Item 1. Business.
General Overview
Lincolnway Energy, LLC is an Iowa limited liability company that operates a dry mill, coal fired ethanol plant located in Nevada, Iowa. Lincolnway Energy has been processing corn into fuel grade ethanol and distiller's grains at the ethanol plant since May 2006.
The ethanol plant has a nameplate production capacity of 50,000,000 gallons of ethanol per year, which, at that capacity, would also generate approximately 136,000 tons of distiller's grains per year. Lincolnway Energy anticipates, however, being able to operate the plant at anywhere from 9% to 19% above the nameplate production capacity. Lincolnway Energy produced approximately11% over nameplate for the fiscal year ended September 30, 2012.
Lincolnway Energy extracts corn oil from the syrup which is generated in the production of ethanol. Lincolnway Energy estimates that it will produce approximately 4,700 tons of corn oil per year at the plant.
EPCO Carbon Dioxide Products, Inc. has a plant on Lincolnway Energy's site that collects the carbon dioxide that is produced as part of the ethanol production process and converts that raw carbon dioxide into liquid carbon dioxide. EPCO also markets and sells the liquid carbon dioxide. Lincolnway Energy estimates that it will produce approximately 88,000 tons of carbon dioxide per year.
Lincolnway Energy does not anticipate that sales of corn oil and carbon dioxide will be material sources of revenue for Lincolnway Energy, but Lincolnway Energy was able to implement the processes to collect corn oil and carbon dioxide on an economical basis and Lincolnway Energy does not have significant operating or other costs related to those processes.
DuPont Danisco Cellulosic Ethanol, LLC ("DDCE") purchased approximately 59.05 acres of real estate from Lincolnway Energy in October, 2011. The real estate is located to the southwest of the real estate on which Lincolnway Energy's ethanol plant is located. DDCE intends to build a cellulosic or advanced biofuels plant on the real estate.
Lincolnway Energy and DDCE also entered into a Load Out Services Agreement. The Load Out Services Agreement provides, in general, that DDCE will construct an aboveground pipeline from DDCE's plant to a holding tank on Lincolnway Energy's property, and that Lincolnway Energy will load out DDCE's product at Lincolnway Energy's rail or truck facilities. The Load Out Services Agreement sets forth the various fees and other amounts that DDCE will pay to Lincolnway Energy for those services, as well as allocating various costs and expenses between Lincolnway Energy and DDCE. The Load Out Services Agreement provides that if it is terminated, then Lincolnway Energy will grant DDCE an easement for the purpose of DDCE constructing its own rail tracks, and that Lincolnway Energy and DDCE will also at that time enter into a track usage agreement that will address how Lincolnway Energy and DDCE will jointly use certain tracks of Lincolnway Energy and other related matters.
Lincolnway Energy does not anticipate that the revenues under the Load Out Services Agreement will be a material source of revenue for Lincolnway Energy, but Lincolnway Energy believes that it will be able to provide the services required under the Load Out Services Agreement without materially increasing its operating or other costs.
Financial Information
Financial statements for Lincolnway Energy are included in Item 8 of this annual report. The financial statements include information regarding Lincolnway Energy's revenues, profits or losses and total assets. Item 6 of this annual report includes summary selected financial data.
Lincolnway Energy did not derive any revenue during the fiscal year ended September 30, 2012 from any customers located in any foreign country, and Lincolnway Energy did not have any assets located in a foreign country during that fiscal year.
Principal Products and Their Markets
Lincolnway Energy's principal products are fuel grade ethanol and distiller's grains.
Ethanol
Lincolnway Energy produces fuel grade ethanol from corn. The ethanol can be used as a blend component/fuel additive in gasoline. Ethanol increases the octane rating of gasoline and reduces vehicle emissions, primarily carbon monoxide. Although one of the most important federal support programs for ethanol expired on December 31, 2011, the use of ethanol is still supported by some governmental incentives and programs. The loss of one or more of those remaining incentives or programs could be highly detrimental to the ethanol industry.
All of Lincolnway Energy's ethanol production is sold to Green Plains Trade Group LLC. Under the agreement, Green Plains Trade Group LLC has the exclusive right to market all of the ethanol which is produced by Lincolnway Energy, except that Lincolnway Energy may market some of its ethanol in certain limited circumstances, such as ethanol which is the subject of any purchase order which was submitted by Green Plains Trade Group LLC but was rejected by Lincolnway Energy. Lincolnway Energy may reject any purchase orders submitted by Green Plains Trade Group LLC, in Lincolnway Energy's sole discretion. The purchase price payable to Lincolnway Energy under the agreement is Green Plains Trade Group LLC's contract selling price for the ethanol in question, less various costs and a fee to Green Plains Trade Group LLC, but the agreement includes a minimum purchase price. Lincolnway Energy is dependent upon its agreement with Green Plains Trade Group LLC for the marketing and sale of Lincolnway Energy's ethanol, and Lincolnway Energy's loss of the agreement, or Lincolnway Energy's inability to negotiate a new agreement with Green Plains Trade Group LLC or another marketer before the expiration or termination of the agreement, could have material adverse effects on Lincolnway Energy.
On November 29, 2012, Lincolnway Energy and GPTG mutually agreed to terminate the ethanol marketing agreement effective December 31, 2012. The termination was requested by Lincolnway Energy because managers of Lincolnway Energy determined that it was in the best interests of Lincolnway Energy to retain a different ethanol marketer. Lincolnway Energy will actively pursue a contract with another marketer to replace GPTG.
The primary purchasers of ethanol are refiners, blenders or wholesale marketers of gasoline. Lincolnway Energy anticipates that its ethanol production will be sold in various regional markets given the availability of rail service at Lincolnway Energy's ethanol plant and local markets that will be shipped by truck, but Green Plains Trade Group LLC controls the marketing of all of Lincolnway Energy's ethanol output.
Lincolnway Energy’s primary means of shipping and distributing ethanol will be by rail and truck.
The nameplate production capacity of Lincolnway Energy's ethanol plant is 50,000,000 gallons of ethanol per year, or approximately 4,167,000 gallons per month. The ethanol plant exceeded the nameplate production capacity for the fiscal year ended September 30, 2012, however, by approximately 11%, with 55,712,726 gallons of ethanol produced during that period, and with an average daily production of 166,680 gallons. This is a 2.4% decrease from the prior fiscal year.
Lincolnway Energy anticipates that the ethanol plant will produce ethanol at a similar rate or higher during the fiscal year ending September 30, 2013.
Lincolnway Energy's revenues from the sale of ethanol during the fiscal years ended September 30, 2010, September 30, 2011 and September 30, 2012 accounted for approximately 83%, 80% and 75% respectively, of Lincolnway Energy's total revenues during those periods. Lincolnway Energy estimates that its revenues from the sale of ethanol for the fiscal year ending September 30, 2013 will account for approximately 72% of Lincolnway Energy's total revenues for that fiscal year.
Distiller's Grains
Lincolnway Energy's other primary product is distiller's grains, which is a byproduct of the ethanol production process. Distiller's grains are the solids that are left after the processing and fermentation of corn into ethanol. Distiller's grains are a high protein feed supplement that are marketed primarily in the swine, dairy and beef industries. Distiller's grains can also be used in poultry and other livestock feed.
A dry mill ethanol process such as that utilized by Lincolnway Energy can produce wet distiller's grains and dried distiller's grains. Wet distiller's grain contains approximately 60% moisture, and has a shelf life of approximately ten days. Wet distiller's grains can therefore only be sold to users located within relatively close proximity to the ethanol plant. Dried distiller's grain is wet distiller's grain that has been dried to 10% to 12% moisture. Dried distiller's grain has an extended shelf life and may be sold and shipped to any market.
Lincolnway Energy's output of distiller's grains is sold to Hawkeye Gold, LLC under a Distiller's Grains Marketing Agreement. Prior to August 1, 2012, Lincolnway Energy paid Hawkeye Gold, LLC a marketing fee for dried distiller's grains and wet distiller's grains equal to the greater of a set percentage of the FOB plant price or a fixed dollar amount per ton for the dried distiller's grains or wet distiller's grains in question. The agreement was amended on August 1, 2012 to change the fees payable to Hawkeye Gold, LLC. Since that amendment, the fee for dried distiller's grains is a set percentage of the FOB plant price, but with both a specified maximum and minimum per short ton price. The fee for wet distiller's grains is also a set percentage of the FOB plant price, but with a specified maximum per short ton price. The Distiller's Grains Marketing Agreement can be terminated by Lincolnway Energy or Hawkeye Gold, LLC on 90 days written notice. Lincolnway Energy is dependent upon its agreement with Hawkeye Gold, LLC for the marketing and sale of Lincolnway Energy's distiller's grains, and Lincolnway Energy's loss of the agreement, or Lincolnway Energy's inability to negotiate a new agreement with Hawkeye Gold or another marketer before the expiration or termination of the agreement, could have material adverse effects on Lincolnway Energy.
The primary purchasers of distiller's grains are individuals or companies involved in dairy, beef or other livestock production. Lincolnway Energy anticipates that approximately 7% of its distiller's grains will be locally marketed to nearby livestock producers, but Hawkeye Gold, LLC controls the marketing of all of Lincolnway Energy's distiller's grains.
Lincolnway Energy's primary means of shipping and distributing distiller's grain will be by rail and truck. Local livestock producers are also able to pick up distiller's grains directly from the ethanol plant.
Lincolnway Energy produced 147,425 tons of distiller's grains during the fiscal year ended September 30, 2012, or approximately 12,797 tons of distiller's grains per month. The composition of the distiller's grains was approximately 4% wet distiller's grains and 96% dried distiller's grains. Dried distillers production increased approximately 3% from the prior fiscal year.
Lincolnway Energy anticipates processing approximately 156,000 tons of distiller's grains during the fiscal year ending September 30, 2013.
Lincolnway Energy's revenues from the sale of distiller's grains during the fiscal years ended September 30, 2010, September 30, 2011 and September 30, 2012 accounted for approximately 17%, 18% and 23% respectively, of Lincolnway Energy's total revenues during those periods. Lincolnway Energy estimates that its revenues from the sale of distiller's grains for the fiscal year ending September 30, 2013 will account for approximately 26% of Lincolnway Energy's total revenues for that fiscal year.
Other Byproducts
There are other byproducts from the production of ethanol at a dry mill plant, primarily corn oil and carbon dioxide.
Corn Oil
Lincolnway Energy has a corn oil extraction system that extracts corn oil from the syrup that is generated in the production of ethanol. Lincolnway Energy has an agreement with FEC Solutions, L.L.C. under which FEC Solutions, L.L.C. purchases all of Lincolnway Energy's output of corn oil for resale by FEC Solutions, L.L.C. Lincolnway Energy pays FEC Solutions, L.L.C. a marketing and technical assistance fee of a set percentage of the FOB sales price of the corn oil. The agreement renews for successive 36 month terms (on October 13 of the applicable year) unless Lincolnway Energy or FEC Solutions, L.L.C. elect to terminate the agreement at the end of the then current 36 month term. The current 36 month term expires on October 13, 2014.
Lincolnway Energy's primary means of shipping and distributing corn oil will be by truck.
Lincolnway Energy anticipates that FEC Solutions, L.L.C. will sell the corn oil in the biodiesel, livestock feed and industrial industries, but FEC Solutions, L.L.C. controls the marketing of all of Lincolnway Energy's output of corn oil.
Lincolnway Energy estimates that it will produce and sell approximately 4,700 tons of corn oil per year at the plant. Lincolnway Energy does not, however, anticipate that corn oil will be a material product of Lincolnway Energy. Lincolnway Energy’s corn oil sales were approximately $1,500,000, $3,400,000 and $3,800,000 respectively, for the fiscal years ended September 30, 2010 and September 30, 2011, and September 30, 2012 which represented less than 2% , of Lincolnway Energy's total revenues for those respective fiscal years. Lincolnway Energy's oil sales increased approximately 127% during the fiscal year ended September 30, 2011 when compared to the prior fiscal year. The increase was primarily due to an additive that was added to the process to improve the oil yield.
Carbon Dioxide
Lincolnway Energy has a Carbon Dioxide Purchase and Sale Agreement and a related Non-Exclusive CO2 Facility Site Lease Agreement with EPCO Carbon Dioxide Products, Inc. Under those agreements, EPCO constructed a plant on Lincolnway Energy's site to collect the carbon dioxide which is produced as part of the ethanol production process and to convert that raw carbon dioxide into liquid carbon dioxide. The EPCO plant became fully operational in August of 2010.
EPCO also markets and sells the liquid carbon dioxide gas under those agreements. The purchase price payable by EPCO for the raw carbon dioxide provided by Lincolnway Energy is based upon EPCO's shipped tons of liquid carbon dioxide. The agreement also includes a "take or pay" term which requires EPCO to purchase, during each contract year, the greater of 180 shipped tons per day or 70% of the annual liquid carbon dioxide production capacity of the EPCO plant at full capacity. The annual liquid carbon dioxide production capacity of the EPCO plant will be determined based upon the capacity run procedures as set out in the agreement. The take or pay obligation is trued up at the end of each contract year, and the purchase price for any "take or pay" tons will be the average per shipped ton purchase price paid by EPCO during the contract year. The term of the marketing agreement with EPCO is ten years from the date on which liquid carbon dioxide was first produced at the EPCO plant, which was during August, 2010, unless the agreement is earlier terminated for any of the other reasons set out in the agreement. EPCO is required to remove the plant and related equipment following any termination of the agreement.
EPCO is responsible for the shipment of all liquid carbon dioxide, which Lincolnway Energy contemplates, will be by truck.
Lincolnway Energy estimates it will sell approximately 87,000 tons of carbon dioxide per year to EPCO. Lincolnway Energy does not, however, anticipate that revenues from the sale of carbon dioxide to EPCO will be a material product of Lincolnway Energy, given that Lincolnway Energy estimates that those revenues will constitute less than 1% of Lincolnway Energy's total revenues during any fiscal year.
Sources and Availability of Raw Materials
Corn and coal are the primary raw materials that are utilized by Lincolnway Energy in the production of ethanol. Corn is used to produce the ethanol, and coal is Lincolnway Energy's primary energy source for its ethanol plant.
Corn
Lincolnway Energy estimates that it will utilize approximately 21,000,000 bushels of corn per year at its ethanol plant, or approximately 1,750,000 bushels per month, assuming production at a capacity of approximately 59,000,000 gallons of ethanol per year.
Lincolnway Energy's ethanol plant is located in Nevada, Iowa. which is located in Story County. Although Lincolnway Energy anticipates purchasing corn from various sources and areas, Lincolnway Energy believes that Story County will produce a sufficient supply of corn, assuming normal growing conditions, to generate the necessary annual requirements of corn for the ethanol plant. There is not, however, any assurance that Lincolnway Energy will be able to purchase sufficient corn supplies from Story County or regarding the supply or availability of corn given the numerous factors which affect the supply and price for corn.
Lincolnway Energy had an agreement with Heart of Iowa Cooperative, dba Key Cooperative, until October 10,2012, pursuant to which Lincolnway Energy could obtain up to 50% of its corn needs from Key Cooperative's facility located adjacent to Lincolnway Energy's ethanol plant, with the remaining 50% to be obtained from other Key Cooperative facilities or other licensed grain dealers. The 50% limitation for Key Cooperative's Nevada, Iowa location was imposed by the Iowa Department of Natural Resources, as part of the air permitting process. Key Cooperative is a licensed grain dealer and has locations throughout central Iowa. Key Cooperative is also a member of Lincolnway Energy.
Lincolnway Energy terminated the agreement with Key Cooperative effective as of October 10, 2012. Lincolnway Energy is required under the terms of the agreement to pay Key Cooperative a termination fee of $1,700,000. Payments of $425,000 will be made annually over a four year period with interest at the prime rate on the date of termination. The first payment will be made in the month of January 2013.
Lincolnway Energy anticipated originating its corn needs in house, and that it will procure its corn needs going forward from various sources, including possibly Key Cooperative. Lincolnway Energy may also determine at some point to enter into another grain procurement contract.
Lincolnway Energy purchased 19,396,505 bushels of corn for $128,490,494 from Key Cooperative during the fiscal year ended September 30, 2012, and, respectively, 20,029,808 and 19,884,281 bushels of corn for $127,764,206 and $71,804,446 during the fiscal years ended September 30, 2011 and September 30, 2010.
Corn is delivered to Lincolnway Energy's ethanol plant by truck.
Lincolnway Energy has corn storage capabilities for approximately 10 days of continuous ethanol production.
Coal
Lincolnway Energy's ethanol plant is a coal fired plant. Lincolnway Energy's ethanol plant will utilize approximately 300 tons of coal per day, assuming production at a capacity of 59,000,000 gallons of ethanol per year.
Lincolnway Energy purchased approximately 99,000 tons of coal for $7.2 million during the fiscal year ended September 30, 2012, and, respectively, 102,000 and 99,000 tons of coal for $7.0 million and $6.0 million during the fiscal years ended September 30, 2011 and September 30, 2010.
Lincolnway Energy currently obtains all of its coal pursuant to an agreement between Lincolnway Energy and Williams Bulk Transfer. The agreement allows Lincolnway Energy to purchase up to 220,000 tons of coal per year at a per ton price equal to the sum of the coal price and the transportation price, as those terms are defined in the agreement. The coal price and the transportation price are subject to adjustment in various circumstances and based on various factors. For example, the transportation price is subject to quarterly adjustment, upward or downward (but never below the initial transportation price stated in the agreement), by 100% of the quarterly percentage change in the All Inclusive Index-Less Fuel, and to a monthly adjustment, upward but not downward, through the addition of a fuel surcharge determined by the amount by which the average Retail On-Highway Diesel Fuel Price of the U.S. exceeds a specified amount per gallon. The transportation price will also be increased on the scheduled adjustment dates set out in the agreement. The coal price adjustments are based upon, in general, any increased costs as a result of any changes in laws, changes in inflation as determined by designated indices, and the quality of the coal. Lincolnway Energy is required to pay a penalty of $16.00 per ton multiplied by the difference of the minimum requirement and actual quantity purchased, if Lincolnway Energy fails to purchase a minimum of 80,000 tons of coal in any calendar year. The $16.00 per ton penalty amount is subject to adjustment as provided in the agreement. Lincolnway Energy's agreement with Williams Bulk Transfer will expire by its terms on January 1, 2013. Lincolnway Energy was negotiating a new agreement with Williams Bulk Transfer as of the time of the preparation of this annual report and anticipates entering into a new agreement before the close of 2012. Lincolnway energy anticipates the new agreement will be on terms similar to the existing agreement, but with some changes in the pricing provisions and minimum usage requirements.
Lincolnway Energy is dependent upon its agreement with Williams Bulk Transfer for the supply of all of Lincolnway Energy's coal needs. Lincolnway Energy's loss of its contract with Williams Bulk Transfer, or Lincolnway Energy's inability to negotiate a new contract with Williams Bulk Transfer or another supplier on favorable terms before the expiration or termination of the agreement, would have material adverse effects on Lincolnway Energy.
All of the coal utilized by Lincolnway Energy is delivered by truck. Lincolnway Energy has coal storage for approximately 6 days of continuous ethanol production.
Other Raw Materials
Lincolnway Energy's ethanol plant also requires a significant amount of electricity and water supply. Lincolnway Energy's electricity needs are currently met by Alliant Energy. Lincolnway Energy pays the general service rates for its electricity. Lincolnway Energy utilizes approximately two gallons of water to produce a gallon of ethanol, which results in the use of approximately 325,000 gallons of water per day. Lincolnway Energy discharges 275,000 gallons of water per day that has been purified by a reverse osmosis system. Lincolnway Energy's water needs are currently met by the City of Nevada.
Rail Access
Rail access is critical to the operation of Lincolnway Energy's ethanol plant because rail is used for the shipment and distribution of ethanol and distiller's grains. Lincolnway Energy utilizes rail track owned by Lincolnway Energy and tracks owned by the Union Pacific. Lincolnway Energy has agreements with the Union Pacific regarding the use of its railroad tracks.
Lincolnway Energy constructed additional rail spur during 2011. The additional rail spur project cost approximately $3.4 million and was completed in December 2011.
Expansion Plans
Lincolnway Energy currently has no definite plans to expand its ethanol plant or to construct or acquire any additional ethanol plants. Lincolnway Energy will, however, consider those matters as part of its ongoing operations and analysis of its business and the ethanol industry in general.
Technology Changes
Lincolnway Energy continues to monitor and evaluate any opportunities that may arise with respect to possible technological improvements and alternative energy sources for Lincolnway Energy's ethanol plant. Lincolnway Energy is continuing to consider switching the fuel source for its plant from coal to biomass or natural gas. Lincolnway Energy also continues to monitor technological developments in the industry, such as those purported to increase operating or production efficiencies or to generate energy or other savings in ethanol or distillers' grains production.
Research and Development Activities
Lincolnway Energy is not currently engaged in any significant research or development activities.
Competition
The ethanol industry and markets remain highly competitive even though new construction and expansion of ethanol plants in the United States slowed significantly during the last three to four years due to overall generally unfavorable credit and market conditions. As of January 2012, there were approximately 209 ethanol plants located in 29 different states in the U.S. with an ethanol production capacity of approximately 14.9 billion gallons per year. The annualized production of ethanol in the United States during 2011 was approximately 13.9 billion gallons. According to the Iowa Renewable Fuels Association, as of November 2012, Iowa had 41 ethanol plants in production, with a production capacity of approximately 3.7 billion gallons per year and utilizing over 1 billion bushels of corn. Iowa is one of the top five ethanol producing states in the United States. The United States is currently the world's top producer, consumer and exporter of fuel ethanol. World production was approximately 28.9 billion gallons in 2011, as compared to approximately 23 billion gallons in 2010, approximately 19.5 billion gallons in 2009 and approximately 17.3 billion gallons in 2008, and representing over a 400% growth since 2000. Over 40 countries are now producing ethanol, including Brazil, Canada, China, India, Thailand, Columbia, Australia, Turkey, Pakistan, Argentina and various other countries in the European Union and Central America. Many of those countries have also enacted renewable fuel use requirements. Unless otherwise noted, the statistics cited in this paragraph were according to the Renewable Fuels Association.
The general economic and ethanol industry circumstances have, however, been difficult and adverse over much of the past two to four years, with various ethanol plants having been closed or having reduced production. Many plants did, however, return to some level of profitability in the second half of 2009 and into the start of 2010 and again in the last half of 2011. The industry has, however, continued to be somewhat volatile.
The drought during 2012 also affected corn supplies and corn prices, and caused some plants to temporarily cease production.
Given that the Energy Independence and Security Act of 2007 increased the renewable fuels standard to 36 billion gallons of annual renewable fuel use by 2022 (up from the prior mandate of 7.5 billion gallons of annual use by 2012), it is likely that there will be some growth in the ethanol industry, both domestically and internationally, over the longer term; although most of that growth may be in cellulosic and advanced biofuels.
Lincolnway Energy's competitors in the U.S. include regional farmer-owned entities, and also the major oil companies and other large companies.
The competition in the ethanol industry has increased during the past four years, with sustained periods of declining ethanol prices, excess supplies of ethanol and higher and volatile corn prices, including during the 2012 drought.
The ethanol industry will also continue to face increasing competition from international suppliers of ethanol. International suppliers produce ethanol primarily from inputs other than corn, such as sugar cane, and have cost structures that may be substantially lower than Lincolnway Energy's and other U.S. based ethanol producers. The $.54 per gallon tariff on most foreign produced ethanol expired on December 31, 2011. Foreign suppliers of ethanol may significantly increase their imports to the United States.
Smaller competitors also pose a threat. Farmer-owned cooperatives and independent companies consisting of groups of individual farmers and investors have been able to compete successfully in the ethanol industry; although Lincolnway Energy believes that smaller ethanol plants may have increasing difficulty in competing with larger plants over the longer term and if the volatile market conditions of the last few years continue. These smaller competitors operate smaller facilities which do not affect the local price of corn grown in the proximity to the facility as much as larger facilities do, and some of the smaller competitors are farmer-owned and the farmer-owners either commit, or are incented by their ownership in the facility, to sell corn to the facility.
The continuing increase in domestic or foreign competition could cause Lincolnway Energy to have to reduce its prices and take other steps to compete effectively, which could adversely affect Lincolnway Energy's results of operations and financial position.
Many competitors will have greater production capacity, greater experience, more access to information and/or greater capital or other financial resources, any of which will make it difficult for Lincolnway Energy to compete with those competitors. For example, greater ethanol production may allow a competitor to market its ethanol or distiller's grains at lower prices than Lincolnway Energy. Lincolnway Energy believes there may be acquisitions and consolidations in the ethanol industry in 2013, and if those acquisitions and consolidations occur, they could lead to additional competitors with greater advantages over Lincolnway Energy. A competitor may also offer other products or services that are not offered by Lincolnway Energy, which may give the competitor an additional advantage over Lincolnway Energy.
An ethanol plant utilizing corn to produce ethanol may also experience competition in the form of other plants which produce ethanol from other products. For example, ethanol can be produced from corn stover, corn fiber, wheat straw, barley straw, switchgrass, miscanthus, trees, grasses, woodwastes, vegetative wastes and other wastes. Lincolnway Energy's ethanol plant is designed to produce ethanol only from corn.
The Energy Independence and Security Act of 2007 requires that 21 billion gallons of the new 36 billion gallon renewable fuels standard must come from advanced biofuels, with 16 billion gallons of that amount required to come from cellulosic ethanol by 2022. Research is therefore continuing regarding cellulosic ethanol, and various companies are in various stages of developing and constructing some of the first generation cellulosic plants. Some of the cellulosic ethanol plants are working with the U.S. Department of Energy, and have received grant funds. Some of those plants could be characterized as "test" or "pilot" plants, but others are at larger productions levels. Although those plants have faced some financial and technological issues, Lincolnway Energy anticipates that cellulosic technologies and plants will be developed in the near future which will make the production of ethanol from these types of sources economical. As discussed elsewhere in this annual report, DuPont Danisco Cellulosic Ethanol, LLC has purchased approximately 59 acres of real estate from Lincolnway Energy for the purpose of constructing a cellulosic or advanced biofuels plant on the real estate. Lincolnway Energy's plant is not designed to produce ethanol from cellulosic stocks, and Lincolnway Energy does not contemplate converting its plant to produce ethanol from cellulosic stocks.
It is also possible that one or more of the other sources for producing ethanol may have greater advantages than corn, which would adversely affect an ethanol plant that produces ethanol solely from corn. For example, a plant using one of those sources may be able to produce ethanol on a more economical basis or on a more efficient or greater scale.
The increased production of ethanol from other sources could also adversely affect the price for ethanol generally.
Some competitors operate their ethanol plant and produce ethanol using different sources of energy than coal, or using various other sources of energy. The other sources of energy include natural gas and various forms of waste type products, such as woodwaste, tires, construction waste and other waste products. Those competitors may have lower production and input costs and/or higher operating efficiencies than Lincolnway Energy, which would allow them to produce and market their ethanol at lower prices than Lincolnway Energy.
Competition from newly developed fuel additives would also reduce the use of ethanol and Lincolnway Energy's profitability. Although it is difficult to predict if any new fuel additives will be developed, it likely will occur at some point, and it could be in the near future.
Research is also continually being conducted for alternatives to petroleum based fuel products and for additional renewable fuel products. For example, research is ongoing regarding the use of hydrogen, electric or solar powered vehicles and fuel cells. A breakthrough or discovery in any research could conceivably occur at any time, and could have the effect of greatly reducing the use of ethanol or of even making the use of ethanol obsolete at some point. There will be increased incentives to develop alternatives to petroleum based fuel products given the higher gasoline prices that began in 2008 and the continuing security and other concerns with the Middle East and certain other major oil producing nations.
Ethanol is a commodity and is priced on a very competitive basis. Lincolnway Energy believes that its ability to compete successfully in the ethanol industry will depend upon its ability to price its ethanol competitively, which in turn will depend on many factors, many of which are beyond the control of Lincolnway Energy and its management. As indicated above, one of those factors is that Lincolnway Energy is subject to material and substantial competition, including from competitors who will be able to produce or market significantly higher volumes of ethanol and at lower prices.
Lincolnway Energy believes that the principal competitive factors with respect to distiller's grains are price, proximity to purchasers and product quality.
Government Oversight and Regulation
Lincolnway Energy's business is subject to substantial governmental oversight and regulation, including relating to the discharge of materials into the air, water and soil; the generation, storage, handling, use, transportation and disposal of hazardous materials; and the health and safety of Lincolnway Energy's employees.
Lincolnway Energy needs to maintain various permits to be able to maintain and continue its operations. The permits include water and air permits from the Iowa Department of Natural Resources.
Lincolnway Energy obtained a new air quality permit on July 8, 2011 from the Iowa Department of Natural Resources under the 250 ton rules. The new permit has more testing mandates, and Lincolnway Energy will be subject to higher ongoing compliance and operating costs to show compliance under the new air quality permit. The permit was obtained as part of the process of settling allegations of the Iowa Environmental Protection Commission regarding emissions limit exceedences and to otherwise comply with air emissions requirements.
The principal risks associated with the substantial governmental oversight and regulation of Lincolnway Energy and its business are discussed in Item 1A
Item 1A. Risk Factors.
Any of the following risks could significantly and adversely affect Lincolnway Energy's prospects, business, results of operation and financial condition. The following risks are not the only risks Lincolnway Energy is subject to or may face, and they are not intended to be set forth in order of materiality or significance. An investment in units of Lincolnway Energy involves substantial risk, and is a speculative investment.
Risks Relating to Lincolnway Energy and Its Business
The Economy And The Ethanol Industry Continue To Be Subject To Generally Difficult Market, Credit And Other Circumstances The United States and virtually all international economies are still widely viewed as facing difficult and uncertain economic circumstances that may continue well into 2013, and perhaps longer. The United States and nearly all international economic circumstances include a shortage of available loans and credit to many industries, significant unemployment, flat or falling profits or losses in many industries, volatile stock and other investment markets, individual and business failures and bankruptcies, significant deficit spending and "bailout" programs by governments, and uncertain business and consumer confidence.
The ethanol industry has been similarly affected. For example, lenders and the credit markets have been generally unfavorable to the ethanol industry during the last two to four years, and the lack of available credit is one factor that has played a part in the proposed construction or expansion of some ethanol plants being canceled or indefinitely delayed. The ethanol industry also experienced decreasing profits over portions of that time period, and many ethanol plants experienced losses over most or some of that time period. The ethanol industry has also struggled with volatile corn prices, and record high corn prices, during parts of the last three years, triggered in 2012 by the drought that affected much of the United States. The record high corn prices, coupled with declining ethanol prices, negatively impacted profits.
There continues to be a substantial amount of political and economic uncertainty surrounding the budget deficit and related budget and tax issues in the United States. It is not clear at this time what exact measures will be taken to address those various and complex issues, but substantial cuts in the federal budget and changes to the tax code, including the elimination of various tax incentives and deductions and higher tax rates, are likely to occur. Nearly all of the states are facing similar political, economic, budget and tax issues. The possible outcomes to, and effects of, all of those issues are very difficult to analyze or predict at this time, but there will almost certainly be some adverse effects, at least in some ways and for some period of time, on certain groups or sectors of the economy, and perhaps the economy as a whole. Similar issues are also being faced by many other countries.
There is also uncertainty in the economy arising from continuing terrorism concerns, both in the United States and internationally, and the uncertainties and difficulties in Pakistan, Afghanistan, and the Middle East, including Israel, Syria, Iraq and Iran.
There has been substantial amount of civil unrest and other political uncertainty in the Middle East and other oil producing nations over the last two years, and there have been changes in the government in some countries, with additional and further changes appearing to be very likely. It is still not possible to predict with any certainty at this time the possible end results of the unrest and changes in government, and how that may affect oil supplies and prices, the general stability of those countries and the region, and those countries' economies and relationship with the United States. The results could, however, be materially adverse to the United States in general and to energy related industries, such as ethanol.
Lincolnway Energy is therefore still operating in an uncertain and volatile economic and industry environment.
Lincolnway Energy Is Heavily Dependent On A Management Team And Certain Suppliers And Service Providers, But Could Lose Any Of Their Services At Any Time. Lincolnway Energy is heavily dependent upon its core management team of its president and chief executive officer, chief financial officer, plant manager, director of grains and controller, as well as on the companies which provide coal and corn to Lincolnway Energy and the companies which market Lincolnway Energy's ethanol and distiller's grains. If any of those management team members or companies terminate their services or for any reason cease to provide services to Lincolnway Energy, Lincolnway Energy's business and operations could be adversely affected in a sudden and material way. The services could be lost for reasons outside of anyone's control, such as death or disability. The marketing companies may also be heavily dependent upon one or more key employees or other relationships, and the loss of any of those employees or relationships by a company could adversely affect the company's ability to continue to provide timely and quality services to Lincolnway Energy.
Lincolnway Energy Is Subject To Risk Because Its Ethanol Plant Utilizes Coal. The primary energy source for Lincolnway Energy's ethanol plant is coal. The use of coal is subject to numerous federal and state regulations, including regarding permissible emissions levels.
Lincolnway Energy's ability to comply with the emissions and other requirements arising from its use of coal will depend to a degree on the type and quality of coal that is provided to Lincolnway Energy by its coal supplier. If the coal does not meet the content and quality standards anticipated by Lincolnway Energy, Lincolnway Energy may not be able to meet its emissions and other regulatory and permit conditions and requirements.
As global warming and climate change issues become more prevalent and accepted, there will likely be increased governmental and public sentiment for more regulation of the use of coal as a source of energy. Coal is generally viewed unfavorably in any "carbon footprint" type analysis in any event, but may be viewed even more unfavorably when used by an ethanol plant because some experts and federal and state regulatory agencies are taking the position that the ethanol industry in general also performs poorly in any carbon footprint and/or land use type analysis. One result of those types of analysis will likely be stricter emissions requirements, which could lead to the need for capital expenditures in order to meet those requirements and higher ongoing compliance and operating costs. Those expenditures and costs could be material, and adversely affect Lincolnway Energy's results of operation and business.
Many view the Obama administration's stance and policies as unfavorable to coal use, and Lincolnway Energy believes there will be increased regulatory requirements for coal in the future.
The use, storage and handling of coal also creates risks related to dust explosions and fire. Although Lincolnway Energy will take precautions to try to avoid those types of incidents, there is no assurance that those precautions will be successful in every circumstance.
The use of coal also generates fly ash, and Lincolnway Energy may face economic, logistic and environmental issues and difficulties in disposing of its fly ash.
Lincolnway Energy currently obtains all of its coal from one coal supplier. If the agreement is terminated or if that supplier fails to perform for any reason, Lincolnway Energy might face an interruption in the supply of coal and have to seek an alternate supply source. Lincolnway Energy does not have any agreement with any alternative suppliers at this time. As with natural gas and other energy sources, coal supplies can be subject to interruption by weather, strikes, transportation, and production problems that can cause supply interruptions or shortages. Lincolnway Energy has coal storage for approximately 6 days of continuous ethanol production, and an interruption in the supply of coal beyond that period could cause Lincolnway Energy to temporarily halt or discontinue the production of ethanol.
Lincolnway Energy May Not Be Successful In Converting To Another Fuel Source For Its Plant, And Even If It Is Successful, There Will Be Other Risks Associated With Other Fuel Sources. Lincolnway Energy is considering the possibility of changing the energy source for its plant from coal to another source or sources, such as natural gas, wood waste, agricultural residues and/or construction and demolition waste. There is not, however, any assurance that Lincolnway Energy will be successful in converting its plant from coal to another energy source because the conversion involves various material considerations and issues, including regulatory, technological and financial considerations and issues. You therefore should not assume that Lincolnway Energy will be able to convert its plant to another energy source, or on economical terms.
Even if Lincolnway Energy determines that it is technologically and economically feasible to convert its plant to another energy source, and is able to successfully implement the conversion, Lincolnway Energy will still face regulatory and other risks related to another energy source. For example, there will still be air permit and emission limits requirements and issues that will need to be met by Lincolnway Energy. As another example, Lincolnway Energy will need to be able to secure adequate sources of supply of the other energy source at an economical price, and from reputable third parties. Some of the other possible energy sources, such as woodwastes, may vary in availability from time to time due to various factors, such as the economic circumstances of the industry in question. For example, the availability of woodwaste from the construction industry will decline when the construction industry is struggling, such as was the case at the time of the preparation of this annual report. Some of these other risks are not as equally applicable to coal.
If Lincolnway Energy Ever Expands Or Attempts To Convert Its Plant To Another Fuel or Cellulosic Source, It Will Be Subject To The Risks Inherent In The Development And Construction Process. If Lincolnway Energy ever determines to expand its existing ethanol plant or to pursue the construction of an additional ethanol plant, or to convert its plant to a fuel source other than coal or to convert from corn to a cellulosic source, Lincolnway Energy will be subject to the numerous material risks and uncertainties inherent in the development and construction process. For example, it may be difficult to identify a suitable location for another ethanol plant because many favorable locations have already been acquired by other ethanol plants or ethanol plant developers. Lincolnway Energy also believes that it could be difficult to obtain the necessary financing, at least at this time, given the generally unfavorable debt and equity financing market for the ethanol industry at the time of the preparation of this annual report. Any expansion of Lincolnway Energy's plant or conversion of the plant to another fuel or cellulosic source may also involve some down time for the plant, which would in turn result in decreased ethanol and distiller's grain production.
Lincolnway Energy May Make Other Investments Or Engage In Other Business. Lincolnway Energy's board has the authority to cause Lincolnway Energy to construct or acquire or to invest in other ethanol plants or to make other investments or to engage in other businesses. The scope and nature of Lincolnway Energy's business could therefore change significantly, which could expose Lincolnway Energy to numerous other risks and uncertainties. Lincolnway Energy's business may not always be limited only to owning and operating its current ethanol plant.
Lincolnway Energy Is Leveraged And Has Debt And Debt Service Requirements. Lincolnway Energy will have loans outstanding from time to time under its revolving term and seasonal line of credit. Lincolnway Energy does not, however, believe that it was substantially leveraged at the time of the preparation of this annual report.
Lincolnway Energy may, however, increase its debt in the future, and the use of leverage creates risks. For example, if Lincolnway Energy ever became unable to generate profits and cash flow to service its debt and its ongoing operations and working capital needs, Lincolnway Energy could be forced to reduce or delay capital expenditures or any expansion plans, sell assets or operations, obtain additional loans or capital or attempt to restructure its loans and other debt. Lincolnway Energy also may not be able to renew, extend or replace any existing loans or financing arrangements Lincolnway Energy may have in place from time to time. If any of those events occur, Lincolnway Energy will need to attempt to obtain additional financing through the sale of additional units or debt in Lincolnway Energy or through additional loans from other lenders, but there is no assurance that any of those steps would be successful.
Lincolnway Energy will also need to comply with the various restrictions and covenants that will be included as part of Lincolnway Energy's credit and loan agreements. The restrictions and covenants will likely include prohibitions or restrictions on incurring additional debt, granting additional security interests or liens, acquiring additional assets, mergers, the issuance of additional units, and making distributions to Lincolnway Energy's members. The credit and loan agreements will also likely require Lincolnway Energy to maintain various financial ratios and other similar financial covenants. Those restrictions and requirements may limit Lincolnway Energy's flexibility in planning for, or reacting to, competition or changes in the ethanol industry and Lincolnway Energy's ability to pursue other perceived business opportunities.
Lincolnway Energy's loans are secured by liens on all of Lincolnway Energy's assets, and if Lincolnway Energy breaches any of its agreements with its lenders, the lenders will be able to foreclose on Lincolnway Energy's assets.
Lincolnway Energy's Financing Costs Will Rise If Interest Rates Increase. Lincolnway Energy could be affected by any increase in interest rates or other lending costs because Lincolnway Energy will likely generally have some outstanding loans or debt, which at times might be substantial. Although difficult to predict and outside of Lincolnway Energy's control, it is possible that there may be increases in interest rates, at least over the longer term.
Lincolnway Energy's Potential Success Is Almost Exclusively Dependent On Ethanol Sales, And The Price Of Ethanol And Gasoline Can Vary Greatly And Are Beyond Lincolnway Energy's Control. Although Lincolnway Energy's ethanol plant produces distiller's grains, corn oil and carbon dioxide, ethanol is the primary and material source of revenue for Lincolnway Energy, having generated approximately 83%, 80% and 75% of Lincolnway Energy's total revenues for the fiscal years ended September 30, 2010, 2011 and 2012, respectively.
Ethanol prices can vary significantly over both short and long term periods, and it is difficult to accurately predict changes in ethanol prices or in ethanol trends. As examples, the Chicago Mercantile Exchange price of ethanol was $1.975 for July 2012 delivery, but was at $2.79 for December 2011 delivery.
The price of gasoline also varies significantly over both short and long term periods. The price for ethanol has generally had some correlation to the price of gasoline, so low gasoline prices or reductions in gasoline prices will also generally reduce ethanol prices and profitability.
The higher prices for gasoline over the past three years have caused businesses and consumers to actively seek ways to lower or reduce their gasoline consumption. For example, there is increased attention to requiring the auto industry to produce cars with higher fuel efficiency. Higher gasoline prices also increase the focus and attention on the research and development of alternative energy options, such as fuel cells. The existence of higher gasoline prices can therefore also adversely affect gasoline and ethanol prices and the profitability of ethanol plants.
On the other hand, if ethanol becomes more expensive than gasoline, blenders have little incentive to buy more ethanol beyond that required to meet the federal renewable fuel standards. The incentive for blenders became even less in that circumstance on December 31, 2011 when the federal 45 cent per gallon tax credit expired.
Lincolnway Energy's inability to foresee or accurately predict changes in the supply or prices of ethanol or gasoline will adversely affect Lincolnway Energy's business.
If ethanol prices decline to the point where it is unprofitable to produce ethanol and remain at that level, Lincolnway Energy could be required to suspend operations until the price increases to the level where it is once again economical or profitable to produce and market the ethanol. Any suspension of operations would have a material adverse effect on Lincolnway Energy's business, results of operations and financial condition. Some ethanol plants delayed opening or curtailed production due to the unfavorable market conditions which were in existence over the two to four year period preceding the date of this annual report. For example, the drought and corresponding substantial increase in corn prices during 2012, coupled with lower ethanol prices, let various ethanol plants to temporarily idle during parts of 2012.
Even if ethanol prices are generally favorable, Lincolnway Energy still may not be able to sell all of its ethanol, or at favorable prices.
Increases In Supplies Of Ethanol or Other Biofuels May Adversely Affect Ethanol And Ethanol Byproduct Prices. Lincolnway Energy anticipates that there will continue to be increases in ethanol and other biofuels production over the long term, both in the United States and internationally. For example, there will need to be increased ethanol and other biofuels production in order to meet the renewable fuels standards that were part of the Energy Independence and Security Act of 2007.
The existing renewable fuels standard requirements may at least provide some indirect price support as ethanol production increases to meet those standards, but it is possible that increasing ethanol or other biofuels production may at times lead or contribute to lower ethanol prices. For example, at least currently, the demand for ethanol is primarily driven by the renewable fuels standard requirements, as opposed to general consumer demand, so if ethanol or other biofuels production exceeds the amounts required to meet the renewable fuels standard, there could be excess ethanol available, which would lower ethanol prices.
Also, a large portion of the increased biofuels production that will need to occur to meet the renewable fuels standard must come from cellulosic and other advanced biofuels and not ethanol produced from corn. Any increased demand or pricing arising from the implementation of the renewal fuels standards therefore might not apply to or benefit ethanol produced from corn.
Excess ethanol or other biofuels production capacity could also result from decreases in demand for ethanol, which could result from a number of factors, such as regulatory developments at the federal or state level, reduced gasoline consumption in the United States or advancements in alternatives to gasoline or in other gasoline additives.
Any increase in ethanol production will also lead to increases in distillers' grains and corn oil production, and increased supplies of those products could also lead to lower prices for those products.
Continued Growth In The Ethanol Industry Depends On Use Of Increased Ethanol Blends And Related Expansion Of Infrastructure, Change In Public Views And Regulatory Support, Which May Not Occur On A Timely Basis, If At All. Most experts believe that for ethanol use to grow significantly over both the near and longer term, there must be increased use of ethanol blends in excess of 10%, such as E15, E20, E30 and, in particular, E85. Although the U.S. Environmental Protection Agency approved the use of E15 in January 2011, the approval was limited to vehicles manufactured in 2001 or newer and all flew fuel vehicles. There was also resistance to even increasing the percentage from 10% to 15%, and there will be resistance to increasing the percentage above 15%. There are also various areas that need development and expansion in order for there to be any material increase in the use of higher ethanol blends, including E15, such as expanded production of flex fuel vehicles and the expanded use of pumps that can utilize higher ethanol blends, such as blender pumps. A blender pump allows a driver to fill his or her vehicle with any blend of ethanol from 0% to 85% depending on the type of vehicle they drive. There will likely need to be government subsidies and support, however, in order to cause service stations to install those types of pumps on a large scale, and there is currently no material support in Congress for any material type of those support programs. There will also need to be changes in the public's views and perceptions of ethanol in order for there to be increased use of higher blends of ethanol, as well as regulatory developments at both the federal and state level which allow the use of, and promote the use of, higher ethanol blends and the use of blender pumps and flex fuel vehicles.
Reports continue to be issued by various groups, however, such as the National Research Council, that question the use of ethanol and other biofuels, both from an economic and environmental perspective. Ethanol organizations disagree with, and respond to, most of those types of reports, but the reports continue to cause governmental, regulatory and public perception concerns and issues for the ethanol industry.
Lincolnway Energy's Results Of Operations, Financial Position And Business Outlook Will Likely Fluctuate Substantially Because Lincolnway Energy's Business Is Highly Dependent On Commodity Prices, Which Are Subject To Significant Volatility And Uncertainty, And On The Availability Of Raw Materials Supplies. Lincolnway Energy's results of operations will be substantially dependent on commodity prices, especially prices for corn, coal, ethanol and unleaded gasoline. The prices of these commodities are volatile and beyond Lincolnway Energy's control.
Lincolnway Energy estimates that corn costs will, on the average, make up approximately 77% of Lincolnway Energy's total annual operating costs, but the percentage could be higher or lower dependent on the price of corn from time to time. Accordingly, rising corn prices could lower profit margins, and, at certain levels, corn prices would make ethanol uneconomical to produce and to use in the fuel markets. For example, corn prices began to rise significantly in approximately July, 2006 (when the cash corn price in Lincolnway Energy's local market area was approximately $2.09 per bushel) and generally continued to rise until mid-year 2008 (when the cash corn price in Lincolnway Energy's local market area reached approximately $7.15 per bushel). As another example, based on the projected increases in acreage for the 2012 crop year and the related projected increases in corn production based on historical yields, Lincolnway Energy had anticipated the possibility of lower corn prices. Instead, the widespread drought in the U.S. during 2012 greatly increased corn prices, with cash corn price bid reaching $7.70 in November 2012. The cash corn price in Lincolnway Energy's local market area was approximately $7.58 per bushel as of November 30, 2012, as opposed to approximately $5.81 per bushel as of November 30, 2011 and $5.32 per bushel as of November 30, 2010. The corn price on the Chicago Mercantile Exchange daily futures ranged from a low of $5.50 per bushel to a high of $8.49 per bushel during Lincolnway Energy's fiscal year ended September 30, 2012, and from a low of $5.35 per bushel to a high of $7.60 per bushel during Lincolnway Energy's fiscal year ended September 30, 2011, and from a low of $3.25 per bushel to a high of $5.29 per bushel during Lincolnway Energy's fiscal year ended September 30, 2010.
The supply and price of corn are influenced by many factors, including drought, hail and other adverse weather conditions; insects or disease; farmer planting decisions; imports; government policies and subsidies with respect to agriculture and international trade; and global and local demand and supply. The price for corn in the market area encompassing Lincolnway Energy's ethanol plant could be higher than the corn price payable in other markets. Lincolnway Energy will also compete for corn with the livestock producers and elevators located within Lincolnway Energy's market area.
There is also uncertainty regarding climate change, and any climate changes could adversely affect corn production in Lincolnway Energy's primary market area or other corn production areas in the United States and elsewhere, and thereby both the supply and price of corn.
Lincolnway Energy's gross margin will depend significantly on the spread between ethanol and corn prices, and in particular the spread (sometimes referred to as the crush spread) between the price of a gallon of ethanol and the price for the amount of corn required to produce a gallon of ethanol. The price of ethanol and corn fluctuates frequently and widely, however, so any favorable spread between ethanol and corn prices which may exist from time to time cannot be relied upon as indicative of the future. It is possible for the circumstance to arise where corn costs increase and ethanol prices decrease to the point where Lincolnway Energy could be required to suspend operations, as some other ethanol plants did during 2008 and parts of 2009 and in 2012. Any suspension of operations could have a material adverse effect on Lincolnway Energy's business, results of operations and financial condition.
The supply and cost of other inputs needed by Lincolnway Energy can also vary greatly, such as coal, electric and other energy costs. Lincolnway Energy's ethanol plant utilizes coal as its primary energy source, and Lincolnway Energy estimates that coal costs will, on average, make up approximately 4% of Lincolnway Energy's annual total operating costs. The prices for and availability of coal are subject to numerous market conditions and factors which are beyond Lincolnway Energy's control. Significant disruptions in the supply of coal would impair Lincolnway Energy's ability to produce ethanol, and increases in coal prices or changes in Lincolnway Energy's coal costs relative to the costs paid by Lincolnway Energy's competitors would adversely affect Lincolnway Energy's competitiveness and results of operation and financial position.
Lincolnway Energy may attempt to offset a portion of the effects of such fluctuations by entering into forward contracts to supply ethanol and to purchase corn by engaging in hedging and other futures related activities, but those activities also involve substantial risks and may be ineffective to mitigate price fluctuations and may in fact lead to substantial losses.
Transportation issues and costs can also be a factor in the price for ethanol because ethanol is currently shipped by truck or by rail, and not by pipeline, and because ethanol generally needs to be shipped relatively long distances to a terminal where the ethanol can be blended with gasoline.
Lincolnway Energy's inability to foresee or accurately predict changes in the supply or prices of ethanol or of corn, coal and other inputs will adversely affect Lincolnway Energy's business, results of operation and financial position. For example, as noted above, Lincolnway Energy anticipated lower corn prices following the 2012 crop season, but the drought instead resulted in significantly higher corn prices. Also, as a result of the volatility of the prices for these commodities, Lincolnway Energy's results will likely fluctuate substantially over time. Lincolnway Energy will experience periods during which the prices for ethanol and distiller's grains decline and the costs of Lincolnway Energy's raw materials increase, which will result in lower profits or operating losses, which could be material at times, and which will adversely affect Lincolnway Energy's financial condition.
There Are Many Factors Important To The Success Of An Ethanol Plant That Are Beyond The Control Of Lincolnway Energy. Lincolnway Energy's ability to successfully operate its ethanol plant and to market the ethanol, distillers grains and corn oil produced at the plant are subject to numerous factors and risks.
Some of those factors and risks relate directly to Lincolnway Energy, such as Lincolnway Energy's ability to retain qualified employees and other personnel, and on favorable terms, labor disputes or other employee issues, and unforeseen accidents at, or damages to, Lincolnway Energy's plant or other facilities.
Some of the factors and risks relate to the fact that the agricultural economy and the economy in general, and market prices and futures prices for oil, gasoline, ethanol, distiller's grains, corn oil, corn, coal and other inputs needed for Lincolnway Energy's ethanol operation, are all highly volatile and are influenced by many varying factors. It is not possible to identify all possibly relevant factors, but some of the factors include the following and rumors or speculation about the following:
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Changing supply and demand relationships and trade deficit issues;
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Weather and other environmental conditions;
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Acts of God, including drought and storms;
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Agricultural, fiscal, monetary, economic, trade and exchange control programs and policies of governments;
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International, national, regional and local political and economic events and policies;
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Changes in fuel and energy costs or in interest rates or rates of inflation;
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Controversies or disputes about the use of biotechnology in crops, or errors or adverse reactions caused by the use of biotechnology in crops;
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Infestations or diseases in crops;
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Acts of terrorism or war, both nationally and internationally;
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Railcar or truck shortages or strikes within those industries;
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Environmental and other regulations which impact both the demand for ethanol and the cost of operation of an ethanol plant;
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Governmental incentives related to ethanol;
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Illegal or improper activities or scandals by participants in the markets, such as those that have previously occurred in the accounting industry, the stock and mutual fund industry and the insurance industry; and
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The general emotions and psychology of businesses, consumers and of the market place in general, which at times can be totally unrelated to actual economic or market conditions or other more tangible factors.
It is very likely that there will be further acts of terrorism in the United States and abroad, including the possibility of acts aimed at disrupting the economy or the markets or various industries or sectors within the markets. For example, there has been speculation about possible acts of terrorism aimed at the energy, agricultural and food industries. Any speculation or rumors about, or actual acts of, terrorism could cause immediate and substantial reactions in a wide range of the markets and industries and in the economy in general. The continued uncertainty in Afghanistan, Pakistan and the Middle East also continues to create uncertainties and could cause adverse reactions in the oil and energy markets and in the markets and economy in general.
Most of the above factors or occurrences cannot be controlled by Lincolnway Energy, and it will be impossible to always accurately predict or identify which factors are relevant or are likely to occur.
Also, even if Lincolnway Energy were somehow able to have fully current and correct information as to all factors, prices would still not always react as predicted or as would seem likely given the information. For example, there have been many occasions where the movements of the futures markets have seemed totally unrelated to actual supply and demand and other more tangible factors. The latter fact may be caused, in part, because of the substantial speculative trading that occurs in the futures markets.
The Use Of The Futures Markets By Lincolnway Energy Could Be Unsuccessful And Result In Substantial Losses. Lincolnway Energy will likely attempt to minimize the effects of the volatility of corn, ethanol, distiller's grains and other prices by entering into forward pricing contracts and taking positions in the futures markets. The primary intent of those positions will be to attempt to protect the supply of, and the price at which Lincolnway Energy can buy corn and the price at which Lincolnway Energy can sell its ethanol or distiller's grains, but not all of the positions may be able to be properly categorized as being for hedging purposes.
Any attempt by Lincolnway Energy to use forward pricing contracts or the futures markets, whether in the form of hedging strategies or for more speculative trading purposes, may be unsuccessful, and in fact could result in substantial losses because commodity price movements and price movements in futures contracts and options are highly volatile and speculative, and are influenced by many factors which are beyond the control of anyone. Some of those factors include those noted above in "There Are Many Factors Important To The Success Of An Ethanol Plant That Are Beyond The Control Of Lincolnway Energy."
Lincolnway Energy will likely vary the amount of forward pricing, hedging and other risk mitigation strategies Lincolnway Energy may undertake, and Lincolnway Energy may at times choose not to engage in any such transactions. As a result, Lincolnway Energy's results of operations and financial position may be adversely affected by increases in the price of corn or coal or decreases in the price of ethanol or unleaded gasoline.
Futures markets will also sometimes be illiquid, and Lincolnway Energy may not be able to execute a buy or sell order at the desired price, or to close out an open position in a timely manner. The inability to close out an open position in a timely manner may result in substantial losses to Lincolnway Energy. Lincolnway Energy's potential losses and liabilities for any futures or options positions are not limited to margin amounts or to the amount held in or the value of Lincolnway Energy's trading account, and in the event of a deficiency in Lincolnway Energy's trading account due to a margin call made to the trading account, a loss exceeding the value of the trading account, or otherwise, Lincolnway Energy will be responsible for the full amount of the deficiency. Given the volatility of futures trading, margin calls can occur frequently and the amount of a margin call can be significant.
Losses from trades in the futures markets, coupled with the volatility in the corn and ethanol markets are factors that have caused some ethanol companies to incur significant losses and, in some cases, to temporarily idle operations or to seek bankruptcy protection.
Lincolnway Energy's Operations Are Subject To Substantial And Extensive Governmental Laws And Regulations Which Restrict And Increase The Costs Of Lincolnway Energy's Business. Lincolnway Energy's ethanol operations are subject to substantial and extensive governmental laws and regulations, including those relating to the discharge of materials into the air, water or ground, and the generation, storage, handling, use, transportation and disposal of hazardous materials. Some of those laws and regulations require Lincolnway Energy to maintain various permits and other approvals in order to continue ongoing operations. Lincolnway Energy will need to meet the various requirements and conditions necessary to the issuance and maintenance of those permits and approvals. The requirements and conditions may include that the ethanol plant facilities and operations meet various specifications regarding air quality, discharge, water and waste treatment, and various other operational matters. Lincolnway Energy's compliance with all necessary permits, approvals and laws and regulations will increase Lincolnway Energy's costs and expenses. Lincolnway Energy's failure to comply with those requirements or to maintain those permits and approvals may result in fines or penalties, the loss of the right to continue operations or claims by third parties.
Lincolnway Energy also anticipates that there will be changes in the approval requirements and other laws and regulations over time, and that those changes will increase the regulatory oversight and costs and expenses of Lincolnway Energy. For example, the regulation of the environment, including the use of water, wastewater, storm water and air emissions, is a constantly changing area of the law, and it is likely that more stringent federal or state environmental laws, rules or regulations, or interpretation or enforcement of existing laws, rules or regulations, could be adopted which would require Lincolnway Energy to make substantial capital expenditures and/or increase Lincolnway Energy's operating costs and expenses. New laws, rules and regulations may be advanced based upon claims related to global warming and climate change. It is also possible that federal or state environmental laws, rules or regulations could be adopted which have an adverse effect on the use of ethanol, such as changes in the regulations regarding the required oxygen content of automobile fumes. The new laws, rules or regulations could also arise or become necessary because of currently unknown conditions or problems arising from the production or use of ethanol, similar to what occurred with methyl tertiary-butyl ether (MTBE) because of the adverse environmental and health issues now known to be caused by MTBE.
Lincolnway Energy believes that increased regulation of plants powered by coal, such as Lincolnway Energy's ethanol plant, is particularly likely. Lincolnway Energy also foresees the possibility of increased regulation of ethanol plants arising from carbon footprint and life cycle and indirect land use change type analysis by regulators.
For example, in 2009, the State of California adopted a state low carbon fuels standard, which requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which are measured using a life cycle analysis that includes indirect land use change considerations. The current predominant views on how to apply a life cycle and indirect land use change analysis (including those of the United States EPA) generally lead to results that are not favorable to coal or to ethanol, and that is the case for California. The practical effect of California's low carbon fuel standard is that it precludes grain-based ethanol from outside California.
The Renewable Fuels Association, together with other parties, filed a lawsuit challenging California's low carbon fuel standard on the grounds that it violates both the supremacy clause and the commerce clause of the U.S. Constitution. A federal court ruled in late 2011 that the standard did violate the commerce clause, but that ruling has been appealed so the litigation is not over. California represents a significant ethanol market, and if corn based ethanol cannot be utilized in California, it could significantly reduce demand for corn-based ethanol such as that produced by Lincolnway Energy. Various other states are also looking at implementing low carbon fuel standard requirements for their states, so the outcome of the California lawsuit could have significant effects on the ethanol industry.
Lincolnway Energy May Become Subject To Various Environmental And Health And Safety And Property Damage Type Claims And Liabilities. The nature of Lincolnway Energy's operations will expose it to the risk of environmental and health and safety claims and property damage claims. For example, if any of Lincolnway Energy's operations are found to have polluted the air or surface water or ground water, such as through an ethanol spill, Lincolnway Energy could become liable for substantial investigation, clean-up and remediation costs, both for its own property and for the property of others that may have been affected by the pollution or spill. Those types of claims could also be made against Lincolnway Energy based upon the acts or omissions of other persons, including persons transporting or handling ethanol. Environmental and property damages claims and issues can also arise due to spills, losses or other occurrences arising from events outside of Lincolnway Energy's control and which are possible in Lincolnway Energy's business, such as fire, explosions or blowouts.
A serious environmental violation or repeated environmental violation could result in Lincolnway Energy being unable to construct or operate any additional ethanol plants and the loss of defenses to nuisance suits. Lincolnway Energy may also be unable to obtain financing or necessary permits if Lincolnway Energy is subject to any pending administrative or legal action regarding environmental matters.
Any of those types of events could have a material adverse effect on Lincolnway Energy's financial condition and future prospects.
There Is Continuing Negative Press And Public Sentiment Against The Ethanol Industry Which Could Lead To Reduced Governmental And Public Support For The Use Of Ethanol. There continues to be negative press and public sentiment against the ethanol industry based upon claims that the use of corn to produce ethanol drives up grain prices, which hurts livestock farmers and also consumers due to increased food prices. The widespread drought that occurred during 2012 affected corn supplies and prices, and will be pointed to by those arguing the "food versus fuel" position. The claims also include environmental type allegations, including that increased corn acreage and ethanol production could strain water supplies and worsen pollution in rivers and streams. The criticisms also include that ethanol production is leading to land use changes, including the clearing of rain forests and other native lands for purposes of growing corn or other crops to be used for the production of ethanol or to replace land which is now used to produce crops for ethanol, which in turn releases carbon into the atmosphere that has been stored in the soil and otherwise has negative environmental impacts. The continuing and growing criticism has come from, among others, environmental groups, the National Academy of Sciences, the American Lung Association and through the United Nations.
The negative press and public sentiment is also developing towards the "next generation" biofuels that are a significant component of achieving the use mandates in the renewable fuels standards. Those biofuels are those made from nonfeed stocks/cellulose, such as corn stalks, wheat straw, grasses and trees. Some organizations, including the National Resource Council, have issued reports critical of those biofuels, including that those biofuels are not economical without heavy government subsidies and will not have any positive overall environmental effect, and may have negative environmental results.
The criticism of the ethanol and biofuels industry could lead to further reductions in governmental supports for the industry and reduced public support and use of ethanol and other biofuels. The current criticisms regarding ethanol are based primarily on the production of ethanol from corn, and could accelerate the development of other economical sources for the production of ethanol and the development of other biofuels. Lincolnway Energy's plant can only produce ethanol from corn.
Loss Of Governmental Support And Incentives For Ethanol Could Reduce The Use Of Ethanol And Materially And Adversely Affect Lincolnway Energy's Results Of Operations And Financial Position. There have been various federal and state laws and regulations and programs which have lead to the increasing use of ethanol, including various subsidies, tax exemptions and other forms of financial incentives. Some of the laws provide economic incentives to produce or use ethanol and other biofuels and some of the laws mandate the use of ethanol and other biofuels.
No guarantee can be given that any of those laws, regulations or programs will be continued, and the revocation or amendment of any one or more of those laws, regulations or programs could adversely affect the future use and price of ethanol in a material way. Governmental support of the ethanol industry may decrease due to the ongoing governmental budget and deficit issues. The current governmental support of the ethanol industry may also decrease as the ethanol industry matures and advances, or in the event of any adverse environmental or other occurrences in the ethanol industry. Some of the significant federal support programs have already expired or have been discontinued.
For example, various ethanol tax incentives, including the 45¢ per gallon blenders credit for ethanol use and the 54¢ secondary tariff on imported ethanol, expired on December 31, 2011. It appears that this credit and tariff will not be extended or renewed. Although the loss of those tax incentives was expected, the loss still had materially adverse effects on the ethanol industry.
Some other areas where the ethanol industry had hoped for additional legislative or regulatory support were for credits or other forms of support for the installation and use of blender pumps or flex fuel vehicles capable of using ethanol blends in excess of 15% and up to 85% and approvals of the use of ethanol blends in excess of 15%. No advancements were made in those areas during 2011 or 2012, however, and those areas are material issues for increasing the use of ethanol.
As noted above, the ethanol and biofuels industry has received substantial negative press as of late regarding the possible negative effects and side effects of ethanol and other biofuels production. Any negative public sentiment could lead to decreases in governmental support of the ethanol industry.
Another continuing regulatory or governmental support issue for the ethanol industry is the fact that current law and infrastructure effectively preclude the use of higher ethanol blends in conventional automobiles, sometimes referred to as the "blend wall." The prior permitted blend amount was E10. Advocates lobbied the EPA and Congress for years to increase the permitted percentage for all vehicles from anywhere to 12% to 20%, but the EPA elected in January 2011 to only permit E15 and only for use in automobiles with a model year of 2001 or newer and for flex fuel vehicles. The EPA's action was not viewed as significant to the ethanol industry because of the limitation on vehicles and because many retailers do not have the proper dispensing equipment needed in order to offer E15. There was substantial resistance to increasing the permitted ethanol blend percentage from 10% to 15%, and there will be resistance to any further increases over 15%.
The remaining key component of the federal government's support for the ethanol industry is the renewable fuels standard that arose out of the Energy Independence and Security Act of 2007. Under that legislation, the renewable fuels mandate was increased to 36 billion gallons by 2022, with that requirement broken down among conventional biofuel, which includes ethanol derived from corn starch, advanced biofuels and cellulosic biofuels. There have, however, been various waiver requests from those standards filed with the U.S. Environmental Protection Commission, as well as calls for reductions in, or the repeal of, those standards. The EPA did announce in mid-November 2012 that the first of those waiver requests did not meet the statutory threshold for the evidence necessary to grant the waiver request. Additional waiver requests and continued efforts to extend the period of time for complying with the renewable fuels standards, or for reductions in, or the repeal of, those standards, are, however expected. Also, if ethanol and biofuels production does not increase, or declines due to adverse market conditions, that may lead to the need to lower, suspend or extend out further the renewable fuels standards, which might also provide support for those who want to reduce or eliminate those standards. Any of those actions would have adverse effects on the ethanol industry, which could be material, in particular any significant extension of the compliance period or any repeal of, or reductions in, the renewable fuel standards.
The actions of states are also important to the ethanol industry, and some states, such as Iowa and Minnesota, have various requirements which support the ethanol industry. A key state, however, California, has passed a low carbon fuel standard which will effectively shut out grain-based ethanol from outside California in the coming years. As noted elsewhere, a lawsuit has been brought challenging California's low carbon fuel standard, and the outcome of that litigation could have significant effects on the ethanol industry, in particular if California's legislation is allowed to stand, and other states adopt similar legislation. The legislation adopted by California, and any other similar legislation that would be adopted by any other states, could make it difficult to timely meet the renewable fuels standard.
There have also been some adverse movements in other states, such as efforts to ban ethanol in New Hampshire, labeling concerns in Nebraska and a repeal threat of the Florida renewable fuels standards.
Interruptions In The Supply Of Water, Electricity, Coal Or Other Energy Sources Or Other Interruptions In Production Would Have An Adverse Effect On Lincolnway Energy's Ethanol Plant. Interruptions in the supply of water, electricity, coal or other energy sources at Lincolnway Energy's ethanol plant would have a material adverse impact on operations, and could require Lincolnway Energy to halt production at the ethanol plant.
Interruptions in or the loss of the supply of water, electricity, coal or other energy sources could occur, for example, because of software or other computer problems at the ethanol plant or at the plants of the suppliers of the water, electricity, coal or other energy. Lincolnway Energy's and any suppliers' use of its software and other computer systems will be subject to attack by computer hackers, and to failure or interruption through equipment failures, viruses, acts of God and other events beyond the control of Lincolnway Energy or a supplier. As an example, Lincolnway Energy was provided with a notice of force majeure from its coal supplier in June 2012, arising from flooding. Although Lincolnway Energy did not experience any loss of coal deliveries, acts of God or other force majeure events affecting supplies could create supply problems for Lincolnway Energy.
Lincolnway Energy's operations are also subject to significant interruption if its ethanol plant experiences a major accident or is damaged by severe weather or other natural disasters. Lincolnway Energy's operations are also subject to labor disruptions and unscheduled down time, and other operational hazards inherent in the ethanol industry, such as equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties against Lincolnway Energy.
Lincolnway Energy's business is dependent upon the continuing availability of railroads, railcars, truck fleets and other infrastructure necessary for the production, transportation and use of ethanol. Any disruptions or interruptions in that infrastructure could have a material adverse effect on Lincolnway Energy.
Lincolnway Energy may not have insurance covering any of these types of matters or occurrences. Any insurance Lincolnway Energy may have in place may not be adequate to fully cover the potential losses and hazards, and Lincolnway Energy may not be able to renew the insurance on commercially reasonable terms or at all.
Competition From Other Ethanol Producers Or Energy Sources Could Adversely Affect Lincolnway Energy And Could Reduce Lincolnway Energy's Profitability. The ethanol industry is competitive and will likely become increasingly more competitive. The competitors include both regional farmer-owned entities, and also the major oil companies and other large companies. The U.S. ethanol industry also faces significant and increasing competition from international suppliers of ethanol.
Any increase in domestic or foreign competition could cause Lincolnway Energy to have to reduce its prices and take other steps to compete effectively, which could adversely affect Lincolnway Energy's results of operations and financial position.
Many competitors will have greater production capacity and/or greater capital or other financial resources, any of which may make it difficult for Lincolnway Energy to compete with the competitor. A competitor may also offer other products or services that are not offered by Lincolnway Energy, which may give the competitor an additional advantage over Lincolnway Energy.
An ethanol plant utilizing corn to produce ethanol will also experience competition from other plants which produce ethanol from other products. For example, ethanol can be produced from corn stover, rice straw, wheat, cheese whey, potatoes, wheat, oats, barley straw, milo, sorghum, sugar bogasse, rice hulls, various wastes (such as wood and vegetation) and cellulose based biomass. Various federal incentives have been enacted to encourage and support the development of cellulosic based ethanol production, and the Energy Independence and Security Act of 2007 provides that 16 billion gallons of the 36 billion gallon renewable fuels mandate for 2022 must come from cellulosic biofuel. Approximately 25 companies were developing cellulosic based ethanol plants as of the time of the preparation of this annual report. Cellulosic and other ethanol technologies are viewed by many as the "next generation" ethanol technologies.
Although Lincolnway Energy believes there will continue to be a place for corn based ethanol production within the ethanol industry, it is possible that at some point in the future governmental and public support of the ethanol industry may be focused primarily upon, and provide significant advantages or benefits to, cellulosic and other developing ethanol technologies, which could have adverse effects on Lincolnway Energy and corn based ethanol production in general. The requirements for the use of cellulosic and other advanced biofuels in the 2007 energy act are evidence of the government's support of, and trending to, those types of biofuels. The public may also eventually support cellulosic and other advanced biofuels because of the perception that those types of biofuels do not have some of the perceived negative effects of corn based ethanol, such as the food versus fuel debate, given that cellulosic and other advanced biofuels are not made from products otherwise used in the food chain and are in some cases produced from "waste" products.
It is also possible that one or more of the other sources of products for ethanol production may from time to time have greater advantages than corn, which would adversely affect an ethanol plant that produces ethanol solely from corn. For example, a plant using one of those sources may be able to produce ethanol on a more economical basis or on a more efficient or greater scale. The increased production of ethanol from any of those sources could also adversely affect the price for ethanol generally. Lincolnway Energy's ethanol plant is designed to produce ethanol only from corn.
Some competitors operate their ethanol plant and produce ethanol using different sources of energy than coal, or using various other sources of energy. The other sources of energy include natural gas and various forms of waste type products such as wood, tires, construction waste and manure. Those competitors may have lower production and input costs and/or higher operating efficiencies than Lincolnway Energy, which would allow them to produce and market their ethanol at lower prices than Lincolnway Energy.
Competition from newly developed fuel additives would also reduce the use of ethanol and Lincolnway Energy's profitability. Although it is difficult to predict if any new fuel additives will be developed, it will likely occur at some point, and it could be in the near future.
Research is also continually being conducted for alternatives to petroleum based fuel products and for additional renewable fuel products. For example, research is ongoing regarding the use of hydrogen, electric or solar powered vehicles and fuel cells. A breakthrough or discovery in any research could conceivably occur at any time, and will occur at some point, and could have the effect of greatly reducing the use of ethanol or of even making the use of ethanol obsolete over time. There will be increased incentives to develop alternatives to petroleum based fuel products given the high gasoline prices over the last three years and uncertainty in the Middle East. It is also commonly agreed that the dependence of the U.S. on foreign oil places the U.S. in difficult political and economic circumstances, and the federal government will likely assist in the development of alternatives to petroleum based fuel products given the issues that arise from the dependence of the U.S. on foreign oil.
Technological Advances Could Make Lincolnway Energy's Ethanol Plant Less Competitive. Technological advances in the processes and procedures for producing ethanol and in the efficiency of ethanol plants are continually occurring, and further ongoing advances should be expected. It is possible that those advances could make the processes and procedures that are utilized at Lincolnway Energy's ethanol plant or the ethanol and/or other by-products produced at the ethanol plant less competitive when compared to other producers. Any modifications or changes to Lincolnway Energy's ethanol plant to utilize any new technology could be technologically or cost prohibitive, and could, at least initially, reduce Lincolnway Energy's profitability.
There Are Potential Conflicts Of Interest In The Structure And Operation Of Lincolnway Energy. Although Lincolnway Energy does not believe any conflict of interest exists which in practice will be detrimental to Lincolnway Energy, potential conflicts of interest do exist in the structure and operation of Lincolnway Energy and its business. For example, the directors and officers of Lincolnway Energy are not required to devote their full time or attention to Lincolnway Energy, and they are all involved in other full time businesses and may provide services to others. Some of the directors or officers might be owners or otherwise interested in other ethanol plants. The directors and the officers will experience conflicts of interest in allocating their time and services between Lincolnway Energy and their other businesses and interests.
The various companies that provide marketing and other services to Lincolnway Energy are also not required to devote their full time or attention to those services, and they will very likely be involved in other ethanol plants and ethanol related businesses and possibly other businesses or ventures, including having ownership or other interests in other ethanol plants. The companies will therefore experience conflicts of interest in allocating their time and services between Lincolnway Energy and their various other ethanol plants or business ventures. The companies providing ethanol and distiller's grains marketing services to Lincolnway Energy will be providing those same services to other ethanol plants, and may experience conflicts of interest in allocating favorable sales and sales when the supply of ethanol or distiller's grains exceeds the demand.
Risks Relating To Lincolnway Energy's Units.
Lincolnway Energy's Units Are Not A Liquid Investment. No market exists for Lincolnway Energy's units. A market will not develop for the units because the units are not freely transferable and can only be sold, assigned or otherwise transferred in compliance with the federal and applicable state securities laws and the terms and conditions of the second amended and restated operating agreement and unit assignment policy of Lincolnway Energy, which require the prior approval of the board for all sales and assignments of any units. The restrictions set out in the securities laws, the second amended and restated operating agreement and the unit assignment policy may at times preclude the transfer of a unit. The units are therefore not a liquid investment.
There Is No Guarantee Of Any Distributions From Lincolnway Energy. Lincolnway Energy is not required to make any distributions to its members. Lincolnway Energy could also be prohibited, or at least limited or restricted, from making any distributions under the terms of Lincolnway Energy's credit and loan agreements. Lincolnway Energy's financial situation may also not allow it to make any distributions to its members in any event. The payment of distributions will also always be at the discretion of the board of Lincolnway Energy and will depend on, among other things, the board's analysis of Lincolnway Energy's earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions regarding the payment of distributions and any other considerations that the board deems relevant. There is therefore no assurance of regular distributions, or any distributions at all, to Lincolnway Energy's members.
The Staggered Terms Of Lincolnway Energy's Board May Delay Or Prevent Lincolnway Energy's Acquisition By A Third Party. Lincolnway Energy's second amended and restated operating agreement provides for three classes of directors, based upon the term of office, with each director holding a three year term. Some view that type of provision as making more difficult, or as deterring, a merger, tender offer or acquisition involving Lincolnway Energy that might result in the members receiving a premium for their units.
Taxation And Other Risks.
Members Will Owe Taxes On Lincolnway Energy's Profits But May Never Receive Any Distributions From Lincolnway Energy. Lincolnway Energy is not required to make any distributions, and it is possible that no distributions will be made by Lincolnway Energy, even if Lincolnway Energy has profits.
Any Lincolnway Energy profits will be taxable to its members in accordance with the members' respective percentage ownership of the units, whether or not the profits have been distributed. Even if distributions are made, the distributions may not equal the taxes payable by a member on the member's share of Lincolnway Energy's profits.
Lincolnway Energy could also sustain losses offsetting the profits of a prior tax period, so a member might never receive a distribution or be able to sell the member's units for an amount equal to the taxes which have already been paid by the member.
The Internal Revenue Service Could Challenge Allocations And Audit Lincolnway Energy's Tax Returns. The second amended and restated operating agreement of Lincolnway Energy provides for the allocation of profits, losses and credits among the members. The Internal Revenue Service might challenge those allocations and reallocate various items in a manner which reduces deductions or increases income to the members, both of which would result in additional tax liability for members.
The Internal Revenue Service might also audit Lincolnway Energy's returns, and adjustments might be required as a result of an audit. If an audit results in an adjustment, members could be required to file amended returns and to pay back taxes, plus interest and possibly penalties. The members' tax returns might also be audited.
The Tax Laws May Change To The Detriment Of Lincolnway Energy And Its Members. It is possible that the current federal and/or state tax treatment given to an investment in the units or to Lincolnway Energy may be changed by subsequent legislative, administrative or judicial action. Any such changes could significantly alter the tax consequences and decrease the after tax rate of return on investment in the units.
For example, although Lincolnway Energy anticipates being treated as a partnership for tax purposes, if for some reason Lincolnway Energy was classified or treated as a corporation, or Lincolnway Energy's board determined that it would be beneficial for Lincolnway Energy and its members for Lincolnway Energy to become taxed as a corporation, Lincolnway Energy would pay corporate income tax and no profits or losses would flow through to the members. The payment of taxes by Lincolnway Energy would lower the cash available for distribution to the members, and any distributions would be taxed to the members as dividends.
Software Problems And Computer Viruses May Have A Materially Adverse Effect Upon Lincolnway Energy. Lincolnway Energy will utilize various software applications in connection with its ethanol operation. There is no assurance that the operation of any software or other computer systems will be uninterrupted or error free or will otherwise be successful. There is also no assurance or guarantee that the software will continue to be available to Lincolnway Energy or that the software will be able to be maintained and updated as necessary from time to time.
Lincolnway Energy 's use of its software and other computer systems will be subject to attack by computer hackers and to failure or interruption through viruses or acts of God or other occurrences beyond the control of Lincolnway Energy, such as computer failure, communications line failure, power failure, mechanical failure, equipment malfunction or failure, and lightning.
The refiners, suppliers and other persons who Lincolnway Energy has business relationships with are also subject to the same software and computer system risks, and may affect their ability to do business with Lincolnway Energy.
Any problems with any software or other computer systems might have material adverse effects on Lincolnway Energy.
Item 1B.
Item 1B. Unresolved Staff Comments.
This Item is not applicable to Lincolnway Energy because Lincolnway Energy is not an accelerated filer, a large accelerated filer or a well-known seasoned issuer, as those terms are defined in the rules of the Securities and Exchange Commission.
Item 2.
Item 2. Properties.
Lincolnway Energy's office and its ethanol plant are located on approximately 64 acres in Nevada, Iowa. Lincolnway Energy owns the real estate and its office and ethanol plant, but all of those properties are subject to a first mortgage and security interest held by Lincolnway Energy's primary lender, Farm Credit, and to a mortgage and security interest held by the Iowa Department of Transportation.
Lincolnway Energy's office building has approximately 1,400 square feet. Lincolnway Energy utilizes the office building for office space for Lincolnway Energy's management and other staff. Lincolnway Energy was utilizing approximately 90% of the available office space as of the date of this annual report, with the remaining 10% being available to accommodate any expansion of Lincolnway Energy's staff. The office building also includes grain receiving facilities.
Lincolnway Energy's ethanol plant and related facilities include the following material buildings and related fixtures and equipment:
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process building containing lab, offices and control room;
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maintenance building containing offices, storage and a welding shop;
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administration building containing furniture and fixtures, office equipment, computers, telephone system, board room and grain receiving; and
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rail spur, paved access roads, dryers, evaporators, fermenters, grain bins and storage facilities for ethanol and distiller's grains.
Lincolnway Energy also owns approximately 147 acres of real estate which is adjacent to the 64 acre parcel noted above. Approximately 54 acres of this real estate was used to construct additional railroad spur tracks as discussed in the following paragraph. The remaining 93 acres are available for future development, but Lincolnway Energy does not, currently, have any definite plans for the use of that real estate in Lincolnway Energy's ethanol operations, and most of the real estate will likely be custom farmed during 2013.
Lincolnway Energy, LLC completed the construction of an additional 9,372 feet of rail spur to Lincolnway Energy's existing track in December of 2011. The cost of the additional rail spur project was approximately $3.4 million. The primary purpose for constructing the additional rail spur was to add rail car capacity so that Lincolnway Energy will be able to ship ethanol in unit trains, which generally means a rail shipment of between at least 84 cars and generally up to 100 rail cars. The additional track also allows Lincolnway Energy to have a sorting track for 20 cars.
Lincolnway Energy sold 59.05 acres of real estate that was also adjacent to Lincolnway Energy's 64 acre parcel noted above to DuPont Danisco Cellulosic Ethanol, LLC on October 5, 2011. The sale of the real estate is discussed in more detail in Item 1 above in this annual report.
Lincolnway Energy leases 120 hopper rail cars which are used for transporting distiller's grains. Lincolnway Energy has a lease for 90 hopper rail cars for a three year term which is scheduled to expire in March 2014 and a month to month lease agreement for an additional 30 hopper rail cars. Lincolnway Energy also leases 130 tank rail cars that are used for transporting ethanol. The scheduled term of leases goes to March 2014 for 30 cars and September 2016 for 100 cars.
Lincolnway Energy also leases various miscellaneous office equipment and equipment utilized in the operation of the ethanol plant.
Item 3.
Item 3. Legal Proceedings.
Except as noted in the following paragraphs, as of the date of this annual report, Lincolnway Energy was not aware of any material pending legal proceeding to which Lincolnway Energy was a party or of which any of Lincolnway Energy's property was the subject, other than ordinary routine litigation, if any, that was incidental to Lincolnway Energy's business. As of the date of this annual report, Lincolnway Energy was not aware that any governmental authority was contemplating any material proceeding against Lincolnway Energy or any of Lincolnway Energy's property.
On May 3, 2010, Lincolnway Energy was sued by GS CleanTech Corporation ("GS CleanTech"), a wholly owned subsidiary of GS (Green Shift) CleanTech Corporation. The lawsuit involves claims by GS CleanTech that it owns proprietary rights related to the separation of corn oil from the by-product stream of the dry mill ethanol manufacturing process. The lawsuit was initially filed in United Stated District Court for the Northern District of Iowa as Case No. 5:10-cv-04036, and alleged infringement of United States Patent No. 7,601,858 ("858 Patent").
Shortly after the case was filed, GS CleanTech petitioned the Multi-District Litigation Panel of the Federal Judiciary, and was successful in having Lincolnway Energy's case as well as numerous other cases moved to the United States District Court for the Southern District of Indiana for all pretrial activity. The MDL proceeding is captioned: In re: Method of Processing Ethanol Byproducts and Related Subsystems ('858) Patent Litigation, Master Case No.: 1:10-ml-2181-LJM-DML.
Since the beginning of the case, GS CleanTech has obtained issuance of additional United States patents related to the corn oil separation technology. As a result, additional patents have been asserted against Lincolnway Energy. In addition to the '858 Patent, GS CleanTech has now asserted U.S. Patent No. 8,008,516 (the "'516 Patent") and U.S. Patent No. 8,008,517 (the "'517 Patent"), both of which are continuations of, and are based upon the disclosures of, the '858 Patent. GS CleanTech has also asserted U.S. Patent No. 8,168,037 ("'037 Patent") against Lincolnway Energy and certain of the other MDL Defendants. The '037 Patent purports to cover certain process steps and is based upon a slightly differing patent specification as compared to the '858 Patent. Additionally, on November 7, 2012, the United States District Court for the Southern District of Indiana entered an Order granting permission to GS CleanTech to assert newly issued United States Patent No. 8,283,484 ("'484 Patent"). The litigation began as an infringement claim of one patent, but, with the additional patents noted in this paragraph, now involves five different patents.
Claims construction related to the patent claim terms of the '858 Patent has occurred. The Court construed various of the terms. GS CleanTech has requested that further construction be had as it relates to the patent claims of the '516 Patent and the '517 Patent. The Court has not adopted GS CleanTech's position. The newly asserted '037 Patent may require claims construction, and a separate Case Management Order has been entered as it relates to said patent and the parties against whom it is asserted. A claims construction procedure and further modifications to the Case Management Order may also be required in light of the Court's grant of permission to GS CleanTech to assert the '484 Patent.
GS CleanTech is seeking damages in this lawsuit. GS CleanTech has claimed damages consisting of at least a reasonable royalty rate and disgorgement of profits and lost profits. GS CleanTech has further claimed the infringing conduct by Lincolnway Energy is willful resulting in entitlement to recover treble damages and attorney fees pursuant to the provisions of 35 U.S.C. §284.
In the MDL case, the Defendants have filed a Motion for Summary Judgment of Non-Infringement based upon a single claims element. Said element focuses upon the de-oiled syrup stream emerging from the centrifuge after oil separation has occurred, and requires that the de-oiled stream be substantially free of oil. GS CleanTech has filed a separate Motion for Summary Judgment of Infringement asserting that the oil separation processes of all of the Defendants, including Lincolnway Energy, infringe the '858 Patent, the '516 Patent and the '517 Patent. Defendants are working collectively to resist GS Clean Tech's Motion for Summary Judgment of Infringement.
Lincolnway Energy has produced documents pursuant to a Protective Order entered by the US District Court and has provided a corporate deposition to GS CleanTech pursuant to FRCP 30(B)(6). Lincolnway Energy has joined with a number of other ethanol manufacturers as well as ethanol process equipment manufacturers in defending against the GS CleanTech patents and the claims asserted by GS CleanTech thereunder. These defenses include claims of non-infringement as well as claims of patent invalidity based upon a number of grounds. Depositions have been jointly taken by Defendants as to these defenses as well as the claims asserted by GS CleanTech. Discovery is ongoing in this lawsuit.
Lincolnway Energy is unable as of the date of this annual report to determine the likelihood of an unfavorable outcome or the amount or range of possible loss or whether the lawsuit will have a material adverse affect on Lincolnway Energy. The lawsuit has, however, increased Lincolnway Energy's legal costs.
PART II
Item 5.
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Lincolnway Energy is authorized to issue an unlimited number of units, but member approval is required in order to issue more than 45,608 units. Lincolnway Energy had 42,049 outstanding units as of November 30, 2012, which were held of record by 959 different members. The determination of the number of members is based upon the number of record holders of the units as reflected in Lincolnway Energy's internal unit records.
Lincolnway Energy did not issue any units during the fiscal year ended September 30, 2012.
Lincolnway Energy's units are not listed on any exchange, and there is no public trading market for Lincolnway Energy's units. An investment in Lincolnway Energy's units is not a liquid investment because the second amended and restated operating agreement of Lincolnway Energy establishes various conditions on the issuance of additional units and various restrictions on the sale, assignment or other transfer of units.
The second amended and restated operating agreement of Lincolnway Energy provides that the board of Lincolnway Energy may not issue any units for a consideration or value of less than $500 per unit or issue more than an aggregate of 45,608 units, without the vote of the members, except that the directors of Lincolnway Energy may effectuate a split of the outstanding units into a lesser or greater number of units, based upon a uniform multiple, without the vote of the members. In that event, the $500 amount and the 45,608 amount shall also be increased or decreased in accordance with the multiple that was utilized in the split of the units. The second amended and restated operating agreement also provides that Lincolnway Energy may not issue any units to any director or officer of Lincolnway Energy in their capacity as such, without the vote of the members. The necessary vote in any of the circumstances described in this paragraph is the vote of the members holding at least a majority of the outstanding units represented at a meeting at which a quorum of the members is present. The members holding at least 25% of the outstanding units constitute a quorum at any meeting of the members.
The second amended and restated operating agreement of Lincolnway Energy also provides that no member shall, directly or indirectly, own, hold or control more than 49% of the outstanding units at any time, unless the member exceeds that percentage by reason of Lincolnway Energy purchasing units. The second amended and restated operating agreement provides that for this purpose a member will be deemed to indirectly own, hold and control all units which are owned by the member's spouse or any of the member's parents or minor children and by any entity of which any one or more of the member or any of those relatives owns at least 10% of the outstanding voting equity of the entity.
The second amended and restated operating agreement of Lincolnway Energy also establishes restrictions on the sale, assignment or other transfer of units.
The second amended and restated operating agreement provides that a member may not sell, transfer, assign or otherwise dispose of or convey any units, whether voluntarily or involuntarily, or grant a security interest in any units, except in compliance with the second amended and restated operating agreement and also only with the prior written approval of the board of Lincolnway Energy and in compliance and accordance with the policies and procedures as may be adopted from time to time by the board. The board is authorized to adopt and implement those policies and procedures for any reasonable purpose, as determined by the board. A reasonable purpose includes prohibiting, restricting, limiting, delaying or placing conditions on any assignment of units which, alone or together with any other past or anticipated assignments, would or might reasonably be determined to:
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Violate or cause Lincolnway Energy to violate or to otherwise be in noncompliance with any law, rule, regulation or order, including any securities law, rule, regulation or order;
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Cause Lincolnway Energy to be taxed as a corporation for tax purposes, including by reason of Section 7704 of the Internal Revenue Code of 1986;
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Result in the termination of Lincolnway Energy or Lincolnway Energy's tax year for tax purposes, including under Section 708 of the Internal Revenue Code of 1986, or cause the application to Lincolnway Energy of Sections 168(g)(1)(B) or 168(h) of the Internal Revenue Code of 1986 or similar or analogous rules;
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Violate any term or condition of the second amended and restated operating agreement, including the 49% ownership limitation noted above;
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Violate or cause Lincolnway Energy to violate or to otherwise be in noncompliance with any law, rule, regulation or order applicable to Lincolnway Energy's selection or use of its then current fiscal year, including Section 444 of the Internal Revenue Code of 1986;
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Require Lincolnway Energy to become licensed, registered or regulated as an investment company, a broker-dealer or any other form of regulated entity under any law, rule, regulation or order; or
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Create or result in any fractional units.
The policies and procedures adopted by the board regarding the assignment of units are referred to as the unit assignment policy. Lincolnway Energy's current unit assignment policy mirrors the terms of the second amended and restated operating agreement and provides that all assignments require the prior approval of the board, and that the board may prohibit, restrict, limit, delay or place conditions on any assignment which might have any of the effects described in the preceding subparagraphs. Several of those potential effects could be applicable to Lincolnway Energy at any given time.
One example that will be applicable to Lincolnway Energy on an ongoing basis arises from the fact that Lincolnway Energy is taxable as a partnership for income tax purposes. There are various statutes and regulations that Lincolnway Energy must comply with in order to maintain that tax classification. One applicable statute and related regulation is Section 7704 of the Internal Revenue Code of 1986 and Section 1.7704-1 of the Treasury Regulations. Section 7704 provides, in general, that a partnership which becomes a publicly traded partnership under Section 7704 will be taxed as a corporation. Section 7704 provides that a publicly traded partnership is a partnership whose interests either are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent. Section 1.7704-1 sets forth some rules for making a determination of whether a partnership is readily tradable on a secondary market or the substantial equivalent for that purpose, and establishes some specified processes and procedures as "safe harbors" under the publicly traded partnership rules. The safe harbors include a limited matching service and a limited repurchase option.
The general rule under the publicly traded partnership rules is that no more than 2% of a partnership's outstanding units may be transferred during any taxable year, unless the partnership has established one of the safe harbors that are available under the publicly traded partnership rules. As noted above, the safe harbors include a limited matching service and a limited repurchase option. If one or both of those processes have been established, a partnership may permit the transfer of up to an aggregate of 10% of the partnership's outstanding units during any taxable year, so long as no more than 2% of the transfers occur outside of the matching service or the repurchase option and all of the other transfers are made in accordance with the terms of the matching service or the repurchase option.
Lincolnway Energy has established a qualified matching service on Lincolnway Energy's website, and the second amended and restated operating agreement of Lincolnway Energy includes a repurchase provision which complies with the safe harbor for a repurchase option under the publicly traded partnership rules. There are numerous conditions and requirements in both the qualified matching service and the repurchase option, so neither provides any significant liquidity for Lincolnway Energy's units. Also, Lincolnway Energy has no obligation to purchase any units under the repurchase provisions in the second amended and restated operating agreement.
Lincolnway Energy has not made any repurchases of its units pursuant to the repurchase provisions set forth in the second amended and restated operating agreement.
There have been some sales of units pursuant to Lincolnway Energy's qualified matching service. The purchase price and other terms of any transactions pursuant to Lincolnway Energy's qualified matching service are negotiated and established solely by the seller and the buyer. Lincolnway Energy does not endorse or recommend any sale of units and is not responsible for the fairness of the purchase price paid in any transactions made pursuant to the qualified matching service, or for the payment or other terms of any transaction. Lincolnway Energy therefore does not represent or guarantee in any way that any of the prices paid pursuant to the qualified matching service are fair or accurately reflect the value of Lincolnway Energy's units, and Lincolnway Energy does not endorse or recommend any sales of units at any of the prices listed by a member in the qualified matching service or on the same or similar terms.
The publicly traded partnership rules exclude some types of transfers from the 2% and 10% limitations. As an example, a gift of units by a member to certain family members of the member is not counted towards the 2% and 10% limitations.
Another example of a transfer limitation that currently will be applicable to Lincolnway Energy on an ongoing basis arises from the fact that Lincolnway Energy has elected to utilize a September 30 fiscal year end. Given that fact, no more than 5% of Lincolnway Energy's units can be owned by pass-through type entities, such as Subchapter S corporations, limited liability companies or partnerships. At the time of the preparation of this annual report, Lincolnway Energy was at the 5% maximum amount, so no transfers of any units to a pass-through type entity were permitted.
The second amended and restated operating agreement and the unit assignment policy both contemplate that a member desiring to assign any units must present Lincolnway Energy with a unit assignment application and any other information requested by the board. The board is not required to act on a unit assignment application until the next regularly scheduled meeting of the board which follows the date on which Lincolnway Energy receives the completed and executed unit assignment application.
An assignment of a unit which is approved by the board will be effective for all purposes, including for purposes of allocations and distributions, only as of the date determined by the board, but the date must be within 32 days of the date of the approval of the assignment by the board. Lincolnway Energy believes that approach is necessary in order to provide a uniform effective date for assignments of units.
The unit assignment policy also provides that Lincolnway Energy may require the assigning member or the assignee to provide a legal opinion to Lincolnway Energy regarding the assignment, and that Lincolnway Energy may require that Lincolnway Energy be paid or reimbursed for all of its fees, costs and expenses incurred in connection with any assignment, including legal and accounting fees.
As of the date of this annual report, Lincolnway Energy did not have any equity compensation plans (including any individual equity compensation arrangements) in place for any directors, officers, employees or other persons.
As of the date of this annual report, Lincolnway Energy had no plans to, and had not agreed to register any of its units under any federal or state securities laws.
There were no outstanding warrants, options or other rights to purchase any units of Lincolnway Energy as of the date of this annual report, and there were no outstanding securities which were convertible or exchangeable into or for any units of Lincolnway Energy. Lincolnway Energy's units are not convertible into any other securities.
The payment of distributions to members by Lincolnway Energy is within the discretion of the board of Lincolnway Energy, and there is no assurance of any distributions from Lincolnway Energy. The payment of distributions is also subject to Lincolnway Energy's compliance with the various covenants and requirements of Lincolnway Energy's credit and loan agreements, and it is possible that those covenants and requirements will at times prevent Lincolnway Energy from paying a distribution to its members.
Lincolnway Energy has declared six distributions since Lincolnway Energy was organized in May 2004. The first distribution was declared in November 2006 and was in the amount of $150 per unit, resulting in an aggregate distribution of $6,428,850. The second distribution was declared in May 2007, and was in the amount of $200 per unit, resulting in an aggregate distribution of $8,409,800. The third distribution was declared in November 2007, and was in the amount of $125 per unit, resulting in an aggregate distribution of $5,256,125. The fourth distribution was declared in May 2008, and was in the amount of $75 per unit, resulting in an aggregate distribution of $3,153,675. The fifth distribution was declared in February 2010, and was in the amount of $50 per unit, resulting in an aggregate distribution of $2,102,450. The sixth distribution was declared in February 2012, and was in the amount of $25 per unit, resulting in an aggregate distribution of $1,051,225.
Lincolnway Energy does not contemplate being able to establish a definite or regular distribution policy or history because the determination of whether a distribution can or should be made by Lincolnway Energy will need to be made by the board of Lincolnway Energy based upon the then existing facts and circumstances of Lincolnway Energy, which could change materially from time to time. For example, although a distribution was declared in November of both 2006 and 2007 and in May of both 2007 and 2008, the board of Lincolnway Energy determined that no distribution should be made by Lincolnway Energy during November 2008, May 2009 or in November 2009, given the generally unfavorable economic outlook and the prevailing conditions in the ethanol industry. As noted above, Lincolnway Energy did declare a distribution in February of 2010 and February 2012, but both of those distributions were at a lower per unit amount than the prior distributions by Lincolnway Energy. Also, no distribution was declared in November of 2010, in February or November of 2011, or in November 2012. Although no firm decision has been made, it is possible that no, or perhaps reduced, distributions will be declared and paid by Lincolnway Energy during the fiscal year ending September 30, 2013.
None of Lincolnway Energy's units were purchased by or on behalf of Lincolnway Energy or any affiliated purchaser (as defined in Rule 10b-18(a)(3) of the Securities Exchange Act of 1934) of Lincolnway Energy during the period of July 1, 2012 to September 30, 2012. As of the date of this annual report, Lincolnway Energy did not have any publicly announced plans or programs with respect to purchases of its units.
Item 6.
Item 6. Selected Financial Data.
The following information is summary selected financial data for Lincolnway Energy for the fiscal years ended September 30, 2012, 2011, 2010, 2009 and 2008 with respect to statements of operations data and balance sheet data. The data is qualified by, and must be read in conjunction with, Item 1A of this annual report, "Risk Factors", Item 7
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Except for the historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties, and which speak only as of the date of this annual report. No one should place strong or undue reliance on any forward looking statements. Lincolnway Energy's actual results or actions may differ materially from these forward-looking statements for many reasons, including the risks described in Item 1A and elsewhere in this annual report. This Item should be read in conjunction with the financial statements and related notes and with the understanding that Lincolnway Energy's actual future results may be materially different from what is currently expected or projected by Lincolnway Energy.
Overview
Lincolnway Energy is an Iowa limited liability company that operates a dry mill, coal fired ethanol plant located in Nevada, Iowa. Lincolnway Energy has been processing corn into fuel grade ethanol and distillers grains since May 22, 2006. The ethanol plant has a nameplate production capacity of 50,000,000 gallons, which, at that capacity, would also generate approximately 136,000 tons of distillers' grains per year. The ethanol plant produced 55,712,726 gallons of ethanol and 147,425 tons of distillers' grains during the fiscal year ended September 30, 2012. Lincolnway Energy had a planned shut down during the month of November, 2011 and May, 2012 to complete routine maintenance work.
Lincolnway Energy's plant also produces corn oil and carbon dioxide.
Lincolnway Energy's revenues for the fiscal year ended September 30, 2012 were derived from the sale of Lincolnway Energy's ethanol to Green Plains Trading Group, LLC. (GPTG), the sale of its distiller's grains to Hawkeye Gold, LLC, the sale of its corn oil to FEC Solutions, LLC (FECS), and the sale of its carbon dioxide to EPCO Carbon Dioxide Products, Inc.
Lincolnway Energy's ethanol was sold pursuant to an ethanol marketing agreement between Lincolnway Energy and GPTG. The purchase price payable to Lincolnway Energy is GPTG's contract selling price for the ethanol in question, less various costs and a fee to GPTG. The ethanol marketing agreement includes a minimum purchase price. Title and all risk of loss and damage to all ethanol passed to GPTG at the time the ethanol passes across the inlet flange into the rail cars or trucks of the GPTG carrier at the Lincolnway Energy plant. On November 29, 2012, Lincolnway Energy and GPTG mutually agreed to terminate the ethanol marketing agreement effective December 31, 2012. The termination was requested by Lincolnway Energy because managers of Lincolnway Energy determined that it was in the best interests of Lincolnway Energy to retain a different ethanol marketer. Lincolnway Energy will actively pursue a contract with another marketer to replace GPTG.
Lincolnway Energy's output of distiller's grains is sold to Hawkeye Gold, LLC under a Distiller's Grains Marketing Agreement between Lincolnway Energy and Hawkeye Gold, LLC. Prior to August 1, 2012, Lincolnway Energy paid Hawkeye Gold, LLC a marketing fee for dried distiller's grains and wet distiller's grains equal to the greater of a set percentage of the FOB plant price or a fixed dollar amount per ton for the dried distiller's grains or wet distiller's grains in question. The agreement was amended on August 1, 2012 to change the fees payable to Hawkeye Gold, LLC. Since that amendment, the fee for dried distiller's grains is a set percentage of the FOB plant price, but with both a specified maximum and a minimum per short ton price. The fee for wet distiller's grains is also a set percentage of the FOB plant price, but with a specified maximum per short ton price. The Distiller's Grains Marketing Agreement can be terminated by Lincolnway Energy or Hawkeye Gold, LLC on 90 days written notice.
Lincolnway Energy extracts corn oil from the syrup that is generated in the production of ethanol. FECS purchases all of Lincolnway Energy's output of corn oil for resale by FECS pursuant to an agreement that became effective on October 13, 2008. Lincolnway Energy pays FECS a marketing and technical assistance fee of a set percentage of the FOB sales price of the corn oil. The agreement renews for successive 36 month terms, on October 13 of the applicable year, unless Lincolnway Energy or FECS elects to terminate the agreement at the end of the then current 36 month term. The current 36 month term expires in October 2014.
EPCO Carbon Dioxide Products, Inc. constructed a plant on Lincolnway Energy's site in mid 2010 to collect the carbon dioxide which is produced as part of the ethanol production process and to convert that raw carbon dioxide into liquid carbon dioxide gas. Lincolnway Energy and EPCO also have an agreement under which EPCO markets and sells the liquid carbon dioxide . The purchase price payable by EPCO for the carbon dioxide provided by Lincolnway Energy is based upon EPCO's shipped tons of liquid carbon dioxide. The current purchase price is the greater of the fixed per shipped ton price specified in the agreement or the margin price, as that term is defined in the agreement. EPCO has also agreed to a take or pay obligation for each year under the Agreement of the greater of 180 shipped tons per day or 70% of the annual liquid CO2 production capacity of the EPCO plant at full capacity. The term of the marketing agreement with EPCO is ten years from the first date on which liquid carbon dioxide was produced at the EPCO plant, which occurred during August, 2010, unless the agreement is earlier terminated for any of the other reasons set out in the agreement.
Lincolnway Energy is dependent upon its agreements for the marketing and sale of its products, in particular ethanol and distillers' grains, and Lincolnway Energy's loss of those agreements could have material adverse effects on Lincolnway Energy.
Comparison of Fiscal Years Ended September 30, 2012 and 2011
Revenues from operations for the fiscal year ended September 30, 2012 were approximately $169.6 million, consisting of $126.4 million of ethanol sales (net of hedging activity) (75%), $38.6 million in distiller's grains sales (23%) and $4.6 million of corn oil, syrup and CO2 sales (2%). Revenues decreased in fiscal year 2012 by approximately 2.5%, when compared to the fiscal year 2011. Lincolnway Energy sold approximately 55.3 million gallons of ethanol at an average gross price of $2.29 per gallon, 146,516 tons of dried distillers grains at an average gross price of $258.97 per ton, and 6,142 tons of wet distillers grains at an average gross price of $101.19 per ton during the fiscal year ended September 30, 2012. Lincolnway Energy also sold approximately 4,815 tons of corn oil at an average gross price of $780.57 per ton during the 2012 fiscal year. The decrease in revenues for the fiscal year ended September 30, 2012 resulted from a 3.0% decrease in ethanol sales volume and a 6.5% decrease in price for ethanol as compared to the previous fiscal year. The revenues for the year ended September 30, 2012 include combined unrealized and realized net loss on derivative ethanol contracts of $7,308 compared to a $1.1 million loss for the year ended September 30, 2011.
The average price Lincolnway Energy received for its dried distiller's grains increased to $258.97 per ton in fiscal year 2012, from $215.26 per ton in fiscal year 2011. Management believes the increase in the price for distiller's grains is a result of the increase in the price of corn and increased domestic and export demand for dried distillers grains. Distiller grains are typically impacted by increases in corn prices as distillers grains are primarily used as an animal feed substitute for corn. Management anticipates continued strong demand for distillers grains due to higher corn prices.
Lincolnway Energy anticipates that its results of operations for the remainder of calendar year 2012 will continue to be affected by a surplus of ethanol and volatility in the commodity markets.
Lincolnway Energy's cost of goods sold for the fiscal year ended September 30, 2012 totaled approximately $171.8 million, which was an increase of 1.2% when compared to fiscal year 2011. The increase in cost of goods sold for the 2012 fiscal year is primarily due to a 4.4% increase in the average cost of corn per bushel for fiscal year 2012 offset by a 2.4% decrease in ethanol production for the 2012. Cost of goods sold major components are: corn costs, energy costs, ingredient costs, production labor, repairs and maintenance, process depreciation, and ethanol and distiller's grain freight expense and marketing fees.
Corn costs excluding hedging activity for the fiscal year ended September 30, 2012 totaled approximately $129.1 million, compared to $126.0 million for fiscal year 2011. Approximately 19.7 million bushels of corn was ground during fiscal year 2012 at an average cost of $6.62 per bushel, compared to 20.0 million bushels at an average cost of $6.34 for fiscal year 2011. The decrease in bushels ground was due to an decrease in production during fiscal year 2012. The increase in corn price is partially attributed to an increase in corn demand that leads to tight corn supply and the drought that we experienced in the summer of 2012. Ethanol yields stayed relatively neutral from fiscal year 2012 compared to 2011. Corn hedging activity includes a combined unrealized and realized net loss of $1.0 million from derivative instruments compared to a $3.0 million combined unrealized and realized net loss for fiscal year 2011. Corn costs, including the combined unrealized and realized net loss from derivative instruments, represented 75.9% of cost of goods sold for the fiscal year ended September 30, 2012, compared to76.1% of costs of goods sold for fiscal year 2011.
Lincolnway Energy anticipates continued volatility in Lincolnway Energy's corn costs due to the timing of the change in value of the derivative instruments relative to the cost and use of the corn being hedged.
Energy costs for the fiscal year ended September 30, 2012 totaled approximately $9.8 million or 5.7% of cost of goods sold, compared to $9.6 million, or 5.7% of cost of goods sold, for the 2011 fiscal year. Energy costs consist of coal costs, electricity and propane costs. For the fiscal year ended September 30, 2012, Lincolnway Energy purchased 98,801 tons of coal at an approximate total cost of $7.2 million compared to approximately 102,029 tons at an approximate cost of $7.0 million for fiscal year 2011. Electricity and propane costs amounted to approximately $2.3 million, a decrease of $.08 million from fiscal year 2011 and approximately $.3 million of sodium bicarbonate, sand and lime cost for fiscal year 2012 that is added to the combustor with the coal. The increase in energy cost is due to a price increase for coal and offset by the decrease in production gallons for the fiscal year 2012.
Ingredient costs for the fiscal year ended September 30, 2012 totaled approximately $7.0 million or 4.1% of cost of goods sold, compared to $7.1 million, or 4.2% of cost of goods sold, for the 2011 fiscal year. Ingredient costs consist of denaturant, enzymes, fermentation and process chemicals. Denaturant costs (natural gasoline) decreased $.2 million for the fiscal year ended September 30, 2012 compared to fiscal year 2011. This decrease is a result of a 3.0% decrease in ethanol gallons produced for the fiscal year ended September 30, 2012 compared to fiscal year 2011 and a less than 1.0% decrease in price for denaturant.
Production labor, repairs and maintenance and other plant costs totaled approximately $6.7 million, or 3.9% of cost of goods sold, for the fiscal year ended September 30, 2012, compared to $5.8 million, or 3.4% of cost of goods sold, for fiscal year 2011. The increase in cost is due to increased repair and maintenance cost that totaled approximately $2.6 million for fiscal year ended September 30, 2012, compared to $1.6 million, for fiscal year 2012. The increase in cost for repairs and maintenance is due to the age, wear and tear on the plant.
Depreciation totaled approximately $7.0 million, or 4.1% of cost of goods sold, for the fiscal year ended September 30, 2012, compared to $7.5 million, or 4.4% of cost of goods sold, for fiscal year 2011.
Ethanol, distiller's grain and corn oil freight expense and marketing fees totaled approximately $11.0 million, or 6.4% of cost of goods sold, during the fiscal year ended September 30, 2012, compared to $10.6 million, or 6.2% of cost of goods sold, for fiscal year 2011. The increase is due to an increase in sales of distillers grain and corn oil for fiscal year 2012 compared to 2011.
General and administrative expenses totaled approximately $3.0 million during the fiscal year ended September 30, 2012, compared to $2.6 million for fiscal year 2011. The $.4 million increase is due to an increase in legal fees for the patent litigation and air permit appeal and E15 registration fees with the EPA.
For the fiscal year ended September 30, 2012, a contract settlement fee of $1.7 million and gain on land sale of $489,664 was recognized, whereas no comparable items were recognized in fiscal year 2011. The contract settlement fee incurred was related to the early termination of an agreement with Lincolnway Energy's primary corn supplier. The gain on land sale was recognized due to the sale of a land parcel adjacent to Lincolnway Energy's primary site. Management believes both of these matters are generally one-time, nonrecurring items.
Other income and expense totaled approximately $.2 million net expense during the fiscal year ended September 30, 2012, compared to $.6 million net expense for fiscal year 2011. The decrease in net expense is due to a decrease in interest expense compared to 2011.
Comparison of Fiscal Years Ended September 30, 2011 and 2010
Revenues from operations for the fiscal year ended September 30, 2011 were approximately $174.0 million, consisting of $138.5 million of ethanol sales (net of hedging activity) (80%), $31.7 million in distiller's grains sales (18%) and $3.8 million of corn oil, syrup and CO2 sales (2%). Revenues increased in fiscal year 2011 by approximately 52.1%, when compared to the fiscal year 2010. Lincolnway Energy sold approximately 57.0 million gallons of ethanol at an average gross price of $2.45 per gallon, 143,760 tons of dried distillers grains at an average gross price of $215.26 per ton, and 11,706 tons of wet distillers grains at an average gross price of $65.76 per ton during the fiscal year ended September 30, 2011. Lincolnway Energy also sold approximately 3,835 tons of corn oil at an average gross price of $892.00 per ton during the 2011 fiscal year. The increase in revenues for the fiscal year ended September 30, 2011 resulted from a 3.4% increase in ethanol sales volume and a 42.4% increase in price for ethanol as compared to the previous fiscal year. Management believes the ethanol price increase is a result of higher corn and energy prices along with increased exports to Europe, Canada and Brazil which positively impacted ethanol demand during the 2011 fiscal year. The revenues for the year ended September 30, 2011 include combined unrealized and realized net loss on derivative ethanol contracts of $1.1 million compared to a $1.4 million loss for the year ended September 30, 2010.
The average price Lincolnway Energy received for its dried distiller's grains increased to $215.26 per ton in fiscal year 2011, from $145.38 per ton in fiscal year 2010. Management believes the increase in the price for distiller's grains is a result of the increase in the price of corn and increased domestic and export demand for dried distillers grains. Distiller grains are typically impacted by increases in corn prices as distillers grains are primarily used as an animal feed substitute for corn. Management anticipates continued strong demand for distillers grains due to higher corn prices.
Lincolnway Energy anticipates that its results of operations for the remainder of calendar year 2011 and for 2012 will continue to be affected by a surplus of ethanol and volatility in the commodity markets.
Lincolnway Energy's cost of goods sold for the fiscal year ended September 30, 2011 totaled approximately $169.8 million, which was an increase of 59.1% when compared to fiscal year 2010. The increase in cost of goods sold for the 2011 fiscal year is primarily due to a 76.6% increase in the average cost of corn per bushel for fiscal year 2011 and a 3% increase in ethanol production for the 2011. Cost of goods sold major components are: corn costs, energy costs, ingredient costs, production labor, repairs and maintenance, process depreciation, and ethanol and distiller's grain freight expense and marketing fees.
Corn costs excluding hedging activity for the fiscal year ended September 30, 2011 totaled approximately $126.0 million, compared to $70.4 million for fiscal year 2010. Approximately 20.0 million bushels of corn was ground during fiscal year 2011 at an average cost of $6.34 per bushel, compared to 19.7 million bushels at an average cost of $3.59 for fiscal year 2010. The increase in bushels ground was due to an increase in production during fiscal year 2011. The increase in corn price is partially attributed to an increase in corn demand that leads to tight corn supply and the rise of energy prices. Ethanol yields have improved in the fiscal year 2011 because of the quality of the corn crop harvested in 2011 compared to 2010. Corn hedging activity includes a combined unrealized and realized net loss of $3.0 million from derivative instruments compared to a $1.5 million combined unrealized and realized net gain for fiscal year 2010. Corn costs, including the combined unrealized and realized net loss from derivative instruments, represented 76.1% of cost of goods sold for the fiscal year ended September 30, 2011, compared to 64.9% of costs of goods sold for fiscal year 2010.
Lincolnway Energy anticipates continued volatility in Lincolnway Energy's corn costs due to the timing of the change in value of the derivative instruments relative to the cost and use of the corn being hedged.
Energy costs for the fiscal year ended September 30, 2011 totaled approximately $9.6 million or 5.7% of cost of goods sold, compared to $8.8 million, or 8.2% of cost of goods sold, for the 2010 fiscal year. Energy costs consist of coal costs, electricity and propane costs. For the fiscal year ended September 30, 2011, Lincolnway Energy purchased approximately 102,029 tons of coal at an approximate total cost of $7.0 million compared to approximately 98,500 tons at an approximate cost of $6.0 million for fiscal year 2010. Electricity and propane costs amounted to approximately $2.4 million, a decrease of $.2 million from fiscal year 2010 and approximately $.3 million of sodium bicarbonate, sand and lime cost for fiscal year 2011 that is added to the combustor with the coal. The increase in energy cost is due to a price increase for coal and the increase in production gallons for the fiscal year 2011.
Ingredient costs for the fiscal year ended September 30, 2011 totaled approximately $7.1 million or 4% of cost of goods sold, compared to $5.1 million, or 4.8% of cost of goods sold, for the 2010 fiscal year. Ingredient costs consist of denaturant, enzymes, fermentation and process chemicals. Denaturant costs (natural gasoline) increased $.9 million for the fiscal year ended September 30, 2011 compared to fiscal year 2010. Denaturant cost have increased significantly from an average cost per gallon of $1.87 for the 2010 period, compared to $2.30 for the 2011 period. Enzymes, fermentation and process chemicals cost also increased by $1.1 million for the 2011 period compared to the 2010 period. The increase is a result of an increase in production gallons and also the price of chemicals were higher for the fiscal year 2011 compared to fiscal year 2010.
Production labor, repairs and maintenance and other plant costs totaled approximately $5.6 million, or 3.3% of cost of goods sold, for the fiscal year ended September 30, 2011, compared to $5.3 million, or 4.9% of cost of goods sold, for fiscal year 2010. The increase in cost is due to increased labor costs and higher repair and maintenance and plant cost due to increased production and the wear and tear on the plant.
Depreciation totaled approximately $7.5 million, or 4.4% of cost of goods sold, for the fiscal year ended September 30, 2011, compared to $7.6 million, or 7% of cost of goods sold, for fiscal year 2010.
Ethanol, distiller's grain and corn oil freight expense and marketing fees totaled approximately $10.6 million, or 6.2% of cost of goods sold, during the fiscal year ended September 30, 2011, compared to $10.4 million, or 9.8% of cost of goods sold, for fiscal year 2010. The increase is due to an increase in sales of ethanol, distillers grain and corn oil for fiscal year 2011 compared to 2010.
General and administrative expenses totaled approximately $2.7 million during the fiscal year ended September 30, 2011, compared to $2.4 million for fiscal year 2010. The $.3 million increase is due to an increase in legal fees for the patent litigation and air permit appeal.
Other income and expense totaled approximately $.6 million net expense during the fiscal year ended September 30, 2011, compared to $.8 million net expense for fiscal year 2010. The decrease in net expense is due to a decrease in interest expense compared to 2010.
Risks, Trends and Factors that May Affect Future Operating Results
The operations and profitability of Lincolnway Energy are highly dependent on the prices of the key commodities utilized and sold as part of the production process. These include corn, ethanol, and distillers' grain. Since the correlation of prices between these commodities is not perfect, and is in fact often very volatile, Lincolnway Energy is at risk of diminishing returns in periods of rising corn prices and decreasing ethanol prices. The prices of these commodities are determined by a variety of factors, including growing season weather, governmental policies, political change, international trade, and macroeconomic trends. Lincolnway Energy attempts to mitigate or hedge some of these risks through the use of various pricing mechanisms including cash contracts, futures contracts, options on futures, and derivative instruments.
Corn
Corn values in 2012 proved to be one of the most volatile in modern history with December corn futures trading at a new record high of $8.49 per bushel on August 10, 2012. The volatile market was driven by continued severe hot and dry conditions with plagued the majority of the U.S corn belt. USDA made aggressive yield reductions in the July and August crop report. Over a period of two monthly crop reports the U.S. corn yield was lowered a staggering 42.6 bushels per acre. Total 2012/2013 U. S. corn production fell by more than 4.0 billion bushels as a result. Consistently higher corn prices have thus far worked to create the projected demand destruction necessary to balance historically low U.S. corn ending stocks. The 2012/2013 U.S. corn carryout was forecasted at 619 million bushels in October (stocks to use ratio of 5.6%), which represented the lowest U.S. corn stock figure since 1995/1996, 426 million bushels (stocks to use ratio of 5.0%)
Ethanol
The operating environment for the U.S. ethanol producer in the 4th quarter of 2012 continues to be challenged by lower total gasoline consumption in the U.S and secondly, Brazilian sugarcane-based ethanol imports are flowing as a source of advanced biofuels (considered lower in carbon than the U.S. based ethanol production), during a period where the U.S production base is already slowed by a factor of greater than 10 percent. This difficult operating environment for the U.S. ethanol producer has been the longest sustained period of depressed margins the U.S. ethanol industry has seen in the last several years. If U.S. ethanol production continues to decline, ethanol prices may show some recovery. This could, however, encourage some idled U.S. production to ramp up to full capacity, or possibly increased interest from Brazil to import more of the sugarcane-based ethanol.
Other/Regulatory/Governmental
Ethanol production in the United States has benefited by various tax incentives, but the more recent trends in the legislative area have not been favorable to the ethanol industry. For example, one of the most significant tax incentives was the federal Volumetric Ethanol Excise Tax Credit (VEETC). VEETC provided a volumetric ethanol excise tax credit of 45¢ per gallon of ethanol blended with gasoline. This credit expired, however, on December 31, 2011, and it does not appear that the credit will be reinstated or renewed. Although the loss of this tax credit was expected by the industry, the loss still has had materially adverse effects on the ethanol industry.
Some other areas where the ethanol industry had hoped for additional legislative or regulatory support were for credits or other forms of support for the installation and use of blender pumps or flex fuel vehicles capable of using ethanol blends in excess of 15% and up to 85% and approvals of the use of ethanol blends in excess of 15%. No advancements were made in those areas during 2011 or 2012, however, and those areas are material issues for increasing the use of ethanol.
There have also been some adverse movements at the state legislative level, such as efforts to ban ethanol in New Hampshire, labeling concerns in Nebraska and a repeal threat of the Florida renewable fuels standard. Also, although a federal court judge ruled in late 2011 that California's low carbon fuel standard violated the commerce clause of the Constitution, the ruling is being appealed, so there are still concerns regarding access of corn based ethanol to the California market, which is one of the largest U.S. markets for ethanol.
Perhaps the remaining most significant federal legislation supporting the ethanol and biofuels industry is the Energy Independence and Security Act of 2007. The Act provides for the increasing use of ethanol and other biofuels through the renewable fuels standards. There have been various waiver requests from those standards filed with the U.S. Environmental Protection Commission, as well as calls for reductions in, or the repeal of, those standards. The EPA did announce in mid-November 2012 that the first of those requests did not meet the statutory threshold for the evidence necessary to grant the request. Additional waiver requests and continued efforts by some to extend the period of time for complying with the renewable fuels standards, or for reductions in or the repeal of those standards, are, however, expected. Any such actions would have adverse effects on the ethanol industry, which could be material, in particular any repeal of, or reductions in, those standards.
Changes in governmental policies and support, as well as supply and demand factors, therefore continue to be ongoing risk factors for the ethanol industry and for Lincolnway Energy.
Critical Accounting Estimates and Accounting Policies
Lincolnway Energy's financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which Lincolnway Energy operates. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of Lincolnway Energy's financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.
Revenue Recognition
Revenue from the sale of Lincolnway Energy's ethanol and distiller's grains is recognized at the time title and all risks of ownership transfer to the customers. This generally occurs upon the loading of the product. For ethanol, title passes from Lincolnway Energy at the time the product crosses the loading flange in either a railcar or truck. For distiller's grains, title passes upon the loading of distiller's grains into trucks. For railcar shipments, this takes place when the railcar is filled and the marketer receives written notice that the railcars have been loaded and are available for billing. Shipping and handling costs incurred by Lincolnway Energy for the sale of ethanol and distiller's grain are included in costs of goods sold.
Lincolnway Energy's ethanol production is sold to Green Plains Trade Group LLC, as is discussed above in the "Overview" section of this Item. The purchase price payable to Lincolnway Energy under its agreement with Green Plains is Green Plains' contract selling price for the ethanol in question, less various costs and a fee to Green Plains, but the agreement includes a minimum purchase price.
Lincolnway Energy's distiller's grain production is sold to Hawkeye Gold, LLC. Since August 12, 2012, Lincolnway Energy pays Hawkeye Gold, LLC a marketing fee for dried distiller's grains of set percentage of the FOB plant price for the dried distiller's grain, but with both a maximum and a minimum per short ton fee. The marketing fee for wet distiller's grains is currently also a set percentage of the FOB plant price for the wet distiller's grains, but with a maximum per short ton fee. The fee prior to August 12, 2012 for both dry and wet distiller's grains was the greater of a set percentage of the FOB plant price or a fixed dollar amount per ton.
Lincolnway Energy's corn oil production is sold to FEC Solutions, LLC. For corn oil, title passes upon the loading of the corn oil into the trucks. The purchase price payable by FECS for each shipment of corn oil is the FOB sales price less a marketing and technical assistance fee in an amount equal to a specified percentage of the FOB sales price.
Lincolnway Energy's CO2 production is sold to EPCO Carbon Dioxide Products, Inc. For CO2, title passes at the point at which the carbon dioxide pipe from Lincolnway Energy's plant joins the corresponding pipe from the EPCO plant. The purchase price payable by EPCO for the carbon dioxide provided by Lincolnway Energy during each calendar month is based upon EPCO's shipped tons of liquid carbon dioxide. EPCO is under the agreement to purchase, during each contract year, a minimum of the greater of 180 shipped tons per day or 70% of the annual liquid carbon dioxide production capacity of the EPCO plant at full capacity, with that capacity to be determined in accordance with the testing processes set out in the agreement. The "take or pay" obligation is trued up at the end of each contract year, and the purchase price for any "take or pay" tons will be the average per shipped ton purchase price paid by EPCO during the contract year. Lincolnway Energy began selling CO2 to EPCO in August 1, 2010.
Derivative Instruments
Lincolnway Energy enters into derivative contracts to hedge its exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. Lincolnway Energy does not typically enter into derivative instruments other than for hedging purposes. All the derivative contracts are recognized on the September 30, 2012, 2011 and 2010 balance sheets at fair value. Although Lincolnway Energy believes Lincolnway Energy's derivative positions are economic hedges, none has been designated as a hedge for accounting purposes. Accordingly, any realized or unrealized gain or loss related to these derivative instruments is recorded in the statement of operations as a component of cost of goods sold in the case of corn contracts and as a component of revenue in the case of ethanol sales.
The effects on operating income from derivatives is as follows for the years ending September 30, 2012, 2011 and 2010:
Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed "normal purchases and normal sales", and therefore are not marked to market in Lincolnway Energy's financial statements, but are subject to a lower of cost or market assessment.
Inventories
Inventories are stated at the lower of cost or market using the first-in, first-out method. In the valuation of inventories and purchase and sale commitments, market is based on current replacement values except that it does not exceed net realizable values and is not less than net realizable values reduced by allowances for approximate normal profit margin.
For the years ended September 30, 2012 and 2011, the Company recognized a reserve and resulting loss of $368,000 and none, respectively, for a lower of cost or market inventory adjustment.
Off-Balance Sheet Arrangements
Lincolnway Energy currently does not have any off-balance sheet arrangements.
Liquidity and Capital Resources
On September 30, 2012, Lincolnway Energy had $151,824 in cash and equivalents and $11.0 million available under committed loan agreements. Lincolnway Energy’s business is highly impacted by commodity prices, including prices for corn, ethanol and distillers grains. There are times that Lincolnway Energy may operate at negative operating margins.
The following table shows cash flows for the fiscal years ended September 30, 2012 and 2011:
For the fiscal year ended September 30, 2012, cash provided by operating activities was $1.6 million, compared to cash provided by operating activities of $5.4 million for the fiscal year ended September 30, 2011. The $3.8 million decrease is primarily due to a decrease in net income for fiscal year 2012 of $7.6 million offset by changes in working capital components of $3.8 million.
Cash flows from investing activities reflect the impact of property and equipment acquired for the ethanol plant. Net cash provided by investing activities increased by $3.0 million for the fiscal year ended September 30, 2012, when compared to the fiscal year ended September 30, 2011. The increase is primarily due to a decrease of capital expenditures for the fiscal year 2012 and the proceeds received from the sale of property to DuPont Danisco Cellulosic Ethanol, LLC. In the fiscal year 2011, the rail spur addition made up approximately $2.5 million of the capital expenditures.
Cash flows from financing activities include transactions and events whereby cash is obtained or paid back to or from depositors, creditors or investors. Net cash used in financing activities decreased by $3.7 million for the fiscal year ended September 30, 2012, when compared to the fiscal year ended September 30, 2011. The decrease is due to a decrease of $4.8 million of payments made on long-term borrowings for the fiscal year ended September 30, 2012 compared to the 2011 fiscal year. This is offset by the $1.1 million in distribution payments made in fiscal year 2012 to Lincolnway Energy members.
Lincolnway Energy anticipates keeping cash balances at a low but acceptable level that will meet covenants. If Lincolnway Energy should get in a negative cash position, Lincolnway Energy will having access to the $11.0 million line available on the line of credit agreements.
As of September 30, 2012, Lincolnway Energy was in compliance with all covenants in its loan agreements with Farm Credit.
The following table shows cash flows for the fiscal years ended September 30, 2011 and 2010:
For the fiscal year ended September 30, 2011, cash provided by operating activities was $5.4 million, compared to cash provided by operating activities of $8.8 million for the fiscal year ended September 30, 2010. The $3.4 million decrease is primarily due to a decrease in net income for fiscal year 2011 of $3.4 million.
Cash flows from investing activities reflect the impact of property and equipment acquired for the ethanol plant. Net cash used in investing activities increased by $2.0 million for the fiscal year ended September 30, 2011, when compared to the fiscal year ended September 30, 2010. The increase is primarily due to an increase of capital expenditures for the fiscal year 2011. The rail spur addition makes up approximately $2.5 million of the capital expenditures for the fiscal year 2011.
Cash flows from financing activities include transactions and events whereby cash is obtained or paid back to or from depositors, creditors or investors. Net cash used in financing activities decreased by $5.6 million for the fiscal year ended September 30, 2011, when compared to the fiscal year ended September 30, 2010. The decrease is due to no distribution payments being made in fiscal year 2011 to Lincolnway Energy members and a decrease of $3.5 million of additional payments made on long-term borrowing compared to the 2010 fiscal year.
As of September 30, 2011, Lincolnway Energy was in compliance with all covenants in its loan agreements with Co-Bank.
Loans and Agreements
Lincolnway Energy entered into a Master Loan Agreement on August 20, 2012 with Farm Credit Services of America, FLCA and Farm Credit Services of America, PCA, along with various related supplements and collateral related agreements and documents. CoBank, ACB has a participation interest in the underlying loans and serves as administrative agent for the loans, and is therefore also a party to some of the agreements and documents.
One of the supplements is a Revolving Term Loan Supplement, pursuant to which Lincolnway Energy may borrow, repay and reborrow up to $5,000,000 in principal amount at any one time. The revolving term loan is used to provide working capital and to consolidate under the revolving term loan the remaining $1,500,000 that was outstanding under Lincolnway Energy's Construction and Term Loan Supplement dated March 24, 2005. Lincolnway Energy pays interest on the unpaid balance of the revolving term loan at a variable rate (adjusting on a weekly basis) based upon the one-month LIBOR index rate plus 3.50%. Lincolnway Energy must also pay a commitment fee on the average daily unused portion of the loan at the rate of .60% per annum, payable monthly. The revolving term loan commitment will expire, and Lincolnway Energy must pay all unpaid principal amounts outstanding under the revolving term loan, on June 1, 2017.
The other supplement entered into pursuant to the Master Loan Agreement is a Monitored Revolving Credit Supplement, pursuant to which Lincolnway Energy may borrow, repay and reborrow up to $10,000,000 in principal at any one time, provided that the amount available and outstanding under the loan cannot exceed the borrowing base as calculated pursuant to the supplement. The purpose of the loan is to finance inventory and receivables, and the assets included in the borrowing base calculation are therefore primarily inventory and receivables of Lincolnway Energy. Lincolnway Energy will pay interest on the unpaid balance of the loan at a variable rate (adjusting on a weekly basis) based upon the one-month LIBOR index rate plus 3.25%. Lincolnway Energy will also pay a commitment fee on the average daily unused portion of the loan at the rate of .30% per annum, payable monthly. The term of the loan will expire, and Lincolnway Energy must pay all unpaid principal amounts outstanding under the loan, on July 1, 2013.
The loan available under the Monitored Revolving Credit Supplement will replace the $10,000,000 that was available under Lincolnway Energy's existing $10,000,000 revolving term loan with Farm Credit and CoBank.
The aggregate increase in amount of principal available to Lincolnway Energy under the Master Loan Agreement from Lincolnway Energy's existing loan agreements is $3.5 million.
The loans are secured by first priority liens created by security agreements and mortgages covering all of Lincolnway Energy's assets and properties, including Lincolnway Energy's inventory, receivables, plant, real estate and commodity trading accounts.
The Master Loan Agreement includes various conditions and financial covenants that need to be met by Lincolnway Energy, as well as other terms and covenants generally common to loan transactions of this type within the ethanol industry. Lincolnway Energy is also required to pay an annual fee of $4,500 under the Master Loan Agreement.
Lincolnway Energy also had subordinated debt financing which included a subordinated note of $1,250,000 payable to Fagen, Inc., with an interest rate of 4%, and a $1,216,781 note payable to Fagen, Inc., with an interest rate of 5% per annum. On August 26, 2011, Fagen, Inc. allowed Lincolnway Energy to pay the $1,216,781 note in full before it maturity. Lincolnway Energy and Fagen entered into a settlement agreement on November 10, 2011 to settle disputes related to the liability with the State of Iowa alleged air emission violations against Lincolnway Energy. The settlement agreement reduced the $1,250,000 promissory note payable to Fagen, Inc., by $270,000, leaving a balance of $980,000. On November 14, 2011, Lincolnway Energy was required to repay $300,000 of the note plus accrued interest and on December 14, 2011, Lincolnway Energy was required to make the remaining payment of $680,000 plus accrued interest.
Lincolnway Energy also entered into a $500,000 loan agreement with the Iowa Department of Transportation in February 2005. Under the agreement, the loan proceeds were disbursed upon submission of paid invoices and interest at 2.11% per annum began to accrue on January 1, 2007. Payments began on July 1, 2007. The remaining loan balance on the Department of Transportation loan was $238,021 as of September 30, 2012. Lincolnway Energy also had a $300,000 loan agreement and a $100,000 forgivable loan agreement with the Iowa Department of Economic Development. The $300,000 loan did not impose any interest, and the $100,000 loan was forgivable upon the completion of Lincolnway Energy's ethanol plant and the production of at least 50 million gallons of ethanol before the project completion date of October 31, 2008. The Iowa Department of Economic Development determined those conditions to forgiveness of the $100,000 loan were met, and the loan was forgiven on January 22, 2009. Lincolnway Energy made the final payment on the Iowa Department of Economic Development loan on October 5, 2011.
Lincolnway Energy entered into a lease agreement with First Union Rail to lease 90 hopper rail cars for the purpose of transporting distiller’s grain. The initial five-year term of the lease commenced March 2006 and ended March 2011, but the lease was extended to March 2014 by a rider. The rider calls for monthly payments of $56,700 plus applicable taxes. The rider also established an additional usage rental of 2.5 cents per mile for each car that exceeds 30,000 miles. Lincolnway Energy is required to maintain a certificate of deposit of $351,000 as partial security for Lincolnway Energy's obligation under the lease. Lincolnway Energy has classified this certificate of deposit as restricted cash in other assets.
Lincolnway Energy terminated its ethanol marketing agreement with RPMG, Inc. effective October 1, 2009, and as part of that process, Lincolnway Energy was assigned a railcar lease between RPMG, Inc. and Trinity Industries Leasing Company. The lease includes 100 tank rail cars used for transporting ethanol. The lease calls for monthly payments of $52,500 plus applicable taxes, beginning October 1, 2009. There is also an additional usage rental of 3 cents per mile for each car that exceeds 35,000 miles. The lease has a scheduled maturity date of September 2016.
On February 2, 2010, Lincolnway Energy entered into a lease agreement with an Trinity Industries Leasing Company to lease an additional 30 ethanol tank rail cars. The one-year term of the lease ended on February 2011. On March 8, 2011 Lincolnway Energy extended this lease with two riders for 15 railcars each. Each rider calls for monthly payments of $9,750 plus applicable taxes. There was also an additional usage rental of 3 cents per mile for each car that exceeds 30,000 miles. The lease term on the riders is for three years commencing March 2011 and expiring March 2014.
Lincolnway Energy entered into a Purchase and Sale Agreement with DuPont Danisco Cellulosic Ethanol, LLC ("DDCE") on June 23, 2011 pursuant to which DDCE would, subject to the satisfaction of the various contingencies set out in the Agreement, purchase certain real estate from Lincolnway Energy for the purpose of DDCE constructing a cellulosic or advanced biofuels plant on the real estate. The contingencies under the agreement were satisfied, and the closing of the sale and purchase of the real estate occurred on October 5, 2011. The real estate purchased by DDCE was approximately 59.05 acres and is located to the southwest of the real estate on which Lincolnway Energy's ethanol plant is located. The purchase price paid by DDCE under the agreement was $20,000 per acre, resulting in an aggregate purchase price to Lincolnway Energy of $1,181,000.
Lincolnway Energy and DDCE also entered into a Load Out Services Agreement. The Load Out Services Agreement provides, in general, that DDCE will construct an aboveground pipeline from DDCE's plant to a holding tank on Lincolnway Energy's property, and that Lincolnway Energy will load out DDCE's product at Lincolnway Energy's rail or truck facilities. The Load Out Services Agreement sets forth the various fees and other amounts that DDCE will pay to Lincolnway Energy for those services, as well as allocating various costs and expenses between Lincolnway Energy and DDCE. The Load Out Services Agreement provides that if it is terminated, then Lincolnway Energy will grant DDCE an easement for the purpose of DDCE constructing its own rail tracks, and that Lincolnway Energy and DDCE will also at that time enter into a track usage agreement which will address how Lincolnway Energy and DDCE will jointly use certain tracks of Lincolnway Energy and other related matters. The initial term of the Load Out Services Agreement is ten years from the date of the Load Out Services Agreement, which was October 4, 2011. DDCE currently contemplates commencing construction of its plant in the second calendar quarter of 2013, with an estimated start-up date of the fourth calendar quarter of 2014.
Contractual Obligations Table
In addition to long-term debt obligations, Lincolnway Energy has certain other contractual cash obligations and commitments. The following tables provide information regarding Lincolnway Energy's contractual obligations and commitments as of September 30, 2012:
1 Department of Transportation agreement at 2.11%
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
In addition to the risks inherent in the ethanol industry and Lincolnway Energy's operation, Lincolnway Energy is exposed to various market risks. The primary market risks arise as a result of possible changes in interest rates and certain commodity prices.
Interest Rate Risk
Lincolnway Energy has various outstanding loan agreements and promissory notes that expose Lincolnway Energy to market risk related to changes in the interest rate imposed under those loan agreements and promissory notes.
Lincolnway Energy has loan agreements and/or promissory notes with the following entities, and with the principal balance and interest rates indicated:
The interest rate under the IA. Department of Transportation loan agreement is fixed at the interest rates specified above. The interest rate on the Farm Credit monitored revolving credit loan is a variable interest rate loan bases on the one-month LIBOR index rate plus 3.25%, adjusting weekly. The interest rate on the Farm Credit revolving term loan is a variable interest rate based on the one-month LIBOR index plus 3.50% adjusted weekly. For more information on the payments see Item 7 - Loans and Agreements.
Lincolnway Energy does not anticipate any material increase in interest rates during 2013.
Commodity Price Risk
Lincolnway Energy is also exposed to market risk with respect to the price of ethanol, Lincolnway Energy's principal product, and the price and availability of corn, the principal commodity used by Lincolnway Energy to produce ethanol, and coal. The other primary product of Lincolnway Energy is distiller's grains, and Lincolnway Energy is also subject to market risk with respect to the price for distillers grains. The prices for ethanol, distillers' grains, corn and coal are volatile, and Lincolnway Energy will experience market conditions where the prices Lincolnway Energy receives for its ethanol and distillers' grains are declining, but the price Lincolnway Energy pays for its corn, coal and other inputs is increasing. Lincolnway Energy's results will therefore vary substantially over time, and include the possibility of losses, which could be substantial.
In general, rising ethanol and distillers grains prices result in higher profit margins, and therefore represent favorable market conditions. Lincolnway Energy is, however, subject to various material risks related to its production of ethanol and distillers' grains and the price for ethanol and distillers' grains. For example, ethanol and distillers grains prices are influenced by various factors beyond the control of Lincolnway Energy's management, including the supply and demand for gasoline, the availability of substitutes and the effect of laws and regulations.
In general, rising corn prices result in lower profit margins and, accordingly, represent unfavorable market conditions. Lincolnway Energy will generally not be able to pass along increased corn costs to its ethanol customers. Lincolnway Energy is subject to various material risks related to the availability and price of corn, many of which are beyond the control of Lincolnway Energy. For example, the availability and price of corn is subject to wide fluctuations due to various unpredictable factors which are beyond the control of Lincolnway Energy's management, including weather conditions, crop yields, farmer planting decisions, governmental policies with respect to agriculture and local, regional, national and international trade, demand and supply.
If Lincolnway Energy's corn costs were to increase $.10 cents per bushel from one year to the next, the impact on cost of goods sold would be approximately $1.98 million for the year.
Lincolnway Energy's average corn costs for the fiscal years ended September 30, 2012, 2011 and 2010 were, respectively, approximately $6.62 per bushel, $6.34 per bushel and $3.59 per bushel.
During the fiscal year ended September 30, 2012, corn prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $5.50 per bushel in June 2012 to a high of $8.49 per bushel in August 2012. The corn prices based on the Chicago Mercantile Exchange daily futures data during the fiscal year ended September 30, 2011 ranged from a low of $4.65 per bushel to a high of $7.87 per bushel.
The average price Lincolnway Energy received for its ethanol during the fiscal year ended September 30, 2012 was approximately $2.29 per gallon, as compared to $2.45 per gallon and $1.72 during, respectively, the fiscal years ended September 30, 2011 and 2010.
During the fiscal year ended September 30, 2012, ethanol prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $1.975 per gallon in June 2012 to a high of $2.79 per gallon in November 2011. The ethanol price based on the Chicago Mercantile Exchange daily futures data during the fiscal year ended September 30, 2011, ranged from a low of $1.90 per gallon in September 2010, to a high of $3.07 in July 2011.
Lincolnway Energy may from time to time take various cash, futures, options or other positions with respect to its corn and ethanol needs in an attempt to minimize or reduce Lincolnway Energy's price risks related to corn and ethanol. Those activities are, however, also subject to various material risks, including that price movements in the cash and futures corn and ethanol markets are highly volatile and influenced by many factors and occurrences that are beyond the control of Lincolnway Energy.
Although Lincolnway Energy intends that its futures and option positions accomplish an economic hedge against Lincolnway Energy's future purchases of corn or future sales of ethanol, Lincolnway Energy has chosen not to use hedge accounting for those positions, which would match the gain or loss on the positions to the specific commodity purchase being hedged. Lincolnway Energy is instead using fair value accounting for the positions, which generally means that as the current market price of the positions changes, the realized or unrealized gains and losses are immediately recognized in Lincolnway Energy's costs of goods sold in the statement of operations for corn positions or as a component of revenue in the statement of operations for ethanol positions. The immediate recognition of gains and losses on those positions can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the positions relative to the cost and use of the commodity being hedged. For example, Lincolnway Energy's corn position gain and (loss) that was included in its earnings for the fiscal year ended September 30, 2012 was a loss of $1,000,438, as opposed to a loss of $2,990,263 for the fiscal year ended September 30, 2011, and as opposed to a gain of $1,453,950 for the fiscal year ended September 30, 2010. Lincolnway Energy's ethanol position gain and (loss) that was included in its earnings for the fiscal year ended September 30, 2012 was a loss of $7,308, as compared to a loss of $1,126,667 for the fiscal year ended September 30, 2011, and as opposed to a loss of $1,438,563 for the fiscal year ended September 30, 2010.
The extent to which Lincolnway Energy may enter into arrangements with respect to its ethanol or corn during the year may vary substantially from time to time based upon a number of factors, including supply and demand factors affecting the needs of customers to purchase ethanol or suppliers to sell Lincolnway Energy raw materials on a fixed price basis, and Lincolnway Energy's views as to future market trends, seasonal factors and the cost of future contracts.
Another important raw material for the production of Lincolnway Energy's ethanol is coal. Lincolnway Energy's cost per ton for coal under its current coal supply agreement is subject to various fixed and periodic adjustments based on factors which are outside of the control of Lincolnway Energy's management. The factors include changes in certain inflation type indices, increases in transportation costs and the quality of the coal. Lincolnway Energy's coal costs will therefore vary, and the variations could be material. Coal costs represented approximately 4.4% of Lincolnway Energy's total cost of goods sold for the fiscal year ended September 30, 2012, compared to, respectively, 4.3% and 6% for the 2011 and 2010 fiscal years.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Members
Lincolnway Energy, LLC
We have audited the accompanying balance sheets of Lincolnway Energy, LLC as of September 30, 2012 and 2011, and the related statements of operations, members' equity, and cash flows for each of the three years in the period ended September 30, 2012. 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits 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 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 Lincolnway Energy, LLC as of September 30 , 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended September 30 , 2012, in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey LLP
Des Moines, Iowa
December 21, 2012
Lincolnway Energy, LLC
Balance Sheets
September 30, 2012 and 2011
See Notes to Financial Statements.
Lincolnway Energy, LLC
Balance Sheets (Continued)
September 30, 2012 and 2011
Lincolnway Energy, LLC
Statements of Operations
Years Ended September 30, 2012, 2011 and 2010
See Notes to Financial Statements.
Lincolnway Energy, LLC
Statements of Members' Equity
Years Ended September 30, 2012, 2011 and 2010
See Notes to Financial Statements.
Lincolnway Energy, LLC
Statements of Cash Flows
Years Ended September 30, 2012, 2011 and 2010
Lincolnway Energy, LLC
Statements of Cash Flows (Continued)
Years Ended September 30, 2012, 2011 and 2010
See Notes to Financial Statements.
Lincolnway Energy, LLC
Notes to Financial Statements
Note 1. Nature of Business and Significant Accounting Policies
Principal business activity: Lincolnway Energy, LLC (the Company), located in Nevada, Iowa, was formed in May 2004 to pool investors to build a 50 million gallon annual production dry mill corn-based ethanol plant. The Company began making sales on May 30, 2006 and became operational during the quarter ended June 30, 2006. The Company is directly influenced by commodity markets and the agricultural and energy industries and, accordingly, its results of operations and financial condition may be significantly affected by cyclical market trends and the regulatory, political and economic conditions in these industries.
A summary of significant accounting policies follows:
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.
Concentration of credit risk: The Company’s cash balances are maintained in bank deposit accounts which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts.
Cash and cash equivalents: For the purposes of reporting the statement of cash flows, the Company includes as cash equivalents all cash accounts and highly liquid debt instruments which are not subject to withdrawal restrictions or penalties. Certificates of deposit are considered investments as all have been purchased with maturities in excess of ninety days. Although the Company maintains its cash accounts in one bank, the Company believes it is not exposed to any significant credit risk on cash and cash equivalents. The Company has repurchase agreements with one bank, which totaled approximately $175,469 at September 30, 2012. In accordance with the terms of the repurchase agreements, the Company does not take possession of the related securities. The Company’s agreements also contain provisions to ensure that the market value of the underlying assets remain sufficient to protect the Company in the event of default by the banks by requiring that the underlying securities have a total market value of at least 100% of the bank’s total obligations under the agreements.
Trade accounts receivable: Trade accounts receivable are recorded at original invoice amounts less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering customers financial condition, credit history and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of receivables written off are recorded when received. A receivable is considered past due if any portion of the receivable is outstanding more than 90 days.
Inventories: Inventories are stated at the lower of cost or market using the first-in, first-out method. In the valuation of inventories and purchase and sale commitments, market is based on current replacement values except that it does not exceed net realizable values and is not less than net realizable values reduced by allowances for approximate normal profit margin.
Financing costs: Financing costs are recorded at cost and include expenditures directly related to securing debt financing. The Company is amortizing these costs using the effective interest method over the term of the agreement. The financing costs are included in interest expense on the statement of operations.
Property and equipment: Property and equipment is stated at cost. Construction in progress is comprised of costs related to the projects that are not completed. Depreciation is computed using the straight-line method over the following estimated useful lives:
Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized.
Investments: The Company has investments in financial service cooperatives. These investments are carried at cost including allocated retained earnings of the cooperatives.
Derivative financial instruments: The Company enters into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. The Company does not typically enter into derivative instruments other than for hedging purposes. All the derivative contracts are recognized on the balance sheet at their fair market value. Although the Company believes its derivative positions are economic hedges, none have been designated as a hedge for accounting purposes. Accordingly, any realized or unrealized gain or loss related to corn derivatives is recorded in the statement of operations as a component of cost of goods sold. Any realized or unrealized gain or loss related to ethanol derivative instruments is recorded in the statement of operations as a component of revenue. The Company reports all contracts with the same counter party on a net basis on the balance sheet.
Deposit: The Internal Revenue Service (under Section 7519) requires partnerships that elect a fiscal year over a calendar year to make a deposit each year. The deposit is 25% of annual taxable net income, multiplied by the tax rate of 36% for the reporting fiscal year.
Revenue recognition: Revenue from the sale of the Company’s ethanol and distillers grains is recognized at the time title and all risks of ownership transfer to the customers. This generally occurs upon the loading of the product. For ethanol, title passes at the time the product crosses the loading flange in either a railcar or truck. For distiller’s grain, title passes upon the loading into trucks. For railcar shipments, this takes place when the railcar is filled and the marketer receives written notice that they have been loaded and are available for billing. Shipping and handling costs incurred by the Company for the sale of ethanol and distiller’s grain are included in costs of goods sold. Commissions for the marketing and sale of ethanol and distiller grains are included in costs of goods sold.
Revenue by product is as follows:
(Excludes hedging activity)
Income taxes: The Company is organized as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, the Company’s earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements. Management has evaluated the Company's material tax positions and determined there were no uncertain tax positions that require adjustment to the financial statements. The Company does not currently anticipate significant changes in its uncertain tax positions over the next 12 months. Generally, the Company remains subject to income tax examinations by U.S. federal or state tax authorities for fiscal years 2009 and thereafter.
Earnings per unit: Basic and diluted earnings per unit have been computed on the basis of the weighted average number of units outstanding during each period presented.
Fair value of financial instruments: The carrying amounts of cash and cash equivalents, derivative financial instruments, trade accounts receivable, accounts payable and accrued expenses approximate fair value. The carrying amount of long-term debt approximates fair value because the interest rates are based on current rates offered to the Company for debt with similar terms and maturities.
Reclassification: Certain amounts in the 2011 balance sheet have been reclassified to be consistent with their 2012 presentation with no effect on net income.
Note 2. Members' Equity
The Company was formed on May 19, 2004. It was initially capitalized by the issuance of 1,924 membership units totaling $962,000 to the founding members of the Company. The Company has one class of membership units. A majority of the Board of Directors owns a membership interest in the Company. The Company is authorized to issue up to 45,608 membership units without member approval.
Income and losses are allocated to all members based on their pro rata ownership interest. All unit transfers are effective the last day of the month. Units may be issued or transferred only to persons eligible to be members of the Company and only in compliance with the provisions of the operating agreement.
The Company is organized as an Iowa limited liability company. Members' liability is limited as specified in the Company's operating agreement and pursuant to the Iowa Limited Liability Company Act. The duration of the Company shall be perpetual unless dissolved as provided in the operating agreement.
Note 3. Inventories
Inventories consist of the following as of September 30, 2012 and 2011:
For the years ended September 30, 2012 and 2011, the Company recognized a reserve and resulting loss of $368,000 and none, respectively, for a lower of cost or market inventory adjustment.
Note 4. Revolving Credit Loan
The Company entered into a new master loan agreement with a financial institution on August 20, 2012. One of the supplements of the agreement is a monitored revolving credit loan for up to $10,000,000. The amount available and outstanding under the loan cannot exceed the borrowing base as calculated per the agreement (approximately $9,400,000 as of September 30, 2012). The purpose of the loan is to finance inventory and receivables. The Company will pay interest monthly on the unpaid balance at a variable rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate plus 3.25%. The Company will also pay a commitment fee on the average daily unused portion of the loan at the rate of .30% per annum, payable monthly. The term of the loan will expire, and the Company must pay all unpaid principal amounts outstanding under the loan, on July 1, 2013. The loan is secured by substantially all assets of the Company and subject to certain financial and nonfinancial covenants as defined in the master loan agreement. There was a balance of $200,000 outstanding as of September 30, 2012.
Note 5. Long-Term Debt
Long-term debt consists of the following as of September 30, 2012 and 2011
Maturities of long-term debt as of September 30, 2012 are as follows:
(A)
The Company had a construction and term loan with a financial institution. Borrowings under the term loan included a variable interest rate based on the one-month LIBOR index rate plus 3.30%. The rate was reset automatically without notice to the Company, on the first “US Banking Day” of each succeeding week, and each change was applicable to all outstanding balances as of that date. The agreement required 30 principal payments of $1,250,000 per quarter commencing in December 2006 through March 2013. The agreement required the maintenance of certain financial and nonfinancial covenants. Borrowings under this agreement were collateralized by substantially all of the Company’s assets. On August 20, 2012, the $1,500,000 balance remaining on this loan was consolidated under the revolving term loan, described in (C) below, and this construction term loan was closed.
(B)
The Company had a $10,000,000 construction/revolving term credit facility with a financial institution which would expire on September 1, 2016. Borrowings under the credit facility agreement included a variable interest rate based on the one-month LIBOR index rate plus 3.30%. The rate was reset automatically without notice to the Company, on the first “US Banking Day” of each succeeding week, and each change was applicable to all outstanding balances as of that date. Borrowings were subject to borrowing base restrictions as defined in the agreement. The credit facility and revolving credit agreement required the maintenance of certain financial and nonfinancial covenants. Borrowings under this agreement were collateralized by substantially all of the Company’s assets. This credit facility was replaced with the revolving term loan, described in (C) below.
(C)
The Company entered into a new master loan agreement with a financial institution on August 20, 2012. One of the supplements of the agreement is a revolving term loan available for up to $5,000,000. The revolving term loan is to be used to provide working capital and to consolidate under the revolving term loan the remaining $1,500,000 that is outstanding under the construction term loan (A). The Company will pay interest on the unpaid balance at a variable interest rate (adjusted on a weekly basis) based upon the one-month LIBOR index rate plus 3.50%. The Company will also pay a commitment fee on the average daily unused portion of the loan at the rate of .60% per annum, payable monthly. The loan is secured by substantially all assets of the Company and subject to certain financial and nonfinancial covenants as defined in the master loan agreement. The term of the loan will expire, and the Company must pay all unpaid principal amounts outstanding under the revolving term loan, on June 1, 2017.
(D)
The Company also had a $300,000 loan agreement with the Iowa Department of Economic Development (IDED). The $300,000 loan was noninterest-bearing and due in monthly payments of $2,500 beginning December 2006 and a final payment of $152,500 due November 2011. Borrowings under this agreement were collateralized by substantially all of the Company’s assets and subordinate to the above financial institution debt and construction and revolving loan/credit agreements included in (A) and (B). On October 5, 2011, the final payment of $152,500 was made by the Company.
(E)
The Company entered into a $500,000 loan agreement with the Iowa Department of Transportation (IDOT) in February 2005. The proceeds were disbursed upon submission of paid invoices. Interest at 2.11% began accruing on January 1, 2007. Principal payments will be due semiannually through July 2016. The loan is secured by all rail track material constructed as part of the plant construction. The debt is subordinate to the above financial institution debt and construction and revolving loan/credit agreements included in (C) and Note 4.
Note 6. Lease Commitments
The Company entered into a lease agreement with an unrelated third party to lease 90 hopper rail cars for the purpose of transporting distiller’s grain. The five-year term of the lease commenced March 2006 and ended March 2011. On March 26, 2011 the Company extended this lease with a rider. The rider calls for monthly payments of $56,700 plus applicable taxes. There was also an additional usage rental of 2.5 cents per mile for each car that exceeds 30,000 miles. The amendment that was made to the lease agreement on June 19, 2007, allowed the Company to purchase a certificate of deposit for $351,000 in lieu of the letter of credit that was required as partial security for the Company’s obligation under the lease. The Company has classified this certificate of deposit as restricted cash in other assets. The lease term on the rider is for three years commencing March 2011 and expiring March 2014. In conjunction with a change in the Company’s ethanol marketer, on September 21, 2009, the Company was assigned a lease that was previously between the Company’s previous ethanol marketer and an unrelated third party. The lease includes 100 tank rail cars for the purpose of transporting ethanol. The lease calls for monthly payments of $52,500 plus applicable taxes, beginning October 1, 2009. There is also an additional usage rental of 3 cents per mile for each car that exceeds 35,000 miles. The lease has an expiration date of September 2016.
On February 2, 2010, the Company entered into a lease agreement with an unrelated third party to lease an additional 30 ethanol tank rail cars. The one-year term of the lease ended on February 2011. On March 8, 2011 the Company extended this lease with two riders for 15 railcars each. Each rider calls for monthly payments of $9,750 plus applicable taxes. There was also an additional usage rental of 3 cents per mile for each car that exceeds 30,000 miles. The lease term on the riders is for three years commencing March 2011 and expiring March 2014.
The Company also leases office equipment and other equipment under operating leases that will expire at various dates through June 2015.
Approximate minimum lease payments under these operating leases for future years are as follows:
Rent expense under the above operating leases totaled approximately, $1,890,000, $1,745,000 and $1,597,000 for the years ended September 30, 2012, 2011 and 2010, respectively.
Note 7. Related-Party Transactions
The Company has an agreement with the Heart of Iowa Coop (HOIC), dba Key Cooperative, a member of the Company, to provide 100% of the requirement of corn for use in the operation of the ethanol plant. The agreement became effective when the Company began accepting corn for the use at the ethanol plant in May 2006 and will continue for a period of 20 years. The Company pays a handling fee of $.0675 per bushel of corn. If the Company chooses to buy corn that is not elevated by HOIC, and is inside a 60-mile radius of Nevada, Iowa, the Company will be required to pay HOIC $.04 per bushel of corn, outside a 60-mile radius, $.03 per bushel of corn. The agreement may be terminated before the end of the term by providing six months’ notice of termination and paying the other party $2,000,000, reduced by $50,000 for each completed year of the agreement. The amount is payable over four years with interest at the prime rate on the date of termination. The Company purchased corn totaling $128,490,494, $127,764,206 and $71,804,446 for the years ended September 30, 2012, 2011 and 2010, respectively.
As of September 30, 2012, the Company has a corn cash forward contract with HOIC amounting to 588,585 bushels, for a commitment of approximately $4,343,755 and several basis forward contracts representing 1,350,000 bushels of corn. The contracts mature on various dates through December 2012. The Company also has made miscellaneous purchases from HOIC amounting to $200,610, $84,739 and $96,392 for the years ended September 30, 2012, 2011 and 2010, respectively. The 2012 purchases include $117,562 in grain storage fees. As of September 30, 2012 and 2011 the amount due to HOIC is $829,067 and $1,179,981, respectively.
On April 10, 2012, the Company delivered notice to HOIC to terminate the Amended and Restated Grain Handling Agreement they hold with HOIC. The termination of the agreement will be effective January 10, 2013. The Company will begin to originate corn in house at the time of termination. The Company recorded a termination cost of $1,700,000 as required under the agreement, which was expensed for the quarter ending June 30, 2012. Payments of $425,000 will be made annually over a four year period with interest at the prime rate on the date of termination.
The Company is also purchasing propane and anhydrous ammonia from Innovative Ag Services (IAS), a member of the Company. Total purchases for the years ended September 30, 2012, 2011 and 2010 were $170,878, $16,402 and $21,714, respectively.
Note 8. Commitments and Major Customer and Subsequent Event
On September 25, 2009, the Company entered into an agreement with an unrelated entity. The agreement became effective on October 1, 2009. The unrelated entity is responsible for marketing and purchasing all of the ethanol produced by the company. For the years ended September 30, 2012, 2011 and 2010, the Company has expensed $690,664, $712,258 and $695,945, under this agreement for marketing fees, respectively. Revenues with this customer were $126,439,534, $139,535,766 and $94,611,865 for the years ended September 30, 2012, 2011 and 2010, respectively. Trade accounts receivable of $6,778,356 and $6,129,247 was due from the customer as of September 30, 2012 and 2011 respectively. As of September 30, 2012, the Company has ethanol sales commitments with the unrelated entity of 5,380,000 gallons through December 2012. The sales price is approximately 10 cents under the monthly average OPIS-Chicago index price.
Subsequent to year end, the Company and unrelated party mutually agreed to terminate the ethanol marketing agreement effective December 31, 2012.
The Company has entered into an agreement with an unrelated entity for marketing, selling and distributing the distiller’s grain as of October 1, 2007. For the years ended September 30, 2012, 2011 and 2010, the Company has expensed marketing fees of $628,349, $535,226 and $295,353, respectively, under this agreement. Revenues with this customer were $38,564,213, $31,715,564 and $19,434,064 for the years ended September 30, 2012, 2011 and 2010, respectively. Trade accounts receivable of $2,064,496 and $1,083,695 was due from the customer as of September 30, 2012 and 2011, respectively. As of September 30, 2012, the Company has distiller’s grain sales commitments with the unrelated entity of 4,385 tons for a total sales commitment of approximately $1,176,418 less marketing fees.
The Company has an agreement with an unrelated party to provide the coal supply for the ethanol plant. The agreement includes the purchase of coal at a cost per ton and a transportation cost per ton as defined in the agreement. The cost is subject to price adjustments on a monthly basis. If the Company fails to purchase the minimum number of tons of coal for the calendar year , the Company shall pay an amount per ton multiplied by the difference of the minimum requirement and actual quantity purchased. That agreement expired as of January 1, 2008. On October 1, 2007 the Company entered into an amended agreement to the original coal supply agreement. The term of the agreement has been extended from the original expiration date to January 1, 2013. The same minimum purchase commitment is required from the Company as the previous agreement. The calendar year 2012 has a remaining estimated purchase commitment totaling approximately $89,702. For the years ended September 30, 2012, 2011 and 2010, the Company has purchased coal of $7,217,257, $7,001,676 and $5,989,438 respectively.
The Company has entered into a variable contract with a supplier of denaturant. The variable contract is for a minimum purchase of 216,000 gallons at the average of the OPIS Conway In-Well Natural Gasoline High and Low prices for the full calendar month of date of loading plus $0.1875 per net gallon. The term of the contract is from October 1, 2012 through December 31, 2012. The estimated future purchase commitment on this contract is approximately $470,297.
Note 9. Risk Management
The Company’s activities expose it to a variety of market risks, including the effects of changes in commodity prices. These financial exposures are monitored and managed by the Company as an integral part of its overall risk management program. The Company’s risk management program focuses on the unpredictability of commodity markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results.
The Company maintains a risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by market fluctuations. The Company’s specific goal is to protect the Company from large moves in the commodity costs.
To reduce price risk caused by market fluctuations, the Company generally follows a policy of using exchange-traded futures and options contracts to minimize its net position of merchandisable agricultural commodity inventories and forward purchases and sales contracts.
Exchange traded futures and options contracts are designated as non-hedge derivatives and are valued at market price with changes in market price recorded in operating income through cost of goods sold for corn derivatives and through revenue for ethanol derivatives.
Derivatives not designated as hedging instruments as of September 30, 2012 and 2011 are as follows:
The effects on operating income from derivative activities is as follows for the years ending September 30, are as follows:
Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales”, and therefore are not marked to market in the Company’s financial statements, but are subject to a lower of cost or market assessment.
Note 10. Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 Valuations for assets and liabilities traded in active markets from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities.
Level 3Valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
A description of the valuation methodologies used for instruments measured at fair value, including the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value.
Derivative financial instruments: Commodity futures and exchange-traded commodity options contracts are reported at fair value utilizing Level 1 inputs. For these contracts, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the CME and NYMEX markets. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the over-the-counter markets.
The following table summarizes the financial liabilities measured at fair value on a recurring basis as of September 30, 2012 and 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Note 11. Employee Benefit Plan
The Company adopted a 401(k) plan covering substantially all employees effective February 1, 2006. The Company provides matching contributions of 50% for up to 6% of employee compensation. Company contributions and plan expenses for the years ended September 30, 2012, 2011 and 2010 totaled $72,360, $65,495 and $69,069, respectively.
Note 12. Contingency
In May 2010, a lawsuit was filed against the Company and approximately twenty other ethanol plants, design firms and equipment manufacturers by an unrelated party claiming the Company’s operation of the corn oil extraction system is infringing at least one patent. The plaintiff seeks injunctive relief, an award of damages with interest and any other remedies available under certain patent statutes or otherwise under law. The Company is currently defending the lawsuit with legal counsel and has asserted various defenses including that it does not infringe and, further, that the patents are invalid. The Company is unable to determine at this time if the lawsuit will have a material adverse affect on the Company.
Note 13. Sale of Property
On October 5, 2011, the Company completed the sale of a land parcel adjacent to its primary site for a sales price of $1,181,000. A gain of $496,098 was recognized for the sale of property for the year ended September 30, 2012.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
Lincolnway Energy has not had any change in its accountants or any disagreements with its accountants which are required to be disclosed under this Item.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Lincolnway Energy's management, with the participation of Lincolnway Energy's chairman and chief financial officer, have evaluated the effectiveness of Lincolnway Energy's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this annual report. As a result of such evaluation, the chairman and the chief financial officer have concluded that such disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed in the reports Lincolnway Energy files or submits under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and (ii) accumulated and communicated to management, including Lincolnway Energy's principal executive and principal financial officers or persons performing such functions, as appropriate, to allow timely decisions regarding disclosure. Lincolnway Energy believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
Management's Annual Report on Internal Control Over Financial Reporting.
The management of Lincolnway Energy is responsible for establishing and maintaining adequate internal control over financial reporting for Lincolnway Energy. Lincolnway Energy's internal control system was designed to, in general, provide reasonable assurance to Lincolnway Energy's management and board regarding the preparation and fair presentation of published financial statements, but because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Lincolnway Energy's management assessed the effectiveness of Lincolnway Energy's internal control over financial reporting as of September 30, 2012. The framework used by management in making that assessment was the criteria set forth in the document entitled "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, Lincolnway Energy's management has determined that as of September 30, 2012, Lincolnway Energy's internal control over financial reporting was effective for the purposes for which it is intended.
An attestation report from Lincolnway Energy's accounting firm on Lincolnway Energy's internal control over financial reporting is not included in this annual report because an attestation report is only required under the regulations of the Securities and Exchange Commission for accelerated filers or large accelerated filers.
Changes in Internal Control over Financial Reporting
No change in Lincolnway Energy's internal control over financial reporting occurred during the fourth quarter of the fiscal year ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, Lincolnway Energy's internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Lincolnway Energy did not have any information that was required to be disclosed in a report on Form 8-K during the fourth quarter of the fiscal year ended September 30, 2012 that was not reported on a Form 8-K.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The directors and executive officers of Lincolnway Energy as of the date of this annual report were as follows:
An individual may be nominated for election as a director of Lincolnway Energy by the members of Lincolnway Energy in accordance with the procedures set out in the second amended and restated operating agreement, or by the nominating committee of the directors, with the recommendations of the nominating committee being subject to approval by the directors. The directors are elected by the members for three year terms, with the terms of the directors being staggered so that three directors are elected at each annual meeting. The vote by the members is generally done by a written ballot and without any discussion by the members.
Lincolnway Energy therefore does not know what specific experience, qualifications, attributes or skills of the current directors led any particular member or members to vote for any director. All of the current directors were, however, nominated by the nominating committee of the directors, and the nominating committee, and the directors in considering the recommendations of the nominating committee, considered the experience, qualifications, attributes or skills set out in the following paragraphs and in the following biographies of the directors in reaching the conclusion that the current directors should serve as a director and therefore be recommended to the members at the annual meetings of the members at which the directors were elected to their current respective three year terms.
One factor that was considered and that applies to each director is that each director has gained substantial experience, knowledge and background regarding Lincolnway Energy's operations and the ethanol industry in general through their service as a director of Lincolnway Energy. Seven of the current directors have served as a director since Lincolnway Energy was organized in May of 2004, and the other two directors have served since July 27, 2007.
Over that period of time, Lincolnway Energy, along with the ethanol industry in general and the economy as a whole, have experienced a wide range of political, economic and market circumstances, ranging from very favorable to very difficult circumstances. The current directors have therefore gained valuable background and experience over a diverse range of circumstances that do not always occur over just an eight year period of time.
Another factor that was considered and that applies to all of the directors is the training, educational and industry association opportunities that have been engaged in by the directors. For example the majority of directors have attended the Renewable Fuels Association annual conference and the Iowa Institute of Coops director training workshops. Those activities have given the directors additional experience and background both with respect to the ethanol industry and serving on the board of a company.
Another factor that was considered and that applies to each director is that each director has individual experience in operating a business through their own personal business endeavors that are discussed below. Each director has also evidenced a willingness and ability in their individual businesses to consider and pursue innovative or new approaches, as well as a willingness and ability to assume leadership roles in those businesses and industries, all of which are attributes that are helpful in an evolving and changing industry such as the ethanol industry. Another practical consideration is that each director is willing to devote the time, which can be significant at times, that is necessary to serve as a director and on committees of the directors. The following paragraphs provide some information regarding the directors and executive officers of Lincolnway Energy.
Jeff Taylor. Mr. Taylor has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2014. Mr. Taylor served as the vice president/vice chairman of Lincolnway Energy from the time Lincolnway Energy was organized in May, 2004 until April, 2008. Mr. Taylor has served as the chairman of Lincolnway Energy since May, 2008. Mr. Taylor has been self-employed as a farmer since 1988, and he owns and operates farms in Story County, Iowa. Mr. Taylor received a Bachelor of Science degree from Iowa State University in farm operations and agricultural studies. Mr. Taylor provides, among other things, agriculture and management background and experience to the directors. An agricultural background provides, among other things, experience that is useful to the directors in connection with analyzing issues related to corn and distillers' grain. Mr. Taylor also completed board member and chairman certification from the Iowa Institute of Cooperatives.
Kurt Olson. Kurt Olson has been a director of Lincolnway Energy since July 27, 2007, and his current term as a director will end at the annual meeting of the members which is held in 2013. Mr. Olson served as the secretary of Lincolnway Energy from May, 2008 until February, 2011. He has served as the Vice Chairman of Lincolnway Energy since March 1, 2011. Mr. Olson graduated in 1978 from Iowa State University in ag-economics and has been actively involved in business operations and management of real estate in central Iowa for over 28 years. Mr. Olson was employed with Litchfield Realty Company from 1987 to 2003. He served as the president of Litchfield Realty and its subsidiaries, AgServ Company and FarmLand Real Estate and Management, LC. The business of AgServ Company included a grain elevator, an agronomy supplier, a feed manufacturer and a soybean seed processor. In 2003, Mr. Olson purchased Farmland Real Estate and Management, LC. Farmland Real Estate and Management, LC markets crop insurance and manages farmland. Mr. Olson provides, among other things, agricultural, real estate and farm management background and experience to the directors.
Richard Johnson. Richard Johnson has been a director of Lincolnway Energy since July 27, 2007, and his current term as a director will end at the annual meeting of the members that will be held in 2013. He has served as the secretary of Lincolnway Energy since March, 2011. Richard was a self-employed certified public accountant from 2003 until his retirement in 2009. He has served as a director of a bank holding company, Ogden Bancshares, since 2006, and as a director of one of its subsidiaries, Ames Community Bank, since 2009. He served as a director of another Ogden Bancshares subsidiary, Vision Bank of Iowa, from 2006 until April, 2010. He also served as a director of EMC National Life Insurance Company (EMCNL) from 2003 until May, 2010. Richard has been a director and the treasurer of Petroleum Marketers Management Insurance Company (PMMIC) since 2000. Richard serves as chairman of the Capital/Shareholder Committee of Ogden Bancshares and is chairman of the audit committee for PMMIC. Richard served as the audit committee chair of EMCNL from 2003 until May, 2010, and as a member of the audit committee of Vision Bank of Iowa from 2006 until April, 2010. He also served as the elected auditor of the State of Iowa from 1979 to 2003. Richard completed a six year term on December 31, 2006 as a trustee of the Financial Accounting Foundation, which is the board that oversees and provides board member selection and funding of the national Accounting Standards Boards. Richard served as a member of the Iowa Accountancy Examining Board from January 2003 to May 2009. The Accountancy Board licenses and regulates certified public accountants and accounting practitioners in the State of Iowa. Richard brings, among other things, financial accounting experience, including audit committee experience, and outside board and association experience to the directors.
Brian Conrad. Brian Conrad has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2014. Mr. Conrad served as the vice chairman of Lincolnway Energy from May, 2008 until February, 2011. Mr. Conrad has been employed with Exelon Wind as Manager, Business Development since December 2010 and is involved in the development and acquisition of wind projects. Prior to Exelon Wind, Mr. Conrad was employed with John Deere Credit from 1988 until December, 2010. He held various positions with John Deere Credit, including credit operations, and sales and marketing. His last position with John Deere Credit was Business Development Manager for the Western U.S. for John Deere Wind Energy. On December 10, 2010 Exelon Corporation purchased John Deere Wind Energy. Mr. Conrad has an undergraduate degree in economics and business administration and a Masters in Business Administration. Mr. Conrad provides, among other things, background and experience in sales, financing and acquisitions to the directors.
Terrill Wycoff. Terry Wycoff has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2015.
Terry has also served as the treasurer of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. Terry retired on March 31, 2012 from his employment at First National Bank, Ames, Iowa after 50 years of service. Terry's last position with First National Bank was Executive Vice President. He still serves as a member of the board of directors of First National Bank. Terry adds, among other things, background and experience in banking and finance to the directors.
Timothy Fevold. Mr. Fevold has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2014. Mr. Fevold served as the secretary of Lincolnway Energy from the time Lincolnway Energy was organized in May, 2004 until April, 2008. He is currently chairman of Lincolnway Energy's Corporate Governance and Nominating Committee, and he also serves on the Audit Committee. Mr. Fevold has been employed by Hertz Farm Management, based in Nevada, Iowa, since 1982, and is an accredited farm manager. He represents absentee landowners throughout Central Iowa. Mr. Fevold has also been licensed as a real estate broker in Iowa since 1987. Mr. Fevold brings, among other things, additional agriculture, real estate and farm management background and experience to the directors.
William Couser. Mr. Couser has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2015. Mr. Couser was the chairman of Lincolnway Energy from the time Lincolnway Energy was organized in May, 2004 until April, 2008. He also served as the interim president and chief executive officer of Lincolnway Energy from May, 2004 until July 13, 2005. Mr. Couser has served as a director of Iowa Renewable Fuels Association for the past eight years, and he served as the president of the Iowa Renewable Fuels Association from January, 2004 to December, 2010. He is also serving as a director of the Iowa Cattlemen's Association and Iowa Institute for Coops. He has served as director on those boards for the past five years. Mr. Couser has been self-employed as a farmer since 1977. His farming operations include row crops and cattle. Mr. Couser brings, among other things, additional agricultural and management background and experience to the directors. Mr. Couser also brings outside board and affiliations background and experience to the directors, including in the ethanol industry as noted above.
James Hill. Mr. Hill has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members which will be held in 2013. Following graduation from college, Mr. Hill worked in management at Northwestern Bell Telephone Company in various capacities in Minnesota. In 1969, he returned to the family farming and cattle feeding operation in Iowa. While farming and feeding cattle, Mr. Hill became involved in cattle industry organizations, and he has served as chairman of the Iowa Beef Industry Council and president of the Iowa Cattlemen's Association. He also served as president of the board of directors of the Ellsworth-Williams Coop during its merger with Prairie Land Coop. He has also served as an advisory council member for Farm Credit Services of America since approximately 1994. Mr. Hill brings, among other things, additional agricultural, management and outside board and industry association background and experience to the directors.
Rick Vaughan. Rick Vaughan has been a director of Lincolnway Energy since Lincolnway Energy was organized in May, 2004. His current term as a director will end at the annual meeting of the members that will be held in 2015. Rick served as the General Manager of Prairie Land Cooperative from February 1995 until August 2011. Prairie Land Cooperative merged with Innovative Ag Services on September 1, 2011. He became Co-CEO of Innovative Ag Services on September 1, 2011 and CEO in December 2012. Innovative Ag Services is a farm supply business serving producers in grain marketing and services, agronomy products and services, feed manufacturing, diesel fuel and propane products and services. Rick brings, among other things, agricultural, cooperative, management and marketing experience and background to the directors.
Kim Supercynski. Ms. Supercynski has served as the chief financial officer of Lincolnway Energy since October 2005. Kim was appointed to serve as Lincolnway Energy's interim president and chief executive officer effective as of November 9, 2012 and until a new president and chief executive officer is identified and retained by Lincolnway Energy. She served as the corporate controller for Garst Seed Company, located in Slater, Iowa, from approximately February 1996 to October 2005. Her responsibilities in that capacity included overseeing the accounting department. Garst Seed Company is an affiliate of Syngenta, Inc., which is a large international company that sells, markets and produces agricultural seed. Prior to working at Garst Seed Company. Kim was a controller for a third party administrator for employee benefit plans. She also has six years of experience working in public accounting. Kim is a certified public accountant and a certified treasury professional.
Rick Brehm was with Lincolnway Energy from May 17, 2005 until November 9, 2012. Rick first served as the general manager, and then served as president and chief executive officer from July 13, 2005 until November 9, 2012.
Number and Term of Directors and Officers
The number of directors for Lincolnway Energy was fixed at 9 as of the date of this annual report. Each of Lincolnway Energy's directors is elected to a three year term and until his or her successor is elected. The terms of the directors are staggered, so that three of the directors' terms expire in one year, three expire the next year, and three expire the following year.
The officers of Lincolnway Energy are elected annually by the directors at its annual meeting, and hold office until the next annual meeting of the directors and until their respective successors are chosen. Any officer may be removed by the directors at any time, with or without cause, subject to any employment agreement as may exist between Lincolnway Energy and any officer. Lincolnway Energy did not have any written employment agreements with any officer as of the date of this annual report.
Significant Employees
Lincolnway Energy currently has three employees who Lincolnway Energy expects to make a significant contribution to its business, in addition to Lincolnway Energy's executive officers identified above. Those employees are Kristine Strum, David Sommerlot and Owen Shunkwiler. Lincolnway Energy does not have a written employment agreement with any of those employees.
Kristine Strum. Ms. Strum has served as the controller for Lincolnway Energy since December 12, 2005. She was employed as a controller by Iowa Newspapers, Inc., in Ames, Iowa, from August, 1989 to December, 2005. Iowa Newspapers, Inc. is a newspaper publishing company. Ms. Strum is 46.
David Sommerlot. Mr. Sommerlot has been Lincolnway Energy's plant manager since September 8, 2009. He was employed by Cargill, Inc. from 1976 to July 1985, working at Cargill, Inc.'s Iowa Protein Products Soy Specialties facility in Cedar Rapids, Iowa. He was transferred by Cargill, Inc. in July of 1985 to Bloomington, Illinois, where he served as the plant superintendent of Cargill, Inc.'s soy crushing facility. He was transferred again in September 1994 to Des Moines, Iowa, where he served as the plant superintendent for Cargill, Inc.'s oil processing facility until March 2009. Mr. Sommerlot is 58.
Owen Shunkwiler. Mr. Shunkwiler was retained as Lincolnway Energy's Director of Grains on October 22, 2012. He will manage Lincolnway Energy's in-house corn origination. He was employed by Cargill, Inc. from 1979 to 1994 as a country elevator location manager in Montana and Nebraska. He moved to Sioux City, Iowa to serve as the general manager of the Sioux City Livestock Market from 1994 to 1996. He served as location manager for Archer Daniels Midland from 1997 until February 2002 in Iowa and Texas. He was employed by POET in February 2002 as general manager of the dry mill ethanol plant until August 2011. Mr. Shunkwiler was a search consultant with Hedlin Ag Enterprises from March 2012 to October 2012. Mr. Shunkwiler is 56.
Code of Ethics
Lincolnway Energy has adopted a code of ethics that applies to Lincolnway Energy's directors, principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions for Lincolnway Energy.
No Changes to Director Nomination Procedures
There were no material changes during the fiscal year ended September 30, 2012 to the procedures by which the members of Lincolnway Energy may recommend nominees for election as a director of Lincolnway Energy.
Audit Committee Financial Expert
Lincolnway Energy has an audit committee. The members of the audit committee as of the date of this annual report were Richard Johnson, Tim Fevold, Brian Conrad and Rick Vaughan.
Lincolnway Energy's board has determined that Richard Johnson is an audit committee financial expert, as that term is defined in the applicable regulations of the Securities and Exchange Commission. Lincolnway Energy's board has also determined that Richard Johnson and all of the other members of the audit committee meet the standards of independence under the Governance Guidelines and applicable NASDAQ Stock Market listing standards, including that each of the committee members are free of any relationship that would interfere with the member's individual exercise of independent judgment.
Item 11.
Item 11. Executive Compensation.
The information required by this Item is incorporated by reference from the "Compensation Of Directors", "Compensation Of Executive Officers", "Compensation Committee Interlocks And Insider Participation" and "Compensation Committee Report" sections in Lincolnway Energy's definitive proxy statement to be filed by Lincolnway Energy with respect to the annual meeting of the members of Lincolnway Energy which will be held in 2013, which definitive proxy statement shall be filed not later than 120 days after the end of the fiscal year covered by this annual report.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
As of the date of this annual report, Lincolnway Energy was only authorized to issue units of membership interest, and Lincolnway Energy did not have any other classes or series of units.
As of the date of this annual report, Lincolnway Energy did not have any compensation plans, including any individual compensation arrangements, under which units of Lincolnway Energy are authorized for issuance.
The following table sets forth certain information regarding the beneficial ownership of units of Lincolnway Energy as of November 30, 2012 by the directors and executive officers of Lincolnway Energy. Lincolnway Energy had 42,049 outstanding units on November 30, 2012.
Unless otherwise indicated by a footnote, all of the units are directly owned by the listed individual or jointly owned with their spouse and are not pledged as security by the listed individual.
All of the units are pledged as security by the listed individual.
Fifty of the units are held by a trust for which Jeff Taylor serves as one of the trustees.
All of the units are owned by the spouse of the listed individual.
To Lincolnway Energy's knowledge, as of the date of this annual report:
•
No person or group was the beneficial owner of more than 5% of Lincolnway Energy's outstanding units, and no person or group held more than 5% of Lincolnway Energy's outstanding units pursuant to any voting trust or similar agreement, and
•
There are no arrangements, including any pledge of units by any person, the operation of which may at a subsequent date result in a change in control of Lincolnway Energy.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Certain Relationships and Related Transactions
There were no transactions since the beginning of Lincolnway Energy's fiscal year ended September 30, 2012, and there are no currently proposed transactions, in which Lincolnway Energy was or is to be a participant where the amount involved exceeds $120,000, and in which any of the following types of persons had, or will have, a direct or indirect material interest:
•
any director or executive officer of Lincolnway Energy;
•
any person who is known by Lincolnway Energy to be the beneficial owner of more than 5% of Lincolnway Energy's outstanding units; or
•
any immediate family member of any of the foregoing persons.
Director Independence
The directors of Lincolnway Energy are William Couser, Jeff Taylor, Timothy Fevold, Terrill Wycoff, James Hill, Brian Conrad, Rick Vaughan, Richard Johnson and Kurt Olson. Each of the directors meets the standards of independence under the Governance Guidelines and applicable NASDAQ Stock Market listing standards, including that each director is free of any relationship that would interfere with the director's individual exercise of independent judgment.
Item 14.
Item 14. Principal Accounting Fees and Services.
The following table presents fees for professional services rendered by McGladrey LLP for the audit of Lincolnway Energy's annual financial statements for the fiscal years ended September 30, 2011 and 2012 and fees billed for other services rendered by McGladrey LLP and its affiliate RSM McGladrey, Inc. during those periods:
Audit Fees. The audit fees were billed for the audit by McGladrey LLP of Lincolnway Energy's annual financial statements and review of the financial statements included in Lincolnway Energy's quarterly reports on Form 10-Q or services that are normally provided by McGladrey LLP in connection with statutory and regulatory filings or engagements.
Tax Fees. The tax fees were billed for services rendered by McGladrey LLP or RSM McGladrey, Inc. for tax compliance, tax advice and tax planning. The nature of the services comprising the tax fees was for year end tax preparation of the partnership return and associated K-1's.
Each specific engagement of McGladrey LLP is pre-approved by the audit committee of the board of Lincolnway Energy.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)
Financial Statements and Schedules.
The financial statements are set forth in Item 8 of this annual report. Financial statement schedules have been omitted because they are not required or are not applicable, or the information is otherwise included in this annual report.
(b)
Exhibits.
The following exhibits are filed as part of this annual report. Exhibits previously filed are incorporated by reference, as noted.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
EXHIBIT INDEX
Exhibits Filed With Form 10-K
of Lincolnway Energy, LLC
For the Fiscal Year Ended September 30, 2012