**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

**FORM 10-Q**
| **T**                                              | ** ** | **Quarterly report under Section 13 or 15(d) of  the Securities Exchange Act of 1934.** |
|----------------------------------------------------|------------|-----------------------------------------------------------------------------------------|
|                                               |       |                                                                                    |
| **For the  quarterly period ended March 31, 2007** |
|                                               |       |                                                                                    |
| **OR**                                             |
|                                               |       |                                                                                    |
| **£**                                         | ** ** | **Transition report under Section 13 or 15(d) of  the Exchange Act.**                   |
|                                               |       |                                                                                    |

 

**For the transition period from _______   to _________  **

**Commissionfile number 0001170106**

**EAST KANSAS AGRI-ENERGY, LLC**

(Exact name of Registrantas specified in its charter)

 

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

 

**P.O. Box 225, 1304 S. Main, Garnett, Kansas 66032**(Address of principal executive offices)

**(785) 448-2888**

(Registrant’s telephonenumber)

** **

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

|  |   | x Yes          o   No |
|--|--------|-----------------------------------------------------------------------------------|

 

Indicate by check mark whether the registrant is alarge accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

| Large Accelerated Filer o |   | Accelerated  Filer o |   | Non-Accelerated  Filer x |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

|  |   | o Yes          x   No |
|--|--------|-----------------------------------------------------------------------------------|

 

Indicatethe number of shares outstanding for each of the issuer’s classes of commonequity as of the latest practicable date:

As of May 1, 2007, there were 21,898 membership unitsoutstanding.

 

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**INDEX**
|                                                                                                         | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|
| **PART  I.     FINANCIAL INFORMATION**                                         | ** ** |
| **Item  1. Financial Statements.**                                                                      | ** ** |
| **Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations** | ** ** |
| **Item 3. Quantitative and Qualitative Disclosures about  Market Risk.**                                | ** ** |
| **Item 4. Controls and Procedures.**                                                                    | ** ** |
| **Item 4T. Controls  and Procedures.**                                                                  | ** ** |
| ** **                                                                                              | ** ** |
| **PART  II.    OTHER INFORMATION**                                                  | ** ** |
| ** **                                                                                              | ** ** |
| **Item  1. Legal Proceedings.**                                                                         | ** ** |
| **Item  1A. Risk Factors.**                                                                             | ** ** |
| **Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds.**                               | ** ** |
| **Item 3. Defaults Upon Senior Securities.**                                                            | ** ** |
| **Item 4. Submission of Matters to a Vote of Security  Holders.**                                       | ** ** |
| **Item  5. Other Information.**                                                                         | ** ** |
| **Item 6.  Exhibits.**                                                                                  | ** ** |

 

 

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**PARTI.     FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS.**

EAST KANSAS AGRI-ENERGY, LLCBALANCE SHEET (UNAUDITED)MARCH 31, 2007
| **ASSETS**                                                                                                            | ** ** | ** **     | ** **      |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------|-----------------|
| CURRENT ASSETS                                                                                                        |       |           |            |
| Cash and cash  equivalents                                                                                            | ** ** | **$**          | **3,593,511**   | ** ** |
| Trade accounts  receivable - related party                                                                            | ** ** | **4,082,867**  | ** **      |
| Inventory                                                                                                             | ** ** | **3,375,406**  | ** **      |
| Investment in  commodity contracts                                                                                    | ** ** | **258,628**    | ** **      |
| Interest  receivable                                                                                                  | ** ** | **1,279,620**  | ** **      |
| Prepaid expense                                                                                                       | ** ** | **302,176**    | ** **      |
| Total current  assets                                                                                                 | ** ** | **12,892,208** | ** **      |
| PROPERTY, PLANT AND  EQUIPMENT                                                                                        |       |           |            |
| Land                                                                                                                  | ** ** | **580,322**    | ** **      |
| Land  improvements                                                                                                    | ** ** | **2,179,578**  | ** **      |
| Office equipment                                                                                                      | ** ** | **270,866**    | ** **      |
| Buildings                                                                                                             | ** ** | **1,785,915**  | ** **      |
| Equipment                                                                                                             | ** ** | **46,675,996** | ** **      |
| Vehicles                                                                                                              | ** ** | **22,743**     | ** **      |
| Construction in  progress                                                                                             | ** ** | **887,352**    | ** **      |
|                                                                                                                  | ** ** | **52,402,772** | ** **      |
| Less accumulated  depreciation                                                                                        | ** ** | **(5,601,935** | **)**           |
| Total property,  plant, and equipment                                                                                 | ** ** | **46,800,837** | ** **      |
| OTHER ASSETS                                                                                                          |       |           |            |
| Investment in  Industrial Revenue Bonds                                                                               | ** ** | **47,866,117** | ** **      |
| Idle property                                                                                                         | ** ** | **2,317,398**  | ** **      |
| Other investment                                                                                                      | ** ** | **200**        | ** **      |
| Financing costs                                                                                                       | ** ** | **615,288**    | ** **      |
| Less accumulated  amortization                                                                                        | ** ** | **(98,712**    | **)**           |
| Total other  assets                                                                                                   | ** ** | **50,700,291** | ** **      |
| Total assets                                                                                                          | ** ** | **$**          | **110,393,336** | ** ** |
| **LIABILITIES AND MEMBERS’ EQUITY**                                                                              | ** ** | ** **     | ** **      |
| CURRENT LIABILITIES                                                                                                   |       |           |            |
| Current portion  of long-term debt                                                                                    | ** ** | **$**          | **3,185,028**   | ** ** |
| Accounts payable                                                                                                      |       |           |            |
| Trade                                                                                                                 | ** ** | **295,225**    | ** **      |
| Related parties                                                                                                       | ** ** | **979,428**    | ** **      |
| Accrued payroll,  taxes and withholdings                                                                              | ** ** | **131,529**    | ** **      |
| Other accrued  expenses                                                                                               | ** ** | **351,777**    | ** **      |
| Accrued interest                                                                                                      | ** ** | **1,323,350**  | ** **      |
| Total current  liabilities                                                                                            | ** ** | **6,266,337**  | ** **      |
| LONG-TERM DEBT (less  current maturities)                                                                             | ** ** | **11,243,620** | ** **      |
| LEASE OBLIGATION                                                                                                      | ** ** | **47,866,117** | ** **      |
| MEMBERS’ EQUITY                                                                                                  |       |           |            |
| Capital  contributions, 40,000 units authorized, 23,798 units issued of which 1,900  units are held as treasury stock | ** ** | **24,707,100** | ** **      |
| Treasury stock,  at cost                                                                                              | ** ** | **(3,800,000** | **)**           |
| Retained  earnings                                                                                                    | ** ** | **24,110,162** | ** **      |
| Total members’  equity                                                                                           | ** ** | **45,017,262** | ** **      |
| Total liabilities and  members’ equity                                                                           | ** ** | **$**          | **110,393,336** | ** ** |

 

See Notes to UnauditedFinancial Statements

3

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EAST KANSAS AGRI-ENERGY, LLCSTATEMENT OF OPERATIONS (UNAUDITED)
| ** **                                           | ** ** | **Three Months** | ** **     | **Three Months** | ** ** |
|------------------------------------------------------|------------|-----------------------|----------------|-----------------------|------------|
| ** **                                           | ** ** | **Ended**             | ** **     | **Ended**             | ** ** |
| ** **                                           | ** ** | **March 31,**    | ** **     | **March 31,**    | ** ** |
| ** **                                           | ** ** | **2007**              | ** **     | **2006**              | ** ** |
|                                                 |       |                  |           |                  |       |
| REVENUE                                              |       |                  |           |                  |       |
| Related parties                                      | ** ** | **$**                 | **25,605,171** |                  | $          | 21,015,698 |   |
| Incentive funds                                      | ** ** | **—**            |           | 680,830               |       |
|                                                 | ** ** | **25,605,171**        |           | 21,696,528            |       |
|                                                 |       |                  |           |                  |       |
| COST OF SALES                                        |       |                  |           |                  |       |
| Related parties                                      | ** ** | **(14,568,676**       | **)**          | (8,141,512            | )          |
| Other                                                | ** ** | **(6,935,824**        | **)**          | (6,499,761            | )          |
|                                                 | ** ** | **(21,504,500**       | **)**          | (14,641,273           | )          |
|                                                 |       |                  |           |                  |       |
| GROSS PROFIT                                         | ** ** | **4,100,671**         |           | 7,055,255             |       |
|                                                 |       |                  |           |                  |       |
| OPERATING EXPENSES                                   |       |                  |           |                  |       |
| General,  administrative and selling expenses        | ** ** | **842,011**           |           | 875,049               |       |
|                                                 |       |                  |           |                  |       |
| INCOME FROM OPERATIONS                               | ** ** | **3,258,660**         |           | 6,180,206             |       |
|                                                 |       |                  |           |                  |       |
| OTHER INCOME (EXPENSE)                               |       |                  |           |                  |       |
| Interest income                                      | ** ** | **993,034**           |           | 977,073               |       |
| Interest expense                                     | ** ** | **(308,530**          | **)**          | (576,182              | )          |
| Plant lease  interest expense                        | ** ** | **(957,322**          | **)**          | (944,208              | )          |
| Other income                                         | ** ** | **167**               |           | —                |       |
|                                                 | ** ** | **(272,651**          | **)**          | (543,317              | )          |
|                                                 |       |                  |           |                  |       |
| NET INCOME                                           | ** ** | **$**                 | **2,986,009**  |                  | $          | 5,636,889 |   |
|                                                 |       |                  |           |                  |       |
|                                                 |       |                  |           |                  |       |
| BASIC AND DILUTED  INCOME PER UNIT                   | ** ** | **$**                 | **136**        |                  | $          | 237 |   |
|                                                 |       |                  |           |                  |       |
| WEIGHTED AVERAGE UNITS OUTSTANDING BASIC AND DILUTED | ** ** | **21,898**            |           | 23,798                |       |

 

SeeNotes to Unaudited Financial Statements

4

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EAST KANSAS AGRI-ENERGY, LLCSTATEMENT OF CASH FLOWS (UNAUDITED)
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **Three Months** | ** **    | **Three Months** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **Ended**             | ** **    | **Ended**             | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **March 31,**    | ** **    | **March 31,**    | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **2007**              | ** **    | **2006**              | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                              |       |                  |          |                  |       |
| Net income                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **$**                 | **2,986,009** |                  | $          | 5,636,889 |   |
| Adjustments to  reconcile net income to net cash used in operating activities                                                                                                                                                                                                                                                                                                                                                                      |       |                  |          |                  |       |
| Depreciation                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **859,762**           |          | 752,581               |       |
| Amortization                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **19,414**            |          | 23,735                |       |
| (Increase)  decrease in current assets                                                                                                                                                                                                                                                                                                                                                                                                             |       |                  |          |                  |       |
| Accounts  receivable                                                                      | ** ** | **(659,749**          | **)**         | (863,946              | )          |
| Inventory                                                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **(1,093,184**        | **)**         | 163,045               |       |
| Commodity  contracts                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **1,087,124**         |          | (134,711              | )          |
| Prepaid expense                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **195,907**           |          | 19,278                |       |
| Interest  receivable                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **(960,513**          | **)**         | (950,299              | )          |
| Increase  (decrease) in current liabilities:                                                                                                                                                                                                                                                                                                                                                                                                       |       |                  |          |                  |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **(366,869**          | **)**         | (226,101              | )          |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **1,003,226**         |          | 1,016,531             |       |
| NET CASH PROVIDED BY  OPERATING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **3,071,127**         |          | 5,437,002             |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                              |       |                  |          |                  |       |
| Purchase of  plant and equipment, including construction in progress                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **(1,160,552**        | **)**         | (962,116              | )          |
| NET CASH (USED IN)  INVESTING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **(1,160,552**        | **)**         | (962,116              | )          |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                              |       |                  |          |                  |       |
| Payment of  financing fees                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **—**            |          | (3,815                | )          |
| Repayment of  long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **(707,800**          | **)**         | (2,240,771            | )          |
| Distributions                                                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **(2,890,536**        | **)**         | **—**            |       |
| NET CASH (USED IN)  FINANCING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **(3,598,336**        | **)**         | (2,244,586            | )          |
|                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |          |                  |       |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **(1,687,761**        | **)**         | 2,230,300             |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **5,281,272**         |          | 4,569,145             |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **$**                 | **3,593,511** |                  | $          | 6,799,445 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |          |                  |       |
| SUPPLEMENTAL DISCLOSURE  OF CASH FLOW INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                  |       |                  |          |                  |       |
| Cash paid for  interest, net of capitalized interest                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **$**                 | **306,244**   |                  | $          | 601,830 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |          |                  |       |
| NON CASH INVESTING AND  FINANCING ACTIVITIES                                                                                                                                                                                                                                                                                                                                                                                                       |       |                  |          |                  |       |
| Property, plant, and  equipment costs incurred                                                                                                                                                                                                                                                                                                                                                                                                     | ** ** | **$**                 | **—**    |                  | $          | 1,039,137 |   |

 

See Notes to UnauditedFinancial Statements

5

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

**NOTE 1 -              SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

*Nature of Business*

East Kansas Agri-Energy,LLC, (a Kansas limited liability company) located in Garnett, Kansas, was organizedto own and operate a 35 million gallon ethanol plant with distribution withinthe United States. East Kansas Agri-Energy, LLC (the Company) was formallyorganized as a limited liability company as of October 16, 2001. Prior to thatdate the Company operated as a general partnership with no formal partnershipagreement.

*Basis of Accounting*

The unauditedfinancial statements contained herein have been prepared pursuant to the rulesand regulations of the Securities and Exchange Commission.  Accordingly, they do not include all theinformation and footnotes required by accounting principles generally acceptedin 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 of operations for the threemonths ended March 31, 2007 and 2006, are not necessarily indicative of theresults expected for a full year.

These financialstatements should be read in conjunction with the financial statements andnotes included in the Company’s financial statements for the year endedDecember 31, 2006.

*AccountsReceivable*

Accountsreceivable are presented at face value, net of the allowance for doubtfulaccounts.  The allowance for doubtfulaccounts is established through provisions charged against income and ismaintained at a level believed adequate by management to absorb estimated baddebts based on historical experience and current economic conditions.  Management believes all receivables will becollected and therefore the allowance has been established to be zero at March31, 2007.

The Company’s policy is to charge simple interest ontrade receivables past due balances; accrual of interest is discontinued whenmanagement believes collection is doubtful. Receivables are considered past due based upon payment terms set forthat the date of the related sale.  TheCompany has no receivables accruing interest March 31, 2007.

*Financing Costs*

Costs incurred related to origination of debt financing are recorded asan asset and amortized over the expected term of the debt.

*Estimates*

Management usesestimates and assumptions in preparing financial statements. Those estimatesand assumptions affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses. Actual resultscould differ from the estimates used.

6

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

*Earnings Per Unit*

Earnings per unitare calculated based on the period of time units have been issued andoutstanding. For purposes of calculating diluted earnings per capital unit,units subscribed for but not issued are included in the computation ofoutstanding capital units.

*General,administrative and selling expenses*

The primary components of general and administrative expenses aremanagement fees, insurance expense, selling expenses and payroll.

*RevenueRecognition*

Revenue from the production of ethanol and related products is recordedupon transfer of title to our customers. The transfer takes place at the plant site and therefore shipping termsare FOB shipping point.  Interest incomeis recognized as earned.  Income from federaland state incentives are recognized when received due to uncertainty ofavailable funds and pro-rations used by the sponsoring organizations.

*Costof Sales*

The primary components of cost of sales from the production of ethanoland related products are grain expense, energy expense (natural gas andelectricity), raw materials expense (chemicals and denaturant), labor anddepreciation on process equipment.

*Shippingand Handling*

Shipping and handling costs are expensed as incurred and are includedin the cost of sales.

*IncomeTaxes*

The Company is organized as a limited liability company under state lawand is treated as a partnership for income tax purposes.  Under this type of organization, the Company’searnings pass through to the partners and are taxed at the partner level.  Accordingly, no income tax provision has beencalculated.  Differences betweenfinancial statement basis of assets and tax basis of assets is related tocapitalization and amortization of organizational and start-up costs for taxpurposes, whereas these costs are expensed for financial statement purposes,and the difference between the recorded amounts of financial statement and taxdepreciation, unrealized gains or losses on commodity contracts and incentiveprograms payments.

*CashEquivalents*

For purposes of the statement of cash flows, the Company considers allhighly liquid debt instruments purchased with an original maturity of threemonths or less to be cash equivalents.

*FairValue of Financial Instruments*

The Company believes the carrying value of cash and cash equivalentsapproximates fair value due to the short maturity of these instruments.  The Company estimates the fair market valueof the investment in Industrial Revenue Bonds to approximate cost.

The Company believes the carrying amount of long-term note payableobligations approximates fair value.  Forthe permanent financing, fair value approximates the carrying amount due to thevariable interest rate feature of the debt.

7

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

*Inventory*

Inventory is stated atthe lower of cost, determined on a first in, first out basis, or market value.

*Investmentin Commodity Contracts*

SFAS No. 133 requires a company to evaluate itscontracts to determine whether the contracts are derivatives. Certain contractsthat literally meet the definition of a derivative may be exempted from SFASNo. 133 as normal purchases or normal sales. Normal purchases and normal salesare contracts that provide for the purchase or sale of something other than afinancial instrument or derivative instrument that will be delivered inquantities expected to be used or sold over a reasonable period in the normalcourse of business. Contracts that meet the requirements of normal aredocumented as normal and exempted from the accounting and reportingrequirements of SFAS No. 133.

The Company enters into short-term cash grain, optionand futures contracts as a means of securing grain for the ethanol plant andmanaging exposure to changes in commodity prices. All derivatives aredesignated as non-hedge derivatives. Although the contracts are effectiveeconomic hedges of specified risks, they are not designated as and accountedfor as hedging instruments.

As part of itstrading activity, the Company uses futures and option contracts offered throughregulated commodity exchanges to reduce risk and are exposed to risk of loss inthe market value of inventories. To reduce that risk, the Company generallytakes positions using cash and futures contracts and options. During theperiods ended March 31, 2007 and 2006 this activity resulted in net losses of$1,087,124 and 489,289, respectively, which are reported in cost of sales.

*Propertyand Equipment*

Depreciation iscomputed over the estimated useful life of each asset using the straight-linemethod.  Estimated useful lives generallyused in computing depreciation 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        |   |

 

The Company’sproperty and equipment were acquired under lease agreements pursuant to anindustrial revenue bond issue.  TheCompany is required to make semi-annual deposits with the Trustee sufficient toservice the principal maturities and interest requirements.  Title to the property will be transferred tothe Company when the lease is terminated upon retirement of the bonds.  Accordingly, the bonds have been recorded asa direct obligation of the Company.  TheCompany is also the holder of the bonds.

The Companyreviews its property and equipment for impairment whenever events indicate thatthe carrying amount of the asset may not be recoverable.  An impairment loss is recorded if the sum ofthe future cash flows is less than the 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 the asset.  Such assessments did not result in anyadjustment to the value of the non-current assets.

*IdleProperty*

The Company hasincurred $2,317,398 of costs related to the preliminary construction of a railspur project.  The Company does notcurrently have an estimate of when and if the project is going to becompleted.  Accordingly, the costs havebeen classified as idle property.  TheCompany plans to continue to evaluate the status of this project in futureperiods.

8

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

*EnvironmentalLiabilities*

The Company’s operations are subject to federal, state and localenvironmental laws and regulations. These laws require the Company to investigate and remediate the effectsof the release or disposal of materials at its location.  Accordingly, the Company has adoptedpolicies, practices and procedures in the areas of pollution control,occupational health, and the production, handling, storage and use of hazardousmaterials to prevent material environmental or other damage; and to limit thefinancial liability which could result from such events.  Environmental liabilities are recorded whenthe liability is probable and the costs can be reasonably estimated.

**NOTE 2 -**                  INCENTIVE PAYMENTS

TheCompany qualified for the federal U.S. Department of Agriculture Bio EnergyProgram.  The federal program was managedby the Commodity Credit Corporation and was designed to expand the productionof fuel grade ethanol by offering incentives for incremental productioncompared to the same quarter of the prior year. The annually funded program ran through the state’s fiscal year 2006 andincentive payments were pro-rated if applications for incentives exceeded theannual funding.  The maximum annualincentive program payments the Company could receive was $7,500,000; individualproducers were also subject to an annual limitation of 5% of the totalfunding.  During the period ended March31, 2006 the Company received $225,160 in federal incentives.

TheCompany has been approved for the Kansas Qualified Agricultural EthanolProducer Incentive Fund.  The incentiverate is $.075 per gallon of ethanol produced. The Company must establish they have produced 5,000,000 gallons ofethanol before the State of Kansas will disburse the funds.  Incentive payments are limited to 15,000,000gallons per production year.  During theperiods ended March 31, 2007 and 2006, the Company received $0 and $455,671,respectively.

**NOTE 3 -**                  INVENTORY

Inventories aresummarized as follows:

|                  | ** ** | **March 31,** | ** ** |
|------------------|------------|--------------------|------------|
| ** **       | ** ** | **2007**           | ** ** |
|             |       |               |       |
| Raw Material     |       | $                  | 2,112,004  |   |
| Work in Progress |       | 614,611            |       |
| Finished Goods   |       | 648,791            |       |
|             |       |               |       |
|             |       | $                  | 3,375,406  |   |

 

**NOTE 4 -**                  LONG-TERM DEBT

On November 23, 2004, the Company entered into aCredit Agreement with Home Federal Savings Bank, establishing a constructionloan facility for the construction of a 35 million gallon per year ethanolplant. The construction financing is in the amount of $26,000,000 consisting ofa $21,000,000 conventional term loan and a $5,000,000 loan, with both loans beingsecured by substantially all of our assets.

During the construction phase, the Company mademonthly payments of interest only at a variable interest rate equal to primeplus 1.75% with a floor of 6%. On September 20, 2005, following constructioncompletion, the loan was segmented into two loans (1) a $5,000,000 loan(Loan A), and (2) a $21,000,000 conventional term loan (Loan B). 

9

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

The $5,000,000 loan has an amortization period andmaturity date of ten years. The Company makes monthly payments of principal andinterest on the $5,000,000 loan at an interest rate equal to prime.  The $21,000,000 conventional loan has anamortization period of ten years but will mature at the end of five years. TheCompany makes monthly payments of principal and interest on the $21,000,000loan at an interest rate equal to prime. The effective interest rate for both loans at March 31, 2007 was 8.25%.

The Company pays a $20,000 annual administration feerelated to the credit facility.  Thecredit facility is secured by a mortgage on our real property and a securityinterest in all personal and intangible assets of the Company, includingassignment of all material contracts.

On May 4, 2006,the Company agreed to renegotiate terms of their bank financing.  The new terms provide for a $4,000,000 termrevolving loan in addition to the existing term loans.  The interest rate on the term revolving loanis the prime rate.  The term revolvingloan available credit balance is reduced by $400,000 annually beginningDecember 31, 2007 and matures on October 1, 2010.  At March 31, 2007, the Company has not usedany amount related to the term revolving loan.

During the term of the loan, all deposit accounts relatedto the Company must be maintained at Home Federal Savings Bank. The Company issubject to certain financial loan covenants consisting of minimum workingcapital, minimum fixed charge coverage, minimum current ratio, minimum debtservice, minimum net worth and maximum debt to net worth covenants during theterm of the loan. The Company is also prohibited from making distributions totheir members; however, the Company is allowed to distribute 50% of our netincome to our members after our lender has received audited financialstatements for the fiscal year. If the Company meets certain financial ratiorequirements, it may distribute an additional 10% of net income.  The Company must be in compliance with allfinancial ratio requirements and loan covenants before and after anydistributions to the members.  The lendertemporarily waived, through December 31, 2007, the capital expenditurecovenant.  With the waiver, the Companyis in compliance with the applicable loan covenants as of March 31, 2007.

The Company isonly allowed to make annual capital expenditures up to $500,000 annuallywithout the lender’s prior approval. During the term of the loan, the Companyis required to pay to the lender an annual amount equal to the greater of: 1)75% of any Commodity Credit Corporation Bio-Energy income payments receivedduring the year, or 2) 25% of the Company’s free cash flow for each year.Payments consisting of USDA Commodity Credit Corporation Bio-Energy income mustbe paid to the lender within 15 days of receipt of any such payments. Thesepayments will continue until an aggregate sum of $7,500,000 has been receivedby the lender.  The Company is incompliance with the applicable loan covenants as of March 31, 2007.

The Company financed its waste water reuse facilitythrough two bond issues by the City of Garnett. The Utility System Revenue Bonds require annual principal paymentsbeginning on October 1, 2006 and continue through 2015.  Interest payments on these bonds are duesemi-annually, at interest rates ranging from 4.6% to 5.2%.  The first interest payment was due April 1,2006.  The Community Development BlockGrant (CDBG) Bonds require semi-annual principal and interest paymentsbeginning on July 1, 2006 and continue through 2015.  The bonds have a fixed interest rate of 2%.

Long-termobligations of the Company are summarized as follows at March 31, 2007:

| Loan B                        |   | $          | 10,998,987 |   |
|-------------------------------|--------|------------|------------|--------|
| Loan A                        |   | 2,621,109  |       |
| Utility System  Revenue Bonds |   | 485,000    |       |
| CDBG Bonds                    |   | 323,552    |       |
| Less current portion          |   | (3,185,028 | )          |
| Long-term  portion            |   | $          | 11,243,620 |   |

 

10

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

The estimatedmaturities of long-term debt at March 31, 2007, are as follows:

| 12 Month Period Ending March 31, | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|
|                                                      |       |       |       |
| 2008                                                      |       | $          | 3,185,028  |   |
| 2009                                                      |       | 3,333,310  |       |
| 2010                                                      |       | 3,617,756  |       |
| 2011                                                      |       | 3,638,243  |       |
| 2012                                                      |       | 255,219    |       |
| Thereafter                                                |       | 399,092    |       |
|                                                      |       | $          | 14,428,648 |   |

 

**NOTE 5 -**                  MEMBERS’ EQUITY

As specified inthe Company’s Operating Agreement, voting rights are one vote for each votingunit registered in the name of such Member as shown on the MembershipRegistration maintained by the Company. No Member shall directly or indirectlyown or control more than 25% of the issued and outstanding voting membershipinterest in the Company at any time.

Income and lossesof the Company shall be allocated among the Members in proportion to eachMember’s respective percentage of units when compared with the total Unitsissued.

The Company’s cashflow shall first be applied to the payment of the Company’s operating expenses(including debt service) and then to maintenance of adequate cash reserves asdetermined by the board of directors in its sole discretion, and then shall bedistributed from time to time to the Members in proportion to their respectivepercentage units. No member has the right to demand and receive anydistribution from the Company other than in cash. No distribution shall be madeif, as a result thereof, the Company would be in violation of any loanagreement, and of if the Company would be in violation of any loan agreement,of if the Company’s total assets would be less than the sum of its totalliabilities.

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

The board of directorsapproved the redemption of 1,900 units from a member.  The redemption represents the member’s entireunit balance.  On May 10, 2006, theCompany purchased the member’s units for a total of $3,800,000.

On March 23, 2007,the Company made a dividend distribution to its members in the amount of $132per share, for a total payment of $2,890,536.

**NOTE 6 -**                  CONCENTRATION OFCREDIT RISK

The Companymaintains cash balances at five financial institutions in its trade area. Theaccounts are secured by the Federal Deposit Insurance Corporation up to$100,000. At times, the Company’s bank balance may exceed $100,000.

11

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

**NOTE 7 - COMMITMENTS ANDCONTINGENCIES**

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

On November 12,2004, the Company entered into a Distillers Grains Marketing Agreement withUnited Bio Energy Ingredients, LLC, an affiliated related party, pursuant towhich United Bio Energy Ingredients, LLC will purchase all dried and wetdistillers grains produced at the plant for a term of at least five years at aprice of 98% of the FOB plant price United Bio Energy Ingredients, LLC chargesits buyers of dried distillers grains, and 95% of the FOB plant price UnitedBio Energy Ingredients, LLC charges its buyers of wet distillers grains. UnitedBio Energy Ingredients, LLC, will use its best efforts to achieve the highestresale price available under prevailing market conditions. The Company isresponsible for supplying all labor and equipment to load or unload trucks orrail cars without charge to United Bio Energy Ingredients, LLC and is requiredto provide storage for at least 10 days production of wet and dry distillergrains. In addition, the distiller grains must meet quality requirements sothat they will meet current industry standards for primary animal feedingredients. If the Company fails to supply distiller grains that comply withindustry standards, United Bio Energy Ingredients, LLC may reject them.  The Company paid commissions of $133,308 and$78,7865 for the periods ended March 31, 2007 and 2006, respectively, relatedto this marketing agreement.

On November 12,2004, the Company entered into a Raw Grains Agreement with United Bio EnergyIngredients, LLC, an affiliated related party. The Raw Grains Agreementprovides for the Company to purchase all raw grains necessary for ethanolproduction from United Bio Energy Ingredients, LLC for a period of at leastfive years. Pursuant to the agreement, United Bio Energy Ingredients, LLC willuse its best efforts to arrange for the purchase of grain at the lowest priceavailable under prevailing market conditions and we will supply all labor andequipment necessary to load or unload trucks or rail cars. For its service, theCompany will pay United Bio Energy Ingredients, LLC the actual cash procurementprice and all reasonable and necessary expenses to get the grain to the plantplus 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 periods ended March 31, 2007 and2006, the Company paid $84,583 and $72,083, respectively, in brokerage fees forgrain purchases made under this agreement.

On November 12,2004, the Company also entered into an Ethanol Agreement with United Bio EnergyFuels, LLC, an affiliated related party. United Bio Energy Fuels, LLC changed their name to Provista RenewableFuels Marketing, LLC (Provista).  Theterms of the agreement provide that Provista will market all fuel-grade ethanolproduced at our plant. In exchange, the Company agrees to pay Provista a fee of$.01 for each gallon of ethanol produced at the Company’s plant during the termof the agreement. The Company expects that the term of the agreement will be atleast 5 years. Provista also agreed to use its best efforts to obtain thehighest price for ethanol available under prevailing market conditions.  For the periods ended March 31, 2007 and2006, the Company paid $109,855 and $103,481, respectively, in marketing feesfor ethanol marketing under this agreement.

On November 12,2004, the Company entered into a Management Agreement with United Bio EnergyManagement, LLC, a related party, in which United Bio Energy Management, LLCwill supervise and direct the general operations of the plant for ananticipated period of at least five years. United Bio Energy Management, LLCwill provide the services of a full-time general manager to the plant.  The Company had agreed to compensate UnitedBio Energy Management, LLC an annual fee of $250,000 for these services payablein monthly installments of $20,833, plus an incentive bonus based on theattainment of certain financial benchmarks. United Bio Energy Management, LLCwill appoint a general manager to be based on site at our plant, and shall workexclusively 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

12

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

non-bindingmediation. In the event that the dispute is not settled through mediation, thematter must be resolved by non-appealable arbitration in accordance with therules of the American Arbitration Association as applicable in the State ofKansas. The determination of the arbitrator is expected to be final and may notbe appealed to any court. The prevailing party in any arbitration proceeding isentitled to recover reasonable attorneys’ fees and expenses incurred. Theagreement commenced during March 2005. For the period ended March 31, 2006, the Company incurred costs of$269,009 related to this agreement including reimbursable expenses. On December13, 2006 the Company reached an agreement with United Bio Energy Management,LLC to terminate the above Management Agreement effective December 31,2006.  The Company has agreed to continueparticipating in the UBE Plant Manager Program and Group Buying Program for amonthly fee of $10,000 for a term of one year, with the first monthlyinstallment due and payable on January 1, 2007.

On December 1,2006, the Company entered into an agreement with Jade Millrights, Inc. forconstruction of a grain bin for $905,100. As of March 31, 2007, the Company has incurred $737,786 related to theagreement and $120,702 of additional expenses related to the project, none ofwhich are included in accounts payable.

The following is a schedule of the annual commitmentsrelated to the above agreements.

| 12 months ending March, | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|
|                                   |       |       |       |
| 2008                                   |       | $          | 512,775    |   |
| 2009                                   |       | 404,108    |       |
| 2010                                   |       | 398,108    |       |
| 2011                                   |       | 332,108    |       |
| 2012                                   |       | 332,108    |       |
| Thereafter                             |       | 1,022,332  |       |
|                                   |       |       |       |
|                                   |       | $          | 3,001,539  |   |

 

The Company is involved invarious claims arising in the normal course of business.  Management believes that any financialresponsibility that may be incurred would not be material and therefore noadditional accrual is deemed necessary.

**NOTE 8 -**                  SALE / LEASEBACKTRANSACTION

On December 20, 2005, the Company completed anindustrial revenue bond financing with the City of Garnett, Kansas that willprovide property tax savings for 10 years on the plant site.  As part of the financing, title to the plantsite and 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 Bank consented to this transaction, and the bondshave been pledged to Home Federal Savings Bank as security for any obligationsunder the Home Federal Savings Bank Credit Agreement.  As part of the financing, the Company paidthe bond underwriter, Gilmore & Bell, P.C. $40,000.  The maximum principal amount of the bonds is$50,000,000.  The bonds were initiallyissued in the principal amount of $47,866,117, which is the amount of theCompany’s expenditures on the plant as of December 20, 2005.  The additional $2,133,883 is available forfuture capital project costs.

The $40,000 of financing fees paid to the bondunderwriter and $23,656 of legal and other cost associated with the bondclosing will be amortized over the approximately 10.5 year life of thebonds.  A total of $1,512 and $1,433 of 

13

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**EAST KANSAS AGRI-ENERGY, LLCNOTES TO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2007**

amortization expense related to these costs wasrecognized during the periods ended March 31, 2007 and 2006, respectively.

From the proceeds of the bond, the Company purchased the bonds as an investment.  The Company, as holder of the industrialrevenue bonds, is due interest at 8.0% per annum with interest payablesemi-annually on June 1st and December1st, commencing June 1, 2006.  The interest income is directly offset by thelease payments on the plant.  Both thebond and the corresponding lease have terms commencing December 20, 2005 andterminating on June 1, 2016.  The entireoutstanding principal is due upon termination of the bonds.  The outstanding principal at March 31, 2007was $47,866,117.  The lease qualifies asa capital lease.  Interest incomerecognized on the Industrial Revenue Bonds for the periods ended March 31, 2007and 2006 was $957,322 and $944,208, respectively.  These amounts are equal to the lease expenseof the plant for those periods.

Future debt servicerequirements on the Industrial Revenue Bonds at March 31, 2007 are as follows:

|                                | ** ** | ** **   | ** ** | ** **    | ** ** | ** **   | ** ** | ** **  | ** ** |
|--------------------------------|------------|--------------|------------|---------------|------------|--------------|------------|-------------|------------|
| **12 months ending** | ** ** | **Interest** | ** ** | ** **    | ** ** | ** **   | ** ** | ** **  | ** ** |
| **March 31,**             | ** ** | **Rate**     | ** ** | **Principal** | ** ** | **Interest** | ** ** | **Total**   | ** ** |
|                           |       |         |       |          |       |         |       |        |       |
| 2008                           |       | 8%           |       | $             | —     |         | $          | 3,829,289   |       | $ | 3,829,289 |   |
| 2009                           |       | 8%           |       | —        |       | 3,829,289    |       | 3,829,289   |       |
| 2010                           |       | 8%           |       | —        |       | 3,829,289    |       | 3,829,289   |       |
| 2011                           |       | 8%           |       | —        |       | 3,829,289    |       | 3,829,289   |       |
| 2012                           |       | 8%           |       | —        |       | 3,829,289    |       | 3,829,289   |       |
| Thereafter                     |       | 8%           |       | 47,866,117    |       | 17,231,803   |       | 65,097,920  |       |
|                           |       |         |       |          |       |         |       |        |       |
| Totals                         |       |         |       | $             | 47,866,117 |         | $          | 36,378,248  |       | $ | 84,244,365 |   |
|                           |       |         |       |          |       |         |       |        |       |
| Amount representing  interest  |       |         |       |          |       |         |       | (36,378,248 | )          |
|                           |       |         |       |          |       |         |       |        |       |
| Long-Term Obligation           |       |         |       |          |       |         |       | $           | 47,866,117 |   |

 

**NOTE 11 — RETIREMENT PLAN**

During 2005, the Company began a SIMPLE 401(k),Savings Incentive Match Plan for Employees, retirement plan for all eligibleemployees.  All employees are eligible toparticipate in the plan.  The Companymakes a matching contribution of 3% of participants’ eligible wages.  The employees are fully vested uponcontribution to the plan.  The Companymatch for the periods ended March31, 2007 and 2006 was $13,034and $9,359, respectively.

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| **ITEM 2.** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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 three-month period ended March 31, 2007, compared tothe same period of the prior fiscal year. This discussion and analysis should be read in conjunction with thefinancial statements and notes to financial statements included elsewhere inthis report and the information contained in our annual report on Form 10-KSBfor the fiscal year ended December 31, 2006

**ForwardLooking Statements**

Thisreport contains or incorporates by reference “forward-looking statements” thatinvolve future events, our future performance and our expected futureoperations 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.

·                  Projectedgrowth, overcapacity or contraction in the ethanol market in which we operate;

·                  Fluctuations inthe price and market for ethanol and distillers grains;

·                  Changes in plantproduction capacity, variations in actual ethanol and distillers grainsproduction from expectations or technical difficulties in operating the plant;

·                  Availability andcosts of products and raw materials, particularly corn and natural gas;

·                  Changes in ourbusiness strategy, capital improvements or development plans for expanding,maintaining or contracting our presence in the market in which we operate;

·                  Changes ininterest rates and the availability of credit to support capital improvements,development, expansion and operations;

·                  Our ability tomarket and our reliance on third parties to market our products;

·                  Our ability todistinguish ourselves from our current and future competition;

·                  Changes toinfrastructure, including

·                  expansion ofrail capacity,

·                  increases intruck fleets capable of transporting ethanol within localized markets,

·                  additionalstorage facilities for ethanol, expansion of refining and blending facilitiesto handle ethanol,

·                  growth inservice stations equipped to handle ethanol fuels, and

·                  growth in thefleet of FFVs capable of using E85 fuel;

·                  Changes in orelimination of governmental laws, tariffs, trade or other controls orenforcement practices such as:

·                  national, stateor local energy policy;

·                  federal ethanoltax incentives;

·                  legislationmandating the use of ethanol or other oxygenate additives;

·                  state andfederal regulation restricting or banning the use of MTBE; or

·                  environmentallaws and regulations that apply to our plant operations and their enforcement;

·                  Increasedcompetition in the ethanol and oil industries;

·                  Fluctuations inUS oil consumption and petroleum prices;

·                  Changes ingeneral economic conditions or the occurrence of certain events causing aneconomic impact in the agriculture, oil or automobile industries;

·                  The availabilityand adequacy of our cash flow to meet our requirements, including repayment ofdebt;

·                  Our liabilityresulting from litigation;

·                  Our ability toretain key employees and maintain labor relations;

·                  Changes andadvances in ethanol production technology; and

·                  Competition from alternative fuelsand alternative fuel additives.

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Ouractual results or actions could and likely will differ materially from thoseanticipated in the forward-looking statements for many reasons, including thereasons described in this report.  We are not under any duty to update theforward-looking statements contained in this report.  We cannot guaranteefuture results, levels of activity, performance or achievements.  Wecaution you not to put undue reliance on any forward-looking statements, whichspeak only as of the date of this report.  You should read this report andthe documents that we reference in this report and have filed as exhibits,completely and with the understanding that our actual future results may bematerially different from what we currently expect.  We qualify all of ourforward-looking statements by these cautionary statements.

**Overview**

East Kansas Agri-Energy,L.L.C. was formed as a Kansas limited liability company on October 16,2001.  References to “we”, “us”, “our”and “East Kansas” refer to East Kansas Agri-Energy, L.L.C.  Our principal business office is currentlylocated at 1304 South Main Street, Garnett, Kansas 66032.  We are managed by a 11 member board ofdirectors.

Since June 2005, wehave been engaged in the production of ethanol and distillers grains.   We purchase all of our corn and milo fromUnited Bio Ingredients, LLC, an affiliate of US BioEnergy Corporation.  Our revenues are derived from the sale anddistribution of our ethanol and distillers grains, which are sold to United BioEnergy Fuels, LLC (also an affiliate of US BioEnergy Corporation) and UnitedBio Energy Ingredients, LLC, respectively, which subsequently markets and sellsour products.  Theprincipal markets for our ethanol are regional petroleum terminals located inmajor population centers in Kansas and neighboring states, including suchcities as Kansas City, Missouri;Wichita, Kansas; Tulsa, Oklahoma; and St. Louis, Missouri.

Our operating results arelargely driven by the prices at which we sell ethanol and distillers grain andthe costs related to their production.  Historically, the price of ethanolhas fluctuated with the price of petroleum-based products such as unleadedgasoline, heating oil, and crude oil. The price of distillers grains is primarily influenced by the price ofcorn as a substitute livestock feed.  Weexpect these price relationships to continue for the foreseeable future. Inaddition, our revenues are also impacted by such factors as our dependence onone or a few major customers who market and distribute our products; theintensely competitive nature of our industry; possible legislation at thefederal, state, and/or local level; changes in federal ethanol tax incentives.

Ourlargest costs of production are corn, natural gas, and manufacturing chemicals.  The cost of corn is affected primarily bysupply and demand factors such as crop production, carryout, exports,government policies and programs, risk management and weather, much of which wehave no control.  Recently, the increasedproduction of ethanol has placed upward pressure on the price and supply ofcorn, resulting in higher than normal corn prices.  Natural gas prices fluctuate with the energycomplex in general.  Over the last fewyears, natural gas prices have trended higher than average and it appearsprices will continue to trend higher due to the high price of alternative fuelssuch as fuel oil.  Our costs ofproduction are affected by the cost of complying with the extensiveenvironmental laws that regulate our industry.

**Resultsof Operations for the Three Months Ended March 31, 2007 and 2006**

Thefollowing table shows the results of our operations and the percentage ofrevenues, cost of sales, operating expenses and other items to total revenuesin our statements of operations for the fiscal quarters ended March 31, 2007and 2006:
| ** **                          | ** ** | **March 31, 2007** | ** **    | **March 31, 2006** | ** ** |
|-------------------------------------|------------|------------------------------|---------------|------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                   | ** **    | **% of  Revenues**      | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** |
| ** **                          | ** ** | ** **                   | ** **    |                         | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues                            |       | $                            | 25,605,171    |                         |       | 100 | % |   | $ | 21,696,528 |   |   | 100 | % |   |
| Cost of Sales                       |       | $                            | 21,504,500    |                         |       | 84 | % |   | $ | 14,641,273 |   |   | 67 | % |   |
| Gross Profit                        |       | $                            | 4,100,671     |                         |       | 16 | % |   | $ | 7,055,255 |   |   | 33 | % |   |
|                                |       |                         |          |                         |       |   |   |   |   |   |   |   |   |
| Operating  Expenses                 |       | $                            | 842,011       |                         |       | 3 | % |   | $ | 875,049 |   |   | 4 | % |   |
| Operating Income                    |       | $                            | 3,258,660     |                         |       | 12 | % |   | $ | 6,180,206 |   |   | 28 | % |   |
|                                |       |                         |          |                         |       |   |   |   |   |   |   |   |   |
| Other Income  (Expense)             |       | $                            | (272,651      | )                            |       | (1 | )% |   | $ | (543,317 | ) |   | (3 | )% |   |
| **Net Income**                      | ** ** | **$**                        | **2,986,009** | ** **                   |       | **12** | **%** |   | **$** | **5,636,889** | ** ** |   | **26** | **%** |   |

 

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Revenues.  Our revenues from operations come from threeprimary sources:  ethanol sales,distillers grain sales and ethanol incentive payments from the State of Kansas.  The following table shows the sources of ourrevenues for the fiscal quarters ended March 31, 2007 and 2006:
| ** **                  | ** ** | **March 31, 2007** | ** ** | **March 31, 2006** | ** ** |
|-----------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Revenue Sources**    | ** ** | **Amount**                   | ** ** | **% of  Revenues**      | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** |
| ** **                  | ** ** | ** **                   | ** ** |                         | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Ethanol Sales               |       | $                            | 21,655,139 |                         |       | 85 | % |   | $ | 18,302,574 |   |   | 84 | % |   |
| Distillers  Grains Sales    |       | $                            | 3,950,032  |                         |       | 15 | % |   | $ | 2,713,124 |   |   | 13 | % |   |
| Ethanol  Incentive Payments |       | $                            | 0          |                         |       | 0 | % |   | $ | 455,671 |   |   | 3 | % |   |
| Total Revenues              |       | $                            | 25,605,171 |                         |       | 100 | % |   | $ | 21,696,528 |   |   | 100 | % |   |

 

Theincrease in revenues from the three months ended March 31, 2007 compared to thethree months ended March 31, 2006 is due primarily to an increase in the priceof ethanol sold and an increase in volume due to changes made to theplant.  The average price per gallon of ethanol sold increased approximately12% in the three months ended March 31, 2007 compared to the three months endedMarch 31, 2006.  Volume of ethanol soldin the three months ended March 31, 2007 was 6% more than in the three monthsended March 31, 2005.  Revenue from salesof our co-products also increased by 46% in the three months ended March 31,2007 compared to the three months ended March 31, 2006, primarily due toincreasing cost of corn as a comparable feed product and the product mixbetween wet and dry distiller’s grains.

Wecontinued to enjoy very favorable ethanol prices during the first quarter of2007.  The favorable market price forethanol is primarily due to high demand for ethanol, created by a number offactors, including the declining use of MTBE as an oxygenate, and thecurrent price of gasoline.  However, wecannot guarantee that the price of ethanol will not significantly decrease dueto factors beyond our control.

Managementexpects ethanol prices to remain higher than historical averages in theshort-term.  Based on existing marketconditions, we expect favorable pricing to continue at least through the end ofour second fiscal quarter because the price of unleaded gasoline is expected toremain at or above its current price levels as we enter the peak summer drivingseason. In order to sustain these higher price levels, however, managementbelieves the industry will need to continue to grow demand to offset theincreased supply brought to the marketplace by additional production.  According to the Renewable Fuels Association,there are currently 116 ethanol plants in operation nationwide that have thecapacity to annually produce approximately 5.91 billion gallons ofethanol.  In addition, planned expansionof existing plants and current construction of new plants is expected to addapproximately 6.60 billion gallons of yearly nationwide productioncapacity.  This is likely to lead to asignificant increase in the supply of ethanol.

InApril 2007, a final rule was adopted fully implanting the provisions of theRenewable Fuels Standard as contained in the Energy Policy Act of 2005.  The Renewable Fuels Standard requires thefuel blending industry to blend 4.7 billion gallons of renewable fuels in 2007.  This amount increases incrementally to 7.5billion gallons by the year 2012.  TheRenewable Fuels Standard is not likely to have a significant impact on thesupply and demand relationship in the ethanol industry due to the fact thatproduction capacity in the ethanol industry is currently 1.2 billion gallonsmore than the 2007 requirement.  Thistrend is likely to continue in the future such that it is not likely theRenewable Fuels Standard will significantly increase demand for ethanol.  If this is the case, the ethanol industrywill have to generate its own demand for its product based on competitiveadvantages ethanol may have over other renewable fuels and conventionalpetroleum based fuel sources.  If theethanol industry cannot grow sufficient demand to offset current and futureincreases in ethanol supply, the price of ethanol will decline which wouldaffect our revenues.

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Inthe short term, however, we expect ethanol prices will be positively impactedby increased consumer acceptance and exposure of ethanol.  Renewable fuelsuse has become an important issue in both federal and state government whichhas lead to an outpouring of support for the ethanol industry.  Many states are pursuing increased use ofrenewable fuels.  The price of ethanol isalso favorably impacted by current higher petroleum prices.  If the price of gasoline continues to trendhigher, consumers may look for lower priced alternative fuels.  This presents the ethanol industry theopportunity to increase its market share through a competitive price advantageover the price of petroleum.  This is thetype of voluntary ethanol blending and increased market share that will berequired to support current ethanol prices. The Consumer Federation of America published a report that states thatconsumers could save up to $0.08 per gallon at the pump if ethanol were blendedat 10%.  Since ethanol blended fuel is currently a less expensivealternative for consumers, the demand for such ethanol-blended fuel couldincrease, thus increasing the overall demand for ethanol.  This couldpositively affect our earnings.

Weexpect ethanol prices may also be positively impacted by increased ethanoldemand as blenders and refineries increase their use of ethanol in response toenvironmental liability concerns about MTBE.  Although the Energy PolicyAct of 2005 effectively eliminated reformulated gasoline (“RFG”) requirementswith the enactment of the national renewable fuel standard, federal air qualitylaws in some areas of the country still require the use of RFG.  Historically, RFG has been formulated witheither MTBE or ethanol.  Ethanol hasemerged as the replacement of choice for MTBE which as lead to some increaseddemand for ethanol.

Wereceived no income from the United States Department of Agriculture’s CommodityCredit Corporation Bioenergy Program for the three month ending March 31, 2007compared to income of $225,160 for the same period in 2006.  This significant decrease is a result oftermination of the program on June 30, 2006.

We received no income from the State of Kansasthrough the Kansas Qualified Agricultural Ethyl Alcohol Producer’s Program forthe three months ended March 31, 2007, compared to income of $455,671 receivedfor the same period in 2006.  Thedecrease in payments during the three months ending March 31, 2007, as comparedto 2006, is due to program timing and the reduction of state incentive funds. We do not expect more than minimal paymentsunder this program for our 2007 fiscal year.

Costof Sales.   Ourcost of sales as a percentage of revenues was 84% and 67% for the three months endedMarch 31, 2007 and 2006, respectively.  Our cost of sales increased byapproximately $6,863,227 in the three months ended March 31, 2007 as comparedto the three months ended March 31, 2006, even though our revenue onlyincreased by approximately $3,908,643. This significant increase in the cost of sales is primarily a result ofsignificantly higher corn prices.  Ourtotal corn costs increased by approximately 79% for the three months endedMarch 31, 2007 as compared to the same period of 2006.  With the increased demand for corn fromincreased ethanol production, we expect to have high corn prices throughout thefiscal year 2007.  These high corn pricesmight be mitigated somewhat due to increased corn planting in the 2007 growingseason.  Farmers are expected to respondto these high corn prices by planting more than 90.5 million acres of corn, anapproximately 15% increase over the corn production acres for the 2006 growingseason.  This is expected to increase thenumber of bushels of corn produced to approximately 13 billion bushels from the2007 growing season.  If this is thecase, it could offset some of the additional corn demand from the ethanolindustry.  Management however expects tocontinue to endure high corn prices into the near future.

Forthe three months ended March 31, 2007, our natural gas costs decreased byapproximately 34%.  This decrease is dueto a similar decrease in the price of natural gas. Our natural gas consumptiondecreased by approximately 1% for the three months ended March 31, 2007 ascompared to the same period of 2006.

Weengage in hedging activities with respect to corn, natural gas, and ethanolsales.  We recognize the gains or lossesthat result from the changes in the value of our derivative instruments in costof goods sold as the changes occur.  As corn and natural gas pricesfluctuate, the value of our derivative instruments are impacted, which affectsour financial performance.  We partially offset these losses with the cashprice we paid for corn.  We anticipate continued volatility in our cost ofgoods sold due to the timing of the changes in value of the derivativeinstruments relative to the cost and use of the commodity being hedged.

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OperatingExpenses.  Ouroperating expenses as a percentage of revenues were consistent from period toperiod.  These percentages were 3% and 4% for the three months ended March31, 2007 and 2006, respectively.  Weexpect that these expenses will remain constant and keep in line with sales andproduction.

OperatingIncome.  Our incomefrom operations for the three months ended March 31, 2007 was 12% of revenuescompared to 28% of revenues for the three months ended March 31, 2006. This was a result of increased corn prices and their result on our cost ofsales.

OtherIncome (Expense).  Wehad other expense totaling $272,651 for the three months ended March 31, 2007compared to other expenses totaling $543,317 for the three months ended March31, 2007.  This change was primarily a result of a decrease in interestexpense, as partially offset by an increase in plant lease interestexpense.  Our interest income was substantially the same for the threemonth period ended March 31, 2007 as March 31, 2006.  Our interest expense decreased to $308,530for the three months ended March 31, 2007 from $576,182 for the three monthsended March 31, 2006.  This decrease is a result of a reduction in boththe principal amount outstanding on the loans and the interest rate that we arecharged.   Our plant lease interestexpense increased to $957,322 for the three months ended March 31, 2007 from$944,208.

**Changesin Financial Condition for the Three Months Ended March 31, 2007**

Thefollowing table highlights the changes in our financial condition for the threemonths ended March 31, 2007:
| ** **           | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------|------------|--------------------------|------------|-----------------------------|------------|
| Current Assets       |       | $                        | 12,892,208 |                        | $          | 13,149,554 |   |
| Current  Liabilities |       | $                        | 6,266,337  |                        | $          | 5,859,819 |   |
| Long-Term Debt       |       | $                        | 11,243,620 |                        | $          | 12,059,916 |   |
| Lease Obligation     |       | $                        | 47,886,117 |                        | $          | 47,866,117 |   |
| Members’ Equity |       | $                        | 45,017,262 |                        | $          | 44,921,789 |   |

 

CurrentAssets.  Current assetstotaled $12,892,208 at March 31, 2007 down from $13,149,554 at December 31,2006.  The decrease in current assets primarily is the result of adecrease in our investment in commodity contracts which was $258,628 at March31, 2007 compared to $1,345,752 at December 31, 2006, partially offset by anincrease in interest receivable which was $1,279,620 at March 31, 2007 comparedto $319,107 at December 31, 2006.  Inaddition, our cash and cash equivalents decreased to $3,593,511 at March 31,2007 compared to $5,281,272 at December 31, 2006.  This decrease is primarily a result ofdecreased cash on hand due to a distribution of $132 per unit paid out in March2007.

CurrentLiabilities.  Currentliabilities totaled $6,266,337 at March 31, 2007, up from the $5,859,819 atDecember 31, 2006.  This change is largely due to an increase inaccrued interest which totaled $1,323,350 at March 31, 2007 up from $363,742 atDecember 31, 2006, partially offset by a decrease in trade and related partiesaccounts payable which combined was $1,274,653 for the three months ended March31, 2007 and $1,979,857 at December 31, 2006.

Long-TermDebt.  Long-term debt,net of current maturities, totaled $12,892,208 at March 31, 2007, down from$12,059,916 at December 31, 2006, due to our regularly scheduled loan payments,reductions to the principal amounts due to the free flow cash covenants of ourcredit agreement and a reduction required when we renegotiated our creditfacility with Home Federal Savings Bank.

CapitalLease Obligation.  Ourcapital lease obligation totaled $47,866,117 for the three months ended March31, 2007 as well as for the period ended December 31, 2006.

Members’Equity.  The members’contributions are $24,707,100.  Retained earnings as of March 31, 2007 is$24,110,162 compared to $24,014,689 at December 31, 2006.  Total members’ equity as of March 31, 2007,is $45,017,262 up from $44,921,789 at December 31, 2006.

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**Plant Operations**

Management anticipates our plant will continue tooperate at or above name-plate capacity of 40 million gallons per year for thenext 12 months.  We expect to havesufficient cash from cash flow generated by continuing operations, currentlines of credit through our revolving promissory note, and cash reserves tocover our usual operating costs over the next 12 months, which consistprimarily of corn supply, natural gas supply, staffing, office, audit, legal,compliance, working capital costs and debt service obligations.  A number of factors that are outside of ourcontrol affect our operating costs and revenues, including, but not limited to,the following:

·                  Changes in theavailability and price of corn;

·                  Changes in thefederal ethanol tax incentives;

·                  Changes in theenvironmental regulations that apply to our plant operations;

·                  Increasedcompetition in the ethanol industry;

·                  Changes ininterest rates or the availability of credit;

·                  Changes in ourbusiness strategy, capital improvements or development plans;

·                  Changes in plantproduction capacity or technical difficulties in operating the plant;

·                  Changes ingeneral economic conditions or the occurrence of certain events causing aneconomic impact in the agriculture, oil or automobile industries;

·                  Changes in theavailability and price of natural gas;

·                  Increases ordecreases in the supply and demand for distillers grains; and

·                  Changes infederal and/or state laws (including the elimination of any federal and/orstate ethanol tax incentives).

**Liquidityand Capital Resources**

Ourliquidity needs are primarily met through internally generated cash flow. Our primary uses of cash are cost of sales, operating expenses, debt serviceand capital expenditures.  The following table shows cash flows for thethree months ended March 31, 2007 and 2006:
| ** **                                           | ** ** | **March 31, 2007** | ** ** | **March 31, 2006** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Net cash  provided by (used in) operating activities |       | $                            | 3,071,127  |                         | 5,437,002  |   |
| Net cash  provided by (used in) investing activities |       | $                            | (1,160,552 | )                            | (962,116   | ) |
| Net cash provided by  (used in) financing activities |       | $                            | (3,598,336 | )                            | (2,244,586 | ) |

 

Cash Flow Provided By Operations*. *Ouroperating activities for the three months ended March 31, 2007, generated$3,071,127 of net cash flow, down from $5,437,002 in 2006 primarily due to adecrease in net income of $2,986,009 in 2007 as compared to $5,636,889 in2006.  In addition, we used approximately$1,093,184 in cash for inventory in 2007 as opposed to receiving $163,045 frominventory in 2006.  The net cash fromoperating activities primarily includes net income from operations, adjustedfor depreciation and amortization of $879,176.

Cash Flow Used InInvesting Activities*. *Weused $1,160,552 of cash for investing activities for the three months endedMarch 31, 2007, up from the $962,116 we used in the three months ended March 31,2006.  This increase was primarily due to our expansion of our grain storagefacilities.

We estimate that approximately $3.5 million incapital expenditures will be made in the next twelve months, all of which areexpected to be financed from a portion of cash flows from operations or fromcash provided through a revolving credit agreement with Home Federal SavingsBank.

Cash Flow Used InFinancing Activities.  Cash usedfor financing activities increased for the three months ended March 31, 2007 ascompared to the cash used for financing activities for the three months endedMarch 31, 2006.  The increase wasprimarily due to more aggressive repayment of our loans.    We also made $2.9 million in 

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aggregate cashdistributions to our members during the three months ended March 31, 2007 ascompared to $0 in the three months ended March 31, 2006.

Managementanticipates sufficient cash flow from operating activities and revolving debtto cover debt service obligations, operations and planned capital expendituresfor the next 12 months.

**Indebtedness**

### Short-Term Debt.  We maintain a revolving line of credit with Home Federal Savings Bank of Rochester,Minnesota, to finance short-term working capital requirements.  Under the revolving line of credit, we mayborrow up to a maximum of $4,000,000 through December 31, 2007.  As ofMarch 31, 2007, there was no outstanding balance on the revolving line,although we may access these funds in the future.  Beginning on January 1, 2008, themaximum available credit balance will be reduced by $400,000 each year untilthe revolving line expires.  Interest on the revolving line of credit isat prime.  The revolvingline of credit expires on September 30, 2010 and is payable in full onOctober 1, 2010.

Long-TermDebt.  On November 23,2004, we entered into a Credit Agreement with Home Federal Savings Bank ofRochester, Minnesota, establishing a construction loan facility in the amountof $26,000,000 and secured by substantially all of our assets. We converted theconstruction loan into two term loans on September 20, 2005, consisting of(1) a $21,000,000 conventional term loan (“Loan B”), and (2) a$5,000,000 term loan with a potential USDA guarantee of up to 80% of the loanvalue (“Loan A”).  The $5,000,000 loan has an amortization period andmaturity date of 10 years.  We makemonthly payments of principal and interest on the $5,000,000 loan at aninterest rate of prime.  The $21,000,000conventional loan has an amortization period of ten years but will mature atthe end of five years.  We make monthlypayments of principal and interest on the $21,000,000 loan at a rate equal toprime.  We pay a $20,000 annualadministration fee for the credit facility. As of March 31, 2007, the principal balance on Loan A was $2,621,109 andthe principal balance on the Loan B was $10,998,987.  At March 31, 2007, the effective interestrate for both loans was 8.25%.  Asinterest rates increase, we will incur higher interest payments, which couldadversely affect our net income.

Duringthe term of the loan, all our deposit accounts must be maintained at HomeFederal Savings Bank.  We are subject tocertain financial loan covenants consisting of minimum working capital, minimumfixed charge coverage, minimum current ratio, minimum debt service, minimum networth and maximum debt to net worth covenants during the term of the loan.  We are also prohibited from makingdistributions to our members; however, we are allowed to distribute 50% of ournet income to our members after our lender has received audited financialstatements for the fiscal year.  If wemeet certain financial ratio requirements, we may distribute an additional 10%of net income.  We must be in compliancewith all financial ratio requirements and loan covenants before and after anydistributions to the members.  The lendertemporarily waived, through December 31, 2007, certain minimum net worth andmaximum debt to net worth covenants. With the waiver, we are in compliance with the applicable loan covenantsas of March 31, 2007.

IndustrialRevenue Bonds.  OnDecember 20, 2005, we completed an industrial revenue bond financing withthe City of Garnett, Kansas, which we expect to provide property tax savingsfor 10 years on the plant site.  Themaximum principal amount of the bonds is $50,000,000, of which $47,866,117 isoutstanding as of March 31, 2007. Additional costs of $2,133,883 are planned and are expected to beeligible for submission for the bond trustee for additional bond issuances.  As holder of the industrial revenue bonds, weare due interest at 8.0% per annum with interest payable semi-annually onJune 1st and December 1st.  This interestincome is directly offset by the lease payments we pay on the plant.  We and the City of Garnett have waived thepayment of the lease payments and the interest income amounts since theyoffset; however, they are recorded for accounting purposes.  Both the bond and the corresponding leasehave 10-year terms which expire June 1, 2016. The entire outstanding principal is due upon termination of the bonds.

WasteWater Bond Financing. We financed our waste water reuse facility through two bonds issued bythe City of Garnett - Utility System Revenue Bonds (“USR Bonds”) and CommunityDevelopment Block Grant Bonds (“CDBG Bonds”). The USR Bonds require annual principal payments beginning on October 1,2006 and continue through 2015.  Interest on USR Bonds is at ratesranging from 4.6% to 5.2% and is due semi-annually beginning April 1,2006.  The CDBG Bonds require semi-annualprincipal and interest payments beginning on July 1, 2006 

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and continuethrough 2015, at a fixed interest rate of 2%. As of March 31, 2007, the principal balance on the USR Bonds was$485,000 and the principal balance on the CDBG Bonds was $323,552.

ContractualObligations and Commercial Commitments.  There was no material changes in ourcontractual obligations and commercial commitments during the three monthsended March 31, 2007.

**Distributionto Unit Holders**

The loan agreement with Home Federal Savings Banklimits distributions to our members; except we may distribute up to 50% of ournet income if our lender has received audited financial statements for thefiscal year demonstrating our compliance with all financial ratio requirementsand loan covenants before and after any distributions to the members.  Wetake all of these factors into consideration, in addition to our anticipatedcash requirements for future operations, in evaluating the propriety of anyfuture distributions to members.

OnMarch 21, 2007, our board of directors approved a cash distribution of $132 perunit to the holders of membership units of record at the close of business onDecember 31, 2006 for a total payment of $2,890,536.  We expect that this distribution will notaffect our ability to maintain financial covenants and meet operating costs.

**Applicationof Critical Accounting Estimates**

There was nomaterial changes in our accounting estimates during the three months endedMarch 31, 2007.

**OffBalance Sheet Arrangements.**

We do not have any off-balance sheet arrangements.

**ITEM 3.**                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Weare exposed to the impact of market fluctuations associated with commodityprices as discussed below.  We have noexposure to foreign currency risk as all of our business is conducted in U.S.Dollars. We use derivative financial instruments as part of an overall strategyto manage market risk. We use cash, futures and option contracts to hedgechanges to the commodity prices of corn, natural gas and ethanol. We do not enterinto these derivative financial instruments for trading or speculativepurposes, nor do we designate these contracts as hedges for accounting purposespursuant to the requirements of SFAS 133, *Accountingfor Derivative Instruments and Hedging Activities*.

**CommodityPrice Risk**

Weare also exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn andnatural gas in the ethanol production process and from fluctuations in theprice of ethanol that we sell.  We seek to minimize the risks fromfluctuations in the prices of corn, natural gas and ethanol through the use ofhedging instruments.  In practice, as markets move, we actively manage ourrisk and adjust hedging strategies as appropriate.  Although we believeour hedge positions accomplish an economic hedge against our future purchases,they are not designated as such for hedge accounting purposes, which wouldmatch the gain or loss on our hedge positions to the specific commodity purchasebeing hedged.  We are marking to market our hedge positions, which meansas the current market price of our hedge positions changes, the gains andlosses are immediately recognized in our cost of sales.

Theimmediate recognition of hedging gains and losses 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.  We recorded a net loss of approximately $1,087,124 related toderivative instruments for the three months ended March 31, 2007.  We recorded a net loss of approximately$489,289 related to derivative instruments for the three months ended March 31,2006.  There are several variables that could affect the extent to whichour derivative instruments are impacted by price fluctuations in the cost ofcorn, natural gas or ethanol.  However, it is likely that commodity cashprices will have the greatest impact on the derivatives instruments withdelivery dates nearest the current cash price.

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Tomanage our corn price risk, our hedging strategy is designed to establish aprice ceiling and floor for our corn purchases.  We have taken a net longposition on our exchange traded futures and options contracts, which allows usto offset increases or decreases in the market price of corn.  The upperlimit of loss on our futures contracts is the difference between the contractprice and the cash market price of corn at the time of the execution of thecontract. The upper limit of loss on our exchange traded and over-the-counteroption contracts is limited to the amount of the premium we paid for theoption.

Weestimate that our expected corn usage is approximately 14 million bushels peryear for the production of 40 million gallons of ethanol.  We have priceprotection for approximately 80% of our expected corn usage for fiscal yearended December 31, 2007 using CBOT futures and options and Over theCounter option contracts.  As we move forward, additional protection maybe 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.  As wemove forward, additional price protection may be required to solidify ourmargins into fiscal year 2008.  Depending on market movements, cropprospects and weather, these price protection positions may cause immediateadverse effects, but are expected to produce long-term positive growth for us.

Wehave price protection in place for approximately 10% of our natural gas needsfor fiscal year ended December 31, 2007 using CBOT futures and options and Overthe Counter option contracts.    As wemove forward, additional price protection may be required to solidify ourmargins into fiscal year 2008.  However,we may not be able to secure natural gas for prices less than current marketprice and we may not recover high costs of production resulting from highnatural gas prices, which may raise our costs of production and reduce our netincome.

Asensitivity analysis has been prepared to estimate our exposure to corn andnatural gas price risk. The table presents the fair value of our derivativeinstruments as of March 31, 2007 and December 31, 2006 and the potential lossin fair value resulting from a hypothetical 10% adverse change in such prices.The fair value of the positions is a summation of the fair values calculated byvaluing each net position at quoted market prices as of the applicable date.The results of this analysis, which may differ from actual results, are asfollows:
| ** **        | ** ** | **Fair Value** | ** ** | **Effect of Hypothetical  Adverse  Change — Market Risk** | ** ** |
|-------------------|------------|---------------------|------------|-----------------------------------------------------------------------------------------|------------|
| March 31, 2007    |       | $                   | 258,628    |                                                                                    |       | $ | (25,863 | ) |   |
| December 31, 2006 |       | $                   | 1,345,752  |                                                                                    |       | $ | (134,575 | ) |   |

 

**ITEM 4.**                    CONTROLS ANDPROCEDURES.

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 and Principal Financial Officer, to allow for timely decisionsregarding required disclosure.   Indesigning and evaluating the disclosure controls and procedures, the PrincipalExecutive Officer and Principal Financial Officer recognize that any controlsand procedures, 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 the cost-benefitrelationship of possible controls and objectives.

Ourmanagement (including the Principal Executive Officer and Principal FinancialOfficer) has evaluated the effectiveness of our disclosure controls andprocedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as ofthe end of the period covered by this Quarterly Report on Form 10-Q.  Based on such evaluation, The PrincipalExecutive Officer and Principal Financial Officer have agreed that, as of theend of such period, our disclosure controls and procedures are effective inrecording, processing, summarizing and reporting, on a timely basis,information required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act.

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Ourmanagement (including the Principal Executive Officer and Principal FinancialOfficer) has reviewed and evaluated any changes in our internal control overfinancial reporting that occurred as of March 31, 2007 and there has been nochange that has materially affected or is reasonably likely to materiallyaffect our internal control over financial reporting.

**PART II — OTHER INFORMATION**

**ITEM 1. **              LEGAL PROCEEDINGS.

Nomaterial developments have occurred in the three months ended March 31, 2007.

**ITEM 1A.**           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-KSB for the year ended December31, 2006.  In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form10-KSB for the year ended December 31, 2006, which could materially affectour business, financial condition or future results. The risks described in ourAnnual Report on Form 10-KSB are not the only risks facing us.  Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

**ITEM 2. **              UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS.

None.

**ITEM 3.  **              DEFAULTS UPON SENIORSECURITIES.

None.

**ITEM 4.  **              SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS.

None.

**ITEM 5.  **              OTHER INFORMATION.

None.

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**ITEM 6.**                    EXHIBITS.

The following exhibits are filed as part of thisreport.  Exhibits previously filed areincorporated 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)      |
|             |       |                                                 |
| 32.1             |       | Certificate  Pursuant to 18 U.S.C. Section 1350 |
|             |       |                                                 |
| 32.2             |       | Certificate  Pursuant to 18 U.S.C. Section 1350 |

 

**SIGNATURES**

In accordance with Section 13 or 15(d) ofthe Exchange Act, the registrant caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.
|        |         |   | EAST KANSAS AGRI-ENERGY, LLC                                            |
|--------|--------------|--------|-------------------------------------------------------------------------|
|   |         |   |                                                                    |
| Date:  | May 11, 2007 |   | /s/ William R. Pracht                                                   |
|   |         |   | William R. Pracht                                                       |
|   |         |   | President (Principal Executive Officer)                                 |
|   |         |   |                                                                    |
| Date:  | May 11, 2007 |   | /s/ Thomas D. Leitnaker                                                 |
|   |         |   | Thomas D. Leitnaker                                                     |
|   |         |   | Chief Financial Officer (Principal Financial &  Accounting Officer) |

 

 

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