UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

 

For the fiscal quarter ended September 30, 2006.

OR

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

 

For the transition period from               to               .

LAKE AREA CORN PROCESSORS, LLC
(Exact name of small business issuer as specified in its charter)

 

46269 SD Highway 34
P.O. Box 100
Wentworth, South Dakota 57075
(Address of principal executive offices)

(605) 483-2676

(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 Securities Exchange Act of 1934 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 is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one):

Large Accelerated Filer o

Accelerated Filer o

Non-Accelerated Filer x

 

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

Indicate the number of shares outstanding for each of the issuer’s classes of common equity as of the latest practicable date:  As of November 14, 2006, there were 29,620,000 units outstanding.

INDEX

 

		Page No.
PART I.   FINANCIAL INFORMATION		3
ITEM 1. FINANCIAL STATEMENTS		3
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		21
ITEM 4. CONTROLS AND PROCEDURES		22
PART II.   OTHER INFORMATION		23
ITEM 1. LEGAL PROCEEDINGS		23
ITEM 1A. RISK FACTORS		23
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		23
ITEM 5. OTHER INFORMATION		24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K		24
SIGNATURES		24

 

2

PART I.     FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

LAKE AREA CORN PROCESSORS, LLC
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

		September 30, 2006			December 31, 2005*
ASSETS
CURRENT ASSETS
Cash		$	267,687		$	704,282
Receivables
Ethanol		3,523,084			—
Ethanol — related party		—			4,928,479
Distillers grains		283,681			343,456
Incentives		166,667			166,667
Other		—			75,000
Inventory
Raw materials		1,519,699			449,887
Finished goods		872,934			651,580
Parts inventory		967,102			889,481
Work in process		368,628			304,610
Investment in commodity contracts		961,185			170,125
Prepaid expenses		133,835			353,455
Total current assets		9,064,502			9,037,022
PROPERTY AND EQUIPMENT
Land		126,097			106,394
Land improvements		2,665,358			2,329,933
Buildings		8,088,853			7,439,179
Equipment		36,552,625			32,894,616
Construction in progess		10,037			19,967
		47,442,970			42,790,089
Less accumulated depreciation		(11,135,053		)	(9,321,715		)
Net property and equipment		36,307,917			33,468,374
OTHER ASSETS
Goodwill		10,394,233			—
Guarantee premium		286,789			359,206
Other		60,660			81,520
Total other assets		10,741,682			440,726
		$	56,114,101		$	42,946,122

* Derived from audited financial statements

See Notes to Unaudited Consolidated Financial Statements

3

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LAKE AREA CORN PROCESSORS, LLC
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

		September 30, 2006			December 31, 2005*
LIABILITIES AND MEMBERS’ EQUITY
CURRENT LIABILITIES
Accounts payable		$	2,620,120		$	4,427,614
Accounts payable — related party		—			180,488
Accrued liabilities		549,428			525,434
Current portion of guarantee payable		62,617			62,617
Current portion of notes payable		1,594,029			1,900,534
Total current liabilities		4,826,194			7,096,687
LONG-TERM LIABILITIES
Guarantee payable		406,540			372,950
Notes payable		7,018,477			8,228,246
Total long-term liabilities		7,425,017			8,601,196
MINORITY INTEREST		—			3,234,649
COMMITMENTS AND CONTINGENCIES
MEMBERS’ EQUITY
Capital units, $0.50 stated value, 29,620,000 units issued and outstanding		14,810,000			14,810,000
Additional paid-in capital		96,400			96,400
Retained earnings		28,956,490			9,107,190
Total members’ equity		43,862,890			24,013,590
		$	56,114,101		$	42,946,122

* Derived from audited financial statements

See Notes to Unaudited Consolidated Financial Statements

4

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LAKE AREA CORN PROCESSORS, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

		Three Months			Three Months			Nine Months			Nine Months
		Ended			Ended			Ended			Ended
		September 30,			September 30,			September 30,			September 30,
		2006			2005			2006			2005
REVENUES
Sales		$	27,281,613		$	16,354,595		$	79,269,811		$	50,088,733
Sales — related party		—			2,307,107			—			7,119,235
Incentive income		250,000			210,114			525,910			405,699
Total revenues		27,531,613			18,871,816			79,795,721			57,613,667
COST OF REVENUES		13,818,302			16,076,597			45,455,442			46,271,842
GROSS PROFIT		13,713,311			2,795,219			34,340,279			11,341,825
EXPENSES
General and administrative		1,211,035			1,017,075			2,783,447			2,790,534
INCOME FROM OPERATIONS		12,502,276			1,778,144			31,556,832			8,551,291
OTHER INCOME (EXPENSE)
Interest and other income		24,124			80,555			81,890			153,432
Interest expense		(212,926		)	(279,784		)	(667,646		)	(828,483		)
Total other income (expense)		(188,802		)	(199,229		)	(585,756		)	(675,051		)
NET INCOME BEFORE MINORITY INTEREST		12,313,474			1,578,915			30,971,076			7,876,240
MINORITY INTEREST IN SUBSIDIARY		—			(188,041		)	(2,235,776		)	(953,789		)
NET INCOME		$	12,313,474		$	1,390,874		$	28,735,300		$	6,922,451
BASIC AND DILUTED EARNINGS PER CAPITAL UNIT		$	0.42		$	0.05		$	0.97		$	0.23
BASIC AND DILUTED WEIGHTED AVERAGE CAPITAL UNITS OUTSTANDING		$	29,620,000		29,620,000			29,620,000			29,620,000
DISTRIBUTIONS PER CAPITAL UNIT DECLARED		$	0.10		$	0.06		$	0.30		$	0.22
DISTRIBUTIONS PER CAPITAL UNIT PAID		0.10			$	0.06		$	0.30		$	0.22

 

See Notes to Unaudited Consolidated Financial Statements

5

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LAKE AREA CORN PROCESSORS, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

		2006			2005
OPERATING ACTIVITIES
Net income		$	28,735,300		$	6,922,451
Changes to income not affecting cash
Depreciation		1,813,338			1,699,980
Amortization		93,277			105,315
Minority interest in subsidiary		2,235,776			953,789
Other		(19,499		)	57,711
(Increase) decrease in
Receivables		1,540,170			184,338
Inventory		(1,432,807		)	(226,311		)
Prepaid expenses		219,619			(53,133		)
Investment in commodity contracts		(791,060		)	(825,308		)
Increase (decrease) in
Accounts payable		(1,987,981		)	(1,850,578		)
Accrued liabilities		57,584			2,246,036
NET CASH FROM OPERATING ACTIVITIES		30,463,717			9,214,290
INVESTING ACTIVITIES
Change in other assets		—			213,015
Acquisition of minority interest in subsidiary		(14,885,489		)	—
Purchase of property and equipment		(4,652,880		)	(1,096,282		)
NET CASH USED FOR INVESTING ACTIVITIES		(19,538,369		)	(883,267		)
FINANCING ACTIVITIES
Outstanding checks in excess of bank balance		—			704,054
Notes payable issued		19,100,000			—
Principal payments on notes payable		(20,616,274		)	(1,309,065		)
Financing costs paid		(143,250		)	—
Distributions paid to minority member		(816,419		)	(1,194,976		)
Distributions paid to LACP members		(8,886,000		)	(8,589,800		)
NET CASH USED FOR FINANCING ACTIVITIES		(11,361,943		)	(10,389,787		)
NET DECREASE IN CASH		(436,595		)	(2,058,764		)
CASH AT BEGINNING OF PERIOD		704,282			2,207,504
CASH AT END OF PERIOD		$	267,687		$	148,740
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for interest		$	821,313		$	568,203

 

See Notes to Unaudited Consolidated Financial Statements

6

LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

NOTE 1 —      NATURE OF OPERATIONS

Principal Business Activity

Lake Area Corn Processors, LLC (the Company) is a South Dakota limited liability company located in Wentworth, South Dakota. The Company was organized by investors to provide a portion of the corn supply for a 40 million-gallon (annual capacity) ethanol plant, owned by Dakota Ethanol, LLC (Dakota Ethanol). On September 4, 2001, the ethanol plant commenced its principal operations. The Company sells ethanol and related products to customers located in North America.

NOTE 2 —      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The unaudited financial statements contained herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America.

In the opinion of management, all adjustments considered necessary for a fair presentation have been included in the accompanying financial statements. The results of operations for the nine and three months ended September 30, 2006 and 2005 are not necessarily indicative of the results to be expected for a full year.

These financial statements should be read in conjunction with the financial statements and notes included in the Company’s financial statements for the year ended December 31, 2005.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its 100% owned subsidiary, Dakota Ethanol. All significant inter-company transactions and balances have been eliminated in consolidation.

Revenue Recognition

Revenue from the production of ethanol and related products is recorded when title transfers to customers, net of allowances for estimated returns. Generally, ethanol and related products are shipped FOB shipping point, based on written contract terms between Dakota Ethanol and it customers.  Collectibility of revenue is reasonably assured based on historical evidence of collectibility between Dakota Ethanol and its customers.  Interest income is recognized as earned.

Revenue is recorded for the sale of ethanol and distiller’s grains based on the net selling price reported to Dakota Ethanol by the marketer.

Cost of Revenues

The primary components of cost of revenues from the production of ethanol and related co-product are corn expense, energy expense (natural gas and electricity), raw materials expense (chemicals and denaturant), shipping and marketing costs on sales, and direct labor costs.

Under the previous ethanol marketing agreement in place during 2005, revenue for the sale of ethanol was recorded based on the gross selling price reported to Dakota Ethanol and shipping costs incurred in the sale of ethanol were recorded as a component of cost of revenues.  The shipping costs for the sale of ethanol recorded as a component of cost of revenues were $829,359 and $187,078 for the nine and three months ended September 30, 2005, respectively.

7

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LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

General and Administrative Expenses

The primary components of general and administrative expenses are professional fee expenses (legal and audit), and insurance expenses.

Investment in Commodities Contracts, Derivative Instruments and Hedging Activities

SFAS No. 133 requires a company to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted from SFAS No. 133 as normal purchases or normal sales. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal are documented as normal and exempted from the accounting and reporting requirements of SFAS No. 133.

Dakota Ethanol enters into short-term cash grain, option and futures contracts as a means of securing corn for the ethanol plant and managing exposure to changes in commodity prices. All of Dakota Ethanol’s derivatives are designated as non-hedge derivatives. Although the contracts are effective economic hedges of specified risks, they are not designated as and accounted for as hedging instruments.

As part of its trading activity, the Company uses futures and option contracts offered through regulated commodity exchanges to reduce risk and is exposed to risk of loss in the market value of inventories. To reduce that risk, the Company generally takes positions using cash and futures contracts and options.

Unrealized gains and losses related to derivative contracts are included as a component of cost of revenues in the accompanying consolidated financial statements. Inventories are recorded at net realizable value so that gains and losses on derivative contracts are offset by gains and losses on inventories and reflected in earnings currently. For the statement of cash flows, such contract transactions are classified as operating activities.

We have recorded an increase to cost of revenues of $984,140 and a decrease to cost of revenues of $76,250 related to our derivative contracts for the nine and three months ended September 30, 2006, respectively.  We have recorded a decrease to cost of revenues of $1,147,308 and $713,450 related to our derivative contracts for the nine and three months ended September 30, 2005, respectively.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.

Environmental Liabilities

Dakota Ethanol’s operations are subject to environmental laws and regulations adopted by various governmental authorities in the jurisdiction in which it operates. These laws require Dakota Ethanol to investigate and remediate the effects of the release or disposal of materials at its locations. Accordingly, Dakota Ethanol 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, which could result from such events. Environmental liabilities are recorded when Dakota Ethanol’s liability is probable and the costs can be reasonably estimated.

Goodwill

Under Financial Accounting Standards Board (FASB) Statement No. 142, Goodwill and Other Intangible Assets, it is not permissible to amortize goodwill to expense. Rather, an impairment approach must be used for valuation whereby a decrease in the intangible asset’s fair value below its carrying amount will result in a write-down of the

8

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LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

asset. If there is no decrease in value below the carrying amount as determined by impairment testing, the carrying amount of goodwill does not change. For the nine months ended September 30, 2006, management reviewed the fair value of goodwill and determined that it was not impaired.  Goodwill is amortized over a fifteen year period for income tax purposes.

NOTE 3 —      SHORT-TERM NOTES PAYABLE

On April 21, 2006, Dakota Ethanol renewed a revolving promissory note from First National Bank of Omaha in the amount of $3,000,000.  The note expires on April 20, 2007 and the amount available is subject to certain financial ratios.  Interest on the outstanding principal balances accrues at 50 basis points above the bank’s base rate (8.25 percent at September 30, 2006).  This rate is subject to adjustments based on various levels of indebtedness to net worth, as defined by the agreement.  There is a commitment fee of 3/8 percent on the unused portion of the $3,000,000 availability.  The note is collateralized by the ethanol plant, its accounts receivable and inventories.  On September 30, 2006, Dakota Ethanol had $0 outstanding and $3,000,000 available to be drawn on the revolving promissory note.

On June 30, 2006, Dakota Ethanol received a promissory note from First National Bank of Omaha in the amount of $19,100,000 to finance Lake Area Corn Processor’s purchase of the minority interest in Dakota Ethanol.  The note is due in full on or before October 28, 2006.  Interest on the outstanding principal balance accrues at the bank’s base rate (8.25 percent at September 30, 2006) and is payable monthly.  The note is collateralized by the ethanol plant, its accounts receivable and inventories.  On September 30, 2006, Dakota Ethanol had $0 outstanding and $0 available to be drawn on the note.

NOTE 4 —      LONG-TERM NOTES PAYABLE

The balance of the notes payable are as follows:

		September, 30			December 31,
		2006			2005 *
		(unaudited)
Note payable to First National Bank of Omaha
Term Note 2		$	8,612,506		$	9,718,308
Term Note 4		—			410,472
Term Note 5		—			—
		8,612,506			10,128,780
Less current portion		(1,594,029		)	(1,900,534		)
		$	7,018,477		$	8,228,246

*              Derived from audited financial statements

9

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LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

Minimum principal payments for the next five years are estimated as follows:

Twelve Months Ended September 30,				Amount
2007				$	1,594,029
2008				1,742,960
2009				1,909,108
2010				2,089,366
2011				1,277,043

 

Dakota Ethanol had the ability to draw upon the entire $5,000,000 available balance on Term Note 5 at September 30, 2006 and December 31, 2005, respectively.

NOTE 5 —      COMMITMENTS, CONTINGENCIES AND AGREEMENTS

Dakota Ethanol receives an incentive payment from the United States Department of Agriculture (USDA) for the use of corn to produce ethanol. In accordance with the terms of this arrangement, revenue is recorded based on incremental production of ethanol compared to the prior year.  No incentive income or expense was recorded for the nine and three months ended September 30, 2006, respectively, as ethanol production decreased compared to the same periods in the prior year.  Incentive expense of $45,949 and $39,886 was recorded for the nine and three months ended September 30, 2005, respectively, as ethanol production decreased compared to the same period in the prior year and a refund of incentives received earlier in the program year was owed.  It is uncertain if there is enough funding for the program to pay fully all applications during the year.  Dakota Ethanol’s participation in the program ended June 30, 2006 as the incentive will expire on September 30, 2006.

Dakota Ethanol also receives an incentive payment from the State of South Dakota to produce ethanol. In accordance with the terms of this arrangement, revenue is recorded based on ethanol sold.  Incentive revenue of $525,910 and $250,000 was recorded for the nine and three months ended September 30, 2006, respectively.  Incentive revenue of $451,648 and $250,000 was recorded for the nine and three months ended September 30, 2005, respectively.  Dakota Ethanol earned its final allocation in March 2006 for the program year ended June 30, 2006.  Dakota Ethanol did not receive the annual maximum for the 2006 program year due to budget constraints on the State of South Dakota program and will not likely receive the annual maximum under the 2007 program year.

Environmental — During the year ended December 31, 2002, management became aware that the ethanol plant may have exceeded certain emission levels allowed by their operating permit. The Company has disclosed the situation to the appropriate state regulatory agency and has taken steps to reduce the emissions to acceptable levels. Management has not accrued a liability for environmental remediation costs since the costs, if any, cannot be estimated.

NOTE 6 —      MINORITY INTEREST PURCHASE

On June 30, 2006, the Company executed an Assignment Agreement with members of the Broin family for the purchase of all of the outstanding minority interest (11.898%) in Dakota Ethanol. The Company purchased the minority interest under the right of first refusal when the Broins negotiated to sell their interest to a third party to allow the company to take advantage of prevailing market conditions.  The purchase transaction closed on June 30, 2006. Dakota Ethanol is now operated as a wholly-owned subsidiary. The Company paid to the Broins a purchase price of $17,116,000 plus an amount representing the Broins’ share of estimated net income through June 30, 2006. The total amount paid to the Broins was $19,351,776.

In order to fund our buyout of the minority interest, the Company entered into a credit facility of $19,100,000 with our senior lender, First National Bank of Omaha. The credit facility is a 120 day term note with a principal balance of $19,100,000 accruing interest at a variable rate based on the Bank’s base rate as published from time to time as its national base rate. The note requires interest only payments on a monthly basis. The payments commence on

10

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LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

July 30, 2006. The principal balance and any outstanding accrued interest under the note is due upon the earlier of (i) our resale of the capital units purchased from the minority interest owners; or (ii) expiration of the note which is October 28, 2006.  The entire balance of the note was repaid from operating funds prior to September 30, 2006.

Because Dakota Ethanol was already 88% owned by the Company since inception, the results of its operations have already been reflected in the Company’s balance sheets and statements of operations since the inception of Dakota Ethanol.

The acquisition costs for the minority interest, including purchase price, legal fees and appraisal fees, were $19,376,369.

		6/30/2006			6/30/2006			FAS 141			FAS 141
		Book			Appraised			Adjustments			Balance Sheet
Current assets		$	18,762,092		$	18,762,092		$	—		$	18,762,092
Net property and equipment		32,622,054			69,000,000			4,328,132			36,950,186
Other assets		378,229			378,229			—			378,229
Goodwill		—			—			10,394,233			10,394,233
Total assets		$	51,762,375		$	88,140,321		$	14,722,365		$	66,484,740
Current liabilities		$	4,864,717		$	4,864,717		$	—		$	4,864,717
Long-term liabilities		7,826,255			7,826,255			—			7,826,255
Equity		39,071,403			75,449,349			14,722,365			53,793,768
Total liabilities and equity		$	51,762,375		$	88,140,321		$	14,722,365		$	66,484,740

 

Acquisition of minority interest of subsidiary:

Current assets		$	2,232,254
Property and equipment		8,214,813
Other assets		45,000
Current liabilities		(578,788		)
Long-term liabilities		(931,143		)
Goodwill		10,394,233
		$	19,376,369

 

There are no contingent provisions or research and development assets purchased or written off in the purchase of the minority interest.

11

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LAKE AREA CORN PROCESSORS, LLC
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006 AND 2005

The following pro forma statements of operations are prepared assuming the Company had acquired the minority interest at the beginning of the periods presented:

		Three Months			Three Months			Nine Months			Nine Months
		Ended			Ended			Ended			Ended
		Sept 30, 2006			Sept 30, 2005			Sept 30, 2006			Sept 30, 2005
REVENUES
Sales		$	27,281,613		$	16,354,595		$	79,269,811		$	50,088,733
Sales — related party		—			2,307,107			—			7,119,235
Incentive income		250,000			210,114			525,910			405,699
Total revenues		27,531,613			18,871,816			79,795,721			57,613,667
COST OF REVENUES		13,818,302			16,076,597			45,455,442			46,271,842
GROSS PROFIT		13,713,311			2,795,219			34,340,279			11,341,825
EXPENSES
General and administrative		1,211,035			1,017,075			2,783,447			2,790,534
INCOME FROM OPERATIONS		12,502,276			1,778,144			31,556,832			8,551,291
OTHER INCOME (EXPENSE)
Interest and other income		24,124			80,555			81,890			153,432
Interest expense		(212,926		)	(279,784		)	(667,646		)	(828,483		)
Total other income (expense)		(188,802		)	(199,229		)	(585,756		)	(675,051		)
NET INCOME		$	12,313,474		$	1,578,915		$	30,971,076		$	7,876,240
BASIC AND DILUTED EARNINGS PER CAPITAL UNIT		$	0.42		$	0.05		$	1.05		$	0.27
BASIC AND DILUTED WEIGHTED AVERAGE CAPITAL UNITS OUTSTANDING		29,620,000			29,620,000			29,620,000			29,620,000
DISTRIBUTIONS PER CAPITAL UNIT DECLARED		$	0.10		$	0.06		$	0.30		$	0.22
DISTRIBUTIONS PER CAPITAL UNIT PAID		$	0.10		$	0.06		$	0.30		$	0.22

 

12

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations for the three-month and nine-month periods ended September 30, 2006, compared to the same periods of the prior fiscal year. This discussion should be read in conjunction with the consolidated financial statements and the Management’s Discussion and Analysis section for the fiscal year ended December 31, 2005, included in the Company’s Annual Report on Form 10-K.

Disclosure Regarding Forward-Looking Statements

This report contains or incorporates by reference “forward-looking statements” that involve future events, our future performance and our expected future operations and actions.  In some cases, you can identify forward-looking statements by the use of words such as “may,” “will,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions.  These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties.  Our actual results or actions may differ materially from these forward-looking statements for many reasons, including, but not limited to, those described in the “Risk Factors” section of our Annual Report on Form 10-K, those listed below, and those business risks and factors described elsewhere in this report and our other Securities and Exchange Commission filings.  While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include:

·		Projected growth, overcapacity or contraction in the ethanol market in which we operate;
·		Fluctuations in the price and market for ethanol and distillers grains;
·		Changes in plant production capacity, variations in actual ethanol and distillers grains production from expectations or technical difficulties in operating the plant;
·		Availability and costs of products and raw materials, particularly corn and natural gas;
·		Changes in our business strategy, capital improvements or development plans;
·		Costs of construction and equipment;
·		Results of hedging strategies;
·		Our ability to market and our reliance on third parties to market our products;
·		Our ability to distinguish ourselves from our current and future competition;
·		Changes to infrastructure, such as expansion of rail capacity and other transportation changes, additional ethanol blending and storage facilities, and changes in the service stations equipped to handle ethanol fuels;
·		Changes in or elimination of governmental laws, tariffs, trade or other controls or enforcement practices such as:
		·	national, state or local energy policy;
		·	federal ethanol tax incentives;
		·	legislation mandating the use of ethanol or other oxygenate additives;
		·	state and federal regulation restricting or banning the use of MTBE; or
		·	environmental laws and regulations that apply to our plant operations and their enforcement;
·		Increased competition in the ethanol and oil industries;
·		Fluctuations in US oil consumption and petroleum prices;
·		Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
·		Anticipated trends in our financial condition and results of operations;
·		Our liability resulting from litigation;
·		Our ability to retain key employees and maintain labor relations;
·		Changes and advances in ethanol production technology; and
·		Competition from alternative fuels and alternative fuel additives.

 

 

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf.  We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.  We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report.  You should read this report and the documents that we reference in this report and have filed as exhibits

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completely and with the understanding that our actual future results may be materially different from what we currently expect.  We qualify all of our forward-looking statements by these cautionary statements.

Overview

Lake Area Corn Processors, LLC (the “Company”) is a South Dakota limited liability company that owns and manages Dakota Ethanol, LLC.  Dakota Ethanol, LLC owns and operates an ethanol plant located near Wentworth, South Dakota that has a nameplate production capacity of 40 million gallons of ethanol per year.  Lake Area Corn Processors, LLC is referred to in this report as “LACP,” the “Company,” “we,” or “us.”  Dakota Ethanol, LLC is referred to in this report as “Dakota Ethanol” or the “Ethanol Plant.”

From the inception of Dakota Ethanol until June 30, 2006, we owned approximately 88% of the interest in Dakota Ethanol.  The remaining approximately 12% interest was owned by members of the Broin family.  However, on June 30, 2006, we executed an Assignment Agreement with the members of the Broin family to purchase all of the outstanding minority interest in Dakota Ethanol.  As a result, we now operate Dakota Ethanol as our wholly-owned subsidiary.

Our revenues are derived from the sale and distribution of Dakota Ethanol’s ethanol and distillers grains throughout the continental United States.  The Dakota Ethanol plant currently operates in excess of its nameplate capacity, producing approximately 48 million gallons of ethanol per year.  Corn is supplied to us primarily from our members who are local agricultural producers and from purchases of corn on the open market. After processing the corn, the ethanol is sold to our ethanol marketer, which subsequently markets and sells the ethanol to gasoline blenders and refineries located throughout the continental United States.  Our ethanol is marketed by RMPG pursuant to our ethanol marketing agreement.  We have elected to use a pooled marketing arrangement, which means that the ethanol we produce is pooled with other ethanol producers and marketed by RPMG.  We pay RPMG a pooling fee for ethanol delivered to the pool, and RPMG pays us a netback price per gallon that is based upon the difference between the pooled average delivered ethanol selling price and the pooled average distribution expense.  These averages are calculated based upon each pool participant’s selling price and expense averaged in direct proportion to the volume of ethanol supplied by each participant to the pool.  Except for the distillers grains we sell directly to local farmers, our distillers grains are sold through a marketer that markets and sells our product to livestock feeders.  Our distillers grains are marketed by Commodity Specialist Company (CSC).  For our distillers grains, we receive a percentage of the selling price actually received by CSC in marketing the distillers grains to its customers.

We are subject to industry-wide factors that affect our operating income and cost of production.  Our operating results are largely driven by the prices at which we sell ethanol and distillers grains and the costs related to their production.  Historically, the price of ethanol has fluctuated with the price of petroleum-based products such as unleaded gasoline, heating oil, and crude oil.  The price of distillers grains is primarily influenced by the price of corn as a substitute livestock feed.  We expect these price relationships to continue for the foreseeable future.  In addition, our revenues are also impacted by such factors as our dependence on one or a few major customers who market and distribute our products; the intensely competitive nature of our industry; possible legislation at the federal, state, and/or local level; and changes in federal ethanol tax incentives.

Our largest costs of production are corn, natural gas, and manufacturing chemicals.  The cost of corn is affected primarily by supply and demand factors over which we have little or no control, such as crop production, carryout, exports, government policies and programs, risk management and weather.  Natural gas and chemical/denaturant pricing levels are tied directly to the overall energy sector, including the prices of crude oil and unleaded gasoline.   Our costs of production are also affected by the cost of complying with the extensive environmental laws that regulate our industry.

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Results of Operations for the Three Months Ended September 30, 2006 and 2005

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items in relation to total revenues in our consolidated statements of operations for the three months ended September 30, 2006 and 2005:

		September 30, 2006					September 30, 2005
Income Statement Data		Amount			%		Amount			%
Revenues		$	27,531,613		100.0		$	18,871,816		100.0
Cost of Revenues		$	13,818,302		50.2		$	16,076,597		85.2
Gross Profit		$	13,713,311		49.8		$	2,795,219		14.8
General and Administrative Expense		$	1,211,035		4.4		$	1,017,075		5.4
Income from Operations		$	12,502,276		45.4		$	1,778,144		9.4
Other Income (Expense)		$	(188,802	)	0.7		$	(199,229	)	1.1
Net Income Before Minority Interest		$	12,313,474		44.7		$	1,578,915		8.4
Minority Interest in Subsidiary Income		$					$	(188,041	)	1.0
Net Income		$	12,313,474		44.7		$	1,390,874		7.4

 

Revenues.  Our Revenues for the quarter ended September 30, 2006 include $25,042,234 in sales of ethanol and $2,239,379 in sales of distillers grains, in addition to $250,000 of incentive revenue.

The increase in revenues from the three months ended September 30, 2006 compared to the three months ended September 30, 2005 is due primarily to an increase in the price of ethanol sold.  For the three months ended September 30, 2006, the average price of the ethanol we sold increased approximately 55% from the average price of ethanol sold for the three months ended September 30, 2005.  The volume of ethanol sold in the three months ended September 30, 2006 was 1% higher than in the three months ended September 30, 2005.

We continued to enjoy very favorable ethanol prices during the third quarter of 2006.  The favorable market price for ethanol is primarily due to high demand for ethanol, created by a number of factors, including the declining use of MTBE as an oxygenate, and the price of gasoline.  However, ethanol prices began to trend lower during the last month of the third quarter of 2006 due to a number of factors, including the lower price of petroleum gasoline and a drop in seasonal demand.  We believe this trend will continue through the rest of this fiscal year and into 2007.  While ethanol prices were lower late in the third quarter than at the beginning of the third quarter, they are still higher than the historical average.

With respect to distillers grains prices, the decrease in revenues from the three months ended September 30, 2006 compared to the three months ended September 30, 2005 is due primarily to a decrease in the amount of distillers grains sold.  For the three months ended September 30, 2006, the average price of the distillers grains we sold increased approximately 2% from the average price paid for the three months ended September 30, 2005.  The volume of distillers grains sold in the three months ended September 30, 2006 was 7% lower than in the three months ended September 30, 2005.

Our revenues also include incentive revenue from state and federal programs.  For the three months ended September 30, 2006, Dakota Ethanol did not receive any revenue from the United States Department of Agriculture’s Commodity Credit Bioenergy Program because Dakota Ethanol did not produce any incremental gallons compared to the same period in 2005, as required for payment under the program compared to a refund of $39,886 for the same period of 2005.  Further, we do not expect to qualify for the Commodity Credit Bioenergy

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Program in the future because the program has been terminated.  Incentive revenue from the State of South Dakota was $250,000 for the three months ended September 30, 2006, which is equal to the same period in 2005.  We expect that Dakota Ethanol will not receive the maximum for the 2006 program year due to budget constraints on the South Dakota program.

Cost of Revenues.  Our cost of revenues as a percentage of revenues was 50.2% and 85.2% for the three months ended September 30, 2006 and 2005, respectively.  This change is primarily a result of the increased price we received for our ethanol and not as a result of significantly decreased costs of revenue.  However, our cost of revenues decreased by $2,258,295 in the three months ended September 30, 2006 compared to the same quarter of 2005 while our total revenues increased by $8,659,797.  The decrease in our cost of revenues for the current period versus the same period in 2005 is primarily due to decreased natural gas costs.

The cost of our natural gas decreased approximately 26% for the three months ended September 30, 2006 compared to the three months ended September 30, 2005.  As a result of a natural gas supply agreement we entered into that limited the fluctuation range of the natural gas prices we pay, we may not be able to realize the total amount of cost savings associated with the decreased cost of natural gas.  We expect natural gas prices to start to trend upward in the coming months which could increase our natural gas costs substantially, which will increase our cost of goods sold and may cause our net income to decrease.

The average price per bushel we paid for our corn increased for the three months ended September 30, 2006 compared to the three months ended September 30, 2005.  Corn costs significantly impact our cost of goods sold.  Although corn carryout supplies for the 2006 marketing year appear adequate, an increase in corn exports as well as sustained domestic usage may increase total demand for corn and result in continued upward pressure on corn prices.  Additionally, due to increased exposure of ethanol, corn is now being viewed as an “energy commodity” as opposed to strictly a “grain commodity.” This has placed upward pressure on corn prices.   We expect that the increased demand of corn resulting from additional ethanol plants will lead to greater competition for corn in our geographic area, which we expect will lead to higher corn prices.  Currently, however, we do not anticipate difficulty securing sufficient grain to operate the Ethanol Plant.  Any increase in the price of corn will cause our cost of goods sold to rise and, as a result, our net income may decline.

We recognize gains or losses that result from changes in the value of our derivative instruments in cost of goods sold as the changes occur.  As corn and natural gas prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance.  We partially offset these losses with the cash price we paid for corn.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of our derivative instruments relative to the cost and use of the commodity being hedged.

General and Administrative Expense.  Our general and administrative expenses as a percentage of revenues were 4.4% and 5.4% for the three months ended September 30, 2006 and 2005, respectively.  However, our administrative expenses increased slightly due to a general increase in expenses.  The increase in expenses was offset by the elimination of management fees paid to Broin Management following the termination of our contract with them.

Income from Operations.  Our income from operations before minority interest for the three months ended September 30, 2006 totaled $12,502,276 compared to $1,778,144 for the three months ended September 30, 2005.  This change was a result of the increase in revenues and the elimination of the management fees paid to Broin for the three months ended September 30, 2006.

Other Income (Expense).  Our total other income and expense for the three months ended September 30, 2006 was substantially the same as the other income and expense for the three months ended September 30, 2005.

Minority Interest in Subsidiary Income.  Minority interest in subsidiary income was $0 for the three months ended September 30, 2006 as compared to $188,041 for the three months ended September 30, 2005.  This change was due to the Company’s purchase of the minority interest on June 30, 2006.

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Results of Operations for the Nine Months Ended September 30, 2006 and 2005

The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items in relation to total revenues in our consolidated statements of operations for the nine months ended September 30, 2006 and 2005:

		September 30, 2006					September 30, 2005
Income Statement Data		Amount			%		Amount			%
Revenues		$	79,795,721		100.0		$	57,613,667		100.0
Cost of Revenues		$	45,455,442		57.0		$	46,271,842		80.3
Gross Profit		$	34,340,279		43.0		$	11,341,825		19.7
General and Administrative Expense		$	2,783,447		3.5		$	2,790,534		4.8
Income from Operations		$	31,556,832		39.5		$	8,551,291		14.8
Other Income (Expense)		$	(585,756	)	0.7		$	(675,051	)	1.2
Net Income Before Minority Interest		$	30,971,076		38.8		$	7,876,240		13.7
Minority Interest in Subsidiary Income		$	(2,235,776	)	2.8		$	(953,789	)	1.7
Net Income		$	28,735,300		36.0		$	6,922,451		12.0

 

Revenues.  Our revenues for the nine months ended September 30, 2006 include $71,791,999 in sales of ethanol and $7,477,812 in sales of distillers grains, in addition to $525,910 of incentive revenue.

The increase in revenues from the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, is due primarily to an increase in the price and amount of ethanol sold.  For the nine months ended September 30, 2006, the average price of the ethanol we sold increased approximately 46% from the average price paid for the nine months ended September 30, 2005.  Volume of ethanol sold in the nine months ended September 30, 2006 was slightly higher than that sold in the nine months ended September 30, 2005.

Cost of Revenues.  Our cost of revenues as a percentage of revenues was 57.0% and 80.3% for the nine months ended September 30, 2006 and 2005, respectively.  However, our cost of revenues decreased by $816,400 in the nine months ended September 30, 2006.  While natural gas prices decreased from the record highs, the total cost of our natural gas increased 5% for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005.  The corn cost was approximately 11% less for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005.

General and Administrative Expense.  Our general and administrative expenses as a percentage of revenues were 3.5% and 4.8% for the nine months ended September 30, 2006 and 2005, respectively.  Our administrative expenses decreased slightly for the nine months ended September 30, 2006 due primarily to the elimination of the management fee paid to Broin Management.

Income from Operations.  Our income from operations before minority interest for the nine months ended September 30, 2006 totaled $31,556,832 compared to $8,551,291 for the nine months ended September 30, 2005.  This was a result of the increase in revenues and the elimination of the management fee paid to Broin for the nine months ended September 30, 2006.

Other Income (Expense).  Our total other income and expense for the nine months ended September 30, 2006 was substantially the same as the other income and expense for the nine months ended September 30, 2005.

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Minority Interest in Subsidiary Income.  Minority interest in subsidiary income was $2,235,776 for the nine months ended September 30, 2006 as compared to $953,789 for the nine months ended September 30, 2005, due to the higher income from operations in 2006.

Changes in Financial Condition for the Nine Months Ended September 30, 2006

 

Consolidated assets totaled $56,114,101 at September 30, 2006 compared to $42,946,122 at December 31, 2005.  Current assets totaled $9,064,502 at September 30, 2006, a slight increase from $9,037,022 at December 31, 2005.  While we have less cash and receivables, our current asset value has increased due to increased inventory.

Consolidated current liabilities totaled $4,826,194 at September 30, 2006 as compared to $7,096,687 at December 31, 2005.  The decrease in current liabilities is due primarily to decreased accounts payable and a slightly lower current value of notes payable compared to December 31, 2005.

Long term liabilities totaled $7,425,017 at September 30, 2006, down from $8,601,196 at December 31, 2005, due to a decrease in the value of notes payable.

Plant Operations

Management anticipates that the plant will continue to operate at or above name-plate capacity of 40 million gallons per year for the next 12 months.  We expect to have sufficient cash from cash flow generated by continuing operations, current lines of credit through our revolving promissory note, and cash reserves to cover our usual operating costs over the next 12 months, which consist primarily of corn supply, natural gas supply, staffing, office, audit, legal, compliance, working capital costs and debt service obligations.

A number of factors that are outside of our control affect our operating costs and revenues, including, but not limited to, the following:

·                  Changes in the availability and price of corn;

·                  Changes in federal ethanol tax incentives;

·                  Changes in the environmental regulations that apply to our plant operations;

·                  Increased competition in the ethanol industry;

·                  Changes in interest rates or the availability of credit;

·                  Changes in our business strategy, capital improvements or development plans;

·                  Changes in plant production capacity or technical difficulties in operating the plant;

·                  Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;

·                  Changes in the availability and price of natural gas;

·                  Increases or decreases in the supply and demand for distillers grains; and

·                  Changes in federal and/or state laws (including the elimination of any federal and/or state ethanol tax incentives).

Our board of managers is engaging in preliminary discussions concerning a potential change in corporate structure, merger, public offering or business combination of Lake Area Corn Processors with one or more companies.  As of the date of this report, no agreement, arrangement or understanding concerning a potential transaction had been reached.  We expect that our board will continue these preliminary discussions.

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On June 30, 2006, the Company executed an Assignment Agreement with members of the Broin family for the purchase of all of the outstanding minority interest (11.898%) in Dakota Ethanol.  We purchased the minority interest under the right of first refusal triggered by the Broins’ negotiation of the sale of their interest to a third party.  Our purchase of the Broins’ interest will allow us to make future business decisions and to take advantage of prevailing market conditions.  Under the agreement, we paid the Broins a purchase price of $17,116,000 for their interest plus an amount representing the Broins’ share of estimated net income through June 30, 2006.  The total amount paid to the Broins was $19,351,776.  The purchase transaction closed on June 30, 2006.  As a result, Dakota Ethanol is now operated as our wholly-owned subsidiary.  In order to fund our buyout of the minority interest, we entered into a credit facility of $19,100,000 with our senior lender, First National Bank of Omaha.  As of September 30, 2006, the Company has paid off the $19,100,000 promissory note used to purchase the Broin’s minority interest.

Liquidity and Capital Resources

The following table shows cash flows for the nine months ended September 30, 2006 and 2005:

 

Cash Flow From Operations.  The increase in net cash flow provided from operating activities between 2006 and 2005 was primarily due to a favorable spread between the price of corn and the price of ethanol.  Our capital needs are being adequately met through cash from our operating activities and our current credit facilities.

Cash Flow From Investing Activities.  Investing activities increased in the nine months ended September 30, 2006 as compared to the nine months ended September 30, 2005, primarily due to the purchase of the Broin minority interest in Dakota Ethanol.

Cash Flow From Financing Activities.  The increase in cash used for financing activities was due primarily to increases in distributions made to the Company’s members and retiring the promissory note issued for the purchase of the Broin minority interest in Dakota Ethanol.

Management anticipates sufficient cash flow from operating activities and revolving debt to cover debt service obligations, operations and planned capital expenditures for the next 12 months.

Indebtedness

Short-Term Debt Sources

On April 21, 2006, Dakota Ethanol renewed a revolving promissory note from First National Bank of Omaha in the amount of $3,000,000.  The note expires on April 20, 2007 and the amount available is subject to certain financial ratios.  Interest on any outstanding principal balance accrues at fifty basis points above the bank’s base rate. There is a commitment fee of 3/8% on the unused portion of the $3,000,000 availability.  The note is collateralized by the Ethanol Plant, its accounts receivable and inventories.  On September 30, 2006, Dakota Ethanol had an outstanding balance on the note of $0, and $3,000,000 was available to be drawn on the revolving promissory note.

On June 30, 2006, Dakota Ethanol received a promissory note from First National Bank of Omaha in the amount of $19,100,000 to finance Lake Area Corn Processor’s purchase of the minority interest in Dakota Ethanol.  The note was due in full on or before October 28, 2006.  Interest on the outstanding principal balance accrued at the bank’s base rate (8.25 percent at September 30, 2006) and was payable monthly.  The note is collateralized by the Ethanol Plant, its accounts receivable and inventories.  There was a $0 outstanding balance as of September 30, 2006.

 

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