Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**x****       ****Quarterly report underSection 13 or 15(d) of the Securities Exchange Act of 1934.**

 

**For thefiscal quarter ended January 31, 2009**

** **

**OR**

 

**o ****Transition report underSection 13 or 15(d) of the Exchange Act.**

** **

**For thetransition period from                                to             .**

 

**COMMISSION FILE NUMBER 000-51825**

 

**HERONLAKE BIOENERGY, LLC**

(Exactname 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**

(Addressof principal executive offices)

 

**(507) 793-0077**

(Issuer’stelephone number)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days.    x   Yes     o   No

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer,”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 markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   o   Yes     x   No

 

As of March 16, 2009,there were 27,104,625 Class A units outstanding.

 

 

 

----

Table of Contents

 

**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 | 10                |
| Item 4. Controls  and Procedures                                                                     | 13                |
| PART II.  OTHER INFORMATION                                                                          |              |
| Item 1A. Risk Factors                                                                                     | 14                |
| Item 3.  Defaults Upon Senior Securities                                                             | 14                |
| Item 6. Exhibits                                                                                     | 14                |
| SIGNATURES                                                                                                | 15                |

 

----

Table of Contents

 

**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements**

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

CondensedConsolidated Balance Sheets

 
| ** **                      | ** ** | **January 31,** | ** **  | **October 31,** | ** ** |
|---------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                      | ** ** | **2009**             | ** **  | **2008**             | ** ** |
| ** **                      | ** ** | **(Unaudited)**      | ** **  | ** **           | ** ** |
| **ASSETS**                      | ** ** | ** **           | ** **  | ** **           | ** ** |
| **Current Assets**              |       |                 |        |                 |       |
| Cash and equivalents            |       | $                    | 428,345     |                 | $          | 11,355,075 |   |
| Restricted cash                 |       | 768,067              |        | 1,499,472            |       |
| Accounts receivable             |       | 2,367,365            |        | 3,368,076            |       |
| Inventory                       |       | 12,098,702           |        | 9,633,749            |       |
| Derivative instruments          |       | 653,302              |        | 750,172              |       |
| Prepaid expenses                |       | 893,622              |        | 616,641              |       |
| Total current assets            |       | 17,209,403           |        | 27,223,185           |       |
|                            |       |                 |        |                 |       |
| Property and Equipment          |       |                 |        |                 |       |
| Land and improvements           |       | 12,571,092           |        | 12,552,721           |       |
| Plant buildings and equipment   |       | 97,288,459           |        | 97,159,759           |       |
| Vehicles and other equipment    |       | 597,921              |        | 597,921              |       |
| Office buildings and equipment  |       | 613,358              |        | 597,508              |       |
|                            |       | 111,070,830          |        | 110,907,909          |       |
| Less accumulated depreciation   |       | 8,426,277            |        | 7,025,870            |       |
|                            |       | 102,644,553          |        | 103,882,039          |       |
|                            |       |                 |        |                 |       |
| **Other Assets**                |       |                 |        |                 |       |
| Deferred loan costs, net        |       | —               |        | 467,128              |       |
| Restricted cash                 |       | 920,635              |        | 995,804              |       |
| Other intangibles               |       | 515,285              |        | 464,304              |       |
| Debt service deposits and other |       | 398,700              |        | 368,350              |       |
| Total other assets              |       | 1,834,620            |        | 2,295,586            |       |
|                            |       |                 |        |                 |       |
| **Total Assets**                |       | $                    | 121,688,576 |                 | $          | 133,400,810 |   |

 

See Notes to CondensedConsolidated Financial Statements

 

1

----

Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

CondensedConsolidated Balance Sheets

 
| ** **                                                           | ** ** | **January 31,** | ** **  | **October 31,** | ** ** |
|----------------------------------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                                           | ** ** | **2009**             | ** **  | **2008**             | ** ** |
| ** **                                                           | ** ** | **(Unaudited)**      | ** **  | ** **           | ** ** |
| **LIABILITIES AND MEMBERS’ EQUITY**              |       |                 |        |                 |       |
| **Current Liabilities**                                              |       |                 |        |                 |       |
| Line of credit                                                       |       | $                    | 1,000,000   |                 | $          | — |   |
| Current maturities of long-term debt                                 |       | 58,427,993           |        | 5,649,354            |       |
| Accounts payable:                                                    |       |                 |        |                 |       |
| Trade accounts payable                                               |       | 3,015,043            |        | 5,635,204            |       |
| Trade accounts payable — related party                          |       | 3,016                |        | 792,450              |       |
| Construction payable — related party                            |       | 3,839,413            |        | 3,839,413            |       |
| Accrued expenses                                                     |       | 563,971              |        | 512,709              |       |
| Accrued losses on forward contracts                                  |       | 5,228,679            |        | 7,122,966            |       |
| Total current liabilities                                            |       | 72,078,115           |        | 23,552,096           |       |
|                                                                 |       |                 |        |                 |       |
| **Long-Term Debt,******net of current maturities                     |       | 5,274,087            |        | 59,265,534           |       |
|                                                                 |       |                 |        |                 |       |
| **Commitments and Contingencies**                                    |       |                 |        |                 |       |
|                                                                 |       |                 |        |                 |       |
| **Members’ Equity, 27,104,625 Class A  units outstanding** |       | 44,336,374           |        | 50,583,180           |       |
|                                                                 |       |                 |        |                 |       |
| **Total Liabilities and Members’ Equity**                       |       | $                    | 121,688,576 |                 | $          | 133,400,810 |   |

 

See Notes to CondensedConsolidated Financial Statements

 

2

----

Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

CondensedConsolidated Statements of Operations

 
| ** **                                                  | ** ** | **Three Months  Ended January 31,** | ** ** | **Three Months  Ended January 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                           | ** ** | **2008**                                           | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                                    | ** ** | **(Unaudited)**                                    | ** ** |
|                                                        |       |                                               |       |                                               |       |
| **Revenues**                                                |       | $                                                  | 18,095,366 |                                               | $          | 31,981,484 |   |
|                                                        |       |                                               |       |                                               |       |
| **Cost of Goods Sold**                                      |       |                                               |       |                                               |       |
| Cost of goods sold                                          |       | 19,877,852                                         |       | 24,501,156                                         |       |
| Lower of cost or market adjustment                          |       | 2,009,849                                          |       | —                                             |       |
| **Total Cost of Goods Sold**                                |       | 21,887,701                                         |       | 24,501,156                                         |       |
|                                                        |       |                                               |       |                                               |       |
| **Gross Margin**                                            |       | (3,792,335                                         | )          | 7,480,328                                          |       |
|                                                        |       |                                               |       |                                               |       |
| **Selling, General, and Administrative  Expenses**          |       | 1,008,518                                          |       | 750,040                                            |       |
|                                                        |       |                                               |       |                                               |       |
| **Operating Income (Loss)**                                 |       | (4,800,853                                         | )          | 6,730,288                                          |       |
|                                                        |       |                                               |       |                                               |       |
| **Other Income (Expense)**                                  |       |                                               |       |                                               |       |
| Interest income                                             |       | 37,880                                             |       | 15,120                                             |       |
| Interest expense                                            |       | (1,040,186                                         | )          | (1,547,032                                         | )          |
| Write-off of loan costs                                     |       | (444,985                                           | )          | —                                             |       |
| Other income, net                                           |       | 1,338                                              |       | 28,020                                             |       |
| Total other expense, net                                    |       | (1,445,953                                         | )          | (1,503,892                                         | )          |
|                                                        |       |                                               |       |                                               |       |
| **Net Income (Loss)**                                       |       | $                                                  | (6,246,806 | )                                                  | $          | 5,226,396 |   |
|                                                        |       |                                               |       |                                               |       |
| **Net Income (Loss) Per Unit - Basic and  Diluted**         |       | $                                                  | (0.23      | )                                                  | $          | 0.20 |   |
|                                                        |       |                                               |       |                                               |       |
| **Weighted Average Units Outstanding - Basic  and Diluted** |       | 27,104,625                                         |       | 26,361,406                                         |       |

 

See Notes to CondensedConsolidated Financial Statements

 

3

----

Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

CondensedConsolidated Statements of Cash Flows

 
| ** **                                                                         | ** ** | **Three Months  Ended January 31,** | ** ** | **Three Months  Ended January 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                           | ** ** | **2008**                                           | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                                    | ** ** | **(Unaudited)**                                    | ** ** |
| **Operating Activities**                                                           |       |                                               |       |                                               |       |
| Net income (loss)                                                                  |       | $                                                  | (6,246,806 | )                                                  | $          | 5,226,396 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                               |       |                                               |       |
| Depreciation and amortization                                                      |       | 1,409,261                                          |       | 1,394,531                                          |       |
| Amortization of loan costs included with  interest expense                         |       | 22,143                                             |       | 36,928                                             |       |
| Write-off of loan costs                                                            |       | 444,985                                            |       | —                                             |       |
| Lower of cost or market adjustments                                                |       | 2,009,849                                          |       | —                                             |       |
| Gain on disposal of assets                                                         |       | —                                             |       | (16,500                                            | )          |
| Change in fair value of derivative  instruments                                    |       | (68,002                                            | )          | (63,750                                            | )          |
| Other                                                                              |       | —                                             |       | (9,052                                             | )          |
| Change in operating assets and liabilities:                                        |       |                                               |       |                                               |       |
| Restricted cash                                                                    |       | 593,923                                            |       | (521,400                                           | )          |
| Accounts receivable                                                                |       | 1,000,711                                          |       | (1,848,918                                         | )          |
| Inventory                                                                          |       | (2,659,700                                         | )          | 7,177,388                                          |       |
| Derivative instruments                                                             |       | 164,872                                            |       | (58,737                                            | )          |
| Prepaid expenses                                                                   |       | (276,981                                           | )          | (543,343                                           | )          |
| Accounts payable                                                                   |       | (3,409,595                                         | )          | (5,960,840                                         | )          |
| Accrued expenses                                                                   |       | 51,262                                             |       | (149,463                                           | )          |
| Accrued loss on forward contracts                                                  |       | (3,709,389                                         | )          | —                                             |       |
| Net cash provided by (used in) operating  activities                               |       | (10,673,467                                        | )          | 4,663,240                                          |       |
|                                                                               |       |                                               |       |                                               |       |
| **Investing Activities**                                                           |       |                                               |       |                                               |       |
| Proceeds from sale of assets                                                       |       | —                                             |       | 43,500                                             |       |
| Payments for intangibles                                                           |       | (59,835                                            | )          | —                                             |       |
| Capital expenditures                                                               |       | (162,921                                           | )          | (304,180                                           | )          |
| Net cash used in investing activities                                              |       | (222,756                                           | )          | (260,680                                           | )          |
|                                                                               |       |                                               |       |                                               |       |
| **Financing Activities**                                                           |       |                                               |       |                                               |       |
| Checks written in excess of bank balance                                           |       | —                                             |       | (514,633                                           | )          |
| Proceeds from line of credit, net                                                  |       | 1,000,000                                          |       | —                                             |       |
| Payments on notes payable — related party                                     |       | —                                             |       | (4,202,930                                         | )          |
| Payments of long-term debt                                                         |       | (1,212,808                                         | )          | (2,538,578                                         | )          |
| Proceeds from issuance of long-term debt                                           |       | —                                             |       | 3,289,176                                          |       |
| Debt service deposits included with other  assets                                  |       | (30,350                                            | )          | (45,525                                            | )          |
| Release of restricted cash                                                         |       | 212,651                                            |       | 29,776                                             |       |
| Net cash used in financing activities                                              |       | (30,507                                            | )          | (3,982,714                                         | )          |
|                                                                               |       |                                               |       |                                               |       |
| **Net increase (decrease) in cash and equivalents**                                |       | (10,926,730                                        | )          | 419,846                                            |       |
|                                                                               |       |                                               |       |                                               |       |
| **Cash and Equivalents****— Beginning of Period**                             |       | 11,355,075                                         |       | 3,090,329                                          |       |
|                                                                               |       |                                               |       |                                               |       |
| **Cash and Equivalents — End of Period**                                      |       | $                                                  | 428,345    |                                               | $          | 3,510,175 |   |
|                                                                               |       |                                               |       |                                               |       |
| **Supplemental Cash Flow Information**                                             |       |                                               |       |                                               |       |
| Interest expense paid                                                              |       | $                                                  | 977,123    |                                               | $          | 1,574,520 |   |
| Total interest paid                                                                |       | $                                                  | 977,123    |                                               | $          | 1,574,520 |   |
|                                                                               |       |                                               |       |                                               |       |
| **Supplemental Disclosure of Noncash  Investing and Financing Activities**         |       |                                               |       |                                               |       |
| Restricted cash from long term debt  proceeds                                      |       | $                                                  | —     |                                               | $          | 1,710,000 |   |

 

Notes to CondensedConsolidated Financial Statements are an integral part of these Statements.

 

4

----

Table of Contents

** **

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notesto Condensed Consolidated Financial Statements

 

January 31,2009 (Unaudited)

 

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

 

The accompanying unauditedcondensed consolidated interim financial statements have been prepared pursuantto the rules and regulations of the Securities and Exchange Commission.Certain information and disclosures normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted as permitted bysuch rules and regulations. These financial statements and related notesshould be read in conjunction with the financial statements and notes theretoincluded in the Company’s audited financial statements for the year ended October 31,2008, contained in the Company’s annual report on Form 10-K.

 

In the opinion ofmanagement, the condensed consolidated interim financial statements reflect alladjustments (consisting of normal recurring accruals, with the exception of theadjustments to write-off deferred loan costs and to reclassify certain debt ascurrent) that we consider necessary to present fairly the Company’s results ofoperations, financial position and cash flows. The results reported in thesecondensed consolidated interim financial statements should not be regarded asnecessarily indicative of results that may be expected for the entire year.

 

*Nature ofBusiness*

 

TheCompany was organized to fund and construct a 50 million gallon ethanol plantnear Heron Lake, Minnesota with ethanol distribution to upper Midwest states. Inaddition, the Company produces and sells distillers grains with solubles asco-products of ethanol production.

 

*AccountingEstimates*

 

Management uses estimatesand assumptions in preparing these financial statements in accordance withgenerally accepted accounting principles. Those estimates and assumptionsaffect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities, and the reported revenues and expenses.                 The Company uses estimates and assumptions inaccounting for significant matters including, among others, the carrying valueand useful lives of property and equipment and estimates of losses on forwardcontract commitments and inventory, and analysis of future projections,resolution of debt terms and other assumptions in consideration of continuingas a going concern. The Company periodically reviews estimates and assumptions,and the effects of revisions are reflected in the period in which the revisionis made. Actual results could differ from those estimates.

 

*Revenue Recognition*

 

The Company generally sellsethanol and related products pursuant to marketing agreements. Revenues arerecognized when the marketing company (the “customer”) has taken title and hasassumed the risks and rewards of ownership, prices are fixed or determinableand collectability is reasonably assured.

 

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

 

The financial statementshave been prepared on a going-concern basis, which contemplates therecoverability of assets and the satisfaction of liabilities in the normalcourse of business. Significant volatility in the commodity markets and adecline in ethanol prices have caused margins in the ethanol industry to benegative. The Company incurred a loss of approximately $6.2 million and usedcash of approximately $10.7 million for operating activities in the threemonths ending January 31, 2009. At January 31, 2009, the Company wasout of compliance with the minimum working capital requirement provision of itsmaster loan agreement with AgStar Financial Services, PCA (AgStar). Inaddition, the Company anticipates that the minimum net worth and fixed chargecoverage ratio covenants will not be met through or as of fiscal year end 2009.The Company is currently in negotiations with AgStar regarding the waiver ofthe actual or expected violations of the master loan agreement. However, thereis no assurance when any waiver or amendment will be provided by the lender, ifever, or that the Company will be able to comply in the future with allcovenants and obligations of the master loan agreement. Further, AgStar is alsoreviewing the availability of the line of credit under the master loanagreement, which matures on April 1, 2009. There can be no assurance thatAgStar will extend the maturity of the line of credit or extend the line ofcredit for any particular availability. At January 31, 2009, the Companyhas reclassified the long-term debt related to this agreement to current sinceAgStar has a right to demand immediate repayment, among other rights as asecured lender. Additionally, the Company expensed the remaining unamortizedloan costs totaling approximately $445,000 associated with this debt. If AgStarexercised its right to accelerate the maturity of the debt outstanding underthe master loan agreement or did not extend the maturity of the line of creditbeyond April 1, 2009, the Company would not have adequate available cashto repay the amounts currently outstanding. These factors may raise doubt aboutthe Company’s ability to continue as a going concern.

 

5

----

Table of Contents

** **

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notesto Condensed Consolidated Financial Statements

 

January 31,2009 (Unaudited)

 

Further, while an event ofdefault exists, the Company is not permitted to borrow additional fundsunder its line of credit or revolving term note unless AgStar consents. TheCompany’s plan to address the expected shortfall of working capital is toconserve funds by utilizing and reducing corn inventory as well as reducingoperating expenses through cost controls. The Company believes it hassufficient funding for its business in the short-term if it is not required torepay the outstanding indebtedness to AgStar or the outstanding indebtedness onthe line of credit, based on converting and selling inventory, and reducingexpenses. Further, if a waiver of covenant defaults is received, the Companymay continue borrowing on its line of credit and its revolving term note withAgStar, providing additional liquidity for its business. The Company continuesto negotiate with AgStar regarding changes to the master loan agreement,including the potential to delay principal payments on the debt over the nextyear. There can be no assurance that the Company will be able to achieve any ofthese objectives. If the current industry conditions continue and the Companyis not able to maintain sufficient funding in the short-term, the Company maybe forced to restructure or significantly curtail its operations, file forbankruptcy 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.

 

**3.****             ****UNCERTAINTIES**

 

TheCompany has certain risks and uncertainties that it experienced during volatilemarket conditions such as what the Company experienced during fiscal 2008. Thesevolatilities can have a severe impact on operations. The Company’s revenues arederived from the sale and distribution of ethanol and distillers grains tocustomers primarily located in the U.S. Corn for the production process issupplied to our plant primarily from local agricultural producers and from purchaseson the open market. Ethanol sales average 75 - 80% of total revenues and corncosts average 70% - 80% of cost of goods sold.

 

TheCompany’s operating and financial performance is largely driven by the pricesat which we sell ethanol and the net expense of corn. The price of ethanol isinfluenced by factors such as supply and demand, the weather, governmentpolicies and programs, unleaded gasoline prices and the petroleum markets as awhole, although since 2005 the prices of ethanol and gasoline began adivergence with ethanol selling for less than gasoline at the wholesale level.Excess ethanol supply in the market, in particular, puts downwardpressure on the price of ethanol. Our largest cost of production is corn.The cost of corn is generally impacted by factors such as supply anddemand, the weather, government policies and programs, and our risk managementprogram used to 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 and profitability.

 

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

 

EffectiveNovember 1, 2008, we adopted Statement of Financial Accounting Standard No. 157,Fair Value Measurements (SFAS 157), as it applies to our financial instruments,and Statement of Financial Accounting Standard No. 159, The Fair ValueOption for Financial Assets and Financial Liabilities – Including an amendmentof FASB Statement No. 115 (SFAS 159). SFAS 157 defines fair value,outlines a framework for measuring fair value, and details the requireddisclosures about fair value measurements. SFAS 159 permits companies toirrevocably choose to measure certain financial instruments and other items atfair value. SFAS 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparison between entities that choose differentmeasurement attributes for similar types of assets and liabilities.

 

UnderSFAS 157, fair value is defined as the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date in the principal or most advantageousmarket. SFAS 157 establishes a hierarchy in determining the fair value of anasset or liability. The fair value hierarchy has three levels of inputs, bothobservable and unobservable. SFAS 157 requires the utilization of the lowestpossible level of input to determine fair value. Level 1 inputs include quotedmarket prices in an active market for identical assets or liabilities. Level 2inputs are market data, other than Level 1, that are observable either directlyor indirectly. Level 2 inputs include quoted market prices for similar assetsor liabilities, quoted market prices in an inactive market, and otherobservable information that can be corroborated by market data. Level 3 inputsare unobservable and corroborated by little or no market data.

 

Exceptfor those assets and liabilities which are required by authoritative accountingguidance to be recorded at fair value in our balance sheets, the Company haselected not to record any other assets or liabilities at fair value, aspermitted by SFAS 159. No events occurred during the quarter ended January 31,2009 that would require adjustment to the recognized balances of assets orliabilities that are recorded at fair value on a nonrecurring basis.

 

6

----

Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notesto Condensed Consolidated Financial Statements

 

January 31,2009 (Unaudited)

 

Thefollowing table provides information on those assets measured at fair value ona recurring basis.

 
| ** **                       | ** ** | **Fair Value as of**  | ** ** | **Fair Value Measurement Using** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                       | ** ** | **January 31,  2009** | ** ** | **Level 1**                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Restricted cash – current   |       | $                                    | 337,257    |                                            | $          | 337,257 |   | $ | — |   | $ | — |   |
|                             |       |                                 |       |                                            |       |   |   |   |   |   |   |   |   |
| Restricted cash – long-term |       | $                                    | 920,635    |                                            | $          | 920,635 |   | $ | — |   | $ | — |   |
|                             |       |                                 |       |                                            |       |   |   |   |   |   |   |   |   |
| Commodity derivative instruments |       | $                                    | 653,302    |                                            | $          | 653,302 |   | $ | — |   | $ | — |   |

 

Thefair value of the commodity derivative instruments, which relate to corn andethanol, and restricted cash, which includes money market funds, are based onquoted market prices in an active market.

 

**5.****             ****INVENTORY**

 

Inventory consisted of thefollowing at January 31, 2009 and October 31, 2008:

 
| ** **      | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|-----------------|------------|----------------------|------------|----------------------|------------|
| ** **      | ** ** | **2009**             | ** ** | **2008 ***      | ** ** |
| Raw materials   |       | $                    | 8,301,999  |                 | $          | 5,830,477 |   |
| Work in process |       | 926,112              |       | 1,200,242            |       |
| Finished goods  |       | 1,141,245            |       | 725,365              |       |
| Supplies        |       | 1,046,067            |       | 683,007              |       |
| Other grains    |       | 683,279              |       | 1,194,658            |       |
| Total           |       | $                    | 12,098,702 |                 | $          | 9,633,749 |   |

 

----

| * |   | Derived from  audited financial statements |
|---|--------|--------------------------------------------|

 

The Company recorded lossesof approximately $195,000 for the three months ended January 31, 2009related to inventory where the market value was less than the cost basis,attributable primarily to decreases in market prices of corn and ethanol. Theloss was recorded with the lower of cost or market adjustment in the statementof operations. At January 31, 2009 and October 31, 2008, the Companystored grain inventory for farmers. The value of these inventories owned byothers is approximately $694,000 and $658,000 based on market prices at January 31,2009 and October 31, 2008, respectively.

 

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

 

AtJanuary 31, 2009 and October 31, 2008, the Company recorded an assetfor derivative instruments of approximately $650,000 and $750,000,respectively. None of the positions open at January 31, 2009 and October 31,2008 are designated as cash flow or fair value hedges.  The Company hasrecorded a gain of approximately $450,000 and $716,000 in cost of goods soldrelated to its corn derivative instruments for the quarters ending January 31,2009 and 2008, respectively. The Company has recorded a gain of approximately$375,000 in revenues related to ethanol derivatives for the quarter ended January 31,2009. There was no gain recognized in revenues related to derivatives for thequarter ended January 31, 2008.

 

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

 

TheCompany has a line of credit for up to $7,500,000, subject to certain borrowingbase requirements, and is due April 1, 2009. Interest accrues onborrowings at the one month LIBOR plus 3.25%, which totaled 3.67% at January 31,2009 and 5.74% at October 31, 2008. The Company has a .25% commitment feeon the unused portion of the line of credit. As of January 31, 2009, theCompany had drawn $1,000,000 on the line. There was no balance outstanding onthe line of credit at October 31, 2008.

 

Theline of credit, along with the term note and revolving term note described inNote 8, is subject to amaster loan agreement with AgStar. At January 31, 2009, the Company wasnot in compliance with the working capital requirement of the master loanagreement. Additionally, the Company anticipates being out of compliance withone or more covenants through or as of fiscal year end 2009.

 

7

----

Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notesto Condensed Consolidated Financial Statements

 

January 31,2009 (Unaudited)

 

The Company is negotiatingwith AgStar to waive the actual and probable violations of the loan agreement,but has not received a waiver from AgStar. There is no assurance when anywaiver or amendment will be provided by the lender, or that the Company will beable to comply in the future with all covenants and obligations of the masterloan agreement. The Company has reclassified the term note and revolving termnote to current liabilities since AgStar has the right to accelerate theindebtedness and declare it immediately due. In the absence of a waiver of theactual or probable covenant violations, amendment to the loan agreement orrefinancing of the loan agreement, the Company does not have adequate capitalto repay all of the amounts that would become due upon acceleration. TheCompany is currently in discussions with AgStar to extend the maturity of theline of credit at its current level, to waive the actual or probable violationsof the loan agreement, and delay principal payments on the term note andrevolving term note. There is no assurance that any amendment, extension ofmaturity or available amounts, or delay in principal payments will be providedby AgStar. See Note 2 regarding the presentation of the financial informationcontained in this Form 10-Q in light of this event of default.

 

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

 

Debt financing consists ofthe following:

 
| ** **                                                   | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **2009**             | ** ** | **2008***            | ** ** |
| Term note payable to lending institution,  see terms below   |       | $                    | 56,534,738 |                 | $          | 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                                          |       | 3,905,153            |       | 3,910,266            |       |
|                                                         |       |                 |       |                 |       |
| Notes payable to electrical company                          |       | 1,950,299            |       | 2,173,826            |       |
|                                                         |       |                 |       |                 |       |
| Equipment note                                               |       | 56,018               |       | 65,956               |       |
|                                                         |       |                 |       |                 |       |
| Total                                                        |       | 63,702,080           |       | 64,914,888           |       |
|                                                         |       |                 |       |                 |       |
| Less amounts due on demand or within one  year               |       | 58,427,993           |       | 5,649,354            |       |
|                                                         |       |                 |       |                 |       |
| Net long term debt                                           |       | $                    | 5,274,087  |                 | $          | 59,265,534 |   |

 

----

| * |   | Derived from  audited financial statements |
|---|--------|--------------------------------------------|

 

As described in Note 2, weare currently out of compliance with a covenant of the master loan agreementwith AgStar and have reclassified the long-term portion of the debt with themto current.

 

*Term Note*

 

* *The term noterequires monthly payments of approximately $702,000 of principal and interest. Interestaccrues at the one-month LIBOR plus 3.25%, which totaled 3.67% and 5.74% at January 31,2009 and October 31, 2008, respectively. In May 2008, the Companylocked in an interest rate of 3.58% plus 3.00%, which totals 6.58% on$45,000,000 of the note, for three years ending April 30, 2011. Asdescribed in Note 7, the Company is currently out of compliance with the masterloan agreement, has not received a waiver from AgStar, and has reclassified theterm note and the revolving term note described below to current liabilities. Theterm note originally had a ten year amortization, with a final balloon paymentdue in October 2012. In addition, the Company is required to makeadditional payments on the term note of excess cash flow, as defined in theagreement, up to $2,000,000 per year to the lending institution until theCompany meets a specified financial ratio. As part of the debt financing, thepremium above LIBOR may be reduced based on the ratio of members’ equity toassets. The owner of the general contractor has personally guaranteed up to$3,740,000 of our obligations under the master loan agreement.

 

8

----

Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notesto Condensed Consolidated Financial Statements

 

January 31,2009 (Unaudited)

 

*RevolvingTerm Note*

 

TheCompany has a revolving term note with the same lending institution for up to$4,500,000 for cash and inventory management purposes. The Company paysinterest on principal advances monthly at the one-month LIBOR rate plus 3.25%,which totaled 3.67% and 5.74% at January 31, 2009 and October 31,2008 respectively. The availability under this note declines by $500,000annually until October 2011 when it will be $3,000,000 until maturity in October 2012.The Company pays a commitment fee of 0.35% per annum on the unused portion ofthe revolving term note. Asdescribed above and in Note 2, we are currently out of compliance with themaster loan agreement and have reclassified the amount due on the revolvingterm note to current liabilities.

 

*Maturities*

 

The estimated maturities oflong-term debt at January 31, 2009, are as follows (after reclassificationof $52.7 million of the long-term debt to current, as noted above):

 
| 2010                 |   | $         | 58,427,993 |   |
|----------------------|--------|-----------|------------|--------|
| 2011                 |   | 684,529   |       |
| 2012                 |   | 683,292   |       |
| 2013                 |   | 673,666   |       |
| 2014                 |   | 366,229   |       |
| Thereafter           |   | 2,866,371 |       |
| Total long-term debt |   | $         | 63,702,080 |   |

 

The estimated maturitiesinclude the term note and revolving term note as due currently as AgStar hasthe right to call the loans. However, AgStar has not yet called the loans andthe Company continues to negotiate the waiver of the actual and expectedviolations of the master loan agreement with AgStar.

 

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

 

*PlantConstructions*

 

Ourethanol plant was constructed under a design-build agreement with Fagen, Inc.as the design-builder. As of January 31, 2009, the Company has paid $77.6million and has retained approximately $3.8 million in payments to Fagen, Inc.Final payment will be due once the plant meets certain operating performancecriteria. The ethanol plant must meet certain performance and emissionstandards and the general contractor retains liability for failure to meetthese standards. The Company continues to undergo performance testing in fiscal2009.

 

*ForwardContracts*

 

The Company has forwardcontracts in place for corn purchases of approximately $26,813,000 through December 2009,which represents approximately 46% of the Company’s anticipated purchases infiscal 2009.

 

Currently, some of thesecorn contract prices are above current market prices for corn and netrealizable value once converted to ethanol and distiller grains. Given therecent declining price of corn and ethanol, upon taking delivery under thesecontracts, the Company would incur a loss. The Company had accrued losses onthese purchase commitments of approximately $5,229,000 at January 31,2009. This amount includes additional losses on purchase commitments ofapproximately $1,815,000 during the three months ended January 31, 2009. Losseson purchase commitments are recorded as in the lower of cost or marketadjustment on the statement of operations. The amount of the loss wasdetermined by applying a methodology similar to that used in the lower of costor market evaluation with respect to inventory. Given the uncertainty of futureethanol prices, this loss may or may not be recovered, and further losses onthe outstanding purchase commitments could be recorded in future periods.

 

**10****.****      ****RELATED PARTY TRANSACTIONS**

 

During the quarters ending January 31,2009 and January 31, 2008, the Company purchased corn from members forapproximately $14,232,000 and $5,741,000, respectively.

 

9

----

Tableof Contents

 

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*This Management’s Discussion andAnalysis of Financial Condition and Results of Operations, contains, in additionto historical information, forward-looking statements that are based on ourexpectations, beliefs, intentions or future strategies. These statements aresubject to risks and uncertainties that could cause actual results to**differ materially from thestatements 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 of this Quarterly Reporton Form 10-Q for the quarter ended January 31, 2009, as well as inother filings we make with the Securities and Exchange Commission. Allforward-looking statements included herein are based on information availableto us as of the date hereof, and we undertake no obligation to update any suchforward-looking statements.*

 

The following is adiscussion and analysis of Heron Lake BioEnergy’s financial condition andresults of operations as of and for the three month periods ended January 31,2008 and 2009. This section should be read in conjunction with the condensedconsolidated financial statements and related notes in Item 1 of this reportand the Company’s Annual Report on Form 10-K for the year ended October 31,2008.

 

**Overview**

 

Heron Lake BioEnergy, LLC operatesa coal-fired, dry mill corn-based ethanol plant near Heron Lake, Minnesota. Theplant has a stated capacity to produce 50 million gallons of denaturedfuel grade ethanol and 160,000 tons of dried distillers’ grains per year. Theplant was completed, and full-scale production of ethanol and distillers’grains at the plant began, in September 2007. We began recording revenuefrom plant production in October 2007, the last month of our fiscal year.Our revenues are derived from the sale and distribution of our ethanolthroughout the continental United States and in the sale and distribution ofour distillers’ grains locally, and throughout the continental United States.

 

We are subject to a numberof factors, including those affecting the fuel ethanol industry generally, thatmay affect our future operating and financial performance. These factorsinclude, but are not limited to, the available supply and cost of corn fromwhich our ethanol and distillers grains are processed; the availability andcost of coal, which we use in the production process; dependence on our ethanolmarketer to market and distribute our ethanol; the intensely competitive natureof the ethanol industry; possible legislation at the federal, state and/orlocal level; changes in federal ethanol tax incentives and other policies; andthe cost of complying with extensive environmental laws that regulate ourindustry.

 

Since commencing operations,our focus has been on (i) ensuring the plant is operating as efficientlyas possible and (ii) cost-effective purchasing of key manufacturing inputssuch as corn.

 

**CriticalAccounting Estimates**

 

A description of ourcritical accounting estimates was provided in the *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations*section of our Annual Report on Form 10-K for theyear ended October 31, 2008. At January 31, 2009, our criticalaccounting estimates continue to include those described in our Annual Reporton Form 10-K. In addition, our analysis of future projections, resolutionof debt terms and other assumptions in consideration of continuing as a goingconcern include critical accounting estimates.

 

**Results ofOperations**

 

The following table showssummary information from our Statement of Operations for the three months endedJanuary 31, 2009 and January 31, 2008.

 
| ** **                          | ** ** | **January 31, 2009** | ** ** | **January 31, 2008** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                     | ** ** | **%**                          | ** ** | **Amount** | ** ** | **%** | ** ** |
| Revenues                            |       | $                              | 18,095,366 |                           | 100.0      |   | $ | 31,981,484 |   | 100.0 |   |
|                                |       |                           |       |                           |       |   |   |   |   |
| Cost of Goods Sold                  |       |                           |       |                           |       |   |   |   |   |
| Cost of goods sold                  |       | 19,877,852                     |       | 109.8                          |       | 24,501,156 |   | 76.6 |   |
| Lower of cost or market adjustment  |       | 2,009,849                      |       | 11.1                           |       | — |   | — |   |
| Total Cost of Goods Sold            |       | 21,887,701                     |       | 120.9                          |       | 24,501,156 |   | 76.6 |   |
|                                |       |                           |       |                           |       |   |   |   |   |
| Gross Profit (Loss)                 |       | (3,792,335                     | )          | (20.9                          | )          | 7,480,328 |   | 23.4 |   |
|                                |       |                           |       |                           |       |   |   |   |   |
| Operating Expenses                  |       | 1,008,518                      |       | 5.6                            |       | 750,040 |   | 2.3 |   |
|                                |       |                           |       |                           |       |   |   |   |   |
| Operating Income (Loss)             |       | (4,800,853                     | )          | (26.5                          | )          | 6,730,288 |   | 21.1 |   |
|                                |       |                           |       |                           |       |   |   |   |   |
| Other Expense, net                  |       | (1,445,953                     | )          | (8.0                           | )          | (1,503,892 | ) | (4.7 | ) |
|                                |       |                           |       |                           |       |   |   |   |   |
| Net Income (Loss)                   |       | $                              | (6,246,806 | )                              | (34.5      | ) | $ | 5,226,396 |   | 16.4 |   |

 

10

----

Tableof Contents

 

*Revenues*

 

Revenues are derived fromthe sale of fuel ethanol and distillers’ grains with solubles (“DGS”) producedat the Plant and declined 43% from the quarter ended January 31, 2008 tothe quarter ended January 31, 2009. Ethanol revenues during the quarterended January 31, 2009, were approximately $13.8 million,representing 76.2% of our sales, compared to approximately $24.0 million duringthe quarter ended January 31, 2008, representing 75.0% of our sales. Thedecrease in ethanol revenue was a result of a 22% decrease in the average priceper gallon of ethanol quarter to quarter, in conjunction with a 26% decrease inthe gallons of ethanol sold. The decrease in ethanol prices followed declinesin the gasoline market during the quarter ended January 31, 2009. Productiondifficulties experienced during the first quarter of fiscal 2009 related tocoal handling equipment and was the main contributing factor in the reducednumber of gallons produced and sold during the period. We have taken steps toaddress the production difficulties, but there can be no assurance that futureproduction disruptions will not occur. We had gains of approximately $375,000related to ethanol derivatives for the quarter ended January 31, 2009. Therewere no ethanol derivative gains during the quarter ended January 31,2008.

 

Total sales of DGS duringthe quarter ended January 31, 2009 was approximately $2.6 millioncomprising 14.4% of our sales. DGS sales during the quarter ended January 31,2008, were $4.4 million or 13.8% of sales. The production difficultiesexperienced during the quarter ended January 31 2009 caused DGS productionand sales to decline resulting in a decline DGS revenue.

 

*Cost ofSales*

 

Our costs of sales includes,among other things, the cost of corn used in ethanol and DGS production (whichis the largest component of costs of sales); coal, processing ingredients,electricity, and wages, salaries and benefits of production personnel. We useapproximately 1.5 million bushels of corn per month at the plant. Wecontract with local farmers and elevators for our corn supply.

 

Our cost of goods sold(including lower of cost or market adjustments) as a percentage of revenueswere 120.9% and 76.6% for the three months ended January 31, 2009 and,2008, respectively. The per bushel cost of corn purchased increasedapproximately 29% in the quarter ended January 31, 2009 as compared to thequarter ended January 31, 2008. This increase combined with the 22%decrease in the per gallon sales price of ethanol to cause this increase in thecost of goods sold as a percent of revenues. Cost of goods sold also includeslower of cost or market adjustments of $2,009,849 for the quarter ended January 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 quarter ended January 31, 2008. We had gainsrelated to corn derivative instruments of approximately $450,000 and $716,000for the quarters ended January 31, 2009 and 2008, respectively, whichreduced cost of sales. Our gross margin for the three months ended January 31,2009 decreased to (20.9%) from 23.4% for the three months ended January 31,2008. We had a negative gross margin in the first quarter of fiscal 2009 ascompared to first quarter of fiscal 2008 due to the 22% decline in ethanolprices while corn prices increased 29%. In addition, lower production levelsand fixed costs contributed to the negative gross margin incurred.

 

The cost of corn fluctuatesbased on supply and demand, which, in turn, is affected by a number of factorswhich are beyond our control. We expect our gross margin to fluctuate in thefuture based on the relative prices of corn and fuel ethanol. We use futuresand options contracts to minimize our exposure to movements in corn prices, butthere is no assurance that these hedging strategies will be effective. At January 31,2009, none of our derivative contracts were designated as hedges and, as aresult, changes to the market value of these contracts were recognized as anincrease or decrease to our costs of goods sold. As a result, gains or losseson derivative instruments do not necessarily coincide with the related cornpurchases. This may cause fluctuations in cost of goods sold. While we do notuse hedge accounting to match gains or losses on derivative instruments, webelieve the derivative instruments provide an economic hedge.

 

*Selling,General and Administrative Expenses*

 

Selling, general andadministrative expenses include wages, salaries and benefits of administrativeemployees at the Plant, marketing fees, insurance, professional fees andsimilar costs. These expenses represented 5.6% of total revenues for thequarter ended January 31, 2009 and 2.3% of total revenues for the quarterended January 31, 2008.       These expenses generally do not vary with thelevel of production at the plant. Professional and legal fees increased withadditional accounting and internal control consulting work in anticipation ofrequired compliance with the Sarbanes-Oxley Act of 2002 and SEC reportingrequirements. Decreased revenue for the quarter ended January 31, 2009also negatively affected operating expenses as a percentage of revenue as totalrevenues declined approximately 43%.

 

*OtherIncome (Expense)*

 

Other expense consistedprimarily of interest expense. Interest expense consists primarily of interestpayments on our credit facilities described below. Interest expense, which isdown approximately 33% as compared to the quarter ended January 31, 2008,is dependent on the balances outstanding and on interest rate fluctuations. Forthe quarter ended January 31, 2009, debt balances were

 

11

----

Tableof Contents

 

down approximately 2% andinterest rates decreased as well period over period. Also included in otherexpense is the write-off of loan costs of approximately $445,000. Because wehave not obtained a waiver from AgStar Financial Services, PCA (“AgStar”) foractual or expected violations of our master loan agreement, our long-term debtwith AgStar was classified as currently due. As such, we wrote-off theremaining loan costs rather than amortizing them over the original contractualterm of the loans.

 

**Liquidityand Capital Resources**

 

As of January 31, 2009,we had cash and cash equivalents (other than restricted cash) of approximately$428,000, current assets (including derivative instruments valued atapproximately $653,000) of approximately $17.2 million and total assets ofapproximately $121.7 million.

 

Our principal sources of liquidityconsist of cash provided by operations, cash and cash equivalents on hand, andavailable borrowings under our master loan agreement with AgStar. Under themaster loan agreement, we have three forms of debt: a term note, a revolvingterm note and a line of credit. Among other provisions, our master loanagreement contains covenants requiring us to maintain various financial ratiosand tangible net worth. It also limits our annual capital expenditures andmembership distributions. All of our assets and real property are subject tosecurity interests and mortgages in favor of AgStar as security for theobligations of the master loan agreement.

 

At January 31, 2009, wewere 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$57.7 of the AgStar debt as a current liability. As a result, currentliabilities as of January 31, 2009 totaled approximately $72.1 million,including $52.7 million of long-term debt reclassified as current.

 

We have requested a waiverof the covenant violations from AgStar and are currently in negotiations withAgStar regarding the waiver of current and potential future covenantviolations. However, there is no assurance that any waiver or amendment to themaster loan agreement will be provided by the lender, or that we will be ableto comply in the future with all covenants and obligations of the master loanagreement. Further, there can be no assurance that the lender will not demandimmediate repayment of all $58.7 million in indebtedness outstanding under themaster loan agreement at January 31, 2009 or exercise any of its rights asa secured party with respect to the Company’s assets. The total indebtedness toAgStar at January 31, 2009 consists of $56.5 million under the term note,$1.2 million under the revolving term note and $1.0 million under the line ofcredit. In the absence of a waiver of the covenant defaults, an amendment tothe master loan agreement or refinancing of the master loan agreement, we donot have adequate capital to repay all of the amounts that would become dueupon acceleration.

 

In May 2008, we locked in aninterest rate of 3.58% plus 3.00%, which totals 6.58%, on $45,000,000 of theterm note, for three years ending April 30, 2011. The remainder of theamounts outstanding on the term note is subject to the variable rate based onthe one month LIBOR plus 3.25%.  We arerequired to make equal monthly payments of principal and interest ofapproximately $702,000 to amortize the note over a period not to exceed tenyears, with a final balloon payment due in October 2012. In addition, weare required to make additional payments on the term note of excess cash flow,as defined in the agreement, up to $2,000,000 per year to the lendinginstitution until we meetcertain minimum tangible owner’s equity, as defined in the agreement. As part of the debt financing, the premium aboveLIBOR may be reduced based on the ratio of members’ equity to assets.

 

Also part of our master loanagreement with AgStar is a line of credit for up to $7,500,000. This line ofcredit will mature on April 1, 2009. At January 31, 2009 and March 13,2009, $1,000,000 and $3,000,000, respectively, were outstanding on therevolving line of credit. We are currently in negotiations with AgStar toextend the maturity of the line of credit at $7.5 million of availability, inaddition to waiving the event of default arising from the working capitalcovenant violation. In the absence of a waiver or an amendment to the line ofcredit to extend the maturity date, we do not have adequate capital to repaythe currently outstanding amounts on the line of credit. There is no assurancethat any amendment or extension of maturity will be provided by the lender.

 

Our principal uses of cashare to pay operating expenses of the plant and to make debt service payments onour long-term debt. During the quarter ended January 31, 2009, we usedcash to make principal payments of approximately $1.2 million against ourlong-term debt. During the same period, we drew $1.0 million on our line ofcredit described below.

 

During the quarter ended January 31,2009, we used $10.7 million in cash for operating activities. This use consistsprimarily of a net loss of $6.2 million, payments for corn under deferredpayment agreements and payments under forward purchase contracts the losses onwhich had been accrued on October 31, 2008.

 

During the quarter ended January 31,2009, we used $0.2 million for investing activities to pay for capitalexpenditures and intangibles, and do not anticipate any significant capitalexpenditures during fiscal 2009. During the quarter ended January 31,2009, we used $31,000 for financing activities consisting primarily of paymenton long term debt of $1.0 million net of release of restricted cash and a drawon the line of credit of $1.0 million.

 

12

----

Table of Contents

 

Further, whilean event of default exists, we are not permitted to borrow additionalfunds under our line of credit or revolving term note unless AgStar consents.We expect to address expected shortfall in working capital by conserving fundsby utilizing and reducing corn inventory as well as reducing operating expensesthrough cost controls.  Provided that wereceive waivers from the events of default under the master loan agreement andthat the lender does not exercise its right to demand immediate repayment ofthe outstanding indebtedness under the master loan agreement, we expect thatour current cash reserves, when combined with anticipated revenues and our availableborrowing capacity under our revolving promissory note and line of credit willbe sufficient to fund our working capital and capital resources needs throughfiscal 2009. However, there can be no assurance, that we will not requireadditional financing in the future or that any additional financing will beavailable to us on satisfactory terms, if at all.

 

**Outlook**

 

We anticipate that ethanolprices will recover somewhat during 2009 from the lower prices received duringthree months ended January 31, 2009, based on prices quoted for ethanolfutures on the Chicago Board of Trade, and as energy prices historicallyincrease during the summer driving season. Nevertheless, we expect to seecontinuing volatility in ethanol prices. Future prices for fuel ethanol will be affected by a variety of factorsbeyond 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 alsoaffected by a number of factors beyond our control such as the supply of anddemand for DGS as an animal feed, prices of competing feeds, and perceptions ofnutritional value of DGS as compared to those competing feeds. We believe thatcurrent market prices for DGS can be sustained long-term as long as the pricesof competing animal feeds remain steady or increase, livestock feeders continueto create demand for alternative feed sources such as distillers’ grains andthe supply of distillers’ grains remains relatively stable. On the other hand,if competing commodity price values retreat and DGS supplies increase due togrowth in the ethanol industry, DGS prices may decline.

 

Corn prices have beenvolatile for the past year  due in partto higher demand from the renewable fuels industry. The expansion of ethanolproductive capacity has brought about a substantial increase in demand for cornand thus in corn prices. We expect the price of corn to remain at current pricelevels well into 2009.   Due to increased exposure of ethanol, corn is nowbeing viewed as an “energy commodity” as opposed to strictly a “graincommodity,” contributing to the upward pressure on corn prices.  The USDA’sFebruary 12, 2009 Feed Outlook Report, projects U.S. corn prices for theseason average to be at $3.65 to $4.15 per bushel.

 

**Off-BalanceSheet Arrangements**

 

We do not have anyoff-balance sheet arrangements.

 

**Item 4.Controls and Procedures**

** **

**Effectiveness of DisclosureControls and Procedures**

** **

Ourmanagement, with the participation of our Chief Executive Officer and InterimChief Financial Officer, has evaluated the effectiveness of our “disclosurecontrols and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on that evaluation, our ChiefExecutive Officer and Interim Chief Financial Officer have concluded that, asof the end of such period, our disclosure controls and procedures were noteffective because of the material weakness discussed below.

 

Therewas a material adjustment to our financial statements and other factors duringthe period covered by this report that impacted our closing process and delayedthe preparation of our consolidated financial statements, including allrequired disclosures, in a timely manner. The adjustments to our original trialbalance impacted a balance sheet and an income statement account.  Thesedeficiencies constituted a material weakness in our financial close process.

 

We are in the process ofupgrading our systems, implementing additional financial and managementcontrols, and reporting systems and procedures.  We are currentlyundergoing a comprehensive effort in preparation for compliance with Section 404of the Sarbanes-Oxley Act of 2002. This effort, under the direction of seniormanagement, includes documentation, and testing of our controls and businessprocesses. We are currently in the process of formalizing an internal controlaudit plan that includes performing a risk assessment, establishing a reportingmethodology and testing internal controls and procedures over financialreporting.

 

Inconnection with the material weakness described above, our auditors recommendedthat we continue to create and refine a structure in which critical accountingpolicies and estimates are identified, and together with other complex areas,are subject to multiple reviews by accounting personnel. Our auditors furtherrecommended that we enhance and test our period-end financial close process.

 

**Changes in Internal Control OverFinancial Reporting**

** **

Except as described above,there has been no change in our internal control over financial reporting (asdefined in Rule 13a-15(f) under the Exchange Act) that occurred in thefiscal quarter ended January 31, 2009 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

13

----

Table of Contents

 

**PART II. OTHER INFORMATION**

 

**Item 1A.Risk Factors**

** **

The most significant riskfactors applicable to the Company are described in Part I, Item 1A “RiskFactors” of our Annual Report on Form 10-K for the year ended October 31,2008. There have been no material changes from the risk factors previouslydisclosed in our Annual Report on Form 10-K except as stated below:

 

***We are in default of our master loan agreement with AgStar FinancialServices.***

*** ***

At January 31, 2009, wewere in default of our master loan agreement with AgStar relating to minimumworking capital of $3.0 million. Additionally, we do not expect to be incompliance with one or more covenants of the master loan agreement as of fiscalyear end 2009. All of our assets and real property are subject to securityinterests and mortgages in favor of AgStar as security for the obligations ofthe master loan agreement. Our failure to maintain the required amount ofworking 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$57.7 in long-term debt as a current liability. As a result, current liabilitiesas of January 31, 2009 totaled approximately $72.1 million, including this$57.7 million. This compares to cash and cash equivalents (other thanrestricted cash) at January 31, 2009 of approximately $428,000, currentassets of approximately $17.2 million and total assets of approximately $121.7million. In the absence of a waiver of the covenant defaults, amendment to themaster loan agreement or refinancing of the master loan agreement, we do nothave adequate capital to repay all of the amounts that would become due uponacceleration.

 

Also part of our master loanagreement with AgStar is a line of credit for up to $7,500,000. This line ofcredit will mature on April 1, 2009. At January 31, 2009 and March 13,2009, $1,000,000 and $3,000,000 respectively, were outstanding on the revolvingline of credit. We are currently in negotiations with AgStar to extend thematurity of the line of credit and to waive the event of default arising fromthe failure to meet the minimum working capital covenant. In the absence of awaiver or an amendment to the line of credit to extend the maturity date, we donot have adequate capital to repay the currently outstanding amounts on theline of credit. There is no assurance that any amendment or extension of maturitywill be provided by the lender or that the line of credit, if renewed, willallow for up to $7.5 million in available borrowing. Further, while an event ofdefault exists, we are not permitted to borrow additional funds under ourline of credit or revolving term note unless AgStar consents.

 

If we do not receive waiverof the events of default under the master loan agreement and an extension ofmaturity of our line of credit, we may be required to attempt to refinance ourdebt, curtail significantly, or stop our business activities. If the lenderenforces its rights under the master loan agreement to accelerate theindebtedness or proceed against our assets to collect on the indebtedness, wemay lose control of our business and be forced to sell assets, restructure ourindebtedness or submit to foreclosure proceedings, all of which could result ina material adverse effect upon our business, results of operations andfinancial condition.

 

**Item 3. Defaults Upon SeniorSecurities**

** **

At January 31, 2009,Heron Lake BioEnergy, LLC was in default of the minimum working capitalcovenant of a master loan agreement with AgStar Financial Services, PCA.  This master loan agreement relates toindebtedness at January 31, 2009 consisting of $56.5 million under a termnote, $1.2 million under a revolving term note and $1.0 million under a line ofcredit.

 

**Item 6.Exhibits**

 

The following exhibits areincluded 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.                                                                         |

 

14

----

Table of Contents

 

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                      | HERON LAKE BIOENERGY, LLC                                                      |
|---------------------------|--------------------------------------------------------------------------------|
|                      |                                                                           |
| Date: March 17, 2009 | /s/  Robert J. Ferguson                                                   |
|                      | Robert J Ferguson                                                              |
|                      | President and Chief  Executive Officer  (Principal Executive Officer)          |
|                      |                                                                           |
|                      |                                                                           |
| Date: March 17, 2009 | /s/  Brett L. Frevert                                                     |
|                      | Brett L Frevert                                                                |
|                      | Interim Chief Financial  Officer  (Principal Accounting and Financial Officer) |

 

15

----