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**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

#### **Washington, D.C. 20549**

#### ** **

**FORM 10-K**

** **

| **x**      | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934**                                                                                                                                                                                                                                                                                                                                                                                                                            |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       | **For the fiscal year ended  October 31, 2008.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|       | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | **or**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                                                        |
| ** ** | **for the transition period from                                          to                                          .** |

 

**CommissionFile Number  000-51825**

 

**Heron Lake BioEnergy, LLC**

(Exact name ofregistrant as specified in its charter)

 

| **Minnesota**                                                   | ** ** | **41-2002393**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer  Identification No.) |

 

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

(Address ofprincipal executive offices)

 

Registrant’stelephone number, including area code:  **(507) 793-0077**

 

| Securities registered pursuant to Section 12(b) of the Act: |       | Securities registered pursuant to Section 12(g) of the Act: |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|
| **Class A Units**                                                | ** ** | **None**                                                              |

 

Nameof Exchange on Which Registered: None

 

Indicate by check mark whether the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act:

 

Yes  o                   No  x

 

Indicate by check mark if the registrant is not required to file reportspursuant to Section 13 or Section 15(d) of the Act:

 

Yes  o                   No  x

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.        Yes x                        No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer.

 
| Large Accelerated Filer  o | Accelerated Filer o | Non-Accelerated Filer o | Smaller Reporting  Company x |
|----------------------------|---------------------|-------------------------|------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 126-2of the Act)             Yes o    No x

 

The aggregatemarket value of the Company’s Class A Units held by non-affiliates is notable to be calculated. The Company is a limited liability company whoseoutstanding common equity, consisting of its Class A Units, is subject tosignificant restrictions on transfer under its Member Control Agreement. Nopublic market for common equity of Heron Lake BioEnergy, LLC is established andit is unlikely in the foreseeable future that a public market for its commonequity will develop.

 

As of January 1, 2009, the Company had outstanding  27,104,625 Class A Units.

 

**DOCUMENTS INCORPORATED BY REFERENCE:**  None.

 

 

 

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**TABLE OF CONTENTS**

 
| **PART I**   |                                                                                                                    |   |
|-------------------|-------------------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                                    |   |
| Item 1.           | Business                                                                                                                |   |
| Item 1A.          | Risk Factors                                                                                                            |   |
| Item 1B.          | Unresolved Staff  Comments                                                                                              |   |
| Item 2.           | Properties                                                                                                              |   |
| Item 3.           | Legal Proceedings                                                                                                       |   |
| Item 4.           | Submission of  Matters to a Vote of Security Holders                                                                    |   |
|              |                                                                                                                    |   |
| **PART II**  |                                                                                                                    |   |
| ** **        |                                                                                                                    |   |
| Item 5.           | Market for the  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |   |
| Item 6.           | Selected Financial  Data                                                                                                |   |
| Item 7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |   |
| Item 7A.          | Quantitative  and Qualitative Disclosures about Market Risk                                                             |   |
| Item 8.           | Financial  Statements and Supplementary Data                                                                            |   |
| Item 9.           | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                   |   |
| Item 9A.          | Controls and  Procedures                                                                                                |   |
| Item 9B.          | Other Information                                                                                                       |   |
|              |                                                                                                                    |   |
| **PART III** |                                                                                                                    |   |
| ** **        |                                                                                                                    |   |
| Item 10.          | Directors,  Executive Officers and Corporate Governance                                                                 |   |
| Item 11.          | Executive  Compensation                                                                                                 |   |
| Item 12.          | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |   |
| Item 13.          | Certain  Relationships and Related Transactions, and Director Independence                                              |   |
| Item 14.          | Principal  Accountant Fees and Services                                                                                 |   |
|              |                                                                                                                    |   |
| **PART IV**  |                                                                                                                    |   |
| ** **        |                                                                                                                    |   |
| Item 15.          | Exhibits and  Financial Statement Schedules                                                                             |   |
|              |                                                                                                                    |   |
| **SIGNATURES**    |                                                                                                                    |

** **

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** **

**PART I**

** **

When we use the terms “HeronLake BioEnergy,” “we,” “us,” “our,” the “Company” or similar words in thisAnnual Report on Form 10-K, unless the context otherwise requires, we arereferring to Heron Lake BioEnergy, LLC and its subsidiary, Lakefield FarmersElevator, LLC. Additionally, when we refer to “units” in this Annual Report on Form 10-K,unless the context otherwise requires, we are referring to the Class Aunits of Heron Lake BioEnergy, LLC.

 

# **Forward-LookingStatements**

# ** **

Statementsincluded in this Annual Report on Form 10-K that are not historical orcurrent facts are forward-looking statements. In addition, our officers maymake forward-looking statements in the future. We wish to caution readers thatthese statements are not predictions of actual future results. Our actualresults could differ materially from any such forward-looking statements as aresult of risks and uncertainties, including those set forth below in Item 1A “RisksFactors” and in other documents we file from time to time with the Securitiesand Exchange Commission. Any such forward-looking statements reflect management’sopinions only as of the date of this Annual Report on Form 10-K, and weundertake noobligation to update any such forward-looking statements.

 

**ITEM1.          BUSINESS**

** **

**Overview**

 

We were organized as aMinnesota limited liability company on April 12, 2001 under the name “GenerationII, LLC.”  In June 2004, we changedour name to Heron Lake BioEnergy, LLC.

 

We were formed for the purposeof constructing and operating an ethanol manufacturing facility near HeronLake, Minnesota. On September 21, 2007, we began operations at our drymill, coal fired ethanol plant. Therefore, fiscal year 2007 was the firstfiscal year that includes any revenue generated from our operations. In ourfiscal year 2008 which ended October 31, 2008, we sold approximately 48.4million gallons of ethanol. At nameplate, the ethanol plant has the capacity toprocess approximately 18.0 million bushels of corn each year, producingapproximately 50 million gallons per year (mgy) of fuel-grade ethanol andapproximately 160,000 tons of distillers’ grains with solubles (“DGS”).

 

The following table sets fortha summary of significant milestones in our company’s history:

 
| **Date**            |   | **Milestone**                                                                                                                                                                                         |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          |   | ** **                                                                                                                                                                                            |
| February 2002  |   | We obtained  an option on land that is now part of the 216 acre site of our ethanol plant.                                                                                                            |
| October 2003   |   | We entered into an industrial water supply development and  distribution agreement with the City of Heron Lake, Jackson County, and  Minnesota Soybean Processors.                                    |
| Early 2004          |   | We selected  Fagen, Inc. to be the design-build firm to build our ethanol plant near  Heron Lake, Minnesota, using process technology provided by ICM, Inc.                                 |
| September 2005 |   | We entered  into a Standard Form of Agreement between Owner and Designer — Lump Sum  with Fagen, Inc.                                                                                  |
| December 2005  |   | We purchased  certain assets relating to elevator and grain storage facilities in  Lakefield, Minnesota and Wilder, Minnesota with a combined storage capacity  of approximately 2.8 million bushels. |
| May 2006       |   | We entered into an industrial water supply treatment agreement with  the City of Heron Lake and Jackson County.                                                                                       |
| August 2006    |   | We entered into an electric service agreement with Interstate Power  and Light Company (a wholly-owned subsidiary of Alliant Energy Corporation).                                                     |
| December 2006  |   | We entered into a contract with Federated Rural Electric Association  for the construction of the distribution system and electrical substation for  the plant.                                       |
| June 2007      |   | We entered  into a master coal supply agreement with Northern Coal Transportation Company  (NCTC) to provide Powder River Basin (PRB) coal for the plant.                                             |

 

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| June 2007      |   | We entered  into a coal transloading agreement with Southern Minnesota Beet Sugar  Cooperative (SMBSC). |
|---------------------|--------|---------------------------------------------------------------------------------------------------------|
| September 2007 |   | We began  operations at our dry mill, coal fired ethanol plant.                                         |

 

**Production**

 

Since the beginning ofoperations at our ethanol plant, our primary business is the production andsale of ethanol and co-products, including dried distillers’ grains. Wecurrently do not have or anticipate we will have any other lines of business orother significant sources of revenue other than the sale of ethanol and ethanolco-products.

 

**OurEthanol Plant**

 

Our ethanol plant was designedand built by Fagen Inc. under a September 2005 design-build agreement.Under the design-build agreement, Fagen, Inc. also agreed to utilizecertain proprietary property and information of ICM, Inc. in the designand construction of our ethanol plant.

 

Our ethanol plant uses a drymilling process to produce fuel-grade ethanol and distillers’ grains. The drymilling process involves grinding the entire corn kernel into flour and thestarch is converted to ethanol through fermentation that also produces carbondioxide and distillers’ grains.

 

The ethanol plant consistsprincipally of a coal handling, storage and combustion area; storage andprocessing areas for corn; a fermentation area comprised mainly of fermentationtanks; a distillation finished product storage area; and a drying unit forprocessing the dried distillers’ grains. Additionally, the ethanol plantcontains receiving facilities that have the ability to receive corn by rail andtruck, store it for use in the plant and prepare the corn to be used in theplant. We have storage tanks on site to store the ethanol we produce. The plantalso contains a storage building and silos to hold distillers’ grains until itis shipped to market.

 

The Union Pacific Railroad is the railroad adjacent to our ethanol plant.  The ethanol plant has the facilitiesnecessary to receive corn by truck and rail, coal by truck, and to load ethanoland distillers grains onto trucks and rail cars.

 

As part of our design-buildagreement with Fagen, Inc., we received performance guarantees on theproduction through put and process efficiencies of our ethanol plant. Fagen, Inc.has also warranted that the air emissions on our ethanol facility, taken as awhole, when operating at nameplate capacity meeting all of the performanceguarantee criteria, will meet the requirements of a synthetic minor sourcewithin six months following the date of substantial completion. If thiswarranty is not met, Fagen, Inc. will pay all design, engineering,equipment, labor and construction costs associated with making the necessarycorrections to meet the warranty, subject to certain restrictions.  Notwithstanding that our plant has beenoperational since September 21, 2007, our plant does not yet meet thewarranties relating to air emissions.

 

We have made payments to Fagen, Inc.as required under the design-build agreement and as provided in thedesign-build agreement.  We retained 10%of each payment until 50% of the required work was completed by Fagen, Inc.  As of October 31, 2008, we have retainedapproximately $3.8 million in payments to Fagen, Inc.  We will release to Fagen, Inc. allretained amounts when final completion of construction is achieved and theoperation of our plant satisfies the air emissions warranties specified in thedesign-build agreement with Fagen, Inc.

 

Our ethanol plant requiressignificant and uninterrupted amounts of electricity, coal and water. We haveentered into agreements for our supply of electricity, coal and water.

 

Currently, fly-ash generatedfrom the coal burned by our plant is hauled to a landfill. If it qualifies topredefined industry standards, fly-ash can be used as an admixture for cementmixes instead of being hauled to landfills. We are continuing to explorerevenue-generating alternatives from fly-ash rather than incurring expenseassociated with shipping the fly-ash to landfills.

 

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**OurPrincipal Products**

 

The principal products that weproduce are fuel grade ethanol and distillers’ grains. Raw carbon dioxide isalso a product of the ethanol production process, but we do not capture ormarket any carbon dioxide gas.

 

*Ethanol*

 

Ethanol is a type of alcoholproduced in the U.S. principally from corn. Ethanol is primarily used in theU.S. gasoline fuel market as:

 

·                  an octaneenhancer in fuels;

 

·                  an oxygenatedfuel additive that can reduce ozone and carbon monoxide vehicle emissions;

 

·                  a gasolinesubstitute generally known as E85, a fuel blend composed of 85% ethanol; and

 

·                  as a renewablefuel to displace consumption of imported oil.

 

Ethanol used as an octaneenhancer or fuel additive is blended with unleaded gasoline and other fuelproducts. The principal purchasers of ethanol are generally wholesale gasolinedistributors or blenders.

 

*Distillers’ Grains*

* *

The principal co-product of theethanol production process is distillers’ grains, a high protein andhigh-energy animal feed ingredient.

 

Dry mill ethanol processingcreates three primary forms of distillers’ grains: wet distillers’ grains,modified wet distillers’ grains, and dried distillers’ grains with solubles.Wet distillers’ grains are processed corn mash that contains a substantialamount of moisture. It has a shelf life of approximately three days and isprimarily sold to feeders of beef animals within the immediate vicinity of theethanol plant. Modified wet distillers’ grains are similar to wet distillers’grains except that it has been partially dried and contains less moisture.Modified wet distillers’ grains has a shelf life of a maximum of fourteen days,contains less water to transport, is more easily adaptable to some feedingsystems, and is sold to both local and regional markets, primarily for bothbeef and dairy animals. Dried distillers’ grains with solubles are corn mashthat has been dried to approximately 10% moisture. It has an almost indefiniteshelf life and may be sold and shipped to any market and to almost all types oflivestock. Most of the distillers’ grains that we sell are in the form of drieddistillers’ grains.

 

**Procurement and Marketing Agreements**

 

*Corn Procurement*

* *

The primaryraw material used in the production of ethanol at our plant is corn. We need toprocure approximately 18 million bushels of corn per year for our dry millethanol process. We generally do not have long-term, fixed pricecontracts for the purchase of corn and ourmembers are not obligated to deliver corn to us. Typically, we purchaseour corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake,Minnesota.

 

We generally purchase cornthrough cash fixed-price contracts and may utilize hedging positions in thecorn futures market for a portion of our corn requirements to manage the riskof excessive corn price fluctuations. Our fixed-price forward contracts specifythe amount of corn, the price and the time period over which the corn is to bedelivered. These forward contracts are at fixed prices or prices based on theChicago Board of Trade (CBOT) prices. Our corn requirements can be forwardcontracted on either a fixed-price basis or futures only contracts. Theparameters of these contracts are based on the local supply and demandsituation and the seasonality of the price. We also purchase a portion of ourcorn on a spot basis.

 

The price andavailability of corn is subject to significant fluctuation depending upon anumber of factors that affect commodity prices generally. These include, amongothers, crop conditions, crop production, weather, government programs, andexport demands. Recently, corn prices have been at historicallyhigh levels. We believe that our corn storage facilities in Lakefield andWilder, Minnesota will enable us to more favorably procure corn for theoperation of our plant.

 

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*EthanolMarketing*

* *

In August 2006,we entered into an ethanol marketing agreement with Renewable ProductsMarketing Group, LLC that was transferred to its affiliate RPMG, Inc. Underthe agreement, RPMG must use its best efforts to market all ethanol produced byour ethanol plant pursuant to a pooled marketing arrangement. We receive aprice equal to the actual pooled price received by RPMG, less the expense ofdistribution and a marketing fee charged per gallon of ethanol sold. Theinitial term of the agreement began on the first day of the month we shippedethanol from our plant and continues for a period of at least 24 months, butwill terminate at the end of the first traditional ethanol marketing contractperiod after the 24-month period, the end of September or end of March,whichever occurs first. After the initial term, the agreement automaticallyrenews for successive one-year terms unless terminated by either party upon 90 days’notice. If the ethanol marketing agreement is terminated, whether bynon-renewal or otherwise, we are obligated to leases for railcars that RPMG hasprocured on our behalf. Our ethanol may be distributed by truck and rail fromthe plant.

 

*Distillers’Grains Marketing*

* *

In additionto ethanol, our ethanol plant produces wet, modified wet and dried distillers’grains. We attempt to monitor the market prices for distillers’ grains andproduce a mix of wet, modified wet, and dry distillers’ grains to maximizereturns to the plant.

 

In October 2005,we entered a marketing agreement with Commodity Specialists Corporation for thesale to Commodity Specialists Corporation of all distillers’ grains produced byour ethanol plant. The term of the agreement is for a one-year period from thedate of start-up of our operations, and thereafter, the agreement will remainin effect unless terminated by either party upon 90 days’ written notice. Underthe terms of the agreement, we receive a price equal to the selling price, lessa charge of 2% or 4% of the price for distillers’ grains and a fee of $2.00 perton of solubles, less the cost of delivering the product to the customer. In August 2007,as part of CHS Inc.’s acquisition of Commodity Specialist Corporation, our agreementwith Commodity Specialist Corporation was assigned to CHS Inc. with ourconsent.

 

*Pricing of Cornand Ethanol*

* *

The sale of ethanol representedapproximately 80% of our revenue for the year ended October 31, 2008. Thecost of corn represented approximately 70% of our cost of sales for the yearended October 31, 2008. In the future, we expect that ethanol sales willrepresent our primary revenue source and corn will represent our primarycomponent of cost of goods sold. Therefore, changes in the price at which wecan sell the ethanol we produce and the price at which we buy corn for ourethanol plant present significant operational risks inherent in our business.

 

Generally, the price at whichethanol can be sold does not track with the price at which corn can be bought.Historically, ethanol prices have tended to correlate with wholesale gasolineprices, with demand for and the price of ethanol increasing as supplies ofpetroleum decreased or appeared to be threatened, crude oil prices increasedand wholesale gasoline prices increased. However, the prices of both ethanoland corn do not always follow historical trends. Trends in ethanol prices andcorn prices are subject to a number of factors and are difficult to predict.

 

**Demand For Ethanol**

 

In recent years, the demand forethanol has increased, particularly in the upper Midwest, in part because oftwo major programs established by the Clean Air Act Amendments of 1990:  the Oxygenated Gasoline Program and the ReformulatedGasoline Program.  Under these programs, an additive (oxygenate) was required to beadded to the gasoline used in areas with excessive carbon monoxide or ozonepollution to help mitigate these conditions. Because of the potentialhealth and environmental issues associated with methyl tertiary butyl ether (MTBE) and the actions of the EPA,ethanol is now used as the primary oxygenate in those areas requiring anoxygenate additive under programs associated with the Clean Air Act Amendmentsof 1990 or other federal law.  Accordingto the EPA, as of May 2007, various regions of 15 states and the Districtof Columbia were required to comply with the Reformulated Gasoline Program andall or a portion of an additional 13 states have voluntarily opted into theprogram.

 

In addition to demand forethanol as an oxygenate, ethanol demand has increased because of the adoptionof programs setting national renewable fuels standards (RFS).  The first RFS program was introduced throughthe Energy Policy Act of 2005.  TheEnergy Policy Act of 2005 introduced a RFS program that set a national minimumusage requirement that would phase in over seven years, beginning withapproximately 4.0 billion gallons in 2006 and increasing to 7.5 billion gallonsby 2012.  The minimum usage requirementsunder the 2005 RFS program were

 

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increased withthe Energy Independence and Security Act of 2007. Currently, the minimum usagerequirements are 13.2 billion gallons of renewable biofuels by 2012 and 15.0billion gallons by 2015.  The Energy Independence and Security Act of 2007also mandates a minimum requirement of 36 billion gallons of renewable fuels by2022, with conventional biofuels accounting for 15 billion gallons of thistotal.  Conventional biofuel is ethanol derived from corn starch andconventional ethanol facilities that commence construction after the date ofenactment and must achieve a 20 percent greenhouse gas (GHG) emissionsreduction compared to baseline lifecycle GHG emissions.  Advanced biofuels are defined ascellulosic ethanol and other biofuels derived from feedstock other than cornstarch that achieves a 50 percent GHGemissions reduction requirement. Cellulosic ethanol is any cellulose, hemicellulose, or lignin thatis derived from renewable biomass and achieves a 60 percent GHG emissionreduction requirement.  We believethe RFS program creates greater marketfor renewable fuels, such as ethanol, as a substitute for petroleum-based fuels.

 

In addition to the RFS program,one important incentive for the ethanol industry and its customers is the Volumetric Ethanol Excise Tax Credit,commonly referred to as the “blender’s credit.”  The tax credit is providedto gasoline distributors as an incentive to blend their gasoline withethanol.  For each gallon of gasolineblended with ethanol, the distributors receive a tax credit.  For 2008, the tax credit is 51¢ per gallon ofpure ethanol or 5.1¢ per gallon of gasoline blended with 10% ethanol.  The per gallon credit is scheduled to bereduced to 45¢ per gallon of pure ethanol in 2009.  The tax credit is authorized through December 21,2010.

 

In Minnesota, a market weserve, the demand for ethanol is driven, in part, by state specificrequirements. Minnesotahas enacted a law that requires all Minnesota gasoline to be blendedwith 20 percent ethanol. The newE-20 mandate would take effect in 2013 unless ethanol has already replaced 20percent of the state’s motor vehicle fuel by 2010. The rule would expireat the end of 2010 if Minnesota is not granted federal approval to use E-20gasoline blends.  Minnesota has NorthAmerica’s largest network of E-85 (85% ethanol blend) gas stations withapproximately 130 stations now available to consumers. Minnesota was the firststate to require the use of ethanol in gasoline.  Other states are beginning to enact similarlegislation and this may also drive the demand for ethanol in markets we serve.

 

**MarketsFor Ethanol**

 

There are local, regional andnational markets for ethanol. Typically, a regional market is one that isoutside of the local market, yet within the neighboring states. Some regionalmarkets include large cities that are subject to anti-smog measures in eithercarbon monoxide or ozone non-attainment areas, or that have implementedoxygenated gasoline programs, such as Chicago, St. Louis, Denver andMinneapolis. We consider our primary regional market to be large cities withina 450-mile radius of our ethanol plant. In the national ethanol market, thehighest demand by volume is primarily in the southern United States and theeast and west coast regions.

 

The markets in which ourethanol is sold will depend primarily upon the efforts of RPMG, which buys andmarkets our ethanol. However, we believe that local markets will be limited andmust typically be evaluated on a case-by-case basis. Although local marketswill be the easiest to service, they may be oversold because of the number ofethanol producers near our plant, which may depress the price of ethanol inthose markets. In addition, Minnesota is a net exporter of ethanol. Accordingto the Minnesota Department of Agriculture, as of August 2008, Minnesota’s19 operating ethanol plants have the capacity to produce 850 million gallons ofethanol annually, which will use 308 million bushels of corn. In 2007, the mostrecent year for which statistics are available, about 256 million gallons wereconsumed in Minnesota and the state’s net ethanol export was 414 milliongallons in 2007 or 62% of Minnesota’s total annual ethanol production.Therefore, we will likely be among the ethanol producers whose ethanol isprimarily exported from the State of Minnesota into regional markets. Access toregional markets and the national market will be important to grow ourbusiness.

 

We transport our ethanolprimarily by rail. In addition to rail, we service certain regional markets bytruck from time to time. We believe that regional pricing tends to follownational pricing less the freight difference.

 

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**Markets for Distillers’ Grains**

 

We sell distillers’ grains asanimal feed for beef and dairy cattle, poultry and hogs. However, the modified wet distillers’ grainstypically have a shelf life of a maximum of fourteen days. This provides for amuch smaller market and makes the timing of its sale critical. Further, becauseof its moisture content, the modified wet distillers’ grains are heavier andmore difficult to handle. The customer must be close enough to justify theadditional handling and shipping costs. As a result, modified wet distillers’grains are principally sold only to local feedlots and livestock operations.

 

Various factors affect theprice of distillers’ grain, including, among others, the price of corn, soybeanmeal and other alternative feed products, the performance or value ofdistillers’ grains in a particular feed market, and the supply and demandwithin the market. Like other commodities, the price of distillers’ grains canfluctuate significantly.

 

**Competition**

 

*Producers ofEthanol*

* *

We compete with producers ofethanol products both locally and nationally, with more intense competition forsales of ethanol among ethanol producers in close proximity to our ethanolplant as these competitors may be more likely to sell to the same markets thatwe target for our ethanol. Within an approximately 100 mile radius of ourethanol plant, there are 35 ethanol plants as of December 2008.

 

We sell our ethanol in a highlycompetitive market. We are in direct competition with numerous other ethanolproducers, both regionally and nationally, many of which have more experienceand greater resources than we have. Some of these producers are, among otherthings, capable of producing a significantly greater amount of ethanol or havemultiple ethanol plants that may help them achieve certain benefits that wecould not achieve with one ethanol plant. Further, new products or methods ofethanol production developed by larger and better-financed competitors couldprovide them competitive advantages over us and harm our business. A majorityof the ethanol plants in the U.S. and the greatest number of gallons of ethanolproduction are located in the corn-producing states, such as Iowa, Nebraska,Illinois, Minnesota, South Dakota, Indiana, Ohio, Kansas, and Wisconsin.

 

Below is the U.S. ethanolproduction by state in millions of gallons for the ten states with the mosttotal ethanol production, either online or under construction/expansion, as of January 2008:

 

| **State**      | ** ** | **Online** | ** ** | **Under Construction/  Expansion** | ** ** | **Total** | ** ** |
|----------------|------------|------------|------------|-----------------------------------------|------------|-----------|------------|
| *Iowa*         | * *   | *2,059.0*  | * *   | *1,435.0*                               | * *   | *3,494.0* | * *   |
| *Nebraska*     | * *   | *1,143.5*  | * *   | *691.0*                                 | * *   | *1,834.5* | * *   |
| *Illinois*     | * *   | *887.0*    | * *   | *254.0*                                 | * *   | *1,141.0* | * *   |
| *Minnesota*    | * *   | *619.6*    | * *   | *457.5*                                 | * *   | *1,077.1* | * *   |
| *South Dakota* | * *   | *683.0*    | * *   | *283.0*                                 | * *   | *966.0*   | * *   |
| *Indiana*      | * *   | *470.0*    | * *   | *450.0*                                 | * *   | *920.0*   | * *   |
| *Ohio*         | * *   | *68.0*     | * *   | *470.0*                                 | * *   | *538.0*   | * *   |
| *Kansas*       | * *   | *432.5*    | * *   | *75.0*                                  | * *   | *507.5*   | * *   |
| *Wisconsin*    | * *   | *408.0*    | * *   | *90.0*                                  | * *   | *498.0*   | * *   |
| *Texas*        | * *   | *100.0*    | * *   | *255.0*                                 | * *   | *355.0*   | * *   |

 

*Source: Renewable FuelsAssociation, January 2008*

 

Accordingly, we face increasedcompetition because of the location of our ethanol plant in Minnesota.

 

According to the Renewable FuelAssociation (RFA), as of January 2009, 172 U.S. facilities have thecapacity to produce approximately 10.5 billion gallons of ethanol annually withan additional 2.4 billion gallons of capacity under construction. Despite the rapid increase in production,consumption of ethanol has been outpacing production for the past few years, whichhas led to increased imports in the United States, primarily from Brazil.According to the RFA, from January to October of 2008, the U.S.produced 7.5 billion gallons of fuel ethanol and imported 515.6 milliongallons. In addition to intense competition with local, regional and nationalproducers of ethanol, we expect increased competition with imported ethanol andforeign producers of ethanol.

 

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*Producers of OtherFuel Additives and Alternative Fuels*

* *

In addition to competing withethanol producers, we also compete with producers of other gasoline oxygenates.Many gasoline oxygenates are produced by other companies, including oilcompanies, that have far greater resources than we have. Historically, as agasoline oxygenate, ethanol primarily competed with two gasoline oxygenates,both of which are ether-based:  MTBE(methyl tertiary butyl ether) and ETBE (ethyl tertiary butyl ether). Manystates have enacted legislation prohibiting the sale of gasoline containingcertain levels of MTBE or are phasing out the use of MTBE because of health andenvironmental concerns. As a result, national use of MTBE has decreased significantlyin recent years. Use of ethanol now exceeds that of MTBE and ETBE as a gasolineoxygenate.

 

While ethanol has displacedthese two gasoline oxygenates, the development of ethers intended for use asoxygenates is continuing and we will compete with producers of any futureethers used as oxygenates.

 

A number of automotive,industrial and power generation manufacturers are developing alternative fuelsand power systems, both for vehicles and other applications. Fuel cells haveemerged as a potential alternative power system to certain existing powersources because of their higher efficiency, reduced noise and lower emissions.Fuel cell industry participants are currently targeting the transportation,stationary power and portable power markets in order to decrease fuel costs,lessen dependence on crude oil and reduce harmful emissions.

 

Additionally, there are more than a dozenalternative and advanced fuels currently in development, production or use,including the following alternative fuels that, like ethanol, have been or arecurrently commercially available for vehicles:

 
| · | biodiesel   |   |   |
|--------|-------------|--------|--------|
|   |        |   |   |
| · | electricity |   |   |
|   |        |   |   |
| · | hydrogen    |   |   |
|   |        |   |   |
| · | methanol    |   |   |
|   |        |   |   |
| · | natural gas |   |   |
|   |        |   |   |
| · | propane     |   |   |

 

Several emerging fuels arecurrently under development. Many of these fuels are also consideredalternative fuels and may have other benefits such as reduced emissions ordecreasing dependence upon oil. Examples of emerging fuels include:

 
| · | Biobutanol:  Like ethanol, biobutanol is an alcohol that can be produced through the  processing of domestically grown crops, such as corn and sugar beets, and  other biomass, such as fast-growing grasses and agricultural waste products.                                                                     |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                              |
| · | Biogas:  Biogas is produced from the anaerobic digestion of organic matter such as  animal manure, sewage, and municipal solid waste. After it is processed to  required standards of purity, biogas becomes a renewable substitute for  natural gas and can be used to fuel natural gas vehicles.                |
|   |                                                                                                                                                                                                                                                                                                              |
| · | Fischer-Tropsch  Diesel: Diesel made by converting gaseous hydrocarbons, such as natural gas  and gasified coal or biomass, into liquid fuel, including transportation fuel                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                              |
| · | Hydrogenation-Derived  Renewable Diesel (HDRD): The product of fats or vegetable oils—alone or  blended with petroleum—that has been refined in an oil refinery                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                              |
| · | P-Series: A  blend of natural gas liquids (pentanes plus), ethanol, and the  biomass-derived co-solvent methyltetrahydrofuran (MeTHF) formulated to be  used in flexible fuel vehicles                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                              |
| · | Ultra-Low  Sulfur Diesel: This is diesel fuel with 15 parts per million or lower sulfur  content. This ultra-low sulfur content enables the use of advanced emission  control technologies on vehicles using ULSD fuels produced from non-petroleum  and renewable sources that are considered alternative fuels. |

 

Additionally, there aredeveloped and developing technologies for converting natural gas, coal andbiomass to liquid fuel, including transportation fuels such as gasoline,diesel, and methanol.

 

We expect that competition willincrease between ethanol producers, such as Heron Lake BioEnergy, LLC andproducers of these or other newly developed alternative fuels or power systems,especially to the extent they are used in similar applications such asvehicles.

 

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*Competition ForCorn*

* *

We will compete with ethanolproducers in close proximity for the supplies of corn we will require tooperate our plant.  Ethanol productionconsumes a significant portion of Minnesota’s corn crop, approximately 30% for2008.  The existence and development ofother ethanol plants, particularly those in close proximity to our plant, willincrease the demand for corn that may result in higher costs for supplies ofcorn.

 

We compete with other users ofcorn, including ethanol producers regionally and nationally, producers of foodand food ingredients for human consumption (such as high fructose corn syrup,starches, and sweeteners), producers of animal feed and industrial users.According to the U.S. Department of Agriculture, for 2008:  3.6 billion bushels of U.S. corn was used inethanol production, with 1.3 billion bushels being used in food and otherindustrial uses, and 23 millions bushels used for seed.

 

*Competition forPersonnel*

* *

We will also compete with ethanolproducers in close proximity for the personnel we will require to operate ourplant. The existence and development of other ethanol plants will increasecompetition for qualified managers, engineers, operators and other personnel.We also compete for personnel with businesses other than ethanol producers andwith businesses located outside the community of Heron Lake, Minnesota.

 

*Competition forDistillers’ Grains*

* *

The amount of distillers’grains produced annually in North America is expected to increase significantlyas the number of ethanol plants increase. We compete with other producers ofdistillers’ grains products both locally and nationally, with more intensecompetition for sales of distillers’ grains among ethanol producers in closeproximity to our ethanol plant. These competitors may be more likely to sell tothe same markets that we target for our distillers’ grains.

 

Additionally, distillers’grains compete with other feed formulations, including corn gluten feed, drybrewers grain and mill feeds. The primary value of these products as animalfeed is their protein content. Dry brewers grain and distillers’ grains haveabout the same protein content, and corn gluten feed and mill feeds haveslightly lower protein contents. Distillers’ grains contain nutrients, fatcontent, and fiber that we believe will differentiate our distillers’ grainsproducts from other feed formulations. However, producers of other forms ofanimal feed may also have greater experience and resources than we do and theirproducts may have greater acceptance among producers of beef and dairy cattle,poultry and hogs. We believe that the demand for distillers’ grains mayincrease as the feed industry becomes more familiar with its benefits. Themarket for distillers’ grains is generally confined to locations where freightcosts allow it to be competitively priced against other feed ingredients.

 

**Hedging**

 

We may hedge anticipated cornpurchases and ethanol and distillers’ grain sales through a variety ofmechanisms.

 

We procure corn through spotcash, fixed-price forward, basis only, futures only, and delayed pricingcontracts. Additionally, we may use hedging positions in the corn futures andoptions market to manage the risk of excessive corn price fluctuations for aportion of our corn requirements.

 

For our spot purchases, we postdaily corn bids so that corn producers can sell to us on a spot basis. Ourfixed-price forward contracts specify the amount of corn, the price and thetime period over which the corn is to be delivered. These forward contracts areat fixed prices indexed to Chicago Board of Trade, or CBOT, prices. Our cornrequirements can be contracted in advance under fixed-price forward contractsor options. The parameters of these contracts are based on the local supply anddemand situation and the seasonality of the price. For delayed pricingcontracts, producers will deliver corn to our elevators, but the pricing forthat corn and the related payment will occur at a later date.

 

To hedge a portion of our exposureto corn price risk, we may buy and sell futures and options positions on theCBOT. In addition, our facilities have significant corn storage capacity. Wegenerally maintain inventories of corn at our ethanol plant, but can draw fromour elevators at Lakefield and Wilder to protect against supply disruption. Atthe ethanol plant, we have the ability to store approximately 10 days of cornsupply and our elevators have capacity for approximately an additional 50 daysof supply.

 

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We market all of our ethanolthrough RPMG, Inc., which is obligated to use reasonable efforts to obtainthe best price for our ethanol. To mitigate ethanol price risk and to obtainthe best margins on ethanol that is marketed and sold by RPMG, we may utilizeethanol swaps, over-the-counter (“OTC”) ethanol swaps, or OTC ethanol optionsthat are typically settled in cash, rather than gallons of the ethanol weproduce.

 

Our marketing and riskmanagement committee, consisting of Doug Schmitz, David J. Woestehoff, TimothyO. Helgemoe, and David M. Reinhart, assists the board and our risk managementpersonnel to, among other things, establish appropriate policies and strategiesfor hedging and enterprise risk.

 

**Compliance with Environmental Laws and OtherRegulatory Matters**

 

Our business subjects us tovarious federal, state and local environmental laws and regulations, includingthose relating to discharges into the air, water and ground; the generation,storage, handling, use, transportation and disposal of hazardous materials; andthe health and safety of our employees.

 

These laws and regulationsrequire us to obtain and comply with numerous permits to construct and operateour ethanol plant, including water, air and other environmental permits. On March 12,2007, we entered into an agreement with Fagen Engineering, LLC, an affiliate ofFagen, Inc., for the development of environmental compliance programs andrelated services, which was completed in September 2007. On March 26,2008, we entered into an agreement with Fagen Engineering, LLC forenvironmental compliance training services.

 

The costs associated withobtaining these permits and meeting the demands of regulators reflected in thepermits have increased our costs of construction. In particular, we haveincurred additional costs relating to an air-emission permit from the MinnesotaPollution Control Agency (“MPCA”). We applied for a synthetic minorair-emissions source permit in July 2004 that was granted by the MPCA in May 2005.In June 2005, a coalition of two environmental groups and one energy groupchallenged the grant of this air emissions permit by an appeal to the MinnesotaCourt of Appeals. In July 2006, the Minnesota Court of Appeals affirmedthe MPCA’s issuance of the permit. In conjunction with the permit and thepermit dispute and to prevent further appeals by the coalition, we entered intoa compliance agreement with the MPCA on January 23, 2007 that currentlygoverns the air emissions from our plant. Under the compliance agreement, weagreed to submit an amendment to our air permit to qualify our facility as a “majoremissions source”. The compliance agreement also allowed us to continue withand complete the construction of our facility pending the issuance of anamended permit qualifying our ethanol plant as a major source. Under thecompliance agreement, we agreed to operate our facility after the completion ofconstruction in a manner such that the emissions of each of the criteriapollutants generated by our ethanol plant, as determined on a 12 month rollingsum, do not exceed 95 tons per year and agreed to comply in all other respectswith the air emissions permit previously issued by the MPCA. We have submittedan amendment to our air permit as required under the compliance agreement andexclusively to comply with that agreement. However, we are continuingdiscussions with the MPCA regarding the necessity for qualifying our facilityas a major emissions source, particularly in light of recent changes in federallaw that increased the limit of certain emissions allowed as a synthetic minorsource. Pending the resolution of this air permit issue, we continue to operateunder the air emissions thresholds described in the compliance agreement inlieu of an amended permit.

 

During June and July 2008,we completed air pollution control device testing to determine compliance withsynthetic minor source thresholds. After this testing, we determined thatcorrective action required both changes in our operations and changes in thelimitations under our permit.  Since thattime we, with the ongoing assistance of Fagen, Inc., have conductedadditional air emissions engineering testing under different conditions todetermine relationships between optimum operating conditions and environmentalcompliance. Further testing is scheduled for early 2009 to gain real-timeemission results to better tune operations and explore optimum emission controls.On December 19, 2008, we submitted a major air permit modificationapplication to the MPCA. This modification application requests adjustment tocertain permit conditions based on recent stack testing at the facility and areview of continuous emissions monitoring data from the bubbling fluidized bedboiler. This request for modification also seeks adjustments for othercomponents of plant operations and production. At the current time, we continue to operate under our complianceagreement pending MPCA consideration for the submitted modificationapplication.

 

Other than as discussed above,we have obtained all permits we believe are necessary for the construction andoperation of our ethanol plant.

 

Compliance with these laws andpermits in the future could require expensive pollution control equipment oroperational changes to limit actual or potential impacts to the environment, aswell as significant management time

 

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and expense. Aviolation of these laws, regulations or permit conditions can result insubstantial fines, natural resource damage, criminal sanctions, permitrevocations and/or plant shutdown, any of which could have a material adverseeffect on our operations. We have incurred costs associated with obtaining theair permits and costs associated with the compliance agreement of approximately$107,000 in fiscal year 2006, $187,000 in fiscal year 2007 and $208,000 infiscal year 2008.

 

**Employees**

 

As of October 31, 2008, wehad 46 full-time employees, of which 37 are in operations and 9 are inexecutive, general management and administration. We also have three part-timeemployees in operations. We also have engaged Brett L. Frevert of CFO Systems,LLC as our interim chief financial officer on a contract basis. We do notmaintain an internal sales organization, but instead rely upon third-parties tomarket and sell the ethanol and distillers’ grains that we produce.

 

**CorporateInformation**

 

Our principalexecutive offices are located at 91246 390th Avenue, Heron Lake, Minnesota 56137 and ourtelephone number is 507-793-0077. We maintain an Internet website atwww.heronlakebioenergy.com. We make available free of charge on or through ourInternet website, www.heronlakebioenergy.com, all of our reports and allamendments to those reports as soon as reasonably practicable after suchmaterial is electronically filed with, or furnished to, the Securities and ExchangeCommission (SEC). We will provide electronic or paper copies of these documentsfree of charge upon request.

 

Additionally,the SEC maintains an Internet site that contains reports, proxy and informationstatements, and other information regarding issuers that file electronicallywith the SEC at www.sec.gov.

 

**ITEM1A.       RISK FACTORS**

** **

If any of thefollowing risks actually occur, our results of operations, cash flows and thevalue of our units could be negatively impacted.

 

**RisksRelated to Our Business and Operations**

 

***Our business ishighly dependent on commodity prices, which are subject to significantvolatility and uncertainty, so our results could fluctuate significantly.***

*** ***

We generallydo not have long-term, fixed price contracts for the purchase of corn, ourprincipal input, or for the sale of ethanol, our principal product. Therefore,our results of operations, financial position and business outlook aresubstantially dependent on commodity prices, especially prices for corn,ethanol and unleaded gasoline. Prices for these commodities are generallysubject to significant volatility and uncertainty. As a result, our futurefinancial results may fluctuate substantially.

 

In addition,we may experience periods of declining prices for our ethanol and increasingcosts for our raw materials, which could result in operating losses. We mayattempt to offset a portion of the effects of such fluctuations by enteringinto forward contracts to supply ethanol or to purchase corn, or by engaging intransactions involving options and futures contracts. These activities involvesubstantial cost and substantial risk, and ultimately may be ineffective inmitigating the fluctuations in corn and ethanol prices.

 

***Corn priceswill fluctuate and could increase significantly, which will increase ouroperating costs and could adversely affect our operating results because wegenerally cannot pass on increases in corn prices to our customers.***

*** ***

Corn is the principal rawmaterial we use to produce ethanol and distillers’ grains. At certain levels, corn prices would make ethanoluneconomical to use in fuel markets. The price of corn is influenced by weatherconditions (including droughts) and other factors affecting crop yields,farmers’ planting decisions and general economic, market and regulatoryfactors, including governmental policies and subsidies with respect toagriculture and international trade, and global and local supply and demand. Inparticular, increasing domestic ethanol capacity could boost demand for cornand result in increased corn prices. Any decline in the corn harvest, caused byfarmers’ planting decisions or otherwise, could cause corn prices to increaseand negatively impact our gross margins. The

 

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price of corn has fluctuated significantly in the past and mayfluctuate significantly in the future. Generally, we are unable to pass along increased corn costs to ourcustomers, and accordingly, rising corn prices will tend to produce lowerprofit margins.

*** ***

***Fluctuations in theselling price and production cost of gasoline may reduce our profit margins.***

*** ***

Ethanol ismarketed both as a fuel additive to reduce vehicle emissions from gasoline andas an octane enhancer to improve the octane rating of gasoline with which it isblended. As a result, ethanol prices are influenced by the supply and demandfor gasoline and our business, future results of operations and financialcondition may be materially adversely affected if gasoline demand or pricesdecrease.

 

***The price ofdistillers’ grains is affected by the price of other commodity products, suchas soybeans, and decreases in the price of these commodities could decrease theprice of distillers’ grains.***

*** ***

Distillers’grains compete with other protein-based animal feed products. The price ofdistillers’ grains may decrease when the price of competing feed productsdecrease. The prices of competing animal feed products are based in part on theprices of the commodities from which they are derived. Downward pressure oncommodity prices, such as soybeans, will generally cause the price of competinganimal feed products to decline, resulting in downward pressure on the price ofdistillers’ grains. The price of distillers’ grains is not tied to productioncosts. However, decreases in the price of distillers’ grains would result inless revenue from the sale of distillers’ grains and could result in lowerprofit margins.

 

***As more ethanolplants are built, ethanol production will increase and, if demand does notsufficiently increase, the price of ethanol and distillers’ grains maydecrease.***

*** ***

According tothe RFA, domestic ethanol production capacity has increased steadily from 1.7billion gallons per year in 1999 to 6.5 billion gallons per year in 2007. Inaddition, there is a significant amount of production capacity being added tothe ethanol industry. According to the RFA, approximately 4 billion gallons peryear of production capacity will come online in 2008 from 65 plants underconstruction or expanding. This capacity is being added to address anticipatedincreases in demand. However, demand for ethanol may not increase as quickly asexpected or to a level that exceeds supply, or at all. Recently, severalethanol companies have announced the postponement of ethanol plants underconstruction due, in part, to concerns about excess production capacity in theethanol industry and its impact on ethanol prices.

 

Excessethanol production capacity also may result from decreases in the demand forethanol or increased imported supply, which could result from a number offactors, including regulatory developments and reduced gasoline consumption inthe U.S. Reduced gasoline consumption could occur as a result of increasedprices for gasoline or crude oil, which could cause businesses and consumers toreduce driving or acquire vehicles with more favorable gasoline mileage, or asa result of technological advances, such as the commercialization of enginesutilizing hydrogen fuel-cells, which could supplant gasoline-powered engines.There are a number of governmental initiatives designed to reduce gasolineconsumption, including tax credits for hybrid vehicles and consumer educationprograms.

 

If ethanolprices decline for any reason, including excess production capacity in theethanol industry, our business, results of operations and financial conditionmay be materially and adversely affected.

 

In addition,because ethanol production produces distillers’ grains as a co-product,increased ethanol production will also lead to increased production ofdistillers’ grains. An increase in the supply of distillers’ grains, withoutcorresponding increases in demand, could lead to lower prices or an inabilityto sell our distillers’ grains production. A decline in the price of distillers’grains or the distillers’ grains market generally could have a material adverseeffect on our business, results of operations and financial condition.

 

***Our operations couldbe adversely affected by infrastructure disruptions and the price of ourethanol could be depressed by lack of adequate transportation and storageinfrastructure in certain areas.***

*** ***

We ship ourethanol to our customers primarily by the railroad adjacent to our site. Wealso have the potential to receive inbound corn via the railroad, although wecurrently receive corn by truck from our facilities in Lakefield,Minnesota and Wilder, Minnesota, each of whichis less than 15 miles away from our plant. Our customers require appropriatetransportation and storage capacity to take delivery of the products weproduce. Therefore, our business is dependent on the continuing availability ofrail, highway and related infrastructure. Any disruptions in this

 

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infrastructure network, whether caused by labor difficulties,earthquakes, storms, other natural disasters, human error or malfeasance orother reasons, could have a material adverse effect on our business. We relyupon third-parties to maintain the rail lines from our plant to the nationalrail network, and any failure on their part to maintain the lines could impedeour delivery of products, impose additional costs on us and could have amaterial adverse effect on our business, results of operations and financialcondition.

 

In addition,lack of this infrastructure prevents the use of ethanol in certain areas wherethere might otherwise be demand and results in excess ethanol supply in areaswith more established ethanol infrastructure, depressing ethanol prices inthose areas. Inorder for the ethanol industry to grow and expand into additional markets andfor our ethanol to be sold in these new markets, there must be substantialdevelopment of infrastructure including:

 

·                  additional rail capacity;

 

·                  additional storage facilities for ethanol;

 

·                  increases in truck fleets capable of transportingethanol within localized markets;

 

·                  expansion of refining and blending facilities tohandle ethanol;  and

 

·                  growth in service stations equipped to handle ethanolfuels.

 

Thesubstantial investments that will be required for these infrastructure changesand expansions may not be made on a timely basis, if at all, and decisionsregarding these infrastructure improvements are outside of our control.Significant delay or failure to improve the infrastructure that facilitates thedistribution could curtail more widespread ethanol demand or reduce prices forour products in certain areas, which would have a material adverse effect onour business, results of operations or financial condition.

 

***We face intensecompetition from competing ethanol producers.***

*** ***

Competitionin the ethanol industry is intense. We face formidable competition in everyaspect of our business from established producers of ethanol, including ArcherDaniels Midland Company, Cargill, Inc., VeraSun Energy Corporation, andfrom other companies that are seeking to develop large-scale ethanol plants andalliances. According to the RFA, the top ten producers accounted forapproximately 56% of the ethanol production capacity in the U.S. in 2007. Someof our competitors are divisions of substantially larger enterprises and havesubstantially greater financial, operational, procurement, marketing, distribution andtechnical resources than we have.Additionally, smaller competitors, such as farmer-owned cooperatives andindependent companies owned by farmers and investors, have been able to competesuccessfully in the ethanol industry. Some of these competitors have businessadvantages, such as the ability to more favorably procure corn by operatingsmaller plants that may not affect the local price of corn as much as a larger-scaleplant like ours or requiring their farmer-owners to sell them corn as arequirement of ownership. A significant portion of production capacity in ourindustry consists of smaller-sized plants. We expect competition to increase,both from large and small competitors, as the ethanol industry becomes morewidely known and demand for ethanol increases.

 

We also faceincreasing competition from international suppliers. Although there is a tariffon foreign-produced ethanol (which is scheduled to expire in 2010) that isroughly equivalent to the federal ethanol tax incentive, ethanol importsequivalent to up to 7.0% of total domestic production from certain countriesare exempted from this tariff under the Caribbean Basin Initiative to spureconomic development in Central America and the Caribbean. Currently,international suppliers produce ethanol primarily from sugar cane, which is asignificantly more efficient raw material from which to produce ethanol thancorn, and have cost structures that can be substantially lower than ours.

 

Competing ethanol producers may alsointroduce competitive pricing pressures that may adversely affect our saleslevels and margins or our ability toprocure corn at favorable prices. As a result, we cannot assure you that we will be able to competesuccessfully with existing or new competitors.

 

***We have a limitedoperating history and a history of losses, and our business may not besuccessful.***

*** ***

We were organized as aMinnesota limited liability company in April 2001 and did not beginproducing ethanol until September 21, 2007. In October 2007, we beganrecording revenues from our ethanol production activity. Accordingly, we have alimited operating history from which to evaluate our business and prospects. Wehave accumulated losses from inception through October 31, 2007 ofapproximately $6.4 million offset by net income for

 

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the yearended October 31, 2008 of approximately $8.6 million. If we cannot successfully address these risks, ourbusiness, future results of operations and financial condition may bematerially adversely affected. Whilewe had a net income of approximately $8.6million for the year ended October 31, 2008, we cannot assure youthat we will be able to increase our revenues, operate profitably, orsuccessfully operate our business. Ourprospects must be considered in light of the risks and uncertaintiesencountered by an early-stage company and in a rapidly evolving market, such asthe ethanol market, where supply and demand may change significantly in a shortperiod of time. In addition, most of our governors and executiveofficers have no expertise in the ethanol industry or governing and operating apublic company. While our governors and executive officers are experienced inbusiness generally, their lack of experience in the ethanol industry andmanaging a public company may present additional risks to our business.

 

Some of therisks and uncertainties we may encounter relate to our potential inability to:

 

·                  effectively manage our business and operations, inparticular the pricing risks inherent in the sale of ethanol and purchase ofcorn;

 

·                  recruit and retain key personnel;

 

·                  comply with our obligations as a public reportingcompany while maintaining a low-cost structure; and

 

·                  successfully address the other risks describedthroughout this annual report on Form 10-K.

 

***We engage in hedgingtransactions which involve risks that can harm our business.***

*** ***

In an attemptto offset some of the effects of volatility of ethanol prices and corn costs,we may enter into cash fixed-price contracts to sell a portion of our ethanoland distillers’ grains production or purchase a portion of our cornrequirements. We may use exchange-traded futures contracts and options tomanage commodity risk. The impact of these activities depends upon, among otherthings, the prices involved and our ability to sell sufficient products to useall of the corn for which we have futures contracts. Hedging arrangements alsoexpose us to the risk of financial loss in situations where the other party tothe hedging contract defaults on its contract or, in the case ofexchange-traded contracts, where there is a change in the expected differentialbetween the underlying price in the hedging agreement and the actual pricespaid or received by us. Hedging activities can themselves result in losses whena position is purchased in a declining market or a position is sold in a risingmarket. A hedge position is often settled in the same time frame as thephysical commodity is either purchased (corn) or sold (ethanol). We mayexperience hedging losses in the future. We also vary the amount of hedging orother price mitigation strategies we undertake, and we may choose not to engagein hedging transactions at all. As a result, whether or not we engage inhedging transactions, our business, results of operations and financialcondition may be materially adversely affected by increases in the price ofcorn or decreases in the price of ethanol.

 

***Operationaldifficulties at our plant could negatively impact our sales volumes and couldcause us to incur substantial losses.***

*** ***

Ouroperations are subject to labor disruptions, unscheduled downtime and otheroperational hazards inherent in our industry, such as equipment failures,fires, explosions, abnormal pressures, blowouts, pipeline ruptures,transportation accidents and natural disasters. Some of these operationalhazards may cause personal injury or loss of life, severe damage to ordestruction of property and equipment or environmental damage, and may resultin suspension of operations and the imposition of civil or criminal penalties.Our insurance may not be adequate to fully cover the potential operationalhazards described above or we may not be able to renew this insurance oncommercially reasonable terms or at all. Furthermore, we may have difficultymanaging the necessary process maintenance required to maintain our nameplateproduction capacity of 50 mgy. If our ethanol plant does not produce ethanoland distillers’ grains at the levels we expect, our business, results ofoperations, and financial condition may be materially adversely affected.

 

***Competition for qualifiedpersonnel in the ethanol industry is intense and we may not be able to hire andretain qualified personnel to operate our ethanol plant.***

*** ***

Our successdepends in part on our ability to attract and retain competent personnel. Forour ethanol plant, we must hire qualified managers, operations personnel,accounting staff and others, which can be challenging in a rural community.Competition for employees in the ethanol industry is intense, and we may not beable to attract and retain qualified personnel. If we are unable to hireproductive and competent personnel and retain our existing

 

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personnel, our business may be adversely affected and we may not beable to efficiently operate our ethanol business and comply with our otherobligations.

 

***Technology in our industry evolves rapidly,potentially causing our plant to become obsolete, and we must continue toenhance the technology of our plant or our business may suffer.***

*** ***

We expectthat technological advances in the processes and procedures for processingethanol will continue to occur. It is possible that those advances could makethe processes and procedures that we utilize at our ethanol plant lessefficient or obsolete. These advances could also allow our competitors toproduce ethanol at a lower cost than we are able. If we are unable to adopt orincorporate technological advances, our ethanol production methods andprocesses could be less efficient than those of our competitors, which couldcause our ethanol plant to become uncompetitive.

 

Ethanolproduction methods are constantly advancing. The current trend in ethanolproduction research is to develop an efficient method of producing ethanol fromcellulose-based biomass such as agricultural waste, forest residue andmunicipal solid waste. This trend is driven by the fact that cellulose-basedbiomass is generally cheaper than corn and producing ethanol from cellulose-basedbiomass would create opportunities to produce ethanol in areas that are unableto grow corn. Another trend in ethanol production research is to produceethanol through a chemical or thermal process, rather than a fermentationprocess, thereby significantly increasing the ethanol yield per pound offeedstock. Although current technology does not allow these production methodsto be financially competitive, new technologies may develop that would allowthese methods to become viable means of ethanol production in the future. If weare unable to adopt or incorporate these advances into our operations, our costof producing ethanol could be significantly higher than those of ourcompetitors, which could make our ethanol plant obsolete. Modifying our plantto use the new inputs and technologies would likely require materialinvestment.

 

***If ethanol fails to compete successfully withother existing or newly-developed oxygenates or renewable fuels, our businesswill suffer.***

*** ***

Alternativefuels, additives and oxygenates are continually under development. Alternativefuels and fuel additives that can replace ethanol are currently underdevelopment, which may decrease the demand for ethanol. Technological advancesin engine and exhaust system design and performance could reduce the use ofoxygenates, which would lower the demand for ethanol, and our business, resultsof operations and financial condition may be materially adversely affected.

 

***We have asignificant amount of debt, and our existing debt financing agreements contain,and our future debt financing agreements may contain, restrictive covenantsthat limit distributions and impose restrictions on the operation of ourbusiness. Our debt level or our failure to comply with applicable debtfinancing covenants and agreements could have a material adverse effect on ourbusiness, results of operations and financial condition.***

*** ***

As of October 31,2008, our total long-term debt was approximately $64.9 million and did not haveany balance outstanding  on our revolvingline of credit. We had total available long-term borrowing capacity on ourrevolving term note of $3.4****million andtotal short-term borrowing capacity on our revolving line of credit of $7.1million. We also may incur additional debt to fund operations at our plant orin connection with other development projects or acquisitions.

 

The use ofdebt financing makes it more difficult for us to operate because we must makeprincipal and interest payments on the indebtedness and abide by covenantscontained in our debt financing agreements. The level of our debt may haveimportant implications on our operations, including, among other things:

 

·                  limiting our ability to obtain additional debt orequity financing;

 

·                  making us vulnerable to increases in prevailinginterest rates;

 

·                  placing us at a competitive disadvantage because wemay be substantially more leveraged than some of our competitors;

 

·                  subjecting all or substantially all of our assets toliens, which means that there may be no assets left for members in the event ofa liquidation;

 

·                  limiting our ability to adjust to changing marketconditions, which could make us more vulnerable to a downturn in the generaleconomic conditions of our business; and

 

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·                  limiting our ability to make business and operationaldecisions regarding our business and our subsidiaries, including, among otherthings, limiting our ability to pay dividends to our members, make capitalimprovements, sell or purchase assets or engage in transactions we deem to beappropriate and in our best interest.

 

The terms ofour existing debt financing agreements contain, and any future debt financingagreement we enter into may contain, financial, maintenance, organizational,operational and other restrictive covenants. If we are unable to comply withthese covenants or service our debt, we may lose control of our business and beforced to reduce or delay planned capital expenditures, sell assets,restructure our indebtedness or submit to foreclosure proceedings, all of whichcould result in a material adverse effect upon our business, results ofoperations and financial condition.

 

***We are subject to financial reporting and other requirements for whichour accounting, internal audit and other management systems and resources maynot be adequately prepared.***

 

Weare subject to reporting and other obligations under the Securities ExchangeAct of 1934, as amended, or the Exchange Act. Only one of our governors and our interim chief financial officer hasserved as such with a company that is required to file reports under theExchange Act. These reporting and other obligations will placesignificant demands on our management, administrative, operational, andaccounting resources. As a result, wemay not be able or qualified to efficiently manage our financial accounting andpreparation of the Exchange Act reports. If we are unable to manage ourfinancial accounting and prepare our Exchange Act reports, we may be exposed tosignificant liabilities and have difficulty raising additional capital.

 

***Our failure to achieve and maintain effective internal controls overfinancial reporting may have a material effect on our business.***

*** ***

In connection with the audit of our financialstatements for our fiscal year ended October 31, 2008, we have identifiedmaterial weaknesses in our internal control over financial reporting relatingto lack of segregation of duties, period-end closing procedures, and inadequatenumber of accounting department personnel. We have engaged and involved outsideconsultants with technical accounting expertise, as needed, to evaluate ourinternal control processes relating to these deficiencies and to recommendcorrective action or controls to mitigate those deficiencies.  We have begun implementing, and intend tofully implement, corrective actions that we believe will mitigate the materialweaknesses identified and described above. Further, we intend to develop procedures for the testing of the controlsimplemented through these corrective actions to determine if the weaknesseshave been remediated.

 

We cannot be certain that any steps we taketo remediate these deficiencies will ensure that we implement and maintainadequate controls over our financial reporting processes. In addition, wecannot assure you that we will not in the future identify further materialweaknesses or significant deficiencies in our internal control over financialreporting, which may impact the reliability of our financial reporting andfinancial statements

 

In the future we will be subject to Section 404of the Exchange Act, which requires an annual management assessment of theeffectiveness of our internal control over financial reporting and anattestation by our independent auditors on management’s assessments. Inanticipation of these requirements, we are in the process of upgrading oursystems, implementing additional financial and management controls, reportingsystems and procedures, implementing an internal audit function and evaluatingthe necessity of hiring additional accounting, internal audit and financestaff. The requirements of Section 404 will place significant demands onour management and internal accounting and we cannot assure you that ourefforts to comply with Section 404 will result in adequate internalcontrols.

 

If we fail to implementrequired, new, or improved controls, if we encounter difficulties inimplementing internal controls, or if we fail to remediate any existing orfuture material weakness, we may not be able to timely and reliably report ourfinancial information, which may result in material misstatements in ourfinancial statements or cause us to fail to meet our reporting obligations. Theexistence of a material weakness in internal controls, difficulties inimplementing appropriate internal controls, and the development andimplementation of remediation plans may also result in increased expenseassociated with accounting, auditing and compliance professionals. Ourinability to provide timely and reliable financial information and otherwisemeet our reporting obligations could cause investors to lose confidence in ourreported financial information. This inability could also damage our reputationwith customers, suppliers, lenders, investors, and others.

 

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***Certain of ourmembers exert significant influence over us. Their interests may not coincidewith ours or the interests of our unitholders, and they may make decisions withwhich we or our unitholders may disagree.***

*** ***

As of January 1,2009, Project Viking, LLC beneficially owned 21.8% of our outstanding units.Project Viking is owned by Roland J. (Ron) Fagen and Diane Fagen,the principal shareholders of Fagen, Inc., our design-build firm. Project Viking, together with our executiveofficers and governors, together control approximately 25.8% of our outstandingunits as of January 1, 2009. As a result, these unitholders, actingindividually or together, could significantly influence our management andaffairs and all matters requiring member approval, including the election ofgovernors and approval of significant corporate transactions. Thisconcentration of ownership may also have the effect of delaying or preventing achange in control of our company and might affect the market price of ourunits.

 

The interestsof these members may not coincide with our interests or the interests of ourother members. For example, Fagen, Inc. has invested and may continue toinvest in a number of other ethanol producers, some of whom may compete withus. As a result of these and other potential conflicting interests, theseexisting members may make decisions with respect to us with which we or ourmembers may disagree.

 

***Because we areprimarily dependent upon one product, our business is not diversified, and wemay not be able to adapt to changing market conditions or endure any decline inthe ethanol industry.***

*** ***

Our success depends on ourability to efficiently produce and sell ethanol, and, to a lesser extent,distillers’ grains. We do not have any other lines of business or othersignificant sources of revenue to rely upon if we are unable to produce andsell ethanol and distillers’ grains, or if the market for those productsdecline. Our lack of diversification means that we may not be able to adapt tochanging market conditions, changes in regulation, increased competition or anysignificant decline in the ethanol industry.

 

**Risks Related to the Units**

 

***There is no public market for our units andno public market is expected to develop.***

*** ***

There is noestablished public trading market for our units, and we do not expect one todevelop in the foreseeable future. To maintain our partnership tax status, wedo not intend to list the units on any stock exchange or automatic quotationsystem such as OTC Bulletin Board. As a result, units held by our members maynot be easily resold and members may be required to hold their unitsindefinitely. Even if members are able to resell our units, the price may be lessthan the members’ investment in the units or may otherwise be unattractive tothe member.

 

***There aresignificant restrictions on the transfer of our units.***

*** ***

To protect our status as apartnership for tax purposes and to assure that no public trading market in ourunits develops, our units are subject to significant restrictions on transferand transfers are subject to approval by our board of governors. All transfersof units must comply with the transfer provisions of our Member ControlAgreement and the unit transfer policy adopted by our board of governors. Ourboard of governors will not approve transfers which could cause us to lose ourtax status or violate federal or state securities laws. On November 5,2008, our board of governors adopted a revised unit transfer policy. While therevised policy permits transfers of our units under certain circumstances,including certain transfers of units for value, there continue to besignificant restrictions on transfer of our units. Among other things, the revisedunit transfer policy places limits on the number of units that may betransferred during any fiscal year and requires the transferor and transfereeto complete a unit transfer agreement and application form and submit these tous along with the required documents and an application fee. As a result,members may not be able to transfer their units and may be required to assumethe risks of the investment for an indefinite period of time.

 

A transferee may be admitted asa member only upon approval by the board of governors and upon satisfaction ofcertain other requirements, including the transferee meeting the minimum unitownership requirements to become a member (which for our present units requiresholding a minimum of 2,500 units). Any transferee that is not admitted as amember will be deemed an unadmitted assignee. An unadmitted assignee will be anon-member unit holder and will have the same financial rights as other unitholders, such as the right to receive distributions that we declare or that areavailable upon our dissolution or liquidation. As a non-member unit holder, anunadmitted assignee will not have the voting or other governance rights ofmembers and will not be entitled to any information or accountings regardingour business or to inspect our books and records.

 

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***There is noassurance that we will be able to make distributions to our unit holders, whichmeans that holders could receive little or no return on their investment.***

*** ***

Distributions of our net cashflow may be made at the sole discretion of our board of governors, subject tothe provisions of the Minnesota Limited Liability Company Act, our MemberControl Agreement and restrictions imposed by our creditors. There is noassurance that we will generate any distributable cash from operations.Although our intention is to make cash distributions sufficient to dischargeour members’ anticipated tax liabilities arising from any taxable incomegenerated, our board may elect to retain cash for operating purposes, debtretirement, plant improvements or expansion. Consequently, members may receivelittle or no return on their investment in the units.

 

***We may authorize andissue units of new classes which could be superior to or adversely affectholders of our outstanding units.***

*** ***

Our board of governors, uponthe approval of a majority in interest of our members, has the power toauthorize and issue units of classes which have voting powers, designations,preferences, limitations and special rights, including preferred distributionrights, conversion rights, redemption rights and liquidation rights, differentfrom or superior to those of our present units. New units may be issued at aprice and on terms determined by our board of governors. The terms of the unitsand the terms of issuance of the units could have an adverse impact on yourvoting rights and could dilute your financial interest in us.

 

***Our use of astaggered board of governors and allocation of governor appointment rights mayreduce the ability of investors to affect the composition of the board.***

*** ***

We are managed by a board ofgovernors, currently consisting of eight elected governors and two appointedgovernors. The seats on the board that are not subject to a right ofappointment will be elected by the other members. The initial board designatedfrom among themselves three classes of governors. The terms of the threeclasses of governors is staggered such that, beginning in 2008, our memberswill elect one-third (or as nearly as possible) of the non-appointed members ofthe board of governors annually. An appointed governor serves indefinitely atthe pleasure of the member appointing him or her (so long as such member andits affiliates continue to hold a sufficient number of units to maintain theapplicable appointment right) until a successor is appointed, or until theearlier death, resignation or removal of the appointed governor.

 

The effect of these provisionsmay make it more difficult for a third party to acquire, or may discourage athird party from acquiring, control of us and may discourage attempts to changeour management, even if an acquisition or these changes would be beneficial toour members.

 

***Our units representboth financial and governance rights, and loss of status as a member wouldresult in the loss of the holder’s voting and other rights and would allow usto redeem such holder’s units.***

*** ***

Holders of units are entitledto certain financial rights, such as the right to any distributions, and togovernance rights, such as the right to vote as a member. If a unit holder doesnot continue to qualify as a member or such holder’s member status isterminated, the holder would lose certain rights, such as voting rights, and wecould redeem such holder’s units. The minimum number of units presentlyrequired for membership is 2,500 units. In addition, holders of units may beterminated as a member if the holder dies or ceases to exist, violates ourMember Control Agreement or takes actions contrary to our interests, and forother reasons. Although our Member Control Agreement does not define whatactions might be contrary to our interests, and our board of governors has notadopted a policy on the subject, such actions might include providingconfidential information about us to a competitor, taking a board or managementposition with a competitor or taking action which results in significantfinancial harm to us in the marketplace. If a holder of units is terminated asa member, our board of governors will have no obligation to redeem such holder’sunits.

 

***Voting rights ofmembers are not necessarily equal and are subject to certain limitations.***

*** ***

Members of our company areholders of units who have been admitted as members upon their investment in ourunits and who are admitted as members by our board of governors. The minimumnumber of units required to retain membership is 2,500 units. Any holder ofunits who is not a member will not have voting rights. Transferees of unitsmust be approved by our board of governors to become members. Members who areholders of our present units are entitled to one vote for each unit held. Theprovisions of our Member Control Agreement relating to voting rights applicableto any class of units will apply equally to all units of that class. However,our Member Control Agreement

 

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gives memberswho hold significant amounts of equity in us the right to designate governorsto serve on our board of governors. For every 9% of our units held, the memberhas the right to appoint one person to our board. Project Viking, LLC has theright to appoint two persons to our board pursuant to this provision. If unitsof any other class are issued in the future, holders of units of that otherclass will have the voting rights that are established for that class by ourboard of governors with the approval of our members. Consequently, the votingrights of members may not be completely proportional to the number of unitsheld. Cumulative voting for governors is not allowed, which makes itsubstantially less likely that a minority of members could elect a member tothe board of governors. Members do not have dissenter’s rights. This means thatthey will not have the right to dissent and seek payment for their units in theevent we merge, consolidate, exchange or otherwise dispose of all orsubstantially all of our property. Holders of units who are not members have novoting rights. These provisions may limit the ability of members to change thegovernance and policies of our company.

 

***All memberswill be bound by actions taken by members holding a majority of our units, andbecause of the restrictions on transfer and lack of dissenters’ rights, memberscould be forced to hold a substantially changed investment.***

*** ***

We cannot engage in certaintransactions, such as a merger, consolidation, dissolution or sale of all orsubstantially all of our assets, without the approval of our members. However,if holders of a majority of our units approve a transaction, then all memberswill also be bound to that transaction regardless of whether that member agreeswith or voted in favor of the transaction. Under our Member Control Agreement,members will not have any dissenters’ rights to seek appraisal or payment ofthe fair value of their units. Consequently, because there is no public marketfor the units, members may be forced to hold a substantially changedinvestment.

 

**Risks Related to Our Debt Financing**

 

***Our debt financing agreements containrestrictive covenants that limit distributions and impose restrictions on theuse of working capital, and these restrictions could have a material adverseeffect upon our business.***

*** ***

We must abide by the financial,maintenance, organizational, operational and other restrictive covenantscontained in our master loan agreement with AgStar Financial Services, PCA (“AgStar”)and our other debt financing agreements, which may make it more difficult forus to operate. These covenants may have important implications on ouroperations, including, among other things:

 

·                  Limiting ourability to obtain additional debt or equity financing;

 

·                  Placing us at acompetitive disadvantage because we may be substantially more leveraged thansome of our competitors;

 

·                  Limiting ourability to adjust to changing market conditions, which could make us morevulnerable to a downturn in the general economic conditions of our business;and

 

·                  Limiting ourability to make business and operational decisions regarding our business andour subsidiaries, including, among other things, limiting our ability to makedistributions to our unit holders, make capital improvements, sell or purchaseassets or engage in transactions we deem to be appropriate and in our bestinterest.

 

If we are unable to comply withthese covenants, we may lose control of our business and be forced to reduce ordelay planned capital expenditures, sell assets, restructure our indebtednessor submit to foreclosure proceedings, all of which would result in a materialadverse effect upon our business.

 

***Certainprovisions of our master loan agreement with AgStar present special risks toour business.***

*** ***

As of October 31, 2008,our debt with AgStar consists of approximately $43.8 million in fixed rateobligations and $13.7 in variable rate obligations after giving effect to our electionunder our master loan agreement with AgStar to fix an interest rate of 6.58% on$45.0 million of our debt effective May 1, 2008 through April 30,2011. The variable rate on a portion of our debt may make us vulnerable toincreases in prevailing interest rates. If the interest rate on our variablerate debt were to increase, our aggregate annualized interest and principalpayments would also increase and could increase significantly.

 

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Additionally, the principal andinterest payments on our $57.5 term loan are calculated using an amortizationperiod of ten years even though the note will mature on October 1, 2012,five years from the date of its issuance. As a result, at maturity of the termloan, there would be approximately $38.9 million in principal remaining underthe term loan, without any additional payments that may be required under themaster loan agreement. In order to finance this large payment of principal thatwould be due at maturity, we may attempt to extend the term of the loan underthe master loan agreement, refinance the indebtedness under the master loanagreement, in full or in part, or obtain a new loan to repay the term loan. Wecannot assure you that will be successful in obtaining an extension of orrefinancing our indebtedness. We also cannot assure you that we will be able toobtain a new loan in an amount that is sufficient for our needs, in a timelymanner or on terms and conditions acceptable to us or our members.

 

We also have a $4.5 millionrevolving term loan. As of October 31, 2008, we have used approximately$1.1 million of AgStar’s commitment under this loan. Beginning with October 1,2008, and annually thereafter, AgStar’s commitment and the available amount ofthe loan decreases by $500,000 until October 2011. At October 31,2007 and for the period of fiscal year 2008, the amount available under therevolving term note was $5,000,000.  Theloan will mature on October 1, 2012. As with the term loan, at maturity wemay attempt to extend, refinance, or obtain a new loan to repay any outstandingbalance. We cannot assure you that any alternative will be sufficientfor our needs, available in a timely manner or on terms and conditionsacceptable to us or our members.

 

If we are unable to service ourdebt, we may lose control of our business and be forced to reduce or delayplanned capital expenditures, sell assets, restructure our indebtedness orsubmit to foreclosure proceedings, all of which would result in a materialadverse effect upon our business.

 

**Risks Related to Construction of the Ethanol Plant**

 

***Our ethanolplant is not complete under our design-build agreement with Fagen, Inc.because the warranties relating to air emissions has not been satisfied.***

*** ***

Our ethanol plant wasconstructed under a design-build agreement with Fagen, Inc. as thedesign-builder. As of October 31, 2008, $77.6 million has been paid and wehave retained approximately $3.8 million in payments to Fagen, Inc. Finalpayment will be due when final completion of construction is achieved and whenour plant satisfies the air emissions warranties specified in the design-buildagreement. Under that warranty, Fagen, Inc. has warranted that within sixmonths following the date of substantial completion, the emissions of ourethanol plant will meet the requirements of a synthetic minor source. In lieuof an amended permit, we are currently operating subject to a complianceagreement with the Minnesota Pollution Control Agency that specifies airemissions thresholds. Under the compliance agreement, we agreed to submit anamendment to our air permit to qualify our facility as a “major emissionssource”.

 

During June and July 2008,we completed air pollution control device testing to determine compliance withsynthetic minor source thresholds. Some of these results have been provided tothe MPCA, while others are still being processed. Additionally, we, with theongoing assistance of Fagen, Inc., have conducted additional air emissionsengineering testing under different conditions to determine relationshipsbetween optimum operating conditions and environmental compliance. Furthertesting is scheduled for early 2009 to gain real-time emission results tobetter tune operations and explore optimum emission controls. On December 19,2008, a Major Air Permit Modification Application was submitted to MPCA. Thismodification application requests adjustment to certain permit conditions basedon recent stack testing at the facility and a review of continuous emissionsmonitoring (CEMS) data from the bubbling fluidized bed boiler (BFB). Thisrequest for modification also seeks adjustments for other key components ofplant operations.  At the current time,we continue to operate under the compliance agreement pending MPCAconsideration for the submitted application. We have experienced substantial delays in construction due to issuesassociated with the air emissions permit for our plant and we have incurredsubstantial additional costs associated with air emissions permitting. We maybe required to incur additional costs to modify our plant to achieve compliancewith the more stringent minor source emissions limits or to qualify our facilityas a major emissions source. We also may experience increased costs ofoperations to comply with any air emissions permit we receive. Further, wecannot assure you when our plant will be complete under the design-buildagreement or when we will remit the retainage to Fagen, Inc.

 

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***We may encounter defects in material,workmanship or design, which may hinder our ability to efficiently operate theethanol plant.***

*** ***

If there are defects inmaterial, workmanship or design in our ethanol plant, we will rely on Fagen, Inc.and ICM, Inc. to adequately address such deficiency. The performanceguarantees and warranties we have received from Fagen are unsecured and we maynot be able to recover any losses we sustain arising from such deficiencies. IfFagen and/or ICM were unable to correct such deficiency in an acceptable manneror without the financial resources to pay for such deficiency as may berequired by our design-build agreement, we may be forced to halt or discontinueour production of ethanol, which could damage our ability to generate revenues.

 

**Government and Regulatory Risks**

 

***Federal and stateregulation heavily influence the ethanol industry and***changes in government regulation thatadversely affect the demand for or supply of ethanol will have a materialadverse effect on our business.

*** ***

Various federal and state laws, regulationsand programs impact the supply of and demand for ethanol. Some governmentregulation, for example those that provide economic incentives to ethanolproducers, stimulate supply of ethanol by encouraging production and theincreased capacity of ethanol plants. Others, such as a federal excise tax incentive program that providesgasoline distributors who blended ethanol with gasoline to receive a federalexcise tax rate reduction for each blended gallon they sell, stimulate demand for ethanol by making itprice competitive with other oxygenates. Further, tariffs generally apply tothe import of ethanol from certain other countries, where the cost ofproduction can be significantly less than in the U.S. These tariffs aredesigned to increase the cost of imported ethanol to a level more comparable tothe cost of domestic ethanol by offsetting the benefit of the federal excisetax program. Tariffs have the effect ofmaintaining demand for domestic ethanol. Additionally, the federal governmenthas established renewable fuels standard (RFS) programs, most recently underthe Energy Independence and Security Act of 2007, that set minimum national standards for use of renewablefuels. The RFS and other state programs that require or provide incentives forthe use of ethanol create demand for ethanol. Government regulation andgovernment programs that create demand for ethanol may also indirectly createsupply for ethanol as additional producers expand or new companies enter theethanol industry to capitalize on demand.

 

Federal and state laws, regulations andprograms are constantly changing. We cannot predict what material impact, ifany, these changes might have on our business. Future changes in regulationsand programs could impose more stringent operational requirements or couldreduce or eliminate the benefits we receive, directly and indirectly, undercurrent regulations and programs. Future changes in regulations and programsmay increase or add benefits to ethanol producers other than us or eliminate orreduce tariffs or other barriers to entry into the U.S. ethanol market, any ofwhich could prove beneficial to our competitors, both domestic andinternational. Future changes in regulation may also hurt our business byproviding economic incentives to producers of other renewable fuels oroxygenates or encouraging use of fuels or oxygenates that compete with ethanol.In addition, both national and state regulation is influenced by public opinionand changes in public opinion. For example, certain states oppose the use ofethanol because, as net importers of ethanol from other states, the use ofethanol could increase gasoline prices in that state and because that statedoes not receive significant economic benefits from the ethanol industry, whichare primarily experienced by corn and ethanol producing states. Further, someargue that the use of ethanol will have a negative impact on gasoline prices toconsumers, result in rising food prices, add to air pollution, harm car andtruck engines, and actually use more fossil energy, such as oil and naturalgas, than the amount of ethanol that is produced. We cannot predict the impactthat opinions of consumers, legislators, industry participants, or competitorsmay have on the regulations and programs currently benefiting ethanolproducers.

 

***We may be adversely affected byenvironmental, health and safety laws, regulations and liabilities.***

*** ***

We are subject to variousfederal, state and local environmental laws and regulations, including thoserelating to the discharge of materials into the air, water and ground, and thehealth and safety of our employees.

 

Some of these laws andregulations require our plant to operate under permits that are subject torenewal or modification. These laws, regulations and permits may requirepollution control equipment or operational changes to limit actual or potentialimpacts to the environment.

 

The costs associated with obtainingand complying with permits and complying with environmental laws have increasedour costs of construction and production. In particular, we have incurredadditional costs relating to an air-emission permit from the MinnesotaPollution Control Agency (“MPCA”). We applied for a synthetic minor air-emissions

 

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source permitin July 2004 that was granted by the MPCA in May 2005. In June 2005,a coalition of two environmental and one energy group challenged the grant of thisair emissions permit by an appeal to the Minnesota Court of Appeals and in July 2006,the Minnesota Court of Appeals affirmed the MPCA’s issuance of the permit. Inconjunction with the permit and the permit dispute and to prevent furtherappeals by the coalition, we entered into a compliance agreement with the MPCAon January 23, 2007 that currently governs the air emissions from ourplant. Under the compliance agreement, we also agreed to submit an amendment toour air permit to qualify our facility as a “major emissions source”. We havesubmitted an amendment to our air permit as required under the complianceagreement and exclusively to comply with that agreement. However, we arecontinuing discussions with the MPCA regarding the necessity for qualifying ourfacility as a major emissions source, particularly in light of recent changesin federal law that increased the limit of certain emissions allowed as asynthetic minor source. Pending the resolution of this air permit issue, wecontinue to operate under the air emissions thresholds described in thecompliance agreement in lieu of an amended permit. During June and July 2008,we completed air pollution control device testing to determine compliance withsynthetic minor source thresholds. After this testing, we determined thatcorrective action required both changes in our operations and changes in thelimitations under our permit. Since that time, we, with the ongoing assistanceof Fagen, Inc., have conducted additional air emissions engineering testingunder different conditions to determine relationships between optimum operatingconditions and environmental compliance. Further testing is scheduled for early2009 to gain real-time emission results to better tune operations and exploreoptimum emission controls. On December 19, 2008, we submitted a major airpermit modification application to the MPCA. This modification applicationrequests adjustment to certain permit conditions based on recent stack testingat the facility and a review of continuous emissions monitoring data from thebubbling fluidized bed boiler. This request for modification also seeksadjustments for other components of plant operations and production.  At the current time, we continue to operateunder our compliance agreement pending MPCA consideration for the submittedmodification application.

 

There can be no assurance thatwe will be able to comply with any of the conditions of the complianceagreement, any of our other permits, or with environmental laws applicable tous. However, if the requested air permit modification is granted without changeby the MPCA, it will substantially increase our ability to operate consistentlyat or below limitations as a synthetic minor source. Compliance with these lawsand permits could require expensive pollution control equipment or operationalchanges to limit actual or potential impacts to the environment, as well assignificant management time and expense. The resolution of our air emissionspermit issue will likely involve significant management time and expense andmay involve ongoing operational expense or further modifications to the designor equipment in our plant. There can be no assurance that we will succeed inour discussions with the MPCA to qualify our ethanol plant as a minor emissionssource. A violation of environmental laws, regulations or permit conditions canresult in substantial fines, natural resource damage, criminal sanctions,permit revocations or plant shutdown, any of which could have a materialadverse effect on our operations.

 

The hazards and risks associated withproducing and transporting our products (such as fires, natural disasters,explosions, and abnormal pressures and blowouts) may also result in personalinjury claims or damage to property and third parties. As protection againstoperating hazards, we maintain insurance coverage against some potentiallosses. However, losses could be sustained for uninsurable or uninsured risks,or in amounts in excess of existing insurance coverage. Events that result in significantpersonal injury or damage to our property or third parties or other losses thatare not fully covered by insurance could have a material adverse effect on ourresults of operations and our financial position.

 

Federal and state regulationsaffecting the operation of our ethanol plant are subject to future change. Wecannot predict what material impact, if any, these changes might have on ourbusiness. Future changes in regulations or enforcement policies could imposemore stringent requirements on us, compliance with which could requireadditional capital expenditures, increase our operating costs or otherwiseadversely affect our business. These changes may also relax requirements thatcould prove beneficial to our competitors and thus adversely affect ourbusiness. In addition, regulations of the EPA and the MCPA depend heavily onadministrative interpretations. We cannot assure you that futureinterpretations made by the EPA, or other regulatory authorities, with possibleretroactive effect, will not adversely affect our business, financial conditionand results of operations.

 

Failure to comply with existingor future regulatory requirements could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

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**Risks Related to Tax Issues in a LimitedLiability Company**

 

**EACH UNITHOLDER SHOULD CONSULT THE INVESTOR’S OWN TAX ADVISOR WITH RESPECT TO THEFEDERAL AND STATE TAX CONSEQUENCES OF AN INVESTMENT IN HERON LAKE BIOENERGY,LLC AND ITS IMPACT ON THE INVESTOR’S TAX REPORTING OBLIGATIONS AND LIABILITY.**

 

***If we are nottaxed as a partnership, we will pay taxes on all of our net income and you willbe taxed on any earnings we distribute, and this will reduce the amount of cashavailable for distributions to holders of our units.***

*** ***

We consider Heron LakeBioEnergy, LLC to be a partnership for federal income tax purposes. This meansthat we will not pay any federal income tax, and our members will pay tax ontheir share of our net income. If we are unable to maintain our partnership taxtreatment or qualify for partnership taxation for whatever reason, then we maybe taxed as a corporation. We cannot assure you that we will be able tomaintain our partnership tax classification. For example, there might bechanges in the law or our company that would cause us to be reclassified as acorporation. As a corporation, we would be taxed on our taxable income at ratesof up to 35% for federal income tax purposes. Further, distributions would betreated as ordinary dividend income to our unit holders to the extent of ourearnings and profits. These distributions would not be deductible by us, thusresulting in double taxation of our earnings and profits. This would alsoreduce the amount of cash we may have available for distributions.

 

***Your taxliability from your allocated share of our taxable income may exceed any cashdistributions you receive, which means that you may have to satisfy this taxliability with your personal funds.***

*** ***

As a partnership for federalincome tax purposes, all of our profits and losses “pass-through” to our unitholders. You must pay tax on your allocated share of our taxable income everyyear. You may incur tax liabilities from allocations of taxable income for aparticular year or in the aggregate that exceed any cash distributions youreceive in that year or in the aggregate. This may occur because of various factors,including but not limited to, accounting methodology, the specific tax ratesyou face, and payment obligations and other debt covenants that restrict ourability to pay cash distributions. If this occurs, you may have to pay incometax on your allocated share of our taxable income with your own personal funds.

 

***You may not beable to fully deduct your share of our losses or your interest expense.***

*** ***

It is likely that your interestin us will be treated as a “passive activity” for federal income tax purposes.In the case of unit holders who are individuals or personal servicescorporations, this means that a unit holder’s share of any loss incurred by uswill be deductible only against the holder’s income or gains from other passiveactivities, e.g., S corporations and partnerships that conduct a business inwhich the holder is not a material participant. Some closely held Ccorporations have more favorable passive loss limitations. Passive activitylosses that are disallowed in any taxable year are suspended and may be carriedforward and used as an offset against passive activity income in future years.Upon disposition of a taxpayer’s entire interest in a passive activity to anunrelated person in a taxable transaction, suspended losses with respect tothat activity may then be deducted.

 

Interest paid on any borrowingsincurred to purchase units may not be deductible in whole or in part becausethe interest must be aggregated with other items of income and loss that theunit holder has independently experienced from passive activities and subjectedto limitations on passive activity losses.

 

***You may besubject to federal alternative minimum tax***

*** ***

Individual taxpayers aresubject to an “alternative minimum tax” if that tax exceeds the individual’sregular income tax. For alternative minimum tax purposes, an individual’sadjusted gross income is increased by items of tax preference. We may generatesuch preference items, the most significant of which is accelerateddepreciation. Accordingly, preference items from our operations together withother preference items you may have may cause or increase an alternativeminimum tax to a unit holder. You are encouraged and expected to consult withyour individual tax advisor to analyze and determine the effect on yourindividual tax situation of the alternative minimum taxable income you may beallocated, particularly in the early years of our operations.

 

***Preparation ofyour tax returns may be complicated and expensive.***

*** ***

The tax treatment of limitedliability companies and the rules regarding partnership allocations arecomplex. We will file a partnership income tax return and will furnish eachunit holder with a Schedule K-1 that sets forth our determination of that unitholder’s allocable share of income, gains, losses and deductions. In additionto United 

 

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States federalincome taxes, unit holders will likely be subject to other taxes, such as stateand local taxes, that are imposed by various jurisdictions. It is theresponsibility of each unit holder to file all applicable federal, state andlocal tax returns and pay all applicable taxes. You may wish to engage a tax professionalto assist you in preparing your tax returns and this could be costly to you.

 

***Any audit ofour tax returns resulting in adjustments could result in additional taxliability to you.***

*** ***

The IRS may audit our taxreturns and may disagree with the positions that we take on our returns or anySchedule K-1. If any of the information on our partnership tax return or aSchedule K-1 is successfully challenged by the IRS, the character and amount ofitems of income, gains, losses, deductions or credits in a manner allocable tosome or all our unit holders may change in a manner that adversely affectsthose unit holders. This could result in adjustments on unit holders’ taxreturns and in additional tax liabilities, penalties and interest to you. Anaudit of our tax returns could lead to separate audits of your personal taxreturns, especially if adjustments are required.

 

**ITEM1B.**                                  UNRESOLVED STAFF COMMENTS

** **

Not applicable.

 

**ITEM2.**                                           PROPERTIES

** **

We ownapproximately 216 acres of land located near Heron Lake, Minnesota on which wehave constructed our ethanol plant, which also includes corn, coal, ethanol,and distillers’ grains storage and handling facilities. Located on these 216acres is an approximately 7,320 square foot building that serves as ourheadquarters. Our address is 91246 390th Avenue, Heron Lake, Minnesota 56137-3175.

 

We also own elevator and grainstorage facilities in Lakefield, Minnesota and Wilder, Minnesota. The elevatorand grain storage facilities at each location have grain handling equipment andboth upright and flat storage capacity. The storage capacity of the Lakefield,Minnesota facility is approximately 1.9 million bushels and the storagecapacity of the Wilder, Minnesota facility is approximately 900,000 bushels.

 

All of our real property issubject to mortgages in favor of AgStar Financial Services, PCA as security forloan obligations.

 

**ITEM 3.**                                           LEGAL PROCEEDINGS

** **

None.

 

**ITEM 4.****                                          ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

Not applicable.

 

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**PART II**

** **

**ITEM 5.**                                     MARKET FOR THE REGISTRANT’S COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

** **

**Market Information**

 

Although matching services maybe available to help match buyers and seller of our units, there is noestablished public trading market for the units and we do not expect one todevelop in the foreseeable future. To maintain our partnership tax status, wedo not intend to list the units on any stock exchange or over-the-countersecurities market such as the OTC Bulletin Board.

 

As of January 1, 2009,there were 27,104,625 units outstanding, held of record by 1,098 persons. Thereare no outstanding options or warrants to purchase, or securities convertibleinto, our units.

 

**Distributions**

 

We have never declared anydistributions. Our agreements with lenders currently materially limit ourability to make distributions to our members and these agreements are likely tolimit materially the future payment of distributions. For a further descriptionof these restrictions, please see “Item 7. Management’s Discussion and Analysisof Financial Condition and Results of Operations” and Note 7 of the notes toour audited consolidated financial statements. In September 2007, we beganoperation of our ethanol plant and began generating revenue. If our financialperformance and loan covenants permit, we expect to make cash distributions attimes and in amounts that will permit our members to make income tax payments.If our financial performance and loan covenants further permit, we intend tomake distributions in excess of those amounts. Cash distributions are notassured, however, and we may never be in a position to make distributions.

 

Under Minnesota law, we cannotmake a distribution to a member if, after the distribution, we would not beable to pay our debts as they become due or our liabilities, excludingliabilities to our members on account of their capital contributions, wouldexceed our assets.

 

**Securities Authorized for Issuance underEquity Compensation Plans**

 

There are no “compensationplans” (including individual compensation arrangements) under which any of ourequity securities are authorized for issuance.

 

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**ITEM6.**                                           SELECTED FINANCIAL DATA

** **

**Selected Consolidated Financial Data**

 

The following table presentsselected consolidated financial and operating data as of the dates and for theperiods indicated. The selected financial data for October 31, 2007 and2008 have been derived from the audited consolidated financial statementsincluded elsewhere in this Annual Report on Form 10-K.

 

This selected consolidatedfinancial data should be read in conjunction with Item 7 — “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements and the accompanying notes includedelsewhere in this Annual Report on Form 10-K. Among other things, thosefinancial statements include more detailed information regarding the basis ofpresentation for the following consolidated financial data.

 
| ** **                                           | ** ** | **Fiscal Year Ended** | ** **  |
|------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                           | ** ** | **October 31,  2008**      | ** **  | **October 31,  2007** | ** ** | **October 31,  2006** | ** ** |
| ** **                                           | ** ** | ** **                      | ** **  | ** ** | ** ** | ** ** | ** ** |
| **Statement of Operations Data:**                    | ** ** | ** **                      | ** **  | ** ** | ** ** | ** ** | ** ** |
| Revenues                                             |       | $                               | 131,070,642 |   | $ | 23,560,498 |   | $ | 10,111,931 |   |
| Cost of goods sold                                   |       | 114,411,541                     |        | 24,313,695 |   | 9,818,395 |   |
| Gross profit (loss)                                  |       | 16,659,101                      |        | (753,197 | ) | 293,536 |   |
| Operating expenses                                   |       | 3,351,252                       |        | 3,527,199 |   | 1,965,342 |   |
| Operating income (loss)                              |       | 13,307,849                      |        | (4,280,396 | ) | (1,671,806 | ) |
| Other income (expense)                               |       | (4,689,810                      | )           | (1,167,890 | ) | 1,030,661 |   |
| Net income (loss)                                    |       | $                               | 8,618,039   |   | $ | (5,448,286 | ) | $ | (641,145 | ) |
|                                                 |       |                            |        |   |   |   |   |
| Weighted average units  outstanding                  |       | 27,104,625                      |        | 26,361,406 |   | 23,129,554 |   |
|                                                 |       |                            |        |   |   |   |   |
| Net income (loss) per unit —  Basic and diluted |       | $                               | .32         |   | $ | (0.21 | ) | $ | (0.03 | ) |

 
| ** **                                  | ** ** | **As of**             | ** **  |
|---------------------------------------------|------------|----------------------------|-------------|
| ** **                                  | ** ** | **October 31,  2008** | ** **  | **October 31,  2007** | ** ** |
|                                        |       |                       |        |   |   |
| **Balance Sheet Data:**                     |       |                       |        |   |   |
| Assets:                                     |       |                       |        |   |   |
| Current assets                              |       | $                          | 27,223,185  |   | $ | 24,382,053 |   |
| Property and equipment                      |       | 103,882,039                |        | 108,852,921 |   |
| Other assets                                |       | 2,295,586                  |        | 724,984 |   |
| Total assets                                |       | $                          | 133,400,810 |   | $ | 133,959,958 |   |
|                                        |       |                       |        |   |   |
| Current liabilities                         |       | $                          | 23,552,096  |   | $ | 29,712,918 |   |
| Long-term debt                              |       | 59,265,534                 |        | 62,281,899 |   |
| Members’ equity                        |       | 50,583,180                 |        | 41,965,141 |   |
| Total liabilities and members’  equity |       | $                          | 133,400,810 |   | $ | 133,959,958 |   |

 

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**ITEM 7.**                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

** **

*The following discussion should be read in conjunction with ourfinancial statements and related notes contained elsewhere in this AnnualReport on Form 10-K. This discussion may contain forward-lookingstatements based upon current expectations that involve risks anduncertainties. Our actual results and the timing of selected events could differmaterially from those anticipated in these forward-looking statements as aresult of selected factors, including those set forth under “Risk Factors” inItem 1A. All forward-looking statements included herein are based oninformation available to us as of the date hereof, and we undertake noobligation to update any such forward-looking statements.*

 

We prepared the followingdiscussion and analysis to help readers better understand our financialcondition, changes in our financial condition, and results of operations forthe fiscal year ended October 31, 2008. Since our plant became operationalin September 2007, the financial data derived from our operations andrelated production and sales data for the twelve months ended October 31,2007 is not comparable to that of fiscal year ended October 31, 2008.  Accordingly, we do not provide a comparisonof these elements of our financial results between the periods October 31,2008 and October 31, 2007 in this report.

 

**Overview**

 

Heron LakeBioEnergy, LLC is a Minnesota limited liability company that was formed April 12,2001 under the name “Generation II, LLC”. In June 2004, we changed ourname to Heron Lake BioEnergy, LLC. We were formed for the purpose ofconstructing and operating a dry mill corn-based ethanol plant near Heron Lake,Minnesota. The plant has a stated capacity to produce 50 million gallonsof denatured fuel grade ethanol and 160,000 tons of dried distillers’ grainsper year. The plant was completed, and full-scale production of ethanol anddistillers’ grains at the plant began, in September 2007. We beganrecording revenue from plant production in October 2007, the last month ofour fiscal year. Our revenues are derived from the sale and distribution of ourethanol throughout the continental United States and in the sale anddistribution of our distillers’ grains locally, and throughout the continentalUnited States.

 

Our operating results arelargely driven by the prices at which we sell ethanol and distillers grains andthe costs related to their production, particularly the cost of corn.Historically, the price of ethanol tended to fluctuate in the same direction asthe price of unleaded gasoline and other petroleum products. However, duringfiscal 2008 and continuing into fiscal 2009, it appears ethanol prices tendedto move up and down proportionately, with changes in corn prices. The price ofethanol can also be influenced by factors such as general economic conditions,concerns over blending capacities, and government policies and programs. Theprice of distillers grains is generally influenced by supply and demand, theprice of substitute livestock feed, such as corn and soybean meal, and otheranimal feed proteins. Our largest component of and cost of production is corn.The cost of corn is affected primarily by factors over which we lack anycontrol such as crop production, carryout, exports, government policies andprograms, and weather. The growth of the ethanol industry has increased thedemand for corn. We believe that continuing increase in global demand willresult in corn prices above historic averages.  As an example of our potential sensitivity to price changes, if theprice of ethanol rises or falls $.10 per gallon, our revenues may increase ordecrease accordingly by approximately $5.0 million, assuming no otherchanges in our business. Additionally, if the price of corn rises or falls$0.25 per bushel, our cost of goods sold may increase or decrease by$5.0 million, again assuming no other changes in our business. During ourfiscal 2008, the market price of ethanol and corn were extremely volatile. Theprices on the Chicago Board of Trade for ethanol reached a high of $2.95 pergallon and the price of corn reached $7.60 per bushel.  Prices of these commodities then fellsignificantly during the fourth quarter of our fiscal 2008. As of October 31,2008, ethanol had fallen to $1.76 per gallon and corn prices fell to $4.02 perbushel.  The downward trend continuedinto the first quarter of fiscal 2009 with ethanol hitting a low of $1.37 pergallon and corn has averaged $3.74 per bushel.

 

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**Trends andUncertainties Impacting Our Operations**

** **

Our currentand future results of operation are affected and will continue to be affectedby factors such as (a) volatile and uncertain pricing of ethanol and corn;(b) availability of corn that is, in turn, affected by trends such as cornacreage, weather conditions, and yields on existing and new acreage divertedfrom other crops; and (c) the supply and demand for ethanol, which isaffected by acceptance of ethanol as a substitute for fuel, public perceptionof the ethanol industry, government incentives and regulation, and competitionfrom new and existing construction, among other things. Other factors that mayaffect our future results of operation include those factors discussed in “Item1. Business” and “Item 1A. Risk Factors.”

 

**CriticalAccounting Estimates**

** **

We review long-lived assets andestimates related to inventory and forward purchase commitments for impairmentwhenever events or changes in circumstances indicate that the related carryingamounts may not be recoverable. Impairment testing for assets requires variousestimates and assumptions, including an allocation of cash flows to thoseassets and, if required, an estimate of the fair value of those assets. Ourestimates are based upon assumptions believed to be reasonable, but which areinherently uncertain and unpredictable. These valuations require the use ofmanagement’s assumptions, which do not reflect unanticipated events andcircumstances that may occur. In our analysis, we consider future corn costsand ethanol prices, break-even points for our plant and our risk managementstrategies in place through our derivative instruments and forward contracts.Given the significant assumptions required and the possibility that actualconditions will differ, we consider the assessment of impairment of ourlong-lived assets to be a critical accounting estimate.

 

We reviewed our long-livedassets for impairment at October 31, 2008. As a result of this review andour related analysis, we believe our long-lived assets were not impaired as of October 31,2008, as the carrying amounts of our long-lived assets exceeded their fairvalue.

 

We enter forward contracts forcorn purchases to supply the plant. These contracts represent firm purchase commitments which along withinventory on hand must be evaluated for potential losses.  We have estimated a loss on these firmpurchase commitments to corn contracts in place and for corn on hand at October31, 2008 where the price of corn exceeds the market price and upon being used inthe manufacturing process and eventual sale of products we anticipatelosses.  Our estimates include variousassumptions including the future prices of ethanol, distillers grains and corn.

 

**Financial Summary and Discussion of theFiscal Year Ended October 31, 2008**

 

The following table shows the results of ouroperations and the percentage of revenues, cost of goods sold, operatingexpenses and other itemsto total revenues in our statements of operations for the fiscal year ended October 31,2008:

 
| ** **                                     | ** ** | **2008**    | ** **  |
|------------------------------------------------|------------|-------------|-------------|
| **Income Statement Data**                      | ** ** | **Amount**  | ** **  | **%** | ** ** |
| Revenues                                       |       | $           | 131,070,642 |   | 100.0 |   |
|                                           |       |        |        |   |   |
| Cost of Goods Sold                             |       | 114,411,541 |        | 87.3 |   |
|                                           |       |        |        |   |   |
| Gross Margin                                   |       | 16,659,101  |        | 12.7 |   |
|                                           |       |        |        |   |   |
| Selling, General, and Administrative  Expenses |       | 3,351,252   |        | 2.5 |   |
|                                           |       |        |        |   |   |
| Operating Income                               |       | 13,307,849  |        | 10.2 |   |
|                                           |       |        |        |   |   |
| Other Expense                                  |       | (4,689,810  | )           | (3.6 | ) |
|                                           |       |        |        |   |   |
| Net Income                                     |       | $           | 8,618,039   |   | 6.6 |   |

 

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*Revenues*

* *

As previously noted, commercial production offuel ethanol and distillers’ grains began in September 2007. Accordingly,our first full year of revenues from the sale of fuel ethanol and distillers’grains with solubles (“DGS”) produced at the plant occurred during the fiscal year ended October 31, 2008.Ethanol revenues during the period ended October 31, 2008 wereapproximately $101.8 million, comprising 78% of our revenues. All sales ofethanol were made pursuant to the terms of our ethanol marketing agreement withRPMG, Inc. Under the agreement,RPMG must use its best efforts to market all ethanol produced by our ethanolplant pursuant to a pooled marketing arrangement. We receive a price equal tothe actual pooled price received by RPMG, less the expense of distribution anda marketing fee charged per gallon of ethanol sold. For the year ended October 31,2008, we sold approximately 48.4 million gallons of ethanol at an average priceof $2.10 per gallon. For the2008 fiscal year, we believe that the number of gallons of ethanol sold wereaffected by the plant’s productivity that was impacted by scheduled andunscheduled downtime during the year, including as a result of testing andprocess changes relating to our air emissions. Further, the price of ethanolduring our fiscal year was affected by the demand for ethanol as a motor fuelwhich is affected by, among other factors, regulatory developments, gasolineconsumption, and the price of crude oil. Gasoline consumption was volatile during the fiscal year as the pricefor crude oil fluctuated radically.  Theprice was also affected by federal RFS blending mandates.

 

We may hedge anticipatedethanol sales through a variety of mechanisms. We market all of our ethanolthrough RPMG, Inc., which is obligated to use reasonable efforts to obtainthe best price for our ethanol. To mitigate ethanol price risk and to obtainthe best margins on ethanol that is marketed and sold by RPMG, we may utilizeethanol swaps, over-the-counter (“OTC”) ethanol swaps, or OTC ethanol optionsthat are typically settled in cash, rather than gallons of the ethanol weproduce.  For the year ended October, 31,2008, we recorded gains of $3.6 million related to derivative instruments.  There are timing differences in therecognition of gains on derivatives as compared to the corresponding sale ofethanol.  As such, the gains recognizedcould be associated with related sales in fiscal years 2007, 2008 or 2009.

 

Ethanol prices reached $2.95 per gallon in July 2008,but have declined substantially since that time.   Lower ethanol prices continued into thefirst quarter of fiscal 2009, and we expect to see continuing fluctuations inethanol prices over the next fiscal year. While the demand for ethanol isexpected to continue since gasoline blenders will need increasing amounts ofethanol to meet the Renewable Fuels Standard’s blending requirements, thesupply is also expected to increase as additional production facilities arecompleted. In addition, low prices for petroleum and gasoline will exertdownward pressure on ethanol prices. If ethanol prices decline, our earningswill also decline, particularly if corn prices remain substantially higher thanhistoric averages.

 

Future prices for fuel ethanol will beaffected by a variety of factors beyond our control including, the demand forethanol as a motor fuel, federal incentives for ethanol production, the amountand timing of additional domestic ethanol production and ethanol imports andpetroleum and gasoline prices.

 

Total sales of DGS during fiscal year 2008 equaledapproximately $18.2 million, comprising 14% of our revenues. Under a marketing agreement with CHS, Inc., CHSmarkets and sells all distillers’ grains produced by our ethanol plant. Underthe terms of the agreement, we receive a price equal to the selling price, lessa charge of 2% or 4% of the price for distillers’ grains and a fee of $2.00 perton of solubles, less the cost of delivering the product to the customer.   In fiscal year 2008 we sold approximately 113,000 tons of drieddistillers’ grains at an average price of approximately $147 per ton. In fiscalyear 2008 we sold approximately 32,000 tons of modified wet distillers’ grainsat an average price of approximately $48 per ton.

 

Similarly, the prices for DGS increasedsignificantly during the first three quarters of fiscal 2008, due to the risingprice of corn, soybean meal, and other animal feed proteins that aresubstitutes for DGS. However, during the last quarter of fiscal 2008,decreasing corn prices placed downward pressure on DGS prices. In addition, theaverage price we received for our DGS in fiscal 2008 was limited by forward wetdistillers grains contracts locking in a portion of our DGS prices.

 

Prices for distillers’ grains are affected bya number of factors beyond our control such as the supply of and demand fordistillers’ grains as an animal feed and prices for competing feeds. We believethat current market prices for distillers’ grains are approaching levels thatcan be sustained long-term as long as the prices of competing animal feedsremain steady or increase, livestock feeders continue to create demand foralternative feed sources such as distillers’ grains and the supply ofdistillers’ grains remains relatively stable. On the other hand, if competing

 

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commodity price valuesretreat and distillers’ supplies increase due to growth in the ethanolindustry, distillers’ grains prices may decline.

 

*Cost of Goods Sold*

* *

Cost of goods sold during the year ended October 31,2008 was $114,411,541 million, representing 87% of total revenues. Cost ofgoods sold consists primarily of the costs of corn, coal, depreciation,electricity and denaturant.  We useapproximately 1.5 million bushels of corn and 8,000 tons of coal per monthat our ethanol plant. We contract with local farmers and elevators for our cornsupply and secure coal under our agreement with Northern Coal TransportCompany.  Corn prices on the Chicago Board of Trade reached $7.60 per bushelduring mid-summer of 2008. Prices declined significantly since that time, butthe average price paid for corn during the fiscal year ended October 31,2008 was $4.78 per bushel

 

The cost of both corn and coal fluctuatesbased on supply and demand which, in turn, is affected by a number of factors which are beyond our control. We expect our grossmargin to fluctuate in the future based on the relative prices of corn, coaland fuel ethanol. We use futures and options contracts to minimize our exposureto movements in corn prices, but there is no assurance that these hedgingstrategies will be effective. At October 31, 2008, none of our derivativecontracts were designated as hedges and, as a result, changes to the marketvalues of these contracts are recognized as an increase or decrease to ourcosts of goods sold. For the year ended October 31, 2008, we recognized again of approximately $6.3 million with respect to these contracts, which decreasedcosts of goods sold during the period by this amount.

 

The Company has forward contracts in placefor corn purchases of approximately $31,663,000 through October 2009,which represents approximately 38% of the Company’s anticipated purchases infiscal 2009. Currently, some of these corn contract prices are above currentmarket prices for corn.  Given the recentdeclining price of corn and ethanol, upon taking delivery under thesecontracts, the Company would incur a loss. Accordingly, the Company recorded a loss on these purchase commitmentsof approximately $7,123,000 at October 31, 2008.  The loss, along with a write down ofinventory on hand of $1,628,000, was recorded as a lower of cost or marketadjustment on the statement of operations. The amount of the loss was determined by applying a methodology similarto that used in the lower of cost or market evaluation with respect toinventory.  Given the uncertainty offuture ethanol prices, this loss may or may not be recovered, and furtherlosses on the outstanding purchase commitments could be recorded in futureperiods.  Based on the positions at October 31,2008, further adverse price changes of 10% in the price of ethanol and cornsubsequent to year-end would result in additional losses of approximately $1,254,000.

 

In order to mitigate riskassociated with price fluctuations of coal, The Company has entered into coalsupply agreements with a minimum commitment of approximately $4,950,000 peryear until May 2012, including transportation, with provisions for fuelsurcharges and adjustments for inflation.

 

*Selling, General, and Administrative Expense*

* *

Selling, general and administrative expensesinclude wages, salaries and benefits of administrative employees at the plant,insurance, professional fees and similar costs. These expenses decreased infiscal year 2008 as compared to fiscal year 2007 by approximately $192,000 to$3.3 million or 2.5% of total revenues. The decrease is due, in part, to increased expenses in fiscal year 2007resulting from the delayed production start date.

 

*Operating Income*

* *

Our income from operations for fiscal year2008 totaled approximately $13.3 million, compared to an operating loss ofapproximately $4.3 million for fiscal year 2007. This change was a result ofour transition from a development stage company to an operational company.

 

*Other Income and (Expense)*

* *

Other income and expenseconsists primarily of interest expense of approximately $4.81 million. Interestexpense consists primarily of interest payments under our agreements withAgStar Financial Services, PCA (“AgStar”). Also included in other income andexpense were interest income and other income totaling approximately $118,000.

 

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**Year Ended October 31, 2007 Compared toYear Ended October 31, 2006**

 

*ExecutiveSummary of Fiscal Year 2007.*Our business activity forthe first ten months of fiscal year 2007 consisted of financing and overseeingthe design and construction of our ethanol plant, which was originallyscheduled to start production as early as May 2007. On September 21,2007, after significant delays in start up of the plant primarily due toconstruction and permitting issues, we began producing ethanol. We beganselling ethanol and co-products in October 2007. In anticipation of startup of the plant, we purchased corn to be used in production and hiredadditional personnel. With the delay of start up of the plant, we sold cornthat would otherwise have been used in production to free up storage for thecorn we were required to purchase under our commitments. Additionally, as aresult of the delay, increased labor costs and expense were not immediatelyoffset by corresponding revenue, which resulted in overall higher thananticipated expenses and a negative gross profit margin.

 

Highlights for the year ended October 31,2007 are as follows:

 

·                 We completedconstruction of our ethanol plant during the fourth quarter of fiscal year 2007and our ethanol plant began operations on September 21, 2007.

 

·                 From September 21,2007 until the end of fiscal year 2007, revenue from sales of ethanol anddistillers’ grains was approximately $6.8 million.

 

·                 Revenue forfiscal year 2007 increased by approximately $13.4 million to approximately$23.6 million.

 

·                 Our net lossincreased by approximately $4.8 million from approximately $0.6 million infiscal year 2006 to approximately $5.4 million in fiscal year 2007.

 

·                 Loss per unitincreased from $0.03 per unit in fiscal year 2006 to $0.21 per unit for fiscalyear 2007.

 

*Revenue.*Revenueincreased by approximately $13.4 million, or 133%, from approximately $10.1million in fiscal year 2006 to approximately $23.6 million in fiscal year 2007.Of the total revenue increase, approximately $6.3 million was attributable toethanol sales, approximately $439,000 to distillers’ grain sales, andapproximately $6.7 million in grain and other revenue. There was no revenuefrom the sale of ethanol or distillers’ grains in fiscal year 2006.

 

Ethanol Revenue — Our plantstarted production in September 2007. Our ethanol was first sold in October 2007,the last month of our fiscal year. From the start of production to the end ofour fiscal year 2007, we sold approximately 4.0 million gallons of ethanol atan average price of $1.57 per gallon.

 

Distillers’ Grains — We firstsold distillers’ grains in October 2007. We sold approximately 3,000 tonsof dried distillers’ grains at an average price of approximately $100 per ton.We sold approximately 7,000 tons of modified wet distillers’ grains at anaverage price of approximately $19 per ton. We continually review marketpricing, storage availability and shelf life of product to determine the bestproduction mix of dried distillers’ grains and modified wet distillers’ grainsat any given time. For the period of production during fiscal year 2007, ourproduct mix was negatively affected by issues associated with start up as wefocused on producing ethanol as our main product, operational issues with ourdistillers’ grains dryer, and increased supply of modified wet distillers’grains in local markets that depressed prices for modified wet distillers’grains.

 

Grain and Other Revenue — Grainand other revenue consist of revenue from the sale of grains, primarily cornand soybeans, sales of gasoline and diesel, and revenue from grain relatedservices, such as storage and drying. For fiscal year 2007, revenue from salesof grain and other sources was $16.8 million as compared to $10.1 million infiscal year 2006. The sale of grain accounted for a majority of this revenue inboth fiscal year 2007 and 2006. The increase in revenue from the sale of grainin fiscal year 2007 as compared to fiscal year 2006 was the result of both anincreased number of corn bushels sold by approximately 27.3% and an increase inthe average price of corn sold from $1.91 to $3.50 per bushel. Becauseoperations began nearly five months later than anticipated, we sold corn thatwe would have used in ethanol production to create storage as we fulfilled ourongoing corn purchase commitments, which resulted in the increased number ofbushels sold in fiscal year 2007. The increased price per bushel of corn wasdue to market factors. However, with the start-up of our ethanol plant, ourprimary use of the corn we purchase will be to produce ethanol. Grain and otherrevenue are and will be insignificant as compared to the sale of our primaryproduct, ethanol and its co-product, distillers’ grains.

 

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* *

*Cost ofGoods Sold.*Cost of goods sold consists primarily ofthe costs of corn, coal, depreciation, electricity and denaturant. Cost ofgoods sold increased from approximately $9.8 million in fiscal 2006 toapproximately $24.3 million in fiscal 2007. This represented an increase of$14.5 million, or 148%. Of this increase, approximately $8.0 million wasrelated to the sale of ethanol and distillers’ grains in October 2007. Theremaining increase of approximately $6.5 million was related to the sale ofcorn and other sales. Within the $6.5 million increase was approximately a $1.9million increase in the recognition of derivative losses, which totaled $2.6million in fiscal year 2007 as compared to $0.7 million in fiscal year 2006.

 

We recognize the gains or losses that resultfrom the changes in the value of our derivative instruments in cost of goodssold at the end of each financial reporting period. This method of recognitionis referred to as “mark to market”. As corn prices fluctuate, the value of ourderivative instruments are impacted and, at the end of each financial reportingperiod, these fluctuations result in recognition of a gain or loss impactingcost of goods sold.

 

Corn is a market basedcommodity whose price can vary widely due to supply and demand circumstances,influenced by such factors as planting intentions, weather patterns, andforeign export demand. Our hedging strategies and instruments relating to cornaffect our cost of goods sold. We recognize gains or losses on corn hedginginstruments at the end of each financial period in cost of goods sold. One ofour strategies to control cost of goods sold focuses on utilizing our cornstorage capacity to manage the number of bushels and the purchase price of cornto be used in our ethanol plant. In order to reduce the pricing risk, we mayuse a significant portion of the 2.8 million bushels of space provided by ourelevator facilities as a means of mitigating the more limited storage space atthe ethanol plant, which totals 500,000 bushels. By having this spaceavailable, we have more flexibility in the timing of our corn procurement needsand the use of derivative instruments such as forward purchases, futures, andoption contracts to manage our corn costs.

 

*GrossProfit*. Gross profit decreased from a gross profit ofapproximately $0.3 million in fiscal 2006 to a loss of approximately $0.8million in fiscal year 2007.

 

Overall gross profit wasnegatively impacted in fiscal year 2007 by derivative losses of approximately$2.7 million in 2007 as compared to a loss of approximately $0.7 million in2006, and an unfavorable mix between dried distillers’ grains and modified wetdistillers’ grains affecting our revenue from distillers’ grains.

 

*OperatingExpenses*. Operating expenses increased approximately$1.6 million to approximately $3.5 million for fiscal 2007 from approximately$1.9 million for fiscal 2006. The increase was primarily the result ofincreases in salaries and wages of $678,000, consulting and professional feesof approximately $336,000, repair and supply items of $180,000, depreciationand amortization of $114,000, and insurance of $80,000. The increase inoperating expenses in fiscal year 2007 as compared to fiscal year 2006 wasprimarily attributable to delays in start up of our ethanol plant. Anticipatingstart up as early as May 2007, we hired plant and other employees earlierin the year and we also experienced increased expenses associated withaddressing construction and permitting delays.

 

*OtherIncome (Expense).*Interest income decreased fromapproximately $995,000 in fiscal 2006 to approximately $9,000 in fiscal 2007.This decrease was primarily due to equity funds being invested in property andequipment in fiscal 2007 rather than being held as cash and equivalents.

 

Prior to production, interestcosts were being capitalized as part of property and equipment cost. With thecommencement of production, interest is recognized as interest expense.Therefore, interest expense increased from approximately $77,000 in fiscal 2006to approximately $1.2 million in fiscal 2007. Of this increase, approximately$732,000 was due to increased borrowings, primarily to finance inventory costs.The remaining increase of $372,000 was due to commencement of ethanoloperations.

 

*Net Income(Loss).*For fiscal year 2007, our net loss wasapproximately $5.4 million as compared to a net loss of approximately $641,000in fiscal year 2006. The increase in net loss was primarily attributable toincreased cost of goods sold and operating expenses. While we generatedsignificantly more revenue in fiscal year 2007 as compared to fiscal year 2006,cost of goods sold exceeded revenue for fiscal year 2007 by 3%, whereas cost ofgoods sold was less than revenue for fiscal year 2006 by 3%. Costs of goodssold were significantly higher in fiscal year 2007 as compared to fiscal year2006 due to derivative losses of approximately $2.7 million in 2007 as comparedto derivative losses of approximately $0.7 million in 2006. In addition wehired more employees in anticipation of start-up of our ethanol plant as earlyas May 2007 and experienced delays in start-up in fiscal year 2007.Additionally, in fiscal year 2007, we had other expense of approximately $1.2million as compared to other income of $1.1 million in fiscal year 2006.

 

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**Liquidity and Capital Resources**

 

Through fiscal 2008, ourprincipal sources of liquidity consisted primarily of cash flow from operationsand proceeds from borrowings under our loan agreements with AgStar FinancialServices, PCA (“AgStar”). Secondarily, we received proceeds from our sharedsavings contract and related escrow agreement with Interstate Power and LightCompany and loan proceeds from a secured promissory note from Federated RuralElectric Association.

 

Our primary uses of liquidityprior to start up on September 21, 2007 were the use of cash to constructthe plant, fund pre-startup costs, service debt, and for general corporatepurposes. For fiscal year 2008, our primary uses of liquidity were to servicedebt and general corporate purposes.

 

As of October 31, 2008, we had cash andcash equivalents (other than restricted cash) of approximately$11.4 million and total assets of approximately $133.4 million. As ofOctober 31, 2008, we had approximately $1.0 in cash that isrestricted.  We are periodically requiredto maintain cash balances at our broker related to derivative instrumentpositions.  In addition, at October 31,2008, we maintained restricted cash of approximately $1,472,000 related toequipment costs financed through an alternative savings plan with a utilitycompany.  We expect that our existingfunds, when combined with anticipated revenues generated from the sale ofethanol and distillers’ grains produced at our plant, will meet our operations,working capital and capital resources needs for at least the next twelvemonths. However, there is no assurance that our cash, cash generated fromoperations and, if necessary, available borrowing under our agreement withAgStar, will be sufficient to fund our anticipated capital needs and operating expenses,particularly if the sale of ethanol and DGS does not produce revenues in theamounts currently anticipated or if our operating costs, including specificallythe cost of corn, coal and other inputs, are greater than anticipated.  Due to current volatility in the ethanol andcorn markets, our future profit margins might be tight or not exist at all.

 

As of October 31, 2008, we have retainedapproximately $3.8 million in payments to Fagen, Inc. under ourdesign-build agreement relating to our plant. Final payment will be duewhen final completion of construction is achieved and when our plant satisfiesthe air emissions warranties specified in the design-build agreement. Underthat warranty, Fagen, Inc. has warranted that within six months followingthe date of substantial completion, the emissions of our ethanol plant willmeet the requirements of a synthetic minor source.

 

The following table summarizes oursources and uses of cash and equivalents from our condensed consolidatedstatements of cash flows for the periods presented (in thousands):

 
| ** **                                           | ** ** | **Year Ended  October 31** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2008**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net cash provided by (used in) operating  activities |       | $                                    | 23,193     |   | $ | (12,721 | ) | $ | (1,956 | ) |
| Net cash used in investing activities                |       | (1,436                               | )          | (4,175 | ) | (36,316 | ) |
| Net cash provided by (used in) financing  activities |       | (13,492                              | )          | 17,362 |   | 776 |   |
| Net increase  (decrease) in cash and equivalents     |       | $                                    | 8,265      |   | $ | 466 |   | $ | (37,496 | ) |

 

During fiscal 2008,we were not in compliance with a covenant of our loan agreements with AgStarrequiring the submission of quarterly financial statements within 30 days ofthe end of each quarter. However, AgStar waived these events of non-compliancewith this covenant. Other than this covenant relating to delivery of financialstatements, we were in compliance with the covenants of our loan agreementswith AgStar during fiscal year 2008.

 

*Year Ended October 31, 2008 Compared to Year Ended October 31,2007*

* *

Operating Activities – Wegenerated approximately $23 million from operating activities in fiscal year2008 compared to fiscal year 2007 during which we used approximately $13million for operating activities. This increase of approximately $36 millionwas due to a number of factors. Contributing to the net increase were thefollowing:

 

(1)                                Netincome was $8.6 million for the year ended October 31, 2008 compared to anet loss of $5.4 million for year ended October 31, 2007.

 

(2)                                Depreciationand amortization expense for the year ended October 31, 2008 as comparedto the year ended October 31, 2007 increased $ 4.4  million to $5.7 million.

 

(3)                                Asof October 31, 2007, we had used cash to purchase inventory in the amountof $19 million compared to October 31, 2008 at which time inventory levelswere reduced to $9.6 million.

 

(4)                                Cashwas used during the year ended October 31, 2008 to reduce accounts payableby $3.6 million compared to an increase of accounts payable for the year ended October 31,2007 of $7.7 million.

 

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InvestingActivities—During the year ended October 31, 2008, we used $1.4 millionfor investing activities compared to $4.2 million used during the year ended October 31,2007. This difference is due, primarily, to a reduction of capitalexpenditure-following completion of our plant.

 

Financing Activities—We used$13.5 for financing activities for the year ended October 31, 2008 ascompared to the year ended October 31, 2007 during which we raised $17.4million in cash through financing activities. Contributing to the change werethe following:

 

(1)                                Werepaid $7.0 million on our line of credit with AgStar in fiscal year 2008compared to advances on the line of credit of $6.1 million in fiscal year 2007.

 

(2)                                Wereceived loan proceeds of $4.2 million in 2007 from a related party for ourpurchase of corn inventory and retention of previously purchased corn inventoryuntil our plant was operating. That note was paid in full in fiscal year 2008.

 

(3)                                Wepaid down a net of $1.8 million on long term debt in fiscal year 2008 comparedto repayment of $0.3 million in fiscal year 2007.

 

(4)                                Wereceived $7.5 million in proceeds from the sale of equity in 2007. There wereno such proceeds in fiscal year 2008.

 

At October 31, 2008, wehad cash balances of approximately $11.4 million. In addition, we hadapproximately $3.8 million of long-term borrowing capacity and $7.1 million ofshort term borrowing capacity, net of outstanding letters of credit.

 

*Year Ended October 31, 2007 Compared to Year Ended October 31,2006*

* *

Operating Activities – We usedapproximately $12.8 million in operating activities in fiscal 2007 compared tousing approximately $2.0 million in fiscal 2006. This increase of approximately$10.8 million was due to a number of factors. Contributing to the increase werethe following:

 

(1)                                Ournet loss for the year ended October 31, 2007 increased by $4.8 millioncompared to the year ended October 31, 2006. The increase in net loss canbe attributed to delays in start-up of the ethanol plant and hedging losses ofapproximately $2.6 million.

 

(2)                                Weused cash to increase our inventories in fiscal year 2007 by $14.8 million inexpectation of starting the plant.

 

(3)                                Inaddition, accounts receivable and derivative instruments decreased byapproximately $1.6 million and approximately $0.9 million, respectively.

 

(4)                                Increasesin accounts payable, as well as depreciation and accrued expenses, offset aportion of the increases in current assets.

 

Investing Activities – We usedapproximately $4.2 million in investing activities in fiscal 2007 compared to$36.3 million in fiscal 2006. The net decrease of $32.1 million was due toproperty and equipment purchases being financed in 2006 equity proceeds,whereas the property and equipment purchases were primarily financed with debtin fiscal 2007.

 

Financing Activities – Cashprovided by financing activities increased by $16.6 million in fiscal 2007compared to fiscal 2006. Contributing to the increase were the following:

 

(1)                                Wereceived proceeds of approximately $10.3 million of term debt in fiscal 2007compared to approximately $0.8 million in fiscal 2006. Of this activity, $4.2million was borrowed from a major investor to assist in the carrying of corninventory until our plant was operating.

 

(2)                                Wereceived proceeds from the issuance of equity of approximately $7.7 million infiscal 2007, of which $7.5 million of funds received were from a major existinginvestor and $180,000 were proceeds from the exercise of warrants issued to ourgovernors. We received no proceeds from the sale of equity in fiscal 2006.

 

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In addition to the cashactivity described above, we had significant non-cash increases in property andequipment that were financed with construction payables of approximately $4.2million and long-term debt of approximately $55.1 million.

 

At October 31, 2007, wehad a $5.3 million deficiency in working capital. Of this deficiency, $4.1million****was due to construction retainage andpayables, which we anticipate satisfying primarily from resources availablefrom our long-term borrowing capacity when certain warranties are met. We hadan additional $2.7 million in current maturities of long-term debt at October 31,2007, which we anticipate satisfying from operations in fiscal 2008.

 

At October 31, 2007, wehad cash balances of approximately $3.1 million. In addition, we had approximately$3.9 million of long-term borrowing capacity and $126,000 of short termborrowing capacity, net of outstanding letters of credit.

 

**Off Balance-Sheet Arrangements**

 

We have no off balance-sheet arrangements.

 

**Credit Arrangements**

 

*Credit Arrangements with AgStar*

 

On September 29,2005, we entered into a credit agreement with AgStar Financial Services, PCA (“AgStar”)  establishing a senior credit facility forconstruction of the plant in the amount of $59,583,000. Simultaneously, we andAgStar entered into a Second Supplement that provided for a revolving loan inthe amount of $2,000,000 to provide for general, corporate and operatingexpenses. In December 2006, the construction loan was amended to increasethe amounts available up to $64,583,000. The construction loan converted to a$59,583,000 term note and a $5,000,000 revolving term note in October 2007.

 

The term noterequired interest only payments from November 2007 to April 2008 atthe one-month LIBOR plus 3.25%, which totaled 5.739% and 9.07% at October 31,2008 and 2007, respectively. In May 2008, we locked in an interest rate of3.58% plus 3.00%, which totals 6.58%, on $45,000,000 of the note, for threeyears ending April 30, 2011. The remainder of the amounts outstanding onthe term note is subject to the variable rate based on LIBOR. We will makeequal monthly payments of principal and interest of approximately $702,000 toamortize the note over a period not to exceed ten years, with a final balloonpayment due in October 2012. In addition, we are required to makeadditional payments on the term note of excess cash flow, as defined in theagreement, up to $2,000,000 per year to the lending institution until we need aspecified financial ratio. As part of the debt financing, the premium above LIBORmay be reduced based on the ratio of members’ equity to assets.

 

As of October 31,2008, we have used approximately $1.1 million of AgStar’s commitment under therevolving term note.  Beginning with October 1,2008, and annually thereafter, AgStar’s commitment and the available amount ofthe loan decreases by $500,000 until October 2011. The term note andrevolving term note will mature on October 1, 2012.

 

We also havea line of credit for up to $7,500,000 with AgStar, subject to certain borrowingbase requirements, due November 2009. Amounts available under the line ofcredit are reduced by outstanding standby letters of credit. Interest accrueson borrowings at the one month LIBOR plus 3.25%, which totaled 5.74% and 9.07%at October 31, 2008 and 2007, respectively. We must pay a 0.25% commitmentfee on the average daily unused portion of the line of credit. At October 31,2008 and 2007, outstanding borrowings on the line of credit were none and$6,974,235, respectively. We have outstanding standby letters of credit of$400,000 at October 31, 2008, which expired in November 2008.

 

AgStar hasbeen granted a security interest in substantially all of the assets of HeronLake BioEnergy and its subsidiary, Lakefield Farmers Elevator, LLC. We alsoassigned to AgStar our interest in our agreements for the sale of ethanol anddistillers grains, and for the purchases of coal, corn and electricity, as wellas our design-build agreement with Fagen, Inc.  AgStar also received a mortgage relating toour real property and that of Lakefield Farmers Elevator.  Roland J. (Ron) Fagen personally guaranteesour obligations under the credit agreement with AgStar, up to a maximum of$3,740,000, through a personal guaranty. Mr. Fagen did not, and has not, received any consideration from usfor acting as guarantor.  Fagen, Inc.also guaranteed a portion of our indebtedness to AgStar, but this guarantee waseliminated effective October 1, 2007. The guaranty agreements specify certain events of 

 

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default, including: material breaches of representations andwarranties; failure to perform or comply with any covenant or agreement in theguaranty agreement; or the occurrence of an event of default under the masterloan agreement or other loan documents.

 

During theterm of the loans, we are subject to certain financial loan covenantsconsisting of minimum working capital, minimum debt coverage, and minimumtangible net worth. After the construction phase, we are only allowed to makeannual capital expenditures up to $500,000 annually without prior approval. Theloan agreements also impose restrictions on our ability to make cashdistributions to our members.

 

Upon anoccurrence of an event of default or an event that will lead to our default,AgStar may upon notice terminate its commitment to loan funds and declare theentire unpaid principal balance of the loans, plus accrued interest, immediatelydue and payable. An event of default includes, but is not limited to, ourfailure to make payments when due, insolvency, any material adverse change inour financial condition or our breach of any of the covenants, representationsor warranties we have given in connection with the transaction.

 

As of October 31,2008, we estimate the fair value of our credit arrangements with AgStar toapproximate the $60.7 million carrying value based on the variable interestrate debt. The fair value of the debt may fluctuate to the extent that interestrates are fixed and the current fair value rates are more or less than thefixed rate. While the debt markets have experienced significant volatilityrecently, our long-term debt with AgStar matures in October 2012 and we donot believe we are exposed to any unusual liquidity risks given the long-termnature of our debt. The market conditions for credit at the time of maturity ofour debt in 2012 will determine our ability to refinance our debt and the termsassociated with refinancing.

 

*OtherCredit Arrangements*

 

In addition to our primarycredit arrangement with AgStar, we have other material credit arrangements anddebt obligations.

 

In October 2003, weentered into an industrial water supply development and distribution agreementwith the City of Heron Lake, Jackson County, and Minnesota Soybean Processors.In consideration of this agreement, we and Minnesota Soybean Processors areallocated equally the debt service on $735,000 in water revenue bonds that wereissued by the City to support this project that mature in February 2019.The parties have agreed that prior to the scheduled expiration of theagreement, they will negotiate in good faith to replace the agreement with afurther agreement regarding the wells and related facilities. In May 2006,we entered into an industrial water supply treatment agreement with the City ofHeron Lake and Jackson County. Under this agreement, we pay monthlyinstallments over 24 months starting January 1, 2007 equal to one years’debt service on approximately $3.6 million in water revenue bonds, which willbe returned to us if any funds remain after final payment in full on the bondsand assuming we comply with all payment obligations under the agreement. As of October 31,2008, there was a total of $3.9 million in outstanding water revenue bonds andwe classify our obligations under these bonds as assessments payable. Theinterest rates on the bonds range from 0.50% to 8.73%.

 

In November 2007, weentered into a shared savings contract with Interstate Power and Light Company(“IPL”), our electrical service provider. Under the agreement, IPL is requiredto pay $1,850,000 to fund project costs for the purchase and installation ofelectrical equipment. In exchange, we are required to share a portion of theenergy savings with IPL that may be derived from the decreased energyconsumption from the new equipment. We are required to pay IPL approximately$30,000 for the first thirteen billing cycles, $140,000 at the end of thethirteenth billing cycle, and thereafter, approximately $30,000 for theremainder of the billing cycles. These amounts represent IPL’s portion of theshared savings. We also granted IPL a security interest in the electricalequipment to be installed on our site. The shared savings contract expires December 31,2012.

 

In connection with the sharedsavings contract, IPL deposited $1,710,000 of the $1,850,000 in an escrowaccount on our behalf and we received the remaining $140,000 as cash proceeds.The escrow account expires at the same time as the shared savings contract or atermination by IPL of the escrow arrangement, at which time any remaining fundswill be distributed to IPL. We earn interest at a rate of 4.2% on the fundsescrowed and we pay a rate of interest of 1.5% on the funds deposited intoescrow. Each month, a distribution from the escrow account is made to IPL topay its portion of the shared savings under the shared savings contract.

 

To fund the purchase of the distribution system and substation for theplant, we entered into a loan agreement with Federated Rural ElectricAssociation pursuant to which we borrowed $600,000 by a secured promissorynote. 

 

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Under the notewe are required to make monthly payments to Federated Rural ElectricAssociation of $6,250 consisting of principal and an annual fee of 1% beginningon October 10, 2009. In exchange for this loan, Federated Rural ElectricAssociation was granted a security interest in the distribution system and substation for the plant.

 

**ITEM7A.**              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

** **

NotApplicable to Smaller Reporting Companies

 

**ITEM8.**                       FINANCIAL STATEMENTS AND SUPPLEMENTARYDATA

** **

The following financialstatements are included in this Annual Report on Form 10-K beginning atthe “F” page noted:

 
| ** **                                                                                                                   | ** ** | **Page Reference** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|
|                                                                                                                         |       |                    |
| Report of Independent Registered Public  Accounting Firm                                                                     |       | F-1                     |
|                                                                                                                         |       |                    |
| Consolidated Balance Sheets as of  October 31, 2008 and 2007                                                            |       | F-2                     |
|                                                                                                                         |       |                    |
| Consolidated  Statements of Operations for the fiscal years ended October 31, 2008,  2007 and 2006                      |       | F-4                     |
|                                                                                                                         |       |                    |
| Consolidated  Statements of Changes in Members’ Equity for the fiscal years ended  October 31, 2008, 2007 and 2006 |       | F-5                     |
|                                                                                                                         |       |                    |
| Consolidated  Statements of Cash Flows for the fiscal years ended October 31, 2008,  2007 and 2006                      |       | F-6                     |
|                                                                                                                         |       |                    |
| Notes to  Consolidated Financial Statements                                                                                  |       | F-8                     |

** **

**ITEM9.**                       CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

** **

None.

 

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**ITEM9A.**              CONTROLS AND PROCEDURES

** **

**Evaluation**of Disclosure Controls and Procedures

 

TheSecurities and Exchange Commission defines the term “disclosure controls andprocedures” to mean a company’s controls and other procedures of an issuer thatare designed to ensure that information required to be disclosed in the reportsthat it files or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms. Disclosure controlsand procedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by an issuer in the reportsthat it files or submits under the Securities Exchange Act of 1934 isaccumulated and communicated to the issuer’s management, including its chiefexecutive and chief financial officers, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.  We maintain such a system of controls and procedures inan effort to ensure that all information which it is required to disclose inthe reports it files under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified under theSEC’s rules and forms and that information required to be disclosed isaccumulated and communicated to chief executive and chief financial officers toallow timely decisions regarding disclosure.

 

Our ChiefExecutive Officer, Robert J. Ferguson, and Interim Chief Financial Officer, BrettL. Frevert have evaluated our disclosure controls and procedures as of the end of the period coveredby this report. Based upon their review, they have concluded that thecorrective actions in place will alleviate the weaknesses and ensure controlsand procedures are effective.

 

**Changes in Internal Controls over FinancialReporting**

 

There havebeen no changes in internal control over financial reporting that occurredduring the most recently completed fiscal quarter covered by this report that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting except for the remediation of the internal controldeficiencies and improvements to the internal control environment as describedbelow.

 

This annual report does notinclude a report of management’s assessment regarding internal control overfinancial reporting or an attestation report of the company’s registered public accountingfirm due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.

 

In connection with the audit of our financialstatements for our fiscal year ended October 31, 2008, we have identifiedmaterial weaknesses in our internal control over financial reporting relatingto lack of segregation of duties, period-end closing procedures, and inadequatenumber of accounting department personnel. We have engaged and involved outsideconsultants with technical accounting expertise, as needed, to evaluate ourinternal control processes relating to these deficiencies and to recommendcorrective action or controls to mitigate those deficiencies.  We have begun implementing, and intend tofully implement, corrective actions that we believe will mitigate the materialweaknesses identified and described above. Further, we intend to develop procedures for the testing of the controlsimplemented through these corrective actions to determine if the materialweaknesses have been remediated.

 

**ITEM9B.**              OTHER INFORMATION

** **

None.

 

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**PART III**

** **

**ITEM10.**                DIRECTORS, EXECUTIVE OFFICERS AND CORPORATEGOVERNANCE

** **

Our board ofgovernors manages our business and affairs. Under our Member Control Agreement,the board of governors will consist of not less that seven nor more than elevengovernors. Currently, our board of governors consists of ten governors.

 

Under our Member ControlAgreement, a member and its affiliates holding nine percent or more of theunits outstanding are entitled to appoint one governor to the board for every9% of our units held. Project Viking, LLC, which holds 21.8% of our outstandingunits as of January 1, 2009, has appointed two governors under thisprovision: Brian D. Thome and David M. Reinhart. An appointed governor servesindefinitely at the pleasure of the member appointing him or her (so long assuch member and its affiliates continue to hold a sufficient number of units tomaintain the applicable appointment right) until a successor is appointed, oruntil the earlier death, resignation or removal of the appointed governor. Amember that is entitled to appoint one or more governors under the appointmentright provided in the Member Control Agreement and such member’s affiliates arenot entitled to vote for the election of governors by the members. Currently,Project Viking, LLC and its affiliates are not entitled to vote in the electionof governors.

 

All governors named below wereappointed as initial board members at the time of our formation in April 2001.In order to preserve continuity of governance and harmonious transition fromthe initial board, the initial board designated from among themselves threeclasses of governors to serve staggered terms so that members will electone-third (or as nearly as possible) of the non-appointed members of the boardof governors annually. At the Annual Meeting of Members held on March 29,2008 members first elected Robert J. Ferguson, David J. Woestehoff and TimothyO. Helgemoe to serve three year terms expiring at the Annual Meeting of Membersin 2011.

 

The names, ages, addresses,terms, expiration dates and certain biographical information regarding ourcurrent governors and executive officers are set forth below.

 
| **Name**             | ** ** | **Age** | ** ** | **Position**                                                            | ** ** | **Term  Expires/Appointed** |
|----------------------|------------|---------|------------|-------------------------------------------------------------------------|------------|-----------------------------|
|                 |       |    |       |                                                                    |       |                        |
| Doug  Schmitz        | ** ** | 45      |       | Governor,  Vice Chairman of the Board                                   |       | Term expires 2009           |
|                 |       |    |       |                                                                    |       |                        |
| Robert  J. Wolf      |       | 55      |       | Governor                                                                |       | Term expires 2009           |
|                 |       |    |       |                                                                    |       |                        |
| David  J. Bach       |       | 47      |       | Governor                                                                |       | Term expires 2009           |
|                 |       |    |       |                                                                    |       |                        |
| Michael  S. Kunerth  | ** ** | 40      |       | Governor,  Board Treasurer                                              |       | Term expires 2010           |
|                 |       |    |       |                                                                    |       |                        |
| Milton  J. McKeown   | ** ** | 62      |       | Governor                                                                |       | Term expires 2010           |
|                 |       |    |       |                                                                    |       |                        |
| Robert  J. Ferguson  |       | 59      |       | Governor,  Chairman of the Board, President and Chief Executive Officer |       | Term expires 2011           |
|                 |       |    |       |                                                                    |       |                        |
| David  J. Woestehoff |       | 38      |       | Governor,  Board Secretary                                              |       | Term expires 2011           |
|                 |       |    |       |                                                                    |       |                        |
| Timothy  O. Helgemoe |       | 42      |       | Governor                                                                |       | Term expires 2011           |
|                 |       |    |       |                                                                    |       |                        |
| David  M. Reinhart   |       | 59      |       | Governor                                                                |       | Appointed                   |
|                 |       |    |       |                                                                    |       |                        |
| Brian  D. Thome      |       | 35      |       | Governor                                                                |       | Appointed                   |
|                 |       |    |       |                                                                    |       |                        |
| Brett  L. Frevert    |       | 46      |       | Interim  Chief Financial Officer                                        |       |                        |

 

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*DougSchmitz*. Mr. Schmitz attended Willmar CommunityCollege in Willmar, Minnesota, and majored in Ag Business. Doug is a thirdgeneration farmer who has been farming with his brother since 1988. In additionto agriculture, Mr. Schmitz owns and operates Schmitz Grain, Inc.,which was purchased from his father in 1991. Schmitz Grain has three locationsin southwestern Minnesota and provides services to area farmers in grainmerchandising, custom drying, feed sales, seed sales and fertilizer andchemical application. He also currently serves on the board of twoprivately-held companies: Agri-Tech Systems, Inc. located in Las Vegas,Nevada, and United Ag Resources of Slayton, Minnesota.

 

*Robert J.Wolf*. Since 1994, Mr. Wolf has owned and operatedCounty Seed, Inc. He is currently a director of the Nobles County Corn &Soybean Association, and is a member of Minnesota Corn Growers Association andMinnesota Soybean Association. He is a Certified Crop Advisor and is a memberof Knights of Columbus. Mr. Wolf received an Associate of Arts Degree inAg Business from Worthington Community College in Worthington, Minnesota.

 

*David J.Bach*. Mr. Bach was raised on a family farm andhas been farming full-time since 2001. From 1987 to 2001, Mr. Bach wasemployed at Pillsbury/Green Giant in Le Sueur, Minnesota. During his time atPillsbury/Green Giant, Mr. Bach held primarily supervisory positions andwas most recently the Ag Research Station Coordinator. He graduated from theUniversity of Minnesota in St. Paul with a B.S. degree in Agronomy.

 

*Michael S.Kunerth*.  Mr. Kunerthhas operated a corn and soybean farm in Brewster, Minnesota since 1990. Since1992, Mr. Kunerth has also operated a retail seed service business. Since1994, Mr. Kunerth has also served as the Clerk of Graham Lakes Township.He holds a B.S. Degree in Business Management from St. John’s University,Collegeville, Minnesota.

 

*Milton J.McKeown*. From 1991 to his retirement in October 2006,Mr. McKeown managed the Heron Lake Insurance Agency. While he is currentlyretired, Mr. McKeown is active in community affairs. In addition toserving on our board of governors, Mr. McKeown is currently a board memberof the Southwest Minnesota Workforce Council. Mr. McKeown graduated fromDakota State University with a B.S. degree in Industrial Arts.

 

*Robert J.Ferguson*. Since 1972, Mr. Ferguson has farmednear Heron Lake, Minnesota. Mr. Ferguson is a Jackson County Commissionerand serves on the Jackson County Planning and Zoning board and the PrairielandEconomic Development board. In addition, Mr. Ferguson is a member of theChief Elected Officials board for the Private Industry Council and President ofHeron Lake Development Corporation. He is a member of the Jackson County Cornand Soybean Associations, and the Heron Lake /Okabena Community Club. Mr. Fergusonattended Worthington Community College to pursue his associate of arts degreein business administration but just after graduation was drafted by the U.S.Army to serve in the Vietnam War.

 

*David J.Woestehoff*. Mr. Woestehoff operates grain farmingoperations in Belle Plaine, Minnesota and Arlington, South Dakota. Mr. Woestehoffis also the founder and 50% owner of Brewery Hill Grain Company, which operates independent grain elevators inCleveland and Le Sueur, Minnesota.  Mr. Woestehoffalso serves on various committees at First Lutheran Church in Le Sueur,Minnesota. Mr. Woestehoff graduated from the University of Wisconsin in1990 with a B.S. degree in Agricultural Business and minors in Economics andAnimal Science.

 

*Timothy O.Helgemoe*. Mr. Helgemoe is a fifth generationfarmer who has been farming with his brother since 1993. In addition to raisingcorn, soybeans, and custom farming, Mr. Helgemoe has owned and operatedHelgemoe Bros, Inc., a local trucking business, since October 1999. Mr. Helgemoereceived his B.S. degree with an emphasis in dairy from the University ofMinnesota.

 

*David M.Reinhart*. Since 1975, Mr. Reinhart has operatedfamily-owned supermarkets in Guthrie Center, Panora, and Stuart, Iowa. Mr. Reinhartserves as a board member of four privately-held ethanol productioncompanies:  CORN, LP in Goldfield, Iowa;Big River Resources, LLC in West Burlington, Iowa; and Amaizing Energy inDenison, Iowa. Mr. Reinhart graduated from Iowa Central Community Collegewith an Associate’s Degree in Business and from the University of South Dakotawith a Bachelor of Science degree in Education.

 

*Brian D.Thome*. Since March 2007, Mr. Thome has ownedhis own business consulting firm. After serving on its board of directors frominception, Mr. Thome served as President of US BioEnergy Corporation from March 2006to March 2007. From December 2004 to March 2006, he served asthe Director of Financial Investments for Fagen, Inc. From January 1999to December 2004, he was employed with First National Bank of Omaha, servingas 

 

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Second VicePresident of Corporate Lending. Mr. Thome graduated from the University ofNebraska with a B.S. in Business Administration, with majors in finance andmarketing, and later completed his Executive MBA.

 

*Brett L.Frevert*. Brett L. Frevert began service as our InterimChief Financial Officer on November 25, 2008 through a letter agreementwith CFO Systems, LLC. Mr. Frevertfounded CFO Systems in late 2004. He has served as Managing Director of CFOSystems since its founding, as well as acting as a part-time CFO for severalcompanies. Prior to founding CFO Systems, Mr. Frevert was the Chief FinancialOfficer of Grubb & Ellis Pacific Realty Group from September 2002to October 2004. Mr. Frevert received his bachelors degree inbusiness from Wayne State College in 1985.

 

*Section 16(a) BeneficialOwnership Reporting Compliance*

 

Section 16(a) of the Exchange Act requiresour governors, officers and persons who own more than 10% of our units to filereports of ownership and changes in ownership in our units with the Securitiesand Exchange Commission, and to furnish us with copies of the reports. Based onour review of such reports, we believe that our governors, officers and ownersof 10% or more of our units timely filed all required Section 16(a) reportsduring our fiscal year ended October 31, 2008..

 

*Code of Ethics*

 

Our board has adopted a codeof ethics that applies to our officers and governors, including our chiefexecutive officer and chief financial officer, and a code of business conductand ethics that applies to our officers, governors and employees. Copies ofthese codes of ethics are available to members without charge by writing to usat 91246 390th Avenue, Heron Lake, MN  56137.

 

We intend to satisfy the disclosure requirements of the Securities and Exchange Commissionregarding certain amendments to, or waivers from, provisions of our code ofethics that apply to our principal executive officer, principal financialofficer, principal accounting officer or controller by posting such informationon our website at www.heronlakebioenergy.com.

 

For information regardingthe membership of, qualifications for service on, and function of eachcommittee of the board of governors, see Item 13.  “Certain Relationship and RelatedTransactions, and Director Independence.”

 

**ITEM11.**                EXECUTIVE COMPENSATION

** **

**Summary Compensation Table**

 

The following table showsinformation concerning compensation earned for services in all capacitiesduring fiscal years 2008, 2007 and 2006 for (i) Robert J. Ferguson, whoacted as our Chief Executive Officer in fiscal year 2007 and 2008; and (ii) JamesA. Gerber, who served as our Interim Chief Financial Officer in fiscal year2007 and 2008 until his resignation on November 25, 2008 (togetherreferred to as our “Named Executive Officers”). There were no other executiveofficers of our company in fiscal years 2008, 2007 or 2006.

 
| **Name and Principal Position** | ** ** | **Year** | ** ** | **Salary ($)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total ($)** | ** ** |
|------------------------------------------------|------------|----------|------------|---------------------|------------|---------------------------------------|------------|--------------------|------------|
| Robert J. Ferguson (1)                         |       | 2008     |       | $                   | 159,830    |                                  | —     |               | $          | 162,030 |   |
| Chief Executive Officer                        |       | 2007     |       | $                   | 20,571     |                                  | $          | 50,000             | (2)        | $ | 70,571 |   |
|                                           |       | 2006     |       | —              |       | $                                     | 50,000     | (2)                |       |   |
| James A. Gerber (3)                            |       | 2008     |       | —              |       | $                                     | 94,664     |               | $          | 94,664 |   |
| Interim Chief Financial Officer                |       | 2007     |       | —              |       | $                                     | 58,144     |               | $          | 58,144 |   |
|                                           |       | 2006     |       | —              |       | $                                     | 9,047      |               |       |   |

 

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(1)                                Salaryfor Mr. Ferguson represents amounts other than meeting fees and additionalfees for service as the board President paid to Mr. Ferguson in 2007. Foran explanation of compensation paid to

 

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                                                Mr. Fergusonin 2007 for his services as our governor and an officer of the board, pleasesee the section of this Item 11 entitled “Governor Compensation”.

 

(2)                                  Representscompensation paid in August 2006 and January 2007 to Mr. Fergusonfor oversight of the construction of our plant. See “Employment Arrangementswith Named Executive Officers” for a description of this arrangement.

 

(3)                                  Allother compensation for Mr. Gerber represents amounts we paid to Gerber &Haugen, PLLP, a public accounting firm of which Mr. Gerber is a partner.For fiscal year 2006 and for the period from November 1, 2006 to February 28,2007, amounts were for accounting services rendered by the firm to us. For theperiod from March 1, 2007 to October 31, 2008, amounts were for theservices of Mr. Gerber as our Interim Chief Financial Officer. See “EmploymentArrangements with Named Executive Officers and Post-Employment Compensation”for a description of the arrangements with Gerber & Haugen, PLLP.

 

**Employment Arrangements with Named ExecutiveOfficers and Post-Employment Compensation**

 

In December 2007, ourboard of governors formed and adopted a written charter for the CompensationCommittee, which has responsibility for compensation of our executive officers.Because the Compensation Committee was only recently formed, the arrangementsdescribed below with the Named Executive Officers were not approved by theCompensation Committee, but instead were approved by the board of governors(excluding Mr. Ferguson in the case of his own compensation). We expectthat future compensation agreements and arrangements with our executiveofficers will be reviewed and approved by the Compensation Committee.

 

Robert J. Ferguson has served as the President of our board since ourinception and, since September 1, 2007, has acted as our Chief ExecutiveOfficer through his position as board President. As an officer of the board, Mr. Fergusonreceived $27,000 in compensation in 2007 for that service in addition to thesame per meeting fees paid to other governors. The amounts for meeting fees andadditional fees for service as board President paid to Mr. Ferguson in2007 are included in the table set forth in the section of Item 6 of thisAnnual Report on Form 10-K entitled “Governor Compensation”.

 

In addition to compensation for his services as our governor and anofficer of the board, we also entered into an agreement with Mr. Fergusonunder which we would pay Mr. Ferguson a total of $100,000 for hisoversight of the construction of our plant. Under this agreement we paid Mr. Ferguson$50,000 in August 2006 and we paid $50,000 in January 2007. On September 1,2007, we hired Mr. Ferguson an employee to serve as our Chief ExecutiveOfficer and entered into an employment agreement with him. The amounts paid to Mr. Fergusonin 2007 for construction oversight and for his service as our Chief ExecutiveOfficer are included in the Summary Compensation Table set forth in Item 6 ofthis Annual Report on Form 10-K entitled “Executive Compensation.”

 

Mr. Ferguson serves as our Chief Executive Officer.  Until September 1, 2008, he served underan employment agreement and currently serves at the pleasure of the board as an“at will” employee.  Mr. Ferguson ispaid an annual base salary of $120,000 on a bi-weekly basis and is eligible toparticipate in any bonus to employees at the discretion of the board ofgovernors.

 

James A. Gerber has served as our Interim Chief Financial Officer sinceMarch 1, 2007 through a services agreement with Gerber & Haugen,PLLP, a public accounting firm. Mr. Gerber has been a partner with Gerber &Haugen, PLLP since 1989. In fiscal year 2006 and from November 1, 2006 to February 28,2007, Gerber & Haugen, PLLP provided accounting services to us forwhich we paid $9,047 and $24,811, respectively. Under the services agreementwith Gerber & Haugen, PLLP, we will pay a minimum of $50,000 for theperiod from March 1, 2007 to March 1, 2008 for Mr. Gerber’s servicesas our Interim Chief Financial Officer. In addition, we will pay Gerber &Haugen, PLLP $50.00 per hour for each hour of Mr. Gerber’s service inexcess of 1,000 hours in the period from March 2007 through February 2008.However, the total compensation under our agreement with Gerber &Haugen, PLLP is capped at $85,000. The services agreement was scheduled toterminate on March 1, 2008, but in February 2008, we extended thearrangement with Gerber & Haugen, PLLP for a minimum of 30 additionaldays. The parties continue to operate under this services agreement on anon-going basis. Mr. Gerber resigned as our Interim Chief Financial Officeron November 25, 2008.

 

Effective November 25, 2008, we entereda letter agreement with CFO Systems, LLC and Brett L. Frevert. Under the letteragreement, CFO Systems will provide financial and consulting services to us ata rate of $130 per 

 

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hour. The consultingservices will include providing day-to-day leadership and oversight for ourfinance department; CFO-level expertise in areas such as the annual audit, SECfilings, reports to members, lender reporting and tax filings; and strategicplanning, forecasting, and budgeting. The letter agreement contemplates aminimum of 500 hours of service and up to 800 hours of service. In connectionwith the letter agreement, Mr. Frevert agreed to serve as our InterimChief Financial Officer.

 

Our agreements with Messrs. Ferguson,Gerber and Frevert do not provide for severance or any other compensationfollowing termination of the employment or services.

 

**Governor Compensation**

 

Members of our board ofgovernors receive a per diem of $100 per half day and $200 per full day forattending meetings and carrying out duties on our behalf. Members of our boardof governors are also reimbursed for reasonable expenses included in carryingout their duties as governors, including mileage reimbursement for travel tomeetings.

 

In addition to per meetingfees, officer of the board receive additional compensation for their boardservice. Doug Schmitz served as the Vice President of the board and received anadditional $8,800 in 2008. Michael S. Kunerth served as the Treasurer of theboard and received an additional $4,300 in 2008. David J. Woestehoff served asSecretary of the board and received an additional $1,150 in 2008.

 

Robert J. Ferguson has servedas the President of our board since our inception, and until September 1,2007, acted as our Chief Executive Officer through his position as boardPresident. On September 1, 2007, we hired Mr. Ferguson an employee toserve as our Chief Executive Officer. In addition to compensation for hisservices as our governor and an officer of the board, we also paid Mr. Ferguson$50,000 on January 12, 2007 and $20,571 on November 20, 2007 inrespect of his service as our Chief Executive Officer. The amounts other thanmeeting fees and additional fees for service as the board President paid to Mr. Fergusonin 2008 are included in the Summary Compensation Table set forth in Item 11 ofthis Annual Report on Form 10-K entitled “Executive Compensation”.

 

The following table shows forfiscal year 2008, the other compensation paid by us to each of our governors:

 
| **Name**             | ** ** | **Fees Earned or Paid in  Cash ($) (1)** | ** ** |
|----------------------|------------|------------------------------------------------------------------------|------------|
| Robert J. Ferguson   |       | $                                                                      | 2,200      |   |
| Doug Schmitz         |       | $                                                                      | 11,000     |   |
| Michael S. Kunerth   |       | $                                                                      | 7,050      |   |
| David J. Woestehoff  |       | $                                                                      | 2,950      |   |
| David J. Bach        |       | $                                                                      | 2,800      |   |
| Timothy O. Helgemoe  |       | $                                                                      | 2,200      |   |
| Milton J. McKeown    |       | $                                                                      | 3,200      |   |
| Robert J. Wolf       |       | $                                                                      | 3,100      |   |
| David M. Reinhart    |       | $                                                                      | 2,000      |   |
| Fagen, Inc. (2) |       | $                                                                      | 600        |   |

 

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(1)          Represents cash retainerand meeting fees for fiscal year 2008 as described above and total compensationto each governor.

 

(2)          Represents amounts paid to Fagen, Inc.in respect of the services of Brian D. Thome who is separately compensated byFagen, Inc. for his service on our board.

 

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** **

**ITEM12.**                      SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

** **

The following table sets forthcertain information as of January 1, 2009 with respect to our unitsbeneficially owned by (i) each governor, (ii) each person known to usto beneficially own more than 5% percent of our units, (iii) eachexecutive officer named in the Summary Compensation Table (the “Named ExecutiveOfficers”), and (iv) all current executive officers and governors as agroup. The beneficial ownership percentages are based on 27,104,625 unitsissued and outstanding as of January 1, 2009.

 

Under our Member ControlAgreement, any member who, together with such member’s affiliates, holds 9% ormore of the units outstanding is entitled to appoint one governor to the boardfor every 9% of units held. Project Viking, LLC has appointed two governorsunder this provision: Brian D. Thome and David M. Reinhart. An appointedgovernor serves indefinitely at the pleasure of the member appointing him orher (so long as such member and its affiliates continue to hold a sufficientnumber of units to maintain the applicable appointment right) until a successoris appointed, or until the earlier death, resignation or removal of theappointed governor.

 

In determining the voting powerpresent for the purpose of the election of governors, units held by members whoare entitled to appoint one or more governors under the Member ControlAgreement and such members’ affiliates will not be considered, and members whoare entitled to appoint one or more governors under the Member ControlAgreement and such member’s affiliates are not entitled to vote for theelection of governors. Therefore, Project Viking, LLC and its affiliates arenot entitled to vote for the election of governors.

 

Unless otherwise indicated andsubject to community property laws where applicable, each unit holder named inthe table below has sole voting and investment power with respect to the units shownopposite such unit holder’s name. Each holder may be reached at our offices inHeron Lake, Minnesota.

 
| ** **                                                            | ** ** | **Units Beneficially Owned** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|
| **Name**                                                              | ** ** | **Number**                             | ** ** | **Percent** | ** ** |
|                                                                  |       |                                   |       |   |   |
| **Holders of More Than 5% of Units**                                  | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Project Viking, LLC (1)                                               |       | 5,902,500                              |       | 21.8 | % |
|                                                                  |       |                                   |       |   |   |
| **Governors and Officers**                                            |       |                                   |       |   |   |
|                                                                  |       |                                   |       |   |   |
| Robert J. Ferguson (2)(3)(4)                                          |       | 147,250                                |       | * |   |
|                                                                  |       |                                   |       |   |   |
| **Name**                                                              | ** ** | **Number**                             | ** ** | **Percent** | ** ** |
|                                                                  |       |                                   |       |   |   |
| Doug Schmitz (2)(5)                                                   |       | 208,000                                |       | * |   |
| Michael S. Kunerth (2)(6)                                             |       | 126,000                                |       | * |   |
| David J. Woestehoff (2)(7)                                            |       | 320,625                                |       | 1.2 | % |
| David J. Bach (2)(8)                                                  |       | 101,750                                |       | * |   |
| Timothy O. Helgemoe (2)(9)                                            |       | 61,500                                 |       | * |   |
| Milton J. McKeown (2)(10)                                             |       | 87,000                                 |       | * |   |
| Robert J. Wolf (2)(11)                                                |       | 66,000                                 |       | * |   |
| David M. Reinhart (2)(12)                                             |       | —                                 |       | * |   |
| Brian D. Thome (2)(12)                                                |       | —                                 |       | * |   |
| James A. Gerber (3)(13)                                               |       | —                                 |       | * |   |
| All current executive officers and  governors as a group (11 persons) |       | 1,097,125                              |       | 4.0 |   |

 

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* Indicates ownership of less than 1%.

 

(1)                      Project Viking, LLC is owned byRoland J. (Ron) Fagen and Diane Fagen, the principal shareholders of Fagen, Inc.Our ethanol plant was design-built by Fagen, Inc.

 

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(2)                      Serves as a governor

 

(3)                      Named Executive Officer

 

(4)                      Includes 126,250 units ownedjointly by Mr. Ferguson and his spouse and 21,000 owned by a son whoresides with Mr. Ferguson.

 

(5)                      Includes 25,000 units owned by Doug Schmitz, 10,500 units owned by Mr. Schmitz and his spouse, 25,000 unitsowned by Mr. Schmitz’s spouse, and 147,500 units owned by SchmitzGrain Inc., which is controlled by Doug Schmitz.

 

(6)                      Includes 63,000 units owned byMichael Kunerth and his spouse, Dawn Kunerth, as trustees of the MichaelKunerth Trust under agreement dated July 18, 2006, and 63,000 units ownedby Dawn Kunerth and Michael Kunerth astrustees of the Dawn Kunerth Trust under agreement dated July 18, 2006.

 

(7)                      All units are owned jointly by Mr. Woestehoffand his spouse.

 

(8)                      All units are owned jointly by Mr. Bachand his spouse.

 

(9)                      Includes 15,000 units owned by Mr. Helgemoe’s spouse, 25,000 unitsowned jointly by Mr. Helgemoe and his spouse, and 21,500 units ownedjointly by Mr. Helgemoe’s spouse and Mr. Helgemoe’s brother.

 

(10)                All units are owned jointly by Mr. McKeownand his spouse.

 

(11)                All units are owned jointly by Mr. Wolfand his spouse.

 

(12)                Appointed as a governor by ProjectViking, LLC.

 

(13)                Mr. Gerber resigned as our InterimChief Financial Officer on November 25, 2008.

 

**ITEM 13.****                                    CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND****DIRECTOR INDEPENDENCE**

** **

**Transactions in Fiscal Year 2008**

 

Since the beginning of fiscalyear 2008, we have not entered into any transaction and there are no currentlyproposed transactions, in which we were or are to be a participant and theamount involved exceeds $120,000, and in which any related person had or willhave a direct or indirect material interest, except as described in “Item 11.Executive Compensation” of this Form 10-K or as described below.

 

*CornTransactions*. In the ordinary course of business, weregularly enter into transactions to buy grain. From time to time, we may buygrain from related persons on the same basis as we buy grain from un-relatedparties. During fiscal years 2008, we purchased approximately $0.5 million ingrain from Robert J. Ferguson, approximately $1.5 in grain from Brewery Hill Grain Company andapproximately $0.8 million in grain from David J. Woestehoff, and approximately$11.5 million in grain from Schmitz Grain, Inc. Robert J. Ferguson is ourgovernor and our Chief Executive Officer. Brewery Hill Grain Company is 50% owned by David J. Woestehoff, ourgovernor.  Schmitz Grain, Inc. iscontrolled by Doug Schmitz, our governor.

* *

*Design-BuildAgreement & Environmental Agreements with Fagen*.From October 2005 to September 2007,we paid Fagen, Inc. $77.5 million under the design-buildagreement for our plant entered into in October 2005.  We haveretained approximately $3.8 million in payments to Fagen, Inc.under the design-build agreement.  Final payment will be due whenfinal completion of construction is achieved and the operation of our plantsatisfies the air emissions warranties specified in the design-build agreementwith Fagen, Inc. In fiscal year 2008, we have not entered into anyagreements with Fagen, Inc. or its affiliates except for a March 2008agreement with Fagen Engineering, LLC for environmental compliance trainingprograms for $3,100.

 

**Process for Review, Approval or Ratification of Transactions withRelated Persons**

 

The charter of our AuditCommittee provides that the Audit Committee is responsible for reviewing andapproving the terms and conditions of all transactions we enter into in whichan officer, governor or any member holding greater than 5% or any affiliate ofthese persons has a direct or indirect material interest. Our Code of BusinessConduct and Ethics, which is applicable to all of our employees and governors,also prohibits our 

 

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employees,including our executive officers, and our governors from engaging in conflictof interest transactions. Requests for waivers by our executive officers andgovernors from the provisions of, or requests for consents by our executiveofficers and governors under, our Code of Business Conduct and Ethics must bemade to the Audit Committee.

 

In addition, in December 2007,we adopted a formal related person transaction approval policy, which setsforth our policies and procedures for the review, approval or ratification ofany transaction required to be reported in our filings with the Securities andExchange Commission. Our policy applies to any financial transaction,arrangement or relationship or any series of similar transactions, arrangementsor relationships in which our company is a participant and in which a relatedperson has a direct or indirect interest. Through the policy, the AuditCommittee has also identified and pre-approved certain transactions withrelated persons, including:

 

·                  employment andcompensation of our executive officers or governor compensation, if required tobe reported in under the disclosure requirements of the Securities and ExchangeCommission,

 

·                  payment ofordinary expenses and businessreimbursements;

 

·                  transactionswith related companies in which the dollar amount does not exceed $100,000 or2% of the other company’s total revenues;

 

·                  transactionswith another company controlled by a related party or with a related party forthe purchase by us of corn where (A) the amount of corn sold in thetransaction does not exceed 200,000 bushels; (B) the contract for deliveryof the corn specifies a delivery date of not more than sixty (60) days from thedate of the contract; (C) the price per bushel is fixed at the time of thecontract; and (D) the amount paid per bushel or other material terms ofthe transaction are based on consideration or criteria generally applicable toother sellers of corn of a like quality and quantity, given the conditions ofthe grain markets at the time of sale;

 

·                  charitablecontributions in which the dollar amount does not exceed $10,000 or 2% of thecharitable organization’s receipts;

 

·                  payments madeunder our articles of organization, member control agreement, insurancepolicies or other agreements relating to indemnification;

 

·                  transactions inwhich our members receive proportional benefits; and

 

·                  transactionsthat involve competitive bids, banking transactions and transactions underwhich the terms are regulated by law or governmental authority.

 

The Audit Committee mustapprove any related person transaction subject to this policy beforecommencement of the related party transaction. If pre-approval is not feasible,the Audit Committee may ratify, amend or terminate the related persontransaction. The Audit Committee will analyze the following factors, inaddition to any other factors the Committee deems appropriate, in determiningwhether to approve a related party transaction:

 

·                  whether theterms are fair to us;

 

·                  whether theterms of the related party transaction are no less favorable than termsgenerally available to an unaffiliated third-party under the same or similarcircumstances;

 

·                  whether therelated party transaction is material to us;

 

·                  the role therelated party has played in arranging the transaction;

 

·                  the structure ofthe related party transaction;

 

·                  the interests ofall related parties in the transaction;

 

·                  the extent ofthe related party’s interest in the transaction; and

 

·                  whether thetransaction would require a waiver of our Code of Business Conduct and Ethics.

 

The Audit Committee may, in itssole discretion, approve or deny any related person transaction. Approval of arelated person transaction may be conditioned upon our company and the relatedperson taking such precautionary actions as the Audit Committees deemsappropriate.

 

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**Committees of the Board of Governors**

 

Our board has established fiveseparate standing committees: the Audit Committee, the Compensation Committee,the Nomination and Governance Committee, the Marketing and Risk ManagementCommittee, and the Finance and Planning Committee. In December 2007, ourboard of governors adopted written charters for the Audit Committee, theCompensation Committee, and the Nomination and Governance Committee. Thecomposition and function of these committees are set forth below.

 

*CompensationCommittee*. Currently, the Compensation Committeeconsists of three governors: Michael S. Kunerth (chair), Brian D. Thome, andDavid M. Reinhart. The Compensation Committee oversees our compensation andemployee benefit plans and practices, including our executive compensationplans, governor compensation plans and incentive compensation and equity-basedplans. The charter of the Compensation Committee requires that this committeeconsist of no fewer than two members. A majority of members of the CompensationCommittee must satisfy the independence requirements of the Nasdaq MarketplaceRules, Section 16b-3 of the Exchange Act (if Section 16 is applicableto us), and Section 162(m) of the Internal Revenue Code of 1986. Eachmember of our Compensation Committee meets these requirements.

 

*Nominationand Governance Committee*. Currently, the Nominationand Governance Committee consists of three governors:  Robert J. Wolf (chair), Milton J. McKeown andDoug Schmitz. The Nomination and Governance Committee’s responsibilitiesinclude (1) identifying and recommending to the board individualsqualified to serve as governors and on committees of the board, (2) advisingthe governors with respect to the board’s composition, procedures and committees,(3) developing and recommending to the board a set of corporate governanceprinciples and (4) overseeing the evaluation of the board and the boardcommittees. The charter of the Nomination and Governance Committee must consistof at least two members, a majority of whom must satisfy the independencerequirements of the Nasdaq Marketplace Rules.  Mr. Wolf and Mr. McKeown of our Nomination and Governancecommittee meet these requirements.  Mr. Schmitzis not independent because he each sold a significant amount of grain to us infiscal year 2008, individually or through affiliated entities

 

*AuditCommittee*. Currently, the Audit Committee consists ofsix governors: Michael S. Kunerth (chair), David M. Reinhart, Robert J.Wolf, David J. Bach, Milton J. McKeown, and Brian D. Thome. The Audit Committeeassists the board in fulfilling its oversight responsibility for (1) theintegrity of our financial statements and financial reporting process and oursystems of internal accounting and financial controls, (2) the performanceof our internal audit function, (3) the annual independent integratedaudit of our consolidated financial statements and internal control overfinancial reporting and (4) our compliance with legal and regulatoryrequirements, including our disclosure controls and procedures. The duties andresponsibilities of the Audit Committee include the engagement of ourindependent registered public accounting firm and the evaluation of ouraccounting firm’s qualifications, independence and performance. The charter ofthe Audit Committee requires that the Audit Committee be comprised of threemembers, a majority of whom must be “independent” under the Nasdaq MarketplaceRules. A majority of the members must also be non-executive governors, freefrom any relationship that would interfere with the exercise of independentjudgment and “independent” as defined by the applicable rules andregulations of the Securities and Exchange Commission. Moreover, all members ofthe committee must have a basic understanding of finance and accounting and beable to read and understand fundamental financial statements, and at least onemember of the committee must have accounting or related financial managementexpertise. The board of governors determined that the membership of the AuditCommittee meets the requirements of its charter

 

In January 2009, the board ofgovernors reviewed the qualifications of each member of the AuditCommittee for the purpose of determining whether any governor serving on theAudit Committee would qualify as an “audit committee financial expert” as thatterm is defined under the rules of the Securities and ExchangeCommission.  Based upon that review, it was determined thatMr. Thome qualifies as an audit committee financial expert.

 

*Marketing andRisk Management Committee*. Currently, the Marketingand Risk Management Committee consists of four governors: Doug Schmitz (chair),David J. Woestehoff, Timothy O. Helgemoe, and David M. Reinhart. The Marketingand Risk Management Committee assists the board and our management to, amongother things, enhance our profitability and manage commodity price risk, byestablishing appropriate policies and strategies for grain procurement,marketing of ethanol and distillers’ grains, and managing enterprise risk.

 

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*Finance andPlanning Committee*. Currently, the Finance andPlanning Committee consists of three governors: Michael S. Kunerth, David M.Reinhart and Brian D. Thome. The Finance and Planning Committee assists theboard and our management by (1) establishing effective financialmanagement of our company and our subsidiaries, (2) establishingappropriate capital and operating budgets and financial forecasts and (3) evaluatingmatters relating to potential mergers, acquisitions or dispositions of assets.

 

**Board Independence**

 

The board of governorsundertook a review of governor independence in January 2009 as to all tengovernors then serving. As part of that process, the board reviewed alltransactions and relationships between each governor (or any member of hisimmediate family) and Heron Lake BioEnergy, its executive officers and itsauditors, and other matters bearing on the independence of governors. Inparticular, the board reviewed corn transactions by governors or theiraffiliates in relationship to the governor’s ability to exercise independentjudgment, as well as the rights of Project Viking, LLC to appoint governors.

 

Although our units are notlisted on any stock exchange, the board of governors is required to select andapply the independence standards of a stock exchange. For the purposes ofdetermining the independence of our governors and committee members, the boardof governors selected the Nasdaq Marketplace Rules. This is also the definitionused for “independence” for the purposes of determining eligibility ofgovernors to serve on committees.

 

As a result of its review, theboard of governors affirmatively determined that Timothy O. Helgemoe, Robert J.Wolf, David J. Bach, Michael S. Kunerth, Milton J. McKeown, and Brian D. Thomeare independent according to the “independence” definition of the NasdaqMarketplace Rules.

 

Robert J. Ferguson is not “independent”under the Nasdaq Marketplace Rules because he served as our ChiefExecutive Officer in fiscal year 2008, and sold a significant amount of grainto us in our fiscal year 2008 and in the current fiscal year.  Messrs. Woestehoff and Schmitz are alsonot independent because they each sold a significant amount of grain to us infiscal year 2008, individually or through affiliated entities. Mr. Reinhartis not independent because he is the brother of Diane Fagen, a principalshareholder in Fagen, Inc.   We havesignificant transactions with Fagen, Inc as described herein. The charters ofthe Audit Committee, Compensation Committee, and Nomination and GovernanceCommittee also established separate criteria for eligibility to serve as amember of those committees, which are discussed above.

 

**ITEM14.**                      PRINCIPAL ACCOUNTANT FEES AND SERVICES

** **

**Explanation of Fees**

 

The following is an explanationof the fees billed to us by Boulay, Heutmaker, Zibell & Co.P.L.L.P. for professional services rendered for the fiscal years ended October 31,2008 and October 31, 2007, which totaled $223,581 and $154,146,respectively.

 

*Audit Fees*.The aggregate fees billed to us for professional services related to the auditof our annual financial statements, review of financial statements included inour reports with the Securities and Exchange Commission, or other servicesnormally provided by Boulay, Heutmaker,Zibell & Co. P.L.L.P. in connection with statutory andregulatory filings or engagements for the fiscal years ended October 31,2008 and October 31, 2007 totaled $214,326 and $144,497, respectively.

 

*Audit-RelatedFees*. There were no fees billed to us for professionalservices for assurance and related services by Boulay, Heutmaker, Zibell & Co. P.L.L.P. that werereasonably related to the performance of the audit or review of our financialstatements and were not reported above under “Audit Fees” for the fiscal yearsended October 31, 2008 and October 31, 2007, respectively.

 

*Tax Fees.*The aggregate fees billed to us by Boulay,Heutmaker, Zibell & Co. P.L.L.P. for professional servicesrelated to tax compliance, tax advice, and tax planning for the fiscal yearended October 31, 2008 and October 31, 2007 totaled $9,255 and$9,649, respectively.

 

*All OtherFees*. For the fiscal year ended October 31, 2008and October 31, 2007, there were no fees billed to us by Boulay, Heutmaker, Zibell & Co.P.L.L.P. for professional services or products not previously disclosed.

 

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**Audit Committee Pre-Approval Policies**

 

We haveadopted pre-approval policies and procedures for the Audit Committee thatrequire the Audit Committee to pre-approve all audit and all permittednon-audit engagements and services (including the fees and terms thereof) bythe independent auditors, except that the Audit Committee may delegate theauthority to pre-approve any engagement or service less than $10,000 to one ofits members, but requires that the member report such pre-approval at the nextfull Audit Committee meeting. The Audit Committee may not delegate itspre-approval authority for any services rendered by our independent auditorsrelating to internal controls. These pre-approval policies and proceduresprohibit delegation of the Audit Committee’s responsibilities to ourmanagement. Under the policies and procedures, the Audit Committee maypre-approve specifically described categories of services which are expected tobe conducted over the subsequent twelve months on its own volition, or uponapplication by management or the independent auditor.

 

All of theservices described above for fiscal year 2008 were pre-approved by the AuditCommittee or a member of the committee before Boulay, Heutmaker, Zibell &Co. P.L.L.P. was engaged to render the services.

 

**PART IV**

** **

**ITEM15.**                      EXHIBITS AND FINANCIAL STATEMENTSSCHEDULES

** **

(a)                                  Financial Statements

 
| ** **                                                                                                                   | ** ** | **Page Reference** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                   | ** ** | ** **              | ** ** |
| Audited Financial Statements                                                                                                 |       |                    |       |
|                                                                                                                         |       |                    |       |
| Report of  Independent Registered Public Accounting Firm                                                                     |       | F-1                     |       |
|                                                                                                                         |       |                    |       |
| Consolidated Balance Sheets as of October 31, 2008 and 2007                                                             |       | F-2                     |       |
|                                                                                                                         |       |                    |       |
| Consolidated Statements of Operations for  the fiscal years ended October 31, 2008, 2007 and 2006                       |       | F-4                     |       |
|                                                                                                                         |       |                    |       |
| Consolidated Statements of Changes in  Members’ Equity for the fiscal years ended October 31, 2008, 2007 and  2006 |       | F-5                     |       |
|                                                                                                                         |       |                    |       |
| Consolidated  Statements of Cash Flows for the fiscal years ended October 31, 2008,  2007 and 2006                      |       | F-6                     |       |
|                                                                                                                         |       |                    |       |
| Notes to  Consolidated Financial Statements                                                                                  |       | F-8                     |       |

 

(b)                                 Exhibits

 

See“Exhibit Index” on the page following the Signature Page.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
| Dated:  January 28, 2009 |       |                                         |
|-----------------------------------------|------------|----------------------------------------------|
|                                    |       |                                         |
|                                    | ** ** | **HERON LAKE BIOENERGY, LLC**                |
|                                    |       |                                         |
|                                    |       |                                         |
|                                    |       | By:                                          | /s/  Robert J. Ferguson |
|                                    |       | Robert  J. Ferguson, Chief Executive Officer |
|                                    |       | (principal executive officer)                |

 

Each personwhose signature appears below hereby constitutes and appoints Robert J.Ferguson  and Brett L. Frevert, and eachof them, as his true and lawful attorney-in-fact and agent, with full power ofsubstitution, to sign on his behalf, individually and in each capacity stated below,all amendments to this Form 10-K and to file the same, with all exhibitsthereto and any other documents in connection therewith, with the Securitiesand Exchange Commission, granting unto said attorneys-in-fact and agents fullpower and authority to do and perform each and every act and thing requisiteand necessary to be done in and about the premises, as fully and to all intentsand purposes as each might or could do in person, hereby ratifying andconfirming each act that said attorneys-in-fact and agents may lawfully do orcause to be done by virtue thereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below on behalf of the registrant by the followingpersons in the capacities indicated on January 28, 2009.

 
| /s/ Robert J. Ferguson  |   | Chief Executive Officer and President      |
|-------------------------|--------|--------------------------------------------|
| Robert J. Ferguson      |   | (principal executive officer), Governor    |
|                    |   |                                       |
| /s/ Brett L. Frevert    |   | Interim Chief Financial Officer (principal |
| Brett L. Frevert        |   | financial and accounting officer)          |
|                    |   |                                       |
| /s/ Doug Schmitz        |   | Governor                                   |
| Doug Schmitz            |   |                                       |
|                    |   |                                       |
| /s/ Michael S. Kunerth  |   | Governor                                   |
| Michael S. Kunerth      |   |                                       |
|                    |   |                                       |
| /s/ David J. Woestehoff |   | Governor                                   |
| David J. Woestehoff     |   |                                       |
|                    |   |                                       |
| /s/ David J. Bach       |   | Governor                                   |
| David J. Bach           |   |                                       |
|                    |   |                                       |
| /s/ Timothy O. Helgemoe |   | Governor                                   |
| Timothy O. Helgemoe     |   |                                       |
|                    |   |                                       |
| /s/ Milton J. McKeown   |   | Governor                                   |
| Milton J. McKeown       |   |                                       |
|                    |   |                                       |
| /s/ David M. Reinhart   |   | Governor                                   |
| David M. Reinhart       |   |                                       |
|                    |   |                                       |
| /s/ Brian D. Thome      |   | Governor                                   |
| Brian D. Thome          |   |                                       |
|                    |   |                                       |
| /s/ Robert J. Wolf      |   | Governor                                   |
| Robert J. Wolf          |   |                                       |

 

49

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REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Governors

Heron Lake BioEnergy, LLC and Subsidiary

Heron Lake, Minnesota

 

We have audited the accompanying consolidated balance sheets of HeronLake BioEnergy, LLC and Subsidiary as of October 31, 2008 and 2007, andthe related consolidated statements of operations, changes in members’ equity,and cash flows for each of the fiscal years in the three-year period ended October 31,2008.  Heron Lake BioEnergy, LLC andSubsidiary’s management is responsible for these financial statements. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. The company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of Heron LakeBioEnergy, LLC and Subsidiary as of October 31, 2008 and 2007, and theresults of its operations and its cash flows for each of the fiscal years inthe three-year period ended October 31, 2008 in conformity with accountingprinciples generally accepted in the United States of America.

 

 
|   | /s/ Boulay, Heutmaker, Zibell & Co. P.L.L.P. |
|--------|-------------------------------------------------------|
|   |                                                  |
|   | Certified Public Accountants                          |

Minneapolis, Minnesota

January 29, 2009

 

F-1

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

ConsolidatedBalance Sheets

 
| ** **                      | ** ** | **October 31, 2008** | ** **  | **October 31, 2007** | ** ** |
|---------------------------------|------------|--------------------------------|-------------|--------------------------------|------------|
|                            |       |                           |        |                           |       |
| **ASSETS**                      |       |                           |        |                           |       |
| **Current Assets**              |       |                           |        |                           |       |
| Cash and equivalents            |       | $                              | 11,355,075  |                           | $          | 3,090,329 |   |
| Restricted cash                 |       | 1,499,472                      |        | 221,350                        |       |
| Accounts receivable             |       | 3,368,076                      |        | 1,954,126                      |       |
| Inventory                       |       | 9,633,749                      |        | 18,991,390                     |       |
| Derivative instruments          |       | 750,172                        |        | —                         |       |
| Prepaid expenses                |       | 616,641                        |        | 124,858                        |       |
| Total current assets            |       | 27,223,185                     |        | 24,382,053                     |       |
|                            |       |                           |        |                           |       |
| **Property and Equipment**      |       |                           |        |                           |       |
| Land and improvements           |       | 12,552,721                     |        | 12,283,575                     |       |
| Plant buildings and equipment   |       | 97,159,759                     |        | 96,859,303                     |       |
| Vehicles and other equipment    |       | 597,921                        |        | 661,272                        |       |
| Office buildings and equipment  |       | 597,508                        |        | 566,928                        |       |
|                            |       | 110,907,909                    |        | 110,371,078                    |       |
| Accumulated depreciation        |       | (7,025,870                     | )           | (1,518,157                     | )          |
|                            |       | 103,882,039                    |        | 108,852,921                    |       |
|                            |       |                           |        |                           |       |
| **Other Assets**                |       |                           |        |                           |       |
| Deferred loan costs, net        |       | 467,128                        |        | 572,234                        |       |
| Restricted cash                 |       | 995,804                        |        | —                         |       |
| Other intangibles               |       | 464,304                        |        | —                         |       |
| Debt service deposits and other |       | 368,350                        |        | 152,750                        |       |
| Total other assets              |       | 2,295,586                      |        | 724,984                        |       |
|                            |       |                           |        |                           |       |
| **Total Assets**                |       | $                              | 133,400,810 |                           | $          | 133,959,958 |   |

 

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

F-2

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Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Consolidated Balance Sheets

 
| ** **                                                             | ** ** | **October 31, 2008** | ** **  | **October 31, 2007** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------|-------------|--------------------------------|------------|
|                                                                   |       |                           |        |                           |       |
| **LIABILITIES AND MEMBERS’ EQUITY**                               |       |                           |        |                           |       |
| **Current Liabilities**                                                |       |                           |        |                           |       |
| Checks written in excess of bank balance                               |       | $                              | —      |                           | $          | 514,633 |   |
| Line of credit                                                         |       | —                         |        | 6,974,235                      |       |
| Note payable - related party                                           |       | —                         |        | 4,202,930                      |       |
| Current maturities of long-term debt                                   |       | 5,649,354                      |        | 2,747,061                      |       |
| Accounts payable:                                                      |       |                           |        |                           |       |
| Trade accounts payable                                                 |       | 5,635,204                      |        | 8,610,097                      |       |
| Trade accounts payable - related party                                 |       | 792,450                        |        | 1,435,520                      |       |
| Construction payable                                                   |       | —                         |        | 349,042                        |       |
| Construction payable - related party                                   |       | 3,839,413                      |        | 3,839,413                      |       |
| Accrued expenses                                                       |       | 512,709                        |        | 853,750                        |       |
| Lower of cost or market adjustment                                     |       | 7,122,966                      |        | —                         |       |
| Derivative instruments                                                 |       | —                         |        | 186,237                        |       |
| Total current liabilities                                              |       | 23,552,096                     |        | 29,712,918                     |       |
|                                                                   |       |                           |        |                           |       |
| **Long-Term Debt,**net  of current maturities                          |       | 59,265,534                     |        | 62,281,899                     |       |
|                                                                   |       |                           |        |                           |       |
| **Commitments and Contingencies**                                      |       |                           |        |                           |       |
|                                                                   |       |                           |        |                           |       |
| **Members’ Equity****,**27,104,625 Class A units outstanding |       | 50,583,180                     |        | 41,965,141                     |       |
|                                                                   |       |                           |        |                           |       |
| **Total Liabilities and Members’ Equity**                         |       | $                              | 133,400,810 |                           | $          | 133,959,958 |   |

 

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

 Consolidated Statements of Operations

 
| ** **                                                  | ** ** | **Year Ended**            | ** **  | **Year Ended**            | ** ** | **Year Ended**            | ** ** |
|-------------------------------------------------------------|------------|--------------------------------|-------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                  | ** ** | **October 31, 2008** | ** **  | **October 31, 2007** | ** ** | **October 31, 2006** | ** ** |
|                                                        |       |                           |        |                           |       |                           |       |
| **Revenues**                                                |       | $                              | 131,070,642 |                           | $          | 23,560,498                     |       | $ | 10,111,931 |   |
|                                                        |       |                           |        |                           |       |                           |       |
| **Cost of Goods Sold**                                      |       |                           |        |                           |       |                           |       |
| Cost of goods sold                                          |       | 105,660,541                    |        | 24,313,695                     |       | 9,818,395                      |       |
| Lower of cost or market adjustment                          |       | 8,751,000                      |        | —                         |       |                           |       |
| **Total Cost of Goods Sold**                                |       | 114,411,541                    |        | 24,313,695                     |       | 9,818,395                      |       |
|                                                        |       |                           |        |                           |       |                           |       |
| **Gross Profit**                                            |       | 16,659,101                     |        | (753,197                       | )          | 293,536                        |       |
|                                                        |       |                           |        |                           |       |                           |       |
| **Operating Expenses**                                      |       | 3,351,252                      |        | 3,527,199                      |       | 1,965,342                      |       |
|                                                        |       |                           |        |                           |       |                           |       |
| **Operating Income (Loss)**                                 |       | 13,307,849                     |        | (4,280,396                     | )          | (1,671,806                     | )          |
|                                                        |       |                           |        |                           |       |                           |       |
| **Other Income (Expense)**                                  |       |                           |        |                           |       |                           |       |
| Interest income                                             |       | 84,078                         |        | 9,166                          |       | 994,660                        |       |
| Interest expense                                            |       | (4,807,965                     | )           | (1,181,442                     | )          | (76,695                        | )          |
| Other income                                                |       | 34,077                         |        | 4,386                          |       | 112,696                        |       |
| **Total other income (expense), net**                       |       | (4,689,810                     | )           | (1,167,890                     | )          | 1,030,661                      |       |
|                                                        |       |                           |        |                           |       |                           |       |
| **Net Income (Loss)**                                       |       | $                              | 8,618,039   |                           | $          | (5,448,286                     | )          | $ | (641,145 | ) |
|                                                        |       |                           |        |                           |       |                           |       |
| **Weighted Average Units Outstanding - Basic  and Diluted** |       | 27,104,625                     |        | 26,361,406                     |       | 23,129,554                     |       |
|                                                        |       |                           |        |                           |       |                           |       |
| **Net Income (Loss) Per Unit - Basic and  Diluted**         |       | $                              | 0.32        |                           | $          | (0.21                          | )          | $ | (0.03 | ) |

 

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

ConsolidatedStatements of Changes in Members’ Equity

 
| **Balance - October 31, 2005**                                                                          |       | $          | 40,361,572 |   |
|--------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------|
|                                                                                                         |       |       |       |
| Issuance of 6,500 Class A units for  the purchase of easement, November 2005                       |       | 13,000     |       |
|                                                                                                         |       |       |       |
| Net loss for the year ended  October 31, 2006                                                           |       | (641,145   | )          |
|                                                                                                         |       |       |       |
| **Balance - October 31, 2006**                                                                          |       | 39,733,427 |       |
|                                                                                                         |       |       |       |
| Capital Contribution - 3,750,000  Class A units, $2.00 per unit, December 2006                     |       | 7,500,000  |       |
|                                                                                                         |       |       |       |
| Capital Contribution - exercise of warrants  for 225,000 Class A units, $.80 per unit, August 2007 |       | 180,000    |       |
|                                                                                                         |       |       |       |
| Net loss for the year ended  October 31, 2007                                                           |       | (5,448,286 | )          |
|                                                                                                         |       |       |       |
| **Balance - October 31, 2007**                                                                          |       | 41,965,141 |       |
| ** **                                                                                                   | ** ** | ** ** | ** ** |
| Net income for the year ended  October 31, 2008                                                         |       | 8,618,039  |       |
| ** **                                                                                                   | ** ** | ** ** | ** ** |
| **Balance - October 31, 2008**                                                                          |       | $          | 50,583,180 |   |

** **

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

F-5

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Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

ConsolidatedStatements of Cash Flows

 
| ** **                                                                                          | ** ** | **Year**                       | ** ** | **Year**                       | ** ** | **Year**                       | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                                                          | ** ** | **Ended**                      | ** ** | **Ended**                      | ** ** | **Ended**                      | ** ** |
| ** **                                                                                          | ** ** | **October 31, 2008** | ** ** | **October 31, 2007** | ** ** | **October 31, 2006** | ** ** |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Cash Flow From Operating Activities**                                                             | ** ** | ** **                     | ** ** | ** **                     | ** ** | ** **                     | ** ** |
| Net income (loss)                                                                                   |       | $                              | 8,618,039  |                           | $          | (5,448,286                     | )          | $ | (641,145 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |                           |       |                           |       |                           |       |
| Depreciation and amortization                                                                       |       | 5,688,300                      |       | 1,269,117                      |       | 302,647                        |       |
| Lower of cost or market adjustment                                                                  |       | 8,751,000                      |       | —                         |       | —                         |       |
| Change in fair value of derivative  instruments                                                     |       | (678,713                       | )          | 150,088                        |       | 915,533                        |       |
| Gain on disposal of assets                                                                          |       | 3,317                          |       | (4,396                         | )          | (28,540                        | )          |
| Change in assets and liabilities:                                                                   |       |                           |       |                           |       |                           |       |
| Restricted cash                                                                                     |       | (803,383                       | )          | 291,500                        |       | (512,850                       | )          |
| Accounts receivable                                                                                 |       | (1,413,950                     | )          | (1,550,443                     | )          | (380,383                       | )          |
| Inventory                                                                                           |       | 7,729,607                      |       | (14,861,633                    | )          | (3,569,069                     | )          |
| Derivative instruments                                                                              |       | (257,695                       | )          | (879,384                       | )          | (60,580                        | )          |
| Prepaid expenses                                                                                    |       | (491,783                       | )          | (51,784                        | )          | —                         |       |
| Accounts payable                                                                                    |       | (3,611,106                     | )          | 7,718,778                      |       | 1,821,999                      |       |
| Accrued expenses                                                                                    |       | (341,041                       | )          | 645,577                        |       | 196,288                        |       |
| Net cash provided by (used in) operating  activities                                                |       | 23,192,592                     |       | (12,720,866                    | )          | (1,956,100                     | )          |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Cash Flows from Investing Activities**                                                            |       |                           |       |                           |       |                           |       |
| Proceeds from sale of assets                                                                        |       | 224,498                        |       | 29,421                         |       | 338,000                        |       |
| Payments for elevator assets                                                                        |       | —                         |       | —                         |       | (1,093,298                     | )          |
| Capital expenditures                                                                                |       | (1,186,148                     | )          | (4,204,339                     | )          | (35,560,610                    | )          |
| Payment for other intangibles                                                                       |       | (474,183                       | )          | —                         |       | —                         |       |
| Net cash used in investing activities                                                               |       | (1,435,833                     | )          | (4,174,918                     | )          | (36,315,908                    | )          |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Cash Flows from Financing Activities**                                                            |       |                           |       |                           |       |                           |       |
| Checks written in excess of bank balance                                                            |       | (514,633                       | )          | (8,972                         | )          | 523,605                        |       |
| Proceeds from (payments on) line of credit,  net                                                    |       | (6,974,235                     | )          | 6,126,175                      |       | 848,060                        |       |
| Proceeds from (payments on) note payable -  related party                                           |       | (4,202,930                     | )          | 4,202,930                      |       | —                         |       |
| Proceeds from long-term debt                                                                        |       | 3,289,177                      |       | —                         |       | —                         |       |
| Payments on long-term debt                                                                          |       | (5,113,249                     | )          | (307,168                       | )          | (98,726                        | )          |
| Payments for loan costs                                                                             |       | —                         |       | (179,166                       | )          | (496,723                       | )          |
| Debt service deposits                                                                               |       | (215,600                       | )          | (151,750                       | )          | —                         |       |
| Release of restricted cash                                                                          |       | 239,457                        |       | —                         |       | —                         |       |
| Member contributions                                                                                |       | —                         |       | 7,500,000                      |       | —                         |       |
| Member contributions related to warrants  exercised                                                 |       | —                         |       | 180,000                        |       | —                         |       |
| Net cash provided by (used in) financing activities                                                 |       | (13,492,013                    | )          | 17,362,049                     |       | 776,216                        |       |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Net Increase (Decrease) in cash and  equivalents**                                                |       | 8,264,746                      |       | 466,265                        |       | (37,495,792                    | )          |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Cash and Equivalents - Beginning of period**                                                      |       | 3,090,329                      |       | 2,624,064                      |       | 40,119,856                     |       |
|                                                                                                |       |                           |       |                           |       |                           |       |
| **Cash and Equivalents - End of period**                                                            |       | $                              | 11,355,075 |                           | $          | 3,090,329                      |       | $ | 2,624,064 |   |

 

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

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Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Consolidated Statements of Cash Flows

 
| ** **                                            | ** ** | **Year**                       | ** ** | **Year**                       | ** ** | **Year**                       | ** ** |
|-------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **Ended**                      | ** ** | **Ended**                      | ** ** | **Ended**                      | ** ** |
| ** **                                            | ** ** | **October 31, 2008** | ** ** | **October 31, 2007** | ** ** | **October 31, 2006** | ** ** |
| ** **                                            |       |                           |       |                           |       |                           |       |
| **Supplemental Disclosure of Cash Flow  Information** |       |                           |       |                           |       |                           |       |
| Interest expense paid                                 |       | $                              | 5,100,895  |                           | $          | 589,118                        |       | $ | 76,707 |   |
| Interest capitalized paid                             |       | —                         |       | 2,802,010                      |       | 378,851                        |       |
| Total interest paid                                   |       | $                              | 5,100,895  |                           | $          | 3,391,128                      |       | $ | 455,558 |   |
|                                                  |       |                           |       |                           |       |                           |       |
| **Supplemental Disclosure of Non-Cash  Activities**   |       |                           |       |                           |       |                           |       |
| Restricted cash from long-term debt  proceeds         |       | $                              | 1,710,000  |                           | $          | —                         |       | $ | — |   |
| Property and equipment in construction  payables      |       | $                              | 3,839,413  |                           | $          | 4,188,455                      |       | $ | 14,882,948 |   |
| Property and equipment financed by  long-term debt    |       | $                              | —     |                           | $          | 40,245,680                     |       | $ | 2,010,575 |   |
| Assessment payable related to property and  equipment |       | $                              | —     |                           | $          | 867,500                        |       | $ | 3,550,000 |   |
| Loan costs capitalized with property and  equipment   |       | $                              | —     |                           | $          | 99,387                         |       | $ | 151,931 |   |
| Construction payables refinanced with  long-term debt |       | $                              | —     |                           | $          | 14,882,948                     |       | $ | — |   |
| Note payable for elevator assets purchased            |       | $                              | —     |                           | $          | —                         |       | $ | 1,950,000 |   |
| Issuance of units for easement                        |       | $                              | —     |                           | $          | —                         |       | $ | 13,000 |   |
| Note payable repaid with construction note            |       | $                              | —     |                           | $          | —                         |       | $ | 439,900 |   |

 

Notes to Consolidated Financial Statements are an integral part of thisStatement.

 

F-7

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Table of Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes toConsolidated Financial Statements

 

October 31, 2008 and 2007

 

 

**1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Natureof Business*

 

TheCompany was organized to fund and construct a 50 million gallon ethanol plantnear Heron Lake, Minnesota with ethanol distribution to upper Midweststates.  In addition, the Companyproduces and sells distillers grains with solubles as co-products of ethanolproduction.  The Company was formed on April 12,2001 to have an indefinite life.  TheCompany began its ethanol plant operations in September 2007.  Prior to September 2007, the Company wasin the development stage.  In December 2005,the Company acquired certain corn storage assets to give the Company theability to procure and store corn more favorably as described in Note 3.  Since the plant did not commence ethanoloperations until September 2007, the Company generated revenue of $6.2million and $16.8 million in fiscal years 2008 and 2007 respectively throughthe sale and distribution of corn and other grains.  Revenues from ethanol sales wereapproximately $101.8 million and $6.3 million in fiscal 2008 and 2007,respectively.

 

*Principlesof Consolidation*

 

Thefinancial statements include the accounts of Heron Lake BioEnergy, LLC and itswholly owned subsidiary, Lakefield Farmers Elevator, LLC, collectively, the “Company.”  All significant intercompany balances andtransactions are eliminated in consolidation.

 

*FiscalReporting Period*

 

TheCompany’s fiscal year end for reporting financial operations is October 31.

 

*AccountingEstimates*

 

Managementuses estimates and assumptions in preparing these financial statements inaccordance with generally accepted accounting principles.  Those estimates and assumptions affect thereported amounts of assets and liabilities, the disclosure of contingent assetsand liabilities, and the reported revenues and expenses.   The Company uses estimates and assumptionsin accounting for significant matters including, among others, the carryingvalue and useful lives of property and equipment and estimates of losses onforward contract commitments and inventory. The Company periodically reviews estimates and assumptions, and theeffects of revisions are reflected in the period in which the revision is made.Actual results could differ from those estimates.

 

*RevenueRecognition*

 

Revenue from sales isrecorded when title transfers to the customer, collection of the relevantreceivable is probable, persuasive evidence of an arrangement exists, and thesales price is fixed and determinable.   The title transfers when the product is loaded into the railcar ortruck, the customer takes ownership and assumes risk of loss.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

*Cashand Equivalents*

 

TheCompany considers all highly liquid debt instruments purchased with a maturityof three months or less to be cash and equivalents.

 

The Company maintains its accounts at five financial institutions.  At times throughout the year, the Company’scash balances may exceed amounts insured by the Federal Deposit InsuranceCorporation and the Securities Investor Protection Corporation.  The Company does not believe it is exposed toany significant credit risk on cash and equivalents.

 

*RestrictedCash*

 

TheCompany is periodically required to maintain cash balances at its brokerrelated to derivative instrument positions. In addition, at October 31, 2008 the Company maintained restrictedcash of approximately $1,472,000 related to a loan agreement as described inNote 9.

 

*AccountsReceivable*

 

Creditterms are extended to customers in the normal course of business.   The Company performs ongoing creditevaluations of its customers’ financial condition and, generally, requires nocollateral.

 

Accounts receivable are recorded at estimated net realizablevalue.   Accounts are consideredpast due if payment is not made on a timely basis in accordance with theCompany’s credit terms.  Accounts considered uncollectible are writtenoff.  The Company’s estimate of the allowance for doubtful accounts isbased on historical experience, its evaluation of the current status ofreceivables, and unusual circumstances, if any.  At October 31, 2008and 2007, the Company was of the belief that such accounts would be collectableand thus an allowance was not considered necessary.

 

*Inventory*

 

Inventoryconsists of raw materials, work in process, finished goods, supplies, and othergrain inventory. Corn is the primary raw material and, along with other rawmaterials and supplies, is stated at the lower of cost or market on a first-in,first-out (FIFO) basis.  Work in processand finished goods, which consists of ethanol and distillers grains produced,is stated at the lower of average cost or market.  Other grain inventory, which consists ofagricultural commodities, is valued at market value (net realizablevalue).  Other grain inventory is readilyconvertible to cash because of its commodity characteristics, widely availablemarkets and international pricing mechanisms. Other grain inventory is also freely traded, has quoted market prices,may be sold without significant further processing, and has predictable andinsignificant disposal costs. Merchandise inventory is valued at lower of cost or market on afirst-in, first-out (FIFO) basis.

 

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** **

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

*DerivativeInstruments*

 

TheCompany accounts for derivative instruments and hedging activities inaccordance with Statement of Financial Accounting Standards (SFAS) No. 133,*Accounting for Derivative Instruments andHedging Activities*, as amended. SFAS No. 133 requires a companyto evaluate its contracts to determine whether the contracts arederivatives.  Certain contracts thatliterally meet the definition of a derivative may be exempted from SFAS No. 133as normal purchases or normal sales. Normal purchases and normal sales are contracts that provide for thepurchases or sale of something other than a financial instrument or derivativeinstrument that will be delivered in quantities expected to be used or soldover a reasonable period in the normal course of business.  Contracts that meet the requirements ofnormal are documented as normal and exempted from accounting and reportingrequirements of SFAS No. 133, and therefore, are not marked to market in ourfinancial statements.

 

Inorder to reduce the risk caused by market fluctuations of corn and ethanol, theCompany may use option, futures and swap contracts.  These contracts are used to fix the purchaseprice of the Company’s anticipated requirements of corn in productionactivities.  The fair value of thesecontracts is based on quoted prices in active exchange-traded orover-the-counter markets.  The fair valueof the derivatives is continually subject to change due to the changing marketconditions.  The Company does nottypically enter into derivative instruments other than for hedgingpurposes.  On the date the derivativeinstrument is entered into, the Company will designate the derivative as ahedge.  Changes in the fair value of aderivative instrument that is designated as, and meets all of the requiredcriteria, for a cash flow or fair value hedge is recorded in accumulated othercomprehensive income and reclassified into earnings as the hedged items affectearnings.  Changes in the fair value of aderivative instrument that is not designated as, and accounted for, as a cashflow or fair value hedge is recorded in current period earnings.  Although certain derivative instruments maynot be designated as, and accounted for, as a cash flow or fair value hedge,they are economic hedges of specified risks.

 

*Other Intangibles*

 

Otherintangibles are stated at cost and include road improvements located near theplant in which the Company has a beneficial interest in but does not own theroad.  The Company began amortizing the assets over the economic usefullife of 15 years in fiscal year 2008.

 

*Propertyand Equipment*

 

Propertyand equipment are recorded at cost. Depreciation is provided over an estimated useful life by use of thestraight-line deprecation method. Maintenance and repairs are expensed as incurred; major improvements andbetterments are capitalized. Construction in progress is comprised of costs related to the constructionof the ethanol plant facilities. Interest is capitalized during the construction period.  Depreciable useful lives are as follows:

 
| Land  improvements              |   | 15 Years     |   |
|---------------------------------|--------|--------------|--------|
| Plant  building and equipment   |   | 7 - 40 Years |   |
| Vehicles  and equipment         |   | 5 - 7 Years  |   |
| Office  buildings and equipment |   | 3 - 40 Years |   |

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

*Long-Lived Assets*

 

The Company reviews property and equipment and other long-lived assetsfor impairment in accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets * Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountmay not be recoverable.  Circumstanceswhich could trigger a review include, but are not limited to: significantdecreases in the market price of the asset; significant adverse changes in thebusiness climate or legal factors; accumulation of costs significantly inexcess of the amount originally expected for the acquisition of construction ofthe asset; current period cash flow or operating losses combined with a historyof losses or a forecast of continuing losses associated with the use of theassets; and current expectation that the asset will more likely than not besold or disposed significantly before the end of its estimated useful life.

 

Recoverability is assumed based on the carrying amount of the asset andits fair value that is generally determined based on the sum of theundiscounted cash flows expected to result from the use of the eventualdisposal of the asset, as well as specific appraisal in certain instances.  An impairment loss is recognized when thecarrying amount is not recoverable and exceeds fair value.  The Company has not recognized any long-livedasset impairment charges as of October 31, 2008 and 2007.

 

*DeferredLoan Costs*

 

Costsassociated with the issuance of the debt discussed in Note 8 and 9 are recordedas deferred loan costs, net of accumulated amortization.  Loan costs are amortized to operations overthe term of the related debt using the effective interest method. Prior to thecommencement of operations in September 2007, the Company capitalized loancosts with interest costs during the construction of the plant.  Once operations commenced, loan costamortization was expensed.

 

*Grants*

 

TheCompany recognizes grant proceeds for reimbursement of expenditures incurredupon complying with the conditions of the grant.  For reimbursements of incremental expenses(expenses the Company otherwise would not have incurred had it not been for thegrant), the grant proceeds are recognized as a reduction of the relatedexpense.  For reimbursements of capitalexpenditures, the grants are recognized as a reduction of the basis of theasset upon complying with the conditions of the grant.

 

*Financial Instruments*

 

The Company believes the carrying value of cash and equivalents andrestricted cash approximate fair value.

 

The Company believes the carrying amount of derivative instrumentsapproximates fair value based on quoted prices in active exchange-traded orover-the-counter markets.

 

The Company believes the carrying amount of the line of credit and notepayable approximates the fair value due to the variable interest rate andshort-term nature of the debt.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

Thecarrying amount of the long-term debt exceeded the fair value at October 31,2008. Due to declining interest rates during 2008 and having fixed the interestrate on debt as noted in Note 9, the carrying amount of the long-term debt wasless than the fair value at October 31, 2008.  The carrying amount and the fair value oflong-term debt are as follows:

 
| ** **                              | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|---------------------|------------|
|                                    |       |                     |       |                |       |
| Long-term debt at October 31, 2008 |       | $                        | 64,914,888 |                | $          | 66,043,522 |   |
| Long-term debt at October 31, 2007 |       | $                        | 65,028,960 |                | $          | 65,028,960 |   |

 

*IncomeTaxes*

 

TheCompany is treated as a partnership for federal and state income tax purposesand generally does not incur income taxes. Instead, its earnings and losses areincluded in the income tax returns of the members.  Therefore, no provision or liability forfederal or state income taxes has been included in these financialstatements.  Differences betweenfinancial statement basis of assets and tax basis of assets is related tocapitalization and amortization of organization and start-up costs for taxpurposes, whereas these costs are expensed for financial statement purposes. Inaddition, the Company uses the alternative depreciation system (ADS) for taxdepreciation instead of the straight-line method that is used for bookdepreciation, which also causes temporary differences.  The Company’s tax year end is December 31.

 

In June 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*(FIN 48).  FIN 48 clarifies the requirements of SFAS109, *Accounting for Income Taxes,* relating tothe recognition of income tax benefits. FIN 48 provides a two-step approach torecognizing and measuring tax benefits when realization of the benefits isuncertain.  The first step is todetermine whether the benefit meets the more-likely-than-not condition forrecognition and the second step is to determine the amount to be recognizedbased on the cumulative probability that exceeds 50%.  Primarily due to the Company’s tax status asa partnership, the adoption of FIN 48 on November 1, 2008, had no materialimpact on the Company’s financial condition or results of operations.

 

*Share-BasedCompensation*

 

In2006, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004) (SFAS No. 123R), *Share-BasedPayment*, which addresses the accounting for stock-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. In January 2005, the SEC issued SAB No. 107,which provides supplemental implementation guidance for SFAS No. 123R.SFAS No. 123R eliminates the ability to account for stock-basedcompensation transactions using the intrinsic value method under AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and instead generally requires thatsuch transactions be accounted for using a fair-value-based method. The Companyuses the Black-Scholes-Merton (“BSM”) option-pricing model to determine thefair-value of stock-based awards.

 

*Net Income (Loss) per Unit*

 

Basicnet income (loss) per unit is computed by dividing net income (loss) by theweighted average number of members’ units outstanding during the period.  Diluted net income or loss per unit iscomputed by dividing net income (loss) by the weighted average number ofmembers’ units and members’ unit equivalents outstanding during theperiod.  During fiscal 2007 and 2006, theCompany had  warrants outstanding butthey were not included in the calculation of diluted net income (loss) per unitas they would have been anti-dilutive. All warrants were exercised during fiscal 2007.  No member unit equivalents were outstandingduring fiscal year 2008.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

*Environmental Liabilities*

 

TheCompany’s operations are subject to environmental laws and regulations adoptedby various governmental entities in the jurisdiction in which itoperates.  These laws require the Company to investigate and remediate theeffects of the release or disposal of materials at its location.  Accordingly,the Company has adopted policies, practices, and procedures in the areas ofpollution control, occupational health, and the production, handling, storageand use of hazardous materials to prevent material environmental or otherdamage, and to limit the financial liability, which could result from suchevents.  Environmental liabilities arerecorded when the liability is probable and the costs can be reasonablyestimated.

 

*RecentlyIssued Accounting Pronouncements*

 

InSeptember 2006, the FASB issued Statement of Financial AccountingStandards No. 157 (“SFAS 157”), *Fair Value Measurements*.  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements.  The statement is effectivefor financial statements beginning in the Company’s fiscal year ending October 31,2009 and interim periods within that fiscal year. It is effective fornon-financial assets and liabilities in financial statements beginning in theCompany’s fiscal year ending October 31, 2010 and interim periods withinthat fiscal year.  The Company iscurrently evaluating the effect that the adoption of SFAS 157 will have, ifany, on its results of operations, financial position and related disclosures,but does not expect it to have a material impact on the financial statements.

 

InFebruary 2007, the FASB issued Statement of Financial Accounting StandardsNo. 159, (“SFAS 159”), *The Fair Value Option forFinancial Assets and Financial Liabilities*which included anamendment of FASB Statement 115.  Thisstatement provides companies with an option to report selected financial assetsand liabilities at fair value.  Thisstatement is effective beginning in the Company’s fiscal year ending October 31,2009, with early adoption permitted.  TheCompany is in the process of evaluating the effect, if any, that the adoptionof SFAS 159 will have on its results of operations and financial position.

 

InMarch 2008, the FASB issued SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities*, an amendment ofFASB 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 161 requires entities to provide greatertransparency through additional disclosures about how and why an entity usesderivative instruments, how derivative instruments and related hedged items areaccounted for under SFAS 133 and its related interpretations, and howderivative instruments and related hedged items affect an entity’s financialposition, results of operations, and cash flows.  SFAS 161 is effective as of the beginning ofthe Company’s interim period ending April 30, 2009.  Because SFAS 161 requires enhanceddisclosures but does not modify the accounting treatment of derivativeinstruments and hedging activities, the Company believes the adoption of thisstandard will have no impact on its financial position, results of operations,or cash flows.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**2. UNCERTAINTIES**

 

The Company has certain risks and uncertainties that it experiencedduring volatile market conditions such as what the Company experienced duringfiscal 2008.  These volatilities can havea severe impact on operations.  TheCompany’s revenues are derived from the sale and distribution of ethanol anddistillers grains to customers primarily located in the U.S.  Corn for the production process is suppliedto our plant primarily from local agricultural producers and from purchases onthe open market.  Ethanol sales average75 - 80% of total revenues and corn costs average 65 - 75% of cost of goodssold.

 

The Company’s operating and financial performance is largely driven bythe prices at which we sell ethanol and the net expense of corn.  The price of ethanol is influenced by factorssuch as supply and demand, the weather, government policies and programs,unleaded gasoline prices and the petroleum markets as a whole, although since2005 the prices of ethanol and gasoline began a divergence with ethanol sellingfor less than gasoline at the wholesale level.  Excess ethanol supply in the market, in particular, puts downwardpressure on the price of ethanol.  Ourlargest cost of production is corn.   Thecost of corn is generally impacted by factors such as supply and demand, theweather, government policies and programs, and our risk management program usedto protect against the price volatility of these commodities.  Market fluctuations in the price of anddemand for these products may have a significant adverse effect on the Company’soperations and profitability.

 

**3.  ASSETS PURCHASED**

 

The Company formed its wholly owned subsidiary, Lakefield FarmersElevator, LLC, for the purpose of purchasing assets from Farmers Co-operativeElevator of Lakefield.  On December 15,2005, the Company purchased certain current assets, primarily inventory ofapproximately $561,000 and property and equipment of approximately $2,600,000for a total purchase price of approximately $3,161,000.  The assets are intended to provide additionalstorage of corn inventory and to allow the Company to more favorably procurecorn for its ethanol operations.  TheCompany paid cash for these assets. Since the ethanol plant experienced delays in commencing operations, theCompany sold and distributed corn and other grains during fiscal 2008, 2007 and2006, but considers this activity ancillary to its primary purpose of providingadditional storage and procurement of corn for the ethanol plant.

 

**4.  CONCENTRATIONS**

 

The Company sells all of the ethanol and distiller grains produced totwo customers under marketing agreements as described in Note 14.  At October 31, 2008 and 2007, these twocustomers comprised 93% and 91% of accounts receivable, respectively.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**5.   INVENTORY**

 

Inventory consists of the following at October 31:

 
| ** **      | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|-----------------|------------|-----------|------------|-----------|------------|
|            |       |      |       |      |       |
| Raw materials   |       | $         | 5,830,477  |      | $          | 14,922,916 |   |
| Work in process |       | 1,200,242 |       | 899,160   |       |
| Finished goods  |       | 725,365   |       | 1,050,411 |       |
| Supplies        |       | 683,007   |       | 160,840   |       |
| Other grains    |       | 1,194,658 |       | 1,958,063 |       |
| Totals          |       | $         | 9,633,749  |      | $          | 18,991,390 |   |

 

Inaddition, the Company stored grain inventory for farmers.  The value of these inventories owned byothers is approximately $658,000 and $281,000 based on market prices at October 31,2008 and 2007, respectively.

 

AtOctober 31, 2008, the Company recorded a loss of approximately $1,628,000related to inventory in which the net realizable value was less than the costbasis, attributable primarily to decreases in market prices of corn andethanol.  The loss was recorded with thelower of cost or market adjustment in the statement of operations.

 

**6.DERIVATIVE INSTRUMENTS**

 

At October 31, 2008 and 2007, the Company recorded an asset forderivative instruments of approximately $750,000 and a liability for $186,000,respectively.  None of the positions areopen at October 31, 2008 and 2007 are designated as cash flow or fairvalue hedges.  The Company has recorded a gain of approximately $6,287,000in fiscal year 2008 and a loss of approximately $2,654,000 in fiscal year 2007in cost of goods sold related to its corn derivative instruments.  The Company has recorded a gain ofapproximately $3,600,000 in revenues for fiscal year 2008 related to ethanolderivatives.  There was no gainrecognized in revenues related to derivatives in fiscal year 2007.

 

**7. CONSTRUCTION IN PROGRESS**

 

The Company capitalizes construction costs and construction periodinterest until the assets are placed in service. During fiscal 2007, the Companycapitalized interest during the construction period of approximately$2,901,000.  Capitalized interestincludes deferred loan costs that are amortized over the life of the loans,which totaled approximately $105,000, $99,000 and $152,000 during fiscal 2008,2007 and 2006, respectively.

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**8.  LINE OF CREDIT**

 

The Company has a line of credit for up to $7,500,000, subject tocertain borrowing base requirements, due November 2009.  Amounts available under the line of creditare reduced by outstanding standby letters of credit.  Interest accrues on borrowings at the onemonth LIBOR plus 3.25%, which totaled 5.74% and 9.07% at October 31, 2008and 2007, respectively.  The Company hasa .25% commitment fee on the unused portion of the line of credit.  There was no balance outstanding on the lineof credit at October 31, 2008.  At October 31,2007, outstanding borrowings on the line of credit equaled $6,974,235.  The Company has outstanding standby lettersof credit of $400,000 at October 31, 2008, which expired in November 2008.

 

The line of credit and the term note and revolving term note discussedin Note 9 are subject to a general security agreement with the lendinginstitution bank.  The terms of thisagreement require the Company to maintain certain financial ratios andcovenants such as working capital and net worth requirements, minimum debt toequity and debt service coverage, and restrictions on distributions.  Borrowings under the agreement are secured bysubstantially all corporate assets.  Duringfiscal 2008, the Company was not in compliance with the debt covenant relatedto the submission of quarterly financial statements within 30 days duringfiscal 2008.  The lender waivedcompliance for these violations.

 

**9.  LONG-TERM DEBT**

 

Long-term debt consists of the following:

 
| ** **                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **October 31** | ** ** | **October 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **2008**            | ** ** | **2007**            | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                          |       |                |       |                |       |
| Term note payable to lending institution,  see terms below.                                                                                                                                                                                                                                                                                                                   |       | $                   | 57,508,968 |                | $          | 59,583,000 |   |
|                                                                                                                                                                                                                                                                                                                                                                          |       |                |       |                |       |
| Revolving term note payable to lending  institution, see terms below.                                                                                                                                                                                                                                                                                                         |       | 1,155,872           |       | 1,116,505           |       |
|                                                                                                                                                                                                                                                                                                                                                                          |       |                |       |                |       |
| Note payable to Jackson County with  interest at 4.00%, forgivable two years after plant completion based upon job  creation thresholds at specified wages as part of the plant development, but  no later than November 1, 2009. If the Company fails to meet the terms  of the note, principal and accrued interest will be due and payable on  November 1, 2009. |       | 100,000             |       | 100,000             |       |
|                                                                                                                                                                                                                                                                                                                                                                          |       |                |       |                |       |
| Balance forward                                                                                                                                                                                                                                                                                                                                                               |       | $                   | 58,764,840 |                | $          | 60,799,505 |   |

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **October 31** | ** ** | **October 31** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **2008**            | ** ** | **2007**            | ** ** |
| Balance from previous page                                                                                                                                                                                                                                                                                                                                                                                                           |       | $                   | 58,764,840 |                | $          | 60,799,505 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Assessment payable as part of water  treatment agreement, due in semi-annual installments of $189,393 with  interest at 6.55%, enforceable by statutory lien, with the final payment due  in 2021. The Company is required to make deposits over 24 months, which began  in January 2007, for one years’ worth of debt service payments that are  held on deposit to be applied with the final payments of the assessment. |       | 3,173,624           |       | 3,326,250           |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Assessment payable as part of water  treatment agreement, due in semi-annual installments of $25,692 with interest  at 0.50%, enforceable by statutory lien, with the final payment due in 2016.                                                                                                                                                                                                                                     |       | 401,985             |       | 451,115             |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Assessment payable as part of water supply  agreement, due in monthly installments of $4,126 with interest at 8.73%,  enforceable by statutory lien, with the final payment due in 2019.                                                                                                                                                                                                                                             |       | 334,657             |       | 354,229             |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Note payable for equipment, with monthly  payments of $3,676 including effective interest of 6.97%, due in  April 2011, secured by equipment.                                                                                                                                                                                                                                                                                   |       | 65,956              |       | 97,861              |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Note payable to electrical provider, with  monthly payments of $29,775 including implicit interest of 1.50%, due in  December 2013, secured by equipment and restricted cash.                                                                                                                                                                                                                                                   |       | 1,573,826           |       | —              |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Note payable to electrical company with  monthly payments beginning in October 2009 of $6,250 with a 1%  maintenance fee due each October, due September 2017. The electrical  company is a member of the Company.                                                                                                                                                                                                         |       | 600,000             |       | —              |       |
| Totals                                                                                                                                                                                                                                                                                                                                                                                                                               |       | 64,914,888          |       | 65,028,960          |       |
| Less amounts due within one year                                                                                                                                                                                                                                                                                                                                                                                                     |       | 5,649,354           |       | 2,747,061           |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                |       |                |       |
| Net long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                   |       | $                   | 59,265,534 |                | $          | 62,281,899 |   |

 

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**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

* Term Note Payable*

 

The Company obtained debt financing from a lending institution in theform of a construction loan and line of credit, as described in Note 8.  The construction loan converted to a$59,583,000 term note and a $5,000,000 revolving term note in October 2007.

 

The term note required interest only payments from November 2007to April 2008 at the one-month LIBOR plus 3.25%, which totaled 5.74% and9.07% at October 31, 2008 and 2007, respectively.  In May 2008, the Company locked in aninterest rate of 3.58% plus 3.00%, which totals 6.58% on $45,000,000 of thenote, for three years ending April 30, 2011.  The Company will make equal monthly paymentsof principal and interest of approximately $702,000 to amortize the note over aperiod not to exceed ten years, with a final balloon payment due in October 2012.  In addition, the Company is required to makeadditional payments on the term note of excess cash flow, as defined in theagreement, up to $2,000,000 per year to the lending institution until theCompany meets a specified financial ratio. As part of the debt financing, the premium above LIBOR may be reducedbased on the ratio of members’ equity to assets.

 

The term note, the revolving term note described below, and the line ofcredit described in Note 8 are subject to a common credit agreement containingvarious financial and non-financial covenants that limit distributions, requireminimum debt service coverage, net worth and working capital requirements andare secured by a security agreement on all of the Company’s businessassets.  The owner of the generalcontractor has guaranteed approximately $3,740,000 of the term note andrevolving term note.

 

*Revolving Term Note*

 

The Company has a revolving term note with the same lending institutionfor up to $4,500,000 for cash and inventory management purposes.  The Company pays interest on principaladvances monthly at the one-month LIBOR rate plus 3.25%, which totaled 5.74%and 9.07% at October 31, 2008 and 2007, respectively.  The availability under this note declines by$500,000 annually until October 2011 when it will be $3,000,000 untilmaturity in October 2012.  TheCompany pays a commitment fee of 0.35% per annum on the unused portion of therevolving term note.  During fiscal 2008,the Company was not in compliance with the debt covenant related to thesubmission of quarterly financial statements within 30 days.  The lender waived compliance for thisviolation.

 

Estimated maturities of long-term debt at October 31, 2008 are asfollows:

 
| 2009                 |   | $          | 5,649,354  |   |
|----------------------|--------|------------|------------|--------|
| 2010                 |   | 5,842,037  |       |
| 2011                 |   | 5,884,907  |       |
| 2012                 |   | 44,213,511 |       |
| 2013                 |   | 423,988    |       |
| After 2013           |   | 2,901,091  |       |
|                 |   |       |       |
| Total long-term debt |   | $          | 64,914,888 |   |

 

F-18

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**10.  MEMBERS’ EQUITY**

 

TheCompany is authorized to issue 50,000,000 capital units, of which 28,750,000have been designated Class A units, 11,250,000 have been designated as Class Bunits, and 10,000,000 have not yet been designated.  Members of the  Company are holders of units who have beenadmitted as members upon their investment in our units and who are admitted asmembers by our board of governors.  Theminimum number of units required to retain membership is 2,500 units.  Any holder of units who is not a member willnot have voting rights.  Transferees ofunits must be approved by our board of governors to become members.  Members who are holders of our present unitsare entitled to one vote for each unit held. Subject to the Member ControlAgreement, all units share equally in the profits and losses, distributions ofassets, and voting rights on a per unit basis.

 

InDecember 2006, an affiliate of the general contractor invested anadditional $7,500,000 in exchange for 3,750,000 Class A units as describedin Note 13.

 

AtOctober 31, 2008 and 2007, the Company had 27,104,625 Class A unitsissued and outstanding.

 

*Warrants*

 

TheCompany authorized warrants in fiscal 2004 for 25,000 Class A units to theexisting nine members of the Board of Governors.  The warrants granted to each member of theBoard of Governors the right to purchase 25,000 Class A units at anexercise price of $.80 per unit.  Thewarrants vested October 31, 2005 and were exercisable for a period of fiveyears thereafter.  These units were notused in the computation of net loss per unit for fiscal 2007 or 2006 as theywould have been anti-dilutive.  All ofthe warrants were exercised in August 2007 whereby the Company received$180,000.

 

**11. LEASES**

 

The Company leases equipment, primarily rail cars, under operatingleases through 2017.  Equipment underoperating lease primarily represents rail cars for which the rentals began in August 2007.  Rent expense for fiscal 2008, 2007, and 2006was approximately $853,000, $225,000, and $9,000 respectively.

 

At October 31, 2008, the Company had the following minimum futurelease payments, which at inception had non-cancelable terms of more than oneyear:

 
| 2009                    |   | $         | 837,352   |   |
|-------------------------|--------|-----------|-----------|--------|
| 2010                    |   | 831,600   |      |
| 2011                    |   | 831,600   |      |
| 2012                    |   | 831,600   |      |
| 2013                    |   | 831,600   |      |
| Thereafter              |   | 3,187,800 |      |
|                    |   |      |      |
| Total lease commitments |   | $         | 7,351,552 |   |

 

F-19

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**12.INCOME TAXES**

 

The differences between consolidated financial statement basis and taxbasis of assets are as follows at October 31:

 
| ** **                                                                                  | ** ** | **2008**   | ** **  | **2007**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|-------------|------------|------------|
|                                                                                        |       |       |        |       |       |
| Consolidated financial statement basis of  assets                                           |       | $          | 133,400,810 |       | $          | 133,959,958 |   |
| Plus: Organization and start-up costs  capitalized                                          |       | 2,195,063  |        | 2,352,792  |       |
| Less: Unrealized gains on derivatives                                                       |       | (678,713   | )           | —     |       |
| Less: Accumulated tax depreciation and  amortization greater than financial statement basis |       | (7,614,210 | )           | (1,858,200 | )          |
|                                                                                        |       |       |        |       |       |
| Income tax basis of assets                                                                  |       | $          | 127,302,950 |       | $          | 134,454,550 |   |

 
| ** **                                             | ** ** | **2008**   | ** ** | **2007** | ** ** |
|--------------------------------------------------------|------------|------------|------------|----------|------------|
|                                                   |       |       |       |     |       |
| Consolidated financial statement basis of  liabilities |       | $          | 82,817,630 |     | $          | 91,994,817 |   |
| Less: Unrealized losses on derivatives                 |       | —     |       | (186,238 | )          |
| Less: Accrued expenses                                 |       | (7,635,675 | )          | (71,311  | )          |
|                                                   |       |       |       |     |       |
| Income tax basis of liabilities                        |       | $          | 75,181,955 |     | $          | 91,737,268 |   |

 

**13. RELATED PARTY TRANSACTIONS**

 

An affiliate of the general contractor of the plant became a member ofthe Company during fiscal 2005 by investing $4,100,000. In December 2006,the affiliate invested an additional $7,500,000 in exchange for 3,750,000 Class Aunits. The Company incurred approximately $81,287,000 in costs related to thedesign-build agreement and change orders as described in Note 14. In July 2007,the Company was advanced approximately $4,203,000 from the owner of the generalcontractor for the purchase of inventory, which was repaid in November 2007.

 

In May 2006, the Company purchased land and buildings from amember for $500,000 that is adjacent to the site where the ethanol plant islocated.

 

In December 2006, the Company entered into an agreement with amember to construct an electrical substation for approximately $1,020,000. In November 2007,the Company obtained a loan from this member as described in Note 9.

 

The Company purchased approximately $47,569,000, $8,836,000 and$1,218,000 of corn from members in fiscal 2008, 2007 and 2006, respectively.

 

F-20

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

**14. COMMITMENTS AND CONTINGENCIES**

 

*Plant Construction*

 

Our ethanol plant was constructed under a design-build agreement withFagen, Inc. as the design-builder. As of October 31, 2008, theCompany has paid $77.5 million and has retained approximately $3.8 million inpayments to Fagen, Inc. Final payment will be due once the plant meetscertain operating performance criteria. The design-build agreement included aprovision whereby the general contractor receives an early completion bonus of$10,000 per day for each day the construction is complete prior to 470 days. Inaddition, the general contractor will owe the Company liquidated damages of$20,000 per day for each day construction is not complete after 500 days,limited to $10,000,000. No amounts have been recorded based on the completiondate of the plant. The ethanol plant must meet certain performance and emissionstandards and the general contractor retains liability for failure to meetthese standards along with potential liquidated damages. The Company hasundergone performance testing in 2008 and has not yet determined if anyliquidated damages will be owed to the Company.

 

*Water Agreements*

 

In October 2003, the Company entered into an industrial watersupply development and distribution agreement with the City of Heron Lake for15 years. The Company has the exclusive rights to the first 600 gallons perminute of capacity that is available from the well, and provides for theCompany, combined with Minnesota Soybean Processors (MnSP), to approve anyother supply contracts that the City may enter into. In consideration, theCompany will pay one half of the City’s water well bond payments of $735,000,plus a 5% administrative fee, totaling approximately $594,000, and operatingcosts, relative to the Company’s water usage, plus a 10% profit. These costswill be paid as water usage fees. The Company recorded an assessment ofapproximately $367,000 with long-term debt as described in Note 9. The Companypays operating and administrative expenses of approximately $12,000 per year.

 

In May 2006, the Company entered into a water treatment agreementwith the City of Heron Lake and Jackson County for 30 years. The Company willpay for operating and maintenance costs of the plant in exchange for receivingtreated water. In addition, the Company agreed to an assessment for a portionof the capital costs of the water treatment plant. The Company recordedassessments with long-term debt of $500,000 and $3,550,000 in fiscal 2007 and2006, respectively, as described in Note 9. The Company pays operating andmaintenance expenses of approximately $205,000 per year.

 

*Marketing Agreements*

 

The Company has a marketing agreement with an unrelated party for theexclusive right to market, sell and distribute the entire ethanol inventoryproduced by the Company. The Company pays a marketing fee of $.01 per gallon. Theinitial term is for two years expiring September 2009, with renewaloptions thereafter. The Company would assume certain rail car leases if theagreement is not renewed.

 

F-21

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

The Company has a distiller’s grain marketing agreement with anunrelated party to purchase all of the Company’s distiller’s grains. Theagreement provides for predetermined formulas for the sale of distiller’sgrains and solubles. The initial term was for one year after operationscommenced and was automatically renewed on a monthly basis. The contract isterminable with 90 days written notice.

 

*Legal Proceeding*

 

The Company was subject to a legal challengefrom three special interest groups related to its air-emissions permit for theplant. The permit and subsequent amendment were issued by the MinnesotaPollution Control Agency and were appealed to the Minnesota Court of Appealsand Minnesota Supreme Court. The Minnesota Court of Appeals affirmed theissuance of the permit in 2006. In fiscal 2007, the Minnesota Supreme Courtdismissed the appeal after the Company agreed to expand its air permit to amajor emissions source. The application for the major source permit was filedin August 2007. At the current time, the Company continues to operateunder the compliance agreement pending MPCA consideration for the submittedapplication.

 

On December 19, 2008, a Major Air PermitModification Application was submitted to MPCA. This modification applicationrequests adjustment to certain permit conditions based on recent stack testingat the faculty and a review of continuous emissions monitoring (CEMS) data fromthe bubbling fluidized bed boiler (BFB). This request for modification alsoseeks adjustments for other key components of plant operations. At the currenttime, the Company continues to operate under the compliance agreement pendingMPCA consideration for the submitted application.

 

*Contractual Obligations*

 

Thefollowing table provides information regarding the consolidated contractualobligations of the Company as of October 31, 2008:

 
| ** **                     | ** ** | **Total**  | ** **  | **Less than  One Year** | ** ** | **One to Three  Years** | ** ** | **Three to  Five Years** | ** ** | **Greater  Than Five  Years** | ** ** |
|--------------------------------|------------|------------|-------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| Long-term debt obligations (1) |       | $          | 79,402,497  |                              | $          | 9,577,827                         |       | $                                  | 18,424,817 |                               | $          | 47,661,873 |   | $ | 3,737,980 |   |
| Operating lease obligations    |       | 7,351,552  |        | 837,352                           |       | 1,663,200                         |       | 1,663,200                          |       | 3,187,800                          |       |
| Purchase obligations (2)       |       | 50,238,781 |        | 36,624,989                        |       | 10,534,226                        |       | 3,079,566                          |       | —                             |       |
| Total contractual obligations  |       | $          | 136,992,830 |                              | $          | 47,040,168                        |       | $                                  | 30,622,243 |                               | $          | 52,404,639 |   | $ | 6,925,780 |   |

 

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(1)          Long-term debt obligations include estimated interest and interest onunused debt.

(2)          Purchase obligations primarily include forward contracts for corn andcoal.

 

TheCompany also has agreements to pay for the operating costs and maintenanceexpenses associated with the water agreement of approximately $12,000 and$205,000 per year with term lengths of approximately 15 and 30 years,respectively.

 

The Company has coal supply agreements with a minimum commitment ofapproximately $4,950,000 per year until May 2012, includingtransportation, with provisions for fuel surcharges and adjustments forinflation. The amounts related to these agreements are included with purchaseobligations in the table above.

 

F-22

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Tableof Contents

 

**HERON LAKE BIOENERGY, LLC AND SUBSIDIARY**

 

Notes to Consolidated Financial Statements

 

October 31, 2008 and 2007

 

*Forward Contracts*

 

The Company has forwardcontracts in place for corn purchases of approximately $31,663,000 through October 2009,which represents approximately 38% of the Company’s anticipated purchases infiscal 2009.

 

Currently, some of thesecorn contract prices are above current market prices for corn. Given the recentdeclining price of corn and ethanol, upon taking delivery under thesecontracts, the Company would incur a loss. Accordingly, the Company recorded aloss on these purchase commitments of approximately $7,123,000 at October 31,2008. The loss was recorded as a 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. Based on the positions at October 31,2008, further adverse price changes of 10% in the price of ethanol and cornsubsequent to year-end would result in additional losses of approximately $1,254,000.

 

F-23

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Table of Contents

** **

**HERONLAKE BIOENERGY, LLC**

 

**INDEX TOEXHIBITS TO FORM 10-K FOR FISCAL YEAR ENDED OCTOBER 31, 2008**

 
| **Exhibit  Number** | ** ** | **Exhibit Title** | ** **                                                                                                                                                                                                                             | **Incorporated by Reference To:** | ** **                                                                                                                                                                                                  |
|---------------------|------------|------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                   |                                                                                                                                                                                                                                   |                                             |                                                                                                                                                                                                        |
| 3.1                 |       |                   | First  Amended and Restated Articles of Organization of Heron Lake BioEnergy, LLC                                                                                                                                                      |                                             | Exhibit 3.1  of the Company’s Registration Statement on Form 10 (SEC Accession  No. 0001104659-08-054557) filed on August 22, 2008 (the “2008  Registration Statement”). |   |
| 3.2                 |       |                   | Member  Control Agreement of Heron Lake BioEnergy, LLC, as amended through  March 29, 2008                                                                                                                                        |                                             | Exhibit 3.2  of the Company’s 2008 Registration Statement.                                                                                                                                        |   |
| 4.1                 |       |                   | Form of  Class A Unit Certificate                                                                                                                                                                                            |                                             | Exhibit 4.1  of the Company’s 2008 Registration Statement.                                                                                                                                        |   |
| 4.2                 |       |                   | Unit  Transfer Policy adopted November 5, 2008                                                                                                                                                                                    |                                             | Exhibit 4.1  of the Company’s Current Report on Form 8-K dated November 5, 2008.                                                                                                        |   |
| 10.1                |       |                   | Fourth Amended and Restated Loan Agreement dated  October 1, 2007 by and between AgStar Financial Services, PCA and Heron  Lake BioEnergy, LLC                                                                                    |                                             | Exhibit 10.1 of the Company’s 2008  Registration Statement.                                                                                                                                       |   |
| 10.2                |       |                   | Third  Supplement dated October 1, 2007 to Fourth Amended and Restated Loan Agreement by and between AgStar  Financial Services, PCA and Heron Lake BioEnergy, LLC                                                                |                                             | Exhibit 10.2  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.3                |       |                   | Fourth  Supplement dated October 1, 2007 to Fourth Amended and Restated Loan Agreement by and between AgStar  Financial Services, PCA and Heron Lake BioEnergy, LLC                                                               |                                             | Exhibit 10.3  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.4                |       |                   | Term  Note dated October 1, 2007 in principal amount of $59,583,000 by Heron  Lake BioEnergy, LLC to AgStar Financial  Services, PCA as lender                                                                                    |                                             | Exhibit 10.4  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.5                |       |                   | Term  Revolving Note dated October 1, 2007 in principal amount of $5,000,000  by Heron Lake BioEnergy, LLC to AgStar Financial Services, PCA as lender                                                                            |                                             | Exhibit 10.5  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.6                |       |                   | Personal  Guaranty dated October 1, 2007 by Roland Fagen, guarantor, in favor of  AgStar Financial Services, PCA                                                                                                                  |                                             | Exhibit 10.6  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.7                |       |                   | Fourth  Amended and Restated Guaranty dated October 1, 2007 by Lakefield Farmers  Elevator, LLC in favor of AgStar Financial Services, PCA                                                                                        |                                             | Exhibit 10.7  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.8                |       |                   | Fifth  Supplement dated November 19, 2007 to Fourth Amended and Restated Loan Agreement by and between AgStar  Financial Services, PCA and Heron Lake BioEnergy, LLC                                                              |                                             | Exhibit 10.8  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.9                |       |                   | Revolving  Line of Credit Note dated November 19, 2007 in principal amount of  $7,500,000 by Heron Lake BioEnergy, LLC to AgStar Financial Services, PCA as lender                                                                |                                             | Exhibit 10.9  of the Company’s 2008 Registration Statement.                                                                                                                                       |   |
| 10.10               |       |                   | Industrial  Water Supply Development and Distribution Agreement dated October 27,  2003 among Heron Lake BioEnergy, LLC (f/k/a Generation II Ethanol, LLC), City  of Heron Lake, Jackson County, and Minnesota Soybean Processors |                                             | Exhibit 10.10  of the Company’s 2008 Registration Statement.                                                                                                                                      |   |
| 10.11               |       |                   | Industrial  Water Supply Treatment Agreement dated May 23, 2006 among Heron Lake  BioEnergy, LLC, City of Heron Lake and County of Jackson                                                                                        |                                             | Exhibit 10.11  of the Company’s 2008 Registration Statement.                                                                                                                                      |   |

 

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Table of Contents

 
| **Exhibit  Number** | ** ** | **Exhibit Title** | ** **                                                                                                                                                                                                    | **Incorporated by Reference To:** | ** **                                                              |
|---------------------|------------|------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|-------------------------------------------------------------------------|
| 10.12               |       |                   | Standard  Form of Agreement between Owner and Designer — Lump Sum dated  September 28, 2005 by and between Fagen, Inc. and Heron Lake  BioEnergy, LLC†                               |                                             | Exhibit 10.12  of the Company’s 2008 Registration Statement.  |   |
| 10.13               |       |                   | Distiller’s  Grain Marketing Agreement dated October 5, 2005 by and between Heron  Lake BioEnergy, LLC and Commodity Specialist Company as assigned to CHS Inc.  as of August 17, 2007         |                                             | Exhibit 10.13  of the Company’s 2008 Registration Statement.  |   |
| 10.14               |       |                   | Ethanol  Fuel Marketing Agreement dated August 7, 2006 by and between  RPGM, Inc. and Heron Lake BioEnergy, LLC                                                                                     |                                             | Exhibit 10.14  of the Company’s 2008 Registration Statement.  |   |
| 10.15               |       |                   | Letter  Agreement re: Environmental Compliance Support dated March 12, 2007 by  and between Fagen Engineering, LLC Heron Lake BioEnergy, LLC                                                             |                                             | Exhibit 10.  15 of the Company’s 2008 Registration Statement. |   |
| 10.16               |       |                   | Coal  Loading, Transport, and Delivery Agreement effective as of April 1, 2007  by and between Tersteeg Transport Inc. and Heron Lake BioEnergy, LLC                                                     |                                             | Exhibit 10.16  of the Company’s 2008 Registration Statement.  |   |
| 10.17               |       |                   | Coal  Transloading Agreement dated June 1, 2007 by and between Southern  Minnesota Beet Sugar Cooperative and Heron Lake BioEnergy, LLC†                                                            |                                             | Exhibit 10.17  of the Company’s 2008 Registration Statement.  |   |
| 10.18               |       |                   | Master  Coal Purchase and Sale Agreement dated June 1, 2007 by and between  Northern Coal Transport Company and Heron Lake BioEnergy, LLC, including  confirmation letter dated July 13, 2007† |                                             | Exhibit 10.18  of the Company’s 2008 Registration Statement.  |   |
| 10.19               |       |                   | Loan Agreement dated December 28, 2007 by and  between Federated Rural Electric Association and Heron Lake BioEnergy, LLC                                                                                |                                             | Exhibit 10.19 of the Company’s 2008  Registration Statement.  |   |
| 10.20               |       |                   | Secured Promissory Note issued December 28,  2007 by Heron Lake BioEnergy, LLC as borrower to Federated Rural Electric  Association as lender in principal amount of $600,000                            |                                             | Exhibit 10.20 of the Company’s 2008  Registration Statement.  |   |
| 10.21               |       |                   | Security Agreement dated December 28, 2007 by  Heron Lake BioEnergy, LLC in favor of Federated Rural Electric Association                                                                                |                                             | Exhibit 10.21 of the Company’s 2008  Registration Statement.  |   |
| 10.22               |       |                   | Electric  Service Agreement dated October 17, 2007 by and between Interstate Power  and Light Company and Heron Lake BioEnergy, LLC                                                                      |                                             | Exhibit 10.22  of the Company’s 2008 Registration Statement.  |   |
| 10.23               |       |                   | Shared  Savings Contract dated November 16, 2007 by and between Interstate Power  and Light Company and Heron Lake BioEnergy, LLC                                                                        |                                             | Exhibit 10.23  of the Company’s 2008 Registration Statement.  |   |
| 10.24               |       |                   | Escrow  Agreement dated November 16, 2007 by and between Heron Lake BioEnergy,  LLC , Farmers State Bank of Hartland for the benefit of Interstate Power and  Light Company                              |                                             | Exhibit 10.24  of the Company’s 2008 Registration Statement.  |   |
| 10.25               |       |                   | Employment Agreement dated February 1, 2008  by and between Heron Lake BioEnergy, LLC and Robert J. Ferguson *                                                                                           |                                             | Exhibit 10.25 of the Company’s 2008  Registration Statement.  |   |
| 10.26               |       |                   | Services Contract dated March 1, 2007 by and  between Heron Lake BioEnergy, LLC and Gerber & Haugen, P.L.L.P.  relating to the services of James A. Gerber *                                    |                                             | Exhibit 10.26 of the Company’s 2008  Registration Statement.  |   |
| 10.27               |       |                   | Letter Agreement dated February 28, 2008 by  and between Heron Lake BioEnergy, LLC and Gerber & Haugen, P.L.L.P.  relating to the services of James A. Gerber *                                 |                                             | Exhibit 10.27 of the Company’s 2008  Registration Statement.  |   |

 

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Table of Contents

 
| **Exhibit  Number** | ** ** | **Exhibit Title** | ** **                                                                                                                                                                     | **Incorporated by Reference To:** | ** **                                                                          |
|---------------------|------------|------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|-------------------------------------------------------------------------------------|
| 10.28               |       |                   | Compliance Agreement effective January 23,  2007 by and between Heron Lake BioEnergy, LLC and the Minnesota Pollution  Control Agency                                     |                                             | Exhibit 10.28 of the Company’s 2008  Registration Statement.              |   |
| 10.29               |       |                   | Unit Transfer Policy of Heron Lake BioEnergy, LLC  dated November 2008                                                                                                    |                                             | Exhibit 4.1 to Current Report on  Form 8-K dated November 5, 2008.   |   |
| 10.30               |       |                   | Letter Agreement dated November 25, 2008 by  and between Heron Lake BioEnergy, LLC, CFO Systems, LLC and Brett L. Frevert  relating to the services of Brett L. Frevert * |                                             | Exhibit 10.1 to Current Report on  Form 8-K dated November 26, 2008. |   |
| 21.1                |       |                   | Subsidiaries  of the Registrant                                                                                                                                                |                                             | Exhibit 21.2  of the Company’s 2008 Registration Statement.               |   |
| 31.1                |       |                   | Certification of Chief  Executive Officer (principal executive officer) pursuant to  Rules 13a-14(a) and 15d-14(a) of the Exchange Act.                         |                                             | Attached  hereto.                                                                   |   |
| 31.2                |       |                   | Certifications of Chief  Financial Officer (principal financial officer) pursuant to  Rules 13a-14(a) and 15d-14(a) of the Exchange Act.                        |                                             | Attached  hereto.                                                                   |   |
| 32                  |       |                   | Certification pursuant  to 18 U.S.C. § 1350.                                                                                                                              |                                             | Attached  hereto.                                                                   |   |

 

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| *      |   |   | Indicates  compensatory agreement.                                                                                                                                                                                                                                                                                 |
|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| † |   |   | Certain  portions of this exhibit have been redacted and filed on a confidential basis  with the Commission pursuant to a request for confidential treatment under  Rule 24b-2 of under the Exchange Act. Spaces corresponding to the  deleted portions are represented by brackets with asterisks [ * * * ]. |

 

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