Item 1. Business.
Overview
Northern Growers, LLC (“Northern Growers”) is a South Dakota limited liability company, consisting of 950 members who principally reside in South Dakota and the upper Midwest. Northern Growers owns and manages a 77.16% interest in its subsidiary, POET™ Biorefining - Big Stone (“Big Stone”), an ethanol and distillers grains plant (the “plant” or “our plant”) located near the city of Big Stone City, South Dakota. (Northern Growers and Big Stone are referred to collectively in this report as “we,” “our,” or “us”). Our plant is built with an annual name-plate capacity of 75 million gallons of ethanol.
Our revenues are derived from the sale and distribution of ethanol and distillers grains to customers primarily located in the U.S. Corn for our plant’s production process is supplied primarily from local agricultural producers and from purchases on the open market. After processing the corn, ethanol is sold to POET™ Ethanol Products, LLC (f/k/a 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 our marketing agent, POET™ Nutrition, Inc. (f/k/a Dakota Gold Marketing), which markets and sells the product to livestock feeders primarily located in the continental U.S. The day-to-day operations of our plant are managed by POET™ Plant Management, LLC, of Sioux Falls, South Dakota.
Our operating results are largely driven by the prices at which we sell ethanol and distillers grains and the costs related to their production. Historically, the price of ethanol tends to fluctuate in the same direction as the price of unleaded gasoline and other petroleum products, although in 2005 the prices of ethanol and gasoline began a divergence, with ethanol selling for less than gasoline at the wholesale level. The greatest effect on the price of ethanol is the supply and demand for ethanol in the U.S. markets. Our two largest costs of production are corn and natural gas, although our use of natural gas is offset by the use of steam supplied directly from the adjacent energy power plant called Big Stone Plant. The price of distillers grains is generally influenced by supply and demand, the price of substitute livestock feed, such as corn and soybean meal, and other animal feed proteins. Surplus grain supplies tend to put downward price pressure on distillers grains.
General Developments of Business
Northern Growers was originally organized in 2000 as a South Dakota cooperative for the purpose of owning and managing its interest in Big Stone and providing a major source of corn supply to the plant. Northern Growers was subsequently reorganized in 2003 as a South Dakota limited liability company at which time it became subject to the reporting requirements under the Securities Act of 1933 and Securities Exchange Act of 1934. Northern Growers is taxed as a partnership for federal income tax purposes, meaning that all of its income is subject to single-level, pass through tax treatment at the member level rather than at the company level.
Construction of our plant was completed and operations commenced in July 2002. Our plant was originally built with an annual name-plate production capacity of 40 million gallons of ethanol. Since that time, we have made significant capital improvements. In March 2006, we completed a rail expansion project, which provides our plant with additional capacity to store rail cars for the shipment of products. In October 2006, we completed construction for the incorporation of BPX™ technology into the production process. In addition to reducing energy costs, BPX™ releases additional starch content, increases the protein content and quality of by-products and decreases plant emissions. In May 2007, we completed the construction on our plant expansion, increasing its annual name-plate capacity to 75 million gallons of ethanol In October 2007, we increased our grain storage capacity by adding two grain bins with a storage capacity of 569,000 bushels of corn. The design and construction of the BPX™, grain storage and expansion projects, was completed by POET™ Design and Construction, Inc. (f/k/a Broin and Associates, Inc.), of Sioux Falls, South Dakota.
Principal Products
The principal products produced at our plant are fuel grade ethanol and distillers grains.
Ethanol
Ethanol is ethyl alcohol. Ethanol is produced from starch or sugar-based feed products such as corn, potatoes, wheat, and sorghum, as well as from agricultural waste products including sugar, rice straw, cheese whey, beverage wastes and forestry and paper wastes. Historically, corn has been the primary source of producing ethanol because of its relatively low cost, wide availability and ability to produce large quantities of carbohydrates that convert into glucose more easily than other products. Today, approximately 90% of the ethanol produced in the U.S. is produced from corn.
Ethanol is used for three primary purposes: 1) as an oxygenated fuel additive; 2) as an octane enhancer in fuels; and 3) as a non-petroleum based gas substitute. Approximately 95% of all ethanol is used for blending with unleaded gasoline and other fuel products. Ethanol has been utilized as a fuel additive since the late 1970s when its value as a product extender for gasoline was discovered during the OPEC oil embargo crisis. In the 1980s, ethanol began to see widespread use as an octane enhancer, replacing other environmentally harmful components in gasoline such as lead and benzene. Ethanol’s use as an oxygenate continued to increase with the passage of the Clean Air Act Amendments of 1990, which required the addition of oxygenates to gasoline in the nation’s most polluted areas. Because ethanol contains approximately 35% oxygen, its combination with gasoline increases the percentage of oxygen in gasoline. As a result, the gasoline burns cleaner and releases less carbon monoxide and other exhaust emissions into the atmosphere.
For fiscal years ended December 31, 2007, 2006 and 2005, our revenues from sales of ethanol were approximately 84.0%, 86.1% and 81.0% of total revenues, respectively.
Distillers Grains
A principal by-product of the ethanol production process is distillers grains. Distillers grains are a high protein, high energy feed supplement marketed primarily to the dairy, beef, sheep, swine, and poultry industries. It is a popular animal feed supplement, with millions of tons produced in North America annually. Most of the distillers grains produced in the U.S. are sold for use in animal feeds within the continental U.S., although a growing percentage is exported to countries such as Canada, Mexico and in Asia and Europe.
Dry mill ethanol processing produces, generally, three forms of distillers grains, all of which differ in moisture content and shelf life: 1) dried distillers grains with solubles (DDGS); 2) distillers wet grains or “wet cake”; and 3) modified distillers grains. Distillers wet grains are processed corn mash that does not go through a drying process and contains approximately 70% moisture content. Distillers wet grains have a short shelf life of approximately three days and can be sold only to livestock producers within the immediate vicinity of the plant. Modified distillers grains are distillers wet grains that are dried to a 50% moisture content. Modified distillers grains have a slightly longer shelf life and are often sold to nearby livestock producers. DDGS is distillers wet grains that are dried to an 8-10% moisture content. DDGS have an almost indefinite shelf life and may be sold and shipped to any market regardless of its vicinity to the plant.
For fiscal years ended December 31, 2007, 2006 and 2005, our revenues from sales of distillers grains were approximately 15.5%, 13.3%, and 18.2% of total revenues, respectively.
Marketing and Distribution
Ethanol
The ethanol produced at our plant is sold to POET™ Ethanol Products, LLC (f/k/a Ethanol Products, LLC), the terms of which are governed by an ethanol marketing agreement. After purchasing the ethanol from us, POET™ Ethanol Products markets and sells the ethanol to major, multi-national oil companies with blending and refinery facilities located throughout the continental U.S. The price that we receive from the sale to POET™ Ethanol Products is based upon various contracts between POET™ Ethanol Products and its customers, and is fixed upon the transfer of title to POET™ Ethanol Products.
The ethanol produced at our plant is shipped by POET™ Ethanol Products using rail cars operated by POET™ Ethanol Products or trucks supplied by companies with which POET™ Ethanol Products contracts. Transfer of title and risk of loss shifts to POET™ Ethanol Products upon the loading of ethanol onto railcars and trucks at the plant. Our plant is served by rail facilities and connections to the Burlington Northern Santa Fe railroad system, which facilitate the transportation of ethanol to the customers’ terminals, and by multiple South Dakota state highways and Interstate Highway 29, which provide transportation links in all directions.
The marketing agreement with POET™ Ethanol Products is in effect until July 2012, renewing automatically for five-year terms unless either party provides at least ninety days written notice of termination prior to the end of the term. POET™ Ethanol Products charges us a marketing and service fee based upon each gallon of ethanol sold. POET™ Ethanol Products also charges us a fee for each gallon of ethanol to which renewable identification numbers, or RINS, are assigned, which is necessary for complying with the federal renewable fuels standard and the U.S. Environmental Protection Agency’s enforcement of such standard. Shipping costs relating to the transportation of ethanol are borne by us and are included in our gross revenues and cost of revenues. In the event that the contractual relationship with POET™ Ethanol Products is interrupted for any reason, we believe that another entity to market the ethanol could be located. Any interruption, however, could temporarily disrupt the sale of ethanol and adversely affect our business and operations.
Distillers Grains
The distillers grains produced at our plant are sold through POET™ Nutrition, Inc. (f/k/a Dakota Gold Marketing), the terms of which are governed by a distillers grains marketing agreement. As our exclusive marketing agent, POET™ Nutrition markets and sells the distillers grains to customers. The price received from the sale of distillers grain is the price received from the customers with which POET™ Nutrition has negotiated and entered into a contract for sale.
We produce at our plant three variations of distillers grains which are marketed through POET™ Nutrition: 1) DDGS; 2) Dakota Gold™; and 3) distillers wet grains. Dakota Gold™ is DDGS which is certified by POET™ Nutrition indicating that DDGS meet certain standards and specifications.
POET™ Nutrition markets distillers grains to local, regional, national and international markets. We sell and ship a substantial majority of our distillers grains to customers in the southwestern and western parts of the U.S., the remainder of which is shipped to other areas of the U.S. and to Mexico. Shipments to national and international markets are primarily completed by the use of rail due to a longer shelf life, whereas shipments to local or regional markets are primarily completed by truck. We also contract with POET™ Nutrition for the use of railcars in the shipping of DDGS and Dakota Gold™, paying POET™ Nutrition a flat fee per railcar in connection with each shipment. By marketing through POET™ Nutrition, we are not dependent upon one or a limited number of customers.
The marketing agreement with POET™ Nutrition is in effect until March 2012, renewing automatically for additional five-year terms unless discontinued by either party upon at least three months prior written notice. POET™ Nutrition charges us a marketing fee based upon a percentage of gross monthly sales of distillers grains less shipping costs. All shipping costs associated with the transportation of distillers grains are borne by us and are included in our gross revenues and cost of revenues, and POET™ Nutrition is responsible for invoicing all loads and receiving payments from the customers, the payment of which is remitted to us.
Risk Management
Due to fluctuations in the price of corn and natural gas, we use risk management or hedging strategies to minimize our commodity risk. Hedging is a means of protecting the price at which corn and natural gas is bought in the future. All of the commodity risk management services relating to corn and natural gas are provided by POET™ Plant Management in accordance with a corn and natural gas price risk management agreement. Under the agreement, we pay POET™ Plant Management an annual flat fee. The agreement is in effect until January 2012, renewing automatically for additional five-year terms unless discontinued by either party upon written notice prior to the expiration of the term.
Dependence Upon a Single or Few Customers
We, as discussed above, are substantially dependent upon POET™ Ethanol Products for the purchase, marketing and distribution of ethanol. POET™ Ethanol Products purchases 100% of the ethanol produced at our plant, all of which is marketed and distributed to its customers.
Financial Information about Geographic Areas
All of our operations are domiciled in the U.S. All of the products sold to our customers for fiscal years 2007, 2006 and 2005 were produced in the U.S., and all of our long-lived assets are domiciled in the U.S. In addition, 98% of our total revenues were derived from sales to customers in the U.S., whereas 2% were derived from sales to customers in Mexico.
Sources and Availability of Raw Materials
Corn. Our major raw material for the production process is corn. To operate our plant at full name-plate capacity, we require the supply of approximately 27 million bushels of corn annually. All of our corn requirements are purchased on the open market from local producers and storage elevators. In 2008, we expect a sufficient supply of corn to be available to meet our plant’s bushel requirement.
Steam. Our production process requires a constant supply of steam. Steam is used for the cooking, evaporation, and distillation processes. While the production of steam in the ethanol production process is generally received from an ethanol plant’s on-site boilers, our plant receives a substantial portion of its steam from Big Stone Plant, a coal fired, electrical generating facility located immediately adjacent to our plant. Big Stone Plant is co-owned by three utilities, namely, Otter Tail Corporation, Montana-Dakota Utilities and NorthWestern Corporation. The benefit of steam from Big Stone Plant is that it reduces our dependence on natural gas for operations. In 2007, for example, 39% of our natural gas requirements for operations were replaced directly with steam from Big Stone Plant, compared to 48% of our requirements in 2006.
Big Stone Plant generally provides us with a consistent supply of steam to meet our requirements except during its semi-annual maintenance shutdowns. When Big Stone Plant shuts down for any prolonged period of time, or if the transfer of steam is unexpectedly diminished or interrupted, we use two on-site boilers powered by natural gas to generate steam. However, as discussed below under “Natural Gas,” when we are required to rely on our on-site boilers to generate steam, our natural gas supply prevents us from generating a sufficient volume of steam to operate at full name-plate production capacity.
The purchase of steam is governed by a steam sale agreement between us and Big Stone Plant. The agreement’s ten year term ends on June 1, 2012, but automatically renews for two additional five-year terms unless terminated by either party by providing 12 months advance notice.
Natural Gas. Our production process requires a constant supply of natural gas. Natural gas is the primary energy source for the drying of distillers grains. It is primarily responsible for powering the two on-site boilers for the generation of steam in the event that additional steam is necessary or the supply of steam from Big Stone Plant is unexpectedly diminished or interrupted. We contract with CenterPoint Energy Services, Inc., of Houston, Texas, for the supply and distribution of natural gas to the plant. In April 2007, Centerpoint purchased from our previous supplier, NorthWestern Public Service, our natural gas supply agreement. The agreement with CenterPoint is for a term of ten years ending in 2012.
Prior to the completion of our expansion in May 2007, we did not experience any interruption or shortage of natural gas supply. However, since completion of expansion, we have experienced shortages. When our plant’s supply of steam from Big Stone Plant is interrupted for any prolonged period of time, such as during Big Stone Plant’s general maintenance shut downs, our plant’s natural gas capacity is insufficient to allow our plant to operate at its full 75 million gallon name-plate production capacity. Consequently, our plant is required to scale back production during this period. In the fourth quarter of 2007, for example, we were required to scale back production by approximately 30% for six weeks because Big Stone Plant was shut down for maintenance. We are currently exploring options to increase our natural gas supply in order to allow us to operate at full name-plate production when Big Stone Plant is shut down.
Electricity. Our production process requires a constant supply of electricity. Electricity is necessary to generate lighting and to power the machinery and equipment at the plant. We contract with Otter Tail Power Company of Otter Tail, Minnesota, to provide us with all of our electric power requirements. The agreement automatically renews for one year terms unless terminated by either party by providing 12 months advance written notice. Since operations were commenced, we have not had interruptions or shortages in the supply of electricity.
Water. The production process requires a constant supply of water. Water is necessary for the slurry and cooking processes, cooling towers and boiler operations. We contract with the city of Big Stone City and Big Stone Plant to supply our plant with water for the production process. The agreement with the city of Big Stone City is in effect until 2012, and automatically renews for two, five-year terms unless terminated by either party with 12 months advance written notice. Since operations were commenced, the city of Big Stone City and Big Stone Plant have provided us with an ample and consistent supply of water to meet operational requirements.
Research and Development
We do not conduct any research and development of our own relating to the production of ethanol and distillers grains. Instead, we rely on POET™ Research, Inc., of Sioux Falls, South Dakota, to research and develop new technologies in order to improve the production process and end products. POET™ Research provides us this technology through a license agreement, where we pay POET™ Research a licensing fee quarterly. The license agreement terminates on June 30, 2015.
Competition
Domestic
We are in direct competition with numerous other ethanol and distillers grains producers, many of which have significantly greater resources. Additional ethanol and distillers grains producers also continue to enter the market. As of February 2008, the ethanol industry has grown to 141 production facilities in the U.S., compared to 113 production facilities as of February 2007. The largest ethanol producers include Archer Daniels Midland, Aventine Renewable Energy, Cargill, and VeraSun Energy Corporation, all of which are capable of producing more ethanol than we do. There are numerous
ethanol plants of a similar size to our plant located in the Midwest region. In addition, at least 59 new ethanol plants and seven expanding plants, with a combined annual production capacity of over 5.4 billion gallons annually, are set to come into production in the next 18 months, which will increase the ethanol production capacity of competitors. In South Dakota, excluding our plant, there are currently 13 plants in full production and one under construction, all of which have a combined production capacity of approximately 759 million gallons. We believe that, despite this concentration and growth, we will continue to compete favorably with other ethanol and distillers grains’ producers because of our plant’s existing efficiencies, the use of new technology from POET™ Research, and the marketing arrangements with the companies owned by POET™, LLC.
The following table identifies most of the producers in the U.S. along with their production capacities.
Under
Current
Construction/
Capacity
Expansions
Company
Location
Feedstock
(mgy)
(mgy)
Abengoa Bioenergy Corp.
York, NE
Corn/milo
Colwich, KS
Portales, NM
Ravenna, NE
Aberdeen Energy*
Mina, SD
Corn
Absolute Energy, LLC*
St. Ansgar, IA
Corn
ACE Ethanol, LLC
Stanley, WI
Corn
Adkins Energy, LLC*
Lena, IL
Corn
Advanced Bioenergy
Fairmont, NE
Corn
AGP*
Hastings, NE
Corn
Agri-Energy, LLC*
Luverne, MN
Corn
Al-Corn Clean Fuel*
Claremont, MN
Corn
Amaizing Energy, LLC*
Denison, IA
Corn
Atlantic, IA
Corn
Archer Daniels Midland
Decatur, IL
Corn
1,070
Cedar Rapids, IA
Corn
Clinton, IA
Corn
Columbus, NE
Corn
Marshall, MN
Corn
Peoria, IL
Corn
Wallhalla, ND
Corn/barley
Arkalon Energy, LLC
Liberal, KS
Corn
Aventine Renewable Energy, LLC
Pekin, IL
Corn
Aurora, NE
Corn
Mt. Vernon, IN
Corn
Badger State Ethanol, LLC*
Monroe, WI
Corn
Big River Resources, LLC*
West Burlington, IA
Corn
BioFuel Energy - Pioneer Trail Energy, LLC
Wood River, NE
Corn
BioFuel Energy - Buffalo Lake Energy, LLC
Fairmont, MN
Corn
Blue Flint Ethanol
Underwood, ND
Corn
Bonanza Energy, LLC
Garden City, KS
Corn/milo
Bushmills Ethanol, Inc.*
Atwater, MN
Corn
Calgren
Pixley, CA
Corn
Cardinal Ethanol
Harrisville, IN
Corn
Cargill, Inc.
Blair, NE
Corn
Eddyville, IA
Corn
Cascade Grain
Clatskanie, OR
Corn
Castle Rock Renewable Fuels, LLC
Necedah, WI
Corn
Celunol
Jennings, LA
Sugar cane bagasse
1.5
Center Ethanol Company
Sauget, IL
Corn
Central Indiana Ethanol, LLC
Marion, IN
Corn
Central MN Ethanol Coop*
Little Falls, MN
Corn
21.5
Chief Ethanol
Hastings, NE
Corn
Chippewa Valley Ethanol Co.*
Benson, MN
Corn
Cilion Ethanol
Keyes, CA
Corn
Commonwealth Agri-Energy, LLC*
Hopkinsville, KY
Corn
Corn, LP*
Goldfield, IA
Corn
Cornhusker Energy Lexington, LLC
Lexington, NE
Corn
Corn Plus, LLP*
Winnebago, MN
Corn
Coshoctan Ethanol, OH
Coshoctan, OH
Corn
Dakota Ethanol, LLC*
Wentworth, SD
Corn
DENCO, LLC
Morris, MN
Corn
21.5
E Energy Adams, LLC
Adams, NE
Corn
E Caruso (Goodland Energy Center)
Goodland, KS
Corn
East Kansas Agri-Energy, LLC*
Garnett, KS
Corn
Elkhorn Valley Ethanol, LLC
Norfolk, NE
Corn
ESE Alcohol Inc.
Leoti, KS
Seed corn
1.5
Ethanol Grain Processors, LLC
Obion, TN
Corn
First United Ethanol, LLC (FUEL)
Mitchell Co., GA
Corn
Front Range Energy, LLC
Windsor, CO
Corn
Gateway Ethanol
Pratt, KS
Corn
Glacial Lakes Energy, LLC*
Watertown, SD
Corn
Global Ethanol/Midwest Grain Processors
Lakota, IA
Corn
Riga, MI
Corn
Golden Cheese Company of California*
Corona, CA
Cheese whey
Golden Grain Energy, LLC*
Mason City, IA
Corn
Golden Triangle Energy, LLC*
Craig, MO
Corn
Grand River Distribution
Cambria, WI
Corn
Grain Processing Corp.
Muscatine, IA
Corn
Granite Falls Energy, LLC*
Granite Falls, MN
Corn
Greater Ohio Ethanol, LLC
Lima, OH
Corn
Green Plains Renewable Energy
Shenandoah, IA
Corn
Superior, IA
Corn
Hawkeye Renewables, LLC
Iowa Falls, IA
Corn
Fairbank, IA
Corn
Menlo, IA
Corn
Shell Rock, IA
Corn
Heartland Corn Products*
Winthrop, MN
Corn
Heartland Grain Fuels, LP*
Aberdeen, SD
Corn
Huron, SD
Corn
Heron Lake BioEnergy, LLC
Heron Lake, MN
Corn
Holt County Ethanol
O’Neill, NE
Corn
Husker Ag, LLC*
Plainview, NE
Corn
26.5
Idaho Ethanol Processing
Caldwell, ID
Potato Waste
Illinois River Energy, LLC
Rochelle, IL
Corn
Indiana Bio-Energy
Bluffton, IN
Corn
Iroquois Bio-Energy Company, LLC
Rensselaer, IN
Corn
KAAPA Ethanol, LLC*
Minden, NE
Corn
Kansas Ethanol, LLC
Lyons, KS
Corn
KL Process Design Group
Upton, WY
Wood waste
1.5
Land O’ Lakes*
Melrose, MN
Cheese whey
2.6
Levelland/Hockley County Ethanol, LLC
Levelland, TX
Corn
Lifeline Foods, LLC
St. Joseph, MO
Corn
Lincolnland Agri-Energy, LLC*
Palestine, IL
Corn
Lincolnway Energy, LLC*
Nevada, IA
Corn
Little Sioux Corn Processors, LP*
Marcus, IA
Corn
Marquis Energy, LLC
Hennepin, IL
Corn
Marysville Ethanol, LLC
Marysville, MI
Corn
Merrick & Company
Golden, CO
Waste beer
MGP Ingredients, Inc.
Pekin, IL
Corn/wheat starch
Atchison, KS
Mid America Agri Products/Wheatland
Madrid, NE
Corn
Mid America Agri Products/Horizon
Cambridge, NE
Corn
Mid-Missouri Energy, Inc.*
Malta Bend, MO
Corn
Midwest Renewable Energy, LLC
Sutherland, NE
Corn
Minnesota Energy*
Buffalo Lake, MN
Corn
NEDAK Ethanol
Atkinson, NE
Corn
New Energy Corp.
South Bend, IN
Corn
North Country Ethanol, LLC*
Rosholt, SD
Corn
Northeast Biofuels
Volney, NY
Corn
Northwest Renewable, LLC
Longview, WA
Corn
Otter Tail Ag Enterprises
Fergus Falls, MN
Corn
57.5
Pacific Ethanol
Madera, CA
Corn
Boardman, OR
Corn
Burley, ID
Corn
Stockton, CA
Corn
Panda Ethanol
Hereford, TX
Corn/milo
Parallel Products
Louisville, KY
Beverage waste
5.4
R. Cucamonga, CA
Patriot Renewable Fuels, LLC
Annawan, IL
Corn
Penford Products
Cedar Rapids, IA
Corn
Phoenix Biofuels
Goshen, CA
Corn
Pinal Energy, LLC
Maricopa, AZ
Corn
Pine Lake Corn Processors, LLC*
Steamboat Rock, IA
Corn
Plainview BioEnergy, LLC
Plainview, TX
Corn
Platinum Ethanol, LLC*
Arthur, IA
Corn
Plymouth Ethanol, LLC*
Merrill, IA
Corn
POET™
Sioux Falls, SD
1,208
Alexandria, IN
Corn
#
Ashton, IA
Corn
Big Stone, SD
Corn
Bingham Lake, MN
Corn
Caro, MI
Corn
Chancellor, SD
Corn
Coon Rapids, IA
Corn
Corning, IA
Corn
Emmetsburg, IA
Corn
Fostoria, OH
Corn
#
Glenville, MN
Corn
Gowrie, IA
Corn
Groton, SD
Corn
Hanlontown, IA
Corn
Hudson, SD
Corn
Jewell, IA
Corn
Laddonia, MO
Corn
Lake Crystal, MN
Corn
Leipsic, OH
Corn
Macon, MO
Corn
Marion, OH
Corn
#
Mitchell, SD
Corn
North Manchester, IN
Corn
#
Portland, IN
Corn
Preston, MN
Corn
Scotland, SD
Corn
Prairie Horizon Agri-Energy, LLC
Phillipsburg, KS
Corn
Quad-County Corn Processors*
Galva, IA
Corn
Range Fuels
Soperton, GA
Wood waste
Red Trail Energy, LLC
Richardton, ND
Corn
Redfield Energy, LLC*
Redfield, SD
Corn
Reeve Agri-Energy
Garden City, KS
Corn/milo
Renew Energy
Jefferson Junction, WI
Corn
Siouxland Energy & Livestock Coop*
Sioux Center, IA
Corn
Siouxland Ethanol, LLC
Jackson, NE
Corn
Southwest Iowa Renewable Energy, LLC*
Council Bluffs, IA
Corn
Sterling Ethanol, LLC
Sterling, CO
Corn
Tate & Lyle
Loudon, TN
Corn
Ft. Dodge, IA
Corn
The Andersons Albion Ethanol LLC
Albion, MI
Corn
The Andersons Clymers Ethanol, LLC
Clymers, IN
Corn
The Andersons Marathon Ethanol, LLC
Greenville, OH
Corn
Tharaldson Ethanol
Casselton, ND
Corn
Trenton Agri Products, LLC
Trenton, NE
Corn
United Ethanol
Milton, WI
Corn
United WI Grain Producers, LLC*
Friesland, WI
Corn
US BioEnergy Corp.
Albert City, IA
Corn
Woodbury, MI
Corn
Hankinson, ND
Corn
#
Central City , NE
Corn
#
Ord, NE
Corn
Dyersville, IA
Corn
#
Janesville, MN
Corn
#
Marion, SD
Corn
Utica Energy, LLC
Oshkosh, WI
Corn
VeraSun Energy Corporation
Aurora, SD
Corn
Ft. Dodge, IA
Corn
Albion, NE
Corn
Charles City, IA
Corn
Linden, IN
Corn
Welcome, MN
Corn
#
Hartely, IA
Corn
#
Bloomingburg, OH
Corn
#
Western New York Energy, LLC
Shelby, NY
Corn
Western Plains Energy, LLC*
Campus, KS
Corn
Western Wisconsin Renewable Energy, LLC*
Boyceville, WI
Corn
White Energy
Hereford, TX
Corn/Milo
Russell, KS
Milo/wheat starch
Wind Gap Farms
Baconton, GA
Brewery waste
0.4
Renova Energy
Torrington, WY
Corn
Xethanol BioFuels, LLC
Blairstown, IA
Corn
Yuma Ethanol
Yuma, CO
Corn
Total Current Capacity at 141 ethanol biorefineries
7,999.9
Total Under Construction (59)/Expansions (7)
5,406.0
Total Capacity
13,405.9
* locally-owned
# plant under construction
Updated: February 12, 2008
International
Ethanol production is expanding internationally. Brazil has long been the world’s largest producer and exporter of ethanol, although since 2005 ethanol production in the U.S. has exceeded Brazilian production. Ethanol is produced more cheaply in Brazil than in the U.S. because of the use of sugarcane, a less expensive raw material alternative to corn. However, because of various tariffs on the importation of ethanol into the U.S., the price of ethanol produced in the U.S. is currently more competitive than ethanol imported from Brazil. In the event that these tariffs are reduced or eliminated, which are scheduled to expire in December 2008, the price of ethanol produced in the U.S. may become less competitive, which could adversely impact our ability to sell ethanol.
In addition, the Caribbean Basin Initiative, or CBI, allows for ethanol produced in participating Caribbean Basin countries to be imported into the U.S. duty free. While the CBI caps the amount of duty free ethanol imported into the U.S. at 7% of total U.S. production from the previous year, as total production in the U.S. grows, the amount of ethanol produced from the Caribbean area and sold in the U.S. will grow accordingly, which could impact our and the industry’s ability to sell ethanol.
Alternative Production Methods and Fuels
Alternative ethanol production methods, fuels and gasoline oxygenates are continually under development. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, municipal solid waste, and energy crops. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass may create opportunities to produce ethanol in areas which are unable to grow corn. In addition, beginning in 2010, the Energy Independence and Security Act of 2007 (HR 6) requires that a specific volume of the renewable fuels standard, or RFS, be met by ethanol derived from cellulosic feedstocks. If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively with companies that incorporate this production method.
Further, a number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells or clean burning gaseous fuels. Like ethanol, the emerging fuel cell industry offers a technological option to address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to decrease fuel costs, lessen dependence on crude oil and reduce harmful emissions. If the fuel cell and hydrogen industries continue to expand and gain broad acceptance and hydrogen becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our profitability.
Distillers Grains
We also face direct competition with numerous ethanol producers that produce distillers grains as a by-product of the production process. Sales of distillers grains are highly dependent on product quality, availability, and price of competing feed ingredients such as corn and soybean meal. As domestic ethanol production increases, the amount of distillers grains entering the market is expected to increase and may reach the point of market saturation. If it reaches this point, we may need to sell an increasing supply of DDGS and Dakota Gold™ to international markets.
Federal and State Government Supports
Various federal and state laws, regulations, and programs have led to an increasing use of ethanol in fuel, including subsidies, tax credits, policies and other forms of financial incentives. Some of these laws provide economic incentives to produce and blend ethanol and others mandate the use of ethanol.
The Renewable Fuels Standard
The most recent ethanol supports are contained in the Energy Independence and Security Act of 2007 (HR 6) which was signed into law on December 19, 2007. The bill increases the renewable fuels standard, or RFS, which sets the annual requirements for the amount of renewable fuels produced and used in motor vehicles. The first RFS was established under the Energy Policy Act of 2005, which required that 4 billion gallons of ethanol and biodiesel be used in 2006 and 7.5 billion gallons be used by 2012. Under HR 6, however, the RFS is increased further, requiring 9 billion gallons of renewable fuels in 2008 and progressively increasing to 36 billion gallons by 2022. Beginning in 2010, a specific volume of the annual mandate is met by ethanol derived from cellulosic feedstocks, as opposed to corn. The specified volume of cellulosic ethanol use required increases incrementally, culminating in the use of 16 billion gallons of cellulosic ethanol annually in 2022. While the precise impact of HR 6 cannot yet be determined, we anticipate that it will maintain or enhance production of ethanol in the U.S.
The Clean Air Act and Oxygenated Gasoline Program
Ethanol sales have been favorably affected by the Clean Air Act amendments of 1990, particularly the Oxygenated Gasoline Program, which became effective November 1, 1992. The Oxygenated Gasoline Program requires the sale of oxygenated motor fuels during the winter months in certain major metropolitan areas to reduce carbon monoxide pollution. Ethanol use has also increased as the result of a second Clean Air Act program, the Reformulated Gasoline Program. This program became effective January 1, 1995 and requires the sale of reformulated gasoline in numerous areas to reduce pollutants, specifically those that contribute to ground level ozone, better known as smog. Reformulated gasoline that meets the performance criteria set by the Clean Air Act can be reformulated in a number of ways, including the addition of oxygenates to the gasoline. The two major oxygenates added to reformulated gasoline pursuant to these programs are MTBE and ethanol. MTBE has been linked to groundwater contamination and has been banned from use in approximately 25 states.
The Volumetric Ethanol Excise Tax Credit
The use of ethanol as an alternative fuel source has been aided by federal tax policy. In 2004, the Volumetric Ethanol Excise Tax Credit (“VEETC”) was created. This law amended the federal gasoline excise tax structure effective January 1, 2005. As amended, the law creates a new volumetric ethanol excise tax credit of $0.51 per gallon of ethanol blended at 10%. The credit provided by VEETC replaced an exemption which allowed ethanol blended fuel to be taxed at a lower rate than regular gasoline. The use of ethanol as a fuel additive is enhanced by the availability of a credit from the federal gasoline excise tax. The VEETC is scheduled to expire on December 31, 2010
Small Ethanol Producer Tax Credit
The Energy Policy Act of 2005 expanded who qualifies for the small ethanol producer tax credit. Historically, small ethanol producers were allowed a 10-cents-per-gallon production income tax credit on up to 15 million gallons of production annually. The size of the plant eligible for the tax credit was limited to 30 million gallons. Under the Energy Policy Act, the size limitation on the production capacity for small ethanol producers increased from 30 million to 60 million gallons. The tax credit is capped at $1.5 million per year per producer. Because of our plant’s expansion in May 2007, we are no longer eligible for this credit.
Clean-Fuel Vehicle Refueling Equipment Tax Credit
The Energy Policy Act of 2005 created a new tax credit that permits taxpayers to claim a 30% credit (up to $30,000) for the cost of installing clean-fuel vehicle refueling equipment, such as an E85 fuel pump, to be used in a trade or business of the taxpayer or installed at the principal residence of the taxpayer. Under the provision, clean fuels are any fuel at least 85% of the volume of which consists of ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas and hydrogen and any mixture of diesel fuel and biodiesel containing at least 20% biodiesel. The provision is effective for equipment placed in service until January 1, 2010. The credit has helped raise consumer awareness of alternative sources of fuel including ethanol.
Imported Ethanol Tariffs and Quotas
Currently, there is a $0.54 per gallon tariff on imported ethanol, which is scheduled to expire in 2008. In addition, ethanol imports from 24 countries in Central America and the Caribbean region are exempted from this tariff under the Caribbean Basin Initiative or CBI, which provides that specified nations may export annually to the U.S. an aggregate of 7.0% of U.S. ethanol production, with additional exemptions from ethanol produced from feedstock in the Caribbean region over the 7.0% limit.
State Legislation Banning or Limiting MTBE Use
As of August 2007, 25 states, including California and New York, have banned or significantly limited the use of MTBE due to environmental and public health concerns. Ethanol has served as a replacement for much of the discontinued volumes of MTBE and is expected to continue to replace future volumes of MTBE that are removed from the fuel supply.
South Dakota
In South Dakota, the state provides an incentive production payment to ethanol producers operating in South Dakota. The production incentive consists of a direct payment to South Dakota ethanol producers of up to $0.20 per gallon, which is divided among producers of fuel ethanol within South Dakota up to a maximum of $1 million per year per plant (a maximum of $83,333 per month in 2007) and a maximum of $10 million over the life of a plant. The program caps the payments that can be distributed to all plants based in South Dakota in a program year to no more than $7 million in payments in 2007 (program year ends on June 30), and every year thereafter. The payments are distributed to each plant in proportion to the total number of gallons of ethanol produced and marketed annually by all the plants in South Dakota. As more plants commence production, or existing plants increase production, each plant receives a lower proportionate share of the maximum payment under the program.
Environmental Regulation and Costs
We are subject to extensive environmental regulation at the federal and state levels. The federal environmental regulations with which must comply were promulgated by the U.S. Environmental Protection Agency (EPA) pursuant to the Clean Air Act. The state environmental regulations with which we must comply, in contrast, are promulgated by the South Dakota Department of Environment and Natural Resources (DENR). The EPA and the DENR regulate air quality, particularly our plant’s emissions into the air. The DENR also regulates water collection and discharge. In addition to its own enforcement authority under this law, the EPA has delegated permitting and enforcement authority to the DENR. To conduct operations, we are required to have the following permits from these and other agencies:
· Title Five Operating Permit from the DENR. In South Dakota, the Title Five Operating Permit serves as the air quality and operation permit for our plant. We must conduct ongoing emissions testing to verify compliance with the Title Five Operating permit. This permit is due for renewal in September 2011.
· Bureau of Alcohol, Tobacco, Firearms and Explosives and Fuel Permit from the U.S. Department of Treasury. We are required to have this permit because of the alcohol content of ethanol. The permit is due for renewal annually.
· General Permit for Storm Water Discharge. This permit is required for the runoff of storm water from our plant and is due for renewal every five years.
While we are currently in compliance with all applicable environmental laws, regulations and permits, we must continue to comply with the permits and regulatory requirements. To ensure this, we maintain an on-going compliance program. Maintaining compliance can also require us to incur expenditures for such things as new or upgraded equipment or processes, some of which can be material and costly at times.
In addition, federal and state government’s regulation of the environment changes constantly. It is possible that more stringent federal or state environmental rules or regulations could be adopted, which could increase our plant’s future operating costs and expenses. It also is possible that federal or state environmental rules or regulations could be adopted that could have an adverse effect on the use of ethanol. For example, changes in the environmental regulations regarding ethanol’s use due to currently unknown effects on the environment could have an adverse effect on the ethanol industry. Furthermore, our plant’s operations are governed by the Occupational Safety and Health Administration (“OSHA”). OSHA regulations may change such that the future costs of the operation of our plant may increase. Any of these regulatory factors may result in higher costs or other materially adverse conditions effecting our operations, cash flows and financial performance.
Management and Employees
POET™ Plant Management, LLC manages the day-to-day operations of our plant under a management agreement. Under the agreement, which is in effect until June 2015, POET™ Plant Management receives a fixed annual fee, adjusted annually for inflation, and an incentive bonus based on our profitability. We also pay certain expenses incurred with respect to the operation of the plant while other expenses, including, but not limited to, the provision of a full-time technical manager and general manager, are included as part of POET™ Plant Management’s fees. Mr. Blaine Gomer, our plant’s general manager, is an employee of POET™ Plant Management, and is responsible for operations and production at the plant on a day-to-day basis.
As of the date of this filing, our plant employs 48 employees, including a commodities manager, a commodities supervisor, an operations manager, a maintenance manager, a microbiologist, a chief mechanical operator, a controller, plant operators, maintenance technicians, grains assistants, accountants, and a membership coordinator. This does not include Mr. Gomer and the technical manager, both of whom are employees of POET™ Plant Management.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to the Securities Exchange Act of 1934, as amended, are filed with the SEC. Such reports and other information filed by us with the SEC are available on the SEC website (www.sec.gov). The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy, and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing.
Our website is at www.poetenergy.com, then clicking on “Meet POET,” “Plants,” “Big Stone, SD,” and finally “Becoming an Investor.” Our reports, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, are not directly available on our website as we instruct readers to obtain the reports through a link to www.sec.gov. However, we provide paper copies of the reports to any person who requests it, free of charge. Beginning in early May 2008, we will make available on our website our most recent Annual Report on Form 10-K.
Item 1A.
Item 1A. Risk Factors.
Risks Related to Our Business
Our financial performance is dependent on market prices for ethanol and distillers grains and corn, and our financial condition and results of operation are directly affected by changes in these market prices. Our results of operations and financial condition are significantly affected by the cost and supply of corn and by the selling price for ethanol and distillers grains. Changes in the price and supply of these commodities are subject to and determined by market forces over which we have no or little control, including overall supply and demand, government programs and policies, weather, availability and price of competing products, and other factors.
Our business is highly sensitive to corn prices, and we generally cannot pass on increases in corn prices to our customers. Corn is the principal raw material we use to produce ethanol and distillers grains. Because ethanol competes with fuels that are not corn-based, we generally are unable to pass along increased corn costs to our customers, and, accordingly, rising corn prices tend to produce lower profit margins. At certain levels, corn prices would make ethanol uneconomical to use in fuel markets. The price of corn is influenced by weather conditions (especially droughts) and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors, including government policies and subsidies with respect to agriculture and international trade, and global and local supply and demand. The price of corn has fluctuated significantly in the past and may fluctuate significantly in the future. In addition, increasing domestic ethanol capacity could boost demand for corn and result in increased corn prices. We may also have difficulty from time to time in purchasing corn on economical terms due to supply shortages. Any supply shortage could require us to suspend operations until corn became available at economical terms. Suspension of operations could have a material adverse effect on our business, results of operations and financial condition.
The price of distillers grains is affected by the price of other commodity products, and decreases in the price of these commodities could decrease the price of distillers grains. Distillers grains compete with other protein-based animal feed products such as soybean meal. The price of distillers grains may decrease when the price of competing feed products decrease. The prices of competing animal feed products are based in part on the prices of the commodities from which they are derived. Downward pressure on commodity prices, such as soybeans, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers grains. As a result, we may experience lower revenue and income.
Our business is subject to seasonal fluctuations. Our operating results are influenced by seasonal fluctuations in the price of our primary production inputs, namely corn, and the price of our primary product, ethanol. In recent years, the spot price of corn tends to rise during the spring planting season in May and June and tends to decrease during the fall harvest in October and November. The price for natural gas, however, tends to move opposite of corn and tends to be lower in the spring and summer and higher in the fall and winter. In addition, our ethanol prices are substantially correlated with the price of unleaded gasoline. As a result, because the price of unleaded gasoline tends to rise during the summer, the price of ethanol generally rises in the summer.
Hedging transactions involve risks that could harm our profitability. In an attempt to minimize the effects of the volatility of corn and natural gas on operating profits, we engage in hedging activities in the corn and natural gas futures markets. The effectiveness of such hedging activities is dependent, among other things, upon the cost of corn and natural gas and our ability to sell sufficient products to utilize all of the corn and natural gas subject to the futures contracts. There is no assurance that our hedging activities will reduce the risk caused by price fluctuation which may leave us vulnerable to high corn and natural gas prices. In addition, we may choose not to take hedging positions in the future, which may adversely affect our financial condition if corn and natural gas prices increase. Our hedging activities can also result in increased costs because price movements in corn and natural gas are highly volatile and are influenced by many factors that are beyond our control.
Our business is not diversified because it is limited to the fuel grade ethanol industry, which may limit our ability to adapt to changing business and market conditions. Our sole business is the production and sale of fuel grade ethanol produced from corn and its by-product, distillers grains. Our plant does not have the capability of producing industrial or food and beverage grade ethanol, which is used in such products as cosmetics, perfume, paint thinner and vinegar. Our plant is also not equipped to capture carbon dioxide, another co-product of the ethanol production process. The lack of diversification of our business may limit our ability to adapt to changing business and market conditions.
We are heavily dependent upon POET™, LLC. We have several agreements in place with companies owned and controlled by POET™, LLC, of Sioux Falls, South Dakota, including those related to the purchase or marketing of ethanol and distillers grains, management of the plant, design and construction, research and technology, and information technology. If any of the agreements were to terminate, we might not be able to secure suitable and timely replacements for those services at a reasonable cost or at all, which would materially harm our business.
We are dependent upon POET™ Ethanol Products, LLC to purchase and market all of the ethanol produced at our plant. POET™ Ethanol Products is the exclusive purchaser of all of the ethanol produced at our plant which, in turn, markets and transports the ethanol to refineries located throughout the U.S. If POET™ Ethanol Products breaches the ethanol marketing agreement or is not in the financial position to purchase all of the ethanol produced, we may not have any readily available means to sell the ethanol and our financial condition will be adversely and materially affected. If the ethanol marketing agreement with POET™ Ethanol Products were to terminate, we would be forced to seek other arrangements to sell the ethanol produced, but there are no assurances that these arrangements would achieve results comparable to those achieved by POET™ Ethanol Products.
Interruptions in energy supplies could delay or halt production at our plant, which will reduce our profitability. Ethanol production requires a constant and consistent supply of energy, including electricity, steam and natural gas. If there is any interruption in our plant’s supply of energy for whatever reason, such as supply, delivery or mechanical problems, we may be required to halt production. If production is halted for any extended period of time, it will reduce our profitability. Our plant has agreements with various companies to provide it with necessary energy, but we cannot assure that these companies will continue to be able to supply reliably such energy. If our plant were to suffer interruptions in energy supply, our business would be harmed.
We have limited natural gas available for operations and rely heavily on the adjacent Big Stone Plant. We rely on Big Stone Plant to supply approximately 50% of our energy needs for production. When Big Stone Plant steam is not operating or the transfer of steam to our plant is interrupted, we rely on our natural gas supply to power our boilers in order to generate steam for the production process. The natural gas supply, however, is limited as it alone cannot power our plant to operate at its full 75 million annual name-plate production capacity. Therefore, if Big Stone Plant shuts down for any prolonged period of time, our plant must reduce production based on the amount of natural gas that is supplied to the plant. Reducing production could have a material adverse effect on our revenues and profitability.
Risks Related to the Industry
Overcapacity in the industry may result in a decrease in the price of ethanol and distillers grains. Excess capacity in the ethanol industry would have an adverse impact on our results of operations, cash flows and general financial condition. Excess capacity may also result or intensify from increases in production capacity coupled with insufficient demand. If the demand for ethanol does not grow at the same pace as increases in supply, we would expect the price for ethanol to decline. If excess capacity in the ethanol industry occurs, the market price of ethanol may decline to a level that is inadequate to generate sufficient cash flow to cover our costs. In addition, because ethanol production produces distillers grains as a by-product, increased ethanol production could lead to increased supplies of distillers grains. An increase in the supply of distillers grains, without corresponding increases in demand, could lead to lower prices or an inability to sell our distillers grains. Any decline in the price of distillers grain or the distillers grain market generally could have a material adverse effect on our business.
We operate in an intensely competitive industry and there is no assurance that we will be able to compete effectively. The ethanol business is highly competitive, and other companies presently in the market, or that are about to enter the market, could adversely affect prices for the products we sell. Commodity groups in the Midwest have encouraged the construction of ethanol plants, and there are
numerous other entities considering the construction of ethanol plants. Nationally, the ethanol industry is becoming much more competitive given the substantial construction and expansion occurring in the industry. We also compete with other ethanol producers such as Archer Daniels Midland, Cargill, among others, all of which are capable of producing significantly greater quantities of ethanol than the amount we produce. In light of such competition, there is no assurance that we will be able to compete effectively in the industry.
Competition from the advancement of technology may lessen the demand for ethanol and negatively impact our profitability. Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing more efficient engines, hybrid engines and alternative clean power systems using fuel cells or clean burning gaseous fuels. Vehicle manufacturers are working to develop vehicles that are more fuel efficient and have reduced emissions using conventional gasoline. Vehicle manufacturers have developed and continue to work to improve hybrid technology, which powers vehicles by engines that utilize both electric and conventional gasoline fuel sources. In the future, the emerging fuel cell industry offers a technological option to address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to decrease fuel costs, lessen dependence on crude oil and reduce harmful emissions. If the fuel cell and hydrogen industries continue to expand and gain broad acceptance, and hydrogen becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our financial condition.
Corn-based ethanol may compete with cellulose-based ethanol in the future, which could make it more difficult for us to produce ethanol on a cost-effective basis. Most ethanol is currently produced from corn and other raw grains, such as milo or sorghum-especially in the Midwest. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, municipal solid waste, and energy crops. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas which are unable to grow corn. Although current technology is not sufficiently efficient to be competitive, new conversion technologies may be developed in the future. By 2010, the renewable fuels standard mandates that a specific volume of ethanol be derived from cellulosic feedstocks. If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively. If we are unable to produce ethanol as cost-effectively as cellulose-based producers, our ability to generate revenue will be negatively impacted.
Consumer resistance to the use of ethanol based on the belief that ethanol is expensive, adds to air pollution, harms engines and takes more energy to produce than it contributes, may affect the demand for ethanol which could affect our ability to market our product. Certain individuals believe that use of ethanol will have a negative impact on retail prices. Many also believe that ethanol adds to air pollution and harms car and truck engines. Still other consumers believe that the process of producing ethanol actually uses more fossil energy, such as oil and natural gas, than the amount of ethanol that is produced. These consumer beliefs could potentially be wide-spread. If consumers choose not to buy ethanol, it would affect the demand for the ethanol that we produce which could lower demand for ethanol and negatively affect our profitability.
Risks Related to Governmental and Regulatory Action
A change in government policies favorable to ethanol may cause demand for ethanol to decline. Growth and demand for ethanol may be driven primarily by federal and state government policies, such as state laws banning MTBE and the national renewable fuels standard. The continuation of these policies is uncertain, which means that demand for ethanol may decline if these policies change or are discontinued. A decline in the demand for ethanol is likely to cause lower ethanol prices which in turn will negatively affect our business and financial condition.
Tariffs effectively limit imported ethanol into the U.S., and their reduction or elimination could undermine the ethanol industry in the U.S. Imported ethanol is generally subject to a $0.54 per gallon tariff that was designed to offset the $0.51 per gallon ethanol incentive available under the federal excise tax incentive program for refineries that blend ethanol in their fuel. There is, however, a special exemption from this tariff for ethanol imported from 24 countries in Central America and the Caribbean Islands, which is limited to a total of 7% of U.S. ethanol production per year. Imports from the exempted countries may increase as a result of new plants in development. Since production costs for ethanol in these countries are significantly less than what they are in the U.S., the duty-free import of ethanol through the countries exempted from the tariff may negatively affect the demand for domestic ethanol and the price at which we sell our ethanol. We do not know the extent to which the volume of imports would increase or the effect on U.S. prices for ethanol if the tariff is not renewed beyond its current expiration date in December 2008. Any changes in the tariff or exemption from the tariff could have a material adverse effect on our business and financial condition.
Government incentives for ethanol production may be eliminated in the future. The ethanol industry and our business are assisted by various federal ethanol tax incentives, including those contained in The Energy Independence and Security Act of 2007. Under this law, the renewable fuels standard is increased to a mandate of 36 billion gallons by 2022. The renewable fuels standard helps support a market for ethanol that might disappear without this incentive. The elimination or reduction of this law could reduce the market for ethanol, which could reduce prices and our revenues by making it more costly or difficult for us to produce and sell ethanol. If this and other federal tax incentives are eliminated or sharply curtailed, we believe that a decreased demand for ethanol will result, which could negatively affect our profitability and financial condition.
Changes in environmental regulations or violations of the regulations could reduce our profitability. We are subject to extensive air, water and other environmental laws and regulations. In addition some of these laws require our plant to operate under a number of environmental permits. These laws, regulations and permits can often require expensive pollution control equipment or operation changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, damages, criminal sanctions, permit revocations and/or plant shutdowns. We do not assure you that we have been, are or will be at all times in complete compliance with these laws, regulations or permits or that we have had or have all permits required to operate our business. We do not assure you that we will not be subject to legal actions brought by environmental advocacy groups and other parties for actual or alleged violations of environmental laws or our permits. Additionally, any changes in environmental laws and regulations, both at the federal and state level, could require us to invest or spend considerable resources in order to comply with future environmental regulations. The expense of compliance could be significant enough to reduce our profitability and negatively affect our financial condition.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our plant is located immediately adjacent to Big Stone Plant in the city of Big Stone City, Grant County, South Dakota. The land on which our plant is located is leased from Big Stone-Grant Industrial Development and Transportation, LLC, which is owned by Otter Tail Power Company, Montana-Dakota Utilities, and NorthWestern Corporation. The term of the lease is for 99 years. The rent is $2,520 per year until December 31, 2010, after which the rent is increased by 5.0%. In addition, our plant has transportation facilities including a rail track, rail spur and paved access roads.
Our plant consists of the following main buildings or properties:
· An administrative building, which contains office equipment, computer systems, and furniture and fixtures.
· A mechanical building, which contains boilers and water treatment equipment.
· A process building, which contains slurry and fermentation equipment, drums and a lab.
· An evaporation building, which contains evaporators and related equipment.
· A distillation building, which contains distillation columns and mole sieves.
· A ring dryer building, which contains a dryer and a fluid bed.
All of our tangible and intangible property, including our leasehold interest, easement rights, improvements, equipment, personal property, and contracts, serve as the collateral for the debt financing with U.S. Bank National Association, of Sioux Falls, South Dakota, which is described below under “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations-Indebtedness.”
Item 3.
Item 3. Legal Proceedings.
From time to time in the ordinary course of business, we may be named as a defendant in legal proceedings related to various issues, including without limitation, workers’ compensation claims, tort claims, or contractual disputes. We are not currently involved in any material legal proceedings, directly or indirectly.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
We did not submit any matter to a vote of our security holders through the solicitation of proxies or otherwise during the fourth quarter of 2007.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchaser of Equity Securities.
As of March 5, 2008, Northern Growers had 963 members.
Trading Activity and Restrictions
Northern Growers’ capital units are not traded on an established trading market such as a stock exchange or The NASDAQ Stock Market; rather, the capital units are traded on a “qualified matching service” as defined by the publicly traded partnership rules of the federal tax code. Under the qualified matching service, interested buyers and sellers of capital units are matched on the basis of a set of rules and conditions set forth by the federal tax code, and all trades are subject to board of managers’ approval. Northern Growers’ qualified matching service is operated through Alerus Securities Corporation, a registered broker-dealer operating an SEC registered Alternative Trading System. The following table contains historical information by quarter for the past two years regarding the trading of capital units under the qualified matching service:
(1) All unit prices and number of units traded are adjusted to reflect a four-for-one capital unit split made effective on September 1, 2005 and a two-for-one split made effective on July 1, 2006. In addition, our qualified matching service does not permit firm bids per the rules established by the federal tax code; thus, the prices reflect actual sales.
There were no issuer purchases of equity securities during the fourth quarter ended December 31, 2007.
As a limited liability company being taxed as a partnership, Northern Growers is required to restrict the transfer of its capital units in order to preserve its preferential single-level tax status. Such restrictions are set forth in Northern Growers’ Operating Agreement and Capital Units Transfer System. Under the Capital Units Transfer System, transfers are limited to those through our qualified matching service, transfers made to qualified family members, or transfers by gift, block, upon death, and like transfers, subject to final board of managers’ approval.
Pursuant to the Operating Agreement, a minimum of 2,500 capital units is required to become and remain a member. In addition to the transfer restrictions described above, the board of managers retains the right to redeem the capital units at $0.20 per capital unit in the event a member breaches the Operating Agreement, upon a member’s failure to fulfill the membership requirements and with respect to other matters. Under the qualified matching service, the number of capital units traded annually cannot exceed 10% of Northern Growers’ total issued and outstanding capital units.
Distributions
Under the terms of Northern Growers’ Amended and Restated Operating Agreement dated January 1, 2006, the board of managers is required to make annual (or more frequent) distributions to its members and may not retain more than $200,000 of net cash from operations, unless (i) a super majority of the board of managers (75%) decides otherwise, (ii) it would violate or cause a default under the terms of any debt financing or other credit facilities, or (iii) it is otherwise prohibited by law. For further details of the restrictions under our debt facilities, please see “Item 7, Management’s Discussion and Analysis of Financial Conditions and Results of Operations-Indebtedness.” Distributions are required to be issued to members of record as of the last day of the quarter immediately prior to the quarter in which the distribution was approved by the board of managers.
In 2006, Big Stone made cash distributions to Northern Growers of approximately $22.95 million and $6.79 million to its minority member. Northern Growers, in turn, distributed to its members approximately $22.67 million, or $0.448 per capital unit.
In 2007, Big Stone made cash distributions to Northern Growers of approximately $19.52 million and $5.78 million to its minority member. Northern Growers, in turn, distributed to its members approximately $17.32 million, or $0.342 per capital unit. Thus far in 2008, Northern Growers distributed to its members approximately $1.5 million, or $0.03 per capital unit.
The ability to issue similar distributions is substantially dependent upon our profitability, the discretion of our board of managers subject to the provisions of the Operating Agreement, and the approval from our lender, U.S. Bank. Unless current economic conditions improve, which we do not expect in the near term, we do not anticipate making similar distributions to members in 2008 as in 2007.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth our selected financial data for the periods indicated. The audited financial statements included in Item 8 of this report have been audited by our independent auditors, Eide Bailly LLP.
(1) Northern Growers reorganized from a cooperative to a limited liability company on April 1, 2003.
(2) Adjusted for a four-for-one capital unit split made effective September 1, 2005 and a two-for-one split effective July 1, 2006.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
You should read the following discussion along with our financial statements and the notes to our financial statements included elsewhere in this report. The following discussion contains forward-looking statements that are subject to risks, uncertainties and assumptions. Our actual results, performance and achievements may differ materially from those expressed in, or implied by, such forward-looking statements. See “Cautionary Statement Regarding Forward-Looking Information” at the beginning of this report.
Overview
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 near the city of 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 are an immaterial source of revenue and income. The price of ethanol is influenced by factors such as prices of unleaded gasoline and the petroleum markets, weather, government policies and programs, and supply and demand. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The price of distillers grains is influenced by 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 Big Stone Plant. The cost of natural gas and 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.
Executive Summary
We generated higher than expected profits in 2007 but significantly lower profits compared to 2006. Our net income decreased from $40.7 million in 2006 to $14.1 million in 2007. The major factors driving this result are an increase in corn costs, an increase in production costs associated with our plant’s expansion, and a decrease in ethanol prices. Our corn costs increased 85% from 2006 to 2007 primarily due to an increase in the market price of corn, which is driven by increased demand from the ethanol industry and lower corn supply projections. The price of ethanol decreased 11% between periods because of excess supply in the industry. Production costs increased after production volume increased 22% following the expansion of our plant to a 75 million gallon facility in May 2007. Partially offsetting this, however, are increases in our revenue from the sale of ethanol and distillers grains. Revenue from the sale of ethanol rose because of an increase in sales volume following a 22% increase in production. Revenue from the sale of distillers grains increased 31% between periods, due principally to increases in production and price. The price of distillers grains rose because of increases in demand from livestock producers who increased their use of distillers grains for feed purposes due to the high price of corn and other protein based feed products.
We are expecting significant challenges in 2008, which may lead to further profit erosion. Our first challenge is dealing with the high price of corn. While the 2007 corn crop in the U.S. set a record of 13.1 billion bushels harvested, up 24% from 2006, we expect prices to linger at or above their current level ($5 per bushel as of January 2008) through at least the summer. A factor contributing to this expectation is the lower than projected carryout from 2007. On January 11, 2008, the USDA revised its December carryout projection from 1.797 billion bushels to 1.438 billion bushels, because of increased feed use for livestock and other residual uses. Another factor, and an additional challenge we face, is the increase in demand for corn from the ethanol industry. In the U.S., another 5.6 billion gallons of ethanol are expected to enter the market in the next 18 months, all from new or expanding plants. Unless new markets for ethanol open up to absorb these gallons, we anticipate that prices will remain depressed or possibly commence a downward trend. The newly enacted renewable fuels standard, or RFS, which mandates the use in the U.S. of 9.0 billion gallons of renewable fuels in 2008 and 15 billion gallons by 2015, though it is expected to create new markets to absorb this excess supply, the timing of its impact in 2008 and beyond is uncertain.
While challenges lie ahead, we are encouraged by factors that could partially counter the effects of these challenges. Distillers grains’ revenues are expected to remain strong, as the high prices of corn and soybean meal should make the use of distillers grains more attractive to livestock producers. We also believe that natural gas costs should remain stable through at least June because of high inventories nationwide. Further, our plant should be more efficient as a result of new economies of scale following expansion. Nevertheless, we believe it will be difficult to overcome completely the challenges that lie ahead. Sterner fiscal measures are likely to be necessary, including preserving more cash from operations, which will mean a decrease in distributions to members compared to 2007.
Results of Operations
Comparison of years ended December 31, 2007 and December 31, 2006.
Revenues - Revenue increased $15.4 million, or 12.5%, to $138.2 million for the year ended December 31, 2007 from $122.8 million for the year ended December 31, 2006. Revenues increased due to an increase in sales of ethanol and distillers grains.
Revenue from the sale of ethanol increased $10.4 million, or 10%, to $116.1 million for the year ended December 31, 2007 from $105.7 million for the year ended December 31, 2006. The increase is primarily due to a 23% increase in sales volume between periods, offset by an 11% decrease in the average sales price per gallon. Sales volume increased because of an increase in production volume following our plant’s expansion, only to be offset by the decrease in ethanol prices between periods due to the excess supply of ethanol in the market.
Revenue from the sale of distillers grains increased $5.1 million, or 31%, to $21.4 million for the year ended December 31, 2007 from $16.3 million for the year ended December 31, 2006. The increase is due to increases in sales volume and sales price per ton. Like ethanol, sales increased due to an increase in plant production between periods. Unlike ethanol, however, the price of distillers grains increased approximately 18% in conjunction with the rise in prices of corn and soybean meal.
Cost of Revenues - Cost of revenues, which includes production expenses, increased $50.0 million, or 80%, to $112.7 million for the year ended December 31, 2007 from $62.7 million for the year ended December 31, 2006. The increase is primarily due to an increase in corn costs and production expenses.
Corn costs per bushel increased 85% between periods. The increase is primarily the result of an approximately 65% increase in the market price of corn between periods. The market price continued to be adversely impacted by lower corn carryout from 2006 and from a very strong demand from the ever-growing ethanol industry. With a lower than projected carryout for 2007 and increased demand from the ethanol industry and world markets, we believe that the current trend of high corn prices is likely to remain through 2008.
Also included in the increase in corn costs is a $1.9 million net loss under our corn price risk management program. Gains and losses that result from a change in value of corn and natural gas hedging and forward contract instruments are recognized in cost of revenues as the changes occur. Gains are recognized as a decrease to cost of revenues, and losses are recognized as an increase to cost of revenues. For the year ended December 31, 2007, cost of revenues includes losses of $1.6 million from the use of corn hedging instruments. This loss is caused by a significant increase in the market price of corn in the fourth quarter of 2007 and the impact that the price decrease had on the value of our hedging instruments at December 31, 2007. The remaining part of the $1.9 million loss is attributed to losses on our forward contracts for corn at December 31, 2007.
In addition, cost of revenues rose because the 22% increase in production volume following expansion increased overall production expenses. Expenses, including chemicals, depreciation, electricity, and maintenance, all rose directly due to expansion.
General and Administrative Expenses - General and administrative expenses decreased $1.56 million, or 25%, to $4.80 million for the year ended December 31, 2007 from $6.36 million for the year ended December 31, 2006. The decrease is primarily due to a decrease in management incentive fees and costs, which are attributed to a decrease in net income.
Interest Expense - Interest expense increased $1.6 million, or 128%, to $2.9 million for the twelve months December 31, 2007 from $1.3 million for the twelve months December 31, 2006. The increase is primarily due to an increase of $18.3 million of long-term debt used to finance various construction projects in 2007 including expansion.
Net Income - Net income decreased $26.6 million to $14.1 million for the year ended December 31, 2007 from $40.7 million for the year ended December 31, 2006. This change is caused primarily by an increase in corn costs, offset partially by an increase in revenues from the sale of ethanol and distillers grains.
Comparison of years ended December 31, 2006 and December 31, 2005.
Revenues - Revenue from the sale of ethanol increased 46% from the year ended December 31, 2005 to the year ended December 31, 2006. The increase is due to a 41% increase in the average price of ethanol per gallon and a 4% increase in sales volume. Ethanol prices rose significantly between periods as a result of increased demand from refineries and increases in the price of unleaded gasoline in 2006. Refineries increased their demand for ethanol as many accelerated the phase out of MTBE in the refinery process, switching to ethanol in its place.
Revenue from the sale of distillers grains increased just slightly from the year ended December 31, 2005 to the year ended December 31, 2006, the increase being driven by an increase in sales volume following a slight increase in production volume.
The incentive revenue from the U.S. Department of Agriculture’s Commodity Credit Corporation Bioenergy Program, which terminated on June 30, 2006, decreased $40,000 to $9,000 for the year ended December 31, 2006 from $49,000 for the year ended December 31, 2005. Incentive revenue from the State of South Dakota, in contrast, increased $70,000, or 10%, to $776,000 for the year ended December 31, 2006 from $705,000 for the year ended December 31, 2005.
Cost of Revenues - Cost of revenues decreased $800,000, or 1%, to $62.7 million for the year ended December 31, 2006 from $63.5 million for the year ended December 31, 2005. Cost of revenues decreased slightly between periods because of a decrease in energy costs. Corn costs remained relatively constant between periods because a net gain under our corn risk management program offset a rise in the market price of corn.
Our energy costs decreased 6% from 2005 to 2006. This decrease is due to an increased use of steam from Big Stone Plant and lower natural gas costs. Our volume usage of steam, the cost of which is less than natural gas, increased 19% from 2005 to 2006 because Big Stone Plant had fewer general maintenance shut-downs in 2006 compared to 2005. During the same period, natural gas costs decreased 4% from 2005 due primarily to an 11% decrease in the cost per unit. This decrease is due to stable natural gas prices in 2006, compared to 2005 when an active hurricane season caused the reverse effect.
Corn prices rose 13% between periods because of low corn carryout for 2006 and increased demand for corn from the ethanol industry. A $2.9 million net gain under our corn risk management program in 2006, however, offset the 13% increase. For the year ended December 31, 2006, cost of revenues includes losses of $2.7 million from the use of corn hedging instruments. This loss is caused by a significant increase in the market price of corn in the fourth quarter of 2006 and its effect on the value of the hedging instruments at December 31, 2006. Offsetting this loss is a $5.6 million gain on our forward contracting for corn. In August 2006, the prices at the Chicago Board of Trade (CBOT) rose due to a reduction in bushels of corn to be harvested nationwide. But since we had locked in lower prices for corn under our forward contracts, the value of forward contracts rose and resulted in a $5.6 million gain at December 31, 2006.
General and Administrative Expenses - General and administrative expenses increased $2.45 million, or 63%, to $6.36 million for the year ended December 31, 2006 from $3.91 million for the year ended December 31, 2005. The increase is primarily due to increased management incentive fees and costs during the year, which are based on an increase in our profitability.
Interest Expense - Interest expense decreased $60,000, or 4%, to $1.26 million for the year ended December 31, 2006 from $1.32 million for the year ended December 31, 2005. The decrease in interest expense is due to a $1.9 million reduction in non-construction related debt outstanding from December 31, 2005 to December 31, 2006 as we reduced our debt through principal payments.
Net Income - Net income increased $24.5 million to $40.7 million for the year ended December 31, 2006 from $16.2 million for the year ended December 31, 2005. This change is caused primarily by, as discussed above, an increase in ethanol revenue at a time of relatively constant cost of revenues.
Liquidity and Capital Resources
Our primary sources of liquidity are cash provided by operations and borrowings under our $17.0 million revolving credit facilities which are discussed below under “Indebtedness.” Net working capital is $19.72 million as of December 31, 2007 compared to $15.98 million as of December 31, 2006. The increase in working capital is due to a $2.17 million reduction in construction related-party payable ($0 at December 31, 2007 as all construction projects are complete), as well as a $5.27 million reduction in distributions payable to Northern Growers’ members and a $2.51 million reduction in distributions payable to the minority member.
The following table shows the cash flows between the year ended December 31, 2007 and the year ended December 31, 2006:
Cash Flow From Operating Activities - Net cash flow from operating activities decreased $13.5 million between periods, due principally to a decrease in cash provided by net income between periods, offset by an increase in cash provided by inventory. Ethanol inventory decreased 62% from 2006 to 2007 due to a decrease in the number of gallons in inventory and a decrease in the net realizable value.
Cash Flow From Investing Activities - Net cash flow used for investing activities decreased $9.9 million between periods, due primarily to a decrease in payments for property and equipment on the plant’s expansion and BPX™ project. The total cost of the plant’s expansion and BPX™ project is $42.3 million, of which $33 million is financed with debt and the remainder with cash from operations. We completed construction on the expansion and BPX™ projects in May 2007 and October 2006, respectively, having spent $14.0 million and $28.3 in cash for these projects in 2007 and 2006, respectively.
Cash Flow From Financing Activities - Net cash used for financing activities decreased by $5.0 million between periods, due primarily to a $6.4 million decrease in distributions paid to Northern Growers’ members and the minority member of POET™ Biorefining - Big Stone. This decrease is partially offset by a $900,000 increase in principal payments on long-term debt because we commenced principal payments during the fourth quarter of 2007 relating to the financing of our three main capital improvement projects, namely, expansion, BPX™ and grain storage.
We believe that cash flows from operations and our revolving debt will be sufficient to meet our expected capital and liquidity requirements for the foreseeable future. We anticipate that our capital improvement projects in 2008 will be miscellaneous in nature and financed with cash from operations. However, because we anticipate less cash flow from operations due to current market forces, we plan to rely more on our revolving debt to fund operations. Further, until we see tangible improvement in the market, we do not anticipate paying distributions to our members.
The following table shows the cash flows between the year ended December 31, 2006 and the year ended December 31, 2005:
Cash Flow From Operating Activities - The increase of $13.5 million in net cash flow provided from operating activities is primarily due to a significant increase in net income between periods, offset by an increase in cash used for accounts receivable and inventory.
Cash Flow From Investing Activities - Net cash flow used for investing activities increased $27.9 million between periods due to capital improvement projects. In 2006, we made significant cash expenditures to pay for the plant’s expansion and incorporation of BPX™ technology into the production process.
Cash Flow From Financing Activities - Net cash used for financing activities decreased $3.7 million between periods, due primarily to the $18.9 million advanced by U.S. Bank under a construction note used to pay for the expansion and BPX™ projects. This advance is offset by a $13.5 million increase in distributions paid to members in 2006.
Indebtedness
We have six notes and loans outstanding under our loan agreement with our lender, U.S. Bank: 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 the cost of non-corn related items at the plant at any time. We had $8 million available for use as of December 31, 2007.
The $9 million note 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 during a time of tightened margins. We had $9 million available for use as of December 31, 2007.
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 ($16.1 million and $8.0 million as of December 31, 2007) are subject to an interest rate swap agreement with U.S. Bank. (see also Item 7A
Item 7A. Quantitative and Qualitative Disclosure 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. The interest rate swap agreement is accounted for as a cash flow hedge pursuant to the requirements of SFAS 133, as amended, Accounting for Derivative Instruments and Hedging Activities.
Commodity Price Risk
We produce ethanol and its by-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 - March 31st) seasons. The price of distillers grains is principally influenced by the price of corn and soybean meal, and 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 fair 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.
A sensitivity analysis has been prepared to estimate our exposure to commodity price risk. The table presents the fair value of open futures and option positions for corn and natural gas as of December 31, 2007 and December 31, 2006 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:
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 and using the interest rate swap agreement on the term note. Our interest rate risk exposure pertains primarily to our variable rate, long-term debt. Specifically, we had $10.87 million in variable rate, long-term debt outstanding as of December 31, 2007, or approximately 21% of our total indebtedness. The interest rate on $2.83 million of the $3.9 million variable rate, long-term debt is U.S. Bank’s prime rate, which is 7.25% as of December 31, 2007. The variable rate on the $8.04 million portion of the expansion note is 7.571% (One-Month LIBOR plus 2.75%) as of December 31, 2007.
In order to achieve a fixed interest rate on a portion of our $33.0 term note, we entered into 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 ($16.1 million and $8.04 million, respectively as of December 31, 2007). The remaining amount, $8.04 million, is subject to a variable rate of One-Month LIBOR plus 2.75%. While our exposure is reduced under the swap agreement, 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.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Reference is made to the “Table of Contents” of Northern Growers, LLC located on the page prior to page of this report, and financial statements for the year ended December 31, 2007 referenced therein, which are hereby incorporated by reference.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. Our management, including the participation of our Chief Executive Officer/Chief Financial Officer, has concluded that, based on management’s evaluation as of the end of the period covered by this Annual Report on Form 10-K, the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Additionally, based on management’s evaluation, our disclosure controls and procedures were effective in ensuring that information required to be disclosed in our Exchange Act reports is accumulated and communicated to our management, including our Chief Executive Officer/Chief Financial Officer, to allow timely decisions regarding required disclosures.
Management’s report on internal control over financial reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed our internal control over financial reporting in relation to criteria described in Internal Control- Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment using those criteria, we concluded that, as of December 31, 2007, our internal control over financial reporting was effective.
Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2007 has been audited by Eide Bailly LLP, an independent registered public accounting firm, as stated in their report which appears on page of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
/s/ Robert Narem
Robert Narem, Chief Executive Officer
and Chief Financial Officer, Manager
(Principal Executive Officer)
Item 9B.
Item 9B. Other Information.
None.
PART III
Pursuant to General Instructions G(3), we omit Part III, Items 10, 11, 12, 13 and 14, and incorporate such items by reference to an amendment to this Annual Report on Form 10-K or to an Information Statement to be filed with the Commission within 120 days after the close of the fiscal year covered by this report (December 31, 2007).
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a) The following exhibits and financial statements are filed as part of, or are incorporated by reference into, this report:
(1) Financial Statements-Reference is made to the “Table of Contents” of Northern Growers, LLC located on the page prior to page of this report for a list of the financial statements and schedules for the year ended December 31, 2007 included herein. The financial statements begin on page of this Report.
(2) All supplemental schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the Consolidated Financial Statements or notes thereto.
(3) The exhibits we have filed herewith or incorporated by reference herein are set forth on the attached Exhibit Index. The following exhibits constitute a management contract: 10.14 and 10.16.
(b) See Item 15(a)(3)
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NORTHERN GROWERS, LLC
Date:
March 5, 2008
/s/ Robert Narem
Robert Narem, Chief Executive
Officer/Chief Financial Officer
(Principal Executive and Financial Officer)
Pursuant to the requirements of the Securities Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
NORTHERN GROWERS, LLC
Date:
March 5, 2008
/s/ Robert Narem
Robert Narem, Chief Executive Officer
and Chief Financial Officer, Manager
Date:
March 5, 2008
/s/ Robert Narem
Ronald Anderson, Manager
Date:
March 5, 2008
/s/ Leroy Bergan
Leroy Bergan, Manager
Date:
March 5, 2008
/s/ Wendall Falk
Wendell Falk, Manager
Date:
March 5, 2008
/s/ Lars Herseth
Lars Herseth, Manager
Date:
March 5, 2008
/s/ Mark Lounsbery
Mark Lounsbery, Manager
Date:
March 5, 2008
/s/ Robert Metz
Robert Metz, Manager
Date:
March 5, 2008
/s/ Jeff Olson
Jeff Olson, Manager
Date:
March 5, 2008
/s/ Ronald Olson
Ronald Olson, Manager
Date:
March 5, 2008
/s/ Heath Peterson
Heath Peterson, Manager
Date:
March 5, 2008
/s/ Delton Strasser
Delton Strasser, Manager
Date:
March 5, 2008
/s/ Steve Street
Steve Street, Manager
Date:
March 5, 2008
/s/ Bill Whipple
Bill Whipple, Manager
Date:
March 5, 2008
/s/ Robert Wittnebel
Robert Wittnebel, Manager
EXHIBIT INDEX
Exhibit
No.
Description
Filed
Herewith
Incorporated by
Reference
2.1
Plan of Organization.
Appendix A to Registrant’s Prospectus filed with the Commission on March 17, 2003.
3.1
Articles of Organization.
Appendix B to Registrant’s Prospectus filed with the Commission on March 17, 2003.
3.2
Fourth Amended and Restated Operating Agreement dated July 1, 2006.
Exhibit 3.2 to the Registrant’s Form 10-Q filed with the Commission on August 14, 2006.
4.1
Form of Class A Certificate.
Exhibit 4.1 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.1
Loan Agreement with U.S. Bank dated July 11, 2001.
Exhibit 10.7 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.2
Lease Agreement with Big Stone - Grant Industrial Development and Transportation, dated April 18, 2001.
Exhibit 10.9 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.3
Steam Sale Agreement with Otter Tail Power Company, dated April 18, 2001.
Exhibit 10.10 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.4
Water and Fuel Oil Agreement with Otter Tail Power Company, dated August 14, 2001.
Exhibit 10.11 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.5
Electric Service Agreement with Otter Tail Power Company, dated September 26, 2001.
Exhibit 10.12 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.6
Water and Sanitary Sewer Agreement with the City of Big Stone City, dated December 21, 2001.
Exhibit 10.13 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.7
Access and Rail Agreement with Otter Tail Corporation, dated April 18, 2001.
Exhibit 10.14 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.8
Industry Track Agreement with Burlington Northern and Santa Fe Railway Company, dated January 8, 2002.
Exhibit 10.15 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.9
Service Request Form and Extended Service Agreement with NorthWestern Public Service, dated March 19, 2002.
Exhibit 10.17 to the Registrant’s Form S-4 filed with the Commission on July 26, 2002.
10.10
Amendment to U.S. Bank Loan Agreement, dated June 22, 2004.
Exhibit 10.1 to the Registrant’s Form 10-Q filed with the Commission on August 16, 2004.
10.11
Second Amendment to U.S. Bank Loan Agreement, dated March 30, 2005.
Exhibit 10.26 to the Registrant’s Form 10-K filed with the Commission on March 31, 2005.
10.12
$15.8 Million Promissory Note with U.S. Bank, dated March 30, 2005.
Exhibit 10.27 to the Registrant’s Form 10-K filed with the Commission on March 31, 2005.
10.13
$3.9 Million Promissory Note with U.S. Bank, dated March 30, 2005.
Exhibit 10.28 to the Registrant’s Form 10-K filed with the Commission on March 31, 2005.
10.14
Management Agreement with POET™ Plant Management, LLC, dated April 20, 2005.
Exhibit 10.2 to the Registrant’s Form 10-Q filed with the Commission on May 16, 2005.
10.15
Technology and Patent Rights License Agreement with POET™ Design and Construction, LLC, dated October 25, 2005.*
Exhibit 10.1 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2005.
10.16
Amendment to the Management Agreement with POET™ Plant Management, dated October 25, 2005.
Exhibit 10.2 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2005.
10.17
Design Build Agreement with POET™ Design and Construction, Inc., dated October 25, 2005.
Exhibit 10.3 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2005.
10.18
Amended and Restated Loan Agreement with U.S. Bank dated August 28, 2006.
Exhibit 10.1 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
10.19
Expansion Construction Note Agreement dated August 28, 2006.
Exhibit 10.2 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
10.20
$8.0 Million Variable Rate, Revolving Note dated August 28, 2006.
Exhibit 10.3 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
10.21
Construction Mortgage and Addendum dated August 28, 2006.
Exhibit 10.4 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
10.22
Security Agreement dated August 28, 2006.
Exhibit 10.5 to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
10.23
Corn and Natural Gas Price Risk Management Agreement dated April 1, 2007.
Exhibit 10.2 to the Registrant’s Form 10-Q filed with the Commission on May 10, 2007.
10.24
Amendment No. 1 to Water Fuel Agreement dated March 21, 2007.
Exhibit 10.1 to the Registrant’s Form 10-Q filed with the Commission on May 10, 2007.
10.25
Ethanol Marketing and Services Agreement dated April 24, 2007.
Exhibit 10.3 to the Registrant’s Form 10-Q filed with the Commission on May 10, 2007.
10.26
Design Build Agreement with POET™ Design and Construction dated April 3, 2007.
Exhibit 10.4 to the Registrant’s Form 10-Q filed with the Commission on May 10, 2007.
10.27
Amendment to Amended and Restated Loan Agreement with U.S. Bank dated September 21, 2007.
Exhibit 10.1 to the Registrant’s Form 10-Q filed with the Commission on November 9, 2007
10.28
$9.0 Million Promissory Note with U.S. Bank dated September 21, 2007.
Exhibit 10.2 to the Registrant’s Form 10-Q filed with the Commission on November 9, 2007
10.29
$4.3 Million Promissory Note with U.S. bank dated September 21, 2007.
Exhibit 10.3 to the Registrant’s Form 10-Q filed with the Commission on November 9, 2007
10.30
Mortgage in Favor of U.S. Bank dated September 21, 2007.
Exhibit 10.4 to the Registrant’s Form 10-Q filed with the Commission on November 9, 2007
21.1
Subsidiaries of the Registrant.
X
Rule 13a-14(a)/15d-14(a) Certifications
X
Section 1350 Certification
X
*The redacted portions of this exhibit were filed separately with the SEC subject to a request for confidential treatment dated November 14, 2005.
NORTHERN GROWERS, LLC
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheets
Statements of Operations
Statements of Changes in Members’ Equity and Comprehensive Income
Statements of Cash Flows
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Audit Committee and Members
Northern Growers, LLC
Big Stone City, South Dakota
We have audited the accompanying consolidated balance sheets of Northern Growers, LLC as of December 31, 2007 and 2006, and the related consolidated statements of operations, members’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited Northern Growers, LLC’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Northern Growers, LLC’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Northern Growers, LLC as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Northern Growers, LLC maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in the Internal Control-Integrated Framework issued by the Committee of the Sponsoring Organizations of the Treadway Commission (COSO).
Sioux Falls, South Dakota
February 22,
PEOPLE. PRINCIPLES. POSSIBILITIES.
www.eidebailly.com
E. 10th Street, Suite 500 | PO Box 5125 | Sioux Falls, South Dakota 57117-5125 | Phone 605.339.1999 | Fax 605.339.1306 | EOE
NORTHERN GROWERS, LLC
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements
NORTHERN GROWERS, LLC
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements
Northern Growers, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
See Notes to Consolidated Financial Statements
Northern Growers, LLC
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS’ EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
See Notes to Consolidated Financial Statements
NORTHERN GROWERS, LLC CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
See Notes to Consolidated Financial Statements
(continued on next page)
CONSOLIDATED STATEMENTS OF CASH FLOWS - page 2
See Notes to Consolidated Financial Statements
NORTHERN GROWERS, LLC
NOTES TO 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.
On April 1, 2002, Whetstone Ethanol, LLC “Whetstone” was formed. The initial member of Whetstone was the Cooperative. Whetstone was formed for the purpose of acquiring the assets and liabilities of the Cooperative. On April 10, 2002, the Board of Directors of the Cooperative approved a plan of reorganization related to an exchange whereby Whetstone would acquire the assets and liabilities of the Cooperative. On March 27, 2003, the members of the Cooperative approved the plan of reorganization to take effect on April l, 2003. The transaction was an exchange of interests whereby the assets and liabilities of the Cooperative were transferred for capital units of Whetstone. For financial statements purposes, no gain or loss was recorded as a result of the exchange transaction.
As a result of the exchange, the Cooperative was dissolved, with Whetstone’s capital units distributed to the members of the Cooperative at a rate of one Whetstone capital unit for each share of equity common stock and all voting common stock of the Cooperative was surrendered and retired. In connection with the reorganization, Whetstone subsequently changed its name to Northern Growers, LLC. Under the amended Northern Growers’ Operating Agreement, a minimum of 2,500 capital units is required to become a member. Such units are subject to certain transfer restrictions, including approval by the Board of Managers of Northern Growers. Northern Growers also retains the right to redeem the capital units at $.20 per unit in the event a member attempts to dispose of the units in a manner not in conformity with the Operating Agreement, if a member becomes a holder of less than 2,500 units or if a member becomes bankrupt. The Operating Agreement also includes provisions whereby cash flow in excess of $200,000 will be distributed to unit holders subject to limitations imposed by a super majority vote of the Board of Managers or restrictions imposed by loan covenants.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
Cash and Cash Equivalents
Cash and cash equivalents consist of all highly liquid investments with an original maturity of three months or less.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
Revenue from the production of ethanol and related product is recorded upon transfer of title to customers, net of allowances for estimated returns on related products. Generally, ethanol is shipped FOB shipping point and related product is shipped FOB destination. Interest income is recognized as earned.
Revenue from federal and state incentive programs is recorded when the Company has produced or sold the ethanol and satisfied the reporting requirements under each applicable program. When it is uncertain that the Company will receive full allocation and payment due under the incentive programs, it derives an estimate of the incentive revenue for the relevant period based on various factors. The estimate is subject to change as management becomes aware of increases or decreases in the amount of funding available under the incentive programs or other factors that affect funding or allocation of funds under such programs.
Receivables and Credit Policies
Trade receivables are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days from the invoice date. Customer account balances with invoices dated over 30 days old are considered delinquent. Interest is not charged on any delinquent accounts.
Trade receivables are stated at the amount billed to the customer.
Payments of trade receivables are allocated to the specific invoices identified on the customer’s remittance advice or, if unspecified, are applied to the earliest unpaid invoices.
The carrying amount of trade receivables is reduced by a valuation allowance that reflects management’s best estimate of the amounts that will not be collected. Management reviews all trade receivable balances that exceed 30 days from the invoice date and based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. Management believes that all trade receivables are collectible; therefore, there is no valuation allowance as of December 31, 2007 and 2006.
Inventory
Ethanol and related product inventory is stated at net realizable value. Corn inventory is stated at market value, which approximates net realizable value (local market prices less cost of disposal), based on local market prices determined by grain terminals in the area of the plant. Other raw materials, spare parts and work-in-process inventory are stated at the lower of cost or market on an average cost method.
Inventories at December 31, 2007 and 2006 are as follows:
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 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 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 an increase (decrease) to cost of revenues of $1,595,577, $3,181,810 and ($211,011) related to our derivative contracts for the year ended December 31, 2007, 2006 and 2005, 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.
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 $24,131,250 and $16,252,000 as of December 31, 2007 and 2006, respectively. A derivative liability to record the fair value of the swap of $900,826 and $187,069 has been recorded, with a corresponding entry of $550,734 and $144,342 to accumulated other comprehensive loss to the members’ equity section of the balance sheet and a decrease of $163,023 and $42,727 to minority interest for the years ended December 31, 2007 and 2006, respectively.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 December 31, 2007 and 2006, accumulated other comprehensive loss consists of an unrealized loss from our interest rate swap agreements designated as a cash flow hedge.
Minority Interest
Amounts recorded as minority interest on the balance sheet relate to the investment by Broin Investments I, LLC in POET™ Biorefining - Big Stone, plus or minus any allocation of income or loss of POET™ Biorefining - Big Stone, plus or minus any allocation of accumulated other comprehensive income or loss, less distributions from POET™ Biorefining - Big Stone. Earnings/losses and distributions of POET™ Biorefining - Big Stone are allocated to its members in proportion to the member’s capital accounts.
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.
Concentrations of Credit Risk
Cash balances are maintained in bank depositories and periodically exceed federally insured limits.
Property and Equipment
Property and equipment is stated at cost. Significant additions and betterments are capitalized, while expenditures for maintenance, repairs and minor renewals are charged to operations when incurred. Depreciation on assets placed in service is computed using the straight-line method over estimated useful lives as follows:
Land improvements consist of landscaping, additional fencing and improvements to the roads for entering and exiting the plant.
Equipment consists of grain systems, trucks, mechanical and electrical production and process equipment, cooling towers, boilers and a reboiler, field sensors and power supplies.
Buildings consists of administrative offices, sheds, catwalks, platforms, and mechanical and grain buildings.
Long-Lived Assets
In accordance with Financial Accounting Standard Board (FASB) Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets, such as property, plant, and equipment, and purchased intangible assets subject to amortization, are reviewed for
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
A loss on impairment of assets of $625,195 was recognized by the Company’s management during 2007 and is included in cost of revenues. A subset of the plant’s thermal oxidizers, built during the original construction of the plant, was deemed impaired for $614,640 when environmental testing indicated that the equipment recently installed to replace the subset was sufficient to meet environmental compliance rules. The estimated fair market value of this asset is $100,000, for which management intends to sell on the open market, and is listed on the Consolidated Balance Sheet as “Assets held for sale.” In addition, the Company recorded a loss on impairment of assets of $10,555 for a compilation of several small equipment items that were deemed unusable.
A loss on impairment of assets of $450,362 was recognized by the Company’s management during 2006 and is included in cost of revenues. Upon the completion and incorporation of BPXTM technology into the plant’s production process in October 2006, there were multiple tanks, motors and other equipment deemed to be unusable. Two tanks were sold. Management determined that the balance of the unsuable assets was without value as the scrap value of such assets approximated the costs of disposal.
A loss on impairment of assets for $355,177 was recognized by the Company’s management during 2005 and is included in cost of revenues. A subset of the thermal oxidizers was deemed impaired and no longer useful due to extreme internal heat damage. Due to the extreme degradation of the subset, management determined that this asset was without value as the scrap value of such asset approximated the costs of disposal.
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.
Income Taxes
The Company is not a taxpaying entity for federal and state income tax purposes due to its treatment as a partnership. Accordingly, no provision or liability for federal or state income taxes has been included in these financial statements. Income of the Company is taxed to the members in their respective returns.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the requirements of SFAS 109, Accounting for Income Taxes, relating to the recognition of income tax benefits. FIN 48 provides a two-step approach to recognizing and measuring tax benefits when realization of the benefits is uncertain. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. Primarily due to the Company’s tax status as a partnership, the adoption of FIN 48 on January 1, 2007, had no material impact on the Company’s financial condition or results of operations.
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NORTHERN GROWERS, LLC
NOTES TO 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).
Reclassifications
Certain reclassifications have been made to the 2006 and 2005 financial statements to conform to the presentation in 2007. These reclassifications had no change in previously reported net income.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for (1) financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years and (2) certain non-financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company is evaluating the effect, if any, that the adoption of SFAS 157 will have on its results of operations, financial position, and the related disclosures.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (Accounting for Certain Investments in Debt and Equity Securities). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. The Company is evaluating the effect, if any, that the adoption of SFAS 159 will have on its results of operations, financial position, and the related disclosures.
In 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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NORTHERN GROWERS, LLC
NOTES TO 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.
NOTE 3 - 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 December 31, 2007 and 2006.
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 $4,300,000 for additional grain storage and to finance a $9,000,000 short-term revolving note. 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 7.25% at December 31, 2007. 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.
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.
The amended and restated loan agreement restructured the $3.0 million and $5.0 million notes into an $8 million revolving note (Note #91). The new 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. 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.
Note #190, the construction note of $33,000,000, was converted to a term note on August 31, 2007. The notional amount ($24,131,250 as of December 31, 2007) is subject to the interest rate swap agreements discussed in Note 2 under “Interest Rate Swap Agreements”. The loan will be amortized over a ten-year period which began August 31, 2007 and is subject to a maturity of August 31, 2014. Payments of principal are due quarterly and began November 30, 2007. Payments of interest are due monthly, subject to a variable rate of one-month LIBOR plus 2.75%, adjusted monthly (7.571% at December 31, 2007).
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note #232, the $4.3 million note, which was issued to finance additional grain storage and handling equipment, is subject to a variable rate of LIBOR plus 3.00% (8.225% at December 31, 2007), 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 (8.225% at December 31, 2007). 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 million was available at 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 full compliance at December 31, 2007. Under the Septemer 21, 2007 amendment to the loan agreement, the working capital requirement increased from $7.5 million to $10 million on October 1, 2007. 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.
The balance of the long-term notes payable as of December 31, 2007 and 2006 is as follows:
At December 31, 2007 and 2006, there were no outstanding borrowings against the variable rate revolving notes and the balance available on these notes was $8,000,000.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Minimum principal payments, through the maturity of the notes, are estimated as follows:
NOTE 4 - RELATED PARTY TRANSACTIONS
Northern Growers and Broin Investments I, LLC, are the members of POET™ Biorefining - Big Stone. Northern Growers invested $12,500,000 and Broin Investments I, LLC invested $3,700,000 in POET™ Biorefining - Big Stone for their respective ownership interests of 77.16% and 22.84%. In accordance with the Operating Agreement of POET™ Biorefining - Big Stone, Broin Investments I, LLC, has the right to elect two of seven members of the Board of Managers of POET™ Biorefining - Big Stone.
Additional agreements with related parties are included in Note 6.
NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company considers the carrying amount of significant classes of financial instruments on the balance sheets, including cash, accounts receivable, inventories, other assets, accounts payable, accrued liabilities, and variable rate long-term debt to be reasonable estimates of fair value either due to their length of maturity or the existence of variable interest rates underlying such financial instruments that approximate prevailing market rates at December 31, 2007. The Company’s other significant classes of financial instruments on the balance sheets for which the carrying amounts and estimated fair values differ at December 31, 2007 are detailed below.
As of December 31, 2006, the carrying amount of the fixed-rate, long-term note payable obligations exceeded fair value. Due to declining interest rates during 2007, the carrying amount of the fixed-rate, long-term note payable obligations were less than fair value at December 31, 2007. As the following table presents, the carrying amount and the fair value of long-term note payable obligations at December 31, 2007 and 2006 are as follows:
The Company believes the carrying amount of short-term notes payable approximates their value due to the short maturity of these instruments.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
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 at December 31, 2007. The liability incurred on this construction contract was $0 and $2,173,905 at December 31, 2007 and 2006, respectively.
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, and increases marketing fees by $0.002 per gallon sold. The Company has sales commitments with POET™ Ethanol Products of approximately 28 million gallons over the next twelve months, of which 14 million gallons are contracted at a variable price and 14 million gallons are contracted at a fixed sales price ranging from $1.58 to $1.98 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.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 61,000 tons of various distiller grains at an average fixed price of approximately $146 per ton as of December 31, 2007.
Revenues and expenses related to agreements with related parties for the years ended December 31, 2007, 2006 and 2005 are as follows:
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. 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.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Expenses related to the property lease and steam agreements for the years ended December 31, 2007, 2006 and 2005 were $2,962,099, $3,052,753 and $2,361,367, respectively.
Minimum payments related to the above agreements are summarized in the following table:
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. In addition, POET™ Biorefining - Big Stone agreed to honor all member forward contracts for 2006 delivery if the contract was written by September 15, 2005. Purchases of corn from corn delivery agreements and cash contracts from the Northern Growers’ members totaled approximately $36,357,000, $26,346,000 and $22,016,000 for the years ending December 31, 2007, 2006 and 2005, respectively, of which $3,898,937 and $1,505,428 was recorded as a liability at December 31, 2007 and 2006, respectively.
Incentive Revenue - The Company previously received incentive payments from the United States Department of Agriculture (USDA) for the use of corn to produce ethanol. The program ended June 30, 2006. The USDA had set the annual maximum not to exceed $7,500,000 for each eligible producer. The incentive was calculated on the USDA fiscal year of October 1 to September 30. Revenue of $31,385 and $26,835 was earned for the USDA program years ended September 30, 2006 and 2005, respectively. Incentive revenue of $0, $8,551, and $48,681 was recorded for the twelve months ended December 31, 2007, 2006 and 2005, respectively, for this program due to the variability of program rules for payout ratios.
The Company also 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 $416,667, $750,000 and $776,333 for the program years ended June 30, 2008, 2007 and 2006, respectively. Incentive revenue of $750,001, $776,333 and $705,404 was recorded for the twelve months ended December 31, 2007, 2006 and 2005, 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.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 2005, POET™ Biorefining - Big Stone approved a $5,000,000 distribution, which it paid on February 1, 2005. Northern Growers received $3,858,000 and the minority member received $1,142,000. In conjunction with this cash distribution, on February 7, 2005, Northern Growers paid a distribution of $3,778,051 to its members of record as of December 31, 2004.
During July 2005, POET™ Biorefining - Big Stone approved an $8,000,000 distribution, which it paid on July 28, 2005. Northern Growers received $6,172,800 and the minority member received $1,827,200. In conjunction with this cash distribution, on July 29, 2005, Northern Growers paid a distribution of $5,972,839 to its members of record as of April 30, 2005.
During October 2005, POET™ Biorefining - Big Stone approved a $3,200,000 distribution, which it paid on October 28, 2005. Northern Growers received $2,469,120 and the minority member received $730,880. In conjunction with this cash distribution, on October 31, 2005 Northern Growers paid a distribution of $2,469,064 to its members of record as of August 31, 2005.
During January 2006, POET™ Biorefining - Big Stone approved a $4,162,763 distribution, which it paid on January 24, 2006. Northern Growers received $3,211,988 and the minority member received $950,775. In conjunction with this cash distribution, on January 30, 2006, Northern Growers paid a distribution of $3,212,093 to its members of record as of December 31, 2005.
During April 2006, POET™ Biorefining - Big Stone approved a $3,675,448 distribution, which it paid on May 1, 2006. Northern Growers received $2,835,976 and the minority member received $839,472. In conjunction with this cash distribution, on May 8, 2006, Northern Growers paid a distribution of $2,760,998 to its members of record as of March 31, 2006.
During July 2006, POET™ Biorefining - Big Stone approved a $10,899,284 distribution, which it paid on August 2, 2006. Northern Growers received $8,409,888 and the minority member received $2,489,396. In conjunction with this cash distribution, on August 7, 2006, Northern Growers paid a distribution of $8,359,696 to its members of record as of June 30, 2006.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During October 2006, POET™ Biorefining - Big Stone approved an $11,000,000 distribution, which it paid on October 30, 2006. Northern Growers received $8,487,600 and the minority member received $2,512,400. In conjunction with this cash distribution, on November 6, 2006, Northern Growers paid a distribution of $8,337,419 to its members of record as of September 30, 2006.
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.
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.
Prior period financial statements have been restated to reflect the capital unit splits stated above.
NOTE 9 - INCOME TAXES
As of December 31, 2007 and 2006, the Company’s book basis of assets exceeded their tax basis by approximately $32,800,000 and $30,100,000, respectively. As of December 31, 2007 and 2006, the Company’s book basis of liabilities exceeded their tax basis by $900,826 and $187,069, respectively, due to the treatment of the derivative financial instruments.
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NORTHERN GROWERS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - 401(K) PLAN
On February 1, 2003, the Company set up a 401(k) plan for substantially all employees who work more than 1,000 hours per year. Employees can make voluntary contributions up to federally designated limits. The Company matches employee voluntary contributions at a 50% level up to an effective maximum of 2% of gross employee pay. Eligible employees are always fully vested in their account balances resulting from employee voluntary contributions. The Company 401(k) expense for the years ended December 31, 2007, 2006 and 2005 was $25,283, $33,646 and $25,192, respectively.
NOTE 11 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Summary quarterly results are as follows:
The above quarterly financial data is unaudited, but in the opinion of management, all adjustments necessary for a fair presentation of the selected data for these interim periods presented have been included. Basic earnings or loss per unit are presented on the 50,628,000 units currently issued and outstanding.