk management program used to protect against the price volatility of these commodities.
Our net income decreased by approximately $10.2 million from the three months ended September 30, 2007 to the three months ended September 30, 2008, and by approximately $15.4 million for the nine months ended September 30, 2007 to September 30, 2008. Net income decreased between periods because of rising corn costs which were not offset by rises in ethanol and distillers grain prices. Corn costs were primarily affected by a 62% and 48% increase in the market price of corn between the three and nine month periods, respectively. Prices increased due to increases in demand for grain from global markets, increased speculation in the commodity markets including oil and corn, low corn carryout from 2007, and inclement spring weather. Corn costs also rose between quarters due to a change in value of our market-to-arrive contracts, which were adversely affected by the change in market price. We experienced a 16% and 3% rise in ethanol prices between the three and nine months ended, respectively. Ethanol prices rose mainly in conjunction with the increase in the price of corn and crude oil. We also experienced a 67% and 57% rise in distillers grains prices between the three and nine months ended, respectively. Distillers grains prices rose due to increased value relative to the price of corn and increased demand as producers increased their use of distillers grains as a source of feed for livestock.
We anticipate that our results of operations for the remainder of 2008 and into 2009 will continue to be affected by high corn prices, a surplus of ethanol, low ethanol prices, and volatility in the commodity markets. While the market price of corn has since dropped to $4.03 per bushel on October 31, 2008 as quoted on the CBOT for December 2008 futures, from a peak of $7.88 per bushel in late June 2008 as quoted on the CBOT, it still remains relatively volatile. The volatility is due to various factors, including uncertainty with respect to the fall harvest and corn carryout in 2008, increased demand for grain from global and national markets, speculation in the commodity markets, and demand for corn from the ethanol industry. Concurrently, the price of ethanol ($1.75 per gallon as of October 31, 2008 on the CBOT for December 2008 futures) is expected to lag due to excess supply in the market and sluggish demand growth. Currently, 176 ethanol biorefineries in the U.S. have a capacity to produce more than 10.7 billion gallons annually. Another 27 biorefineries are under construction or expanding, which could add
21
approximately 2.3 billion gallons of new production capacity in the next 6 to 12 months. Consequently, we expect margins to be tight or exist not at all, though not on the scale as the third quarter of 2008. There is reason for optimism, however. The ethanol supply situation, though uncertain as to exactly when, is anticipated to correct itself through the postponement and cancellation of new construction due to current market conditions and rising, albeit slow, demand growth. Moreover, corn prices have lowered considerably and a favorable fall harvest is anticipated which should facilitate this current price trend. Our liquidity position also remains strong.
Results of Operations
Comparison of the three months ended September 30, 2008 and 2007
The following table presents, for the periods indicated, the relative composition of selected income data:
|
| Quarter Ended September 30, |
| ||||||
|
| 2008 |
| 2007 |
| ||||
|
| $ |
| % |
| $ |
| % |
|
Revenues: |
|
|
|
|
|
|
|
|
|
Ethanol |
| 38,271,909 |
| 80% |
| 34,589,824 |
| 86% |
|
Distillers Grains |
| 9,255,526 |
| 19% |
| 5,360,277 |
| 13% |
|
Incentive |
| 250,000 |
| 1% |
| 250,000 |
| 1% |
|
Total |
| 47,777,435 |
| 100% |
| 40,200,101 |
| 100% |
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues |
| 52,678,557 |
| 110% |
| 31,397,187 |
| 78% |
|
|
|
|
|
|
|
|
|
|
|
General and Administrative Expenses |
| 743,183 |
| 2% |
| 1,301,220 |
| 3% |
|
|
|
|
|
|
|
|
|
|
|
Other Operating Income (Expense) |
| (840,247 | ) | (2)% |
| (746,316 | ) | (2)% |
|
|
|
|
|
|
|
|
|
|
|
Minority Interest |
| 1,468,919 |
| 3% |
| (1,549,455 | ) | (4)% |
|
|
|
|
|
|
|
|
|
|
|
Net Income (Loss) |
| (5,015,633 | ) | (10)% |
| 5,205,923 |
| 13% |
|
Revenues - Revenue increased $7.6 million, or 19%, to $47.8 million for the three months ended September 30, 2008 from $40.2 million for the three months ended September 30, 2007. Revenues increased due to an increase in sales of ethanol and distiller grains.
Revenue from the sale of ethanol increased $3.7 million, or 11%, to $38.3 million for the three months ended September 30, 2008 from $34.6 million for the three months ended September 30, 2007. The increase is primarily driven by a 16% increase in the average sales price per gallon. Ethanol prices increased between periods as ethanol prices
22
began tracking in part the price of corn. Since the quarter end, however, the price of ethanol has decreased by approximately 15% because of an oversupply in the industry and a decline in the price of corn since the end of June 2008.
Revenue from the sale of distillers grains increased $3.9 million, or 73%, to $9.3 million for the three months ended September 30, 2008 from $5.4 million for the three months ended September 30, 2007. The increase is primarily driven by a 67% increase in the sales price per ton. This increase is primarily due to an increase in value relative to the price of corn and due to an increase in demand from livestock producers who increasingly switched to distillers grains as a source of feed due to the high price of corn during the quarter.
Cost of Revenues - Cost of revenues, which includes production expenses, increased $21.3 million, or 68%, to $52.7 million for the three months September 30, 2008 from $31.4 million for the three months ended September 30, 2007. An increase in corn costs between quarters is the largest contributing factor, followed by an increase in energy production costs.
Corn costs, which are primarily attributed to the market price of corn and losses, if any, from our risk management strategies, rose 97% between periods. This increase is primarily due to a 62% increase in the market price of corn, which is due to an increase in demand and decrease in supply of grains globally, an increase in commodity speculation including corn and oil, and an increase in demand for corn from the ethanol industry.
Our use of risk management strategies, primarily consisting of the use of derivatives and market-to-arrive or forward contracts, also contributed in part to the remaining increase in corn costs. During the three months ended September 30, 2008, we experienced a $16.0 million gain on derivatives contracts, only to be offset by $18.7 million loss on our forward contracts. Gains from the use of risk management instruments are recognized as a decrease in corn costs and losses from the use of risk management instruments are recognized as an increase in corn costs. As market prices reached their peak the end of June 2008, we maintained our hedging positions to protect against market fluctuations. When market prices fell during the third quarter of 2008, the value of our hedging positions increased and resulted in a $16.0 million gain at September 30, 2008. This gain, however, was offset by an $18.7 million loss on our forward contracts for corn at September 30, 2008 and a corresponding increase to our cost of revenues. The value of our forward contracts fell during this period because, after purchasing corn on a forward contract basis earlier in the year at higher prices, the market price of corn decreased by $2.70 per bushel during third quarter 2008.
Energy costs per gallon of ethanol rose 42% between quarters primarily due to an increase in natural gas costs. Natural gas costs per unit increased 51% between periods due to an increase in volume used as well as price. Prices rose in correlation with rising crude oil prices.
23
General and Administrative Expenses - General and administrative expenses decreased $560,000, or 43%, to $740,000 for the three months September 30, 2008 from $1.30 million for the three months ended September 30, 2007. The decrease is primarily due to a decrease in management incentive fees and costs, which resulted from a decrease in net income on which these fees and costs are determined.
Other Income (Expenses) – Other income remained relatively constant between periods.
Net Income(Loss) - Net income decreased $10.2 million, or 196%, to a net loss of $5.0 million for the three months ended September 30, 2008 from a net profit of $5.2 million for the three months ended September 30, 2007. This change is caused primarily by a significant increase in cost of revenues due to rising corn costs, offset by an increase in revenues from the sale of ethanol and distillers grains.
Comparison of the nine months ended September 30, 2008 and 2007
The following table presents, for the periods indicated, the relative composition of selected income data:
|
| Nine Months Ended September 30, |
| ||||||
|
| 2008 |
| 2007 |
| ||||
|
| $ |
| % |
| $ |
| % |
|
Revenues: |
|
|
|
|
|
|
|
|
|
Ethanol |
| 110,986,002 |
| 81% |
| 92,116,005 |
| 86% |
|
Distillers Grains |
| 25,546,646 |
| 19% |
| 14,754,732 |
| 14% |
|
Incentive |
| 395,595 |
| 0% |
| 500,000 |
| 0% |
|
Total |
| 136,928,243 |
| 100% |
| 107,370,737 |
| 100% |
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues |
| 134,577,245 |
| 98% |
| 85,127,185 |
| 79% |
|
|
|
|
|
|
|
|
|
|
|
General and Administrative Expenses |
| 2,661,418 |
| 2% |
| 3,730,742 |
| 3% |
|
|
|
|
|
|
|
|
|
|
|
Other Operating Income (Expense) |
| (2,686,780 | ) | (2)% |
| (1,500,230 | ) | (1)% |
|
|
|
|
|
|
|
|
|
|
|
Minority Interest |
| 643,507 |
| 0% |
| (3,928,290 | ) | (4)% |
|
|
|
|
|
|
|
|
|
|
|
Net Income (Loss) |
| (2,353,693 | ) | (2)% |
| 13,084,290 |
| 12% |
|
Revenues – Revenue increased $29.5 million, or 28%, to $136.9 million for the nine months ended September 30, 2008 from $107.4 million for the nine months ended September 30, 2007. Revenues increased due to an increase in sales of ethanol and distiller grains.
24
Revenue from the sale of ethanol increased $18.9 million, or 20%, to $111.0 million for the nine months ended September 30, 2008 from $92.1 million for the nine months ended September 30, 2007. The increase is primarily driven by a 17% increase in sales volume and a modest rise in ethanol prices. Sales increased because of an 18% increase in production volume following the completion of our plant’s expansion in May of 2007. In May 2007, we increased the annual production capacity of our plant from a name-plate production of 40 million gallons to 75 million gallons. Ethanol prices increased between periods as prices began tracking more closely the rise in corn and crude oil prices.
Revenue from the sale of distillers grains increased $10.8 million, or 73%, to $25.5 million for the nine months ended September 30, 2008 from $14.7 million for the nine months ended September 30, 2007. The increase is primarily driven by a 57% increase in sales price per ton and a 10% increase in sales volume. Like ethanol, sales of distillers grains increased due to the increase in production volume following our plant’s expansion. The increase in price per ton is due to an increase in the value of distillers grains relative to the price of corn and due to an increase in demand from livestock producers who increasingly switched to distillers grains as a source of feed due to the high price of corn.
Cost of Revenues – Cost of revenues, which includes production expenses, increased $49.5 million, or 58%, to $134.6 million for the nine months September 30, 2008 from $85.1 million for the nine months ended September 30, 2007. The primary reasons for the increase are an increase in production costs, corn costs, and energy costs. Production, corn and energy costs were all impacted by the 18% increase in production volume between periods due to our plant’s expansion.
Aside from the increase in production volume, corn and energy costs rose between periods due to other factors. Corn costs, which consists primarily of the market price of corn and losses, if any, from our risk management or hedging strategies, rose 46% between periods. This increase is primarily due to a 48% increase in the market price of corn, which was adversely impacted from increased demand and decreased supply of grains globally, increased speculation in commodity markets, increased demand for corn from the ethanol industry, and flooding in the upper Midwest this past spring.
Corn costs also were impacted by a net loss of $3.4 million from risk management, though on a much smaller scale compared to the market rise in corn. As market prices reached their peak the end of June 2008, we maintained our hedging positions to protect against market fluctuations. When prices fell during the third quarter of 2008 our hedging positions resulted in a $2.2 million gain at September 30, 2008, which offset the market price increase and decreased our cost of revenues. This gain, however, was offset by a $5.6 million loss on our forward contracts for corn at September 30, 2008 and a corresponding increase to our cost of revenues. The value of our forward contracts fell during this period because, after purchasing corn on a forward contract basis earlier in the year at higher prices, the market price of corn decreased by $2.70 per bushel during third quarter 2008 as speculators exited the commodities markets.
25
Energy costs per gallon rose 32% between periods, rising primarily due to an increase in natural gas and steam costs. Natural gas costs per unit rose 39% between periods. In contrast to previous periods when prices moved more in conjunction with supply and demand, natural gas prices began moving more in correlation with a rise in crude oil prices. Steam costs per unit increased 28% between periods because of an increase in the price of steam charged by Big Stone Plant.
General and Administrative Expenses – General and administrative expenses decreased $1.0 million, or 29%, to $2.7 million for the nine months ended September 30, 2008 from $3.7 million for the nine months ended September 30, 2007. The decrease is primarily due to a decrease in management incentive fees and costs, which resulted from a decrease in net income on which these fees and costs are based.
Other Income (Expenses) – Interest expense increased $820,000, or 43%, to $2.72 million for the nine months ended September 30, 2008 from $1.90 million for the nine months ended September 30, 2007. The increase is primarily due to an increase in interest expense on the expansion and revolving loans. With respect to the expansion loan, we capitalized interest on the expansion loan during early 2007, discontinuing interest capitalization and recording as an expense in May of 2007. With respect to the revolving loans, because our cash position tightened between periods due to less favorable conditions in the corn and ethanol markets, we drew more down on both loans which required more interest to be paid on the outstanding balances.
Net Income - Net income decreased $15.4 million, or 118%, to a net loss of $2.3 million for the nine months ended September 30, 2008 from a $13.1 million net profit for the nine months ended September 30, 2007. This change is caused primarily by an increase in cost of revenues, offset by an increase in revenues from the sale of ethanol and distillers grains resulting from our plant’s expansion.
Liquidity and Capital Resources
Our primary sources of liquidity are cash provided by operations and borrowings under our $8.0 million and $9.0 million revolving credit facilities which are discussed below under “Indebtedness.” Net working capital, which includes the amount that may be borrowed under the $8.0 million revolving note, is $24.2 million as of September 30, 2008, compared to $24.0 million as of September 30, 2007. Although we experienced a significant decrease in net income between periods, our cash flows from operations and revolving debt is expected to remain sufficient to meet our anticipated capital and liquidity requirements for the foreseeable future. Greater reliance on our revolving debt to fund operations may be more necessary, however, due to current and projected market conditions.
The following table shows the cash flows between the nine months ended September 30, 2008 and the nine months ended September 30, 2007:
26
|
| Nine Months Ended |
| ||
|
| 2008 |
| 2007 |
|
|
| $ |
| $ |
|
Net cash provided by (used for) operating activities |
| 5,211,060 |
| 26,333,436 |
|
Net cash provided by (used for) investing activities |
| 665,331 |
| (17,970,016 | ) |
Net cash provided by (used for) financing activities |
| (5,801,473 | ) | (10,528,280 | ) |
Cash Flow From Operating Activities - Net cash flow from operating activities decreased $21.1 million between periods, due principally to a decrease in cash provided by net income between periods, offset by a significant decrease in cash used for corn inventory. The number of corn bushels in inventory from December 31, 2007 to September 30, 2008 decreased by 74% as we decreased inventories in anticipation of filling our inventory with a new crop during the fall 2008 harvest.
Cash Flow From Investing Activities - Net cash flow from investing activities increased $18.6 million between periods due to a decrease in purchases of property and equipment and the receipt of a sales and excise tax refund from the State of South Dakota during 2008. In contrast to 2007, we purchased significantly less property and equipment in 2008 because we had completed construction of our plant’s expansion in May 2007. In addition, we received in 2008 from the State of South Dakota a series of tax refunds totaling $1,016,697 for sales and excise taxes paid in 2007 on the construction of the plant’s expansion.
Cash Flow From Financing Activities - Net cash used for financing activities decreased $4.7 million between periods due to a $21.5 million decrease in distributions paid to members and minority interest from 2007 to 2008. Advances on long-term debt also decreased between periods because we no longer drew down on the $33 million construction note following our plant’s expansion. The $8.0 million in long-term notes payable issued for the nine months ended September 30, 2008 resulted from draws against the $8 million revolving note to cover operating expenses, including corn-related costs, though it was paid down to a zero balance at September 30, 2008.
Indebtedness
We have six notes and loans outstanding under our current loan agreement with our lender, U.S. Bank of Sioux Falls, South Dakota: 1) a $33.0 million term note; 2) a $15.8 million fixed-rate note; 3) a $3.9 million variable-rate, non-revolving note; 4) an $8 million variable rate, revolving note; 5) a $9 million variable rate, revolving note; and 6) a $4.3 million variable rate note.
The $8 million note permits us to borrow, on a revolving basis, the difference between the unpaid principal balance and $8 million. The principal purpose of this revolver is to cover our operating expenses. We had $8 million available for use as of September 30, 2008.
27
The $9 million note permits us to borrow, on a revolving basis, the difference between the outstanding principal amount and the lesser of the borrowing base or $9.0 million. The borrowing base is defined as 75% of the total of the fair market value of the outstanding inventory, eligible accounts receivable, and hedging accounts at fair market value. The principal purpose of this revolver is to cover our operating expenses. We had $9 million available for use as of September 30, 2008.
The $33 million term note, which was converted from a construction note on August 31, 2007, is subject to two interest rate arrangements. The notional amounts ($15.3 million and $7.6 million as of September 30, 2008) are subject to an interest rate swap agreement with U.S. Bank. (see also Item 7A below-”Quantitative and Qualitative Disclosures About Market Risk”). Under the agreement, the notional amounts are subject to a fixed rate of 7.98% and 7.52% respectively, which is payable monthly until maturity on August 30, 2014. The remaining portion of the note is subject to a variable rate of one-month LIBOR plus 2.75%, adjusted and due monthly (5.236% at September 30, 2008). A principal payment of $825,000 is due quarterly on the note, which commenced on November 30, 2007.
The principal balance outstanding on the $15.8 million fixed-rate note (6.38%) is $11.4 million as of September 30, 2008. We made principal payments of $345,000 and $1.02 million on this note during the three and nine months ended September 30, 2008, respectively.
The principal balance outstanding on the $3.9 million variable rate (5.00%) non-revolving loan is $2.54 million as of September 30, 2008. A principal payment of $97,500 is due quarterly on this note.
The principal balance outstanding on the $4.3 million variable rate note (5.486% at September 30, 2008) is $3.68 million. A principal payment of $154,000 is due quarterly on this note.
All of loans and notes outstanding are secured by our tangible and intangible property, including a leasehold interest, easement rights, improvements, equipment, personal property, accounts receivable, inventory and contracts. In addition to standard covenants and conditions in the amended and restated loan agreement, we are subject to the following material conditions and covenants: 1) a capital expenditure limitation not exceeding $1 million in any calendar year; 2) a cash distribution limitation to members not exceeding 80% of net income annually; 3) a minimum working capital of $10 million; and 4) a fixed charge coverage ratio of 1.15:1 as of the last day of any fiscal quarter for the four consecutive fiscal quarters ending on that date. We were in compliance with all conditions and covenants under our loan agreement with U.S. Bank as of September 30, 2008 and the date of this filing, except for the fixed charge coverage ratio due to our net loss to which we received a waiver from U.S. Bank.
28
Off-Balance Sheet Arrangements
We do not use or have any material off-balance sheet financial arrangements.
Recent Accounting Pronouncements
None.
Critical Accounting Policies and Estimates
Preparation of our financial statements require estimates and judgments to be made that affect the amounts of assets, liabilities, revenues and expenses reported. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. We continually evaluate these estimates based on historical experience and other assumptions we believe to be reasonable under the circumstances.
The difficulty in applying these policies arises from the assumptions, estimates and judgments that have to be made currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations as well as management intentions. As the difficulty increases, the level of precision decreases, meaning that actual results can and probably will be different from those currently estimated. Of the significant accounting policies described in the notes to the financial statements, we believe that the following may involve a higher degree of estimates, judgments, and complexity:
Commitments and Contingencies. Contingencies, by their nature, relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred, as well as in estimating the amount of the potential expense. In conformity with accounting principles generally accepted in the United States, we accrue an expense when it is probable that a liability has been incurred and the amount can be reasonably estimated.
Inventory Valuation. We account for corn inventory at estimated net realizable market value. Corn is an agricultural commodity that is freely traded, has quoted market prices, may be sold without significant further processing, and has predictable and insignificant costs of disposal. We derive our estimates from local market prices determined by grain terminals in our area. Changes in the market value of corn inventory are recognized as a component of cost of revenues. Ethanol and distillers grains are stated at net realizable value. Work-in-process, chemical and parts inventory are stated at an average cost method.
Revenue Recognition. Revenue from the production of ethanol and related products is recorded when title transfers to customers, net of allowances for estimated returns. Interest income is recognized when earned.
Revenue from state incentive programs is recorded when we have produced or sold the ethanol and satisfied the reporting requirements under the program.
29
Long-Lived Assets. Depreciation and amortization of our property, plant, and equipment is provided on the straight-line method by charges to operations at rates based upon the expected useful lives of individual or groups of assets. Economic circumstances or other factors may cause management’s estimates of expected useful lives to differ from actual.
Long-lived assets, including property, plant and equipment, and investments are evaluated for impairment on the basis of undiscounted cash flows whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impaired asset is written down to our estimated fair market value based on the best information available. Considerable management judgment is necessary to estimate discounted future cash flows and may differ from actual cash flows.
Accounting for Derivative Instruments and Hedging Activities. We enter into derivative instruments to hedge our exposure to price risk related to forecasted corn and natural gas purchases, forward corn purchase contracts and forecasted ethanol sales. We do not typically enter into derivative instruments other than for hedging purposes. All derivative contracts are recognized on the September 30, 2008 and December 31, 2007 balance sheets at their fair market value. Currently, none of the derivative instruments are classified as cash-flow hedges for accounting purposes.
On the date the derivative instrument is entered into, we designate the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge) or (3) will not designate the derivative as a hedge. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Changes in the fair value of a derivative that is not designated as a hedge are recorded in current period earnings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to the impact of market fluctuations associated with commodity prices and interest rates as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. Specifically, we use forward, futures and option contracts to hedge changes to the commodity prices of corn and natural gas, as well as interest rate swaps to hedge against changes in interest rates. However, we do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes pursuant to the requirements of SFAS 133, Accounting for Derivative Instruments and Hedging Activities.
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Commodity Price Risk
We produce ethanol and its co-product, distillers grains, from corn, and, as such, we are sensitive to changes in the price of corn. The price of corn is subject to fluctuations due to unpredictable factors such as weather, total corn planted and harvested acreage, changes in national and global supply and demand, and government programs and policies. We also use natural gas in the production process, and as such are sensitive to changes in the price of natural gas. The price of natural gas is influenced by such weather factors as heat or cold in the summer and winter, in addition to the threat of hurricanes in the spring, summer and fall. Other natural gas price factors include the domestic onshore and offshore rig count, and the amount of natural gas in underground storage during both the injection (April 1st – November 7th) and withdrawal (November 14th – September 30th) seasons. The price of distillers grains is principally influenced by the price of corn and soybean meal, competing protein feed products.
We attempt to reduce the market risk associated with fluctuations in the price of corn and natural gas by employing a variety of risk management strategies. Strategies include the use of derivative financial instruments such as futures and options initiated on the Chicago Board of Trade and/or the New York Mercantile Exchange, as well as the daily cash management of our total corn and natural gas ownership relative to our monthly demand for each commodity, which may incorporate the use of forward cash contracts or basis contracts.
Corn is hedged with derivative instruments including futures and options contracts offered through the Chicago Board of Trade. Forward cash corn and basis contracts are also utilized to minimize future price risk. Likewise, natural gas is hedged with futures and options contracts offered through the New York Mercantile Exchange. Basis contracts are also utilized to minimize future price risk.
Gains and losses on futures and options contracts used as economic hedges of corn inventory, as well as on forward cash corn and basis contracts, are recognized as a component of cost of revenues for financial reporting on a monthly basis using month-end settlement prices for corn futures on the Chicago Board of Trade. Corn inventories are marked to net realizable value using market based prices so that gains or losses on the derivative contracts, as well as forward cash corn and basis contracts, are offset by gains or losses on inventories during the same accounting period.
Gains and losses on futures and options contracts used as economic hedges of natural gas, as well as basis contracts, are recognized as a component of cost of revenues for financial reporting on a monthly basis using month-end settlement prices for natural gas futures on the New York Mercantile Exchange. The natural gas inventories hedged with these derivatives or basis contracts are valued at the spot price of natural gas, plus or minus the gain or loss on the futures or options positions relative to the month-end settlement price on the New York Mercantile Exchange.
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A sensitivity analysis has been prepared to estimate our exposure to commodity price risk. The table presents the fair value of corn inventory, forward purchase contracts and open futures and option positions for corn and natural gas as of September 30, 2008 and September 30, 2007 and the potential loss in fair value resulting from a hypothetical 10% adverse change in corn and natural gas prices. The fair value of the positions is a summation of the fair values calculated by valuing each net position at quoted market prices as of the applicable date. The results of this analysis, which may differ from actual results, are as follows:
Year Ended |
| Fair Value |
| Effect of Hypothetical |
| ||
September 30, 2008 |
| $ | 6,660,419 |
| $ | 666,042 |
|
September 30, 2007 |
| $ | 3,708,867 |
| $ | 370,887 |
|
Interest Rate Risk
We manage our interest rate risk by monitoring the effects of market changes on the interest rates and using fixed-rate debt whenever possible. We also enter into interest rate swap agreements.
Our interest rate risk exposure pertains primarily to our variable rate, long-term debt. Specifically, we had $13.6 million in variable rate, long-term debt outstanding as of September 30, 2008, or approximately 29% of our total long-term indebtedness. The interest rate on $2.5 million of the variable rate, long-term debt is U.S. Bank’s prime rate, which was 5.0% as of September 30, 2008. The interest rate on $3.7 million of the variable rate debt is subject to an interest rate of 5.486% at September 30, 2008. The variable rate on the $7.4 million portion of the term note is 5.236% (One-Month LIBOR plus 2.75%) as of September 30, 2008.
In order to achieve a fixed interest rate on a portion of our $33.0 million term note, we are a party to an interest rate swap agreement with U.S. Bank. The swap agreement covers a seven-year term financing period through August 30, 2014. This agreement assists us in protecting against exposure to increases in interest rates and fixes the interest rate at 7.98% and 7.52% on the notional amounts ($14.9 million and $7.4 million, respectively as of September 30, 2008). The remaining amount, $7.4 million, is subject to a variable rate of One-Month LIBOR plus 2.75%. While our exposure is now reduced, there is no assurance that the interest rate swap will provide us with protection in all scenarios. For example, under the swap agreement, when One-Month LIBOR plus 2.75% exceeds 7.98% or 7.52%, we receive payments from U.S. Bank for the difference between the market rate and the swap rate. Conversely, when the One-Month LIBOR plus 2.75% falls below 7.98% or 7.52%, we make payments to U.S. Bank for the difference. The interest rate on the variable portion of our $33.0 million term note decreased 3.079% from September 30, 2007 to September 30, 2008, which required us to pay more in interest to U.S. Bank on two swap transactions.
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Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our chief executive officer and chief financial officer and management, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report, have concluded that the disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that it files with the Securities and Exchange Commission.
Changes in Internal Controls
There have been no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.
None.
None.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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None.
See Exhibit Index following the signature page to this report.
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| NORTHERN GROWERS, LLC | |
Dated: November 10, 2008 |
| |
| By | /s/ Robert Narem |
|
| Robert Narem |
|
| Chief Executive Officer and |
|
| Chief Financial Officer |
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EXHIBIT INDEX
TO
FORM 10-Q
OF
NORTHERN GROWERS, LLC
Exhibit |
| Description |
2.1 |
| Plan of Reorganization (1) |
3.1 |
| Articles of Organization (2) |
3.2 |
| Fourth Amended and Restated Operating Agreement dated July 1, 2006 (3) |
4.1 |
| Form of Class A Unit Certificate(4) |
31 |
| Rule 13a-14(a)/15d-14(a) Certification |
32 |
| Section 1350 Certification |
(1) Appendix A to registrant’s prospectus filed with the Commission on March 17, 2003.
(2) Appendix B to registrant’s prospectus filed with the Commission on March 17, 2003.
(3) Exhibit 3(ii)(a) to the registrant’s Form 8-K filed with the Commission on January 5, 2006.
(4) Exhibit 4.1 to the registrant’s Form S-4 filed with the Commission on July 26, 2002.
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