Table of Contents

 

 

 

**UNITEDSTATESSECURITIES 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 April 30, 2009**                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                       |
| **OR**                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                       |       |                                                                                               |
| **o**                                                                                                                                                                                                                                                                      | ** ** | **Transition  report under Section 13 or 15(d) of the Exchange Act.**                    |
|                                                                                                                                                                                                                                                                       |
| **For  the transition period from                    to                  .** |

 

**COMMISSIONFILE NUMBER 000-51825**

 

**HERON LAKEBIOENERGY, LLC**

(Exact name of Registrantas specified in its charter)

 

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

 

**91246390****th**** Avenue,Heron Lake, MN 56137-1375**

(Address of principal executiveoffices)

 

**(507)793-0077**

(Issuer’s telephonenumber)

 

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 June 15, 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                                                                     | 18                |
| PART II.  OTHER INFORMATION                                                                         |              |
| Item  1A. Risk Factors                                                                                   | 19                |
| Item 3. Defaults Upon Senior Securities                                                             | 20                |
| Item 4. Submission of Matter to Vote of Security  Holders                                                | 20                |
| Item  5. Other Information                                                                               | 22                |
| Item 6.  Exhibits                                                                                   | 22                |
| SIGNATURES                                                                                               | 23                |

 

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Table of Contents

 

**PART I.  FINANCIALINFORMATION**

 

**Item 1.  FinancialStatements**

 

**HERONLAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Condensed ConsolidatedBalance Sheets

 
| ** **                       | ** ** | **April 30,** | ** **  | **October 31,** | ** ** |
|----------------------------------|------------|--------------------|-------------|----------------------|------------|
| ** **                       | ** ** | **2009**           | ** **  | **2008**             | ** ** |
| ** **                       | ** ** | **(Unaudited)**    | ** **  | ** **           | ** ** |
| **ASSETS**                       |       |               |        |                 |       |
| **Current  Assets**              |       |               |        |                 |       |
| Cash and equivalents             |       | $                  | 2,135,558   |                 | $          | 11,355,075 |   |
| Restricted cash                  |       | 591,685            |        | 1,499,472            |       |
| Accounts receivable              |       | 2,601,259          |        | 3,368,076            |       |
| Inventory                        |       | 7,368,486          |        | 9,633,749            |       |
| Derivative instruments           |       | 105,325            |        | 750,172              |       |
| Prepaid expenses                 |       | 1,147,739          |        | 616,641              |       |
| Total current assets             |       | 13,950,052         |        | 27,223,185           |       |
|                             |       |               |        |                 |       |
| Property and equipment           |       |               |        |                 |       |
| Land and improvements            |       | 12,571,092         |        | 12,552,721           |       |
| Plant buildings and  equipment   |       | 97,362,365         |        | 97,159,759           |       |
| Vehicles and other  equipment    |       | 618,710            |        | 597,921              |       |
| Office buildings and  equipment  |       | 614,643            |        | 597,508              |       |
|                             |       | 111,166,810        |        | 110,907,909          |       |
| Less accumulated  depreciation   |       | 9,804,056          |        | 7,025,870            |       |
|                             |       | 101,362,754        |        | 103,882,039          |       |
|                             |       |               |        |                 |       |
| **Other  Assets**                |       |               |        |                 |       |
| Deferred loan costs,  net        |       | —             |        | 467,128              |       |
| Restricted cash                  |       | 904,521            |        | 995,804              |       |
| Other intangibles                |       | 506,193            |        | 464,304              |       |
| Debt service deposits  and other |       | 398,700            |        | 368,350              |       |
| Total other assets               |       | 1,809,414          |        | 2,295,586            |       |
|                             |       |               |        |                 |       |
| **Total  Assets**                |       | $                  | 117,122,220 |                 | $          | 133,400,810 |   |

 

See Notes to Condensed Consolidated FinancialStatements

 

1

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**HERONLAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Condensed ConsolidatedBalance Sheets

 
| ** **                                                           | ** ** | **April 30,** | ** **  | **October 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------|-------------|----------------------|------------|
| ** **                                                           | ** ** | **2009**           | ** **  | **2008**             | ** ** |
| ** **                                                           | ** ** | **(Unaudited)**    | ** **  | ** **           | ** ** |
| **LIABILITIES AND MEMBERS’ EQUITY**              |       |               |        |                 |       |
| **Current  Liabilities**                                             |       |               |        |                 |       |
| Line of credit                                                       |       | $                  | 2,000,000   |                 | $          | — |   |
| Current maturities of  long-term debt                                |       | 58,433,818         |        | 5,649,354            |       |
| Accounts payable:                                                    |       |               |        |                 |       |
| Trade accounts payable                                               |       | 1,830,412          |        | 5,635,204            |       |
| Trade accounts payable  — related party                         |       | 522,992            |        | 792,450              |       |
| Construction payable —  related party                           |       | 3,839,413          |        | 3,839,413            |       |
| Accrued expenses                                                     |       | 649,846            |        | 512,709              |       |
| Accrued losses on  forward contracts                                 |       | 3,027,246          |        | 7,122,966            |       |
| Total current  liabilities                                           |       | 70,303,727         |        | 23,552,096           |       |
|                                                                 |       |               |        |                 |       |
| **Long-Term  Debt,** net of  current maturities                      |       | 5,260,051          |        | 59,265,534           |       |
|                                                                 |       |               |        |                 |       |
| **Commitments  and Contingencies**                                   |       |               |        |                 |       |
|                                                                 |       |               |        |                 |       |
| **Members’  Equity, 27,104,625 Class A units outstanding** |       | 41,558,442         |        | 50,583,180           |       |
|                                                                 |       |               |        |                 |       |
| **Total  Liabilities and Members’ Equity**                      |       | $                  | 117,122,220 |                 | $          | 133,400,810 |   |

 

See Notes to Condensed Consolidated FinancialStatements

 

2

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**HERONLAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Condensed ConsolidatedStatements of Operations

 
| ** **                                                  | ** ** | **Three  Months  Ended April 30,** | ** ** | **Three Months  Ended April 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                     | ** ** | **2008**                                         | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                              | ** ** | **(Unaudited)**                                  | ** ** |
|                                                        |       |                                         |       |                                             |       |
| **Revenues**                                                |       | $                                            | 21,493,104 |                                             | $          | 33,590,181 |   |
|                                                        |       |                                         |       |                                             |       |
| **Cost  of Goods Sold**                                     |       |                                         |       |                                             |       |
| Cost of goods sold                                          |       | 21,241,824                                   |       | 26,154,559                                       |       |
| Lower of cost or market  adjustment`                        |       | 1,448,381                                    |       | —                                           |       |
| **Total  Cost of Goods Sold**                               |       | 22,690,205                                   |       | 26,154,559                                       |       |
|                                                        |       |                                         |       |                                             |       |
| **Gross  Margin (Loss)**                                    |       | (1,197,101                                   | )          | 7,435,622                                        |       |
|                                                        |       |                                         |       |                                             |       |
| **Selling,  General, and Administrative Expenses**          |       | 705,677                                      |       | 782,168                                          |       |
|                                                        |       |                                         |       |                                             |       |
| **Operating  Income (Loss)**                                |       | (1,902,778                                   | )          | 6,653,454                                        |       |
|                                                        |       |                                         |       |                                             |       |
| **Other  Income (Expense)**                                 |       |                                         |       |                                             |       |
| Interest income                                             |       | 13,991                                       |       | 22,545                                           |       |
| Interest expense                                            |       | (905,485                                     | )          | (1,191,222                                       | )          |
| Other income, net                                           |       | 16,339                                       |       | 4,645                                            |       |
| Total other expense,  net                                   |       | (875,155                                     | )          | (1,164,032                                       | )          |
|                                                        |       |                                         |       |                                             |       |
| **Net  Income (Loss)**                                      |       | $                                            | (2,777,933 | )                                                | $          | 5,489,422 |   |
|                                                        |       |                                         |       |                                             |       |
| **Net  Income (Loss) Per Unit - Basic and Diluted**         |       | $                                            | (0.10      | )                                                | $          | 0.20 |   |
|                                                        |       |                                         |       |                                             |       |
| **Weighted  Average Units Outstanding - Basic and Diluted** |       | 27,104,625                                   |       | 27,104,625                                       |       |

 

See Notes to Condensed Consolidated FinancialStatements

 

3

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**HERONLAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Condensed ConsolidatedStatements of Operations

 
| ** **                                                  | ** ** | **Six Months  Ended April 30,** | ** ** | **Six Months  Ended April 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                       | ** ** | **2008**                                       | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                                | ** ** | **(Unaudited)**                                | ** ** |
|                                                        |       |                                           |       |                                           |       |
| **Revenues**                                                |       | $                                              | 39,588,470 |                                           | $          | 65,571,665 |   |
|                                                        |       |                                           |       |                                           |       |
| **Cost  of Goods Sold**                                     |       |                                           |       |                                           |       |
| Cost of goods sold                                          |       | 41,119,676                                     |       | 50,655,715                                     |       |
| Lower of cost or market  adjustment                         |       | 3,458,230                                      |       | —                                         |       |
| **Total  Cost of Goods Sold**                               |       | 44,577,906                                     |       | 50,655,715                                     |       |
|                                                        |       |                                           |       |                                           |       |
| **Gross  Margin (Loss)**                                    |       | (4,989,436                                     | )          | 14,915,950                                     |       |
|                                                        |       |                                           |       |                                           |       |
| **Selling,  General, and Administrative Expenses**          |       | 1,736,337                                      |       | 1,532,208                                      |       |
|                                                        |       |                                           |       |                                           |       |
| **Operating  Income (Loss)**                                |       | (6,725,773                                     | )          | 13,383,742                                     |       |
|                                                        |       |                                           |       |                                           |       |
| **Other  Income (Expense)**                                 |       |                                           |       |                                           |       |
| Interest income                                             |       | 51,872                                         |       | 37,665                                         |       |
| Interest expense                                            |       | (1,923,529                                     | )          | (2,738,254                                     | )          |
| Write off of loan costs                                     |       | (444,985                                       | )          | —                                         |       |
| Other income, net                                           |       | 17,677                                         |       | 32,665                                         |       |
| Total other expense,  net                                   |       | (2,298,965                                     | )          | (2,667,924                                     | )          |
|                                                        |       |                                           |       |                                           |       |
| **Net  Income (Loss)**                                      |       | $                                              | (9,024,738 | )                                              | $          | 10,715,818 |   |
|                                                        |       |                                           |       |                                           |       |
| **Net  Income (Loss) Per Unit - Basic and Diluted**         |       | $                                              | (0.33      | )                                              | $          | 0.40 |   |
|                                                        |       |                                           |       |                                           |       |
| **Weighted  Average Units Outstanding - Basic and Diluted** |       | 27,104,625                                     |       | 27,104,625                                     |       |

 

See Notes to Condensed Consolidated FinancialStatements

 

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**HERONLAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Condensed ConsolidatedStatements of Cash Flows

 
| ** **                                                                         | ** ** | **Six Months  Ended April 30,** | ** ** | **Six Months  Ended April 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                       | ** ** | **2008**                                       | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                                | ** ** | **(Unaudited)**                                | ** ** |
| **Operating  Activities**                                                          |       |                                           |       |                                           |       |
| Net income (loss)                                                                  |       | $                                              | (9,024,738 | )                                              | $          | 10,715,818 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                           |       |                                           |       |
| Depreciation and  amortization                                                     |       | 2,796,132                                      |       | 2,799,016                                      |       |
| Amortization of loan  costs included with interest expense                         |       | 22,143                                         |       | 45,456                                         |       |
| Write-off of loan costs                                                            |       | 444,985                                        |       | —                                         |       |
| Lower of cost or market  adjustments                                               |       | 3,458,230                                      |       | —                                         |       |
| Gain on disposal of  assets                                                        |       | —                                         |       | (16,500                                        | )          |
| Change in fair value of  derivative instruments                                    |       | (93,873                                        | )          | (116,284                                       | )          |
| Change in operating assets  and liabilities:                                       |       |                                           |       |                                           |       |
| Restricted cash                                                                    |       | 770,726                                        |       | 143,445                                        |       |
| Accounts receivable                                                                |       | 766,817                                        |       | (2,967,954                                     | )          |
| Inventory                                                                          |       | 2,011,004                                      |       | 8,400,252                                      |       |
| Derivative instruments                                                             |       | 738,720                                        |       | (297,992                                       | )          |
| Prepaid expenses                                                                   |       | (531,098                                       | )          | (761,694                                       | )          |
| Accounts payable                                                                   |       | (4,074,250                                     | )          | (8,170,638                                     | )          |
| Accrued expenses                                                                   |       | 137,137                                        |       | (171,608                                       | )          |
| Accrued loss on forward  contracts                                                 |       | (7,299,691                                     | )          | —                                         |       |
| Net cash provided by  (used in) operating activities                               |       | (9,877,756                                     | )          | 9,601,317                                      |       |
|                                                                               |       |                                           |       |                                           |       |
| **Investing  Activities**                                                          |       |                                           |       |                                           |       |
| Proceeds from sale of  assets                                                      |       | —                                         |       | 43,500                                         |       |
| Payments for  intangibles                                                          |       | (59,835                                        | )          | —                                         |       |
| Capital expenditures                                                               |       | (258,901                                       | )          | (687,451                                       | )          |
| Net cash used in  investing activities                                             |       | (318,736                                       | )          | (643,951                                       | )          |
|                                                                               |       |                                           |       |                                           |       |
| **Financing  Activities**                                                          |       |                                           |       |                                           |       |
| Checks written in  excess of bank balance                                          |       | —                                         |       | (514,633                                       | )          |
| Proceeds from line of  credit, net                                                 |       | 2,000,000                                      |       | (2,074,235                                     | )          |
| Payments on notes  payable — related party                                    |       | —                                         |       | (4,202,930                                     | )          |
| Payments of long-term  debt                                                        |       | (2,232,505                                     | )          | (2,632,269                                     | )          |
| Proceeds from issuance  of long-term debt                                          |       | 1,011,486                                      |       | 3,289,176                                      |       |
| Debt service deposits  included with other assets                                  |       | (30,350                                        | )          | (91,050                                        | )          |
| Release of restricted  cash                                                        |       | 228,344                                        |       | 92,702                                         |       |
| Net cash provided by  (used in) financing activities                               |       | 976,975                                        |       | (6,133,239                                     | )          |
|                                                                               |       |                                           |       |                                           |       |
| **Net  increase (decrease) in cash and equivalents**                               |       | (9,219,517                                     | )          | 2,824,127                                      |       |
|                                                                               |       |                                           |       |                                           |       |
| **Cash  and Equivalents****— Beginning of Period**                            |       | 11,355,075                                     |       | 3,090,329                                      |       |
|                                                                               |       |                                           |       |                                           |       |
| **Cash  and Equivalents — End of Period**                                     |       | $                                              | 2,135,558  |                                           | $          | 5,914,456 |   |
| **Supplemental  Cash Flow Information**                                            |       |                                           |       |                                           |       |
| Total interest paid                                                                |       | $                                              | 1,849,256  |                                           | $          | 2,863,338 |   |
| **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 SIGNIFICANT ACCOUNTING 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.

 

*Nature of 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.

 

*Accounting Estimates*

 

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.

 

*Revenue Recognition*

 

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.

 

*Derivative Instruments*

 

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-Lived Assets*

 

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 ethanolproduction facilities, has an installed capacity of 50 million gallons peryear.  The carrying value of thesefacilities at March 31, 2009 was approximately $99 million. Inaccordance with the Company’s policy for evaluating impairment of long-livedassets described above, management has evaluated the recoverability of thefacilities based on projected future cash flows from operations over thefacilities’ estimated useful lives. Management has determined that theprojected future undiscounted cash flows from operations of these facilitiesexceed their carrying value at March 31, 2009; therefore, no impairmentloss was indicated or recognized. In determining the projected futureundiscounted cash flows, the Company has made significant assumptionsconcerning the future viability of the ethanol industry, the future price ofcorn in relation to the future price of ethanol and the overall demand inrelation to production and supply capacity.

 

**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 causedmargins in the ethanol industry to be negative. The Company incurred a loss ofapproximately $2.8 million and generated cash of approximately $800,000 fromoperating activities during the three months ended April 30, 2009.  For the six months ended April 30, 2009,the Company incurred a loss of approximately $9.0 million and used cash ofapproximately $9.9 million for operating activities.  At April 30, 2009 as at January 31,2009, the Company was out of compliance with the minimum working capitalrequirement provision of its master loan agreement with AgStar FinancialServices, PCA (AgStar). In addition, the Company anticipates that the minimumnet worth and fixed charge coverage ratio covenants will not be met through oras of fiscal year end 2009 unless amended. At January 31, 2009, theCompany reclassified the long-term debt related to this agreement to currentbecause the Company was not in compliance with the minimum working capitalrequirement. That reclassification remains as of April 30, 2009 because ofthe covenant default stated above and because of the Company’s failure to repaythe revolving line of credit that matured on April 1, 2009 and was due on May 1,2009.  The Company did not repay therevolving line of credit when due because of ongoing negotiations with AgStarregarding the renewal of the line of credit, which on June 12, 2009resulted in a renewal of the line of credit effective May 29, 2009 asdescribed below.  Additionally, theCompany expensed the remaining unamortized loan costs totaling approximately$445,000 associated with this debt during the quarter ended January 31,2009. If AgStar had exercised its right to accelerate the maturity of the debtoutstanding under the master loan agreement or the line of credit, the Companywould not have adequate available cash to repay the amounts currentlyoutstanding at April 30, 2009. Further, while an event of default existed,the Company was not permitted to borrow additional funds under its line ofcredit or revolving term note without AgStar’s consent. These factors raisesubstantial doubt about the Company’s ability to continue as a going concern.

 

On June 12, 2009,the Company and AgStar agreed upon the terms of the renewal of the Company’sline of credit effective May 29, 2009. Therefore, effective May 29, 2009, the Company entered into anAmendment No. 3 to the Fifth Supplement (the “Amendment”) to its masterloan agreement, as previously amended and supplemented, with AgStar.  Among other things, the effect of thisamendment was to renew the Company’s revolving line of credit loan at a maximumcommitment of $6,750,000 and a maturity date of November 1, 2009.  In connection with the renewal, AgStar alsowaived the Company’s noncompliance with the working capital covenant of themaster loan agreement for the period ending January 31, 2009. Further, on June 12,2009, AgStar waived the Company’s noncompliance with the working capitalcovenant of the master loan agreement for the period ending April 30,2009.  AgStar also waived excess cashflow payment provisions for the year ended October 31, 2008 inconsideration of an excess cash flow payment by the Company of $94,700 on June 12,2009.

 

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 April 30, 2010 based upon its current cash reserves,inventory sales, anticipated revenues and the available borrowing under themaster loan agreement, as well as the effect of expense reduction measures,provided that the Company is not otherwise required to repay its indebtednessto AgStar under the master loan agreement. The Company’s expense reductionmeasures and cash conservation measures include utilizing and reducing corninventory as well as reducing operating expenses through cost controls.  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 restructure or significantly curtail itsoperations, file for bankruptcy or cease operations. The financial statementsdo not include any adjustments relating to the recoverability andclassification of recorded asset amounts or amounts and classification ofliabilities that might be necessary should the Company be forced to take anysuch actions.

 

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**3.**             **UNCERTAINTIES**

 

The Company has certain risks and uncertainties thatit experienced during volatile market conditions such as what the Companyexperienced during fiscal 2008. These volatilities can have a severe impact onoperations. The Company’s revenues are derived from the sale and distributionof ethanol and distillers grains to customers primarily located in the U.S.Corn for the production process is supplied to the plant primarily from localagricultural producers.  Ethanol salesaverage 75 - 80% of total revenues and corn costs average 70% - 80% of cost ofgoods 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 andgasoline began a divergence with ethanol selling for less than gasoline at thewholesale level. Excess ethanol supply in the market, in particular, putsdownward pressure on the price of ethanol. The largest cost of production iscorn. The cost of corn is generally impacted by factors such as supply and demand,the weather, government policies and programs, and a risk management programused 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, 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.

 

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 April 30, 2009 that would require adjustment to therecognized balances of assets or liabilities that are recorded at fair value ona nonrecurring 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** | ** ** |
|-----------------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **April 30, 2009**        | ** ** | **Level 1**                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Restricted cash –  current   |       | $                                   | 591,685    |                                            | $          | 591,685 |   | $ | — |   | $ | — |   |
|                              |       |                                |       |                                            |       |   |   |   |   |
| Restricted cash –  long-term |       | $                                   | 904,521    |                                            | $          | 904,521 |   | $ | — |   | $ | — |   |
|                              |       |                                |       |                                            |       |   |   |   |   |
| Commodity derivative  instruments |       | $                                   | 105,325    |                                            | $          | 105,325 |   | $ | — |   | $ | — |   |

 

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 the commodity derivative instruments, which relate to corn andrestricted cash, which includes money market funds, are based on quoted marketprices for identical assets or liabilities in an active market.

 

**5.**             **INVENTORY**

 

Inventory consisted of the following at April 30,2009 and October 31, 2008:

 
| ** **      | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
|-----------------|------------|--------------------|------------|----------------------|------------|
| ** **      | ** ** | **2009**           | ** ** | **2008***            | ** ** |
| Raw materials   |       | $                  | 4,341,353  |                 | $          | 5,830,477 |   |
| Work in process |       | 680,925            |       | 1,200,242            |       |
| Finished goods  |       | 825,548            |       | 725,365              |       |
| Supplies        |       | 1,174,032          |       | 683,007              |       |
| Other grains    |       | 346,628            |       | 1,194,658            |       |
| Total           |       | $                  | 7,368,486  |                 | $          | 9,633,749 |   |

 

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----

*   Derived from audited financial statements

 

The Company recorded losses of approximately $60,000and $254,000 for the three and six months ended April 30, 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 April 30, 2009 and October 31, 2008,the Company stored grain inventory for farmers. The value of these inventoriesowned by others is approximately $180,000 and $658,000 based on market pricesat April 30, 2009 and October 31, 2008, respectively.

 

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

 

As of April 30, 2009, the Company has enteredinto corn derivative instruments, which are required to be recorded as eitherassets or liabilities at fair value in the Condensed Balance Sheet. Derivativesqualify for treatment as hedges when there is a high correlation between thechange in fair value of the derivative instrument and the related change invalue of the underlying hedged item and when the Company formally documents,designates, and assesses the effectiveness of transactions that receive hedgeaccounting initially and on an on-going basis. The Company must designate thehedging instruments based upon the exposure being hedged as a fair value hedgeor a cash flow hedge. The Company does not enter into derivative transactionsfor 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 April 30, 2009, the notionalamount of the Company’s outstanding derivative instruments was approximately1,020,000 bushels that were entered into to hedge forecasted corn and grainpurchases through July 2009.

 

The following tables provide details regarding theCompany’s fair value of the derivative instruments at April 30, 2009, noneof which are designated as hedging instruments:

 
| ** **     | ** ** | **Balance  Sheet location** | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
|----------------|------------|-----------------------------|------------|------------|------------|-----------------|------------|
| Corn contracts |       | Derivative instruments      |       | $          | 105,325    |            | $          | — |   |
|                |            |                             |            |            |            |                 |            |  |  |

 

In addition, as of April 30, 2009 the Company hadapproximately $245,000 of restricted cash related to margin requirements forthe Company’s derivative instrument positions.

 

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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 April 30,** | ** ** |
|-------------------|------------|--------------------------|------------|----------------------------------------|------------|
| ** **        | ** ** | **Operations  location** | ** ** | **2009**                               | ** ** | **2008** | ** ** |
| Corn contracts    |       | Cost of goods sold       |       | $                                      | 647,000    |   | $ | 1,518,000 |   |
|              |       |                     |       |                                   |       |   |   |
| Ethanol contracts |       | Revenues                 |       | —                                 |       | (906,000 | ) |
| Totals            |       |                     |       | $                                      | 647,000    |   | $ | 612,000 |   |

 
| ** **        | ** ** | **Statement  of**        | ** ** | **Six-Months  Ended April 30,** | ** ** |
|-------------------|------------|--------------------------|------------|--------------------------------------|------------|
| ** **        | ** ** | **Operations  location** | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| Corn contracts    |       | Cost of goods sold       |       | $                                    | 1,134,000  |   | $ | 2,234,000 |   |
|              |       |                     |       |                                 |       |   |   |
| Ethanol contracts |       | Revenues                 |       | 373,000                              |       | (906,000 | ) |
| Totals            |       |                     |       | $                                    | 1,507,000  |   | $ | 1,328,000 |   |

 

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

 

The Company had a line of credit with AgStar for up to$7,500,000, subject to certain borrowing base requirements, that matured on April 1,2009 and was due on May 1, 2009.  TheCompany did not repay amounts due upon maturity under the line of creditbecause of continuing negotiations with AgStar regarding the renewal of theline of credit under the master loan agreement. 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 for the period ending January 31,2009. Further, as of June 12, 2009, AgStar waived the Company’snoncompliance with the working capital covenant of the master loan agreementfor the period ending April 30, 2009.  Interest accrues on borrowings at theone-month LIBOR plus 3.25%, which totaled 3.70% at April 30, 2009 and5.74% at October 31, 2008. From May 1, 2009 through May 29, 2009,AgStar added a 2.0% surcharge to the interest rate on the outstanding amountsunder the Company’s master loan agreement. The Company has a .25% commitment fee on the unused portion of the lineof credit. As of April 30, 2009, the Company had drawn $2,000,000 on theline. There was no balance outstanding on the line of credit at October 31,2008. 

 

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

 

Debt financing consists of the following:

 
| ** **                                                   | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **2009**           | ** ** | **2008***            | ** ** |
| Term note payable to  lending institution, see terms below   |       | $                  | 55,538,241 |                 | $          | 57,508,968 |   |
|                                                         |       |               |       |                 |       |
| Revolving term note to  lending institution, see terms below |       | 2,155,872          |       | 1,155,872            |       |
|                                                         |       |               |       |                 |       |
| Note payable to County  government                           |       | 100,000            |       | 100,000              |       |
|                                                         |       |               |       |                 |       |
| Assessments payable                                          |       | 3,899,927          |       | 3,910,266            |       |
|                                                         |       |               |       |                 |       |
| Notes payable to  electrical company                         |       | 1,922,387          |       | 2,173,826            |       |
|                                                         |       |               |       |                 |       |
| Equipment note                                               |       | 77,442             |       | 65,956               |       |
|                                                         |       |               |       |                 |       |
| Total                                                        |       | 63,693,869         |       | 64,914,888           |       |
|                                                         |       |               |       |                 |       |
| Less amounts due on  demand or within one year               |       | 58,433,818         |       | 5,649,354            |       |
|                                                         |       |               |       |                 |       |
| Net long term debt                                           |       | $                  | 5,260,051  |                 | $          | 59,265,534 |   |

 

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*   Derived from audited financial statements

 

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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.

 

*Term Note*

 

The term note requires monthly payments ofapproximately $702,000 of principal and interest. Interest accrues at theone-month LIBOR plus 3.25%, which totaled 3.70% and 5.74% at April 30,2009 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 Notes 2 and 7, as of January 31, 2009, the Company was out ofcompliance with the master loan agreement, had not received a waiver fromAgStar for the working capital covenant defaults, and, therefore, reclassifiedthe term note and the revolving term note described below to currentliabilities. The Company subsequently received waivers of the violations forthe periods ending January 31, 2009 and April 30, 2009, but anticipates thatthe minimum net worth and fixed charge coverage ratio covenants will not be metthrough or as of fiscal year end 2009 unless amended and so the long-term debtwith AgStar remains current. The term note originally had a ten yearamortization, 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, AgStaradded a 2.0% surcharge to the interest rate on the outstanding amounts underthe Company’s master loan agreement.

 

*Revolving Term 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 3.70% and 5.74% at April 30, 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 April 30, 2009, the Company was out of compliance with the masterloan agreement and reclassified the amount due on the revolving term note tocurrent liabilities.  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.

 

*Maturities*

 

The potential maturities of long-term debt at April 30,2009, are as follows:

 
| 2010                 |   | $         | 58,433,818 |   |
|----------------------|--------|-----------|------------|--------|
| 2011                 |   | 690,541   |       |
| 2012                 |   | 711,190   |       |
| 2013                 |   | 644,470   |       |
| 2014                 |   | 366,229   |       |
| Thereafter           |   | 2,847,621 |       |
| Total long-term debt |   | $         | 63,693,869 |   |

 

The estimated maturities include the term note andrevolving term note as due currently.  Asof April 30, 2009, the Company was not in compliance with the covenants ofthe master loan agreement.  On June 12,2009, the Company received a waiver from AgStar for the periods ended January 31,2009 and ended April 30, 2009. However, we do not expect to be in compliance with one or more covenantsof the master loan agreement as of July 30, 2009 or October 31, 2009unless these covenants are amended.  Ifwe do not negotiate amendments to these covenants or receive waivers for anydefault of any covenant of the master loan agreement, we will be in default ofthe master loan agreement, which will entitle AgStar to accelerate all of theindebtedness under the master loan agreement.  As such, $52.7 million is included in amounts due within the next twelvemonths that would otherwise be classified as long-term.  The Company continues to negotiate withAgStar regarding waivers and amendments to the master loan agreement, thereceipt of which cannot be assured.

 

**9.**             **COMMITMENTS AND CONTINGENCIES**

 

*Plant Construction*

 

The ethanol plant was constructed under a design-buildagreement with Fagen, Inc. as the design-builder. As of April 30,2009, 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.

 

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*Forward Contracts*

 

The Company has forward contracts in place for cornpurchases of approximately $15.4 million through January 2010, whichrepresents approximately 42% of the Company’s anticipated purchases in fiscal2009.

 

Currently, some of these corn contract prices areabove current market prices for corn and net realizable value once converted toethanol and distiller grains. Given the recent declining price of corn andethanol, upon taking delivery under these contracts, the Company would incur aloss. The Company had accrued losses on these purchase commitments ofapproximately $3.0 million at April 30, 2009. This amount includesadditional losses on purchase commitments of approximately $1,388,000 and$3,204,000 in the three and six months ended April 30, 2009respectively.  Losses on purchasecommitments are recorded as in the lower of cost or market adjustment on thestatement of operations. The amount of the loss was determined by applying amethodology similar to that used in the lower of cost or market evaluation withrespect to inventory. Given the uncertainty of future ethanol prices, this lossmay or may not be recovered, and further losses on the outstanding purchasecommitments could be recorded in future periods.

 

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

 

During the three months ending April 30, 2009 andApril 30, 2008, the Company purchased corn from members for approximately$10.6 million and $12.8 million, respectively. The Company purchased corn from members of approximately $24.8 millionand $18.5 million during the six months ended April 30, 2009 and April 30,2008 respectively.  Purchases frommembers comprise the majority of total corn purchases for the respectiveperiods.  Certain of the members areofficers or governors of the Company or their respective affiliates.

 

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

 

Following the quarter ended April 30, 2009, theCompany and AgStar agreed upon the terms of a renewed line of credit.  On June 12, 2009 and 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 for the period ending January 31,2009.  Further, as of June 12, 2009,AgStar waived the Company’s noncompliance with the working capital covenant ofthe master loan agreement for the period ending April 30, 2009.  AgStar also waived excess cash flow paymentprovisions for the year ended October 31, 2008 in consideration of an excesscash flow payment by the Company of $94,700 on June 12, 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 six month periods ended April 30, 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.

 

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

 

**Critical Accounting 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.At April 30, 2009, our critical accounting estimates continue to includethose described 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 to current.  We have a line ofcredit with AgStar, which matured on April 1, 2009 and was due on May 1,2009.  Our line of credit wassubsequently renewed at $6,750,000 until November 2009.  We subsequently received waivers of theviolations 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 through or as of fiscal year end 2009 unless amended or waivedand so the long-term debt with AgStar remains current.  Our ability to continue as a going concern isdependent on our operations.  Managements’forecasts relating to our operating results include significant assumptionsabout the prices for ethanol, distillers grains, and corn as well as ouroperating efficiencies.

 

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**Results of Operations for the ThreeMonths Ended April 30, 2009 and 2008**

 

The following table shows summary information from ourStatement of Operations for the three months ended April 30, 2009 and April 30,2008.

 
| ** **                          | ** ** | **Three  Months Ended********April 30, 2009** | ** ** | **Three  Months Ended********April 30, 2008** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                                         | ** ** | **%**                                              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Revenues                            |       | $                                                  | 21,493,104 |                                               | 100.0      |   | $ | 33,590,181 |   | 100.0 |   |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Cost of Goods Sold                  |       |                                               |       |                                               |       |   |   |   |   |
| Cost of goods sold                  |       | 21,241,824                                         |       | 99.6                                               |       | 26,154,559 |   | 77.9 |   |
| Lower of cost or market  adjustment |       | 1,448,381                                          |       | 6.0                                                |       | — |   | — |   |
| Total Cost of Goods  Sold           |       | 22,690,205                                         |       | 105.6                                              |       | 26,154,559 |   | 77.9 |   |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Gross Profit (Loss)                 |       | (1,197,101                                         | )          | (5.6                                               | )          | 7,435,622 |   | 22.1 |   |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Operating Expenses                  |       | 705,677                                            |       | 3.3                                                |       | 782,168 |   | 2.3 |   |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Operating Income (Loss)             |       | (1,902,778                                         | )          | (8.9                                               | )          | 6,653,454 |   | 19.8 |   |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Other Expense, net                  |       | (875,155                                           | )          | (4.0                                               | )          | (1,164,032 | ) | (3.5 | ) |
|                                |       |                                               |       |                                               |       |   |   |   |   |
| Net Income (Loss)                   |       | $                                                  | (2,777,933 | )                                                  | (12.9      | ) | $ | 5,489,422 |   | 16.3 |   |

 

*Revenues*

 

Revenues are derived from the sale of fuel ethanol anddistillers’ grains with solubles (“DGS”) produced at our ethanol plant anddeclined 36.0% from the quarter ended April 30, 2008 to the quarter ended April 30,2009. Ethanol revenues during the quarter ended April 30, 2009, wereapproximately $16.7 million, representing 77.7% of our sales, compared toapproximately $28.4 million during the quarter ended April 30, 2008,representing 84.5% 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,in conjunction with a 10% decrease in the gallons of ethanol sold.  Production and sales volume declined as weworked to improve production efficiencies and plant performance.  The decrease in ethanol prices followeddeclines in the gasoline market during the quarter ended April 30,2009.  We realized losses on ethanolhedges of $906,000 for the three months ended April 30, 2008.  There were no gains or losses on ethanolhedges for the three months ended April 30, 2009.

 

Total sales of DGS during the three months ended April 30,2009 were approximately $3.8 million comprising 17.7% of ourrevenue. DGS sales during the three months ended April 30, 2008, were$4.4 million or 13.1% of sales.

 

*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 105.6% and 77.9% for the threemonths ended April 30, 2009 and, 2008, respectively. The per bushel costof corn combined with accrued losses on forward contracts increased approximately7.2% in the three months ended April 30, 2009 as compared to the threemonths ended April 30, 2008. This increase combined with the 35% decreasein the per gallon sales price of ethanol caused this increase in the cost ofgoods sold as a percent of revenues. Cost of goods sold also includes lower ofcost or market adjustments of $1.4 million for the three months ended April 30,2009, 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 April 30, 2008. We hadgains related to corn derivative instruments of approximately $647,000 and$1,518,000 for the three months ended April 30, 2009 and 2008,respectively, which reduced cost of sales. Our gross margin (loss) for thethree months ended April 30, 2009 decreased to (5.6%) from 22.1% for thethree months ended April 30, 2008. We had a negative gross margin in thesecond quarter of fiscal 2009 as compared to a positive margin in the secondquarter of fiscal 2008 due to the 35% decline in 

 

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ethanol prices while corn costs increased 7.2%. Inaddition, lower production levels and fixed costs contributed to the negativegross 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. At April 30, 2009, noneof our derivative contracts were designated as hedges and, as a result, changesto the market value of these contracts were recognized as an increase ordecrease to our costs of goods sold. As a result, gains or losses on derivativeinstruments do not necessarily coincide with the related corn purchases. Thismay cause fluctuations in cost of goods sold. While we do not use hedgeaccounting to match gains or losses on derivative instruments, we believe thederivative instruments provide an economic hedge.

 

*Operating Expenses*

 

Operating expenses include wages, salaries andbenefits of administrative employees at the plant, insurance, professional feesand similar costs. These expenses represented 3.3% of total revenues for thethree months ended April 30, 2009 and 2.3% of total revenues for the threemonths ended April 30, 2008.  These expenses generally do not vary withthe level of production at the plant. Professional and legal fees decreased forthe three months ended April 30, 2009 as compared to the prior year periodbecause of a reduction in legal, accounting, and consulting fees.  Decreased revenue for the three months ended April 30,2009 also negatively affected operating expenses as a percentage of revenue astotal revenues declined approximately 36%.

 

*Other Expense, Net*

 

Other expense consisted primarily of interest expensethat consists primarily of interest payments on our credit facilities describedbelow. Interest expense, which is down approximately 23% as compared to thethree months ended April 30, 2008, is dependent on the balancesoutstanding and on interest rate fluctuations. For the three months ended April 30,2009, debt balances were down approximately 9% and interest rates decreased aswell period over period.  From May 1,2009 through May 29, 2009, AgStar added a 2.0% surcharge to the interest rateon the outstanding amounts under the Company’s master loan agreement.

 

**Results of Operations for the SixMonths Ended April 30, 2009 and 2008**

 

The following table shows summary information from ourStatement of Operations for the six months ended April 30, 2009 and April 30,2008.

 
| ** **                          | ** ** | **Six  Months Ended********April 30, 2009** | ** ** | **Six  Months Ended********April 30, 2008** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| **Income Statement Data** | ** ** | **Amount**                                       | ** ** | **%**                                            | ** ** | **Amount** | ** ** | **%** | ** ** |
| Revenues                            |       | $                                                | 39,588,470 |                                             | 100.0      |   | $ | 65,571,665 |   | 100.0 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Cost of Goods Sold                  |       |                                             |       |                                             |       |   |   |   |   |
| Cost of goods sold                  |       | 41,119,676                                       |       | 104.3                                            |       | 50,655,715 |   | 77.3 |   |
| Lower of cost or market  adjustment |       | 3,458,230                                        |       | 8.3                                              |       | — |   | — |   |
| Total Cost of Goods  Sold           |       | 44,577,906                                       |       | 112.6                                            |       | 50,655,715 |   | 77.3 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Gross Profit (Loss)                 |       | (4,989,436                                       | )          | (12.6                                            | )          | 14,915,950 |   | 22.7 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Operating Expenses                  |       | 1,736,337                                        |       | 4.3                                              |       | 1,577,664 |   | 2.4 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Operating Income (Loss)             |       | (6,725,773                                       | )          | (16.9                                            | )          | 13,338,286 |   | 20.3 |   |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Other Expense, net                  |       | (2,298,965                                       | )          | (5.9                                             | )          | (2,622,468 | ) | (4.0 | ) |
|                                |       |                                             |       |                                             |       |   |   |   |   |
| Net Income (Loss)                   |       | $                                                | (9,024,738 | )                                                | (22.8      | ) | $ | 10,715,818 |   | 16.3 |   |

 

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*Revenues*

 

Revenues derived from the sale of fuel ethanol anddistillers’ grains with solubles (“DGS”) produced at our ethanol plant declined40% from the six months ended April 30, 2008 to the six months ended April 30,2009. Ethanol revenues during the six months ended April 30, 2009, wereapproximately $30.4 million, representing 76.9% of our sales, compared toapproximately $52.4 million during the six months ended April 30, 2008,representing 79.9% of our sales. The decrease in ethanol revenue was a resultof a 29% decrease in the average price per gallon of ethanol period to period,in conjunction with an 18% decrease in the gallons of ethanol sold. Thedecrease in ethanol prices followed declines in the gasoline market during thesix months ended April 30, 2009. Production difficulties experiencedduring the first quarter of fiscal 2009 related to coal handling equipment wasthe main contributing factor in the reduced number of gallons produced and soldduring the period. We have taken steps to address the production difficulties,but there can be no assurance that future production disruptions will notoccur.  For the quarter ended January 31,2009, we operated for 70 days and the plant was not operated for 537hours.  For the quarter ended April 30,2009, we operated for 85 days with 100 hours in which the plant was notoperated.   We had gains of approximately$373,000 and a loss of $906,000 related to ethanol derivatives for the sixmonths ended April 30, 2009 and 2008, respectively.

 

Total sales of DGS during the six months ended April 30,2009 were approximately $6.4 million comprising 16.1% of ourrevenue. DGS sales during the six months ended April 30, 2008, were$8.8 million or 13.4% of revenue. The production difficulties experiencedduring the first fiscal quarter ended January 31 2009 caused tonnage ofDGS production to decline resulting in a decline in DGS revenue.

 

*Cost of 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 112.6% and 77.3% for the sixmonths ended April 30, 2009 and, 2008, respectively.  The per bushel cost of corn purchased (net oflosses realized in fiscal year 2008 for bushels delivered in the first twoquarters of 2009) decreased approximately 19% in the six months ended April 30, 2009 as compared to the sixmonths ended April 30, 2008. However, cost of goods sold includes lower of cost or market adjustmentsof $3.5 million for the six months ended April 30, 2009, which related toforward purchase contracts and inventory where the fixed price was more thanthe estimated realizable value. There was no lower of cost or market adjustmentfor the six months ended April 30, 2008 because market value exceededcost.  We had gains related to cornderivative instruments of approximately $1,134,000 and $2,234,000 for the sixmonths ended April 30, 2009 and 2008, respectively, which reduced cost ofsales.  These factors  combine with the 29% decrease in the pergallon sales price of ethanol caused the increase in the cost of goods sold asa percent of revenues for the six months ended April 30, 2009. Our grossmargin (loss) for the six months ended April 30, 2009 decreased to (12.6%)from 22.7% for the six months ended April 30, 2008. We had a negativegross margin in the first two quarters of fiscal 2009 as compared to positivegross margin in the first two quarters of fiscal 2008 due to the decline inethanol prices; increased costs of goods sold, relative to revenues, due tounrealized losses on forward contracts; and decreased gains on derivativeinstruments. In addition, lower production levels and fixed costs contributedto 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. At April 30, 2009, noneof our derivative contracts were designated as hedges and, as a result, changesto the market value of these contracts were recognized as an increase ordecrease to our costs of goods sold. As a result, gains or losses on derivativeinstruments do not necessarily coincide with the related corn purchases. Thismay cause fluctuations in cost of goods sold. While we do not use hedgeaccounting to match gains or losses on derivative instruments, we believe thederivative instruments provide an economic hedge.

 

*Operating Expenses*

 

Operating expenses include wages, salaries andbenefits of administrative employees at the plant, insurance, professional feesand similar costs. These expenses represented 4.3% of total revenues for thesix months ended April 30, 2009 and 2.4% of total revenues for the sixmonths ended April 30, 2008.  These expenses generally do not vary withthe level of production at the plant. Professional fees increased for the sixmonths ended April 30, 2009 as compared to the prior year period becauseof additional 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 six months ended April 30,2009 also negatively affected operating expenses as a percentage of revenue astotal revenues declined approximately 40%.

 

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*Other Expense, 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 29%as compared to the six months ended April 30, 2008, is dependent on thebalances outstanding and on interest rate fluctuations. For the six monthsended April 30, 2009, debt balances were down approximately 9% andinterest rates decreased as well period over period. 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.  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 currently due. As such, we wrote-off the remaining loan costsrather than amortizing them over the original contractual term of the loans.

 

**Liquidity and Capital Resources**

 

As of April 30, 2009, we had cash and cashequivalents (other than restricted cash) of approximately $2,135,000, currentassets (including derivative instruments valued at approximately $105,000) ofapproximately $13.9 million and total assets of approximately$117.1 million.

 

Our principal sources of liquidity consist of cash providedby operations, cash and cash equivalents on hand, and available borrowingsunder our master loan agreement with AgStar. Under the master loan agreement,we have three forms of debt: a term note, a revolving term note and a line ofcredit. Among other provisions, our master loan agreement contains covenantsrequiring us to maintain various financial ratios and tangible net worth. Italso limits our annual capital expenditures and membership distributions. Allof our assets and real property are subject to security interests and mortgagesin 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 $702,000 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 a 2.0%interest rate surcharge effective May 1, 2009 through May 29, 2009,on the total debt outstanding in accordance with the terms of the master loanagreement 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 six months ended April 30, 2009, we used cash to make principalpayments of approximately $2.3 million against our long-term debt. During thesame period, we drew $2.0 million on our line of credit described below anddrew $1.0 million on the revolving term note.

 

During the six months ended April 30, 2009, weused $9.9 million in cash for operating activities. This use consists primarilyof a net loss of $9.0 million, payments for corn under deferred paymentagreements and payments under forward purchase contracts the losses on whichhad been accrued on October 31, 2008 net of cash realized from thedecrease of corn inventory.

 

During the six months ended April 30, 2009, weused $319,000 for investing activities to pay for capital expenditures andintangibles, and do not anticipate any significant capital expenditures duringfiscal 2009. During the six months ended April 30, 2009, we generated$900,000 from  financing activitiesconsisting primarily of payment on long term debt of $2.1 million net ofrelease of restricted cash and a draw on the line of credit and revolving termnote of $3.0 million.

 

At January 31, 2009 through April 30, 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 $52.7of the AgStar debt as a current liability. As a result, current liabilities asof April 30, 2009 totaled approximately $70.3 million, including $52.7million of long-term debt reclassified as current.  On June 12, 2009, AgStar waived theCompany’s noncompliance with the working capital covenant of the master loanagreement for the period ending January 31, 2009 and for the period endingApril 30, 2009. Our debt with AgStar remains current based on projectedviolations of debt covenants within the next year. 

 

Our line of credit under the master loan agreement isfor a maximum of $7,500,000. This line of credit matured on April 1, 2009and was due on May 1, 2009. At April 1, 2009 and April 30, 2009,$2,000,000 was outstanding on the line of credit. We did not repay amounts dueon May 1, 2009 under the line of credit because of continuing negotiationswith AgStar regarding the renewal of the line of credit.  On June 12, 2009, AgStar renewed ourrevolving line of credit loan effective May 29, 2009 at a maximum commitmentof $6,750,000 and a maturity date of November 1, 2009.

 

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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 noassurance that the lender will not demand immediate repayment of all $59.7million in indebtedness outstanding under the master loan agreement at April 30,2009 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 April 30, 2009 consists of $55.5 millionunder the term note, $2.2 million under the revolving term note and $2.0million under the line of credit. We do not have adequate capital to repay allof the amounts that would become due upon acceleration of our obligations underthe master loan agreement at April 30, 2009.  Further, if an event ofdefault exists, the Company is not permitted to borrow additional funds underits line of credit or revolving term note unless AgStar consents to theadvance. While AgStar consented to advance us $2.0 million on the revolvingterm loan on June 4, 2009, our inability to borrow funds under the masterloan agreement may result in a working capital shortfall.

 

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 anticipate that ethanol prices will recoversomewhat during our fiscal year 2009 from the lower prices received during the sixmonths ended April 30, 2009, based on recent 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 ethanolwill be affected by a variety of factors beyond our control including theamount and timing of additional domestic ethanol production and ethanolimports; petroleum and gasoline prices; and the development of otheralternative 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 higher demand from the renewable fuels industry. Theexpansion of ethanol productive capacity has brought about a substantialincrease in demand for corn and thus in corn prices. We expect the price ofcorn to remain at current price levels well into 2009.   Due to increasedexposure of ethanol, corn is now being viewed as an “energy commodity” asopposed to strictly a “grain commodity”, contributing to the upward pressure oncorn prices.  The USDA’s February 12, 2009 Feed Outlook Report,projects U.S. corn prices for the season average to be at $3.65 to $4.15 perbushel.

 

**Off-Balance Sheet Arrangements**

 

We do not have any off-balance sheet arrangements.

 

**Item 4. Controls and Procedures**

 

**Effectiveness of Disclosure Controlsand Procedures**

 

Our management, with theparticipation of our Chief Executive Officer and Interim Chief FinancialOfficer, has evaluated the effectiveness of our “disclosure controls andprocedures” (as defined in Rules 13a-15(e) under the SecuritiesExchange Act of 1934, as amended ) as of the end of the period covered by thisreport. Based on that evaluation, our Chief Executive Officer and Interim ChiefFinancial Officer have concluded that, as of the end of such period, ourdisclosure controls and procedures were not effective.

 

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**Changes in Internal Control overFinancial Reporting**

 

We are in the process of upgrading our systems,implementing additional financial and management controls, and reportingsystems and procedures.  We are currently undergoing a comprehensiveeffort in preparation for compliance with the reporting requirement of 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.  Some of these efforts toprepare for the reporting requirement have resulted in changes to our internalcontrol over financial 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 April 30, 2009that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**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 quarter ended January 31,2009. There have been no material changes from the risk factors previouslydisclosed in our Annual Report on Form 10-K and Quarterly Report on Form 10-Qexcept as stated below:

 

***We have withheldand continue to withhold $3.8 million in retainage from its Plantdesign-builder, Fagen, Inc., because the warranties relating to airemissions have not been satisfied.***

 

Our ethanol plantwas constructed under a design-build agreement with Fagen, Inc. (“Fagen”)as the design-builder. We have retained approximately $3.8 million in paymentsto Fagen under the design-build agreement and final payment will be due whenfinal completion of construction is achieved and when our plant satisfies theair emissions warranties specified in the design-build agreement. Under thatwarranty, Fagen has warranted that within six months following the date ofsubstantial completion, the emissions of our ethanol plant will meet therequirements of a synthetic minor source. Notwithstanding that, our plant hasbeen operational since September 21, 2007, our plant does not yet meet thewarranties relating to air emissions and therefore, we continue to withholdapproximately $3.8 million in retainage.

 

We, in cooperation with Fagen, have designed andtested a number of possible solutions to enable our plant to meet the airemissions warranties.  To date, none ofthese solutions has been effective and there may be no solution that will allowour plant to meet the warranties relating to air emissions.  Further, in testing these potentialsolutions, we have suffered substantial reduction in daily ethanol productionand plant shutdowns as a result. As we attempt new solutions in the future, wealso expect that we will be required to limit production or shutdown our plant,which will impair our ability to produce ethanol and generate revenue.  There is also no assurance that we willresolve the air emissions warranty or retainage issue with Fagen to oursatisfaction or that we will resolve it without significant additional expense.We may incur additional expense because of modifications to our plant toachieve compliance with the air emissions warranties, to achieve compliancewith the more stringent minor source emissions limits, or to qualify ourfacility as a major emissions source. We also may experience increased costs ofoperations, even if our plant is modified to comply with the air emissionswarranty.  Our ongoing attempts bring ourplant into compliance with the warranties relating to air emissions have hadand may have in the future a material adverse effect on our business, financialcondition and results of operations.

 

***Our level ofindebtedness may adversely affect our ability to react to changes in ourbusiness, and we may be limited in our ability to refinance our existing debtor use debt to fund future capital needs.***

 

We have a substantial amount of indebtedness. Because of our substantial debt, demands on our cash resources are higher thanthey otherwise would be which could negatively impact our business, results ofoperations and financial condition.  As a result of our substantialindebtedness, we may be more vulnerable to general adverse economic andindustry conditions. We may find it more difficult to obtain additionalfinancing to fund future working capital, capital expenditures and othergeneral operating requirements. We will be required to dedicate a substantialportion of our cash flow from operations to the payment of principal andinterest on our debt, reducing the available cash flow to manage our corn andethanol price risk, fund operations or make capital expenditures. We may have acompetitive disadvantage relative to other companies in our industry with lessdebt.  We may also experience decreases in our regular trade credit fromvendors, which could adversely impact our cash flow if we need to startprepaying for items we have been able to purchase on trade credit in thepast.  In early 2007, a crisis began in the sub prime mortgagesector, as a result of rising delinquencies and credit quality deterioration,and has subsequently

 

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spread throughout the credit market. There can be noassurances that this credit crisis will not worsen or impact our availabilityand cost of debt financing including with respect to any refinancings.

 

***Approval of a LowCarbon Fuel Standard (“LCFS”) by the California Air Resources Board (“CARB”)may have a negative impact on our ability to market our ethanol in California.***

 

The CARB recently proposed rules to implement aLCFS, which would set standards for the carbon intensity of fuels used in theState of California starting in 2011.  While the proposed rules arestill subject to rulemaking process in California, certain provisions of theproposed LCFS rules have the potential to ban ethanol produced at ourplant from being sold in California.  While we believe there may besome negative impact to our sales from the approval of the LCFS in California,we believe we will still be able to market all the ethanol produced by ourplant.  However, if additional states where our ethanol is marketed,or the federal government, adopt similar provisions it could have a severenegative impact on our ability to sell all of the ethanol produced at ourplant.

 

**Item 3. Defaults upon SeniorSecurities**

 

At April 30, 2009, Heron Lake BioEnergy, LLC wasin default of the minimum working capital covenant of a master loan agreementwith AgStar Financial Services, PCA.  This master loan agreement relatesto indebtedness at April 30, 2009 consisting of $55.5 million under a termnote, $2.2 million under a revolving term note and $2.0 million under a line ofcredit.  Further, the Company did not paywhen due on May 1, 2009 the $2.0 million outstanding on the line of creditdue to negotiations with AgStar relating to the line of credit. Thenon-compliance with the working capital covenant and failure to repay the lineof credit are events of default under the master loan agreement, entitlingAgStar to accelerate all outstanding indebtedness under the master loanagreement and exercise any of its other rights under the master loan agreementand as a secured party.

 

On June 12, 2009,the Lender renewed the Company’s revolving line of credit loan effective May 29,2009 pursuant to 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 the 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 for the period ending January 31,2009.  Further, as of June 12, 2009,AgStar waived the Company’s noncompliance with the working capital covenant ofthe master loan agreement for the period ending April 30, 2009.  The Lender also waived excess cash flowpayment provisions for the year ended October 31, 2008 in consideration ofan excess cash flow payment by the Company of $94,700 on June 1,2009.  The balance due of the October 31,2008 excess cash flow payment in the amount of $1,799,300 is deferred untilsuch time as the Company makes a request to the Lender for certaindistributions to its members.

 

From May 1, 2009 through May 29, 2009,AgStar added a 2.0% surcharge to the interest rate on the outstanding amountsunder the Company’s master loan agreement.

 

**Item 4. Submission of Matters toa Vote of Security Holders**

 

We held our Annual Meeting of Members on March 20,2009.  Of the 27,104,625 Class Aunits outstanding and entitled to vote at the meeting as of the record date of February 9,2009, 15,937,775 units were present, either in person or by proxy.

 

The following describes the maters considered bymembers at the Annual Meeting, as well as the results of the votes cast at theAnnual Meeting.

 

Proposal 1: To elect three (3) directors to holdoffice for a term of three years or until their respective successors have beenelected and shall qualify.

 
| **Nominee**    | ** ** | **For**   | ** ** | **Withheld** | ** ** |
|----------------|------------|-----------|------------|--------------|------------|
| Doug Schmitz   |       | 9,206,775 |       | 828,500      |       |
| Robert J. Wolf |       | 9,230,525 |       | 804,750      |       |
| David J. Bach  |       | 9,230,525 |       | 804,750      |       |

 

Therefore, each of Messrs. Schmitz, Wolf and Bach was elected atthe Annual Meeting for a term of three years or until their respectivesuccessors have been elected and qualify.

 

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The terms of Messrs. Kunerth, McKeown, Ferguson, Woestehoff,Helgemoe, Reinhart and Thome continued following the Annual Meeting.  On April 3, 2009, subsequent to theAnnual Meeting, Project Viking, LLC, which holds a right to appoint twogovernors based on its holdings of our units, elected to appoint Chad Core asits designee in place of Brian Thome.

 

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**Item 5. Other Information**

 

On June 12, 2009,Heron Lake BioEnergy, LLC entered into an Amendment No. 3 to FifthSupplement (the “Amendment”) to its Master Loan Agreement, as previouslyamended and supplemented (the “Loan Agreement”), with AgStar FinancialServices, PCA (the “Lender”) effective May 29, 2009.

 

Pursuant to theAmendment, the Lender renewed the Company’s revolving line of credit loan witha maximum commitment of $6,750,000 and a maturity date of November 1,2009.  The parties also agreed upon aminimum interest rate of 6.0% under the revolving line of credit loan.  Additionally, the Amendment amended andrestated certain definitions to reflect the terms of the renewed revolving lineof credit loan.  The terms of theAmendment are reflected in an Amended and Restated Revolving Line of CreditNote dated May 29, 2009 in the principal amount of $6,750,000 (the “Note”).

 

In connection with theAmendment, the Lender waived the Company’s noncompliance with the workingcapital covenant of the Loan Agreement for the periods ending January 31,2009 and April 30, 2009.  The Lenderalso 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.

 

The foregoingdescriptions of the Amendment and the Note do not purport to be complete andare qualified in their entirety by reference to the Amendment and the Note,which are filed as Exhibits 10.1 and 10.2 hereto, respectively, and areincorporated, by reference herein.

 

**Item 6. Exhibits**

 

The following exhibits are included in this report:

 
| **Exhibit  No.** | ** ** | **Exhibit**                                                                                                                                                                                               |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                      |
| 10.1             |       | Amendment No. 3 to Fifth Supplement to Master  Loan Agreement (Revolving Line of Credit Loan) dated May 29, 2009 by and  between Heron Lake BioEnergy, LLC and AgStar Financial Services, PCA.  |
|             |       |                                                                                                                                                                                                      |
| 10.2             |       | Amended and Restated Revolving Line of Credit Note  dated May 29, 2009 in the principal amount of $6,750,000 by Heron Lake  BioEnergy, LLC as borrower and AgStar Financial Services, PCA as lender. |
|             |       |                                                                                                                                                                                                      |
| 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: June 15, 2009 | /s/  Robert J. Ferguson                                                   |
|                     | Robert J Ferguson                                                              |
|                     | President and Chief Executive Officer   (Principal Executive Officer)          |
|                     |                                                                           |
|                     |                                                                           |
| Date: June 15, 2009 | /s/  Brett L. Frevert                                                     |
|                     | Brett L. Frevert                                                               |
|                     | Interim Chief Financial Officer 

(Principal Accounting and Financial Officer) |

 

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