PART I FINANCIAL INFORMATION
Item 1. Financial Statements
RED TRAIL ENERGY, LLC
Condensed Balance Sheets
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ASSETS
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December 31, 2012
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September 30, 2012
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(Unaudited)
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Current Assets
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Cash and equivalents
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$
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1,000
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$
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1,000
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Restricted cash
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302,276
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6,904
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Accounts receivable, primarily related party
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4,175,317
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3,750,301
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Other receivables
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55,960
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40,069
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Commodities derivative instruments, at fair value
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—
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180,110
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Inventory
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19,718,174
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13,650,907
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Prepaid expenses
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220,606
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87,523
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Total current assets
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24,473,333
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17,716,814
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Property, Plant and Equipment
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Land
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836,428
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833,131
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Land improvements
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4,127,372
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4,127,372
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Buildings
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5,492,612
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5,634,430
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Plant and equipment
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76,740,390
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76,696,675
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Construction in progress
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28,113
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25,885
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87,224,915
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87,317,493
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Less accumulated depreciation
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32,941,381
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31,945,268
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Net property, plant and equipment
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54,283,534
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55,372,225
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Other Assets
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Debt issuance costs, net of amortization
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76,411
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70,751
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Investment in RPMG
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605,000
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605,000
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Patronage equity
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2,030,726
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1,943,226
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Deposits
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40,150
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40,150
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Total other assets
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2,752,287
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2,659,127
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Total Assets
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$
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81,509,154
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$
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75,748,166
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Notes to Unaudited Condensed Financial Statements are an integral part of this Statement.
RED TRAIL ENERGY, LLC
Condensed Balance Sheets
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LIABILITIES AND MEMBERS' EQUITY
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December 31, 2012
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September 30, 2012
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(Unaudited)
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Current Liabilities
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Disbursements in excess of bank balances
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$
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2,311,374
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$
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1,728,931
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Accounts payable
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3,030,462
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1,354,988
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Accrued expenses
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9,105,609
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6,273,695
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Commodities derivative instruments, at fair value
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54,650
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—
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Accrued loss on firm purchase commitments
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636,000
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—
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Short-term borrowings
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1,068,000
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242,000
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Current maturities of long-term debt
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2,536,042
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2,584,429
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Total current liabilities
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18,742,137
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12,184,043
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Long-Term Liabilities
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Notes payable
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20,626,367
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21,252,164
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Contracts payable
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275,000
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275,000
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Total long-term liabilities
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20,901,367
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21,527,164
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Commitments and Contingencies (Note 7)
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—
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—
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Members’ Equity
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41,865,650
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42,036,959
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Total Liabilities and Members’ Equity
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$
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81,509,154
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$
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75,748,166
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Notes to Unaudited Condensed Financial Statements are an integral part of this Statement.
RED TRAIL ENERGY, LLC
Condensed Statements of Operations (Unaudited)
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Three Months Ended
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Three Months Ended
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December 31, 2012
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December 31, 2011
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(Unaudited)
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(Unaudited)
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Revenues, primarily related party
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$
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42,258,878
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$
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37,427,000
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Cost of Goods Sold
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Cost of goods sold
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40,826,626
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36,330,308
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Lower of cost or market inventory adjustment
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249,000
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140,754
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Loss on firm purchase commitments
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636,000
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—
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Total Cost of Goods Sold
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41,711,626
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36,471,062
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Gross Profit
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547,252
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955,938
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General and Administrative Expenses
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526,247
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675,307
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Operating Income
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21,005
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280,631
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Other Income (Expense)
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Interest income
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9,262
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14,233
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Other income
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37,415
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1,800,685
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Interest expense
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(238,991
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)
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(474,799
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)
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Total other income (expense), net
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(192,314
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)
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1,340,119
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Net Income (Loss)
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$
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(171,309
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)
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$
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1,620,750
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Weighted Average Units Outstanding
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Basic
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40,163,160
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40,213,973
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Diluted
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40,168,160
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40,218,973
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Net Income Per Unit
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Basic
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$
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—
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$
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0.04
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Diluted
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$
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—
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$
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0.04
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Notes to Condensed Unaudited Financial Statements are an integral part of this Statement.
RED TRAIL ENERGY, LLC
Condensed Statements of Cash Flows (Unaudited)
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Three Months Ended
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Three Months Ended
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December 31, 2012
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December 31, 2011
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Cash Flows from Operating Activities
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(Unaudited)
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(Unaudited)
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Net income (loss)
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$
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(171,309
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)
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$
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1,620,750
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Adjustments to reconcile net income (loss) to net cash provided by operating activities:
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Depreciation and amortization
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1,007,987
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862,003
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Change in fair value of derivative instruments
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234,760
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(26,025
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)
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Equity-based compensation
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—
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5,000
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Lower of cost or market inventory adjustment
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249,000
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140,754
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Gain on disposal of fixed assets
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(20,796
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)
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—
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Loss on firm purchase commitments
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636,000
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—
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Noncash patronage equity
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(87,500
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)
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—
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Change in operating assets and liabilities:
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Restricted cash
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(295,372
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)
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—
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Accounts receivable
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(425,016
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)
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1,395,488
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Other receivables
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(15,891
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)
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178,640
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Inventory
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(6,316,267
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)
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(466,365
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)
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Prepaid expenses
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(133,083
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)
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66,834
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Other assets
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—
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145,000
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Accounts payable
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1,675,474
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3,400,945
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Accrued expenses
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2,831,914
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1,519,351
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Cash settlements on interest rate swap
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—
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(422,618
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)
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Net cash (used in) provided by operating activities
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(830,099
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)
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8,419,757
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Cash Flows from Investing Activities
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Proceeds from disposal of fixed asset
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160,250
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—
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Capital expenditures
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(54,485
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)
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(1,024,159
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)
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Net cash provided by (used in) investing activities
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105,765
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(1,024,159
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)
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Cash Flows from Financing Activities
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Disbursements in excess of bank balances
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582,443
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—
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Loan fees
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(9,925
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)
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—
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Net advances on short-term borrowings
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826,000
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—
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Debt repayments
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(674,184
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)
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(4,225,362
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)
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Net cash provided by (used in) financing activities
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724,334
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(4,225,362
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)
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Net Increase in Cash and Equivalents
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—
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3,170,236
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Cash and Equivalents - Beginning of Period
|
1,000
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|
4,672,997
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Cash and Equivalents - End of Period
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$
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1,000
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$
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7,843,233
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Supplemental Disclosure of Cash Flow Information
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Interest paid net of swap settlements
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$
|
240,940
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$
|
416,164
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Noncash Investing and Financing Activities
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Assets acquired under capital lease
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$
|
—
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|
$
|
—
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Capital expenditures in accounts payable
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$
|
—
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|
|
$
|
—
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|
Notes to Unaudited Condensed Financial Statements are an integral part of this Statement.
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
The accompanying condensed unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). 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. These 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 twelve-month period ended September 30, 2012, contained in the Company's Annual Report on Form 10-K.
In the opinion of management, the interim condensed unaudited financial statements reflect all adjustments considered necessary for fair presentation. The adjustments made to these statements consist only of normal recurring adjustments. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2013.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Red Trail Energy, LLC, a North Dakota limited liability company (the “Company”), owns and operates a
50 million
gallon annual name-plate production ethanol plant near Richardton, North Dakota (the “Plant”).
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. Significant items subject to such estimates and assumptions include the useful lives of property, plant and equipment, valuation of derivatives, inventory, patronage equity and purchase commitments; the analysis of long-lived assets impairment and other contingencies. Actual results could differ from those estimates.
Net Income (Loss) Per Unit
Net income (loss) per unit is calculated on a basic and fully diluted basis using the weighted average units outstanding during the period.
2. DERIVATIVE INSTRUMENTS
Commodity Contracts
As part of its hedging strategy, the Company may enter into ethanol, soybean oil, and corn commodity-based derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices in order to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sales, corn oil sales, and corn purchase commitments where the prices are set at a future date. 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 fair market value gains or losses are included in the results of operations and are classified as revenue and corn derivative changes in fair market value are included in cost of goods sold.
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
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As of:
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December 31, 2012 (unaudited)
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September 30, 2012
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Contract Type
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# of Contracts
|
Notional Amount (Qty)
|
Fair Value
|
|
# of Contracts
|
Notional Amount (Qty)
|
Fair Value
|
|
Corn futures
|
|
110
|
|
550,000
|
|
bushels
|
$
|
(54,650
|
)
|
|
—
|
|
—
|
|
bushels
|
$
|
—
|
|
|
Corn options
|
|
—
|
|
—
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|
bushels
|
$
|
—
|
|
|
400
|
|
2,000,000
|
|
bushels
|
$
|
173,750
|
|
|
Soybean oil futures
|
|
—
|
|
—
|
|
pounds
|
$
|
—
|
|
|
10
|
|
600,000
|
|
pounds
|
$
|
6,360
|
|
|
Total fair value
|
|
|
|
|
$
|
(54,650
|
)
|
|
|
|
|
$
|
180,110
|
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|
Amounts are recorded separately on the balance sheet - negative numbers represent liabilities
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Interest Rate Contracts
Prior to refinancing its term debt in April 2012, the Company had interest rate swap agreements that exchanged variable interest rates for fixed rates over the term of the agreements. As of December 31, 2012, the Company no longer had any interest rate swap contracts in place.
The Company recorded net settlements on interest rate swap agreements of approximately
zero
and
$423,000
for the three months ended December 31, 2012 and 2011, respectively.
The following tables provide details regarding the Company's derivative financial instruments at December 31, 2012 and September 30, 2012:
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|
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|
|
|
|
|
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|
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Derivatives not designated as hedging instruments:
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|
|
|
|
|
|
|
|
|
|
Balance Sheet - as of December 31, 2012 (unaudited)
|
|
Asset
|
|
Liability
|
|
Commodity derivative instruments, at fair value
|
|
|
|
|
$
|
54,650
|
|
|
Total derivatives not designated as hedging instruments for accounting purposes
|
|
$
|
—
|
|
|
$
|
54,650
|
|
|
|
|
|
|
|
|
Balance Sheet - as of September 30, 2012
|
|
Asset
|
|
Liability
|
|
Commodity derivative instruments, at fair value
|
|
$
|
180,110
|
|
|
$
|
—
|
|
|
Total derivatives not designated as hedging instruments for accounting purposes
|
|
$
|
180,110
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statement of Operations Income/(expense)
|
|
Location of gain (loss) in fair value recognized in income
|
|
Amount of gain(loss) recognized in income during the three months ended December 31, 2012 (unaudited)
|
|
Amount of gain (loss) recognized in income during the three months ended December 31, 2011 (unaudited)
|
|
Corn derivative instruments
|
|
Cost of Goods Sold
|
|
$
|
302,528
|
|
|
$
|
(165,808
|
)
|
|
Soybean oil derivative instruments
|
|
Revenue
|
|
3,084
|
|
|
—
|
|
|
Interest rate swaps
|
|
Interest Expense
|
|
—
|
|
|
1,537
|
|
|
Total
|
|
|
|
$
|
305,612
|
|
|
$
|
(164,271
|
)
|
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
3. INVENTORY
Inventory is valued at lower of cost or market. Inventory values as of December 31, 2012 and September 30, 2012 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
December 31, 2012
(unaudited)
|
|
September 30, 2012
|
|
Raw materials, including corn, chemicals and supplies
|
$
|
13,747,003
|
|
|
$
|
7,455,660
|
|
|
Work in process
|
1,186,369
|
|
|
1,231,096
|
|
|
Finished goods, including ethanol and distillers grains
|
3,385,920
|
|
|
3,704,046
|
|
|
Spare parts
|
1,398,882
|
|
|
1,260,105
|
|
|
Total inventory
|
$
|
19,718,174
|
|
|
$
|
13,650,907
|
|
Lower of cost or market adjustments for the three months ended December 31, 2012 and 2011 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended December 31, 2012
(unaudited)
|
|
For the three months ended December 31, 2011(unaudited)
|
|
Loss on firm purchase commitments
|
|
$
|
636,000
|
|
|
$
|
—
|
|
|
Loss on lower of cost or market adjustment for inventory on hand
|
|
249,000
|
|
|
140,754
|
|
|
Total loss on lower of cost or market adjustments
|
|
$
|
885,000
|
|
|
$
|
140,754
|
|
The Company has entered into forward corn purchase contracts under which it is required to take delivery at the contract price. At the time the contracts were created, the price of the contract price approximated market price. Subsequent changes in market conditions could cause the contract prices to become higher or lower than market prices. As of December 31, 2012, the average price of corn purchased under certain fixed price contracts, that had not yet been delivered, was slightly higher than market price. Based on this information, the Company accrued an estimated loss on firm purchase commitments of
$636,000
for the three months ended December 31, 2012. The loss is recorded in “Loss on firm purchase commitments” on the statements of operations. The amount of the loss was determined by applying a methodology similar to that used in the impairment valuation with respect to inventory. Given the uncertainty of future ethanol prices, this loss may or may not be recovered, and further losses on the outstanding purchase commitments could be recorded in future periods.
The Company recorded inventory valuation impairments of
$249,000
and
$140,754
for the three months ended December 31, 2012 and 2011, respectively. The impairments, as applicable, were attributable primarily to decreases in market prices of ethanol. The inventory valuation impairment was recorded in “Lower of cost or market adjustment” on the statements of operations.
4. BANK FINANCING
|
|
|
|
|
|
|
|
|
|
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|
|
As of
|
|
December 31, 2012 (unaudited)
|
|
September 30, 2012
|
|
Notes payable under loan agreement to bank
|
|
$
|
23,125,000
|
|
|
$
|
23,750,000
|
|
|
Capital lease obligations (Note 6)
|
|
37,409
|
|
|
86,593
|
|
|
Total Long-Term Notes Payable
|
|
23,162,409
|
|
|
23,836,593
|
|
|
Less amounts due within one year
|
|
2,536,042
|
|
|
2,584,429
|
|
|
Total Long-Term Notes Payable Less Amounts Due Within One Year
|
|
$
|
20,626,367
|
|
|
$
|
21,252,164
|
|
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
The Company's notes payable consist of a term loan and a long-term revolver (LTR). As of December 31, 2012, the variable interest rate on both the term loan and the LTR was
3.82%
. Both of these loans mature on April 16, 2017.
The Company also has a
$12,000,000
operating line-of-credit that matures on April 16, 2013. At December 31, 2012, the Company had
$1,068,000
drawn on this line-of-credit leaving a balance of
$10,932,000
available. The variable interest rate was
3.72%
.
|
|
|
|
|
|
|
|
|
Scheduled debt maturities for the twelve months ending December 31
|
|
|
|
|
|
Totals
|
|
2013
|
|
$
|
2,536,042
|
|
|
2014
|
|
2,501,367
|
|
|
2015
|
|
2,500,000
|
|
|
2016
|
|
2,500,000
|
|
|
2017
|
|
13,125,000
|
|
|
Thereafter
|
|
—
|
|
|
Total
|
|
$
|
23,162,409
|
|
As of December 31, 2012, the Company was in compliance with all of its debt covenants.
Interest Rate Swap Agreements
The Company does not have any interest rate swap agreements in place at December 31, 2012 pursuant to the terms of the refinance with its senior lender in April 2012.
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
For the three months ended December 31, 2012
(unaudited)
|
|
For the three months ended December 31, 2011 (unaudited)
|
|
Interest expense on term debt
|
|
$
|
238,991
|
|
|
$
|
476,336
|
|
|
Interest rate swaps
|
|
—
|
|
|
(1,537
|
)
|
|
Total interest expense
|
|
$
|
238,991
|
|
|
$
|
474,799
|
|
5. FAIR VALUE MEASUREMENTS
The following table provides information on those assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2012 and September 30, 2012, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Using
|
|
|
Carrying Amount as of December 31, 2012 (unaudited)
|
|
Fair Value as of December 31, 2012 (unaudited)
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Commodities derivative instruments
|
$
|
54,650
|
|
|
$
|
54,650
|
|
|
$
|
54,650
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Using
|
|
|
Carrying Amount as of September 30, 2012
|
|
Fair Value as of September 30, 2012
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
Commodities derivative instruments
|
$
|
180,110
|
|
|
$
|
180,110
|
|
|
$
|
180,110
|
|
|
$
|
—
|
|
|
$
|
—
|
|
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
The fair value of the corn, ethanol and soybean oil derivative instruments are based on quoted market prices in an active market.
Financial Instruments Not Measured at Fair Value
The estimated fair value of the Company's long-term debt, including the short-term portion, at December 31, 2012 and September 30, 2012 approximated the carrying value of approximately
$23.2 million
and
$23.8 million
, respectively. Fair value was estimated using estimated variable market interest rates as of December 31, 2012. The fair values and carrying values consider the terms of the related debt and exclude the impacts of debt discounts and derivative/hedging activity.
6. LEASES
The Company leases equipment under operating and capital leases through June 2015. The Company is generally responsible for maintenance, taxes, and utilities for leased equipment. Equipment under operating lease includes a locomotive and rail cars. Rent expense for operating leases was approximately
$138,000
and
$219,000
for the three months ended December 31, 2012 and 2011, respectively. Equipment under capital leases consists of office equipment and plant equipment.
Equipment under capital leases is as follows at:
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
December 31, 2012
(unaudited)
|
|
September 30, 2012
|
|
Equipment
|
$
|
483,217
|
|
|
$
|
483,217
|
|
|
Less accumulated amortization
|
(31,812
|
)
|
|
(26,460
|
)
|
|
Net equipment under capital lease
|
$
|
451,405
|
|
|
$
|
456,757
|
|
At December 31, 2012, the Company had the following minimum commitments, which at inception had non-cancelable terms of more than one year. Amounts shown below are for the 12 months period ending December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases
|
|
Capital Leases
|
|
2013
|
$
|
214,522
|
|
|
$
|
36,590
|
|
|
2014
|
125,442
|
|
|
1,398
|
|
|
2015
|
10,500
|
|
|
—
|
|
|
Thereafter
|
—
|
|
|
—
|
|
|
Total minimum lease commitments
|
$
|
350,464
|
|
|
37,988
|
|
|
Less amount representing interest
|
|
|
(579
|
)
|
|
Present value of minimum lease commitments included in liabilities on the balance sheet
|
|
|
$
|
37,409
|
|
7. COMMITMENTS AND CONTINGENCIES
Firm Purchase Commitments for Corn
To ensure an adequate supply of corn to operate the Plant, the Company enters into contracts to purchase corn from local farmers and elevators. At December 31, 2012, the Company had various fixed price contracts for the purchase of approximately
2.3 million
bushels of corn. Using the stated contract price for the fixed price contracts, the Company had commitments of approximately
$16.2 million
related to the
2.3 million
bushels under contract.
RED TRAIL ENERGY, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 2012
8. RELATED-PARTY TRANSACTIONS
The Company has balances and transactions in the normal course of business with various related parties for the purchase of corn, sale of distillers grains and sale of ethanol. The related parties include Unit holders, members of the board of governors of the Company, and RPMG, Inc. (“RPMG”). Significant related party activity affecting the financial statements are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2012
(unaudited)
|
|
September 30, 2012
|
|
Balance Sheet
|
|
|
|
|
|
Accounts receivable
|
|
$
|
3,288,107
|
|
|
$
|
2,853,704
|
|
|
Accounts payable
|
|
2,397,407
|
|
|
839,059
|
|
|
|
|
|
|
|
|
|
|
For the three
months ended
December 31, 2012 (unaudited)
|
|
For the three
months ended December 31, 2011 (unaudited)
|
|
Statement of Operations
|
|
|
|
|
|
Revenues
|
|
$
|
33,531,926
|
|
|
$
|
33,643,658
|
|
|
Cost of goods sold
|
|
747,603
|
|
|
703,728
|
|
|
General and administrative
|
|
34,687
|
|
|
26,245
|
|
|
|
|
|
|
|
|
Inventory Purchases
|
|
$
|
6,432,118
|
|
|
$
|
6,733,684
|
|
9. UNCERTAINTIES IMPACTING THE ETHANOL INDUSTRY AND OUR FUTURE OPERATIONS
The Company has certain risks and uncertainties that it experiences during volatile market conditions, which can have a severe impact on operations. The Company's revenues are derived from the sale and distribution of ethanol and distillers grains to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers and from purchases on the open market. The Company's operating and financial performance is largely driven by prices at which the Company sells ethanol and distillers grains and by the cost at which it is able to purchase corn for operations. The price of ethanol is influenced by factors such as prices, supply and demand, weather, government policies and programs, and unleaded gasoline and the petroleum markets, although since 2005 the prices of ethanol and gasoline began a divergence with ethanol selling for less than gasoline at the wholesale level. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The Company's largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, weather, government policies and programs. The Company's risk management program is used to protect against the price volatility of these commodities.
The Company anticipates that the results of operations during the remainder of fiscal 2013 will continue to be affected by volatility in the commodity markets. The volatility is due to various factors, including uncertainty with respect to the availability and supply of corn, increased demand for grain from global and national markets, speculation in the commodity markets, demand for corn from the ethanol industry and drought conditions currently being experienced by much of the United States.
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 December 31, 2012, 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 September 30, 2012.
Forward Looking Statements
This report contains forward-looking statements that involve future events, our future performance and our future operations and actions. In some cases you can identify forward-looking statements by the use of words such as "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. Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the following factors:
|
|
|
|
|
|
|
|
Ÿ
|
Fluctuations in the price and market for ethanol, distillers grains and corn oil;
|
|
|
Ÿ
|
Availability and costs of products and raw materials, particularly corn and coal;
|
|
|
Ÿ
|
Changes in the environmental regulations that apply to our plant operations and our ability to comply with such regulations;
|
|
|
Ÿ
|
Ethanol supply exceeding demand and corresponding ethanol price reductions impacting our ability to operate profitably and maintain a positive spread between the selling price of our products and our raw material costs;
|
|
|
Ÿ
|
Our ability to generate and maintain sufficient liquidity to fund our operations, meet debt service requirements and necessary capital expenditures;
|
|
|
Ÿ
|
Our ability to continue to meet our loan covenants;
|
|
|
Ÿ
|
Limitations and restrictions contained in the instruments and agreements governing our indebtedness;
|
|
|
Ÿ
|
Results of our hedging transactions and other risk management strategies;
|
|
|
Ÿ
|
Changes in or elimination of governmental laws, tariffs, trade or other controls or enforcement practices that currently benefit the ethanol industry including:
|
|
|
|
Ÿ
national, state or local energy policy - examples include legislation already passed such as the
California low-carbon fuel standard as well as potential legislation in the form of carbon cap and trade;
|
|
|
|
Ÿ
federal and state ethanol tax incentives;
|
|
|
|
Ÿ
legislation mandating the use of ethanol or other oxygenate additives;
|
|
|
|
Ÿ
environmental laws and regulations that apply to our plant operations and their enforcement; or
|
|
|
Ÿ
|
Changes and advances in ethanol production technology; and
|
|
|
Ÿ
|
Competition from alternative fuels and alternative fuel additives.
|
Available Information
Information about us is also available at our website at
www.redtrailenergyllc.com
, which includes links to reports we have filed with the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Quarterly Report on Form 10-Q.
Overview
Red Trail Energy, LLC, a North Dakota limited liability company (the "Company," "Red Trail," or "we," "our," or "us"), owns and operates a 50 million gallon annual name-plate production ethanol plant near Richardton, North Dakota (the "Plant"). Our revenues are derived from the sale and distribution of our ethanol, distillers grains and corn oil primarily in the continental United States. Corn is our largest cost component and our profitability is highly dependent on the spread between the price of corn and the price of ethanol.
Results of Operations for the Three Months Ended
December 31, 2012
and
2011
The following table shows the results of our operations and the percentages of revenues, cost of goods sold, general and administrative expenses and other items to total sales and revenues in our unaudited statements of operations for the three months ended
December 31, 2012
and
2011
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
December 31, 2012 (Unaudited)
|
|
Three Months Ended
December 31, 2011 (Unaudited)
|
|
Statement of Operations Data
|
Amount
|
|
%
|
|
Amount
|
|
%
|
|
Revenues
|
$
|
42,258,878
|
|
|
100.00
|
|
|
$
|
37,427,000
|
|
|
100.00
|
|
Cost of Goods Sold
|
41,711,626
|
|
|
98.71
|
|
|
36,471,062
|
|
|
97.45
|
|
Gross Profit
|
547,252
|
|
|
1.29
|
|
|
955,938
|
|
|
2.55
|
|
General and Administrative Expenses
|
526,247
|
|
|
1.25
|
|
|
675,307
|
|
|
1.80
|
|
Operating Income
|
21,005
|
|
|
0.05
|
|
|
280,631
|
|
|
0.75
|
|
Other Income (Expense)
|
(192,314
|
)
|
|
(0.46
|
)
|
|
1,340,119
|
|
|
3.58
|
|
Net Income (Loss)
|
$
|
(171,309
|
)
|
|
(0.41
|
)
|
|
$
|
1,620,750
|
|
|
4.33
|
The following table shows additional data regarding production and price levels for our primary inputs and products for the three months ended
December 31, 2012
and 2011.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months ended December 31, 2012 (unaudited)
|
|
Three Months ended
December 31, 2011
(unaudited)
|
|
Production:
|
|
|
|
|
|
Ethanol sold (gallons)
|
|
13,925,421
|
|
|
12,532,704
|
|
|
Dried distillers grains sold (tons)
|
|
28,068
|
|
|
27,228
|
|
|
Modified distillers grains sold (tons)
|
|
24,496
|
|
|
17,696
|
|
|
Corn oil sold (pounds)
|
|
2,205,800
|
|
|
—
|
|
|
Revenues:
|
|
|
|
|
|
Ethanol average price per gallon
|
|
$
|
2.21
|
|
|
$
|
2.43
|
|
|
Dried distillers grains average price per ton
|
|
262.18
|
|
|
192.20
|
|
|
Modified distillers grains average price per ton
|
|
124.35
|
|
|
95.95
|
|
|
Corn oil average price per pound
|
|
0.33
|
|
|
—
|
|
|
Primary Inputs:
|
|
|
|
|
|
Corn ground (bushels)
|
|
5,216,972
|
|
|
4,643,253
|
|
|
Costs of Primary Inputs:
|
|
|
|
|
|
Corn average price per bushel (net of hedging)
|
|
$
|
6.69
|
|
|
$
|
6.56
|
|
|
Other Costs:
|
|
|
|
|
|
Chemical and additive costs per gallon of ethanol sold
|
|
$
|
0.086
|
|
|
$
|
0.093
|
|
|
Denaturant cost per gallon of ethanol sold
|
|
0.052
|
|
|
0.046
|
|
|
Electricity cost per gallon of ethanol sold
|
|
0.049
|
|
|
0.054
|
|
|
Direct labor cost per gallon of ethanol sold
|
|
0.044
|
|
|
0.050
|
|
Revenue
We experienced a significant increase in the gallons of ethanol we sold in the three month period ended
December 31, 2012
as compared to the same period in
2011
. The primary reason for this increase was the regularly scheduled fall maintenance shutdown in 2012 was moved from October to July. In 2011 the maintenance shutdown was in October. The average price at which we sold our ethanol was $2.21 and $2.43 for the three month periods ending
December 31, 2012
and
2011
, respectively. Management attributes this decrease in ethanol prices with lower gasoline demand and relatively higher ethanol supplies which put downward pressure on ethanol prices during the 2012 period.
We experienced an increase in the total tons of of distillers grains we sold in the three month period ended
December 31, 2012
as compared to the same period in
2011
primarily due to increased production. We also sold more of our distillers grains in the modified form during the 2012 period compared to the same period of 2011 again due to increased production. We sold
24,496
and
17,696
tons of modified distillers grains during the three month periods ended
December 31, 2012
and
2011
, respectively. The average price per ton of modified distillers grains was $124.35 and $95.95 for the three month periods ending
December 31, 2012
and
2011
, respectively. We sold
28,068
and
27,228
tons of dried distillers grains during the three month periods ended
December 31, 2012
and
2011
, respectively. The average price per ton of dried distillers grains was
$262.18
and
$192.20
for the three month periods ending
December 31, 2012
and
2011
, respectively. Management attributes this increase in distillers grains prices with higher corn prices.
Due to our increased ethanol and distillers grains production, we had a 12.4% increase in the amount of corn ground during the three month period ending
December 31, 2012
as compared to the same period in
2011
. Our average price per bushel of corn ground, net of hedging, was
$6.69
for the quarter ended
December 31, 2012
compared to
$6.56
for the quarter ended
December 31, 2011
. Management attributes this increase in our corn prices as being reflective of overall increases in commodity prices in 2012. Management anticipates that corn prices will remain volatile throughout our 2013 fiscal year primarily due to drought conditions which existed in much of the country's corn producing areas in 2012.
For the three months ended
December 31, 2012
, we received approximately 73% of our revenue from the sale of fuel ethanol, approximately 25% of our revenue from the sale of distillers grains, and approximately 2% of our revenue from the sale of corn oil. Our revenue from ethanol increased during the three months ended
December 31, 2012
compared to the same period in
2011
primarily due to more gallons of ethanol being produced. The impact of this increased ethanol production was offset somewhat by the average price we received per gallon being lower in 2012. During the three months ended
December 31, 2012
, we experienced a decreasing trend in the price we received for our ethanol as ethanol prices lost ground in relation to corn prices. If the price of ethanol and our revenues are outpaced by rising corn prices, management believes our operating margins will be pressured downward.
Cost of Goods Sold
Our cost of goods sold from the production of ethanol and distillers grains is primarily made up of corn and energy expenses. Our cost of goods sold as a percentage of revenues was
98.7
% for the three months ended
December 31, 2012
as compared to
97.4
% for the same period in
2011
. This increase in cost of goods sold as a percentage of revenues was primarily the result of the decrease in the price we receive for our ethanol for the three months ended
December 31, 2012
as compared to the same period in
2011
along with an increase in our cost of goods sold due to our increased corn consumption during the 2012 period.
Corn Costs
Competition for corn in our area has increased basis levels. Although we believe there is corn available nationally from a supply and demand standpoint, there is uncertainty over the amount, quantity, and quality of local corn for the plant. The cost of corn is the highest cost input to the plant and further increases in corn costs could dramatically affect our expected cost of goods sold. During the three month period ended
December 31, 2012
, corn prices fluctuated significantly and we expect continued volatility in corn prices for the rest of our fiscal year which could impact our cost of goods sold.
In the ordinary course of business, we enter into forward purchase contracts for our commodity purchases and sales. At
December 31, 2012
, we have forward corn purchase contracts for various delivery periods through May 2013 for a total commitment of approximately $16.2 million. Our outstanding corn derivatives are projected to settle by March 2013.
Coal Costs
Our coal costs increased approximately 40% during the three month period ended
December 31, 2012
compared to the same period of
2011
. This increase was primarily due to increased coal usage related to increased ethanol production and also related to a coal inventory adjustment that was recorded in 2012. We continue to see a benefit in our coal usage from implementation of our flue gas recirculation project which was originally placed in service in May
2011
.
General and Administrative Expenses
Our general and administrative expenses as a percentage of revenues were 1.2% for the three months ended
December 31, 2012
compared to
1.8
% in the same period of
2011
. General and administrative expenses include salaries and benefits of administrative employees, insurance, taxes, professional fees and other general administrative costs. We experienced a decrease in actual general and administrative expenses of approximately $149,000 for the three month period ended
December 31, 2012
as compared to the same period in
2011
. Our efforts to optimize efficiencies and maximize production may result in a decrease
in our general and administrative expenses on a per gallon basis going forward. However, because these expenses generally do not vary with the level of production at the plant, we expect our actual operating expenses to remain steady throughout the remainder of the 2013 fiscal year.
Operating Income/(Loss)
Our income from operations for the three months ended
December 31, 2012
was approximately
0.05
% of our revenues compared to 0.75% for the same period in
2011
. The decrease in our operating gain for the three month period ended
December 31, 2012
was primarily due to a lower average price received for ethanol per gallon sold during the 2012 period combined with slightly higher prices per bushel of corn in 2012.
Other Income/Expense
Our other expense for the three months ended
December 31, 2012
was
0.5
% of our total revenues compared to other income of
3.6
% of revenues for the same period in
2011
. Our other income for the three month period ended
December 31, 2012
consisted primarily of a gain on disposal of fixed assets. We had other income during the 2011 period related to the federal Alternative Fuel Credit that we received in 2011 related to our use of alternative fuel as a fuel source for our operations. This tax credit expired as of December 31, 2011. Other expense for three month period ended
December 31, 2012
and 2011 consisted primarily of interest expense.
Changes in Financial Condition for the Three Months Ended
December 31, 2012
Current Assets
. Our trade accounts receivable were slightly higher at
December 31, 2012
compared to
September 30, 2012
primarily due to the timing of cash payments received from our ethanol sales. The value of our inventory was significantly higher at
December 31, 2012
compared to
September 30, 2012
primarily due to an increase in the number of bushels in our corn inventory. The market value of our commodities derivatives account was lower at
December 31, 2012
compared to
September 30, 2012
because we had significantly fewer commodity derivatives in place at
December 31, 2012
than at
September 30, 2012
. Our prepaid expenses were higher at
December 31, 2012
compared to
September 30, 2012
primarily due to the timing of a payment for prepaid insurance which was made in November 2012.
Property, Plant and Equipment
. The gross value of our property, plant and equipment was lower at
December 31, 2012
compared to
September 30, 2012
primarily due to the sale of a residence that had been used for employee housing. This decrease was offset somewhat by capital expenditures related to replacing a computer server in our administrative office and upgrading our accounting software. The net value of our property, plant and equipment was lower at
December 31, 2012
compared to
September 30, 2012
primarily as a result of increases in our accumulated depreciation.
Other Assets
. Our other assets were higher at
December 31, 2012
compared to
September 30, 2012
primarily due to an increase in our patronage equity in our electricity provider which is a cooperative. Other assets also increased due to additional loan fees related to a loan amendment entered into effective November 2012. This increase was offset somewhat by increases in our accumulated amortization related to our loan fees.
Current Liabilities
. Our current liabilities were significantly higher at
December 31, 2012
compared to
September 30, 2012
, primarily due to increased payables related to our corn inventory purchases. We also had a loss on firm purchase commitments of $636,000 accrued at
December 31, 2012
compared to no loss on firm purchase commitments accrued at
September 30, 2012
. This estimated loss was accrued due to fixed price corn purchase contracts we had in place which were for prices higher than market value at
December 31, 2012
. Our short-term borrowings were also higher at December 31, 2012 compared to September 30, 2012 due to increased borrowings on our operating line-of-credit.
Long-term Liabilities
. Our long-term liabilities were lower at
December 31, 2012
compared to
September 30, 2012
, due to payment of our scheduled quarterly loan payment in December 2012.
Liquidity and Capital Resources
Based on financial forecasts performed by our management, we anticipate that we will have sufficient cash from our current credit facilities and cash from our operations to continue to operate the ethanol plant for the next 12 months. Should we experience unfavorable operating conditions in the future, we may have to secure additional debt or equity sources for working capital or other purposes.
The following table shows cash flows for the
three months
ended
December 31, 2012
and
2011
:
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|
|
|
|
|
|
|
|
|
|
2012
(unaudited)
|
|
2011
(unaudited)
|
|
Net cash (used in) provided by operating activities
|
|
$
|
(830,099
|
)
|
|
$
|
8,419,757
|
|
|
Net cash provided by (used in) investing activities
|
|
105,765
|
|
|
(1,024,159
|
)
|
|
Net cash provided by (used in) financing activities
|
|
724,334
|
|
|
(4,225,362
|
)
|
|
Net increase in cash
|
|
$
|
—
|
|
|
$
|
3,170,236
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
1,000
|
|
|
$
|
7,843,233
|
|
Cash Flow from Operations
Our cash provided by operations was significantly lower during our first three months of 2012 compared to the same period of 2011 primarily due to increased cash used for corn inventory purchases. Our cash from operations was also negatively affected in 2012 as we generated a net loss for the three months ended December 31, 2012 versus net income for the three months ended December 31, 2011.
Cash Flow From Investing Activities
We used less cash for investing activities during the
three month
period ended
December 31, 2012
compared to the same period in
2011
due primarily to significantly lower capital expenditures in 2012. We also received cash from investing activities in 2012 related to the sale of a residence which had been used for employee housing.
Cash Flow from Financing Activities
We used less cash for financing activities during the
three month
period ended
December 31, 2012
as compared to the same period in
2011
due to increased payments we made on our long-term debt during the 2011 period.
Our liquidity, results of operations and financial performance will be impacted by many variables, including the market price for commodities such as, but not limited to, corn, ethanol and other energy commodities, as well as the market price for any co-products generated by the facility and the cost of labor and other operating costs. Assuming future relative price levels for corn, ethanol and distillers grains remain consistent, we expect operations to generate adequate cash flows to maintain operations.
Capital Expenditures
The Company had approximately $28,000 in construction in progress as of
December 31, 2012
. During the three months ended
December 31, 2012
, the Company placed in service approximately $54,000 in capital projects with the majority of these costs related to the installation of a new accounting server and upgrade to our accounting software.
Capital Resources
Short-Term Debt Sources
The Company has a revolving line-of-credit of $12,000,000 with $1,068,000 drawn on this line-of-credit as of
December 31, 2012
. This revolving line-of-credit matures in April 2013. The variable interest rate on this line-of-credit is 3.5% over the one-month LIBOR with a rate of 3.72% as of December 31, 2012.
Long-Term Debt Sources
As of
December 31, 2012
, our long-term debt consisted of a term loan and a long-term revolving line-of-credit. The following table summarizes our long-term debt instruments with our senior lender.
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|
|
|
|
|
|
|
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|
|
|
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|
|
|
|
Outstanding Balance (Millions)
|
|
Interest Rate
|
|
|
|
|
|
Term Note
|
|
December 31, 2012 (Unaudited)
|
|
September 30, 2012
|
|
December 31, 2012 (Unaudited)
|
|
September 30, 2012
|
|
Quarterly
Principal
Payment Amounts
|
|
Notes
|
|
Term Note
|
|
$
|
18.5
|
|
|
$
|
19.00
|
|
|
3.82
|
%
|
|
3.93
|
%
|
|
$500,000
|
|
1,2
|
|
Long-Term Revolving Note
|
|
4.6
|
|
|
4.75
|
|
|
3.82
|
%
|
|
3.93
|
%
|
|
$125,000
|
|
1,2,3
|
Notes
1 - Maturity date of April 2017.
2 - Variable interest rate at 3.5% over the three-month LIBOR, reset quarterly.
3 - Quarterly payments are equal to required quarterly reductions in total available/principal payments of $125,000. Amount available and drawn on this note as of December 31, 2012 was $4,625,000.
Restrictive Covenants
We are subject to a number of covenants and restrictions in connection with our credit facilities, including:
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•
|
Providing FNBO with current and accurate financial statements;
|
|
|
|
|
•
|
Maintaining certain financial ratios including minimum working capital and fixed charge coverage ratio;
|
|
|
|
|
•
|
Maintaining adequate insurance;
|
|
|
|
|
•
|
Making, or allowing to be made, any significant change in our business or tax structure;
|
|
|
|
|
•
|
Limiting our ability to make distributions to members; and
|
|
|
|
|
•
|
Maintain a threshold of capital expenditures.
|
As of
December 31, 2012
we are in compliance with our loan covenants.
Industry Support
North Dakota Grant
In 2006, we entered into a contract with the State of North Dakota through the Industrial Commission for a lignite coal grant not to exceed $350,000. We received $275,000 from this grant during 2006 with this amount currently shown in the long-term liability section of our Balance Sheet as Contracts Payable. Because we have not met the minimum lignite usage requirements specified in the grant for any year in which the plant has operated, we expect to have to repay the grant and are awaiting instructions from the Industrial Commission as to the terms of the repayment schedule. This repayment could begin at some point in 2013, but as of
December 31, 2012
we have not received any instructions from the Industrial Commission.
Critical Accounting Estimates
Our most critical accounting policies, which are those that require significant judgment, include policies related to the carrying amount of property, plant and equipment; valuation of derivatives, inventory and purchase commitments of inventory. An in-depth description of these can be found in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012. For valuation allowances related to firm purchase commitments of inventory, please refer to the disclosures in Note 3 of the Notes to the Unaudited Condensed Financial Statements in this Quarterly Report. Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed financial statements in accordance with generally accepted accounting principles. There have been no changes in the policies for our accounting estimates for the quarter ended
December 31, 2012
.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
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 use cash, futures and option contracts to hedge changes to the commodity prices of corn, ethanol 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 pursuant to the requirements of Generally Accepted Accounting Principles ("GAAP").
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 in the ethanol production process and the sale of ethanol.
We enter into fixed price contracts for corn purchases on a regular basis. It is our intent that, as we enter into these contracts, we will use various hedging instruments (puts, calls and futures) to maintain a near even market position. For example, if we have 1 million bushels of corn under fixed price contracts we would generally expect to enter into a short hedge position to offset our price risk relative to those bushels we have under fixed price contracts. Because our ethanol marketing company (RPMG) is selling substantially all of the gallons it markets on a spot basis we also include the corn bushel equivalent of the ethanol we have produced that is inventory but not yet priced as bushels that need to be hedged.
Although we believe our hedge positions will accomplish an economic hedge against our future purchases, they are not designated as hedges for accounting purposes, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We use fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the gains and losses are immediately recognized in our cost of sales. The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from quarter to quarter and year to year due to the timing of the change in value of derivative instruments relative to the cost of the commodity being hedged. However, it is likely that commodity cash prices will have the greatest impact on the derivatives instruments with delivery dates nearest the current cash price.
As of
December 31, 2012
we had approximately 2.3 million bushels of corn under fixed price contracts. Some of these contracts were priced above current market prices so an accrual for a loss on firm purchase commitments of $636,000 was recorded.
It is the current position of our ethanol marketing company, RPMG, that under current market conditions selling ethanol in the spot market will yield the best price for our ethanol. RPMG will, from time to time, contract a portion of the gallons they market with fixed price contracts.
We estimate that our expected corn usage will be between 18 million and 20 million bushels per calendar year for the production of approximately 50 million to 54 million gallons of ethanol. As corn prices move in reaction to market trends and information, our income statements will be affected depending on the impact such market movements have on the value of our derivative instruments.
To manage our coal price risk, we entered into a coal purchase agreement with our supplier to supply us with coal, fixing the price at which we purchase coal. If we are unable to continue buying coal under this agreement, we may have to buy coal in the open market.
Interest Rate Risk
We are exposed to market risk from changes in interest rates on our senior debt which bears variable interest rates. We anticipate that a hypothetical 1% change in the interest rate on our senior debt as of
December 31, 2012
, would cause an adverse change to our income in the amount of approximately $231,000.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d - 15(e) under the Securities
Exchange Act of 1934 ("Exchange Act"), as amended, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of
December 31, 2012
, have concluded that our disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that we file with the SEC.
Changes in Internal Controls
There have been no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the fiscal quarter ended
December 31, 2012
, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Inherent Limitations on the Effectiveness of Controls
Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the control systems are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of internal controls over financial reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected or will be detected.
These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies and procedures.
