**U.S. SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-KSB**

 

| **ANNUAL REPORT FOR SMALL BUSINESS ISSUERS SUBJECT TO THE  1934 ACT REPORTING REQUIREMENTS** |
|----------------------------------------------------------------------------------------------|
|                                                                                         |
| **ý**                                                                                   |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                         |   |   |
|                                                                                         |   | **For  the Fiscal Year Ended December 31, 2002** |
|                                                                                         |   |   |
|                                                                                         |   | **OR** |
|                                                                                         |   |   |
| **o**                                                                                        |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                         |   |   |
|                                                                                         |   | **For  the Transition Period from                  to              ** |

 

**Commissionfile number  333-50568**

** **

| **BADGER  STATE ETHANOL, LLC**                                   |
|------------------------------------------------------------------|
| (Name of Small Business  Issuer in Its Charter)                  |
|                                                             |   |   |
| **Wisconsin**                                                    |   | **39-1996522** |
| (State or Other  Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |   |
| **820 West 17th Street,  Monroe, Wisconsin  53566**         |
| (Address and Zip Code  of Principal Executive Offices)           |

 

Registrant’sTelephone Number, Including Area Code  **(608)329-3900**

 

----

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act:  **None**

 

Securitiesregistered under Section 12(g) of the Exchange Act:  **Class A member units**

 
| Indicate by checkmark 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. |   | Yes ý  No o |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|
|                                                                                                                                                                                                                                                                                                                                                                    |   |                  |
| Indicate by checkmark if disclosure of delinquent  filers pursuant to Item 405 of Regulation S-B is not contained  herein, and will not be contained, to the best of registrant’s knowledge, in  definitive proxy or information statements incorporated by reference in Part  III of this Form 10-KSB or any amendment to this Form 10-KSB.             |   |   o              |

 

State issuer’s revenues for its most recent fiscalyear.  $10,125,926

 

The aggregate market value of the member units held bynon-affiliates of the registrant (computed by reference to book value of suchmember units) was $10,573,462 as of December 31, 2002.  There is no established public or privatetrading market for our securities.

 

DOCUMENTS INCORPORATED BYREFERENCE.

None.

 

 

----

 

**TABLE OFCONTENTS**

 
|                     |                                                                                                | **Page** |
|--------------------------|-----------------------------------------------------------------------------------------------------|----------|
|                     |                                                                                                |     |
| **PART I**               |                                                                                                | 1        |
|                     | Item 1.  Description Of Business                                                               | 1        |
|                     | Item 2.  Description Of Properties                                                             | 13       |
|                     | Item 3.  Legal Proceedings                                                                     | 13       |
|                     | Item 4.  Submission Of Matters To A Vote Of  Security Holders                                  | 13       |
| **PART II**              |                                                                                                | 13       |
|                     | Item 5.  Market For The Registrant’s Member Units  And Related Member Matters             | 13       |
|                     | Item 6.  Management’s Discussion And Analysis And  Plan Of Operations                     | 14       |
|                     | Item 7.  Financial Statements                                                                  | 17       |
|                     | Item 8.  Changes In And Disagreements With  Accountants On Accounting And Financial Disclosure | 17       |
| **PART III**             |                                                                                                | 17       |
|                     | Item  9.  Directors, Executive Officers And  Key Employees Of The Registrant                   | 17       |
|                     | Item 10.  Executive Compensation                                                               | 19       |
|                     | Item 11.  Security Ownership Of Certain Beneficial  Owners And Management                      | 21       |
|                     | Item 12.  Certain Relationships And Related  Transactions                                      | 21       |
|                     | Item 13.  Exhibits, Financial Statements, Schedules And Reports On Form  8-K                   | 23       |
|                     | Item 14.  Controls And Procedures                                                              | 25       |
|                     |                                                                                                |
| **SIGNATURES**           | 26                                                                                                  |
|                     |
| **CERTIFICATIONS**       | 27                                                                                                  |
|                     |
| **FINANCIAL STATEMENTS** | F-1                                                                                                 |

 

i

----

 

**CAUTIONARYSTATEMENT REGARDING FORWARD-LOOKING STATEMENTS**

** **

This report contains forward-looking statements.  In addition, we may make forward-lookingstatements orally in the future by or on behalf of the Company.  When used, the words “believe,” “expect,”“will,” “can,” “estimate,” “anticipate” and similar expressions are intended toidentify forward-looking statements. Readers should not place undue reliance on any forward-lookingstatements and recognize that the statements are not predictions of actualfuture results.  Actual results couldand likely will differ materially from those anticipated in the forward-lookingstatements due to the risks and uncertainties set forth in our Form SB-2registration statement under the caption “Risk Factors,” as well as others notnow anticipated.  These risks anduncertainties include, without limitation, our assumptions concerning financingrequirements and future operations, our ability to obtain debt financing,changes in state and federal ethanol subsidies, our need for additionalcapital, our ability to manufacture our products on a commercial scale and incompliance with regulatory requirements, increased competition, and changes ingovernment regulation.  We undertake noresponsibility to update any forward-looking statement.

 

ii

----

 

**PART I**

** **

**ITEM 1.  DESCRIPTION OF BUSINESS**

 

Badger State Ethanol, LLC, a Wisconsin limitedliability company organized in 2000 (the “Company”), is engaged in theproduction and sale of fuel grade ethanol. Unless otherwise indicated, whenever we use term we, us, our or ours, wemean the Company.

 

Fuel grade ethanol is our primary product accountingfor the majority of our revenue.  Inaddition, we sell distillers grains, a principal by-product of the ethanolproduction process, which may be sold as distillers dried grains and distillersmodified wet grains.  We have an annualcapacity to process approximately 14.4 million bushels of corn intoapproximately 40 million gallons of ethanol. We completed construction of our plant and started operations in October2002.

 

**Descriptionof Dry Mill Process**

 

Our ethanol plant, which is located in Monroe,Wisconsin, produces ethanol by processing corn.  The corn is received by rail and by semi-trailer truck, and isweighed and cleaned of rocks and debris before it is conveyed to one of twoconcrete storage silos. The corn is then transported to a hammermill or grinderwhere it is ground into flour and conveyed into a slurry tank forprocessing.  We add water, heat andenzymes to break the ground corn into a corn mash.  This mash is heat sterilized and pumped to a tank where other enzymesare added to convert the starches into glucose sugars.  Next, the mash is pumped into one of threefermenters, where yeast is added, to begin a forty-eight to fifty hour batchfermentation process.  A distillationprocess vaporizes the alcohol from the corn mash.  The alcohol is further dried in a rectifier and molecularsieve.  The resulting 200 proof alcoholis then pumped to shift tanks and blended with five percent gasoline as it ispumped into denatured ethanol storage tanks.

 

Corn mash exiting the distillation process is pumpedinto one of several centrifuges.  Waterfrom the centrifuges, called thin stillage, is condensed into a thicker syrupcalled condensed solubles.  The solidsthat exit the centrifuge are called wet cake or distillers wet grains.  Typically, this wet cake is conveyed todryers where condensed solubles are added and moisture is removed to producedistillers dried grains, which may be used as animal feed.

 

**PrincipalProducts and Their Markets**

 

The principal products we produce at our ethanol plantare fuel grade ethanol and distillers grains.

 

***Ethanol***

 

Ethanol is ethyl alcohol, which has many industrialuses.  At our plant, we produce ethanolto be used as a fuel component that serves as:

 

•                  Anoctane enhancer in fuels;

 

•                  Anoxygenated fuel additive that can reduce carbon monoxide vehicle emissions; and

 

•                  Anon-petroleum-based gasoline extender.

 

Ethanol in its primary form is mostly used forblending with unleaded gasoline and other fuel products.  The implementation of the Federal Clean AirAct has made ethanol fuels an important domestic renewable fuel additive.  Used as a fuel oxygenate, ethanol provides ameans to reduce carbon monoxide vehicle emissions.  The principal purchasers of ethanol are generally the refined andwholesale gasoline marketer or blender. Our principal end markets for our ethanol are petroleum terminals inWisconsin, Illinois and other states in the upper Midwest.

 

1

----

 

***Distillers Grains***

 

A principal by-product of the ethanol productionprocess is distillers grains, a high-protein, high-energy animal feedsupplement primarily marketed to the dairy and beef industry.  Our plant uses a dry mill ethanol processwith a dryer system that allows production of two moisture levels of distillersgrains: distillers modified wet grains and distillers dried grains.  Distillers modified wet grains are processedcorn mash and condensed solubles that contain approximately 50% moisture.  It has a shelf life slightly longer thanthree days and is often sold to nearby markets.  Distillers dried grains are corn mash that has been dried to 10%moisture.  It has an almost indefiniteshelf life and may be sold and shipped via truck, rail car, barge or ship toany market regardless of its vicinity to our ethanol plant.

 

In fiscal 2002, we experienced higher natural gasprices, which led to higher by-product processing costs.  To mitigate higher processing costs, weincreased our production of distillers modified wet grains, which require lessnatural gas to produce.  Consequently,we also increased the marketing campaign for distillers modified wet grains, inpart by promoting the nutritional benefits of distillers modified wet grains.

 

**Customers**

 

We entered into an ethanol purchase and marketingagreement with Murex, N.A., Ltd., for the exclusive rights to purchase andmarket all ethanol produced by our plant. For fiscal year ended December 31, 2002, Murex, N.A., Ltd.accounted for all of our ethanol sales and approximately 78% of our aggregaterevenues.  We believe that the loss ofMurex, N.A., Ltd. as a customer would have a material adverse effect onour sales and revenues.  Murex ownsClass A member units and has a representative on our Board ofDirectors.  This exclusive agreement hasan initial term of seven years until October 23, 2010, and automatically renewsfor successive one-year terms unless written notice of termination is issued 90days prior to the end of the then current term.

 

We entered into a distillers grains purchase andmarketing agreement with ICM Marketing, Inc. for the exclusive rights topurchase and market all distillers grains produced by our plant.  For fiscal year ended December 31, 2002, ICMMarketing, Inc. accounted for virtually all of our distillers grains sales andapproximately 19% of our aggregate revenues. We believe that the loss of ICM Marketing, Inc. as a customer would havea material adverse effect on our sales and revenues.  This exclusive agreement has an initial term of three years untilOctober 25, 2005, and automatically renews for successive one-year terms unlesswritten notice of termination is issued 90 days prior to the end of the thencurrent term.  ICM, Inc., the parentcompany of IMC Marketing, Inc., owns class A member units and has arepresentative on our Board of Directors.

 

**SeasonalFactors in Business**

 

In an effort to improve air quality in regions wherecarbon monoxide and ozone are a problem, the United States federal governmentrequires the use of gasoline with a higher oxygen content in these regionsduring the fall and winter.  Gasolinethat is blended with ethanol has a higher oxygen content than gasoline thatdoes not contain ethanol.  As a result,we expect moderate seasonality with respect to our gross profit margins on ourfuel grade ethanol allowing us to, potentially, be able to sell our fuel gradeethanol at a premium during the mandated oxygenate period (which coincides withour third and fourth fiscal quarters). Conversely, our average sales price for fuel grade ethanol during thesummer, when fuel grade ethanol is primarily used as an octane enhancer or afuel supply extender, has historically been lower.  We primarily contract for six-month blending cycles to correspondto the different winter and summer market periods.

 

**EthanolIndustry**

 

Ethanol has important applications, primarily as anoctane enhancer in fuels, an oxygenated fuel additive that can reduce carbonmonoxide vehicle emissions and a non-petroleum-based gasoline extender.  The ethanol industry is heavily dependent,however, on several governmental economic incentives.

 

2

----

 

***Federal Ethanol Supports***

 

Ethanol sales have been favorably affected by theClean Air Act Amendments of 1990, particularly the Federal Oxygen Program whichbecame effective November 1, 1992.  TheFederal Oxygen Program requires the sale of oxygenated motor fuels during thefall and winter months in certain major metropolitan areas to reduce carbonmonoxide pollution.  Ethanol use hasincreased due to a second Clean Air Act program, the Reformulated GasolineProgram.  This program became effectiveJanuary 1, 1995, and requires the sale of reformulated gasoline in certainmajor urban areas to reduce pollutants, including those that contribute toground level ozone, better known as smog.

 

The use of ethanol as an oxygenate to blend with fuelto comply with federal mandates also has been aided by federal tax policy.  The Energy Tax Act of 1978 exempted ethanolblended gasoline from the federal gas tax as a means of stimulating thedevelopment of a domestic ethanol industry and mitigating the United State’sdependence on foreign oil.  As amended,the federal tax credit currently allows the market price of ethanol to competewith the price of domestic gasoline. Although the federal tax credit is not directly available to us, itallows us to sell our ethanol at prices that are competitive with other lessexpensive additives and gasoline.  Thecredit for an ethanol blend is the equivalent of providing a per gallon“equalization” payment that allows blenders to pay more for ethanol than thewholesale price of gasoline and still retain the same profit margins.  Under current legislation, the federal gasolinetax is $0.184 per gallon and the tax on gasoline blended with 10% ethanol is$0.13 per gallon, providing a $0.054 difference.  Smaller credits of $0.0408 and $0.0302, are available forgasoline blended with 7.7% and 5.7% ethanol, respectively.  The federal tax on a gallon of 10% ethanolblended gasoline will gradually increase to $.133 by 2005, dropping thedifference to $.051 per gallon.  By2007, the federal tax credit for ethanol blended gasoline will expire, and itis scheduled to be taxed at the standard federal gasoline tax rate.

 

Fuel grade ethanol prices traditionally have varieddirectly with the wholesale price of gasoline. However, in some states, fuel grade ethanol typically sells for a higherprice per gallon than wholesale gasoline because of the aforementioned excisetax incentives.  Historically, fuelgrade ethanol prices have also reflected a premium due to the oxygenate andoctane enhancing properties of this motor fuel additive.

 

During the year 2003, we anticipate receiving up to$7.5 million from the United States Department of Agriculture Commodity CreditCorporation’s Bioenergy Program.  Underthe program, we are eligible to receive a cash incentive for incremental grainconsumption for the purpose of producing fuel grade ethanol.  This program is only available to ethanolplants in the first full calendar year after such ethanol plant has increasedits production, in an amount based upon the increase in production at suchplant, up to a total of $7.5 million.

 

***State Ethanol Supports***

 

In part, the success of our business is dependent uponthe availability of cash payments to ethanol producers from the State ofWisconsin under Wisconsin Statutes Section 20.115(3)(d) and 93.75 (referred tohereinafter as the “Producer Subsidy Payment”).  Under the Wisconsin Producer Subsidy Payment program, the Stateof Wisconsin will pay certain ethanol producers $.20 per gallon for up to15,000,000 gallons of ethanol produced in Wisconsin in each 12 monthperiod.  The Producer Subsidy Paymentswill be prorated if the State of Wisconsin has insufficient funds to pay alleligible ethanol producers $.20 per gallon. If this occurs, we will receive less than $0.20 per gallon of ethanolproduced.  Under the program, a Wisconsinethanol producer is eligible for the payments if it has been producing ethanolin Wisconsin for fewer than 60 months, it produces more than 10,000,000 gallonsof ethanol a year and it purchases the corn or other substances from which theethanol is produced from local Wisconsin sources.  The maximum subsidy available to an ethanol producer under thisprogram is $3,000,000 annually.  We arecurrently eligible for the Producer Subsidy Payment and have applied to receiveit.  Producer Subsidy Payment program ispresently scheduled to expire in 2006. Furthermore, the Producer Subsidy Payments could be eliminated orreduced by the Wisconsin legislature at any time.

 

**Business Location; Proximity toMarkets**

 

We are operating an ethanol plant in Monroe,Wisconsin, which is in Green County, in the southern central section ofWisconsin.  We purchased for $1 from theCity of Monroe, Wisconsin an approximately 28-acre site on which to build theethanol plant.  We selected the Monroesite because of its location to existing grain production,

 

3

----

 

accessibility to road and rail transportation and its proximity tomajor population centers.  It is alsoserved by the Wisconsin Southern Railroad Company, a short line rail operator.  In addition, it is also in close proximityto major highways that connect to major population centers such as Madison andMilwaukee, Wisconsin and Chicago, Illinois.

 

**Development Agreement with the Cityof Monroe**

 

We entered into a development agreement with the Cityof Monroe to construct the ethanol plant and for site improvements.  As part of the development agreement, weagreed to on-going obligations, including the following:

 

•                  Constructingone or more rail spurs connecting into an existing rail line;

 

•                  Providingthe City of Monroe a warranty that on or before January 1, 2002 and for aperiod of ten years thereafter, the fair market value of the site, includingimprovements, will not be less that $10 million or pay a non-performancepenalty not to exceed $280,000 per year; and

 

•                  Repayingup to $1.6 million of the City of Monroe’s tax incremental financing for siteimprovements through regular property tax assessments that, other than the fairmarket value warranty described above, are no higher than what would otherwisebe assessed on the site after construction and operation if purchased from athird party.

 

**Procurements**

 

***Grain Delivery***

 

According to the Wisconsin Agricultural StatisticalService, over 360 million bushels of corn are produced annually inWisconsin.  Of that total, the greatestpercentage is produced in the southern portion of the state.  According to the Wisconsin AgriculturalStatistical Service, approximately 200 million bushels of corn are producedannually within a 100-mile radius of Monroe, Wisconsin.  Our plant is located in Monroe, Wisconsin, inGreen County, approximately eight miles from the Illinois state border.  We obtain approximately 98% of our cornsupply from producers located within a 100-mile radius of Monroe.  This amounts to approximately 3% of the cornproduced within a 100-mile radius of Monroe. We purchase most of our corn from Wisconsin producers because cornpurchased from Wisconsin residents qualifies for incentive payments to ethanolproducers from the State of Wisconsin. We have no agreements, commitments or understandings with any cornproducers.

 

***Grain Elevators***

 

We have ongoing business relationships with localgrain elevators to acquire the grain we need. We have identified approximately 36 elevators as potential sources ofgrain in southern Wisconsin and continue to discuss with them future corndelivery.  Although we are currentlyprocuring grains from these sources, we cannot guarantee that we will be ableto continue procuring such grains on acceptable terms or at all.

 

***Transportation and Delivery***

 

Grain is delivered to our ethanol plant by trucks andrail.  We also are dependent on rail andcommercial trucks to distribute our ethanol and distillers grains.  Any disruption in the rail system orcommercial truck system would have a significant detrimental effect on ouroperations.  The Wisconsin and SouthernRailroad Company provides rail service to the plant.  The railroad provides direct access for shippers via the Chicago,Illinois gateway, which connects with all major railroads via the Belt Railwayof Chicago, Burlington Northern at Prairie du Chien, Wisconsin, Union Pacific,Canadian Pacific and Wisconsin Central railroads at various points on thesystem.  In addition, access to bargefacilities is also available at Prairie du Chien, Wisconsin.

 

In July 2001, we entered into a rail trackreimbursement and construction agreement, as well as a transportationagreement, with Wisconsin and Southern Railroad Company for construction of arail track to our

 

4

----

 

ethanol plant and for rail transportation services.  Under the reimbursement and constructionagreement, we will receive reimbursements from the rail operator for trackconstruction costs based upon a rate of $10 per freight car shipped or receivedat our ethanol plant.  Thereimbursements are payable on a monthly basis not to exceed ten years or thecost of the track.  The transportationagreement provides us with rail transportation services for deliveries to andfrom the ethanol plant at negotiated rates. The transportation agreement has been approved by the SurfaceTransportation Board of the U.S. Department of Transportation and the agreementcommenced on January 1, 2003.

 

***Hedging***

 

Due to rapid fluctuations in the price of corn, withinsix months prior to our ethanol plant beginning operations, we engaged FirstCapital Ag to help us develop a Grain Risk Management Program hedging strategyto minimize our commodity risk exposure. Our Grain Risk Management Program is intended to use grain purchasecontracts together with grain futures derivatives to fix the cost of some ofour expected future grain purchases. Our policy allows for the use of fixed price forward purchase contracts,un-priced forward basis purchase contracts, and Chicago Board of Trade (CBOT)derivative contracts (over-the-counter and traditional options).  During 2002, approximately 85% of our fiscal2002 grain requirements were hedged through a combination of fixed priceforward purchase contracts, and CBOT traditional and over-the-counter optionhedges to protect our cost of grain. During 2002, our practice of protecting the cost of our grain, generallyaccounted for 85% of forecasted grain purchases in the upcoming twelve months.  We took this action because of our start-upnature and the volatility of corn price. Under our program, all components of the position are monitored and allhedges are designated against future grain requirements to ensure that we donot enter into commitments or derivatives for grain in excess of expected grainrequirements.

 

***Storage Capacity***

 

We have sufficient corn storage facilities on-site forapproximately nine days of continuous production.  Since our inception, we have maintained our own in-house grainprocurement department, to procure all our grain needs.  We believe that by establishing internalgrain procurement, we can better develop local supply relationships that willreduce the need to buy and store grain offsite and better manage our rawmaterial risk management program.  Wehired a commodities manager to ensure the consistent scheduling of graindeliveries and to establish and fill forward contracts through grainelevators.  The commodities managercoordinates grain deliveries between the railroad and the participatingelevators, as well as negotiates price protection with hedging specialists.

 

***Water***

 

Water supply is important to our ethanolbusiness.  The water quality at ourplant currently meets the needs of the facility without significant filteringor processing.  To satisfy our waterneeds, we have drilled one 500,000 gallon-per-day well on the property.  Based upon current production of currentlyexisting wells in the City of Monroe, we believe there is sufficient groundwater to support this well.  Inaddition, we are also connected to the City of Monroe’s water supply in theevent the water supplied by the well is not sufficient.

 

***Natural Gas***

 

Ethanol production is an energy intensive processusing significant amounts of electricity and natural gas.  We have contracted with Wisconsin ElectricPower Company (“WE Energies”) for firm service natural gas delivery and with USEnergy Services, Inc. to coordinate purchase and delivery of the gas to theplant and otherwise manage our energy needs. Due to the competitive nature of the natural gas market, we believe nosignificant risk of long-term interruption exists.  US Energy Services, Inc. also helps us to negotiate and procurenatural gas and electricity.  Naturalgas prices have historically fluctuated dramatically.  According to US Energy Services, Inc., the current price ofnatural gas as reported on the New York Mercantile Exchange is up 60% from lastyear.  US Energy Services, Inc. providesprice risk management services to us to manage natural gas prices in a mannerthat we believe will provide price stability.

 

Natural gas supplies must be procured and delivered ona daily basis in an amount equal to anticipated daily plant usage.  Transporters must be notified each dayregarding our plant’s expected usage and the physical supply

 

5

----

 

source.  To the extent thatactual plant usage is greater than or less than expected usage (which usuallyis the case) the imbalance must be managed. US Energy Services, Inc. provides us with these kinds of managementservices and monitors gas delivery, ensures timely payment of invoices, andreviews and reconciles the final invoices.

 

We have an arrangement with Wisconsin Gas Company tobe the exclusive supplier of transportation for natural gas for the plantoperations.

 

***Electricity***

 

We purchase electricity from Alliant Energy Company,the local utility that holds the service franchise for the area in which ourethanol plant is located.  We have notentered into any agreement with Alliant regarding electrical service.

 

**Sales and Marketing**

 

We entered into a seven-year ethanol purchase andmarketing agreement with Murex, N.A., Ltd., Dallas, Texas, for the exclusiverights to purchase and market all ethanol produced by our plant.  Murex owns Class A member units and has arepresentative on our Board of Directors.

 

We also entered into a three-year purchase andmarketing agreement with ICM Marketing, Inc. for the exclusive rights topurchase and market all of the distillers dried grains produced by ourplant.  ICM, Inc., the parent company ofICM Marketing, Inc., was a prime subcontractor for the construction of theethanol plant, owns Class A member units, and has a representative on our Boardof Directors.

 

**Competition**

 

We are in direct competition with other ethanolproducers, many of whom have greater resources than we do.  We expect that additional ethanol producerswill enter the market as the demand for ethanol increases.

 

***Ethanol Producers***

 

According to the Renewable Fuels Association, U.S.Fuel Ethanol Production Capacity, March 2003 Report, the largest ethanolproducers include Archer Daniels Midland, Cargill, New Energy Corp., HighPlains Corp., MGP Ingredients, Inc., Williams Bio-Energy, A.E. Staley and ChiefEthanol, all of which are capable of producing many times the amount of ethanolwe produce or expect to produce in the near future.

 

In addition, we are aware that several regionalethanol production entities have recently formed, or are forming, that arecurrently of a similar size and with similar resources to ours.  For example, Adkins Energy recentlycompleted building an ethanol plant in Lena, Illinois, which is approximately20 miles away.  The Adkins plant expectsto produce 40 million gallons of ethanol annually.  Also, Ace Ethanol in Stanley, Wisconsin is operating and expectsto produce 15 million gallons of ethanol annually.  We are also aware of several other potential projects inWisconsin that may or may not begin production.  Wisconsin projects that rely on corn as a raw material couldcompete with us in the market for corn as well as for other raw materials, andcompete with us in selling ethanol and animal feed products.  The emergence of other Wisconsin ethanolplants that are eligible for the Producer Subsidy Payment would reduce theamount of payments we receive because the Wisconsin Producer Subsidy Payment of$0.20 per gallon up to a maximum of $3,000,000 annually per producer isallocated pro rata to all eligible producers.

 

Plans to construct new plants or to expand existingplants have been announced which would increase the ethanol production capacityof our competitors.  We are unable todetermine the number and production capacity of plants that ultimately may beconstructed, the timing of such construction or the effect of resultingproduction upon the demand for or price of our ethanol.  We expect to compete with other ethanolproducers based on price and, to a lesser extent, delivery service. The ethanolindustry has grown to more than 60 production facilities in the UnitedStates.  It is estimated that thesefacilities and those facilities currently under construction could produce over3.2 billion gallons of ethanol per year.

 

6

----

 

The following table lists all of the major ethanolproducers in the United States according to the Renewable Fuels Association,U.S. Fuel Ethanol Production Capacity, March 2003 Report.

 

7

----

 

**U.S. PRODUCTION CAPACITY**

**milliongallons per year (mmgy)**

 
| **COMPANY**                           |   | **LOCATION**        |   | **FEEDSTOCK** |   | **CURRENT  CAPACITY  (MMGY)** |   | **UNDER  CONSTRUCTION/  EXPANSIONS  (MMGY)** |
|---------------------------------------|--------|---------------------|--------|---------------|--------|-------------------------------|--------|----------------------------------------------|
| ACE Ethanol                           |   | Stanley, WI         |   | Corn          |   | 15                            |   |                                         |
| Adkins Energy, LLC*                   |   | Lena, IL            |   | Corn          |   | 40                            |   |                                         |
| A.E. Staley                           |   | Loudon, TN          |   | Corn          |   | 65                            |   |                                         |
| AGP*                                  |   | Hastings, NE        |   | Corn          |   | 52                            |   |                                         |
| Agra Resources  Coop, d.b.a. EXOL*    |   | Albert Lea, MN      |   | Corn          |   | 37                            |   |                                         |
| Agri-Energy, LLC*                     |   | Luverne, MN         |   | Corn          |   | 21                            |   |                                         |
| Alchem Ltd. LLLP                      |   | Grafton, ND         |   | Corn          |   | 10.5                          |   |                                         |
| Al-Corn Clean Fuel*                   |   | Claremont, MN       |   | Corn          |   | 30                            |   |                                         |
| Algoma Ethanol^                       |   | Oshkosh, WI         |   | Corn          |   |                          |   | 20                                           |
| Archer Daniels Midland                |   | Decatur, IL         |   | Corn          |   | 1070                          |   |                                         |
|                                  |   | Cedar Rapids, IA    |   | Corn          |   |                          |   |                                         |
|                                  |   | Clinton, IA         |   | Corn          |   |                          |   |                                         |
|                                  |   | Columbus, NE        |   | Corn          |   |                          |   |                                         |
|                                  |   | Marshall, MN        |   | Corn          |   |                          |   |                                         |
|                                  |   | Peoria, IL          |   | Corn          |   |                          |   |                                         |
|                                  |   | Wallhalla, ND       |   | Corn/barley   |   |                          |   |                                         |
| Badger State Ethanol, LLC*            |   | Monroe, WI          |   | Corn          |   | 40                            |   |                                         |
| Big River Resources, LLC*^            |   | West Burlington, IA |   | Corn          |   |                          |   | 40                                           |
| Broin Enterprises, Inc.               |   | Scotland, SD        |   | Corn          |   | 9                             |   |                                         |
| Cargill, Inc.                         |   | Blair, NE           |   | Corn          |   | 83                            |   |                                         |
|                                  |   | Eddyville, IA       |   | Corn          |   | 35                            |   |                                         |
| Central MN Ethanol Coop*              |   | Little Falls, MN    |   | Corn          |   | 20                            |   |                                         |
| Chief Ethanol                         |   | Hastings, NE        |   | Corn          |   | 62                            |   |                                         |
| Chippewa Valley Ethanol Co.*          |   | Benson, MN          |   | Corn          |   | 21                            |   | 20                                           |
| Commonwealth  Agri-Energy, LLC*^      |   | Hopkinsville, KY    |   | Corn          |   |                          |   | 20                                           |
| Cornhusker  Energy Lexington, LLC*^   |   | Lexington, NE       |   | Corn          |   |                          |   | 42                                           |
| Corn Plus*                            |   | Winnebago, MN       |   | Corn          |   | 44                            |   |                                         |
| Dakota Ethanol, LLC*                  |   | Wentworth, SD       |   | Corn          |   | 47                            |   |                                         |
| DENCO, LLC*                           |   | Morris, MN          |   | Corn          |   | 20                            |   |                                         |
| ESE Alcohol Inc.                      |   | Leoti, KS           |   | Seed corn     |   | 1.5                           |   |                                         |
| Ethanol 2000, LLP*                    |   | Bingham Lake, MN    |   | Corn          |   | 30                            |   |                                         |
| Glacial Lakes Energy, LLC*            |   | Watertown, SD       |   | Corn          |   | 45                            |   |                                         |
| Golden Cheese  Company of California* |   | Corona, CA          |   | Cheese whey   |   | 5                             |   |                                         |
| Golden Triangle Energy, LLC*          |   | Craig, MO           |   | Corn          |   | 20                            |   | 20                                           |
| Gopher State Ethanol                  |   | St. Paul, MN        |   | Corn          |   | 15                            |   |                                         |
| Grain Processing Corp.                |   | Muscatine, IA       |   | Corn          |   | 10                            |   |                                         |
| Great Plains Ethanol, LLC*^           |   | Chancellor, SD      |   | Corn          |   |                          |   | 40                                           |
| Heartland Corn Products*              |   | Winthrop, MN        |   | Corn          |   | 35                            |   |                                         |

 

8

----

 
| Heartland Grain Fuels, LP*              |   | Aberdeen, SD       |   | Corn                   |   | 8      |   |   |
|-----------------------------------------|--------|--------------------|--------|------------------------|--------|--------|--------|--------|
|                                    |   | Huron, SD          |   | Corn                   |   | 14     |   |   |
| High Plains Corp.                       |   | York, NE           |   | Corn/milo              |   | 50     |   |   |
|                                    |   | Colwich, KS        |   |                   |   | 20     |   |   |
|                                    |   | Portales, NM       |   |                   |   | 15     |   |   |
| Husker Ag, LLC*                         |   | Plainview, NE      |   | Corn                   |   | 20     |   |   |
| James Valley Ethanol, LLC^              |   | Groton, SD         |   | Corn                   |   |   |   | 45     |
| J.R. Simplot                            |   | Caldwell, ID       |   | Potato waste           |   | 6      |   |   |
|                                    |   | Heyburn, ID        |   |                   |   |   |   |   |
| KAAPA Ethanol, LLC*^                    |   | Axtell, NE         |   | Corn                   |   |   |   | 40     |
| Land O’ Lakes*                     |   | Melrose, MN        |   | Cheese whey            |   | 2.6    |   |   |
| Lincolnladn Agri-Energy, LLC*^          |   | Robinson, IL       |   | Corn                   |   |   |   | 40     |
| Little Sioux  Corn Processors, LLC*^    |   | Marcus, IA         |   | Corn                   |   |   |   | 40     |
| Manildra Energy Corp.                   |   | Hamburg, IA        |   | Corn/milo/wheat starch |   | 8      |   |   |
| Merrick/Coors                           |   | Golden, CO         |   | Waste beer             |   | 1.5    |   |   |
| Michigan Ethanol, LLC                   |   | Caro, MI           |   | Corn                   |   | 45     |   |   |
| MGP Ingredients, Inc.                   |   | Pekin, IL          |   | Corn/wheat starch      |   | 78     |   |   |
| Midwest Grain Processors*               |   | Lakota, IA         |   | Corn                   |   | 45     |   |   |
| Miller Brewing Co.                      |   | Olympia, WA        |   | Brewery waste          |   | 0.7    |   |   |
| Minnesota Energy*                       |   | Buffalo Lake, MN   |   | Corn                   |   | 18     |   |   |
| New Energy Corp.                        |   | South Bend, IN     |   | Corn                   |   | 95     |   |   |
| Northeast Missouri Grain, LLC*          |   | Macon, MO          |   | Corn                   |   | 22     |   | 18     |
| Northern Lights Ethanol, LLC*           |   | Big Stone City, SD |   | Corn                   |   | 45     |   |   |
| Permeate Refining                       |   | Hopkinton, IA      |   | Sugars & starches  |   | 1.5    |   |   |
| Pine Lake Corn Processors, LLC*^        |   | Steamboat Rock, IA |   | Corn                   |   |   |   | 20     |
| Plover Ethanol                          |   | Plover, WI         |   | Seed corn              |   | 4      |   |   |
| Pro-Corn, LLC*                          |   | Preston, MN        |   | Corn                   |   | 40     |   |   |
| Quad-County Corn Processors*            |   | Galva, IA          |   | Corn                   |   | 18     |   |   |
| Reeve Agri-Energy                       |   | Garden City, KS    |   | Corn/milo              |   | 12     |   |   |
| 78th Street Ethanol, LLC                |   | Blairstown, IA     |   | Corn                   |   | 5.5    |   |   |
| Siouxland Energy  & Livestock Coop* |   | Sioux Center, IA   |   | Corn                   |   | 14     |   |   |
| Tall Corn Ethanol, LLC*                 |   | Coon Rapids, IA    |   | Corn                   |   | 45     |   |   |
| Tri-State Ethanol Co., LLC*             |   | Rosholt, SD        |   | Corn                   |   | 18     |   |   |
| U.S. Energy Partners, LLC               |   | Russell, KS        |   | Milo/wheat starch      |   | 40     |   |   |
| U.S. Liquids                            |   | Louisville, KY     |   | Beverage waste         |   | 4      |   |   |
|                                    |   | Bartow, FL         |   |                   |   | 4      |   |   |
|                                    |   | R. Cucamonga, CA   |   |                   |   | 4      |   |   |
| VeraSun Energy Corporation^             |   | Aurora, SD         |   | Corn                   |   |   |   | 100    |
| Williams Bio-Energy                     |   | Pekin, IL          |   | Corn                   |   | 100    |   |   |
|                                    |   | Aurora, NE         |   | Corn                   |   | 35     |   |   |
| Wyoming Ethanol                         |   | Torrington, WY     |   | Corn                   |   | 5      |   |   |

 

9

----

 
| **Total  Existing Capacity**             |   |   |   |   |   | **2726.8** |   |      |
|------------------------------------------|--------|--------|--------|--------|--------|------------|--------|-----------|
| **Total  Under Construction/Expansions** |   |   |   |   |   |       |   | **505.0** |
| **Total  Capacity**                      |   |   |   |   |   | **3231.8** |   |      |

 

----

* farmer-owned

^ under construction

 

Last updated March 2003

 

Source: Renewable Fuels Association, U.S. Fuel Ethanol ProductionCapacity, March 2003.

 

10

----

 

***Alternative Fuel Additives***

 

We also compete with producers of methyl tertiarybutyl ether (commonly referred as “MTBE”), a petrochemical derived frommethanol which costs less to produce than ethanol.  MTBE is a commonly used oxygenate in fuels for compliance withFederal Clean Air Act mandates, and is a major competitor of ethanol.  Many major oil companies produce MTBE, andstrongly support its use because it is petroleum based.  These companies have significant resourcesto market MTBE and to influence legislation and public perception of MTBE.  These companies also have sufficient resourcesto begin production of ethanol should they choose to do so.

 

Alternative fuels, gasoline oxygenates and ethanolproduction methods are continually under development by ethanol and oilcompanies with far greater resources than we have.  Development of new products and methods of ethanol production bylarger and financially more viable competitors could provide them withsignificant competitive advantages over us and thus could harm our business.

 

**Employees**

 

As of December 31, 2002, we have employed 34 persons,in a full-time capacity, including 13 in ethanol production operations, 6 ingeneral management, sales, administration and grain procurement, and 15 ingrain receiving, grain handling, maintenance and the laboratory.  We also employ one part-time employee.

 

**EnvironmentalDisclosure**

 

We are subject to extensive environmental regulationat the federal, state and local levels. Air quality at the plant is regulated by the U.S. EnvironmentalProtection Agency and the Bureau of Air Management, Wisconsin Department ofNatural Resources.  The Department ofNatural Resources regulates emission of volatile organic compounds into theair.  Volatile organic compoundemissions are tested on a semi-annual basis, and we must submit semi-annualreports to the Department of Natural Resources regarding these emissionstests.  We are required to obtain an airoperating permit from the Department of Natural Resources and must obtainDepartment of Natural Resources approval to make plant alterations that couldchange the emission levels.  TheDepartment of Natural Resources also regulates the water usage, wastewaterdischarge and hazardous waste under Wisconsin water pollution control andhazardous waste laws.  Water usage andwastewater effluent quality is monitored daily.  Monthly reports regarding water usage and quality are filed withthe Department of Natural Resources.  Wealso are required to submit periodic reports pursuant to the Wisconsin andFederal Emergency Planning Community Right-to-Know Act.  At the local level, we file semi-annualreports with the Green Count Emergency Response Committee.  We do not believe we will be required tospend material amounts to maintain compliance with applicable environmentallaws.

 

**RegulatoryPermits**

 

RMT Inc., an environmental consulting firm inBrookfield, Wisconsin, assisted us in obtaining an Air Pollution Constructionand Operation Permit, a Storm Water Discharge Permit and Storm Water PollutionPrevention Plan and advised us on environmental compliance generally.  We also obtained various other environmentaland operating permits, as discussed below.

 

The Department of Natural Resources has prepared anenvironmental assessment on the construction of the ethanol plant, which wasmade available to the public for comment on February 19, 2001.  The environmental assessment is a publicreport that reviews and analyzes the environmental impact that the ethanolplant may have on the surrounding area. We are aware that, in the past, several individuals have voicedobjections to our business to the Wisconsin Department of Natural Resources,however, we have met no significant opposition from the public in ourefforts.  Public objection andcomplaints could arise, however, and subject us to greater regulatory scrutiny,claims and costly compliance expenditures.

 

11

----

 

***Air Pollution Construction and Operation Permit***

 

Our facility is considered a Wisconsin synthetic minorsource of regulated air pollutants.  Thetypes of regulated pollutants that may be found at our plant include,particulate matter, carbon monoxide, oxides of nitrogen, volatile organiccompounds and sulfur dioxide.  To emitthese agents during construction, we needed an Air Pollution ConstructionPermit.  We received the Air PollutionConstruction Permit on March 22, 2001. The permit is valid for a period of 28 months from the date of grant.

 

On October 31, 2001, we submitted a Modified AirPermit Application to reflect a change in our plant design regardingemissions.  Our original plant designcontemplated routing the boiler exhaust through dryers and then to a waterscrubber for air pollution control on the distillers dried grains dryeremissions, and then to a common stack. In our new plant design, we proposed to utilize a thermal oxidizer foremissions control rather than rely on the water scrubber.  The thermal oxidizer reduced emissions fromour plant.  We received the approval ofthis design and our Modified Air Permit Application from the EnvironmentalProtection Agency on March 22, 2002. The Environmental Protection Agency is scheduled to conduct airemissions testing in April, 2003.  If wesuccessfully complete the air emissions testing we will be awarded an AirPollution Operation Permit.

 

***Wisconsin Pollutant Discharge Elimination Permits***

 

*GeneralPermit*.  We useapproximately 66,500 gallons of water per day to cool our closed circuitsystems in the ethanol plant.  Weobtained a Wisconsin Pollutant Discharge Elimination System general permit fromthe Department of Natural Resources to discharge the water into a nearbycreek.  We received this permit on July18, 2002 and it is valid until July 31, 2007.

 

*StormWater Discharge for Industrial Activities Permit*.  Before we could begin operating, we had toobtain a Storm Water Discharge for Industrial Activities Permit from theDepartment of Natural Resources, which we received on April 9, 2001.  In addition, we also had to prepare a StormWater Pollution Prevention Plan outlining measures we planned to implement toprevent storm water pollution during operation.

 

***High Capacity Well Permit***

 

We drilled a 500,000-gallon per day well near ourethanol plant.  The Department ofNatural Resources considers this a high capacity well, and we have applied forand obtained a high capacity well permit. The high capacity well permit was issued on December 13, 2001.  The permit allows for a maximum daily usageof 720,000 gallons of water per day.

 

***Spill Prevention, Control and Countermeasures Plan***

 

Before we could begin operations, we had to prepare aspill prevention, control and countermeasures plan.  The plan outlines our spill prevention measures for oil productssuch as ethanol.  The plan waspreliminarily reviewed and approved prior to when we began operations, and wascertified by a professional engineer on January 3, 2003.

 

***Risk Management Program***

 

We use anhydrous ammonia in our productionprocess.  Therefore, we had to develop arisk management program to address handling and use of the ammonia and gasesemitted from such use.  We established aprevention program to prevent spills or leaks of ammonia, and an emergencyresponse program in the event of spills, leaks, explosions or other events thatmay lead to the release of ammonia into the surrounding area.  We conducted a hazard assessment andprepared models to assess the impact of an ammonia release into the surroundingarea.  The program was presented at apublic meeting.

 

12

----

 

***EPA; Nuisance***

 

We are subject to the regulations on emissions of theUnited States Environmental Protection Agency. Current EPA rules do not require us to obtain any permits or approvalsin connection with construction and operation of our business.  Wisconsin and EPA rules can and do change,and any such changes could result in greater regulatory burdens on us.  Our ethanol production will require us toemit a significant amount of carbon dioxide into the air.  Current Wisconsin law regulating emissionsdoes not restrict or prevent us from emitting carbon dioxide gas into the air,but this could change in the future.  Wecould also be subject to environmental or nuisance claims from adjacentproperty owners or residents in the area arising from foul smells or other airor water discharges from the plant.  Weare aware of recent nuisance claims that have been brought against an ethanolbusiness in Saint Paul, Minnesota.  Webelieve that among the objectives of this litigation are to force the ethanolmanufacturer to upgrade the facility’s emissions control system and possiblypay damages to nearby residents.  We arealso aware of neighborhood opposition to our facility.  This opposition could result in claims fornuisance, which could lead to increased compliance costs and monetary damages.

 

**ITEM 2.  DESCRIPTION OF PROPERTIES**

 

Our principal executive office is located at ourethanol plant site, 820 West 17th Street, Monroe, Wisconsin53566.  We presently own approximately28 acres of land and improvements thereon which comprise our plant.  Our primary lender holds a mortgage on approximately28 acres of land where the facility is situated as security for loans providedto us.  We anticipate using all of ourowned real estate in the operation of our ethanol plant in the foreseeablefuture.

 

**ITEM3.  LEGAL PROCE****EDINGS**

 

None.

 

**ITEM4.  SUBMISSION OF MA****TTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

**PART II**

** **

**ITEM5.  MARKET FOR THE REG****ISTRANT’S MEMBER UNITS AND RELATED MEMBER MATTERS**

 

There is no public trading market for oursecurities.  As of March 18, 2003, therewere approximately 466 unit holders of record of our Class A member units determinedby an examination of our transfer book.

 

We have no current plans to make any cash or propertydistributions to the unit holders from the Company in the foreseeablefuture.  The payment and rate of futuredistributions, if any, would be subject to review by the Board of Directors inlight of our financial condition, results of operations, capital requirementsand other factors deemed relevant at that time.  Loan covenants mandate that $2 million of working capital must beaccumulated prior to making any distributions to the unit holders.  Additional covenants require 20% of anyexcess cash flow (as that term is defined in such senior debt agreements) to beapplied toward the principal of the senior debt and that we cannot make anydistributions without the consent the holders of our senior debt.

 

**ITEM6.  MANAGEMENT’S DISCUS****SION AND ANALYSIS AND PLAN OF OPERATIONS**

 

**Application of Critical AccountingPolicies**

 

Accounting policies, methods and estimates are anintegral part of our financial statements and are based upon management’scurrent judgments. Certain accounting policies, methods and estimates areparticularly important because of their significance to the financialstatements. Note A of the Notes to Financial Statements includes a summary of thesignificant accounting policies and methods we use. The following is adiscussion of what we believe to be the most critical of these policies andmethods.

 

13

----

 

***Inventories***

 

Inventories are stated at the lower of cost or netrealizable value. Estimates are used in determining the net realizable value ofour inventories. These estimates include the measurement of inventories inbins, other storage facilities and in production, which use formulas inaddition to actual measurements taken to arrive at appropriate quantities.

 

***Derivatives***

 

We enter into exchange-traded commodity futures andoptions contracts to hedge exposure to price fluctuations on grain and ethanoltransactions to the extent considered practicable for minimizing risk. We donot use derivatives for speculative purposes. Futures and options contractsused for hedging are purchased and sold through regulated commodity exchanges.Fluctuations in inventory valuations, however, may not be completely hedged,due to our assessment of exposure from expected price fluctuations. We alsomanage risk by entering into fixed price purchase contracts and establishingappropriate limits with pre-approved grain elevators. We are exposed to loss inthe event of nonperformance by the counterparties to the contracts. However, wedo not anticipate nonperformance by counterparties. The fair value of futuresand options contracts are determined primarily from quotes listed on regulatedcommodity exchanges.  Fixed price purchasecontracts are with various counterparties, and the fair values of suchcontracts are determined from the market price of the underlying product.

 

Our derivative contracts are recorded in accordancewith Financial Accounting Standards Board Statement of Financial AccountingStandards (SFAS) No. 133, Accounting for Derivative Instruments and HedgingActivities.   At December 31, 2002, noneof our derivative contracts are designated as hedges as defined within SFAS No.133 for the purpose of applying hedge accounting.  Accordingly, all the company’s derivative contracts at December31, 2002 are recorded at fair market value with changes in the fair value ofthe derivatives recorded in current period earnings.

 

**Overview**

 

We are engaged in the production and sale of fuelgrade ethanol.  We have an annualcapacity to process approximately 14.4 million bushels of corn intoapproximately 40 million gallons of ethanol. In addition, we sell distillers grains, a principal by-product of theethanol-production process, which we sell as distillers modified wet grains anddistillers dried grains.

 

During fiscal 2002, we completed construction of theplant, negotiated for the conversion our construction loan to a term mortgage(which was finalized on January 1, 2003), successfully began plant production,passed performance tests, established our marketing presence and establishedour flexibility in the delivery of products and improved operationalefficiencies.  At the same time, weestablished a risk management strategy that helped us to level out the effectsof the volatility of the commodity markets that affect our industry.

 

**Plan ofOperation for the Next 12 Months**

 

We expect to spend the next 12 months operating ourethanol plant.  We expect to havesufficient cash available to cover our costs over the next 12 months, includingstaffing, office, audit, legal, compliance costs and working capitalcosts.  The following is our estimate ofour costs and expenditures for the next 12 months.  It is only an estimate and our actual expenses could be muchhigher due to a variety of factors described in our Form SB-2 registrationstatement under the section entitled “Risk Factors.”

 

| Insurance                            |   | $ | 463,000    |   |
|--------------------------------------|--------|---|------------|--------|
| Selling, General  and Administrative |   | $ | 7,170,079  |   |
| Interest                             |   | $ | 1,593,820  |   |
| Production                           |   | $ | 50,208,078 |   |
| Total                                |   | $ | 59,434,977 |   |

 

14

----

 

We anticipate spending approximately $59.4 millionover the next 12 months.  Of thatamount, we estimate that we will spend approximately: (i) $463,000 on directorsand officers’ insurance, general commercial liability, worker’s compensationand property insurance; (ii) $7,170,079 on selling, general and administrativeexpenses, including managerial fees, out-of-pocket reimbursements and general officeexpenses; and (iii) $3,065,518 on mortgage payments.

 

During the next 12 months we plan on hiring oneadditional employee needed to operate our ethanol plant.  We intend to hire staff only for the directoperations and administration of our ethanol business, such as production,shipping, and receiving.  We currentlyemploy one individual to make sales of distillers grains to the localmarket.  We intend to rely on third-partymarketing arrangements, and pay commissions to marketing agents to market andsell our products.

 

We expect to fund our costs and expenditures for thenext 12 months using cash from operations and existing lines of credit.

 

Our primary raw material during fiscal 2002 wascorn.  Early in the year ended December31, 2002, we implemented a new Grain Risk Management Program.  This program’s stated objective is tostabilize our cost of grain and to generate more predictable margins.

 

Operation of our ethanol production facilitiesrequires the purchase of corn, and the sale of fuel-grade ethanol. Accordingly,assuming ongoing operations, we are naturally “short” on grain and “long” onfuel ethanol.

 

Our Grain Risk Management Program is intended to usegrain purchase contracts together with grain futures derivatives to fix thecost of some of our expected future grain purchases.  Our policy allows for the use of fixed price forward purchasecontracts, un-priced forward basis purchase contracts, and Chicago Board ofTrade (CBOT) derivative contracts (over-the-counter and traditional options).During 2002, we had approximately 85% of our fiscal 2002 grain requirementswere hedged through a combination of fixed price forward purchase contracts,and CBOT traditional and over-the-counter option hedges to protect our cost ofgrain.  During 2002, our practice ofprotecting the cost of our grain, generally accounted for 85% of forecastedgrain purchases in the upcoming twelve months. We took this action because of our start-up nature and the volatility ofcorn price.  Under our program, allcomponents of the position are monitored and all hedges are designated againstfuture grain requirements to ensure that we do not enter into commitments orderivatives for grain in excess of expected grain requirements.

 

Grain markets were relatively volatile during fiscal2002.  As always, weather, exports,government programs, and other factors all have potentially major impacts ongrain pricing, and any unexpected changes in those factors could adverselyaffect the price that we pay for our grain. As of January 1, 2003, we had hedged or purchased approximately 11million bushels or 73% of our anticipated corn requirements for the upcoming 12months.

 

Volatility in grain prices has brought both higherprices and stronger demand for our feed by-products,  distillers modified wet grains and distillers dried grains.  While prices for feed by-productshistorically rise in the late fall and winter, they also tend to follow cornprices.  Significant improvement inthese prices occurred due to anticipated volatility in grain prices, andlocalized storage of feed ingredients in the marketplace.  In response, we have emphasized theproduction and marketing of distillers modified wet grains rather than drieddistillers grain with solubles. Distillers modified wet grains has certain benefits that distinguish itfrom other competing feed products, and allow some price premium to be realizedin highly competitive markets.  We haveincluded the forward contracting of feed sales in our overall decisionsregarding risk management.

 

During 2002, we also implemented a Fuel Ethanol RiskManagement Program.  The program’sstated objectives are to stabilize our sales price of fuel ethanol, and togenerate more predictable margins.  Partof this program involves un-priced forward contracts to sell portions of ourfuel ethanol output to customers with variable prices that are tied directly tothe price of unleaded gasoline as quoted on national exchanges.  We may use derivative contracts to fix the priceunder the forward contract.

 

15

----

 

Under this program, we do not enter into forward salescommitments in excess of expected fuel ethanol output, and we only enter intogasoline derivatives to the extent that we have un-priced forward sales contractswith customers with variable pricing arrangements that are tied to the price ofgasoline as quoted on national exchanges. During the fourth quarter of 2002, we sold approximately 11% of our fuelethanol output under the above-described program.

 

Our risk management also includes the oversight ofpurchases of natural gas needed to produce steam to run the plants, and fuel tofire the distillers grain dryers.  Werequire a substantial uninterrupted supply of natural gas to maintaincontinuous production.  Consequently, wecontracted with WE Energies for firm service natural gas delivery and with USEnergies to coordinate purchase and delivery of the gas to the plant.  However, due to the competitive nature ofthe natural gas market, we believe no significant risk of long-terminterruption exists.  Natural gas pricesincreased significantly through the last half of fiscal 2002.

 

**Liquidityand Capital Resources**

 

As of December 31, 2002, we had cash and cashequivalents of $592,366, current assets of $6,442,007 and available unusedlines of credit of $1,752,020.  InOctober 2002, we completed the construction of our plant and beganoperations.  During 2002, cash used inoperating activities was $4,468,313 and cash paid for property and equipmentwas $30,849,545.  These activities weresubstantially financed through increases of $1,747,980 in our line of creditand long-term debt financing of $29,018,738.

 

As of January 1, 2003, our indebtedness and lines ofcredit consisted primarily of the following:

 

•                                          $30,600,000term loan due January 1, 2008;

•                                          $3,548,411electric utility note payable due November 1, 2007; and

•                                          $3,500,000line of credit expiring August 28, 2003.

 

In August 2001, we entered into a $30.6 millionconstruction loan facility with First National Bank of Omaha.  Effective as of January 1, 2003, thisconstruction loan was converted into a $30.6 million term loan.  Quarterly payments, including principal andinterest, of $1,021,839 are scheduled to begin on April 1, 2003 based upon afive-year amortization with a balloon payment due on the maturity date ofJanuary 1, 2008.  The term loan isstructured as three notes and interest accrues monthly on the notes at bothfixed and variable rates.  The fixedrate will accrue at 6.528% on $15,300,000 of the term loan and the variablerate will accrue on $15,300,000 of the term loan based on the prime rate(effective rate of 5.25% at December 31, 2002).  The amount outstanding on the construction loan was $29,672,120 atDecember 31, 2002.  The term loan is securedby substantially all of our assets and contains various restrictions, includingthe maintenance of certain financial covenants.

 

On August 22, 2001, we entered into a subordinatedcredit facility of $3.6 million from Alliant Energy – Wisconsin Power and LightCompany to finance the electrical infrastructure and other constructionneeds.  This credit facility wasconverted to a term note upon completion of construction of our facility.  Monthly payments, including principal andinterest, of $34,762 began November 1, 2002 based upon a ten-year amortizationwith a balloon payment due on the maturity date of November 1, 2007.   Interest accrues monthly on the loan at3%.  The amount outstanding on theelectric utility note payable is $3,548,411 at December 31, 2002.  The electric utility note payable is securedby our equipment, inventory and a guarantee by the City of Monroe, and containsvarious restrictions.

 

In connection with our construction loan, we enteredinto a $3,500,000 364 day revolving credit facility with First National Bank ofOmaha.  The revolving line of credit islimited to the borrowing base collateral, which is based upon 75% of the valueof the inventory and allowable accounts receivable, and has a variable interestrate based upon the prime rate.  Theamount outstanding on the revolving loan was $1,747,980 at December 31,2002.  The revolving loan is secured bysubstantially all of our assets and contains various restrictions.  Upon expiration of our revolving line ofcredit in August 2003, we believe that we will have the ability to renew ourline of credit.

 

16

----

 

**ITEM7.  FINANCI****AL STATEMENTS**

 

Our financial statements are included on pages F-1 toF-14 of this Report.

 

**ITEM 8.  CHANGES IN AND DISAGREEMEN****TS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

**PART III**

** **

**ITEM 9****.  DIRECTORS,EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT**

** **
| **Name**         |   | **Age** |   | **Position**                                      |
|------------------|--------|---------|--------|---------------------------------------------------|
|             |   |    |   |                                              |
| John L. Malchine |   | 65      |   | Chairman of the Board and Chief Executive Officer |
| Gary L. Kramer   |   | 54      |   | President, General Manager and Director           |
| Jeff Roskam      |   | 45      |   | Vice President and Director                       |
| David Kolsrud    |   | 54      |   | Secretary and Director                            |
| Don Endres       |   | 42      |   | Treasurer and Director                            |
| Wayne Mitchell   |   | 47      |   | Director*                                         |
| Robert Wright    |   | 50      |   | Director                                          |
| Kevin Stroup     |   | 43      |   | Director*                                         |
| James Leitzinger |   | 47      |   | Chief Financial Officer                           |

 

----

*****Mr. Wayne Mitchell and Mr. Kevin Stroupcollectively occupy one seat on the Board of Directors.  They may attend Board meetings but areentitled to only one vote on matters coming before the Board.

 

***John L. Malchine,Chairman of the Board and Chief Executive Officer***

 

Mr. Malchine has served on our Board of Directorssince May 2000. His term as a Director expires in 2003.  From 1989 to March 2001, he served aspresident and co-owner of Norway Associates, Inc., a private real estatecompany that develops real estate projects for clinics. Norway Associates iscurrently inactive. From 1954 to 1994, Mr. Malchine was a self-employed farmer.From 1995 to the present, Mr. Malchine has been the chairman of the WisconsinAgriculture, Trade and Consumer Protection Board. From 1997 to the present, hehas also been a member of the Board of the Wisconsin Tax Commission, whichregulates agricultural assessments in Wisconsin. From 1983 to the present, hehas been a member of the Board of Directors of a unit of M & I Bank, inBurlington, Wisconsin, and is currently chairman of the loan committee. Mr.Malchine is also on the Board of Governors of the Southern Region of the AuroraHealth Care System, which owns three hospitals and 21 clinics in southernWisconsin. Mr. Malchine was elected to the Board of Adkins Energy in February2000. He resigned in April 2000 from Adkins, and the cooperative redeemed hisinvestment without interest.

 

***Gary L. Kramer,D.V.M., President, General Manager and Director***

 

Dr. Kramer has served on our Board of Directors sinceMay 2000. His term as a Director expires in 2004.  From 1973 to 2001, Dr. Kramer was a veterinarian, and recentlyretired as president and senior partner at Chapin, Sutter, Chapin, Ltd., ofLena, Illinois, a veterinary service corporation employing eight veterinarians.He received a doctorate in Veterinary Medicine from Iowa State University.Prior to co-founding Badger State Ethanol, Dr. Kramer served as President ofthe Adkins Energy Cooperative from December 1998 to April 2000. Adkins EnergyCooperative was formed in May 1996 to build a 30 million gallon dry millethanol plant in Lena, Illinois. The Adkins site is approximately 20 miles fromour Monroe site. Dr. Kramer invested in this farmers cooperative in 1997. Hewas appointed to fill a vacancy on the Board of Directors in August 1997. InNovember 1998, he was

 

17

----

 

elected to the Board by the members to serve a three year term. He waselected president of the Board in December 1998 and re-elected in March 2000.Dr. Kramer resigned from the Adkins Board in April 2000, and the cooperativeredeemed his investment, without interest. At the time of his resignation, theproposed Adkins ethanol project had not been constructed, although thecooperative was continuing its efforts and negotiations to secure necessarycommitments and contracts to complete the project. Dr. Kramer received nocompensation from Adkins for his service other than reimbursement ofout-of-pocket expenses of approximately $4,600. Dr. Kramer has also served as amember of a number of professional organizations, and has served on otherprofit and non-profit Boards, including the American Veterinary MedicalAssociation, American Association of Bovine Practitioners, Illinois VeterinaryMedical Association, Northern Illinois Veterinary Medical Association and theLena Park District Board

 

***Jeff Roskam,Vice-President and Director***

 

Mr. Roskam has served on our Board of Directors sinceMay 2000.  He occupies ICM’s permanentseat on the Board of Directors.  He hasserved as Senior Vice President of ICM, Inc. since March 1997. Prior to joiningICM, he served as operations manager from October 1996 to February 1997 forRenewable Oxygenates, Inc., which produced ethanol from whey and potato paste.From March 1994 to October 1996, he worked as an engineer at Broin &Associates, Inc. where he served as Project Manager on the development and managementof several ethanol plants. Prior to joining Broin & Associates, Inc. heserved as Reverse Osmosis Production Manager for EBCO, Inc., an Ohio drinkingwater equipment manufacturer, and as Vice President of Operations for Pure-BestWater, Inc., a California beverage company. Prior to that, Mr. Roskam served asassistant manager for Household Finance Corporation. Mr. Roskam has a B.A.degree in Finance from Iowa State University.

** **

***David Kolsrud,Secretary and Director***

 

Mr. Kolsrud has served on our Board of Directors sinceAugust 2001. His term as a Director expires in 2002.  Mr. Kolsrud is the General Manager and a member of the Board ofDirectors of CORN—er Stone Farmers Cooperative, which he founded in 1995 andserved as Chairman until 2000. Mr. Kolsrud also continues to work as aself-employed farmer, an occupation he has had since 1973. He also serves asChairman of the Valley Springs Farmers Cooperative, a farm supply co-op inValley Springs, South Dakota. He has served on that Board for 15 years and servedas Chairman for the past 12 years. He formerly served as the Chairman of theMinnesota Coalition for Ethanol. Mr. Kolsrud also serves on the Board ofGovernors of AGRI-Energy, LLC (a 12 million gallon a year ethanol facility inLuverne, Minnesota). He has served on that Board since 1997 and served as itsVice President until 1999.

 

***Don Endres,Treasurer and Director***

 

Mr. Endres has served on our Board of Directors sinceAugust 2001.  His term as a Directorexpires in 2004.  Mr. Endres currentlyserves on the Board of Directors of Glacial Lakes Energy and First NationalBank Venture Capital. He is currently Chairman of the Brookings Chambere-commerce committee. Mr. Endres is also the President of VeraSun EnergyCorporation, a company he founded in June 2001. Prior to forming VeraSun, heserved as Chief Executive Officer of ExpressGold.com, Inc., a company heco-founded in 1997. ExpressGold.com merged with Cybersource Corporation in2000. Prior to that, Mr. Endres served as President and General Manager ofSpecial Teams, Inc., a company he founded in 1985. Special Teams was acquiredby the American Express Company in 1995, and Mr. Endres served as President ofAmerican Express Special Teams until 1997. He has also served on the Board ofDirectors of CoEv, Inc., a magnetic component company, until its merger withTyco International Ltd. in 2000. Mr. Endres graduated from South Dakota StateUniversity with a degree in Animal Science and minors in Computer Science andEconomics. In 2001, he was recognized by South Dakota State University’sCollege of Engineering as “Entrepreneur of the Year.”

 

***Wayne Mitchell,Director***

 

Mr. Mitchell has served on our Board of Directorssince May 2001, when he was appointed to fill the Fagen, Inc. seat. He occupiesFagen, Inc.’s permanent seat on the Board of Directors.  Mr. Mitchell is Vice President, Technologyand Business Development for Fagen, Inc. and has worked for Fagen since June2000.  Prior to joining Fagen, he servedas Process Team Leader from may 1998 to June 2000 for Reilly Industries, Inc.,where

 

18

----

 

he directed multidisciplinary teams engaged in chemical processresearch and owner of Solid Rock Consulting, LLC, a private company providingconsulting services to the ethanol industry. Solid Rock Consulting is currently inactive.  From May 1996 to May 1998, he worked as Plant Manager and QualityAssurance Manager for Micronutrients, LLC, an animal feed supplementmanufacturer.  From January 1993 to May1996, he served as the Design Engineer for Broin and Associates, Inc. where heperformed detailed process design and start-up of dry grind ethanolplants.  Prior to joining Broin, heserved as senior environmental project engineer for Heritage EnvironmentalServices, Inc. where he was involved in environmental consulting and projectmanagement at major oil refineries. Prior to that, Mr. Mitchell served as an area manager for EthylCorporation. Mr. Mitchell also serves on the Board of Directors of GoldenTriangle Energy, LLC, an ethanol plant in Craig, Missouri, and Husker AgProcessing, LLC, an ethanol plant under construction in Plainview,Nebraska.  Mr. Mitchell has a B.S. inChemical Engineering from the University of Wisconsin-Madison.

 

***Robert Wright,Director***

 

Mr. Wright has served on our Board of Directors sinceAugust 2001. His term as a Director expires in 2003.  Mr. Wright has served as the President, Chief Executive Officerand a principal shareholder of Murex N.A. since May 1992. Murex is a marketerof gasoline “blendstocks,” such as fuel grade Ethanol, MTBE, Toluene, Methanoland Alkylate, to independent and major refiners in the United States. Mr.Wright is a graduate of Ohio State University with a degree in ChemicalEngineering and the University of Toledo with a Masters in BusinessAdministration.

 

***Kevin Stroup, Director***

 

Mr. Stroup has served on our Board of Directors sinceMay 2001, when he was appointed to fill the Fagen, Inc. seat. As describedabove, Mr. Wayne Mitchell and Mr. Kevin Stroup collectively occupy one seat onthe Board of Directors, which is Fagen, Inc.’s permanent seat on the Board ofDirectors.  Mr. Stroup is a partner inthe law firm of Christianson, Stoneberg, Giles & Stroup, P.A. in Marshall,Minnesota, where he has been employed since 1986.  Mr. Stroup practices in the areas of business law andtransactions, including commercial litigation. Mr. Stroup is a 1985 graduate of the University of Minnesota Law Schooland 1982 graduate of Southwest State University in Marshall, Minnesota, where hereceived a B.A. degree in history.  Mr.Stroup currently serves on the Board of Directors of the Granite Falls Bank,Granite Falls, Minnesota, and the Foundation Board for Southwest StateUniversity, Marshall, Minnesota.  Mr.Stroup just completed a one-year term as President of the 9thDistrict Bar Association of the State of Minnesota.

 

***James Leitzinger, Chief Financial Officer***

 

Mr. Leitzinger has served as our Chief FinancialOfficer since July, 2002.  Previously,Mr. Leitzinger served as the Director of Finance for the City of Freeport, ILfor approximately two years.  Prior tothat, Mr. Leitzinger was employed as the Controller for Agri-Tech FS, Inc. from1990 until 2000, and as the controller for Widen Colourgraphics, LTD from 1988to 1990.  Mr Leitzinger graduated fromEdgewood College in Madison, Wisconsin.

 

**ITEM 10.  EXEC****UTIVE COMPENSATION**

 

Gary Kramer serves as our President and GeneralManager.  He was compensated as anindependent contractor at the rate of $3,000 each month during 2002 until theend of July, 2002.  In August, 2002, Dr.Kramer became employed by us at a base salary of $100,000 per year.  John Malchine serves as Chief ExecutiveOfficer and, in January 2002, was compensated $60,000 by us for services heprovided to us as an independent contractor in 2000 and 2001.  Mr. Malchine became employed by us inOctober, 2002 at a base salary of $3,000 each month.  In July 22, 2002, we hired James Leitzinger as our ChiefFinancial Officer.  Mr. Leitzingerreceives a base salary of $65,000 per year.

 

We reimburse our officers for expenses incurredrelating to services rendered on our behalf. We recruit and hire permanent employees who are compensated on a regularbasis pursuant to agreed upon salaries. We have not and do not expect to establish any option based or othertype of equity incentive plan for employees. However, we

 

19

----

 

offer typical health and other employee benefits to our full timeemployees that do not discriminate in scope, terms or operation in favor of ourexecutive officers or directors and that are available to all of our salariedemployees.

 

The following table shows the compensation that wepaid to our officers for services that they rendered to us.

 
| **Name and Principal Position**                          |   | **Fiscal  Year** |   | **Salary** |   | **Bonus** |   |
|----------------------------------------------------------|--------|------------------|--------|------------|--------|-----------|--------|
|                                                     |   |             |   |       |   |      |   |
| John L. Malchine                                         |   | 2000             |   | $          | 24,000 | (1)       | $      | 0 |   |
| Chief Executive Officer                                  |   | 2001             |   | 36,000     | (1)    | 0         |   |
|                                                     |   | 2002             |   | 9,000      |   | 0         |   |
|                                                     |   |             |   |       |   |      |   |
| Gary Kramer                                              |   | 2000             |   | $          | 24,000 |      | $      | 0 |   |
| President and General  Manager (formerly Chief Executive |   | 2001             |   | 36,000     |   | 0         |   |
| Officer)                                                 |   | 2002             |   | 62,154     |   | 0         |   |
|                                                     |   |             |   |       |   |      |   |
| James Leitzinger                                         |   | 2000             |   | $          | — |      | $      | — |   |
| Chief Financial Officer                                  |   | 2001             |   | —     |   | —    |   |
|                                                     |   | 2002             |   | 28,750     |   | 0         |   |

 

----

(1)  This salary was paid inJanuary 2002 for services performed in 2000 and 2001.

 

**Employment Agreements**

 

We have no written employment agreements with anyofficer or Director.  We may in thefuture enter into employment agreements with our officers or other employeesthat we may hire.

 

**Reimbursement of Expenses**

 

Other than Mr. Malchine, Dr. Kramer, and Mr.Leitzinger, we do not pay our officers and Directors any fees or salaries fortheir services to us; however, we do reimburse our officers for expensesincurred in connection with their service to us.  Our reimbursement policy is to reimburse our officers andDirectors for out-of-pocket expenses. Since our inception in May 2000, we have reimbursed our officers andDirectors a total of $28,100.  Weestimate that our officers and Directors will incur approximately $20,000 inout-of-pocket expenses in the next 12 months. This is only an estimate and our officers and Directors expenses couldbe substantially higher than we anticipate.

 

20

----

 

**ITEM11.  SECURITY OWN****ERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The following table sets forth certain informationconcerning the beneficial ownership of our Class A member units as of March 18,2003.

 
| **Title**                                     |   | **Name and Address  of Beneficial Owner** |   | **Amount and Nature  of Beneficial Owner** |   | **Percent of  Class** |   |
|-----------------------------------------------|--------|-------------------------------------------|--------|--------------------------------------------|--------|-----------------------|--------|
|                                          |   |                                      |   |                                       |   |                  |   |
| Director &  Executive Officer             |   | John L. Malchine                          | (1)    | 600                                        |   | 3.03                  | %      |
| Director &  Executive Officer             |   | Gary L. Kramer                            | (2)    | 920                                        |   | 4.65                  | %      |
| Director                                      |   | Jeff Roskam                               | (3)    | 0                                          |   | 0.00                  | %      |
| Director                                      |   | David Kolsrud                             | (4)    | 50                                         |   | 0.25                  | %      |
| Director                                      |   | Don Endres                                | (5)    | 2,000                                      |   | 10.11                 | %      |
| Director                                      |   | Wayne Mitchell                            | (6)    | 0                                          |   | 0.00                  | %      |
| Director                                      |   | Robert Wright                             | (7)    | 1,000                                      |   | 5.06                  | %      |
| Director                                      |   | Kevin Stroup                              | (8)    | 0                                          |   | 0.00                  | %      |
| Chief Financial  Officer                      |   | James Leitzinger                          | (9)    | 0                                          |   | 0.00                  | %      |
| Director &  Executive Officers as a group |   | All executive officers and directors      | (10)   | 4,570                                      |   | 23.11                 | %      |
| Beneficial Owner                              |   | Murex, N.A., Ltd.                         | (11)   | 1,000                                      |   | 5.06                  | %      |

 

----

(1)  John Malchine’s address at Badger StateEthanol, LLC is 820 West 17th Street, Monroe, Wisconsin  53566. Beneficial ownership includes 500 units owned individually and 100 unitsowned in joint tenancy

(2)  Gary Kramer’s address at Badger StateEthanol, LLC is 820 West 17th Street, Monroe, Wisconsin  53566. Beneficial ownership includes 520 units owned individually and 400 unitsowned by arrangement.

(3)  Jeff Roskam’s address at ICM, Inc. is 310North First Street, P.O. Box 397, Colwich, KS 67030.

(4)  David Kolsrud’s address is RR 1 Box 58,Beaver Creek, MN 56116.

(5)  Don Endres’ address is 100 22ndAve., Suite 103, Brookings, SD 57006.

(6)  Wayne Mitchell’s address at Fagen, Inc. is501 W. Hwy 212 P.O. Box 159, Granite Falls, MN 56241.

(7)  Robert Wright’s address at Murex, N.A., Ltd.is 15411 Knoll Trail, Suite 260, Dallas, TX 75248.  This amount includes 1,000 units owned by Murex, N.A., Ltd.,  for which Mr. Wright disclaims beneficialinterest.

(8)  Kevin Stroup’s address at Fagen, Inc. is 501W. Hwy 212 P.O. Box 159, Granite Falls, MN 56241.

(9)  James Leitzinger’s address at Badger StateEthanol, LLC is 820 West 17th Street, Monroe, Wisconsin  53566.

(10) Includes thebeneficial ownership of seven Directors and executive officers (except Mr.Kevin Stroup, who, with Mr. Wayne Mitchell, are both affiliated with Fagen,Inc. and collectively occupy one seat on the Board of Directors).

(11) Murex, N.A.,Ltd.’s address is 15411 Knoll Trail, Suite 260, Dallas, TX 75248.

 

**ITEM 12.  CERTAIN RELA****TIONSHIPS AND RELATED TRANSACTIONS**

 

**Since our inception, we haveengaged in several transactions with related parties.  We currently do not have outside Directors or unaffiliatedmembers to evaluate related party transactions.  Management believes that these transactions were as favorable asthose that could have been obtained in an arms-length transaction.**

** **

**Fagen and ICM**

** **

On July 11, 2001, we entered into a contract with Fagenin which Fagen would provide services to us in connection with our plan tobuild an ethanol plant.  Under the termsof the contract, Fagen agreed to design and provide construction relatedservices to us not to exceed $43.8 million.

 

Additionally, Fagen and ICM, Inc. have entered into asubcontractor relationship for the construction of the ethanol plant, wherebyFagen was the general contractor and ICM, Inc. was the subcontractor.

 

21

----

 

Fagen purchased 500 Class A member units in our publicoffering.  ICM also purchased 500 ClassA member units as well as 100 Class B member units (which were converted to 100Class A member units).  Fagen and ICM’spurchase of the units were for investment purposes, and are subject to the sameterms and conditions, including restrictions on transfer, as all otherinvestors.

 

**Start-up Capital**

 

We were capitalized with limited cash investments fromDr. Gary Kramer and Mr. John Malchine, our founders.  Dr. Kramer and Mr. Malchine each contributed $10,000 to us inexchange for 500 Class C member units. Dr. Kramer and Mr. Malchine paid $20 perunit.  These units have been convertedto Class A member units.

 

**Executive Salaries**

 

We are currently compensating Gary Kramer, our chief executiveofficer, $100,000 per year pursuant to an oral agreement.  Prior to completion of the ethanol plant, wewere compensating Dr. Kramer $36,000 per year. We are compensating John L. Malchine $36,000 per year for hisservices.  Mr. Malchine was paid $60,000in January, 2002, for services provided during 2001 and 2000.

 

**Ethanol Agreement**

 

We entered into a seven-year ethanol purchase andmarketing agreement with Murex, N.A., Ltd. for the exclusive rights to purchaseand market all ethanol produced by the plant. Murex is a Class A member and has a representative on our Board ofDirectors.

 

**Dried Distillers Grains and SolublesAgreement**

 

We entered into a three-year purchase and marketingagreement with ICM Marketing, Inc. for the exclusive rights to purchase andmarket all of the distillers dried grains produced by the plant.  ICM Marketing was a prime subcontractor forthe construction of the ethanol plant, is a Class A member, and has arepresentative on our Board of Directors.

 

**Promissory Notes from Officers**

 

We received proceeds of $50,000 in June of 2001 fromthe issuance of a $12,500 promissory note to Dr. Gary Kramer, our President andGeneral Manager and Director, a $12,500 promissory note to Mr. John Malchine,our Chief Executive Officer and Director, and a $25,000 promissory note to ICM,Inc., our prime subcontractor and Director. The notes bore interest at the rate of 9% per annum and were due when weclosed our public offering.  The noteswere unsecured debt obligations of the Company.  The notes were paid with interest upon the closing of our publicoffering.

 

**Conflicts of Interest**

 

Conflicts of interest exist and may arise in thefuture as a result of the relationships between and among our members,officers, Directors and their affiliates. Although our officers and Directors have fiduciary duties to us, certainof our Directors also owe fiduciary duties and other obligations to entitieswith whom we compete or do business with. Whenever conflicts arise between us and an officer or Director or anentity with whom that officer or Director is affiliated, the Board as a wholewill seek to resolve the conflict.  ADirector will not participate when the Board considers a transaction where heor she has a conflict of interest.  Wedo not have a committee of independent Directors or members or an otherwisedisinterested body to consider transactions or arrangements that result from,or are fraught with conflicts of interest. Some conflict situations including, disputes that may arise between usand Fagen or ICM as a result of the construction of the ethanol plant areexpected to be resolved through binding arbitration according to constructionindustry rules.

 

Conflicts of interest could arise in the situationsdescribed below, among others:

 

22

----

 

•                  We will engagein transactions with affiliates of our Directors.  Members will have no right to individually enforce theobligations of our Directors or their affiliates in our favor.

 

•                  Our Directors’decisions regarding various matters, including expenditures that we make forour business, reserves for accrued expenses, including officers salaries andreimbursement of Director’s expenses, loan covenants, capital improvements andcontingencies that will effect the amount of cash available for distribution tomembers.  We have representatives ofFagen and ICM on the Board and engage in transactions with ICM and Fagen. Ourexpenditures, reserves and the amount of cash available for distribution may beaffected by these transactions and our relationship to Fagen and ICM.

 

•                  We willreimburse our Directors for out-of-pocket expenses relating to ourbusiness.  We do not have areimbursement policy or guideline for determining what expenses will bereimbursed.  We will review andreimburse all reasonable expenses that Directors submit to us.

 

•                  We have retainedcounsel that has assisted us in various aspects of our formation anddevelopment.  We have not retainedseparate counsel on behalf of unit holders.

** **

•                  Fagen and ICM,and Mr. Roskam, Mr. Mitchell and Mr. Stroup, are involved in various ethanolconstruction and development projects throughout the United States and inWisconsin.  These projects will competewith our project for financing, corn and other raw material supplies, and thesale of ethanol and animal feed.  Ouroperating agreement does not prevent our Directors from being involved inactivities that compete with us.

 

•                  John Malchine’srole on the Wisconsin Agriculture, Trade and Consumer Protection Board, and theWisconsin Tax Commission.

 

•                  Our Directors ortheir affiliates may loan money to us for which we may pay interest up to arate of prime plus 4%.

 

**ITEM 13.  EXHIBI****TS,FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K**

** **

**Exhibits. **The following exhibits are filed as part ofthis report.  Exhibits previously filedare incorporated by reference, as noted.

 
| **Exhibit  No.** |   | **Exhibit**                                                                                                                                                                                                                                                     |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |   | Articles of  Organization of the registrant.  Filed  as Exhibit 3.1 to the registrant’s registration statement on Form SB-2  (Commission File 333-50568) and incorporated by reference herein.                                                        |
|             |   |                                                                                                                                                                                                                                                            |
| 3.2              |   | Operating  Agreement of the registrant.  Filed as  Exhibit 3.2 to the registrant’s registration statement on Form SB-2  (Commission File 333-50568) and incorporated by reference herein.                                                             |
|             |   |                                                                                                                                                                                                                                                            |
| 3.3              |   | Amended and  Restated Operating Agreement of the registrant. Filed as Exhibit 3.2 to the  registrant’s February 27, 2001 amendment to the registration statement on  Form SB-2 (Commission File 333-50568) and incorporated by reference herein.           |
|             |   |                                                                                                                                                                                                                                                            |
| 3.4              |   | Second Amended  and Restated Operating Agreement of the registrant.  Filed as Exhibit 3.2 to the registrant’s March 29, 2001  amendment to the registration statement on Form SB-2 (Commission File  333-50568) and incorporated by reference herein. |
|             |   |                                                                                                                                                                                                                                                            |
| 4.1              |   | Form of Class A  Unit Certificate of the registrant.   Filed as Exhibit 4.1 to the registrant’s February 27, 2001 amendment  to the registration statement on Form SB-2 (Commission File 333-50568) and  incorporated by reference herein.            |
|             |   |                                                                                                                                                                                                                                                            |
| 4.2              |   | Form of Subscription  Agreement of the registrant.  Filed as  Exhibit 4.2 to the registrant’s February 27, 2001 amendment to the  registration statement on Form SB-2 (Commission File 333-50568) and  incorporated by reference herein.              |

 

23

----

 
| 4.3    |   | Escrow  Agreement.  Filed as Exhibit 4.3 to  the registrant’s February 27, 2001 amendment to the registration statement on  Form SB-2 (Commission File 333-50568) and incorporated by reference herein.                                                                                                           |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 4.4    |   | Form of Class A  Unit Certificate of the registrant.   Filed as Exhibit 4.1 to the registrant’s March 29, 2001 amendment to  the registration statement on Form SB-2 (Commission File 333-50568) and  incorporated by reference herein.                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 4.5    |   | Form of  Subscription Agreement of the registrant.   Filed as Exhibit 4.2 to the registrant’s March 29, 2001 amendment to  the registration statement on Form SB-2 (Commission File 333-50568) and  incorporated by reference herein.                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 4.6    |   | Form of  Subscription Agreement of the registrant.   Filed as Exhibit 4.2 to the registrant’s April 20, 2001 amendment to  the registration statement on Form SB-2 (Commission File 333-50568) and  incorporated by reference herein.                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.1   |   | Agreement dated  June 14, 2000 between Badger State Ethanol, LLC and U.S. Energy Services.  Filed as Exhibit 10.4 to the registrant’s registration statement on Form SB-2  (Commission File 333-50568) and incorporated by reference herein.                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.2   |   | Development  Agreement dated October 11, 2000 between Badger State Ethanol, LLC and the City  of Monroe, Wisconsin. Filed as Exhibit 10.5 to the registrant’s registration  statement on Form SB-2 (Commission File 333-50568) and incorporated by  reference herein.                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.3   |   | Form of Teaming  Agreement. Filed as Exhibit 10.6 to the registrant’s registration statement  on Form SB-2 (Commission File 333-50568) and incorporated by reference  herein.                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.4   |   | Amendment to  Development Agreement between Badger State Ethanol, LLC and the City of  Monroe, Wisconsin. Filed as Exhibit 10.1 to the registrant’s quarterly report  for the period ending March 31, 2001 on Form 10-QSB (Commission File  333-50568) and incorporated by reference herein.                           |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.5   |   | Ethanol Purchase  and Sale Agreement dated August 8, 2001, between Badger State Ethanol, LLC  and Murex N.A., Ltd.  Filed as Exhibit  10.1 to the registrant’s quarterly report for the period ending September 30,  2001 on Form 10-QSB (Commission File 333-50568) and incorporated by reference  herein.*      |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.6   |   | Purchase and  Sale Agreement dated August 28, 2001, between Badger State Ethanol, LLC and  ICM Marketing, Inc. Filed as Exhibit 10.2 to the registrant’s quarterly  report for the period ending September 30, 2001 on Form 10-QSB (Commission  File 333-50568) and incorporated by reference herein.*                 |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.7   |   | Construction Loan Agreement dated August 28, 2001,  by and between Badger State Ethanol, LLC and First National Bank of Omaha.  Filed as Exhibit 10.3 to the registrant’s quarterly report for the period  ending September 30, 2001 on Form 10-QSB (Commission File 333-50568) and  incorporated by reference herein. |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.8   |   | First Amendment to Construction Loan Agreement dated  August 27, 2002, by and between First National Bank of Omaha and Badger State  Ethanol, LLC.                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 10.9   |   | Second Amendment to Construction Loan Agreement  dated January 1, 2003, by and between First National Bank of Omaha and Badger  State Ethanol, LLC.                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 99.1   |   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                        |
| 99.2   |   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                    |

 

----

*  Material hasbeen omitted pursuant to a request for confidential treatment and suchmaterials have been filed separately with the Securities and ExchangeCommission.

 

24

----

 

**Financial Statements.**  An index to the financial statementsincluded in this report appears at page F-1. The financial statements appear at page F-2 through F-14 of this report.

 

**Form 8-K.**  None.

 

**ITEM14.  CONTROL****S AND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

Our Chief Executive Officer and Chief FinancialOfficer, after evaluating the effectiveness of our disclosure controls andprocedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of1934, as amended), as of a date (the “Evaluation Date”) within 90 days beforethe filing date of this annual report, have concluded that our disclosurecontrols and procedures are effective in ensuring that material informationrequired to be disclosed is included in the reports that we file with theSecurities and Exchange Commission.

 

**Changesin Internal Controls**

 

There were no significant changes in our internalcontrols or in other factors that could significantly affect these controlssubsequent to the date of the Evaluation Date referred to above.

 

25

----

 

**SIGNATURES**

 

**In accordance with Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this Report tobe signed on its behalf by the undersigned, thereunto duly authorized.**

 
| Dated:  March 27, 2003 | **BADGER  STATE ETHANOL, LLC** |
|-----------------------------|--------------------------------|
|                        |                           |   |
|                        |                           |   |
|                        | By:                            |     /s/ Gary L. Kramer |   |
|                        |                           |     Gary L. Kramer |
|                        |                           |     President and General Manager |

 

In accordance withthe requirements of the Securities Exchange Act of 1934, this Report has beensigned below by the following persons on behalf of the Registrant, and in thecapacities and on the dates indicated.

 
| /s/ John L. Malchine                              |   | March 27, 2003 |
|---------------------------------------------------|--------|----------------|
| John L. Malchine                                  |   |
| Chairman of the Board and Chief Executive Officer |   |
|                                              |   |
| /s/ Gary L. Kramer                                |   | March 27, 2003 |
| Gary L. Kramer                                    |   |
| Director, President and General Manager           |   |
|                                              |   |
| /s/ Jeff Roskam                                   |   | March 27, 2003 |
| Jeff Roskam                                       |   |
| Director and Vice President                       |   |
|                                              |   |
| /s/ David Kolsrud                                 |   | March 27, 2003 |
| David Kolsrud                                     |   |
| Director and Secretary                            |   |
|                                              |   |
| /s/ Don Endres                                    |   | March 27, 2003 |
| Don Endres                                        |   |
| Director and Treasurer                            |   |
|                                              |   |
| /s/ Wayne Mitchell                                |   | March 27, 2003 |
| Wayne Mitchell                                    |   |
| Director                                          |   |
|                                              |   |
| /s/ Robert Wright                                 |   | March 27, 2003 |
| Robert Wright                                     |   |
| Director                                          |   |

 

26

----

 

**CERTIFICATIONS**

 

I, John L. Malchine, certify that:

 

1. I have reviewed this annual report on Form 10-KSB of Badger StateEthanol, LLC;

 

2. Based on my knowledge, this annual report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officer and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

a) Designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b) Evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) Presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent function):

 

a) All significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) Any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifying officer and I have indicated inthis annual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: March 27, 2003 |   |                    |
|----------------------|--------|-------------------------|
|                 |   |                    |
|                 |   | /s/ John L. Malchine    |   |
|                 |   | John L. Malchine        |
|                 |   | Chief Executive Officer |

 

27

----

 

I, James Leitzinger, certify that:

 

1. I have reviewed this annual report on Form 10-KSB of Badger StateEthanol, LLC;

 

2. Based on my knowledge, this annual report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officer and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

a) Designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b) Evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) Presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent function):

 

a) All significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) Any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifying officer and I have indicated inthis annual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: March 27, 2003 |   |                    |
|----------------------|--------|-------------------------|
|                 |   |                    |
|                 |   | /s/ James Leitzinger    |   |
|                 |   | James Leitzinger        |
|                 |   | Chief Financial Officer |

 

28

----

 

**INDEX TO FINANCIAL STATEMENTS**

 
|                                                | **Page** |
|-----------------------------------------------------|----------|
|                                                |     |
| Report  of Independent Certified Public Accountants | F-2      |
|                                                |
| Financial Statements                                |     |
|                                                |
| Balance Sheet                                       | F-3      |
|                                                |
| Statements  of Operations                           | F-4      |
|                                                |
| Statements of Members’  Equity                 | F-5      |
|                                                |
| Statements  of Cash Flows                           | F-6      |
|                                                |
| Notes to Financial  Statements                      | F-7      |

 

F-1

----

 

## **REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS**

 

 

 

Board of Directors andMembers

Badger State Ethanol, LLC

 

** **

We have audited the accompanying balancesheet of Badger State Ethanol, LLC as of December 31, 2002, and therelated statements of operations, members’ equity, and cash flows for each ofthe two years in the period ended December 31, 2002.  These financial statements are the responsibility of thecompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of Badger State Ethanol, LLC as of December31, 2002, and the results of its operations and its cash flows for each oftwo years in the period ended December 31, 2002, in conformity with accountingprinciples generally accepted in the United States of America.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|
|                   |
| Madison, Wisconsin     |
| February 7, 2003       |

 

F-2

----

 

##### **BADGER STATE ETHANOL, LLC**

BALANCE SHEET

December 31, 2002

 
| ASSETS                                          |   |       |       |
|-------------------------------------------------|--------|------------|------------|
|                                            |   |       |       |
| CURRENT  ASSETS                                 |   |       |       |
| Cash and cash equivalents                       |   | $          | 592,366    |   |
| Accounts  receivable                            |   | 3,416,381  |       |
| Inventories                                     |   | 1,751,243  |       |
| Margin deposits                                 |   | 410,000    |       |
| Other assets                                    |   | 272,017    |       |
|                                            |   |       |       |
| Total current assets                            |   | 6,442,007  |       |
|                                            |   |       |       |
| PROPERTY AND  EQUIPMENT, at cost                |   |       |       |
| Plant buildings  and equipment                  |   | 44,816,297 |       |
| Land  improvements                              |   | 1,170,214  |       |
| Office buildings  and equipment                 |   | 448,518    |       |
|                                            |   | 46,435,029 |       |
| Less accumulated  depreciation and amortization |   | 358,254    |       |
|                                            |   | 46,076,775 |       |
|                                            |   |       |       |
| OTHER ASSETS                                    |   | 595,056    |       |
|                                            |   |       |       |
| TOTAL ASSETS                                    |   | $          | 53,113,838 |   |
|                                            |   |       |       |
| LIABILITIES AND  MEMBERS’ EQUITY           |   |       |       |
|                                            |   |       |       |
| CURRENT  LIABILITIES                            |   |       |       |
| Line of credit                                  |   | $          | 1,747,980  |   |
| Current  maturities of long-term debt           |   | 2,074,287  |       |
| Accounts payable                                |   | 1,908,619  |       |
| Accrued  liabilities                            |   | 1,422,907  |       |
|                                            |   |       |       |
| Total current  liabilities                      |   | 7,153,793  |       |
|                                            |   |       |       |
| LONG-TERM DEBT,  less current maturities        |   | 31,240,273 |       |
|                                            |   |       |       |
| COMMITMEMTS  AND CONTINGENCIES                  |   | —     |       |
|                                            |   |       |       |
| MEMBERS’  EQUITY                           |   |       |       |
| Member contributions                            |   | 17,859,787 |       |
| Accumulated  deficit                            |   | (3,140,015 | )          |
|                                            |   | 14,719,772 |       |
|                                            |   |       |       |
| TOTAL  LIABILITIES AND MEMBERS’ EQUITY     |   | $          | 53,113,838 |   |

 

The accompanying notesare an integral part of this statement.

 

F-3

----

 

##### **BADGER STATE ETHANOL, LLC**

STATEMENTS OFOPERATIONS

Years ended December 31, 2002 and 2001

 
|                                         |   | **2002**   |       | **2001** |   |
|----------------------------------------------|--------|------------|------------|----------|--------|
|                                         |   |       |       |     |   |
| Net sales and revenues                       |   | $          | 10,125,926 |     | $      | — |   |
| Cost of sales                                |   | 10,889,768 |       | —   |   |
| Gross margin  (loss)                         |   | (763,842   | )          | —   |   |
|                                         |   |       |       |     |   |
| Selling, general and administrative expenses |   | 1,124,979  |       | 882,227  |   |
|                                         |   |       |       |     |   |
| Operating loss                               |   | (1,888,821 | )          | (882,227 | )      |
|                                         |   |       |       |     |   |
| Interest expense                             |   | (398,165   | )          | —   |   |
| Interest income                              |   | 6,521      |       | 130,530  |   |
| Other income                                 |   | 22,745     |       | —   |   |
|                                         |   |       |       |     |   |
| Net loss                                     |   | $          | (2,257,720 | )        | $      | (751,697 | ) |
|                                         |   |       |       |     |   |
| Net loss per unit – basic and diluted   |   | $          | (114       | )        | $      | (95 | ) |
|                                         |   |       |       |     |   |
| Weighted average  units outstanding          |   | 19,774     |       | 7,952    |   |

 

The accompanying notes are an integral part of these statements.

 

F-4

----

 

##### **BADGER STATE ETHANOL, LLC**

STATEMENTS OFMEMBERS’ EQUITY

Years ended December 31, 2002 and 2001

 

 
|                                              |   | **Class A**              |   | **Class B** |       | **Class C**              |   |       |   |                     |   |       |
|---------------------------------------------------|--------|--------------------------|--------|-------------|------------|--------------------------|--------|------------|--------|--------------------------|--------|------------|
|                                              |   | **Members’  units** |   | **Amount**  |       | **Members’  units** |   | **Amount** |   | **Members’  units** |   | **Amount** |   | **Accumulated  deficit** |   | **Total** |   |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Balance, December 31, 2000                        |   | —                   |   | $           | —     |                     | 720    |       | $      | 359,272                  |   | 1,000      |   | $ | 17,522 |   | $ | (130,598 | ) | $ | 246,196 |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Issuance of  members’ units                  |   | 18,054                   |   | 18,054,000  |       | —                   |   | —     |   | —                   |   | —     |   | — |   | 18,054,000 |   |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Costs related to  issuance of members’ units |   | —                   |   | (571,007    | )          | —                   |   | —     |   | —                   |   | —     |   | — |   | (571,007 | ) |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Conversion of  members’ units                |   | 1,720                    |   | 376,794     |       | (720                     | )      | (359,272   | )      | (1,000                   | )      | (17,522    | ) | — |   | — |   |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Net loss                                          |   | —                   |   | —      |       | —                   |   | —     |   | —                   |   | —     |   | (751,697 | ) | (751,697 | ) |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Balance,  December 31, 2001                       |   | 19,774                   |   | 17,859,787  |       | —                   |   | —     |   | —                   |   | —     |   | (882,295 | ) | 16,977,492 |   |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Net loss                                          |   | —                   |   | —      |       | —                   |   | —     |   | —                   |   | —     |   | (2,257,720 | ) | (2,257,720 | ) |   |
|                                              |   |                     |   |        |       |                     |   |       |   |                     |   |       |   |   |   |   |   |   |
| Balance,  December 31, 2002                       |   | 19,774                   |   | $           | 17,859,787 |                     | — |       | $      | —                   |   | —     |   | $ | — |   | $ | (3,140,015 | ) | $ | 14,719,772 |   |   |
|                                                   |        |                          |        |             |            |                          |        |            |        |                          |        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these statements.

 

F-5

----

 

##### **BADGER STATE ETHANOL, LLC**

STATEMENTS OF CASHFLOWS

Years ended December 31,2002 and 2001

 
|                                                                               |   | **2002**    |       | **2001**    |   |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|
|                                                                               |   |        |       |        |   |
| Cash flows from  operating activities                                              |   |        |       |        |   |
| Net loss                                                                           |   | $           | (2,257,720 | )           | $      | (751,697 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities        |   |        |       |        |   |
| Depreciation and  amortization                                                     |   | 357,102     |       | 1,152       |   |
| Changes in  operating assets and liabilities:                                      |   |        |       |        |   |
| Accounts  receivable                                                               |   | (3,416,381  | )          | —      |   |
| Inventories                                                                        |   | (1,751,243  | )          | —      |   |
| Margin deposits                                                                    |   | (410,000    | )          | —      |   |
| Other assets                                                                       |   | (240,098    | )          | (18,250     | )      |
| Accounts payable                                                                   |   | 1,827,120   |       | 6,731       |   |
| Accrued  liabilities                                                               |   | 1,422,907   |       | —      |   |
|                                                                               |   |        |       |        |   |
| Net cash used in  operating activities                                             |   | (4,468,313  | )          | (762,064    | )      |
|                                                                               |   |        |       |        |   |
| Cash flows from  investing activities                                              |   |        |       |        |   |
| Cost of property  and equipment                                                    |   | (30,849,565 | )          | (14,647,124 | )      |
|                                                                               |   |        |       |        |   |
| Cash flows from  financing activities                                              |   |        |       |        |   |
| Net change in  line of credit                                                      |   | 1,747,980   |       | —      |   |
| Payments of  financing fees                                                        |   | —      |       | (608,725    | )      |
| Proceeds from  long-term debt financing                                            |   | 29,018,738  |       | 3,413,102   |   |
| Payments on  long-term debt financing                                              |   | (55,620     | )          | —      |   |
| Proceeds from  issuance of members’ units                                     |   | —      |       | 18,054,000  |   |
| Cost of issuing  members’ units                                               |   | —      |       | (354,663    | )      |
|                                                                               |   |        |       |        |   |
| Net cash provided  by financing activities                                         |   | 30,711,098  |       | 20,503,714  |   |
|                                                                               |   |        |       |        |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH   EQUIVALENTS                       |   | (4,606,780  | )          | 5,094,526   |   |
|                                                                               |   |        |       |        |   |
| Cash and cash  equivalents at beginning of year                                    |   | 5,199,146   |       | 104,620     |   |
|                                                                               |   |        |       |        |   |
| Cash and cash  equivalents at end of year                                          |   | $           | 592,366    |        | $      | 5,199,146 |   |
|                                                                               |   |        |       |        |   |
| Supplemental  disclosure of cash flow information:                                 |   |        |       |        |   |
| Interest paid                                                                      |   | $           | 25,830     |        | $      | — |   |
|                                                                               |   |        |       |        |   |
| Supplemental  disclosure of noncash operating, investing and financing activities: |   |        |       |        |   |
| Construction  payable for construction in progress                                 |   | $           | —     |        | $      | 4,594,152 |   |
|                                                                               |   |        |       |        |   |
| Purchases of  equipment with long-term debt                                        |   | 269,725     |       | —      |   |
|                                                                               |   |        |       |        |   |
| Capitalized  interest related to long-term debt                                    |   | 653,382     |       | 15,233      |   |

 

The accompanying notes are an integral part of these statements.

 

F-6

----

 

**BADGERSTATE ETHANOL, LLC**

NOTES TO FINANCIALSTATEMENTS

December 31, 2002 and 2001

 

 

NOTE A - SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

 

Badger StateEthanol, LLC (the company) was formed May 11, 2000 and operates a 40 milliongallon ethanol plant in Wisconsin.  Theplant began operations in October 2002. The company sells its production of ethanol and related by-productsdomestically and operates in one business segment.

 

At December 31,2001, the company was primarily involved in organizational activities andconstruction of the plant.  Accordingly,the company was considered to be in the development stage and the financialstatements presented were those of a development stage enterprise.

 

A summary of thesignificant accounting policies consistently applied in the preparation of theaccompanying financial statements follows:

 

1.               Useof Estimates

 

Preparingfinancial statements in conformity with accounting principles generally acceptedin the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

2.               RevenueRecognition

 

The companyrecognizes revenue at the time title to the goods and all risks of ownershiptransfer to customers.  This generallyoccurs upon the date of shipment.

 

The companyexpects to record revenue from federal and state incentive programs, related tothe company’s production of ethanol. Revenue from federal and state incentive payments will be earned andrecognized by the company when it has produced the ethanol and completed allrequirements of the applicable incentive program.  No federal or state incentive program revenue was recognized forthe year ended December 31, 2002.

 

3.               Freightcosts

 

The company reflectsfreight costs associated with shipping its products to customers as a componentof cost of goods sold.

 

F-7

----

 

4.               Cashand Cash Equivalents

 

The companyconsiders all highly liquid debt instruments purchased with original maturitiesof three months or less to be cash equivalents.

 

5.               AccountsReceivable

 

The company grants credit to customers in the normalcourse of business.  Management performson-going credit evaluations of customers and maintains allowances for potentialcredit losses when required.  AtDecember 31, 2002, the company believes all receivables are fully collectible.

 

6.               Concentrationsof Credit Risk

 

The company’s cashbalances are maintained in bank depositories primarily at one financialinstitution and exceed federally insured limits.  Accounts receivable are primarily with two customers and thecompany does not require collateral or other security to support thesereceivables.

 

7.               FairValue of Financial Instruments

 

The carrying amountsof financial instruments including cash and cash equivalents, accountsreceivable and accounts payable approximate fair value, because of therelatively short maturity of these instruments.   The carrying value of long-term debt, including the current portion,approximates fair value due to either the interest being determined by variablerates, repricing periodically, or because the fixed rate approximates thecurrent market rate of interest available to the company.  All derivative contracts are recorded atfair market value.

 

8.               Inventories

 

Inventories are stated at the lower of cost or netrealizable value.  Costs are determinedusing the first-in, first-out (FIFO) method.

 

F-8

----

 

9.               DerivativeInstruments

 

The company enters into derivative contracts to hedgethe company’s exposure to price risk related to forecasted corn purchases,forward corn purchase contracts and forecasted ethanol sales.  The company does not typically enter intoderivative instruments other than for hedging purposes.  All derivative contracts are recognized onthe December 31, 2002 balance sheet at their fair market value and are includedin accrued liabilities.  On the date thederivative instrument is entered into, the company will designate thederivative as either (1) a hedge of the fair value of a recognized asset orliability or of an unrecognized firm commitment (fair value hedge), (2) a hedgeof a forecasted transaction or of the variability of cash flows to be receivedor paid related to a recognized asset or liability (cash flow hedge) or (3)will not designate the derivative as a hedge. Changes in the fair value of a derivative that is designated as andmeets all the required criteria for a fair value hedge, along with the gain orloss on the hedged asset or liability that is attributable to the hedged risk,are recorded in current period earnings. Changes in the fair value of a derivative that is designated as andmeets all the required criteria for a cash flow hedge are recorded inaccumulated other comprehensive income and reclassified into earnings as theunderlying hedged item affects earnings. Changes in the fair value of a derivative that is not designated as ahedge are recorded in current period earnings. At December 31, 2002 no derivative contracts were designated as hedgesand all changes in market value have been recognized through cost ofsales.  The company has recorded cost ofsales of $809,921 related to its derivative contracts for the year endedDecember 31, 2002.

 

10.         Propertyand Equipment

 

Depreciation and amortization of property andequipment are provided in amounts sufficient to relate the cost of the relatedassets to operations over their estimated service lives using the straight-linemethod.  Depreciation and amortizationfor income tax reporting purposes are computed using accelerated methods.  The ranges of the estimated useful lives forthe major classes of property and equipment are as follows:

 
| Plant buildings  and equipment  |   | 5 to 30 years  |
|---------------------------------|--------|----------------|
| Land  improvements              |   | 10 to 30 years |
| Office buildings  and equipment |   | 3 to 30 years  |

 

F-9

----

 

11.         NetLoss per Unit

 

Basic and diluted net loss per unit are computed bydividing the net loss by the weighted average units outstanding for theyear.  At December 31, 2002, the companyhas no equity instruments that would be considered member unit equivalents forpurposes of calculating net loss per unit.

 

12.         Reclassifications

 

Certain prior year amounts have been reclassified toconform with the current year’s presentation. These reclassifications had no effect on previously recorded net loss ormembers’ equity.

 

13.         RecentAccounting Pronouncements

 

In December 2002, the FASB issued FASB Interpretation45 (FIN 45), *Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*.  FIN 45 addresses the measurement andrecognition of the fair value of a guarantee at its inception and provides newdisclosures regarding the nature of any guarantees, the maximum potentialamount of future guarantee payments, the current carrying amount of theguarantee liability, and the nature of any recourse provisions or assets heldas collateral that could be liquidated and allow the guarantor to recover allor a portion of its payments in the event guarantee payments are required.  The initial recognition and measurementrequirements of FIN 45 are effective prospectively for guarantees issued ormodified after December 31, 2002.  However,the disclosure requirements are effective for financial statement periodsending after December 15, 2002.  Thecompany has complied with the disclosure requirements.

 

The company does not expect that the adoption of otherrecent accounting pronouncements will have a material impact on its financialstatements.

 

NOTE B - INVENTORIES

 

Inventories consist ofthe following at December 31, 2002:

 
| Raw materials      |   | $       | 981,688   |   |
|--------------------|--------|---------|-----------|--------|
| Work-in-process    |   | 282,552 |      |
| Finished goods     |   | 487,003 |      |
|               |   |    |      |
| Total  inventories |   | $       | 1,751,243 |   |

 

F-10

----

 

NOTE C - ACCRUEDLIABILITIES

 

Accruedliabilities consist of the following at December 31, 2002:

 
| Accrued interest           |   | $       | 372,335   |   |
|----------------------------|--------|---------|-----------|--------|
| Derivative  liability      |   | 431,239 |      |
| Accrued other              |   | 619,333 |      |
|                       |   |    |      |
| Total accrued  liabilities |   | $       | 1,422,907 |   |

 

The derivative liabilityrepresents the fair market value of the company’s open derivative instrumentsat December 31, 2002.

 

 

NOTE D - LINE OF CREDIT

 

The company has available a $3,500,000 line of creditwith a financial institution expiring in August 2003.  At December 31, 2002, the company has outstanding borrowings of$1,747,980.  Borrowings outstandingunder the line are collateralized by a general business securityagreement.  Interest is payable monthlyat a variable rate (effective rate of 5.25% at December 31, 2002).  Upon expiration of the current line ofcredit in August 2003, the company has the intent and believes it will have theability to renew its line of credit.

 

 

NOTE E - LONG-TERM DEBT

 

Long-term debt as of December 31, 2002 consists of aconstruction loan, an electric utility note payable, and three notes payablerelated to vehicle purchases.

 

Effective January 1, 2003, the construction loan wasconverted to a term loan in the amount of $30,600,000.  Quarterly payments, including principal andinterest, of $1,021,839 will begin on April 1, 2003 based upon a five-yearamortization with a balloon payment due on the maturity date of January 1,2008.  The term loan is structured asthree notes and interest accrues monthly on the notes at both fixed andvariable rates.  The fixed rate willaccrue at 6.528% on $15,300,000 of the term loan and the variable rate willaccrue on $15,300,000 of the term loan based on the prime rate (effective rateof 5.25% at December 31, 2002).  Theamount outstanding on the construction loan is $29,672,120 at December 31,2002.  The loan is collateralized by allassets of the company and contains various customary restrictions, includingthe maintenance of certain financial covenants.

 

F-11

----

 

The electricutility note payable is collateralized by equipment, inventory and a guaranteeby the City of Monroe.  Interest,advanced as principal on the note payable, accrued monthly at 5.83% through theconstruction period up to a maximum loan amount of $3,600,000.  Monthly payments, including principal andinterest, of $34,762 began November 1, 2002 based upon a ten-year amortizationwith a balloon payment due on the maturity date of November 1, 2007.   Interest accrues monthly on the loan at3%.  The amount outstanding on theelectric utility note payable is $3,548,411 at December 31, 2002.

 

The company hasthree notes payable with various institutions that are collateralized by avehicle and equipment.  There is nointerest on two of the notes payable and interest on the third note payableaccrues monthly at 2.5%.  These notesexpire at various dates through 2007. The amount outstanding on these notes payable is $94,029 at December 31,2002.

 

Future maturitiesof long-term debt as of December 31, 2002 are as follows:

 
| **Year  ending December 31,** |   |       |       |
|-------------------------------|--------|------------|------------|
| 2003                          |   | $          | 2,074,287  |   |
| 2004                          |   | 2,778,162  |       |
| 2005                          |   | 2,935,588  |       |
| 2006                          |   | 3,079,047  |       |
| 2007                          |   | 5,128,193  |       |
| 2008                          |   | 17,319,283 |       |
|                          |   | $          | 33,314,560 |   |

 

 

NOTE F - MEMBERS’ EQUITY

 

As specified inthe company’s operating agreement, the company has three classes of memberunits:  Class A, Class B, and ClassC.  Upon the closing of the Class Aequity offering in 2001, all Class B member units (720) and Class C memberunits (1,000) converted to Class A units at the rate of one Class A unit foreach Class B and C member unit held.

 

Class A memberunits have voting and income allocation rights based upon the number of unitsheld.

 

F-12

----

 

NOTE G -COMMITMENTS

 

At December 31,2002, the company had forward contracts to purchase approximately 3,004,000bushels of corn at various prices and forward contracts to purchaseapproximately 117,500 bushels of corn that were not yet priced.  The company recorded an unrealized loss of$248,887 on open forward contracts that were priced at December 31, 2002.

 

The company leasesrailcars under operating leases requiring monthly payments of $6,750 throughNovember 2003.  Total rent expense forall operating leases was $13,500 for 2002. Future minimum lease payments under these leases as of December 31, 2002is $67,500 for the year ending December 31, 2003.

 

 

NOTE H - RELATEDPARTIES

 

The company’sgeneral contractor and a subcontractor are members of the company and haverepresentatives on the company’s Board of Directors.  The subcontractor also has exclusive rights to market thecompany’s distiller’s grains.  Thecompany owed these members $500,000 as of December 31, 2002 for constructionactivities.  The company has madepayments to them of $33,103,403 as of December 31, 2002. Sales for the yearended December 31, 2002 to the subcontractor were $1,968,351 and trade accountsreceivable at December 31, 2002 were $432,767.

 

The company’s soleethanol marketing company is a member and has a representative on the company’sBoard of Directors.  Sales for the yearended December 31, 2002 to the member were $7,924,945 and trade accountsreceivable at December 31, 2002 were $2,978,692.

 

In connection withthe sales activities of the ethanol marketing company and the subcontractor,the company recorded expenses of $735,273 related to railcar, freight and marketing fees.

 

 

NOTE I -RETIREMENT PLAN

 

Effective January1, 2003, the company established a 401(k) Plan for all employees of thecompany.  The company may make profitsharing contributions to the plan which are at the discretion of the company’sBoard of Directors.  No contributionswere made in 2002.

 

F-13

----

 

NOTEJ - MAJOR CUSTOMERS

 

The company has two majorcustomers that accounted for 78% and 19% of net sales for the year endedDecember 31, 2002.

 

 

NOTE K - INCOMETAXES

 

Due to the company’s organization as a limited liability company, theincome or loss of the company is reportable by the respective members on theirpersonal income tax returns.  Therefore,no income tax provision has been included in the accompanying financialstatements.

 

F-14

----