ITEM 1. BUSINESS
General Overview
Husker Ag, LLC, a Nebraska limited liability company f/k/a Husker Ag Processing, LLC (“Husker Ag” or the “Company”), was organized on August 29, 2000 to construct and operate an ethanol plant located near Plainview, Nebraska. The Company completed construction of its plant and began operating in early 2003. Husker Ag is managed by a thirteen member Board of Directors.
Husker Ag’s ethanol plant converts, on an annual basis, roughly ten million bushels of corn into approximately 27 million gallons of ethanol per year. The ethanol plant also produces over 160,000 tons annually of animal feed known as distillers grain, which may be sold as distillers dried grain with solubles, distillers modified wet grain and distillers wet grain. These types of distillers grain are the principal co-products of the ethanol production process. The Company currently produces and sells only modified wet distillers grain.
General Developments
Expansion of Plant
The Company’s current plant expansion project, which was approved by the Company’s members at the 2006 Annual Meeting of Members held on June 26, 2006, will add approximately 40 million gallons per year of ethanol production capacity to the Company’s existing operations. The total cost of the project is estimated to be approximately $63 million.
The Company anticipates that it will finance the plant expansion project partially from the net proceeds received from our rights offering (approximately $14.7 million) and partially from the debt financing from our primary lender (approximately $35 million). The remainder of the cost for the project will need to be financed out of our available cash resources from current earnings, if any. See “Rights Offering” below under this Item 1 for information regarding the Company’s rights offering. See “Liquidity and Capital Resources” below under Item 7 of this Form 10-K for information regarding the Company’s debt financing for this project.
On July 25, 2006, the Company executed an Agreement between Owner and Design/Builder on the Basis of a Stipulated Price (the “Design-Build Agreement”) with ICM, Inc., an ethanol plant design build contractor located in Colwich, Kansas (“ICM”). Under the Design-Build Agreement, ICM is responsible for the design, construction and start-up of a stand-alone dry mill fuel-grade ethanol plant that would add 40 million gallons per year of ethanol production capacity to the Company’s existing operations. This expansion is adjacent to the Company’s existing plant and will result in the Company’s total plant capacity exceeding 60 million gallons per year.
Under the terms of the Design-Build Agreement, the Company will pay ICM approximately $44,284,000 for the design and construction of this expansion, subject to adjustments made in accordance with the general conditions of the agreement. As part of the agreement, the Company also entered into a limited License Agreement with ICM to use the technology and information in the design and construction of the plant expansion. ICM began construction on the plant expansion project in October 2006, and the Company anticipates that the project will be completed before the end of 2007.
The Design-Build Agreement required the Company to pay ICM a down payment in the amount of 10% of the total contract price, which was paid in full by October 15, 2006. Thereafter, the Company makes payments to ICM on a progress billing basis, based upon periodic applications for payment for all work performed as of the date of the application. The Company will retain 5% of the amount submitted in each application for payment. Upon substantial completion of the entire project, as defined in the agreement, the Company will release all retained amounts, less an amount equal to $500,000 plus the reasonable cost to complete all remaining items. When the new plant meets the performance criteria set forth in the agreement, which includes the requirement that the new plant operate at a rate of 40 million gallons per year of ethanol based on a seven-day performance test, the Company will release the $500,000 retainage.
A copy of the Design-Build Agreement was attached as an exhibit to the Company’s Form 10-Q for the period ended June 30, 2006 which was filed with the SEC on August 14, 2006.
Rights Offering
On June 26, 2006, at the Husker Ag Annual Meeting of Members, the members approved a proposed plant expansion. To help finance the plant expansion, the Company proceeded with a rights offering where each member of the Company as of August 1, 2006, the record date, was offered a nontransferable subscription right to subscribe to one membership unit for each unit held at a subscription price of $1,000 per unit. As of the record date, there were 15,318 membership units outstanding, and the total rights offering was for a maximum of 15,318 units or $15,318,000.
On September 5, 2006, the Company filed a Registration Statement with the SEC registering up to 15,318 subscription rights and 15,318 membership units in the Company. This Registration Statement, which was amended on October 11, 2006, and October 23, 2006, was approved and declared effective by the SEC on October 25, 2006.
On or about October 27, 2006, the Company provided a prospectus to each of its members of record as of August 1, 2006. The prospectus was the formal written offer to existing members of the Company (as of the record date) of the right to subscribe to newly issued membership units on a pro rata basis, based on each member’s percentage ownership interest in the Company. A copy of the final prospectus was filed with the SEC on October 27, 2006, and is available on the SEC’s website at www.sec.gov. The Company’s Registration Statement, as amended, and related exhibits are also available on the SEC’s website.
In accordance with the terms of the Registration Statement, the Company retained the right to extend the rights offering beyond the initial expiration date of November 30, 2006, and the Board of Directors extended the right to exercise the subscription rights through December 18, 2006. These subscription rights were subject to acceptance by the Company’s Board of Directors after the Company obtained debt financing to help pay for the plant expansion project.
On January 5, 2007, the Company signed a Credit Agreement with Union Bank and Trust Company, Lincoln, Nebraska (Union Bank), whereby Union Bank agreed, subject to the terms of the Credit Agreement, to provide up to $35,000,000 of debt financing for the plant expansion project. See “Liquidity and Capital Resources” below under Item 7 of this Form 10-K for additional information regarding this new loan. Thereafter, on January 12, 2007, the Board of Directors accepted the subscription rights and issued the membership certificates upon receipt of the funds from the escrow agent.
In the rights offering, the Company sold a total of 14,812 membership units for total proceeds in the amount of $14,812,000, with 506 subscription rights remaining unsubscribed and 506 membership units remaining unsold.
As of January 12, 2007, after the completion of the rights offering, the Company has 30,130 membership units issued and outstanding.
The Company will apply the net proceeds from the rights offering to the payment of the Company’s design build contractor for the design and construction of the plant expansion project.
Loss of Federal Small Producer’s Tax Credit. The Company’s members have received the benefits of the federal small producer’s tax credit which is a $.10 per gallon of ethanol tax credit available for ethanol produced at plants with 60 million gallons or less of annual capacity. For the past several years, many members have been eligible to deduct from their federal income tax $.10 per gallon on the first 15 million gallons produced annually. The amount of any such credit received by a member must be included in the gross income of the member for tax purposes. Upon completion of the plant expansion project, Husker Ag will no longer qualify as a small producer and the small producer tax credit will end for Husker Ag members in the year that the Company’s total production capacity surpasses the 60 million gallon limit. The small producer tax credit is otherwise scheduled to sunset December 31, 2010.
Exchange of Investment in Val-E Ethanol, LLC for Investment in US BioEnergy Corporation
In December 2005, the Company purchased a 24.1% interest in Val-E Ethanol, LLC, a Nebraska limited liability company (“Val-E Ethanol”), which was created to construct, own and operate a 45-million gallon per year ethanol plant located near Ord, Nebraska (which was completed in 2006). The Company purchased 1,200 units of Val-E Ethanol for $5,000 per unit for an aggregate total of $6,000,000. Husker Ag borrowed $4,500,000 for the purchase of this interest. See “Liquidity and Capital Resources” below under Item 7 of this Form 10-K for additional information regarding this loan.
Platte Valley Fuel Ethanol, LLC, a Nebraska limited liability company, was then the majority owner of Val-E Ethanol. On February 16, 2006, US BioEnergy Corporation, a Brookings, South Dakota based corporation (“US BioEnergy”), announced that it was acquiring Platte Valley Fuel Ethanol, LLC. That transaction closed on April 30, 2006. Subsequent to that announcement, US BioEnergy offered to acquire the remaining membership interests in Val-E Ethanol for shares of common stock in US BioEnergy. The Company and each of the other minority owners of Val-E Ethanol agreed to this proposed exchange.
As a result, on May 2, 2006, the Company executed a Membership Interest Purchase Agreement with US BioEnergy, whereby the Company agreed to exchange its entire interest in Val-E Ethanol for 3,000,000 shares of common stock of US BioEnergy.
US BioEnergy is an entity that intends to continue to build, own and operate biofuel plants. More information about US BioEnergy is available on its website at www.USbioenergy.net.
On August 3, 2006, US BioEnergy filed a Form S-1 Registration Statement with the Securities and Exchange Commission (the “SEC”) announcing its intention to proceed with an initial public offering (“IPO”). In December 2006, the SEC declared US BioEnergy’s registration statement effective and US BioEnergy completed its IPO. US BioEnergy’s stock is currently listed on the NASDAQ Stock Market under the symbol “USBE”.
Following a 1 for 4 reverse stock split that occurred concurrently with the IPO, the number of Husker Ag’s shares in US BioEnergy was reduced from 3,000,000 to 750,000 shares.
However, Husker Ag’s shares in US BioEnergy are “restricted securities” under Rule 144 of the Securities Act of 1933, or Rule 144, which may not be resold except pursuant to an effective registration statement or an applicable exemption from registration, including an exemption under Rule 144. In addition to any restrictions on the sale of Husker Ag’s shares in US BioEnergy under federal securities laws, the Company entered into a lock-up agreement with US BioEnergy in September 2006. Under this agreement, except for certain specified exceptions, Husker Ag may not sell or otherwise transfer its shares in US BioEnergy for 180 days after the date that the final prospectus is filed with the SEC by US BioEnergy. As a result, Husker Ag will not be able to sell its shares in US BioEnergy until June 2007.
The Company holds these 750,000 shares in common stock of US BioEnergy as trading securities. See Note 1 to the Company’s Financial Statements included below for additional information regarding the Company’s accounting for this investment.
Description of Dry Mill Process
The Company’s ethanol plant produces ethanol by processing corn. The corn is delivered, weighed and then unloaded in a receiving building. It is then transported to a scalper to remove rocks and debris before it is conveyed to storage bins. Thereafter, the corn is transported to a hammermill or grinder where it is ground into flour and conveyed into a tank for processing. Water, heat and enzymes are added to break down the starch in the ground corn. The resulting slurry is heat sterilized and pumped to a tank where additional enzymes are added to further breakdown the starch. Next, the mash is pumped into fermenters, where other enzymes and yeast are added, to begin a batch fermentation process. A distillation process divides the alcohol from the corn beer. The alcohol, which exits the distillation process, is then further dried using a molecular sieve. The resulting 200 proof alcohol is then pumped to farm shift tanks and blended with five percent gasoline denaturant as it is pumped into storage tanks.
Stillage from the distillation process is then pumped into one of several centrifuges and water from the centrifuges is evaporated into a thick syrup. The solids that exit the centrifuge are called wet cake and may be conveyed to a dryer for drying. Syrup may be added to the wet cake as it enters the dryer, where moisture will be removed. This process produces distillers dried grain with solubles, which may be used as animal feed. The wet grain and syrup may be combined and sold as animal feed without drying or with only partial drying.
Principal Products
Ethanol
Ethanol is ethyl alcohol, a fuel component made primarily from corn and various other grains, and can be used as: (a) an octane enhancer in fuels; (b) an oxygenated fuel additive that can reduce ozone and carbon monoxide vehicle emissions; and (c) a non-petroleum-based gasoline extender. Ethanol has important applications and is used primarily as a high quality octane enhancer and an oxygenate capable of reducing air pollution and improving automobile performance. The overwhelming majority of all ethanol is used in its primary form for blending with unleaded gasoline and other fuel products. As a fuel additive, the demand for ethanol is derived from the overall demand for gasoline, as well as the competition of ethanol versus competing oxygenate products and technologies. For the years ended December 31, 2006, 2005 and 2004, ethanol sales comprised 82.9%, 81.1% and 74.2%, respectively, of the Company’s total net sales.
Distillers Grain
A principal co-product of the ethanol production process is distillers grain, a high protein, high-energy animal feed supplement primarily marketed to the dairy and beef industry. Dry mill ethanol processing may create three forms of distillers grain: distillers wet grain, distillers modified wet grain, and distillers dried grain. Distillers wet grain is processed corn mash that contains approximately 70% moisture. It has a shelf life of approximately 3 summer days (5 winter days). Distillers modified wet grain is similar except that it has been dried to approximately 50% moisture. It has a slightly longer shelf life of approximately two to three weeks and is often sold to nearby markets. Dried distillers grain is corn mash that has been dried to 10% moisture. It has an almost indefinite shelf life and may be sold and shipped to any market regardless of its vicinity to an ethanol plant. The Company is currently producing almost entirely distillers modified wet grain which is sold to nearby markets. The Company could switch to dried distillers grain if there were a significant change in local demand or a material change in market conditions for the Company’s current modified wet grain product. For the years ended December 31, 2006, 2005 and 2004, distillers grain sales comprised 12.3%, 12.9% and 15.3%, respectively, of the Company’s total net sales.
Customers
Management does not consider the Company’s business to be dependent on a single customer or a few customers, and the loss of any of our customers would not have a material adverse effect on our results. However, as of December 31, 2006, the Company had receivables from Eco-Energy, Inc. (“Eco-Energy”) amounting to 52% of the total trade receivables. Eco-Energy is a re-seller of ethanol and therefore its customers are indirectly a part of the Company’s customer base. While the Company acknowledges the potential credit risk from this large customer, the Company currently has sufficient demand for its products and Management would expect to find other customers should Eco-Energy’s purchases from the Company decrease for any reason. See the section entitled “Marketing and Distribution Methods - Ethanol” below for information regarding the Company’s agreement with Eco-Energy.
Ethanol Industry
Fuel ethanol is sold primarily to oil refiners and gasoline distributors for blending with gasoline. By extending fuel supplies, enhancing fuel octane, and serving as an oxygenate for meeting environmental standards, fuel ethanol provides a strategic benefit to marketers of gasoline. Fuel grade ethanol prices
traditionally have varied directly with the wholesale price of gasoline. Historically, fuel grade ethanol prices have also reflected a premium due to the oxygenate and octane enhancing properties of this motor fuel additive. However, given the large amount of ethanol production coming on line in the foreseeable future, ethanol prices may be driven down regardless of whether the wholesale price of gasoline continues to rise. See sections below entitled “Competition” and “Risk Factors” for further discussion of this issue.
According to the Renewable Fuels Association, ethanol production in the United States has increased more than 300% since 2000. This growth has been the result of strong underlying economic demand and public support for fuel ethanol, which has been driven by a variety of factors. One of the most important factors is the strategic benefit gasoline suppliers receive from using fuel ethanol as an octane enhancer and as an extender of gasoline supplies. Another significant factor has been the environmental benefits of fuel ethanol as an oxygenate, which has made it attractive to gasoline suppliers for marketing purposes and for meeting environmental standards.
The ethanol industry has been highly dependent on several governmental economic incentives.
Federal Ethanol Supports
Clean Air Act Amendments of 1990. In order to address two distinct pollution problems, the Clean Air Act Amendments of 1990 created two programs mandating changes in fuel composition: the Federal Oxygen Program aimed at carbon monoxide; and the Reformulated Gasoline (RFG) Program targeted at smog-forming emissions. These programs created a market for ethanol as an oxygenate.
The Federal Oxygen Program became effective November 1, 1992, and had the largest effect on ethanol sales. This program requires the sale of oxygenated motor fuels during the fall and winter months in certain major metropolitan areas to reduce carbon monoxide pollution. The RFG Program became effective January 1, 1995. This program requires the sale of reformulated gasoline in certain major urban areas to reduce pollutants, including those that contribute to ground level ozone (i.e., smog).
Although the federal oxygenate requirements for RFG included in the Clean Air Act were completely eliminated on May 5, 2006 by the Energy Policy Act of 2005, refiners continue to use oxygenated gasoline in order to meet continued federal and state fuel emission standards.
Renewable Fuels Standard. In August 2005, President George W. Bush signed into law the Energy Policy Act of 2005. The legislation created the first-ever nationwide Renewable Fuels Standard (the “RFS”) in federal law, requiring that at least 4 billion gallons of ethanol and biodiesel be used in 2006, increasing approximately 700 million gallons per year until it reaches a requirement of 7.5 billion gallons in 2012.
The RFS is a mandate requiring fuel refiners to use a certain minimum amount of renewable fuel blends in our nation’s fuel supply. It is anticipated that the vast majority of the renewable fuel used will be ethanol. According to the Renewable Fuels Association, the Energy Policy Act is expected to double the domestic ethanol industry in the next 6 years.
Since current national ethanol production capacity exceeds the 2007 RFS requirement of 4.7 billion gallons, the RFS requirements may not impact the demand for and the resulting price for ethanol in the short-term. However, it is possible that the increased RFS requirement of 7.5 billion gallons of renewable fuel by 2012 may help support ethanol prices in the long-term.
Federal Excise Tax Exemption. Ethanol blends have been either wholly or partially exempt from the federal excise tax on gasoline for over 25 years. The exemption allows gasoline distributors who blend ethanol with gasoline to receive a federal excise tax credit for each gallon of ethanol they blend. The American Jobs Creation Act of 2004 extended the subsidy to 2010 and created the Volumetric Ethanol Excise Tax Credit (“VEETC”). The VEETC program replaced the federal ethanol excise tax credit that existed previously with a new volumetric ethanol excise tax credit of 51 cents per gallon of ethanol blended through December 31, 2010.
Federal Small Producer’s Credit. Husker Ag has also received the benefits of the federal small producer’s credit which is a $.10 per gallon of ethanol tax credit available for ethanol produced at plants with 60 million gallons or less of annual capacity. Ethanol producers that qualify can deduct from their federal income tax $.10 per gallon on the first 15 million gallons produced annually. The small producer tax credit is scheduled to sunset December 31, 2010. With the passing of the Energy Policy Act of 2005, the definition of a small producer was increased from 30 million to 60 million gallons. The pass-through nature of Husker Ag’s partnership taxation structure applies to any small producer tax credit received. The credit, if any, received by Husker Ag, will be passed through to its members; however, the amount of any such credit received by a member must also be included in the gross income of the member, which could result in the taxation of the amount of the credit distributed to the member.
In October 2006, the Company began construction on its 40 million gallon plant expansion. Upon completion of the expansion, Husker Ag will no longer qualify as a small producer and the small producer tax credit will end for Husker Ag members in the year that the Company’s total production capacity surpasses the 60 million gallon limit.
State Ethanol Supports
Husker Ag has also received and anticipates continuing to receive economic benefits to produce ethanol at the state level. The State of Nebraska established a production tax credit of $.18 per gallon of ethanol produced during a 96 consecutive month period by newly constructed ethanol facilities in production prior to June 30, 2004. The tax credit is only available to offset Nebraska motor fuels excise taxes. The tax credit is transferable and therefore Husker Ag transfers credits received to a Nebraska gasoline retailer who then reimburses Husker Ag for the face value of the credit amount less a handling fee. Under current Nebraska law, no producer can receive tax credits for more than 15,625,000 gallons of ethanol produced in one year and no producer can receive tax credits for more than 125 million gallons of ethanol produced over a consecutive 96 month period. The minimum production level to qualify for credits is 100,000 gallons of ethanol annually. Assuming Husker Ag continues to produce at least 15,625,000 gallons of ethanol in a year, this producer tax credit could result in payments of up to $2,812,500 to Husker Ag annually; subject to the statutory maximum limit. The production incentive is scheduled to expire June 30, 2012. See “Risk Factors” below.
Marketing and Distribution Methods
Ethanol
Commencing June 1, 2005, the Company entered into the Risk Management and Ethanol Marketing Contract (the “2005 Marketing Agreement”) with FC Stone, LLC, an Iowa limited liability company (“FC Stone”), and Eco-Energy, Inc., a Tennessee corporation (“Eco-Energy”) pursuant to which FC Stone provides the Company with a full service price risk management program, and Eco-Energy purchases the Company’s entire output of ethanol in good faith at fair market rates for the term of the agreement. The current term of the 2005 Marketing Agreement expires on September 30, 2007, and it will be automatically renewed unless the Company provides notice of termination prior to June 1, 2007.
The Company has had an on-going relationship with Eco-Energy and FC Stone since 2002 when the parties executed the Risk Management and Ethanol Marketing Contract dated November 27, 2002 (the “2002 Marketing Agreement”). The 2005 Marketing Agreement amended and superseded the 2002 Marketing Agreement.
Under the 2005 Marketing Agreement, Eco-Energy markets ethanol for an agreed-upon fee, which includes the cost of the rail shipment and collects the sales amount from the ultimate customers, remitting the net sales price to the Company within three business days after the sale.
On October 5, 2006, the Company entered into a new Risk Management and Ethanol Marketing Contract (the “2006 Marketing Agreement”) with FC Stone and Eco-Energy pursuant to which Eco-Energy purchases the Company’s entire output of ethanol for the 40 million gallon plant expansion in good faith at fair market rates for the term of the agreement subject to the Company’s sale of up to 5,000 gallons per month to local customers and sale of ethanol to any Company-owned E-85 station. This 2006 Agreement applies only to the Company’s proposed 40 million gallon plant expansion and does not apply to the Company’s existing plant. The 2006 Agreement does not amend or supersede the 2005 Agreement.
As a re-seller of ethanol, Eco-Energy’s customers are indirectly a part of the Company’s customer base. Eco-Energy markets and sells most of its ethanol throughout the United States, primarily by rail. The target market area for the ethanol produced at the Company’s ethanol plant includes local, regional and national markets. The local and regional markets include the State of Nebraska, as well as markets in South Dakota, Kansas, Missouri, Colorado, Minnesota, Illinois, Iowa, California, New Mexico and Oregon.
Distillers Grain
The dry milling process that produces ethanol also produces distillers grain, which are primarily used as a high protein animal feed. The price of distillers grain generally varies with grain prices, so that increases in grain costs are partially offset by increases in distillers grain prices. Husker Ag is currently producing almost entirely distillers modified wet grain which is marketed and sold primarily to feedlots, cattle feeders and dairies within a 120-mile radius of the ethanol plant.
On January 25, 2004, the Husker Ag Board of Directors adopted a Policy on Marketing which, among other things, provides that commencing April 1, 2004, no employee of Husker Ag, no member of the Board of Directors, and no person performing marketing functions for the Company, shall haul or have any ownership interest in trucks or entities which haul the Company’s products. During 2004, Husker Ag hired a full-time employee to undertake primary responsibility for the sale and marketing of distillers grain.
Competition
Husker Ag is in direct competition with numerous other ethanol producers, many of whom have greater resources than the Company does. The Company expects that additional ethanol producers will continue to enter the market if the demand for ethanol continues to increase. Husker Ag’s ethanol plant will compete with other ethanol producers on the basis of price and, to a lesser extent, delivery service.
During the last twenty years, ethanol production capacity in the United States has grown from almost nothing to more than 5.5 billion gallons at the end of 2006. Based upon information provided by the Renewable Fuels Association (the “RFA”), 110 ethanol plants located in 19 states produced a record 4.9 billion gallons of ethanol in 2006, an increase of more than 25% from 2005. Fifteen new facilities combined with expansions at existing plants, increased the industry’s annual production capacity by a record 1.051 billion gallons according to the RFA. The RFA reported that 73 plants and 8 major expansions were under construction at the end of 2006 that would add approximately 6 billion gallons of new annual production capacity by 2009. This increase in capacity may be expected to continue in the near future. Husker Ag cannot determine the effect of this type of an increase upon the demand or price of ethanol, although such plants may compete with the Company in the sale of ethanol and related products.
As of December 2006, there are approximately 94 producers operating 110 production facilities in the United States. The largest ethanol producers include Archer Daniels Midland, Cargill, Midwest Grain Processors, LLC, VeraSun Energy Corporation, Aventine Renewable Energy, Inc., and US BioEnergy Corporation, all of which are capable of producing much more ethanol than the Company expects to produce. In addition, there are several regional entities recently formed, or in the process of formation, of a similar size and with similar resources to those of Husker Ag.
In addition to the plants under construction, plans to construct additional new plants or to expand existing plants have been announced which would further increase the ethanol production capacity of the Company’s competitors. Husker Ag is unable to determine the number and production capacity of plants that ultimately may be constructed, the timing of such construction or the effect of resulting production upon the demand for or price of the Company’s ethanol. However, it is possible that the plant-building boom will create a market glut for ethanol thereby driving ethanol prices, along with the Company’s revenues, down due to the increasing supply.
Raw Materials and Other Inputs
The principal costs associated with the operation of the plant are employment costs, utilities, purchase of corn inventory, purchase of enzymes, chemicals and other materials necessary to operate the plant, interest on indebtedness and general and administrative expenses. Increases in the price of corn and/or other inputs such as natural gas may have a material impact on the profitability of the Company.
Corn Supply and Corn Prices
The Husker Ag ethanol plant needs between approximately 8.5 and 9.5 million bushels of corn per year or approximately 26,000 bushels per day as the feedstock for its dry milling process. The grain supply for the ethanol plant is obtained primarily from local markets. During the five year period between 1996 to 2000, corn production averaged 94 million bushels annually in the five county area surrounding the plant. Since 2000, the corn production has increased somewhat in this five county area. Management believes that the average annual corn production is this area should generally remain consistent in the near future.
The price and availability of corn are subject to significant fluctuations depending upon a number of factors which affect commodity prices in general, including crop conditions, weather, governmental programs and foreign purchases. Because the market price of ethanol is not related to grain prices, ethanol producers are generally not able to compensate for increases in the cost of grain feedstock through adjustments in prices charged for their ethanol. Therefore, the Company’s profitability will be negatively impacted during periods of high grain prices.
Corn prices have increased sharply since August 2006. Corn prices have risen at least partially due to additional demand from the ethanol industry. Because of forward corn contracts purchased by the Company for the last half of 2006, the Company was able to reduce the impact of this price increase. However, if corn prices remain at historically high prices through 2007, the Company’s margins can be expected to reduced accordingly. See “Risk Factors” below.
The Company has also retained Husker Trading, Inc. to originate and acquire corn for plant usage rather than hiring an on-site commodities manager. As part of its responsibilities, Husker Trading, Inc. will ensure the consistent scheduling of grain deliveries and to establish and fill forward contracts through grain elevators and will coordinate grain deliveries between the railroad, participating elevators and producers, as well as negotiate price protection with hedging specialists.
Options and Futures Contracts - Hedging
In an attempt to minimize the effects of the volatility of corn and natural gas costs and other inputs on operating profits, Husker Ag has taken hedging positions in corn and natural gas futures and option markets. Similarly, in an attempt to minimize the effects of market volatility of the Company’s gas-plus forward contracts for the sale of ethanol, Husker Ag has taken hedging positions in unleaded gas futures and options markets.
Hedging means protecting the price at which the Company buys corn and natural gas and the price at which it will sell its products in the future. It is a way to attempt to reduce the risk caused by price fluctuation. The effectiveness of hedging activities is dependent upon, among other things, the cost of corn, natural gas and unleaded gas as well as Husker Ag’s ability to sell sufficient amounts of ethanol and distillers grain to utilize all of the commodities subject to the option and futures contracts. Hedging activities can result in costs to the Company because price movements in grain, natural gas and unleaded gas contracts are highly volatile and are influenced by many factors which are beyond the Company’s control.
The Company uses natural gas as its main source of energy. Natural gas prices have historically fluctuated significantly. Increases in the price of natural gas would harm the Company by increasing its energy costs. An increase in the price of natural gas has a direct impact on the Company’s costs to produce ethanol. For this reason, the Company began purchasing option and futures contracts on natural gas for the first time in January 2005.
A relatively small percentage of the Company’s forward contracts for the sale of ethanol are priced as “gas-plus” contracts where the Company receives a price per gallon of ethanol sold equal to the then average unleaded gas price per gallon plus a fixed amount. Since unleaded gas prices fluctuate, decreases in gasoline prices cause the Company’s revenues on these gas-plus contracts to decrease. Therefore, as part of its hedging strategy, the Company also began purchasing option and futures contracts on unleaded gas for the first time in January 2005.
The Company enters into option and futures contracts, which are designated as hedges of specific volumes of corn and natural gas projected to be used in the manufacturing process and ethanol expected to be sold. The Company uses derivative financial instruments to manage the exposure to price risk related to corn and natural gas purchases and ethanol sales. The Company currently does not meet the requirements for cash flow hedging under FASB 133. See Note 7 to the Company’s Financial Statements included below for additional information.
As noted above, the Company has entered into a risk management agreement with FC Stone, LLC (“FC Stone”), a commodities risk management firm, under which FC Stone provides the Company with advice, assistance and a price risk management program for corn products necessary for the operation of the plant.
In February 2004, the Husker Ag Board of Directors adopted a Risk Management Policy, which establishes a Risk Management Committee to serve as the liaison between management and Board regarding forward pricing and risk management issues. The Risk Management Committee is currently comprised of General Manager Seth Harder, and Board members Mike Kinney, Stanley Gyberg, Leonard Wostrel and David Stearns. The Risk Management Policy also establishes position limits and forward pricing guidelines with respect to risk exposure for corn, distillers grain, ethanol, denaturant and natural gas, as well as approval procedures for management and the Risk Management Committee, approved commodity transaction instruments, and reporting and accounting function verification requirements.
Government Regulation and Environmental Matters
The operations of Husker Ag are subject to various federal, state and local laws and regulations with respect to environmental matters, including air and water quality and underground fuel storage tanks. Husker Ag believes it is currently in substantial compliance with environmental laws and regulations. Protection of the environment requires Husker Ag to incur expenditures for equipment, processes and permitting. If Husker Ag were found to have violated federal, state or local environmental regulations, the Company could incur liability for cleanup costs, damage claims from third parties and civil or criminal penalties that could materially adversely affect its business.
The Company filed an application with the Nebraska Department of Environmental Quality (the “NDEQ”) for its National Pollutant Discharge Elimination System (NPEDS) waste water permit on August 2, 2002, and received its waste water permit from the NDEQ and such permit was effective February 26, 2003. As of December 31, 2006, the NDEQ had not yet issued Husker Ag its Air Quality Operating Permit. Therefore, the Company has been subject to its Construction Permit which was issued in January 2002. Before being modified in 2005, this permit limited production at the plant to 25,000,000 gallons of denatured alcohol.
Because Husker Ag elected to purchase a thermal oxidizer rather than use a boiler, the NDEQ determined that the Husker Ag Air Quality Operating Permit needed modification to include the impact of the thermal oxidizer on the plant’s dispersion modeling. The Company completed stack testing as required under the NDEQ regulations and submitted the results of such testing on October 24, 2003. The submission also included a request to increase the ethanol production permitted under the permit to approximately 27,000,000 gallons of denatured alcohol per year. The Air Quality Operating Permit was submitted to the NDEQ on March 3, 2004. The NDEQ required the Company to comply with certain conditions including the paving of the plant roadways. This paving was completed in April 2005.
For the twelve months ended December 31, 2004, Husker Ag produced more than 25,000,000 gallons of denatured alcohol, which exceeded its Construction Permit limit. The Company informed the NDEQ of this matter. The Company does not expect any penalty for exceeding its limit in 2004. During 2005, prior to
receiving its modified permit, Husker Ag operated its plant at a rate of 25,000,000 gallons, or less, of denatured alcohol per year. On February 25, 2005, the Company submitted a modification to the construction permit application requesting a limit of approximately 32,000,000 gallons per year and the Company received approval for the modified construction air permit from the NDEQ on June 13, 2005. This modified permit allowed the Company to increase its production.
During October and November 2005, Husker Ag conducted compliance testing as required by the NDEQ to determine whether it was operating in compliance with its modified air permit issued June 13, 2005. The Company submitted the final results of such testing in December 2005. The preliminary results from this test were favorable and indicated that the plant is in compliance with the limits of its modified construction air permit issued June 13, 2005. During the fourth quarter of 2006, the NDEQ notified the Company that it will be operating on the modified construction air permit until the plant expansion has been completed. Husker Ag anticipates that it will have a resolution to its operating permit application upon completion of the plant expansion and successful compliance testing which is currently anticipated by the end of 2007. In the meantime, Husker Ag believes that it is in compliance with its modified air permit.
Plant expansion update. On November 9, 2006, the Director of the NDEQ issued an Order of Variance providing a variance from a state law requiring the Company to obtain a new construction air permit before beginning construction on the plant expansion. In its Order, the Director found that the start of concrete work would be unnecessarily delayed by cold winter weather if the Company was required to wait for a new permit. The Order of Variance provides that Husker Ag may commence its plant expansion without a construction air permit, provided that the Company may not operate the new plant until the NDEQ issues a new construction air quality permit for the expansion. This Order does not replace or otherwise affect the Company’s current modified construction air permit which covers the existing plant. Unless terminated earlier by its terms, the Order of Variance shall terminate and expire on November 9, 2007.
During 2006, Husker Ag filed a formal application with the NDEQ for permission to modify its existing plant in accordance with the plant expansion project, such application requesting a limit of 76,000,000 gallons of annual ethanol production. In accordance with the Nebraska Air Quality Regulations, notice of our application was given to the public on February 12, 2007, with the 30 day public notice period having ended on March 13, 2007. While the NDEQ received no public comment, Husker Ag continues to work with the NDEQ to review its application. The Company has been given no assurance from the NDEQ regarding the issuance of its construction air permit.
Husker Ag’s financing agreement with Union Bank & Trust Company for the plant expansion project specifically states that Husker Ag may not draw on its construction loan unless and until the NDEQ issues a new construction air quality permit for the expansion. See “Liquidity and Capital Resources” below under Item 7 for additional information regarding the Company’s debt financing for the expansion. In the event the construction air permit is not approved by the NDEQ by the time the Company is otherwise ready to draw on its construction loan, Husker Ag may be required to borrow money on its line of credit to make payments necessary under its Design-Build Agreement with ICM, and/or seek modifications of its agreements with Union Bank or ICM.
Employees
As of March 30, 2007, Husker Ag had a total of 32 employees managing and operating the ethanol plant facility. Husker Ag is not subject to any collective bargaining agreements and has not experienced any work stoppages. Husker Ag management considers its relationship with its employees to be good.
ITEM 1A.
ITEM 1A. RISK FACTORS
Husker Ag’s business is not diversified and this could reduce the value of the membership units.
Husker Ag’s success depends largely upon its ability to profitably operate its ethanol business, while the success of the plant expansion depends largely upon the Company’s ability to timely complete and profitably operate its expanded ethanol business. Husker Ag does not have any other lines of business or other sources of revenue if it is unable to manufacture ethanol and distillers grain. If economic or political factors adversely affect the market for ethanol, the value of its membership units could decline because the Company has no other line of business to fall back on if the ethanol business declines. Husker Ag’s business would also be significantly harmed if its ethanol plant, with or without the expansion, could not operate at full capacity for any extended period of time.
Husker Ag faces intense competition from competing ethanol and other fuel additive producers.
Competition in the ethanol industry is intense. Husker Ag faces formidable competition in every aspect of its business from established producers of ethanol, including Archer Daniels Midland Company and Cargill, Inc., and from other companies that are seeking to develop large-scale ethanol plants and alliances. For 2006, the top ten producers accounted for approximately 44% of the ethanol production capacity in the U.S. according to the Renewable Fuels Association (the “RFA”), a national trade association for the ethanol industry. A number of Husker Ag’s competitors are divisions of substantially larger enterprises and have substantially greater financial resources than the Company.
Husker Ag expects competition to increase as the ethanol industry becomes more widely known and demand for ethanol increases. Most new ethanol plants in development across the country are independently owned. In addition, various investors could heavily invest in ethanol production facilities and oversupply ethanol, resulting in higher raw material costs and lower ethanol price levels that could materially adversely affect Husker Ag’s business, results of operations and financial condition.
Any increase in domestic or foreign competition could cause Husker Ag to reduce its prices and take other steps to compete effectively, which could materially adversely affect Husker Ag’s business, results of operations and financial condition.
The rapid growth of production capacity in the ethanol industry creates some market uncertainty for the ethanol industry.
Domestic ethanol production capacity has increased steadily from 1.7 billion gallons per year in January of 1999 to 5.5 billion gallons per year in January 2007. In addition, there is a significant amount of capacity being added to the ethanol industry. According to the RFA, approximately 6.0 billion gallons per year of production capacity was under construction at the end of 2006. This capacity is being added to address anticipated increases in demand. However, demand for ethanol may not increase as quickly as expected or to a level that exceeds supply, or at all. Husker Ag cannot determine what effect this increase in production will have upon the demand or price of ethanol. At a minimum, this increased capacity creates some uncertainty for the ethanol industry. If the ethanol industry has excess capacity and such excess capacity results in a fall in prices, it will have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Excess capacity may result from the increases in capacity coupled with insufficient demand. Demand could be impaired due to a number of factors, including regulatory developments and reduced U.S. gasoline consumption. Reduced gasoline consumption could occur as a result of increased gasoline or oil prices. For example, price increases could cause businesses and consumers to reduce driving or acquire vehicles with more favorable gasoline mileage. Demand for ethanol can also fall if gasoline prices decrease because ethanol is used as a potential substitute for gasoline.
The increased production of ethanol could have other adverse effects as well. For example, the increased production will also lead to increased supplies of co-products from the production of ethanol, such as distillers grain. Those increased supplies could lead to lower prices for those co-products. Also, the increased production of ethanol has resulted in increased demand for corn which has in turn led to increases in the price of corn, resulting in higher costs of production and lower profits.
Husker Ag’s business is highly dependent on commodity prices. These prices are subject to significant volatility and uncertainty, so Husker Ag’s results could fluctuate significantly.
Husker Ag’s results of operations, financial position and business outlook will continue to be substantially dependent on commodity prices, especially prices for corn, natural gas, ethanol and unleaded gasoline. Prices for these commodities are generally subject to significant volatility and uncertainty. As a result, the Company’s future results may fluctuate substantially, and it may experience periods of declining prices for its products and increasing costs for its raw materials, which could result in lower profits. Husker Ag may
continue to attempt to offset a portion of the effects of such fluctuations by entering into forward contracts to supply ethanol or to purchase corn, natural gas or other items or by engaging in transactions involving hedging contracts, but these activities involve substantial costs and substantial risks and may be ineffective to mitigate these fluctuations.
The spread between ethanol and corn prices can vary significantly.
Husker Ag’s gross margins will depend principally on the spread between ethanol and corn prices. In recent periods, the spread between ethanol and corn prices has been at a historically high level, driven in large part by high oil prices and historically low corn prices. However, more recently the price of corn has increased significantly, reducing such gross margins. The spread between the price of a gallon of ethanol and the price of the amount of corn required to produce a gallon of ethanol may not remain at, or return to, recent high levels and fluctuations will continue to occur. Any reductions in the spread between ethanol and corn prices, whether as a result of an increase in corn prices or a reduction in ethanol prices, could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Husker Ag’s business is dependent upon the availability and price of corn. Significant disruptions in the supply of corn will have a material adverse effect on Husker Ag’s business, results of operations and financial condition. In addition, since the Company generally cannot pass on increases in corn prices to its customers, continued periods of historically high corn prices will also materially adversely affect Husker Ag’s business, results of operations and financial condition.
Corn is the principal raw material used by the Company to produce ethanol and distillers grain. Because ethanol competes with fuels that are not corn-based, Husker Ag generally is unable to pass along increased corn costs to its 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 (including 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. In 2006, corn bought by ethanol plants represented nearly 17% of the total domestic corn supply for that year according to results reported by the National Corn Growers Association, and this percentage is expected to increase as additional ethanol capacity comes online. The significant increase in domestic ethanol capacity under construction could outpace increases in corn production, which may increase corn prices and significantly impact the Company’s profitability.
At a more local level, the price Husker Ag pays for corn could also increase as a result of the pending expansion at the current plant location or if other ethanol production facilities were built in the same general vicinity. Husker Ag may also have difficulty from time to time in purchasing corn on economical terms due to supply shortages. Any supply shortage could require Husker Ag to suspend operations until corn became available at economical terms. Suspension of operations could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
The Company also attempts to reduce the risks related to corn price volatility through the futures and option markets. However, these hedging transactions also involve risk to the Company’s business.
The market for natural gas is subject to market conditions that create uncertainty in the price and availability of the natural gas that Husker Ag utilizes in the ethanol manufacturing process.
Husker Ag relies upon third-parties for its supply of natural gas, which is consumed in the manufacture of ethanol. The prices for and availability of natural gas are subject to volatile market conditions. These market conditions often are affected by factors beyond Husker Ag’s control such as weather conditions (including hurricanes), overall economic conditions and foreign and domestic governmental regulation and relations. Significant disruptions in the supply of natural gas could impair Husker Ag’s ability to manufacture ethanol for its customers. Further, increases in natural gas prices could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Due to capacity constraints in the natural gas pipeline from Grand Island, Nebraska to the Company’s plant site, Husker Ag does not currently have sufficient firm transportation for the natural gas required for its expansion. While the Company anticipates that in the short-term it will be able to acquire sufficient natural gas for its operating needs through the released market, neither Kinder Morgan nor our natural gas provider Cornerstone Energy can guarantee that our natural gas supply will be uninterrupted.
In an effort to secure firm transportation for our anticipated future natural gas needs, in February 2007, Husker Ag entered into a Precedent Agreement with Kinder Morgan Interstate Gas Transmission LLC (“Kinder Morgan”) whereby Husker Ag agreed, subject to the terms of the Precedent Agreement, to enter into a 10-year Firm Transportation Service Agreement providing for firm interstate natural gas transportation service to be provided by Kinder Morgan for Husker Ag. Husker Ag agreed to contract for 3,500 MMBtus per day which is the anticipated need for the expansion. The Precedent Agreement also allows Husker Ag to pay for its share of Kinder Morgan’s capacity expansion project and related facilities over a ten-year period at the “negotiated reservation rate” of $0.6250 per MMBtu per month.
Kinder Morgan’s obligation under the Precedent Agreement is subject to several conditions including sufficient firm capacity subscription from other consumers, all appropriate and final government approvals, and all rights-of-way and other surface required to site and maintain the pipeline facilities. Given these conditions, Husker Ag does not expect this new pipeline to be in place until late 2008. If Kinder Morgan abandons this project, Husker Ag would be forced to rely on the released natural gas market and may be required to pursue alternative solutions to its long terms natural gas needs.
Fluctuations in the selling price and production cost of gasoline may reduce Husker Ag’s profit margins.
Ethanol is marketed both as a fuel additive to reduce vehicle emissions from gasoline and as an octane enhancer to improve the octane rating of gasoline with which it is blended. As a result, ethanol prices are influenced by the supply and demand for gasoline and Husker Ag’s business, future results of operations and financial condition may be materially adversely affected if gasoline demand or price decreases.
The price of distillers grain is affected by the price of other commodity products, such as soybeans, and decreases in the price of these commodities could decrease the price of distillers grain.
Distillers grain compete with other protein-based animal feed products. The price of distillers grain 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 corn and soybeans, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers grain. Because the price of distillers grain is not tied directly to production costs, decreases in the price of distillers grain will result in Husker Ag generating less revenue and lower profit margins.
The use and demand for ethanol and its supply are highly dependent on various federal and state legislation and regulation, and any changes in legislation or regulation could cause the demand for ethanol to decline or its supply to increase, which could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Various federal and state laws, regulations and programs have led to increased use of ethanol in fuel. For example, certain laws, regulations and programs provide economic incentives to ethanol producers and users. These laws, regulations and programs are constantly changing. Federal and state legislators and environmental regulators could adopt or modify laws, regulations or programs that could adversely affect the use of ethanol. These laws, regulations or programs will continue in the future.
Federal regulations concerning tax incentives or other federal incentive programs could expire or change which could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
The cost of producing ethanol has historically been significantly higher than the market price of gasoline.
The production of ethanol is made significantly more competitive with regular gasoline by federal tax incentives. Before January 1, 2005, the federal excise tax incentive program allowed gasoline distributors who blended ethanol with gasoline to receive a federal excise tax rate reduction for each blended gallon they sold. If the fuel was blended with 10% ethanol, the refiner/marketer paid $0.052 per gallon less tax, which equated to an incentive of $0.52 per gallon of ethanol. The $0.52 per gallon incentive for ethanol was reduced to $0.51 per gallon in 2005 and is scheduled to expire (unless extended) in 2010. The federal ethanol tax incentives may not be renewed in 2010 or they may be renewed on different terms.
Husker Ag may also receive benefits from other federal incentive programs. For example, historically, Husker Ag has received incentive payments to produce ethanol from the United States Department of Agriculture, or USDA, under its Commodity Credit Corporation Bioenergy Program. Under this program, Husker Ag received payments of approximately $4.6 million and $2.2 million in 2003 and 2004, respectively. However, Husker Ag did not receive any substantial payments under this program during 2005 or 2006. The USDA program expired on June 30, 2006, and existing or future incentive programs may also expire or be eliminated. The elimination or significant reduction in the federal ethanol tax incentive or other programs benefiting ethanol could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Nebraska state producer incentives may be unavailable or could be modified which could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
In 2001 the State of Nebraska enacted LB 536, a legislative bill which established a production tax credit of 18¢ per gallon of ethanol produced during a 96 consecutive month period by newly constructed ethanol facilities in production prior to June 30, 2004. The tax credit is only available to offset Nebraska motor fuels excise taxes. The tax credit is transferable and therefore Husker Ag transfers credits received to a Nebraska gasoline retailer who then reimburses Husker Ag for the face value of the credit amount less a handling fee. No producer can receive tax credits for more than 15,625,000 gallons of ethanol produced in one year and no producer will receive tax credits for more than 125 million gallons of ethanol produced over the consecutive 96 month period. The minimum production level for a plant to qualify for credits is 100,000 gallons of ethanol annually. Husker Ag has entered into a written agreement with the Tax Commissioner on behalf of the State of Nebraska pursuant to which Husker Ag agreed to produce ethanol at its designated facility and the State of Nebraska agreed to furnish the producer tax credits in accordance with the terms of the law.
The production incentive is scheduled to expire June 30, 2012. Assuming Husker Ag continues to produce at least 15,625,000 gallons of ethanol annually, this producer tax credit could result in payments of up to $2,812,500 to the Company annually, subject to the statutory maximum limit. Any changes to existing state law, regulations or programs could have an adverse effect on Husker Ag’s revenue.
In recent years, because of State of Nebraska budget shortfalls, various tax credit provisions in effect in Nebraska, including LB 536, came under increased scrutiny from the Nebraska Unicameral. As a result there can be no assurance that the Nebraska legislature will not in enact new legislation in the future which would revise LB 536, or otherwise adversely impact ethanol plants, such as Husker Ag’s plant, which are to benefit from LB 536.
Husker Ag believes there are a number of existing projects in Nebraska that are also eligible for LB 536 payments which will require the legislature to increase funding for the producer incentive program through either an increase in general fund appropriation or other sources such as the grain check-off program. Despite the Company’s written agreement with the State of Nebraska, the Nebraska legislature could reduce or eliminate the producer tax credits at any time; however, a reduction or elimination in payments to Husker Ag contrary to the terms of its written agreement would constitute a breach of the contract by the State of Nebraska. The State of Nebraska could also impose taxes on the ethanol plants to provide additional funds for the ethanol production incentive fund. If the State of Nebraska established such a tax, Husker Ag could be for example, required to pay taxes on the distillers grain it produces, which could have a material adverse impact on Husker Ag’s business, results of operations and financial condition.
On February 6, 2004, the Nebraska Attorney General issued an opinion concerning certain proposed legislation which was then before the Nebraska legislature, in which the Attorney General concluded that the “statute authorizing execution of these agreements specifically binds the State to provide such [ethanol
tax] credits under the law in effect at the time of execution of the agreements.” In the opinion of Husker Ag, the Attorney General opinion provides support for Husker Ag’s position that it is important that the State of Nebraska continue to meet its obligations in accordance with the terms of the Company’s written agreement.
During April 2006, Governor Heineman signed LB 968 which calls for additional general fund transfers to the Ethanol Production Incentive Cash (EPIC) Fund in the amount of $5 million for both fiscal years 2005-2006 and 2006-2007. This is in addition to the transfers approved in 2005 totaling $20.5 million through fiscal year 2011-2012. The EPIC Fund is used to offset the cost of providing incentives to ethanol producers. While this is a positive step toward the funding of the Nebraska state producer incentives, estimates of the state’s total liability for ethanol production credits range from $100 million to $200 million.
The Company cannot predict whether the State of Nebraska will continue to be able to meet its obligations under LB 536. The elimination or significant reduction in this state incentive program could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Update for 2007 Legislative Session: The 2007 Nebraska Unicameral legislative session is expected to end on or about May 31, 2007. The legislature is currently considering funding mechanisms to help ensure that LB 536 remains funded. However, none of the applicable legislative bills have come to a final vote by the legislature as of March 29, 2007. The legislature is expected to continue to debate, and possibly vote on, one or more ethanol related bills during the second quarter of 2007.
The effect of the Renewable Fuels Standard, or RFS, in the recent Energy Policy Act of 2005 on the ethanol industry is uncertain.
The use of fuel oxygenates, including ethanol, was mandated through regulation, and much of the forecasted growth in demand for ethanol was expected to result from additional mandated use of oxygenates. Most of this growth was projected to occur in the next few years as the remaining markets switch from MTBE to ethanol. The recently enacted energy bill, however, eliminated the mandated use of oxygenates and instead established minimum nationwide levels of renewable fuels (ethanol, biodiesel or any other liquid fuel produced from biomass or biogas) to be included in gasoline or diesel. Because biodiesel and other renewable fuels in addition to ethanol are counted toward the minimum usage requirements of the RFS, the elimination of the oxygenate requirement for reformulated gasoline may result in a decline in ethanol consumption, which in turn could have a material adverse effect on Husker Ag’s business, results of operations and financial condition.
Technological advances could significantly decrease the cost of producing ethanol or result in the production of higher-quality ethanol, and if Husker Ag is unable to adopt or incorporate technological advances into its operations, both Husker Ag’s current and proposed ethanol plant could become uncompetitive or obsolete.
Husker Ag expects that technological advances in the processes and procedures for processing ethanol will continue to occur. It is possible that those advances could make the processes and procedures that Husker Ag utilizes at its ethanol plant (and intend to use in the new expansion) less efficient or obsolete, or cause the ethanol it produces to be of a lesser quality. These advances could also allow the Company’s competitors to produce ethanol at a lower cost than Husker Ag. If the Company is unable to adopt or incorporate technological advances, its ethanol production methods and processes could be less efficient than those of its competitors, which could cause both Husker Ag’s existing and expanded ethanol plant to become uncompetitive.
Ethanol production methods are also constantly advancing. 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, and municipal solid waste. 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 that are unable to grow corn. Continued increases in the price of corn, or sustained high corn prices, could decrease the relative attractiveness of corn-based ethanol where alternatives exist, thereby adversely affecting Husker Ag’s business, operating results or financial condition. Another trend in ethanol production research is to produce ethanol through a chemical
process rather than a fermentation process, thereby significantly increasing the ethanol yield per pound of feedstock. Although current technology does not allow these production methods to be competitive, new technologies may develop that would allow these methods to become viable means of ethanol production in the future. If the Company is unable to adopt or incorporate these advances into its operations, Husker Ag’s cost of producing ethanol could be significantly higher than those of its competitors, which could make Husker Ag’s ethanol plant obsolete.
Husker Ag is subject to extensive environmental regulation and operational safety regulations that could result in higher than expected compliance costs and liabilities.
The operations of Husker Ag are subject to various federal, state and local laws and regulations with respect to environmental matters, including air and water quality and underground fuel storage tanks. Ethanol production involves the emission of various airborne pollutants, including particulate matters, carbon monoxide, oxides of nitrogen, volatile organic compounds and sulfur dioxide.
To construct the plant expansion and operate the expanded business after its completion, Husker Ag needs appropriate permits from the Nebraska Department of Environmental Quality (the “NDEQ”). (See section above entitled “Government Regulation and Environmental Matters” for information regarding Husker Ag’s permit process with the NDEQ.)
Even if Husker Ag receives all required permits from the State of Nebraska, it may be subject to regulations on emissions from the United States Environmental Protection Agency (the “EPA”). Further, EPA and Nebraska’s environmental regulations are subject to change and often such changes are not favorable to industry. Consequently, even if Husker Ag has the proper permits now, it may be required to invest or spend considerable resources to comply with future environmental regulations.
The Company’s failure to comply or the need to respond to threatened actions involving environmental laws and regulations may adversely affect its business, operating results or financial condition. As an operational company, Husker Ag has developed procedures for the proper handling, storage, and transportation of finished products and materials used in the production process and for the disposal of waste products. In addition, state or local requirements may also restrict the Company’s production and distribution operations. Husker Ag could incur significant costs to comply with applicable laws and regulations as production and distribution activity increases. Protection of the environment will require Husker Ag to incur expenditures for equipment or processes.
Members may be required to pay taxes on their share of Husker Ag’s income even if it makes no distributions to members.
Husker Ag expects to continue to be treated as a partnership for federal income tax purposes unless there is a change of law or trading in the membership units is sufficient to classify Husker Ag as a “publicly traded partnership.” This means that Husker Ag will pay no income tax and all profits and losses will “pass-through” to its members who will pay tax on their share of Husker Ag’s profits. Husker Ag’s members may receive allocations of taxable income that exceed any cash distributions made, if any. This may occur because of various factors, including but not limited to, accounting methodology, lending covenants that restrict Husker Ag’s ability to pay cash distributions, or its decision to retain or use the cash generated by the business to fund its operating activities and obligations. Accordingly, members may be required to pay income tax on the allocated share of Husker Ag’s taxable income with personal funds, even if the members receive little or no cash distributions from the Company.
Husker Ag’s plant expansion project could suffer delays or defects in plant construction that could postpone our ability to generate revenues on the expanded plant.
Construction projects often involve delays. If it takes longer to obtain necessary permits or construct the plant than we anticipate, it would delay our ability to generate revenues from the expansion. Moreover, there is no assurance that defects in materials and/or workmanship of the project will not occur. Under the terms of our Design-Build Agreement with ICM, we have warranties that are limited in scope. Husker Ag will be relying on our design build contractor to satisfy its warranties, and these warranties may not provide adequate resources if there are defects in materials and/or workmanship. Notwithstanding any warranties, such defects could delay the commencement of operations, or if discovered after operations have commenced, could cause us to halt or discontinue operations of the plant expansion.
To ensure compliance with requirements imposed by the Internal Revenue Service, the Company informs you that any U.S. federal tax advice contained in this Form 10-K is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any matters addressed herein.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The Company is not an accelerated filer or large accelerated filer or well-known seasoned issuer and has received no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of its 2006 fiscal year and that remain unresolved.
ITEM 2.
ITEM 2. PROPERTY
The Company’s corporate offices are located at the plant site in the administrative building at 54048 Highway 20, Plainview, Nebraska 68769, phone number (402) 582-4446. The administrative building consists of approximately 5,700 square feet. The Husker Ag ethanol plant is on 47 acres of real property located 3 1/2 miles east of Plainview, Nebraska between the railroad and US Highway 20 located in Pierce County, Nebraska. The ethanol plant and plant site are subject to real estate mortgage liens granted to the Company’s primarily lender, Union Bank & Trust Company, as described below under Management’s Discussion and Analysis of Financial Condition and Results of Operations. Husker Ag’s management believes the properties and facilities of Husker Ag are adequate to support Husker Ag’s ethanol business operations. The Company’s ethanol plant currently has the capacity to produce approximately 27 million gallons of ethanol per year. As noted above in Item 1, the Company is currently constructing a plant expansion that would add 40 million or more gallons per year of ethanol production capacity to its existing operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Husker Ag has not been informed of any legal matters that would have a material adverse effect on its financial condition, results of operation or cash flow.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of members during the quarterly period ended December 31, 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED MEMBER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is no established trading market for Husker Ag’s membership units. To maintain its partnership tax status, members of Husker Ag may not trade the membership units on an established securities market or readily trade the membership units on a secondary market (or the substantial equivalent thereof). All transfers are subject to a determination that the transfer will not cause Husker Ag to be deemed a publicly traded partnership.
Husker Ag restricted the ability of members to transfer membership units in its Operating Agreement. To help ensure that a secondary market does not develop, Husker Ag’s Operating Agreement prohibits transfers without the approval of its Board of Directors. The Board of Directors will not approve transfers unless they fall within “safe harbors” contained in the publicly-traded partnership rules under the tax code, which include: (a) transfers by gift, (b) transfer upon death of a member, (c) transfers between family members, and (d) transfers that comply with the “qualifying matching services” requirements. Any transfers of membership units in violation of the publicly traded partnership rules or without the prior consent of the Board will be invalid.
Under the Internal Revenue Code and the related rules and regulations (the “Tax Code”), a matching service is qualified only if it meets a number of specified requirements, including: (1) it consists of a computerized or printed system that lists customers’ bid and/or ask prices in order to match members who want to sell with persons who want to buy, (2) matching occurs either by matching the list of interested buyers with the list of interested sellers or through a bid and ask process that allows interested buyers to bid on the listed interest, (3) the seller cannot enter into a binding agreement to sell the interest until the 15th calendar day after his interest is listed (which date must be confirmable by maintenance of contemporaneous records), (4) the closing of a sale effected through the matching service does not occur prior to the 45th calendar day after the interest is listed, (5) the matching service displays only quotes that do not commit any person to buy or sell an interest at the quoted price (non firm price quotes) or quotes that express an interest in acquiring an interest without an accompanying price (nonbinding indications of interest) and does not display quotes at which any person is committed to buy or sell a interest at the quoted price (firm quotes), (6) the seller’s information is removed within 120 days of its listing and is not reentered into the system for at least 60 days after its deletion, and (7) the sum of the percentage interests transferred during the entity’s tax year (excluding private transfers) cannot exceed 10% of the total interests in partnership capital or profits. The Husker Ag Trading System described below has incorporated these Tax Code requirements into its rules and procedures required to be followed by those using the system.
On October 15, 2004, the Company received approval from the Nebraska Department to operate its own trading system (the “Trading System”) limited to trading in membership units of Husker Ag. As a result of this approval, the Company commenced operation of its Trading System on December 1, 2004. The Trading System operates on a trimester basis commencing December 1, April 1 and September 1 of each year. In accordance with Section 10.9(b) of the Husker Ag Operating Agreement, the Husker Ag Board has established the trimester period as an “interim transfer period” with respect to transfers affected through the Trading System.
The Trading System is intended to match a list of interested buyers with a list of interested sellers, along with their non-firm price quotes. The Trading System does not automatically affect matches between potential sellers and buyers and it is the sole responsibility of sellers and buyers to contact each other to make a determination as to whether an agreement to transfer Husker Ag membership units may be reached. There are detailed timelines that must be followed under the Trading System Rules and Procedures with respect to offers and sales of membership units. All transactions must comply with the Husker Ag Trading Systems Rules and Procedures, the Husker Ag Operating Agreement, and are subject to approval by the Husker Ag Board of Directors.
The Husker Ag Trading System has been designed to comply with federal tax laws and IRS regulations establishing a “qualified matching service,” as well as state and federal securities laws. As a result, transfers of Husker Ag membership units are strictly regulated, and the Nebraska Department’s approval is based on representations made to the Nebraska Department concerning the operation of the Trading System, including the Husker Ag Trading System Rules and Procedures. The Husker Ag Trading System Rules and Procedures are available on the Husker Ag website, www.huskerag.com.
The Husker Ag Board of Directors has adopted a policy that the Trading System is intended to be the exclusive method of trading membership units for value in transactions which would otherwise be applied against the Trading System’s 10% maximum annual limitation, except in extraordinary circumstances as determined by the Board in its sole discretion. Transfers such as bona fide gifts and transfers upon death which are not included in the 10% annual maximum limitation are not included in the policy.
Holders
As of March 30, 2007, there were approximately 594 unit holders of the Company’s membership units determined by an examination of the Company’s transfer book.
Distributions
Effective September 17, 2003, the Husker Ag Board of Directors adopted the following policy with respect to the announcement of any future distributions to be made by Husker Ag to its members, in order to provide members, and any persons considering the purchase of Husker Ag membership units, adequate prior notice of such distributions:
The Company will make a public announcement of any distribution to members which has been approved by the Husker Ag Board of Directors within the 60 day period prior to the commencement of the calendar trimester in which the record date for the distribution would occur. The calendar trimester commencement dates are December 1, April 1, and September 1, and the announcement by Husker Ag would include both the future record date for the distribution and the amount per membership unit of such distribution.
The Company has declared and paid the following distributions since its inception through December 31, 2006:
The Company’s lender, Union Bank and Trust Company (“Union Bank”) and former lender, Stearns Bank, N.A. (“Stearns Bank”), approved each of these distributions as required under the Company’s existing loan agreements with Union Bank and Stearns Bank, respectively.
Any distributions are payable at the discretion of the Husker Ag Board of Directors, subject to the provisions of the Nebraska Limited Liability Company Act, and the Husker Ag Operating Agreement. The Board of Directors has no obligation to distribute profits, if any, to members, and there can be no assurance as to the ability of Husker Ag to declare or pay distributions in the future. In addition, the terms of the permanent debt financing agreements entered into by Husker Ag with Union Bank place certain restrictions on the Company’s ability to makes distributions.
First, the Company must be in compliance with all of its loan covenants with Union Bank prior to making any distributions in the future. With the Credit Agreement signed with Union Bank for the financing of the plant expansion project, the Company will be required to obtain prior approval from 66.67% of all financial institutions participating in this new financing. See “Liquidity and Capital Resources” below under Item 7 for additional information regarding the covenants for the Company’s debt.
Securities Authorized for Issuance under Equity Compensation Plans
Husker Ag currently has no equity compensation plan.
Recent Sales of Unregistered Securities; Use of Proceeds from Unregistered Securities
Husker Ag had no unregistered sales of securities during the past three fiscal years.
Purchases of Equity Securities by Husker Ag
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the consolidated financial statements and notes under Item 8 of this Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Husker Ag and its representatives may from time to time make written or oral forward-looking statements, including statements made in this report, that represent Husker Ag’s expectations or beliefs concerning future events, including statements regarding future sales, future profits and other results of operations, the continuation of historical trends, the sufficiency of cash balances and cash generated from operating and financing activities for Husker Ag’s future liquidity and capital resource needs, and the effects of any regulatory changes. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Husker Ag cautions you that any forward-looking statements made by Husker Ag in this report, in other reports filed by Husker Ag with the Securities and Exchange Commission or in other announcements by Husker Ag are qualified by certain risks and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Such risks and factors include, but are not limited to, the risk factors set forth in the section above entitled “RISK FACTORS”.
Overview
The Company owns and operates an ethanol plant located near Plainview, Nebraska. Husker Ag’s business consists of the production of ethanol and an ethanol co-product, distillers grains. The Company began grinding corn and producing ethanol in March 2003. Currently the ethanol plant converts roughly ten million bushels of corn into approximately 27 million gallons of ethanol per year. The ethanol plant also currently produces and sells over 160,000 tons of modified wet distillers grain on an annual basis.
Husker Ag’s operating results are largely driven by the prices at which it sells ethanol and distillers grain and the costs related to its production. The price of ethanol and distillers grain is influenced by factors such as supply and demand, prices of unleaded gasoline and substitute products, weather, government policies and programs, and foreign trade. Although federal and state government support programs have been a significant source of revenue and income since Husker Ag began production in March of 2003, the federal program is now much less significant because of the means by which the program structures, funds, and conditions the payments (see “Energy Production Credits” under “Results of Operations for the years ended December 31, 2006 and 2005” below for further discussion of this issue). With respect to the various costs in the production process, the two most significant are the costs of corn and natural gas. The cost of natural gas and corn is affected by factors such as supply and demand, weather, government policies and programs, foreign trade, and the risk management or hedging strategy used to protect against the price volatility of these commodities. See “Quantitative and Qualitative Disclosures about Market Risk” below for additional information.
Results of Operations for the years ended December 31, 2006 and 2005
The following table shows sales and revenues, cost of sales, loss on options, operating expenses and other items as a percentage of total sales and revenues as derived from the Company’s Statements of Income for the years ended December 31, 2006 and 2005. This table should be read in conjunction with the Company’s financial statements and accompanying notes under Item 8 of this Form 10-K.
Sales and Revenues
The Company’s sales and revenues are divided into three main categories including ethanol sales, distillers grain sales and energy production credits. For the years ended December 31, 2006 and 2005, ethanol sales comprised 82.9% and 81.1%, respectively, of total net sales. Distillers grain sales comprised 12.3% and 12.9% of the Company’s total net sales for the years ended December 31, 2006 and 2005, respectively; while federal and state energy production credits make up the remaining 4.8% and 6.0% of the Company’s total net sales for 2006 and 2005, respectively. If energy production credits are excluded, ethanol sales represent 87.1% and 86.3%, and distillers grain sales represent 12.9% and 13.7%, of the total revenue of the Company from the sales of its products for the years ended December 31, 2006 and 2005, respectively.
Net sales for the year ended December 31, 2006 increased by approximately $11.4 million, or 24.2% over the prior year. This increase in net sales in 2006 compared to 2005 resulted from an increase in ethanol sales of over $10 million, along with an increase in distiller grain sales of over $1 million. These individual categories of net sales are discussed further below.
Ethanol Sales
Ethanol sales for 2006 increased by 26.9% over the prior year. This was primarily due to an approximate 10.4% increase in the production of ethanol or 2.6 million gallons over 2005 coupled with a 15.1% increase in selling price from the previous year.
The vast majority of ethanol sold during 2006 was sold pursuant to a forward contract. At December 31, 2006, the Company had forward contracts for the sale of approximately 15.3 million gallons of ethanol with fixed prices ranging from $1.35 to $2.20 per gallon to be delivered through December 2007.
Distillers Grain Sales
Sales of distillers grain increased by over $1.1 million, or 18.4% for 2006 compared to 2005. This sales increase is largely due to two factors, an increase of production of over 10.7% or approximately 18,000 tons and an 8.8% increase in average selling price from 2006 to 2005.
Energy Production Credits
Net sales included approximately $2.8 million of energy production credits for the year ended December 31, 2006, which is nearly the same amount of net production credits earned during 2005. Except for a small adjustment for federal credits, energy production credits for 2006 are derived entirely from the State of Nebraska. Credits from the State of Nebraska remained relatively consistent for 2006 compared to 2005. The Company’s net income for the year ended December 31, 2006 without the energy production credits included in net sales would have been approximately $25.5 million (compared to actual net income of approximately $28.4 million).
While the producer credits from the State of Nebraska should remain relatively consistent for 2007 (subject to appropriate financing by the Nebraska Legislature; see “Risk Factors” above), the Company does not expect to receive any revenues from the federal program in the future.
Energy Credits - Federal Program. The ethanol producer credits from the federal government included incentive revenue from the United States Department of Agriculture’s Commodity Credit Corporation (“CCC”) under its Bioenergy Program. This program expired on June 30, 2006. Under this program, the CCC made payments to eligible bioenergy producers to encourage increased purchases of agricultural commodities, such as corn, for the purpose of expanding production of bioenergy and to encourage the construction of new production capacity. Cash payments to eligible ethanol producers were based on the increase in gallons of ethanol produced from the prior federal fiscal year (which is an October 1 to September 30 fiscal year) and the market price of corn at the end of each quarter, with a more favorable calculation structure used for producers who generate less than 65 million gallons of ethanol annually.
Since the plant was operating at nearly full capacity for all of 2004 and 2005, the Company did not earn any federal ethanol producer credits during 2006, and with the termination of the program on June 30, 2006, the Company does not expect to receive any payments from this program in the future.
Energy Credits - Nebraska Program. In addition to Bioenergy Program cash incentives, LB 536, a State of Nebraska legislative bill which came into law on May 31, 2001, established a production tax credit of 18¢ per gallon of ethanol produced during a 96 consecutive month period by newly constructed ethanol facilities in production prior to June 30, 2004. The tax credit is only available to offset Nebraska motor fuels excise taxes. The tax credit is transferable and therefore Husker Ag transfers credits received to a Nebraska gasoline retailer who then reimburses Husker Ag for the face value of the credit amount less a handling fee. On March 24, 2003, Husker Ag entered into an agreement with Rite Way Oil & Gas Co., Inc. (“Rite Way”) pursuant to which Husker Ag may transfer up to $500,000 in ethanol production credits to Rite Way per month. Rite Way then pays Husker Ag the credit amount less a handling fee. No producer can receive tax credits for more than 15,625,000 gallons of ethanol produced in one year and no producer will receive tax credits for more than 125 million gallons of ethanol produced over the consecutive 96 month period. The minimum production level for a plant to qualify for credits is 100,000 gallons of ethanol annually. The production incentive is scheduled to expire June 30, 2012. Assuming the Company continues to produce at least 15,625,000 gallons of ethanol annually, this producer tax credit could result in payments of up to $2,812,500 to the Company annually, subject to the statutory maximum limit. Any changes to existing state law, regulations or programs could have an adverse effect on the Company’s revenue. See “Risk Factors” above.
This program may not have sufficient funds to cover the allocations to eligible producers in future years. Husker Ag is currently unable to predict whether there may be a funding shortfall and what the effect such a shortfall would have on the Company’s allocation.
Gain on Option and Futures Contracts
In an attempt to minimize the effects of the volatility of corn and natural gas costs and other inputs on operating profits, in the past 24 months, Husker Ag has taken hedging positions in corn and natural gas futures and option markets. Similarly, in an attempt to minimize the effects of market volatility of the Company’s gas-plus forward contracts for the sale of ethanol, Husker Ag has taken hedging positions in unleaded gas futures and options markets. However, the Company did not purchase any option and futures contracts on natural gas or unleaded gas during 2006 nor did the Company have any such contracts outstanding as of December 31, 2006.
Hedging means protecting the price at which the Company buys corn and natural gas and the price at which it will sell its products in the future. It is a way to attempt to reduce the risk caused by price fluctuation. The effectiveness of hedging activities is dependent upon, among other things, the cost of corn, natural gas and unleaded gas as well as Husker Ag’s ability to sell sufficient amounts of ethanol and distillers grain to utilize all of the commodities subject to the option and futures contracts. Hedging activities can result in costs to the Company because price movements in grain, natural gas and unleaded gas contracts are highly volatile and are influenced by many factors which are beyond the Company’s control.
The Company enters into option and futures contracts, which are designated as hedges of specific volumes of corn and natural gas projected to be used in the manufacturing process and ethanol expected to be sold. The Company uses derivative financial instruments to manage the exposure to price risk related to corn and natural gas purchases and ethanol sales. The Company currently does not meet the requirements for cash flow hedging under FASB 133. The Company has entered into a risk management agreement with FC Stone, LLC (“FC Stone”), a commodities risk management firm, under which FC Stone provides the Company with advice, assistance and a price risk management program for corn products necessary for the operation of the plant. See “Quantitative and Qualitative Disclosures about Market Risk” below for additional information.
The Company has also retained Husker Trading, Inc. to originate and acquire corn for plant usage rather than hiring an on-site commodities manager. Husker Trading, Inc. is responsible for the consistent scheduling of grain deliveries and to establish and fill forward contracts through grain elevators. It also coordinates grain deliveries between the railroad, participating elevators and producers, as well as negotiates price protection with hedging specialists.
In February 2004, the Husker Ag Board of Directors adopted a Risk Management Policy, which established a Risk Management Committee to serve as the liaison between management and Board regarding forward pricing and risk management issues. The Risk Management Committee is currently comprised of General Manager Seth Harder, and Board members Stanley Gyberg, Mike Kinney, David Stearns and Leonard Wostrel. The Risk Management Policy also establishes position limits and forward pricing guidelines with respect to risk exposure for corn, distillers grain, denaturant and natural gas, as well as approval procedures for management and the Risk Management Committee, approved commodity transaction instruments, and reporting and accounting function verification requirements.
The Company uses natural gas as its main source of energy. Natural gas prices have historically fluctuated significantly. An increase in the price of natural gas has a direct impact on the Company’s costs to produce ethanol. For this reason, in January 2005, the Company began purchasing option and futures contracts on natural gas for the first time. However, the Company did not enter into any option and futures contracts on natural gas during 2006 and did not have any such contracts outstanding on December 31, 2006. During the second quarter of 2006, and again in March 2007, the Company renewed its participation in the management procurement fund with Cornerstone Energy through March 2008. This fund is intended to help even out the price fluctuations in the Company’s natural gas purchases.
During 2005 and the first half of 2006, a relatively small percentage of the Company’s forward contracts for the sale of ethanol were priced as “gas-plus” contracts where the Company receives a price per gallon of ethanol sold equal to the then average unleaded gas price per gallon plus a fixed amount. Since unleaded gas prices fluctuate, decreases in gasoline prices cause the Company’s revenues on these gas-plus contracts to decrease. Therefore, as part of its hedging strategy, in 2005, the Company began purchasing option and futures contracts on unleaded gas for the first time in January 2005. However, the Company did not enter into any gas-plus contracts during 2006 until December 18, 2006, and the Company only had this one gas-plus contract outstanding on December 31, 2006. Because the Company only purchased this one gas-plus contract late in 2006, it did not purchase any option and futures contracts on unleaded gas during 2006 and did not have any such contracts outstanding on December 31, 2006. However, in 2007 Husker Ag did purchase a hedging contract against this gas-plus contract.
The Company’s net income for 2006 included net realized gains on option and futures contracts in the amount of $1,659,862. Contracts on unleaded gas created $25,855 of this gain, with the balance coming from corn contracts.
Market conditions for corn during 2006 were very favorable for the Company’s option and futures contracts creating the majority of this gain. However, the Company cannot predict whether it will realize additional gains on option and futures contracts in the future.
For 2005, the Company reported a loss on option and futures contracts in the amount of $1,807,964. This amount consists of a loss on contracts corn of $1,510,945 and a loss of $297,019 on natural and unleaded gas contracts.
Cost of Sales
Husker Ag’s cost of sales includes production expenses. For the years ended December 31, 2006 and 2005, the Company’s cost of sales, as a percentage of total net sales, was 62.6% and 69.2%, respectively. In actual dollars, cost of sales increased by 12.3% from 2006 compared to 2005. Cost of sales primarily consists of purchases of corn and both natural gas and natural gasoline. Natural gas is used in the production process while natural gasoline is used as a denaturant. Corn costs comprised 59.5% and 59.6% of total cost of sales for the years ended December 31, 2006 and 2005 respectively. Natural gas and the denaturant made up 19.7% and 18.4% of cost of sales for 2006 and 2005, respectively.
The primary reason for the increase in cost of sales is due to a 10.4% increase in ethanol production in 2006 compared to 2005. Corn costs increased approximately $2.3 million due to increased production and an approximate 9.0% increase in the average price in corn. Natural gas increased $415,000 due to increased production and an approximate 2% increase in the average price of natural gas. Denaturant costs increased approximately $806,000 also due to an increase in production coupled with an increase in prices during the year.
Depending upon the corn and gas markets, the Company expects to continue to experience efficiencies in the operation of its plant during 2007. However, the Company’s cost of sales is largely dependent upon the corn and gas markets.
Selling, General and Administrative Expenses
For 2006 and 2005, the Company’s selling, general and administrative expenses, as a percentage of total net sales excluding energy production credits, were 3.4% and 5.1%, respectively. The Company’s selling, general and administrative expenses decreased by approximately $379,000 or 16.7% for 2006 compared to 2005. The Company’s selling, general and administrative expenses in 2005 included large non-recurring expenses in 2005 including (i) the Company’s refinancing of its long term debt in February, 2005 which resulted in prepayment penalties in the amount of approximately $310,000; and (ii) the write-off of the Company’s remaining unamortized debt origination costs from its initial financing with Stearns Bank in the approximate amount of $562,000 which were being amortized over the life of the original loan. After accounting for these expenses, the Company’s selling, general and administrative expenses for 2006 increased from 2005, generally corresponding to an increase in the Company’s net sales.
For 2007, Husker Ag anticipates its typical selling, general and administrative expenses will generally remain in a range consistent with prior years as a percentage of the Company’s net sales excluding energy production credits. However, the Company will experience some nonrecurring administrative expenses over the next 6 to 12 months due to the plant expansion project. See “General Developments” under Item 1 above for a description of the plant expansion project.
Interest and Other Income
Interest and other income for the year ended December 31, 2006, consisted of approximately $366,000 of interest income, an unrealized gain on securities of approximately $6.8 million and $17,000 of other income. For the year ended December 31, 2005, the Company had interest income of approximately $210,000 and other income of approximately $118,000. Interest income was much higher in 2006 due to
large amounts of cash equivalents held by the Company during the year. The unrealized gain on securities of $6.8 million is an adjustment of the Company’s US BioEnergy stock to fair market value in accordance with GAAP treatment for trading securities. See “General Developments” above under Item 1 for additional information on the Company’s investment in US BioEnergy. Other income for 2005 consisted primarily of a refund of sales taxes paid by the Nebraska Department of Revenue in the amount of $112,504.
Interest Expense
Interest expense for the year ended December 31, 2006, was approximately $517,000 compared to roughly $669,000 for the prior year ended December 31, 2005. This decrease is due to the capitalization of interest in the amount of $284,734 for projects under construction.
During the last half of 2006, a large amount of the Company’s interest obligations on its debt ($284,734) was capitalized for the plant expansion project (see the financial statements and specifically Note 1). If you include the capitalized interest with the Company’s interest expense for 2006, interest expense actually increased approximately 19.9% primarily due to the Company’s financing of its investment in Val-E Ethanol, LLC (now US Bio Energy Corporation.) in January 2006 (see “General Developments” under Item 1 above). Also, see the section entitled “Liquidity and Capital Resources” under this Item below for discussion on the Company’s long-term debt.
Equity in Net Income of Affiliate
In December 2005, the Company purchased a 24.1% membership interest in Val-E Ethanol, LLC’s equity. Val-E Ethanol, LLC is a Fagen/ICM 45 million gallon ethanol plant in Ord, Nebraska. Husker Ag reported income of $20,596 from its affiliate in 2006, compared to a loss of $25,362 in 2005.
See “General Developments” under Item 1 above for a description of the Company’s exchange of its interest in Val-E Ethanol, LLC for 3,000,000 shares of common stock in US BioEnergy Corporation in May 2006 (later converted to 750,000 shares pursuant to a 1 for 4 reverse stock split). As a result of this exchange, the Company did not report any income from this affiliate after May 2006.
Net Income
Net income for Husker Ag for the year ended December 31, 2006 was approximately $28.4 million, consisting mostly of income from operations of approximately $21.7 million, and approximately $6.8 million of unrealized gain on securities and $366,000 of interest income offset by approximately $517,000 of interest expense. Net income from operations for 2006 included an approximate $1.7 million gain on option and futures contracts.
By comparison, the Company experienced net income for the year ended December 31, 2005 in the approximate amount of $10.1 million, largely due to income from operations of approximately $10.5 million, along with approximately $118,000 of other income and $210,000 of interest income offset by interest expense in the approximate amount of $669,000. Income from operations for 2005 included a loss on option and futures contracts in the approximate amount of $1.8 million.
For the reasons set forth above, the Company’s net income for 2006 increased by approximately $18.3 million more than 2005. The primary reasons for this increase include an increase in ethanol sales of over $10.3 million coupled with the unrealized income of nearly $6.8 million from the Company’s investment in US BioEnergy Corporation.
Results of Operations for the years ended December 31, 2005 and 2004
The following table shows sales and revenues, cost of sales, loss on options, operating expenses and other items as a percentage of total sales and revenues as derived from the Company’s Statements of Income for the years ended December 31, 2005 and 2004. This table should be read in conjunction with the Company’s financial statements and accompanying notes under Item 8 of this Form 10-K:
Sales and Revenues
The Company’s sales and revenues are divided into three main categories including ethanol sales, distillers grain sales and energy production credits. For the years ended December 31, 2005 and 2004, ethanol sales comprised 81.1% and 74.2%, respectively, of total net sales. Distillers grain sales comprised 12.9% and 15.3% of the Company’s total net sales for the years ended December 31, 2005 and 2004, respectively; while federal and state energy production credits make up the remaining 6.0% and 10.5% of the Company’s total net sales for 2005 and 2004, respectively. If energy production credits are excluded, ethanol sales represent 86.3% and 82.9%, and distillers grain sales represent 13.7% and 17.1%, of the total revenue of the Company from the sales of its products for the years ended December 31, 2005 and 2004.
Net sales for the year ended December 31, 2005 decreased by approximately $561,000, or 1.2% over the prior year. This decrease in net sales in 2005 compared to 2004 resulted from decreases in distiller grain sales of approximately $1.2 million and energy production credits of approximately $2.2 million, partially offset by an increase in ethanol sales of approximately $2.9 million. These individual categories of net sales are discussed further below.
Ethanol Sales
Ethanol sales for calendar year 2005 increased by 8.1% over the prior year. This is primarily due to an increase of 10.2% in the average price received per gallon for 2005 over 2004.
The vast majority of ethanol sold during 2005 was sold pursuant to a forward contract. At December 31, 2005, the Company had forward contracts for the sale of approximately 19.9 million gallons of ethanol with fixed prices ranging from $1.20 to $2.10 per gallon and 1.7 million gallons at variable prices to be delivered through December 2006.
Distillers Grain Sales
Sales of distillers grain decreased by $1.2 million, or 16.7% for 2005 compared to 2004. Since the price of distillers grain has a close relationship to the price of corn, this decrease in distillers grain sales resulted from a decrease in corn prices. The Company’s average price of corn decreased by over 9.4% for 2005
compared to 2004. By comparison, the Company’s average sales price per ton of distillers grain decreased by 16.9% from 2004 to 2005, which accounted for the Company’s decrease in distillers grain sales.
Energy Production Credits
Net sales included approximately $2.8 million of energy production credits for the year ended December 31, 2005, which is approximately $2.2 million less than the net production credits earned in 2004. Credits from the State of Nebraska remained relatively consistent for 2005 compared to 2004. However, for reasons explained above, federal credits for 2005 decreased by approximately $2.2 million over the prior year.
The Company’s net income for 2005 without the energy production credits included in net sales would have been approximately $7.3 million (compared to actual net income of approximately $10.1 million). Both federal and Nebraska credits are discussed in detail above.
Loss on Option and Futures Contracts
The Company’s net income for the year ended December 31, 2005, included net realized and unrealized loss on option and futures contracts in the amount of $1,807,964. This amount consists of a loss on contracts on corn of $1,510,945 and a loss of $297,019 on natural and unleaded gas contracts. Market conditions during 2005 were relatively unfavorable for the Company’s option and futures contracts on corn and natural and unleaded gas.
For 2004, the Company reported a loss on option and futures contracts in the amount of $1,612,429 comprised solely by corn hedging. This loss generally resulted from falling corn prices during the year.
Cost of Sales
For the years ended December 31, 2005 and 2004, the Company’s cost of sales, as a percentage of total net sales, was 69.2% and 71.6%, respectively. In actual dollars, cost of sales decreased by 4.4 percent in 2005 compared to 2004.
Corn costs comprised 59.67% and 63.2% of total cost of sales for the years ended December 31, 2005 and 2004 respectively. Natural gas and the denaturant made up 18.4% and 16.6% of cost of sales for the years of 2005 and 2004, respectively. The average price of corn for 2004 was $2.34 per bushel compared to $2.12 in 2005, a decrease of approximately 9.4%. This resulted in a savings of over $2.1 million in corn purchases during 2005 compared to the prior year. However, this savings was partially offset by an increase of nearly $575,000 in natural gas purchases due to increased energy costs.
Selling, General and Administrative Expenses
For the years ended December 31, 2005 and 2004, the Company’s selling, general and administrative expenses, as a percentage of total net sales excluding energy production credits, were 5.1% and 3.7%, respectively. The Company’s selling, general and administrative expenses increased by over $690,000 or 44.2% for 2005 compared to 2004. This large increase was due to (i) the Company’s refinancing of its long term debt in February, 2005 which resulted in prepayment penalties in the amount of approximately $310,000; and (ii) the write-off of the Company’s remaining unamortized debt origination costs from its initial financing with Stearns Bank in the approximate amount of $562,000 which were being amortized over the life of the original loan. After accounting for these expenses, the Company’s selling, general and administrative expenses for 2005 decreased from 2004.
Interest and Other Income
Interest and other income for the year ended December 31, 2005, consisted of $210,201 of interest income and $118,205 of other income. For the year ended December 31, 2004, the Company had interest income of $128,462 and other income of $240,520. Interest income was slightly higher in 2005 primarily due to higher interest rates and the Company’s investment of some of its available cash in short-term certificates of deposit. The substantial decrease in other income is due to a one time USDA-Value Added Grant of $226,850 that was received in 2004.
Interest Expense
Interest expense for the year ended December 31, 2005, was $668,533 compared to $1,010,846 for the year ended December 31, 2004. This decrease is due to the refinancing of the long-term debt during the first quarter of 2005 (see the section entitled “Liquidity and Capital Resources” below) which decreased the interest rate on, and the amount of, the principal portion of long-term debt.
Equity in Net Loss of Affiliate
In December 2005, Husker Ag invested in Val-E Ethanol, LLC, a Nebraska limited liability company with a principal place of business in Ord, Nebraska. The Company’s investment in this affiliate is described above it this Item 7, under the section entitled “Results of Operations for the years ended December 31, 2006 and 2005”. Husker Ag reported a loss of $25,362 from its affiliate in 2005.
Net Income
Net income for Husker Ag for 2005 was approximately $10 million, consisting mostly of income from operations of approximately $10.4 million, along with approximately $118,000 of other income and $210,000 of interest income, and partially offset by approximately $669,000 of interest expense. Income from operations for 2005 included an approximate $1.8 million loss on option and futures contracts, which includes both the actual net losses on option and futures contracts closed during 2005 and the change during the twelve months in the market value of option and futures contracts outstanding as of December 31, 2005 and 2004. As noted above, the Company’s net income for 2005 without the state and federal production credits included would have been approximately $7.3 million.
By comparison, the Company experienced net income for 2004 in the approximate amount of $9.8 million, largely due to income from operations of approximately $10.4 million, and approximately $241,000 of other income and $128,000 of interest income partially offset by interest expense in the approximate amount of $1 million. Income from operations for 2004 included an approximate $1.6 million loss on option and futures contracts.
For the reasons set forth above, the Company’s net income for 2005 was approximately $324,000 more than in 2004.
Trends that may Impact the Company’s Future Operating Results
Demand and Prices for Ethanol Products
Demand and the corresponding prices for ethanol products can vary significantly over time and decreases in price levels could adversely affect Husker Ag’s profitability and viability. Historically, the price for ethanol has had some relation to the price for gasoline. Any lowering of gasoline prices may also lead to lower prices for ethanol and adversely affect the Company’s operating results.
During 2006, high oil prices and continued MTBE bans resulted in strong ethanol demand and record high ethanol prices. However, because the ethanol industry has been dependent upon government supports, and more importantly, because the production capacity for ethanol is increasing so rapidly, there can be no assurance that the demand for ethanol will keep up with its supply in the near future - regardless of what happens to the price of gasoline.
Production of ethanol
As noted above, with the new ethanol plants and plant expansions currently under construction along with new construction expected in the near future, the nationwide production capacity for ethanol is expected to increase dramatically in the next couple of years. Experts in the ethanol industry have differing views as to whether this increased production will create a surplus in the ethanol market. At a minimum, this increased capacity creates some uncertainty for the ethanol industry.
Ethanol demand in the U.S. in 2006 exceeded production. The shortfall in 2006 was filled by imports from other countries, principally Brazil. At the end of 2006, U.S. production capacity was approximately 5.5 billion gallons annually. According to the RFA, another 6.0 billion gallons of production capacity was under construction at year-end.
It is expected that total ethanol production capacity in the U.S. will be in excess of 7.5 billion gallons annually by the end of 2007, which is the amount of the RFS required in 2012. This additional capacity may cause supply to exceed demand. If additional demand for ethanol is not created, the excess supply may cause ethanol prices to decrease, perhaps substantially. In that case, the Company’s revenues would decrease accordingly.
The increased production of ethanol could have other adverse effects as well. For example, the increased production will also lead to increased supplies of co-products from the production of ethanol, such as distillers grain/solubles. Those increased supplies could lead to lower prices for those co-products. Also, the increased production of ethanol has resulted in increased demand for corn which has at a minimum been a contributing factor for recent increases in corn prices. See “Inputs” below for additional information regarding trends in corn prices due to expected increases in U.S. ethanol production.
Government supports
As discussed above, current federal law is favorable to ethanol, and there appears to be a positive trend for the ethanol industry from the federal government. Recent federal legislation has benefited the ethanol industry. For example, as noted above in Item 1, the Renewable Fuels Standard (“RFS”) established by the Energy Policy Act of 2005 mandates that fuel refiners use a certain minimum amount of renewable fuels (including ethanol) which will rise to 7.5 billion gallons by 2012. In addition, ethanol benefits significantly from an excise tax credit of $0.51 per ethanol gallon. This excise tax credit provides incentives for blenders and refiners to blend ethanol with gasoline.
Regardless of the current favorable trend, changes to federal and state statutes, regulations or programs could have an adverse effect on Husker Ag’s business.
Inputs
Corn
The Company uses corn as its primary feedstock. Rising corn prices produce lower profit margins for the production of ethanol and therefore, represent unfavorable market conditions. Similarly, decreases in the price of corn may increase revenues to the Company and therefore, would increase the profitability of the Company. The corn market is dependent upon a variety of factors unrelated to the ethanol market. The price of corn is generally dependent upon the regional and international grain supplies, which can be very volatile. Corn supplies and the resultant prices are affected by weather, governmental policy, disease and other conditions.
The USDA estimated that approximately 10.5 billion bushels of corn were harvested in 2006, the third largest harvest on record. Despite the large 2006 corn crop, corn prices have increased sharply since August 2006. Corn prices have risen at least partially due to additional demand from the ethanol industry. Corn prices may remain at historically high prices.
Management expects corn prices to remain at historical high levels for the first half of 2007. After that corn prices will be largely dependent on the corn crop grown during the summer of 2007. While the Company expects an increase in the number of corn acres in 2007 to possibly record levels, any production shortfall during the 2007 growing season will create increased price volatility and will result in increased corn costs which would increase the Company’s cost to produce ethanol.
If the supply of corn does not keep up with the increased demand for corn due to expected increases in the ethanol production and exports, corn prices can be expected to increase or at a minimum maintain their high recent prices, resulting in higher costs of production and lower profits. See section entitled “Risk Factors” above.
Utilities
Changes in the cost of utilities may also have a material impact on the profitability of the Company. Ethanol production requires a constant and consistent supply of energy. If there is any interruption in Husker Ag’s supply of energy for whatever reason, such as supply, delivery or mechanical problems, the Company may be required to halt production. Increases in the price of natural gas would harm Husker Ag’s business by increasing its energy costs (see discussion below). The Company also needs to purchase significant amounts of electricity to operate the plant. The prices which Husker Ag is required to pay for electrical power will have a direct impact on its costs of producing ethanol and its financial results.
Natural Gas
Natural gas is an important input in the Company’s production process. Husker Ag uses natural gas to dry its distillers grains. As discussed above, the Company currently dries nearly all of its distillers grain to a level of approximately 50% moisture (modified wet grain). Upon completion of the plant expansion project, the Company will produce roughly 150% more distillers grain than its current production. In order to market this extra product, the Company may be forced to dry some of its distillers grain to 10% moisture (dried distillers grain) to allow for storage and transportation over longer distances.
Although natural gas prices trended lower during the second half of 2006, and prices fluctuated in a narrower price band during this time, natural gas prices could again increase significantly as a result of actual or perceived shortages in supply. In addition, in order to ensure adequate supplies of natural gas for the plant expansion project, Husker Ag will be required to contribute to cost of the infrastructure necessary to deliver the new natural gas capacity to the Plainview area. See Risk Factors above under Item IA for a discussion of Husker Ag’s Precedent Agreement with Kinder Morgan requesting additional capacity of natural gas. There is no guarantee that Kinder Morgan will construct the necessary pipeline and additional infrastructure necessary to deliver the necessary additional firm capacity to the Company’s plant site. If Kinder Morgan does not proceed with its capacity expansion project, Husker Ag may be forced to consider alternatives for its long term natural gas needs.
The Precedent Agreement requires Husker Ag to pay for its share of Kinder Morgan’s capacity expansion project and related facilities over a ten-year period at the “negotiated reservation rate” of $0.6250 per MMBtu per month. The agreement allows Husker Ag to pay this incremental charge in lieu of contributing aid in construction to Kinder Morgan for the new pipeline facilities.
As a result, if Husker Ag does enter into a Firm Transportation Service Agreement with Kinder Morgan pursuant to the Precedent Agreement, the Company’s relative proportional costs of natural gas will be higher for the expansion than for the existing plant, due to our requirement to help pay for the new delivery pipeline facilities.
Our current natural gas usage is approximately 54,000 MMBtus per month. After the plant expansion is placed into production, Husker Ag anticipates that its natural gas usage will be approximately 162,000 MMBtus per month.
Other
In addition to general market fluctuations and economic conditions, Husker Ag could experience significant cost increases associated with the on-going operation of the plant caused by a variety of factors, many of which are beyond the Company’s control. Labor costs can increase over time, particularly if there is any shortage of labor, or shortage of persons with the skills necessary to operate the ethanol plant. Changes in price, operation and availability of truck and rail transportation may affect the Company’s profitability with respect to the transportation of ethanol and other products to its customers. In addition, the operation of the ethanol plant is subject to ongoing compliance with all applicable governmental regulations, such as those regulations governing pollution control, ethanol production, grain purchasing and other matters. If any of these regulations were to change, it could cost Husker Ag significantly more to comply with them. Further, other regulations may arise in future years regarding the operation of the ethanol plant, including the possibility of required additional permits and licenses. Husker
Ag might have difficulty obtaining any such additional permits or licenses, and they could involve significant unanticipated costs. Husker Ag will be subject to all of those regulations whether or not the operation of the ethanol plant is profitable.
Expansion
Husker Ag is currently expanding its capacity at its existing site by approximately 40 million gallons of capacity, an increase of nearly 150% from the Company’s current production capacity. The timing of this expansion, the terms of the Design-Build Agreement with ICM and the terms of the Company’s financing may all have a material affect on Husker Ag’s results of operations. For a discussion of the plant expansion project, see “General Developments” above under Item 1 of this Form 10-K. While this expansion may allow the Company to better market its ethanol and distillers grain, the expansion will also significantly increase the Company’s need for inputs such as corn and natural gas.
Books and Records
Husker Ag currently relies on its internal staff for the maintenance of its books and records. Husker Ag has employed an internal accountant, who is primarily responsible for the maintenance of its accounting books and records. Such person is assisted by full time office administrative personnel, all of whom are responsible for compliance with the rules and regulations promulgated under the Securities and Exchange Act of 1934 concerning the maintenance of accurate books and records.
Liquidity and Capital Resources
The Company’s liquidity and capital resources will be affected in the short-term by our plant expansion project which is discussed in detail above. See “General Developments” above under Item 1 of this Form 10-K for further discussion on this expansion.
As of December 31, 2006, the Company had current assets of approximately $23.3 million, including cash and cash equivalents of approximately $5.5 million and the Company had total assets of approximately $63.5 million. As of December 31, 2006, the Company had current liabilities totaling approximately $9.5 million. As of December 31, 2006, the Company’s ratio of current assets to current liabilities was 2.45 to one, compared to 2.05 to one as of December 31, 2005.
As of December 31, 2006, the Company had total members’ equity of approximately $45.7 million, or $2,984.25 per unit. This represents an increase of 85.7% when compared to total members’ equity of approximately $24.6 million, or $1,607.19 per unit as of December 31, 2005. Total members’ equity was approximately $21.4 million, or $1,398.33 per unit as of December 31, 2004. Members’ equity increased by approximately $21.1 million during 2006 due to net income for the period in the approximate amount of $28.4 million offset by distributions declared and paid in the approximate amount of $7.3 million.
Cash Flow from Operating Activities. The operating activities of Husker Ag for 2006 generated approximately $21.1 million of net cash flow. The net cash from operating activities includes, among several other material items, net income in the approximate amount of $28.4 million. The operating activities of Husker Ag for the year ended December 31, 2005, generated approximately $12.4 million of net cash flow, which primarily included net income from operations of approximately $10.1 million.
Cash Flow from Investing Activities. During the year ended December 31, 2006, net cash used for investing activities totaled approximately $15.0 million which primarily included $11.8 million to purchase property and equipment, $4.5 million to pay the subscription for an investment in affiliate (Val-E Ethanol, LLC) and $2.5 million to purchase certificates of deposit. These payments were offset by approximately $4.1 million received from the sale of certificates of deposit. This use of cash in 2006 for investing activities compares to approximately $3.5 million of cash used for investing activities for the year ended December 31, 2005, which primarily consists of $1.5 million to purchase an interest in Val-E Ethanol (the initial down payment) and $1.5 million to purchase certificates of deposit.
Cash Flow from Financing Activities. Net cash used for financing activities for the year ended December 31, 2006, totaled approximately $5.7 million, consisting of distributions paid to members ($7,276,050) and net payments on long-term debt including debt origination costs ($2,908,383), offset by loan proceeds in the amount of $4.5 million for the Val-E Ethanol investment. This compares to the cash used for financing activities for the year ended December 31, 2005, in the approximate amount of $15.5 million, consisting primarily of distributions paid to members ($8,424,900) and payments on the construction loan and other long-term debt including debt origination costs ($17,071,604) offset by proceeds from long term debt refinancing of $10,000,000.
Primary Company Debt. Prior to February 23, 2005, the senior and primary lender for Husker Ag was Stearns Bank, N.A., St. Cloud, Minnesota (“Stearns Bank”). The Company financed the construction of its ethanol plant through Stearns Bank. From October 3, 2002 through December 31, 2003, the Company borrowed a total of $19,827,860 from Stearns Bank under its construction loan. On January 20, 2004, the Company converted its construction loan into three permanent loans. In June 2004, the Company paid off the smallest of the three loans (original principal amount of $1,505,900).
On February 22, 2005, the Company signed a Commercial Loan Agreement with Union Bank and Trust Company, Lincoln, Nebraska (“Union Bank”) and Midwest Bank National Association, Plainview, Nebraska (“Midwest Bank”), whereby Union Bank and Midwest Bank agreed to loan Husker Ag the funds necessary to refinance the Company’s outstanding obligations with Stearns Bank and to provide the Company with a revolving line of credit. On February 23, 2005, Husker Ag used the proceeds from its new loan with Union Bank, along with approximately $5.8 million of its cash reserves, to pay off its obligation to Stearns Bank in full. The total payoff was approximately $15.8 million which included a prepayment penalty of approximately $310,000.
As part of this refinancing, Midwest Bank provided the Company with a multiple advance revolving line of credit loan with maximum borrowings of $5,000,000. On February 22, 2006, Midwest Bank extended the Company’s revolving line of credit until April 30, 2006. On May 23, 2006, the Company executed a Commercial Loan Agreement and related promissory note with Union Bank for a revolving line of credit with maximum borrowings of $5,000,000, replacing the Company’s revolving line of credit provided by Midwest Bank.
Since that date, Union Bank has been the Company’s primary and sole lender. On December 31, 2006, the Company had the following outstanding loan obligations with Union Bank:
1. Term Loan - single advance term loan in the amount of $10,000,000. This term note is amortized over a seven year period with a final maturity date of February 22, 2012. This note is payable in equal monthly installments of $119,050 plus interest. The interest rate on this note is fixed at 6.20% for the first five years. Thereafter, the interest rate will be the then 2-year Treasury Constant Maturity Rate plus 3.00%.
2. Line of Credit - multiple advance revolving line of credit loan with maximum borrowings of $5,000,000. Interest is due monthly on this revolving line of credit. This note will accrue interest at the Wall Street Journal Prime Rate plus 0.75% adjusted every time this index rate changes (the WSJ Prime Rate was last changed to 8.25% on June 29, 2006, with a resultant interest rate of 9.00% as of November 17, 2006). Principal is due at maturity on or before April 30, 2007. Husker Ag intends to utilize this line of credit when needed for operating purposes. The Company had not borrowed any money from Union Bank pursuant to this line of credit as of March 30, 2007.
3. Val-E Loan - single advance term loan in the amount of $4,500,000. On December 28, 2005, Husker Ag executed a new Commercial Loan Agreement and related promissory note with Union Bank for a single advance term loan in the amount of $4,500,000 (the “Val-E Loan”). This Val-E Loan provided Husker Ag the funds necessary to purchase a 24.1% equity interest in Val-E Ethanol, LLC. See “General Developments” above for further discussion on this investment including an update on the Company’s recent exchange of this investment for an investment in another company. The proceeds from the Val-E Loan were wired to Husker Ag on or about January 4, 2006. This term note is amortized over a sixty (60) month period commencing February 4, 2006, with a final maturity date of January 4, 2011. The interest rate is fixed at 6.85% per year for the term of the note. On January 31, 2006, Husker Ag used the proceeds from this term loan for the balance of its purchase of its membership interest in Val-E Ethanol, LLC; the Company had also paid $1,500,000 of its own cash for this investment.
Union Bank Loan Terms. These loans with Union Bank are secured by a first mortgage on the Company’s real estate and plant, as well as a first security interest on all accounts receivable, inventory, equipment, fixtures, and on all personal property and general intangibles. The primary term loan and the Val-E Loan are each subject to a 3% prepayment penalty if refinanced with another lender. Otherwise, Husker Ag may pay off the loans without penalty.
Loan Covenants. Each of these Commercial Loan Agreements with Union Bank require lender approval prior to making distributions to Husker Ag members in excess of 35% of the Company’s net income determined on both a year-to-date and annual basis. Distributions may be made up to this 35% limitation without lender approval so long as Husker Ag complies with certain conditions including compliance with all financial loan covenants determined after giving effect to such distribution. In addition, Husker Ag must obtain prior approval from Union Bank for any capital improvements in excess of $2,800,000 for 2006; such capital improvement limit may be amended annually with the approval of Union Bank. This limit will need to be increased for the pending plant expansion project. The Commercial Loan Agreements also impose a number of other covenants, stating that Husker Ag must maintain: (i) a minimum tangible net worth of $20,500,000; (ii) working capital of not less than $2,500,000; and (iii) a debt coverage ratio of 1.2:1 measured at the end of each year (“debt coverage ratio” is defined as net income plus depreciation plus interest on term debt divided by principal plus interest on term debt).
While these loan terms and covenants remain in effect, the Company will be subject to additional terms and more restrictive loan covenants pursuant to its Credit Agreement with Union Bank signed on January 5, 2007, for purposes of financing the plant expansion project. Those terms and covenants are explained in detail below. As explained below, some of these terms and covenants are effective as of January 5, 2007, while others are not effective until the plant expansion is completed.
Plant Expansion Loan. On January 5, 2007, the Company signed a Credit Agreement with Union Bank, whereby Union Bank agreed, subject to the terms and conditions set forth in the Credit Agreement, to provide the Company up to $35,000,000 of debt financing to be used for the construction of the Company’s plant expansion project. See “General Developments” under Item 1 above for information regarding the plant expansion project. Husker Ag had not borrowed any money from Union Bank pursuant to this Credit Agreement as of March 30, 2007.
On January 5, 2007, the Company had the following loan commitments with Union Bank pursuant to the Credit Agreement and the resultant promissory notes:
1. Construction Loan - multiple advance loan during the construction period with maximum borrowings of $25,000,000. Advances for construction are available under the Construction Loan until Substantial Completion of the plant expansion project, as defined in the Credit Agreement, or February 15, 2008, whichever occurs first. The Credit Agreement requires the Company to pay interest on the outstanding principal indebtedness on a quarterly basis during the construction period and thereafter until converted into a term loan. Six months following Substantial Completion of the plant expansion project, the Construction Loan will convert into a term loan which would be repayable on a quarterly basis over a 7-year period, subject to the possible mandatory additional payments described below.
2. Revolving Loan - multiple advance revolving loan with maximum borrowings of $10,000,000. Advances are restricted to the construction of the plant expansion project, and are available under the Revolving Loan until the expiration of 39 months after the Construction Loan has been paid in full or matures, whichever occurs first, but no later than June 1, 2018. The Credit Agreement requires the Company to pay interest on the outstanding principal indebtedness on a quarterly basis during this loan advancement period. Three months after the final maturity or payment of the Construction Loan, whichever is earlier, but no later than September 1, 2015, the Revolving Loan will convert into a term loan which would be repayable on a quarterly basis over a 3-year period, subject to the possible mandatory additional payments described below.
Under the Credit Agreement, the Company must use its equity funds prior to incurring indebtedness under either of the loans. Union Bank has required the Company to inject a minimum of 40% equity into the plant
expansion project (that is, the equity must equal at least 40% of the total of amount of equity and indebtedness). In addition, the Credit Agreement imposes a number of conditions which must be met by the Company on an on-going basis prior to Union Bank’s disbursement of loan funds under either loan. Union Bank has broad powers of discretion with respect to its disbursement of funds under either loan, depending upon the Company’s compliance with the Credit Agreement covenants and conditions.
Additional material terms of the debt financing from Union Bank are as follows:
Interest Rate. The Credit Agreement provides for the same interest rate for both loans. Until the first principal payment is due under the Construction Loan (six months after Substantial Completion), each of the loans will accrue interest at the one month London Interbank Offered Rate (LIBOR) plus 3.00% adjusted monthly.
Subject to performance pricing indicated below, when the first principal payment is due under the Construction Loan, each of the loans will accrue interest at the three month LIBOR plus 3.00% adjusted monthly.
The Credit Agreement states that performance pricing will be available after the principal payments begin on the Construction Loan based upon the Company’s member equity position. Depending on the percentage of the Company’s total members’ equity to total assets, Union Bank will reduce the interest rate on the Company’s loans by as much as 70 basis points or .70%. Adjustments will be completed on an annual basis based on the Company’s audited financial statements. Interest will be adjusted in accordance with the following rate index:
* - Members’ equity ratio is defined as total members’ equity divided by total assets.
When the first payment is due under the Construction Loan, the Credit Agreement provides that Husker Ag may select a fixed interest rate for one or both of the loans based on the Federal Home Loan Bank (FHLB) 3-year or 5-year fixed advance rate plus 3.00%.
Collateral. These new loans are secured by a first mortgage on the Company’s real estate and plant, as well as a first security interest on all accounts receivable, inventory, equipment, fixtures, and on all personal property and general intangibles.
Prepayment Penalty. The loans are subject to a prepayment penalty if refinanced with another lender (3.0% penalty if refinanced during the first three years of principal payments; 1.0% penalty thereafter). Otherwise, the Company may pay off either or both of these loans without penalty. However, if the Company selects the fixed rate option, the Credit Agreement requires a minimum 2.0% prepayment penalty for any prepayments.
Mandatory Additional Principal Payments - Free Cash Flow. In addition to the scheduled principal payments provided above, the Company would be required to make an annual payment applied to principal in an amount equal to 10% of available Free Cash Flow. These payments would be capped at $1.5 million per year with a maximum aggregate payment of $5 million over the life of the loans. This additional payment would be applied to scheduled principal installments in inverse order of maturity on these new loans If the amount of any such additional payment would result in a covenant default, the amount of payment will be reduced to an amount that would not cause covenant default.
“Free Cash Flow” is defined as the Company’s annual net income, minus an amount equal to 36% of the net income (as an estimated tax rate); plus the respective calendar year depreciation and amortization expense; minus allowed capital expenditures and principal payments to Union Bank and other authorized creditors.
Covenants/restrictions. The primary financial covenants and restrictions, all determined in accordance with generally accepted accounting principles, as applied on a consistent basis, would include the following:
•
Beginning with the month in which Substantial Completion occurs, the Company must maintain working capital of not less than $6,000,000; this calculation will include any unadvanced portion of the Company’s existing revolving term commitment of $5,000,000.
•
Beginning three months after Substantial Completion and quarterly thereafter, the Company must maintain a debt service coverage ratio of not less than 1.5:1 measured quarterly based on a rolling 4 quarter average (this ratio is defined as net income plus depreciation and amortization; minus extraordinary gain/loss divided by current principal of long term debt).
•
Beginning on January 5, 2007, the Company must have a minimum tangible net worth (total assets minus intangible assets and minus total liabilities, as defined by GAAP) of not less than $34,800,000. The Company shall maintain minimum tangible net worth of no less than the amount that will not allow members’ equity to be below 49%.
•
All distributions to the Company’s members would be subject to prior approval by 66.67% of all financial institutions participating in these loans (determined by the dollar amount of the Company’s total indebtedness to Union Bank and its participants). Before granting any such approval, Union Bank would require the Company to be in compliance with each of the loan covenants before and after the distribution.
•
Other than for the construction of the plant expansion project, the Company must obtain approval from Union Bank for any capital improvements in excess of $1,700,000.00, subject to annual revision.
•
Cash distributions could be paid out up to three times per year in April (based on March year-to-date financial results), August or September (based on June year-to-date results) and December (based on November year-to-date results). The Company’s distributions will be limited to the distribution schedule below:
•
When a distribution is approved above the estimated 36% tax rate (the assumed normal effective tax rate of the Company’s members as determined by Union Bank), an amount equal to 10% of the amount above the 36% rate would be applied to the outstanding principal balance of the new loans, to be applied to scheduled principal installments in inverse order of maturity on these new loans.
Management believes that its cash reserves and cash from operations are adequate to meet its operational expenses and short and long-term debt repayment obligations.
Off-Balance Sheet Arrangements
At December 31, 2006, the Company did not have any arrangements which meet the definition of an off-balance sheet arrangement as provided in the SEC regulations. However, other off-balance sheet arrangements are disclosed in Notes 3 and 5 to the Company’s audited financial statements.
Contractual Obligations
The Company has the following contractual obligations as of December 31, 2006:
Payments Due By Period
Critical Accounting Policies
The Securities and Exchange Commission (“SEC” or the “Commission”) recently issued disclosure guidance for “critical accounting policies”. The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
Accounts Receivable
Accounts receivable are stated at the amount billed to customers. If necessary, the Company will provide an allowance for doubtful accounts, which is based upon a review of outstanding receivables, historical collection information and existing economic conditions.
Inventories
Inventories are stated at the lower of cost or market. Cost of raw materials, work-in-progress and finished goods are determined using last cost and average cost under the first-in, first-out (FIFO) method.
Revenue Recognition
Revenue from the sale of the Company’s products is recognized when title passes based on delivery or shipping terms. The Company records revenue from federal and state incentive programs related to the production of ethanol when the Company has produced the ethanol and completed all the requirements of the applicable incentive program.
Derivative Instruments
The Company enters into option and futures contracts, which are designated as hedges of specific volumes of corn expected to be used in the manufacturing process. The Company uses derivative financial instruments to manage the exposure to price risk related to corn purchases. The Company does not typically enter into derivative instruments for any reason other than cash flow hedging purposes. The option and futures contracts are recorded on the Company’s balance sheet at fair value. On the date that the contract is entered into, the Company designates the option or contract as a hedge of variable cash
flows of certain forecasted purchases of corn used in the manufacturing process (a “cash flow hedge”). The Company formally documents relationships between the option and futures contracts, which serve as the hedging instruments, and the hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. When it is determined that an option or futures contract is not highly effective as a hedge or has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively. Changes in the fair value of option and futures contracts that are highly effective and that are designated and qualify as cash flow hedges are recorded in other comprehensive loss. Gains and losses that are realized will be recognized in the statement of income when the related corn purchased is recognized in cost of sales.
Currently, option and futures contracts on corn purchased by the Company do not meet the requirements for cash flow hedging treatment. As a result, changes in the market value of option and futures contracts are recorded on the income statement in gain/loss on option and futures contracts.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the potential loss arising from adverse changes in market rates and prices. Certain market risks are inherent in the ethanol business with respect to commodity prices, from both an input (corn, natural gas, etc.) and output (ethanol and distillers grain) perspective. The Company is also exposed to market risk from changes in interest rates.
Commodity Price Risk
Husker Ag uses derivative financial instruments as part of an overall strategy to manage market risk. It uses forward, option and futures contracts to hedge changes to the commodity prices of ethanol, corn, natural gas and unleaded gas. The Company does not typically enter into derivative instruments for any reason other than cash flow hedging purposes; it does not enter into these derivative financial instruments for trading or speculative purposes. (For additional information, see “Options and Futures Contracts - Hedging” above under Item 1 of this Form 10-K, as well as Note 6 to the Company’s financial statements included below under Item 8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements
Husker Ag, LLC
December 31, 2006 and 2005
Report of Independent Registered Public Accounting Firm-Eide Bailly LLP
To the Board of Directors, Audit Committee and
Members of Husker Ag, LLC
Plainview, Nebraska
We have audited the accompanying balance sheet of Husker Ag, LLC as of December 31, 2006, and the related statements of income, members’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Husker Ag, LLC as of December 31, 2006, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Eide Bailly LLP
Minneapolis, Minnesota
April 2, 2007
Report of Independent Registered Public Accounting Firm - BKD LLP
Audit Committee, Board of Directors
and Members
Husker Ag, LLC
Plainview, Nebraska
We have audited the accompanying balance sheet of Husker Ag, LLC as of December 31, 2005, and the related statements of income, members’ equity and cash flows for each of the two years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Husker Ag, LLC as of December 31, 2005, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
/s/ BKD, LLP
Lincoln, Nebraska
February 1, 2006
Husker Ag, LLC
Balance Sheets
December 31, 2006 and 2005
See Notes to Financial Statements
Husker Ag, LLC
Statements of Income
Years Ended December 31, 2006, 2005 and 2004
See Notes to Financial Statements
Husker Ag, LLC
Statements of Members’ Equity
Years Ended December 31, 2006, 2005 and 2004
See Notes to Financial Statements
Husker Ag, LLC
Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
See Notes to Financial Statements
Husker Ag, LLC
Statements of Cash Flows - Continued
Years Ended December 31, 2006, 2005 and 2004
See Notes to Financial Statements
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Husker Ag, LLC (the Company), a Nebraska Limited Liability Company, was formed August 29, 2000 and is located in Plainview, Nebraska. Prior to formation of the LLC, the Company operated as a partnership. The Company was organized to obtain equity investors and debt financing to construct, own and operate an ethanol plant with an annual production capacity of approximately 27 million gallons. Construction began in 2001 and operations commenced in March 2003. The Company’s products include fuel grade ethanol sold in limited markets throughout the United States and distillers grain sold in surrounding counties in Nebraska. The Company extends unsecured credit to its customers, with credit extended to one customer of approximately 52% and 54% of trade accounts receivable as of December 31, 2006 and 2005, respectively. Substantially all ethanol sales are made to one broker.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2006 and 2005, cash equivalents consisted primarily of a retail repurchase agreement and short-term institutional financial investment trusts.
The Company maintains its cash accounts primarily at two financial institutions. At time throughout the periods and at December 31, 2006 and 2005, the Company’s cash and certificate of deposit balances at individual institutions exceeded federally insured limits. The Company believes it is not exposed to any significant credit risk on cash. The Company is required by a bank to maintain certain cash reserves to secure letter of credit obligations.
The Company maintains cash in a retail repurchase agreement at a financial institution and the financial institution pledges securities as collateral to secure the balance held under the agreement.
Restricted cash is comprised of two letters of credit issued by Midwest Banks for Northeast Nebraska Public Power, $260,643, and Kinder Morgan, $75,000, for collateral security agreements. There is $506,000 in a Short Term Federal Investment Trust with Union Bank related to a contribution made by the Company for the unsubscribed for rights offering shares. The Union Bank loan (see note 14) agreement required the dollar amount from the rights offering to be $15,318,000 of which there was $506,000 remaining.
Accounts Receivable
Accounts receivable are stated at the amount billed to customers. As of December 31, 2006 and 2005, the Company believes all receivables are fully collectible. If necessary, the Company will provide an allowance for doubtful accounts, which is based upon a review of outstanding receivables, historical collection information and existing economic conditions. Accounts receivable are ordinarily due in 3 business days for ethanol and 15 days after the issuance of the invoice for distillers grain. Accounts that are unpaid after 30 days bear interest at 18% and are
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies - continued
considered delinquent if past due over 120 days. Delinquent receivables are written off based on individual credit evaluation and specific circumstances of the customer. There were two accounts in delinquent status totaling $9,917. Both accounts are still considered receivable as the Company is pursuing legal collection actions on these accounts.
Inventories
Inventories are stated at the lower of cost or market. Cost on raw materials is determined using last cost and average cost under the first-in, first-out (FIFO) method. Cost on finished goods is determined using average cost under the FIFO method. Inventories were comprised of the following at December 31:
Other Assets
The deposit on construction amount is comprised of a $4,475,000 deposit requirement with ICM, Inc. for the construction of a 40 million gallon plant (Note 14). Two million dollars was required at the time of signing the Letter of Intent, which was executed on April 4, 2006. An additional $2 million was required when the Company’s members approved the plant expansion project. The supermajority vote was obtained on June 26, 2006 at the 2006 Annual Meeting of Members and payment was remitted on June 28, 2006. The final deposit payment of $475,000 was made upon the signing of a Notice to Proceed dated October 15, 2006. Of this total deposit amount, $926,618 has been reclassified to Construction in progress as a part of progress payments made to ICM, Inc as of December 31, 2006. The total cost for the plant expansion is estimated to be $63,325,000 of which $44,284,000 is related to the Company’s contract with ICM.
Debt Origination Costs
On February 23, 2005, the Company refinanced its long-term debt requiring loan origination costs totaling $39,656 to be capitalized and unamortized costs totaling $562,442 related to the repaid debt to be written off as of that date. The remaining debt origination costs have been deferred and are amortized over approximately seven years (the life of the loan) using the straight-line method. Debt origination costs, net of accumulated amortization, amounted to $29,133 and $34,798 at December 31, 2006 and 2005, respectively. Amortization expense for the years ended December 31, 2006, 2005 and 2004 was $5,665, $19,157 and $95,456 respectively.
Income Taxes
The Company’s members have elected to have the Company’s income taxed as a partnership under provisions of the Internal Revenue Code and a similar section of the Nebraska income tax law. Therefore, taxable income or loss is reported to the individual members for inclusion in their respective tax returns and no provision for federal and state income taxes is included in these statements.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies - continued
Reclassifications
Certain reclassifications have been made to the 2005 financial statements to conform to the 2006 financial statement presentation. These reclassifications had no effect on net earnings.
Investments
The Company’s securities investments that are bought and held principally for the purpose of selling them in the near term are classified as trading securities. Trading securities are recorded at fair value on the balance sheet in current assets, with the change in fair value during the period included in earnings. Unrealized holding gains on such securities, which were reported on the Company’s income statement during 2006 was $6,754,766.
Securities investments that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and recorded at amortized cost in investments and other assets.
Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders’ equity.
Investments in securities are summarized as follows at December 31, 2006:
On December 28, 2005, the Company purchased a 24.1% ownership interest in Val-E Ethanol, LLC, a development stage company for $6,000,000. The investment was recorded at an amount equal to the Company’s equity in Val-E Ethanol, LLC’s net assets as of the acquisition date less the Company’s equity in Val-E Ethanol’s net losses from the acquisition date. Financial position and results of operations of Val-E Ethanol prior to the exchange agreement are summarized below:
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies - continued
On May 2, 2006, the Company executed a Membership Interest Purchase Agreement with US BioEnergy Corporation for 3,000,000 shares of common stock of US BioEnergy in exchange for the Company’s 24.1% ownership in Val-E Ethanol. With the occurrence of this transaction, the investment is being recorded using the cost basis method of accounting as disclosed below. On December 12, 2006, US Bio Energy did an initial public offering with a reverse stock split of 4 for 1. The Company holds 750,000 shares in common stock of US Bio Energy, Inc. operating in the ethanol industry as trading securities.
The Company purchased a United States Treasury Note on December 15, 2006 with a face value of $250,000 that has been pledged to the Tobacco and Trade Bureau as collateral for the ATF bond for plant operations. The Treasury note matures on January 15, 2009 and bears interest at a fixed rate of 3.25%.
It is the accounting policy of the Company, to account for investments using the equity method of accounting when the investment represents 20% - 50% ownership of the investment entity. The Company uses the cost basis method when the investment is less than 20% ownership of the investment entity.
On November 3, 2006, Husker Ag executed a Subscription Agreement to purchase two shares of Ethanol Risk Management, SPC, Ltd., a Cayman Islands insurance company (ERM). This is a captive insurance company which provides a portion of the property and casualty insurance for its owners. Husker Ag invested $51,541 total to participate in the two available “Portfolios” (one for property insurance and one for general liability and workers compensation or casualty insurance) for less than 4 percent ownership.
Non-Monetary Exchange
In accordance with Financial Accounting Standards Board No. 153, non-monetary exchanges of productive assets are accounted for at fair value unless fair value cannot be reasonably determined or the transaction lacks commercial substance. As discussed above, the Company exchanged its investment in one non-public entity for an investment in another non-public entity.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies - continued
Fair value of the non-public entities cannot be reasonably determined since the entities are either a development stage entity or an entity that had not commenced operations within their stated primary line of business at the time of the exchange. Accordingly, the Company has recorded the value of the acquired investment at the book value cost basis of the asset relinquished in the transaction.
Revenue Recognition
Revenue from the sale of the Company’s products is recognized when products are shipped to customers and title passes. The Company records revenue from federal and state incentive programs related to the production of ethanol when the Company has produced the ethanol and completed all the requirements of the applicable incentive program.
Property and Equipment
Property and equipment are depreciated over the estimated useful life of each asset which ranges from 3 to 30 years. Annual depreciation is primarily computed using the straight-line method.
The Company capitalized interest costs as a component of construction in progress, based on weighted-average rates for borrowing. Total interest incurred each year was:
It is the Company’s accounting policy to capitalize interest on capital expenditures. In accordance with this policy for the year ended December 31, 2006, $284,734 of interest has been capitalized using the Company’s average interest rate and has been included in the Construction in progress account on the balance sheet.
Grant Income
In September 2004, the Company received a $226,850 Value-Added Agricultural Product Market Development grant from the United States Department of Agriculture to assist the Company in paying for employee salaries and corn purchases. The Company recognized this amount as income upon meeting the conditions of the grant. The amount is included in other income in 2004 in the accompanying financial statements.
Earnings Per Membership Unit
For purposes of calculating basic earnings per membership unit, units subscribed and issued by the Company are considered outstanding on the effective date of issue. For purposes of calculating diluted earnings per membership unit, units subscribed for but not issued by the Company are also included in the computation of outstanding membership units. All membership units which have not been released from the escrow agent are not included in computation of outstanding membership units.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 2: Members’ Equity
In November 2006, the Board of Directors declared a cash distribution of $125 per membership unit to all members of record as of December 1, 2006. The total distribution of $1,914,750 was approved by the Company’s lender and paid to the members on December 15, 2006.
On August 3, 2006, the Board of Directors declared a cash distribution of $200 per membership unit to all members of record as of August 1, 2006. The total distribution of $3,063,600 was approved by the Company’s lender, Union Bank and Trust Company, on August 3, 2006, and paid to the members on August 16, 2006.
In March 2006, the Company’s Board of Directors declared a cash distribution of $150 per membership unit to all members of record as of April 1, 2006 payable on April 20, 2006. A distribution payable in the amount of $2,297,700 was recorded by the Company as of March 31, 2006 by a charge to members’ equity.
There are significant transfer restrictions on transferability of membership unit. The Company’s Operating Agreement, as well as relevant portions of the Nebraska Limited Liability Company Act and regulations of the Internal Revenue Service (IRS) significantly restricts the transfer of the membership units. Unit holders cannot assign or transfer a membership unit without approval from the Company’s Board of Directors and the transfer or assignment must comply with applicable Nebraska laws and IRS regulations. Members are not personally liable for any debts or losses of the Company beyond their respective capital contribution.
The Board of Directors will not approve transfers if the Board determines the transfer would cause the Company to be treated as a “publicly traded partnership.” Any transfers of membership units in violation of the publicly traded partnership rules or without the prior consent of the Board of Directors will be null and void.
Note 3: Commitments and Related Parties
At December 31, 2006, the Company had entered into agreements to purchase 4,610,163 bushels of corn at an average price of $2.55 per bushel to be delivered between January 2007 and December 2008. One hundred four contracts totaling 972,095 bushels are with related parties.
At December 31, 2006, the Company had contracts for the sale of approximately 15,254,000 gallons of ethanol with prices ranging from $1.35 to $2.20 per gallon with delivery from January through December 2007.
The Company has committed to purchase various equipment related to a grain bin expansion. The cost of the expansion is estimated to be $1,500,000. Of the estimated costs, there has been $1,176,575 expended for the grain bin project as of December 31, 2006.
The Company has transactions in the normal course of business with various members. Significant related party transactions affecting the financial statements as of and for the periods ended December 31 are approximately as follows:
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 4: Long-term Debt
Long-term debt consists of the following as of December 31, 2006 and 2005:
The Company has a line of credit, with maximum borrowings of $5,000,000, expiring April 30, 2007. At December 31, 2006 and 2005, there were no borrowings against the line. The line is collateralized by a security agreement dated February 22, 2005 and a first deed of trust on real property. The line bears interest at a variable interest rate of Wall Street Journal Prime plus 0.75% making 9.0% the effective interest rate at December 31, 2006. Interest is payable monthly. The Company also has a letter of credit with Midwest Bank N.A. in the amount of $75,000, expiring September 1, 2007, to be used to serve the Company’s natural gas obligations. The letter of credit requires the Company to maintain cash at the bank in an amount equal to the letter of credit.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 4: Long-term Debt - continued
Future annual maturities of long-term debt as of December 31, 2006 are as follows:
Note 5: Retirement Plan
On January 12, 2004, the Company implemented a retirement plan covering substantially all employees. The Company matches employee contributions up to a maximum of 3% of employee compensation. Company contributions to the plan were $47,520, $45,682 and $37,322 for the years ended December 31, 2006, 2005 and 2004 respectively.
Note 6: Derivative Instruments
The Company enters into option and futures contracts, which are designated as hedges of specific volumes of corn expected to be used in the manufacturing process and ethanol expected to be sold. The Company uses derivative financial instruments to manage the exposure to price risk related to corn and ethanol sales. The Company does not typically enter into derivative instruments for any reason other than cash flow hedging purposes.
The option and futures contracts presented on the December 31, 2006 and 2005 balance sheets are recorded at fair value. On the date that the contract is entered into, the Company designates the option or contract as a hedge of variable cash flows of certain forecasted purchases of corn and forecasted sales of ethanol produced by the manufacturing process (a “cash flow hedge”).
In order for these open contracts to qualify for cash flow hedging treatment under Statement of Financial Accounting Standard (SFAS) No. 133 “Accounting for Derivative Instruments and Hedging Activities”, the Company must formally document relationships between the option and futures contracts, which serve as the hedging instruments, and the hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. When it is determined that an option or futures contract is not highly effective as a hedge or has ceased to be a highly effective hedge, the Company must discontinue hedge accounting prospectively. Changes in the fair value of option and futures contracts that are highly effective and that are designated and qualify as cash flow hedges are recorded in other comprehensive income or loss.
Gains and losses that are realized will be recognized in the statement of income when the related corn purchased is recognized in cost of sales or when the related sale of ethanol is recognized in sales.
Currently, option and futures contracts on corn purchased and ethanol sold by the Company do not meet the requirements for cash flow hedging treatment. As a result, changes in the market value of option and future contracts are recorded on the statements of income in gain/loss on option and futures contracts.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 7: Rights Offering
On June 26, 2006, at the Annual Meeting of Members, the members approved a proposed plant expansion. To help finance the plant expansion, the Company proceeded with a rights offering where each member of the Company as of August 1, 2006, the record date, was offered a nontransferable subscription right to subscribe to one membership unit for each unit held at a subscription price of $1,000 per unit. As of the record date, there were 15,318 membership units outstanding, and the total rights offering was for a maximum of 15,318 units or $15,318,000.
On September 5, 2006, the Company filed a Registration Statement with the Securities and Exchanges Commission registering up to 15,318 subscription rights and 15,318 membership units in the Company. This Registration Statement, which was amended on October 11, 2006, and October 23, 2006, was approved and declared effective by Securities and Exchange Commission on October 25, 2006.
On or about October 27, 2006, the Company provided a prospectus to each of its members of record as of August 1, 2006. The prospectus was the formal written offer to existing members of the Company (as of the record date) of the right to subscribe to newly issued membership units on a pro rata basis, based on each member’s percentage ownership interest in the Company.
In accordance with the terms of the Registration Statement, the Company retained the right to extend the rights offering beyond the initial expiration date of November 30, 2006, and the Board of Directors extended the right to exercise the subscription rights through December 18, 2006. These subscription rights were subject to acceptance by the Company’s Board of Directors after the Company obtained debt financing to help pay for the plant expansion project.
On January 5, 2007, the Company signed a Credit Agreement with Union Bank and Trust Company, Lincoln, Nebraska (Union Bank), whereby Union Bank agreed, subject to the terms of the Credit Agreement, to provide up to $35,000,000 of debt financing for the plant expansion project (Note 12). Thereafter, on January 12, 2007, the Board of Directors accepted the subscription rights and issued the membership certificates upon receipt of the funds from the escrow agent.
In the rights offering, the Company sold a total of 14,812 subscription rights and 14,812 membership units for total proceeds in the amount of $14,812,000, with 506 membership units remaining unsold.
As of January 12, 2007, after the completion of the rights offering, the Company has 30,130 membership units issued and outstanding (Note 13).
As of December 31, 2006, Union Bank, as escrow agent, held $14,812,000 in an escrow account on behalf of those members that properly exercised their subscription rights. In accordance with the terms of the Registration Statement, the funds in this escrow account were not the Company’s property, and the Company had no right to such funds until it was able to secure debt financing (on January 5, 2007) and the subscriptions were accepted by the Company (as of January 12, 2007). As of the end of 2006, interest had accrued on the escrow account funds in the amount of $55,589. This accrued interest is not shown on the Company’s balance sheet as of December 31, 2006.
The Company will apply the net proceeds from the rights offering to the payment of the Company’s design build contractor for the design and construction of the plant expansion project.
Note 8: Energy Production Incentive Credits
The Company is currently participating in a state energy production credit program. Under this program, the Company earns a credit of $0.18 per gallon of ethanol produced, not to exceed 15,625,000 gallons annually and no more than 125,000,000 gallons over a consecutive 96-month period. The program expires June 30, 2012. Credits earned under the state program for the years ended December 31, 2006, 2005 and 2004 were $2,812,500.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 8: Energy Production Incentive Credits - continued
The Company was also participating in a federal production credit program which ended June 30, 2006. Credits earned under this program are based on the increased utilization of corn in the production of ethanol. Since the Company began operations in March 2003 and credits earned under this program are based on the increased utilization of corn, the majority of the revenue generated under this program was realized within the first 12 months of operations. Credits earned under the federal program for the years ended December 31, 2006, 2005 and 2004 were $7,785, $(7,309) and $2,200,891, respectively.
Credits earned under the aforementioned state and federal energy production program are included in net sales in the accompanying statements of income.
Note 9: Repurchase Agreement
In order to perfect the security interest of the Company in securities that act as collateral under the repurchase agreement, Midwest Bank, N.A. (the Bank) has transferred such securities to a third party custodian. The custodian is the Company’s agent for the purposes of possessing and perfecting the Company’s security interest in said securities at December 31, 2006. To the extent that the market value of the securities used as collateral falls below the outstanding amount of repurchase obligation, the Company may become an unsecured creditor of the Bank. The market value of securities pledged as collateral exceeds the carrying amount of the repurchase agreement and the agreement has a weighted average maturity of one day as of December 31, 2006.
Note 10: Contingencies
Husker Ag, LLC is subject to various federal, state and local environmental laws and regulations that govern emissions of air pollutants; discharges or water pollutants; and generation, handling, storage and disposal of hazardous substances. The Company is also subject to potential liabilities arising under state laws that require responsible parties to remediate releases of hazardous or solid waste constituents into the environment associated with past or present activities. The Company continues to operate under an amended construction air permit. Emission test results are currently under review by Nebraska DEQ for consideration of an operating air permit.
Note 11: Income Taxes
As of December 31, 2006 and 2005, the Company’s book basis of assets exceeded their tax basis by approximately $13,930,000 and $13,810,000, respectively. There were no significant differences between the book basis and tax basis of liabilities as of December 31, 2006 or 2005.
Note 12: Plant Expansion Project; Design-Build Agreement
The Company’s current plant expansion project, which was approved by the Company’s members at the 2006 Annual Meeting of Members held on June 26, 2006, will add approximately 40 million gallons per year of ethanol production capacity to the Company’s existing operations. The total cost of the project is estimated to be approximately $63 million.
On July 25, 2006, the Company executed an Agreement between Owner and Design/Builder on the Basis of a Stipulated Price (the Design-Build Agreement) with ICM, Inc., an ethanol plant design build contractor located in Colwich, Kansas (ICM). Under the Design-Build Agreement, ICM is responsible for the design, construction and start-up of a stand-alone dry mill fuel-grade ethanol plant that would add 40 million gallons per year of ethanol production capacity to the
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 12: Plant Expansion Project; Design-Build Agreement - continued
Company’s existing operations. Under the terms of the Design-Build Agreement, the Company will pay ICM approximately $44,284,000 for the design and construction of this expansion, subject to adjustments made in accordance with the general conditions of the agreement. ICM began construction on the plant expansion project in October 2006, and the Company anticipates that the project will be completed before the end of 2007.
Note 13: Earnings per Share - Rights offering impact
The following transaction occurred after December 31, 2006, which, had they taken place during fiscal 2006, would have changed the number of shares used in the computations of earnings per share. There were 14,812 common shares issued in a public offering closed on January 12, 2007 (Note 7).
Note 14: Subsequent Events
On January 5, 2007, the Company signed a Credit Agreement with Union Bank and Trust Company, Lincoln, Nebraska (Union Bank), whereby Union Bank agreed, subject to the terms and conditions set forth in the Credit Agreement, to provide the Company up to $35,000,000 of debt financing to be used for the construction of the Company’s plant expansion project (Note 12). This plant expansion project, which commenced in October 2006, will add approximately 40 million gallons per year of ethanol production capacity to the Company’s existing operations.
Union Bank made the following loans to the Company on January 5, 2007, pursuant to the Credit Agreement and the resultant promissory notes:
Construction Loan - multiple advance loan during the construction period with maximum borrowings of $25,000,000. Advances for construction are available under the Construction Loan until Substantial Completion of the plant expansion project, as defined in the Credit Agreement, or February 15, 2008, whichever occurs first. The Credit Agreement requires the Company to pay interest on the outstanding principal indebtedness on a quarterly basis during the construction period and thereafter until converted into a term loan. Six months following Substantial Completion of the plant expansion project, the Construction Loan will convert into a term loan which would be repayable on a quarterly basis over a 7-year period, subject to the possible mandatory additional payments described below.
Revolving Loan - multiple advance revolving loan with maximum borrowings of $10,000,000. Advances are restricted to the construction of the plant expansion project, and are available under the Revolving Loan until the expiration of 39 months after the Construction Loan has been paid in full or matures, whichever occurs first, but no later than June 1, 2018. The Credit Agreement requires the Company to pay interest on the outstanding principal indebtedness on a quarterly
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 14: Subsequent Events - continued
basis during this loan advancement period. Three months after the final maturity or payment of the Construction Loan, whichever is earlier, but no later than September 1, 2015, the Revolving Loan will convert into a term loan which would be repayable on a quarterly basis over a 3-year period, subject to the possible mandatory additional payments described below.
Under the Credit Agreement, the Company must use its equity funds prior to incurring indebtedness under either of the loans. Union Bank has required the Company to inject a minimum of 40% equity into the plant expansion project (that is, the equity must equal at least 40% of the total of amount of equity and indebtedness).
In addition, the Credit Agreement imposes a number of conditions which must be met by the Company on an on-going basis prior to Union Bank’s disbursement of loan funds under either loan. Union Bank has broad powers of discretion with respect to its disbursement of funds under either loan, depending upon the Company’s compliance with the Credit Agreement covenants and conditions.
Additional material terms of the debt financing from Union Bank are as follows:
Interest Rate. The Credit Agreement provides for the same interest rate for both loans. Until the first principal payment is due under the Construction Loan (six months after Substantial Completion), each of the loans will accrue interest at the one month London Interbank Offered Rate (LIBOR) plus 3.00% adjusted monthly.
Subject to performance pricing indicated below, when the first principal payment is due under the Construction Loan, each of the loans will accrue interest at the three month LIBOR plus 3.00% adjusted monthly.
The Credit Agreement states that performance pricing will be available after the principal payments begin on the Construction Loan based upon the Company’s member equity position. Depending on the percentage of the Company’s total members’ equity to total assets, Union Bank will reduce the interest rate on the Company’s loans by as much as 70 basis points or .70%. Adjustments will be completed on an annual basis based on the Company’s audited financial statements. Interest will be adjusted in accordance with the following rate index:
*
-
Members’equity ratio is defined as total members’ equity divided by total assets.
When the first payment is due under the Construction Loan, the Credit Agreement provides that Husker Ag may select a fixed interest rate for one or both of the loans based on the Federal Home Loan Bank (FHLB) 3-year or 5-year fixed advance rate plus 3.00%.
Collateral. These loans, along with the Company’s existing debt with Union Bank, are secured by a first mortgage on the Company’s real estate and plant, as well as a first security interest on all accounts receivable, inventory, equipment, fixtures, and on all personal property and general intangibles.
Financing Costs. The Credit Agreement requires the Company to pay a .75% origination fee ($262,500), plus third party expenses, such as title insurance, legal fees, appraisal and filing fees. The actual total financing costs are expected to be $320,000 and will be amortized over the life of loans.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 14: Subsequent Events - continued
Prepayment Penalty. The loans are subject to a prepayment penalty if refinanced with another lender (3.0% penalty if refinanced during the first three years of principal payments; 1.0% penalty thereafter). Otherwise, the Company may pay off either or both of these loans without penalty. However, if the Company selects the fixed rate option, the Credit Agreement requires a minimum 2.0% prepayment penalty for any prepayments.
Mandatory Additional Principal Payments - Free Cash Flow. In addition to the scheduled principal payments provided above, the Company would be required to make an annual payment applied to principal in an amount equal to 10% of available Free Cash Flow.
These payments would be capped at $1.5 million per year with a maximum aggregate payment of $5 million over the life of the loans. This additional payment would be applied to scheduled principal installments in inverse order of maturity on these new loans. If the amount of any such additional payment would result in a covenant default, the amount of payment will be reduced to an amount that would not cause covenant default.
Free Cash Flow is defined as the Company’s annual net income, minus an amount equal to 36% of the net income (as an estimated tax rate); plus the respective calendar year depreciation and amortization expense; minus allowed capital expenditures and principal payments to Union Bank and other authorized creditors.
Covenants/restrictions. The primary financial covenants and restrictions, all determined in accordance with generally accepted accounting principles, as applied on a consistent basis, would include the following:
•
Beginning with the month in which Substantial Completion occurs, the Company must maintain working capital of not less than $6,000,000; this calculation will include any unadvanced portion of the Company’s existing revolving term commitment of $5,000,000.
•
Beginning three months after Substantial Completion and quarterly thereafter, the Company must maintain a debt service coverage ratio of not less than 1.5:1 measured quarterly based on a rolling 4 quarter average (this ratio is defined as net income plus depreciation and amortization; minus extraordinary gain/loss divided by current principal of long term debt).
•
Beginning on January 5, 2007, the Company must have a minimum tangible net worth (total assets minus intangible assets and minus total liabilities, as defined by GAAP) of not less than $34,800,000. The Company shall maintain minimum tangible net worth of no less than the amount that will not allow members’ equity to be below 49%.
•
All distributions to the Company’s members would be subject to prior approval by 66.67% of all financial institutions participating in these loans (determined by the dollar amount of the Company’s total indebtedness to Union Bank and its participants). Before granting any such approval, Union Bank would require the Company to be in compliance with each of the loan covenants before and after the distribution.
•
Other than for the construction of the plant expansion project, the Company must obtain approval from Union Bank for any capital improvements in excess of $1,700,000.00, subject to annual revision.
Husker Ag, LLC
Notes to Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 14: Subsequent Events - continued
•
Cash distributions could be paid out up to three times per year in April (based on March year-to-date financial results), August or September (based on June year-to-date results) and December (based on November year-to-date results). The Company’s distributions will be limited to the distribution schedule below:
•
When a distribution is approved above the estimated 36% tax rate (the assumed normal effective tax rate of the Company’s members as determined by Union Bank), an amount equal to 10% of the amount above the 36% rate would be applied to the outstanding principal balance of the new loans, to be applied to scheduled principal installments in inverse order of maturity on these new loans.
Default. Each of these new loans may be accelerated upon default. However, the Credit Agreement provides the Company with a right to cure any default. Default provisions include, among other things, (i) the Company’s failure to pay amounts when due; and (ii) the Company’s failure to perform any material condition or to comply with any material promise or covenant of the Credit Agreement or any of the related loan documents.
On March 20, 2007, the Board of Directors declared a cash distribution in the amount of $70.00 per membership unit to members of record as of April 1, 2007 payable on or before April 6, 2007 for a total distribution of $2,109,100 based on 30,130 membership units issued and outstanding. On March 27, 2007, the Company’s primary lender approved this distribution in accordance with the Company’s loan covenants.
Supplementary Financial Information
Quarterly Information (unaudited)
The following is an unaudited summary of the Company’s quarterly operating results for the years ended December 31, 2006 and 2005:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer as of the end of the period covered by this report. The Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving the desired control objectives. In connection with the preparation of this Form 10-K, management considered the weaknesses discussed below and the remedial actions taken by the Company to address such weaknesses. After consideration of the aforementioned factors, the Company’s Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as currently in effect are not effective at the reasonable assurance level in ensuring that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) accumulated and communicated to Company management (including the Principal Executive Officer and Principal Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
The Principal Executive Officer and Principal Financial Officer have identified material weaknesses in the Company’s controls over the financial reporting processes including the accurate reporting and disclosure of amounts and other disclosure items in our financial statements. In addition, these officers have concluded that the Company has a material weakness in both its lack of segregation of duties for its accounting functions and in its failure to establish adequate monitoring controls to ensure that information generated for financial reporting purposes is complete and accurate.
These material weaknesses in the Company’s disclosure controls and procedures were first identified and reported in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, which was filed on May 15, 2005. These weaknesses were identified by our Principal Financial Officer and our then Principal Executive Officer in conjunction with the evaluation of the Company’s disclosures and procedures that was performed as of March 31, 2005. The officers identified these material weaknesses in conjunction with their discussions with the Company’s audit committee and its then independent accountants. Due to the limited size and technical accounting experience of our accounting staff, the Company has had weaknesses in its disclosure controls and procedures since it commenced operations in 2003. However, the Principal Executive Officer and Principal Financial Officer did not identify these weaknesses as material until the evaluation of the Company’s disclosure controls and procedures that was performed as of March 31, 2005.
As of December 31, 2006, the Principal Executive Officer and Principal Financial Officer have identified the following specific material weaknesses in the Company’s controls over its financial reporting processes:
1. The Company had insufficient qualified personnel resources and technical accounting expertise within the accounting function to accurately report, disclose and/or resolve certain accounting matters as of December 31, 2006. As a direct result of this weakness, it was necessary for the Company’s independent accountants to propose certain changes to our financial statements related to misclassifications of amounts in the income statement and statement of cash flows. Specifically, in the Company’s internally prepared financial statements, (i) overhead was not included within the cost of sales classification and was instead included as part of selling, general and administrative expenses; and (ii) the cash flow statement had amounts that were related to plant acquisition included in the cash flows from operations instead of including them in cash flow from investing activities.
2. Due to the limited number of personnel involved in the processing of accounting data (Husker Ag currently has three employees devoted full time to the accounting function), and specifically in the number of personnel involved in the preparation and review of financial information for inclusion within the financial statements, the Company did not maintain the proper segregation of duties and oversight over financial reporting.
In light of the foregoing, management is in the process of developing additional procedures to help address these issues. As of December 31, 2006, the Company had taken the following remedial actions:
1. The Company has engaged Milo Belle Consultants, LLC as an independent accounting consulting firm to assess the Company’s internal controls as well as its financial reporting function. Milo Belle was hired to assist the Company with its internal controls and procedures including the Company’s efforts to segregate duties with a limited accounting staff. At the completion of its assessment, Milo Belle is expected to work with the Company’s management in the design of necessary remediation of the noted weaknesses. This engagement is expected to be completed, along with the proposed recommendations and remediation, during the second quarter of 2007.
2. To address the weakness in our financial reporting function, the Company is currently pursuing several options for an external review of the drafted financial statements by qualified personnel before being submitted to the Company’s independent accountants.
3. The Company has appropriate accounting personnel pursuing continuing education and training to improve their skill and abilities and to become more qualified in the financial reporting function.
Management believes that the foregoing actions have improved and will continue to improve the Company’s disclosure controls and procedures. Husker Ag’s management, with the oversight of the audit committee, will continue to identify and take steps to remedy any material weaknesses and enhance the overall design and capability of the Company’s control environment.
(b) Changes in Internal Controls: During the Company’s fourth fiscal quarter ended December 31, 2006, we have taken the actions set forth above that are intended to help remediate the material weaknesses identified above. Specifically, we engaged a professional accounting consulting firm; pursued a professional external review of our financial statements before submission to our independent accountants; and pursued continuing education for our accounting staff. Other than the changes identified above, there have not been any significant changes in the Company’s internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management can not assure that the changes implemented in the Company’s internal control over financial reporting during the fourth quarter of 2006 have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
During the fourth quarter of 2006, no information was required to be disclosed in a report on Form 8-K, but not reported.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to the Company’s Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the Company’s Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MEMBER MATTERS
The information required by this Item is incorporated herein by reference to the Company’s Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to the Company’s Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
BKD, LLP (“BKD”) served as the Company’s independent certified public accountants for the three year period ended December 31, 2005, and performed various audit, audit-related, tax and other services for Husker Ag. Effective March 31, 2006, the Company elected not to retain BKD to audit the Company’s financial statements for the year ending December 31, 2006. On February 23, 2006, the Company’s Audit Committee recommended to the Board of Directors the dismissal of BKD upon its completion of the audit and the filing of the Form 10-K for the year ended December 31, 2005 and the retention of Eide Bailly LLP (“Eide Bailly”) as the Company’s independent accountant for fiscal year 2006. The Board of Directors approved the Audit Committee’s recommendations on February 28, 2006, subject to acceptance by Eide Bailly of its engagement. On April 5, 2006, Eide Bailly accepted its appointment as the Company’s independent accountant.
The following table represents fees for professional audit services rendered by (i) BKD for the audit of the Company’s annual financial statements for the year ended December 31, 2005 and fees for other services rendered by BKD during that period, and (ii) Eide Bailly for the audit of the Company’s annual financial statements for the year ended December 31, 2006 and fees for other services rendered by Eide Bailly during that period:
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Fees for audit services include fees associated with the annual audit and reviews of the Company’s quarterly financial statements included in the reports on Forms 10-Q and services normally provided in connection with statutory and regulatory filings or engagements.
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Principally accounting consultation and work related to rights offering.
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Includes $22,884 in 2006 and $14,000 in 2005 for tax preparation and $2,699 in 2006 and $2,800 in 2005 for tax compliance, advice, and planning.
Pre-Approval Policies and Procedures. In accordance with Section 10(A)(i) of the Securities and Exchange Act of 1934, the Company Audit Committee approves the engagement of our independent accountants to render audit and non-audit services before those services are rendered, considering, among other things, whether the proposed engagement would impact the independence of the auditors. All of the fees of BKD and Eide Bailly reflected above were approved by the Audit Committee.
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 - An index to the Company’s financial statements is located above on page 41 of this report. The financial statements appear on page 44 through page 62 of this report.
(2) Financial Statement Schedules - The Company’s unaudited quarterly financial information is located on page 63 above under Item 8 - Supplementary Financial Information. All other supplemental schedules are omitted because of the absence of conditions under which they are required or because the information shown in the financial statements or notes thereto.
(3) Exhibits - The exhibits we have filed herewith or incorporated by reference herein are set forth on the attached Exhibit Index.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto authorized.
In accordance with the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
* - By Mike Kinney pursuant to Power of Attorney.
EXHIBIT INDEX
*
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Material has been omitted pursuant to a request for confidential treatment and such materials have been filed separately with the Securities and Exchange Commission.