Heron Lake BioEnergy (HLBYL) 10-Q 2013 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended July 31, 2013

OR

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

For the transition period from                    to                  .

COMMISSION FILE NUMBER 000-51825

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

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

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

(Address of principal executive offices)

(507) 793-0077

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 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.  x  Yes  o  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  xYes  o  No

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

Large accelerated filer  o	Accelerated filer  o
Non-accelerated filer  x (Do not check if a smaller reporting company)	Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o  Yes  x  No

As of September 9, 2013, there were 46,697,107 Class A units and 15,000,000 Class B units issued and outstanding.

INDEX

	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3. Quantitative and Qualitative Disclosures About Market Risk	19
Item 4. Controls and Procedures	19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	20
Item 1A. Risk Factors	20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	20
Item 3. Defaults Upon Senior Securities	20
Item 4. Mine Safety Disclosures	20
Item 5. Other Information	21
Item 6. Exhibits	21
SIGNATURES	22

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	July 31, 2013			October 31, 2012
	(Unaudited)
ASSETS
Current Assets
Cash and equivalents	$	1,022,764		$	653,361
Restricted cash	—			65,259
Restricted certificates of deposit	510,955			650,000
Accounts receivable	3,005,121			1,784,761
Inventory	2,303,157			3,588,572
Prepaid expenses	1,107,025			796,829
Total current assets	7,949,022			7,538,782
Property and Equipment
Land and improvements	9,111,838			9,252,379
Plant buildings and equipment	71,415,804			76,155,846
Vehicles and other equipment	611,976			645,481
Office buildings and equipment	611,826			622,711
Construction in Progress	—			645,486
	81,751,444			87,321,903
Accumulated depreciation	(30,125,670		)	(29,222,617		)
	51,625,774			58,099,286
Other Assets
Other intangibles	235,813			256,513
Debt service deposits and other	942,924			686,438
Total other assets	1,178,737			942,951
Total Assets	$	60,753,533		$	66,581,019

See Notes to Condensed Consolidated Financial Statements

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	July 31, 2013		October 31, 2012
	(Unaudited)
LIABILITIES AND MEMBERS’ EQUITY
Current Liabilities
Line of credit	$	—	$	480,000
Current maturities of revolving line of credit	—		4,211,163
Current maturities of long-term debt	3,008,029		37,840,239
Accounts payable	936,893		2,085,882
Accrued expenses	399,623		382,953
Total current liabilities	4,344,545		45,000,237
Revolving Term Loan, net of current maturities	10,650,377		—
Long-Term Debt, net of current maturities	20,480,986		4,031,335
Members’ Equity
Controlling interest in equity 61,697,107 and 38,622,107 units issued and oustanding at July 31, 2013 and October 31, 2012, respectively	24,902,731		17,344,433
Noncontrolling interest	374,894		205,014
Total members’ equity	25,277,625		17,549,447
Total Liabilities and Members’ Equity	$	60,753,533	$	66,581,019

See Notes to Condensed Consolidated Financial Statements

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

	Three Months			Three Months
	Ended			Ended
	July 31, 2013			July 31, 2012
	(Unaudited)			(Unaudited)
Revenues	$	45,583,441		$	41,908,904
Cost of Goods Sold	41,523,283			39,987,071
Gross Profit	4,060,158			1,921,833
Selling, General, and Administrative Expenses	674,200			714,906
Operating Income	3,385,958			1,206,927
Other Income (Expense)
Interest income	310			2,441
Interest expense	(755,532		)	(653,663		)
Other income	10,925			2,182
Total other expense, net	(744,297		)	(649,040		)
Net Income	2,641,661			557,887
Net Income Attributable to Noncontrolling Interest	(87,168		)	(87,289		)
Net Income Attributable to Heron Lake BioEnergy, LLC	$	2,554,493		$	470,598
Weighted Average Units Outstanding - Basic	38,875,678			38,622,107
Net Income Per Unit - Basic	$	0.07		$	0.01
Weighted Average Units Outstanding - Diluted	42,741,063			38,622,107
Net Income Per Unit - Diluted	$	0.06		$	0.01

See Notes to Condensed Consolidated Financial Statements

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

	Nine Months			Nine Months
	Ended			Ended
	July 31, 2013			July 31, 2012
	(Unaudited)			(Unaudited)
Revenues	$	125,203,672		$	121,956,934
Cost of Goods Sold	119,568,050			118,668,185
Gross Profit	5,635,622			3,288,749
Selling, General, and Administrative Expenses	2,537,919			2,428,646
Settlement Expense	—			900,000
Operating Income (Loss)	3,097,703			(39,897		)
Other Income (Expense)
Interest income	17,063			9,299
Interest expense	(2,254,167		)	(1,943,578		)
Other income	30,198			34,136
Total other expense, net	(2,206,906		)	(1,900,143		)
Net Income (Loss)	890,797			(1,940,040		)
Net Income Attributable to Noncontrolling Interest	(254,999		)	(258,520		)
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC	$	635,798		$	(2,198,560	)
Weighted Average Units Outstanding - Basic	38,706,942			38,472,447
Net Income (Loss) Per Unit - Basic	$	0.02		$	(0.06	)
Weighted Average Units Outstanding - Diluted	40,000,140			38,472,447
Net Income (Loss) Per Unit - Diluted	$	0.02		$	(0.06	)

See Notes to Condensed Consolidated Financial Statements

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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Consolidated Statements of Cash Flows

	Nine Months			Nine Months
	Ended			Ended
	July 31, 2013			July 31, 2012
	(Unaudited)			(Unaudited)
Cash Flow From Operating Activities
Net income (loss)	$	890,797		$	(1,940,040	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	3,034,267			4,277,887
Change in operating assets and liabilities:
Restricted certificates of deposit	139,045			16,000
Accounts receivable	(1,220,360		)	136,566
Inventory	1,285,415			983,514
Prepaid expenses	(312,197		)	223,489
Accounts payable	(1,148,989		)	(2,010,782		)
Accrued expenses	(29,517		)	(38,260		)
Net cash provided by operating activities	2,638,461			1,648,374
Cash Flows from Investing Activities
Capital expenditures	(268,724		)	(2,444,010		)
Proceeds from disposal of property and equipment	3,728,669			—
Net cash provided by (used in) investing activities	3,459,945			(2,444,010		)
Cash Flows from Financing Activities
Payments on line of credit	(480,000		)	—
Proceeds from long-term debt	520,210			—
Proceeds from convertible debt	1,407,000			—
Payments on revolving term loan, net	(11,843,911		)	—
Payments on long-term debt	(2,026,644		)	(5,550,360		)
Release of restricted cash	65,259			257,630
Member contributions	6,922,500			707,017
Cost of raising capital	—			(3,169		)
Distributions to noncontrolling interest	(38,932		)	(72,928		)
Deferred financing fees	(254,485		)
Net cash used in financing activities	(5,729,003		)	(4,661,810		)
Net Increase (Decrease) in cash and equivalents	369,403			(5,457,446		)
Cash and Equivalents - Beginning of period	653,361			7,140,573
Cash and Equivalents - End of period	$	1,022,764		$	1,683,127
Supplemental Disclosure of Cash Flow Information
Interest expense paid	$	2,253,814		$	1,933,499
Supplemental Disclosure of Non-Cash Activities
Cost of raising capital offset against member contributions	$	—		$	165,045
Distribution to noncontrolling interest in accrued expenses	46,187			11,807
Capital expenditures financed with note payable	—			1,325,000
Energy efficiency rebate receivable	—			554,577

See Notes to Condensed Consolidated Financial Statements

5

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

July 31, 2013 (Unaudited)

1.         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and 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 October 31, 2012, contained in the Company’s annual report on Form 10-K.

In the opinion of management, the condensed consolidated interim financial statements reflect all adjustments consisting of normal recurring accruals that we consider necessary to present fairly the Company’s results of operations, financial position and cash flows. The results reported in these condensed consolidated interim financial statements should not be regarded as necessarily indicative of results that may be expected for any other quarter or for the fiscal year.

Nature of Business

The Company owns and operates an ethanol plant near Heron Lake, Minnesota with a permitted capacity of approximately 59.2 million gallons.  In addition, the Company produces and sells distillers grains with solubles and corn oil as co-products of ethanol production.

The Company entered into an asset purchase agreement dated January 22, 2013, which provided for the sale of substantially all of the Company’s assets to, and the assumption of certain of the Company’s liabilities by, Guardian Energy Heron Lake, LLC (Guardian). On April 4, 2013, the Company terminated the agreement in accordance with its terms. As a result of terminating the purchase agreement and the Company renegotiating their loan agreements with AgStar Financial Services, PCA (“AgStar”), AgStar required certain principal paydowns by July 31, 2013. The Company raised all the required funds to pay down its debt to AgStar, to provide adequate working capital to operate the Company effectively and to meet AgStar’s requirements.

Pursuant to an asset purchase agreement dated January 3, 2013, the Company’s subsidiary, Lakefield Farmers Elevator, LLC, sold substantially all of its assets consisting of the elevator and grain storage facilities in Lakefield, Minnesota and Wilder, Minnesota to FCA Co-op, a Minnesota cooperative, for approximately $3.7 million plus the purchase price for corn and fuel inventory (the “Elevator Sale”).  The Elevator Sale closed on February 1, 2013.

Principles of Consolidation

The financial statements include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiaries, Lakefield Farmers Elevator, LLC and HLBE Pipeline Company, LLC, collectively, the “Company.”  HLBE Pipeline Company, LLC owns 73% of Agrinatural Gas, LLC (“Agrinatural”). Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the financial statements of Agrinatural with its consolidated financial statements, with the equity and earnings (loss) attributed to the remaining 27% noncontrolling interest identified separately in the accompanying Consolidated Balance Sheets and Statements of Operations. All significant intercompany balances and transactions are eliminated in consolidation.

Noncontrolling Interest

Amounts recorded as noncontrolling interest on the balance sheet relate to the net investment by an unrelated party in Agrinatural. Income and losses are allocated to the members of Agrinatural based on their respective percentage of membership units held. Agrinatural will provide natural gas to the plant with a specified price per MMBTU for an initial term of 10 years, with two renewal options for five year periods.

Accounting Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  The Company uses estimates and assumptions in accounting for significant matters including, among others, the analysis of impairment of long-lived assets, contingencies and valuation of forward purchase contract

6

commitments and inventory.  The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.

Long-Lived Assets

The Company reviews property, plant and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  If circumstances require a long-lived asset to be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset.  If the carrying value of the long-lived asset is not recoverable on an undiscounted basis, impairment is recognized to the extent the carrying value exceeds fair value.  Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

Fair Value of Financial Instruments

Except for those assets and liabilities which are required by authoritative accounting guidance to be recorded at fair value in our balance sheets, the Company has elected not to record any other assets or liabilities at fair value. No events occurred during the periods ended July 31, 2013 or October 31, 2012 that required adjustment to the recognized balances of assets or liabilities, which are recorded at fair value on a nonrecurring basis.

The carrying value of cash and equivalents, restricted cash, restricted certificates of deposit, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short maturity of these instruments. The fair value of long-term debt has been estimated using discounted cash flow analysis based upon the Company’s current incremental borrowing rates for similar types of financing arrangements. The fair value of outstanding debt will fluctuate with changes in applicable interest rates. Fair value will exceed carrying value when the current market interest rate is lower than the interest rate at which the debt was originally issued. The fair value of a company’s debt is a measure of its current value under present market conditions. It does not impact the financial statements under current accounting rules. The Company believes the carrying amount of the debt approximates the fair value.

Environmental Liabilities

The Company’s operations are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which it operates.  These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its location.  Accordingly, the Company has adopted policies, practices, and procedures in the areas of pollution control, occupational health, and the production, handling, storage and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability that could result from such events.  Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.

Net Income (Loss) per Unit

Basic net income (loss) per unit is computed by dividing net income (loss) by the weighted average number of members’ units outstanding during the period.  Diluted net income per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period.

2.GOING CONCERN

The financial statements have been prepared on a going-concern basis, which contemplates the recoverability of assets and the satisfaction of liabilities in the normal course of business.  The Company has previously disclosed losses related to operations related to difficult market conditions and operating performance.  The Company has had instances of unwaived debt covenant violations and had been operating under

7

forbearance agreements with AgStar Financial Services, PCA (“Agstar”).  In addition, the Company’s working capital was at a lower level than desired.  These conditions contributed to the long-term debt with Agstar being classified as current in previously filed financial statements.  These factors and the continual volatile commodity prices raise substantial doubt about the Company’s ability to continue as a going concern.

The Company has continued to make changes to plant operations, including converting from a coal-fired ethanol plant to a natural gas plant in October 2011 and the addition of corn oil separation in February 2012.   These changes have improved the operating performance of the plant, and lead to lower operating costs.  Additionally, market conditions have improved during the three months ended July 31, 2013.  The Company raised additional equity of approximately $6.9 million as of July 31, 2013, as well as issued convertible secured debt as described in Note 8.  As a result, the Company was able to reduce their debt obligations as of July 31, 2013 and is in compliance with their debt covenants as of July 31, 2013.

The Company renegotiated its loans with AgStar into a Term Loan and a Revolving Term Loan and entered into a Sixth Amended and Restated Master Loan Agreement with AgStar on May 17, 2013. The Revolving Term Loan will be used by the Company to optimize its cash management.  The additional equity raised was used to improve working capital availability by paying down the Revolving Term Loan and meeting the required $5 million payment obligation by July 31, 2013. The Company’s Board of Governors loaned the Company $1.4 million in convertible secured debt, which was used to bring the previous AgStar loans up to date.   In addition, the Company is expecting to raise approximately $3.6 million, subsequent to July 31, 2013, in convertible secured debt, which will be released from escrow as described in Note 8.

While the Company believes these changes will improve the operating performance of the plant, provide additional working capital, and reduce the effects on our plant of volatility in the industry, it is not yet certain as to whether these efforts and changes will be successful.

3.UNCERTAINTIES

The Company has certain risks and uncertainties that it experienced during volatile market conditions. These volatilities can have a severe impact on operations. The Company’s revenues are derived from the sale and distribution of ethanol and distillers grains to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers.  Ethanol sales average 75% - 80% of total revenues and corn costs average 85% - 90% of cost of goods sold.

The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol and the net expense of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, unleaded gasoline prices and the petroleum markets as a whole. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and a risk management program used to protect against the price volatility of these commodities. Market fluctuations in the price of and demand for these products may have a significant adverse effect on the Company’s operations, profitability and the availability and adequacy of cash flow to meet the Company’s working capital requirements.

4.CONCENTRATIONS

The Company sells all of the ethanol and dry distiller grains produced to one customer under marketing agreements at July 31, 2013.

5.INVENTORY

Inventory consisted of the following:

	July 31,		October 31,
	2013		2012
Raw materials	$	285,490	$	521,865
Work in process	1,084,300		1,149,214
Supplies	933,367		922,384
Other grains	—		995,109
Total	$	2,303,157	$	3,588,572

6.DERIVATIVE INSTRUMENTS

As of July 31, 2013, the Company had no derivative instruments in place.

8

The following tables provide details regarding the losses from the Company’s derivative instruments included in the Condensed Consolidated Statements of Operations, none of which were designated as hedging instruments:

	Statement of	Three-Months Ended July 31,
	Operations Locations	2013		2012
Corn contracts	Cost of goods sold	$	—	$	862,000
Natural gas contracts	Cost of goods sold	—		119,000
Totals		$	—	$	981,000
	Statement of	Nine-Months Ended July 31,
	Operations Locations	2013		2012
Corn contracts	Cost of goods sold	$	—	$	1,088,000
Natural gas contracts	Cost of goods sold	—		(446,000		)
Totals		$	—	$	642,000

7.LINE OF CREDIT

Agrinatural obtained a line of credit with lending institution in September 2012 which provided up to $600,000 until March 31, 2013. Interest was charged at 5.43%. On January 1, 2013, this line of credit was replaced by a note payable which is included in Note 8 below.

On May 17, 2013, the Company renegotiated its revolving term loan with AgStar to extend the maturity date of the revolving term loan to September 2016. Amounts borrowed by the Company under the term revolving term loan can be repaid and may be re-borrowed at any time prior to maturity date of the term revolving loan, provided that outstanding advances may not exceed the amount of the term revolving loan commitment. Amounts outstanding on the term revolving loan bear interest at a variable rate equal to the greater of a LIBOR rate plus 3.50% or 5.0%, payable monthly.  At July 31, 2013, revolving term loan carried an interest rate of 5.00%.  The Company also pays an unused commitment fee on the unused portion of the term revolving term loan commitment at the rate of 0.35% per annum, payable in arrears in quarterly installments during the term of the evolving term loan.  At July 31, 2013, the Company had approximately $20.5 million available under the revolving term loan.  The amount available under the revolving term loan is reduced by $2 million at October 31st each year until September 2016 when the unpaid balance is due.  The revolving term loan is secured by substantially all business assets and is subject to various financial and non-financial covenants as described in Note 8.

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8.DEBT FINANCING

Debt financing consists of the following:

	July 31, 2013		October 31, 2012
Term note payable to lending institution, see terms below	$	17,137,087	$	36,627,901
Assessments payable	2,758,529		2,895,151
Notes payable to electrical company	312,500		457,328
Corn oil recovery system note payable	750,835		—
Notes payable on pipeline assets (Agrinatural notes)	1,123,064		—
Subordinated Debt	1,407,000		—
Construction notes payable	—		1,891,194
Total	23,489,015		46,082,737
Less amounts due on demand or within one year	3,008,029		42,051,402
Net long term debt	$	20,480,986	$	4,031,335

At July 31, 2013, the Company was in compliance with certain covenants in the AgStar loan agreements. At October 31, 2012 and during 2013, the Company was out of compliance with certain covenants in the AgStar loan agreements including the minimum working capital amount, minimum tangible net worth amount, and the fixed charge coverage ratio, and reclassified the debt with AgStar to current. The Company failed to pay when due the required monthly principal payments on December 1, 2012, January 1, 2013, February 1, 2013, March 1, 2013, April 1, 2013, and May 1, 2013. In connection with a forbearance agreement dated April 12, 2013, the Company paid the December 2012 and January 2013 installments of principal.  In connection with the renegotiated loan agreement with AgStar entered into on May 17, 2013, the Company has paid the required installments of principal that were due February 1, 2013, March 1, 2013, April 1, 2013, May 1, 2013, and June 1, 2013.

On December 21, 2012, the Company and AgStar entered into a forbearance agreement whereby the Company agreed to, among other things, sell substantially all plant assets to Guardian. AgStar also began charging a default interest premium on the AgStar loans of an additional 2.0%. Advances on the revolving term note were frozen until the Company entered into an asset sale agreement for substantially all plant assets.   The forbearance agreement dated December 21, 2012 was subsequently amended and restated on January 22, 2013, February 12, 2013 and March 29, 2013, in order to permit the Company to close on the transactions contemplated by the asset purchase agreement dated January 22, 2013 between the Company and Guardian.  The asset purchase agreement with Guardian was terminated by the Company on April 4, 2013.  The forbearance agreement was amended and restated again on April 12, 2013 in order to accommodate certain proposals related to recapitalization and restructuring of the loans.

The forbearance agreement was amended and restated for a fifth time on May 10, 2013 in order to extend the forbearance period relating to the above-described covenant defaults and required monthly principal installment payments to permit the Company additional time to document and implement a written management, governance improvement and capitalization plan.   On May 17, 2013, the Company entered into a Sixth Amended and Restated Master Loan Agreement and related loan documents with AgStar to replace and supersede the Fifth Amended and Restated Master Loan Agreement dated as of September 1, 2011, the Fifth Amended and Restated Forbearance Agreement dated May 10, 2013, and related loan documents.  Under the Sixth Amended and Restated Master Loan Agreement, AgStar agreed to restructure the Term Loan and the Term Revolving Loan based upon the submission of a loan restructuring proposal and payment of approximately $1.4 million in cash for Term Loan principal payments in arrears and reduction of the Term Revolving Note.

Term Note

On May 17, 2013, the Company renegotiated its term loan with AgStar in the amount of $17.4 million.  The Company must make equal monthly payments of principal and interest on the term loan based on a 10-year amortization, provided the entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on the maturity date of September 1, 2016.  In addition, the Company is required to make additional payments annually on debt for up to 25% of the excess cash flow, as defined by the agreement, up to $2 million per year.  Through September 1, 2014, the loan bears interest at 5.75% as long as the Company is in compliance with their debt covenants.

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On September 1, 2014, the interest term loan will be adjusted to LIBOR plus 3.50% but not less than 5%.  The loan agreements are secured by substantially all business assets and are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements.  As described above, the Company was in compliance with the covenants of its master loan agreement with AgStar as of July 31, 2013 and reclassification of the debt previously included in current liabilities to long-term.

Convertible Secured Debt

On May 17, 2013, the Company’s Board of Governors loaned the Company approximately $1.4 million as part of the convertible secured debt.  The convertible secured debt is subordinated to the AgStar debt.  The notes bear interest at 7.25% and are due in May 2018.  On October 1, 2014, or immediately prior to the effective time of any sale of all or substantially all of the Company assets, each holder has the right at the holder’s option to irrevocably convert all of such holder’s interim subordinated notes into Class A units of the Company, at the rate of $0.30 per Class A unit.  The Company reserves the right to issue Class B units upon conversion if the principal balance of the 7.25% convertible secured debt exceeds the authorized Class A units at the conversion rate.

The convertible secured debt raise was not completed as of July 31, 2013.  As of July 31, 2013, the Company was expecting to issue approximately $3,671,000 of additional convertible secured debt; however subscribers have agreed to lend approximately $6,524,000.  The cash received from subscribers is being held in escrow, but will be released in the fourth quarter of fiscal 2013.  The Company expects to return approximately $2,853,000 during the fourth quarter of fiscal 2013 to the subscribers.

Estimated annual maturities of debt at July 31, 2013 are as follows based on the most recent debt agreements:

August 1, 2013 — July 31, 2014	$	3,008,029
August 1, 2014 — July 31, 2015	2,688,634
August 1, 2015 — July 31, 2016	2,264,846
August 1, 2016 — July 31, 2017	2,264,808
August 1, 2017 — July 31, 2018	3,541,492
Thereafter	9,721,206
Total debt	$	23,489,015

9.LEASES

The Company leases equipment, primarily rail cars, under operating leases through 2017.   Rent expense for the nine months ended July 31, 2013 and 2012 was approximately $1,313,000 and $1,400,000, respectively.  Rent expense for the three months ended July 31, 2013 and 2012 was approximately $406,000 and $650,000, respectively.

At July 31, 2013, the Company had the following annual minimum future lease payments, which at inception had non-cancelable terms of more than one year:

August 1, 2013 — July 31, 2014	$	1,412,842
August 1, 2014 — July 31, 2015	847,014
August 1, 2015 — July 31, 2016	833,140
August 1, 2016 — July 31, 2017	831,600
August 1, 2017 — July 31, 2018	69,300
Total lease commitments	$	3,993,896

10.COMMITMENTS AND CONTINGENCIES

Forward Contracts

The Company has natural gas agreements with a minimum purchase commitment of approximately 1.6 million MMBTU per year until October 31, 2014.

Management Services Agreement

On July 31, 2013, Project Viking, L.L.C. (“Project Viking”) held a controlling interest in the Company. On July 31, 2013, Project Viking sold its interest to Granite Falls Energy, LLC (“GFE”), which is now considered a related party. GFE operates an ethanol plant in the Midwest. The Company entered into a Management Services Agreement with GFE.  Under the Management Services Agreement, GFE agreed to supply its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager.  The initial term of the Management Services Agreement is three years.  The Company agreed to pay GFE $35,000 per month for the first year of the Management Services Agreement. 

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During years two and three of the agreement, the Company agreed to pay GFE 50% of the total salary, bonuses, and other expenses and costs incurred by GFE for the three management positions.  At the expiration of the initial term, the agreement will automatically renew for successive one-year terms unless and until the Company or GFE gives the other party 90-days written notice of termination prior to expiration of the initial term or the start of a renewal term.

Termination of Marketer Agreement

On August 20, 2013, the Company gave notice to their marketer to terminate the agreements related to corn purchases as well as ethanol and distillers grains sales effective October 31, 2013.  During the fourth quarter of fiscal year 2013, the Company anticipates entering into a marketing agreement with a new marketer for the sale of ethanol and distillers grains.

11.       MEMBERS’ EQUITY

As of July 31, 2013, the Company has authorized two classes of membership units: Class A and Class B. At July 31, 2013, there are 46,697,107 Class A units issued and outstanding and 15,000,000 Class B units issued and outstanding.  At October 31, 2012, there were 38,622,107 Class A units and -0- Class B units issued and outstanding.   The total units issued and outstanding are 61,697,107 and 38,622,107 at July 31, 2013 and October 31, 2012, respectively.  On July 31, 2013, the Company issued 8,075,000 Class A units and 15,000,000 Class B units for total proceeds of approximately $6.9 million.  The Company is authorized to issue an aggregate of 80,000,000 units, of which 65,000,000 have been designated Class A units and 15,000,000 has been designated as Class B units. Members of the Company are holders of units who have been admitted as members and who hold at least 2,500 units. Any holder of units who is not a member will not have voting rights. Transferees of units must be approved by our board of governors to become members. Members are entitled to one vote for each unit held. Subject to the Member Control Agreement, all units share equally in the profits and losses and distributions of assets on a per unit basis.

12.       SALE OF ASSETS

The Company entered into an asset purchase agreement on January 3, 2013, with FCA Co-op for the sale of the Company’s grain storage and handling facilities. The sale closed on February 1, 2013, for approximately $3.7 million. The net proceeds of the sale were used to repay AgStar debt.

The Company entered into an asset purchase agreement on January 22, 2013, with Guardian Energy for the sale of the ethanol assets.  The purchase price was to be the sum of $55,000,000 plus closing net working capital, less the amount owed on the closing date under assumed debt.  On April 4, 2013, the Company terminated the asset purchase agreement dated January 22, 2013 between the Company and Guardian.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains, in addition to historical information, forward-looking statements that are based on our expectations, beliefs, intentions or future strategies. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements because of certain factors, including those set forth under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the period ended October 31, 2012 and under Part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the period ended January 31, 2013 and April 30, 2013, as well as in other filings we make with the Securities and Exchange Commission. All forward-looking statements included herein are based on information available to us as of the date hereof, and we undertake no obligation to update any such forward-looking statements.

The following is a discussion and analysis of Heron Lake BioEnergy’s financial condition and results of operations as of and for the three and nine month periods ended July 31, 2013 and 2012. This section should be read in conjunction with the condensed consolidated financial statements and related notes in Item 1 of this report and the Company’s Annual Report on Form 10-K for the year ended October 31, 2012.

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the three and nine months ended July 31, 2013.

Overview

Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota. The plant has a stated capacity to produce 50 million gallons of denatured fuel grade ethanol and 160,000 tons of dried distillers’ grains (DDGS) per year. Our revenues are derived from the sale and distribution of our ethanol throughout the continental United States and in the sale and distribution of our distillers’ grains (DGS) locally, and throughout the continental United States. Our subsidiary, Lakefield Farmers Elevator, LLC, had grain facilities at Lakefield and Wilder, Minnesota that were sold on February 1, 2013.  Our subsidiary, HLBE Pipeline Company, LLC, owns 73% of Agrinatural Gas, LLC, the pipeline company formed to construct, own, and operate a natural gas pipeline that provides natural gas to the Company’s ethanol production facility through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota.

Our operating results are largely driven by the prices at which we sell ethanol and distillers grains and the costs related to their production, particularly the cost of corn. Historically, the price of ethanol tended to fluctuate in the same direction as the price of unleaded gasoline and other petroleum products. However, during fiscal 2010 and continuing into fiscal 2013, ethanol prices tended to move up and down proportionately with changes in corn prices. The price of ethanol can also be influenced by factors such as general economic conditions, concerns over blending capacities, and government policies and programs. The price of distillers grains is generally influenced by supply and demand, the price of substitute livestock feed, such as corn and soybean meal, and other animal feed proteins. Our largest component of cost of production is corn. The cost of corn is affected primarily by factors over which we lack any control such as crop production, carryout, exports, government policies and programs, and weather. The growth of the ethanol industry has increased the demand for corn. We believe that continuing increases in global demand will result in corn prices above historic averages.   During the third quarter of fiscal year 2013 ended July 31, 2013, our average ethanol sales price was $2.45 per gallon.  During the same period, our average corn purchase price was $6.77 per bushel.

Trends and Uncertainties Impacting Our Operations

Our current and future results of operation are affected and will continue to be affected by 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 corn acreage, weather conditions, and yields on existing and new acreage diverted from other crops; and (c) the supply and demand for ethanol, which is affected by acceptance of ethanol as a substitute for fuel, public perception of the ethanol industry, government incentives and regulation, and competition from new and existing construction, among other things. Other factors that may affect our future results of operation include those factors discussed in “Item 1. Business” and “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended October 31, 2012, “Part II, Item 1A Risk Factors” of our Quarterly Report on Form 10-Q for the period ended January 31, 2013 and April 30, 2013 and of this Form 10-Q, and in other filings we make with the Securities and Exchange Commission.

Critical Accounting Estimates

A description of our critical accounting estimates was provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended October 31, 2012. At July 31, 2013, our critical accounting estimates continue to include those described in our Annual Report on Form 10-K. In addition, our analysis of future projections, resolution of debt terms and other assumptions in consideration of continuing as a going concern include critical accounting estimates.

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Results of Operations for the Three Months Ended July 31, 2013 and 2012

The following table shows summary information from our Condensed Consolidated Statements of Operations for the three months ended July 31, 2013 and 2012.

	Three Months			Three Months
	Ended			Ended
	July 31, 2013			July 31, 2012
	(Unaudited)			(Unaudited)
Revenues	$	45,583,441		$	41,908,904
Cost of Goods Sold	41,523,283			39,987,071
Gross Profit	4,060,158			1,921,833
Selling, General, and Administrative Expenses	674,200			714,906
Operating Income	3,385,958			1,206,927
Other Income (Expense)
Interest income	310			2,441
Interest expense	(755,532		)	(653,663		)
Other income	10,925			2,182
Total other expense, net	(744,297		)	(649,040		)
Net Income	2,641,661			557,887
Net Income Attributable to Noncontrolling Interest	(87,168		)	(87,289		)
Net Income Attributable to Heron Lake BioEnergy, LLC	$	2,554,493		$	470,598

Revenues

Revenues increased by 8.8% for the three months ended July 31, 2013 as compared to the three months ended July 31, 2012 due primarily to increased ethanol prices.  Net ethanol revenues during the three months ended July 31, 2013 were approximately $36.4 million compared to approximately $32.1 million during the three months ended July 31, 2012.  The average price we received for our ethanol increased by approximately 12% for the three months ended July 31, 2013 as compared to the three months ended July 31, 2012. Additionally, we sold approximately 2.1% more gallons of ethanol during the three months ended July 31, 2013 as compared to the three months ended July 31, 2012.  There were no ethanol derivative gains or losses during the three months ended July 31, 2013 and 2012.

Total sales of DGS during the three months ended July 31, 2013 were approximately $7.8 million. DGS sales during the three months ended July 31, 2012 were $7.9 million. The average dried DGS price increased 9.9% for the three months ended July 31, 2013 as compared to the three months ended July 31, 2012, with an approximate 11.6% decrease in dried DGS sold during the three months ended July 31, 2013 as compared to the three months ended July 31, 2012.

Corn oil separation began in February 2012. Corn oil sales for the three months ended July 31, 2013 and 2012 were approximately $1.1 million and $0.9 million, respectively.  Our quantity of corn oil sold increased approximately 27.4% for the three months ended July 31, 2013 as compared to the three months ended July 31, 2012.

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Cost of Goods Sold

Our costs of sales include, among other things, the cost of corn used in ethanol and DGS production (which is the largest component of costs of sales); natural gas, processing ingredients, electricity, and wages, salaries and benefits of production personnel. We use approximately 1.5 million bushels of corn per month at the plant.

The per bushel cost of corn increased approximately 0.1% in the three months ended July 31, 2013 as compared to the three months ended July 31, 2012. We had no losses or gains related to corn or natural gas derivative instruments for the three months ended July 31, 2013.  We had a gain related to natural gas derivative instruments of approximately $119,000 for the three months ended July 31, 2012.  We had a gain related to corn derivative instruments of approximately $862,000 for the three months ended July 31, 2012.  We had an increased gross margin in the third quarter of fiscal 2013 as compared to the same period in 2012 due to increases in the prices of ethanol and DGS.

The cost of corn fluctuates based on supply and demand, which, in turn, is affected by a number of factors which are beyond our control. We expect our gross margin to fluctuate in the future based on the relative prices of corn and fuel ethanol. We may use futures and option contracts to minimize our exposure to movements in corn prices, but there is no assurance that these hedging strategies will be effective. As a result, gains or losses on derivative instruments do not necessarily coincide with the related commodity purchases. This may cause fluctuations in our statement of operations. While we do not use hedge accounting to match gains or losses on derivative instruments, we believe the derivative instruments provide an economic hedge.

Operating Expenses

Operating expenses consist of selling, general and administrative expense and include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs. Operating expense for the three months ended July 31, 2013 was approximately $674,000, a decrease of approximately 5.7% as compared to operating expense of approximately $715,000 for the three months ended July 31, 2012.  These expenses represented 1.5% of total revenues for the three months ended July 31, 2013 and 1.7% of total revenues for the three months ended July 31, 2012.   Although we are focused on increasing operating efficiencies, these expenses generally do not vary with the level of production at the plant.

Other Expense, Net

Other expense, net consists primarily of interest expense. Interest expense consists primarily of interest payments on our credit facilities described below. Interest expense, which was up 15.6% for the three months ended July 31, 2013, as compared to the three months ended July 31, 2012, is dependent on the balances outstanding and on interest rates, including an additional 2% default interest rate we paid on our AgStar loans. Of the total indebtedness at July 31, 2013 to AgStar, approximately $17.1 million includes interest at a fixed rate of 5.75%, and approximately $10.7  million includes interest at a variable rate, which at July 31, 2013 was 5.0%.

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Results of Operations for the Nine Months Ended July 31, 2013 and 2012

The following table shows summary information from our Condensed Consolidated Statements of Operations for the nine months ended July 31, 2013 and 2012.

	Nine Months			Nine Months
	Ended			Ended
	July 31, 2013			July 31, 2012
	(Unaudited)			(Unaudited)
Revenues	$	125,203,672		$	121,956,934
Cost of Goods Sold	119,568,050			118,668,185
Gross Profit	5,635,622			3,288,749
Selling, General, and Administrative Expenses	2,537,919			2,428,646
Settlement Expense	—			900,000
Operating Income (Loss)	3,097,703			(39,897		)
Other Income (Expense)
Interest income	17,063			9,299
Interest expense	(2,254,167		)	(1,943,578		)
Other income	30,198			34,136
Total other expense, net	(2,206,906		)	(1,900,143		)
Net Income (Loss)	890,797			(1,940,040		)
Net Income Attributable to Noncontrolling Interest	(254,999		)	(258,520		)
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC	$	635,798		$	(2,198,560	)

Revenues

Revenues increased by 2.7% for the nine months ended July 31, 2013 as compared to the nine months ended July 31, 2012 due primarily to increased dried DGS prices.  Net ethanol revenues during the nine months ended July 31, 2013 were approximately $95.5 million compared to approximately $94.2 million during the nine months ended July 31, 2012. The average price we received for our ethanol increased by approximately 7.8% for the nine months ended July 31, 2013 as compared to the nine months ended July 31, 2012.  However, we sold approximately 6.7% fewer gallons of ethanol during the nine months ended July 31, 2013 as compared to the nine months ended July 31, 2012.  There were no ethanol derivative gains or losses during the nine months ended July 31, 2013 and 2012.

Total sales of DGS during the nine months ended July 31, 2013 were approximately $25.8 million. DGS sales during the nine months ended July 31, 2012 were approximately $22.3 million. The average dried DGS price increased 25.6% for the nine months ended July, 2013 as compared to the nine months ended July 31, 2012, with an approximate 7.2% decrease in dried DGS sold during the first nine months of fiscal year 2013 compared to fiscal year 2012.

Corn oil separation began in February 2012. Corn oil sales for the nine months ended July 31, 2013 and 2012 were approximately $2.9 million and $1.5 million, respectively.  Our quantity of corn oil sold increased approximately 111% for the nine months ended July 31, 2013 as compared to the nine months ended July 31, 2012, although as noted above, we did not begin separating corn oil until February 2012.

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Cost of Goods Sold

Our costs of sales include, among other things, the cost of corn used in ethanol and DGS production (which is the largest component of costs of sales); natural gas, processing ingredients, electricity, and wages, salaries and benefits of production personnel. We use approximately 1.5 million bushels of corn per month at the plant.

The per bushel cost of corn increased approximately 8.7% in the nine months ended July 31, 2013 as compared to the nine months ended July 31, 2012.  We had a gain related to corn derivative instruments of approximately $1.1 million for the nine months ended July 31, 2012. We had a loss related to natural gas derivative instruments of approximately $446,000 for the nine months ended July 31, 2012.  We had an increased gross margin in the first nine months of fiscal 2013 as compared to the same period in 2012 due to increases in the prices of ethanol and DGS and an increase in the quantity of corn oil sold.

The cost of corn fluctuates based on supply and demand, which, in turn, is affected by a number of factors which are beyond our control. We expect our gross margin to fluctuate in the future based on the relative prices of corn and fuel ethanol. We may use futures and option contracts to minimize our exposure to movements in corn prices, but there is no assurance that these hedging strategies will be effective. As a result, gains or losses on derivative instruments do not necessarily coincide with the related commodity purchases. This may cause fluctuations in our statement of operations. While we do not use hedge accounting to match gains or losses on derivative instruments, we believe the derivative instruments provide an economic hedge.

Operating Expenses

Operating expenses consist of selling, general and administrative expense and include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs. Operating expense for the nine months ended July 31, 2013 was approximately $2,538,000, an increase of approximately 4.5% as compared to operating expense of approximately $2,429,000 for the nine months ended July 31, 2012 due primarily to fees related to the planned plant asset sale.  These expenses represented 2.0% of total revenues for the nine months ended July 31, 2013 and July 31, 2012.  Although we are focused on increasing operating efficiencies, these expenses generally do not vary with the level of production at the plant.   In addition, during the nine months ended July 31, 2012 we recorded a settlement expense of approximately $900,000 related to the settlement of our coal contract.

Other Expense, Net

Other expense, net consists primarily of interest expense. Interest expense consists primarily of interest payments on our credit facilities described below. Interest expense, which was up 16.0% for the nine months ended July 31, 2013, as compared to the nine months ended July 31, 2012, is dependent on the balances outstanding and on interest rates, including an additional 2% default interest rate we paid on our AgStar loans.

Liquidity and Capital Resources

As of July 31, 2013, we had cash and equivalents of approximately $1.0 million, current assets of approximately $7.9 million and total assets of approximately $60.8 million.

Our principal sources of liquidity consist of cash provided by operations, cash and equivalents on hand, and available borrowings under our master loan agreement with AgStar. Under the master loan agreement, we have two forms of debt: a term note and a revolving term note.  The total indebtedness to AgStar at July 31, 2013, was approximately $27.8 million, consisting of approximately $17.1 million under the term note and approximately $10.7 million under the revolving term note.  These borrowings are made pursuant to the Sixth Amended and Restated Master Loan Agreement dated May 17, 2013 between the Company and AgStar.  Under the Sixth Amended and Restated Master Loan Agreement, AgStar agreed to restructure the term loan and the term revolving loan based upon the submission of a loan restructuring proposal and payment of approximately $1.4 million in cash for term loan principal payments in arrears and reduction of the term revolving note.  The Company also raised additional equity of approximately $6.9 million as of July 31, 2013, which was used to reduce the Company’s debt obligations to AgStar as of July 31, 2013.

With respect to the term loan, the Company must make equal monthly payments of principal and interest on the term loan based on a 10-year amortization, provided the entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on the maturity date of September 1, 2016.  In addition, the Company is required to make additional payments annually on debt for up to 25% of the excess cash flow, as defined by the agreement, up to $2 million per year.  Through September 1, 2014, the loan bears interest at 5.75% as long as the Company is in compliance with its debt covenants.   On September 1, 2014, the interest on the term loan will be adjusted to LIBOR plus 3.50%, but the total interest rate shall not be less than 5%.

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With respect to the revolving term loan, the loan matures in September 2016.  Amounts borrowed by the Company under the term revolving loan can be repaid and may be re-borrowed at any time prior to maturity date of the term revolving loan, provided that outstanding advances may not exceed the amount of the term revolving loan commitment. Amounts outstanding on the term revolving loan bear interest at a variable rate equal to the greater of a LIBOR rate plus 3.50% or 5.0%, payable monthly.  At July 31, 2013, the revolving term loan carried an interest rate of 5.0%.  The Company also pays an unused commitment fee on the unused portion of the term revolving term loan commitment at the rate of 0.35% per annum, payable in arrears in quarterly installments during the term of the evolving term loan.  At July 31, 2013, the Company had $10.6 million outstanding under the revolving term loan and an additional $9.9 million was available.  The amount available under the revolving term loan is reduced by $2 million at October 31 each year until September 2016, when the unpaid balance is due.

Our loan agreements with AgStar are secured by substantially all business assets and are subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, net worth, and working capital requirements.  The Company was in compliance with the covenants of its loan agreements with AgStar as of July 31, 2013.  In the past, the Company’s failure to comply with the covenants of the master loan agreement and failure to timely pay required installments of principal has resulted in events of default under the master loan agreement, entitling AgStar to accelerate and declare due all amounts outstanding under the master loan agreement. If AgStar accelerated and declared due all amounts outstanding under the master loan agreement, the Company would not have adequate cash to repay the amounts due, resulting in a loss of control of our business or bankruptcy.  There can be no assurance that the Company will be able to maintain compliance with its agreements with AgStar, raise additional capital, or improve its financial performance.

There is no assurance that our cash, cash generated from operations and, if necessary, available borrowing under our agreement with AgStar, 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 the amounts currently anticipated or if our operating costs, including specifically the cost of corn, natural gas and other inputs, are greater than anticipated.  Due to current volatility in the ethanol and corn markets, our future profit margins might be tight or not exist at all.

Our principal uses of cash are to pay operating expenses of the plant and to make debt service payments on our long-term debt. During the nine months ended July 31, 2013, the Company paid debt of approximately $14.4 million and borrowed approximately $520,000 from AgStar.  During this period the Company also raised approximately $1.4 million in convertible debt from persons serving on the Company’s Board of Governors and the Company raised approximately $6.9 million in member contributions.  The Company also sold grain storage assets for approximately $3.7 million.  As of July 31, 2013, the Company expects to raise approximately $3,671,000 of additional convertible secured debt during the fourth quarter of fiscal year 2013, which is being held in escrow at July 31, 2013.

The following table summarizes our sources and uses of cash and equivalents from our condensed consolidated statements of cash flows for the periods presented:

	Nine months Ended July 31
	2013			2012
Net cash provided by operating activities	$	2,638,461		$	1,648,374
Net cash provided by (used in) investing activities	3,459,945			(2,444,010		)
Net cash used in financing activities	(5,729,003		)	(4,661,810		)
Net increase (decrease) in cash and equivalents	$	369,403		$	(5,457,446	)

During the nine months ended July 31, 2013, operating activities provided approximately $2.6 million in cash. This consists primarily of the net income of approximately $0.9 million plus non-cash expenses including depreciation and amortization of approximately $3.0 million, decreases in inventory of approximately $1.3 million, decreases in accounts payable of $1.1 million, and increases of accounts receivable of $1.2 million.

During the nine months ended July 31, 2012, operating activities provided approximately $1.6 million. This consists primarily of the net loss of $1.9 million plus non-cash expenses including depreciation and amortization of $4.3 million, decreases in inventory of approximately $984,000, and decreases in accounts payable by approximately $2.0 million.

During the nine months ended July 31, 2013, we had cash flows provided by investing activities of approximately $3.5 million mainly attributable to the sale of grain storage assets for approximately $3.7 million. In the same period in 2012, we used approximately $2.4 million for capital expenditures.   This consists primarily of costs associated with the conversion of our plant from coal-fired to natural gas and the installation of the natural gas pipeline.

During the nine months ended July 31, 2013, we used approximately $5.7 million in cash in financing activities.  We made payments on our line of credit, net payments on our revolving term loan, and payment on long-term debt totaling approximately $14.4 million.  We received proceeds from long-term debt, convertible debt, and member contributions totaling approximately $8.8 million. 

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Our cash used in financing activities was greater than the approximately $4.7 million we used in financing activities in the same period in 2012, when we received approximately $707,000 in member contributions and paid approximately $5.6 million on long-term debt.

Outlook

Ethanol prices have been very volatile over the past nine months, and we expect to see that continue during 2013.   There are many factors that will continue that volatility of prices during 2013, including amount of domestic ethanol production, the amount of ethanol exports and domestic usage, petroleum and gasoline prices, and the development of other alternative fuels.  As of August 30, 2013, the Energy Information Administration (EIA) reported that ethanol production for the week was 240.8 million gallons, or a 12.54 billion gallon annualized rate.

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

Corn prices have been volatile due in part to higher demand from the renewable fuels industry. The expansion of ethanol productive capacity has brought about a substantial increase in demand for corn and thus in corn prices.  The volatility is also a result of less than trend line yields in the U.S. last two years, thus impacting the corn supply.  Due to increased exposure of ethanol, corn is now being viewed as an “energy commodity” as opposed to strictly a “grain commodity,” contributing to the upward pressure on corn prices.  The USDA’s World Agricultural Supply and Demand Estimates published on August 12, 2013 projects domestic corn production of 13.76 billion bushels for the 2013 growing season, a decrease from previous estimates but still a significant increase over the estimate of 10.78 billion bushels produced during the 2012 growing season.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risks concerning our debt financing and future prices of corn, natural gas, ethanol and distillers grains.  We consider market risk to be the impact of adverse changes in market prices on our results of operations.  In general, ethanol prices are affected by the supply and demand for ethanol, the cost of ethanol production, the availability of other fuel oxygenates, the regulatory climate and the cost of alternative fuels such as gasoline. The price of corn is affected by weather conditions and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors.   From time to time, we may purchase corn futures and options to hedge a portion of the corn we anticipate we will need. In addition, we may contract for future physical delivery of corn. We are exposed to the full impact of market fluctuations associated with interest rates and commodity prices.

We are also subject to market risk on the selling prices of our distiller grains. These prices fluctuate seasonally when the price of corn or other cattle feed alternatives fluctuate in price.

As an example of our potential sensitivity to price changes, if the price of ethanol rises or falls $0.10 per gallon, our annual revenues may increase or decrease accordingly by approximately $5.8 million, assuming no other changes in our business. Additionally, if the price of corn rises or falls $0.25 per bushel, our annual cost of goods sold may increase or decrease by $5.5 million, again assuming no other changes in our business.  During the quarter ended July 31, 2013, our average ethanol sales price was $2.45 per gallon, with basis.  During the same period, our average corn purchase price was $6.77 per bushel, with basis.  Our future earnings may be affected by changes in interest rates due to the impact those changes have on our interest expense on borrowings under our credit facilities. As of July 31, 2013, we had $10.6 million of outstanding borrowings with variable interest rates. With each 1% change in interest rates our annual interest expense would change by $106,000.

Item 4. Controls and Procedures

Effectiveness of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were not effective.   As previously reported in our Form 10-K for the year ended October 31, 2012, our management concluded that our disclosure controls and procedures were not effective as of October 31, 2012 due to a material weakness in internal control over financial reporting relating to the errors in pricing ethanol and distillers grains revenue and the effects of this revenue

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recognition error upon the financial statements and reports.  This material weakness is not considered fully remediated as of July 31, 2013 because while remedial procedures have been implemented, they have not operated for an appropriate period and have not been tested to allow management to conclude that they are operating effectively.  Accordingly, the Company’s disclosure controls and procedures are likewise not considered effective.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred in the fiscal nine months ended July 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, other than the implementation of additional controls and procedures to remediate the material weakness in internal control over financial reporting described above.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time in the ordinary course of business, Heron Lake BioEnergy, LLC may be named as a defendant in legal proceedings related to various issues, including workers’ compensation claims, tort claims, or contractual disputes. We are not currently involved in any material legal proceedings.

Item 1A. Risk Factors

The most significant risk factors applicable to the Company are described in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the period ended October 31, 2012 and in Part II, Item 1A “Risk Factors” of our Quarterly Report on Form 10-Q for the period ended January 31, 2013.  We also face the risk factors set forth below as well as additional risks and uncertainties, including risks and uncertainties not presently known to us, or that we currently deem immaterial, could also have an adverse effect on our business, financial condition and/or results of operations.

Project Viking owns a large percentage of our units, which may allow it to control or heavily influence matters requiring member approval, and Project Viking has been granted additional board rights under our member control agreement.

As of July 31, 2013, Project Viking, L.L.C. (“Project Viking”) beneficially owned 63.3% of our outstanding units. Project Viking is owned by Granite Falls Energy, LLC (“Granite Falls Energy”). As a result, Granite Falls Energy could significantly influence our management and affairs and all matters requiring member approval, including the approval of significant corporate transactions.

Additionally, our member control agreement gives members who hold significant amounts of equity in us the right to designate governors to serve on our board of governors. As of July 31, 2013, Project Viking has the right to appoint five persons to our nine-person board pursuant to this provision. With the right to designate a majority of our board, Project Viking influences the decisions of our board and our business.

Further, the interests of Project Viking may not coincide with our interests or the interests of our other members. For example, Granite Falls Energy owns and operates an ethanol production facility that could be considered our competitor.  As a result of these and other potential conflicting interests, this could result in decisions with respect to us with which our members may disagree.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

At July 31, 2013, we were in compliance with the covenants of our Sixth Amended and Restated Master Loan Agreement with AgStar Financial Services, PCA (“AgStar”), which we entered into on May 17, 2013.  However, prior to entering into the Sixth Amended and Restated Master Loan Agreement with AgStar, we were in default of covenants of our prior loan agreement with AgStar requiring us to maintain at least $5.0 million minimum working capital; at least $39.5 million of tangible net worth; and a fixed charge ratio of 1.20 to 1.00 or greater.  Under this prior loan agreement, we also failed to make monthly principal payments to AgStar on February 1, 2013, March 1, 2013, April 1, 2013 and May 1, 2013.  As a result of these defaults, we entered into multiple forbearance agreements with AgStar, under which AgStar forbear its rights.  Under the Sixth Amended and Restated Master Loan Agreement, AgStar agreed to restructure our Term Loan and our Term Revolving Loan based upon our submission of a loan restructuring proposal and payment of approximately $1.4 million in cash for Term Loan principal payments in arrears and reduction of the Term Revolving Note.  In addition, we met the required principal paydown of $5 million on July 31, 2013.

Item 4. Mine Safety Disclosures

None.

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Item 5.  Other Information

None.

Item 6. Exhibits

The following exhibits are included in this report:

Exhibit No.	Exhibit
10.1	Assignment and Amendment Agreement dated July 2, 2013 by and among Heron Lake BioEnergy, LLC, Gavilon, LLC and Gavilon Global Ag Holdings, LLC. +
10.2	Subscription Agreement Including Investment Representations, dated July 31, 2013, by and between Heron Lake BioEnergy, LLC and Project Viking, L.L.C.
10.3	Subscription Supplement Agreement dated July 31, 2013, by and among Heron Lake BioEnergy, LLC, Granite Falls Energy, LLC and Project Viking, L.L.C.
10.4	Management Services Agreement effective as of July 31, 2013 between Granite Falls Energy, LLC and Heron Lake BioEnergy, LLC.
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act.
32	Certification pursuant to 18 U.S.C. § 1350.
101.1	The following materials from Heron Lake BioEnergy’s Quarterly Report on Form 10-Q for the quarterly period ended July 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

+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 under the Exchange Act. Spaces corresponding to the deleted portions are represented by brackets with asterisks [***].

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SIGNATURES

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

	HERON LAKE BIOENERGY, LLC
Date: September 16, 2013	/s/  Steve Christensen
	Steve Christensen
	Chief Executive Officer
Date: September 16, 2013	/s/  Stacie Schuler
	Stacie Schuler
	Chief Financial Officer

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