Badger State Ethanol 10QSB 2003 Q3 Quarterly report (small business)

UNITED STATES
U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-QSB

ý	QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM             TO
COMMISSION FILE NUMBER: 333-50568

BADGER STATE ETHANOL, LLC

(Exact name of registrant as specified in its charter)

WISCONSIN	39-1996522
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
820 West 17th Street Monroe, Wisconsin 53566
(Address of principal executive offices)
(608) 329-3900
(Issuer’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

As of November 13, 2003, the Company has issued 19,774 Class A membership units.

Transitional Small Business Disclosure Format: Yes o   No ý

BADGER STATE ETHANOL, LLC

FORM 10-QSB QUARTERLY REPORT FOR THE QUARTER ENDED

September 30, 2003

TABLE OF CONTENTS

Part I – Financial Information
	Item 1.		Financial Statements
		Condensed Balance Sheet as of September 30, 2003
		Condensed Statements of Operations and Comprehensive Income for the Three and Nine Months ended September 30, 2003 and 2002
		Condensed Statements of Cash Flows for the Nine Months ended September 30, 2003 and 2002
		Notes to Condensed Financial Statements
	Item 2.		Management’s Discussion and Analysis or Plan of Operations
	Item 3.		Controls and Procedures
Part II - Other Information
	Item 1.		Legal Proceedings
	Item 6.		Exhibits and Reports on Form 8-K
Signatures
Certifications
Exhibits

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

BADGER STATE ETHANOL, LLC

CONDENSED BALANCE SHEET

(Unaudited)

	September 30, 2003
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	2,943,685
Accounts receivable:
Trade	4,023,710
Incentives	138,515
Inventories	1,412,509
Derivative contracts	145,059
Other assets	205,138
Total current assets	8,868,616
PROPERTY AND EQUIPMENT, at cost
Plant buildings and equipment	45,038,568
Land improvements	1,398,917
Office buildings and equipment	464,018
	46,901,503
Less accumulated depreciation and amortization	1,976,329
	44,925,174
OTHER ASSETS	854,616
TOTAL ASSETS	$	54,648,406
LIABILITIES AND MEMBERS’ EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt	$	3,021,800
Accounts payable	1,938,982
Accrued and other liabilities	1,252,207
Total current liabilities	6,212,989
LONG-TERM DEBT, less current maturities	24,817,318
COMMITMENTS AND CONTINGENCIES	—
MEMBERS’ EQUITY
Member contributions	17,859,787
Retained earnings	5,758,312
	23,618,099
TOTAL LIABILITIES AND MEMBERS’ EQUITY	$	54,648,406

The accompanying notes are an integral part of this statement.

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BADGER STATE ETHANOL, LLC

CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

	Three months ended						Nine months ended
	September 30, 2003			September 30, 2002			September 30, 2003			September 30, 2002
Sales and revenues	$	18,297,066		$	—		$	55,945,878		$	—
Cost of sales	14,222,014			—			43,654,410			—
Gross margin	4,075,052			—			12,291,468			—
Selling, general and administrative expenses	673,634			512,390			1,935,454			875,243
Operating income (loss)	3,401,418			(512,390		)	10,356,014			(875,243		)
Interest expense	(449,274		)	—			(1,461,334		)	—
Interest income	2,383			—			3,647			6,521
Net income (loss)	$	2,954,527		$	(512,390	)	$	8,898,327		$	(868,722	)
Unrealized gain on cash flow hedges	—			1,073,029			—			1,593,992
Comprehensive income	$	2,954,527		$	560,639		$	8,898,327		$	725,270
Net income (loss) per unit – basic and diluted	$	149.41		$	(25.91	)	$	450.00		$	(43.93	)
Weighted average units outstanding	19,774			19,774			19,774			19,774

The accompanying notes are an integral part of these statements.

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BADGER STATE ETHANOL, LLC

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended September 30, 2003			Nine months ended September 30, 2002
Cash flows from operating activities
Net income (loss)	$	8,898,327		$	(868,722	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Depreciation and amortization	1,664,515			1,491
Other	—			1,223
Changes in operating assets and liabilities:
Accounts receivable	(745,844		)	9,298
Inventories	338,734			(113,726		)
Derivative contracts	(145,059		)	(233,487		)
Other assets	476,879			(714,749		)
Accounts payable	30,363			106,106
Accrued and other liabilities	(170,700		)	27,430
Net cash provided by (used in) operating activities	10,347,215			(1,785,136		)
Cash flows from investing activities
Cost of property and equipment	(466,474		)	(26,524,403		)
Cash flows from financing activities
Net change in line of credit	(1,747,980		)	—
Payments of financing fees	(306,000		)	(17,649		)
Proceeds from long-term debt financing	927,882			23,209,925
Payments on long-term debt financing	(6,403,324		)	—
Net cash provided (used in) by financing activities	(7,529,422		)	23,192,276
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	2,351,319			(5,117,263		)
Cash and cash equivalents at beginning of period	592,366			5,199,146
Cash and cash equivalents at end of period	$	2,943,685		$	81,883
Supplemental disclosure of cash flow information:
Interest paid	$	1,463,788		$	—
Supplemental disclosure of noncash operating, investing and financing activities:
Construction payable for construction in progress	$	—		$	3,048,300
Accumulated other comprehensive income	—			1,593,992
Capitalized interest related to long-term debt	—			620,744

The accompanying notes are an integral part of these statements.

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BADGER STATE ETHANOL, LLC

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2003

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Badger State Ethanol, LLC (the “Company”) was formed May 11, 2000 and operates a 40 million gallon ethanol plant in Wisconsin.  The plant began operations in October 2002.  The Company sells its production of ethanol and related by-products domestically and operates in one business segment.

The accompanying unaudited condensed financial statements as of September 30, 2003 and for the three and nine months ended September 30, 2003 and 2002 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  These financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended December 31, 2002, contained in the Company’s annual report on Form 10-KSB for 2002.

In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods indicated.  The results of operations for the three and nine months ended September 30, 2003 are not necessarily indicative of the results expected for the full year.

NOTE B - INVENTORIES

Inventories consist of the following at September 30, 2003:

Raw materials	$	743,277
Work-in-process	299,875
Finished goods	369,357
Total inventories	$	1,412,509

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NOTE C – DERIVATIVE INSTRUMENTS

The Company enters into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn and natural gas purchases, forward corn purchase contracts and forecasted ethanol sales.  The Company does not typically enter into derivative instruments other than for hedging purposes.  All derivative contracts are recognized on the September 30, 2003 balance sheet at their fair market value.

On the date the derivative instrument is entered into, the Company will designate the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge) or (3) will not designate the derivative as a hedge.  Changes in the fair value of a derivative that is designated as and meets all the required criteria for a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings.  Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings.  Changes in the fair value of a derivative that is not designated as a hedge are recorded in current period earnings.

At September 30, 2003 no derivative contracts were designated as hedges and all changes in market value have been recognized through cost of sales.  The Company has recorded an increase to cost of sales of $117,857 and $982,862 related to its derivative contracts for the three and nine months ended September 30, 2003.

NOTE D – GOVERNMENT INCENTIVE PAYMENTS

The Company recognizes revenue from federal and state incentive payments when all requirements of the program have been met and payments are assured.  The Company has recorded revenue of $1,632,292 related to incentive payments received under the State of Wisconsin Producer Subsidy Payment program for the nine months ended September 30, 2003.  The Company has recorded revenue of $2,025,000 and $7,500,000 related to incentive payments under the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program for the three and nine months ended September 30, 2003.

NOTE E - RELATED PARTIES

The Company’s general contractor and a subcontractor are members of the Company and have representatives on the Company’s Board of Directors.  The subcontractor also has the exclusive rights to market the Company’s distillers grains.  Sales for the three and nine months ended September 30, 2003 to the subcontractor were $2,708,502 and $7,960,841 and trade accounts receivable at September 30, 2003 were $287,140.

The Company’s sole ethanol marketing company is a member and has a representative on the Company’s Board of Directors.  Sales for the three and nine months ended September 30, 2003 to the member were $13,499,909 and $38,099,550 and trade accounts receivable at September 30, 2003 were $3,730,137.

NOTE F – RECLASSIFICATIONS

Certain reclassifications have been made to the September 30, 2002 financial statements to conform to the presentation used in the September 30, 2003 financial statements.

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Item 2. Management’s Discussion and Analysis or Plan of Operations

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements.  In addition, we may make forward-looking statements orally in the future by or on behalf of the Company. We undertake no responsibility to update any forward-looking statement.  When used, the words “believe,” “expect,” “will,” “can,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements.  Readers should not place undue reliance on any forward-looking statements and recognize that the statements are not predictions of actual future results.  Actual results could and likely will differ materially from those anticipated in the forward-looking statements due to risks and uncertainties.  These risks and uncertainties include, without limitation, the following and those business risks and factors described elsewhere in this report or our other Securities and Exchange Commission filings, our assumptions concerning financing requirements and future operations, changes in state and federal ethanol subsidies, our need for additional capital, our ability to manufacture our products on a commercial scale and in compliance with regulatory requirements, increased competition, and changes in government regulation.

RISK FACTORS

RISKS RELATED TO OUR FORMATION AND FINANCING PLAN

We are recently formed.

We are a start-up business venture, with a limited history of operations.  There can be no assurance that we will be able to operate profitably.

We have incurred substantial debt and debt service requirements.

We have incurred substantial debt to implement our business plan. Therefore, we have substantial debt and debt service requirements.  Since our capital structure will be highly leveraged, the amount of debt we have incurred will have important consequences including:

•Our ability to borrow additional amounts for working capital, capital expenditures and other purposes will be limited or may not be available on terms favorable to us or at all;

•A substantial portion of our cash flows from operations will be used to pay interest and principal on our debt, which will reduce the funds that would otherwise be available to us for our operations and future business opportunities;

•We will be vulnerable to increases in prevailing interest rates;

•We may be substantially more leveraged than some of our competitors, which may place us at a competitive disadvantage;

•Our indebtedness is expected to be secured by all or substantially all of our assets, which means that there will be virtually no assets left for unit holders in the event of a liquidation; and

•Our substantial degree of leverage may limit our flexibility to adjust to changing market conditions, reduce our ability to withstand competitive pressures and make us more vulnerable to a downturn in general economic conditions or our business.

To service our debt, we will require a significant amount of cash and our ability to generate cash depends on many factors.

Our ability to repay our debt will depend on our financial and operating performance and on our ability to successfully implement our business strategy. We cannot assure you that we will be successful in implementing our strategy or in realizing our anticipated financial results. Our financial and operational performance depends on

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numerous factors including prevailing economic conditions and on certain financial, business and other factors beyond our control. We cannot assure you that our cash flows and capital resources will be sufficient to repay our anticipated debt obligations. In the event that we are unable to pay our debt service obligations, we may be forced to reduce or eliminate distributions or capital expenditures. We could be forced to sell assets, obtain additional equity capital or refinance or restructure all or a portion of our debt. In the event that we are unable to refinance our indebtedness or raise funds through asset sales, sales of equity or otherwise, our business would be adversely affected.

Our debt financing contains numerous covenants, in which a breach may result in default.

Our debt obligations contain a number of significant covenants. These covenants limit our ability to, among other things:

•Incur additional indebtedness;

•Make capital expenditures in excess of prescribed thresholds;

•Make distributions to our unit holders, redeem or repurchase our units;

•Make various investments;

•Create liens on our assets;

•Utilize asset sale proceeds;

•Merge or consolidate or dispose of all or substantially all of our assets.

A breach of any of these covenants could result in default under our debt agreements. If we default on any of these covenants, and if not waived, a lender could rightfully accelerate our indebtedness, in which case the debt would become immediately due and payable. If this occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it. Even if new financing is available, it may not be on terms that are acceptable to us.  This could cause us to cease operations.

RISKS RELATED TO DEVELOPMENT

We are heavily dependent upon the services that Fagen, Inc. (“Fagen”), ICM Marketing, Inc. (“ICM”) and Murex, N.A., Ltd. (“Murex”) are providing. Without these services, we would not have been able to build our ethanol plant.  Representatives of Fagen, ICM and Murex are members of the Company, serve on our Board of Directors, and have been involved in nearly all aspects of our formation, capital raising and operation to date.  Consequently, the terms of our agreements and understandings with Fagen, ICM and Murex have not been negotiated at arm’s length, and therefore, there is no assurance that our arrangements with them are as favorable to us as those we could have obtained from unaffiliated third parties. Because of Fagen’s, ICM’s and Murex’s role in this project, and their current representation on our Board of Directors, it could be difficult or impossible to enforce claims that we may have against these parties if, for example, one or all of them breaches agreements or understandings with us.

We are dependent on a development agreement with the City of Monroe, Wisconsin.

We have entered into a development agreement with the City of Monroe, Wisconsin, to construct the ethanol plant and for site improvements.  As part of the agreement, we have on-going obligations, including representing that the fair market value of the site will not be less than $10 million, or pay a nonperformance penalty not to exceed $280,000 per year and repaying up to $1.6 million of the City of Monroe’s tax incremental financing for site improvements through regular property tax assessments.  In connection with the agreement, we delivered a mortgage to the City of Monroe.  The mortgage secures our performance under the agreement.

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RISKS RELATED TO ETHANOL PRODUCTION

Federal regulations and tax incentives concerning ethanol could expire or change, which could harm our business.

Congress currently provides certain federal tax incentives for oxygenated fuel producers and marketers, including those who purchase ethanol to blend with gasoline in order to meet federally mandated oxygenated fuel requirements. These tax incentives include, generally, an excise tax exemption from the federal excise tax on gasoline blended with at least 10 percent, 7.7 percent, or 5.7 percent ethanol, and income tax credits for blenders of ethanol mixtures and small ethanol producers. The ethanol industry depends on continuation of the federal ethanol subsidy. Without this subsidy, ethanol production could fall to near zero in Wisconsin and the nation. The federal subsidies and tax incentives are scheduled to expire September 30, 2007. Although these subsidies and tax incentives have been continued beyond their original and rescheduled expiration dates in the past, there can be no assurance that the federal subsidies and tax incentives to the ethanol industry continue beyond their scheduled expiration date or, if they continue, the incentives would continue at the same level. The elimination or reduction of the federal subsidy and tax incentives to the ethanol industry would have a material adverse impact on our business.

Additionally, Congress provides an ethanol production incentive through the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program.  This program provides a one time payment on any increase in ethanol production by qualifying ethanol plants.  The elimination or reduction of this federal incentive to the ethanol industry would have a material adverse impact on our business.

Wisconsin state producer incentive payment may not be available or could be modified which could harm our business.

Under the Wisconsin ethanol producer incentive program (the “Ethanol Incentive Program”), the State of Wisconsin authorized the payment to certain ethanol producers of $0.20 per gallon for up to 15,000,000 gallons of ethanol produced in Wisconsin in each 12 month period.  The payments are prorated if the State of Wisconsin has insufficient funds to pay all eligible ethanol producers $0.20 per gallon.  A Wisconsin ethanol producer will be eligible for the payments if it has been producing ethanol in Wisconsin for fewer than 60 months, it produces more than 10,000,000 gallons of ethanol a year and it purchases the corn or other substances from which the ethanol is produced from Wisconsin sources. The maximum subsidy statutorily available to an ethanol producer under this program is $3,000,000 annually. We have applied with the Wisconsin Department of Agriculture, Trade and Consumer Protection to qualify for the statutory maximum of these ethanol producer payments. Additionally, if another ethanol plant came online and produced 10 million gallons of ethanol, it could qualify for the producer payment which would reduce the funds available to us.

The recently passed Wisconsin state budget only allocated $1,900,000 to the Ethanol Incentive Program.  Therefore, assuming the legislature does not increase, reduce or eliminate the funds available under this program, the $1,900,000 million will be prorated between the qualifying ethanol plants in Wisconsin, including ours.  It is our belief that the maximum the Company will be eligible to receive under this program will be approximately $633,000; however, other ethanol plants could begin operations in the next year which would reduce the funds available to us.  The Wisconsin legislature could reduce or eliminate these payments at any time. We intend to partially collateralize a substantial portion of our subordinated debt financing with these payments, and therefore, if these payments were eliminated or reduced, it would be very damaging to our business and prospects.

Operating our ethanol plant may require additional capital.

The processing of corn into ethanol and the marketing of ethanol and its byproducts are capital intensive and require substantial amounts of cash reserves. We may not generate sufficient operating cash to meet these capital requirements. We could need additional financing in order to compete in the ethanol industry. This financing will be senior in priority to the equity of investors, and we could be subject to restrictive covenants that could restrict our ability to pay cash distributions or limit our ability to grow our business by issuing additional securities or debt. If we obtain additional financing by issuing additional units, our members would suffer dilution of their units, which would reduce the value of their units. There can be no assurance that additional financing would be available if

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required or, if available, that it would be on terms acceptable to us. If future financing were unavailable for any reason, we may be forced to discontinue operations.

The ethanol industry is very competitive.

The ethanol industry continues to grow and there is significant competition among ethanol producers. Nationally, ethanol production is concentrated in a few large companies. Investors should understand that we face a competitive challenge from larger ethanol plants, from ethanol plants that can produce a wider range of products than our ethanol plant, and from other ethanol plants similar to our ethanol plant.  Furthermore, we will be in direct competition with other ethanol producers, many of which have greater resources than we currently have or will have in the future. Large ethanol producers such as Archer Daniels Midland and Cargill, among others, are capable of producing significantly greater quantities than the amount of ethanol we expect to produce. In addition, there are several Wisconsin, Minnesota and other Midwestern regional ethanol producers which have recently formed, are in the process of forming, or are under consideration, which are or would be of a similar size and have similar resources to us.

We will also compete with producers of other gasoline additives having similar octane and oxygenate values as ethanol, such as producers of methyl tertiary butyl ether (“MTBE”), a petrochemical derived from methanol which costs less to produce than ethanol. Many major oil companies produce MTBE and because it is petroleum-based, its use is strongly supported by major oil companies. Alternative fuels, gasoline oxygenates and alternative ethanol production methods are also continually under development. The major oil companies have significantly greater resources than we have to market MTBE, to develop alternative products, and to influence legislation and public perception of MTBE and ethanol. These companies also have sufficient resources to begin production of ethanol should they choose to do so.

To produce ethanol we intend to purchase significant amounts of corn that is subject to disease and other risks.

Ethanol production at our facility will require corn. Corn, as with most other crops, is affected by weather conditions. A significant reduction in the quantity of corn harvested due to adverse weather conditions, disease or other factors could result in increased corn costs with adverse financial consequences to us. Significant variations in actual growing conditions from normal growing conditions may adversely affect our ability to procure corn for the plant. We also have no definitive agreements with any corn producers to provide corn to the ethanol plant.

The price of corn is influenced by general economic, market and government factors. These factors include weather conditions, farmer planting decisions, domestic and foreign government farm programs and policies, global demand and supply. Changes in the price of corn can significantly affect our business. Generally, rising corn prices produce lower profit margins and therefore represent unfavorable market conditions. This is especially true if market conditions do not allow us to pass along increased corn costs to our customers. The price of corn has fluctuated significantly in the past and may fluctuate significantly in the future. We can not assure that we will be able to offset any increase in the price of corn by increasing the price of our products. If we cannot offset increases in the price of corn, our financial performance may be materially and adversely effected.

To produce ethanol, we will need a significant supply of water.

Water supply and water quality are important requirements to produce ethanol. To satisfy our water needs, we have drilled one 500,000 gallon-per-day well on the property.

We expect that the well will provide all of the water that we will need to operate the ethanol plant, but our estimates regarding water needs or the water available from the well on the property could be understated and we could need additional water. If we need more water, we will be forced to find other sources and this could require us to spend additional capital which could harm our business and its prospects. Further, there can be no assurance that we will be able to find alternate sources of water at commercially reasonable prices, or at all.

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Interruptions in our supply of energy could have a material adverse impact on our business.

Ethanol production also requires a constant and consistent supply of energy into the ethanol plant. If there is any interruption in our supply of energy for whatever reason, such as supply, delivery or mechanical problems, we may be required to halt production. If production is halted for any extended period of time, it will have a material adverse effect on our business. We have contracted with gas and electric utilities to provide our needed energy, but there can be no assurance that those utilities will be able to reliably supply the gas and electricity that we need. If we were to suffer interruptions in our energy supply, our business would be harmed.

Our success will depend on hiring and retaining key personnel.

Our success will depend in part on our ability to attract and retain competent personnel who will be able to help us achieve our goals. We must hire and retain qualified managers, accounting, human resources and other personnel to staff our business.  If we are unsuccessful in hiring and retaining productive and competent personnel, our business could be harmed.

We are subject to extensive environmental regulation.

Ethanol production involves the emission of various airborne pollutants, including particulate (PM₁₀), carbon monoxide (CO), oxides of nitrogen (N0x) and volatile organic compounds. To operate the ethanol plant, we have obtained permits from the State of Wisconsin. Wisconsin authorities could impose additional conditions or other restrictions that could harm our business.

We are also subject to regulations on emissions from the United States Environmental Protection Agency (“EPA”) as more fully described herein in the section entitled Regulatory Permits. Additionally, EPA and Wisconsin’s environmental regulations are subject to change and often such changes are not favorable to industry. We also could be subject to environmental nuisance or related claims by employees or property owners or residents in the vicinity of the ethanol plant arising from air or water discharges or other reasons. Ethanol production has been known to produce an unpleasant odor to which surrounding residents could object. Claims or increased environmental compliance costs could harm our business.

Ethanol production is energy intensive, and we will need significant amounts of electricity and natural gas.

We have engaged U.S. Energy Services, Inc. to help us manage our natural gas needs and to assist us in negotiating agreements to purchase natural gas.  We purchase electricity from Alliant Energy Company but have not entered into any agreement.  In addition, natural gas and electricity prices have historically fluctuated significantly. Increases in the price of natural gas or electricity would harm our business by increasing our energy costs.

Our business is not diversified.

Our success depends largely upon our ability to profitably operate our ethanol plant. We do not have any other lines of business or other sources of revenue if we are unable to operate our ethanol plant.

We established an output contract with only one distributor, Murex, N.A., who will purchase all of the ethanol we produce; we contracted only with ICM Marketing, Inc. for the marketing and distribution of our feed products.

We will sell all of the ethanol we produce to one distributor, Murex, N.A., pursuant to an output contract. As a result, we are dependent on one distributor to sell our ethanol. If this distributor breaches our output contract or is not in the financial position to purchase all of the ethanol we produce, we will not have any readily available means to sell our ethanol and our financial performance will be adversely and materially effected. Our financial performance is dependent upon the financial health of the distributor we contract with.

We only contracted with ICM Marketing for the marketing and distribution of our feed products. We rely solely upon ICM Marketing to market and distribute our feed products. This is not an output contract and ICM Marketing

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will only purchase that portion of our feed products that they are able to sell. If ICM Marketing is unable to sell any portion of the feed products we produce, we will be left with feed products that must be disposed of. This may have a material adverse impact on our financial performance.

Further, ICM Marketing may also have different agreements with respect to compensation in their agreements with other entities that produce the same products that we do.  It is possible that ICM’s ability or willingness to perform on our behalf could be impaired by the financial agreements that they may have with other entities not related to us.

Our operating results could fluctuate.

Our quarterly operating results could fluctuate significantly in the future as a result of a variety of factors many of which are outside our control. These factors include:

•Weather, supply and demand and other variables affecting the price and supply of corn;

•Changes in interest rates and availability of credit;

•Reliability and construction quality of the ethanol plant to permit it to operate at a level that we expect;

•Legislative changes in policy at the federal or state level concerning ethanol and gasoline additives to reduce emissions;

•Amount and timing of capital expenditures and other costs relating to maintenance or expansion of our operations;

•Technical difficulties in operating the ethanol plant;

•New products and new plants from ethanol producers or oil companies; and

•General economic conditions, or economic events specific to agriculture, oil or automobile markets.

As a result of these factors, and other described risk factors, our operating results for any particular quarter may not be indicative of future operating results and you should not rely on them as indications of our future performance.

Application of Critical Accounting Policies

Accounting policies, methods and estimates are an integral part of our financial statements and are based upon management’s current judgments. Certain accounting policies, methods and estimates are particularly important because of their significance to the financial statements. Note A of the Notes to Financial Statements included in this Form 10-QSB includes a summary of the more significant accounting policies and methods we use. The following is a discussion of what we believe to be the most critical of these policies and methods.

Inventories

Inventories are stated at the lower of cost or net realizable value. Estimates are used in determining the net realizable value of our inventories. These estimates include the measurement of inventories in bins, other storage facilities and in production, which use formulas in addition to actual measurements taken to arrive at appropriate quantities.

Derivatives

We enter into exchange-traded commodity futures and options contracts to hedge exposure to price fluctuations on grain, natural gas and ethanol transactions to the extent considered practicable for minimizing risk. We do not use derivatives for speculative purposes. Futures and options contracts used for hedging are purchased and sold through regulated commodity exchanges. Fluctuations in inventory valuations, however, may not be completely hedged, due to our assessment of exposure from expected price fluctuations. We also manage risk by entering into fixed price purchase contracts and establishing appropriate limits with pre-approved grain elevators. We are exposed to loss in the event of nonperformance by the counterparties to the contracts. However, we do not anticipate nonperformance

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by counterparties. The fair value of futures and options contracts are determined primarily from quotes listed on regulated commodity exchanges. Fixed price purchase contracts are with various counterparties, and the fair values of such contracts are determined from the market price of the underlying product.

Our derivative contracts are recorded in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. At September 30, 2003, none of our derivative contracts are designated as hedges as defined within SFAS No. 133 for the purpose of applying hedge accounting. Accordingly, all the Company’s derivative contracts at September 30, 2003 are recorded at fair market value with changes in the fair value of the derivatives recorded in current period earnings.

Overview

We are engaged in the production and sale of fuel grade ethanol.  We have an annual capacity to process approximately 14.4 million bushels of corn into approximately 40 million gallons of ethanol.  In addition, we sell distillers grains, a principal by-product of the ethanol-production process, which we sell as distillers modified wet grains and distillers dried grains.

During fiscal 2002, we completed construction of the plant, negotiated for the conversion our construction loan to a term mortgage (which was finalized on January 1, 2003), successfully began plant production, passed performance tests, established our marketing presence and established our flexibility in the delivery of products and improved operational efficiencies.  At the same time, we established a risk management strategy that helped us to reduce the effects of the volatility of the commodity markets that affect our industry.

Plan of Operation for the Next 12 Months

We expect to spend the next 12 months operating our ethanol plant.  We expect to have sufficient cash available to cover our costs over the next 12 months, including staffing, office, audit, legal, compliance costs and working capital costs.  The following is our estimate of our costs and expenditures for the next 12 months.  It is only an estimate and our actual expenses could be much higher due to a variety of factors described in this report under the section entitled “Risk Factors.”

Insurance	$	462,000
Selling, General and Administrative	$	5,219,296
Principal and Interest	$	4,510,000
Production	$	54,961,646
Total	$	65,152,942

We anticipate spending approximately $65.2 million over the next 12 months.  Of that amount, we estimate that we will spend approximately: (i) $462,000 on directors and officers’ insurance, general commercial liability, worker’s compensation and property insurance; (ii) $5,219,296 on selling, general and administrative expenses, including management salaries, out-of-pocket reimbursements and general office expenses; and (iii) $4,510,000 on principal and interest payments.

We intend to hire staff only as needed for the direct operations and administration of our ethanol business, such as production, shipping, and receiving.  We currently employ one individual to make sales of distillers grains to the local market.  We intend to rely on third-party marketing arrangements, and pay commissions to marketing agents to market and sell our products.

We expect to fund our costs and expenditures for the next 12 months using cash flow from continuing operations, drawing on our existing lines of credit and receiving cash supports from the State of Wisconsin under the Producer Subsidy Payment Program and federal incentive payments under the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program.

Our primary raw material is corn. Operation of our ethanol production facility requires the purchase of corn, and the sale of fuel-grade ethanol. Accordingly, assuming ongoing operations, we are naturally “short” on grain and “long”

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on fuel ethanol.  We have continued our Grain Risk Management Program.  This program’s stated objective is to stabilize our cost of grain and to generate more predictable margins.

Our Grain Risk Management Program is intended to use grain purchase contracts together with grain futures derivatives to fix the cost of some of our expected future grain purchases.  Our policy allows for the use of fixed price forward purchase contracts, un-priced forward basis purchase contracts, and Chicago Board of Trade (CBOT) derivative contracts (over-the-counter and traditional options).  We have approximately 40% of our next 12 months total grain requirements hedged through a combination of fixed price forward purchase contracts, and CBOT traditional and over-the-counter option hedges to protect our cost of grain.  Under our program, all components of the positions are monitored and all hedges are designated against future grain requirements to ensure that we do not enter into commitments or derivatives for grain in excess of expected grain requirements.  The Company has recorded an increase to cost of sales of $117,857 and $982,862 related to its derivative contracts for the three and nine months ended September 30, 2003.

Grain markets continued to be volatile during the first nine months of 2003, and there continues to be much uncertainty in the grain markets due in part to growing conditions that steadily worsened as the crop year progressed, as well as due to the import and export activities of China.  As always, weather, exports, government programs, and other factors all have potentially major impacts on grain pricing, and any unexpected changes in those factors could adversely affect the price that we pay for our grain.  As of October 15, 2003, we had hedged or purchased approximately 9.5 million bushels or 41% of our anticipated corn requirements for the upcoming 12 months.  Furthermore, substantially higher soybean prices have helped the Company improve its sales of dried distiller’s dried grains.

During 2003, we also maintained a Fuel Ethanol Risk Management Program.  The program’s stated objectives are to stabilize our sales price of fuel ethanol, and to generate more predictable margins.  Part of this program involves un-priced forward contracts to sell portions of our fuel ethanol output to customers with variable prices that are tied directly to the price of unleaded gasoline as quoted on national exchanges.  We may use derivative contracts to fix the price under the forward contract.

Under this program, we do not enter into forward sales commitments in excess of expected fuel ethanol output, and we only enter into gasoline derivatives to the extent that we have un-priced forward sales contracts with customers with variable pricing arrangements that are tied to the price of gasoline as quoted on national exchanges.  We have currently sold approximately 25%of our fuel ethanol output under the above-described program for the last three months of 2003.

Our risk management also includes the oversight of purchases of natural gas needed to produce steam to run the plants, and fuel to fire the distillers grain dryers.  We require a substantial uninterrupted supply of natural gas to maintain continuous production.  Consequently, we contracted with WE Energies for firm service natural gas delivery and with US Energies to coordinate purchase and delivery of the gas to the plant.  However, due to the competitive nature of the natural gas market, we believe no significant risk of long-term interruption exists.  Natural gas prices have declined from early highs due to an unseasonably cool summer on the East Coast and larger than anticipated inventories.  We have purchased approximately 85% of our natural gas requirements for the last three months of 2003, and approximately 70% of our natural gas requirements for the first three months of 2004, through cash contract arrangements.

Liquidity and Capital Resources

As of September 30, 2003, we had cash and cash equivalents of $2,943,685, current assets of $8,868,616 and available unused lines of credit of $3,500,000.  In October 2002, we completed the construction of our plant and began operations.  During the first nine months of 2003, cash provided by operating activities was $10,347,215, payment for financing activities, including repayment of long-term debt, was $7,529,422 and cash paid for property and equipment was $466,474.

As of September 30, 2003, our indebtedness and lines of credit consisted primarily of the following:

•$24,453,698 term loan due January 1, 2008;

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•$3,313,049 electric utility note payable due November 1, 2007; and

•no amount outstanding on the line of credit expiring August 25, 2004.

In August 2001, we entered into a $30.6 million construction loan facility with First National Bank of Omaha.  Effective as of January 1, 2003, this construction loan was converted into a $30.6 million term loan.  Quarterly payments, including principal and interest, of $1,021,839 began on April 1, 2003 based upon a five-year amortization with a balloon payment due on the maturity date of January 1, 2008.  The term loan is structured as three notes and interest accrues monthly on the notes at both fixed and variable rates.  The fixed rate will accrue at 6.528% on $15,300,000 of the term loan and the variable rate will accrue on $15,300,000 of the term loan based on the prime rate (effective rate of 5.00% at September 30, 2003).  The amount outstanding on the term loan was $24,453,698 at September 30, 2003.  The term loan is secured by substantially all of our assets and contains various restrictions, including the maintenance of certain financial covenants.

On August 22, 2001, we entered into a subordinated credit facility of $3.6 million from Alliant Energy – Wisconsin Power and Light Company to finance the electrical infrastructure and other construction needs.  This credit facility was converted to a term note upon completion of construction of our facility.  Monthly payments, including principal and interest, of $34,762 began November 1, 2002 based upon a ten-year amortization with a balloon payment due on the maturity date of November 1, 2007.   Interest accrues monthly on the loan at 3%.  The amount outstanding on the electric utility note payable is $3,313,049 at September 30, 2003.  The electric utility note payable is secured by our equipment, inventory and a guarantee by the City of Monroe, and contains various restrictions.

In connection with our construction loan, we entered into a $3,500,000 364 day revolving line of credit with First National Bank of Omaha.  The revolving line of credit is limited to the borrowing base collateral, which is based upon 75% of the value of the inventory and allowable accounts receivable, and has a variable interest rate based upon the prime rate.  There was no amount outstanding on the revolving line of credit as of September 30, 2003.  The revolving line of credit is secured by substantially all of our assets and contains various restrictions.  This revolving line of credit was renewed on August 28, 2003, on substantially the same terms as the previous line of credit, with an expiration date of August 25, 2004.

Our gross margin on sales of $18,297,066 for the quarter ended September 30, 2003 was positively impacted by recognition in revenue of the United States Department of Agriculture subsidy payment. We expect our margins to improve in 2003 and 2004 as the plant is expected to operate at or near full capacity.  Gross margin on ethanol sales is highly dependent on the cost of corn and natural gas, our hedging contracts and the sales price of ethanol and will fluctuate from quarter to quarter. The sales price of ethanol is volatile, but tends to vary with the wholesale price of gasoline.  Corn prices generally vary with regional grain supplies, and can be significantly affected by weather, storage, planting and carryout projections, government loan programs, exports, and other national and international market conditions.

Webelieve that state and federal government subsidies will continue to have a positive impact on our gross margin in 2003.  For the nine months ended September 30, 2003, we recorded revenue of $1,632,292 related to incentive payments received under the State of Wisconsin Ethanol Incentive Program, and we recorded revenue of $7,500,000 related to incentive payments, $138,515 of which amount has yet to be received under the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program.  The incentive payments received under the State of Wisconsin Ethanol Incentive Program are part of a five year incentive program for which we will be eligible to receive payments, subject to the availability of funding from the State of Wisconsin, for four more years.  The recently passed Wisconsin state budget allocated $1,900,000 to the Ethanol Incentive Program.  Therefore, assuming the legislature does not increase, reduce or eliminate the funds available under this program, the $1,900,000 million will be prorated between the qualifying ethanol plants in Wisconsin, including ours.  It is our belief that the maximum the Company will be eligible to receive under this program will be approximately $633,000; however, other ethanol plants could begin operations in the next year which would reduce the funds available to us.

The incentive payments to be received under the United States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program are one time payments on any increase in ethanol production by us.  Therefore, the $7,500,000 recognized as revenue by us is a one time payment based on the Company increasing its production of ethanol from zero to its current production.  We will only receive additional incentive payments from the United

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States Department of Agriculture Commodity Credit Corporation’s Bioenergy Program if we increase our ethanol production over our current production and such program is still in place and funded.

Regulatory Permits

RMT Inc., an environmental consulting firm in Brookfield, Wisconsin, assisted us in obtaining an Air Pollution Construction and Operation Permit, a Storm Water Discharge Permit and Storm Water Pollution Prevention Plan and advised us on environmental compliance generally.  We also obtained various other environmental and operating permits, as discussed below.

The Department of Natural Resources has prepared an environmental assessment on the construction of the ethanol plant, which was made available to the public for comment on February 19, 2001.  The environmental assessment is a public report that reviews and analyzes the environmental impact that the ethanol plant may have on the surrounding area.  We are aware that, in the past, several individuals have voiced objections to our business to the Wisconsin Department of Natural Resources, however, we have met no significant opposition from the public in our efforts.  Public objection and complaints could arise, however, and subject us to greater regulatory scrutiny, claims and costly compliance expenditures.

Air Pollution Construction and Operation Permit

Our facility is considered a Wisconsin synthetic minor source of regulated air pollutants.  The types of regulated pollutants that may be found at our plant include, particulate matter, carbon monoxide, oxides of nitrogen, volatile organic compounds and sulfur dioxide.  To emit these agents during construction, we needed an Air Pollution Construction Permit.  We received the Air Pollution Construction Permit on March 22, 2001.  The permit was originally valid for a period of 28 months from the date of grant and was extended on June 25, 2003, until May 29, 2005.

On October 31, 2001, we submitted a Modified Air Permit Application to reflect a change in our plant design regarding emissions.  Our original plant design contemplated routing the boiler exhaust through dryers and then to a water scrubber for air pollution control on the distillers dried grains dryer emissions, and then to a common stack.  In our new plant design, we proposed to utilize a thermal oxidizer for emissions control rather than rely on the water scrubber.  The thermal oxidizer reduced emissions from our plant.  We received the approval of this design and our Modified Air Permit Application from the Environmental Protection Agency on March 22, 2002.  The Environmental Protection Agency conducted air emissions testing in April, 2003 and we were awarded an Air Pollution Operation Permit.  We are also in good standing with the Wisconsin Department of Natural Resources Bureau of Air Management.  We have applied for and received permission to add additional emissions control equipment which is expected to be installed and become operational by December 15, 2003, which were successfully completed.  Upon completion of the installation of this equipment, additional air emissions testing will again be required to verify that we are still in compliance.

Wisconsin Pollutant Discharge Elimination Permits

General Permit.  We use approximately 66,500 gallons of water per day to cool our closed circuit systems in the ethanol plant.  We obtained a Wisconsin Pollutant Discharge Elimination System general permit from the Department of Natural Resources to discharge the water into a nearby creek.  We received this permit on July 18, 2002 and it is valid until July 31, 2007.

Storm Water Discharge for Industrial Activities Permit.  Before we could begin operating, we had to obtain a Storm Water Discharge for Industrial Activities Permit from the Department of Natural Resources, which we received on April 9, 2001.  In addition, we also had to prepare a Storm Water Pollution Prevention Plan outlining measures we planned to implement to prevent storm water pollution during operation.

High Capacity Well Permit

We drilled a 500,000-gallon per day well near our ethanol plant.  The Department of Natural Resources considers this a high capacity well, and we have applied for and obtained a high capacity well permit.  The high capacity well

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permit was issued on December 13, 2001.  The permit allows for a maximum daily usage of 720,000 gallons of water per day.

Spill Prevention, Control and Countermeasures Plan

Before we could begin operations, we had to prepare a spill prevention, control and countermeasures plan.  The plan outlines our spill prevention measures for oil products such as ethanol.  The plan was preliminarily reviewed and approved prior to when we began operations, and was certified by a professional engineer on January 3, 2003.

Risk Management Program

We use anhydrous ammonia in our production process.  Therefore, we had to develop a risk management program to address handling and use of the ammonia and gases emitted from such use.  We established a prevention program to prevent spills or leaks of ammonia, and an emergency response program in the event of spills, leaks, explosions or other events that may lead to the release of ammonia into the surrounding area.  We conducted a hazard assessment and prepared models to assess the impact of an ammonia release into the surrounding area.  The program was presented at a public meeting.

EPA; Nuisance

We are subject to the regulations on emissions of the United States Environmental Protection Agency.  Current EPA rules do not require us to obtain any permits or approvals in connection with construction and operation of our business.  Wisconsin and EPA rules can and do change, and any such changes could result in greater regulatory burdens on us.  Our ethanol production will require us to emit a significant amount of carbon dioxide into the air.  Current Wisconsin law regulating emissions does not restrict or prevent us from emitting carbon dioxide gas into the air, but this could change in the future.  We could also be subject to environmental or nuisance claims from adjacent property owners or residents in the area arising from foul smells or other air or water discharges from the plant.  We are aware of recent nuisance claims that have been brought against an ethanol business in Saint Paul, Minnesota.  We believe that among the objectives of this litigation are to force the ethanol manufacturer to upgrade the facility’s emissions control system and possibly pay damages to nearby residents.  We are also aware of neighborhood opposition to our facility.  This opposition could result in claims for nuisance, which could lead to increased compliance costs and monetary damages.

Item 3. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended), as of a date (the “Evaluation Date”) within 90 days before the filing date of this quarterly report, have concluded that our disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that we file with the Securities and Exchange Commission.

Changes in Internal Controls

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the Evaluation Date referred to above.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

On July 13, 2003, we received a Notice of Probable Violation from the U.S. Department of Transportation’s Federal Railroad Administration (the “FRA”) for two alleged violations of regulations applicable to the shipment of hazardous material by rail.  The notice states that on or about November 13, 2002, staff at the Union Pacific terminal in Phoenix, Arizona noticed that a small amount of ethanol (reported as approximately one gallon) had dripped from the internal liquid valve outlet while the rail car was stopped at the terminal.  The notice also alleges that inaccurate information was contained on the tank car’s shipping papers.  We do not believe that we are responsible for this problem and have responded to the FRA and requested a conference in an attempt to reach a solution.  The Company is aware of four other potential violations of regulations applicable to the shipment of ethanol by rail.  We do not believe that these potential violations, either individually or in the aggregate, will have a material effect on our operations or financial performance.

Item 6. Exhibits and Reports on Form 8-K

a.Exhibits

31.1Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b.Reports on Form 8-K

Current Report on Form 8-K, dated October 21, 2003, containing a copy of the Company’s Newsletter.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		BADGER STATE ETHANOL, LLC
Date:	November 13, 2003		By:	/s/ Gary L. Kramer
			Gary L. Kramer
			President and General Manager

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