Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x** | **Quarterly report under Section 13 or  15(d) of the Securities Exchange Act of 1934.** |
|-------|---------------------------------------------------------------------------------------------------|

 

**For the fiscal quarter ended July 31,2009**

 

**OR**

 
| **o** | **Transition report under Section 13 or  15(d) of the Exchange Act.** |
|-------|---------------------------------------------------------------------------------|

 

**For the transition periodfrom            to             .**

 

**COMMISSION FILE NUMBER 000-51825**

** **

**HERON LAKE BIOENERGY, LLC**

(Exact name of Registrant as specified in its charter)

 

| **Minnesota**                                 | ** ** | **41-2002393**                       |
|-----------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of organization) |       | (I.R.S. Employer Identification No.) |

 

**91246 390****th**** Avenue,Heron Lake, MN 56137-1375**

(Address of principal executive offices)

 

**(507) 793-0077**

(Issuer’s telephone number)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  x  Yes  o  No

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  o  Yes  o  No

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

(Do not check if a smaller reporting company) |   | Smaller reporting company  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

 

As of September 11, 2009, there were 27,104,625 Class Aunits outstanding.

 

 

** **

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**INDEX**

 
| ** **                                                                                               | **Page No.** |
|----------------------------------------------------------------------------------------------------------|-------------------|
| PART I. FINANCIAL INFORMATION                                                                       |              |
| Item 1. Financial Statements                                                                        | 1                 |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 13                |
| Item 4. Controls and Procedures                                                                     | 19                |
| PART II. OTHER INFORMATION                                                                          |              |
| Item 1A. Risk Factors                                                                                    | 20                |
| Item 3. Defaults Upon Senior Securities                                                             | 20                |
| Item 6. Exhibits                                                                                    | 21                |
| SIGNATURES                                                                                               | 22                |

 

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**PART I.  FINANCIALINFORMATION**

 

**Item 1.  FinancialStatements**

 

**HERON LAKE BIOENERGY, LLC ANDSUBSIDIARY**

 

Condensed Consolidated Balance Sheets

 
| ** **                       | ** ** | **July 31,** | ** **  | **October 31,** | ** ** |
|----------------------------------|------------|-------------------|-------------|----------------------|------------|
| ** **                       | ** ** | **2009**          | ** **  | **2008**             | ** ** |
| ** **                       | ** ** | **(Unaudited)**   | ** **  | ** **           | ** ** |
| **ASSETS**                       |       |              |        |                 |       |
| **Current  Assets**              |       |              |        |                 |       |
| Cash and  equivalents            |       | $                 | 1,057,481   |                 | $          | 11,355,075 |   |
| Restricted cash                  |       | 338,523           |        | 1,499,472            |       |
| Accounts  receivable             |       | 2,737,334         |        | 3,368,076            |       |
| Inventory                        |       | 7,443,936         |        | 9,633,749            |       |
| Derivative instruments           |       | —            |        | 750,172              |       |
| Prepaid expenses                 |       | 339,062           |        | 616,641              |       |
| Total current  assets            |       | 11,916,336        |        | 27,223,185           |       |
|                             |       |              |        |                 |       |
| **Property  and equipment**      |       |              |        |                 |       |
| Land and  improvements           |       | 12,571,092        |        | 12,552,721           |       |
| Plant buildings  and equipment   |       | 97,367,057        |        | 97,159,759           |       |
| Vehicles and  other equipment    |       | 618,710           |        | 597,921              |       |
| Office buildings  and equipment  |       | 616,871           |        | 597,508              |       |
|                             |       | 111,173,730       |        | 110,907,909          |       |
| Less accumulated  depreciation   |       | 11,207,940        |        | 7,025,870            |       |
|                             |       | 99,965,790        |        | 103,882,039          |       |
|                             |       |              |        |                 |       |
| **Other  Assets**                |       |              |        |                 |       |
| Deferred loan  costs, net        |       | —            |        | 467,128              |       |
| Restricted cash                  |       | 827,750           |        | 995,804              |       |
| Other  intangibles               |       | 497,102           |        | 464,304              |       |
| Debt service  deposits and other |       | 398,700           |        | 368,350              |       |
| Total other  assets              |       | 1,723,552         |        | 2,295,586            |       |
|                             |       |              |        |                 |       |
| **Total  Assets**                |       | $                 | 113,605,678 |                 | $          | 133,400,810 |   |

 

See Notes toCondensed Consolidated Financial Statements

 

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**HERON LAKE BIOENERGY, LLC ANDSUBSIDIARY**

 

Condensed Consolidated Balance Sheets

 
| ** **                                                           | ** ** | **July 31,** | ** **  | **October 31,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------|-------------|----------------------|------------|
| ** **                                                           | ** ** | **2009**          | ** **  | **2008**             | ** ** |
| ** **                                                           | ** ** | **(Unaudited)**   | ** **  | ** **           | ** ** |
| **LIABILITIES AND MEMBERS’ EQUITY**              |       |              |        |                 |       |
| **Current  Liabilities**                                             |       |              |        |                 |       |
| Line of credit                                                       |       | $                 | 5,000,000   |                 | $          | — |   |
| Current  maturities of long-term debt                                |       | 56,347,040        |        | 5,649,354            |       |
| Accounts  payable:                                                   |       |              |        |                 |       |
| Trade accounts  payable                                              |       | 1,748,983         |        | 5,635,204            |       |
| Trade accounts  payable — related party                         |       | 797,496           |        | 792,450              |       |
| Construction  payable — related party                           |       | 3,839,413         |        | 3,839,413            |       |
| Accrued expenses                                                     |       | 497,808           |        | 512,709              |       |
| Accrued losses  on forward contracts                                 |       | 2,550,325         |        | 7,122,966            |       |
| Total current  liabilities                                           |       | 70,781,065        |        | 23,552,096           |       |
|                                                                 |       |              |        |                 |       |
| **Long-Term  Debt,** net of  current maturities                      |       | 5,051,315         |        | 59,265,534           |       |
|                                                                 |       |              |        |                 |       |
| **Commitments  and Contingencies**                                   |       |              |        |                 |       |
|                                                                 |       |              |        |                 |       |
| **Members’  Equity, 27,104,625 Class A units outstanding** |       | 37,773,298        |        | 50,583,180           |       |
|                                                                 |       |              |        |                 |       |
| **Total  Liabilities and Members’ Equity**                      |       | $                 | 113,605,678 |                 | $          | 133,400,810 |   |

 

See Notes toCondensed Consolidated Financial Statements

 

2

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**HERON LAKE BIOENERGY, LLC ANDSUBSIDIARY**

 

Condensed Consolidated Statements of Operations

 
| ** **                                                  | ** ** | **Three Months  Ended July 31,** | ** ** | **Three Months  Ended July 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                   | ** ** | **2008**                                        | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                            | ** ** | **(Unaudited)**                                 | ** ** |
|                                                        |       |                                       |       |                                            |       |
| **Revenues**                                                |       | $                                          | 22,196,118 |                                            | $          | 34,815,685 |   |
|                                                        |       |                                       |       |                                            |       |
| **Cost  of Goods Sold**                                     |       |                                       |       |                                            |       |
| Cost of goods  sold                                         |       | 21,420,797                                 |       | 27,290,998                                      |       |
| Lower of cost or  market adjustment                         |       | 1,863,605                                  |       | —                                          |       |
| Total cost of goods sold                                    |       | 23,284,402                                 |       | 27,290,998                                      |       |
|                                                        |       |                                       |       |                                            |       |
| **Gross  Margin (Loss)**                                    |       | (1,088,284                                 | )          | 7,524,687                                       |       |
|                                                        |       |                                       |       |                                            |       |
| **Operating  Expenses**                                     |       | 1,632,166                                  |       | 750,108                                         |       |
|                                                        |       |                                       |       |                                            |       |
| **Operating  Income (Loss)**                                |       | (2,720,450                                 | )          | 6,774,579                                       |       |
|                                                        |       |                                       |       |                                            |       |
| **Other  Income (Expense)**                                 |       |                                       |       |                                            |       |
| Interest income                                             |       | 13,606                                     |       | 21,871                                          |       |
| Interest expense                                            |       | (1,081,480                                 | )          | (1,086,936                                      | )          |
| Other income,  net                                          |       | 3,177                                      |       | —                                          |       |
| Total other  expense, net                                   |       | (1,064,697                                 | )          | (1,065,065                                      | )          |
|                                                        |       |                                       |       |                                            |       |
| **Net  Income (Loss)**                                      |       | $                                          | (3,785,147 | )                                               | $          | 5,709,514 |   |
|                                                        |       |                                       |       |                                            |       |
| **Net  Income (Loss) Per Unit - Basic and Diluted**         |       | $                                          | (0.14      | )                                               | $          | 0.21 |   |
|                                                        |       |                                       |       |                                            |       |
| **Weighted  Average Units Outstanding - Basic and Diluted** |       | 27,104,625                                 |       | 27,104,625                                      |       |

 

See Notes toCondensed Consolidated Financial Statements

 

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**HERON LAKE BIOENERGY, LLC ANDSUBSIDIARY**

 

Condensed Consolidated Statements of Operations

 
| ** **                                                  | ** ** | **Nine Months  Ended July 31,** | ** **  | **Nine Months  Ended July 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|-------------|-------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                  | ** **  | **2008**                                  | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                           | ** **  | **(Unaudited)**                           | ** ** |
|                                                        |       |                                      |        |                                      |       |
| **Revenues**                                                |       | $                                         | 61,784,588  |                                      | $          | 100,387,350 |   |
|                                                        |       |                                      |        |                                      |       |
| **Cost  of Goods Sold**                                     |       |                                      |        |                                      |       |
| Cost of goods  sold                                         |       | 62,540,473                                |        | 77,946,713                                |       |
| Lower of cost or  market adjustment                         |       | 5,321,835                                 |        | —                                    |       |
| Total cost of goods sold                                    |       | 67,862,308                                |        | 77,946,713                                |       |
|                                                        |       |                                      |        |                                      |       |
| **Gross  Margin (Loss)**                                    |       | (6,077,720                                | )           | 22,440,637                                |       |
|                                                        |       |                                      |        |                                      |       |
| **Operating  Expenses**                                     |       | 3,368,503                                 |        | 2,282,316                                 |       |
|                                                        |       |                                      |        |                                      |       |
| **Operating  Income (Loss)**                                |       | (9,446,223                                | )           | 20,158,321                                |       |
|                                                        |       |                                      |        |                                      |       |
| **Other  Income (Expense)**                                 |       |                                      |        |                                      |       |
| Interest income                                             |       | 65,478                                    |        | 59,536                                    |       |
| Interest expense                                            |       | (3,005,009                                | )           | (3,825,190                                | )          |
| Write-off of  loan costs                                    |       | (444,985                                  | )           | —                                    |       |
| Other income,  net                                          |       | 20,854                                    |        | 32,665                                    |       |
| Total other  expense, net                                   |       | (3,363,662                                | )           | (3,732,989                                | )          |
|                                                        |       |                                      |        |                                      |       |
| **Net  Income (Loss)**                                      |       | $                                         | (12,809,885 | )                                         | $          | 16,425,332 |   |
|                                                        |       |                                      |        |                                      |       |
| **Net  Income (Loss) Per Unit - Basic and Diluted**         |       | $                                         | (0.47       | )                                         | $          | 0.61 |   |
|                                                        |       |                                      |        |                                      |       |
| **Weighted  Average Units Outstanding - Basic and Diluted** |       | 27,104,625                                |        | 27,104,625                                |       |

 

See Notes toCondensed Consolidated Financial Statements

 

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**HERON LAKE BIOENERGY, LLC ANDSUBSIDIARY**

Condensed Consolidated Statements of Cash Flows

 
| ** **                                                                         | ** ** | **Nine Months  Ended July 31,** | ** **  | **Nine Months  Ended July 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------|-------------|-------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                  | ** **  | **2008**                                  | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                           | ** **  | **(Unaudited)**                           | ** ** |
| **Operating  Activities**                                                          |       |                                      |        |                                      |       |
| Net income  (loss)                                                                 |       | $                                         | (12,809,885 | )                                         | $          | 16,425,332 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                      |        |                                      |       |
| Depreciation and  amortization                                                     |       | 4,209,107                                 |        | 4,193,087                                 |       |
| Amortization of  loan costs included with interest expense                         |       | 22,143                                    |        | 68,373                                    |       |
| Write-off of  loan costs                                                           |       | 444,985                                   |        | —                                    |       |
| Lower of cost or  market adjustments                                               |       | 5,321,835                                 |        | —                                    |       |
| Loss on disposal  of assets                                                        |       | —                                    |        | 21,600                                    |       |
| Change in fair  value of derivative instruments                                    |       | —                                    |        | (1,817,777                                | )          |
| Change in  operating assets and liabilities:                                       |       |                                      |        |                                      |       |
| Restricted cash                                                                    |       | 1,023,888                                 |        | (601,388                                  | )          |
| Accounts  receivable                                                               |       | 630,742                                   |        | 1,288,794                                 |       |
| Inventory                                                                          |       | 1,840,272                                 |        | 8,509,261                                 |       |
| Derivative  instruments                                                            |       | 750,172                                   |        | (1,335,187                                | )          |
| Prepaid expenses                                                                   |       | 277,579                                   |        | (871,743                                  | )          |
| Accounts payable                                                                   |       | (3,881,175                                | )           | (6,663,825                                | )          |
| Accrued expenses                                                                   |       | (14,901                                   | )           | (332,606                                  | )          |
| Accrued loss on  forward contracts                                                 |       | (9,544,935                                | )           | —                                    |       |
| Net cash  provided by (used in) operating activities                               |       | (11,730,173                               | )           | 18,883,921                                |       |
|                                                                               |       |                                      |        |                                      |       |
| **Investing  Activities**                                                          |       |                                      |        |                                      |       |
| Proceeds from  sale of assets                                                      |       | —                                    |        | 194,898                                   |       |
| Payments for  intangibles                                                          |       | (59,835                                   | )           | (474,183                                  | )          |
| Capital  expenditures                                                              |       | (265,821                                  | )           | (863,169                                  | )          |
| Net cash used in  investing activities                                             |       | (325,656                                  | )           | (1,142,454                                | )          |
|                                                                               |       |                                      |        |                                      |       |
| **Financing  Activities**                                                          |       |                                      |        |                                      |       |
| Checks written  in excess of bank balance                                          |       | —                                    |        | (514,633                                  | )          |
| Proceeds from  line of credit, net                                                 |       | 5,000,000                                 |        | (6,974,235                                | )          |
| Payments on  notes payable — related party                                    |       | —                                    |        | (4,202,930                                | )          |
| Payments of  long-term debt                                                        |       | (3,528,019                                | )           | (3,942,127                                | )          |
| Proceeds from  issuance of long-term debt                                          |       | 11,486                                    |        | 3,289,177                                 |       |
| Debt service  deposits included with other assets                                  |       | (30,350                                   | )           | (170,075                                  | )          |
| Release of  restricted cash                                                        |       | 305,118                                   |        | 165,064                                   |       |
| Net cash  provided by (used in) financing activities                               |       | 1,758,235                                 |        | (12,349,759                               | )          |
|                                                                               |       |                                      |        |                                      |       |
| **Net  increase (decrease) in cash and equivalents**                               |       | (10,297,594                               | )           | 5,391,708                                 |       |
|                                                                               |       |                                      |        |                                      |       |
| **Cash  and Equivalents****— Beginning of Period**                            |       | 11,355,075                                |        | 3,090,329                                 |       |
|                                                                               |       |                                      |        |                                      |       |
| **Cash  and Equivalents — End of Period**                                     |       | $                                         | 1,057,481   |                                      | $          | 8,482,037 |   |
| ** **                                                                         |       |                                      |        |                                      |       |   |   |
| **Supplemental  Cash Flow Information**                                            |       |                                      |        |                                      |       |
| Total interest  paid                                                               |       | $                                         | 2,989,903   |                                      | $          | 4,012,327 |   |
|                                                                               |       |                                      |        |                                      |       |   |   |
| **Supplemental  Disclosure of Noncash Investing and Financing Activities**         |       |                                      |        |                                      |       |
| Restricted cash  from long term debt proceeds                                      |       | $                                         | —      |                                      | $          | 1,710,000 |   |

 

Notes to Condensed Consolidated Financial Statementsare an integral part of these Statements.

 

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**1.**                                      **SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

The accompanying unaudited condensed consolidatedinterim financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information anddisclosures normally included in annual financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted as permitted by such rules andregulations. These financial statements and related notes should be read inconjunction with the financial statements and notes thereto included in theCompany’s annual report on Form 10-K for the year ended October 31,2008.

 

In the opinion of management, the condensedconsolidated interim financial statements reflect all adjustments (consistingof normal recurring accruals, with the exception of the adjustments towrite-off deferred loan costs and to reclassify certain debt as current) thatare considered necessary to present fairly the Company’s results of operations,financial position and cash flows. The results reported in these condensedconsolidated interim financial statements should not be regarded as necessarilyindicative of results that may be expected for any other quarter or for thefiscal year.

 

*Natureof Business*

 

The Company owns and operates a 50 million gallonethanol plant near Heron Lake, Minnesota with ethanol distribution to upperMidwest states. In addition, the Company produces and sells distillers grainswith solubles as co-products of ethanol production.  The Company incurred unusual costs ofapproximately $651,000, included with operating expenses, associated with thecollapse of certain equipment during the three months ended July 31, 2009.

 

*AccountingEstimates*

 

Management uses estimates and assumptions in preparingthese financial statements in accordance with generally accepted accountingprinciples. Those estimates and assumptions affect the reported amounts ofassets and liabilities, the disclosure of contingent assets and liabilities,and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significantmatters including, among others, the carrying value and useful lives ofproperty and equipment, estimates of losses on forward contract commitments andinventory, and analysis of future projections, resolution of debt terms andother assumptions in consideration of continuing as a going concern. Managementperiodically reviews these estimates and assumptions, and makes adjustmentswhen circumstances have changed, with the effects of revisions reflected in theperiod in which the revision is made. Actual results could differ from thoseestimates.

 

*RevenueRecognition*

 

The Company generally sells ethanol and relatedproducts pursuant to marketing agreements. Revenues are recognized when themarketing company (the “customer”) has taken title and has assumed the risksand rewards of ownership, prices are fixed or determinable and collectabilityis reasonably assured.

 

*DerivativeInstruments*

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and HedgingActivities*, an amendment of FASB Statement No. 133. SFAS 161applies to all derivative instruments and nonderivative instruments that aredesignated and qualify as hedging instruments pursuant to paragraphs 37 and 42of SFAS 133 and related hedged items accounted for under SFAS 133. SFAS 161requires entities to provide greater transparency through additionaldisclosures about how and why an entity uses derivative instruments, howderivative instruments and related hedged items are accounted for under SFAS133 and its related interpretations, and how derivative instruments and relatedhedged items affect an entity’s financial position, results of operations, andcash flows. SFAS 161 is effective for the Company’s fiscal quarter ended April 30,2009. Because SFAS 161 requires enhanced disclosures but does not modify theaccounting treatment of derivative instruments and hedging activities, theCompany believes the adoption of this standard had no impact on its financialposition, results of operations, or cash flows. The additional disclosures required by this standard are included inNote 6.

 

## *Long-LivedAssets*

## * *

Long-lived assets, such as property, plant, and equipmentsubject to amortization, are reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. If circumstances require a long-lived asset be tested for possibleimpairment, the Company first compares undiscounted cash flows expected to begenerated by an asset to the carrying value of the asset. If the carrying valueof the long-lived asset is not recoverable on an undiscounted cash flow basis,an impairment is recognized to the extent that the carrying value exceeds itsfair value. Fair value is determined through various valuation techniquesincluding discounted cash flow models, quoted market values and third-partyindependent appraisals, as considered necessary.

 

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The Company’s ethanol production facilities, has aninstalled capacity of 50 million gallons per year.  The carrying value of these facilities at July 31,2009 was approximately $99 million. In accordance with the Company’spolicy for evaluating impairment of long-lived assets described above,management has evaluated the recoverability of the facilities based onprojected future cash flows from operations over the facilities’ estimateduseful lives. Management has determined that the projected future undiscountedcash flows from operations of these facilities exceed their carrying value at July 31,2009; therefore, no impairment loss was indicated or recognized. In determiningthe projected future undiscounted cash flows, the Company has made significantassumptions concerning the future viability of the ethanol industry, the futureprice of corn in relation to the future price of ethanol and the overall demandin relation to production and supply capacity. Given the uncertainties in the ethanol industry, should management berequired to adjust the carrying value of the facilities at some future point intime, the adjustment could be significant and could significantly impact theCompany’s financial position and results of operations.  No adjustment has been made to thesefinancial statements for this uncertainty.

 

*RecentlyAdopted Accounting Pronouncements*

 

# In April 2009,the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about FairValue of Financial Instruments”. FSP FAS 107-1 and APB 28-1 require disclosuresabout fair value of financial instruments for interim reporting periods as wellas in annual financial statements. This new accounting standard was adopted forour financial statements as of and for the three months ending July 31,2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material impacton our financial statements.

#  

In May 2009, theFASB issued Statement of Financial Accounting Standards No. 165 (SFAS165), “Subsequent Events”. SFAS 165 establishes the general standards of accountingfor and disclosure of subsequent events. In addition, it requires disclosure ofthe date through which an entity has evaluated subsequent events and the basisfor that date. This new accounting standard was adopted for our financialstatements as of and for the three months ending July 31, 2009. Theadoption of SFAS 165 did not have a material impact on our financialstatements.

 

*FinancialInstruments*

 

TheCompany believes the carrying value of cash and equivalents and restricted cashapproximate fair value.

 

TheCompany believes the carrying amount of the line of credit approximates thefair value due to the variable interest rate and short-term nature of the debt.

 

Thecarrying amount of the debt financing exceeded the fair value at July 31,2009 and October 31, 2008. Due to declining interest rates during 2008 and2009 along with having fixed the interest rate on debt as noted in Note 8, thecarrying amount of the debt financing was less than the fair value as follows:

 
| ** **                    | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** |
|-------------------------------|------------|--------------------------|------------|---------------------|------------|
|                          |       |                     |       |                |       |
| Debt at July 31, 2009    |       | $                        | 61,398,355 |                | $          | 61,694,750 |   |
| Debt at October 31, 2008 |       | $                        | 64,914,888 |                | $          | 66,043,522 |   |

 

**2.**                                      **GOING CONCERN**

 

The financial statements have been prepared on agoing-concern basis, which contemplates the recoverability of assets and thesatisfaction of liabilities in the normal course of business. Significantvolatility in the commodity markets and a decline in ethanol prices have causemargins in the ethanol industry to be negative. The Company incurred a loss ofapproximately $3.8 million and used cash of approximately $1.9 million foroperating activities during the three months ended July 31, 2009.  For the nine months ended July 31, 2009,the Company incurred a loss of approximately $12.8 million and used cash ofapproximately $11.7 million for operating activities.  At July 31, 2009 as at April 30,2009 and January 31, 2009, the Company was out of compliance with theminimum working capital requirement provision of its master loan agreement withAgStar Financial Services, PCA (AgStar). In addition, the Company anticipatesthat the minimum net worth and fixed charge coverage ratio covenants will notbe met through or as of fiscal year end 2009 unless amended. At January 31,2009, the Company reclassified the long-term debt related to this agreement tocurrent liabilities because the Company was not in compliance with the minimumworking capital requirement. That reclassification remains as of July 31,2009 because of the actual and anticipated covenant default stated above.Additionally, the Company expensed the remaining unamortized loan coststotaling approximately $445,000 associated with this debt during the quarterended January 31, 2009. If AgStar exercises its right to accelerate thematurity of the debt outstanding under the master loan agreement or the line ofcredit, the Company will not have adequate available cash to repay the amountscurrently outstanding at July 31, 2009. Further, while an event of defaultexists, the Company is not permitted to borrow additional funds under itsline of credit or revolving term note without AgStar’s consent. These factorsraise substantial doubt about the Company’s ability to continue as a goingconcern.

 

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On June 12, 2009, the Company and AgStar agreedupon the terms of the renewal of the Company’s line of credit effective May 29,2009.  Therefore, effective May 29,2009, the Company entered into an Amendment No. 3 to the Fifth Supplement(the “Amendment”) to its master loan agreement, as previously amended andsupplemented, with AgStar.  Among otherthings, the effect of this amendment was to renew the Company’s revolving lineof credit loan at a maximum commitment of $6,750,000 and a maturity date of November 1,2009.  In connection with the renewal,AgStar also waived the Company’s noncompliance with the working capitalcovenant of the master loan agreement as of and for the periods ending January 31,2009 and April 30, 2009.  AgStaralso waived excess cash flow payment provisions for the year ended October 31,2008 in consideration of an excess cash flow payment by the Company of $94,700on June 12, 2009.  The balance dueof the October 31, 2008 excess cash flow payment in the amount of$1,799,300 is deferred until such time as the Company makes a request to theLender for certain distributions to its members.  On September 9, 2009, AgStar waived theCompany’s noncompliance with the working capital covenant of the master loanagreement for the period ended July 31, 2009.

 

With the extension of the revolving line of credit on June 12,2009 and effective May 29, 2009, the Company believes it has sufficientcapital resources through July 31, 2010 based upon its current cashreserves, inventory sales, anticipated revenues and the available borrowingunder the master loan agreement, as well as the effect of expense reductionmeasures, provided that the Company is not otherwise required to repay itsindebtedness to AgStar under the master loan agreement. The Company’s expensereduction measures and cash conservation measures include utilizing andreducing corn inventory as well as reducing operating expenses through costcontrols.  If the current industry conditionscontinue and the Company is not able to maintain sufficient funding in theshort-term, the Company may be forced to raise additional capital throughsubordinated debt, if available, sell additional equity, restructure orsignificantly curtail its operations, file for bankruptcy or ceaseoperations.  The financial statements donot include any adjustments relating to the recoverability and classificationof recorded asset amounts or amounts and classification of liabilities thatmight be necessary should the Company be forced to take any such actions*.*

 

**3.**                                      **UNCERTAINTIES**

 

The Company has certain risks and uncertainties thatit experienced during volatile market conditions such as what the Companyexperienced during fiscal 2008 and 2009. These volatilities can have a severe impact on operations. The Company’srevenues are derived from the sale and distribution of ethanol and distillersgrains to customers primarily located in the U.S. Corn for the productionprocess is supplied to the plant primarily from local agriculturalproducers.  Ethanol sales average 75% -84% of total revenues and corn costs average 58% - 75% of cost of goods sold.

 

The Company’s operating and financial performance islargely driven by the prices at which it sells ethanol and the net expense ofcorn. The price of ethanol is influenced by factors such as supply and demand,the weather, government policies and programs, unleaded gasoline prices and thepetroleum markets as a whole, although since 2005 the prices of ethanol and gasolinebegan a divergence with ethanol selling for less than gasoline at the wholesalelevel. Excess ethanol supply in the market, in particular, puts downwardpressure on the price of ethanol. The largest cost of production is corn. Thecost of corn is generally impacted by factors such as supply and demand, theweather, government policies and programs, and a risk management program usedto protect against the price volatility of these commodities. Marketfluctuations in the price of and demand for these products may have asignificant adverse effect on the Company’s operations, profitability and theavailability and adequacy of cash flow to meet the Company’s working capitalrequirements.

 

**4.**                                      **FAIR VALUE MEASUREMENTS**

 

Effective November 1, 2008, the Company adoptedStatement of Financial Accounting Standard No. 157, Fair ValueMeasurements (SFAS 157), as it applies to the financial instruments, andStatement of Financial Accounting Standard No. 159, The Fair Value Optionfor Financial Assets and Financial Liabilities — Including an amendment of FASBStatement No. 115 (SFAS 159). SFAS 157 defines fair value, outlines aframework for measuring fair value, and details the required disclosures aboutfair value measurements. SFAS 159 permits companies to irrevocably choose tomeasure certain financial instruments and other items at fair value. SFAS 159also establishes presentation and disclosure requirements designed tofacilitate comparison between entities that choose different measurementattributes for similar types of assets and liabilities.

 

Under SFAS 157, fair value is defined as the pricethat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date in theprincipal or most advantageous market. SFAS 157 establishes a hierarchy indetermining the fair value of an asset or liability. The fair value hierarchyhas three levels of inputs, both observable and unobservable. SFAS 157 requiresthe utilization of the lowest possible level of input to determine fair value.Level 1 inputs include quoted market prices in an active market for identicalassets or liabilities. Level 2 inputs are market data, other than Level 1, thatare observable either directly or indirectly. Level 2 inputs include quotedmarket prices for similar assets or liabilities, quoted market prices in aninactive market, and other observable information that can be corroborated bymarket data. Level 3 inputs are unobservable and corroborated by little or nomarket data.

 

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Except for those assets and liabilities, which arerequired by authoritative accounting guidance to be recorded at fair value inour balance sheets, the Company has elected not to record any other assets orliabilities at fair value, as permitted by SFAS 159. No events occurred duringthe quarter ended July 31, 2009 that would require adjustment to the recognizedbalances of assets or liabilities that are recorded at fair value on anonrecurring basis.

 

The following table provides information on thoseassets measured at fair value, as defined by SFAS 157, on a recurring basis.

 
| ** **                        | ** ** | **Fair Value as of** | ** ** | **Fair Value Measurement Using** | ** ** |
|-----------------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **July 31, 2009**         | ** ** | **Level 1**                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Restricted cash  — current   |       | $                                   | 338,523    |                                            | $          | 338,523 |   | $ | — |   | $ | — |   |
|                              |       |                                |       |                                            |       |   |   |   |   |
| Restricted cash  — long-term |       | $                                   | 827,750    |                                            | $          | 827,750 |   | $ | — |   | $ | — |   |

 

These items were previously and will continue to bemarked-to-market at each reporting period; however, the definition of fairvalue used for these mark-to-markets is applied using SFAS No. 157. Thefair value of restricted cash, which includes money market funds, is based onquoted market prices for identical assets in an active market.

 

**5.**                                      **INVENTORY**

 

Inventory consisted of the following at July 31,2009 and October 31, 2008:

 
| ** **      | ** ** | **July 31,** | ** ** | **October 31,** | ** ** |
|-----------------|------------|-------------------|------------|----------------------|------------|
| ** **      | ** ** | **2009**          | ** ** | **2008***            | ** ** |
| Raw materials   |       | $                 | 4,459,973  |                 | $          | 5,830,477 |   |
| Work in process |       | 764,388           |       | 1,200,242            |       |
| Finished goods  |       | 1,005,081         |       | 725,365              |       |
| Supplies        |       | 1,131,007         |       | 683,007              |       |
| Other grains    |       | 83,487            |       | 1,194,658            |       |
| Total           |       | $                 | 7,443,936  |                 | $          | 9,633,749 |   |

 

----

*                 Derived from audited financial statements

 

The Company recorded losses of approximately $95,000and $349,000 for the three and nine months ended July 31, 2009,respectively, related to inventory, in addition to losses recorded on forwardcontracts as noted in Note 9, where the market value was less than the costbasis, attributable primarily to decreases in market prices of corn andethanol. The loss was recorded with the lower of cost or market adjustment inthe statement of operations. At July 31, 2009 and October 31, 2008,the Company stored grain inventory for farmers. The value of these inventoriesowned by others is approximately $44,000 and $658,000 based on market prices atJuly 31, 2009 and October 31, 2008, respectively.

 

**6.**                                      **DERIVATIVE INSTRUMENTS**

 

As of July 31, 2009, the Company held nopositions in corn or ethanol derivative instruments, which are required to berecorded as either assets or liabilities at fair value in the Condensed BalanceSheet. Derivatives qualify for treatment as hedges when there is a highcorrelation between the change in fair value of the derivative instrument andthe related change in value of the underlying hedged item and when the Companyformally documents, designates, and assesses the effectiveness of transactionsthat receive hedge accounting initially and on an on-going basis. The Companymust designate the hedging instruments based upon the exposure being hedged asa fair value hedge or a cash flow hedge. The Company does not enter intoderivative transactions for trading purposes.

 

The Company enters into corn and ethanol derivativesin order to protect cash flows from fluctuations caused by volatility incommodity prices for periods up to 24 months. These derivatives are put inplace to protect gross profit margins from potentially adverse effects ofmarket and price volatility on ethanol sales and corn purchase commitmentswhere the prices are set at a future date. Although these derivativeinstruments serve the Company’s purpose as an economic hedge, they are notdesignated as effective hedges for accounting purposes. For derivativeinstruments that are not accounted for as hedges, or for the ineffectiveportions of qualifying hedges, the change in fair value is recorded throughearnings in the period of change. As of July 31, 2009, the Company did nothold any outstanding derivative instruments.

 

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The following tables provide details regarding thegains and (losses) from the Company’s derivative instruments in statementsof operations, none of which are designated as hedging instruments:

 
| ** **         | ** ** | **Statement of**        | ** ** | **Three-Months Ended July 31,** | ** ** |
|--------------------|------------|-------------------------|------------|--------------------------------------|------------|
| ** **         | ** ** | **Operations location** | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| Corn contracts     |       | Cost of goods  sold     |       | $                                    | 122,000    |   | $ | 920,000 |   |
| Ethanol  contracts |       | Revenues                |       | —                               |       | 2,022,000 |   |
| Totals             |       |                    |       | $                                    | 122, 000   |   | $ | 2,942,000 |   |

 
| ** **         | ** ** | **Statement of**        | ** ** | **Nine-Months Ended July 31,** | ** ** |
|--------------------|------------|-------------------------|------------|-------------------------------------|------------|
| ** **         | ** ** | **Operations location** | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| Corn contracts     |       | Cost of goods  sold     |       | $                                   | 1,208,000  |   | $ | 3,154,000 |   |
| Ethanol  contracts |       | Revenues                |       | 373,000                             |       | 1,116,000 |   |
| Totals             |       |                    |       | $                                   | 1,581,000  |   | $ | 4,270,000 |   |

 

**7.**                                      **LINE OF CREDIT**

 

The Company had a line of credit with AgStar subjectto certain borrowing base requirements. On June 12, 2009 and effective May 29, 2009, the Companyentered into an Amendment No. 3 to the Fifth Supplement (the “Amendment”)to its master loan agreement, as previously amended and supplemented, withAgStar.  Among other things, the effectof this amendment was to renew the Company’s revolving line of credit loan at amaximum commitment of $6,750,000 and a maturity date of November 1,2009.  In connection with the renewal,AgStar also waived the Company’s noncompliance with the working capitalcovenant of the master loan agreement as of and for the periods ending January 31,2009 and April 30, 2009.  Interestaccrues on borrowings at the one-month LIBOR plus 3.25%, which totaled 3.55% atJuly 31, 2009 and 5.74% at October 31, 2008. From May 1, 2009through May 29, 2009, AgStar added a 2.0% surcharge to the interest rateon the outstanding amounts under the Company’s master loan agreement.  The Company has a .25% commitment fee on theunused portion of the line of credit. As of July 31, 2009, the Company haddrawn $5,000,000 on the line. There was no balance outstanding on the line ofcredit at October 31, 2008.  As of July 31,2009, the Company was not in compliance with the minimum working capitalprovision of the master loan agreement.  On September 9, 2009, AgStar waived the Company’s noncompliancewith the working capital covenant of the master loan agreement for the periodended July 31, 2009.

 

**8.**                                      **DEBT FINANCING**

 

Debt financing consists of the following:

 
| ** **                                                   | ** ** | **July 31,** | ** ** | **October 31,** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **2009**          | ** ** | **2008***            | ** ** |
| Term note  payable to lending institution, see terms below   |       | $                 | 54,424,269 |                 | $          | 57,508,968 |   |
|                                                         |       |              |       |                 |       |
| Revolving term  note to lending institution, see terms below |       | 1,155,872         |       | 1,155,872            |       |
|                                                         |       |              |       |                 |       |
| Note payable to  County government                           |       | 100,000           |       | 100,000              |       |
|                                                         |       |              |       |                 |       |
| Assessments  payable                                         |       | 3,808,246         |       | 3,910,266            |       |
|                                                         |       |              |       |                 |       |
| Notes payable to  electrical company                         |       | 1,838, 441        |       | 2,173,826            |       |
|                                                         |       |              |       |                 |       |
| Equipment note                                               |       | 71,527            |       | 65,956               |       |
|                                                         |       |              |       |                 |       |
| Total                                                        |       | 61,398,355        |       | 64,914,888           |       |
|                                                         |       |              |       |                 |       |
| Less amounts due  on demand or within one year               |       | 56,347,040        |       | 5,649,354            |       |
|                                                         |       |              |       |                 |       |
| Net long term  debt                                          |       | $                 | 5,051,315  |                 | $          | 59,265,534 |   |

 

----

*                 Derived from audited financial statements

 

As described in Note 2, the Company does not expect tobe in compliance with covenants of the master loan agreement with AgStar as of October 31,2009 and has reclassified the long-term portion of the debt with AgStar tocurrent liabilities.

 

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*TermNote*

 

The term note requires monthly payments ofapproximately $640,000 of principal and interest. Interest accrues at theone-month LIBOR plus 3.25%, which totaled 3.55% and 5.74% at July 31, 2009and October 31, 2008, respectively. In May 2008, the Company lockedin an interest rate of 3.58% plus 3.00%, which totals 6.58% on $45,000,000 ofthe note, for three years ending April 30, 2011. As described in Notes 2and 7, as of July 31, 2009, the Company was not in compliance with thecovenants of the master loan agreement. On June 12, 2009, the Company received a waiver from AgStar as ofand for the periods ended January 31, 2009 and April 30, 2009.  However, the Company does not expect to be incompliance with one or more covenants of the master loan agreement as of October 31,2009 unless the covenants are amended. Therefore, the term note and the revolving term note described belowhave been classified as current liabilities. The term note originally had a tenyear amortization, with a final balloon payment due in October 2012. Inaddition, the Company is required to make additional payments on the term noteof excess cash flow, as defined in the agreement, up to $2,000,000 per year toAgStar until the Company meets a specified financial ratio. As part of the debtfinancing, the premium above LIBOR may be reduced based on the ratio of members’equity to assets. The owner of the general contractor, who is a member, haspersonally guaranteed up to $3,740,000 of the Company’s obligations under themaster loan agreement.  From May 1,2009 through May 29, 2009, AgStar added a 2.0% surcharge to the interestrate on the outstanding amounts under the Company’s master loan agreement.  On September 9, 2009, AgStar waived theCompany’s noncompliance with the working capital covenant of the master loanagreement for the period ended July 31, 2009.

 

*RevolvingTerm Note*

 

The Company has a revolving term note with AgStar forup to $5,000,000 for cash and inventory management purposes. The Company paysinterest on principal advances monthly at the one-month LIBOR rate plus 3.25%,which totaled 3.55% and 5.74% at July 31, 2009 and October 31, 2008respectively. The Company pays a commitment fee of 0.35% per annum on theunused portion of the revolving term note. As described above and in Note 2 and7, as of and for the period ending July 31, 2009, the Company was out ofcompliance with the master loan agreement and does not anticipate being incompliance as of and for the period ending October 31, 2009.  As such, amounts due under the revolving termnote have been classified as current liabilities.  From May 1, 2009 through May 29,2009, AgStar added a 2.0% surcharge to the interest rate on the outstandingamounts under the Company’s master loan agreement.   On September 9, 2009, AgStar waived theCompany’s noncompliance with the working capital covenant of the master loanagreement for the period ended July 31, 2009.

 

*Maturities*

 

The potential maturities of long-term debt at July 31,2009, are as follows:

 
| 2010                  |   | $         | 56,347,040 |   |
|-----------------------|--------|-----------|------------|--------|
| 2011                  |   | 693,219   |       |
| 2012                  |   | 719,631   |       |
| 2013                  |   | 564,834   |       |
| 2014                  |   | 374,959   |       |
| Thereafter            |   | 2,698,672 |       |
| Total long-term  debt |   | $         | 61,398,355 |   |

 

The estimated maturities include the term note and revolvingterm note as due currently.  As of July 31,2009, the Company was not in compliance with the covenants of the master loanagreement.  On June 12, 2009, theCompany received a waiver from AgStar as of and for the periods ended January 31,2009, and ended April 30, 2009. However, the Company does not expect to be in compliance with one ormore covenants of the master loan agreement through July 31, 2010**unless these covenants are amended.  If the Company does not negotiate amendmentsto these covenants or receive waivers for any default of any covenant of themaster loan agreement, it will be in default of the master loan agreement,which will entitle AgStar to accelerate all of the indebtedness under themaster loan agreement.   As such, $50.4million is included in amounts due within the next twelve months that wouldotherwise be classified as long-term. The Company continues to negotiate with AgStar regarding waivers andamendments to the master loan agreement, the receipt of which cannot be assured.

 

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**9.**                                      **COMMITMENTS ANDCONTINGENCIES**

 

*PlantConstruction*

 

The ethanol plant was constructed under a design-buildagreement with Fagen, Inc. as the design-builder. As of July 31,2009, the Company has paid $77.6 million and has retained approximately $3.8million in payments to Fagen, Inc. Final payment will be due once theplant meets certain operating performance criteria. The ethanol plant must meetcertain performance and emission standards and the general contractor retainsliability for failure to meet these standards. The Company continues to undergoperformance testing in fiscal 2009.

 

*ForwardContracts*

 

The Company has forward contracts in place for cornpurchases of approximately $10.9 million through March 2010, whichincludes $9.7 million through October 31, 2009 representing approximately54% of the Company’s anticipated purchases in fiscal 2009.

 

Currently, some of these corn contract prices areabove current market prices for corn and net realizable value once converted toethanol and distiller grains. If corn prices continue to decline, upon takingdelivery under these contracts, the Company would incur an additional loss. TheCompany had accrued losses on these purchase commitments of approximately $2.6million at July 31, 2009. This amount includes additional losses onpurchase commitments of approximately $1,758,000 and $4,962,000 in the threeand nine months ended July 31, 2009 respectively.  Losses on purchase commitments are recordedas in the lower of cost or market adjustment on the statement of operations.The amount of the loss was determined by applying a methodology similar to thatused in the lower of cost or market evaluation with respect to inventory. Giventhe uncertainty of future ethanol prices, this loss may or may not berecovered, and further losses on the outstanding purchase commitments could berecorded in future periods.

 

**10.****                              ****RELATED PARTYTRANSACTIONS**

 

During the three months ending July 31, 2009 and2008, the Company purchased corn from members for approximately $12.2 millionand $13.6 million, respectively.  TheCompany purchased corn from members of approximately $37.0 million and $32.1million during the nine months ended July 31, 2009 and 2008,respectively.  Purchases from memberscomprise the majority of total corn purchases for the respective periods.  Certain of the members are officers orgovernors of the Company or their respective affiliates.

 

**11.**                               **SUBSEQUENT EVENTS**

 

The Company has evaluated subsequent events through September 11,2009 the date which the financial statements were available to be issued.

 

On September 2, 2009, the Company entered into anEthanol Purchase and Marketing Agreement (the “Agreement”) with C&N EthanolMarketing Corporation (“C&N”).  Underthe Agreement, C&N will purchase, market and re-sell all of the ethanolproduced at the Company’s plant for the three year term of the Agreement.  Following the three year term, the Agreementwill automatically renew for subsequent year terms unless either partyterminates the agreement 60 days before the end of the term.  The Agreement contains provisions addressingpayment terms and other matters, including forecasting, the quality of product,transfer of title and auditing of records.

 

Additionally, the Company has notified RPMG, Inc.of the termination effective September 30, 2009 of the Ethanol FuelMarketing Agreement between the Company and RPMG, Inc. dated August 7,2006.

 

On September 9, 2009, AgStar waived the Company’snoncompliance with the working capital covenant of the master loan agreementfor the period ended July 31, 2009.

 

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**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

*This Management’s Discussion andAnalysis of Financial Condition and Results of Operations, contains, inaddition to historical information, forward-looking statements that are basedon our expectations, beliefs, intentions or future strategies.**Words such as “plan,” “expect,” “believe,”“project,” “anticipate,” “intend,” “estimate,” “could” and other words andterms of similar meaning, typically identify such forward-looking statements.**These statements aresubject to risks and uncertainties that could cause actual results to****differ materially fromthe statements because of certain factors, including those set forth under Part I,Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the yearended October 31, 2008 and Part II, Item 1A “Risk Factors” of thisQuarterly Report on Form 10-Q , as well as in other filings we make withthe Securities and Exchange Commission. All forward-looking statements includedherein are based on information available to us as of the date hereof, and weundertake no obligation to update any such forward-looking statements.*

 

The following is a discussion and analysis of HeronLake BioEnergy’s financial condition and results of operations as of and forthe three month and nine month periods ended July 31, 2008 and 2009. Thissection should be read in conjunction with the condensed consolidated financialstatements and related notes in Item 1 of this Quarterly Report and the Company’sAnnual Report on Form 10-K for the year ended October 31, 2008.

 

**Overview**

 

Heron Lake BioEnergy, LLC operates a coal-fired, drymill corn-based ethanol plant near Heron Lake, Minnesota. The plant has aname-plate capacity to produce 50 million gallons of denatured fuel gradeethanol and 160,000 tons of dried distillers’ grains per year. The plant wascompleted, and full-scale production of ethanol and distillers’ grains at theplant began, in September 2007. We began recording revenue from plantproduction in October 2007.  Ourrevenues are derived from the sale and distribution of our ethanol throughoutthe continental United States and in the sale and distribution of ourdistillers’ grains locally, and throughout the continental United States.

 

We are subject to a number of factors, including thoseaffecting the fuel ethanol industry generally that may affect our futureoperating and financial performance. These factors include, but are not limitedto, the available supply and cost of corn from which our ethanol and distillersgrains are processed; the availability and cost of coal, which we use in theproduction process; the supply and demand for ethanol as fuel; dependence onour ethanol marketer to market and distribute our ethanol; the intenselycompetitive nature of the ethanol industry; possible legislation at thefederal, state and/or local level; changes in federal ethanol tax incentivesand other policies; and the cost of complying with extensive environmental lawsthat regulate our industry.  Effective September 30,2009, we terminated our ethanol marketing agreement with RPMG, Inc. andentered into a new ethanol marketing agreement with C&N Ethanol marketingCorporation. The new ethanol marketing agreement is believed to providemanagement with more transparent ethanol pricing information and better controlover operating margins.

 

Since commencing operations, our focus has been on (i) ensuringthe plant is operating efficiently including performance testing and applicableenvironmental standards , (ii) cost-effective purchasing of keymanufacturing inputs such as corn and (iii) addressing liquidity issues toensure adequate working capital.

 

**CriticalAccounting Estimates**

 

A description of our critical accounting estimates wasprovided in the *Management’s Discussion andAnalysis of Financial Condition and Results of Operations* section ofour Annual Report on Form 10-K for the year ended October 31, 2008. AtJuly 31, 2009, our critical accounting estimates continue to include thosedescribed in our Annual Report on Form 10-K. In addition, we havepresented our financial statements assuming we continue as a goingconcern.  Extremely volatile conditionswithin the ethanol industry and recent debt covenant violations as well asprojected violations of our master loan agreement with AgStar without receivingwaivers and/or amendments have caused us to reclassify our long-term debt withAgStar as a current liability.  We have aline of credit for $6,750,000 with AgStar, which matures on November 2009.  We received waivers of the violations as ofand for the periods ending January 31, 2009 and April 30, 2009, butanticipate that the minimum net worth and fixed charge coverage ratio covenantswill not be met as of October 31, 2009 as well as other covenants through July 31,2010**unless amended or waived and so thelong-term debt with AgStar remains classified as a current liability.    Our ability to continue as a going concernis dependent on our operations. Managements’ forecast relating to our operating results includessignificant assumptions about the prices for ethanol, distillers grains, andcorn as well as our operating efficiencies.  

 

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**Resultsof Operations for the Three Months Ended July 31, 2009 and 2008**

 

The following table shows summary information from ourStatement of Operations for the three months ended July 31, 2009 and July 31,2008.

 
| ** **                          | ** ** | **Three Months Ended********July 31, 2009** | ** ** | **Three Months Ended********July 31, 2008** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                                       | ** ** | **%**                                            | ** ** | **Amount** | ** ** | **%** | ** ** |
| Revenues                            |       | $                                                | 22,196,118 |                                             | 100.0      |   | $ | 34,815,685 |   | 100.0 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Cost of Goods  Sold                 |       |                                             |       |                                             |       |   |   |   |   |
| Cost of goods  sold                 |       | 21,420,797                                       |       | 96.5                                             |       | 27,290,998 |   | 78.4 |   |
| Lower of cost or  market adjustment |       | 1,863,605                                        |       | 8.4                                              |       | — |   | — |   |
| Total Cost of  Goods Sold           |       | 23,284,402                                       |       | 104.9                                            |       | 27,290,998 |   | 78.4 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Gross Profit  (Loss)                |       | (1,088,284                                       | )          | (4.9                                             | )          | 7,524,687 |   | 21.6 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Operating  Expenses                 |       | 1,632,166                                        |       | 7.3                                              |       | 750,108 |   | 2.1 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Operating Income  (Loss)            |       | (2,720,450                                       | )          | (12.2                                            | )          | 6,774,579 |   | 19.5 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Other Expense,  net                 |       | (1,064,697                                       | )          | (4.8                                             | )          | (1,065,065 | ) | (3.1 | ) |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Net Income  (Loss)                  |       | $                                                | (3,785,147 | )                                                | (17.0      | ) | $ | 5,709,514 |   | 16.4 |   |

 

*Revenues*

 

Revenues are derived from the sale of fuel ethanol anddistillers’ grains with solubles (“DGS”) produced at our ethanol plant anddeclined 36.2% from the quarter ended July 31, 2008 to the quarter ended July 31,2009. Ethanol revenues during the quarter ended July 31, 2009, wereapproximately $17.9 million, representing 80.6% of our revenues, compared toapproximately $27.3 million during the quarter ended July 31, 2008,representing 78.4% of our sales. The decrease in ethanol revenue was a resultof a 35% decrease in the average price per gallon of ethanol period to period,on a negligible increase in the number of gallons sold.  Production and sales volume declined in May 2009due to an extended unplanned maintenance shutdown. During the quarter ended July 31,2009, the plant was shut down for 5 days for planned annual maintenance.  Upon shutdown, portions of the refractorysection of the boiler collapsed.  Whilethere were no injuries sustained, significant additional costs were incurred tosecure the refractory, ensure the safety of the workers completing repairs andto complete the repairs.  This addedeleven days to the shutdown for a total of sixteen days shutdown duringMay.  We have taken steps to address theproduction difficulties, but there can be no assurance that future productiondisruptions will not occur.  For the threemonths ended July 31, 2009, we operated for 75 days and the plant was notoperated for 392 hours. However, sales volumes in June and July 2009were higher than the same months in 2008.  The decrease in ethanol prices followed declines in the gasoline marketduring the quarter ended July 31, 2009 compared to the same period in2008.  We realized gains on ethanol hedgesof $2,022,000 for the three months ended July 31, 2008.  There were no gains or losses on ethanolhedges for the three months ended July 31, 2009.

 

Total sales of DGS during the three months ended July 31,2009 were approximately $3.2 million comprising 14.4% of ourrevenue. DGS sales during the three months ended July 31, 2008, were$3.9 million or 11.2% of revenue.  Thedecrease in revenue is due to a decrease in the average price at which we couldsell DDG of approximately 27%.

 

*Cost of Goods Sold*

 

Our costs of sales include, among other things, thecost of corn (which is the largest component of costs of sales), coal,processing ingredients, electricity, and wages, salaries and benefits ofproduction personnel. We use approximately 1.5 million bushels of corn permonth at the plant. We contract with local farmers and elevators for our cornsupply.  We are able to store corn thatwe purchase in our elevator in Lakefield, Minnesota, as well as in on-sitestorage at the plant.

 

Our costs of sales (including lower of cost or marketadjustments) as a percentage of revenues were 104.9% and 78.4% for the threemonths ended July 31, 2009 and, 2008, respectively. The per bushel cost ofcorn combined with accrued losses on forward contracts decreased approximately22% in the three months ended July 31, 2009 as compared to the threemonths ended July 31, 2008. This combined with the 

 

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35% decrease inthe per gallon sales price of ethanol and a 5% decrease in the efficiency atwhich the plant converted corn to ethanol caused this increase in the cost ofgoods sold as a percent of revenues. Cost of goods sold includes lower of costor market adjustments of $1.9 million for the three months ended July 31,2009, which related to forward purchase contracts and inventory where the fixedprice was more than the estimated realizable value. There was no lower of costor market adjustment for the three months ended July 31, 2008. We hadgains related to corn derivative instruments of approximately $122,000 and$920,000 for the three months ended July 31, 2009 and 2008, respectively,which reduced cost of sales. Our gross margin (loss) for the three months endedJuly 31, 2009 decreased to (4.9%) from 21.6% for the three months ended July 31,2008. We had a negative gross margin in the third quarter of fiscal 2009 ascompared to a positive margin in the third quarter of fiscal 2008 due to the35% decline in ethanol prices while corn costs decreased 22%. In addition,lower efficiency levels and fixed costs contributed to the negative grossmargin incurred.

 

The cost of corn fluctuates based on supply anddemand, which, in turn, is affected by a number of factors that are beyond ourcontrol. We expect our gross margin to fluctuate in the future based on therelative prices of corn and fuel ethanol. We use futures and options contractsto minimize our exposure to movements in corn prices, but there is no assurancethat these hedging strategies will be effective. Typically, none of ourderivative contracts are designated as hedges and, as a result, changes to themarket value of these contracts are recognized as an increase or decrease to ourcosts of goods sold. As a result, gains or losses on derivative instruments donot necessarily coincide with the related corn purchases. This may causefluctuations in cost of goods sold. While we do not use hedge accounting tomatch gains or losses on derivative instruments, we believe the derivativeinstruments provide an economic hedge.

 

Costs of sales also include expenses directlyattributable to the repair and maintenance of the plant.  During the three months ended July 31,2009, we incurred costs of approximately $300,000 as part of a five day plannedannual shutdown and maintenance procedure. Upon shutdown, portions of the refractory section of the boilercollapsed.  While there were no injuriessustained, significant additional time and costs were incurred to secure therefractory, ensure the safety of the workers completing repairs and to completethe repairs.  This added eleven days tothe shutdown for a total of sixteen days shutdown during May.  Costs associated with the unusual repairswere approximately $700,000 and are included in operating expenses.  We are currently evaluating our options underthe warranty provisions of the design build contract.

 

During the three months ended July 31, 2009, weentered into Amendment 2 to our agreement with a leasing company under which welease certain rail cars.  The terms ofAmendment 2 reduces the rail cars under lease by 50 cars and increases themonthly rental amount per remaining rail car until July 1, 2014.   This will result in a monthly cash savingsof $425 per rail car or $21,250.

 

*OperatingExpenses*

 

Operating expenses include wages, salaries andbenefits of administrative employees at the plant, insurance, professional feesand similar costs.   Operating expenses generally do not vary with thelevel of production at the plant but increased 117.6% to $1,632,000 for thethree months ended July 31, 2009 as compared to $750,000 for the threemonths ended July 31, 2008.  Upon aplanned annual shutdown, portions of the refractory section of the boilercollapsed.  While there were no injuriessustained, significant additional time and costs were incurred to secure therefractory, ensure the safety of the workers completing repairs and to completethe unusual repairs.  Costs associatedwith the unusual repairs were approximately $700,000 and are included inoperating expenses.  We are currentlyevaluating our options under the warranty provisions of the design buildcontract.  Professional and legal feesincreased for the three months ended July 31, 2009 as compared to theprior year period because of an increase in legal, accounting, and consultingfees.  Decreased revenue for the threemonths ended July 31, 2009 negatively affected operating expenses as apercentage of revenue as total revenues declined approximately 36%.

 

*OtherExpense, Net*

 

Other expense consisted primarily of interest expensethat consists primarily of interest payments on our credit facilities describedbelow. Interest expense, which is up approximately 1.6% as compared to thethree months ended July 31, 2008, is dependent on the balances outstandingand on interest rate fluctuations. For the three months ended July 31,2009, debt balances were up approximately 0.5% and interest rates increasedperiod over period due, primarily, to a 2% surcharge AgStar charged from May 1,2009 through May 29, 2009.

 

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**Resultsof Operations for the Nine Months Ended July 31, 2009 and 2008**

 

The following table shows summary information from ourStatement of Operations for the nine months ended July 31, 2009 and July 31,2008.

 
| ** **                          | ** ** | **Nine Months Ended********July 31, 2009** | ** **  | **Nine Months Ended********July 31, 2008** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|-------------|-------------------------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                                      | ** **  | **%**                                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Revenues                            |       | $                                               | 61,784,588  |                                            | 100.0      |   | $ | 100,387,350 |   | 100.0 |   |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Cost of Goods  Sold                 |       |                                            |        |                                            |       |   |   |   |   |
| Cost of goods  sold                 |       | 62,540,473                                      |        | 101.2                                           |       | 77,946,713 |   | 77.6 |   |
| Lower of cost or  market adjustment |       | 5,321,835                                       |        | 8.6                                             |       | — |   | — |   |
| Total Cost of  Goods Sold           |       | 67,862,308                                      |        | 109.8                                           |       | 77,946,713 |   | 77.6 |   |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Gross Profit  (Loss)                |       | (6,077,720                                      | )           | (9.8                                            | )          | 22,440,637 |   | 22.4 |   |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Operating  Expenses                 |       | 3,368,503                                       |        | 5.5                                             |       | 2,282,316 |   | 2.3 |   |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Operating Income  (Loss)            |       | (9,446,223                                      | )           | (15.3                                           | )          | 20,158,321 |   | 20.1 |   |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Other Expense,  net                 |       | (3,363,662                                      | )           | (5.4                                            | )          | (3,732,989 | ) | (3.7 | ) |
|                                |       |                                            |        |                                            |       |   |   |   |   |
| Net Income  (Loss)                  |       | $                                               | (12,809,885 | )                                               | (20.7      | ) | $ | 16,425,332 |   | 16.4 |   |

 

*Revenues*

 

Revenues derived from the sale of fuel ethanol anddistillers’ grains with solubles (“DGS”) produced at our ethanol plant declined38.4% from the nine months ended July 31, 2008 to the nine months ended July 31,2009. Ethanol revenues during the nine months ended July 31, 2009, wereapproximately $48.3 million, representing 78.2% of our revenues, comparedto approximately $79.6 million during the nine months ended July 31, 2008,representing 79.3% of our sales. The decrease in ethanol revenue was a resultof a 31% decrease in the average price per gallon of ethanol period to period,in conjunction with a 12% decrease in the gallons of ethanol sold. The decreasein ethanol prices followed declines in the gasoline market during the ninemonths ended July 31, 2009. Production difficulties experienced during thefirst quarter of fiscal 2009 related to coal handling equipment was the maincontributing factor in the reduced number of gallons produced and sold duringthat quarter.   During the quarter ended July 31,2009, the plant was shut down for 5 days for planned annual maintenance.  Upon shutdown, portions of the refractorysection of the boiler collapsed.  Whilethere were no injuries sustained, significant additional costs were incurred tosecure the refractory, ensure the safety of the workers completing repairs andto complete the repairs.  This added elevendays to the shutdown for a total of sixteen days shutdown during May.  We have taken steps to address the productiondifficulties, but there can be no assurance that future production disruptionswill not occur.  For the nine monthsended July 31, 2009, we operated for 240 days and the plant was notoperated for 1,013 hours. We had gains of approximately $373,000 and $1,116,000related to ethanol derivatives for the nine months ended July 31, 2009 and2008, respectively.

 

Total sales of DGS during the nine months ended July 31,2009 were approximately $9.5 million comprising 15.4% of ourrevenue. DGS sales during the nine months ended July 31, 2008, were$12.7 million or 12.7% of revenue. Due to lower production of ethanol,production of DGS decreased approximately 8.1% for the nine months ended July 31,2009 as compared to the nine months ended July 31, 2008.  Over the same period, the average sellingprice of DGS decreased approximately 18%.

 

*Costof Goods Sold*

 

Our costs of sales include, among other things, thecost of corn used in ethanol and DGS production (which is the largest componentof costs of sales), coal, processing ingredients, electricity, and wages,salaries and benefits of production personnel. We use approximately1.5 million bushels of corn per month at the plant. We contract with localfarmers and elevators for our corn supply. We are able to store corn that wepurchase in our elevator in Lakefield, Minnesota, as well as in on-site storageat the plant.

 

Our costs of sales (including lower of cost or marketadjustments) as a percentage of revenues were 109.8% and 77.6% for the ninemonths ended July 31, 2009 and, 2008, respectively.  The per bushel cost of corn purchased (net oflosses realized in fiscal year 2008 for bushels delivered in the first threequarters of 2009) decreased approximately 7% in the nine months ended July 31,2009 as compared to the nine 

 

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months ended July 31,2008.  However, cost of goods soldincludes lower of cost or market adjustments of $5,322,000 for the nine monthsended July 31, 2009, which related to forward purchase contracts andinventory where the fixed price was more than the estimated realizable value.There was no lower of cost or market adjustment for the nine months ended July 31,2008 because market value exceeded cost. We had gains related to corn derivative instruments of approximately$1,208,000 and $3,154,000 for the nine months ended July 31, 2009 and2008, respectively, which reduced cost of sales.  These factors combine with the 31% decreasein the per gallon sales price of ethanol caused the increase in the cost ofgoods sold as a percent of revenues for the nine months ended July 31,2009. Our gross margin (loss) for the nine months ended July 31, 2009decreased to (9.8%) from 22.4% for the nine months ended July 31, 2008. Wehad a negative gross margin in the first three quarters of fiscal 2009 ascompared to positive gross margin in the first three quarters of fiscal 2008due to the decline in ethanol prices; increased costs of goods sold, relativeto revenues, due to losses on forward contracts; and decreased gains onderivative instruments. In addition, lower production levels and fixed costscontributed to the negative gross margin incurred.

 

The cost of corn fluctuates based on supply anddemand, which, in turn, is affected by a number of factors that are beyond ourcontrol. We expect our gross margin to fluctuate in the future based on therelative prices of corn and fuel ethanol. We use futures and options contractsto minimize our exposure to movements in corn prices, but there is no assurancethat these hedging strategies will be effective.  Through July 31, 2009, none of ourderivative contracts were designated as hedges and, as a result, changes to themarket value of these contracts were recognized as an increase or decrease toour costs of goods sold. As a result, gains or losses on derivative instrumentsdo not necessarily coincide with the related corn purchases. This may causefluctuations in cost of goods sold. While we do not use hedge accounting tomatch gains or losses on derivative instruments, we believe the derivativeinstruments provide an economic hedge.

 

Costs of sales also include expenses directlyattributable to the repair and maintenance of the plant.  During the nine months ended July 31,2009, we incurred costs of approximately $300,000 as part of a five day plannedannual shutdown and maintenance procedure. Upon shutdown, portions of the refractory section of the boilercollapsed.  While there were no injuriessustained, significant additional costs were incurred to secure the refractory,ensure the safety of the workers completing repairs and to complete therepairs.  This added eleven days to theshutdown for a total of sixteen days shutdown during May.  We are currently evaluating our options underthe warranty provisions of the design build contract.

 

During the nine months ended July 31, 2009, weentered into Amendment 2 to our agreement with a leasing company under which welease certain rail cars.  The terms ofAmendment 2 reduces the rail cars under lease by 50 cars and increases themonthly rental amount per remaining rail car until July 1, 2014.   This will result in a monthly cash savingsof $425 per rail car or $21,250.

 

*OperatingExpenses*

 

Operating expenses include wages, salaries andbenefits of administrative employees at the plant, insurance, professional feesand similar costs and generally do not vary with the level of production at theplant.  These expenses were $3.4 millionfor the nine months ended July 31, 2009 up 47.5% from $2.3 million for thenine months ended July 31, 2008. Upon a planned annual shutdown, portions of the refractory section ofthe boiler collapsed.  While there wereno injuries sustained, significant additional costs were incurred to secure therefractory, ensure the safety of the workers completing repairs and to completethe repairs.  Costs associated with theunplanned repairs were approximately $700,000 and are included in operatingexpenses.  We are currently evaluatingour options under the warranty provisions of the design build contract.  Professional fees increased for the ninemonths ended July 31, 2009 as compared to the prior year period because ofadditional legal, accounting and internal control consulting work inanticipation of required compliance with the Sarbanes-Oxley Act of 2002 and SECreporting requirements. Decreased revenue for the nine months ended July 31,2009 negatively affected operating expenses as a percentage of revenue as totalrevenues declined approximately 38%.

 

*OtherExpense, Net*

 

Other expense consisted primarily of interest expense.Interest expense consists primarily of interest payments on our creditfacilities described below. Interest expense, which is down approximately 21%as compared to the nine months ended July 31, 2008, is dependent on thebalances outstanding and on interest rate fluctuations. For the nine monthsended July 31, 2009, debt balances were down approximately 0.5% andinterest rates decreased as well period over period.  The average 1 month LIBOR rate for the ninemonths ended July 31, 2009 was 0.61% compared to 3.32% for the nine monthsended July 31, 2008.  From May 1,2009 through May 29, 2009, AgStar added a 2.0% surcharge to the interestrate on the outstanding amounts under the Company’s master loan agreement.  Also included in other expense is thewrite-off of loan costs of approximately $445,000. Because we have not obtaineda waiver from AgStar Financial Services, PCA (“AgStar”) for actual or expectedviolations of our master loan agreement, our long-term debt with AgStar wasclassified as a current liability. As such, we wrote-off the remaining loancosts rather than amortizing them over the original contractual term of theloans.

 

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**Liquidityand Capital Resources**

 

As of July 31, 2009, we had cash and cashequivalents (other than restricted cash) of approximately $1.1 million, currentassets of approximately $11.9 million and total assets of approximately$113.6 million.

 

Our principal sources of liquidity consist of cashprovided by operations, cash and cash equivalents on hand, and availableborrowings under our master loan agreement with AgStar. Under the master loanagreement, we have three forms of debt: a term note, a revolving term note anda line of credit. Among other provisions, our master loan agreement containscovenants requiring us to maintain various financial ratios and tangible networth. It also limits our annual capital expenditures and membership distributions.All of our assets and real property are subject to security interests andmortgages in favor of AgStar as security for the obligations of the master loanagreement.

 

In May 2008, we locked in an interest rate of3.58% plus 3.00%, which totals 6.58%, on $45.0 million of the term note, forthree years ending April 30, 2011. The remainder of the amountsoutstanding on the term note is subject to the variable rate based on theone-month LIBOR plus 3.25%.  We are required to make equal monthlypayments of principal and interest of approximately $640,000 to amortize thenote over a period not to exceed ten years, with a final balloon payment due inOctober 2012. In addition, we are required to make additional payments onthe term note of excess cash flow, as defined in the agreement, up to $2.0million per year to the lending institution until we meet certain minimumtangible owner’s equity, as defined in the agreement. As part of the debtfinancing, the premium above LIBOR may be reduced based on the ratio of members’equity to assets.  AgStar implemented a2.0% interest rate surcharge effective May 1, 2009 through May 29,2009, on the total debt outstanding in accordance with the terms of the masterloan agreement due to the defaults explained below.

 

Our principal uses of cash are to pay operatingexpenses of the plant and to make debt service payments on our long-term debt.During the nine months ended July 31, 2009, we used cash to make principalpayments of approximately $3.6 million against our long-term debt. During thesame period, we drew $5.0 million on our line of credit described below.

 

During the nine months ended July 31, 2009, weused $11.7 million in cash for operating activities. This use consistsprimarily of a net loss of $12.9 million, payments for corn under deferredpayment agreements and payments under forward purchase contracts net of cashrealized from the decrease of corn inventory. A portion of the losses on forward purchase contracts had been accruedduring the period ending October 31, 2008.

 

During the nine months ended July 31, 2009, weused $326,000 for investing activities to pay for capital expenditures andintangibles, and do not anticipate any significant capital expenditures duringfiscal 2009.

 

During the nine months ended July 31, 2009, wegenerated $1.7 million from financing activities consisting primarily ofadvances on the line of credit of $5.0 million and payments on long term debtof approximately $3.6 million.

 

At January 31, 2009 through July 31, 2009,we were not in compliance with the requirement of our master loan agreement tomaintain at least $3.0 million in working capital. Additionally, we do notexpect to be in compliance with one or more additional covenants of the masterloan agreement as of fiscal year end 2009. Our failure to maintain the requiredamount of working capital constitutes an event of default under the master loanagreement, entitling the lender to accelerate and declare due all amountsoutstanding under the master loan agreement. Therefore, we have classified$50.4 million of the AgStar debt as a current liability that would otherwise beclassified as long term. As a result, current liabilities as of July 31,2009 totaled approximately $70.8 million, including $50.4 million of long-termdebt reclassified as current liabilities. On June 12, 2009, AgStar waived the Company’s noncompliance withthe working capital covenant of the master loan agreement as of and for theperiods ending January 31, 2009 and April 30, 2009.  On September 9, 2009, AgStar waived theCompany’s noncompliance with the working capital covenant of the master loanagreement for the period ended July 31, 2009.  Our debt with AgStar remains classified as acurrent liability based on projected violations of debt covenants within thenext year.

 

Our line of credit under the master loan agreementwith AgStar renewed at a maximum commitment of $6,750,000 and a maturity dateof November 1, 2009.  As of July 31,2009, we had drawn $5.0 million on the line of credit.

 

There is no assurance that we will be able to complyin the future with all covenants and obligations of the master loan agreementor that any waiver or amendment to the master loan agreement will be providedby AgStar.  Further, there can be noabsolute assurance that AgStar will not demand immediate repayment of all $60.6million in indebtedness outstanding under the master loan agreement at July 31,2009 or exercise any of its rights as a secured party with respect to theCompany’s assets should we fail to comply with any covenants in the future. Thetotal indebtedness to AgStar at July 31, 2009 consists of $54.4 millionunder the term note, $1.2 million under the revolving term note and $5.0million under the line of credit. We do not have adequate capital to repay allof the amounts that would become due if AgStar accelerates our obligationsunder the master loan agreement.  Further, if an event of default exists,the Company is not permitted to borrow additional funds under its line ofcredit or revolving term note unless AgStar consents to the advance. WhileAgStar has consented to make advances in the past, our potential inability toborrow additional funds under the master loan agreement may result in a workingcapital shortfall.

 

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The Company’s plan to address the expected shortfallof working capital is to conserve funds by utilizing and reducing corninventory as well as reducing operating expenses through cost controls. TheCompany believes it has sufficient funding for its business in the short-termif it is not required to repay the outstanding indebtedness to AgStar or theoutstanding indebtedness on the line of credit, based on converting and sellinginventory, and reducing expenses. If the current industry conditions continueand the Company is not able to maintain sufficient funding in the short-term,the Company may be forced to raise subordinated debt, if available, selladditional equity, restructure or significantly curtail its operations, filefor bankruptcy or cease operations. The financial statements do not include anyadjustments relating to the recoverability and classification of recorded assetamounts or amounts and classification of liabilities that might be necessaryshould the Company be forced to take any such actions.  However, there can be no assurance, that wewill not require additional financing in the future or that any additionalfinancing will be available to us on satisfactory terms, if at all.

 

**Outlook**

 

We expect to see continuing volatility in ethanolprices.  Future prices for fuel ethanol will be affected by a variety offactors beyond our control including the amount and timing of additional domesticethanol production and ethanol imports; petroleum and gasoline prices; and thedevelopment of other alternative fuels.

 

Prices for DGS are also affected by a number offactors beyond our control such as the supply of and demand for DGS as ananimal feed, prices of competing feeds, and perceptions of nutritional value ofDGS as compared to those of competing feeds. We believe that current marketprices for DGS can be sustained long-term as long as the prices of competinganimal feeds remain steady or increase, livestock feeders continue to createdemand for alternative feed sources such as distillers’ grains and the supplyof distillers’ grains remains relatively stable. On the other hand, ifcompeting commodity price values retreat and DGS supplies increase due togrowth in the ethanol industry, DGS prices may decline.

 

Corn prices have been volatile for the pastyear due in part to demand from the renewable fuels industry. Theexpansion of ethanol productive capacity has brought about a substantial increasein demand for corn and thus in corn prices. We expect the price of corn toremain at current price levels well into 2009.   Due to increased exposureof ethanol, corn is now being viewed as an “energy commodity” as opposed tostrictly a “grain commodity”, contributing to the upward pressure on cornprices.  The USDA’s August 14, 2009 Feed Outlook Report projects U.S.corn prices for the season average to be at $3.10 to $3.90 per bushel.

 

**Off-BalanceSheet Arrangements**

 

We do not have any off-balance sheet arrangements.

 

**Item 4. Controls and Procedures**

 

**Effectiveness of Disclosure Controlsand Procedures**

 

Our management, with the participation of our ChiefExecutive Officer and Interim Chief Financial Officer, has evaluated theeffectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) underthe Securities Exchange Act of 1934, as amended) as of the end of the periodcovered by this report. Based on that evaluation, our Chief Executive Officerand Interim Chief Financial Officer have concluded that, as of the end of suchperiod, our disclosure controls and procedures were effective.

 

**Changesin Internal Control over Financial Reporting**

 

We are in the process of upgrading our systems,implementing additional financial and management controls, and reportingsystems and procedures.  We are currently preparing for compliance withthe reporting requirement of Section 404 of the Sarbanes-Oxley Act of2002. This effort, under the direction of senior management, includesdocumentation, and testing of our controls and business processes. We arecurrently in the process of formalizing an internal control audit plan thatincludes performing a risk assessment, establishing a reporting methodology andtesting internal controls and procedures over financial reporting.  Some of these efforts to prepare for thereporting requirement have resulted in changes to our internal control overfinancial reporting.

 

However, there has been no change in our internalcontrol over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) that occurred in the fiscal quarter ended July 31, 2009that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II.OTHER INFORMATION**

 

**Item 1A. Risk Factors**

 

The most significant risk factors applicable to theCompany are described in Part I, Item 1A “Risk Factors” of our AnnualReport on Form 10-K for the year ended October 31, 2008, assupplemented by the risks described in Part II, Item 1A “Risk Factors” ofour Quarterly Report on Form 10-Q for the quarters ended January 31,2009 and April 30, 2009. There have been no material changes from the riskfactors previously disclosed in our Annual Report on Form 10-K andQuarterly Reports on Form 10-Q.

 

**Item 3. Defaults upon SeniorSecurities**

 

At July 31, 2009, Heron Lake BioEnergy, LLC wasin default of the minimum working capital covenant of a master loan agreementwith AgStar Financial Services, PCA (“AgStar”).  This master loanagreement relates to indebtedness at July 31, 2009 consisting of $54.4million under a term note, $1.2 million under a revolving term note and $5.0million under a line of credit.  Thenon-compliance with the working capital covenant is an event of default underthe master loan agreement, entitling AgStar to accelerate all outstanding indebtednessunder the master loan agreement and exercise any of its other rights under themaster loan agreement and as a secured party.

 

On September 9, 2009, AgStar waived the Company’snoncompliance with the working capital covenant of the master loan agreementfor the period ended July 31, 2009.

 

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**Item 6. Exhibits**

 

The followingexhibits are included in this report:

 
| **Exhibit  No.** | ** ** | **Exhibit**                                                                                                        |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------|
| 31.1             |       | Certification of  Chief Executive Officer Pursuant to Section 13a-14 and 15d-14 of the  Exchange Act.         |
|             |       |                                                                                                               |
| 31.2             |       | Certification of  Interim Chief Financial Officer Pursuant to Section 13a-14 and 15d-14 of  the Exchange Act. |
|             |       |                                                                                                               |
| 32               |       | Certification  pursuant to 18 U.S.C. 1350.                                                                         |

 

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**SIGNATURES**

 

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                           | HERON LAKE  BIOENERGY, LLC                                                     |
|--------------------------------|--------------------------------------------------------------------------------|
|                           |                                                                           |
| Date:  September 11, 2009 | /s/  Robert  J. Ferguson                                                  |
|                           | Robert J  Ferguson                                                             |
|                           | President and  Chief Executive Officer  (Principal Executive Officer)          |
|                           |                                                                           |
|                           |                                                                           |
| Date:  September 11, 2009 | /s/  Brett  L. Frevert                                                    |
|                           | Brett L. Frevert                                                               |
|                           | Interim Chief  Financial Officer  (Principal Accounting and Financial Officer) |

 

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