10-Q 1 highwater-20220131.htm 10-Q highwater-20220131
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
For the quarterly period endedJanuary 31, 2022
OR
 
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
For the transition period from               to               .
 
COMMISSION FILE NUMBER
000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota20-4798531
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
24500 US Highway 14,Lamberton,MN56152
(Address of principal executive offices)(Zip Code)

(507) 752-6160
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
Title of each classTrading Symbol(s)Name of each exchange on which registered

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes     o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
x Yes     o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large Accelerated FilerAccelerated Filer
Non-accelerated FilerSmaller Reporting Company
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes     No

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of March 9, 2022 there were 4,766 membership units outstanding.
1


INDEX


2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HIGHWATER ETHANOL, LLC
Condensed Balance Sheets
 ASSETSJanuary 31, 2022October 31, 2021
(Unaudited)
Current Assets
Cash and cash equivalents$8,617,966 $7,549,008 
Derivative instruments322,336 368,269 
Accounts receivable5,536,473 7,788,574 
Inventories17,321,871 14,748,142 
Prepaids and other639,219 719,699 
Total current assets32,437,865 31,173,692 
Property and Equipment
Land and land improvements12,836,332 12,836,332 
Buildings38,848,218 38,848,218 
Office equipment1,171,866 1,171,866 
Plant and process equipment86,499,009 86,425,155 
Vehicles123,779 123,779 
Construction in progress258,400 193,244 
139,737,604 139,598,594 
Less accumulated depreciation(93,345,672)(90,919,014)
Net property and equipment46,391,932 48,679,580 
Other Assets
Investments3,709,835 3,452,027 
  Right of use asset - operating leases380,448 417,001 
  Right of use asset - finance leases1,064,028 1,098,351 
Other1,083,232 1,208,232 
Deposits312,269 312,269 
Total other assets6,549,812 6,487,880 
Total Assets$85,379,609 $86,341,152 
3



LIABILITIES AND MEMBERS' EQUITYJanuary 31, 2022October 31, 2021
(Unaudited)
Current Liabilities
Accounts payable$10,221,088 $16,790,834 
Distribution payable10,972,150  
Accrued expenses1,070,222 1,272,463 
Current maturities of long-term debt499,000 2,991,291 
  Current portion of operating lease liability151,332 149,271 
  Current portion of finance lease liability119,853 118,220 
Total Current Liabilities23,033,645 21,322,079 
Long-Term Liabilities
  Long term debt 499,000 
  Operating lease liability229,116 267,730 
  Finance lease liability1,006,297 1,036,880 
Total Long-Term Liabilities1,235,413 1,803,610 
Commitments and Contingencies
Members' Equity
Members' equity, 4,770 and 4,782 units outstanding
61,110,551 63,215,463 
Total Liabilities and Members’ Equity$85,379,609 $86,341,152 

Notes to Condensed Unaudited Financial Statements are an integral part of this Statement.
4


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Operations

Three Months Ended
January 31, 2022January 31, 2021
Revenues$58,643,436 $28,435,747 
Cost of Goods Sold41,482,340 28,146,929 
Gross Profit 17,161,096 288,818 
Operating Expenses1,121,700 825,910 
Operating Income (Loss)16,039,396 (537,092)
Other Income (Expense)
Interest income8,567 3 
Other income62,312 100,291 
Interest expense(88,836)(142,076)
Gain on debt extinguishment 712,200 
Income from equity method investments80,049 30,312 
Total other income (expense), net62,092 700,730 
Net Income $16,101,488 $163,638 
Weighted Average Units Outstanding4,771 4,793 
Net Income Per Unit, Basic and Diluted$3,374.87 $34.14 
Distributions Declared Per Unit$3,800 $ 

Notes to Condensed Unaudited Financial Statements are an integral part of this Statement.
5


HIGHWATER ETHANOL, LLC
Statements of Changes in Members' Equity (Unaudited)

Members' Equity
Balance - October 31, 2020$49,563,285 
Net income for the three-month period ended January 31, 2021163,638 
Member unit repurchase, 6 units
(33,000)
Balance - January 31, 2021$49,693,923 

Members' Equity
Balance - October 31, 2021$63,215,463 
Net income for the three-month period ended January 31, 202216,101,488 
Member distribution(18,130,900)
Member unit repurchase, 12 units
(75,500)
Balance - January 31, 2022$61,110,551 

Notes to Condensed Unaudited Financial Statements are an integral part of this Statement.
6


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Cash Flows
Three Months Ended
January 31, 2022January 31, 2021
Cash Flows from Operating Activities
Net income $16,101,488 $163,638 
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Depreciation and amortization2,594,690 2,498,975 
Earnings in excess of distributions (distributions in excess of earnings) from equity method investments(100,548)4,688 
Gain on debt extinguishment (712,200)
Non-cash patronage income(157,260)(193,068)
Changes in assets and liabilities
Accounts receivable2,252,101 1,728,268 
Inventories(2,573,729)(2,379,990)
Derivative instruments45,933 65,696 
Prepaids and other80,480 26,896 
Accounts payable(6,569,745)(2,653,640)
Accrued expenses(202,241)(121,926)
Net cash provided by (used in) operating activities11,471,169 (1,572,663)
Cash Flows from Investing Activities
Capital expenditures(139,011)(3,455,530)
   Net cash used in investing activities(139,011)(3,455,530)
Cash Flows from Financing Activities
Payments on long-term debt(3,000,000)(7,000,000)
Proceeds from long-term debt 14,000,000 
Member unit repurchases(75,500)(33,000)
Payment on finance lease liability(28,950)(27,404)
Member distributions paid(7,158,750) 
Net cash provided by (used in) financing activities(10,263,200)6,939,596 
Net Increase in Cash and Cash Equivalents1,068,958 1,911,403 
Cash and Cash equivalents – Beginning of Period7,549,008 667,317 
Cash and Cash equivalents – End of Period$8,617,966 $2,578,720 
Supplemental Cash Flow Information
Cash paid for interest$29,708 $135,685 
Supplemental Disclosure of Noncash Financing and Investing Activities
Capital expenditures included in accounts payable$ $113,643 
Distribution payable$10,972,150 $ 

Notes to Condensed Unaudited Financial Statements are an integral part of this Statement.
7

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  The accompanying balance sheet and related notes as of October 31, 2021 are derived from the audited financial statements as of that date. These condensed financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended October 31, 2021, contained in the Company’s Form 10-K.
 
In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for fair presentation of the Company's financial position as of January 31, 2022 and the results of operations and cash flows for all periods presented.

Nature of Business

Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) operates an ethanol plant near Lamberton, Minnesota. The ethanol plant was constructed as a 50 million gallon per year nameplate ethanol plant. The plant currently operates in excess of its nameplate capacity due to the approval of air permit by the Minnesota Pollution Control Agency which allows for 70.2 million gallons of denatured ethanol per 12-month rolling average. The Company produces and sells, primarily through third-party professional marketers, fuel ethanol and co-products of the fuel ethanol production process in the continental United States.

Accounting Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters, among others, the carrying value of property and equipment and related impairment testing, inventory valuation, and derivative instruments. Actual results could differ from those estimates and such differences may be material to the financial statements. The Company periodically reviews estimates and assumptions and the effects of revisions are reflected in the period in which the revision is made.

Revenue Recognition

ASC Topic 606, Revenue from Contracts with Customers, further details the Company’s requirement to recognize revenue of transferred goods or services to customers in an amount which is expected to be received in exchange for those goods or services. Five steps are required as part of the new guidance: 1. Identify the contract 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate the transaction price to the performance obligation 5. Recognize revenue when each performance obligation is satisfied.
The Company generally sells ethanol and related products pursuant to marketing agreements. The Company’s products are shipped FOB shipping point. The Company recognizes revenue when control of goods is transferred, which is consistent with the Company's previous policy where revenues were recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales by single manifest railcars and trucks, and distillers grains sales, control transfers when loaded into the rail car. Beginning December 15, 2020, for ethanol sales by unit trains, control transfers once the last railcar of the unit train has loaded and the shipping documentation transferred to the marketer.
In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.

The following is a description of principal activities from which we generate revenue. Revenues from contracts with customers are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the
8

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

consideration that we expect to receive in exchange for those goods or services.

ethanol sales
modified distillers grains sales
dried distillers grains sales
corn oil sales

Disaggregation of revenue:

All revenue recognized in the statement of operations is considered to be revenue from contracts with customers. The following table depicts the disaggregation of revenue according to product line for the three months ended January 31, 2022 and 2021:
Three Months Ended January 31, 2022Three Months Ended January 31, 2021
Revenue SourcesAmount Amount
Ethanol Sales$48,357,467 $21,096,669 
Modified Distillers Grains Sales1,741,199 1,062,859 
Dried Distillers Grains Sales5,386,603 4,762,051 
Corn Oil Sales3,158,167 1,514,168 
Total Revenues$58,643,436 $28,435,747 

Contract assets and contract liabilities:

The Company receives payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Contract liabilities include payments received in advance of performance under the contract, and are realized with the associated revenue recognized under the contract.

The Company had short term contract liabilities from contracts with customers of $144,822 at January 31, 2022 and $0 at October 31, 2021.

Shipping Costs

Shipping costs incurred by the Company in the sale of ethanol, dried distillers grains and corn oil are not specifically identifiable and as a result, revenue from the sale of those products is recorded based on the net selling price reported to the Company from the marketer.

Operating Segment

The Company uses the "management approach" for reporting information about segments in annual and interim financial statements. The management approach is based on the way the chief operating decision-maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure and any other manner in which management disaggregates a company. Based on the "management approach" model, the Company has determined that its business is comprised of a single operating segment.

Derivative Instruments

Derivatives are recognized in the balance sheets and the measurement of these instruments are at fair value. In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other
9

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

comprehensive income until the hedged item is recognized in earnings.

Contracts are evaluated to determine whether the contracts are derivatives. Certain contracts that meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting as derivatives, therefore, are not marked to market in our financial statements.

The Company enters into ethanol, corn and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in prices. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Ethanol derivative changes in fair market value are included in revenue. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.

Carrying Value of Long-Lived Assets

Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset group to the carrying value of the asset group. If the carrying value of the long-lived asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, when a triggering event occurs management evaluates the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. In determining the projected future undiscounted cash flows, the Company makes significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. The Company has not recorded any impairment for the three months ended January 31, 2022 and 2021.

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable, and accounts payable, and other working capital items approximate fair value at January 31, 2022 due to the short maturity nature of these instruments (Level 2).

Derivative instruments are carried at fair value, based on dealer quotes and live trading levels (Note 5).

The Company believes the carrying amount of the term debt approximates fair value due to the indebtedness containing variable interest rates and this rate is a market interest rate for these borrowings (Level 2).

Investments

The Company has a 5.26% investment interest in an unlisted company, Renewable Products Marketing Group, LLC (RPMG), who markets the Company’s ethanol. The Company also has a 7% ownership interest in Lawrenceville Tank, LLC (LT), which owns and operates a trans load/tank facility near Atlanta, Georgia. These investments are flow-through entities and are being accounted for by the equity method of accounting under which the Company’s share of net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company consistently follows the practice of recognizing the net income (loss) from equity method investments based on the most recent reliable data. Therefore, the net income (loss) which is reported in the Company's statement of operations for the period ended January 31, 2022 is based on the investee’s results of operations for the period ended December 31, 2021.

10

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

The Company has cost method of investments in cooperatives. The corresponding patronage income is recorded in costs of goods sold.

2. UNCERTAINTIES

The Company derives substantially all of its revenues from the sale of ethanol, distillers grains and corn oil. These products are commodities and the market prices for these products display substantial volatility and are subject to a number of factors which are beyond the control of the Company. The Company’s most significant manufacturing inputs are corn and natural gas. The price of these commodities is also subject to substantial volatility and uncontrollable market factors. In addition, these input costs do not necessarily fluctuate with the market prices for ethanol and distillers grains. As a result, the Company is subject to significant risk that its operating margins can be reduced or eliminated due to the relative movements in the market prices of its products and major manufacturing inputs. As a result, market fluctuations in the price of or demand for these commodities can have a significant adverse effect on the Company’s operations, profitability, and availability of cash flows to make loan payments and maintain compliance with the loan agreement.

The ethanol industry experienced adverse conditions throughout most of 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels compounded by the COVID-19 pandemic resulting in negative operating margins, lower cash flow from operations and net operating losses. Ethanol demand rebounded in 2021 due to the lifting of COVID-19 restrictions in many areas having a positive effect on ethanol prices resulting in positive operating margins, higher cash flow from operations and net operating income for that period. However, the Company continues to monitor COVID-19 developments and the potential effect on demand for its products.

3. INVENTORIES

Inventories consisted of the following at:
January 31, 2022October 31, 2021
Raw materials$9,858,076 $8,471,843 
Spare parts and supplies4,343,035 4,093,108 
Work in process1,159,331 1,074,341 
Finished goods1,961,429 1,108,850 
 Total$17,321,871 $14,748,142 

The Company recorded a lower of cost or net realizable value write-down on finished goods inventory of approximately $12,000 and $0 at January 31, 2022 and October 31, 2021, respectively.

4. DERIVATIVE INSTRUMENTS

As of January 31, 2022, the Company had entered into corn derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge or a cash flow hedge. The derivative instruments outstanding at January 31, 2022 are not designated as hedges for accounting purposes.


11

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

Commodity Contracts

The following tables provide details regarding the Company's derivative instruments at January 31, 2022 and October 31, 2021:
          InstrumentBalance Sheet locationJanuary 31, 2022October 31, 2021
Corn, natural gas and ethanol contracts
In gain position$94,903 $ 
In loss position(729,271)(915,027)
Deposits with broker956,704 1,283,296 
Current assets$322,336 $368,269 

The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments:
Statement of Three Months Ended January 31,
Operations location 20222021
Ethanol contractsRevenues4,388 $ 
Corn contractsCost of goods sold569,872 (140,143)
Natural gas contractsCost of goods sold(125,867) 

5. FAIR VALUE MEASUREMENTS

The following table provides information on those assets (liabilities) measured at fair value on a recurring basis.
  Fair Value as of Fair Value Measurement Using
  January 31, 2022 Level 1Level 2Level 3
Derivative instruments - commodities
     In gain position$94,903 $5,278 $89,625 $ 
     In loss position(729,271)(7,750)(721,521) 

  Fair Value as of Fair Value Measurement Using
  October 31, 2021 Level 1Level 2Level 3
Derivative instruments - commodities
In gain position$ $ $ $ 
     In loss position$(915,027)$(72,129)$(842,898)$ 

The Company determines the fair values of commodities by obtaining the fair value measurements from an independent pricing service based on dealer quotes and live trading levels from the Chicago Board of Trade.

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HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

6. DEBT FINANCING

Long-term debt consists of the following at:
January 31, 2022October 31, 2021
Term Revolving Loan$499,000 $499,000 
2020 Term Loan 3,000,000 
Total499,000 3,499,000 
Less Debt Issuance Costs (8,709)
Less amounts due within one year(499,000)(2,991,291)
Net long-term debt$ $499,000 

Bank Financing

The Company has a loan facility with Compeer Financial f/k/a AgStar Financial Services, PCA ("Compeer") that includes a $20,000,000 Term Revolving Loan, a term loan with an original amount of $6,000,000 (the "2020 Term Loan") to be used to fund certain improvements to the ethanol production facility and a Revolving Line of Credit Loan. On February 8, 2022, the Company amended the loan facility to modify the interest rates for the Term Revolving Loan and the the Revolving Line of Credit, effective March 1, 2022, and extend the Revolving Line of Credit Loan to January 22, 2023.
The loan facility with Compeer is secured by substantially all business assets and also subjects the Company to various financial and non-financial covenants.
Term Revolving Loan

The Term Revolving Loan is for $20,000,000, with a variable interest rate that is based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2022 was 3.35%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan. Payment of all amounts outstanding are due on January 22, 2023. The outstanding balance on this note was $499,000 at January 31, 2022. The Company pays interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. The Company has no letters of credit outstanding at January 31, 2022. The Company is also required to pay unused commitment fees for the Term Revolving Loan. Beginning on March 1, 2022, interest will accrue on this loan at a variable interest rate based on the Wall Street Journal's Prime Rate plus 10 basis points with a minimum interest rate of 2.10%.

2020 Term Loan

The 2020 Term Loan was for up to $6,000,000 with a variable interest rate based on the Wall Street Journal's Prime Rate plus 45 basis points with no minimum interest rate. Beginning on January 1, 2021, monthly principal payments were due on the 2020 Term Loan of approximately $250,000 plus accrued interest with payments of all amounts outstanding due on September 14, 2022. On December 14, 2021, the Company paid off the loan balance.

Revolving Line of Credit Loan

The Revolving Line of Credit Loan is for an amount equal to the borrowing base, with a maximum limit of $10,000,000, with a variable interest rate that is based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The amount available to borrow per the borrowing base calculations at January 31, 2022 was approximately $4,900,000. The applicable interest rate at January 31, 2022 was 3.35%. The Revolving Line of Credit Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Revolving Line of Credit Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $0 at January 31, 2022. The Company is also
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HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

required to pay unused commitment fees for the Revolving Line of Credit Loan. Beginning on March 1, 2022, interest will accrue on this loan at a variable interest rate based on the Wall Street Journal's Prime Rate plus 10 basis points with a minimum interest rate of 2.10%.

Covenants and other Miscellaneous Terms
    
The loan facility with Compeer is secured by substantially all business assets. The Company executed a mortgage creating a first lien on its real estate and plant and a security interest in all personal property located on the premises and assigned all rents and leases to property, marketing contracts, risk management services contract, and natural gas, electricity, water service and grain procurement agreements.

The Company is also subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage and working capital requirements. The debt service coverage ratio is no less than 1.25:1.00 measured annually by comparing adjusted EBITDA to scheduled payments of principal and interest. The minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under the Term Revolving Loan and undrawn amounts on outstanding letters of credit, less current liabilities, and is measured quarterly.

The Company is limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments without prior approval of Compeer. The Company is allowed to make cash distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and the outstanding balance on the 2020 Term Loan is $0. The Company believes that it will be in compliance with its financial covenants for at least the next 12 months.
The estimated maturities of the long-term debt at January 31, 2022 are as follows:
PrincipalDebt Issuance CostsTotal
January 2023$499,000 $ $499,000 
     Long-term debt$499,000 $ $499,000 

7.  LEASES

The Company leases rail cars for its facility to transport dried distillers grains to its end customers. We classified these identified assets as operating leases after assessing the terms under lease classification guidance.

The Company has a contract for use of a natural gas pipeline which transports natural gas from the Northern Natural Gas pipeline to the Company’s facility. This natural gas line has no alternate use and is specifically for the benefit of the Company. The contract has minimum volume requirements as well as a fixed monthly fee. This contract meets the definition of a lease and is classified as a finance lease. Right of use assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term.
The discount rate used in determining the lease liability for each individual lease is the Company's estimated incremental borrowing rate. An incremental borrowing rate of 5.5% was utilized for each of the Company's leases.

The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s operating and finance leases have remaining lease terms of approximately 3 years and 9 years, respectively. These leases include options to extend the lease. When it is reasonably certain the Company will exercise those options, the Company will update the remaining terms of the leases. The Company does not have lease arrangements with residual value guarantees, sale leaseback terms or material restrictive covenants.


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HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2022

The following table summarizes the remaining maturities of the Company’s operating and finance lease liabilities as of January 31, 2022:
For the Period Ending January 31,Operating LeasesFinance Leases
2023$168,480 $178,800 
2024168,480 178,800 
202570,200 178,800 
2026 178,800 
2027 178,800 
Thereafter 491,700 
Totals407,160 1,385,700 
Amount representing interest(26,712)(259,550)
Lease liability$380,448 $1,126,150 

Lease CostThree Months ended
January 31, 2022
Operating lease cost$42,120 
Short term lease cost10,415 
Finance lease cost
Amortization of leased assets34,323 
Interest on lease liabilities15,750 
Net lease cost$102,608 

8. COMMITMENTS AND CONTINGENCIES

Marketing Agreements

The Company has an ethanol marketing agreement with a marketer (RPMG) to purchase, market, and distribute the ethanol produced by the Company. The Company also entered into a member control agreement with the marketer whereby the Company made capital contributions and became a minority owner of the marketer. The member control agreement became effective on February 1, 2011 and provides the Company a membership interest with voting rights. The marketing agreement will terminate if the Company ceases to be a member. The Company will assume certain of the member’s rail car leases if the agreement is terminated. The Company can sell its ethanol either through an index arrangement or at an agreed upon fixed price. The marketing agreement is perpetual until terminated according to the agreement.  The Company may be obligated to continue to market its ethanol through the marketer for a period of time. The amended agreement requires minimum capital amounts invested as required under the agreement. RPMG will also purchase, market, and distribute the Company's high purity alcohol.

The Company has a distillers grains marketing agreement with a marketer to market all the dried distillers grains produced at the plant. Under the agreement the marketer charges a maximum of $2.00 per ton and a minimum of $1.50 per ton using 2% of the FOB plant price actually received by them for all dried distillers grains removed. The agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, the marketer is responsible for all transportation arrangements for the distribution of the dried distillers grains. The Company markets and sells its modified and wet distillers grains.

The Company has a crude corn oil marketing agreement with a marketer (RPMG) to market all corn oil to be produced at the plant for an initial term. Under the agreement, the Company must provide estimates of production and inventory of corn oil.
The marketer may execute sales contracts with buyers for future delivery of corn oil. The Company receives a percentage of the F.O.B. sale price less a marketing fee, actual freight and transportation costs and certain taxes and other charges related to the purchase, delivery or sale. The Company is required to provide corn oil meeting certain specifications as provided in the agreement and the agreement provides for a process for rejection of nonconforming corn oil. The agreement automatically renews for successive terms unless terminated in accordance with the agreement.

Regulatory Agencies

The Company is subject to oversight from regulatory agencies regarding environmental concerns which arise in the ordinary course of its business.

Forward Contracts

In the ordinary course of business, we enter into forward contracts for our commodity purchases and sales. Forward contracts outstanding are as follows at January 31, 2022:
QuantityAverage PriceDelivery Date
Purchase of corn (in bushels):
    Basis Contracts4,627,797 By 12/31/23
    Priced Contracts1,903,049 $5.43 By 10/31/23
        Total6,530,846 
Purchase of natural gas (in dekatherms):
    Priced contracts3,630,000 $2.83 By 10/31/25
        Total3,630,000 
Purchase of denaturant (in gallons):
    Priced contracts138,000 $1.93 By 2/28/22
        Total138,000 
Sales of dry distillers grains (in tons):
    Priced contracts9,838 $190.13 By 5/31/22
        Total9,838 
Sales of modified distillers grains (in tons)
    Priced contracts25,600 $97.00 By 8/31/22
        Total25,600 
Sales of corn oil (in pounds)
    Priced contracts1,550,000 $0.65 By 3/31/22
        Total1,550,000 

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

    We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations for the three month period ended January 31, 2022, compared to the same period of the prior fiscal year. This discussion should be read in conjunction with the condensed financial statements and notes and the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 2021.

Forward-Looking Statements

    This report contains forward-looking statements that involve future events, our future performance and our expected future operations and actions.  In some cases you can identify forward-looking statements by the use of words such as “will,” “may,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to:
Changes in the availability and price of corn and natural gas;
Reduction or elimination of the Renewable Fuel Standard;
Volatile commodity and financial markets;
Changes in legislation benefiting renewable fuels;
Our ability to comply with the financial covenants contained in our credit agreements with our lenders;
Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw material costs;
Results of our hedging activities and other risk management strategies;
Ethanol and distillers grains supply exceeding demand and corresponding price reductions;
Our ability to generate cash flow to invest in our business and service our debt;
Changes in the environmental regulations that apply to our plant operations and changes in our ability to comply with such regulations;
Changes in our business strategy, capital improvements or development plans;
Changes in plant production capacity or technical difficulties in operating the plant;
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Lack of transportation, storage and blending infrastructure preventing ethanol from reaching high demand markets;
Changes in federal and/or state laws or policies impacting the ethanol industry;
Changes and advances in ethanol production technology and the development of alternative fuels and energy sources and advanced biofuels;
Competition from alternative fuel additives;
Changes in interest rates and lending conditions;
Decreases in the price we receive for our ethanol and distillers grains;
Our inability to secure credit or obtain additional equity financing we may require in the future;
Our ability to retain key employees and maintain labor relations;
Changes in the price of oil and gasoline;
Competition from clean power systems using fuel cells, plug-in hybrids and electric cars;
International trade disputes and the imposition of tariffs by foreign governments on our products;
Use by the EPA of small refinery exemptions; and
A slowdown in global and regional economic activity, reduced demand for our products and the potential for labor shortages and shipping disruptions resulting from the COVID-19 pandemic.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We are not under any duty to update the forward-looking statements contained in this report. Furthermore, we cannot guarantee future results, levels of activity, performance or achievements. We caution you not to put undue reliance on any forward-looking statements, which
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speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.

Available Information

Our website address is www.highwaterethanol.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), are available, free of charge, on our website at www.highwaterethanol.com under the link “SEC Compliance,” as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Quarterly Report on Form 10-Q.

Overview

Highwater Ethanol, LLC (“we,” “our,” “Highwater Ethanol” or the “Company”) was formed as a Minnesota limited liability company organized on May 2, 2006, for the purpose of constructing, owning, and operating an ethanol plant near Lamberton, Minnesota. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the plant. In October 2019, our air permit application to the Minnesota Pollution Control Agency to allow for 70.2 million gallons of denatured ethanol per 12-month rolling average was approved.

    On August 26, 2020, we entered into an agreement with Nelson Baker BioTech, Inc. to install a system which will allow us to produce USP grade high purity alcohol for use in the sanitizer market. We commenced construction in November, 2020. The project was completed in October 2021 and limited production of high purity alcohol commenced. However, we had only limited production of high purity alcohol in our 2021 fiscal year due to current positive margins in ethanol. We expect to begin sales in our 2022 fiscal year. We have executed an agreement with RPMG, Inc. ("RPMG") to be the exclusive marketer of our high purity alcohol. RPMG is currently our exclusive marketer and distributor of ethanol and corn oil. We are also an owner of Renewable Products Marketing Group, LLC, the parent entity of RPMG.

    On November 17, 2021, our board of governors declared a cash distribution of $1,500 per membership unit to unit holders of record at the close of business on November 17, 2021, for a total distribution of $7,158,750. The distribution was paid on December 17, 2021.

On January 19, 2022, our board of governors declared a cash distribution of $2,300 per membership unit to unit holders of record at the close of business on December 31, 2021, for a total distribution of $10,972,150. The distribution was paid on February 11, 2022.

On February 8, 2022, we executed a First Amendment to the Third Amended and Restated Credit Agreement (the "First Amendment"), which amends the Third Amended and Restated Credit Agreement dated March 15, 2021 with Compeer Financial, PCA f/k/a AgStar Financial Services, PCA, as administrative agent ("Compeer"). The primary purpose of the First Amendment was to modify the interest rate for the Term Revolving Loan and the Revolving Line of Credit, effective March 1, 2022. The First Amendment removed references to the LIBOR rate and provided that the Term Revolving Loan and the Revolving Line of Credit Loan will each accrue interest at a variable interest rate based on the Wall Street Journal's Prime Rate plus ten basis points with a minimum interest rate of 2.10%. The Revolving Line of Credit Loan, which was set to mature on March 15, 2022, was also extended until January 22, 2023.
We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities. However, should we experience unfavorable operating conditions in the ethanol industry that prevent us
from profitably operating the ethanol plant, we may need to seek additional funding.


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Results of Operations for the Three Months Ended January 31, 2022 and 2021
 
    The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the three months ended January 31, 2022 and 2021:
 20222021
Statements of Operations DataAmount
(unaudited)
%Amount
(unaudited)
%
Revenues$58,643,436 100.00 %$28,435,747 100.00 %
Cost of Goods Sold41,482,340 70.74 %28,146,929 98.98 %
Gross Profit 17,161,096 29.26 %288,818 1.02 %
Operating Expenses1,121,700 1.91 %825,910 2.90 %
Operating Income (Loss)16,039,396 27.35 %(537,092)(1.88)%
Other Income, net62,092 0.11 %700,730 2.46 %
Net Income $16,101,488 27.46 %$163,638 0.58 %

    The following table shows the sources of our revenue for the three months ended January 31, 2022 and 2021:
20222021
Revenue SourcesAmount
(Unaudited)
%Amount
(Unaudited)
%
Ethanol Sales$48,357,467 82.46 %$21,096,669 74.19 %
Modified Distillers Grains Sales1,741,199 2.97 %1,062,859 3.74 %
Dried Distillers Grains Sales5,386,603 9.18 %4,762,051 16.75 %
Corn Oil Sales3,158,167 5.39 %1,514,168 4.56 %
Total Revenues$58,643,436 100.00 %$28,435,747 100.00 %

Revenue

    Ethanol
    Our ethanol revenues were higher for the three months ended January 31, 2022, as compared to the three months ended January 31, 2021. Revenue from ethanol sales increased by approximately 129.2% during the three months ended January 31, 2022, as compared to the three months ended January 31, 2021, due primarily to an increase in the average price per gallon and the number of gallons of ethanol sold during the three months ended January 31, 2022.
The average price per gallon of ethanol sold for the three months ended January 31, 2022 was approximately 106.7% higher than the average price we received for the three months ended January 31, 2021. Ethanol prices for the three months ended January 31, 2021 were higher due to higher corn prices and increases in demand during the period. We also received a premium on ethanol shipped to California during the three months ended January 31, 2022 due to approval from CARB for our cellulosic pathway pursuant to the Low Carbon Fuel Standard (the “LCFS”). The LCFS requires renewable fuels to meet certain standards in order to be sold into California. However, this pathway does not guarantee a premium for ethanol shipped into California.
Factors likely to affect ethanol prices in the future include changes in domestic corn prices and corn supply, trade disputes with foreign governments, changes in domestic and foreign demand due to the evolving COVID-19 pandemic and seasonal demand for ethanol. Any actions by the Environmental Protection Agency or Congress which result in either reduction of the renewable volume obligations under the Renewable Fuels Standard or the granting of exemptions from those obligations could also have a negative effect on ethanol prices. In addition, the Russian invasion of Ukraine has resulted in global economic uncertainty and rising oil prices which could impact the market price of ethanol depending on the length of the conflict and actions taken by the United States, European Union and other countries in response.

    The number of gallons of ethanol sold during the three months ended January 31, 2022 increased by approximately 11.0%, as compared to the three months ended January 31, 2021. Our ethanol production levels for the three months ended
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January 31, 2021 were at an annual rate of approximately 70 million gallons due to our increasing ethanol production levels in response to positive operating conditions for the period. Management anticipates that the amount of ethanol produced may decrease in the future if current positive operating conditions worsen and we reduce ethanol production levels.

At January 31, 2022, we had no forward fixed price ethanol sales contracts.

We had gains related to ethanol based derivative instruments of $4,388 and $0 for the three months ended January 31, 2022 and 2021, respectively.

    Distillers Grains

    Revenue from distillers grains sales increased by approximately 22.4% during the three months ended January 31, 2022, as compared to the three months ended January 31, 2021. The tons of dried distillers grains sold during the three months ended January 31, 2022, increased by approximately 11.5%, as compared to the three months ended January 31, 2021 and the tons of modified distillers grains sold during the three months ended January 31, 2022, increased by approximately 32.9%, as compared to the three months ended January 31, 2021. Overall, distillers grains sold increased due primarily to increased corn grind offset by higher corn oil production levels for the period which led to higher production levels for the period. Management anticipates that the amount of distillers grains produced may decrease in the future if current positive operating conditions worsen and we reduce ethanol production levels which would then have a corresponding effect on distillers grains.

    For the three months ended January 31, 2022, the average price per ton of dried distillers grains sold was approximately 1.3% higher than the average price we received during the three months ended January 31, 2021, due to increases in the domestic prices of corn and soybeans for the period. For the three months ended January 31, 2022, the average price per ton of modified distillers grains sold was approximately 23.2% higher than during the three months ended January 31, 2021, due to increased demand and reduced production in our local area.

    Distillers grains prices typically change in proportion to domestic corn prices and availability of corn. Domestic demand for distillers grains could decrease if corn prices decline and end-users switch to lower priced alternatives. Management anticipates that both domestic and foreign demand for distillers grains may be negatively affected by the COVID-19 pandemic. Other factors likely to affect distillers grains prices include prices and availability of other commodities, the continued imposition by China of anti-dumping and anti-subsidy duties on distillers grains produced in the United States and other trade actions by the United States and foreign governments.

Corn Oil

Revenue from corn oil sales increased by approximately 108.6% during the three months ended January 31, 2022, as compared to the three months ended January 31, 2021. This is primarily the result of an increase in the price and the amount of corn oil sold during the three months ended January 31, 2022. The average price per pound of corn oil sold was approximately 78.1% higher during the three months ended January 31, 2022, as compared to the three months ended January 31, 2021 due to an increase in the domestic prices of corn and soybeans and increased biodiesel production for the period. Factors likely to affect corn oil prices include biodiesel demand, prices of corn and soybeans, the status of the biodiesel blenders' tax credit and new crop corn oil content.

The pounds of corn oil sold during the three months ended January 31, 2022, increased by approximately 15.7%, as compared to the three months ended January 31, 2021. The amount of corn oil sold increased due to increased corn grind and improved efficiencies leading to increased production for the period. Management anticipates that the amount of corn oil produced may decrease in the future if current positive operating conditions worsen and we reduce ethanol production levels which would then have a corresponding effect on corn oil.

Cost of Goods Sold

    Our two largest costs of production are corn (79.1% of cost of goods sold for the three months ended January 31, 2022) and natural gas (4.6% of cost of goods sold for the three months ended January 31, 2022). Our total cost of goods sold was approximately 47.4% more during the three months ended January 31, 2022, as compared to the three months ended January 31, 2021.


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Corn

    Our average price per bushel of corn for the three months ended January 31, 2022 increased by approximately 43.3% per bushel, as compared to the three months ended January 31, 2021 primarily due to higher market value for corn as a result of increased demand which outpaced supply.
    Management expects there to be an adequate corn supply available in our area to operate the ethanol plant. However, yields in our local area have been lower due to dry weather which could have a negative affect on the price we pay for our corn. Corn prices are dependent on weather conditions, supply and demand, stocks and other factors which could contribute to price volatility and significantly impact our costs of production. In addition, corn prices could be impacted by the Russian invasion of Ukraine.

    We used approximately 8.1% more bushels of corn in the three months ended January 31, 2022, as compared to the three months ended January 31, 2021, due to increased ethanol production for the period.

    At January 31, 2022, we had 4,627,797 bushels of forward fixed basis corn purchase contracts and 1,903,049 bushels of forward fixed price corn contracts valued at approximately $10,329,000. These purchase contracts are for various delivery periods through December 31, 2023 and October 31, 2023, respectively.

We had gains (losses) related to corn derivative instruments of $569,872 and ($140,143) for the three months ended January 31, 2022 and 2021, respectively.

    Natural Gas

    The average market price per MMBTU of natural gas was approximately 12.4% higher for the three months ended January 31, 2022, as compared to the three months ended January 31, 2021. However, because we have sufficient forward natural gas purchase contracts in place for our current needs, we paid below market prices for our natural gas. Management anticipates that natural gas prices will continue at current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

    For the three months ended January 31, 2022, we purchased approximately 8.6% more natural gas as compared to the three months ended January 31, 2021. This increase in natural gas usage is primarily due to an increase in corn grind and dried distillers grains production.

    At January 31, 2022, we had 3,630,000 MMBTUs of forward natural gas purchase contracts valued at approximately $10,285,000 for various delivery periods through October 31, 2025.

For the three months ended January 31, 2022 and 2021, we recorded gains (losses) due to the change in fair value of our outstanding natural gas derivative positions of approximately ($125,867) and $0, respectively.

Operating Expense

    We had operating expenses for the three months ended January 31, 2022 of $1,121,700, as compared to operating expenses of $825,910 for the three months ended January 31, 2021. Management attributes this increase in operating expenses primarily to an increase in professional and IT fees for the three months ended January 31, 2022, as compared to the three months ended January 31, 2021. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Other Income

    We had total other income for the three months ended January 31, 2022 of $62,092, as compared to total other income of $700,730, for the three months ended January 31, 2021. Our other income for the three months ended January 31, 2021, was higher due primarily due to our recording a gain on debt extinguishment in the statement of operations for $712,000 related to the forgiveness of our Paycheck Protection Program loan.


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Changes in Financial Condition for the Three Months Ended January 31, 2022

    The following table highlights the changes in our financial condition as of January 31, 2022 from our previous fiscal year ended October 31, 2021:
January 31, 2022October 31, 2021
Current Assets$32,437,865 $31,173,692 
Current Liabilities23,033,645 21,322,079 
Long-Term Liabilities1,235,413 1,803,610 

Current Assets

    The increase in current assets is primarily the result of increases in cash and cash equivalents and inventories at January 31, 2022, as compared to October 31, 2021. This was partially offset by a decrease in accounts receivable.
    
Current Liabilities

    The increase in current liabilities is due primarily to an increase in distribution payable at January 31, 2022, as compared to October 31, 2021 as our board of directors declared a distribution on January 19, 2022 but the distribution had not yet been paid to our members at January 31, 2022. This was partially offset by a decrease in accounts payable and current maturities of long-term debt.

Long-Term Liabilities

    Long-term liabilities decreased at January 31, 2022, as compared to October 31, 2021, primarily due to the 2020 Term Loan being paid off on December 14, 2021.

Liquidity and Capital Resources

The ethanol industry experienced adverse conditions throughout 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels compounded by the COVID-19 pandemic resulting in negative operating margins, lower cash flow from operations and net operating losses. Ethanol demand rebounded in 2021 due to the lifting of COVID-19 restrictions in many areas having a positive effect on ethanol prices resulting in positive operating margins, higher cash flow from operations and net operating income for the period. However, we continue to monitor evolving COVID-19 developments and the potential effect on demand for our products. Based on financial forecasts prepared by our management, we anticipate that we will have sufficient cash on hand, cash from our current credit facilities, and cash from our operations to continue to operate the ethanol plant for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term in order to fund operations. However, if market conditions worsen, we could have difficulty maintaining our liquidity and may need to rely on our revolving lines of credit or seek increases.

The following table shows cash flows for the three months ended January 31, 2022 and 2021:
20222021
(unaudited)(unaudited)
Net cash provided by (used in) operating activities$11,471,169 $(1,572,663)
Net cash used in investing activities(139,011)(3,455,530)
Net cash provided by (used in) financing activities(10,263,200)6,939,596 

Cash Flow From Operations

We had more cash provided by operating activities for the three months ended January 31, 2022, as compared to the same period in 2021. This increase was primarily due to an increase in net income partially offset by changes in accounts payable for the three months ended January 31, 2022, as compared to the same period in 2021.


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Cash Flow From Investing Activities

We used less cash in investing activities for the three months period ended January 31, 2022, as compared to the same period in 2021. This change was primarily due to a decrease in capital expenditures during the three months ended January 31, 2022.

Cash Flow From Financing Activities

We used more cash in financing activities during the three months ended January 31, 2022, as compared to the same period in 2021. Our cash used in financing activities increased primarily due to increased distributions to our members and decreased net borrowings on long-term debt during the three months ended January 31, 2022.

Short-Term and Long-Term Debt Sources

    Our loan facility with Compeer Financial f/k/a AgStar Financial Services, PCA ("Compeer") includes a $20,000,000 Term Revolving Loan, a Revolving Line of Credit Loan and a term loan with an original amount of $6,000,000 (the "2020 Term Loan") to be used to fund certain improvements to the ethanol production facility. On December 14, 2021, we paid the balance on the 2020 Term Loan. On February 8, 2022, we amended the loan facility to modify the interest rates for the Term Revolving Loan and the Revolving Line of Credit, effective March 1, 2022, and extend the Revolving Line of Credit Loan to January 22, 2023.

Our loan facility with Compeer is secured by substantially all business assets and also subjects the Company to various financial and non-financial covenants.

Term Revolving Loan

The Term Revolving Loan is for up to $20,000,000, with a variable interest rate that is based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2022 was 3.35%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $499,000 at January 31, 2022. We pay interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. We had no letters of credit outstanding at January 31, 2022. We are also required to pay unused commitment fees for the Term Revolving Loan. Beginning on March 1, 2022, interest will accrue on this loan at a variable interest rate based on the Wall Street Journal's Prime Rate plus 10 basis points with a minimum interest rate of 2.10%.

    2020 Term Loan

The 2020 Term Loan had a variable interest rate based on the Wall Street Journal's Prime Rate plus 45 basis points with no minimum interest rate. Beginning January 1, 2021, monthly principal payments were due on the 2020 Term Loan of approximately $250,000 plus accrued interest with payments of all amounts outstanding due on September 14, 2022. On December 14, 2021, we paid off the loan balance.

Revolving Line of Credit Loan

The Revolving Line of Credit Loan is for an amount equal to the borrowing base, with a maximum limit of $10,000,000, with a variable interest rate that is based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The amount available to borrow per the borrowing base calculations at January 31, 2022 was approximately $4,900,000. The applicable interest rate at January 31, 2022 was 3.35%. The Revolving Line of Credit Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Revolving Line of Credit Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $0 at January 31, 2022. We are also required to pay unused commitment fees for the Revolving Line of Credit Loan. Beginning on March 1, 2022, interest will accrue on this loan at a variable interest rate based on the Wall Street Journal's Prime Rate plus 10 basis points with a minimum interest rate of 2.10%.

Covenants and Other Miscellaneous Financing Agreement Terms
    
The loan facility with Compeer is secured by substantially all business assets. We executed a mortgage in favor of Compeer creating a first lien on our real estate and plant and a security interest in all personal property located on the premises
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and assigned in favor of Compeer, all rents and leases to our property, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.

We are also subject to various financial and non-financial covenants that limit distributions and new debt and require minimum debt service coverage and working capital requirements. Our debt service coverage ratio is to be no less than 1.25:1.00 measured annually by comparing our adjusted EBITDA to our scheduled payments of principal and interest. Our minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under our Term Revolving Loan and undrawn amounts on outstanding letters of credit, less current liabilities, and is measured quarterly.

We are limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments as described in the Amended and Restated Credit Agreement without prior approval of Compeer. We are allowed to make cash distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and the outstanding balance on the 2020 Term Loan is $0.

    Presently, we are meeting our liquidity needs and complying with our financial covenants and the other terms of our loan agreements. We will continue to work with Compeer to try to ensure that the terms of our loan agreements are met going forward. However, we cannot provide any assurance that our actions will result in sustained profitable operations or that we will not be in violation of our loan covenants or in default on our principal payments in the future. Should unfavorable market conditions result in our violation of the terms or covenants of our loan and we fail to obtain a waiver of any such term or covenant, Compeer could deem us in default of our loans and require us to immediately repay a significant portion or possibly the entire outstanding balance of our loans. In the event of a default, Compeer could also elect to proceed with a foreclosure action on our plant.

Capital Expenditures    

    On August 26, 2020, we entered into an agreement with Nelson Baker BioTech, Inc. to install a system which will allow us to produce USP grade high purity alcohol for use in the sanitizer market. We commenced construction in November, 2020. The project was completed in October 2021 and limited production of high purity alcohol commenced. We expect to begin sales in our 2022 fiscal year. However, we had only limited production of high purity alcohol so far in our 2022 fiscal year due to current positive margins in ethanol.

Critical Accounting Estimates
    
Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:

Long-Lived Assets
         
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable.  Impairment testing for assets requires various estimates and assumptions, including an allocation of cash flows to those assets and, if required, an estimate of the fair value of those assets.  Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions, which do not reflect unanticipated events and circumstances that may occur.  Given the significant assumptions required and the possibility that actual conditions will differ, we consider the assessment of carrying value of property and equipment to be a critical accounting estimate.

Inventory Valuation

We value our inventory at lower of cost or net realizable value. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions which do not reflect unanticipated events and circumstances that may occur. In our analysis, we consider corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our derivative
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instruments. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the valuation of the lower of cost or net realizable value on inventory to be a critical accounting estimate.

Derivatives

We are exposed to market risks from changes in interest rates, corn, natural gas, and ethanol prices. We may seek to minimize these commodity price fluctuation risks through the use of derivative instruments. In the event we utilize derivative instruments, we will attempt to link these instruments to financing plans, sales plans, market developments, and pricing activities. Such instruments in and of themselves can result in additional costs due to unexpected directional price movements.

We have entered into ethanol, corn and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices. In practice, as markets move, we actively attempt to manage our risk and adjust hedging strategies as appropriate. We do not use hedge accounting which would match the gain or loss on our hedge positions to the specific commodity contracts being hedged. Instead, we use fair value accounting for our hedge positions, which means that as the current market price of our hedge position changes, the gains and losses are immediately recognized in our statement of operations. The immediate recognition of hedging gains and losses under fair value accounting can cause net income (loss) to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

    As of January 31, 2022, the fair values of our commodity-based derivative instruments are a net liability of approximately $634,000. As the prices of the hedged commodity moves in reaction to market trends and information, our statement of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to protect the Company over the term of the contracts for the hedged amounts.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. We may use cash, futures and option contracts to hedge changes to the commodity prices of corn and natural gas. We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes.

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our Term Revolving Loan and Revolving Line of Credit Loan, each bearing a variable interest rate.  As of January 31, 2022, we had $499,000 outstanding on the Term Revolving Loan and $0 outstanding on the Revolving Line of Credit Loan. As of January 31, 2022, interest accrued on these loans based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate and the applicable interest rate was 3.35%. Given the balance owed on these loans as of January 31, 2022 and the applicable interest rates, we have determined that our exposure to market risk from changes in interest rates is not material. The specifics of each loan are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

Commodity Price Risk

We expect to be exposed to market risk from changes in commodity prices.  Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process and the sale of ethanol and distillers grains. We may seek to minimize the risks from fluctuations in the prices of raw material inputs through the use of corn commodity-based and natural gas derivatives. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.

    In the ordinary course of business, we enter into forward contracts for our commodity purchases. At January 31, 2022, we had 4,627,797 bushels of forward fixed basis corn purchase contracts and 1,903,049 bushels of forward fixed price corn purchase contracts valued at approximately $10,329,000. These purchase contracts are for various delivery periods through December 31, 2023 and October 31, 2023, respectively. At January 31, 2022, we had 3,630,000 MMBTUs of forward natural gas fixed price purchase contracts valued at approximately $10,285,000 for delivery periods through October 31, 2025. In
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addition, at January 31, 2022, we had 138,000 gallons of forward fixed price denaturant purchase contracts valued at approximately $266,000 for delivery periods through February 28, 2022.

    In the ordinary course of business, we enter into forward contracts for our commodity sales. At January 31, 2022, we have no forward fixed price ethanol sales contracts. At January 31, 2022, we had 9,838 tons of forward fixed price dried distillers grains sales contracts valued at approximately $1,871,000 for delivery periods through May 31, 2022. At January 31, 2022, we had 25,600 tons of forward fixed price modified distillers grains sales contracts valued at approximately $2,483,000 for delivery periods through August 31, 2022. At January 31, 2022, we had 1,550,000 pounds of forward fixed price corn oil sales contracts valued at approximately $1,010,000 for delivery periods through March 31, 2022.
    We recorded gains (losses) due to changes in the fair value of our outstanding corn derivative future positions of approximately $569,872 and ($140,143) for the three months ended January 31, 2022 and 2021, respectively. We recorded gains due to changes in the fair value of our outstanding ethanol derivative future positions of approximately $4,388 and $0 for the three months ended January 31, 2022 and 2021, respectively. For the the three months ended January 31, 2022 and 2021, we recorded gains (losses) due to the change in fair value of our outstanding natural gas derivative future positions of approximately ($125,867) and $0, respectively.

    As commodity prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of January 31, 2022, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from January 31, 2022. The results of this analysis, which may differ from actual results, are approximately as follows:
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)Unit of MeasureHypothetical Adverse Change in Price as of
January 31, 2022
Approximate Adverse Change to Income
Natural Gas118,000 MMBTU10 %$57,466 
Ethanol66,000,000 Gallons10 %$13,464,000 
Corn20,114,000 Bushels10 %$12,350,000 
DDGs106,000 Tons10 %$2,120,000 

Item 4.  Controls and Procedures
 
    Disclosure Controls and Procedures

Our management is responsible for maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In addition, the disclosure controls and procedures must ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial and other required disclosures.

Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Lucas Schneider, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of January 31, 2022.  Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal
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executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended January 31, 2022, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

    None.
    
Item 1A. Risk Factors
    
The following risk factor is provided due to material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended October 31, 2021. The risk factor set forth below should be read in conjunction with the risk factors section and the Management's Discussion and Analysis section included in our annual report on Form 10-K for the fiscal year ended October 31, 2021.

The invasion of Ukraine by Russia and resulting sanctions by the United States, European Union and other countries could result in a slowdown in global economic growth, market disruptions and increased volatility in commodity prices in the United States. On February 24, 2022, a full-scale military invasion of Ukraine by Russian troops was reported. In response to the attacks on Ukraine, sanctions and other penalties have been levied by the United States, European Union and other countries and additional sanctions and penalties have been proposed. The invasion by Russia and resulting sanctions have created global economic uncertainty and could result in significant market disruptions and increased volatility in commodity prices such as corn, oil and natural gas. Although the duration and extent of the ongoing military conflict is highly unpredictable and the magnitude of the potential economic impact is currently unknown, Russian military actions and resulting sanctions could have a negative effect on our financial condition and operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES
PeriodTotal Number of Units PurchasedAverage Price Paid per Unit $Total Number of Units Purchased as Part of Publicly Announced Plans or ProgramsMaximum Number of Units that May Yet Be Purchased Under the Plans or Programs
November 1, 2021 -
November 30, 2021
6,250 — — 
December 1, 2021 -
December 31, 2021
6,250 — — 
January 1, 2022 -
January 31, 2022
6,750 — — 
Total12 75,500 — — 
    
Item 3. Defaults Upon Senior Securities

    None.

Item 4. Mine Safety Disclosures

    None.


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Item 5. Other Information

    None.


Item 6. Exhibits.

(a)The following exhibits are filed as part of this report.
Exhibit No.Exhibit
Certificate Pursuant to 17 CFR 240.13a-14(a)*
Certificate Pursuant to 17 CFR 240.13a-14(a)*
Certificate Pursuant to 18 U.S.C. Section 1350*
Certificate Pursuant to 18 U.S.C. Section 1350*
101.INSInline XBRL Instance Document – the instance document does not appear on the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCHInline XBRL Taxonomy Extension Schema Document
101.CALInline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEFInline XBRL Taxonomy Extension Definition Linkbase Document
101.LABInline XBRL Taxonomy Extension Labels Linkbase Document
101.PREInline XBRL Presentation Linkbase Document
104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in the Interactive Data Files submitted as Exhibit 101).
(+) Confidential Treatment Requested.
* Filed herewith.
** Furnished herewith.
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SIGNATURES

    Pursuant to the requirements 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.
HIGHWATER ETHANOL, LLC
Date:March 9, 2022/s/ Brian Kletscher
Brian Kletscher
Chief Executive Officer
(Principal Executive Officer)
Date:March 9, 2022/s/ Lucas Schneider
Lucas Schneider
Chief Financial Officer
(Principal Financial and Accounting Officer)

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