LAKE AREA CORN PROCESSORS LLC - Annual Report: 2007 (Form 10-K)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

LAKE AREA CORN PROCESSORS, LLC

(Exact name of registrant 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)

 

Securities registered pursuant to Section 12(b) of the Exchange Act:  None

 

Securities registered pursuant to Section 12(g) of the Exchange Act:  Membership Units

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   o Yes  x No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   o Yes  x No

 

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  £ No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. T

 

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 definitions of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer ¨		Accelerated Filer ¨
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

 

The aggregate market value of the registrant’s membership units held by non-affiliates of the registrant was $14,090,742.50 computed by reference to the most recent public offering price on Form S-4.

 

As of March 15, 2008, there are 29,620,000 membership units of the registrant outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Annual Report.

 

 

INDEX

 

		Page
PART I		4
ITEM 1. BUSINESS		4
U.S. FUEL ETHANOL PRODUCTION CAPACITY		11
ITEM 1A. RISK FACTORS		15
ITEM 2. PROPERTIES		20
ITEM 3. LEGAL PROCEEDINGS		21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		21
PART II		21
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS		21
ITEM 6. SELECTED FINANCIAL DATA		24
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION		25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.		37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE		57
ITEM 9A(T). CONTROLS AND PROCEDURES.		57
ITEM 9B. OTHER INFORMATION.		57
PART III		58
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE		58
ITEM 11. EXECUTIVE COMPENSATION		58
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS		58
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE		58
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES		58
PART IV.		58
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES		58
SIGNATURES		61

 

2

 

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to future events, our future financial performance, or our expected future operations and actions.  In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “future,” “intend,” “could,” “hope,” “predict,” “target,” “potential,” or “continue” or the negative of these terms or other similar expressions.  These forward-looking statements are only our predictions based upon current information and involve numerous assumptions, risks and uncertainties.  Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the reasons described in this report.  While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include:

 

·		Overcapacity within the ethanol industry causing supply to exceed demand;
·		Actual ethanol and distillers grains production varying from expectations;
·		Availability and costs of products and raw materials, particularly corn and natural gas;
·		Changes in the price and market for ethanol and distillers grains;
·		Our ability to market and our reliance on third parties to market our products;
·		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 establishing a renewable fuel standard or other 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;
·		Changes in the weather or general economic conditions impacting the availability and price of corn and natural gas;
·		Changes in total U.S. consumption of gasoline;
·		Fluctuations in petroleum prices;
·		Changes in plant production capacity or technical difficulties in operating the plant;
·		Costs of construction and equipment;
·		Changes in our business strategy, capital improvements or development plans;
·		Results of our hedging strategies;
·		Changes in interest rates or the availability of credit;
·		Our ability to generate free cash flow to invest in our business and service our debt;
·		Our liability resulting from litigation;
·		Our ability to retain key employees and maintain labor relations;
·		Changes and advances in ethanol production technology;
·		Competition from alternative fuels and alternative fuel additives; and
·		Other factors described elsewhere in this report.

 

3

 

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 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.

 

PART I

 

ITEM 1.  BUSINESS.

 

Overview

 

Lake Area Corn Processors, LLC is a South Dakota limited liability company that currently owns and manages its wholly-owned subsidiary Dakota Ethanol, LLC.  Prior to June 2006, the Broin family owned a minority interest of approximately 12% of Dakota Ethanol, LLC.  On June 30, 2006, we entered into an assignment agreement with the Broin family to purchase its minority interest in Dakota Ethanol, LLC.  Following execution of the assignment agreement, we own 100% of Dakota Ethanol, LLC and operate it as a wholly-owned subsidiary.  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.”

 

Since September 4, 2001, Dakota Ethanol has been engaged in the production of ethanol and distillers grains.  Fuel grade ethanol is Dakota Ethanol’s primary product accounting for the majority of its revenue.  Dakota Ethanol also sells distillers grains, a principal co-product of the ethanol production process.   During our 2007 fiscal year, Dakota Ethanol processed approximately 17.5 million bushels of corn into approximately 48.9 million gallons of ethanol.  Dakota Ethanol also produced approximately 150,000 tons of distillers grains in 2007.  In 2008, we anticipate that Dakota Ethanol’s ethanol and distillers grains production levels will be substantially the same as in fiscal year 2007.  There is, however, no assurance that Dakota Ethanol will be able to operate at these production levels.

 

General Development of Business

 

LACP was formed as a South Dakota cooperative on May 25, 1999.  On August 20, 2002, our members approved a plan to reorganize into a South Dakota limited liability company.  The reorganization became effective on August 31, 2002, and the assets and liabilities of the cooperative were transferred to the newly formed limited liability company.  Following the reorganization, our legal name was changed to Lake Area Corn Processors, LLC.

 

Our ownership of Dakota Ethanol represents substantially all of our assets and our only source of revenue.  Since we operate Dakota Ethanol as a wholly-owned subsidiary, we receive all revenues generated by Dakota Ethanol.  We distribute the revenues received from Dakota Ethanol to our unit holders in proportion to the number of units held by each member.

 

Dakota Ethanol underwent a significant change in its mode of operations on June 6, 2005, when it elected not to renew its management agreement and other marketing agreements with Broin Management, LLC and other various Broin-related entities.  Between June 6, 2005 and December 31, 2005, Dakota Ethanol and the Broin-related entities negotiated termination of the contracts and Dakota Ethanol entered into agreements with new risk management and marketing service providers.  In addition, on October 16, 2005, Dakota Ethanol entered into an employment agreement with Scott Mundt to serve in the position of Transition Coordinator.  Mr. Mundt’s employment began on October 17, 2005, the effective date of his employment agreement.  Effective January 1, 2006, Mr. Mundt’s position changed to General Manager.  Subsequently, on August 1, 2007, Mr. Mundt was

 

4

 

appointed Chief Executive Officer of Lake Area Corn Processors, LLC.  Mr. Mundt’s duties include day-to-day management of the operations of Dakota Ethanol.

 

In the first fiscal quarter of 2007, Dakota Ethanol commenced construction of an 860,000 bushel grain storage bin.  The total cost of this project was estimated to be approximately $2,000,000.  Construction commenced on the grain storage bin in June 2007.  The grain storage bin is complete.  We spent approximately $2,032,000 to construct the grain storage bin.

 

Financial Information

 

Please refer to “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information about our revenues, profit and loss measurements and total assets and “Item 8 - Financial Statements and Supplementary Data” for our consolidated financial statements.

 

Principal Products and Their Markets

 

The principal products produced at the ethanol plant are fuel grade ethanol and distillers grains.

 

Ethanol

 

  Ethanol is ethyl alcohol, a fuel component made primarily from corn and various other grains.  According to the Renewable Fuels Association, approximately 85 percent of the ethanol produced in the United States today is produced from corn, and approximately 90 percent of ethanol is produced from a corn and other input mix. Corn produces large quantities of carbohydrates, which convert into glucose more easily than most other kinds of biomass. As of March 4, 2008, the Renewable Fuels Association estimates United States ethanol production capacity at more than 8 billion gallons.

 

An ethanol plant is essentially a fermentation plant.  Ground corn and water are mixed with enzymes and yeast to produce a substance called “beer,” which contains about 10% alcohol and 90% water.  The “beer” is boiled to separate the water, resulting in ethyl alcohol, which is then dehydrated to increase the alcohol content.  This product is then mixed with a certified denaturant such as gasoline to make the product unfit for human consumption and commercially saleable.

 

Ethanol can be used as: (i) an octane enhancer in fuels; (ii) an oxygenated fuel additive for the purpose of reducing ozone and carbon monoxide vehicle emissions; and (iii) a non-petroleum-based gasoline substitute.  Approximately 95% of all ethanol is used in its primary form for blending with unleaded gasoline and other fuel products.  Used as a fuel oxygenate, ethanol provides a means to control carbon monoxide emissions in large metropolitan areas where oxygenated fuels are required during certain times of the year.  The principal purchasers of ethanol are generally wholesale gasoline marketers or blenders.  The principal markets for our ethanol are petroleum terminals in the continental United States.

 

Dakota Ethanol began producing ethanol in September 2001.  For our fiscal year ended December 31, 2007, revenues from sales of ethanol were approximately 89% of our total revenues.  The following table shows the percentage of our total revenues that were from sales of ethanol for each of the last three fiscal years:

 

Fiscal Year		Percentage of Revenues from Sales of Ethanol
Ended December 31, 2007		89	%
Ended December 31, 2006		91	%
Ended December 31, 2005		86	%

 

Distillers Grains

 

A principal co-product of the ethanol production process is distillers grains, a high protein, high-energy animal feed supplement primarily marketed to the dairy and beef industry.  Distillers grains contain by-pass protein that is superior to other protein supplements such as cottonseed meal and soybean meal.  By-pass proteins are more

 

5

 

digestible to the animal, thus generating greater lactation in milk cows and greater weight gain in beef cattle.  Dry mill ethanol processing creates four forms of distiller grains: Distillers Wet Grains (“DWS”), Distillers Modified Wet Grains (“DMWS”), Condensed Distillers Solubles (“CDS”) and Distillers Dried Grains with Solubles (“DDGS”).  DWS is processed corn mash that contains approximately 70% moisture.  DWS has a shelf life of approximately seven days and can be sold only to consumers within the immediate vicinity of an ethanol plant.  DMWS is DWS that has been dried to approximately 50% moisture.  DMWS has a slightly longer shelf life of approximately ten days and is often sold to nearby markets.  CDS contains approximately 75% moisture and is marketed locally.  It has a shelf life of approximately thirty days.  DDGS is DWS that has been dried to 10% to 12% moisture.  DDGS has an almost indefinite shelf life and may be sold and shipped to any market regardless of its vicinity to an ethanol plant.  At our plant, the composition of the distillers grains we produce is approximately 1% DWS, 46% DMWS, 3% CDS and 50% DDGS.

 

For our fiscal year ended December 31, 2007, revenues from sales of distillers grains were approximately 11% of our total revenues.  The following table shows the percentage of our total revenues that were from sales of distillers grains for each of the last three fiscal years:

 

Fiscal Year		Percentage of Revenues from Sales of Distillers Grains
Ended December 31, 2007		11	%
Ended December 31, 2006		8	%
Ended December 31, 2005		13	%

 

Distribution of Principal Products

 

The ethanol plant is located near Wentworth, South Dakota in Lake County, in eastern South Dakota.  We selected the Wentworth site because of its proximity to existing grain production, accessibility to road and rail transportation and its proximity to major population centers.  It is served by the Burlington Northern Santa Fe railroad system.  It is in close proximity to multiple state highways and is near Interstate Highways 29 and 90.

 

Ethanol Distribution

 

From the date Dakota Ethanol began operations through the fiscal year ended December 31, 2005, Dakota Ethanol marketed the ethanol produced at the plant through an exclusive marketing agreement with Ethanol Products, LLC (“Ethanol Products”), a Broin affiliate.  On June 6, 2005, Dakota Ethanol elected not to renew its agreement with Ethanol Products and agreed that termination would become effective as of January 1, 2006.

 

On November 30, 2005, Dakota Ethanol entered into an Ethanol Fuel Marketing Agreement with Renewable Products Marketing Group (“RPMG”) of Shakopee, Minnesota, for the purposes of marketing and distributing our ethanol. On April 1, 2007, Dakota Ethanol became an owner of RPMG by making a capital contribution to RPMG and executing certain other agreements.  Dakota Ethanol’s capital contribution was $605,000, of which $105,000 was paid upon execution and balance will be paid over time with a portion of our ethanol sales revenue.  Dakota Ethanol became a party to RPMG’s operating agreement, executed a contribution agreement that governs the funding of Dakota Ethanol’s capital contribution to RPMG, and entered into a new member ethanol fuel marketing agreement for members of RPMG.  Becoming an owner of RPMG allows Dakota Ethanol to share any profits made by RPMG and reduces the fees Dakota Ethanol pays RPMG to market its ethanol.  Pursuant to Dakota Ethanol’s member ethanol fuel marketing agreement, we use a pooled marketing arrangement, which means that the ethanol we produce is pooled with other ethanol producers and marketed by RPMG.  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.

 

Distillers Grains Distribution

 

From the date we began operations through the fiscal year ended December 31, 2005, we marketed our distillers grains through a contract with Broin Enterprises, Inc. d/b/a Dakota Gold Marketing, a Broin affiliate.  On

 

6

 

June 6, 2005, we elected not to renew our agreement with Dakota Gold Marketing and agreed to a termination date of December 1, 2005.

 

On November 28, 2005, we entered into a Distillers Grain Marketing Agreement with Commodity Specialists Company (CSC) of Minneapolis, Minnesota for the purpose of marketing the distillers grains we produce.  CSC was purchased by CHS, Inc. (CHS) during the summer of 2007.  On August 8, 2007, CSC assigned our distillers grains marketing agreement to CHS effective October 1, 2007.  Therefore, our distillers grains are now marketed and sold by CHS.  The terms of our marketing agreement with CHS are the same as the terms of our agreement with CSC.  Under the distillers grains marketing agreement, we receive a percentage of the selling price actually received by CHS in marketing the distillers grains to its customers.  The term of the agreement began on December 1, 2005 and renews automatically annually for additional one year terms unless prior written notice of non-renewal is provided by either party.  In December 2007, this agreement with CHS was renewed pursuant to the automatic renewal provision for an additional one year term.

 

Beginning on December 1, 2005, we began marketing some of our distillers grains to our local market without the use of an external marketer.  Shipments of these products are made to local markets by truck.  This has allowed us to sell less distillers grains in the form of DDGS which has decreased our natural gas usage and increased our revenues from the sale of distillers grains.

 

Seasonal Factors in Business

 

In an effort to improve air quality in regions where carbon monoxide and ozone are a problem, the Federal Clean Air Act requires the sale of oxygenated motor fuels during the winter months in certain major metropolitan areas.  Gasoline that is blended with ethanol has a higher oxygen content than gasoline that does not contain ethanol.  As a result, we expect fairly light seasonality with respect to our revenue from ethanol sales allowing us to, potentially, be able to sell our ethanol at a slight premium during the mandated oxygenate period.  Conversely, we expect our average sales price for ethanol to be slightly lower during the summer, when fuel-grade ethanol is primarily used as an octane enhancer or a fuel supply extender.

 

Sources and Availability of Raw Materials

 

Corn Feedstock Supply

 

The major raw material required for our ethanol plant to produce ethanol and distillers grains is corn.  To operate at a nameplate capacity of 40 million gallons, the plant requires a supply of approximately 14 million bushels of corn annually.  The plant currently operates in excess of its nameplate capacity, producing approximately 48.9 million gallons of ethanol annually from approximately 17.5 million bushels of corn.  The area surrounding the plant near Wentworth in Lake County, South Dakota currently provides an ample supply of corn to meet and exceed our raw material requirements for the nameplate production capacity of the plant and our current higher than nameplate production capacity.  In 2004, 2005 and 2006, the United States produced record corn crops of approximately 11.8 billion bushels, 11.11 billion bushels and 10.74 billion bushels respectively.  Further, the 2007 corn crop produced a record 13.1 billion bushels of corn.  These four years represent the four largest United States corn crops in history.  However, despite the record high corn production in 2007, corn prices continue to rise as a result of increased global demand.  We expect that these increased corn prices will continue into our 2008 fiscal year.

 

For the fiscal year ended December 31, 2005, we operated under an agreement with Broin Management, LLC for price risk management related to the corn requirements of the plant.  However, we terminated the agreement effective January 1, 2006.

 

On November 28, 2005, we entered into a Risk Management Contract with FCStone, LLC (“FCStone”) of West Des Moines, Iowa.  Under the contract, FCStone provides all risk management services and programs relating to our production and sale of ethanol and distillers grains.  In exchange for these services, we pay FCStone a fee of $3,333.33 per month, which is based on a rate of $0.001 per gallon of ethanol produced from an annual production capacity of 40 million gallons.  In addition, we will pay any commission, fee, service charge or mark-up arising from any option, futures or other risk management or cash commodity transaction executed or brokered through

 

7

 

FCStone, not to exceed $12.50 per round turn for exchange-traded futures and options contracts and equal to $10.00 per round turn for over-the-counter transactions.  The initial term of the contract began on December 1, 2005 and went until October 31, 2006.  Following the initial term, the contract renews automatically for additional one-year terms unless prior written notice of non-renewal is provided by either party.  This agreement was renewed for an additional one-year term pursuant to the automatic renewal provision of the contract on October 31, 2007.

 

Corn is supplied to us primarily from our members who are local agricultural producers and from purchases of corn on the open market.  Certain of our members have corn delivery contracts that require them to supply us with corn as a condition of being a member of the company.  On August 1, 2007, our board of directors approved a resolution making it voluntary for these members to deliver corn to us under their respective corn delivery agreements.  We anticipate that many of our members will continue to supply us with corn on a voluntary basis.

 

                Natural Gas

 

Natural gas is an important input to our manufacturing process.  We use natural gas to dry our distillers grains products to moisture contents at which they can be stored for long periods of time.  This allows the distillers grains we produce to be transported greater distances which allows them to serve broader livestock markets, including poultry and swine markets in the continental United States.  We contract with NorthWestern Energy for our natural gas.  Under our agreement, the price for our natural gas is based on market rates.  The agreement is in effect until 2011 and automatically renews for successive one-year terms unless the agreement is terminated.  Since operations commenced in 2001, there have been no interruptions in the supply of natural gas from NorthWestern Energy, and all of our natural gas requirements have been met.

 

Electricity

 

Electricity is necessary for lighting and powering much of the machinery and equipment used in the production process.  We contract with Sioux Valley Energy, Inc. to provide all of the electric power and energy requirements for the ethanol plant.   The agreement is in effect until 2011 and automatically renews for five-year terms, unless at least 18 months notice is given by either party to terminate the agreement prior to the expiration of the current term.  We have had no interruption or shortages in the supply of electricity to the plant since operations commenced in 2001.

 

Water

 

Water is a necessary part of the ethanol production process.  It is used in the fermentation process and to produce steam for the cooking, evaporation, and distillation processes.  We contract with Big Sioux Community Water System, Inc. to supply and meet our water requirements for the ethanol and distillers grains production process.  Our agreement with Big Sioux is for automatically renewing five-year terms.  Since our operations commenced in September 2001, we have had no interruption in the supply of water and all our requirements have been met.  This agreement was renewed for a term of one year starting on July 1, 2007 at a rate of $0.55 per thousand gallons of usage.  The Big Sioux Community Water System will not guarantee any of the parameters of the original agreement due to our water usage levels.  The agreement also allows us to use water from the Skunk River Aquifer to meet the plant’s water needs.  In all other respects, the terms of the original contract are the same.

 

Federal Ethanol Supports

 

The ethanol industry is dependent on several economic incentives to produce ethanol, including federal ethanol supports.  One significant federal ethanol support is the Renewable Fuels Standard (the “RFS”).  The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective.  The RFS requires that in each year, a certain amount of renewable fuels be utilized in the United States.  The RFS was increased by the Energy Independence and Security Act of 2007 which became law in December 2007.  Currently, the RFS requires the use of 9 billion gallons of renewable fuels in 2008, increasing to 36 billion gallons in 2022.  However, the RFS requires that a significant portion of these 36 billion gallons come from “advanced” renewable fuels.  Grain based ethanol, such as the ethanol we produce, that may be used to meet the RFS is capped at 15 billion gallons per year starting in 2015.  Therefore, demand for corn based ethanol may not expand significantly past the 15 billion gallons per year cap.

 

8

 

The advanced renewable fuels that can be used to satisfy the remaining gallons of the RFS include cellulosic ethanol.  Cellulosic ethanol is ethanol that is produced from cellulose, which is the main component of plant cell walls and is the most common organic compound on earth.  Cellulose is found in wood chips, corn stalks, rice straw, amongst other common plants.  Current technology makes it difficult or impossible to produce ethanol cost-effectively from cellulose.  However, the RFS and state and federal grant programs are encouraging the development of commercial cellulosic ethanol production.  Several grants were recently made for pilot projects that are attempting to produce cellulosic ethanol on a commercial scale.

 

In April 2007, the EPA adopted a final rule that fully implemented the RFS requirement.  The rule created a credit trading program that is designed to allow the fuel refining industry as a whole to meet the RFS requirement in the most cost effective manner possible.  The credit trading program allows refiners who blend more renewable fuels than they are required to sell credits to refiners who blend less renewable fuels than they are required.  This credit trading program was designed to decrease any potential burden the RFS might place on small fuel refiners.

 

The increase in the RFS is likely to increase both the supply and demand for ethanol.  The production capacity of the ethanol industry as of March 4, 2008 is estimated by the RFA to be more than 8 billion gallons.  Ethanol production in the United States during 2007 was estimated by the RFA to be 6.5 billion gallons.  Monthly ethanol demand increased by nearly 150 million gallons between January 2007 and December 2007, the last demand figures available from the RFA. The expanded RFS will likely further increase demand for ethanol.  However, as demand for ethanol increases, we expect the ethanol industry to increase ethanol supply to meet this increased demand.  Increases in supply may more than offset increases in demand associated with the RFS.

 

Historically, ethanol sales have also been favorably affected by the Clean Air Act amendments of 1990, particularly the Federal Oxygen Program which became effective November 1, 1992.  The Federal Oxygen Program requires the sale of oxygenated motor fuels during the winter months in certain major metropolitan areas to reduce carbon monoxide pollution.  Ethanol use has increased due to a second Clean Air Act program, the Reformulated Gasoline Program.  This program became effective January 1, 1995, and requires the sale of reformulated gasoline in nine major urban areas to reduce pollutants, including those that contribute to ground level ozone, better known as smog.  The two major oxygenates added to reformulated gasoline pursuant to these programs are MTBE and ethanol, however MTBE has caused groundwater contamination and has been banned from use by many states.  Although the Energy Policy Act of 2005 did not impose a national ban of MTBE, its failure to include liability protection for manufacturers of MTBE is expected to result in refiners and blenders using ethanol as an oxygenate rather than MTBE to satisfy the reformulated gasoline oxygenate requirement.  We believe all of the increase in ethanol demand as a result of the phase out of MTBE has already occurred.  The Energy Policy Act repeals the Clean Air Act’s 2% oxygenate requirement for reformulated gasoline.  However, the Act did not repeal the 2.7% oxygenate requirement for carbon monoxide non-attainment areas which are required to use oxygenated fuels in the winter months.  While we expect ethanol to be the oxygenate of choice in these areas, there is no assurance that ethanol will in fact be used.

 

                 The Energy Policy Act of 2005 expanded who qualifies for the small ethanol producer tax credit.  Historically, small ethanol producers were allowed a 10-cents-per-gallon production income tax credit on up to 15 million gallons of production annually.  The size of the plant eligible for the tax credit was limited to 30 million gallons.  Under the Energy Policy Act of 2005, the size limitation on the production capacity for small ethanol producers increased from 30 million to 60 million gallons.  As a result, we are eligible for the small producer tax credit and received the $1,500,000 maximum credit under the program during our 2007 fiscal year.  The credit is effective for taxable years ending after the date of enactment.  The credit is directly passed through to our members and is not recorded in our financial statements.

 

In addition, the Energy Policy Act of 2005 creates a new tax credit that permits taxpayers to claim a 30% credit (up to $30,000) for the cost of installing clean-fuel vehicle refueling equipment, such as an E85 fuel pump, to be used in a trade or business of the taxpayer or installed at the principal residence of the taxpayer. Under the provision, clean fuels are any fuel where at least 85% of the volume consists of ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas, and hydrogen and any mixture of diesel fuel and biodiesel containing at least 20% biodiesel.  The provision is effective for equipment placed in service after December 31, 2005 and before January 1, 2010. While it is unclear how this credit will affect the demand for ethanol in the short

 

9

 

term, we expect it will help raise consumer awareness of alternative sources of fuel and could positively impact future demand for ethanol.

 

       The use of ethanol as an alternative fuel source has been aided by federal tax policy.  On October 22, 2004, President Bush signed H.R. 4520, which contained the Volumetric Ethanol Excise Tax Credit (“VEETC”) and amended the federal excise tax structure effective as of January 1, 2005.  Prior to VEETC, ethanol-blended fuel was taxed at a lower rate than regular gasoline (13.2 cents on a 10% blend).  Under VEETC, the ethanol excise tax exemption has been eliminated, thereby allowing the full federal excise tax of 18.4 cents per gallon of gasoline to be collected on all gasoline and allocated to the highway trust fund.  In place of the exemption, the bill created a new volumetric ethanol excise tax credit of 5.1 cents per gallon of ethanol blended at 10%.  Refiners and gasoline blenders apply for this credit on the same tax form as before only it is a credit from general revenue, not the highway trust fund.  Based on volume, the VEETC is expected to allow much greater refinery flexibility in blending ethanol since it makes the tax credit available on all ethanol blended with all gasoline, diesel and ethyl tertiary butyl ether (“ETBE”), including ethanol in E85 and E20 in Minnesota.  The VEETC is scheduled to expire on December 31, 2010.

 

The ethanol industry and our business depend upon continuation of the federal ethanol supports discussed above.  These incentives have supported a market for ethanol that might disappear without the incentives.  Alternatively, the incentives may be continued at lower levels than at which they currently exist.  The elimination or reduction of such federal ethanol supports would make it more costly for us to sell our ethanol and would likely reduce our net income.

 

Our Competition

 

                We are in direct competition with numerous other ethanol producers, many of whom have greater resources than we do.  During our 2007 fiscal year, there was relatively slower growth in the number of new ethanol producers entering the market due to high corn prices and relatively lower ethanol prices as compared to the preceding two years.  However, should demand for, or price of, ethanol increase, for example, as a result of the increase in renewable fuels standard that was recently adopted, we expect existing ethanol producers and new ethanol producers to increase production capacity within the ethanol industry.  This increase in supply may more than offset the increase in demand.  Ethanol is a commodity product, like corn, which means our ethanol plant competes with other ethanol producers on the basis of price and, to a lesser extent, delivery service.  We believe we compete favorably with other ethanol producers due to our proximity to ample grain supplies and multiple modes of transportation.  In addition, we believe our plant’s location offers an advantage over other ethanol producers in that it has ready access by rail to growing ethanol markets, which may reduce our cost of sales.

 

According to the Renewable Fuels Association, as of March 4, 2008, the ethanol industry has grown to 143 production facilities in the United States. There are 57 new plants currently under construction along with 7 plant expansions.  The Renewable Fuels Association currently estimates that the United States ethanol industry has capacity to produce more than 8 billion gallons of ethanol per year.  The new ethanol plants under construction along with the plant expansions under construction could push United States production of fuel ethanol in the near future to more than 13.4 billion gallons per year.  The largest ethanol producers include Abengoa Bioenergy Corp., Archer Daniels Midland, Aventine Renewable Energy, Inc., Hawkeye Renewable, POET (Formerly Broin), US BioEnergy Corp., and VeraSun Energy Corporation, each of which are capable of producing more ethanol than we produce.  Further, many consider the ethanol industry ripe for consolidation.  Currently, there are a few large producers of ethanol and many smaller producers of ethanol.  It is likely that in the future, some consolidation of the ethanol industry will occur which will result in a smaller number of producers which control a large percentage of the ethanol production market.  This may allow these larger producers to influence the ethanol industry in ways that are not beneficial to us.  These larger ethanol producers may realize economies of scale in the production of ethanol and distillers grains that we cannot take advantage of, specifically with respect to larger sales of ethanol and increased bargaining power for raw materials.  On November 29, 2007, VeraSun Energy Corporation and US BioEnergy Corporation announced a merger that would increase the annual production capacity of VeraSun to 1.6 billion gallons of ethanol by the end of 2008.  This is significantly more than we currently produce or expect to produce in the future.

 

10

 

In the past we considered various types of corporate mergers and acquisitions, including discussions we had with Countryside Renewable Energy.  However, none of these plans or negotiations resulted in any merger.  Since Countryside abandoned its plans with respect to consolidating several ethanol producers into one company, we do not anticipate entering into any such transaction in the near future.

 

The following table identifies the majority of the largest ethanol producers in the United States along with their production capacities.

 

U.S. FUEL ETHANOL PRODUCTION CAPACITY

BY TOP PRODUCERS

Producers of Approximately 200
million gallons per year (mmgy) or more

 

				Current		Under Construction/
				Capacity		Expansions
Company		Location		(mmgy)		(mmgy)
Abengoa Bioenergy Corp		York, NE		55
		Colwich, KS		25
		Portales, NM		30
		Revenna, NE		88
Aventine Renewable Energy, Inc.*		Pekin, IL		207		226
		Aurora, NE
		Mt. Vernon, IN
Archer Daniels Midland*		Decatur, IL		1,070		550
		Cedar Rapids, IA
		Clinton, IA
		Columbus, NE
		Marshall, MN
		Peoria, IL
		Wallhalla, ND
POET*		Sioux Falls, SD		1,208		327
		Alexandria, IN
		Ashton, IA
		Big Stone, SD
		Bingham Lake, MN
		Caro, MI
		Chancellor, SD
		Coon Rapids, IA
		Corning, IA
		Emmetsburg, IA
		Fostoria, OH
		Glenville, MN
		Gowrie, IA
		Groton, SD
		Hanlontown, IA
		Hudson, SD
		Jewell, IA
		Laddonia, MO
		Lake Crystal, MN
		Leipsic, OH
		Macon, MO
		Marion, OH
		Mitchell, SD
		N. Manchester, IN
		Portland. IN
		Preston, MN
		Scotland, SD

 

11

 

Hawkeye Renewables, LLC		Iowa Falls, IA		105
		Fairbank, IA		115
		Menlo, IA				100
		Shell Rock, IA				110
US BioEnergy Corp*		Albert City, IA		310		440
		Woodbury, MI
		Hankinson, ND
		Central City, NE
		Ord, NE
		Dyersville, IA
		Janesville, MN
		Marion, SD
VeraSun Energy Corporation*		Aurora, SD		560		330
		Ft. Dodge, IA
		Albion, NE
		Charles City, IA
		Linden, IN
		Welcome, MN
		Hartely, IA
		Bloomingburg, OH

 

*Individual state production capacity not reported

 

Updated: March 4, 2008

 

Competition with Ethanol Imported from Other Countries

 

Ethanol production is also expanding internationally.  Brazil has historically been a significant producer of ethanol for both its domestic and export markets.  According to the Renewable Fuels Association, in 2007, Brazil exported nearly 190 million gallons of ethanol to the United States through November 2007 (the last available data).  Further, ethanol produced or processed in certain countries in Central American and the Caribbean region is eligible for tariff reduction or elimination upon importation to the United States under a program known as the Caribbean Basin Initiative.  Some ethanol producers, including Cargill, have started taking advantage of this situation by building dehydration plants in participating Caribbean Basin countries, which convert ethanol into fuel-grade ethanol for shipment to the United States.  Ethanol imported from Caribbean Basin countries may be a less expensive alternative to domestically produced ethanol and may affect our ability to sell our ethanol profitably.

 

In 2007, President Bush entered into discussions with South American countries regarding increasing ethanol production in South America.  There was no discussion regarding reduction or elimination of tariffs that protect the United State’s ethanol industry and no action has been taken to reduce or eliminate those tariffs.  Any reduction of tariffs could result in increased importation of ethanol from South and Central American countries which could create additional competition in the United States ethanol market and could adversely affect the prices we receive for our ethanol.

 

Competition from Alternative Fuels

 

Our ethanol plant also competes with producers of other gasoline additives having similar octane and oxygenate values as ethanol, such as producers of MTBE, a petrochemical derived from methanol that costs less to produce than ethanol.  Although currently the subject of several state bans, many major oil companies can produce MTBE, and because it is petroleum-based, its use may receive strong support from major oil companies.

 

Alternative fuels, gasoline oxygenates and alternative ethanol production methods are continually under development by ethanol and oil companies with far greater resources than we possess. The major oil companies have significantly greater resources than we have to develop alternative products and to influence legislation and public perception of ethanol.  New ethanol products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages and harm our business.

 

12

 

Further, recent legislation, including the Energy Independence and Security Act of 2007, clearly encourages the development of advanced renewable fuels such as cellulosic ethanol that can be produced from feedstock other than raw grains.  This alternative may be preferable to corn based ethanol and may enjoy more governmental and consumer support.  This may decrease the demand for and price of the ethanol we produce.

 

Distillers Grains Competition

 

Our plant primarily competes with other ethanol producers in the production and sales of distillers grains.  According to the University of Minnesota’s DDGS—General Information website (last updated November 29, 2007) approximately 3,200,000 to 3,500,000 tons of distillers grains are produced annually in North America, approximately 98% of which are produced by ethanol plants. The remaining 1 to 2% of DDGS is produced by the alcoholic beverage industry.  The amount of distillers grains produced is expected to continue to increase as the number of operating ethanol plants increases.  This could negatively impact the price at which we sell our distillers grains unless demand expands in relation to the expanding supply.  Our distillers grains compete with other livestock feed products such as soybean meal, corn gluten feed, dry brewers grain and mill feeds.  However, due to current high corn and soybean prices, the price of distillers grains has risen.  However, increases in distillers grains supply may dampen any increases in distillers grains prices that we have experienced as a result of corn and soybean price increases.

 

General Ethanol Demand and Supply

 

Ethanol has important applications, primarily as a high-quality octane enhancer and an oxygenate capable of reducing air pollution and improving automobile performance.  Ethanol contains 35% oxygen by weight.  As a result, gasoline, when blended with ethanol, burns cleaner, and releases less carbon monoxide and other exhaust emissions into the atmosphere.

 

According to the Renewable Fuels Association, demand for fuel ethanol in the United States continued to increase in 2007.  Domestic ethanol demand was more than 6.8 billion gallons in 2007 according to Renewable Fuels Association statistics.  Further, domestic ethanol production is estimated by the RFA to be nearly 6.5 billion gallons.  If the supply of ethanol increases at a more rapid rate than demand, the price at which we can sell our ethanol may decrease.  The ethanol industry must continue to grow demand for ethanol in order to support current ethanol prices and allow the ethanol industry to remain profitable.

 

Demand for ethanol may remain strong as a result of increased consumption of E85 fuel. E85 fuel is a blend of 85% ethanol and 15% gasoline.  The National Ethanol Vehicle Coalition reports as of February 14, 2008, that there are approximately 1,500 retail gasoline stations supplying E85.  While the number of retail E85 suppliers increases significantly each year, this remains a relatively small percentage of the total number of U.S. retail gasoline stations, which is approximately 170,000.  According to the RFA, as of February 2008, there are more than 6 million flex fuel vehicles on the road in the United States.  As public awareness of ethanol and E85 increases along with E85’s increased availability, management anticipates some growth in demand for ethanol as a result of E85 consumption.

 

The following table shows U.S. ethanol production capacity by state as of January 2008.  This table includes both operating ethanol production facilities and those that are currently under construction.

 

13

 

U.S. ETHANOL PRODUCTION CAPACITY BY STATE

 

    In Millions of Gallons

 

 

 

In addition to domestic increases in the supply of ethanol, as discussed above we face competition from international sources of ethanol, including ethanol produced in Caribbean Basin countries that may be eligible for tariff reductions or elimination pursuant to the Caribbean Basin Initiative.

 

Research and Development

 

We do not conduct any research and development activities associated with the development of new technologies for use in producing ethanol and distillers grains.

 

Dependence on One or a Few Major Customers

 

                As discussed above, we have entered into marketing agreements for services related to marketing and distributing our principal products, ethanol and distillers grains.  Pursuant to our agreements with RPMG and CHS, we rely on others for the sale and distribution of almost all of our products, except for those distillers grains that we market locally.  Therefore, we expect to continue to be highly dependent on RPMG and CHS for the successful marketing of our products.  Any loss of RPMG or CHS as our marketing agent for our ethanol and distillers grains or any lack of performance under these agreements or inability to secure competitive prices could have a significant negative impact on our revenues.

 

Costs and Effects of Compliance with Environmental Laws

 

We are subject to extensive air, water and other environmental regulations, and we have been required to obtain a number of environmental permits to construct and operate the plant.  We have obtained all of the necessary permits to operate the plant.  Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional permits or spend considerable resources on complying with such regulations.

 

                In addition, we may be required to purchase and install equipment for controlling and improving emissions.  In fiscal year 2007, our costs of environmental compliance were approximately $252,000 compared to approximately $81,000 for the same period of 2006.  In 2006 we applied for renewal of our air permit which was approved effective August 16, 2007.  This air permit expires on August 16, 2012.

 

14

 

We are subject to oversight activities by the EPA.  There is always a risk that the EPA may enforce certain rules and regulations differently than South Dakota’s environmental administrators.  South Dakota or EPA rules are subject to change, and any such changes could result in greater regulatory burdens on plant operations.  We could also be subject to environmental or nuisance claims from adjacent property owners or residents in the area arising from possible foul smells or other air or water discharges from the plant.  Such claims may result in an adverse result in court if we are deemed to engage in a nuisance that substantially impairs the fair use and enjoyment of real estate.

 

The government’s regulation of the environment changes constantly.  It is possible that federal or state environmental rules or regulations could be adopted that could have an adverse effect on the use of ethanol.  For example, changes in the environmental regulations regarding the required oxygen content of automobile emissions could have an adverse effect on the ethanol industry.  Furthermore, plant operations are governed by the Occupational Safety and Health Administration (“OSHA”).  OSHA regulations may change such that the costs of the operation of the plant may increase.  Any of these regulatory factors may result in higher costs or other materially adverse conditions effecting our operations, cash flows and financial performance.

 

Employees

 

As of December 31, 2007, we had a total of 39 full-time employees, including 33 full-time employees in ethanol production operations and 6 full-time employees in general management and administration.  We do not expect to hire a significant number of employees in the next 12 months.

 

Financial Information about Geographic Areas

 

All of our operations are domiciled in the United States.  All of the products sold to our customers for fiscal years 2007, 2006 and 2005 were produced in the United States and all of our long-lived assets are domiciled in the United States.  We have engaged third-party professional marketers who decide where our products are marketed and we have no control over the marketing decisions made by our third-party professional marketers.

 

Available Information

 

The public may read and copy materials we file with the Securities and Exchange Commission at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C., 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.  Reports we file electronically with the SEC may be obtained at http://www.sec.gov.  In addition, information about us is also available at our website at http://www.dakotaethanol.com/lacp.html, which includes links to reports we have filed with the Securities and Exchange Commission.  The contents of our website are not incorporated by reference in this Annual Report on Form 10-K.

 

ITEM 1A.               RISK FACTORS.

 

You should carefully read and consider the risks and uncertainties below and the other information contained in this report.  The risks and uncertainties described below are not the only ones we may face.  The following risks, together with additional risks and uncertainties not currently known to us or that we currently deem immaterial could impair our financial condition and results of operation.

 

Risks Relating to Our Business

 

Increases in the price of corn would reduce our profitability.  Our results of operations and financial condition are significantly affected by the price and supply of corn. Changes in the price and supply of corn are subject to and determined by market forces over which we have no control.  The price at which we purchase corn has risen substantially in the last year and we expect the price may continue to increase.  Despite the third largest corn crop on record of approximately 10.74 billion bushels in 2006, the price we paid for corn increased

 

15

 

approximately 89% in our 2007 fiscal year as compared to the same period of 2006.  While the USDA estimates the 2007 corn crop produced a record 13.1 billion bushels of corn, the selling price of corn continues to rise.

 

Increases in demand for corn from both the world foodstuff markets and from increased production of ethanol have increased the price of corn.  We expect demand for corn from the ethanol industry to continue to expand.  The Renewable Fuels Association estimates as of March 4, 2008, there were 143 ethanol plants in operation nationwide with the capacity to produce more than 8 billion gallons of ethanol annually.  An additional 57 new plants and 7 expansions are currently under construction, which will add an additional estimated 5.3 billion gallons of annual production capacity.  Approximately 90% of the ethanol produced in the United States uses corn as its feedstock.  This increased supply of ethanol will continue to increase demand for corn.

 

If the demand for corn continues to increase so will the price we pay for corn.  Since our revenues depend on the spread between the selling price of our ethanol and the price we pay for corn, increases in corn prices affect our ability to generate a profit.  This could negatively affect our future profitability.

 

Our financial performance is significantly dependent on corn and natural gas prices.  Our results of operations and financial condition are significantly affected by the cost and supply of corn and natural gas.  Generally, we cannot pass on increases in input prices to our customers.  Changes in the price and supply of corn and natural gas are subject to and determined by market forces over which we have no control.

 

                Corn, as with most other crops, is affected by weather, disease and other environmental conditions.  The price of corn is also influenced by general economic, market and government factors.  These factors include weather conditions, farmer planting decisions, domestic and foreign government farm programs and policies, global demand supply and quality.  Changes in the price of corn can significantly affect our business. Generally, higher corn prices will produce lower profit margins and, therefore, represent unfavorable market conditions.  If we endure high corn prices for a sustained period of time without corresponding increases in the selling price of ethanol and distillers grains, such pricing may reduce our ability to operate our ethanol plant profitably.  If our region becomes saturated by ethanol plants, corn use for ethanol could consume a significant portion of the total corn production in our region, which would likely increase local corn prices.  We may not be able to offset an increase in the price of corn by increasing the price of our products.

 

The prices for and availability of natural gas are subject to volatile market conditions, including supply shortages and infrastructure incapacities.  Significant disruptions in the supply of natural gas could impair our ability to manufacture ethanol and distillers grains for our customers.  During the end of 2005 and early 2006, natural gas supply disruptions as a result of hurricanes in the Gulf Coast lead to historic high natural gas prices.  At any time, similar supply disruptions may increase the price we pay for natural gas.  Furthermore, increases in natural gas prices or changes in our natural gas costs relative to natural gas costs paid by competitors may adversely affect our results of operations and financial condition.

 

                Increases in the price we pay for corn and natural gas, without corresponding increases in the price we receive for our ethanol and distillers grains, may make our ethanol plant operate unprofitably which could reduce or eliminate the value of our units.

 

The spread between ethanol and corn prices can vary significantly.  Corn costs significantly impact our cost of goods sold.  The spread between the price of ethanol and the price we pay per bushel of corn has fluctuated significantly in the past and may fluctuate significantly in the future.  The spread between the price of ethanol and price of corn may continue to be volatile and may lead to volatility in our net income.  Any reduction in the spread between ethanol and corn prices, whether as a result of an increase in corn prices or a reduction in ethanol prices, would adversely affect our results of operations and financial condition.

 

Our revenues will be greatly affected by the price at which we can sell our ethanol and distillers grains. The prices of ethanol and distillers grains can be volatile as a result of a number of factors. These factors include overall supply and demand, the price of gasoline, the price of corn, government mandates for ethanol use such as the Renewable Fuels Standard, levels of government support, and the availability and price of competing products.

 

16

 

The selling price of ethanol peaked in 2006 and was significantly lower during the summer of 2007.  We anticipate the price of ethanol to be volatile as new ethanol plants come on-line increasing ethanol supply.  The interaction of the new ethanol supply and demand will likely create swings in the price of ethanol into the foreseeable future.  Should ethanol demand expand at a slower pace than increases in ethanol supply, we anticipate the selling price of ethanol to decrease.  Further, we anticipate that increases in ethanol supply will also lead to increases in distillers grains supply.  If the increased supply of distillers grains is not also met with corresponding increases in distillers grains demand, it may reduce the selling price of distillers grains.  As the ethanol industry continues to grow, we anticipate volatility in the price of both ethanol and distillers grains which makes future price projections unreliable.  Any downward changes in the price of ethanol and/or distillers grains may result in less revenue and may impact our ability to operate profitably.

 

Our business is not diversified.  Our success depends largely upon our ability to profitably operate our ethanol plant. We do not have any other lines of business or other sources of revenue if we are unable to operate our ethanol plant and manufacture ethanol and distillers grains.  If economic or political factors adversely affect the market for ethanol, the company has no other line of business to fall back on. Our business would also be significantly harmed if our ethanol plant could not operate at full capacity for any extended period of time.

 

Advances in ethanol production technology could require us to incur costs to update our plant or could otherwise hinder our ability to compete or operate profitably.  Advances and changes in the technology of ethanol production are expected to occur.  Such advances and changes may make the ethanol production technology installed in our plant less desirable or obsolete.  These advances could also allow our competitors to produce ethanol at a lower cost than us.  If we are unable to adopt or incorporate technological advances, our ethanol production methods and processes could be less efficient than our competitors, which could cause our plant to become uncompetitive or completely obsolete.  If our competitors develop, obtain or license technology that is superior to ours or that makes our technology obsolete, we may be required to incur significant costs to enhance or acquire new technology so that our ethanol production remains competitive.  Alternatively, we may be required to seek third-party licenses, which could also result in significant expenditures.  We cannot guarantee or assure you that third-party licenses will be available or, once obtained, will continue to be available on commercially reasonable terms, if at all.  These costs could negatively impact our financial performance by increasing our operating costs and reducing our net income.

 

We sell all of the ethanol we produce to RPMG under our ethanol marketing agreement.  RPMG is the sole buyer of all of our ethanol, and we rely heavily on its marketing efforts to successfully sell our product.  Because RPMG sells ethanol for a number of other producers, we have limited control over its sales efforts.  Our financial performance is dependent upon the financial health of RPMG as a significant portion of our accounts receivable are attributable to RPMG.  If RPMG breaches the ethanol marketing agreement or is not in the financial position to purchase and market all of the ethanol we produce, we may not have any readily available means to sell our ethanol and our financial performance will be adversely and materially affected.  If our agreement with RPMG terminates, we may seek other arrangements to sell our ethanol, including selling our own product, but we give no assurance that our sales efforts would achieve results comparable to those achieved by RPMG.

 

We sell a substantial portion of the distillers grains we produce to CHS under our distillers grains marketing agreement.  CHS is the sole buyer of all of our distillers grains that we do not sell locally, and we rely heavily on its marketing efforts to successfully sell our product.  We currently only market locally a small percentage of the distillers grains we produce.  Because CHS sells distillers grains for a number of other producers, we have limited control over its sales efforts.  Our financial performance is dependent upon the financial health of CHS, as a significant portion of our accounts receivable are attributable to CHS.  If CHS breaches the distillers grains marketing agreement or is not in the financial position to purchase and market all of the distillers grains we produce which are not marketed locally by us, we may not have any readily available means to sell our distillers grains, and our financial performance will be adversely and materially affected.  If our agreement with CHS terminates, we may seek other arrangements to sell our distillers grains, including selling our own product, but we give no assurance that our sales efforts would achieve results comparable to those achieved by CHS.

 

We engage in hedging transactions that may be costly and ineffective.  We are exposed to market risk from changes in commodity prices.  Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process.  We seek to minimize the risks from fluctuations in the prices of corn

 

17

 

and natural gas through the use of hedging instruments.  The effectiveness of our hedging strategies is dependent upon the cost of corn and natural gas and our ability to sell sufficient products to use all of the corn and natural gas for which we have futures contracts.  There is no assurance that our hedging activities will successfully reduce the risk caused by price fluctuation which may leave us vulnerable to high corn and natural prices. Alternatively, we may choose not to engage in hedging transactions in the future.  As a result, our results of operations and financial conditions may also be adversely affected during periods in which corn and/or natural gas prices increase.

 

Hedging activities themselves can result in costs because price movements in corn and natural gas contracts are highly volatile and are influenced by many factors that are beyond our control.  There are several variables that could affect the extent to which our derivative instruments are impacted by price fluctuations in the cost of corn or natural gas.  However, it is likely that commodity cash prices will have the greatest impact on the derivatives instruments with delivery dates nearest the current cash price.  We may incur such costs and they may be significant.

 

Risks Related to Ethanol Industry

 

New plants under construction or decreases in the demand for ethanol may result in excess production capacity in our industry.  The supply of domestically produced ethanol is at an all-time high.  As of March 4, 2008, there were 143 ethanol plants in operation nationwide with the capacity to produce more than 8 billion gallons of ethanol annually.  An additional 57 new plants and 7 expansions are currently under construction, which will add an additional estimated 5.3 billion gallons of annual production capacity.   Excess capacity in the ethanol industry would have an adverse impact on our results of operations, cash flows and general financial condition.  If the demand for ethanol does not grow at the same pace as increases in supply, we would expect the selling price of ethanol to continue to decline.  The market price of ethanol may decline to a level that is inadequate to generate sufficient cash flow to cover our costs.  This could negatively affect our future profitability.

 

We operate in a competitive industry and compete with larger, better financed entities.  There is significant competition among ethanol producers with numerous producer and privately owned ethanol plants planned and operating throughout the Midwest and elsewhere in the United States.  The number of ethanol plants being developed and constructed in the United States continues to increase at a rapid pace. The recent passage of the Energy Independence and Security Act of 2007 increased the renewable fuels use mandate that we expect will further increase the number of domestic ethanol production facilities.  The largest ethanol producers include Abengoa Bioenergy Corp., Archer Daniels Midland, Aventine Renewable Energy, Inc., Hawkeye Renewable, POET (Formerly Broin), US BioEnergy Corp., and VeraSun Energy Corporation, all of which are each capable of producing more ethanol than we produce or expect to produce in the future.  These large ethanol producers may realize economies of scale that we cannot take advantage of and may influence the ethanol industry in ways that are not beneficial to us.  If the demand for ethanol does not grow at the same pace as increases in supply, we expect that lower prices for ethanol will result which may adversely affect our ability to generate profits and harm our financial condition.

 

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

 

Competition from the advancement of alternative fuels may lessen the demand for ethanol.  Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells or clean burning gaseous fuels. Like ethanol, the emerging fuel cell industry offers a technological option to address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to decrease fuel costs, lessen dependence on

 

18

 

crude oil and reduce harmful emissions. If the fuel cell and hydrogen industries continue to expand and gain broad acceptance, and hydrogen becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, resulting in lower ethanol prices that might adversely affect our results of operations and financial condition.

 

Corn-based ethanol may compete with cellulose-based ethanol in the future.  Especially in the Midwest, most ethanol is currently produced from corn and other raw grains, such as milo or sorghum. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, municipal solid waste, and energy crops. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas which are unable to grow corn.  The Energy Independence and Security Act of 2007 offers a very strong incentive to develop commercial scale cellulosic ethanol.  The RFS requires that 16 billion gallons per year of cellulosic ethanol be consumed in the United States by 2022.  We expect this will encourage innovation that may lead to commercially viable cellulosic ethanol plants.  If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively. We do not believe it will be cost-effective to convert our ethanol plant into a plant which will use cellulose-based biomass to produce ethanol. If we are unable to produce ethanol as cost-effectively as cellulose-based producers, our ability to generate revenue and our financial condition will be negatively impacted.

 

Ethanol imported from Caribbean basin countries may be a less expensive alternative to our ethanol.  Ethanol produced or processed in certain countries in Central America and the Caribbean region is eligible for tariff reduction or elimination upon importation to the United States under a program known as the Caribbean Basin Initiative. Large ethanol producers, such as Cargill, have built dehydration plants in participating Caribbean Basin countries, such as El Salvador, which convert ethanol into fuel-grade ethanol for shipment to the United States. Ethanol imported from Caribbean Basin countries may be a less expensive alternative to domestically produced ethanol. Competition from ethanol imported from Caribbean Basin countries may affect our ability to sell our ethanol profitably, adversely affect our results of operations and financial condition.

 

Ethanol imported from Brazil may be a less expensive alternative to our ethanol.  Brazil is currently the world’s largest exporter of ethanol.  Until recently, Brazil was also the world’s largest producer of ethanol.  In Brazil, ethanol is produced primarily from sugarcane, which is also used to produce food-grade sugar. In 2007, according to the Renewable Fuels Association, Brazil produced approximately 5 billion gallons of ethanol and exported a total of nearly 190 million gallons of ethanol to the United States through November 2007 (the last available data).  Ethanol imported from Brazil may be a less expensive alternative to domestically produced ethanol, which is primarily made from corn. Tariffs presently protecting U.S. ethanol producers may be reduced or eliminated. Competition from ethanol imported from Brazil may affect our ability to sell our ethanol profitably and adversely affect our financial condition.

 

Consumer beliefs may affect the demand for ethanol.  We believe that certain consumers perceive the use of ethanol to have a negative impact on gasoline prices at the pump. Some consumers also believe that ethanol adds to air pollution and harms car and truck engines. Still other consumers believe that the process of producing ethanol actually uses more fossil fuel energy, such as oil and natural gas, than the energy in the ethanol that is produced. These consumer beliefs could potentially be widespread. If consumers choose not to buy ethanol, it will affect the demand for the ethanol we produce which could lower the selling price of ethanol and negatively affect our profitability and financial condition.

 

Risks Related to Regulation and Governmental Action

 

A change in government policies favorable to ethanol may cause demand for ethanol to decline.  Growth and demand for ethanol may be driven primarily by federal and state government policies, such as state laws banning Methyl Tertiary Butyl Ether (MTBE), national tax incentives and the renewable fuels standard. The continuation of these policies is uncertain, which means that demand for ethanol may decline if these policies change or are discontinued. A decline in the demand for ethanol is likely to cause lower ethanol prices which in turn will negatively affect our results of operations, financial condition and cash flows.

 

19

 

Government incentives for ethanol production may be eliminated in the future.  The ethanol industry and our business are assisted by various federal ethanol tax incentives, including those included in the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007. The provisions of the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007 likely to have the greatest impact on the ethanol industry is the creation of the Renewable Fuels Standard (RFS). The RFS began in 2006 and was expanded in the Energy Independence and Security Act of 2007.  The RFS requires that 9 billion gallons of renewable fuels be used in 2008, expanding to 36 billion gallons by 2022.  However, only approximately 15 billion gallons of the RFS can be met by corn based ethanol.  The remaining gallons of the RFS may be met by other renewable fuels such as cellulosic ethanol and biodiesel.  The RFS helps support a market for ethanol that might disappear without this incentive. The elimination or reduction of tax incentives to the ethanol industry could also reduce the market for ethanol, which could reduce prices and our revenues by making it more costly or difficult for us to produce and sell ethanol. If the federal tax incentives are eliminated or sharply curtailed, we believe that decreased demand for ethanol will result, which could negatively affect our profitability and financial condition.

 

Another important provision involves increasing the production capacity limit of plants that are eligible for the small ethanol producer tax credit. Small ethanol producers are allowed a 10-cents-per-gallon production income tax credit on up to 15 million gallons of production annually. The size of the plant eligible for the tax credit was historically limited to 30 million gallons. Under the Energy Policy Act of 2005, the size limitation on the production capacity for small ethanol producers increased from 30 million to 60 million gallons. This tax credit may foster additional growth in ethanol plants of a larger size and increase competition in this particular plant size category.  Without these government supports for ethanol, demand for ethanol may decrease which would likely decrease the selling price of ethanol and negatively affect our financial condition.  Without these governmental supports, production of ethanol may become unprofitable which could decrease or eliminate the value of our units.

 

Changes in environmental regulations or violations of the regulations could reduce our profitability.  We are subject to extensive air, water and other environmental laws and regulations.  In addition, some of these laws require our plant to operate under a number of environmental permits. These laws, regulations and permits can often require expensive pollution control equipment or operation changes to limit actual or potential impacts to the environment.  A violation of these laws and regulations or permit conditions can result in substantial fines, damages, criminal sanctions, permit revocations and/or plant shutdowns.  In the future, permit requirements may change or we may exceed certain limits in our permits that may lead to regulatory actions by the State of South Dakota or the EPA.  Further, we may be required to secure additional permits in the future which may be costly and may affect our ability to operate the ethanol plant.  We may also be subject to litigation by environmental advocacy groups and other parties based on actual or alleged violations of environmental laws.  Additionally, any changes in environmental laws and regulations, both at the federal and state level, could require us to spend considerable resources in order to comply with future environmental regulations. The expense of compliance with environmental laws as well as litigation concerning environmental laws could be significant and reduce our profitability and negatively affect our financial condition.

 

Carbon dioxide may be regulated in the future by the EPA as an air pollutant requiring us to obtain additional permits and install additional environmental mitigation equipment, which could adversely affect our financial performance.  The Supreme Court recently decided a case in which it ruled that carbon dioxide is an air pollutant under the Clean Air Act for the purposes of motor vehicle emissions.  The lawsuit sought to require the EPA to regulate carbon dioxide in vehicle emissions.  Similar lawsuits have been filed seeking to require the EPA to regulate carbon dioxide emissions from stationary sources such as our ethanol plant under the Clean Air Act. Our plant produces a significant amount of carbon dioxide that we currently vent into the atmosphere.  While there are currently no regulations applicable to us concerning carbon dioxide, if the EPA or the State of South Dakota regulate carbon dioxide emissions by plants such as ours, we may have to apply for additional permits or we may be required to install carbon dioxide mitigation equipment or take other as yet unknown steps to comply with these potential regulations.  Compliance with any future regulation of carbon dioxide, if it occurs, could be costly and may prevent us from operating the ethanol plant profitably which could decrease or eliminate the value of our units.

 

ITEM 2.  PROPERTIES.

 

We own Dakota Ethanol as a wholly-owned subsidiary.  The ethanol plant is located on Dakota Ethanol’s 77-acre rural site near Wentworth, South Dakota. The plant grinds approximately 17.5 million bushels of corn per

 

20

 

year to produce approximately 48.9 million gallons of ethanol.  All of our operations occur at our plant in Wentworth, South Dakota.  The original construction of the plant was completed in 2001 and consists of the following buildings:

 

·                  A processing building, which contains processing equipment, laboratories, control room and offices;

·                  A grain receiving and shipping building;

·                  A mechanical building, which contains maintenance offices, storage and a welding shop; and

·                  An administrative building, along with furniture and fixtures, office equipment and computer and telephone systems.

 

The plant includes a fermenter walkway, gas dryer, evaporator and storage facilities for ethanol and distillers grains.  The site also contains improvements such as rail tracks and a rail spur, landscaping, drainage systems and access roads.

 

All of Dakota Ethanol’s tangible and intangible property, real and personal, serves as the collateral for debt financing with First National Bank of Omaha described below under “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Indebtedness.”

 

ITEM 3.  LEGAL PROCEEDINGS.

 

From time to time in the ordinary course of business, Dakota Ethanol or Lake Area Corn Processors may be named as a defendant in legal proceedings related to various issues, including without limitation, workers’ compensation claims, tort claims, or contractual disputes.  We are not currently involved in any material legal proceedings, directly or indirectly, and we are not aware of any claims pending or threatened against us or any of the managers that could result in the commencement of legal proceedings.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

We did not submit any matter to a vote of our unit holders through the solicitation of proxies or otherwise during the fourth quarter of 2007.

 

PART II

 

ITEM 5.                                                     MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

 

Recent Sales of Unregistered Securities

 

None.

 

Market Information

 

There is no public trading market for our units.  Our units may only be transferred in accordance with our Capital Units Transfer System, which provides for transfers by gift to family members, upon death, and through a qualified matching service, subject to approval by our board of managers.  Our qualified matching service is operated through Variable Investment Advisors, Inc., a registered broker-dealer based in Sioux Falls, South Dakota.  Variable Investment Advisor’s Alternative Trading System may be accessed at www.agstocktrade.com. The matching service consists of an electronic bulletin board that provides information to prospective sellers and buyers of our units.  We do not receive any compensation relating to the matching service.  We have no role in effecting the transactions beyond approval, as required under our operating agreement and the issuance of new certificates.  So long as we remain a Section 12 registrant and a publicly reporting company, information about the company will be publicly available through the SEC’s filing system.  However, if at any time we cease to be a Section 12 registrant or publicly reporting company, we will continue to make information about the company publicly available on our website.

 

21

 

Unit Holders

 

As of March 15, 2008, the company had 29,620,000 membership units issued and outstanding and a total of approximately 1,015 unit holders.  There is no other class of membership unit issued or outstanding.

 

Bid and Asked Prices

 

The following table contains information concerning completed unit transactions that occurred during the last two fiscal years.  Our bulletin board trading system does not track bid and asked prices and therefore we only have information concerning completed unit transactions.

 

 

“—” Indicates period during which unit trading was suspended by the Company.

 

Distributions

 

Under the terms of our Amended and Restated Operating Agreement, we are required to make distributions to our members and may not retain more than $200,000 of net cash from operations, unless: (1) a 75% supermajority of our board decides otherwise; (2) it would violate or cause a default under the terms of any debt financing or other credit facilities; or (3) it is otherwise prohibited by law.  Our ability to make distributions to our members is dependent upon the distributions made to us by Dakota Ethanol.  All net income generated from plant operations is distributed by Dakota Ethanol to us since Dakota Ethanol is our wholly-owned subsidiary.  Prior to the Broin family’s assignment of its minority interest in Dakota Ethanol, we would receive approximately 88% of the net income generated by Dakota Ethanol.  We distribute the net income received from Dakota Ethanol to our unit holders in proportion to the number of units held by each unit holder.  A unit holder’s distribution percentage is determined by dividing the number of units owned by such unit holder by the total number of units outstanding.  Our expectations with respect to our ability to make future distributions are discussed in greater detail in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Distributions to our unit holders are also subject to certain loan covenants and restrictions that require us to make additional loan payments based on excess cash flow.  These loan covenants and restrictions are described in greater detail under “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Indebtedness.”

 

22

 

2007 Distributions

 

In fiscal year 2007, Dakota Ethanol made total cash distributions to LACP of approximately $18,748,000.  As a result, our board of managers approved cash distributions to our members totaling $17,772,000.  The following chart lists the cash distributions made to our members in fiscal year 2007:

 

Date of Board Approval		Total Distribution			Distribution Per Unit			Distributed to Members of Record as of:
February 7, 2007		$	5,924,000		$	0.20		January 1, 2007
April 25, 2007		$	2,962,000		$	0.10		April 1, 2007
May 30, 2007		$	2,962,000		$	0.10		April 1, 2007
August 1, 2007		$	2,962,000		$	0.10		July 1, 2007
November 20, 2007		$	2,962,000		$	0.10		October 1, 2007
Totals		$	17,772,000		$	0.60

 

2006 Distributions

 

In fiscal year 2006, Dakota Ethanol made total cash distributions to LACP of approximately $13,300,000 and approximately $800,000 to the minority members. As a result, our board of managers approved cash distributions to our members totaling $13,329,000. The following chart lists the cash distributions made to our members in 2006:

 

Date of Board Approval		Total Distribution			Distribution Per Unit			Distributed to Members of Record as of:
February 15, 2006		$	2,962,000		$	0.10		January 1, 2006
April 11, 2006		$	2,962,000		$	0.10		January 1, 2006
August 25, 2006		$	2,962,000		$	0.10		May 1, 2006
November 17, 2006		$	4,443,000		$	0.15		September 1, 2006
Totals		$	13,329,000		$	0.45

 

23

 

Performance Graph

 

The following graph compares the cumulative total return on the Company’s units with the cumulative total return of the NASDAQ Index and the SIC Code Index (SIC Code 2869—Industrial Organic Chemicals, Not Elsewhere Classifed).  The unit price performance shown on the following graph is not intended to forecast and is not indicative of future unit price performance.  The data for this performance graph was compiled for us by Ipreo, LLC.

 

 

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG LAKE AREA CORN PROCESSORS, LLC,

NASDAQ MARKET INDEX AND SIC CODE INDEX

 

 

 

ASSUMES $100 INVESTED ON DEC. 31, 2002
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2007

 

 

ITEM 6.                                                     SELECTED FINANCIAL DATA.

 

The following table sets forth selected consolidated financial data of the Company, which is derived from the audited financial statements for the periods indicated.  The selected consolidated balance sheet financial data as of December 31, 2005, 2004 and 2003 and the selected consolidated income statement data and other financial data for the years ended December 31, 2004 and 2003 have been derived from our audited consolidated financial statements that are not included in this Form 10-K. The selected consolidated balance sheet financial data as of December 31, 2007 and 2006 and the selected consolidated income statement data and other financial data for each of the years in the three year period ended December 31, 2007 have been derived from the audited Consolidated Financial Statements included elsewhere in this Form 10-K. You should read the following table in conjunction with (i) the consolidated financial statements and accompanying notes included elsewhere in this Form 10-K; (ii) “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and (iii) “Item 1A Risk Factors” found elsewhere in this Form 10-K.  Among other things, those financial statements include more detailed information regarding the basis of presentation for the following consolidated financial data.

 

24

 

Statement of Operations Data:		2007			2006			2005			2004			2003
Revenues		$	103,739,699		$	103,889,412		$	80,020,970		$	84,432,486		$	69,391,182
Cost of Revenues		$	80,977,667		$	50,792,418		$	63,201,108		$	71,736,360		$	60,198,865
Gross Profit		$	22,762,032		$	53,096,994		$	16,819,862		$	12,696,126		$	9,192,317
General and Administrative Expense		$	(3,721,813	)	$	(3,938,845	)	$	(3,610,590	)	$	(3,058,024	)	$	(2,620,736	)
Income From Operations		$	19,040,219		$	49,158,149		$	13,209,272		$	9,638,102		$	6,571,581
Interest Expense		$	(695,043	)	$	(1,008,300	)	$	(1,089,364	)	$	(1,300,647	)	$	(1,461,763	)
Other Income (Expense)		$	(339,971	)	$	121,719		$	238,705		$	223,548		$	147,629
Minority Interest in Subsidiary Income		$	—		$	(2,235,776	)	$	(1,494,029	)	$	(1,037,458	)	$	(641,767	)
Net Income		$	18,005,205		$	46,035,792		$	10,864,584		$	7,523,545		$	4,615,680
Capital Units Outstanding		29,620,000			29,620,000			29,620,000			29,620,000			29,620,000
Net Income Per Capital Unit		$	0.61		$	1.55		$	0.37		$	0.25		$	0.16
Cash Distributions per Capital Unit		$	0.60		$	0.45		$	0.32		$	0.21		$	0.12
Balance Sheet Data:		2007			2006			2005			2004			2003
Working Capital		$	16,054,455		$	17,220,709		$	1,940,335		$	(145,791	)	$	(115,841	)
Net Property, Plant & Equipment		$	35,345,093		$	35,695,754		$	33,468,374		$	34,862,856		$	35,998,055
Total Assets		$	73,554,744		$	72,381,310		$	42,946,122		$	46,065,440		$	45,998,055
Long-Term Obligations		$	5,077,137		$	6,921,695		$	8,601,196		$	9,882,779		$	12,682,279
Minority Interest		$	—		$	—		$	3,234,649		$	3,055,597		$	2,863,277
Member’s Equity		$	56,953,587		$	56,720,382		$	24,013,590		$	22,627,406		$	21,324,061
Book Value Per Capital Unit		$	1.92		$	1.91		$	0.81		$	0.76		$	0.72

 

ITEM 7.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

 

Except for the historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties.  We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report.  Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the risks described in “Item 1A - Risk Factors” and elsewhere in this annual report.  Our discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes and with the understanding that our actual future results may be materially different from what we currently expect.

 

25

 

Overview

 

We currently own Dakota Ethanol, LLC as a wholly-owned subsidiary.  In June 2006, we entered into an assignment agreement with members of the Broin family who owned a minority interest in Dakota Ethanol of approximately 12%.  We purchased the approximately 12% minority interest in Dakota Ethanol for approximately $19,400,000 which included the estimated net earnings of Dakota Ethanol through the date of the purchase.

 

Dakota Ethanol owns and operates an ethanol plant with a nameplate capacity of 40 million gallons per year.  The plant currently operates in excess of its nameplate capacity, producing approximately 48.9 million gallons of ethanol per year.  Our revenues are derived from the sale and distribution of our ethanol and distillers grains throughout the continental United States.  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.  Beginning on January 1, 2006, our ethanol has been  marketed by RMPG pursuant to our ethanol marketing agreement.  Previously our ethanol was marketed by a subsidiary of the Broin Company called Ethanol Products, LLC.

 

On May 30, 2007, we made a $605,000 capital contribution to RPMG and executed certain other agreements necessary to become an owner of RPMG.  Specifically, we became a party to RPMG’s operating agreement, executed a contribution agreement that governs the funding of our capital contribution to RPMG, and entered into a new member ethanol fuel marketing agreement for members of RPMG.  Becoming an owner of RPMG allows us to share any profits made by RPMG and reduces the fees we pay RPMG to market our ethanol.  Pursuant to our member ethanol fuel marketing agreement, we use a pooled marketing arrangement, which means that the ethanol we produce is pooled with other ethanol producers and marketed by RPMG.  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.  We elected to pay our capital contribution to RPMG over time with a portion of our ethanol sales revenue.

 

From the commencement of our operations through December 1, 2005, Dakota Gold Marketing, a Broin affiliate, marketed our distillers grains.  From December 1, 2005 until October 1, 2007, our distillers grains were marketed by Commodity Specialist Company (CSC).  CSC was recently purchased by CHS, Inc. (CHS).  On August 8, 2007, CSC assigned our distillers grains marketing agreement to CHS effective October 1, 2007.  Therefore, our distillers grains are currently marketed and sold by CHS under the same terms as our agreement with CSC.  Under the distillers grains marketing agreement, we receive a percentage of the selling price actually received by CHS in marketing the distillers grains to its customers.

 

Our operating income or loss is significantly tied to the price at which our ethanol and distillers grains are sold.  Historically, the price of ethanol tends to fluctuate based on the price of unleaded gasoline and other petroleum products.  This trend was broken recently and the price of ethanol has more closely followed the price of corn.  However, management believes that the price of ethanol may not continue to follow the price of corn in the future.  Surplus ethanol supplies also tend to put downward price pressure on ethanol.  In contrast, the price of distillers grains generally tends to fluctuate based on the price of substitute livestock feed, such as corn and soybean meal.  Surplus grain supplies tend to put downward price pressure on distillers grains.

 

Our cost of revenues, which includes production expenses, is significantly affected by the cost of corn and natural gas.  In 2007, for instance, our corn costs represented approximately 66% of our total cost of revenues, whereas the cost of natural gas represented approximately 15% of our total cost of revenues.  Comparatively, in 2006, the cost of corn was approximately 54% of our total cost of revenues, whereas the cost of natural gas was approximately 27% of our total cost of revenues.  This change in the relative percentages of our cost of revenues attributed to corn is due to the significant increase in corn costs that we experienced during our 2007 fiscal year.  The cost of corn is affected primarily by supply and demand factors such as crop production, carryout, exports, risk management and weather, much of which we have no control over.  Natural gas prices fluctuate with the energy complex in general.  Over the last few years, natural gas prices have trended lower from a peak that we experienced at the end of our 2005 fiscal year and the beginning of our 2006 fiscal year.  We anticipate that natural gas prices will be stable in fiscal year 2008 as compared to fiscal year 2007.

 

26

 

We are subject to industry-wide factors that affect our revenues and profits.  These factors include, but are not limited to, the available supply and cost of corn from which our ethanol and distillers grains are made; the cost of natural gas, which we use in the production of ethanol and distillers grains; 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; changes in federal ethanol tax incentives; and the cost of complying with the extensive environmental laws that regulate our industry.

 

Results of Operations

 

Comparison of Year Ended December 31, 2007 and 2006.

 

The following table shows the results of our operations and the percentage of revenues, cost of revenues, operating expenses and other items to total revenues in our consolidated statements of operations for the fiscal years ended December 31, 2007 and 2006:

 

		2007					2006
Income Statement Data:		Amount			%		Amount			%
Revenues		$	103,739,699		100.0		$	103,889,412		100.0
Cost of Revenues		80,977,667			78.1		50,792,418			48.9
Gross Profit		22,762,032			21.9		53,096,994			51.1
General and Administrative Expense		(3,721,813		)	(3.6	)	(3,938,845		)	(3.8	)
Income From Operations		19,040,219			18.4		49,158,149			47.4
Other Income (Expense)		(1,035,014		)	(1.0	)	(886,581		)	(0.9	)
Minority Interest in Subsidiary Income		—			—		(2,235,776		)	(2.2	)
Net Income		18,005,205			17.4		46,035,792			44.3

 

Revenues

 

During our fiscal year ended December 31, 2007, we experienced a slight decrease in our total revenue compared to our 2006 fiscal year.  This decrease in our revenue was a result of the net effect of decreased ethanol revenue offset by a smaller increase in distillers grains revenue during our 2007 fiscal year as compared to the same period of 2006.  Additionally, we experienced an approximately $26,000 decrease in incentive revenue in fiscal year 2007 as compared to fiscal year 2006.

 

Our revenue from sales of ethanol decreased approximately 3% during our 2007 fiscal year as compared to our 2006 fiscal year.  The reason for this decrease was primarily due to a lower average selling price for our ethanol during our 2007 fiscal year as compared to the same period of 2006, which was partially offset by an increase in the volume of ethanol we sold.  The average price we received for our ethanol during our 2007 fiscal year was approximately 5% lower than the average price we received in fiscal year 2006.  However, ethanol prices reached historic highs during our 2006 fiscal year as a result of the interaction of a number of factors, including significantly increased ethanol demand as a result of the Renewable Fuels Standard and the replacement of MTBE with ethanol as the oxygenate of choice for reformulated gasoline.  Management attributes this decrease in the average sales price of ethanol during our 2007 fiscal year with the significant increase in ethanol supply that came into the market during our 2007 fiscal year.  Management believes that this significant increase in supply may have exceeded demand for ethanol at certain points during our 2007 fiscal year, which negatively affected the price we received for our ethanol.  However, the most significant decreases in ethanol prices occurred during the middle of our 2007 fiscal year, and ethanol prices rebounded towards the end of our 2007 fiscal year.

 

27

 

Management expects that ethanol prices will remain volatile as new ethanol supply enters the market and interacts with increases in ethanol demand.  Management anticipates that ethanol prices may decrease during the summer months of the 2008 fiscal year as a result of increases in ethanol supply that management expects will become operational during that time period.  We depend on RPMG to market the ethanol we produce.  If RPMG is unable to market the ethanol we produce, or market the ethanol we produce at competitive prices, we anticipate that this will negatively affect our revenue.

 

The ethanol industry’s ability to increase demand for ethanol in the coming years to offset increases in supply will be critical to our success.  If demand does not increase in proportion to supply increases, the price of ethanol may decrease and we may not be able to operate profitably.  Increased consumption of E85 fuel and increased consumer awareness of ethanol may increase ethanol demand.  The United States Department of Energy Alternative Fuels Data Center has reported that the availability and use of E85 is growing nationally, and the availability of E85 and Flex Fuel Vehicles is expected to increase significantly in the next few years.  However, demand for ethanol as a result of increased E85 use will only occur if E85 becomes more readily available for consumers to purchase it and if the number of Flex Fuel Vehicles increases.  The National Ethanol Vehicle Coalition reports as of February 14, 2008, that there are currently approximately 1,500 retail gasoline stations supplying E85.  While the number of retail E85 suppliers increases significantly each year, this remains a relatively small percentage of the total number of U.S. retail gasoline stations, which is approximately 170,000.  As public awareness of ethanol and E85 increases along with E85’s increased availability, management anticipates some growth in demand for ethanol as a result of E85 consumption.

 

Additionally, management believes that increased government mandates for renewable fuels use will positively impact demand for ethanol.  As a result of the Energy Independence and Security Act of 2007, the national Renewable Fuels Standard (RFS) increased to 9 billion gallons of renewable fuels in 2008.  The RFS requires the use of 36 billion gallons of renewable fuels by 2022.  However, the RFS requires that a significant portion of these 36 billion gallons come from “advanced” renewable fuels.  Grain based ethanol, such as the ethanol we produce, that may be used to meet the RFS is capped at 15 billion gallons per year starting in 2015.  Therefore, demand for corn based ethanol may not expand significantly past 15 billion gallons due to the cap in the RFS.  The advanced renewable fuels that can be used to satisfy the remaining gallons of the RFS include cellulosic ethanol.  Cellulosic ethanol is ethanol that is produced from cellulose, which is the main component of plant cell walls and is the most common organic compound on earth.  Cellulose is found in wood chips, corn stalks, rice straw, amongst other common plants.  Current technology makes it difficult or impossible to produce ethanol cost-effectively from cellulose.  However, the RFS and state and federal grant programs are encouraging the development of commercial-scale cellulosic ethanol production.  Several grants were recently made for pilot projects that are attempting to produce cellulosic ethanol on a commercial scale.

 

                During our 2007 fiscal year, we increased the number of gallons of ethanol we produced by approximately 2.3% compared to the same period of 2006.  Management attributes this increase in ethanol production to a decrease in the amount of plant down-time that we experienced during our 2007 fiscal year as compared to our 2006 fiscal year.  This increase in ethanol and distillers grains production increased our revenues in fiscal year 2007.

 

                In our 2007 fiscal year, we increased our distillers grains revenue by approximately 29% compared to the same period of 2006.  This increase in the revenue was a result of a combination of an increase in the average price we received for our distillers grains and an increase in the total distillers grains production by us during our 2007 fiscal year as compared to the same period of 2006.  We experienced an increase of approximately 10% in the average price we received for our dried distillers grains during our 2007 fiscal year as compared to the same period 2006.  Additionally, we experienced an increase of approximately 29% in the average price we received for our modified/wet distillers grains during our 2007 fiscal year as compared to the same period of 2006.  Management believes that these increases in the average prices we received for our distillers grains during the 2007 fiscal year was a result of the significant increases in corn and soybean meal prices during 2007.  Distillers grains can be used as a feed substitute for corn and soybean meal.  Management believes that the average selling price of distillers grains will continue to move in correlation to changes in the prices of corn and soybean meal.  Since distillers grains prices tend to increase in response to increases in corn prices, management expects that increased sales revenue from distillers grains sales may somewhat offset increases in our cost of revenues as a result of increases in corn prices.

 

28

 

However, as additional ethanol supply enters the market, management expects the supply of distillers grains will also increase, which may negatively impact the price we receive for our distillers grains.

 

                We increased the total tons of distillers grains we produced during our 2007 fiscal year by approximately 6% compared to the same period of 2007.  This increase in the total distillers grains production was a result of increased ethanol production.  Since distillers grains are the primary co-product of our ethanol production process, as ethanol production increases, distillers grains production will correspondingly increase.

 

                We increased the amount of distillers grains we marketed as wet/modified distillers grains during our 2007 fiscal year as compared to our 2006 fiscal year.  Wet/modified distillers grains require less natural gas to produce than dried distillers grains, which decreases our cost of revenues.  We market a portion of the wet/modified distillers grains we produce locally.  Management expects to continue to make decisions as to whether our distillers grains will be dried and marketed as dried distillers grains based on market conditions that exist in the distillers grains markets.  These market conditions include supply and demand factors as well as the price difference between dried distillers grains and wet/modified distillers grains and the price of natural gas.

 

                During our 2007 fiscal year, we experienced a decrease in incentive income of approximately $26,000.  We annually receive an ethanol producer’s incentive from the State of South Dakota.  In our 2007 fiscal year, we did not receive the annual maximum allocation under this program as a result of budget constraints on the South Dakota program.  Management does not expect that we will receive the maximum allocation in fiscal year 2008 for the same reason.  We did not receive any federal incentive income during our 2007 fiscal year.

 

Cost of Revenues

 

Our cost of revenues as a percentage of revenues was approximately 78% and approximately 49% for the fiscal years ended December 31, 2007 and 2006 respectively.  Our total cost of revenues increased by approximately 59% during our 2007 fiscal year compared to the same period of 2006.  This significant increase in cost of revenues resulted from a significant increase in the average price per bushel we paid for corn during our 2007 fiscal year and increased corn consumption by the ethanol plant as a result of the increased ethanol and distillers grains production.

 

The average price we paid per bushel of corn increased by approximately 89% during Dakota Ethanol’s 2007 fiscal year as compared to the same period of 2006.  This significant increase in the average price we paid for corn has significantly increased our cost of revenues.  Despite the fact that the United States corn crop that was harvested in the fall of 2007 produced approximately 13.1 billion bushels of corn, the most corn ever produced in  one year in the United States, the average price per bushel of corn continues to rise.  Management believes the current high corn prices are a result of expanded domestic demand, including increased corn demand as a result of ethanol production, increased corn exports as a result of a weak United States Dollar, and current high petroleum prices which affect the average price we pay for corn.  Management anticipates that corn prices will remain high into the foreseeable future.  However, management believes that the corn supply will continue to expand due to the current high corn prices which may somewhat control future corn prices.  Management does not anticipate difficulty securing sufficient corn to operate the ethanol plant in the foreseeable future.

 

We use derivative instruments to help protect the prices we pay for our raw materials, including corn and natural gas.  We recognize the gains or losses that result from the 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 pay for corn.  Management anticipates continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged.

 

We use significant amounts of natural gas to dry the distillers grains produced at the ethanol plant.  Total cost of revenues attributed to natural gas decreased during our 2007 fiscal year by approximately 13% compared to the same period of 2006.  This decrease in cost of revenues attributed to natural gas costs was a result of decreased natural gas consumption and a decreased average price we paid for natural gas during our 2007 fiscal year.  Total natural gas consumption at the ethanol plant decreased by approximately 3% during the 2007 fiscal year as compared to same period of 2006.  The reason for this decrease in natural gas consumption was the fact that we sold

 

29

 

less dried distillers grains in fiscal year 2007 and more wet/modified distillers grains.  This decreased the amount of distillers grains drying that was required in fiscal year 2007 and therefore reduced our total natural gas consumption.  Further, we experienced a decrease of approximately 10% in the average price we paid per MMBTU of natural gas in fiscal year 2007 as compared to the same period of 2006.  Natural gas prices increased sharply at the end of 2005 and the beginning of 2006 as a result of supply interruptions from hurricane activity in the Gulf Coast.  These supply interruptions caused a spike in natural gas prices that subsequently decreased in 2007.  Management anticipates relatively stable natural gas prices in fiscal year 2008 barring any supply interruptions like those experienced during our 2006 fiscal year.  Management anticipates that natural gas consumption at the ethanol plant will stay at its current level unless we further reduce the amount of distillers grains we sell in the dried form.

 

General and Administrative Expense

 

Our general and administrative expenses decreased slightly in our 2007 fiscal year compared to the same period of 2006.  This decrease in general and administrative expenses resulted from the net effect of increased professional fees, including legal fees and Sarbanes-Oxley Section 404 Compliance consulting fees and increased environmental compliance fees, and decreased bonus expenses for fiscal year 2007 as compared to fiscal year 2006.  Our general and administrative expenses as a percentage of revenue were approximately 3.6% and 3.8% for fiscal years 2007 and 2006 respectively.

 

Income from Operations

 

Our income from operations for fiscal year 2007 totaled approximately $19,040,000 compared to approximately $49,158,000 for fiscal year 2006.  This significant decrease in income from operations is due primarily to a significant increase in corn costs that significantly increased our cost of revenues.  In fiscal year 2006, the ethanol industry experienced historic high ethanol prices along with relatively lower corn costs.  Since corn is the largest raw material cost to produce ethanol, this created a situation where the profit margin per gallon of ethanol was very high during our fiscal year 2006.  Comparatively, we experienced slightly lower ethanol prices in fiscal year 2007 compared to 2006, and significantly higher corn costs.  The net effect of these changes led to a lower profit margin per gallon of ethanol produced for our 2007 fiscal year compared to fiscal year 2006.

 

Other Income and Expense

 

Our total other expense for the twelve months ended December 31, 2007 was approximately 17% higher compared to our other expense for the 2006 fiscal year.  This increase in other expense for our 2007 fiscal year was a result of increased loss on equity on investments compared to fiscal year 2006.  We offset this increased loss on equity in investments with a larger interest income and decreased interest expense in fiscal year 2007 compared to fiscal year 2006.

 

Minority Interest in Subsidiary Income

 

For our 2007 fiscal year, there was no minority interest in Dakota Ethanol as the Broin family minority interest was repurchased in June 2006.  Dakota Ethanol made distributions to the Broin family of approximately $2,236,000 in fiscal year 2006 pursuant to its minority interest in Dakota Ethanol.  This decreased the distributions that were paid to Lake Area Corn Processors in fiscal year 2006.

 

Net Income

 

Net income decreased by approximately 61% in our 2007 fiscal year, as compared to the same period of 2006.  This significant decrease in net income was a direct result of the significant increase in cost of revenues that we experienced in fiscal year 2007 compared to fiscal year 2006, offset by the lack of a minority interest distribution to the Broin family.

 

30