UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended
March 31, 2017
 
or
o
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: 000-51764

LINCOLNWAY ENERGY, LLC
(Exact name of registrant as specified in its charter)
 
Iowa
20-1118105
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
59511 W. Lincoln Highway, Nevada, Iowa
50201
(Address of principal executive offices)
(Zip Code)
515-232-1010
(Registrant's telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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.
þ  Yes     o   No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
þ   Yes     o  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o
Accelerated filer  o
 
 
 
 
Non-accelerated filer þ
Smaller reporting company  o
 
 
 
 
 
Emerging growth company o
 
 
 
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).
o Yes þ No

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 42,049 membership units outstanding at May 1, 2017.



LINCOLNWAY ENERGY, LLC
FORM 10-Q
For the Quarter Ended March 31, 2017

INDEX

 
 
 
Page
 
 
 
 
Part I.
Financial Information
 
 
 
 
 
 
Item 1.
Unaudited Financial Statements
 
 
 
 
 
 
 
a)   Balance Sheets
 
 
b)   Statements of Operations
 
 
c)   Statements of Cash Flows
 
 
d)   Notes to Unaudited Financial Statements
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
Item 4.
Controls and Procedures
 
 
 
 
Part II.
Other Information
 
 
 
 
 
 
Item 1.
Legal Proceedings
 
Item 1A.
Risk Factors
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 3.
Defaults Upon Senior Securities
 
Item 4.
Mine Safety Disclosures
 
Item 5.
Other Information
 
Item 6.
Exhibits
 
 
 
 
Signatures
 
 
 
 
 
 
Exhibits Filed With This Report
 
 
Rule 13a-14(a) Certification of President and Chief Executive Officer
E-1
 
Rule 13a-14(a) Certification of Director of Finance
E-2
 
Section 1350 Certification of President and Chief Executive Officer
E-3
 
Section 1350 Certification of Director of Finance
E-4
 
Interactive Data Files (filed electronically herewith)
 




PART I - FINANCIAL INFORMATION

Item 1.    Unaudited Financial Statements.


Lincolnway Energy, LLC
Balance Sheets
 
March 31, 2017
 
September 30, 2016
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
351,055

 
$
613,139

Derivative financial instruments (Note 8 and 9)
364,706

 
497,677

Trade and other accounts receivable (Note 7)
2,896,003

 
3,088,958

Inventories (Note 3)
5,274,878

 
5,726,606

Prepaid expenses and other
290,467

 
388,567

Total current assets
9,177,109

 
10,314,947

 
 
 
 
PROPERTY AND EQUIPMENT
 
 
 
Land and land improvements
7,148,360

 
6,982,287

Buildings and improvements
3,220,876

 
3,158,371

Plant and process equipment
80,229,596

 
78,010,712

Office furniture and equipment
462,316

 
460,486

Construction in progress
3,156,316

 
820,036

 
94,217,464

 
89,431,892

Accumulated depreciation
(56,118,380
)
 
(54,502,768
)
Total property and equipment
38,099,084

 
34,929,124

 
 
 
 
OTHER ASSETS
827,884

 
841,367

 
 
 
 
Total assets
$
48,104,077

 
$
46,085,438


See Notes to Unaudited  Financial Statements.

2


 
Lincolnway Energy, LLC
Balance Sheets (continued)

 
March 31, 2017
 
September 30, 2016
 
(Unaudited)
 
 
LIABILITIES AND MEMBERS' EQUITY
 
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
Accounts payable
$1,989,304
 
$3,166,407
Accounts payable, related party (Note 6)
586,868

 
780,303

Current maturities of long-term debt (Note 5)

 
27,571

Accrued expenses
1,224,063

 
1,074,774

Total current liabilities
3,800,235

 
5,049,055

 
 
 
 
NONCURRENT LIABILITIES
 
 
 
Long-term debt, less current maturities (Note 5)
3,100,000

 
2,500,000

Deferred revenue
518,518

 
592,593

Other
474,258

 
450,000

Total noncurrent liabilities
4,092,776

 
3,542,593

 
 
 
 
COMMITMENTS AND CONTINGENCIES (Notes 7)


 


 
 
 
 
MEMBERS' EQUITY
 
 
 
Member contributions, 42,049 units issued and outstanding
38,990,105

 
38,990,105

Retained earnings (deficit)
1,220,961

 
(1,496,315
)
Total members' equity
40,211,066

 
37,493,790

 
 
 
 
Total liabilities and members' equity
$
48,104,077

 
$
46,085,438




3


Lincolnway Energy, LLC
Statements of Operations

 
Three Months Ended
 
Six Months Ended
 
March 31, 2017
 
March 31, 2016
 
March 31, 2017
 
March 31, 2016
 
(Unaudited)
 
(Unaudited)
Revenues (Notes 2 and 7)
$
27,316,985

 
$
22,463,582

 
$
55,878,701

 
$
46,864,241

 
 
 
 
 
 
 
 
Cost of goods sold (Note 7)
26,185,059

 
24,502,618

 
51,550,023

 
49,453,901

 
 
 
 
 
 
 
 
Gross profit (loss)
1,131,926

 
(2,039,036
)
 
4,328,678

 
(2,589,660
)
 
 
 
 
 
 
 
 
General and administrative expenses
826,092

 
669,318

 
1,583,011

 
1,475,654

 
 
 
 
 
 
 
 
Operating income (loss)
305,834

 
(2,708,354
)
 
2,745,667

 
(4,065,314
)
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Interest income
498

 
1,006

 
983

 
2,313

Interest expense
(6,586
)
 
(18,020
)
 
(29,374
)
 
(27,073
)
 
(6,088
)
 
(17,014
)
 
(28,391
)
 
(24,760
)
 
 
 
 
 
 
 
 
Net income (loss)
$
299,746

 
$
(2,725,368
)
 
$
2,717,276

 
$
(4,090,074
)
 
 
 
 
 
 
 
 
Weighted average units outstanding
42,049

 
42,049

 
42,049

 
42,049

 
 
 
 
 
 
 
 
Net income (loss) per unit - basic and diluted
$
7.13

 
$
(64.81
)
 
$
64.62

 
$
(97.27
)


See Notes to Unaudited Financial Statements.

 





4



Lincolnway Energy, LLC
Six Months Ended
 
Six Months Ended
Statements of Cash Flows
March 31, 2017
 
March 31, 2016
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income (loss)
$
2,717,276

 
$
(4,090,074
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
1,894,113

 
3,422,509

Loss on disposal of property and equipment
10,417

 

Gain on equity dividend
(3,614
)
 

Changes in working capital components:
 
 
 
Trade and other accounts receivable
192,955

 
445,673

Inventories
451,225

 
(236,417
)
Prepaid expenses and other
121,921

 
52,720

Accounts payable
(1,436,466
)
 
(145,426
)
Accounts payable, related party
(193,435
)
 
(306,853
)
Accrued loss on firm purchase commitments

 
120,995

Accrued expenses and deferred revenue
56,594

 
(291,978
)
Derivative financial instruments
132,971

 
133,726

Net cash provided by (used in) operating activities
3,943,957

 
(895,125
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of property and equipment
(4,778,470
)
 
(2,770,416
)
Net cash (used in) investing activities
(4,778,470
)
 
(2,770,416
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Checks in excess of bank balance

 
(1,545,993
)
Proceeds from long-term borrowings
28,550,000

 
3,750,000

Payments on long-term borrowings
(27,977,571
)
 
(26,998
)
Net cash provided by financing activities
572,429

 
2,177,009

 
 
 
 
Net (decrease) in cash and cash equivalents
(262,084
)
 
(1,488,532
)
 
 
 
 
CASH AND CASH EQUIVALENTS
 
 
 
Beginning
613,139

 
1,502,498

Ending
$
351,055

 
$
13,966

 
 
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
 
 
 
     INFORMATION, cash paid for interest
$
10,388

 
$
10,815

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH
 
 
 
INVESTING AND FINANCING ACTIVITIES
 
 
 
Construction in progress included in accounts payable
$
295,805

 
$
46,123

Construction in progress included in accrued expenses
19,864

 
84,793


See Notes to Unaudited  Financial Statements.

5

Lincolnway Energy, LLC

Notes to Unaudited 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 build and operate 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.

Basis of presentation and other information: The balance sheet as of September 30, 2016 was derived from the Company's audited balance sheet as of that date.  The accompanying financial statements as of March 31, 2017 and for the three and six months ended March 31, 2017 and 2016 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods.  These unaudited financial statements and notes should be read in conjunction with the audited financial statements and notes thereto, for the year ended September 30, 2016 contained in the Company's Annual Report  on Form 10-K.  The results of operations for the interim periods presented are not necessarily indicative of the results for the entire year.

Use of estimates:  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and cash equivalents: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. 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. At September 30, 2016, the Company closed all repurchase agreements. Prior to September 30, 2016 the Company utilized the repurchase account to invest excess cash in a bank overnight repurchase account.

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. There was no allowance for doubtful account balance as of March 31, 2017 and September 30, 2016.

Inventories:  Inventories are stated at the lower of weighted average cost or net realizable value using the first-in, first-out method.  In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation.

Derivative financial instruments:  The Company periodically 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 and natural gas 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. 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.   

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 distillers grain, title passes upon the loading into trucks or railcars.    Shipping and handling costs incurred by the Company for the sale of distillers grain are included in costs of goods sold. Ethanol revenue is reported free on board (FOB) and all shipping and handling costs are incurred by the ethanol marketer. Commissions for the marketing and sale of ethanol and distiller grains are included in costs of goods sold.


6


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Deferred revenue: Deferred revenue represents fees received under a service agreement in advance of services being performed. The related revenue is deferred and recognized as the services are performed over the 10 year agreement.
 
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.

Earnings per unit:  Basic and diluted net income (loss) per unit have been computed on the basis of the weighted average number of units outstanding during each period presented.



7


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Note 2.    Revenues

Components of revenues are as follows:
 
Three Months Ended
 
Six Months Ended
 
March 31, 2017
 
March 31, 2016

 
March 31, 2017
 
March 31, 2016

Ethanol, net of hedging gain (loss)
$
21,988,544


$
17,075,811

 
$
45,120,148

 
$
36,294,463

Distillers Grains
3,388,441


4,190,517

 
6,989,357

 
8,191,091

Other
1,940,000


1,197,254

 
3,769,196

 
2,378,687

Total
$
27,316,985

 
$
22,463,582

 
$
55,878,701

 
$
46,864,241


Note 3.    Inventories

Inventories consist of the following:
 
March 31,
2017
 
September 30,
2016
 
 
 
 
Raw materials, including corn, chemicals and supplies
$
3,807,553

 
$
4,585,986

Work in process
822,408

 
668,153

Ethanol and distillers grains
644,917

 
472,467

Total
$
5,274,878

 
$
5,726,606



Note 4.    Revolving Credit Loan
 
The Company has a monitored revolving credit loan, with a bank, for up to $8,500,000. 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 2.90%. The Company will also pay a commitment fee on the average daily unused portion of the loan at the rate of .20% 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, 2017. 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 no outstanding balance on the revolving credit loan as of March 31, 2017 and September 30, 2016.



8


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


Note 5.    Long-Term Debt

The Company has a revolving term loan, with a bank, available for up to $11,000,000. 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 3.15%. The Company will also pay a commitment fee on the average daily unused portion of the loan at the rate of .50% 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 November 1, 2020. There were outstanding borrowings of $3,100,000 and $2,500,000, respectively, on the revolving term loan at March 31, 2017 and September 30, 2016.

Note 6.    Related-Party Transactions

The Company had the following related-party activity with members during the six months ended March 31, 2017 and 2016:

Corn Commitment:
March 31, 2017
 
 
 
 
 
 
Corn Forward Purchase Commitment
Basis Corn Commitment (Bushels)
Commitment Through
Amount Due
Related Parties
$
1,310,034

2,810,000

January 2018
$
586,400


Corn Purchased:
 
Three Months Ended March 31, 2017
Three Months Ended March 31, 2016
Six Months Ended March 31, 2017
Six Months Ended March 31, 2016
Related Parties
$
10,015,232

$
10,482,669

$
19,651,606

$
23,202,185





Note 7.    Commitments and Major Customers

The Company has an agreement with an unrelated entity for marketing, selling and distributing all of the ethanol produced by the Company. Revenues from this entity were $21,915,972 and $45,272,635, respectively, for the three and six months ended March 31, 2017. Revenues with this entity were $17,057,595 and $36,221,353, respectively, for the three and six months ended March 31, 2016. Trade accounts receivable of $2,114,031 were due from this entity as of March 31, 2017. As of March 31, 2017, the Company had ethanol unpriced sales commitments with this entity of approximately 14.4 million gallons through September 2017.

The Company has an agreement with an unrelated entity for marketing, selling and distributing all of the distillers grains produced by the Company. Revenues from this entity including both distiller's grains and corn oil were $3,388,441 and $7,148,895, respectively, for the three and six months ended March 31, 2017. Revenues with this entity were $4,324,175 and $8,696,218, respectively, for the three and six months ended March 31, 2016. The Company sells corn oil to this entity as a third party broker independent of its agreement with the entity relating to distillers grain sales. Trade accounts receivable of $205,426 were due from this entity as of March 31, 2017. The Company had distillers grain sales commitments with this entity of approximately 2,144 tons, for a total sales commitment of approximately $.2 million.

As of March 31, 2017, the Company had purchase commitments for corn forward contracts with various unrelated parties, at a corn commitment total of approximately $2.5 million. These contracts mature at various dates through March 2018.
  
The Company has an agreement with an unrelated party for the transportation of natural gas to the Company's ethanol plant. Under the agreement, the Company is committed to future monthly usage fees totaling approximately $3.6 million over the 10 year term

9

Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
_____________________________________________________________________________________________________

which commenced in November 2014. On June 30, 2016, the Company assigned an irrevocable standby letter of credit to the counter-party to stand as security for the Company's obligation under the agreement. The letter of credit will be reduced over time as the Company makes payments under the agreement. At March 31, 2017, the remaining commitment was approximately $2.2 million.

As of March 31, 2017, the Company had purchased commitments for natural gas basis contracts with an unrelated party totaling 300,000 MMBtu's maturing at various dates through December 2017.

On March 10, 2017, the Company signed a contract with an unrelated party for the installation of a grain drying and cooling system. The total commitment is for $4.8 million plus a potential performance bonus of $450,000. The Company made progress payments of $2.4 million under this contract during the three months ended March 31, 2017. The remaining payments will be made as invoiced throughout the life of the project. The project is estimated to be completed in the first quarter of fiscal year 2018.





10


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


Note 8.    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 purchase and sale 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. The Company treats all contracts with the same counterparty on a net basis on the balance sheet.

Derivatives not designated as hedging instruments are as follows:

 
March 31, 2017
 
September 30, 2016
Derivative assets - corn contracts
$
60,263

 
$
1,179,588

Derivative assets - ethanol contracts
21

 
38,325

Derivative liabilities - corn contracts
(11,588
)
 
(118,750
)
Derivative liabilities - ethanol contracts
(66,381
)
 
(165,870
)
Cash held by (due to) broker
382,391

 
(435,616
)
Total
$
364,706

 
$
497,677


























11


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

The effects on operating income from derivative activities is as follows:

 
Three Months Ended
 
Six Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
March 31, 2017

 
March 31, 2016

 
Gains (losses) in revenues due to derivatives related to ethanol sales:
 
 
 
 
 
 
 
 
Realized gain (loss)
$
(124,170
)
 
$
22,575

 
$
(213,672
)
 
$
70,343

 
Unrealized gain (loss)
196,742

 
(4,359
)
 
61,185

 
2,767

 
Total effect on revenues
72,572

 
18,216

 
(152,487
)
 
73,110

 
 
 
 
 
 
 
 
 
 
Gains (losses) in cost of goods sold due to derivatives related to corn costs:
 
 
 
 
 
 
 
 
Realized gain
589,775

 
481,813

 
1,184,481

 
1,033,444

 
Unrealized (loss)
(451,025
)
 
(367,032
)
 
(1,012,163
)
 
(178,719
)
 
Total effect on corn cost
138,750

 
114,781

 
172,318

 
854,725

 
Gains in cost of goods sold due to derivatives related to natural gas costs:
 
 
 
 
 
 
 
 
Realized gain (loss)
(16,620
)
 
97,390

 
2,990

 
124,800

 
Total effect on natural gas cost
(16,620
)
 
97,390

 
2,990

 
124,800

 
    Total effect on cost of goods sold
122,130

 
212,171

 
175,308

 
979,525

 
Total gain due to derivative activities
$
194,702

 
$
230,387

 
$
22,821

 
$
1,052,635

 

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 9.    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:


12


Lincolnway Energy, LLC

Notes to Unaudited Financial Statements
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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 2 -
Valuations 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 3 -
Valuations 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 assets and liabilities measured at fair value on a recurring basis as of March 31, 2017 and September 30, 2016, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 
 
March 31, 2017
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets, derivative financial instruments
 
$
60,284

 
$
60,284

 
$

 
$

 
 
 
 
 
 
 
 
 
Liabilities, derivative financial instruments
 
$
77,969

 
$
77,969

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets, derivative financial instruments
 
$
1,217,913

 
$
1,217,913

 
$

 
$

 
 
 
 
 
 
 
 
 
Liabilities, derivative financial instruments
 
$
284,620

 
$
284,620

 
$

 
$




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


General

The following discussion and analysis provides information which management of Lincolnway Energy, LLC (the “Company”, “we,” “us,” and “our”) believes is relevant to an assessment and understanding of our financial condition and results of operations. This discussion should be read in conjunction with the financial statements included herewith and notes to the financial statements and our Annual Report on Form 10-K for the year ended September 30, 2016 ("Fiscal 2016") including the financial statements, accompanying notes and the risk factors contained herein.

Cautionary Statement on Forward-Looking Statements

Various discussions and statements in this quarterly report are or contain forward-looking statements that express our current beliefs, forecasts, projections and predictions about future events.  All statements other than statements of historical fact are

13


forward-looking statements, and include statements with respect to financial results and condition; anticipated trends in business, revenues, net income, net profits or net losses; projections concerning ethanol prices, distillers grain prices, corn prices, gas prices, operations, capital needs and cash flow; investment, business, growth, joint venture, expansion, acquisition and divestiture opportunities and strategies; management's plans or intentions for the future; competitive position or circumstances; and other forecasts, projections, predictions and statements of expectation.  Words such as "expects," "anticipates," "estimates," "plans," "may," "will," "contemplates," "forecasts," "strategy," "future," "potential," "predicts," "projects," "prospects," "possible," "continue," "hopes," "intends," "believes," "seeks," "should," "could," "thinks," "objectives" and other similar expressions or variations of those words or those types of words help identify forward-looking statements.

Actual future performance, outcomes and results may differ materially from those suggested by or expressed in forward-looking statements as a result of numerous and varied factors, risks and uncertainties, some that are known and some that are not, and many of which are beyond the control of the Company and its management.  We cannot guarantee our future results, performance or business conditions, and strong or undue reliance must not be placed on any forward-looking statements, which speak only as of the date of this report. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by the Company include:

Changes in the availability and price of corn and natural gas;
Negative impacts resulting from reductions in, or other modifications to, the renewable fuel volume requirements under the Renewable Fuel Standard issued by the Environmental Protection Agency;
Changes in federal mandates relating to the blending of ethanol with gasoline, including, without limitation reductions to, or the elimination of, the Renewable Fuel Standard volume obligations;
The inability to comply with the covenants and other requirements of our various loan agreements;
Negative impacts that hedging activities may have on our operations or financial condition;
Decreases in the market prices of ethanol and distiller’s grains;
Ethanol supply exceeding demand and corresponding ethanol price reductions;
Changes in the environmental regulations that apply to our plant operations;
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;
Changes in other federal or state laws and regulations relating to the production and use of ethanol;
Changes and advances in ethanol production technology;
Competition from larger producers as well as completion from alternative fuel additives;
Changes in interest rates and lending conditions of the loan covenants in the Company loan agreements;
Volatile commodity and financial markets;
Disruptions, failures or security breaches relating to our information technology infrastructure; and
Negative impacts on distillers grain prices and demand resulting from the Chinese antidumping and countervailing duty investigation.


14



These forward-looking statements are based on management’s estimates, projections and assumptions as of the date hereof and include the assumptions that underlie such statements. Our actual results or actions could and likely will differ materially from those anticipated in the forward-looking statements for many reasons, including the reasons described in this report.   Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in this report and in the section titled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2016 and in our other prior Securities and Exchange Commission filings. These and many other factors could affect our future financial condition and operating results and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by the Company or on its behalf.  We undertake no obligation to revise or update any forward-looking statements.  The forward-looking statements contained in this report are included in the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

General Overview

Lincolnway Energy is an Iowa limited liability company that operates a dry mill, natural gas fired ethanol plant located in Nevada, Iowa.  We have been processing corn into fuel grade ethanol and distillers grains at the ethanol plant since May 22, 2006.  Our ethanol plant has a nameplate production capacity of 50,000,000 gallons of ethanol per year.

All of the ethanol we produce is marketed by Eco-Energy, LLC (“Eco-Energy”) and all of our distillers grains are marketed by Gavilon Ingredients, LLC (“Gavilon”). Our revenues are derived primarily from the sale of our ethanol and distillers grains.

We also extract corn oil from the syrup generated in the production of ethanol. We market and distribute all of our corn oil directly to end users and third party brokers, including Gavilon, within the domestic market.

Air Products and Chemicals, Inc., formerly known as EPCO Carbon Dioxide Products, Inc. (“Air Products”), has a plant located on the Company’s site that collects the carbon dioxide gas that is produced as part of the fermentation process and converts that raw carbon dioxide gas into liquid carbon dioxide. Air Products also markets and sells the liquid carbon dioxide.

We expect to fund our operations during the next 12 months using cash flow from continuing operations and the revolving line of credit that is available to us.

Recent Regulatory Developments

A significant federal ethanol support is the Federal Renewable Fuels Standard (the “RFS”) which has been and will continue to be a driving factor in the growth of ethanol usage. The RFS requires that in each year a certain amount of renewable fuels must be used in the United States. The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective.   The U.S. Environmental Protection Agency (the “EPA”) is responsible for revising and implementing regulations to ensure that transportation fuel sold in the United States contains a minimum volume of renewable fuel.

On February 3, 2010, the EPA implemented new regulations governing the RFS which are referred to as “RFS2.” The RFS2 requirements increase incrementally each year through 2022 when the mandate requires that the United States use 36 billion gallons of renewable fuels.  Starting in 2009, the RFS required that a portion of the RFS must be met by certain “advanced” renewable fuels. These advanced renewable fuels include ethanol that is not made from corn, such as cellulosic ethanol and biomass based biodiesel. The use of these advanced renewable fuels increases each year as a percentage of the total renewable fuels required to be used in the United States.

Annually, the EPA is supposed to pass a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligations. However, the EPA decided to delay finalizing the rule on the 2014 and 2015 RFS2 standards until after the end of 2014. In May 2015, the EPA released proposed rules for the 2014, 2015 and 2016 renewable volume obligations which proposed significant reductions in the total renewable fuel volume requirements from the statutory mandates initially set by Congress. On November 30, 2015, the EPA issued its final rules in response to the public comments received relating to the reductions in its proposed rules (the “Final 2014-2016 Rule”).

On May 18, 2016, the EPA released a proposed rule to set 2017 renewable volume requirements under RFS2 which set the annual volume requirement for renewable fuel at 18.8 billion gallons per year, of which 14.8 billion gallons may be met with corn-based

15


ethanol. In November 2016, the EPA issued the final rule for 2017 and increased the total volume requirements from 18.8 billion gallons to 19.28 billion gallons (the "Final 2017 Rule"). Although the final 2017 volume requirements are a significant increase over the 2016 volume requirements and the requirements originally proposed in May 2016, the volume requirements are still below the statutory mandate for 2017 of 24 billion gallons per year. However, in connection with the issuance of the Final 2017 Rule, the EPA increased the number of gallons which may be met by corn-based ethanol from 14.8 billion gallons to 15 billion gallons. This brings the renewable volume obligations for conventional renewable fuels that can be met by corn-based ethanol back to the levels called for in the statutory mandate. Although this signals a sign of support of the RFS2 by the EPA and a rejection of arguments by the oil industry relating to the "blend wall", there is no guarantee that for future years the EPA will adhere to the statutory mandate for conventional renewable fuels.

The following chart sets forth the statutory volumes (in billion gallons) for 2014, 2015, 2016 and 2017 and the volumes required under the Final 2014-2016 Rule and the Final 2017 Rule:

 
 
Total Renewable Fuel Volume Requirement
Portion of Volume Requirement That Can Be Met By Corn-based Ethanol
2014
Statutory
18.15
14.10
Final 2014-2016 Rule
16.28
13.61
2015
Statutory
20.50
15.00
Final 2014-2016 Rule
16.93
14.05
2016
Statutory
22.25
15.00
Final 2014-2016 Rule
18.11
14.50
 
Statutory
24
15.00
2017
Final 2017 Rule
19.28
15.00

The volume requirements mandated in the Final 2014-2016 Rule and the Final 2017 Rule are still below the volume requirements statutorily mandated by Congress. These reduced volume requirements, combined with the potential elimination of such requirements by the exercise of the EPA waiver authority or by Congress, could decrease the market price and demand for ethanol which will negatively impact the Company’s financial performance.

Beginning in January 2016, various ethanol and agricultural industry groups petitioned a federal appeals court to hear a legal challenge to the Final 2014-2016 Rule. In addition, various representatives of the oil industry have also filed challenges to the Final 2014-2016 Rule. Management anticipates that there will be further legal challenges to the EPA's reduction in the volume requirements, including, the Final 2017 Rule. However, if the EPA's decision to reduce the volume requirements under the RFS2 is allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

It is also possible that the Trump administration may seek to materially modify, repeal or otherwise invalidate the RFS2 and it is unclear what regulatory framework and renewable volume requirements, if any, will emerge as a result of such reforms; however, any such reform could adversely affect the demand and price for ethanol and our profitability.



Executive Summary

Highlights for the three months ended March 31, 2017, are as follows:

Total revenues increased 21.6%, or $4.9 million, compared to the 2016 comparable period.

Total cost of goods sold increased 6.9%, or $1.7 million, compared to the 2016 comparable period.
        
Net income was $.3 million, which was an increase of approximately $3.0 million when compared to the net loss of $2.7 million for the 2016 comparable period.

On March 10, 2017, the Company entered into an agreement with a third party for the installation of a grains drying and cooling system. The total commitment is for $4.8 million plus a potential performance bonus of $450,000. The Company made progress payments of $2.4 million under this contract during the three months ended March 31, 2017. The remaining payments will be

16


made as invoiced throughout the life of the project. The project is estimated to be completed in the first quarter of fiscal year 2018. This new drying and cooling system will aid in our development of a new high quality species specific animal feed which we have branded as PureStream™ protein.  We currently intend to market this new product to the growing swine and poultry markets in Iowa.  When compared to traditional distillers grains, our new PureStream™ protein animal feed products are expected to be higher in crude protein and richer in the essential amino acids that drive growth in swine and poultry.



Results of Operations

The following table shows the results of operations and the percentages of revenues, cost of goods sold, operating expenses and other items to total revenues in our statement of operations for the three and six months ended March 31, 2017 and 2016 (dollars in thousands):
 
 
 
Three Months Ended March 31,
 
Six Months Ended
 
 
(Unaudited)
 
(Unaudited)
Income Statement Data
 
2017

2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
$27,317
 
100.0
 %
 
$22,464
 
100.0
 %
 
$55,879
 
100.0
 %
 
$46,864
 
100.0
 %
Cost of goods sold
 
26,185

 
95.9
 %
 
24,503

 
109.1
 %
 
51,550

 
92.3
 %
 
49,454

 
105.5
 %
Gross profit (loss)
 
1,132

 
4.1
 %
 
(2,039
)
 
(9.1
)%
 
4,329

 
7.7
 %
 
(2,590
)
 
(5.5
)%
General and administrative expenses
 
826

 
3.0
 %
 
669

 
3.0
 %
 
1,583

 
2.8
 %
 
1,476

 
3.2
 %
Operating income (loss)
 
306

 
1.1
 %
 
(2,708
)
 
(12.1
)%
 
2,746

 
4.9
 %
 
(4,065
)
 
(8.7
)%
Other income (expense), net
 
(6
)
 
 %
 
(17
)
 
(0.1
)%
 
(28
)
 
(0.1
)%
 
(25
)
 
(0.1
)%
Net income (loss)
 
$
300

 
1.1
 %
 
$
(2,725
)
 
(12.2
)%
 
$
2,717

 
4.8
 %
 
$
(4,090
)
 
(8.6
)%


Results of Operations for the Three Months Ended March 31, 2017 as Compared to the Three Months Ended March 31, 2016
 
Revenues. Total revenues increased by 21.6% for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016. Ethanol sales increased by 28.5% and sales from co-products decreased by 1.1% for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016. The change in ethanol revenue was a result of a 9.5% increase in the price per gallon received and a 16.6% increase in production volume for the three months ended March 31, 2017, when compared to the three months ended March 31, 2016. Ethanol prices increased due to higher gasoline demand as well as increased exports. Our sales volume increased due to better production rates with the implementation of new process improvements. Ethanol revenue for the three months ended March 31, 2017 also included a $72,572 net gain for ethanol derivatives, compared to a $18,216 net gain in the same quarter for the prior year.

Management currently anticipates that ethanol prices during the fiscal year ending September 30, 2017 (Fiscal 2017") will remain at the levels consistent with Fiscal 2016 levels, especially if corn and gasoline prices remain low. Additionally, despite the recent modest decrease in the domestic ethanol supply, if ethanol exports during Fiscal 2017 decrease, this could lead to an excess in the domestic ethanol supply and reduce the market price of ethanol. Although ethanol exports have provided some support for ethanol prices with the increase in export demand resulting from the lower domestic ethanol prices, if ethanol prices increase, this could negatively impact export demand. In addition, ethanol exports to China are likely to decrease as a result of the restoration of a 30% tariff on ethanol imports from the U.S. During 2016, the tariff was reduced to 5% which resulted in increased exports of U.S. ethanol to China. The Brazilian Agricultural Minister has also recently requested Brazil's trade counsel impose a tariff on ethanol imports from the U.S. which, if imposed could further decrease export demand and adversely impact the price of ethanol unless alternative markets are found. The recent reductions in the renewable volume obligations by the EPA also may result in an oversupply of renewable fuel credits which could decrease demand for corn-based ethanol despite the increase back to statutory requirements set forth in the Final 2017 Rule.


17


Sales from co-products decreased by 1.1% for the three months ended March 31, 2017 from the three months ended March 31, 2016. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. The change in co-product sales was primarily due to a $.8 million decrease in distillers grain revenue offset by a $.7 million increase in corn oil sales. Distillers grain revenue declined as prices dropped due to lower corn prices and decreased domestic and export market demand principally relating to the decreased demand from China resulting from the antidumping and countervailing investigations and the implementation of significant duties on distillers grains produced in the United States. In January 2017, China announced a final ruling which set the antidumping duties at a range between 42.2% and 53.7%, an increase over the 33.5% duty set forth in its preliminary decision.  China also increased the anti-subsidy duties from a range from 10%-10.7% in its preliminary decision to a range from 11.2% to 12%. Management believes that distillers grain prices will likely continue to be impacted by lower corn prices during Fiscal 2017 as well as decreased export demand. If corn prices remain low and additional demand for distillers grain cannot be developed either in additional export markets or domestically, distillers grain prices will be adversely impacted which would negatively impact our profitability.

The 89% increase in corn oil revenue was due to a 46% increase in production and sales volume after the implementation of several process improvements and an increase in market prices. Management expects corn oil production throughout Fiscal 2017 to be higher than production in Fiscal 2016 as a result of these process improvements; however, corn oil prices will continue to be impacted by changes in corn prices and market demand both of which could decrease as a result of the expiration of the biodiesel blenders' tax credits.

Cost of goods sold. Cost of goods sold increased by 6.9% or approximately $1.7 million, for the three months ended March 31, 2017 from the three months ended March 31, 2016. The increase was primarily due to increases in corn costs offset by a decrease in depreciation. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas costs, electricity, production labor, repairs and maintenance, and depreciation.

Corn costs, including hedging, increased approximately $1.6 million or 9.2% for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. Increased costs from higher production and bushels used were partially offset by higher hedging gains. For the three months ended March 31, 2017 corn costs included a $138,750 net gain for derivatives relating to corn costs, compared to a $114,781 net gain in the same quarter for the prior year. Corn costs represented 71.8% of cost of goods sold for the three months ended March 31, 2017, compared to 68.7% for the three months ended March 31, 2016.
Depreciation totaled approximately $.8 million a decrease of $.8 million for the three months ended March 31, 2017 from the three months ended March 31, 2016. The decrease in depreciation resulted from the fact that the plant reached it's 10-year useful life and a majority of the original assets are now fully depreciated.

Results of Operations for the Six Months Ended March 31, 2017 as Compared to the Six Months Ended March 31, 2016

Revenues. Revenues increased by $9.0 million, or 19.2%, for the six months ended March 31, 2017 from the six months ended March 31, 2016. There was a increase in ethanol sales of $9.1 million, or 25.0%, for the six months ended March 31, 2017 from the six months ended March 31, 2016. The average price per gallon of ethanol sold increased 10.5% for the six months ended March 31, 2017 compared to the six months ended March 31, 2016. Ethanol prices increased due to higher gasoline demand as well as increased exports. Ethanol sales volume increased approximately 13.3% for the six months ended March 31, 2017, when compared to the six months ended March 31, 2016. The increase was due to better production rates with the optimization of the production process. The six months ended March 31, 2017 also included a $152,487 net loss for derivatives related to ethanol sales, compared to a $73,110 net gain in the prior period.

Sales from co-products increased by 1.8%, or $188,775, for the six months ended March 31, 2017 from the six months ended March 31, 2016. Co-products include dried distillers grains, wet distillers grains, corn oil, syrup and carbon dioxide. An increase in corn oil revenue offset by a decrease in dried distillers grains revenue resulted in the slight co-product increase in revenues for the six months ended March 31, 2017 compared to the six months ended March 31, 2016. Corn oil revenue increased $1.3 million, or 88.7%, due to an increase in sales volume after the implementation of several process improvements as well as 16.7% increase in market price resulting from increased demand from the biodiesel industry prior to the expiration of biodiesel blenders' tax credit and increased demand from the corn oil feed market.

Distillers grain revenue decreased $1.2 million primarily due to the reduction in market prices resulting from lower corn prices and decreased export demand, principally resulting from the China anti-dumping and countervailing duties during the six months ended March 31, 2017 from the six months ended March 31, 2016.

Cost of goods sold. Cost of goods sold increased by 4.2% or $2.1 million for the six months ended March 31, 2017 from the six months ended March 31, 2016. The increase was primarily due to increases in corn costs and repairs and maintenance offset by a decrease in depreciation. Increases in other categories were fairly small and considered immaterial. Cost of goods sold includes corn costs, process chemicals, denaturant, natural gas, electricity, production labor, repairs and maintenance, and depreciation.

18



Corn costs, including hedging, increased by $1.5 million, or 4.3%, for the six months ended March 31, 2017 from the six months ended March 31, 2016. Increased costs from higher production and bushels used was offset by lower hedging gains. For the six months ended March 31, 2017, corn costs included a $172,318 net gain for derivatives relating to future contracts, compared to a $.9 million gain for the six months ended March 31, 2016. Corn costs represented 69.6% of cost of goods sold for both six months periods ended March 31, 2017 and March 31, 2016.

Repairs and maintenance increased approximately $.8 million or 94.9% for the six months ended March 31, 2017 from the six months ended March 31, 2016. Much of our equipment is now over 10 years old and more repairs are common. A larger focus has also been made on preventative maintenance to reduce downtime and maintain higher production rates.

Depreciation totaled approximately $1.6 million, a decrease of $1.5 million for the six months ended March 31, 2017 from the six months ended March 31, 2016. The decrease in depreciation resulted from the fact that the plant has completed 10 years of operation and a majority of the original assets are now fully depreciated.



Industry Factors that May Affect Future Operating Results

During the three months ended March 31, 2017, the ethanol industry experienced volatile ethanol margins as a result of the combination of factors including the following:

Corn prices rallied slightly during the first half of the three months ended March 31, 2017 and spot prices rose from $3.35 per bushel to $3.52 only to retreat to $3.28 by the end of the quarter. The price per bushel fluctuated during the quarter as the market gauged the impact of very large demand against the record large corn crop. Excellent South American weather eventually resulted in a lower trend due to the fact that global weather conditions appear to support a record corn crop. For the three months ended March 31, 2017 as compared to the three months ended March 31, 2016, the average price per bushel paid was $3.44 and $3.60, respectively. While this would appear to be a positive for margins, the ability for ethanol facilities to access cheap corn brought increased ethanol production to market adding additional stock to the domestic inventory.

The latest estimates of supply and demand provided by the U.S. Department of Agriculture (the "USDA") forecast 2017 ending corn stocks of over 2.3 billion bushels, suggesting weak corn prices. In response to these estimates, corn prices moved to 2017 lows. Rising and record ethanol stocks uncharacteristically coupled with modestly rising ethanol prices by the end of the quarter on March 31, 2017, yielded a margin rally from the lows registered in January.

Gasoline demand stagnated versus a year earlier as prices rose 10-15% compared to the first quarter of 2016. The U.S. economy continues its pattern of modest growth. Unemployment remains low but as the numbers are nearing a structural bottom representing full employment, it is difficult to obtain further gasoline demand growth from labor market expansion. Even after record production during the quarter ended December 31, 2016, ethanol inventories continued to increase during the three months ended March 31, 2017. The increased supply of ethanol was partially absorbed by higher blending rates rather than offset by any positive impact on the demand and price of ethanol resulting from higher gasoline demand.

Increases in export sales of ethanol to a variety of foreign markets resulted from high blending demand from a variety of customers. Brazilian offtake was especially higher due to higher priced sugar. This positively impacted the attractiveness of U.S. ethanol in the Brazilian market and when coupled with the robust blending demand from other countries, served to partially offset the ethanol stocks increase. However, the Brazilian Agricultural Minister recently requested Brazil's trade counsel impose a tariff on ethanol imports from the U.S. which, if implemented, could decrease demand from Brazil even if sugar prices remain high.

We use futures and options strategies on the Chicago Mercantile Exchange to hedge some of the risk involved with changing corn prices, as well as the purchase and physical delivery of corn contracts from area farmers and commercial suppliers. We also incorporate risk management strategies to cover some of the risk involved with changing ethanol and distillers market prices. We continue to monitor the markets and attempt to provide for an adequate supply of corn and protection against rapid price increases for corn and price decreases for ethanol and distillers grains.

Management currently believes that our margins will remain steady during the remainder of Fiscal 2017. However, low crude oil and unleaded gasoline prices or further decreases in the price of such commodities could have a negative impact on the market price of ethanol which could adversely impact our profitability. This negative impact could worsen in the event that ethanol stocks remain high and U.S. exports of ethanol decline due to the comparable price on ethanol versus unleaded gasoline. China's restoration of 30% tariff on imports

19


of U.S. ethanol will also adversely impact exports to China and could negatively increase the price of ethanol. However, additional demand may be found in other foreign or domestic markets due to additional octane demand and the ongoing blend rate expansion in the U.S.

Our margins have also been, and could continue to be, negatively impacted due to the lower prices received for our distillers grains as a result of increased corn and soybean supplies. The increased supplies of corn and soybeans results in lower corn and soybean prices which adversely impacts the price and demand for distillers grains which are an animal feed substitute for corn and soybeans. Demand and prices for distillers grains may experience further declines due to decreased exports to China as a result of the Chinese antidumping and countervailing duty imposition. China has historically been one of the largest importers of domestically produced distillers grains. Reduced demand from China combined with lower corn and soybean prices has led to an oversupply of distillers grains in the domestic market which could adversely impact our margins and our financial performance.

Corn oil prices have also been adversely impacted by the oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil principally for biodiesel production. However, management currently believes that there remains a possibility for renewal of the biodiesel blenders' tax credit for 2017 which could lead to increased biodiesel production which could result in increased demand for corn oil. This may offset the impact of lower soybean oil prices and the current oversupply of corn oil due to the substantial increase in corn oil production during the last few years.

Credit and Counterparty Risks

Through our normal business activities, we are subject to significant credit and counterparty risks that arise through normal commercial sales and purchases, including forward commitments to buy and sell, and through various other over-the-counter (OTC) derivative instruments that we utilize to manage risks inherent in our business activities.  We define credit and counterparty risk as a potential financial loss due to the failure of a counterparty to honor its obligations.  The exposure is measured based upon several factors, including unpaid accounts receivable from counterparties and unrealized gains (losses) from OTC derivative instruments (including forward purchase and sale contracts).   Part of our risk management strategy requires that we actively monitor credit and counterparty risk through credit analysis.


Liquidity and Capital Resources

Based on the financial projections prepared by management, we anticipate that we will have sufficient cash from existing cash, our current credit facilities, and cash from operations to continue to operate the ethanol plant for the next 12 months. Management believes that an abundant corn supply will cause corn prices to remain near current levels and an anticipated increase in the supply of ethanol will cause ethanol prices to stay near current levels. Working capital was approximately $5.4 million as of March 31, 2017 and is projected to be sufficient with current cash balances and credit facilities available for the remainder of the fiscal year. Management continues to monitor our liquidity position on a weekly basis.
Our financial position and liquidity are, and will continue to be, influenced by a variety of factors, including, without limitation:

our ability to generate cash flows from operations;

the level of our outstanding indebtedness and the interest we are obligated to pay;

our capital expenditure requirements, which consists primarily of plant improvements to improve efficiencies; and

our margin maintenance requirements on all commodity trading accounts.

The following table summarizes our sources and uses of cash and cash equivalents from the unaudited statement of cash flows for the periods presented:
 

20


 
 
Six Months Ended March 31,
 
 
(Unaudited)
Cash Flow Data:
 
2017
 
2016
Net cash provided by (used in) operating activities
 
$
3,943,957

 
$
(895,125
)
Net cash (used in) investing activities
 
(4,778,470
)
 
(2,770,416
)
Net cash provided by financing activities
 
572,429

 
2,177,009

Net (decrease) in cash and cash equivalents
 
$
(262,084
)
 
$
(1,488,532
)


Cash Flow from Operations

For the six months ended March 31, 2017, net cash provided by operating activities increased by $4.8 million when compared to net cash used in operating activities for the six months ended March 31, 2016. The increase in cash provided by operating activities is due to net income and the timing in working capital components.

Cash Flow Used in Investing Activities

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 six months ended March 31, 2017 compared to the six months ended March 31, 2016. The increase is due to initial progress payments on the installation of a grains drying and cooling system. The project is estimated to be completed in the first quarter of fiscal year 2018.

Cash Flow Used in Financing Activities

Cash flows from financing activities include transactions and events whereby cash is obtained from, or paid to, depositors, creditors or investors. Net cash provided by financing activities decreased by $1.6 million for the six months ended March 31, 2017, compared to the six months ended March 31, 2016. The decrease is due to increased cash flow from operations and reduced long term borrowings during the six months ended March 31, 2017.

 

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Critical Accounting Estimates and Accounting Policies

Our 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 we operate. 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 our 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 our ethanol and distillers grains is recognized at the time title and all risks of ownership transfer to the marketing company. This generally occurs upon the loading of the product. For ethanol, title passes from the Company at the time the product crosses the loading flange into either a railcar or truck. 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. For distillers grains, title passes upon the loading of distillers grains into trucks. Shipping and handling costs incurred by us for the sale of ethanol and distillers grain are included in costs of goods sold.

All of our ethanol production is sold to Eco-Energy. The purchase price payable to us under our agreement with Eco-Energy is the purchase price set forth in the applicable purchase order, less a marketing fee payable to Eco-Energy.

We have an agreement with Gavilon to purchase all of the distillers grains produced at our ethanol plant. The purchase price payable to us is the corresponding price being paid to Gavilon for the distillers grains, less certain logistics costs and a service fee.

Derivative Instruments

We enter into derivative contracts to hedge our exposure to price risk related to forecasted corn needs, forward corn purchase contracts and ethanol sales. We do not typically enter into derivative instruments other than for hedging purposes. All future derivative contracts are recognized on the March 31, 2017 balance sheet at their fair value. Although we believe our 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 these derivative instruments is recorded in the statement of operations as a component of cost of goods sold for corn contracts and as a component of revenue for ethanol contracts.

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 our financial statements but are subject to a lower of cost or market assessment.

Inventories and Lower of Cost or Market

Inventories are stated at the lower of weighted average cost or net realizable value using the first-in, first-out method.  In the valuation of inventories and purchase commitments, net realizable value is defined as estimated selling price in the ordinary course of business less reasonable predictable costs of completion, disposal and transportation.

Off-Balance Sheet Arrangements

We currently do not have any off-balance sheet arrangements.

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

In addition to the various risks inherent in the ethanol industry and our operations, we are exposed to various market risks.  The primary market risks arise as a result of possible changes in certain commodity prices and changes in interest rates.

Commodity Price Risk

We are exposed to market risk with respect to the price of ethanol, which is our principal product, and the price and availability of corn and natural gas, which are the principal commodities we use to produce ethanol.  Our other primary product is distillers grains, and we are also subject to market risk with respect to the price for distillers grains.  The prices for ethanol, distillers grains, corn and natural gas are volatile, and we may experience market conditions where the prices we receive for our ethanol and distillers grains are declining, but the price we pay for our corn, natural gas and other inputs is increasing. Our 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.  We are, however, subject to various material risks related to our 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 our management, including the supply and demand for gasoline, the availability of substitutes, international trade and the effects of domestic and foreign laws, regulations and government policies.

In general, rising corn prices result in lower profit margins and, accordingly, represent unfavorable market conditions.  We will generally not be able to pass along increased corn costs to our ethanol customers.  We are subject to various material risks related to the availability and price of corn, many of which are beyond our control.  For example, the availability and price of corn is subject to wide fluctuations due to various unpredictable factors, 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 our corn costs were to increase $.10 per bushel from one year to the next, the impact on costs of goods sold would be approximately $2.3 million for the year, assuming corn use of 23 million bushels during the year.

During the quarter ended March 31, 2017, corn prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $3.54 per bushel for May 2017 delivery to a high of $3.87 per bushel for May 2017 delivery.  The corn prices based on the Chicago Mercantile Exchange daily futures data during the quarter ended March 31, 2016 ranged from a low of $3.57 per bushel for May 2016 delivery to a high of $3.78 per bushel for May 2016 delivery.

The average price we received for our ethanol during the three months ended March 31, 2017 was $1.38 per gallon, a modest improvement as compared to $1.26 per gallon during the three months ended March 31, 2016.

During the quarter ended March 31, 2017, ethanol prices based on the Chicago Mercantile Exchange daily futures data ranged from a low of $1.485 per gallon for April 2017 delivery to a high of $1.623 per gallon for April 2017 delivery. The ethanol prices based on the Chicago Mercantile Exchange daily futures data during the three months ended March 31, 2016 ranged from a low of $1.35 per gallon for April 2016 delivery to a high of $1.47 per gallon for April 2016 delivery.

We may from time to time take various cash, futures, options or other positions in an attempt to minimize or reduce our price risks related to corn and ethanol. The extent to which we enter into such positions may vary substantially from time to time and based on various factors, including seasonal factors and our views as to future market trends. 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 are influenced by many factors and occurrences that are beyond our control. We could incur substantial losses on our cash, futures, options or other positions.

Although we intend our futures and option positions to accomplish an economic hedge against our future purchases of corn or futures sales of ethanol, we have 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.  We are 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 our 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, our net gain on corn derivative financial instruments that was included in our cost of goods sold for the three months ended March 31, 2017 was $138,750, as opposed to a net gain of $114,781 for the three months ended March 31, 2016.


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We attempt to offset or hedge some of the risk involved with changing corn prices through the trading of futures and options on the Chicago Mercantile Exchange, as well as through purchase and physical delivery contracts from suppliers. As of March 31, 2017, we had corn coverage through approximately May 1, 2017. We continue to stay at a near neutral corn position due to a lack of ability to lock in forward profitable ethanol sales margins. We continue to monitor and attempt to ensure adequate corn supply and protection against rapid price increases. As noted above those activities are, however, subject to various material risks, including that price movements in the cash corn and corn futures markets are highly volatile and are influenced by many factors and occurrences which are beyond our control.

Another important raw material for our production of ethanol is natural gas. Our cost per MMBTU is subject to various factors that are outside of the control of our management. The factors include changes in weather, increase in transportation costs and the overall economic activity.  Our natural gas costs will therefore vary, and the variations could be material.  Our natural gas costs for the three months ended March 31, 2017 represented approximately 7.0% of our total cost of goods sold for that period.


Interest Rate Risk

We have various outstanding loan agreements that expose us to market risk related to changes in the interest rate imposed under the loan agreement and promissory notes.

We have entered into loan agreements, including an irrevocable letter of credit, with Farm Credit Services of America, FLCA and Farm Credit Services of America, PCA (collectively, "Farm Credit"). The interest rate on the Farm Credit monitored revolving credit loan is a variable interest rate loan based on the one month LIBOR index rate plus 2.90%, adjusted weekly. The interest rate on the Farm Credit revolving term loan and irrevocable letter of credit is a variable interest rate based on the one-month LIBOR index plus 3.15%. We do not anticipate any significant increase in interest rates during Fiscal 2017.




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Item 4.    Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our  management,  under the supervision and with  the  participation  of  our President and Chief Executive Officer and our Director of Finance (our principal financial officer), have evaluated the  effectiveness of our 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 quarterly report.  Based on that evaluation,  our President and Chief Executive Officer and our Director of Finance have  concluded  that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures have been effective to provide  reasonable  assurance that the information required to be disclosed in the reports our  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 our  principal executive and principal financial officers or persons performing such functions,  as appropriate,  to allow timely decisions regarding  disclosure.  We believe 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.
 
No Changes in Internal Control Over Financial Reporting
 
No change in our internal control over financial reporting occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.    Legal Proceedings.

From time to time the Company is involved in various litigation matters arising in the ordinary course of its business. None of these matters, either individually or in the aggregate, currently is material to the Company except as reported in the Company's annual report on Form 10-K for the year ended September 30, 2016 and there were no material developments to such matters.

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Item 1A. Risk Factors.


There have been no material changes to the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2016. Additional risks and uncertainties, including risk and uncertainties not presently known to us, or that we currently deem immaterial, could also have an adverse effect on our business, financial condition and results of operations.


Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.
    
None.


Item 3.    Defaults Upon Senior Securities.

None.

Item 4.     Mine Safety Disclosures.

Not applicable.

Item 5.    Other Information.

None.


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Item 6.    Exhibits.

The following exhibits are filed as part of this quarterly report.  


Description of Exhibit
 
 
Page
 
 
 
 
31
 
Rule 13a-14(a)/15d-14(a) Certifications
 
 
 
 
 
 
31.1
 
Rule 13a-14(a) Certification of President and Chief Executive Officer
E-1
 
31.2
 
Rule 13a-14(a) Certification of Director of Finance
E-2
 
 
 
 
32
 
Section 1350 Certifications
 
 
 
 
 
 
32.1
 
Section 1350 Certification of President and Chief Executive Officer †
E-3
 
32.2
 
Section 1350 Certification of Director of Finance†
E-4
 
 
 
 
101
 
Interactive Data Files (furnished electronically herewith pursuant to Rule 405 of Regulation S-T)
 
 
 
 
 
† This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference.


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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.

 
LINCOLNWAY ENERGY, LLC
 
 
 
May 11, 2017
By:
/s/   Eric Hakmiller
 
Name:    Eric Hakmiller
 
Title:     President and Chief Executive Officer
 
 
 
 
 
May 11, 2017
By:
/s/   Kristine Strum
 
Name:    Kristine Strum
 
Title:      Director of Finance (Principal Financial Officer)



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EXHIBIT INDEX

Exhibits Filed With Form 10-Q
of Lincolnway Energy, LLC
For the Quarter Ended March 31, 2017

Description of Exhibit
 
 
Page
 
 
 
 
31

Rule 13a-14(a)/15d-14(a) Certifications
 
 
 
 
 
 
31.1

Rule 13a-14(a) Certification of President and Chief Executive Officer
E-1
 
 
 
 
 
31.2

Rule 13a-14(a) Certification of Director of Finance
E-2
 
 
 
 
32

Section 1350 Certifications
 
 
 
 
 
 
32.1

Section 1350 Certification of President and Chief Executive Officer †

E-3
 
 
 
 
 
32.2

Section 1350 Certification of Director of Finance†

E-4
 
 
 
 
101

Interactive Data Files (furnished electronically herewith pursuant to Rule 405 of Regulation S-T)
 
 
 
 
 
 
† This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference.



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