**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 
| **ý**                                                                                                                               | ** ** | **Quarterly  report under Section 13 or 15(d) of the Securities Exchange Act of 1934.** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|
|                                                                                                                                     |       |                                                                                    |
| **For the  quarterly period ended March 31, 2006**                                                                                       |
|                                                                                                                                     |       |                                                                                    |
| **OR**                                                                                                                                   |
|                                                                                                                                     |       |                                                                                    |
| **o**                                                                                                                                    | ** ** | **Transition  report under Section 13 or 15(d) of the Exchange Act.**                   |
|                                                                                                                                     |       |                                                                                    |
| **For the  transition period from                   to** |
|                                                                                                                                     |       |                                                                                    |
| **Commission file number 333-101441**                                                                                                    |

 

**EAST KANSAS AGRI-ENERGY, LLC**

(Exact name of small business issuer asspecified in its charter)

 

| **KANSAS**                                                          | ** ** | **48-1251578**                            |
|---------------------------------------------------------------------|------------|-------------------------------------------|
| **(STATE OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION)** | ** ** | **(I.R.S. EMPLOYER IDENTIFICATION  NO.)** |

 

**P.O. Box225, 1304 S. Main, Garnett, Kansas 66032**

(Address of principal executive offices)

 

**(785) 448-2888**

(Issuer’s telephone number)

 

Check whether the issuer:  (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.              ý  Yes               o  No

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer ý |
|---------------------------|--------|---------------------|--------|------------------------------|

 

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

o  Yes            ý  No

 

State the number of sharesoutstanding for each of the issuer’s classes of common equity as of the latestpracticable date:  As ofMarch 31, 2006, there were 23,798 membership units outstanding.

 

Transitional Small Business Disclosure Format (Check one):              o  Yes               ý  No

 

 

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**INDEX**

 
| **PART  I.    FINANCIAL INFORMATION** | ** **                                                                   |
|-----------------------------------------------------------|------------------------------------------------------------------------------|
| ** **                                                | ** **                                                                   | ** ** |
| ** **                                                | **Item 1. Financial Statements**                                             | ** ** |
| ** **                                                | **Item 2. Management’s  Discussion and Analysis and Plan of Operation** | ** ** |
| ** **                                                | **Item 3. Controls and Procedures**                                          | ** ** |
| ** **                                                | ** **                                                                   | ** ** |
| **PART I.    OTHER  INFORMATION**     | ** **                                                                   |
| ** **                                                | ** **                                                                   | ** ** |
| ** **                                                | **Item 1. Legal Proceedings**                                                | ** ** |
| ** **                                                | **Item 1A. Risk Factors**                                                    | ** ** |
| ** **                                                | **Item 2. Unregistered Sales  of Equity Securities and Use of Proceeds**     | ** ** |
| ** **                                                | **Item 3. Defaults Upon Senior  Securities**                                 | ** ** |
| ** **                                                | **Item 4. Submission of Matters  to a Vote of Security Holders**             | ** ** |
| ** **                                                | **Item 5. Other Information**                                                | ** ** |
| ** **                                                | **Item  6. Exhibits**                                                        | ** ** |

 

----

 

**PART I.     FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**EAST KANSAS AGRI-ENERGY, LLC**

**BALANCE SHEET (UNAUDITED)**

**SEPTEMBER 30, 2005**

 
| **ASSETS**                                                                                                |       |           |            |
|-----------------------------------------------------------------------------------------------------------|------------|----------------|-----------------|
| ** **                                                                                                |       |           |            |
| CURRENT ASSETS                                                                                            |       |           |            |
| Cash and cash equivalents                                                                                 | ** ** | **$**          | **6,799,445**   | ** ** |
| Trade accounts receivable - related party                                                                 | ** ** | **3,515,492**  | ** **      |
| Inventory                                                                                                 | ** ** | **1,432,502**  | ** **      |
| Investment in commodity contracts                                                                         | ** ** | **357,662**    | ** **      |
| Interest receivable                                                                                       | ** ** | **1,265,035**  | ** **      |
| Prepaid expense                                                                                           | ** ** | **392,895**    | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| Total current assets                                                                                      | ** ** | **13,763,031** | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| PROPERTY, PLANT AND EQUIPMENT                                                                             |       |           |            |
| Land                                                                                                      | ** ** | **580,322**    | ** **      |
| Land improvements                                                                                         | ** ** | **2,152,842**  | ** **      |
| Office equipment                                                                                          | ** ** | **270,866**    | ** **      |
| Buildings                                                                                                 | ** ** | **1,668,527**  | ** **      |
| Equipment                                                                                                 | ** ** | **42,070,664** | ** **      |
| Vehicles                                                                                                  | ** ** | **22,743**     | ** **      |
| Construction in progress                                                                                  | ** ** | **2,350,522**  | ** **      |
| ** **                                                                                                | ** ** | **49,116,486** | ** **      |
| Less accumulated depreciation                                                                             | ** ** | **(2,330,601** | **)**           |
|                                                                                                      | ** ** | ** **     | ** **      |
| Total property, plant, and equipment                                                                      | ** ** | **46,785,885** | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| OTHER ASSETS                                                                                              |       |           |            |
| Investment in Industrial Revenue Bonds                                                                    | ** ** | **47,866,117** | ** **      |
| Financing costs                                                                                           | ** ** | **682,914**    | ** **      |
| Less accumulated amortization                                                                             | ** ** | **(43,036**    | **)**           |
| Total other assets                                                                                        | ** ** | **48,505,995** | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| Total assets                                                                                              | ** ** | **$**          | **109,054,911** | ** ** |
|                                                                                                      |       |           |            |
| **LIABILITIES AND MEMBERS’ EQUITY**                                                                  |       |           |            |
| ** **                                                                                                |       |           |            |
| CURRENT LIABILITIES                                                                                       |       |           |            |
| Current portion of long-term debt                                                                         | ** ** | **$**          | **1,926,531**   | ** ** |
| Accounts payable                                                                                          |       |           |            |
| Trade                                                                                                     | ** ** | **496,067**    | ** **      |
| Related parties                                                                                           | ** ** | **649,905**    | ** **      |
| Accrued payroll, taxes and withholdings                                                                   | ** ** | **111,331**    | ** **      |
| Other accrued expenses                                                                                    | ** ** | **128,509**    | ** **      |
| Accrued interest                                                                                          | ** ** | **1,325,817**  | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| Total current liabilities                                                                                 | ** ** | **4,638,160**  | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| LONG-TERM DEBT (less current maturities)                                                                  | ** ** | **22,786,570** | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| LEASE OBLIGATION                                                                                          | ** ** | **47,866,117** | ** **      |
|                                                                                                      | ** ** | ** **     | ** **      |
| MEMBERS’ EQUITY                                                                                      |       |           |            |
| Capital contributions, 40,000 units  authorized, 23,798 units issued and outstanding as of March 31, 2006 | ** ** | **24,707,100** | ** **      |
| Retained earnings                                                                                         | ** ** | **9,056,964**  | ** **      |
| Total members’ equity                                                                                | ** ** | **33,764,064** | ** **      |
| Total liabilities and members’ equity                                                                | ** ** | **$**          | **109,054,911** | ** ** |

 

See Notes to Unaudited Financial Statements

 

1

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**EAST KANSAS AGRI-ENERGY, LLC**

**STATEMENTS OF OPERATIONS (UNAUDITED)**

 
| ** **                                            | ** ** | **Three Months** | ** **     | **Three Months** | ** ** |
|-------------------------------------------------------|------------|-----------------------|----------------|-----------------------|------------|
| ** **                                            | ** ** | **Ended**             | ** **     | **Ended**             | ** ** |
| ** **                                            | ** ** | **March 31,**    | ** **     | **March 31,**    | ** ** |
| ** **                                            | ** ** | **2006**              | ** **     | **2005**              | ** ** |
|                                                  |       |                  |           |                  |       |
| REVENUE                                               |       |                  |           |                  |       |
| Related parties                                       | ** ** | **$**                 | **21,015,698** |                  | $          | — |   |
| Incentive funds                                       | ** ** | **680,830**           |           | —                |       |
| ** **                                            |       | **21,696,528**        |           | —                |       |
|                                                  |       |                  |           |                  |       |
| COST OF SALES                                         |       |                  |           |                  |       |
| Related parties                                       | ** ** | **(8,141,512**        | )              | —                |       |
| Other                                                 | ** ** | **(6,499,761**        | )              | —                |       |
| ** **                                            | ** ** | **(14,641,273**       | **)**          | **—**            | ** ** |
|                                                  |       |                  |           |                  |       |
| GROSS PROFIT                                          | ** ** | **7,055,255**         | ** **     | **—**            | ** ** |
|                                                  |       |                  |           |                  |       |
| OPERATING EXPENSES                                    |       |                  |           |                  |       |
| General, administrative and selling  expenses         | ** ** | **875,049**           |           | —                |       |
| Start-up expenses                                     | ** ** | **—**            |           | 150,287               |       |
| ** **                                            |       | **875,049**           |           | 150,287               |       |
|                                                  |       |                  |           |                  |       |
| INCOME (LOSS) FROM OPERATIONS                         | ** ** | **6,180,206**         | ** **     | **(150,287**          | **)**      |
|                                                  |       |                  |           |                  |       |
| OTHER INCOME (EXPENSE)                                |       |                  |           |                  |       |
| Interest income                                       | ** ** | **977,073**           |           | 852                   |       |
| Interest expense                                      | ** ** | **(1,205,654**        | )              | —                |       |
| Plant lease interest expense                          | ** ** | **(314,736**          | )              | —                |       |
| ** **                                            |       | **(543,317**          | **)**          | 852                   |       |
|                                                  |       |                  |           |                  |       |
| NET INCOME (LOSS)                                     | ** ** | **$**                 | **5,636,889**  | ** **            | **$**      | **(149,435** | **)** |
|                                                  |       |                  |           |                  |       |
| BASIC AND DILUTED INCOME (LOSS) PER UNIT              | ** ** | **$**                 | **237**        |                  | $          | (8 | ) |
|                                                  |       |                  |           |                  |       |
| WEIGHTED AVERAGE UNITS OUTSTANDING BASIC  AND DILUTED | ** ** | **23,798**            |           | 19,707                |       |

 

See Notes to Unaudited Financial Statements

 

2

----

 

**EAST KANSAS AGRI-ENERGY, LLC**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

 
| ** **                                                                  | ** ** | **Three Months** | ** **    | **Three Months** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|---------------|-----------------------|------------|
| ** **                                                                  | ** ** | **Ended**             | ** **    | **Ended**             | ** ** |
| ** **                                                                  | ** ** | **March 31,**    | ** **    | **March 31,**    | ** ** |
| ** **                                                                  | ** ** | **2006**              | ** **    | **2005**              | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                        |       |                  |          |                  |       |
| Net income (loss)                                                           | ** ** | **$**                 | **5,636,889** |                  | $          | (149,435 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities |       |                  |          |                  |       |
| Depreciation                                                                | ** ** | **752,581**           |          | 838                   |       |
| Amortization                                                                | ** ** | **23,735**            |          | —                |       |
| (Increase) decrease in current assets                                       |       |                  |          |                  |       |
| Accounts receivable                                                         | ** ** | **(863,946**          | )             | —                |       |
| Inventory                                                                   | ** ** | **163,045**           |          | —                |       |
| Commodity contracts                                                         | ** ** | **(134,711**          | )             | —                |       |
| Grants receivable                                                           | ** ** | **—**            |          | 54,906                |       |
| Prepaid offering costs                                                      | ** ** | **—**            |          | (2,213                | )          |
| Prepaid expense                                                             | ** ** | **19,278**            |          | 1,925                 |       |
| Interest receivable                                                         | ** ** | **(950,299**          | )             | —                |       |
| Increase (decrease) in current liabilities:                                 |       |                  |          |                  |       |
| Accounts payable                                                            | ** ** | **(226,101**          | )             | (18,100               | )          |
| Accrued expenses                                                            | ** ** | **1,016,531**         |          | (743                  | )          |
| NET CASH PROVIDED BY (USED IN) OPERATING  ACTIVITIES                        | ** ** | **5,437,002**         |          | (112,822              | )          |
|                                                                        |       |                  |          |                  |       |
| CASH FLOWS FROM INVESTING ACTIVITIES                                        |       |                  |          |                  |       |
| Purchase of plant and equipment, including construction  in progress        | ** ** | **(962,116**          | )             | (18,674,279           | )          |
| NET CASH (USED IN) INVESTING ACTIVITIES                                     | ** ** | **(962,116**          | )             | (18,674,279           | )          |
|                                                                        |       |                  |          |                  |       |
| CASH FLOWS FROM FINANCING ACTIVITIES                                        |       |                  |          |                  |       |
| Payment of financing fees                                                   | ** ** | **(3,815**            | )             | (10,071               | )          |
| Proceeds from long-term debt                                                | ** ** | **—**            |          | 6,426,394             |       |
| Repayment of long-term debt                                                 | ** ** | **(2,240,771**        | )             | —                |       |
| Proceeds from units subject to redemption                                   | ** ** | **—**            |          | 6,250,000             |       |
| NET CASH PROVIDED BY (USED IN) FINANCING  ACTIVITIES                        | ** ** | **(2,244,586**        | )             | 12,666,323            |       |
|                                                                        |       |                  |          |                  |       |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                       | ** ** | **2,230,300**         |          | (6,120,778            | )          |
|                                                                        | ** ** | ** **            |          |                  |       |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                             | ** ** | **4,569,145**         |          | 6,210,819             |       |
|                                                                        | ** ** | ** **            |          |                  |       |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                    | ** ** | **$**                 | **6,799,445** |                  | $          | 90,041 |   |

 

(continued on next page)

 

See Notes to Unaudited Financial Statements

 

3

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**EAST KANSAS AGRI-ENERGY, LLC**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

 
| ** **                                                                | ** ** | **Three Months** | ** **    | **Three Months** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|---------------|-----------------------|------------|
| ** **                                                                | ** ** | **Ended**             | ** **    | **Ended**             | ** ** |
| ** **                                                                | ** ** | **March 31,**    | ** **    | **March 31,**    | ** ** |
| ** **                                                                | ** ** | **2006**              | ** **    | **2005**              | ** ** |
|                                                                      |       |                  |          |                  |       |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                          |       |                  |          |                  |       |
| Cash paid for interest, net of capitalized  interest of $106,376 for 2005 | ** ** | **$**                 | **601,830**   |                  | $          | — |   |
|                                                                      |       |                  |          |                  |       |
| NON CASH INVESTING AND FINANCING ACTIVITIES                               |       |                  |          |                  |       |
|                                                                      |       |                  |          |                  |       |
| Property, plant, and equipment costs  incurred                            | ** ** | **$**                 | **1,039,137** |                  | $          | 9,320,112 |   |
|                                                                      |       |                  |          |                  |       |
| Deferred offering costs incurred                                          | ** ** | **$**                 | **—**    |                  | $          | 96,779 |   |
|                                                                      |       |                  |          |                  |       |
| Financing costs incurred                                                  | ** ** | **$**                 | **—**    |                  | $          | 8,126 |   |

 

See Notes to Unaudited Financial Statements

 

4

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**NOTE1 -**                     SUMMARY OF SIGNIFICANTACCOUNTING POLICIES

** **

*Nature of Business*

 

East Kansas Agri-Energy, LLC, (a Kansas limited liability company)located in Garnett, Kansas, was organized to own and operate a 35 milliongallon ethanol plant with distribution within the United States. East KansasAgri-Energy, LLC (the Company) was formally organized as a limited liabilitycompany as of October 16, 2001. Prior to that date the Company operated as ageneral partnership with no formal partnership agreement. The Company began itsprincipal operations June 15, 2005. Prior to that date, the Company wasconsidered to be in development stage.

 

*Basis of Accounting*

 

The unaudited financialstatements contained herein have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission. Accordingly, they do notinclude all the information and footnotes required by accounting principlesgenerally accepted in the United States of America.

 

In the opinion ofmanagement, all adjustments considered necessary for a fair presentation havebeen included in the accompanying financial statements. The results ofoperations for the three months ended March 31, 2006 and 2005, are notnecessarily indicative of the results expected for a full year.

 

These financial statementsshould be read in conjunction with the financial statements and notes includedin the Company’s financial statements for the year ended December 31, 2005.

 

*Accounts Receivable*

 

Accountsreceivable are presented at face value, net of the allowance for doubtfulaccounts. The allowance for doubtful accounts is established through provisionscharged against income and is maintained at a level believed adequate bymanagement to absorb estimated bad debts based on historical experience andcurrent economic conditions. Management believes all receivables will becollected and therefore the allowance has been established to be zero at March31, 2006.

 

The Company’s policy is to charge simple interest on trade receivablespast due balances; accrual of interest is discontinued when management believescollection is doubtful. Receivables are considered past due based upon paymentterms set forth at the date of the related sale. The Company has no receivablesaccruing interest at March 31, 2006.

 

*Prepaid Offering Costs*

 

Costs incurred related tothe sale of units are recorded as prepaid offering costs until the relatedunits are issued. Upon issuance of units, offering costs are deducted fromadditional paid-in capital, with any remaining amount applied to retainedearnings. Offering costs include direct costs related to the offering such aslegal fees, cost of meetings and materials and related costs associated withthe Company’s private offering and public offering.

 

*Financing Costs*

 

Costs incurred related to origination of debtfinancing are recorded as an asset and amortized over the expected term of thedebt.

 

*Estimates*

 

Managementuses estimates and assumptions in preparing financial statements. Thoseestimates and assumptions affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expenses.Actual results could differ from the estimates used.

 

5

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*Earnings Per Unit*

 

Earnings per unit arecalculated based on the period of time units have been issued and outstanding.For purposes of calculating diluted earnings per capital unit, units subscribedfor but not issued are included in the computation of outstanding capitalunits.

 

*General, administrative and selling expenses*

 

The primary components of general andadministrative expenses are management fees, insurance expense, sellingexpenses and payroll.

 

*Revenue Recognition*

 

Revenue from the production of ethanol and relatedproducts is recorded upon transfer of title to our customers. The transfertakes place at the plant site and therefore shipping terms are FOB shippingpoint. Interest income is recognized as earned. Income from federal and stateincentives are recognized when received due to uncertainty of available fundsand pro-rations used by the sponsoring organizations.

 

*Cost of Sales*

 

The primary components of cost of sales from theproduction of ethanol and related products are grain expense, energy expense(natural gas and electricity), raw materials expense (chemicals anddenaturant), labor and depreciation on process equipment.

 

*Shipping and Handling*

 

Shipping and handling costs are expensed asincurred and are included in the cost of sales.

 

*Organization and Start-up Costs*

 

Organizational and start-up costs are expensed asincurred. Organizational costs consist of amounts related to the formation ofthe company. Start-up costs consist of amounts incurred during the developmentstage related to the operation and management of the Company, which do notqualify as capitalized costs.

 

*Income Taxes*

 

The Company is organized as a limited liabilitycompany under state law and is treated as a partnership for income tax purposes.Under this type of organization, the Company’s earnings pass through to thepartners and are taxed at the partner level. Accordingly, no income taxprovision has been calculated. Differences between financial statement basis ofassets and tax basis of assets is related to capitalization and amortization oforganizational and start-up costs for tax purposes, whereas these costs areexpensed for financial statement purposes, and the difference between therecorded amounts of financial statement and tax depreciation, unrealized gainsor losses on commodity contracts and incentive programs payments.

 

*Cash Equivalents*

 

For purposes of the statement of cash flows, theCompany considers all highly liquid debt instruments purchased with an originalmaturity of three months or less to be cash equivalents.

 

*Fair Value of Financial Instruments*

 

The Company believes the carrying value of cash andcash equivalents approximates fair value due to the short maturity of theseinstruments. The Company estimates the fair market value of the investment inIndustrial Revenue Bonds to approximate cost.

 

6

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The Company believes the carrying amount oflong-term note payable obligations approximates fair value. For the permanentfinancing, fair value approximates the carrying amount due to the variableinterest rate feature of the debt.

 

*Inventory*

 

Inventoryis stated at the lower of cost, determined on a first in, first out basis, ormarket value.

 

*Investment in Commodity Contracts*

 

SFAS No. 133 requires acompany to evaluate its contracts to determine whether the contracts arederivatives. Certain contracts that literally meet the definition of aderivative may be exempted from SFAS No. 133 as normal purchases or normalsales. Normal purchases and normal sales are contracts that provide for thepurchase or sale of something other than a financial instrument or derivativeinstrument that will be delivered in quantities expected to be used or soldover a reasonable period in the normal course of business. Contracts that meetthe requirements of normal are documented as normal and exempted from theaccounting and reporting requirements of SFAS No. 133.

 

The Company enters intoshort-term cash grain, option and futures contracts as a means of securinggrain for the ethanol plant and managing exposure to changes in commodityprices. All derivatives are designated as non-hedge derivatives. Although thecontracts are effective economic hedges of specified risks, they are notdesignated as and accounted for as hedging instruments.

 

As part of its trading activity, the Company uses futures and optioncontracts offered through regulated commodity exchanges to reduce risk and isexposed to risk of loss in the market value of inventories. To reduce thatrisk, the Company generally takes positions using cash and futures contractsand options. During the period ended March 31, 2006 this activity resulted innet losses of $489,289 which are reported in cost of sales.

 

*Property and Equipment*

 

Depreciationis computed over the estimated useful life of each asset using thestraight-line method. Estimated useful lives generally used in computingdepreciation are:

 
| Land improvements       |   | 15 to 20  years |   |
|-------------------------|--------|-----------------|--------|
| Buildings               |   | 40 years        |   |
| Machinery and equipment |   | 7 to 15  years  |   |
| Office equipment        |   | 5 to 10 years   |   |
| Computers and software  |   | 3 to 5 years    |   |
| Vehicles                |   | 5 years         |   |

 

TheCompany’s property and equipment were acquired under lease agreements pursuantto an industrial revenue bond issue. The Company is required to makesemi-annual deposits with the Trustee sufficient to service the principalmaturities and interest requirements. Title to the property will be transferredto the Company when the lease is terminated upon retirement of the bonds. Accordingly,the bonds have been recorded as a direct obligation of the Company. The Companyis also the holder of the bonds.

 

TheCompany reviews its property and equipment for impairment whenever eventsindicate that the carrying amount of the asset may not be recoverable. Animpairment loss is recorded if the sum of the future cash flows is less thanthe carrying amount of the asset. The amount of the loss is determined bycomparing the fair market value of the asset to the carrying amount of theasset. Such assessments did not result in any adjustment to the value of thenon-current assets.

 

*Environmental Liabilities*

 

The Company’s operations are subject to federal,state and local environmental laws and regulations. These laws require theCompany to investigate and remediate the effects of the release or disposal of materialsat its location. Accordingly, the Company has adopted policies, practices andprocedures in the areas of pollution control,

 

7

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occupational health, and the production, handling,storage and use of hazardous materials to prevent material environmental orother damage; and to limit the financial liability which could result from suchevents. Environmental liabilities are recorded when the liability is probableand the costs can be reasonably estimated.

 

**NOTE2 -**                     INCENTIVE PAYMENTS

** **

The Company has qualifiedfor the federal U.S. Department of Agriculture Bio Energy Program. The federalprogram is managed by the Commodity Credit Corporation and is designed toexpand the production of fuel grade ethanol by offering incentives forincremental production compared to the same quarter of the prior year. Theannually funded program runs through fiscal year 2006 and incentive paymentsare pro-rated if applications for incentives exceed the annual funding. The maximumannual incentive program payments the Company can receive is $7,500,000;individual producers are also subject to an annual limitation of 5% of thetotal funding. The Company has included federal incentives of $225,160 inrevenue for the period ended March 31, 2006.

 

The Company has beenapproved for the Kansas Qualified Agricultural Ethanol Producer Incentive Fund.The incentive rate is $.075 per gallon of ethanol produced. The Company mustestablish they have produced 5,000,000 gallons of ethanol before the State ofKansas will disburse the funds. The Company has included state incentives of$455,671 in revenue for the period ended March 31, 2006.

 

**NOTE3 -**                     INVENTORY

** **

Asof March 31, 2006, inventory consists of:

 
| Raw Material     |   | $       | 994,570   |   |
|------------------|--------|---------|-----------|--------|
| Work in Progress |   | 302,423 |      |
| Finished Goods   |   | 135,509 |      |
|             |   |    |      |
|             |   | $       | 1,432,502 |   |

 

**NOTE4 -**                     UNITS SUBJECT TOREDEMPTION

** **

OnOctober 11, 2004, the Company executed a Unit Purchase and Redemption Agreementwith ICM, Inc. and Fagen, Inc. in which the Company agreed to issue a total of6,250 units to them in exchange for their combined capital contribution of$6,250,000. The Company also agreed to redeem all 6,250 units from ICM, Inc.and Fagen, Inc. using the proceeds from the sale of units in a futureregistered offering or, to the extent the future offering is unsuccessful, fromcash flow generated by operations subject to certain loan covenants,restrictions and tax distributions. The redemption price was $1,100 per unit. Inconnection with this capital contribution, the Company amended the OperatingAgreement to allow ICM, Inc. and Fagen, Inc. to appoint a total of threedirectors to the Company’s board of directors, subject to the Company’s abilityto terminate one of their director positions for every $2,000,000 dollars inredemption payments made to either or both of ICM, Inc. and Fagen, Inc. OnJanuary 19, 2005, the Company closed on the purchase of these units by ICM,Inc. and Fagen, Inc. and issued 3,125 units to Fagen, Inc. and 3,125 units toICM, Inc. at a purchase price of $1,000 per unit. The purchases were made withcash and the total amount of cash consideration for those securities was$6,250,000. On August 1, 2005, the Company redeemed the 6,250 units from ICM,Inc. and Fagen, Inc. at a price of $1,100 per unit for a total of $6,875,000.

 

OnDecember 16, 2004, the Company filed a registration statement on Form SB-2(Commission File 333-121323) with pre-effective amendments to the registrationstatement on February 1, 2005, April 6, 2005 and April 19, 2005, which becameeffective April 20, 2005.

 

TheCompany accepted units for an aggregate price of $10,000,100 and used theproceeds of the registered offering to redeem the units from ICM, Inc. andFagen, Inc. in accordance with the agreement and retained the balance of theproceeds for working capital. The $6,250,000 of equity associated with theunits subject to redemption was converted to a liability. Interest expense of$625,000 was recorded for the year ended December 31, 2005 when the liabilitywas paid.

 

8

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**NOTE5 -**                     LONG-TERM DEBT

** **

OnNovember 23, 2004, the Company entered into a Credit Agreement with HomeFederal Savings Bank, establishing a construction loan facility for theconstruction of a 35 million gallon per year ethanol plant. The constructionfinancing is in the amount of $26,000,000 consisting of a $21,000,000conventional term loan and a $5,000,000 loan potentially guaranteed 80% by the,and is secured by substantially all of our assets.

 

Duringthe construction phase, the Company made monthly payments of interest only at avariable interest rate equal to prime plus 1.75% with a floor of 6%. OnSeptember 20, 2005, following construction completion, the loan was segmentedinto two loans (1) a $5,000,000 loan (Loan A) with a potential 80% USDAguarantee, and (2) a $21,000,000 conventional term loan (Loan B). The$5,000,000 loan has an amortization period and maturity date of 10 years. TheCompany makes monthly payments of principal and interest on the $5,000,000 loanat a variable interest rate of prime plus 1.75%. This variable rate is adjustedquarterly. The $21,000,000 conventional loan has an amortization period of tenyears but will mature at the end of five years. The Company makes monthlypayments of principal and interest on the $21,000,000 loan at a variable rateequal to prime plus 1.75% with a floor of 6%. The effective interest rate forboth loans at March 31, 2006 was 9.50%.

 

TheCompany pays a $30,000 annual administration fee related to the creditfacility. The credit facility is secured by a mortgage on our real property anda security interest in all personal and intangible assets of the Company,including assignment of all material contracts.

 

The$5,000,000 loan imposes a prepayment penalty depending on the year ofrefinancing starting with the 5% penalty in year one and decreasing to 1% inyear five. The $21,000,000 conventional loan imposes a prepayment penaltystarting with a 3% penalty in year one and decreasing to 1% in year three.

 

Duringthe term of the loan, all deposit accounts related to the Company must bemaintained at Home Federal Savings Bank. The Company is subject to certainfinancial loan covenants consisting of minimum working capital, minimum fixedcharge coverage, minimum current ratio, minimum debt service, minimum net worthand maximum debt to net worth covenants during the term of the loan. TheCompany is also prohibited from making distributions to their members; however,the Company is allowed to distribute 40% of our net income to our members afterour lender has received audited financial statements for the fiscal year. TheCompany must be in compliance with all financial ratio requirements and loancovenants before and after any distributions to the members. The lendertemporarily waived, through December 31, 2006, certain minimum net worth andmaximum debt to net worth covenants. With the waiver, the Company is incompliance with the applicable loan covenants as of March 31, 2006.

 

TheCompany is only allowed to make annual capital expenditures up to $400,000annually without the lender’s prior approval. During the term of the loan, theCompany is required to pay to the lender an annual amount equal to the greaterof: 1) 75% of any Commodity Credit Corporation Bio-Energy income paymentsreceived during the year, or 2) 25% of the Company’s free cash flow for eachyear. Payments consisting of USDA Commodity Credit Corporation Bio-Energyincome must be paid to the lender within 15 days of receipt of any suchpayments. These payments will continue until an aggregate sum of $7,500,000 hasbeen received by the lender. The Company is in compliance with the applicableloan covenants as of March 31 2006.

 

OnMay 10, 2005 the Company entered into a contract with ICM, Inc. to purchase asteam turbine electric generator for $1,760,274. The note is payable inquarterly installments of $146,689.50 plus interest at a variable rate of primeplus 1%, starting October 1, 2005 and maturing July 1, 2008. The variableinterest rate will be adjusted quarterly on the first day of January, April,July and October. The note was paid in full during the period ended March 31,2006.

 

TheCompany financed its waste water reuse facility through two bond issues by theCity of Garnett. The Utility System Revenue Bonds require annual principalpayments beginning on October 1, 2006 and continue through 2015. Interestpayments on these bonds are due semi-annually, at interest rates ranging from4.6% to 5.2%. The first interest payment is due April 1, 2006. The CommunityDevelopment Block Grant (CDBG) Bonds require semi-annual principal and interestpayments beginning on July 1, 2006 and continue through 2015. The bonds have afixed interest rate of 2%.

 

9

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Long-term obligations of the Company are summarized as follows at March31, 2006:

 
| Loan B                       |   | $          | 19,218,492 |   |
|------------------------------|--------|------------|------------|--------|
| Loan A                       |   | 4,594,609  |       |
| Utility System Revenue Bonds |   | 525,000    |       |
| CDBG Bonds                   |   | 375,000    |       |
| Less current portion         |   | (1,926,531 | )          |
| Long-term portion            |   | $          | 22,786,570 |   |

 

The estimated maturities of long-term debt at March 31, 2006, are asfollows:

 
| **12 Month Period Ending 3/31** | ** ** | **Amount** | ** ** |
|-----------------------------------------------------|------------|------------|------------|
| 2007                                                |       | $          | 1,926,531  |   |
| 2008                                                |       | 2,097,481  |       |
| 2009                                                |       | 2,298,392  |       |
| 2010                                                |       | 2,524,187  |       |
| 2011                                                |       | 12,731,808 |       |
| Thereafter                                          |       | 3,134,702  |       |
|                                                |       | $          | 24,713,101 |   |

 

**NOTE6 -**                     MEMBERS’ EQUITY

** **

Asspecified in the Company’s Operating Agreement, voting rights are one vote foreach voting unit registered in the name of such Member as shown on theMembership Registration maintained by the Company. No Member shall directly orindirectly own or control more than 25% of the issued and outstanding votingmembership interest in the Company at any time.

 

Incomeand losses of the Company shall be allocated among the Members in proportion toeach Member’s respective percentage of units when compared with the total Unitsissued.

 

TheCompany’s cash flow shall first be applied to the payment of the Company’soperating expenses (including debt service) and then to maintenance of adequatecash reserves as determined by the board of directors in its sole discretion,and then shall be distributed from time to time to the Members in proportion totheir respective percentage units. No member has the right to demand andreceive any distribution from the Company other than in cash. No distributionshall be made if, as a result thereof, the Company would be in violation of anyloan agreement, and of if the Company would be in violation of any loanagreement, of if the Company’s total assets would be less than the sum of itstotal liabilities.

 

Transfer,disposition or encumbrance of Capital Units is subject to certain restrictions,including approval by the board of directors.

 

DuringSeptember 2004, the Company amended its Operating Agreement whereby the numberof authorized units was increased from 20,000 to 40,000 units. In addition, theamendments to the Operating Agreement provide for two classes of members of theboard of directors, Class A and Class B. Class A members of the board ofdirectors consist of previously existing members of the board of directors,prior to amendment. Up to (3) Class B members of the board of directors may beappointed by Fagen, Inc., ICM, Inc., or both of these parties in conjunctionwith their agreement to purchase units. Fagen, Inc. and ICM, Inc. relinquishedcertain Class B member board of director positions when the units subject toredemption (See Note 4) were redeemed.

 

10

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TheCompany completed its second public offering and escrow was broken in July 2005.A total of 9,091 units were subscribed and paid for during the year endedDecember 31, 2005. Upon issuance ofthe units related to the second public offering, costs related to the issuanceof the units of $168,453 was charged to members’ equity.

 

**NOTE7 -**                     CONCENTRATION OFCREDIT RISK

** **

TheCompany maintains cash balances at five financial institutions in its tradearea. The accounts are secured by the Federal Deposit Insurance Corporation upto $100,000. At times, the Company’s bank balance may exceed $100,000.

 

**NOTE8 -**                     COMMITMENTS ANDCONTINGENCIES

** **

On November 12, 2004, theCompany entered into a Trading Agreement with United Bio Energy Trading, LLC,an affiliated related party, in which United Bio Energy Trading, LLC willprovide market information and consulting services for the Company. The Companyanticipates that the term of the agreement will be for at least five years andwill pay a monthly fee of $6,000.

 

OnNovember 12, 2004, the Company entered into a Distillers Grains MarketingAgreement with United Bio Energy Ingredients, LLC, an affiliated related party,pursuant to which United Bio Energy Ingredients, LLC will purchase all driedand wet distillers grains produced at the plant for a term of at least fiveyears at a price of 98% of the FOB plant price United Bio Energy Ingredients,LLC charges its buyers of dried distillers grains, and 95% of the FOB plantprice United Bio Energy Ingredients, LLC charges its buyers of wet distillersgrains. United Bio Energy Ingredients, LLC, will use its best efforts toachieve the highest resale price available under prevailing market conditions.The Company is responsible for supplying all labor and equipment to load orunload trucks or rail cars without charge to United Bio Energy Ingredients, LLCand is required to provide storage for at least 10 days production of wet anddry distiller grains. In addition, the distiller grains must meet qualityrequirements so that they will meet current industry standards for primaryanimal feed ingredients. If the Company fails to supply distiller grains thatcomply with industry standards, United Bio Energy Ingredients, LLC may rejectthem. The Company paid commissions of $78,865 for the period ended March 31,2006 related to this marketing agreement.

 

On November 12, 2004, theCompany entered into a Raw Grains Agreement with United Bio Energy Ingredients,LLC, an affiliated related party. The Raw Grains Agreement provides for theCompany to purchase all raw grains necessary for ethanol production from UnitedBio Energy Ingredients, LLC for a period of at least five years. Pursuant tothe agreement, United Bio Energy Ingredients, LLC will use its best efforts toarrange for the purchase of grain at the lowest price available underprevailing market conditions and we will supply all labor and equipmentnecessary to load or unload trucks or rail cars. For its service, the Companywill pay United Bio Energy Ingredients, LLC the actual cash procurement priceand all reasonable and necessary expenses to get the grain to the plant plus a$.02 per bushel fee. The title, risk of loss, and responsibility for thequality of grain will transfer to the Company when it unloads the grain at theplant. Prior to that time, United Bio Energy Ingredients, LLC will bear therisk of loss. All grain delivered to the plant shall meet certain qualitystandards and the Company will have the option to reduce the price the Companywill pay or fully reject any delivery that fails to conform to these standards,depending upon the severity of the noncompliance. For the period ended March31, 2006, the Company paid $72,083 in brokerage fees for grain purchases madeunder this agreement.

 

On November 12, 2004, theCompany also entered into an Ethanol Agreement with United Bio Energy Fuels,LLC, an affiliated related party. The terms of the agreement provide thatUnited Bio Energy Fuels, LLC will market all fuel-grade ethanol produced at ourplant. In exchange, the Company agrees to pay United Bio Energy Fuels, LLC afee of $.01 for each gallon of ethanol produced at the Company’s plant duringthe term of the agreement. The Company expects that the term of the agreementwill be at least 5 years. United Bio Energy Fuels, LLC also agreed to use itsbest efforts to obtain the highest price for ethanol available under prevailingmarket conditions. For the period ended March 31, 2006, the Company paid$103,481 in marketing fees for ethanol marketing under this agreement.

 

On November 12, 2004, theCompany entered into a Management Agreement with United Bio Energy Management,LLC, a related party, in which United Bio Energy Management, LLC will superviseand direct the general operations of the plant for an anticipated period of atleast five years. United Bio Energy Management, LLC will

 

11

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provide the services of afull-time general manager to the plant. The Company has agreed to compensateUnited Bio Energy Management, LLC an annual fee of $250,000 for these servicespayable in monthly installments of $20,833, plus an incentive bonus based onthe attainment of certain financial benchmarks. United Bio Energy Management,LLC will appoint a general manager to be based on site at our plant, and shallwork exclusively for us. In the event of a dispute, the Management Agreementprovides that the Company will first attempt to amicably settle any dispute ordifference privately between United Bio Energy Management, LLC and the Company.If the Company cannot resolve the dispute as a result of the discussions, thenthe Company must submit the matter to non-binding mediation. In the event thatthe dispute is not settled through mediation, the matter must be resolved bynon-appealable arbitration in accordance with the rules of the AmericanArbitration Association as applicable in the State of Kansas. The determinationof the arbitrator is expected to be final and may not be appealed to any court.The prevailing party in any arbitration proceeding is entitled to recoverreasonable attorneys’ fees and expenses incurred. The agreement commencedduring March 2005. For the period ended March 31, 2006, the Company incurredcosts of $269,009 related to this agreement including reimbursable expenses, ofwhich $20,833 is in accounts payable and $185,676 is in accrued expenses.

 

The Company has an agreement with the City of Garnett, Kansas to sharethe cost of certain highway improvements. Management estimates the obligationunder this agreement will be approximately $135,000.

 

OnJuly 28, 2005, the Company entered into an agreement with HDB Construction,Inc. for additional work on the railroad spur project not to exceed an amountof $1,567,268. As of March 31, 2006 costs related to the agreement of$1,544,562 and additional costs related to the project of $69,691 had beenincurred, of which 89,964 is in accounts payable.

 

Dueto a builder’s design change during construction of the ethanol plant an extrabeerwell was installed and remains the property of the design/builder. TheCompany has the option to purchase the beerwell as part of the expansion optionin the original design/build agreement. If the Company does not elect toexercise the expansion option the purchase price will be negotiated at thattime. On May 10, 2006, an agreement was reached on a purchase price of$1,800,000 for the additional beerwell. This amount is included in the issuedpurchase orders below.

 

TheCompany has issued purchase orders in the amount of $3,379,673 for plannedcapital expenditures.

 

The following is a schedule of the annual commitments related to theabove agreements.

 
| **12 months ending March 31,** | ** ** |
|----------------------------------------------------|------------|
|                                               |       |   |   |
| 2006                                               |       | $ | 680,150 |   |
| 2007                                               |       | 664,108 |   |
| 2008                                               |       | 664,108 |   |
| 2009                                               |       | 637,275 |   |
| 2010                                               |       | 342,108 |   |
| Thereafter                                         |       | 1,394,440 |   |
|                                               |       |   |   |
|                                               |       | $ | 4,382,189 |   |

 

The Company is involved in various claims arising in the normal courseof business. Management believes that any financial responsibility that may beincurred would not be material and therefore no additional accrual is deemednecessary.

 

**NOTE9 -**                     SALE / LEASEBACKTRANSACTION

** **

OnDecember 20, 2005, the Company completed an industrial revenue bond financingwith the City of Garnett, Kansas that will provide property tax savings for 10years on the plant site. As part of the financing, title to the plant

 

12

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siteand improvements have been transferred to the City of Garnett, Kansas, assecurity for the repayment of the bonds, and the Company is leasing back thesite in an amount that is equal to the amount of the principal and interest tobe paid on The City of Garnett, Kansas bonds. Home Federal Savings Bankconsented to this transaction, and the bonds have been pledged to Home FederalSavings Bank as security for any obligations under the Home Federal SavingsBank Credit Agreement. As part of the financing, the Company paid the bond underwriter,Gilmore & Bell, P.C. $40,000. The maximum principal amount of the bonds is$50,000,000. The bonds were initially issued in the principal amount of$47,866,117, which is the amount of the Company’s expenditures on the plant asof December 20, 2005. Additional project costs of $2,133,883 are planned andare expected to be eligible for submission for the bond trustee for additionalbond issuances.

 

The$40,000 of financing fees paid to the bond underwriter and $20,656 of legal andother cost associated with the bond closing will be amortized over theapproximately 10.5 year life of the bonds. A total of $1,433 of amortizationexpense related to these costs was recognized during the period ended March 31,2006.

 

Fromthe proceeds of the bond, the Company purchased the bonds as an investment. TheCompany, as holder of the industrial revenue bonds, is due interest at 8.0% perannum with interest payable semi-annually on June 1st and December 1st,commencing June 1, 2006. The interest income is directly offset by the leasepayments on the plant. Both the bond and the corresponding lease have termscommencing December 20, 2005 and terminating on June 1, 2016. The entireoutstanding principal is due upon termination of the bonds. The outstandingprincipal at March 31, 2006 was $47,866,117. The lease qualifies as a capitallease. Interest income recognized on the Industrial Revenue Bonds for theperiod ended March 31, 2006 was $944,208. This amount is equal to the leaseexpense of the plant.

 

Future debt service requirements on the Industrial Revenue Bonds atMarch 31, 2006 are as follows:

 
| **12 months ending** | ** ** | **Interest** | ** ** | ** **    | ** ** | ** **   | ** ** | ** **  | ** ** |
|--------------------------------|------------|--------------|------------|---------------|------------|--------------|------------|-------------|------------|
| **March 31,**             | ** ** | **Rate**     | ** ** | **Principal** | ** ** | **Interest** | ** ** | **Total**   | ** ** |
|                           |       |         |       |          |       |         |       |        |       |
| 2007                           |       | 8            | %          | $             | —     |         | $          | 3,893,681   |       | $ | 3,893,681 |   |
| 2008                           |       | 8            | %          | —        |       | 3,893,681    |       | 3,893,681   |       |
| 2009                           |       | 8            | %          | —        |       | 3,893,681    |       | 3,893,681   |       |
| 2010                           |       | 8            | %          | —        |       | 3,893,681    |       | 3,893,681   |       |
| 2011                           |       | 8            | %          | —        |       | 3,893,681    |       | 3,893,681   |       |
| Thereafter                     |       | 8            | %          | 47,866,117    |       | 17,521,565   |       | 65,387,682  |       |
|                           |       |         |       |          |       |         |       |        |       |
| Totals                         |       |         |       | $             | 47,866,117 |         | $          | 36,989,970  |       | $ | 84,856,087 |   |
|                           |       |         |       |          |       |         |       |        |       |
| Amount  representing interest  |       |         |       |          |       |         |       | (36,989,970 | )          |
|                           |       |         |       |          |       |         |       |        |       |
| Long-Term  Obligation          |       |         |       |          |       |         |       | $           | 47,866,117 |   |

 

**NOTE10 -**              RETIREMENT PLAN

** **

During2005, the Company began a SIMPLE 401(k), Savings Incentive Match Plan forEmployees, retirement plan for all eligible employees. All employees areeligible to participate in the plan. The Company makes a matching contributionof 3% of participants’ eligible wages. The employees are fully vested uponcontribution to the plan. The Company match for the period ended March 31, 2006was $9,359.

 

13

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**NOTE11 -**              SUBSEQUENT EVENTS

** **

OnMay 4, 2006, the Company agreed to renegotiate terms of their bank financing. Thenew terms provide for a $4,000,000 term revolving loan in addition to theexisting term loans. The Company will be required to make additional principalpayments on the existing term loans to bring the outstanding loan balance, plusthe $4,000,000 revolving line, to an aggregate sum of $26,000,000 before thenew financing structure will be put in place. The interest rate on the termrevolving loan and the two term loans will be adjusted to prime. The termrevolving loan available credit balance is reduced by $400,000 annuallybeginning December 31, 2007 and matures on October 1, 2010.

 

Theboard of directors approved the redemption of 1,900 units from a member. Theredemption represents the member’s entire unit balance. On May 10, 2006, theCompany agreed to purchase the member’s units for a total of $3,800,000.

 

14

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**ITEM 2.    MANAGEMENT’SDISCUSSION AND ANALYSIS AND PLAN OF OPERATION.**

** **

Weprepared the following discussion and analysis to help you better understandour financial condition, changes in our financial condition, and results ofoperations for the fiscal quarter ended March 31, 2006. This discussionand analysis should be read in conjunction with the financial statements andnotes to financial statements included elsewhere in this report and theinformation contained in our annual report on Form 10-KSB for the fiscal yearended December 31, 2005. Since we only became operational in June 2005,we do not have comparable income, production and sales data for the threemonths ended March 31, 2005. Accordingly, we do not provide a comparison of ourfinancial results between reporting periods in this report. If you undertakeyour own comparison of fiscal quarter ending March 31, 2005 and the fiscalquarter ending March 31, 2006, it is important that you keep that in mind.

 

**ForwardLooking Statements**

 

This report contains or incorporates by reference “forward-lookingstatements” that involve future events, our future performance and our expectedfuture operations and actions.  In some cases you can identify forward-lookingstatements by the use of words such as “may,” “will,” “should,” “anticipate,” “believe,”“expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,”“continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions and involve numerousassumptions, risks and uncertainties, including, but not limited to thosedescribed in the “Risk Factors” section of our Annual Report on Form 10-KSB,those listed below and those business risks and factors described elsewhere inthis report and our other Securities and Exchange Commission filings.

 
| • |   | Projected  growth, overcapacity or contraction in the ethanol market in which we  operate;                                                                                       |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | Fluctuations  in the price and market for ethanol and distillers grains;                                                                                                         |
| • |   | Changes  in plant production capacity, variations actual ethanol and distillers grains  production from expectations or technical difficulties in operating the  plant;          |
| • |   | Availability  and costs of products and raw materials, particularly corn and natural gas;                                                                                        |
| • |   | Changes  in our business strategy, capital improvements or development plans for  expanding, maintaining or contracting our presence in the ethanol market in  which we operate; |
| • |   | Our  ability to market and our reliance on third parties to market our products;                                                                                                 |
| • |   | Our  ability to distinguish ourselves from our current and future competition;                                                                                                   |
| • |   | Changes  in or elimination of governmental laws, tariffs, trade or other controls or  enforcement practices such as:                                                             |
|   |   |                                                                                                                                                                             | • | national,  state or local energy policy; |
|   |   |                                                                                                                                                                             | • | federal  ethanol tax incentives; |
|   |   |                                                                                                                                                                             | • | legislation  mandating the use of ethanol or other oxygenate additives; |
|   |   |                                                                                                                                                                             | • | state  and federal regulation restricting or banning the use of MTBE; or |
|   |   |                                                                                                                                                                             | **•** | environmental  laws and regulations that apply to our plant operations and their  enforcement; |
| • |   | Increased  competition in the ethanol and oil industries;                                                                                                                        |
| • |   | Fluctuations  in US oil consumption and petroleum prices;                                                                                                                        |
| • |   | Changes  in plant production capacity or technical difficulties in operating the  plant;                                                                                         |
| • |   | Changes  in general economic conditions or the occurrence of certain events causing an  economic impact in the agriculture, oil or automobile industries;                        |
| • |   | Anticipated  trends in our financial condition and results of operations                                                                                                         |
| • |   | Changes  and advances in ethanol production technology; and                                                                                                                      |
| • |   | Competition  from alternative fuels and alternative fuel additives.                                                                                                              |

 

Our actual results or actions could and likely willdiffer materially from those anticipated in the forward-looking statements formany reasons, including the reasons described in this report.  We are notunder any duty to update the forward-looking statements contained in thisreport.  We cannot guarantee future results, levels of activity, performanceor achievements.  We caution you not to put undue reliance on anyforward-looking statements, which speak only as of the date of thisreport.  You should read this report and the documents that we referencein this report and have filed as exhibits, completely and with theunderstanding that our actual future results may be materially different fromwhat we currently expect.  We qualify all of our forward-lookingstatements by these cautionary statements.

 

15

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**Overview**

 

Since June 2005, we have been engaged in theproduction of ethanol and distillers grains. Our ethanol plant is managed byUnited Bio Energy Management, LLC, an affiliate of US BioEnergy Corporation ofBrookings, South Dakota, which builds and operates biofuel productionfacilities which may be in competition with our plant. We purchase all of ourcorn and milo from United Bio Ingredients, LLC, another affiliate of USBioEnergy Corporation. Our revenues are derived from the sale and distributionof our ethanol and distillers grains, which are sold to United Bio EnergyFuels, LLC (also an affiliate of US BioEnergy Corporation) and United BioEnergy Ingredients, LLC, respectively, which subsequently markets and sells ourproducts.  The principal markets for our ethanol areregional petroleum terminals located in major population centers in Kansas andneighboring states, including such cities as Kansas City, Missouri; Wichita, Kansas; Tulsa, Oklahoma; and St. Louis,Missouri.

 

Our operating results are largely driven by theprices at which we sell ethanol and distillers grain and the costs related totheir production.  Historically, the price of ethanol has fluctuated withthe price of petroleum-based products such as unleaded gasoline, heating oil, andcrude oil. The price of distillers grains is primarily influenced the price ofcorn as a substitute livestock feed. We expect these price relationships tocontinue for the foreseeable future.

 

Our largest costs ofproduction are corn, natural gas, and manufacturing chemicals. The cost of cornis largely impacted by geopolitical supply and demand factors. Natural gas andchemical/denaturant pricing levels are tied directly to the overall energysector; crude oil, and unleaded gasoline.

 

**Results of Operations**

 

The following table shows the results of ouroperations and the percentage of revenues, cost of goods sold, operatingexpenses and other items to total revenues in our statements of operations forthe fiscal quarter ended March 31, 2006:

 
| **Income Statement Data** | ** ** | **Amount** | ** **    | **% of  Revenues** | ** ** |
|-------------------------------------|------------|------------|---------------|-------------------------|------------|
|                                |       |       |          |                    |       |
| Revenues                            |       | $          | 21,696,528    |                    | 100        | % |
| Cost of Sales                       |       | $          | 14,641,273    |                    | 67         | % |
| Gross Profit                        |       | $          | 7,055,255     |                    | 33         | % |
|                                |       |       |          |                    |       |
| Operating Expenses                  |       | $          | 875,049       |                    | 4          | % |
| Operating Income                    |       | $          | 6,180,206     |                    | 28         | % |
|                                |       |       |          |                    |       |
| Other Income (Expense)              |       | $          | (543,317      | )                       | (3         | )% |
| **Net Income**                      | ** ** | **$**      | **5,636,888** | ** **              | **26**     | **%** |

 

Revenues. Our revenues from operations come from three primary sources:  ethanol sales, distillers grain sales andethanol incentive payments from federal and state governments. For the threemonths ended March 31, 2006 our total revenues were $21,696,528. The followingtable shows the sources of our revenue:

 
| **Revenue Sources**             | ** ** | **Amount** | ** ** | **% of  Total  Revenue** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------------|------------|
|                                 |       |       |       |                          |       |
| Ethanol Sales                        |       | $          | 18,302,574 |                          | 86         | % |
| Distillers Grain Sales               |       | $          | 2,713,124  |                          | 13         | % |
| Ethanol Incentive Payments - Federal |       | $          | 225,159    |                          | 1          | % |
| Ethanol Incentive Payments - State   |       | 455,671    |       | 2                             | %          |
| Total Revenues                       |       | $          | 21,696,528 |                          | 100        | % |

 

16

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Ethanol prices remained high during our firstquarter of 2006. We believe the favorable prices resulted from higher gasolineprices, which encourages voluntary blending, and the growing recognition ofethanol as an alternative energy source. Based on existing market conditions,we expect favorable pricing to continue at least through the end of our secondfiscal quarter because the price of unleaded gasoline is expected to remain ator above its current price levels as we enter the peak summer driving season.

 

Income from the United States Department ofAgriculture’s Commodity Credit Corporation Bioenergy Program is significantlyless than the amount we are eligible for based on our production.  Weexpect minimal payments from this program in2006 because ofincreased participation by ethanol producers, decreased funding, and atermination of the program on June 30,2006. We also derive income from theState of Kansas through the Kansas Qualified Agricultural Ethyl AlcoholProducer’s Program. We have received the maximum reimbursement for the state’s2006 fiscal year, but will be eligible for incentives beginning with ourquarter ending September 30, 2006. We are not expecting more than minimalpayments under this program.

 

Cost of Sales.  Cost of sales for our products forthe three months ended March 31, 2006 was $14,641,273 or 67% of our revenue.

 

Operating Expenses. Operating expenses for three months endedMarch 31, 2006 were equal to 4% of our revenue and totaled $875,049. We expectthat these expenses will remain constant and keep in line with sales andproduction.

 

Net  Income. Net income was 26% of revenues for thequarter ending March 31, 2006. Net income was $5,636,888.

 

Other Income (Expense). Other income and expense for the threemonth period ending March 31, 2006 consisted of an expense of $543,317. Interestexpense is the primary expense in this category.

 

**Changes in Financial Condition for the Three MonthsEnded March 31, 2006**

 

The following table highlights the changes in our financial conditionfor the three months ended March 31, 2006:

 
| ** **           | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------|------------|------------------------------|------------|---------------------------------|------------|
| Current Assets       |       | $                            | 13,763,031 |                            | $          | 9,766,098 |   |
| Current Liabilities  |       | $                            | 4,638,160  |                            | $          | 4,428,030 |   |
| Long-Term Debt       |       | $                            | 22,786,570 |                            | $          | 23,438,059 |   |
| Members’ Equity |       | $                            | 33,764,064 |                            | $          | 28,127,175 |   |

 

Current Assets. Current assets totaled $13,763,031 at March31, 2006 up from $9,766,098 at December 31, 2005.  The change resultedfrom increased cash and cash equivalents which was $6,799,444 at March 31, 2006compared to $4,569,145 at December 31, 2005; increased trade accountsreceivable of $3,515,492 at March 31, 2006 compared to $2,651,546 at December31, 2005; and increased interest receivable for the same periods of $1,265,035and $412,173, respectively.

 

Current Liabilities. Current liabilities totaled $4,638,160 atMarch 31, 2006, up slightly from the $4,428,030 at December 31,2005.  This change is largely due a decreased in the current portionof long-term debt which totaled $1,926,531 at March 31, 2006 down from$2,615,813 at December 31, 2005 and a decrease in related parties accountspayable which was $649,905 and $813,775 for the same periods. These decreaseswere offset by increases in accrued interest, which was $1,325,817 at March 31,2006 compared to $407,257 at December 31, 2005, and accrued payroll, taxes andwithholdings, which was $111,331 at March 31, 2006 compared to $52,574 atDecember 31, 2005.

 

Long-Term Debt. Long-term debt, net of current maturities,totaled $22,786,570 at March 31, 2006, down from $23,438,059 at December 31,2006, due to our regularly scheduled loan payments and additional reductions tothe principal amounts due to the free flow cash covenants of our creditagreement. In addition, on March 1, 2006,

 

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we paid the remainingbalance of our equipment note with ICM, Inc. At March 31, 2006, our leaseobligation remains unchanged from December 31, 2005 as no reductions in thelease are scheduled until June 2006.

 

Members’ Equity. The members’ contributions are$24,707,100.  Retained earnings as of March 31, 2006 is $9,056,964compared to $3,420,075 at December 31, 2005. Total members’ equity as of March31, 2006, is $33,764,064 up from $$28,127,175 at December 31, 2006.

 

**Liquidity and Capital Resources**

 

Our liquidity needs are primarily met throughinternally generated cash flow.  Our primary uses of cash are cost ofsales, operating expenses, debt service and capital expenditures. The following table shows cash flows for thethree months ended March 31, 2006:

 
| ** **                             | ** ** | **March 31, 2006** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| Net cash from operating activities     |       | $                            | 5,437,002  |   |
| Net cash used for investing activities |       | $                            | (962,116   | ) |
| Net cash used for financing activities |       | $                            | (2,244,586 | ) |

 

Cash Flow From Operations*.*Our operating activities for the three monthsended March 31, 2006, generated $5,437,002 of net cash flow, which includedenergy production credits from state and federal programs, as discussed above. Thenet cash from operating activities primarily includes net income fromoperations adjusted for depreciation and amortization of $776,316.

 

The loan agreement with our Home Federal Savings Bank limits distributions to our members; except we may distribute up to 40% of our net income if our lender has received audited financial statements for the fiscal year demonstrating our compliance with all financial ratio requirements and loan covenants before and after any distributions to the members.  We take all of these factors into consideration, in addition to our anticipated cash requirements for future operations, in evaluating the propriety of any future distributions to members.

 

Cash Flow UsedFor Investing Activities*.*We used $962,116 of cash for investingactivities for the three months ended March 31, 2006, all of which was used topurchase personal property and equipment for the plant. Most of theequipment purchases are for infrastructure improvements to optimize theperformance of our facility.

 

Dueto a builder’s design change during construction of the ethanol plant, an extrabeerwell was installed at the plant which remained the property of ICM, Inc. OnMay 10, 2006, we agreed to purchase the beerweel for $1,800,000. Including thepurchase of the beerwell, we estimate that approximately $6 million in capitalexpenditures will be made in the next twelve months, all of which are expectedto be financed from a portion of cash flows from operations or from cashprovided through a revolving credit agreement with Home Federal Savings Bank.

 

Cash Flow Used For Financing Activities*.*By far, the largest source of cash during the three months ended March 31, 2006 was our financing activities, which used $2,244,586 of cash from our debt financing transactions, described below.

 

Long-Term Debt. Our long term debt consists of two termloans with Home Federal Savings Bank of Rochester, Minnesota: (1) a $21,000,000 conventional term loan (“Loan A”),and (2) a $5,000,000 term loan (“Loan B”). As of March 31, 2006, theprincipal balance on Loan A was $19,418,292 and the principal balance on theLoan B was $4,594,609. At March 31, 2006, the effective interest rate for bothloans was 9.50%. The two term loans contain restrictions and financialcovenants to which we are subject during the term of the agreements. As ofMarch 31, 2006, with waivers, we are in compliance with all applicable loancovenants.

 

We are in the process of renegotiating the terms ofthe aforementioned loans with Home Federal Savings Bank. While the loanagreements have not been effected, we have signed a commitment letter thatprovides for a $4,000,000 term revolving loan in addition to the existing termloans and a reduction in our effective interest rate on all three loans toprime. The term revolving loan available credit balance will be reduced by$400,000 annually beginning December 31, 2007 and matures on October 1, 2010. However,we will be required to make additional

 

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principal payments on ourexisting term loans to bring the outstanding loan balance, plus the $4,000,000revolving line, to an aggregate sum of $26,000,000 before the new financingstructure will be put in place.

 

Industrial Revenue Bonds. On December 20, 2005, we completed anindustrial revenue bond financing with the City of Garnett, Kansas, which weexpect to provide property tax savings for 10 years on the plant site. As partof the financing, title to the plant site and improvements have beentransferred to the City of Garnett, Kansas, as security for the repayment ofthe bonds, and we are leasing back the site in an amount that is equal to theamount of the principal and interest to be paid on the bonds (the “sale-leasebacktransaction”). We purchased all of the Bonds offered by the City of Garnett. HomeFederal Savings Bank consented to the sale-leaseback transaction, and the bondshave been pledged to Home Federal Savings Bank as security for our obligationsunder the term debt credit facility. The maximum principal amount of the bondsis $50,000,000, of which $47,866,117 has been issued. Both the bonds and thecorresponding lease have terms of 10 years. The interest income due to us as holderof the bonds is directly offset by the lease payments we owe on the plant. Boththe bond and the corresponding lease have 10-year terms commencing December 20,2005. The entire outstanding principal is due upon termination of the bonds. Theoutstanding principal at March 31, 2006 was $47,866,117.

 

Waste Water Bond Financing. We financed our waste water reuse facilitythrough two bond issues by the City of Garnett - Utility System Revenue Bonds (“USRBonds”) and Community Development Block Grant Bonds (“CDBG Bonds”). The USRBonds require annual principal payments beginning on October 1, 2006 andcontinue through 2015. Interest payments on these bonds are due semi-annuallybeginning April 1, 2006, at interest rates ranging from 4.6% to 5.2%. The CDBGBonds require semi-annual principal and interest payments beginning on July 1,2006 and continue through 2015, at a fixed interest rate of 2%.

 

**CommodityPrice Risk Protection**

 

We seek to minimize therisks from price fluctuations in the prices of raw material inputs and finishedproducts through the use of hedging instruments.  We are usingnon-hedge derivative accounting for our hedge positions, which means as thecurrent market price of our hedge positions changes, the gains and losses areimmediately recognized in our cost of sales. The immediate recognition ofhedging gains and losses under fair value accounting can cause net income to bevolatile from quarter to quarter due to the timing of the change in value ofthe derivative instruments relative to the cost and use of the commodity beinghedged. As of March 31, 2006, the fair value of our derivative instrumentsrelating to corn are reflected as an asset in the amount of $306,988.

 

Asof March 31, 2006, we have price protection in place for approximately 40% ofour corn needs through December 2006. As we move forward, additional protectionmay be necessary. As corn prices move in reaction to market trends andinformation, our income statement will be affected depending on the impact suchmarket movements have on the value of our derivative instruments. Depending onmarket movements, crop prospects and weather, these price protection positionsmay cause immediate adverse effects, but are expected to produce long-termpositive growth for East Kansas.

 

As of March 31, 2006, we currentlyhave no price protection in place for our natural gas needs in fiscal year2006. As we move forward in fiscal year 2006, we may determine that priceprotection for natural gas purchases is necessary to attempt to reduce our susceptibilityto price increases. However, we may not be able to secure natural gas forprices less than current market price and we may not recover high costs ofproduction resulting from high natural gas prices, which may raise our costs ofproduction and reduce our net income.

 

**Application of Critical Accounting Estimates**

 

There were no materialchanges in our accounting estimates during the three months ended March 31,2006.

 

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**Off Balance Sheet Arrangements.**

 

We do not have any off-balance sheet arrangementsother than those described in the notes to our Financial Statements as March31, 2006 located above in Note 4, describing our unit purchase and redemptiontransaction with ICM, Inc. and Fagen, Inc., and Note 9, describingthe sale-leaseback transaction with the City of Garnett.

 

**ITEM 3.    CONTROLS AND PROCEDURES****.**

 

Wemaintain disclosure controls and procedures designed to ensure that informationrequired to be disclosed in our reports under the Securities and Exchange Actof 1934 is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms. Thesedisclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that the information required to be disclosed isaccumulated and communicated to management, including our Principal ExecutiveOfficer, Principal Financial Officer and General Manager, to allow for timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, the Principal Executive Officer, PrincipalFinancial Officer and General Manager recognize that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement is necessarily required to apply judgment in evaluating thecost-benefit relationship of possible controls and objectives.

 

Ourmanagement (including the Principal Executive Officer, Principal FinancialOfficer and General Manager) has evaluated the effectiveness of our disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)), as of the end of the period covered by this Quarterly Report on Form10-QSB. Based on such evaluation, The Principal Executive Officer, PrincipalFinancial Officer and General Manager have agreed that, as of the end of suchperiod, our disclosure controls and procedures are effective in recording,processing, summarizing and reporting, on a timely basis, information requiredto be disclosed by the Company in the reports that it files or submits underthe Exchange Act.

 

Our management (including the Principal Executive Officer,Principal Financial Officer and General Manager) has reviewed andevaluated any changes in our internal control over financial reporting thatoccurred as of March 31, 2006 and there has been no change that has materiallyaffected or is reasonably likely to materially affect our internal control overfinancial reporting.

 

**PART II – OTHER INFORMATION**

 

**ITEM 1.    LEGAL PROCEEDINGS.**

 

None.

 

**ITEMIA.  RISK FACTORS.**

 

Therehave been no material changes from the factors discussed in Part I, “Item 1A.Risk Factors” in our Annual Report on Form 10-K for the year ended December 31,2005. In addition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors” inour Annual Report on Form 10-KSB for the year ended December 31, 2005,which could materially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-KSB are not theonly risks facing us. Additional risks and uncertainties not currently known tous or that we currently deem to be immaterial also may materially adverselyaffect our business, financial condition and/or operating results.

 

**ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS.**

 

None.

 

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**ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.**

 

None.

 

**ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS****.**

 

None.

 

**ITEM 5.    OTHER INFORMATION.**

 

On May 11, 2006, weredeemed of 1,900 units from Energy Investors, LLC at a total redemption price of $3,800,000.In connection with the redemption of all the units held by Energy Investors,LLC, Jerry Jones resigned from hisposition as a director on the Board of Directors of East Kansas. Hisresignation was effective on May 11, 2006. Energy Investors, LLC is an employeebenefit plan for employees of ICM, Inc. and Mr. Jones is the Chief FinancialOfficer of ICM, Inc.

 

**ITEM 6.    EXHIBITS.**

 

The following exhibits are filed as part of this report. Exhibitspreviously filed are incorporated by reference, as noted.

 
| **Exhibit No.** | ** ** | **Exhibit**                                          |
|----------------------|------------|------------------------------------------------------|
| 31.1                 |       | Certificate  Pursuant to 17 CFR 240.13(a)-14(a)      |
|                 |       |                                                 |
| 31.2                 |       | Certificate  Pursuant to 17 CFR 240.13(a)-14(a)      |
|                 |       |                                                 |
| 31.3                 |       | Certificate  Pursuant to 17 CFR 240.13(a)-14(a)      |
|                 |       |                                                 |
| 32.1                 |       | Certificate  Pursuant to 18 U.S.C. Section 1350 |
|                 |       |                                                 |
| 32.2                 |       | Certificate  Pursuant to 18 U.S.C. Section 1350 |
|                 |       |                                                 |
| 32.3                 |       | Certificate  Pursuant to 18 U.S.C. Section 1350 |

 

**SIGNATURES**

 

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   |         |   | EAST KANSAS AGRI-ENERGY, LLC                                          |
|--------|--------------|--------|-----------------------------------------------------------------------|
|   |         |   |                                                                  |
| Date:  | May 15, 2006 |   | /s/ William R. Pracht                                                 |   |
|   |         |   | William R. Pracht                                                     |
|   |         |   | President  (Principal Executive Officer)                              |
|   |         |   |                                                                  |
| Date:  | May 15, 2006 |   | /s/ Thomas D. Leitnaker                                               |   |
|   |         |   | Thomas D. Leitnaker                                                   |
|   |         |   | Chief Financial Officer  (Principal Financial and Accounting Officer) |
|   |         |   |                                                                  |
| Date:  | May 15, 2006 |   | /s/ Mike Goblirsch                                                    |   |
|   |         |   | Mike Goblirsch                                                        |
|   |         |   | General Manager                                                       |

 

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