UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended December 31, 2008
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from to
Commission file number: 000-21467
PACIFIC ETHANOL, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
41-2170618
(I.R.S. Employer Identification No.)
400 Capitol Mall, Suite 2060, Sacramento, California
(Address of principal executive offices)
95814
(Zip Code)
Registrant’s telephone number, including area code: (916) 403-2123
Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.001 par value
Securities registered pursuant to Section 12(g) of the Act: None
(Title of class)
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes 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.
Yes 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. Yes No
Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K 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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer,
or a smaller reporting company. See the definitions of ―large accelerated filer,‖ ―accelerated filer‖ and ―smaller reporting
company‖ in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)
Accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes No
The aggregate market value of the voting common equity held by nonaffiliates of the registrant computed by reference
to the closing sale price of such stock, was approximately $95.9 million as of June 29, 2008, the last business day of the
registrant’s most recently completed second fiscal quarter. The registrant has no non-voting common equity.
The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of March 26, 2009 was
57,750,319.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III incorporates by reference certain information from the registrant’s proxy statement (the ―Proxy Statement‖) for
the 2009 Annual Meeting of Stockholders to be filed on or before April 30, 2009.
TABLE OF CONTENTS
PART I
Page
Item 1.
Business ...................................................................................................................................... 1
Item 1A. Risk Factors. ............................................................................................................................. 13
Item 1B. Unresolved Staff Comments. .................................................................................................... 24
Item 2.
Properties. ................................................................................................................................. 24
Item 3.
Legal Proceedings. .................................................................................................................... 24
Item 4.
Submission of Matters to a Vote of Security Holders............................................................... 26
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities. ................................................................................................. 27
Item 6.
Selected Financial Data. ............................................................................................................ 30
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations. ................................................................................................................................ 31
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. ................................................. 52
Item 8.
Financial Statements and Supplementary Data. ........................................................................ 53
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure. ................................................................................................................................ 53
Item 9A. Controls and Procedures ........................................................................................................... 53
Item 9A(T) Controls and Procedures ......................................................................................................... 57
Item 9B. Other Information. .................................................................................................................... 57
PART III
Item 10. Directors, Executive Officers and Corporate Governance ........................................................ 57
Item 11. Executive Compensation .......................................................................................................... 57
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters .................................................................................................................. 57
Item 13. Certain Relationships and Related Transactions, and Director Independence .......................... 57
Item 14. Principal Accounting Fees and Services ................................................................................... 57
Item 15. Exhibits, Financial Statement Schedules .................................................................................. 57
Index to Financial Statements .................................................................................................................... F-1
PART IV
CAUTIONARY STATEMENT
All statements included or incorporated by reference in this Annual Report on Form 10-K, other than
statements or characterizations of historical fact, are forward-looking statements. Examples of forward-
looking statements include, but are not limited to, statements concerning projected net sales, costs and
expenses and gross margins; our ability to restructure our indebtedness; our ability to continue as a
going concern; our accounting estimates, assumptions and judgments; our success in pending litigation;
the demand for ethanol and its co-products; the competitive nature of and anticipated growth in our
industry; production capacity and goals; our ability to consummate acquisitions and integrate their
operations successfully; and our prospective needs for additional capital. These forward-looking
statements are based on our current expectations, estimates, approximations and projections about our
industry and business, management’s beliefs, and certain assumptions made by us, all of which are
subject to change. Forward-looking statements can often be identified by words such as ―anticipates,‖
―expects,‖ ―intends,‖ ―plans,‖ ―predicts,‖ ―believes,‖ ―seeks,‖ ―estimates,‖ ―may,‖ ―will,‖ ―should,‖
―would,‖ ―could,‖ ―potential,‖ ―continue,‖ ―ongoing,‖ similar expressions and variations or negatives
of these words. These statements are not guarantees of future performance and are subject to risks,
uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ
materially and adversely from those expressed in any forward-looking statements as a result of various
factors, some of which are listed under ―Risk Factors‖ in Item 1A of this Report. These forward-looking
statements speak only as of the date of this Report. We undertake no obligation to revise or update
publicly any forward-looking statement for any reason, except as otherwise required by law.
PART I
Item 1. Business.
Recent Developments
Our financial statements have been prepared on a going concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. As a result of
ethanol industry conditions that have negatively affected our business, we do not currently have sufficient
liquidity to meet our anticipated working capital, debt service and other liquidity needs in the very near-
term. We have suspended operations at three of our four ethanol production facilities due to market
conditions and in an effort to conserve capital. We have also taken and expect to take additional steps to
preserve liquidity. However, despite any additional cost-saving steps we may take, we believe that we
have sufficient working capital to continue operations only until approximately April 30, 2009 at the
latest unless we successfully restructure our debt, experience a significant improvement in margins and
obtain other sources of liquidity.
We are in default under our construction-related term loans in the aggregate amount of
approximately $230 million and under Kinergy’s revolving line of credit as well as $31.5 million in notes
payable to another lender. In February 2009, we entered into forbearance agreements with each of the
lenders, which were amended in March 2009, under which the lenders agreed to forbear from exercising
their rights until April 30, 2009 absent further defaults. Although we are actively pursuing a number of
alternatives, including seeking to restructure our debt and seeking to raise additional debt or equity
financing, or both, there can be no assurance that we will be successful. If we cannot restructure our debt
and obtain sufficient liquidity in the very near term, we may need to seek to protection under the U.S.
Bankruptcy Code. See ―Risk Factors‖ and ―Managements Discussions and Analysis of Financial
Condition and Results of Operations.‖
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Business Overview
Our primary goal is to be the leading marketer and producer of low carbon renewable fuels in the
Western United States.
We produce and sell ethanol and its co-products, including wet distillers grain, or WDG, and
provide transportation, storage and delivery of ethanol through third-party service providers in the
Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and
Washington. We have extensive customer relationships throughout the Western United States and
extensive supplier relationships throughout the Western and Midwestern United States.
Our customers are integrated oil companies and gasoline marketers who blend ethanol into
gasoline. We supply ethanol to our customers either from our own ethanol production facilities located
within the regions we serve, or with ethanol procured in bulk from other producers. In some cases, we
have marketing agreements with ethanol producers to market all of the output of their facilities.
Additionally, we have customers who purchase our co-products for animal feed and other uses.
According to the United States Department of Energy, or DOE, total annual gasoline
consumption in the United States is approximately 140 billion gallons. Total annual ethanol consumption
represented less than 7% of this amount in 2008. We believe that the domestic ethanol industry has
substantial potential for growth to initially reach what we estimate is an achievable level of at least 10%
of the total annual gasoline consumption in the United States, or approximately 14 billion gallons of
ethanol annually and thereafter up to 36 billion gallons of ethanol annually under the new national
Renewable Fuel Standards, or RFS, by 2022. See ―—Governmental Regulation.‖
In September 2008, we completed construction of our fourth ethanol facility. Our four ethanol
facilities, which produce ethanol and its co-products, are as follows:
In addition, we own a 42% interest in Front Range Energy, LLC, or Front Range, which owns a
facility located in Windsor, Colorado, with annual production capacity of up to 50 million gallons. We
also intend to either construct or acquire additional production facilities as financial resources and
business prospects make the construction or acquisition of these facilities advisable. See ―—Production
Facilities.‖
The ethanol industry has experienced significant adverse conditions over the course of the last 12
months, including prolonged negative operating margins. We, too, have experienced these adverse
conditions as well as severe working capital and liquidity shortages, and in response to such conditions,
we have reduced production significantly until market conditions resume to acceptable levels and
working capital becomes available. We first reduced production in December 2008 and continued to
reduce production through the first quarter of 2009. Currently, we have ceased production at our Madera,
Magic Valley and Stockton facilities. We continue to operate our Columbia and Front Range facilities.
We continue to assess market conditions and when appropriate, provided we have adequate available
working capital, we plan to bring these facilities back to operation.
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Facility NameFacility LocationDate Operations BeganEstimated Annual Production Capacity (gallons)StocktonStockton, CASeptember 200860,000,000Magic ValleyBurley, IDApril 200860,000,000ColumbiaBoardman, ORSeptember 200740,000,000MaderaMadera, CAOctober 200640,000,000
We intend to reach our goal to be the leading marketer and producer of low carbon renewable
fuels in the Western United States in part by expanding our relationships with customers and third-party
ethanol producers to market higher volumes of ethanol, by expanding our relationships with animal feed
distributors and end users to build local markets for WDG, the primary co-product of our ethanol
production, and by expanding the market for ethanol by continuing to work with state governments to
encourage the adoption of policies and standards that promote ethanol as a fuel additive and
transportation fuel.
Company History
We are a Delaware corporation formed in February 2005. In March 2005, we completed a
transaction, or Share Exchange Transaction, with the shareholders of Pacific Ethanol, Inc., a California
corporation, or PEI California, and the holders of the membership interests of each of Kinergy, LLC, or
Kinergy, and ReEnergy, LLC, or ReEnergy. Upon completion of the Share Exchange Transaction, we
acquired all of the issued and outstanding shares of capital stock of PEI California and all of the
outstanding membership interests of each of Kinergy and ReEnergy. Immediately prior to the
consummation of the Share Exchange Transaction, our predecessor, Accessity Corp., a New York
corporation, or Accessity, reincorporated in the State of Delaware under the name Pacific Ethanol, Inc.
Our main Internet address is http://www.pacificethanol.net. Our annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other
Securities and Exchange Commission, or SEC, filings are available free of charge through our website as
soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
Our common stock trades on the Nasdaq Global Market under the symbol PEIX. The inclusion of our
website address in this Report does not include or incorporate by reference into this report any
information contained on our website.
Competitive Strengths
We believe that our competitive strengths include the following:
Our customer and supplier relationships. We have developed extensive business
relationships with our customers and suppliers. In particular, we have developed extensive business
relationships with major and independent un-branded gasoline suppliers who collectively control the
majority of all gasoline sales in California and other Western states. In addition, we have developed
extensive business relationships with ethanol and grain suppliers throughout the Western and
Midwestern United States.
Our ethanol distribution network. We believe that we have a competitive advantage due
to our experience in marketing to the segment of customers in major metropolitan and rural markets
in the Western United States. We have developed an ethanol distribution network for delivery of
ethanol by truck to virtually every significant fuel terminal as well as to numerous smaller fuel
terminals throughout California and other Western states. Fuel terminals have limited storage
capacity and we have been successful in securing storage tanks at many of the terminals we service.
In addition, we have an extensive network of third-party delivery trucks available to deliver ethanol
throughout the Western United States.
Our strategic locations. We believe that our focus on developing and acquiring ethanol
production facilities in markets where local characteristics create the opportunity to capture a
significant production and shipping cost advantage over competing ethanol production facilities
provides us with competitive advantages, including transportation cost, delivery timing and logistical
advantages as well as higher margins associated with the local sale of WDG and other co-products.
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Our modern technologies. Our existing production facilities use the latest production
technologies to take advantage of state-of-the-art technical and operational efficiencies in order to
achieve lower operating costs and more efficient production of ethanol and its co-products and
reduce our use of carbon-based fuels.
Our experienced management. Neil M. Koehler, our President and Chief Executive
Officer, has over 20 years of experience in the ethanol production, sales and marketing industry.
Mr. Koehler is a Director of the California Renewable Fuels Partnership, a Director of the Renewable
Fuels Association, or RFA, and is a frequent speaker on the issue of renewable fuels and ethanol
marketing and production. In addition to Mr. Koehler, we have seasoned managers with many years
of experience in the ethanol, fuel, energy and feed industries, leading our various departments. We
believe that the experience of our management over the past two decades and our ethanol marketing
operations have enabled us to establish valuable relationships in the ethanol industry and understand
the business of marketing and producing ethanol.
We believe that these advantages will allow us to capture an increasing share of the total market
for ethanol and its co-products.
Business and Growth Strategy
Our primary goal is to be the leading marketer and producer of low carbon renewable fuels in the
Western United States. Key elements of our business and growth strategy to achieve this objective
include:
Expand ethanol marketing revenues, ethanol markets and distribution infrastructure. We
plan to increase our ethanol marketing revenues by expanding our relationships with third-party
ethanol producers to market higher volumes of ethanol throughout the Western United States when
market conditions are favorable. In addition, we plan to expand relationships with animal feed
distributors and dairy operators to build local markets for WDG. We also plan to expand the market
for ethanol by continuing to work with state governments to encourage the adoption of policies and
standards that promote ethanol as a fuel additive and ultimately as a primary transportation fuel. In
addition, we plan to expand our distribution infrastructure by increasing our ability to provide
transportation, storage and related logistical services to our customers throughout the Western United
States.
Additional production capacity to meet expected future demand for ethanol. We have
completed our development efforts in 2008 by building additional ethanol production facilities to
meet the current and expected future demand for ethanol. This development provides us with annual
production capacity of 220 million gallons, achieving our goal we set in 2005. We are also exploring
opportunities to add production capacity through strategic acquisitions of existing or pending ethanol
production facilities that meet our cost and location criteria.
Focus on cost efficiencies. We plan to develop or acquire ethanol production facilities in
markets where local characteristics create the opportunity to capture a significant production and
shipping cost advantage over competing ethanol production facilities. We believe a combination of
factors will enable us to achieve this cost advantage, including:
o Locations near fuel blending facilities will enable lower ethanol transportation costs
and enjoy timing and logistical advantages over competing locations which require
ethanol to be shipped over much longer distances.
o Locations adjacent to major rail lines will enable the efficient delivery of corn in
large unit trains from major corn-producing regions.
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o Locations near large concentrations of dairy and/or beef cattle will enable delivery of
WDG over short distances without the need for costly drying processes.
In addition to these location-related efficiencies, we have incorporate advanced design
elements into our new production facilities to take advantage of state-of-the-art technical and
operational efficiencies.
Explore new technologies and renewable fuels. We are evaluating a number of
technologies that may increase the efficiency of our ethanol production facilities and reduce our use
of carbon-based fuels. In addition, we are exploring the feasibility of using different and potentially
abundant and cost-effective feedstocks, such as cellulosic plant biomass, to supplement corn as the
basic raw material used in the production of ethanol. On January 29, 2008, the DOE awarded us
$24.3 million in matching funds to build the first cellulosic ethanol demonstration plant in the
Northwest United States.
Employ risk mitigation strategies. As sufficient working capital is available, we seek to
mitigate our exposure to commodity price fluctuations by purchasing forward a portion of our corn
and natural gas requirements through fixed-price contracts with our suppliers, as well as, entering
into derivative instruments to fix or establish a range of corn and natural gas prices. To mitigate
ethanol inventory price risks, we may sell a portion of our production forward under fixed- or index-
price contracts, or both. We may hedge a portion of the price risks associated with index-price
contracts by selling exchange-traded unleaded gasoline futures contracts. Proper execution of these
risk mitigation strategies can reduce the volatility of our gross profit margins.
Evaluate and pursue acquisition opportunities. We intend to evaluate and pursue
opportunities to acquire additional ethanol production, storage and distribution facilities and related
infrastructure as financial resources and business prospects make the acquisition of these facilities
advisable. In addition, we may also seek to acquire facility sites under development.
Industry Overview and Market Opportunity
Overview of Ethanol Market
The primary applications for fuel-grade ethanol in the United States include:
Octane enhancer. On average, regular unleaded gasoline has an octane rating of 87 and
premium unleaded has an octane rating of 91. In contrast, pure ethanol has an average octane
rating of 113. Adding ethanol to gasoline enables refiners to produce greater quantities of lower
octane blend stock with an octane rating of less than 87 before blending. In addition, ethanol is
commonly added to finished regular grade gasoline as a means of producing higher octane mid-
grade and premium gasoline.
Renewable fuels. Ethanol is blended with gasoline in order to enable gasoline refiners to
comply with a variety of governmental programs, in particular, the national RFS designed to
promote alternatives to fossil fuels. See ―—Governmental Regulation.‖
Fuel blending. In addition to its performance and environmental benefits, ethanol is used
to extend fuel supplies. As the need for automotive fuel in the United States increases and the
dependence on foreign crude oil and refined products grows, the United States is increasingly
seeking domestic sources of fuel. Much of the ethanol blending throughout the United States is
done for the purpose of extending the volume of fuel sold at the gasoline pump. Furthermore,
conditions in Brazil, where ethanol accounts for 40% of the gasoline market and is sold in blends
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with gasoline ranging from 25% to 100%, suggest that ethanol could capture a much greater
portion of the United States market in the future.
The ethanol fuel industry is greatly dependent upon tax policies and environmental regulations
that favor the use of ethanol in motor fuel blends in the United States. See ―—Governmental Regulation.‖
Ethanol blends have been either wholly or partially exempt from the federal excise tax on gasoline since
1978. The current federal excise tax on gasoline is $0.184 per gallon and is paid at the terminal by
refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.45 per gallon tax
credit for each gallon of ethanol used in the mixture. Federal law also requires the sale of oxygenated
fuels in certain carbon monoxide non-attainment Metropolitan Statistical Areas, or MSAs, during at least
four winter months, typically November through February.
In addition, the Energy Independence and Security Act of 2007, which was signed into law in
December 2007, significantly increased the prior national RFS. The new national RFS significantly
increases the mandated use of renewable fuels to 11.1 billion gallons in 2009 and 13.0 billion gallons in
2010, and rises incrementally and peaks at 36.0 billion gallons by 2022. The new national RFS mandates
include renewable fuel increases, with corn-based or ―conventional‖ ethanol to 10.5 billion gallons in
2009 and 12.0 billion gallons in 2010, reaching a peak of 15.0 billion gallons by 2015. Beginning in 2016,
increases in the new national RFS targets must be met with advanced biofuels, defined as cellulosic
ethanol and other biofuels derived from feedstock other than corn starch. We believe that these increases
will bolster demand for ethanol.
In January 2007, California’s Governor signed an executive order directing the California Air
Resource Board to implement a Low Carbon Fuels Standard for transportation fuels. The Governor’s
office estimates that the standard will have the effect of increasing current renewable fuels use in
California by three to five times by 2020. The State of Oregon implemented a state-wide renewable fuels
standard effective January 2008. This standard requires a 10% ethanol blend in every gallon of gasoline
and is expected to cause the use of approximately 160 million gallons of ethanol per year in Oregon.
According to the RFA, the domestic ethanol industry produced approximately 9.2 billion gallons
of ethanol in 2008, an increase of approximately 42% from the approximately 6.5 billion gallons of
ethanol produced in 2007. We believe that the ethanol market in California alone consumed
approximately 1.1 billion gallons in 2008, representing approximately 12% of the national market.
However, the Western United States has relatively few ethanol facilities and local ethanol production
levels are substantially below the local demand for ethanol. The balance of ethanol is shipped via rail
from the Midwest to the Western United States. Gasoline and diesel fuel that supply the major fuel
terminals are shipped in pipelines throughout portions of the Western United States. Unlike gasoline and
diesel fuel, however, ethanol is not shipped in these pipelines because ethanol has an affinity for mixing
with water already present in the pipelines. When mixed, water dilutes ethanol and creates significant
quality control issues. Therefore, ethanol must be trucked from rail terminals to regional fuel terminals, or
blending racks.
We believe that approximately 90% of the ethanol produced in the United States is made in the
Midwest from corn. According to the DOE, ethanol is typically blended at 5.7% to 10% by volume, but is
also blended at up to 85% by volume for vehicles designed to operate on 85% ethanol. Compared to
gasoline, ethanol is generally considered to be cleaner burning and contains higher octane. We anticipate
that the increasing demand for transportation fuels coupled with limited opportunities for gasoline
refinery expansions and the growing importance of reducing CO2 emissions through the use of renewable
fuels will generate additional growth in the demand for ethanol in the Western United States.
Ethanol prices, net of tax incentives offered by the federal government, are generally positively
correlated to fluctuations in gasoline prices. In addition, we believe that ethanol prices in the Western
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United States are typically $0.15 to $0.20 per gallon higher than in the Midwest due to the freight costs of
delivering ethanol from Midwest production facilities.
According to the DOE, total annual gasoline consumption in the United States is approximately
140 billion gallons and total annual ethanol consumption represented less than 7% of this amount in 2008.
We believe that the domestic ethanol industry has substantial potential for growth to initially reach what
we estimate is an achievable level of at least 10% of the total annual gasoline consumption in the United
States, or approximately 14 billion gallons of ethanol annually and thereafter up to 36 billion gallons of
ethanol annually required under the new national RFS by 2022.
While we believe that the overall national market for ethanol will grow, we believe that the
market for ethanol in certain geographic areas such as California could experience either increases or
decreases in demand depending on the preferences of petroleum refiners and state policies. See ―Risk
Factors.‖
Overview of Ethanol Production Process
The production of ethanol from starch- or sugar-based feedstocks has been refined considerably
in recent years, leading to a highly-efficient process that we believe now yields substantially more energy
in the ethanol and co-products than is required to make the products. The modern production of ethanol
requires large amounts of corn, or other high-starch grains, and water as well as chemicals, enzymes and
yeast, and denaturants such as unleaded gasoline or liquid natural gas, in addition to natural gas and
electricity.
In the dry milling process, corn or other high-starch grains are first ground into meal and then
slurried with water to form a mash. Enzymes are then added to the mash to convert the starch into the
simple sugar, dextrose. Ammonia is also added for acidic (pH) control and as a nutrient for the yeast. The
mash is processed through a high temperature cooking procedure, which reduces bacteria levels prior to
fermentation. The mash is then cooled and transferred to fermenters, where yeast is added and the
conversion of sugar to ethanol and CO2 begins.
After fermentation, the resulting ―beer‖ is transferred to distillation, where the ethanol is
separated from the residual ―stillage.‖ The ethanol is concentrated to 190 proof using conventional
distillation methods and then is dehydrated to approximately 200 proof, representing 100% alcohol levels,
in a molecular sieve system. The resulting anhydrous ethanol is then blended with about 5% denaturant,
which is usually gasoline, and is then ready for shipment to market.
The residual stillage is separated into a coarse grain portion and a liquid portion through a
centrifugation process. The soluble liquid portion is concentrated to about 40% dissolved solids by an
evaporation process. This intermediate state is called condensed distillers solubles, or syrup. The coarse
grain and syrup portions are then mixed to produce WDG or can be mixed and dried to produce dried
distillers grains with solubles, or DDGS. Both WDG and DDGS are high-protein animal feed products.
Overview of Distillers Grains Market
According to the National Corn Growers Association, approximately 15 million tons of dried
distillers grains were produced during the 2007 and 2008 crop year and fed to livestock. Last year, an
estimated 720 million bushels of corn from feed rations was displaced with these distillers grains,
allowing the corn to be used in other markets.
In the United States, most distillers grains are produced in the Midwest, where producers dry the
grains before shipping. Successful and profitable delivery of DDGS from the Midwest faces a number of
challenges, including product inconsistency, handling difficulty and lower feed values. By not drying the
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distillers grains and by shipping WDG locally, we believe that we will be able to preserve the feed
integrity of these grains.
Historically, the market price for distillers grains has been stable in comparison to the market
price for ethanol. We believe that the market price of DDGS is determined by a number of factors,
including the market value of corn, soybean meal and other competitive ingredients, the performance or
value of DDGS in a particular feed formulation and general market forces of supply and demand. We also
believe that nationwide, the market price of distillers grains historically has been influenced by producers
of distilled spirits and more recently by the large corn dry-millers that operate fuel ethanol facilities. The
market price of distillers grains is also often influenced by nutritional models that calculate the feed value
of distillers grains by nutritional content.
Customers
We produce and also purchase from third-parties and resell ethanol to various customers in the
Western United States. We also arrange for transportation, storage and delivery of ethanol purchased by
our customers through our agreements with third-party service providers. Our revenue is obtained
primarily from sales of ethanol to large oil companies. We began producing ethanol in the fourth quarter
of 2006.
During 2008, 2007 and 2006, we produced or purchased from third parties and resold an
aggregate of approximately 272 million, 191 million and 102 million gallons of fuel-grade ethanol to
approximately 66 customers, 61 customers and 60 customers, respectively. Sales to our two largest
customers in 2008 and in 2007 represented approximately 32% of our net sales for each of those years.
Sales to our two largest customers in 2006 represented approximately 25% of our net sales. Customers
who accounted for 10% or more of our net sales in 2008 and 2007 were Chevron Products USA and
Valero Marketing. Customers who accounted for 10% or more of our net sales in 2006 were New West
Petroleum and Chevron Products USA. Sales to each of our other customers represented less than 10% of
our net sales in each of 2008, 2007 and 2006.
Most of the major metropolitan areas in the Western United States have fuel terminals served by
rail, but other major metropolitan areas and more remote smaller cities and rural areas do not. We believe
that we have a competitive advantage due to our experience in marketing to the segment of customers in
major metropolitan and rural markets in the Western United States. We manage the complicated logistics
of shipping ethanol purchased from third-parties from the Midwest by rail to intermediate storage
locations throughout the Western United States and trucking the ethanol from these storage locations to
blending racks where the ethanol is blended with gasoline. We believe that by establishing an efficient
service for truck deliveries to these more remote locations, we have differentiated ourselves from our
competitors. In addition, by producing ethanol in the Western United States, we believe that we will
benefit from our ability to increase spot sales of ethanol from this additional supply following ethanol
price spikes caused from time to time by rail delays in delivering ethanol from the Midwest to the
Western United States. In addition to producing ethanol, we produce ethanol co-products such as WDG.
We endeavor to position WDG as the protein feed of choice for cattle based on its nutritional
composition, consistency of quality and delivery, ease of handling and its mixing ability with other feed
ingredients. We expect to be one of the few WDG producers with production facilities located in the
Western United States and we primarily sell our WDG to dairy farmers in close proximity to our ethanol
production facilities.
Suppliers
Our marketing operations are dependent upon various producers of fuel-grade ethanol for our
ethanol supplies. In addition, we provide ethanol transportation, storage and delivery services through
third-party service providers with whom we have contracted to receive ethanol at agreed upon locations
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from our suppliers and to store and/or deliver the ethanol to agreed upon locations on behalf of our
customers. These contracts generally run from year-to-year, subject to termination by either party upon
advance written notice before the end of the then-current annual term. We also transport ethanol with our
own fleet of railcars, which we intend to expand to support the continuing growth of our business.
During 2008, 2007 and 2006, we purchased fuel-grade ethanol and corn, the largest component in
producing ethanol, from our suppliers. Purchases from our two largest suppliers in 2008 represented
approximately 49% of our total ethanol and corn purchases. Purchases from our three largest ethanol and
corn suppliers in 2007 represented approximately 47% of our total ethanol and corn purchases. Purchases
from our three largest ethanol suppliers in 2006 represented approximately 50% of our total ethanol and
corn purchases. Purchases from each of our other suppliers represented less than 10% of total ethanol and
corn purchases in 2008, 2007 and 2006.
Our ethanol production operations are dependent upon various raw materials suppliers, including
suppliers of corn, natural gas, electricity and water. The cost of corn is the most important variable cost
associated with the production of ethanol. An ethanol plant must be able to efficiently ship corn from the
Midwest via rail and cheaply and reliably truck ethanol to local markets. We believe that our existing
grain receiving facilities at our ethanol facilities are some of the most efficient grain receiving facilities in
the United States. We source corn using standard contracts, such as spot purchases, forward purchases
and basis contracts. When we have the resources to do so, we seek to limit our exposure to raw material
price fluctuations by purchasing forward a portion of our corn requirements on a fixed price basis and by
purchasing corn and other raw materials futures contracts. In addition, to help protect against supply
disruptions, we may maintain inventories of corn at each of our facilities.
Production Facilities
The table below provides an overview of our ethanol production facilities.
Location ...................................................................................
Quarter/Year operations began ................................................
Annual design basis ethanol
Madera
Facility
Madera, CA
4th Qtr., 2006
Front Range
Facility(1)
Windsor, CO
2nd Qtr., 2006
production capacity (in millions
of gallons) .............................................................................
35
40
Approximate maximum annual
ethanol production capacity (in
millions of gallons) ...............................................................
Ownership ...............................................................................
Primary energy source .............................................................
Estimated annual WDG
production capacity (in
thousands of tons) .................................................................
40
100%
Natural Gas
293
50
42%
Natural Gas
Columbia
Facility
Boardman, OR
3rd Qtr., 2007
Magic
Valley
Facility
Burley, ID
2nd Qtr., 2008
Stockton
Facility
Stockton, CA
3rd Qtr., 2008
35
50
50
40
100%
Natural Gas
60
100%
Natural Gas
60
100%
Natural Gas
335
293
418
418
———————
(1) We own 42% of Front Range, the entity that owns the facility located in Windsor, Colorado.
The ethanol industry has experienced significant adverse conditions over the course of the last 12
months, including prolonged negative operating margins. We, too, have experienced these adverse
conditions as well as severe working capital and liquidity shortages, and in response to such conditions,
we have reduced production significantly until market conditions resume to acceptable levels and
working capital becomes available. We first reduced production in December 2008 and continued to
reduce production through the first quarter of 2009. Currently, we have ceased production at our Madera,
Magic Valley and Stockton facilities. We continue to operate our Columbia and Front Range facilities.
We continue to assess market conditions and when appropriate, provided we have adequate available
working capital, we plan to bring these facilities back to operation.
-9-
Site Location Criteria
Our site location criteria encompass many factors, including proximity of fuel blending facilities
and major rail lines, good road access, water and utility availability and adequate space for equipment and
truck movement. One of our primary business and growth strategies is to develop or acquire ethanol
production facilities in markets where local characteristics create the opportunity to capture a significant
production and shipping cost advantage over competing ethanol production facilities. Therefore, it is
critical that our production sites are located near fuel blending facilities in the Western United States
because many of our competitors ship ethanol over long distances from the Midwest. Also, close
proximity to major rail lines to receive corn shipments from Midwest producers is critical.
Marketing Arrangements
We have exclusive agreements with third-party ethanol producers, including Calgren Renewable
Fuels, LLC and Front Range, the latter of which we are a minority owner, to market and sell their entire
ethanol production volumes. Calgren Renewable Fuels, LLC owns and operates an ethanol production
facility in Pixley, California with annual production capacity of 55 million gallons. Front Range owns and
operates an ethanol production facility in Windsor, Colorado with annual production capacity of 50
million gallons. We also have an exclusive agreement to market and sell WDG produced at the facility
owned by Front Range. We intend to evaluate and pursue opportunities to enter into marketing
arrangements with other ethanol producers as business prospects make these marketing arrangements
advisable.
Competition
We operate in the highly competitive ethanol marketing and production industry. The largest
ethanol producer in the United States is ADM, with wet and dry mill plants in the Midwest and a total
production capacity of about 1.25 billion gallons per year, or approximately 14% of total United States
ethanol production in 2008. According to the RFA, there are approximately 170 ethanol facilities
currently operating with a combined annual production capacity of approximately 10.6 billion gallons. In
addition, we believe that approximately five new ethanol facilities or expansions of existing facilities are
currently under construction with an estimated combined future annual production capacity of
approximately 1.0 billion gallons.
We believe that many smaller ethanol facilities rely on marketing groups such as POET Ethanol
Products, Aventine Renewable Energy, Inc., Eco Energy and Renewable Products Marketing Group LLC
to move their product to market. We believe that, because ethanol is a commodity, many of the Midwest
ethanol producers can target the Western United States, though ethanol producers further west in states
such as Nebraska and Kansas often enjoy delivery cost advantages.
In the second half of 2008 and into the first quarter of 2009, we and our competitors have reduced
production and/or experienced significant working capital deficits. Some of our competitors have filed for
protection under the United States Bankruptcy Code. As a result, our competition may change in the near
term by either further declining production or entrance by others in the marketplace, for example, through
purchases of facilities through liquidation. These competitors may even be some of our current customers.
We believe that our competitive strengths include our strategic locations in the Western United
States, our extensive ethanol distribution network, our extensive customer and supplier relationships, our
use of modern technologies at our production facilities and our experienced management. We believe that
these advantages will allow us to capture an increasing share of the total market for ethanol and its co-
products and earn favorable margins on ethanol and its co-products that we produce.
-10-
Our strategic focus on particular geographic locations designed to exploit cost efficiencies may
nevertheless result in higher than expected costs as a result of more expensive raw materials and related
shipping costs, such as corn, which generally must be transported from the Midwest. If the costs of
producing and shipping ethanol and its co-products over short distances are not advantageous relative to
the costs of obtaining raw materials from the Midwest, then the planned benefits of our strategic locations
may not be realized.
Governmental Regulation
Our business is subject to extensive and frequently changing federal, state and local laws and
regulations relating to the protection of the environment. These laws, their underlying regulatory
requirements and their enforcement, some of which are described below, impact, or may impact, our
existing and proposed business operations by imposing:
restrictions on our existing and proposed business operations and/or the need to install
enhanced or additional controls;
the need to obtain and comply with permits and authorizations;
liability for exceeding applicable permit limits or legal requirements, in certain cases for
the remediation of contaminated soil and groundwater at our facilities, contiguous and
adjacent properties and other properties owned and/or operated by third parties; and
specifications for the ethanol we market and produce.
In addition, some of the governmental regulations to which we are subject are helpful to our
ethanol marketing and production business. The ethanol fuel industry is greatly dependent upon tax
policies and environmental regulations that favor the use of ethanol in motor fuel blends in North
America. Some of the governmental regulations applicable to our ethanol marketing and production
business are briefly described below.
Federal Excise Tax Exemption
Ethanol blends have been either wholly or partially exempt from the federal excise tax on
gasoline since 1978. The exemption has ranged from $0.04 to $0.06 per gallon of gasoline during that 25-
year period. The current federal excise tax on gasoline is $0.184 per gallon, and is paid at the terminal by
refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.45 per gallon tax
credit for each gallon of ethanol used in the mixture. The federal excise tax exemption was revised and its
expiration date was extended for the sixth time since its inception as part of the American Jobs Creation
Act of 2004. The new expiration date of the federal excise tax exemption is December 31, 2010. We
believe that it is highly likely that this tax incentive will be extended beyond 2010 if Congress deems it
necessary for the continued growth and prosperity of the ethanol industry.
Clean Air Act Amendments of 1990
In November 1990, a comprehensive amendment to the Clean Air Act of 1977 established a
series of requirements and restrictions for gasoline content designed to reduce air pollution in identified
problem areas of the United States. The two principal components affecting motor fuel content are the
oxygenated fuels program, which is administered by states under federal guidelines, and a federally
supervised reformulated gasoline, or RFG, program.
Oxygenated Fuels Program
Federal law requires the sale of oxygenated fuels in certain carbon monoxide non-attainment
MSAs during at least four winter months, typically November through February. Any additional MSAs
not in compliance for a period of two consecutive years in subsequent years may also be included in the
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program. The Environmental Protection Agency, or EPA, Administrator is afforded flexibility in
requiring a shorter or longer period of use depending upon available supplies of oxygenated fuels or the
level of non-attainment. This law currently affects the Los Angeles area, where over 150 million gallons
of ethanol are blended with gasoline each winter.
Reformulated Gasoline Program
The Clean Air Act Amendments of 1990 established special standards effective January 1, 1995
for the most polluted ozone non-attainment areas: Los Angeles Area, Baltimore, Chicago Area, Houston
Area, Milwaukee Area, New York City Area, Hartford, Philadelphia Area and San Diego, with provisions
to add other areas in the future if conditions warrant. California’s San Joaquin Valley, the location of both
of our Madera and Stockton facilities, was added in 2002. At the outset of the RFG program there were a
total of 96 MSAs not in compliance with clean air standards for ozone, which represents approximately
60% of the national market.
The RFG program also includes a provision that allows individual states to ―opt into‖ the federal
program by request of the governor, to adopt standards promulgated by California that are stricter than
federal standards, or to offer alternative programs designed to reduce ozone levels. Nearly the entire
Northeast and middle Atlantic areas from Washington, D.C. to Boston not under the federal mandate have
―opted into‖ the federal standards.
These state mandates in recent years have created a variety of gasoline grades to meet different
regional environmental requirements. The RFG program accounts for about 30% of nationwide gasoline
consumption. California refiners blend a minimum of 2.0% oxygen by weight, which is the equivalent of
5.7% ethanol in every gallon of gasoline, or roughly 1.0 billion gallons of ethanol per year in California
alone.
National Energy Legislation
In addition, the Energy Independence and Security Act of 2007, which was signed into law in
December 2007, significantly increased the prior national RFS. The new national RFS significantly
increases the mandated use of renewable fuels to 11.1 billion gallons in 2009 and 13.0 billion gallons in
2010, and rises incrementally and peaks at 36.0 billion gallons by 2022. The new national RFS mandates
include renewable fuel increases, with corn-based or ―conventional‖ ethanol to 10.5 billion gallons in
2009 and 12.0 billion gallons in 2010, reaching a peak of 15.0 billion gallons by 2015. Beginning in 2016,
increases in the new national RFS targets must be met with advanced biofuels, defined as cellulosic
ethanol and other biofuels derived from feedstock other than corn starch.
State Energy Legislation and Regulations
State energy legislation and regulations may affect the demand for ethanol. California recently
passed legislation regulating the total emissions of CO2 from vehicles and other sources. In 2006, the
State of Washington passed a statewide renewable fuel standard effective December 1, 2008. We believe
other states may also enact their own renewable fuel standards.
In January 2007, California’s Governor signed an executive order directing the California Air
Resource Board to implement a Low Carbon Fuels Standard for transportation fuels. The Governor’s
office estimates that the standard will have the effect of increasing current renewable fuels use in
California by three to five times by 2020.
The State of Oregon implemented a state-wide renewable fuels standard effective January 2008.
This standard requires a 10% ethanol blend in every gallon of gasoline and is expected to cause the use of
approximately 160 million gallons of ethanol per year in Oregon.
-12-
Additional Environmental Regulations
In addition to the governmental regulations applicable to the ethanol marketing and production
industries described above, our business is subject to additional federal, state and local environmental
regulations, including regulations established by the EPA, the Regional Water Quality Control Board, the
San Joaquin Valley Air Pollution Control District and the California Air Resources Board. We cannot
predict the manner or extent to which these regulations will harm or help our business or the ethanol
production and marketing industry in general.
Employees
As of March 26, 2009, we employed approximately 150 persons on a full-time basis, including
through our subsidiaries. We believe that our employees are highly-skilled, and our success will depend
in part upon our ability to retain our employees and attract new qualified employees who are in great
demand. We have never had a work stoppage or strike, and no employees are presently represented by a
labor union or covered by a collective bargaining agreement. We consider our relations with our
employees to be good.
Item 1A. Risk Factors.
Risks Related to our Business
There is substantial doubt as to our ability to continue as a going concern. We need additional
financing or capital which may be unavailable or costly.
As a result of ethanol industry conditions that have negatively affected our business, we do not
currently have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity
needs in the very near-term. We believe that we have sufficient working capital to continue operations
only until approximately April 30, 2009 at the latest unless we successfully restructure our debt,
experience a significant improvement in margins and obtain other sources of liquidity. In addition,
although various secured creditors are presently forbearing through April 30, 2009 under outstanding
forbearance agreements from exercising their rights, once those forbearance periods expire or in the event
of additional defaults, we will be in default to those secured creditors who collectively hold security
interests in substantially all of our assets. As a result, our 2008 financial statements include an
explanatory paragraph by our independent registered public accounting firm describing the substantial
doubt as to our ability to continue as a going concern.
As of March 26, 2009, we owed approximately $246.5 million in term loans and lines of credit
associated with the construction and operation of our ethanol plants and approximately $5.3 million under
our revolving credit facility. As of that date, we had only $4.0 million in cash and $4.7 million of
additional borrowing availability under our revolving credit facility. As we continue to reduce the number
of gallons of ethanol we sell and hold in inventory, working capital available to support borrowings under
our revolving credit facility will reduce proportionately.
We do not expect to have sufficient liquidity to meet anticipated working capital, debt service and
other liquidity needs beyond April 30, 2009 at the latest unless we successfully restructure our debt,
experience a significant improvement in margins and obtain other sources of liquidity. Based on the
current spread between corn and ethanol prices, the industry is operating at or near break-even cash
margins. The current spread between ethanol and corn prices cannot support the long-term viability of the
U.S. ethanol industry in general or us in particular.
Although we are actively pursuing a number of alternatives, including seeking to restructure our
debt and seeking to raise additional debt or equity financing, or both, there can be no assurance that we
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will be successful. If we cannot restructure our debt and obtain sufficient liquidity in the very near term,
we may need to seek to protection under the U.S. Bankruptcy Code.
If we seek protection under the U.S. Bankruptcy Code, all of our outstanding shares of capital
stock could be cancelled and holders of our capital stock may not be entitled to any payment in
respect of their shares.
If we seek protection under the U.S. Bankruptcy Code it is possible that all of our outstanding
shares of capital stock could be cancelled and holders of capital stock may not be entitled to any payment
in respect of their shares. It is also possible that our obligations to our creditors may be satisfied by the
issuance of shares of capital stock in satisfaction of their claims. The value of any capital stock so issued
may be less than the face value of our obligations to those creditors, and the price of any such capital
stock may be volatile. In addition, in the event of a bankruptcy filing, our common stock will be
suspended from trading on and delisted from NASDAQ. Accordingly, trading in our common stock may
be limited, and our stockholders may not be able to resell their securities for their purchase price or at all.
We are seeking additional financing and may be unable to obtain this financing on a timely
basis, in sufficient amounts, on terms acceptable to us or at all. Any financing we are able to
obtain may be available only on burdensome terms that may cause significant dilution to our
stockholders and impose onerous financial restrictions on our business.
We are seeking substantial additional financing. Deteriorating global economic and debt and
equity market conditions may cause prolonged declines in lender and investor confidence in and
accessibility to capital markets. Future financing may not be available on a timely basis, in sufficient
amounts, on terms acceptable to us or at all. Any equity financing may cause significant dilution to
existing stockholders. Any debt financing or other financing of securities senior to our common stock will
likely include financial and other covenants that will restrict our flexibility. At a minimum, we would
expect these covenants to include restrictions on our ability to pay dividends on our common stock. Any
failure to comply with these covenants could have a material adverse effect on our business, prospects,
financial condition and results of operations because we could lose any then-existing sources of financing
and our ability to secure new financing may be impaired. In addition, any prospective debt or equity
financing transaction will be subject to the negotiation of definitive documents and any closing under
those documents will be subject to the satisfaction of numerous conditions, many of which could be
beyond our control. We may be unable to obtain additional financing from one or more lenders or equity
investors, or if funding is available, it may be available only on burdensome terms that may cause
significant dilution to our stockholders and impose onerous financial restrictions on our business.
We have incurred significant losses and negative operating cash flow in the past and we will
likely incur significant losses and negative operating cash flow in the foreseeable future.
Continued losses and negative operating cash flow will hamper our operations and prevent us
from expanding our business.
We have incurred significant losses and negative operating cash flow in the past. For the years
ended December 31, 2008, 2007 and 2006, we incurred net losses of approximately $146.5 million, $14.4
million and $142,000, respectively. For the years ended December 31, 2008 and 2006, we incurred
negative operating cash flow of approximately $55.2 million and $8.1 million, respectively. We will
likely incur significant losses and negative operating cash flow in the foreseeable future. We expect to
rely on cash on hand, cash, if any, generated from our operations and cash, if any, generated from our
future financing activities to fund all of the cash requirements of our business. Continued losses and
negative operating cash flow will hamper our operations and prevent us from expanding our business.
Continued losses and negative operating cash flow are also likely to make our capital raising needs more
acute while limiting our ability to raise additional financing on satisfactory terms.
-14-
We recognized impairment charges in 2008 and could recognize additional impairment charges
in the future.
During 2008, we recognized an impairment charge of our goodwill in the amount of $87.0
million and an impairment charge on our construction project in the Imperial Valley near Calipatria,
California, or the Imperial Project, in the amount of $40.9 million. As of December 31, 2008, we
performed our forecast of expected future cash flows of our facilities over their estimated useful lives.
Such forecasts of expected future cash flows are heavily dependent upon management’s estimates of
future market prices for ethanol, our primary product, and corn, our primary production input. As both
ethanol and corn costs have fluctuated significantly in the past year, these estimates are highly subjective
and are management’s best estimates at this time.
If average prices for ethanol and corn during 2008 were used in our forecast rather than
management’s estimate of future market prices, the projections would have resulted in estimated
undiscounted cash flows below carrying values which would require us to compute their fair values. If we
are required to compute the fair value in the future, we may use the work of a qualified valuation
specialist who would assist us in examining replacement costs, recent transactions between third parties
and cash flow that can be generated from operations. Given the recent completion of the facilities,
replacement cost would likely approximate the carrying value of the facilities. However, there have been
recent transactions between independent parties to purchase plants at prices substantially below the
carrying value of the facilities. Some of the facilities have been in bankruptcy and may not be
representative of transactions outside of bankruptcy. Given these circumstances, should management be
required to adjust the carrying value of the facilities to fair value at some future point in time, the
adjustment could be significant and could significantly impact our financial position, results of operations
and possibly any existing financial debt covenants.
If we are unable to attract and retain key personnel, our ability to operate effectively may be
impaired.
Our ability to operate our business and implement strategies depends, in part, on the efforts of our
executive officers and other key employees. We have made certain reductions in staffing which may
have had the effect of creating an uncertain employment environment, which may lead key employees to
seek alternative employment. In addition, our acute financial distress may cause key employees to seek
alternative employment. Our future success will depend on, among other factors, our ability to attract and
retain our current key personnel and qualified future key personnel, particularly executive
management. Failure to attract or retain qualified key personnel, could have a material adverse effect on
our business and results of operations.
Even if we are able to restructure our indebtedness and raise additional capital in the very near
term, various factors could result in inadequate working capital to fully fund our operations.
If ethanol production margins remain at or deteriorate from current levels, if our capital
requirements or cash flows otherwise vary materially and adversely from our current projections, or if
other adverse unforeseen circumstances occur, our working capital may be inadequate to fully fund our
operations even if we are able to restructure our indebtedness and raise additional capital in the very near
term, which may have a material adverse effect on our results of operations, liquidity and cash flows and
may restrict our growth and hinder our ability to compete.
-15-
The crisis in the financial markets, considerable volatility in the commodities markets and
sustained weakening of the economy could further significantly impact our business and
financial condition and may limit our ability to raise additional capital.
As widely reported, financial markets in the United States and the rest of the world are
experiencing extreme disruption, including, among other things, extreme volatility in securities and
commodities prices, as well as severely diminished liquidity and credit availability. As a result, we
believe that our ability to access capital markets and raise funds required for our operations is severely
restricted at a time when we need to do so, which is having a material adverse effect on our ability to meet
our current and future funding requirements and on our ability to react to changing economic and business
conditions. Current economic and market conditions, and particularly, the significant decline in the price
of crude oil, has resulted in reduced demand for our products. We are not able to predict the duration or
severity of the current disruption in financial markets, fluctuations in the price of crude oil or other
adverse economic conditions in the United States. However, if economic conditions continue to worsen, it
is likely that these factors would have a further adverse effect on our results of operations and future
prospects.
Increased ethanol production may cause a decline in ethanol prices or prevent ethanol prices
from rising, and may have other negative effects, adversely impacting our results of operations,
cash flows and financial condition.
We believe that the most significant factor influencing the price of ethanol has been the
substantial increase in ethanol production in recent years. Domestic ethanol production capacity has
increased steadily from an annualized rate of 1.7 billion gallons per year in January 1999 to 9.2 billion
gallons in 2008 according to the RFA. In addition, we believe that a significant amount of ethanol
production capacity—approximately 1.0 billion gallons per year—is currently under construction. This
production capacity is being added to address anticipated increases in demand, including demand from
increased volume requirements under the Energy Independence and Security Act of 2007. See
―Business—Governmental Regulation.‖ However, increases in the demand for ethanol may not be
commensurate with increases in the supply of ethanol, thus leading to lower ethanol prices. Demand for
ethanol could be impaired due to a number of factors, including regulatory developments and reduced
United States gasoline consumption. Reduced gasoline consumption has occurred in the past, and could
occur in the future, as a result of increased gasoline or oil prices. Increased ethanol production could also
have other adverse effects. For example, increased ethanol production could lead to increased supplies of
co-products generated from ethanol production, such as WDG. Those increased supplies could lead to
lower prices for those co-products. Also, increased ethanol production could result in increased demand
for corn. Increased demand for corn could cause higher corn prices, resulting in higher ethanol production
costs and lower profit margins. Accordingly, increased ethanol production may cause a decline in ethanol
prices or prevent ethanol prices from rising, and may have other negative effects, adversely impacting our
results of operations, cash flows and financial condition.
The raw materials and energy necessary to produce ethanol may be unavailable or may
increase in price, adversely affecting our business, results of operations and financial condition.
The principal raw material we use to produce ethanol and its co-products is corn. Changes in the
price of corn can significantly affect our business. In general, and as we have experienced in 2008, rising
corn prices result in lower profit margins and, therefore, represent unfavorable market conditions. This is
especially true since market conditions generally do not allow us to pass along increased corn prices to
our customers because the price of ethanol is primarily determined by other factors, such as the supply of
ethanol and the price of oil and gasoline. At certain levels, corn prices may even make ethanol production
uneconomical depending on the prevailing price of ethanol.
-16-
The price of corn is influenced by general economic, market and regulatory factors. These factors
include weather conditions, crop conditions and yields, farmer planting decisions, government policies
and subsidies with respect to agriculture and international trade and global supply and demand. The
significance and relative impact of these factors on the price of corn is difficult to predict. Any event that
tends to negatively impact the supply of corn will tend to increase prices and potentially harm our
business. Average corn prices as measured by the Chicago Board of Trade increased 41% from 2007 to
2008. The United States Department of Agriculture’s March 2009 World Agriculture Supply and Demand
Estimates projected that corn bought by ethanol plants in the U.S. will represent approximately 31% of
the 2008/2009 crop year’s total corn supply, up from 22% in the prior crop year. Additional increases in
ethanol production could further boost demand for corn and result in further increases in corn prices.
Our business also depends on the continuing availability of rail, road, port, storage and
distribution infrastructure. In particular, due to limited storage capacity at our production facilities and
other considerations related to production efficiencies, we depend on just-in-time delivery of corn. The
production of ethanol also requires a significant and uninterrupted supply of other raw materials and
energy, primarily water, electricity and natural gas. The prices of electricity and natural gas have
fluctuated significantly in the past and may fluctuate significantly in the future. Local water, electricity
and gas utilities may not be able to reliably supply the water, electricity and natural gas that our facilities
will need or may not be able to supply those resources on acceptable terms. Any disruptions in the ethanol
production infrastructure network, whether caused by labor difficulties, earthquakes, storms, other natural
disasters or human error or malfeasance or other reasons, could prevent timely deliveries of corn or other
raw materials and energy and may require us to halt production which could have a material adverse
effect on our business, results of operations and financial condition.
We engage in hedging transactions and other risk mitigation strategies that could harm our
results of operations.
In an attempt to partially offset the effects of volatility of ethanol prices and corn and natural gas
costs, we often enter into contracts to supply a portion of our ethanol production or purchase a portion of
our corn or natural gas requirements on a forward basis. In addition, we engage in other hedging
transactions involving exchange-traded futures contracts for corn, natural gas and unleaded gasoline from
time to time. The financial statement impact of these activities is dependent upon, among other things, the
prices involved and our ability to sell sufficient products to use all of the corn and natural gas for which
we have futures contracts. We also engage in hedging transactions involving interest rate swaps related to
our debt financing activities, the financial statement impact of which is dependent upon, among other
things, fluctuations in prevailing interest rates. Hedging arrangements also expose us to the risk of
financial loss in situations where the other party to the hedging contract defaults on its contract or, in the
case of exchange-traded contracts, where there is a change in the expected differential between the
underlying price in the hedging agreement and the actual prices paid or received by us. Hedging activities
can themselves result in losses when a position is purchased in a declining market or a position is sold in
a rising market. A hedge position for a physical commodity is often settled in the same time frame as the
physical commodity is either purchased or sold. Certain hedging losses may be offset by a decreased cash
price for corn and natural gas and an increased cash price for ethanol. We also vary the amount of
hedging or other risk mitigation strategies we undertake, and from time to time we may choose not to
engage in hedging transactions at all. As a result, our results of operations and financial position may be
adversely affected by fluctuations in the price of corn, natural gas, ethanol, unleaded gasoline and
prevailing interest rates.
The market price of ethanol is volatile and subject to large fluctuations, which may cause our
profitability or losses to fluctuate significantly.
The market price of ethanol is volatile and subject to large fluctuations. The market price of
ethanol is dependent upon many factors, including the supply of ethanol and the price of gasoline, which
-17-
is in turn dependent upon the price of petroleum which is highly volatile and difficult to forecast. For
example, our average sales price of ethanol in 2008 increased by 5%, in 2007 declined by 6% and in 2006
increased by 37% from the prior year’s average sales price per gallon. Fluctuations in the market price of
ethanol may cause our profitability or losses to fluctuate significantly.
We have identified certain material weaknesses in our internal control over financial reporting
in the past and cannot assure you that material weaknesses will not be identified in the future.
If our internal control over financial reporting or disclosure controls and procedures are not
effective, there may be errors in our financial statements that could require a restatement or
our filings may not be timely and investors may lose confidence in our reported financial
information, which could lead to a decline in our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our
internal control over financial reporting as of the end of each year, and to include a management report
assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form
10-K. Section 404 also requires our independent registered public accounting firm to attest to, and report
on, management’s assessment of our internal control over financial reporting. See ―Controls and
Procedures.‖
Our management, including our Chief Executive Officer and Chief Financial Officer, does not
expect that our internal control over financial reporting will prevent all errors and all fraud. A control
system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance
that the control system’s objectives will be met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be considered relative to their
costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the controls. Over time, controls may become inadequate because
changes in conditions or deterioration in the degree of compliance with policies or procedures may occur.
Because of the inherent limitations of a cost-effective control system, misstatements due to error or fraud
may occur and not be detected.
We identified material weaknesses in our internal control over financial reporting for the year
ended December 31, 2007 and we cannot assure you that significant deficiencies or material weaknesses
in our internal control over financial reporting will not be identified in the future. Any failure to maintain
or implement required new or improved controls, or any difficulties we encounter in their
implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely
meet our periodic reporting obligations, or result in material misstatements in our financial statements.
Any such failure could also adversely affect the results of periodic management evaluations and annual
auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over
financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules
promulgated thereunder. The existence of a material weakness could result in errors in our financial
statements that could result in a restatement of financial statements, cause us to fail to timely meet our
reporting obligations and cause investors to lose confidence in our reported financial information, leading
to a decline in our stock price.
Operational difficulties at our production facilities could negatively impact our sales volumes
and could cause us to incur substantial losses.
Our operations are subject to labor disruptions, unscheduled downtimes and other operational
hazards inherent in our industry, such as equipment failures, fires, explosions, abnormal pressures,
blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational
hazards may cause personal injury or loss of life, severe damage to or destruction of property and
equipment or environmental damage, and may result in suspension of operations and the imposition of
civil or criminal penalties. Our insurance may not be adequate to fully cover the potential operational
-18-
hazards described above or we may not be able to renew this insurance on commercially reasonable terms
or at all.
Moreover, our plants may not operate as planned or expected. All of our plants are designed to
operate at or above a certain production capacity. The operation of our plants is and will be, however,
subject to various uncertainties. As a result, our plants may not produce ethanol and its co-products at the
levels we expect. In the event any of our plants do not run at their expected capacity levels, our business,
results of operations and financial condition may be materially and adversely affected.
The United States ethanol industry is highly dependent upon a myriad of federal and state
legislation and regulation and any changes in such legislation or regulation could have a
material adverse effect on our results of operations and financial condition.
The elimination or reduction of federal excise tax incentives could have a material adverse effect
on our results of operations and our financial condition.
The amount of ethanol production capacity in the U.S. exceeds the mandated usage of renewable
biofuels. Ethanol consumption above mandated amounts is primarily based upon the economic benefit
derived by blenders, including benefits received from federal excise tax incentives. Therefore, the
production of ethanol is made significantly more competitive by federal tax incentives. The federal excise
tax incentive program, which is scheduled to expire on December 31, 2010, allows gasoline distributors
who blend ethanol with gasoline to receive a federal excise tax rate reduction for each blended gallon they
sell regardless of the blend rate. The current federal excise tax on gasoline is $0.184 per gallon, and is
paid at the terminal by refiners and marketers. If the fuel is blended with ethanol, the blender may claim a
$0.45 per gallon tax credit for each gallon of ethanol used in the mixture. The 2008 Farm Bill enacted into
law reduced federal excise tax incentives from $0.51 per gallon in 2008 to $0.45 per gallon in 2009. The
federal excise tax incentive program may not be renewed prior to its expiration in 2010, or if renewed, it
may be renewed on terms significantly less favorable than current tax incentives. The elimination or
significant reduction in the federal excise tax incentive program could reduce discretionary blending and
have a material adverse effect on our results of operations and our financial condition.
Various studies have criticized the efficiency of ethanol in general, and corn-based ethanol in
particular, which could lead to the reduction or repeal of incentives and tariffs that promote the
use and domestic production of ethanol or otherwise negatively impact public perception and
acceptance of ethanol as an alternative fuel.
Although many trade groups, academics and governmental agencies have supported ethanol as a
fuel additive that promotes a cleaner environment, others have criticized ethanol production as consuming
considerably more energy and emitting more greenhouse gases than other biofuels and as potentially
depleting water resources. Other studies have suggested that corn-based ethanol is less efficient than
ethanol produced from switchgrass or wheat grain and that it negatively impacts consumers by causing
higher prices for dairy, meat and other foodstuffs from livestock that consume corn. If these views gain
acceptance, support for existing measures promoting the use and domestic production of corn-based
ethanol could decline, leading to a reduction or repeal of these measures. These views could also
negatively impact public perception of the ethanol industry and acceptance of ethanol as an alternative
fuel.
Waivers or repeal of the national RFS minimum levels of renewable fuels included in gasoline
could have a material adverse affect on our results of operations.
Shortly after passage of the Energy Independence and Security Act of 2007, which increased the
minimum mandated required usage of ethanol, a Congressional sub-committee held hearings on the
potential impact of the new national RFS on commodity prices. While no action was taken by the sub-
-19-
committee towards repeal of the new national RFS, any attempt by Congress to re-visit, repeal or grant
waivers of the new national RFS could adversely affect demand for ethanol and could have a material
adverse effect on our results of operations and financial condition.
While the Energy Independence and Security Act of 2007 imposes the national RFS, it does not
mandate only the use of ethanol.
The Energy Independence and Security Act of 2007 imposes the national RFS, but does not
mandate only the use of ethanol. While the RFA expects that ethanol should account for the largest share
of renewable fuels produced and consumed under the national RFS, the national RFS is not limited to
ethanol and also includes biodiesel and any other liquid fuel produced from biomass or biogas.
The ethanol production and marketing industry is extremely competitive. Many of our
significant competitors have greater production and financial resources than we do and one or
more of these competitors could use their greater resources to gain market share at our
expense. In addition, certain of our suppliers may circumvent our marketing services, causing
our sales and profitability to decline.
The ethanol production and marketing industry is extremely competitive. Many of our significant
competitors in the ethanol production and marketing industry, such as ADM, Cargill, Inc., and other
competitors have substantially greater production and/or financial resources than we do. As a result, our
competitors may be able to compete more aggressively and sustain that competition over a longer period
of time than we could. Successful competition will require a continued high level of investment in
marketing and customer service and support. Our lack of resources relative to many of our significant
competitors may cause us to fail to anticipate or respond adequately to new developments and other
competitive pressures. This failure could reduce our competitiveness and cause a decline in our market
share, sales and profitability. Even if sufficient funds are available, we may not be able to make the
modifications and improvements necessary to compete successfully.
We also face increasing competition from international suppliers. Currently, international
suppliers produce ethanol primarily from sugar cane and have cost structures that are generally
substantially lower than ours. Any increase in domestic or foreign competition could cause us to reduce
our prices and take other steps to compete effectively, which could adversely affect our results of
operations and financial condition.
In addition, some of our suppliers are potential competitors and, especially if the price of ethanol
reaches historically high levels, they may seek to capture additional profits by circumventing our
marketing services in favor of selling directly to our customers. If one or more of our major suppliers, or
numerous smaller suppliers, circumvent our marketing services, our sales and profitability may decline.
The high concentration of our sales within the ethanol marketing and production industry
could result in a significant reduction in sales and negatively affect our profitability if demand
for ethanol declines.
We expect to be completely focused on the marketing and production of ethanol and its co-
products for the foreseeable future. We may be unable to shift our business focus away from the
marketing and production of ethanol to other renewable fuels or competing products. Accordingly, an
industry shift away from ethanol or the emergence of new competing products may reduce the demand for
ethanol. A downturn in the demand for ethanol would likely materially and adversely affect our sales and
profitability.
-20-
We produce and sell our own ethanol but also depend on a small number of third-party
suppliers for a significant portion of the ethanol that we sell. If any of these suppliers does not
continue to supply us with ethanol in adequate amounts, we may be unable to satisfy the
demands of our customers and our sales, profitability and relationships with our customers will
be adversely affected.
We produce and sell our own ethanol but also depend on a small number of third-party suppliers
for a significant portion of the ethanol that we sell. We expect to continue to depend for the foreseeable
future upon a small number of third-party suppliers for a significant portion of the ethanol that we sell.
Our third-party suppliers are primarily located in the Midwestern United States. The delivery of ethanol
from these suppliers is therefore subject to delays resulting from inclement weather and other conditions.
If any of these suppliers is unable or declines for any reason to continue to supply us with ethanol in
adequate amounts, we may be unable to replace that supplier and source other supplies of ethanol in a
timely manner, or at all, to satisfy the demands of our customers. If this occurs, our sales, profitability and
our relationships with our customers will be adversely affected.
We may be adversely affected by environmental, health and safety laws, regulations and
liabilities.
We are subject to various federal, state and local environmental laws and regulations, including
those relating to the discharge of materials into the air, water and ground, the generation, storage,
handling, use, transportation and disposal of hazardous materials, and the health and safety of our
employees. In addition, some of these laws and regulations require our facilities to operate under permits
that are subject to renewal or modification. These laws, regulations and permits can often require
expensive pollution control equipment or operational 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,
natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns. In addition,
we have made, and expect to make, significant capital expenditures on an ongoing basis to comply with
increasingly stringent environmental laws, regulations and permits.
We may be liable for the investigation and cleanup of environmental contamination at each of the
properties that we own or operate and at off-site locations where we arrange for the disposal of hazardous
substances. If these substances have been or are disposed of or released at sites that undergo investigation
and/or remediation by regulatory agencies, we may be responsible under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, or other environmental laws for all or
part of the costs of investigation and/or remediation, and for damages to natural resources. We may also
be subject to related claims by private parties alleging property damage and personal injury due to
exposure to hazardous or other materials at or from those properties. Some of these matters may require
us to expend significant amounts for investigation, cleanup or other costs.
In addition, new laws, new interpretations of existing laws, increased governmental enforcement
of environmental laws or other developments could require us to make significant additional
expenditures. Continued government and public emphasis on environmental issues can be expected to
result in increased future investments for environmental controls at our production facilities. Present and
future environmental laws and regulations (and interpretations thereof) applicable to our operations, more
vigorous enforcement policies and discovery of currently unknown conditions may require substantial
expenditures that could have a material adverse effect on our results of operations and financial condition.
The hazards and risks associated with producing and transporting our products (such as fires,
natural disasters, explosions and abnormal pressures and blowouts) may also result in personal injury
claims or damage to property and third parties. As protection against operating hazards, we maintain
insurance coverage against some, but not all, potential losses. However, we could sustain losses for
uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Events that result
-21-
in significant personal injury or damage to our property or third parties or other losses that are not fully
covered by insurance could have a material adverse effect on our results of operations and financial
condition.
We depend on a small number of customers for the majority of our sales. A reduction in
business from any of these customers could cause a significant decline in our overall sales and
profitability.
The majority of our sales are generated from a small number of customers. During each of 2007
and 2008, sales to our two largest customers, each of whom accounted for 10% or more of total net sales,
represented an aggregate of approximately 32% of our total net sales for those years. We expect that we
will continue to depend for the foreseeable future upon a small number of customers for a significant
portion of our sales. Our agreements with these customers generally do not require them to purchase any
specified amount of ethanol or dollar amount of sales or to make any purchases whatsoever. Therefore, in
any future period, our sales generated from these customers, individually or in the aggregate, may not
equal or exceed historical levels. If sales to any of these customers cease or decline, we may be unable to
replace these sales with sales to either existing or new customers in a timely manner, or at all. A cessation
or reduction of sales to one or more of these customers could cause a significant decline in our overall
sales and profitability.
Our lack of long-term ethanol orders and commitments by our customers could lead to a rapid
decline in our sales and profitability.
We cannot rely on long-term ethanol orders or commitments by our customers for protection
from the negative financial effects of a decline in the demand for ethanol or a decline in the demand for
our marketing services. The limited certainty of ethanol orders can make it difficult for us to forecast our
sales and allocate our resources in a manner consistent with our actual sales. Moreover, our expense
levels are based in part on our expectations of future sales and, if our expectations regarding future sales
are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls.
Furthermore, because we depend on a small number of customers for a significant portion of our sales,
the magnitude of the ramifications of these risks is greater than if our sales were less concentrated. As a
result of our lack of long-term ethanol orders and commitments, we may experience a rapid decline in our
sales and profitability.
We are a minority member of Front Range with limited control over that entity’s business
decisions. We are therefore dependent upon the business judgment and conduct of the manager
and majority member of that entity. As a result, our interests may not be as well served as if we
were in control of Front Range, which could adversely affect its contribution to our results of
operations and our business prospects related to that entity.
Front Range operates an ethanol production facility located in Windsor, Colorado. We own
approximately 42% of Front Range, which represents a minority interest in that entity. The manager and
majority member of Front Range owns approximately 54% of that entity and has control of that entity’s
business decisions, including those related to day-to-day operations. The manager and majority member
of Front Range has the right to set the manager’s compensation, determine cash distributions, decide
whether or not to expand the ethanol production facility and make most other business decisions on behalf
of that entity. We are therefore largely dependent upon the business judgment and conduct of the manager
and majority member of Front Range. As a result, our interests may not be as well served as if we were in
control of Front Range. Accordingly, the contribution by Front Range to our results of operations and our
business prospects related to that entity may be adversely affected by our lack of control over that entity.
-22-
Risks Related to our Common Stock
Our common stock may be involuntarily delisted from trading on NASDAQ if we fail to
maintain a minimum closing bid price of $1.00 per share for any consecutive 30 trading day
period. A notification of delisting or a delisting of our common stock would reduce the liquidity
of our common stock and inhibit or preclude our ability to raise additional financing and may
also materially and adversely impact our credit terms with our vendors.
NASDAQ’s quantitative listing standards require, among other things, that listed companies
maintain a minimum closing bid price of $1.00 per share. However, NASDAQ has recently suspended its
minimum closing bid price threshold through July 19, 2009. If, upon reinstatement of the minimum
closing bid price threshold, we fail to satisfy this threshold for any consecutive 30 trading day period, our
common stock may be involuntarily delisted from trading on NASDAQ once the applicable grace period
expires. Our stock price has remained below $1.00 since early November 2008. Given the increased
market volatility arising in part from economic turmoil resulting from the ongoing credit crisis, as well as
a challenging environment in the biofuels industry, the closing bid price of our common stock could be
below $1.00 per share for a consecutive 30 trading day period after the NASDAQ reinstates its rules. A
notification of delisting or delisting of our common stock would reduce the liquidity of our common stock
and inhibit or preclude our ability to raise additional financing and may also materially and adversely
impact our credit terms with our vendors.
As a result of our issuance of shares of Series B Preferred Stock, our common stockholders may
experience numerous negative effects and most of the rights of our common stockholders will be
subordinate to the rights of the holders of our Series B Preferred Stock.
As a result of our issuance of shares of Series B Preferred Stock, our common stockholders may
experience numerous negative effects, including dilution from any dividends paid in preferred stock and
certain antidilution adjustments. In addition, rights in favor of the holders of our Series B Preferred Stock
include: seniority in liquidation and dividend preferences; substantial voting rights; numerous protective
provisions; and preemptive rights. Also, our outstanding Series B Preferred Stock could have the effect of
delaying, deferring and discouraging another party from acquiring control of Pacific Ethanol.
Our stock price is highly volatile, which could result in substantial losses for investors
purchasing shares of our common stock and in litigation against us.
The market price of our common stock has fluctuated significantly in the past and may continue
to fluctuate significantly in the future. The market price of our common stock may continue to fluctuate in
response to one or more of the following factors, many of which are beyond our control:
changing conditions in the ethanol and fuel markets as well as other commodity markets
such as corn;
the volume and timing of the receipt of orders for ethanol from major customers;
competitive pricing pressures;
our ability to produce, sell and deliver ethanol on a cost-effective and timely basis;
the introduction and announcement of one or more new alternatives to ethanol by our
competitors;
changes in market valuations of similar companies;
stock market price and volume fluctuations generally;
our stock’s relative small public float;
regulatory developments or increased enforcement;
fluctuations in our quarterly or annual operating results;
additions or departures of key personnel;
-23-
our inability to obtain construction, acquisition, capital equipment and/or working capital
financing; and
future sales of our common stock or other securities.
Furthermore, we believe that the economic conditions in California and other Western states, as
well as the United States as a whole, could have a negative impact on our results of operations. Demand
for ethanol could also be adversely affected by a slow-down in overall demand for oxygenate and
gasoline additive products. The levels of our ethanol production and purchases for resale will be based
upon forecasted demand. Accordingly, any inaccuracy in forecasting anticipated revenues and expenses
could adversely affect our business. The failure to receive anticipated orders or to complete delivery in
any quarterly period could adversely affect our results of operations for that period. Quarterly results are
not necessarily indicative of future performance for any particular period, and we may not experience
revenue growth or profitability on a quarterly or an annual basis.
The price at which you purchase shares of our common stock may not be indicative of the price
that will prevail in the trading market. You may be unable to sell your shares of common stock at or
above your purchase price, which may result in substantial losses to you and which may include the
complete loss of your investment. In the past, securities class action litigation has often been brought
against a company following periods of stock price volatility. We may be the target of similar litigation in
the future. Securities litigation could result in substantial costs and divert management’s attention and our
resources away from our business.
Any of the risks described above could have a material adverse effect on our sales and
profitability and the price of our common stock.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our corporate headquarters, located in Sacramento, California, consists of a leased 10,000 square
foot office expiring in 2010. We also rent an office in Portland, Oregon, consisting of 3,500 square feet,
expiring in 2012.
Our ethanol production facilities are located in Madera, California, at which a 137 acre facility is
located, Boardman, Oregon, at which a 25 acre facility is located, Burley, Idaho, at which a 160 acre
facility is located, Stockton, California, at which a 30 acre facility is located and Windsor, Colorado, at
which a 40 acre facility is located. We are a minority owner of the entity that owns the Windsor, Colorado
facility. Further, we have options to acquire sites for other potential ethanol production facilities that we
may develop in the future. See ―Business—Production Facilities.‖
Item 3. Legal Proceedings.
We are subject to legal proceedings, claims and litigation arising in the ordinary course of
business. While the amounts claimed may be substantial, the ultimate liability cannot presently be
determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of
those legal proceedings, claims and litigation could adversely affect our quarterly or annual operating
results or cash flows when resolved in a future period. However, based on facts currently available,
management believes such matters will not materially and adversely affect our financial position, results
of operations or cash flows.
-24-
Western Ethanol Company
On January 9, 2009, Western Ethanol Company, LLC (―Western Ethanol‖) filed a complaint in
the Superior Court of the State of California (the ―Superior Court‖) naming Kinergy as defendant. In the
complaint, Western Ethanol alleges that Kinergy breached an alleged agreement to buy and accept
delivery of a fixed amount of ethanol. On January 12, 2009, Western Ethanol filed an application for
issuance of right to attach order and order for issuance of writ of attachment. On February 10, 2009, the
Superior Court granted the right to attach order and order for issuance of writ of attachment against
Kinergy in the amount of approximately $3.7 million. On February 11, 2009, Kinergy filed an answer to
the complaint. Kinergy intends to vigorously defend against Western Ethanol’s claims.
Delta-T Corporation
On August 18, 2008, Delta-T Corporation filed suit in the United States District Court for the
Eastern District of Virginia (the ―Virginia Federal Court case‖), naming Pacific Ethanol, Inc. as a
defendant, along with its subsidiaries Pacific Ethanol Stockton, LLC, Pacific Ethanol Imperial, LLC,
Pacific Ethanol Columbia, LLC, Pacific Ethanol Magic Valley, LLC and Pacific Ethanol Madera,
LLC. The suit alleges breaches of the parties’ Engineering, Procurement and Technology License
Agreements, breaches of a subsequent term sheet and letter agreement and breaches of indemnity
obligations.
All of the defendants have moved to dismiss the Virginia Federal Court Case for lack of personal
jurisdiction and on the ground that all disputes between the parties must be resolved through binding
arbitration, and, in the alternative, moving to stay the Virginia Federal Court Case pending arbitration. In
January 2009, these motions were granted by the Court, compelling the case to arbitration. The complaint
seeks specified contract damages of approximately $6.5 million, along with other unspecified damages.
We intend to vigorously defend against Delta-T Corporation’s claims.
Barry Spiegel – State Court Action
On December 23, 2005, Barry J. Spiegel, a former shareholder and director of Accessity, filed a
complaint in the Circuit Court of the 17th Judicial District in and for Broward County, Florida (Case No.
05018512) (the ―State Court Action‖) against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce
Udell (collectively, the ―Individual Defendants‖). Messrs. Siegel, Udell and Friedman are former
directors of Accessity and Pacific Ethanol. Mr. Kart is a former executive officer of Accessity and Pacific
Ethanol.
The State Court Action relates to the Share Exchange Transaction and purports to state the
following five counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the
Florida Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation
of Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the
actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his
Accessity common stock to diminish and is seeking approximately $22.0 million in damages. On March
8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his
response in opposition on May 30, 2006. The Court granted the motion to dismiss by Order dated
December 1, 2006, on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a
derivative action.
On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the
following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s
Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of
disclosure. The amended complaint included Pacific Ethanol as a defendant, but it was subsequently
voluntarily dismissed on August 27, 2007, by Mr. Spiegel as to Pacific Ethanol. On March 23, 2009, Mr.
-25-
Spiegel filed an amended complaint which renewed his previously voluntarily dismissed case against
Pacific Ethanol. Further Mr. Spiegel seeks depositions of Barry Siegel and Philip B. Kart on or around
April 30, 2009. We intend to vigorously defend against Mr. Spiegel’s claims.
Barry Spiegel – Federal Court Action
On December 28, 2006, Barry J. Spiegel, filed a complaint in the United States District Court,
Southern District of Florida (Case No. 06-61848) (the ―Federal Court Action‖) against the Individual
Defendants and Pacific Ethanol. The Federal Court Action relates to the Share Exchange Transaction and
purports to state the following three counts: (i) violations of Section 14(a) of the Exchange Act and SEC
Rule 14a-9 promulgated thereunder, (ii) violations of Section 10(b) of the Exchange Act and Rule 10b-5
promulgated thereunder, and (iii) violation of Section 20(A) of the Exchange Act. The first two counts are
alleged against the Individual Defendants and Pacific Ethanol and the third count is alleged solely against
the Individual Defendants. Mr. Spiegel bases his claims on, among other things, allegations that the
actions of the Individual Defendants and Pacific Ethanol in connection with the Share Exchange
Transaction resulted in a share exchange ratio that was unfair and resulted in the preparation of a proxy
statement seeking shareholder approval of the Share Exchange Transaction that contained material
misrepresentations and omissions. Mr. Spiegel is seeking in excess of $15.0 million in damages.
Mr. Spiegel amended the Federal Court Action on March 5, 2007, and Pacific Ethanol and the
Individual Defendants filed a Motion to Dismiss the amended pleading on April 23, 2007. Plaintiff
Spiegel sought to stay his own federal case, but the Motion was denied on July 17, 2007. The Court
required Mr. Spiegel to respond to our Motion to Dismiss. On January 15, 2008, the Court rendered an
Order dismissing the claims under Section 14(a) of the Exchange Act on the basis that they were time
barred and that more facts were needed for the claims under Section 10(b) of the Exchange Act. The
Court, however, stayed the entire case pending resolution of the State Court Action.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
Market Information
Our common stock has been traded on the Nasdaq Global Market (formerly, the Nasdaq National
Market) under the symbol ―PEIX‖ since October 10, 2005. Prior to October 10, 2005 and since March 24,
2005, our common stock traded on the Nasdaq Capital Market (formerly, the Nasdaq SmallCap Market)
under the symbol ―PEIX.‖ Prior to March 24, 2005, our common stock traded on the Nasdaq SmallCap
Market under the symbol ―ACTY.‖ The table below shows, for each fiscal quarter indicated, the high and
low closing prices for shares of our common stock. This information has been obtained from The Nasdaq
Stock Market. The prices shown reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.
Price Range
High
Low
Year Ended December 31, 2008:
$ 8.85 $ 4.25
First Quarter (January 1 – March 31) ....................................................................................................
Second Quarter (April 1 – June 30) .......................................................................................................
$ 5.65 $ 1.81
Third Quarter (July 1 – September 30) ..................................................................................................
$ 2.37 $ 1.37
$ 1.41 $ 0.36
Fourth Quarter (October 1 – December 31) ..........................................................................................
Year Ended December 31, 2007:
First Quarter ..........................................................................................................................................
$ 17.85 $ 14.22
Second Quarter ......................................................................................................................................
$ 16.50 $ 12.25
Third Quarter .........................................................................................................................................
$ 14.86 $ 8.58
$ 9.46 $ 4.22
Fourth Quarter .......................................................................................................................................
Security Holders
As of March 26, 2009, we had 57,750,319 shares of common stock outstanding and held of
record by approximately 500 stockholders. These holders of record include depositories that hold shares
of stock for brokerage firms which, in turn, hold shares of stock for numerous beneficial owners. On
March 26, 2009, the closing sale price of our common stock on the Nasdaq Global Market was $0.38 per
share.
Performance Graph
The graph below shows a comparison of the cumulative total stockholder return on our common
stock with the cumulative total return on The NASDAQ Stock Market (U.S.) Index and of public
companies filing reports with the Securities and Exchange Commission under Standard Industrial
Classification Code 2860—Industrial Organic Chemicals, or Peer Group, in each case over the five-year
period ended December 31, 2008.
The graph includes the date of March 23, 2005, the date of the Share Exchange Transaction and
the date on which we effectively began operating in a business properly categorized under Standard
Industrial Classification Code 2860—Industrial Organic Chemicals. Our predecessor, Accessity, was in
an unrelated business prior to March 23, 2005. See ―Business—Company History.‖
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The graph assumes $100 invested at the indicated starting date in our common stock and in each
of The NASDAQ Stock Market (U.S.) Index and the Peer Group, with the reinvestment of all dividends.
We have not paid or declared any cash dividends on our common stock and do not anticipate paying any
cash dividends in the foreseeable future. Stockholder returns over the indicated periods should not be
considered indicative of future stock prices or stockholder returns. This graph assumes that the value of
the investment in our common stock and each of the comparison groups was $100 on December 31, 2002.
PACIFIC ETHANOL, INC.
THE NASDAQ STOCK
MARKET (U.S.) INDEX
SIC 2860—INDUSTRIAL
12/03
12/04
Cumulative Total Return ($)
12/05
3/23/05
12/06
12/07
12/08
100.00
252.34
385.11
460.43
654.89
349.36
18.72
100.00
110.08
104.15
112.88
126.51
138.13
80.47
ORGANIC CHEMICALS
100.00
126.07
118.68
105.11
152.61
122.81
52.96
Dividend Policy
We have never paid cash dividends on our common stock and do not intend to pay cash dividends
on our common stock in the foreseeable future. We anticipate that we will retain any earnings for use in
the continued development of our business.
Our current and future debt financing arrangements may limit or prevent cash distributions from
our subsidiaries to us, depending upon the achievement of certain financial and other operating conditions
and our ability to properly service the debt, thereby limiting or preventing us from paying cash dividends.
In addition, the holders of our outstanding preferred stock are entitled to dividends of 7%, and those
dividends must be paid prior to the payment of any dividends to our common stockholders.
Recent Sales of Unregistered Securities
None.
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COMPARISON OF CUMULATIVE TOTAL RETURN FORTHE FIVE-YEAR PERIOD ENDED DECEMBER 31, 2008$0$100$200$300$400$500$600$70012/0312/073/0512/0512/0612/0712/08Pacific Ethanol, Inc.NASDAQ Composite IndexSIC 2860 — Industrial Organic Chemicals
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We have granted to certain employees and directors shares of restricted stock under our 2006
Stock Incentive Plan pursuant to Restricted Stock Agreements dated and effective as of their respective
grant dates by and between us and those employees and directors.
We were obligated to withhold minimum withholding tax amounts with respect to vested shares
of restricted stock and upon future vesting of shares of restricted stock granted to our employees. Each
employee was entitled to pay the minimum withholding tax amounts to us in cash or to elect to have us
withhold a vested amount of shares of restricted stock having a value equivalent to our minimum
withholding tax requirements, thereby reducing the number of shares of vested restricted stock that the
employee ultimately receives. If an employee failed to timely make such election, we automatically
withheld the necessary shares of vested restricted stock.
In connection with satisfying our withholding requirements, during the month of October 2008,
we withheld an aggregate of 21,249 shares of our common stock and remitted a cash payment to cover the
minimum withholding tax amounts, thereby effectively repurchasing from the employees the 21,249
shares of common stock at a deemed purchase price equal to $1.28 per share for an aggregate purchase
price of $27,199.
In connection with satisfying our withholding requirements, during the month of December 2008,
we withheld an aggregate of 7,045 shares of our common stock and remitted a cash payment to cover the
minimum withholding tax amounts, thereby effectively repurchasing from the employees the 7,045 shares
of common stock at a deemed purchase price equal to $0.55 per share for an aggregate purchase price of
$3,875.
-29-
Item 6. Selected Financial Data.
The following financial information should be read in conjunction with the consolidated audited
financial statements and the notes to those statements beginning on page F-1 of this report, and the section
entitled ―Management’s Discussion and Analysis of Financial Condition and Results of Operations‖
included elsewhere in this report. The consolidated statements of operations data for the years ended
December 31, 2008, 2007 and 2006 and the consolidated balance sheet data at December 31, 2008 and
2007 are derived from, and are qualified in their entirety by reference to, the consolidated audited
financial statements beginning on page F-1 of this report. The consolidated statements of operations data
from January 1, 2004 to December 31, 2005 and the consolidated balance sheet data at December 31,
2004 are derived from, and qualified in their entirety by reference to, the consolidated audited financial
statements of Pacific Ethanol. The historical results that appear below are not necessarily indicative of
results to be expected for any future periods.
Years Ended December 31,
2008
2007
2006
2005
2004
(in thousands, except per share data)
$
Consolidated Statements of Operations Data:
Net sales ..................................................................................
703,926
Cost of goods sold .................................................................. 737,331
(33,405)
Gross profit (loss) ...................................................................
Selling, general and administrative expenses .......................... 30,8
31,796
87,047
Impairment of goodwill………………………….
40,900
Impairment of asset group ...................................................... 30,8
Income (loss) from operations ................................................ 2,224
(193,148)
Other income (expense), net ................................................... (6,068)
Income (loss) before noncontrolling interest in
variable interest entity and provision for
income taxes ......................................................................
(199,216)
Noncontrolling interest in variable interest entity ................... 52,669
Loss before provision for income taxes ..................................
(146,547)
Provision for income taxes......................................................
(146,547)
Net loss ...................................................................................
$
Preferred stock dividends ........................................................
(4,104)
Deemed dividend on preferred stock ...................................... (761)
(151,412)
Loss available to common stockholders .................................
(3.02)
Loss per share, basic and diluted ............................................
Weighted-average shares outstanding,
$
$
$
basic and diluted ................................................................
50,147
Consolidated Balance Sheet Data:
Cash and cash equivalents ......................................................
Working capital (deficit) ......................................................... (57
Total assets ............................................................................. 64
Long-term debt .......................................................................
Stockholders’ equity ...............................................................
11,466
(288,313)
616,834
937
209,373
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
461,513
428,614
32,899
30,822
2,077
(6,801)
(4,724)
(9,676)
(14,400)
(14,400)
$
$
$
226,356
201,527
24,829
24,641
188
3,426
3,614
(3,756)
(142)
(142)
$
$
$
(4,200)
(28)
(18,628)
$
(0.47) $
(2,998)
(84,000)
(87,140)
$
(2.50) $
$
87,599
84,444
3,155
12,638
(9,483)
(440)
20
13
7
2,277
(2,270)
(532)
(9,923)
(9,923)
(9,923)
(2,802)
(2,802)
$ (2,802)
$
(9,923)
$
(0.40) $
(2,802)
(0.23)
39,895
34,855
25,066
12,397
5,707
(37,886)
651,600
151,188
282,286
$
$
$
$
$
44,053
96,094
453,820
28,970
298,445
$
$
$
$
$
4,521
(2,894)
48,185
1,995
28,516
$
$
$
$
$
(1,025)
7,179
4,013
1,356
No cash dividends on our common stock were declared during any of the periods presented
above. Various factors materially affect the comparability of the information presented in the above
table. These factors relate primarily to a Share Exchange Transaction that was consummated on
March 23, 2005 with the shareholders of PEI California, and the holders of the membership interests of
each of Kinergy and ReEnergy, pursuant to which we acquired all of the issued and outstanding capital
stock of PEI California and all of the outstanding membership interests of Kinergy and ReEnergy. See
―Business—Company History.‖ In addition, we acquired a minority interest in Front Range on October
17, 2006, at which date we began treating Front Range, a variable interest entity, as a consolidated
subsidiary, as we are considered the primary beneficiary.
-30-
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with our consolidated
financial statements and notes to consolidated financial statements included elsewhere in this report. This
report and our consolidated financial statements and notes to consolidated financial statements contain
forward-looking statements, which generally include the plans and objectives of management for future
operations, including plans and objectives relating to our future economic performance and our current
beliefs regarding revenues we might generate and profits we might earn if we are successful in
implementing our business and growth strategies. The forward-looking statements and associated risks
may include, relate to or be qualified by other important factors, including, without limitation:
fluctuations in the market price of ethanol and its co-products;
the projected growth or contraction in the ethanol and co-product market in which we
operate;
our strategies for expanding, maintaining or contracting our presence in these markets;
our ability to successfully develop, finance, construct and operate our current and any future
ethanol production facilities;
anticipated trends in our financial condition and results of operations; and
our ability to distinguish ourselves from our current and future competitors.
We do not undertake to update, revise or correct any forward-looking statements, except as
required by law.
Any of the factors described immediately above or in the ―Risk Factors‖ section above could
cause our financial results, including our net income or loss or growth in net income or loss to differ
materially from prior results, which in turn could, among other things, cause the price of our common
stock to fluctuate substantially.
Recent Developments
As a result of ethanol industry conditions that have negatively affected our business, we do not
currently have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity
needs in the very near-term. We believe that we have sufficient working capital to continue operations
only until approximately April 30, 2009 at the latest unless we successfully restructure our debt,
experience a significant improvement in margins and obtain other sources of liquidity. In addition,
although various secured creditors are presently forbearing through April 30, 2009 under outstanding
forbearance agreements from exercising their rights, once those forbearance periods expire or in the event
of additional defaults, we will be in default to those secured creditors who collectively hold security
interests in substantially all of our assets. As a result, our 2008 financial statements include an
explanatory paragraph by our independent registered public accounting firm describing the substantial
doubt as to our ability to continue as a going concern.
As of March 26, 2009, we owed approximately $246.5 million in term loans and lines of credit
associated with the construction and operation of our ethanol plants and approximately $5.3 million under
our revolving credit facility. As of that date, we had only $4.0 million in cash and $4.7 million of
additional borrowing availability under our revolving credit facility. As we continue to reduce the number
of gallons of ethanol we sell and hold in inventory, working capital available to support borrowings under
our revolving credit facility will reduce proportionately.
We do not expect to have sufficient liquidity to meet anticipated working capital, debt service and
other liquidity needs beyond April 30, 2009 at the latest unless we successfully restructure our debt,
experience a significant improvement in margins and obtain other sources of liquidity. Based on the
-31-
current spread between corn and ethanol prices, the industry is operating at or near break-even cash
margins. The current spread between ethanol and corn prices cannot support the long-term viability of the
U.S. ethanol industry in general or us in particular.
Although we are actively pursuing a number of alternatives, including seeking to restructure our
debt and seeking to raise additional debt or equity financing, or both, there can be no assurance that we
will be successful. If we cannot restructure our debt and obtain sufficient liquidity in the very near term,
we may need to seek protection under the U.S. Bankruptcy Code.
Business Overview
Our primary goal is to be the leading marketer and producer of low carbon renewable fuels in the
Western United States.
We produce and sell ethanol and its co-products, including wet distillers grain, or WDG, and
provide transportation, storage and delivery of ethanol through third-party service providers in the
Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and
Washington. We have extensive customer relationships throughout the Western United States and
extensive supplier relationships throughout the Western and Midwestern United States.
In September 2008, we completed construction of our fourth ethanol plant. Our four ethanol plants,
which produce ethanol and its co-products, are as follows:
In addition, we own a 42% interest in Front Range, which owns a plant located in Windsor,
Colorado, with annual production capacity of up to 50 million gallons. We also intend to either construct
or acquire additional production facilities as financial resources and business prospects make the
construction or acquisition of these facilities advisable.
According to the United States Department of Energy, or DOE, total annual gasoline
consumption in the United States is approximately 140 billion gallons. Total annual ethanol consumption
represented less than 7% of this amount in 2008. We believe that the domestic ethanol industry has
substantial potential for growth to initially reach what we estimate is an achievable level of at least 10%
of the total annual gasoline consumption in the United States, or approximately 14 billion gallons of
ethanol annually and thereafter up to 36 billion gallons of ethanol annually under the new national
Renewable Fuel Standards, or RFS, by 2022. See ―Business—Governmental Regulation.‖
The ethanol industry has experienced significant adverse conditions over the course of the last 12
months, including prolonged negative operating margins. We, too, have experienced these adverse
conditions as well as severe working capital and liquidity shortages, and in response to such conditions,
we have reduced production significantly until market conditions resume to acceptable levels and
working capital becomes available. We first reduced production in December 2008 and continued to
reduce production through the first quarter of 2009. Currently, we have ceased production at our Madera,
Magic Valley and Stockton facilities. We continue to operate our Columbia and Front Range facilities.
-32-
Facility NameFacility LocationDate Operations BeganEstimated Annual Production Capacity (gallons)StocktonStockton, CASeptember 200860,000,000Magic ValleyBurley, IDApril 200860,000,000ColumbiaBoardman, ORSeptember 200740,000,000MaderaMadera, CAOctober 200640,000,000
We continue to assess market conditions and when appropriate, provided we have adequate available
working capital, we plan to bring these facilities back to operation.
We intend to reach our goal to be the leading marketer and producer of low carbon renewable
fuels in the Western United States in part by expanding our relationships with customers and third-party
ethanol producers to market higher volumes of ethanol, by expanding our relationships with animal feed
distributors and end users to build local markets for WDG, the primary co-product of our ethanol
production, and by expanding the market for ethanol by continuing to work with state governments to
encourage the adoption of policies and standards that promote ethanol as a fuel additive and
transportation fuel.
Financial Performance Summary
Our net sales increased by $242.4 million, or 53%, to $703.9 million for the year ended
December 31, 2008 from $461.5 million for the year ended December 31, 2007. Our net loss, however,
increased by $132.1 million to $146.5 million for the year ended December 31, 2008 from $14.4 million
for the year ended December 31, 2007.
Factors that contributed to our results of operations for 2008 include:
Net sales. The increase in our net sales in 2008 as compared to 2007 was primarily due to the
following combination of factors:
o Higher sales volumes. Total volume of ethanol sold increased by 41% to 268.4
million gallons in 2008 from 190.6 million gallons in 2007. The increase in sales
volume is primarily due to two additional ethanol production facilities that
commenced operations in 2008. Sales also increased in 2008 from additional supply
purchased from third-party suppliers under our ethanol marketing agreements; and
o Higher ethanol prices. The increase in sales volume was also due to slightly higher
ethanol prices. Our average sales price of ethanol increased 5% to $2.25 per gallon in
2008 as compared to $2.15 per gallon in 2007.
Gross margins. Our gross margins decreased significantly to negative 4.7% for 2008 as
compared to a gross profit margin of 7.1% for 2007. This drop in gross profit margins was
primarily due to higher corn prices and was exacerbated by significant volatility in the corn
market during 2008. Volatility and the time from purchase of the corn to sale of the resulting
ethanol created significant losses during 2008. The average price of corn increased by 53% to
$5.52 per bushel in 2008 from $3.61 per bushel in 2007. The average Chicago Board of
Trade, or CBOT, price for corn increased by 41% to $5.27 per bushel in 2008 from $3.74 per
bushel in 2007.
Selling, general and administrative expenses. Our selling, general and administrative expenses
increased by $1.0 million to $31.8 million in 2008 as compared to $30.8 million in 2007
primarily as a result of increases in administrative staff, bad debt expenses, derivatives
commissions and noncash compensation expenses, partially offset by decreases in
professional fees and amortization of intangible assets. Although these expenses increased in
absolute dollars, they decreased to 4.5% of our net sales in 2008 as compared to 6.6% of our
net sales in 2007 due to the substantial growth in our net sales over those periods.
Impairments of goodwill and asset group. In 2008, we recognized $87.0 million in impairment
of goodwill and $40.9 million in impairment of asset group. The impairment of goodwill
related to our annual goodwill review, mostly reflecting a decline in the valuation of our prior
-33-
purchase of our 42% interest in Front Range. The impairment of asset group reflects our
decision to abandon construction of our Imperial Valley ethanol production facility due to
adverse market conditions.
Other expense. Our other expense decreased by $0.7 million to $6.1 million in 2008 from $6.8
million in 2007. This decrease is primarily due to increased sales of our business energy tax
credits, decreased mark-to-market losses and decreased finance cost amortization, which were
partially offset by an increase in interest expense, decreased interest income and increased
bank fees.
Sales and Margins
Over the past three years, our sales mix has shifted significantly from sales generated solely as a
marketer of ethanol produced by third parties to now include sales generated as a producer of our own
ethanol. Our cost structure also changed significantly, beginning in 2007, as our Madera and Front Range
facilities were in full production and continuing in 2008 as our Columbia facility was in full production
and our Magic Valley and Stockton facilities commenced operations. The shift in our sales mix greatly
altered our dependency on certain market conditions from that based primarily on the market price of
ethanol to that based significantly on the cost of corn, the principal input commodity for our production of
ethanol. Accordingly, our profitability is now highly dependent on the market price of ethanol and the
cost of corn.
Average ethanol sales prices rose in 2008 as compared to 2007. Specifically, the average CBOT
price of ethanol increased by 12% in 2008 as compared to 2007. The increase in the prevailing market
price of ethanol was primarily due to the rise of crude oil during the middle of 2008.
Average corn prices increased significantly in 2008 as compared to 2007. Specifically, the
average CBOT price of corn increased by 41% in 2008 as compared to 2007. The increase in the
prevailing market price of corn was the primary cause of the increase in our average corn price. More
importantly, corn prices experienced significant volatility in a relatively short period of time during 2008.
The average CBOT price of corn increased from $5.99 at the end of May 2008 to a record high of $7.55
on June 27, 2008 and then decreased to $5.88 at the end of July 2008. Since we now produce more of the
ethanol that we sell and there is a time lag from the time we price and purchase our corn to the actual sale
of resultant ethanol to a customer, this volatility created significant negative margins for us in 2008.
We have three principal methods of selling ethanol: as a merchant, as a producer and as an agent.
See ―Critical Accounting Policies—Revenue Recognition‖ below.
When acting as a merchant or as a producer, we generally enter into sales contracts to ship
ethanol to a customer’s desired location. We support these sales contracts through purchase contracts with
several third-party suppliers or through our own production. We manage the necessary logistics to deliver
ethanol to our customers either directly from a third-party supplier or from our inventory via truck or rail.
Our sales as a merchant or as a producer expose us to price risks resulting from potential fluctuations in
the market price of ethanol and corn. Our exposure varies depending on the magnitude of our sales and
purchase commitments compared to the magnitude of our existing inventory, as well as the pricing
terms—such as market index or fixed pricing—of our contracts. We seek to mitigate our exposure to
price risks by implementing appropriate risk management strategies.
When acting as an agent for third-party suppliers, we conduct back-to-back purchases and sales in
which we match ethanol purchase and sale contracts of like quantities and delivery periods. When acting
as an agent for third-party suppliers, we receive a predetermined service fee and we have little or no
exposure to price risks resulting from potential fluctuations in the market price of ethanol.
-34-
We believe that our gross profit margins will primarily depend on five key factors:
the market price of ethanol, which we believe will be impacted by the degree of
competition in the ethanol market, the price of gasoline and related petroleum products,
and government regulation, including tax incentives;
the market price of key production input commodities, including corn and natural gas;
the market price of WDG;
our ability to anticipate trends in the market price of ethanol, WDG, and key input
commodities and implement appropriate risk management and opportunistic strategies;
and
the proportion of our sales of ethanol produced at our facilities to our sales of ethanol
produced by third-parties.
Management seeks to optimize our gross profit margins by anticipating the factors above and,
when resources are available, implementing hedging transactions and taking other actions designed to
limit risk and address the various factors. For example, we may seek to decrease inventory levels in
anticipation of declining ethanol prices and increase inventory levels in anticipation of increasing ethanol
prices. We may also seek to alter our proportion or timing, or both, of purchase and sales commitments.
Our limited resources to act upon anticipated factors above and/or our inability to anticipate these
factors or their relative importance, and adverse movements in the factors themselves, could result in
declining or even negative gross profit margins over certain periods of time. Our ability to anticipate
those factors or favorable movements in the factors themselves may enable us to generate above-average
gross profit margins. However, given the difficulty associated with successfully forecasting any of these
factors, we are unable to estimate our future gross profit margins.
Results of Operations
The following selected financial data should be read in conjunction with our consolidated
financial statements and notes to our consolidated financial statements included elsewhere in this report,
and the other sections of ―Management’s Discussion and Analysis of Financial Condition and Results of
Operations‖ contained in this report.
Certain performance metrics that we believe are important indicators of our results of operations
include:
Gallons sold (in millions)
Average sales price per gallon
Corn cost per bushel—CBOT equivalent(1)
Co-product revenues as % of delivered cost of
corn(2)
Average CBOT ethanol price per gallon
Average CBOT corn price per bushel
Years Ended
December 31,
2007
190.6
$
$
$
$
2.15
3.61
24.8%
1.98
3.74
$
$
$
$
2008
268.4
2.25
5.52
22.5%
2.22
5.27
$
$
$
$
2006
101.7
2.28
2.44
Percentage Variance
From Prior Year
2008
40.8%
4.7%
52.9%
2007
87.4%
(5.7)%
48.0%
33.4%
(9.3)%
(25.7)%
2.52
2.60
12.1%
40.9%
(21.4)%
43.9%
_____________
(1) We exclude transportation—or ―basis‖—costs in our corn costs to calculate a CBOT equivalent in order to more appropriately compare
our corn costs to average CBOT corn prices.
(2) Co-product revenues as % of delivered cost of corn shows our yield based on sales of WDG generated from ethanol we produced.
-35-
Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007
Years Ended
December 31,
2008
2007
Dollar
Variance
Favorable
Percentage
Variance
Favorable
(Unfavorable) (Unfavorable)
(dollars in thousands)
Results as a Percentage
of Net Sales for the
Years Ended
December 31,
2008
2007
703,926 $
$
Net sales ....................................................................
Cost of goods sold ..................................................... 737,331
Gross profit (loss) ...................................................... (33,405)
Selling, general and administrative expenses ............ 31,796
Impairment of goodwill ............................................. 87,047
Impairment of asset group ......................................... 40,900
Income (loss) from operations .................................. (193,148)
Other income (expense), net ...................................... (6,068)
Loss before noncontrolling interest in
461,513 $
428,614
32,899
30,822
—
—
2,077
(6,801)
242,413
(308,717)
(66,304)
(974)
(87,047)
(40,900)
(195,225)
733
52.5%
(72.0)
(201.5)
(3.2)
NM
NM
NM
10.8
100.0%
104.7
(4.7)
4.5
12.4
5.8
(27.4)
(0.9)
100.0%
92.9
7.1
6.6
—
—
0.5
(1.5)
variable interest entity and provision for
income taxes ........................................................... (199,216)
(4,724)
(194,492)
NM
(28.3)
(1.0)
Noncontrolling interest in variable interest
entity ....................................................................... 52,669
Loss before provision for income taxes ..................... (146,547)
Provision for income taxes ........................................ —
Net loss ......................................................................
Preferred stock dividends ..........................................
Deemed dividend on preferred stock .........................
(62,345)
(132,147)
—
$
(132,147)
$ (4,104) $ (4,200) $ 96
(733)
(9,676)
(14,400)
—
(14,400) $
(146,547) $
(761)
(28)
(644.3)
(917.7)
—
(917.7)%
2.3%
NM
Loss available to common stockholders ....................
$
(151,412) $
(18,628) $
(132,784)
(712.8)%
7.5
(20.8)
—
(20.8)%
(0.6)%
(0.1)
(21.5)%
(2.1)
(3.1)
—
(3.1)%
(0.9)%
(0.0)
(4.0)%
Net Sales
The increase in our net sales in 2008 as compared to 2007 was primarily due to a substantial
increase in sales volume, coupled with higher average sales prices.
Total volume of ethanol sold increased by 77.8 million gallons, or 41%, to 268.4 million gallons
in 2008 as compared to 190.6 million gallons in 2007. The substantial increase in sales volume is
primarily due to production at all four of our facilities, two of which were completed in 2008, as well as
increased sales volume from our third-party ethanol marketing agreements. During 2008, we completed
construction of our Stockton and Magic Valley facilities and in 2007, we completed construction of our
Columbia facility. Our Madera facility has been in operation since October 2006. The increased amount
of sales from our Columbia, Magic Valley and Stockton facilities contributed $182.9 million to the
increase in our net sales for 2008.
Our average sales price per gallon increased 5% to $2.25 in 2008 from an average sales price per
gallon of $2.15 in 2007. The average CBOT price per gallon increased 12% to $2.22 in 2008 from an
average CBOT price per gallon of $1.98 in 2007. Our average sales price per gallon did not increase as
much as the average CBOT price per gallon for 2008 due to both the timing of our sales and the
proportion of our fixed-price contracts during a period of rising ethanol prices.
Cost of Goods Sold and Gross Profit (Loss)
Our gross margin declined to a negative $33.4 million for 2008 from a positive $32.9 million for
2007 due to higher corn costs. Corn is the single largest component of the cost of our ethanol production
and has become a larger portion of our cost of goods sold as we have significantly increased our ethanol
production.
Overall, the price of corn had a much larger impact on our production costs due to the timing of
the corn and the related ethanol pricing from the time we purchase corn to the sale of ethanol. Generally,
-36-
we fix our corn price upon shipment from the vendor, and in a falling market, our margins are compressed
as both corn and ethanol prices continue to fall from transit to processing of the corn. Further, during
2008 we experienced unprecedented volatility in the price of corn ranging from the CBOT low for the
year of $2.94 to the CBOT high for the year of $7.55. These prices moved in such a short period of time
that it became difficult to sell the related ethanol production before the prices of both corn and ethanol
changed dramatically- primarily downward-from the time of the corn purchase. Further, due to falling
market prices toward the end of 2008, corn and ethanol ending inventories had been purchased and
produced, respectively, at prices higher than prevailing spot prices for the commodities at the end of
2008. As a result, we recorded additional losses from this market adjustment of approximately $1.7
million in 2008.
Our sales volume resulting from the marketing and sale of ethanol produced by third parties
decreased as an overall percentage of our total net sales, as production of our own ethanol has been
growing rapidly. Our purchase and sale prices of ethanol produced by third parties typically fluctuate
closely with market prices. As a result, our average cost of ethanol purchased from third parties increased
in line with the overall increase in our average sales price per gallon.
Our net derivative losses were $2,820,000 for 2008 as compared to losses of $4,122,000 for 2007.
Included in the net losses for 2008 are net losses of $1,131,000 related to settled non-designated positions.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses, or SG&A, increased by $1.0 million to $31.8
million for 2008 as compared to $30.8 million for 2007. SG&A, however, decreased as a percentage of
net sales due to our significant sales growth. The increase in the dollar amount of SG&A is primarily due
to the following factors:
payroll and benefits increased by $2,531,000 due to increased administrative staff;
bad debt expense increased by $2,216,000 due to growth in accounts receivable and
certain customers facing difficult liquidity positions;
derivative commissions increased by $1,424,000 due to significant trades during the year;
and
noncash compensation expense increased by $791,000 due to additional restricted stock
grant activity during the year.
Partially offsetting the foregoing increases were the following decreases:
professional fees decreased $1,473,000 due to lower consulting fees and temporary
staffing during the year; and
amortization of intangible assets decreased $3,137,000, primarily resulting from a
reduction in amortization expense associated with our acquisition of our 42% ownership
interest in Front Range, as we have fully amortized a significant portion of the intangible
assets associated with the acquisition.
Impairment of Goodwill
Statement of Financial Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible
Assets, requires us to test goodwill for impairment at least annually. In accordance with SFAS No. 142,
we conducted an impairment test of goodwill as of March 31, 2008. As a result, we recorded a non-cash
-37-
impairment charge of $87,047,000, requiring us to write-off our entire goodwill balances from our
previous acquisitions of Kinergy Marketing LLC, or Kinergy, and Front Range. The impairment charge
will not result in future cash expenditures.
Impairment of Asset Group
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, as of September 30, 2008, we performed our impairment analysis for our asset group associated
with our suspended plant construction project in the Imperial Valley near Calipatria, California, or the
Imperial Project. At September 30, 2008, the asset group consisted of gross property and equipment of
$43,751,000. In addition, the Imperial Project had construction-related accounts payable and accrued
expenses of $17,245,000. We do not intend to resume construction of the Imperial Project. In November,
2008, we began proceedings to liquidate these assets and liabilities. After assessing the estimated
undiscounted cash flows, we recorded an impairment charge of $40,900,000, thereby reducing our
property and equipment at September 30, 2008, by that amount. As conditions in the industry and viable
financing options become available, we will assess resuming construction. To the extent we are relieved
of the related liabilities, we may record a gain in the period in which the relief occurs.
Other Income (Expense), Net
Other expense decreased by $0.7 million to $6.1 million in 2008 from other expense of $6.8
million in 2007. The decrease in other expense is primarily due to the following factors:
increased other income of $9,636,000 primarily related to sales of our business energy tax
credits sold as pass through investments to interested purchasers;
decreased net mark-to-market losses of $4,180,000 from our interest rate hedges which
required that we mark-to-market our ineffective positions in a declining interest rate
environment; the ineffectiveness related to our interest rate swaps in 2008 related
primarily to the de-designation of our interest rate swaps associated with our debt
financing, which is currently being restructured and it is not probable that we will make
our required payments as currently structured. In 2007, we recorded a loss of $5,589,000
primarily resulting from the suspension of construction of our Imperial Valley project in
the fourth quarter of 2007; and
decreased finance cost amortization of $2,708,000 related to our prior financing
arrangements, which were replaced by our current financing arrangements, requiring
accelerated amortization on the prior financing arrangements.
These items were partially offset by:
interest expense increased by $10,584,000 as we have increased our debt and ceased
capitalizing interest associated with our plant construction program;
decreased interest income of $4,346,000 due to our use of cash for construction activities
over the past year; and
increased bank fees of $866,000 primarily related to our obtaining waivers for our
construction financing debt, due to non compliance at the end of 2007 and a requirement
that we pay additional bank fees to obtain such waivers during the period.
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Noncontrolling Interest in Variable Interest Entity
Noncontrolling interest in variable interest entity relates to the consolidated treatment of Front
Range, a variable interest entity, and represents the noncontrolling interest of others in the earnings of
Front Range. We consolidate the entire income statement of Front Range for the period covered.
However, because we own only 42% of Front Range, we must reduce our net income or increase our net
loss for the noncontrolling interest, which is the 58% ownership interest that we do not own. This amount
decreased by $62,345,000 to a loss of $52,669,000 in 2008 from income of $9,676,000 in 2007 primarily
due to goodwill impairment associated with amounts recorded in the original acquisition of our interests
in Front Range.
Preferred Stock Dividends
Shares of our Series A and B Preferred Stock are entitled to quarterly cumulative dividends
payable in arrears an amount equal to 5% and 7% per annum, respectively, of the purchase price per share
of the Preferred Stock, or, and only in 2007, at our option, payable in additional shares of Series A
Preferred Stock based on the value of the purchase price per share of the Series A Preferred Stock. In
2008, we declared and paid cash dividends on our Series A and B Preferred Stock in the aggregate
amounts of $1,709,000 and $2,395,000, respectively.
During 2008, the former holder of our Series A Preferred Stock converted all of its shares of
Series A Preferred Stock into shares of our common stock. As a result, at December 31, 2008, there were
no outstanding shares of Series A Preferred Stock.
Deemed Dividend on Preferred Stock
During 2008, we recorded a deemed dividend on preferred stock of $761,000 in connection with
a subsequent issuance of shares of Series B Preferred Stock. This non-cash dividend reflects the implied
economic value to the preferred stockholder of being able to convert the shares into common stock at a
price (as adjusted for the value allocated to the warrants) which was in excess of the fair value of the
Series B Preferred Stock at the time of issuance. The fair value was calculated using the difference
between the conversion price of the Series B Preferred Stock into shares of common stock, adjusted for
the value allocated to the warrants, of $4.79 per share and the fair market value of our common stock of
$5.65 on the date of issuance of the Series B Preferred Stock. The deemed dividend on preferred stock is
a reconciling item and adjusts our reported net loss, together with the preferred stock dividends discussed
above, to loss available to common stockholders.
-39-
Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006
Years Ended
December 31,
2007
2006
Dollar
Variance
Favorable
Percentage
Variance
Favorable
(Unfavorable) (Unfavorable)
(dollars in thousands)
Results as a Percentage
of Net Sales for the
Years Ended
December 31,
2007
2006
461,513 $
$
Net sales ....................................................................
Cost of goods sold ..................................................... 428,614
Gross profit ................................................................ 32,899
Selling, general and administrative expenses ............ 30,822
Income from operations ............................................ 2,077
Other income (expense), net ...................................... (6,801)
Income (loss) before noncontrolling interest
in variable interest entity and provision for
income taxes ........................................................... (4,724)
226,356 $
201,527
24,829
24,641
188
3,426
235,157
(227,087)
8,070
(6,181)
1,889
(10,227)
103.9%
(112.7)
32.5
(25.1)
1,004.8
(298.5)
100.0%
92.9
7.1
6.6
0.5
(1.5)
100.0%
89.0
11.0
10.9
0.1
1.5
3,614
(8,338)
(230.7)
(1.0)
1.6
Noncontrolling interest in variable interest
entity ....................................................................... (9,676)
Loss before provision for income taxes ..................... (14,400)
Provision for income taxes ....................................... —
Net loss ......................................................................
Preferred stock dividends ..........................................
Deemed dividend on preferred stock .........................
(5,920)
(14,258)
—
$
(14,258)
$ (4,200) $ (2,998) $ (1,202)
83,972
(3,756)
(142)
—
(142) $
(14,400) $
(84,000)
(28)
(157.6)
(10,040.9)
—
(10,040.9)%
(40.1)%
100.0
(2.1)
(3.1)
—
(3.1)%
(0.9)%
(0.0)
(1.7)
(0.1)
—
(0.1)%
(1.3)%
(37.1)
Loss available to common stockholders ....................
$
(18,628) $
(87,140) $
68,512
78.6%
(4.0)%
(38.5)%
Net Sales
The increase in our net sales in 2007 as compared to 2006 was primarily due to a substantial
increase in sales volume, which was partially offset by decreased average sales prices.
Total volume of ethanol sold increased by 88.9 million gallons, or 87%, to 190.6 million gallons
in 2007 as compared to 101.7 million gallons in 2006. The substantial increase in sales volume is
primarily due to a full year of ethanol production at our Madera and Front Range facilities in 2007. Our
Madera and Front Range facilities each accounted for less than three months of ethanol production in
2006. In addition, in 2007, we commenced ethanol production at our Columbia facility and also generated
increased sales from the purchase and resale of additional supply from third-parties under our ethanol
marketing agreements. The production and sale of ethanol and its co-products from our Madera and
Columbia facilities, and through Front Range, contributed an aggregate of $194.0 million to our increase
in net sales in 2007.
Our average sales price per gallon declined 6% to $2.15 in 2007 from an average sales price per
gallon of $2.28 in 2006. The average CBOT price per gallon declined 21% to $1.98 in 2007 from an
average CBOT price per gallon of $2.52 in 2006. We believe that we were insulated from some of this
decline due to our fixed-price ethanol contracts which were partially offset by derivative losses incurred
as a result of locking in margins.
Cost of Goods Sold and Gross Profit
The increase in our cost of goods sold in 2007 as compared to 2006 was predominantly due to
increased sales volume and increased corn costs which contributed to higher costs per gallon. Our gross
margin declined to 7.1% in 2007 from 11.0% in 2006 primarily due to increased corn costs, lower average
sales prices per gallon and losses on derivatives, as further discussed below.
Although a large proportion of our sales volume results from the marketing and sale of ethanol
produced by third parties, production of our own ethanol began growing rapidly in 2007 as new facilities
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commenced operations. Our purchase and sale prices of ethanol produced by third parties typically
fluctuate closely with market prices. As a result, our average cost of ethanol purchased from third parties
decreased in line with the overall decline in our average sales price per gallon.
Corn is the single largest component of the cost of our ethanol production. Average corn prices
rose significantly in 2007 as compared to 2006, with greater increases occurring in the second half of
2007 than in the first half of the year. These increases pushed our average corn price higher than the
average market price for all of 2007 because our corn requirements increased significantly during the
second half of 2007 due to the commencement of operations at our Columbia facility in September 2007.
Overall, the price of corn had a much larger impact on our production costs per gallon in 2007 than in
2006 due to the higher proportion of sales from production of our own ethanol in 2007 as compared to
2006.
Cost of goods sold also increased by $4,122,000 from net losses on derivatives in 2007 as
compared to only a nominal amount in 2006. These losses resulted from derivatives that we entered in
order to lock in margins during the year and were partially offset by gains from derivatives we entered in
order to lock in the price of corn. Of these losses, $1,649,000 was related to open positions at December
31, 2007.
Selling, General and Administrative Expenses
Our SG&A increased by $6,181,000 to $30,822,000 for 2007 as compared to $24,641,000 for
2006. SG&A, however, decreased as a percentage of net sales due to our significant sales growth. The
increase in the dollar amount of SG&A is primarily due to the following factors:
payroll and benefits increased by $3,017,000, or 68%, due to increased administrative
staff;
amortization of intangible assets resulting from our acquisition of our 42% ownership
interest in Front Range increased by $2,117,000, as we incurred a full year of
amortization compared to less than three months in 2006;
SG&A attributable to Front Range increased by $2,042,000 as we incurred a full year of
these expenses as compared to less than three months in 2006;
consulting and temporary staff expenses increased by $1,950,000, or 126%, due to the
retention of additional consulting and temporary staff personnel to assist us in meeting
our accounting and public reporting requirements, including as we transitioned our
permanent staff to our new corporate headquarters in Sacramento, California; these
consulting and temporary staff personnel also assisted us in training new administrative
staff members;
recruiting, hiring and training expenses increased by $709,000, or 1,055%, employee
travel and office setup costs increased by $377,000, or 243%, and rent expense increased
by $457,000, or 221%; each of these increases resulted primarily from the relocation of
our corporate headquarters in early 2007 from Fresno to Sacramento;
external audit costs increased by $582,000, or 312%, due to our overall growth and
business initiatives; and
travel-related costs increased by $311,000, or 52%, due to expanded operations and new
office and facility locations.
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Partially offsetting the foregoing increases were the following decreases:
non-cash compensation expense decreased by $4,023,000, or 64%, due to the completion
of vesting of incentive compensation paid to employees and consultants;
legal expenses decreased by $918,000, or 43%, primarily due to one-time costs
associated with greater legal activity from litigation and business transactions that
occurred in 2006; and
costs associated with implementing and testing our internal controls and related
compliance required under the Sarbanes-Oxley Act of 2002 decreased by $902,000, or
76%, as many costs that occurred in 2006 were related predominantly to our initial
implementation and testing of our internal controls.
Other Income (Expense), Net
Other expense increased by $10,227,000 to $6,801,000 in 2007 from other income of $3,426,000
in 2006. The increase in other expense is primarily due to the following factors:
interest expense increased by $1,828,000, or 286%, due to additional borrowings and a
full year of interest accruing on outstanding debt; and
amortization of interest and financing costs increased by $3,164,000, or 305%, primarily
due to an amendment to our construction financing credit facility that reduced its
application from five to four facilities and reduced the total amount of available financing;
as a result, we wrote off $1,962,000 of unamortized costs associated with our Imperial
Valley facility, the construction of which had been suspended; interest and financing costs
incurred under the construction phase of each of our facilities which were being
capitalized until the corresponding facility became operational; this increase in
amortization of interest and financing costs is net of approximately $7,823,000 of
additional capitalized amounts over 2006.
In addition, we recognized losses of $119,000 and $5,442,000 of effective and ineffectiveness
positions, respectively, from our interest rate hedges which required that we mark-to-market our
ineffective positions in a declining interest rate environment. The ineffectiveness related to our interest
rate swaps and primarily resulted from the suspension of construction of our Imperial Valley facility.
Noncontrolling Interest in Variable Interest Entity
Noncontrolling interest in variable interest entity relates to the consolidated treatment of Front
Range, a variable interest entity, and represents the noncontrolling interest of others in the earnings of
Front Range. We consolidate the entire income statement of Front Range for the period covered.
However, because we own only 42% of Front Range, we must reduce our net income or increase our net
loss for the noncontrolling interest, which is the 58% ownership interest that we do not own. This amount
increased by $5,920,000 to $9,676,000 in 2007 from $3,756,000 in 2006 due to the consolidation of Front
Range’s operations for all of 2007 as compared to less than three months in 2006.
Preferred Stock Dividends
Shares of our Series A Preferred Stock are entitled to quarterly cumulative dividends payable in
arrears in cash in an amount equal to 5% per annum of the purchase price per share of the Series A
Preferred Stock, or, at the time, our option, payable in additional shares of Series A Preferred Stock based
on the value of the purchase price per share of the Series A Preferred Stock. In 2007, we declared and
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paid dividends on our Series A Preferred Stock in the aggregate amount of $4,200,000 comprised of cash
dividends in the aggregate amount of $3,150,000 for the first three quarters and a dividend payment-in-
kind in the amount of $1,050,000 that was issued in shares of Series A Preferred Stock for the fourth
quarter.
Deemed Dividend on Preferred Stock
We recorded a deemed dividend on preferred stock of $28,000 for 2007 in connection with our
issuance of shares of Series A Preferred Stock as a dividend payment-in-kind for the fourth quarter. We
also recorded a deemed dividend on preferred stock of $84,000,000 for 2006 in connection with our initial
issuance of shares of Series A Preferred Stock. These non-cash dividends reflect the implied economic
value to the preferred stockholder of being able to convert these additional shares into common stock at
prices which were in excess of the fair value of the Series A Preferred Stock at the times of issuance. The
fair value was calculated using the difference between the agreed-upon conversion price of the Series A
Preferred Stock into shares of common stock of $8.00 per share and the fair market value of our common
stock of $8.21 and $29.27 on the date of issuance of the additional shares of Series A Preferred Stock for
2007 and 2006, respectively. The fair value allocated to the initial issuance of the Series A Preferred
Stock in 2006 was in excess of the gross proceeds received of $84,000,000 in connection with the initial
sale of the Series A Preferred Stock; however, the deemed dividend on the Series A Preferred Stock for
2006 is limited to the gross proceeds received of $84,000,000. The deemed dividend on preferred stock is
a reconciling item and adjusts our reported net loss, together with the preferred stock dividends discussed
above, to loss available to common stockholders.
Liquidity and Capital Resources
Overview and Outlook
Our financial statements have been prepared on a going concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. As a result of
ethanol industry conditions that have negatively affected our business, we do not currently have sufficient
liquidity to meet our anticipated working capital, debt service and other liquidity needs in the very near-
term. We have suspended operations at three of our four wholly-owned ethanol production facilities due
to market conditions and in an effort to conserve capital. We have also taken and expect to take additional
steps to preserve liquidity. However, despite any additional cost-saving steps we may take, we believe
that we have sufficient working capital to continue operations only until approximately April 30, 2009 at
the latest unless we successfully restructure our debt, experience a significant improvement in margins
and obtain other sources of liquidity.
We are in default under our construction-related term loans in the aggregate amount of
approximately $230 million and under Kinergy’s revolving line of credit as well as $31.5 million in notes
payable to another lender. In February 2009, we entered into forbearance agreements with each of the
lenders, which were amended in March 2009, under which the lenders agreed to forbear from exercising
their rights until April 30, 2009 absent further defaults. Although we are actively pursuing a number of
alternatives, including seeking to restructure our debt and seeking to raise additional debt or equity
financing, or both, there can be no assurance that we will be successful. If we cannot restructure our debt
and obtain sufficient liquidity in the very near term, we may need to seek protection under the U.S.
Bankruptcy Code.
Quantitative Year-End Liquidity Status
We believe that the following amounts provide insight into our liquidity and capital resources.
The following selected financial data should be read in conjunction with our consolidated financial
statements and notes to consolidated financial statements included elsewhere in this report, and the other
-43-
sections of ―Management’s Discussion and Analysis of Financial Condition and Results of Operations‖
contained in this report (dollars in thousands):
As of and for the
Year Ended December 31,
2008
2007
Variance
Current assets ................................................................ $
Current liabilities .......................................................... $
Property and equipment, net ......................................... $
Notes payable, net of current portion ............................ $
Cash provided by (used in) operating activities ............ $
Working capital ............................................................ $
Working capital ratio ....................................................
71,891
360,204
530,037
937
(55,175)
(288,313)
0.20
$
$
$
$
$
$
82,193
120,079
468,704
151,188
16,718
(37,886)
0.68
(12.5)%
200.0%
13.1%
(99.4)%
(430.0)%
(661.0)%
(70.6)%
Change in Working Capital and Cash Flows
Working capital decreased to a deficit of $288,313,000 at December 31, 2008 from a deficit of
$37,886,000 at December 31, 2007 as a result of a significant increase in current liabilities of
$240,125,000 and a slight decrease in current assets of $10,302,000.
Current liabilities significantly increased primarily due to an increase in current portion of debt of
$294,322,000, as plant financing and operating lines of credit are both in default and under forbearance
agreements with the related lenders, as new terms are being negotiated. Other increases in current
liabilities are due to an increase in accrued liabilities of $3,809,000, which were partially offset by
decreases in accounts payable and accrued liabilities – construction-related of $35,005,000, a decrease in
trade accounts payable of $8,607,000, a decrease in retentions of $5,252,000 and a decrease in short-term
note payable of $6,000,000 as that note was paid off by the end of the year and a decrease in derivative
liabilities of $2,850,000.
Current assets decreased primarily due to net decreases in marketable securities and accounts
receivable of $11,573,000 and $4,211,000, respectively, the proceeds of which were predominantly used
for operations, which were partially offset by an increase in cash and equivalents of $5,759,000 and
restricted cash of $1,740,000.
Cash used in our operating activities of $55,175,000 resulted primarily from a loss of
$146,547,000, noncontrolling interest in variable interest entity of $52,669,000 and a decrease in accounts
payable and accrued expenses of $20,579,000, partially offset by impairment of goodwill of $87,047,000,
impairment of asset group of $40,900,000, depreciation and amortization of intangibles of $26,635,000
and changes in other assets and liabilities.
Cash used in our investing activities of $140,856,000 resulted primarily from purchases of
additional property and equipment of $152,635,000, partially offset by proceeds from sales of marketable
securities of $11,573,000.
Cash provided by our financing activities of $201,790,000 resulted primarily from proceeds from
our debt financing and lines of credit of $157,322,000, proceeds from issuances of preferred and common
stock of $72,292,000, which were partially offset by cash paid for principal debt payments of
$20,787,000, preferred share dividends of $4,104,000, debt issuance costs of $1,818,000 and dividend
payments to noncontrolling interests of $1,115,000.
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Changes in Other Assets and Liabilities
Goodwill, net, decreased to $0 at December 31, 2008 from $88,168,000 at December 31, 2007
primarily as a result of our annual impairment analysis which caused us to write the balance down due to
a lower current valuation as compared to the original purchase that created the goodwill.
Notes payable, net of current portion, decreased to $937,000 at December 31, 2008 from
$151,188,000 at December 31, 2007 primarily as a result of an increase from loan proceeds used for
construction activities at our ethanol plants which were completed in 2008, which increase was partially
offset by amounts reclassified to current liabilities as the loans and Kinergy’s operating line of credit are
both in default but presently under a forbearance agreement with the related lenders.
Debt Financing
Upon completion of our Stockton facility, our construction loans totaling $230 million converted
to term loans with scheduled quarterly principal and interest payments due starting on December 31,
2008. We made the first payment at the end of 2008. We have been unable to make subsequent required
principal and interest payments on these term loans, resulting in defaults under those loans. In February,
2009, we obtained a waiver and forbearance agreement with our lenders which was extended in March
2009. The waiver and forbearance agreement, as extended, provides that the lenders will forbear from
exercising their rights and remedies under the Debt Financing commencing February 17, 2009 and ending
on April 30, 2009. Further the waiver and forbearance agreement provides that we may withdraw funds
otherwise required to be reserved in two accounts designated solely for the Stockton facility and the other
for future debt service payments. The use of these funds provides approximately $5,385,000 million to us
for operating activities. Further, the lenders have allowed us to cease payments of principal and interest
due during the forbearance period. Upon expiration of the forbearance period, or our earlier default under
the terms of the forbearance, we will be required to repay all outstanding amounts owed to our lenders.
We are presently attempting to negotiate debt restructuring terms with our lenders. However, we cannot
assure you that we will be able to successfully negotiate satisfactory terms with our lenders.
Kinergy Line of Credit
In February 2009, Kinergy determined that it had violated certain of its covenants, including its
financial covenant for 2008. In February 2009, we entered into an amendment and forbearance agreement
with our lender which was further amended in March 2009. The amendment identified certain defaults
under the loan agreement as to which the lender agreed to forebear from exercising its rights and remedies
commencing February 13, 2009 through April 30, 2009. During the forbearance period, Kinergy’s lender
has authorized us to use this line of credit for Kinergy’s operations. The agreement reduced the aggregate
amount of the credit facility from up to $40,000,000 to up to $10,000,000.
The agreement also increased the interest rates applicable to the loan. Kinergy may borrow under
the credit facility based upon (i) a rate equal to (a) the London Interbank Offered Rate (―LIBOR‖),
divided by 0.90 (subject to change based upon the reserve percentage in effect from time to time under
Regulation D of the Board of Governors of the Federal Reserve System), plus (b) 4.50% depending on the
amount of Kinergy’s EBITDA for a specified period, or (ii) a rate equal to (a) the greater of the prime rate
published by Wachovia Bank from time to time, or the federal funds rate then in effect plus 0.50%, plus
(b) 2.25% depending on the amount of Kinergy’s EBITDA for a specified period. In addition, Kinergy is
required to pay an unused line fee at a rate equal to 0.375% as well as other customary fees and expenses
associated with the credit facility and issuances of letters of credit. Kinergy’s obligations under the loan
agreement are secured by a first-priority security interest in all of its assets in favor of the lender.
Upon expiration of the forbearance period, or our earlier default under the terms of the
forbearance, Kinergy will be required to repay all outstanding amounts owed to its lender. We are
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presently attempting to negotiate debt restructuring terms with this lender. However, we cannot assure
you that we will be able to successfully negotiate satisfactory terms with this lender.
Notes Payable
In February 2009, we notified lenders that we would not be able to pay off their notes in the
aggregate amount of $31.5 million due in March 2009. In February 2009, we entered into a forbearance
agreement with the lenders which was amended in March 2009. Under the terms of the forbearance
agreement, the lenders agreed to forbear from exercising their rights and remedies against us through
April 30, 2009. We are presently attempting to negotiate debt restructuring terms with the lenders.
However, we cannot assure you that we will be able to successfully negotiate satisfactory terms.
Contractual Obligations
The following table outlines payments due under our significant contractual obligations (in
thousands):
Contractual Obligations
At December 31, 2008
Sourcing commitments(1) ...........................................................................................................
Debt principal(2) .........................................................................................................................
Debt interest(2) ...........................................................................................................................
Operating leases(3)......................................................................................................................
Preferred dividends(4) .................................................................................................................
Total commitments ....................................................................................................................
2009
$ 28,959
67,981
17,728
3,103
3,202
$ 120,973
2011
$ —
26,176
13,462
2,701
3,202
$ 45,541
2012
$ —
24,134
12,073
2,035
3,202
$ 41,444
2010
$ —
15,581
15,762
3,082
3,202
$ 37,627
2013
$ —
13,976
10,415
1,657
3,202
$ 29,250
Thereafter
$
158,509
19,132
8,794
3,202
Total
— $ 28,959
306,357
88,572
21,372
19,212
$ 189,637 $ 464,472
__________
(1)
(2)
Unconditional purchase commitments for production materials incurred in the normal course of business.
Payments based on debt agreements as of December 31, 2008, and do not reflect current defaults and any potential
change in terms from current negotiations with lenders.
Future minimum payments under non cancelable operating leases.
Represents dividends on 2,346,152 shares of Series B Preferred Stock.
(3)
(4)
The above table outlines our obligations as of December 31, 2008 and does not reflect the
changes in our obligations that occurred after that date.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon
our consolidated financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amount of net sales and expenses for each period. The following represents a summary of our critical
accounting policies, defined as those policies that we believe are the most important to the portrayal of
our financial condition and results of operations and that require management’s most difficult, subjective
or complex judgments, often as a result of the need to make estimates about the effects of matters that are
inherently uncertain.
Going Concern Assumption
We have based our financial statements on the assumption of our operations continuing as a
going concern. Our consolidated financial statements do not include any adjustments relating to the
recoverability and classification of the recorded asset amounts or the amounts and classification of
liabilities that might be necessary should we be unable to continue our existence.
-46-
Revenue Recognition
We recognize revenue when it is realized or realizable and earned. We consider revenue realized
or realizable and earned when it has persuasive evidence of an arrangement, delivery has occurred, the
sales price is fixed or determinable, and collection is reasonably assured in conformity with Staff
Accounting Bulletin No. 104, Revenue Recognition.
We derive revenue primarily from sales of ethanol and related co-products. We recognize revenue
when title transfers to our customers, which is generally upon the delivery of these products to a
customer’s designated location. These deliveries are made in accordance with sales commitments and
related sales orders entered into with customers either verbally or in written form. The sales commitments
and related sales orders provide quantities, pricing and conditions of sales. In this regard, we engage in
three basic types of revenue generating transactions:
As a producer. Sales as a producer consist of sales of our inventory produced at our facilities.
As a merchant. Sales as a merchant consist of sales to customers through purchases from
third-party suppliers in which we may or may not obtain physical control of the ethanol or co-
products, though ultimately titled to us, in which shipments are directed from our suppliers to
our terminals or direct to our customers but for which we accept the risk of loss in the
transactions.
As an agent. Sales as an agent consist of sales to customers through purchases from third-
party suppliers in which, depending upon the terms of the transactions, title to the product
may technically pass to us, but the risk and rewards of inventory ownership remains with
third-party suppliers as we receive a predetermined service fee under these transactions and
therefore act predominantly in an agency capacity.
We have employed the principles detailed in Emerging Issues Task Force, or EITF, Issue No. 99-
19, Reporting Revenue Gross as a Principal Versus Net as an Agent, as guidance in our revenue
recognition policies. Revenue from sales of third-party ethanol and its co-products is recorded net of costs
when we are acting as an agent between the customer and supplier and gross when we are a principal to
the transaction. Several factors are considered to determine whether we are acting as an agent or principal,
most notably whether we are the primary obligor to the customer, whether we have inventory risk and
related risk of loss or whether we add meaningful value to the vendor’s product or service. Consideration
is also given to whether we have latitude in establishing the sales price or have credit risk, or both.
We record revenues based upon the gross amounts billed to our customers in transactions where
we act as a producer or a merchant and obtain title to ethanol and its co-products and therefore own the
product and any related, unmitigated inventory risk for the ethanol, regardless of whether we actually
obtain physical control of the product. When we act in an agency capacity, we record revenues on a net
basis, or our predetermined agency fees only, based upon the amount of net revenues retained in excess of
amounts paid to suppliers.
Consolidation of Variable Interest Entities.
We have determined that Front Range meets the definition of a variable interest entity under the
Financial Accounting Standards Board’s, or FASB’s, Financial Interpretation No., or FIN, 46(R),
Consolidation of Variable Interest Entities. We have also determined that we are the primary beneficiary
and we are therefore required to treat Front Range as a consolidated subsidiary for financial reporting
purposes rather than use equity investment accounting treatment. As a result, we have consolidated the
financial results of Front Range, including its entire balance sheet with the balance of the noncontrolling
interest displayed between liabilities and equity, and the income statement after intercompany
-47-
eliminations with an adjustment for the noncontrolling interest in net income since our acquisition on
October 17, 2006. Under FIN 46(R), and as long as we are deemed the primary beneficiary of Front
Range, we must treat Front Range as a consolidated subsidiary for financial reporting purposes.
Impairment of Intangible and Long-Lived Assets
Our intangible assets, including goodwill, were derived from the acquisition of our interest in
Front Range in 2006 and our acquisition of Kinergy in 2005 in connection with the Share Exchange
Transaction. In accordance with SFAS No. 141, we allocated the respective purchase prices to the
tangible assets, liabilities and intangible assets acquired based upon their estimated fair values. The excess
purchase prices over the fair values of the assets acquired and liabilities assumed were recorded as
goodwill. Our long-lived assets are primarily associated with our ethanol production facilities.
We account for goodwill and intangible assets with indefinite lives in accordance with SFAS No.
142. We review these assets at least annually or more frequently if impairment indicators arise. In our
review, we determine the fair value of these assets using market multiples and discounted cash flow
modeling and compare it to the net book value of the acquired assets. Any assessed impairments will be
recorded permanently and expensed in the period in which the impairment is determined. If it is
determined through our assessment process that any of our intangible assets require impairment charges,
they will be recorded in the line item other operating charges in the consolidated statements of operations.
During the year ended December 31, 2008, we performed our annual review of impairment and
recognized an impairment loss of $87,047,000, the entire amount of our goodwill. We did not recognize
any impairment losses for the years ended December 31, 2007 and 2006.
We evaluate impairment of long-lived assets in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. We assess the impairment of long-lived assets,
including property and equipment and purchased intangibles subject to amortization, when events or
changes in circumstances indicate that suggest the fair value of assets could be less then their net book
value. In such event, we assess long-lived assets for impairment by determining their fair value based on
the forecasted, undiscounted cash flows the assets are expected to generate plus the net proceeds expected
from the sale of the asset. An impairment loss would be recognized when the fair value is less than the
related asset’s net book value, and an impairment expense would be recorded in the amount of the
difference. Forecasts of future cash flows are judgments based on our experience and knowledge of our
operations and the industries in which we operate. These forecasts could be significantly affected by
future changes in market conditions, the economic environment, including inflation, deflation and capital
spending decisions of our customers. During the year ended December 31, 2008, we recognized an
impairment loss on long-lived assets associated with our Imperial Valley ethanol production facility,
which construction has been suspended, of $40,900,000. We did not recognize any impairment losses for
the years ended December 31, 2007 and 2006.
In 2008, we completed construction of our ethanol production facilities, with installed capacity of
220 million gallons per year, our goal since 2005. During 2008, we, along with the ethanol industry as a
whole, experienced significant volatility in the prices of ethanol and corn. Further, we incurred significant
operating losses in the last half of 2008, which required us to make decisions about operating levels at
each of our facilities. As a result, beginning in December 2008 and through the first quarter of 2009, we
reduced our production. Currently we have ceased production at our Madera, Magic Valley and Stockton
facilities. We continue to operate our Columbia and Front Range facilities. We continue to assess market
conditions and when appropriate and with adequate available working capital, we plan to bring these
facilities back to operation. Given the national Renewable Fuel Standards requirements of ethanol, we
believe the ethanol industry is viable and will recover in the near term.
At December 31, 2008, we performed our forecast of expected future cash flows of our facilities
over their estimated useful lives. Such forecasts of expected future cash flows are heavily dependent upon
-48-
management’s estimates of future market prices for ethanol, our primary product, and corn, our primary
production input. As both ethanol and corn costs have fluctuated significantly in the past year, these
estimates are highly subjective and are management’s best estimates at this time. Management developed
estimated future prices consistent with market forecasts, including forecasts from the United States
Department of Agriculture’s long-term forecast. Our forecasts assume that our facilities will only operate
during periods when market price conditions yield acceptable operating margins. Our analysis resulted in
total estimated undiscounted cash flows over the expected lives of our plant assets in excess of their
carrying values. As a result, we did not determine the fair value of our facilities.
If 2008 average prices for ethanol and corn were used in our forecast rather than management’s
estimate of future market prices, the projections would have resulted in estimated undiscounted cash
flows below carrying values which would require us to compute their fair values. If we are required to
compute the fair value in the future, we may use the work of a qualified valuation specialist who would
assist us in examining replacement costs, recent transactions between third parties and cash flow that can
be generated from operations. Given the recent completion of the facilities, replacement cost would likely
approximate the carrying value of the facilities. However, there have been recent transactions between
independent parties to purchase plants at prices substantially below the carrying value of the facilities.
Some of the facilities have been in bankruptcy and may not be representative of transactions outside of
bankruptcy. Given these circumstances, should management be required to adjust the carrying value of
the facilities to fair value at some future point in time, the adjustment could be significant and could
significantly impact our financial position, results of operation and possibly any existing financial debt
covenants. No adjustment has been made in these financial statements for this uncertainty.
Derivative Instruments and Hedging Activities
Our business and activities expose us to a variety of market risks, including risks related to
changes in commodity prices and interest rates. We monitor and manage these financial exposures as an
integral part of our risk management program. This program recognizes the unpredictability of financial
markets and seeks to reduce the potentially adverse effects that market volatility could have on operating
results. We account for our use of derivatives related to our hedging activities pursuant to SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, in which we recognize all of our derivative
instruments in our statement of financial position as either assets or liabilities, depending on the rights or
obligations under the contracts. We have designated and documented contracts for the physical delivery
of commodity products to and from counterparties as normal purchases and normal sales. Derivative
instruments are measured at fair value, pursuant to the definition found in SFAS No. 107, Disclosures
about Fair Value of Financial Instruments. Changes in the derivative’s fair value are recognized currently
in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative’s effective gains and losses to be deferred in accumulated other comprehensive
income (loss) and later recorded together with the gains and losses to offset related results on the hedged
item in the statements of operations. Companies must formally document, designate and assess the
effectiveness of transactions that receive hedge accounting.
The estimated gains (losses) on our derivatives were as follows (in thousands):
Commodity futures
Interest rate options
Total
2008
(2,791)
1,382
(1,409)
$
$
Year Ended December 31,
2007
(5,331)
(5,590)
(10,921)
$
$
$
$
2006
622
(17)
605
-49-
Allowance for Doubtful Accounts
We primarily sell ethanol to gasoline refining and distribution companies and WDG to dairy
operators and animal feed distributors. We had significant concentrations of credit risk from sales of our
ethanol as of December 31, 2008, as described in Note 1 to our consolidated financial statements.
However, those ethanol customers historically have had good credit ratings and historically we have
collected amounts that were billed to those customers. Receivables from customers are generally
unsecured. We continuously monitor our customer account balances and actively pursue collections on
past due balances.
We maintain an allowance for doubtful accounts for balances that appear to have specific
collection issues. Our collection process is based on the age of the invoice and requires attempted contacts
with the customer at specified intervals. If after a specified number of days, we have been unsuccessful in
our collection efforts, we consider recording a bad debt allowance for the balance in question. We would
eventually write-off accounts included in our allowance when we have determined that collection is not
likely. The factors considered in reaching this determination are the apparent financial condition of the
customer, and our success in contacting and negotiating with the customer.
During the years ended December 31, 2008, 2007 and 2006, we recognized $2,191,000, $58,000
and $83,000, respectively, in bad debt expenses as a result of this policy.
Costs of Start-up Activities
Start-up activities are defined broadly in Statement of Position 98-5, Reporting on the Costs of
Start-Up Activities, as those one-time activities related to opening a new facility, introducing a new
product or service, conducting business in a new territory, conducting business with a new class of
customer or beneficiary, initiating a new process in an existing facility, commencing some new operation
or activities related to organizing a new entity. Our start-up activities consist primarily of costs associated
with new or potential sites for ethanol production facilities. We expense all the costs associated with a
potential site, until the site is considered viable by management, at which time costs would be considered
for capitalization based on authoritative accounting literature. These costs are included in selling, general,
and administrative expenses in our consolidated statements of operations.
Impact of New Accounting Pronouncements
In June 2008, the FASB ratified EITF Issue No. 07-5, Determining Whether an Instrument (or
Embedded Feature) is Indexed to an Entity’s Own Stock. EITF No. 07-5 mandates a two-step process for
evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s
own stock. EITF No. 07-5 is effective for us beginning with its first quarter ended March 31, 2009. We do
not expect the adoption of EITF No. 07-5 will have a material impact on our financial condition or results
of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosure about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133. SFAS No. 161 changes the disclosure
requirements for derivative instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement No. 133 and its related interpretations and (c)
how derivative instruments and related hedged items affect an entity’s financial position, financial
performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application encouraged. We do not expect
the adoption of SFAS No. 161 to have a material impact on our financial condition or results of
operations.
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In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No.
141(R) retains the fundamental requirements in SFAS No. 141, Business Combinations, that the
acquisition method of accounting be used for all business combinations and for an acquirer to be
identified for each business combination. SFAS No. 141(R) requires an acquirer to recognize the assets
acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions specified in SFAS No. 141(R). In
addition, SFAS No. 141(R) requires acquisition costs and restructuring costs that the acquirer expected
but was not obligated to incur to be recognized separately from the business combination, therefore,
expensed instead of part of the purchase price allocation. SFAS No. 141(R) will be applied prospectively
to business combinations for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. Early adoption is prohibited. We will adopt
SFAS No. 141(R) to any business combinations after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements, an amendment to ARB No. 51. SFAS No. 160 changes the accounting and reporting
for minority interests, which will be recharacterized as noncontrolling interests and classified as a
component of equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. Early adoption is prohibited. Upon adoption on January
1, 2009, we will present our noncontrolling interest in variable interest entity within stockholders’ equity
in our consolidated balance sheets. We do not expect the adoption of SFAS No. 160 to have a material
impact on our financial condition or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to various market risks, including changes in commodity prices and interest rates.
Market risk is the potential loss arising from adverse changes in market rates and prices. In the ordinary
course of business, we enter into various types of transactions involving financial instruments to manage
and reduce the impact of changes in commodity prices and interest rates. We do not enter into derivatives
or other financial instruments for trading or speculative purposes.
Commodity Risk – Cash Flow Hedges
As part of our risk management strategy, we use derivative instruments to protect cash flows from
fluctuations caused by volatility in commodity prices for periods of up to twelve months. These hedging
activities are conducted to protect gross margins to reduce the potentially adverse effects that market
volatility could have on operating results by minimizing our exposure to price volatility on ethanol sale
and purchase commitments where the price is to be set at a future date and/or if the contract specifies a
floating or index-based price for ethanol that is based on either the New York Mercantile Exchange price
of gasoline or the Chicago Board of Trade price of ethanol. In addition, we hedge anticipated sales of
ethanol to minimize our exposure to the potentially adverse effects of price volatility. These derivatives
are designated and documented as SFAS No. 133 cash flow hedges and effectiveness is evaluated by
assessing the probability of the anticipated transactions and regressing commodity futures prices against
our purchase and sales prices. Ineffectiveness, which is defined as the degree to which the derivative does
not offset the underlying exposure, is recognized immediately in cost of goods sold.
For the year ended December 31, 2008, a loss from ineffectiveness in the amount of $991,000
and an effective gain in the amount of $566,000 were recorded in cost of goods sold. For the year ended
December 31, 2007, a gain from ineffectiveness in the amount of $2,832,000 and an effective loss in the
amount of $1,680,000 were recorded in cost of goods sold. For the year ended December 31, 2006, losses
from ineffectiveness in the amount of $239,000 and an effective loss in the amount of $438,000 were
recorded in cost of goods sold. For the year ended December 31, 2006, an effective gain in the amount of
$1,281,000 was recorded in sales. The notional balance of these derivatives as of December 31, 2008 and
2007 was $0 and $2,427,000, respectively.
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Commodity Risk – Non-Designated Derivatives
As part of our risk management strategy, we use forward contracts on corn, crude oil and
reformulated blendstock for oxygenate blending gasoline to lock in prices for certain amounts of corn,
denaturant and ethanol, respectively. These derivatives are not designated under SFAS No. 133 for
special hedge accounting treatment. The changes in fair value of these contracts are recorded on the
balance sheet and recognized immediately in cost of goods sold. We recognized losses of $2,395,000 (of
which $1,131,000 is related to settled non-designated hedges), $6,484,000 and $0 as the change in the fair
value of these contracts for the year ended December 31, 2008, 2007 and 2006, respectively. The notional
balances remaining on the contracts as of December 31, 2008 and 2007 were $4,215,000 and
$29,999,000, respectively.
Interest Rate Risk
As part of our interest rate risk management strategy, we use derivative instruments to minimize
significant unanticipated earnings fluctuations that may arise from rising variable interest rate costs
associated with existing and anticipated borrowings. To meet these objectives we purchased interest rate
caps and swaps. The rate for notional balances of interest rate caps ranging from $4,268,000 to
$18,990,000 is 5.50%-6.00% per annum. The rate for notional balances of interest rate swaps ranging
from $543,000 to $57,654,000 is 5.01%-8.16% per annum.
These derivatives are designated and documented as SFAS No. 133 cash flow hedges and
effectiveness is evaluated by assessing the probability of anticipated interest expense and regressing the
historical value of the rates against the historical value in the existing and anticipated debt.
Ineffectiveness, reflecting the degree to which the derivative does not offset the underlying exposure, is
recognized immediately in other income (expense). For the year ended December 31, 2008, gains from
ineffectiveness in the amount of $4,999,000, gains from effectiveness in the amount of $75,000 and losses
from undesignated hedges in the amount of $6,456,000 were recorded in other income (expense). These
gains and losses resulted from our efforts to restructure our debt financing and therefore, making it not
probable that the related borrowings would be paid as designated. As such we de-designated certain of
our interest rate caps and swaps.
For the year ended December 31, 2007, losses from ineffectiveness in the amount of $4,836,000,
losses from effectiveness in the amount of $147,000 and losses from undesignated hedges in the amount
of $606,000 were recorded in other income (expense). For the year ended December 31, 2006,
ineffectiveness in the amount of $24,000 was recorded in other income (expense).
We marked all of our derivative instruments to fair value at each period end, except for those
derivative contracts which qualified for the normal purchase and sale exemption pursuant to SFAS No.
133.
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Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) relative to derivatives for the year ended
December 31, 2008 is as follows (in thousands):
Beginning balance, January 1, 2008
Net changes
Less: Amount reclassified to cost of goods sold
Less: Amount reclassified to other income (expense)
Ending balance, December 31, 2008
—————
*Calculated on a pretax basis
$
Commodity
Derivatives
Gain/(Loss)*
(455)
—
455
—
—
$
Interest Rate
Derivatives
Gain/(Loss)*
$(1,928)
(2,637)
—
4,565
—
$
The estimated fair values of our derivatives were as follows (in thousands):
Commodity futures
Interest rate options
Total
Material Limitations
December 31,
2008
(951)
(6,545)
(7,496)
$
$
2007
(1,649)
(7,091)
(8,740)
$
$
The disclosures with respect to the above noted risks do not take into account the underlying
commitments or anticipated transactions. If the underlying items were included in the analysis, the gains
or losses on the futures contracts may be offset. Actual results will be determined by a number of factors
that are not generally under our control and could vary significantly from the factors disclosed.
We are exposed to credit losses in the event of nonperformance by counterparties on the above
instruments, as well as credit or performance risk with respect to our hedged customers’ commitments.
Although nonperformance is possible, we do not anticipate nonperformance by any of these parties.
Item 8. Financial Statements and Supplementary Data.
Reference is made to the financial statements included in this report, which begin at Page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
We conducted an evaluation under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. The term ―disclosure controls and procedures,‖ as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended
(―Exchange Act‖), means controls and other procedures of a company that are designed to ensure that
information required to be disclosed by the company in the reports it files or submits under the Exchange
Act is recorded, processed, summarized and reported, within the time periods specified in the Securities
and Exchange Commission’s rules and forms. Disclosure controls and procedures also include, without
limitation, controls and procedures designed to ensure that information required to be disclosed by a
-53-
company in the reports that it files or submits under the Exchange Act is accumulated and communicated
to the company’s management, including its principal executive and principal financial officers, or
persons performing similar functions, as appropriate, to allow timely decisions regarding required
disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded
as of December 31, 2008 that our disclosure controls and procedures were effective at a reasonable
assurance level.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal
control over financial reporting is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Our internal control over financial reporting includes those
policies and procedures that:
(i)
(ii)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets;
provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in accordance with
authorizations of our management and directors; and
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of our assets that could have a material affect on our
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
A material weakness is defined by the Public Company Accounting Oversight Board’s Audit
Standard No. 5 as being a deficiency, or combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual
or interim financial statements will not be prevented or detected on a timely basis by the company’s
internal controls.
Management assessed and evaluated the effectiveness of our internal control over financial
reporting as of December 31, 2008. Based on the results of management’s assessment and evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2008, our internal
control over financial reporting was effective.
In making its assessment of our internal control over financial reporting, management used
criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (―COSO‖) in
its Internal Control—Integrated Framework. Our independent registered public accounting firm, Hein &
Associates LLP, independently assessed the effectiveness of our internal control over financial reporting.
Hein & Associates LLP has issued an attestation report concurring with management’s assessment, which
is included herein.
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Inherent Limitations on the Effectiveness of Controls
Management does not expect that our disclosure controls and procedures or our internal control
over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of
the control systems are met. Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative to their costs. Because of the
inherent limitations in a cost-effective control system, no evaluation of internal control over financial
reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that all
control issues and instances of fraud, if any, have been or will be detected.
These inherent limitations include the realities that judgments in decision-making can be faulty
and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented
by the individual acts of some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part on certain assumptions about the
likelihood of future events, and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to
future periods are subject to risks. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or procedures.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the most recently completed fiscal quarter that
has materially affected, or is reasonably likely to materially affect, our internal control over financial
reporting.
Attestation Report of Independent Registered Public Accounting Firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee and Management
Pacific Ethanol, Inc.
Sacramento, California
We have audited Pacific Ethanol, Inc.’s internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Pacific Ethanol, Inc.’s management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting included in the accompanying Management’s
Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
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A company's internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Pacific Ethanol, Inc. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2008, based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of Pacific Ethanol, Inc. as of December 31, 2008
and 2007, and the related consolidated statements of operations, comprehensive income (loss),
stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008,
of Pacific Ethanol, Inc. and our report dated March 31, 2009 expressed an unqualified opinion thereon.
/s/ HEIN & ASSOCIATES LLP
Irvine, California
March 31, 2009
Item 9A(T). Controls and Procedures.
Not applicable.
Item 9B. Other Information.
None.
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Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information under the captions ―Information about our Board of Directors, Board
Committees and Related Matters‖ and ―Section 16(a) Beneficial Ownership Reporting Compliance,‖
appearing in the Proxy Statement, is hereby incorporated by reference.
Item 11. Executive Compensation.
The information under the caption ―Executive Compensation and Related Information,‖
appearing in the Proxy Statement, is hereby incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
The information under the captions ―Security Ownership of Certain Beneficial Owners and
Management‖ and ―Equity Compensation Plan Information,‖ appearing in the Proxy Statement, is hereby
incorporated by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information under the captions ―Certain Relationships and Related Transactions‖ and
―Information about our Board of Directors, Board Committees and Related Matters—Director
Independence‖ appearing in the Proxy Statement, is hereby incorporated by reference.
Item 14. Principal Accounting Fees and Services.
The information under the caption ―Principal Accounting Fees and Services,‖ appearing in the
Proxy Statement, is hereby incorporated by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
Reference is made to the financial statements listed on and attached following the Index to
Consolidated Financial Statements contained on page F-1 of this report.
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
Reference is made to the exhibits listed on the Index to Exhibits.
-57-
Index to Financial Statements
Report of Independent Registered Public Accounting Firm ................................................................... F-2
Consolidated Balance Sheets as of December 31, 2008 and 2007 ......................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2008, 2007 and 2006 ................................................................................................. F-5
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
December 31, 2008, 2007 and 2006 ................................................................................................. F-6
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2008, 2007 and 2006 ................................................................................................. F-7
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2008, 2007 and 2006 ................................................................................................. F-10
Notes to Consolidated Financial Statements ........................................................................................... F-12
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Pacific Ethanol, Inc.
Sacramento, California
We have audited the accompanying consolidated balance sheets of Pacific Ethanol, Inc. as of
December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive
income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2008. These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall presentation of the financial statements. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Pacific Ethanol, Inc. at December 31, 2008 and 2007, and
the results of its operations and its cash flows for each of the three years in the period ended December
31, 2008, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a
going concern. As discussed in Note 1, the Company is in default under its loan agreements and has
entered into forbearance agreements with each of the lenders under which the lenders agreed to forbear
from exercising their rights until April 30, 2009 absent further defaults. In addition, the Company does
not currently have sufficient liquidity to meet its anticipated working capital, debt service and other
liquidity needs in the very near term-term. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these matters are also described in
Note 1 to the financial statements. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), Pacific Ethanol, Inc.’s internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission, and our report dated March 31, 2009
expressed an unqualified opinion on the effectiveness of Pacific Ethanol, Inc’s internal control over
financial reporting.
/s/ HEIN & ASSOCIATES LLP
Irvine, California
March 31, 2009
F-2
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
December 31,
2008
2007
Current Assets:
Cash and cash equivalents
Investments in marketable securities
Accounts receivable, net of allowance for doubtful accounts of
$
11,466
7,780
$
$2,210 and $58, respectively
Restricted cash
Inventories
Prepaid expenses
Prepaid inventory
Derivative instruments
Other current assets
Total current assets
23,823
2,520
18,408
2,279
2,016
7
3,592
71,891
5,707
19,353
28,034
780
18,540
1,498
3,038
1,613
3,630
82,193
Property and equipment, net
530,037
468,704
Other Assets:
Goodwill
Intangible assets, net
Other assets
Total other assets
Total Assets
—
5,630
9,276
14,906
88,168
6,324
6,211
100,703
$
616,834
$
651,600
The accompanying notes are an integral part of these consolidated financial statements.
F-3
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands, except shares and par value)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable – trade
Accrued liabilities
Accounts payable and accrued liabilities – construction-related
Contract retentions
Other liabilities – related parties
Current portion – long-term notes payable (including $31,500 and
$
$0 due to a related party, respectively)
Short-term note payable
Derivative instruments
Total current liabilities
Notes payable, net of current portion (including $0 and $30,000 due
to a related party, respectively)
Other liabilities
Total Liabilities
Commitments and contingencies (Notes 1, 6, 7 and 13)
Noncontrolling interest in variable interest entity
Stockholders’ Equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized:
Series A: 7,000,000 shares authorized; 0 and 5,315,625 shares
issued and outstanding as of December 31, 2008 and 2007,
respectively
Series B: 3,000,000 shares authorized; 2,346,152 and 0 shares
issued and outstanding as of December 31, 2008 and 2007,
respectively
Common stock, $0.001 par value; 100,000,000 shares
authorized; 57,750,319 and 40,606,214 shares issued and
outstanding as of December 31, 2008 and 2007,
respectively
Additional paid-in capital
Accumulated other comprehensive loss
Accumulated deficit
Total stockholders’ equity
December 31,
2008
2007
$
14,034
12,335
20,198
106
608
305,420
—
7,503
360,204
937
3,497
364,638
22,641
8,526
55,203
5,358
900
11,098
6,000
10,353
120,079
151,188
1,965
273,232
42,823
96,082
—
2
5
—
58
479,034
—
(269,721)
209,373
41
402,932
(2,383)
(118,309)
282,286
Total Liabilities and Stockholders’ Equity
$
616,834
$
651,600
The accompanying notes are an integral part of these consolidated financial statements.
F-4
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Net sales (including $1, $6,205 and
$16,985 to a related party, respectively)
$
Cost of goods sold
Gross profit (loss)
Selling, general and administrative expenses
Impairment of goodwill
Impairment of asset group
Income (loss) from operations
Other income (expense), net
Income (loss) before noncontrolling
interest in variable interest entity and
provision for income taxes
Noncontrolling interest in variable interest
entity
Loss before provision for income taxes
Provision for income taxes
Net loss
Preferred stock dividends
Deemed dividend on preferred stock
Loss available to common stockholders
Loss per share, basic and diluted
Weighted-average shares outstanding, basic
and diluted
$
$
$
$
Years Ended December 31,
2008
2007
2006
703,926 $
737,331
(33,405)
31,796
87,047
40,900
(193,148)
(6,068)
$
461,513
428,614
32,899
30,822
—
—
2,077
(6,801)
226,356
201,527
24,829
24,641
—
—
188
3,426
(199,216)
(4,724)
3,614
52,669
(146,547)
—
(146,547) $
(4,104) $
(761)
(9,676)
(14,400)
—
(14,400)
(4,200)
(28)
(151,412) $ (18,628)
(0.47)
(3.02) $
(3,756)
(142)
—
(142)
(2,998)
(84,000)
(87,140)
(2.50)
$
$
$
$
50,147
39,895
34,855
The accompanying notes are an integral part of these consolidated financial statements.
F-5
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Net loss
Other comprehensive income (loss), net of
tax:
Cash flow hedges:
Net change in the fair value of
derivatives, net of tax
Unrealized gain (loss) on restricted
available-for-sale securities
Comprehensive income (loss)
For the Years Ended December 31,
2008
2007
2006
$
(146,547) $
(14,400)
$
(142)
2,383
(2,579)
—
(144,164) $
(349)
(17,328)
$
$
196
349
403
The accompanying notes are an integral part of these consolidated financial statements.
F-6
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
(in thousands)
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
$ —
28,874
$
Balances, January 1, 2006
Cumulative effect adjustment (Note 12)
Issuance of preferred stock, net of offering
costs of $1,434
Beneficial conversion feature on issuance of
preferred stock and preferred dividend
declared
Issuance of common stock for private
investment in public equity, net of offering
costs of $7,381
Exercise of warrants and Accessity options
Share-based compensation expense – restricted
stock to employees and directors, net of
cancellations
Common stock issued for purchase of 42%
interest in Front Range
Fair value of warrants issued for purchase of
42% interest in Front Range
Collection of stockholder receivable
Share-based compensation expense – options
and warrants to employees and consultants
Stock issued for exercise of warrants for cash
Stock issued for cashless exercise of warrants
Stock issued for exercise of stock options for
cash
Comprehensive income
—
—
5,250
—
—
—
—
—
—
—
—
—
—
—
—
—
5
—
—
—
—
—
—
—
—
—
—
—
—
5
—
—
—
5,497
71
894
2,082
—
—
—
2,518
150
183
—
40,269
$
29
—
—
—
5
—
1
2
—
—
—
3
—
—
—
40
$
42,071 $
—
82,561
84,000
137,614
89
3,047
30,006
5,087
1
3,201
8,556
—
1,303
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
545
Accumulated
Deficit
Total
$
(13,584)
$ 28,516
1,043
1,043
—
82,566
(86,998)
(2,998)
—
—
—
—
—
—
—
—
—
—
(142)
137,619
89
3,048
30,008
5,087
1
3,201
8,559
—
1,303
403
Balances, December 31, 2006
5,250
$
$
397,536
$
545
$
(99,681)
$ 298,445
The accompanying notes are an integral part of these consolidated financial statements.
F-7
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006 (CONTINUED)
(in thousands)
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Accumulated
Deficit
Total
Balances, January 1, 2007
5,250
$
5
40,269
$
40
$
397,536 $
545
$
(99,681)
$ 298,445
Share-based compensation expense –
restricted stock to employees and
directors, net of cancellations
Share-based compensation expense – options
and warrants to employees and consultants
Stock issued for exercise of warrants for cash
Stock issued for exercise of stock options for
cash
Beneficial conversion feature on issuance of
preferred stock and preferred dividends
declared
Comprehensive loss
—
—
—
—
66
—
Balances, December 31, 2007
5,316
$
—
—
—
—
—
—
5
(34)
—
128
243
—
—
40,606
$
—
—
—
1
—
—
41
1,729
333
363
1,893
1,078
—
—
—
—
—
—
—
—
—
1,729
333
363
1,894
(4,228)
(3,150)
—
(2,928)
(14,400)
(17,328)
$
402,932
$ (2,383)
$ (118,309)
$ 282,286
The accompanying notes are an integral part of these consolidated financial statements.
F-8
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006 (CONTINUED)
(in thousands)
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Accumulated
Deficit
Total
Balances, January 1, 2008
5,316
$
Issuance of preferred stock, net of offering
costs of $156
2,346
5
2
—
40,606
$
41
$
402,932 $ (2,383)
$ (118,309)
$ 282,286
Conversion of preferred stock to common
stock
Issuance of common, net of offering costs of
$62
Share-based compensation expense – restricted
stock to employees and directors, net of
cancellations
Fair value of warrant issued
Deemed dividend and preferred stock
dividends declared
Comprehensive loss
(5,316)
(5)
10,632
—
—
—
—
—
—
6,000
—
—
—
—
2
512
—
—
—
57,750
$
—
10
6
1
—
—
—
58
45,641
(5)
26,642
2,981
82
761
—
—
—
—
—
—
—
—
—
—
—
—
45,643
—
26,648
2,982
82
(4,865)
(4,104)
2,383
(146,547)
(144,164)
$
479,034
$
—
$ (269,721)
$ 209,373
Balances, December 31, 2008
2,346
$
The accompanying notes are an integral part of these consolidated financial statements.
F-9
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended December 31,
2007
2006
2008
$
(146,547) $
(14,400)
$
(142)
Operating Activities:
Net loss
Adjustments to reconcile net loss to
cash provided by (used in) operating activities:
Impairment of goodwill
Impairment of asset group
Depreciation and amortization of intangibles
Inventory valuation
Noncontrolling interest in variable interest entity
Loss on derivative instruments
Amortization of deferred financing fees
Non-cash compensation and consulting expense
(Gain) loss on disposal of equipment
Bad debt expense
Changes in operating assets and liabilities:
87,047
40,900
26,635
6,415
(52,669)
1,138
2,018
3,015
(27)
2,191
—
—
17,513
144
9,676
6,617
4,726
2,225
81
58
—
—
4,402
159
3,756
162
1,069
6,248
—
83
(20,939)
(1,570)
136
(3,856)
(1,030)
(679)
2,498
1,559
$ (8,144)
Accounts receivable
Restricted cash
Notes receivable, related party
Inventories
Prepaid expenses and other assets
Prepaid inventory
Accounts payable and accrued expenses
Accounts payable and accrued expenses, related party
Net cash provided by (used in) operating activities
2,020
(1,740)
—
(1,596)
(4,126)
1,022
(20,579)
(292)
1,230
787
—
(11,089)
(1,649)
(1,009)
10,332
(8,524)
$ (55,175) $ 16,718
Investing Activities:
Additions to property and equipment
Proceeds from sales of available-for-sale investments
Restricted cash designated for construction projects
Advances on equipment
Purchases of available-for-sale investments
Acquisition of 42% interest in Front Range, net of cash
received
Proceeds from sale of equipment
$ (152,635) $ (210,482)
19,417
24,851
—
—
11,573
—
—
—
$ (82,454)
—
(24,851)
(9,041)
(28,962)
—
206
—
—
(29,514)
—
Net cash used in investing activities
$ (140,856) $ (166,214)
$ (174,822)
Financing Activities:
Proceeds from borrowings
Net proceeds from issuance of preferred stock and warrants
Net proceeds from issuance of common stock and warrants
Proceeds from exercise of warrants and stock options
Cash paid for debt issuance costs
Principal payments paid on borrowings
Principal payments paid on borrowings (related party)
Preferred share dividend paid
Dividend payments to noncontrolling interests
Receipt of stockholder receivable
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
$ 157,322 $ 137,725
—
—
2,257
(10,261)
(8,737)
—
(4,200)
(5,634)
—
$ 201,790 $ 111,150
45,643
26,649
—
(1,818)
(20,787)
—
(4,104)
(1,115)
—
5,759
5,707
(38,346)
44,053
$ 1,950
82,566
137,619
9,951
(3,036)
(1,005)
(3,600)
(1,948)
—
1
$ 222,498
39,532
4,521
44,053
Cash and cash equivalents at end of period
$
11,466 $
5,707
$
The accompanying notes are an integral part of these consolidated financial statements.
F-10
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(in thousands)
For the Years Ended December 31,
2007
2006
2008
Supplemental Information:
Interest paid ($9,186, $8,494 and $671 capitalized)
Non-cash financing and investing activities:
Preferred stock dividend declared
Deemed dividend on preferred stock (Note 9)
Unrealized gain on restricted available-for-sale securities
Accrued additions to construction in progress
Accounts payable converted to short-term note payable
Transaction costs associated with acquisition of 42%
interest in Front Range
Issuance of common stock associated with acquisition of
42% interest in Front Range
Issuance of warrant associated with acquisition of 42%
interest in Front Range
Cumulative effect adjustment (Note 12)
Capital lease obligations
$
20,602 $
9,467
$
966
— $
761 $
— $
1,050
$
28
$
(349)
$
$ —
$ 52,172
$ 1,500 $ 6,000
1,050
$
84,000
$
349
$
$ 3,031
—
$
$
$
$
$
$
— $
— $
— $
— $
810 $
—
—
—
—
203
$
$
$
$
$
304
30,008
5,087
2,134
—
The accompanying notes are an integral part of these consolidated financial statements.
F-11
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING
PRONOUNCEMENTS.
Organization and Business – The consolidated financial statements include the accounts of Pacific
Ethanol, Inc., a Delaware corporation (―Pacific Ethanol‖), and all of its wholly-owned subsidiaries,
including Pacific Ethanol California, Inc., a California corporation (―PEI California‖), Kinergy
Marketing, LLC, an Oregon limited liability company (―Kinergy‖) and ReEnergy, LLC, a California
limited liability company (―ReEnergy‖), and, effective October 17, 2006, the consolidated financial
statements of Front Range Energy, LLC, a Colorado limited liability company (―Front Range‖), a
variable-interest entity of which Pacific Ethanol, Inc. owns 42% (collectively, the ―Company‖).
The Company produces and sells ethanol and its co-products, including wet distillers grain (―WDG‖), and
provides transportation, storage and delivery of ethanol through third-party service providers in the
Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and
Washington.
In September 2008, the Company completed construction of its fourth ethanol plant. The Company’s four
ethanol plants, which produce ethanol and its co-products, are as follows:
In addition, the Company owns a 42% interest in Front Range, which owns a plant located in Windsor,
Colorado, with annual production capacity of up to 50 million gallons. The Company also intends to
either construct or acquire additional production facilities as financial resources and business prospects
make the construction or acquisition of these facilities advisable.
On October 17, 2006, Pacific Ethanol and PEI California entered into an agreement with Eagle Energy,
LLC (―Eagle Energy‖) to acquire Eagle Energy’s 42% ownership interest in Front Range by paying cash
and issuing common stock and a warrant to purchase common stock of the Company in a transaction
valued at $65,612,000. The results of operations for the year ended December 31, 2006 consist of the
Company’s operations for the twelve months and the operations of Front Range from October 18, 2006
through December 31, 2006. (See Note 2)
On March 23, 2005, the Company completed a share exchange transaction with the shareholders of PEI
California and the holders of the membership interests of each of Kinergy and ReEnergy, pursuant to
which the Company acquired all of the issued and outstanding capital stock of PEI California and all of
the outstanding membership interests of Kinergy and ReEnergy (the ―Share Exchange Transaction‖).
Immediately prior to the consummation of the Share Exchange Transaction, the Company’s predecessor,
Accessity Corp., a New York corporation (―Accessity‖), reincorporated in the State of Delaware under
the name ―Pacific Ethanol, Inc‖ through a merger of Accessity with and into its then-wholly-owned
Delaware subsidiary named Pacific Ethanol, Inc., which was formed for the purpose of effecting the
reincorporation (the ―Reincorporation Merger‖). In connection with the Reincorporation Merger, the
F-12
Facility NameFacility LocationDate Operations BeganEstimated Annual Production Capacity (gallons)StocktonStockton, CASeptember 200860,000,000Magic ValleyBurley, IDApril 200860,000,000ColumbiaBoardman, ORSeptember 200740,000,000MaderaMadera, CAOctober 200640,000,000
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
shareholders of Accessity became stockholders of the Company and the Company succeeded to the rights,
properties and assets and assumed the liabilities of Accessity. (See Note 2)
Basis of Presentation and Liquidity – The consolidated financial statements and related notes have been
prepared in accordance with accounting principles generally accepted in the United States of America and
include the accounts of Pacific Ethanol, each of its wholly-owned subsidiaries, and effective October 17,
2006, Front Range. All significant intercompany accounts and transactions have been eliminated in
consolidation.
The Company’s financial statements have been prepared on a going concern basis, which contemplates
the realization of assets and the satisfaction of liabilities in the normal course of business. As a result of
ethanol industry conditions that have negatively affected the Company’s business, the Company does not
currently have sufficient liquidity to meet its anticipated working capital, debt service and other liquidity
needs in the very near term. The Company has suspended operations at three of its four wholly-owned
ethanol production facilities due to market conditions and in an effort to conserve capital. The Company
has also taken and expects to take additional steps to preserve liquidity. However, despite any additional
cost-saving steps the Company may take, the Company believes that it has sufficient working capital to
continue operations only until approximately April 30, 2009 at the latest unless it successfully restructures
its debt, experiences a significant improvement in margins and obtains other sources of liquidity.
The Company is in default under its construction-related term loans in the aggregate amount of
approximately $246.5 million and under Kinergy’s revolving line of credit as well as $31.5 million in
notes payable to another lender. In February 2009, the Company entered into forbearance agreements
with each of the lenders, which were amended in March 2009, under which the lenders agreed to forbear
from exercising their rights until April 30, 2009 absent further defaults. The Company classified these
debt obligations as current liabilities in its consolidated financial statements and of and for the year ended
December 31, 2008. Although the Company is actively pursuing a number of alternatives, including
seeking to restructure its debt and seeking to raise additional debt or equity financing, or both, there can
be no assurance that the Company will be successful. If the Company cannot restructure its debt and
obtain sufficient liquidity in the very near term, it may need to seek protection under the U.S. Bankruptcy
Code.
The consolidated financial statements do not include any other adjustments that might result from the
outcome of these negotiations. (See Note 7.)
Cash and Cash Equivalents – The Company considers all highly-liquid investments with an original
maturity of three months or less to be cash equivalents.
Investments in Marketable Securities – The Company’s short-term investments consists of amounts held
in money market portfolio funds and United States Treasury Securities, which represents funds available
for current operations. In accordance with Statement of Financial Accounting Standards (―SFAS‖) No.
115, Accounting for Certain Investments in Debt and Equity Securities, these short-term investments are
classified as available-for-sale and are carried at their fair market value. These securities have stated
maturities beyond three months but were priced and traded as short-term instruments. Available-for-sale
securities are marked-to-market based on quoted market values of the securities, with the unrealized gains
and losses, net of tax, reported as a component of accumulated other comprehensive income (loss).
Realized gains and losses on sales of available-for-sale securities are computed based upon the initial cost
adjusted for any other-than-temporary declines in fair value. The cost of investments sold is determined
on the specific identification method.
F-13
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are presented at
face value, net of the allowance for doubtful accounts. The Company sells ethanol to gasoline refining
and distribution companies and WDG to dairy operators and animal feed distributors generally without
requiring collateral. Due to a limited number of ethanol customers, the Company had significant
concentrations of credit risk from sales of ethanol as of December 31, 2008 and 2007, as described below.
The Company maintains an allowance for doubtful accounts for balances that appear to have specific
collection issues. The collection process is based on the age of the invoice and requires attempted contacts
with the customer at specified intervals. If, after a specified number of days, the Company has been
unsuccessful in its collection efforts, a bad debt allowance is recorded for the balance in question.
Delinquent accounts receivable are charged against the allowance for doubtful accounts once
uncollectibility has been determined. The factors considered in reaching this determination are the
apparent financial condition of the customer and the Company’s success in contacting and negotiating
with the customer. If the financial condition of the Company’s customers were to deteriorate, resulting in
an impairment of ability to make payments, additional allowances may be required.
The allowance for doubtful accounts was $2,210,000 and $58,000 as of December 31, 2008 and 2007,
respectively. The Company recorded bad debt expense of $2,191,000, $58,000 and $83,000 for the years
ended December 31, 2008, 2007 and 2006, respectively. The Company does not have any off-balance
sheet credit exposure related to its customers.
Concentrations of Credit Risk – Credit risk represents the accounting loss that would be recognized at the
reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk,
whether on- or off-balance sheet, that arise from financial instruments exist for groups of customers or
counterparties when they have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other conditions described
below.
Financial instruments that subject the Company to credit risk consist of cash balances maintained in
excess of federal depository insurance limits and accounts receivable, which have no collateral or
security. Some of the accounts maintained by the Company at financial institutions are insured by the
Federal Deposit Insurance Corporation. The Company’s uninsured balance was $10,422,000 and
$8,460,000 as of December 31, 2008 and 2007, respectively. The Company has not experienced any
losses in such accounts and believes that it is not exposed to any significant risk of loss of cash.
The Company sells fuel-grade ethanol to gasoline refining and distribution companies. The Company had
sales from customers representing 10% or more of total net sales as follows:
Years Ended December 31,
2007
2008
2006
Customer A
Customer B
Customer C
19%
13%
3%
16%
16%
6%
12%
9%
13%
As of December 31, 2008, the Company had receivables from these customers of approximately
$6,829,000, representing 29% of total accounts receivable. As of December 31, 2007, the Company had
receivables from these customers of approximately $4,983,000, representing 18% of total accounts
receivable.
F-14
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company purchases fuel-grade ethanol and corn, its largest cost component in producing ethanol,
from its suppliers. The Company had purchases from ethanol and corn suppliers representing 10% or
more of total purchases in the purchase and production of ethanol as follows:
Supplier A
Supplier B
Supplier C
Supplier D
Supplier E
Years Ended December 31,
2007
2008
27%
22%
5%
5%
0%
14%
20%
9%
9%
13%
2006
6%
0%
17%
11%
22%
Restricted Cash – Current Asset – The restricted cash balance of $2,520,000 and $780,000 as of
December 31, 2008 and 2007, respectively, was the balance of deposits held at the Company’s trade
broker in connection with trading instruments entered into as part of the Company’s hedging strategy.
Inventories – Inventories consist primarily of bulk ethanol, unleaded fuel and corn, and are valued at the
lower-of-cost-or-market, with cost determined on a first-in, first-out basis. Inventory balances consisted
of the following (in thousands):
Raw materials
Work in progress
Finished goods
Other
Total
December 31,
2008
9,000
1,895
5,994
1,519
18,408
$
$
2007
3,647
1,809
12,064
1,020
18,540
$
$
Property and Equipment – Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the following estimated useful lives:
Buildings
Facilities and plant equipment
Other equipment, vehicles and furniture
Water rights
40 years
10 – 25 years
5 – 10 years
99 years
The cost of normal maintenance and repairs is charged to operations as incurred. Significant capital
expenditures that increase the life of an asset are capitalized and depreciated over the estimated remaining
useful life of the asset. The cost of fixed assets sold, or otherwise disposed of, and the related
accumulated depreciation or amortization are removed from the accounts, and any resulting gains or
losses are reflected in current operations.
Goodwill – Goodwill represents the excess of cost of an acquired entity over the net of the amounts
assigned to net assets acquired and liabilities assumed. The Company accounts for its goodwill in
accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which requires an annual review
for impairment, or more frequently if indications of impairment arise. This review includes the
determination of each reporting unit’s fair value using market multiples and discounted cash flow
modeling. The Company is operating as a single-segmented, single-reporting unit. The estimates of future
cash flows are judgments based on management’s experience and knowledge of the Company’s
operations and the industries in which the Company operates. These estimates can be significantly
F-15
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
affected by future changes in market conditions, the economic environment, including inflation, and
capital spending decisions of the Company’s customers. Any assessed impairments will be permanent and
expensed in the period in which the impairment is determined. If the Company determines through its
assessment process that any of its goodwill requires impairment charges, the charges will be recorded in
selling, general and administrative expenses in the consolidated statements of operations.
Intangible Assets – Intangible assets have been identified as assets with definite lives. The Company will
amortize these assets using the straight-line method over their established lives, generally 2-10 years.
Additionally, the Company will test these assets with established lives for impairment if conditions exist
that indicates that carrying values may not be recoverable. Possible conditions leading to the
unrecoverability of these assets include changes in market conditions, changes in future economic
conditions or changes in technological feasibility that impact the Company’s assessments of future
operations. If the Company determines that an impairment charge is needed, the charge will be recorded
in selling, general and administrative expenses in the consolidated statements of operations.
Deferred Financing Costs – Deferred financing costs, which are included in other assets, are costs
incurred to obtain debt financing, including all related fees, and are amortized as interest expense over the
term of the related financing using the straight-line method which approximates the interest rate method.
To the extent these fees relate to facility construction, a portion is capitalized with the related interest
expense into construction in progress until such time as the facility is placed into operation.
Derivative Instruments and Hedging Activities – Beginning in 2006, the Company implemented a policy
to minimize its exposure to commodity price risk associated with certain anticipated commodity
purchases and sales and interest rate risk associated with anticipated corporate borrowings by using
derivative instruments. The Company accounts for its derivative transactions in accordance with SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted.
Derivative transactions, which can include forward contracts and futures positions on the New York
Mercantile Exchange and the Chicago Board of Trade and interest rate caps and swaps are recorded on
the balance sheet as assets and liabilities based on the derivative’s fair value. Changes in the fair value of
the derivative contracts are recognized currently in income unless specific hedge accounting criteria are
met. If derivatives meet those criteria, effective gains and losses are deferred in accumulated other
comprehensive income (loss) and later recorded together with the hedged item in income. For derivatives
designated as a cash flow hedge, the Company formally documents the hedge and assesses the
effectiveness with associated transactions. The Company has designated and documented contracts for the
physical delivery of commodity products to and from counterparties as normal purchases and normal
sales.
Consolidation of Variable-Interest Entities – In January 2003, the Financial Accounting Standards Board
(―FASB‖) issued FASB Interpretation No. (―FIN‖) 46, Consolidation of Variable Interest Entities, and in
December 2003, amended it by issuing FIN 46(R). FIN 46(R) addresses consolidation by business
enterprises of variable interest entities that either: (i) do not have sufficient equity investment at risk to
permit the entity to finance its activities without additional subordinated financial support, or (ii) have
equity investors that lack an essential characteristic of a controlling financial interest. Under FIN 46(R),
the primary beneficiary of a variable interest entity is the party that absorbs a majority of the entity’s
expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable
interests, which can be ownership, contractual, or other financial interests that change with the fair value
of the entity’s net assets.
The Company has determined that Front Range meets the definition of a variable interest entity under FIN
46(R). The Company has also determined that it is the primary beneficiary and is therefore required to
F-16
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
treat Front Range as a consolidated subsidiary for financial reporting purposes rather than use equity
investment accounting treatment. As a result, the Company consolidates the financial results of Front
Range, including its entire balance sheet with the balance of the noncontrolling interest displayed between
liabilities and equity, and the income statement after intercompany eliminations with an adjustment for
the noncontrolling interest in net income, in each case since its acquisition on October 17, 2006. Under
FIN 46(R), and as long as the Company is deemed the primary beneficiary of Front Range, it must treat
Front Range as a consolidated subsidiary for financial reporting purposes.
Revenue Recognition – The Company recognizes revenue when it is realized or realizable and earned. The
Company considers revenue realized or realizable and earned when it has persuasive evidence of an
arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably
assured in conformity with the Securities and Exchange Commission’s (―Commission‖) Staff Accounting
Bulletin (―SAB‖) No. 104, Revenue Recognition.
The Company derives revenue primarily from sales of ethanol and related co-products. The Company
recognizes revenue when title transfers to its customers, which is generally upon the delivery of these
products to a customer’s designated location. These deliveries are made in accordance with sales
commitments and related sales orders entered into with customers either verbally or in written form. The
sales commitments and related sales orders provide quantities, pricing and conditions of sales. In this
regard, the Company engages in three basic types of revenue generating transactions:
As a producer. Sales as a producer consist of sales of the Company’s inventory produced at
its ethanol production facilities.
As a merchant. Sales as a merchant consist of sales to customers through purchases from
third-party suppliers in which the Company may or may not obtain physical control of the
ethanol or co-products, though ultimately titled to the Company, in which shipments are
directed from the Company’s suppliers to its terminals or direct to its customers but for
which the Company accepts the risk of loss in the transactions.
As an agent. Sales as an agent consist of sales to customers through purchases from third-
party suppliers in which, depending upon the terms of the transactions, title to the product
may technically pass to the Company, but the risks and rewards of inventory ownership
remains with third-party suppliers as the Company receives a predetermined service fee
under these transactions and therefore acts predominantly in an agency capacity.
The Company records revenues based upon the gross amounts billed to its customers in transactions
where the Company acts as a producer or a merchant and obtains title to ethanol and its co-products and
therefore owns the product and any related, unmitigated inventory risk for the ethanol, regardless of
whether the Company actually obtains physical control of the product.
When the Company acts in an agency capacity, it records revenues based on the principles of Emerging
Issues Task Force (―EITF‖) Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an
Agent. The Company recognizes revenue on a net basis or recognizes its predetermined agency fees only,
based upon the amount of net revenues retained in excess of amounts paid to suppliers. Revenue from
sales of third-party ethanol and its co-products is recorded net of costs when the Company is acting as an
agent between the customer and supplier and gross when the Company is a principal to the transaction.
Several factors are considered to determine whether the Company is acting as an agent or principal, most
notably whether the Company is the primary obligor to the customer, whether the Company has inventory
F-17
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
risk and related risk of loss. Consideration is also given to whether the Company has latitude in
establishing the sales price or has credit risk, or both.
Shipping and Handling Costs – Shipping and handling costs are classified as a component of cost of
goods sold in the accompanying consolidated statements of operations.
Costs of Start-Up Activities – Start-up activities are defined broadly in American Institute of Certified
Public Accountants Statement of Position 98-5, Reporting on the Costs of Start-Up Activities, as those
one-time activities related to opening a new facility, introducing a new product or service, conducting
business in a new territory, conducting business with a new class of customer or beneficiary, initiating a
new process in an existing facility, commencing some new operation or activities related to organizing a
new entity. The Company’s start-up activities consist primarily of costs associated with new or potential
sites for ethanol production facilities. All the costs associated with a potential site are expensed, until the
site is considered viable by management, at which time costs would be considered for capitalization based
on authoritative accounting literature. These costs are included in selling, general and administrative
expenses in the consolidated statements of operations.
Stock-Based Compensation – On January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based
Payments. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in
exchange for the award of equity instruments based on the fair value of the award on the date of grant.
The expense is to be recognized over the period during which an employee is required to provide services
in exchange for the award.
Impairment of Long-Lived Assets – The Company evaluates impairment of long-lived assets in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The
Company assesses the impairment of long-lived assets, including property and equipment and purchased
intangibles subject to amortization, when events or changes in circumstances indicate that the fair value of
assets could be less then their net book value. In such event, the Company assesses long-lived assets for
impairment by determining their fair value based on the forecasted, undiscounted cash flows the assets are
expected to generate plus the net proceeds expected from the sale of the asset. An impairment loss would
be recognized when the fair value is less than the related asset’s net book value, and an impairment
expense would be recorded in the amount of the difference. Forecasts of future cash flows are judgments
based on the Company’s experience and knowledge of its operations and the industries in which it
operates. These forecasts could be significantly affected by future changes in market conditions, the
economic environment, including inflation, and capital spending decisions of the Company’s customers.
Income Taxes – Income taxes are accounted for under SFAS No. 109, Accounting for Income Taxes.
Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and
laws that are expected to be in effect when the differences reverse. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be realized.
Income (Loss) Per Share – The Company computes income (loss) per common share in accordance with
the provisions of SFAS No. 128, Earnings Per Share. SFAS No. 128 requires companies with complex
capital structures to present basic and diluted earnings per share. Basic income (loss) per share is
computed on the basis of the weighted-average number of shares of common stock outstanding during the
period. Preferred dividends are deducted from net income and are considered in the calculation of income
(loss) available to common stockholders in computing basic income (loss) per share. In periods in which
there is a loss available to common stockholders, diluted income per share is equal to basic income per
share.
F-18
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table computes basic and diluted net loss per share (in thousands, except per share data):
Years Ended December 31,
2008
2007
2006
Numerator (basic and diluted):
Net loss
Preferred stock dividends
Deemed dividend on preferred stock
$
(146,547)
$
(14,400)
$
(4,104)
(761)
(4,200)
(28)
Loss available to common stockholders
(151,412)
(18,628)
(142)
(2,998)
(84,000)
(87,140)
Denominator:
Weighted-average common shares
outstanding – basic and diluted
Loss per share – basic and diluted
50,147
39,895
$
(3.02)
$
(0.47) $
34,855
(2.50)
There were an aggregate of 10,930,000, 10,750,000 and 14,568,000 of potentially dilutive shares from
stock options, common stock warrants and convertible securities outstanding as of December 31, 2008,
2007 and 2006, respectively. These options, warrants and convertible securities were not considered in
calculating diluted loss per common share for the years ended December 31, 2008, 2007 and 2006, as
their effect would be anti-dilutive. As a result, for each of the years ended December 31, 2008, 2007 and
2006, the Company’s basic and diluted loss per share are the same.
Financial Instruments – SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires
all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not
recognized on the balance sheet, for which it is practicable to estimate fair value. The carrying value of
cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued
expenses are reasonable estimates of their fair value because of the short maturity of these items. Except
as noted below, the Company believes the carrying values of its notes payable and long-term debt
approximate fair value because the interest rates on these instruments are variable.
The Company believes the carrying values and estimated fair values of its notes payable and long-term
debt are as follows at December 31, 2008 (in thousands):
Carrying Value
Estimated Fair Value
$
306,357
$ 139,568
The Company estimated the fair value of its notes payable and long-term debt associated with its Debt
Financing currently in forbearance consistent with its related interest rate caps and swaps. As discussed in
Note 14, the Company applied a 40% standard market recovery rate to its caps and swaps, and
accordingly, applied the rate to its related debt carrying value. For all other notes payable and long-term
debt, fair value approximates carrying value. As of December 31, 2008 and 2007, the fair value of the
Company’s other financial instruments approximated their carrying values.
Fair Value Measurements – On January 1, 2008, the Company adopted SFAS No. 157 Fair Value
Measurements, which defines a single definition of fair value, together with a framework for measuring it,
and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No.
157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to
be measured at fair value, but does not require any new fair value measurement. The SFAS No. 157
F-19
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
requirements for certain nonfinancial assets and liabilities have been deferred until the first quarter of
2009 in accordance with FASB Staff Position 157-2. The adoption of SFAS No. 157 did not have a
material impact on the Company’s financial position, results of operations or cash flows. See Note 14.
On January 1, 2008, the Company also adopted SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS No. 159 permits an entity to irrevocably elect fair value on a
contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets
and liabilities and certain other items including insurance contracts. Entities electing the fair value option
would be required to recognize changes in fair value in earnings and to expense upfront costs and fees
associated with the item for which the fair value option is elected. The adoption of SFAS No. 159 did not
have a material impact on the Company’s financial position, results of operations or cash flows for the
year ended December 31, 2008.
Estimates and Assumptions – The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Significant estimates are required as part of determining allowance for
doubtful accounts, estimated lives of property and equipment and intangibles, goodwill and long-lived
asset impairments, valuation allowances on deferred income taxes, and the potential outcome of future tax
consequences of events recognized in the Company’s financial statements or tax returns. Actual results
and outcomes may materially differ from management’s estimates and assumptions.
Reclassifications – Certain prior year amounts have been reclassified to conform to the current
presentation. Such reclassification had no effect on the net loss reported in the consolidated statements of
operations.
Recently Issued Accounting Pronouncements – In June 2008, the FASB ratified Emerging Issues Task
Force (―EITF‖) Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to
an Entity’s Own Stock. EITF No. 07-5 mandates a two-step process for evaluating whether an equity-
linked financial instrument or embedded feature is indexed to the entity’s own stock. EITF No. 07-5 is
effective for the Company beginning with its first quarter ended March 31, 2009. The Company does not
expect the adoption of EITF No. 07-5 will have a material impact on its financial condition or results of
operations.
In March 2008, the FASB issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging
Activities, an amendment of FASB Statement No. 133. SFAS No. 161 changes the disclosure requirements
for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures
about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related
hedged items are accounted for under Statement No. 133 and its related interpretations and (c) how
derivative instruments and related hedged items affect an entity’s financial position, financial
performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application encouraged. The Company
does not expect the adoption of SFAS No. 161 to have a material impact to its financial condition or
results of operations.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R)
retains the fundamental requirements in SFAS No. 141, Business Combinations, that the acquisition
method of accounting be used for all business combinations and for an acquirer to be identified for each
business combination. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the
F-20
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions specified in SFAS No. 141(R). In addition, SFAS
No. 141(R) requires acquisition costs and restructuring costs that the acquirer expected but was not
obligated to incur to be recognized separately from the business combination, therefore, expensed instead
of part of the purchase price allocation. SFAS No. 141(R) will be applied prospectively to business
combinations for which the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early adoption is prohibited. The Company will adopt
SFAS No. 141(R) to any business combinations after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements, an amendment to ARB No. 51. SFAS No. 160 changes the accounting and reporting for
minority interests, which will be recharacterized as noncontrolling interests and classified as a component
of equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Early adoption is prohibited. Upon adoption on January 1,
2009, the Company will present its Noncontrolling Interest in Variable Interest Entity within
Stockholders’ Equity in its consolidated balance sheets. The Company does not expect the adoption of
SFAS No. 160 to have a material impact to its financial condition or results of operations.
2. ACQUISITION OF INTEREST IN FRONT RANGE.
On October 17, 2006, the Company entered into a Membership Interest Purchase Agreement with Eagle
Energy to acquire Eagle Energy’s 42% interest in Front Range. Front Range was formed on July 29, 2004
to construct and operate a 50 million gallon dry mill ethanol plant in Windsor, Colorado. Front Range
began producing ethanol in June 2006.
As consideration for the acquisition of Eagle Energy’s interest in Front Range, the Company paid to
Eagle Energy $30,000,000 in cash, 2,081,888 shares of common stock valued at $30,008,000 under the
valuation provisions of the agreement and a warrant to purchase up to 693,963 shares of common stock at
an exercise price of $14.41 per share. The warrant expired unexercised on October 17, 2007. The
Company utilized EITF Issue No. 99-12, Determination of the Measurement Date for the Market Price of
Acquirer Securities Issued in a Purchase Business Combination, to establish the market price of the
securities issued in the transaction where the measurement date was determined to be the date at which
the number of acquirer shares and the amount of consideration becomes fixed and determinable without
subsequent revision. In the transaction, the measurement date on which the shares to be issued became
fixed and determinable was October 17, 2006 and the common stock valuation price was $14.41 per
share, pursuant to the terms of the Front Range acquisition agreement, whereby the 10-day volume-
weighted-average trading price prior to closing was used in determining the number of exercisable shares
in the warrant. Using the Black-Scholes option-pricing model, the value of this warrant on the
measurement date was $5,087,000. The total value of the consideration paid to Eagle Energy was
$65,095,000. The Company incurred, and has capitalized, transaction costs associated with this
acquisition of $517,000. The following summarizes the Company’s estimated fair values of the Front
Range tangible and intangible assets and liabilities acquired, which have been revised for activity in 2007
as discussed in Note 4 (in thousands):
F-21
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total Current Assets
Property and Equipment
Other Assets
Intangible Assets:
Customer backlogs
Non-compete covenants
Goodwill
Total Intangible Assets
Total Assets
Total Current Liabilities
Long Term Debt
Total Liabilities
Noncontrolling interest in variable interest entity
Net Assets
Cash issued to Eagle Energy
Stock issued to Eagle Energy
Value of warrant issued to Eagle Energy
Acquisition expenses
Transaction value
$ 15,090
92,376
584
3,900
400
83,468
87,768
195,818
(10,847)
(28,753)
(39,600)
(90,606)
$ 65,612
$ 30,000
30,008
5,087
517
$ 65,612
Prior to the Company’s acquisition of its ownership interest in Front Range, the Company, directly or
through one of its subsidiaries, had entered into four marketing and management agreements with Front
Range.
The Company entered into a marketing agreement with Front Range on August 19, 2005 that provided the
Company with the exclusive right to act as an agent to market and sell all of Front Range’s ethanol
production. The marketing agreement was amended on August 9, 2006 to extend the Company’s
relationship with Front Range to allow the Company to act as a merchant under the agreement. The
marketing agreement was amended again on October 17, 2006 to provide for a term of six and a half
years with provisions for annual automatic renewal thereafter.
The Company entered into a grain supply agreement with Front Range on August 20, 2005 (amended
October 17, 2006) under which the Company is to negotiate on behalf of Front Range all grain purchase,
procurement and transport contracts. The Company is to receive a $1.00 per ton fee related to this service.
The grain supply agreement has a term of two and a half years with provisions for annual automatic
renewal thereafter.
The Company entered into a WDG marketing and services agreement with Front Range on August 19,
2005 (amended October 17, 2006) that provided the Company with the exclusive right to market and sell
all of Front Range’s WDG production. The Company is to receive the greater of a 5% fee of the amount
sold or $2.00 per ton. The WDG marketing and services agreement has a term of two and a half years
with provisions for annual automatic renewal thereafter. In February 2009, the Company and Front Range
terminated this agreement and entered into a new agreement with similar terms. The revised WDG
marketing and services agreement continues through May 2009.
The Company entered into a management agreement with Front Range on August 30, 2005 under which
the Company is to provide management services to Front Range relating to construction management and
operational support. These services are advisory in nature as Front Range management retains ultimate
decision making authority. The Company is to receive an annual management fee of $150,000 under this
F-22
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
agreement. The management agreement has a term of three years with provisions for annual automatic
renewal thereafter. This agreement was terminated by mutual agreement on February 28, 2007.
The Company’s acquisition of its ownership interest in Front Range does not impact the Company’s
rights or obligations under any of these agreements.
3. PROPERTY AND EQUIPMENT.
Property and equipment consisted of the following (in thousands):
Facilities and plant equipment
Land
Other equipment, vehicles and furniture
Water rights – capital lease
Construction in progress
Accumulated depreciation
December 31,
2008
549,829
5,778
4,787
1,613
11,655
573,662
(43,625)
530,037
$
$
2007
262,235
5,848
3,703
1,613
213,157
486,556
(17,852)
468,704
$
$
In connection with the Company’s construction of its four ethanol production facilities, it has recorded
capitalized interest during their construction and is included in property and equipment. At December 31,
2008, capitalized interest of $16,270,000 is included in facilities and plant equipment and $1,410,000 is
included in construction in progress. At December 31, 2007, capitalized interest of $5,961,000 is included
in construction in progress. Depreciation expense was $25,940,000, $13,682,000 and $2,284,000 for the
years ended December 31, 2008, 2007 and 2006, respectively.
In 2008, the Company performed its impairment analysis for the asset group associated with its
suspended plant construction project in the Imperial Valley near Calipatria, California (―Imperial
Project‖). The asset group consisted of construction in progress of $43,751,000. In addition, the Imperial
Project had construction-related accounts payable and accrued expenses of $17,245,000. The Company
does not intend to resume construction of its Imperial Project. In November, 2008, the Company began
proceedings to liquidate these assets and liabilities. After assessing the estimated undiscounted cash
flows, the Company recorded an impairment charge of $40,900,000, thereby reducing its property and
equipment by that amount. To the extent the Company is relieved of the related liabilities, the Company
may record a gain in the period in which the relief occurs.
The ethanol industry has experienced significant adverse conditions over the course of the last 12 months,
including prolonged negative operating margins. The Company has also experienced these adverse
conditions as well as severe working capital and liquidity shortages, and in response to such conditions,
the Company has reduced its production significantly until market conditions resume to acceptable levels
and working capital becomes available. The Company first reduced production in December 2008 and
continued to reduce production through the first quarter of 2009. As of the end of February 2009, the
Company has ceased production at its Madera, Magic Valley and Stockton facilities. The Company
continues to operate its Columbia and Front Range facilities. The Company continues to assess market
conditions and when appropriate, provided it has adequate available working capital, the Company plans
to bring these facilities back to operation.
F-23
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 2008, the Company completed construction of its ethanol production facilities, with installed capacity
of 220 million gallons per year, its goal since 2005. The carrying value of these facilities at December 31,
2008 was approximately $436.0 million. In accordance with the Company’s policy for evaluating
impairment of long-lived assets in accordance with SFAS No. 144, management has evaluated the
facilities for possible impairment based on projected future cash flows from operations of these facilities,
including the above mentioned suspensions of its facilities in the near term. Management has determined
that the undiscounted cash flows from operations of these facilities over their estimated useful lives
exceed their carrying values, and therefore, no impairment has been recognized at December 31, 2008. In
determining future undiscounted cash flows, the Company has made significant assumptions concerning
the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol
and the overall demand in relation to production and supply capacity. If the Company were required to
compute the fair value in the future, it may use the work of a qualified valuation specialist who would
assist it in examining replacement costs, recent transactions between third parties and cash flow that can
be generated from operations. Given the recent completion of the facilities, replacement cost would likely
approximate the carrying value of the facilities. However, there have been recent transactions between
independent parties to purchase plants at prices substantially below the carrying value of the facilities.
Some of the facilities have been in bankruptcy and may not be representative of transactions outside of
bankruptcy. Given these circumstances, should management be required to adjust the carrying value of
the facilities to fair value at some future point in time, the adjustment could be significant and could
significantly impact the Company’s financial position and results of operation. No adjustment has been
made in these financial statements for this uncertainty.
4. GOODWILL AND OTHER INTANGIBLE ASSETS.
The table below represents the net balances for goodwill and intangible assets (in thousands):
Useful
Life
(Years)
Gross
December 31, 2008
Accumulated
Amortization/
Impairment
Net Book
Value
Gross
December 31, 2007
Accumulated
Amortization/
Impairment
Net Book
Value
$
88,168 $
2,678
88,168
—
$
10
2-3
4,741
1,095
1,789
1,095
— $
2,678
2,952
—
88,168 $
2,678
— $
—
88,168
2,678
4,741
1,095
1,314
876
3,427
219
$
96,682 $
91,052
$
5,630 $
96,682 $
2,190 $
94,492
Non-Amortizing:
Goodwill recognized in
business combinations
Tradename
Amortizing:
Customer relationships
Non-compete covenants
Total goodwill and
intangible assets
Goodwill – The Company recorded goodwill of $2,566,000 as part of the Share Exchange Transaction.
The Company originally recorded goodwill of $80,607,000 as part of the Company’s purchase of
ownership interests in Front Range for the year ended December 31, 2006. During the year ended
December 31, 2007, the Company adjusted the purchase price allocation, increasing goodwill and accrued
liabilities in the aggregate amount of $2,861,000, due to recognition of additional liabilities that existed at
the time of the acquisition.
In 2008, the Company adjusted its goodwill associated with its acquisition of ownership interests in Front
Range resulting in a decrease of goodwill of $1,121,000. Additionally, the Company performed its annual
review of impairment of goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets, as of March 31, 2008. The Company’s annual review estimated the fair value of its single
reporting unit to be below its carrying value. As a result, the Company recognized an impairment charge
F-24
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on its remaining goodwill of $87,047,000, reducing its goodwill balance to zero. The Company did not
record any goodwill impairments for the years ended December 31, 2007 and 2006.
Tradename – The Company recorded tradename of $2,678,000 as part of the Share Exchange
Transaction. The Company determined that the tradename has an indefinite life and therefore, rather than
being amortized, will, be tested annually for impairment. The Company did not record any impairment on
its tradename for the years ended December 31, 2008, 2007 and 2006.
Customer Relationships – The Company recorded customer relationships of $4,741,000 as part of the
Share Exchange Transaction. The Company has established a useful life of ten years for these customer
relationships.
Non-Compete Covenants – The Company recorded non-compete covenants of $400,000 as part of the
Company’s purchase of ownership interest in Front Range and $695,000 as part of the Share Exchange
Transaction. The Company has established estimated useful lives of two and three years, respectively, for
these non-compete covenants.
Amortization expense associated with intangible assets totaled $693,000, $3,831,000 and $1,714,000 for
the years ended December 31, 2008, 2007 and 2006, respectively. The weighted-average unamortized life
of the customer relationships is 6.2 years.
The expected amortization expense relating to amortizable intangible assets in each of the five years after
December 31, 2008, are (in thousands):
Years Ended
December 31,
2009
2010
2011
2012
2013
Thereafter
Total
Amount
$ 474
474
474
474
474
582
$ 2,952
5. SHORT-TERM NOTE PAYABLE.
In November 2007, the Company issued an unsecured note payable for $6,000,000 to finance short-term
cash needs related to its plant construction activities. This note was for final construction costs related to
its Columbia facility and did not result in any cash proceeds to the Company. The note required monthly
principal payments of $500,000 and accrued interest. The note was paid in full at December 31, 2008.
6. DERIVATIVES.
The business and activities of the Company expose it to a variety of market risks, including risks related
to changes in commodity prices and interest rates. The Company monitors and manages these financial
exposures as an integral part of its risk management program. This program recognizes the
unpredictability of financial markets and seeks to reduce the potentially adverse effects that market
volatility could have on operating results. The Company accounts for its use of derivatives related to its
hedging activities pursuant to SFAS No. 133, under which the Company recognizes all of its derivative
instruments in its statement of financial position as either assets or liabilities, depending on the rights or
F-25
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
obligations under the contracts, unless the contracts qualify as a normal purchase or normal sale as further
discussed below. The Company has designated and documented contracts for the physical delivery of
commodity products to and from counterparties as normal purchases and normal sales. Derivative
instruments are measured at fair value. Changes in the derivative’s fair value are recognized currently in
income unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows
a derivative’s effective gains and losses to be deferred in accumulated other comprehensive income (loss)
and later recorded together with the gains and losses to offset related results on the hedged item in
income. Companies must formally document, designate and assess the effectiveness of transactions that
receive hedge accounting. Contracts designated and documented as normal purchases or normal sales are
not recorded at fair value.
Commodity Risk – Cash Flow Hedges – The Company uses derivative instruments to protect cash flows
from fluctuations caused by volatility in commodity prices for periods of up to twelve months in order to
protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sale
and purchase commitments where the prices are set at a future date and/or if the contracts specify a
floating or index-based price for ethanol. In addition, the Company hedges anticipated sales of ethanol to
minimize its exposure to the potentially adverse effects of price volatility. These derivatives are
designated and documented as SFAS No. 133 cash flow hedges and effectiveness is evaluated by
assessing the probability of the anticipated transactions and regressing commodity futures prices against
the Company’s purchase and sales prices. Ineffectiveness, which is defined as the degree to which the
derivative does not offset the underlying exposure, is recognized immediately in cost of goods sold.
For the year ended December 31, 2008, a loss from ineffectiveness in the amount of $991,000 and an
effective gain in the amount of $566,000 were recorded in cost of goods sold. For the year ended
December 31, 2007, a gain from ineffectiveness in the amount of $2,832,000 and an effective loss in the
amount of $1,680,000 were recorded in cost of goods sold. For the year ended December 31, 2006, losses
of ineffectiveness in the amount of $239,000 and an effective loss in the amount of $438,000 was
recorded in cost of goods sold. For the year ended December 31, 2006, an effective gain in the amount of
$1,281,000 was recorded in net sales. The notional balances remaining on these derivatives as of
December 31, 2008 and 2007 were $0 and $2,427,000, respectively.
Commodity Risk – Non-Designated Hedges – As part of the Company’s risk management strategy, it uses
forward contracts on corn, crude oil and reformulated blendstock for oxygenate blending gasoline to lock
in prices for certain amounts of corn, denaturant and ethanol, respectively. These derivatives are not
designated under SFAS No. 133 for special hedge accounting treatment. The changes in fair value of
these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold. The
Company recognized a loss of $2,395,000 (of which $1,131,000 is related to settled non-designated
hedges), $6,484,000 and $0 as the change in the fair value of these contracts for the years ended
December 31, 2008, 2007 and 2006, respectively. The notional balances remaining on these contracts as
of December 31, 2008 and 2007 were $4,215,000 and $29,999,000, respectively.
Interest Rate Risk – As part of the Company’s interest rate risk management strategy, the Company uses
derivative instruments to minimize significant unanticipated income fluctuations that may arise from
rising variable interest rate costs associated with existing and anticipated borrowings. To meet these
objectives the Company purchased interest rate caps and swaps. The rate for notional balances of interest
rate caps ranging from $4,268,000 to $18,990,000 is 5.50%-6.00% per annum. The rate for notional
balances of interest rate swaps ranging from $543,000 to $57,654,000 is 5.01%-8.16% per annum.
These derivatives are designated and documented as SFAS No. 133 cash flow hedges and effectiveness is
evaluated by assessing the probability of anticipated interest expense and regressing the historical value of
F-26
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the rates against the historical value in the existing and anticipated debt. Ineffectiveness, reflecting the
degree to which the derivative does not offset the underlying exposure, is recognized immediately in other
income (expense). For the year ended December 31, 2008, gains from ineffectiveness in the amount of
$4,999,000, gains from effectiveness in the amount of $75,000 and losses from undesignated hedges in
the amount of $6,456,000 were recorded in other income (expense). These gains and losses resulted
primarily from the Company’s efforts to restructure its debt financing and, therefore, making it not
probable that the related borrowings would be paid as designated. As such the Company de-designated
certain of its interest rate caps and swaps.
For the year ended December 31, 2007, losses from ineffectiveness in the amount of $4,836,000, losses
from effectiveness in the amount of $147,000 and losses from undesignated hedges in the amount of
$606,000 were recorded in other income (expense). These losses resulted primarily from the Company’s
deferral of constructing its Imperial Valley facility. (See Note 3.) During the year ended December 31,
2006, ineffectiveness in the amount of $24,000 was recorded in other income (expense). Amounts
remaining in accumulated other comprehensive income (loss) were reclassified to income upon the
recognition of the hedged interest expense.
The Company marked its derivative instruments to fair value at each period end, except for those
derivative contracts that qualified for the normal purchase and sale exemption under SFAS No. 133.
Accumulated Other Comprehensive Income – Accumulated other comprehensive income relative to
derivatives is as follows (in thousands):
Beginning balance, January 1, 2008
Net changes
Less: Amount reclassified to cost of goods sold
Less: Amount reclassified to other income (expense)
Ending balance, December 31, 2008
__________
*Calculated on a pretax basis
Commodity
Derivatives
Gain/(Loss)*
$ (455)
—
455
—
—
$
Interest Rate
Derivatives
Gain/(Loss)*
$ (1,928)
(2,637)
—
4,565
—
$
F-27
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEBT.
Long-term borrowings are summarized in the table below (in thousands):
$
Plant term loans, in forbearance
Plant working capital lines of credit, in forbearance
Kinergy operating line of credit, in forbearance
Notes payable to related party, in forbearance
Swap note, due 2011
Variable rate note, due 2011
Long-term revolving note
Front Range operating line of credit
Water rights capital lease obligations
December 31,
2008
2007
$
227,308
19,175
10,482
31,500
14,987
582
—
1,200
1,123
306,357
(305,420)
92,308
9,200
6,217
30,000
16,370
6,930
—
—
1,261
162,286
(11,098)
Less short-term portion
Long-term debt
$
937
$
151,188
Plant Term Loans & Working Capital Lines of Credit – On February 27, 2007, the Company closed a
debt financing transaction in the aggregate amount of up to $325,000,000 through certain of its wholly-
owned indirect subsidiaries (the ―Borrowers‖). The primary purpose of the debt financing (the ―Debt
Financing‖) was to provide debt financing for the development, construction, installation, engineering,
procurement, design, testing, start-up, operation and maintenance of five ethanol production facilities. On
November 27, 2007, the Company amended the agreement to apply to four ethanol production facilities,
thereby reducing the aggregate amount of available financing to up to $250,769,000. During 2008, the
Company completed construction of its Magic Valley and Stockton plants, each resulting in total draws
on the Company’s plant term loans and working capital lines of $69,231,000 and $5,000,000,
respectively. In addition, the Company utilized approximately $825,000 of its working capital and letter
of credit facility to obtain a letter of credit, which was outstanding at December 31, 2008.
The Debt Financing, as amended, included:
four construction loan facilities in an aggregate amount of up to $230,769,000. Loans made under
the construction loan facilities do not amortize, but require payment of accrued interest, and were
fully due and payable on the earlier of October 27, 2008 or the date the construction loans made
thereunder were converted into term loans (the ―Conversion Date‖), the latter of which was the
date the last of the four plants achieved commercial operations. On October 27, 2008, the
Company achieved commercial operations of its last plant, and at that time converted its
construction loans into term loans;
four term loan facilities in an aggregate amount of up to $230,769,000, which were intended to
refinance the loans made under the construction loan facilities. The term loans are to be repaid
ratably by each Borrower on a quarterly basis from and after the Conversion Date in an amount
equal to 1.5% of the aggregate original principal amount of the corresponding term loan. The
remaining principal balance and all accrued and unpaid interest on the term loans are fully due
and payable on the date that is 84 months after the Conversion Date; and
F-28
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
a working capital and letter of credit facility in an aggregate amount of up to $20,000,000
($5,000,000 per facility) that is fully due and payable on the date that is 12 months after the
Conversion Date. During the term of the working capital and letter of credit facility, the
Borrowers may borrow, repay and re-borrow amounts available under the facility.
Loans and letters of credit under the Debt Financing are subject to conditions precedent, including, among
others, the absence of a material adverse effect; the absence of defaults or events of defaults; the accuracy
of certain representations and warranties; the maintenance of a debt-to-equity ratio that is not in excess of
65:35; the contribution of all required equity by the Company to the Borrowers; and the attainment of at
least a 1.5-to-1.0 debt service coverage ratio. Loans made under the construction and term loan facilities
may not be re-borrowed once repaid or re-borrowed once prepaid.
In addition to scheduled principal payments, starting after the Conversion Date, the term loan facilities
require mandatory repayments of principal in amounts based on the Borrowers’ free cash flow. The
percentage of the Borrowers’ free cash flow to be applied to principal repayments is to vary from 50% in
the first two years following the Conversion Date to 75-100% in succeeding years, based upon repayment
amounts measured against targeted balances.
Borrowings and the Borrowers’ obligations under the Debt Financing are secured by a first-priority
security interest in all of the equity interests in the Borrowers and substantially all the assets of the
Borrowers. The security interests granted by the Borrowers under the Debt Financing restrict the assets
and revenues of the Borrowers and therefore may inhibit the Company’s ability to obtain other debt
financing.
installation, engineering, procurement, design,
In connection with the Debt Financing, the Company also entered into a Sponsor Support Agreement
under which the Company is to provide limited contingent equity support in connection with the
development, construction,
testing, start-up and
maintenance of the four ethanol production facilities. In particular, the Company has agreed to provide a
warranty with respect to all ethanol plants other than its Madera facility, which is under standard warranty
through the contractor. The warranty obligations of the Company with respect to the other three facilities
extend one year beyond the commercial operations start date of each facility. The warranty obligations
will cease in October 2009, one year from the date the final ethanol plant started commercial operations.
The Company’s obligations under the warranty are capped at approximately $28,000,000. Until the
Company’s contingent equity obligations have been fully performed or the warranty period has expired,
the Company may not incur any secured indebtedness for borrowed money, grant liens on its assets or
provide any secured credit enhancements in an aggregate amount in excess of $10,000,000 unless the
Company provides the lenders under the Debt Financing with the same liens or credit support.
The Company incurred $13,317,000 of costs associated with the completion of the Debt Financing
arrangement and has capitalized these costs in other assets, except the portion amortizing during the next
twelve months, which is classified in other current assets. In connection with the amendment discussed
above, the Company recognized a write-off of the corresponding facility’s related unamortized financing
costs of approximately $1,962,000 for the year ended December 31, 2007. For the other facilities, the
Company recognized amortization of financing costs of approximately $2,018,000 and $2,764,000 for the
years ended December 31, 2008 and 2007. The remaining unamortized financing costs continue to be
amortized over a seven-year life.
In March 2008, the Company became aware of various events or circumstances which constituted
defaults under its credit agreement. On March 26, 2008, the Company obtained waivers from its lenders
as to these defaults and was required to pay the lenders a consent fee in an aggregate amount of $521,000.
F-29
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition to the waivers, the Company’s lenders agreed to amend the Debt Financing. These
amendments include an increase in the frequency with which the Company is to deposit certain revenues
into a restricted account each month, an increase of allowable Eurodollar loans from a maximum of seven
to a maximum of ten, and the Company was required to pay all remaining project costs on its Madera and
Columbia plants by May 16, 2008.
In February, 2009, the Company became aware of new and potential events which constituted defaults
under its credit agreement. In February 2009, the Company obtained a waiver and forbearance agreement
with its lenders which was extended in March 2009. The waiver and forbearance agreement, as extended,
provides that the lenders will forbear from exercising their rights and remedies under the Debt Financing
commencing February 17, 2009 and ending on April 30, 2009. Further the waiver and forbearance
agreement provides that the Company may withdraw funds otherwise required to be reserved in two
accounts designated solely for the Stockton facility and the other for future debt service payments. The
use of these funds provides approximately $5,385,000 million to the Company for operating activities.
Further, the lenders have allowed the Company to cease payments of principal and interest due during the
forbearance period. Finally, under the terms of the forbearance agreement, the Company’s obligations
will accrue interest at a rate that is based on the Prime Rate as published by the Wall Street Journal plus
applicable spreads, resulting in rates ranging from 8.29% to 9.35%. Upon expiration of the forbearance
period, or the Company’s earlier default under the terms of the forbearance, the Company will be required
to repay all outstanding amounts owed to its lenders. The Company is presently attempting to negotiate
debt restructuring terms with its lenders. However, the Company cannot provide any assurance that it will
be able to successfully negotiate satisfactory terms with its lenders.
Kinergy Operating Line of Credit – Kinergy was originally a party to a $17,500,000 credit facility dated
as of August 17, 2007 with Comerica Bank. Kinergy’s obligations to Comerica Bank were secured by
substantially all of its assets, subject to certain customary exclusions and permitted liens, and were
guaranteed by the Company. On May 12, 2008, Kinergy and Comerica entered into a forbearance
agreement. The forbearance agreement identified certain existing defaults under the credit facility and
provided that Comerica Bank would forbear for a period of time (the ―Forbearance Period‖) commencing
on May 12, 2008 and ending on the earlier to occur of (i) August 15, 2008, and (ii) the date that any new
default occurred under the Loan Documents, from exercising its rights and remedies under the Loan
Documents and under applicable law.
On July 28, 2008, Kinergy entered into a new Loan and Security Agreement (the ―Loan Agreement‖)
dated July 28, 2008 with Wachovia Capital Finance Corporation (Western) (―Agent‖) and Wachovia
Bank, National Association (―Wachovia‖). Kinergy initially used the proceeds from the closing of this
credit facility to repay all amounts outstanding under its credit facility with Comerica Bank and to pay
certain closing fees.
The original terms of the Loan Agreement provided for a credit facility in an aggregate amount of up to
$40,000,000 based on Kinergy’s eligible accounts receivable and inventory levels, subject to any reserves
established by Agent. Kinergy could also obtain letters of credit under the credit facility, subject to a letter
of credit sublimit of $10,000,000. The credit facility was subject to certain other sublimits, including as to
inventory loan limits. Kinergy could have requested an increase in the amount of the facility in
increments of not less than $2,500,000, up to a maximum aggregate credit limit of $45,000,000, but
Wachovia had no obligation to agree to any such request. The Loan Agreement also contained restrictions
on distributions of funds from Kinergy to the Company. In addition, the Loan Agreement contained a
single financial covenant requiring that Kinergy generate EBITDA in specified amounts during 2008 and
2009. For subsequent periods, the minimum EBITDA covenant amounts were to be determined based
F-30
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
upon financial projections to be delivered by Kinergy and shall be mutually agreed upon by Kinergy and
Agent.
Kinergy paid customary closing fees, including a closing fee of 0.50% of the maximum credit, or
$200,000, to Wachovia, and $150,000 in legal fees to legal counsel to Agent and Wachovia. On July 28,
2008, the Company entered into a Guarantee dated July 28, 2008 in favor of Agent for and on behalf of
Wachovia. The Guarantee provides for the unconditional guarantee by the Company of, and the Company
agreed to be liable for, the payment and performance when due of Kinergy’s obligations under the Loan
Agreement.
In February 2009, Kinergy determined it had violated certain of its covenants, including its EBITDA
covenant for 2008, and as a result, entered into an amendment and forbearance agreement which was
extended in March 2009 (―Amendment‖) with Agent and Wachovia. The Amendment identified certain
defaults under the Loan Agreement, as to which Agent and Wachovia agreed to forebear from exercising
their rights and remedies under the Loan Agreement commencing February 13, 2009 through April 30,
2009. The Amendment reduced the aggregate amount of the credit facility from up to $40,000,000 to
$10,000,000.
The Amendment also increased the interest rates. Kinergy may borrow under the credit facility based
upon (i) a rate equal to (a) the London Interbank Offered Rate (―LIBOR‖), divided by 0.90 (subject to
change based upon the reserve percentage in effect from time to time under Regulation D of the Board of
Governors of the Federal Reserve System), plus (b) 4.50% depending on the amount of Kinergy’s
EBITDA for a specified period, or (ii) a rate equal to (a) the greater of the prime rate published by
Wachovia Bank from time to time, or the federal funds rate then in effect plus 0.50%, plus (b) 2.25%
depending on the amount of Kinergy’s EBITDA for a specified period. In addition, Kinergy is required to
pay an unused line fee at a rate equal to 0.375% as well as other customary fees and expenses associated
with the credit facility and issuances of letters of credit. Kinergy’s obligations under the Loan Agreement
are secured by a first-priority security interest in all of its assets in favor of Agent and Wachovia.
The credit facility originally matured on July 28, 2011, unless sooner terminated. Kinergy is permitted to
terminate the credit facility early upon ten days prior written notice. Agent and Wachovia may terminate
the credit facility early at any time on or after an event of default has occurred and is continuing. In the
event the credit facility is for any reason terminated prior to the maturity date, Kinergy will be required to
pay an early termination fee ranging from 0.50% to 1.00% of the maximum credit, based on the date of
termination if the credit facility is terminated on or before July 29, 2010.
Upon expiration of the Amendment, Kinergy will be required to repay all outstanding amounts to Agent
and Wachovia, and as such, the Company has reclassified all amounts to current on its consolidated
balance sheet. The Company is attempting to negotiate new terms satisfactory to Kinergy, Agent and
Wachovia.
Notes Payable to Related Party – In November 2007, Pacific Ethanol Imperial, LLC (―PEI Imperial‖), an
indirect subsidiary of the Company, borrowed $15,000,000 from Lyles United, LLC under a Secured
Promissory Note containing customary terms and conditions. The loan accrued interest at a rate equal to
the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 2.00%, computed
on the basis of a 360-day year of twelve 30-day months. The loan was due 90-days after issuance or, if
extended at the option of PEI Imperial, 365-days after the end of such 90-day period. This loan was
extended by PEI Imperial to February 25, 2009. The Secured Promissory Note provided that if the loan
was extended, the Company was to issue a warrant to purchase 100,000 shares of the Company’s
F-31
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
common stock at an exercise price of $8.00 per share. The Company issued this warrant simultaneously
with the closing of the issuance of the Company’s Series B Preferred Stock on March 27, 2008. The
warrant is exercisable at any time during the 18-month period after the date of issuance.
In December 2007, PEI Imperial borrowed an additional $15,000,000 from Lyles United, LLC under a
second Secured Promissory Note containing customary terms and conditions. The loan accrued interest at
a rate equal to the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus
4.00%, computed on the basis of a 360-day year of twelve 30-day months. The loan was due on March
31, 2008, but was extended at the option of PEI Imperial, to March 31, 2009. As a result of the extension,
the interest rate increased by 2.00% to the rate indicated above.
In November 2008, PEI Imperial restructured its aggregate $30,000,000 loan from Lyles United, LLC by
paying all accrued and unpaid interest thereon and assigning the aforementioned two Secured Promissory
Notes to the Company. The Company issued an Amended and Restated Promissory Note in the principal
amount of $30,000,000 and Lyles United, LLC cancelled the two Secured Promissory Notes. The
Amended and Restated Promissory Note is due March 15, 2009 and accrues interest at the Prime Rate of
interest as reported from time to time in The Wall Street Journal, plus 3.00%, computed on the basis of a
360-day year of twelve 30-day months. The Company and Lyles United, LLC (―Lyles United‖) jointly
instructed Pacific Ethanol California, Inc. (―PEI California‖) pursuant to an Irrevocable Joint Instruction
Letter to remit directly to Lyles United, LLC any cash distributions received by PEI California on account
of its ownership interests in PEI Imperial and Front Range until such time as the Amended and Restated
Promissory Note is repaid in full. In addition, PEI California entered into a Limited Recourse Guaranty to
the extent of such cash distributions in favor of Lyles United, LLC. Finally, Pacific Ag. Products, LLC
entered into an Unconditional Guaranty as to all of the Company’s obligations under the Amended and
Restated Promissory Note and pledged all of its assets as security therefore pursuant to a Security
Agreement.
In October 2008, upon completion of the Stockton facility, the Company converted final unpaid
construction costs to an unsecured note payable. The note payable is between the Company and Lyles
Mechanical Co. in the principal amount of $1,500,000 and is due with accrued interest on March 31,
2009. Interest accrues at the Prime Rate of interest as reported from time to time in the Wall Street
Journal, plus 2.00%, computed on the basis of a 360-day year of twelve 30-day months.
In February 2009, the Company notified Lyles United and Lyles Mechanical that it would not be able to
pay off its notes due March 15, and March 31, 2009 and as a result, entered into a forbearance agreement,
which was extended in March 2009. Under the terms of the forbearance agreement, as extended, Lyles
United and Lyles Mechanical agreed to forbear from exercising their rights and remedies against the
Company through April 30, 2009. Upon expiration of the forbearance agreement, the Company will be
required to repay the amounts due to Lyles United and Lyles Mechanical, and as such, the Company has
classified all amounts in current liabilities on its consolidated balance sheet.
Swap Note – The swap note is a term loan, with a floating interest rate, established on a quarterly basis,
equal to the 90-day LIBOR plus 3.00%. The Company has entered into a swap contract with the lender to
provide a fixed rate of 8.16%. The loan matures in five years, but has required principal payments due
based on a ten-year amortization schedule. Quarterly payments are approximately $678,000, including
interest with final payment due November 10, 2011.
Variable Rate Note – The variable rate note is a term loan that carries an interest rate that will float at a
rate equal to the 90-day LIBOR plus 2.75-3.50%, depending on a debt-to-net worth ratio. As of December
F-32
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
31, 2008, the interest rate was 5.39%. The variable loan matures in five years but is amortized over 10
years with a final payment due November 10, 2011. Quarterly payments of approximately $654,000
which are applied in a cascading order, as follows: long-term revolving note interest, variable rate note
interest, variable rate note principal and long-term revolving note principal.
Front Range Operating Line of Credit – Front Range has a line of credit of $3,500,000 with a commercial
bank to support working capital, specifically inventories and accounts receivable. The line of credit
expires November 24, 2009 and bears interest at a rate equal to the 30-day LIBOR plus 3.75%. The line
of credit is secured by substantially all of the assets of Front Range.
Long-Term Revolving Note – The long-term revolving note is a revolving loan in the amount of
$5,000,000 and carries an interest rate that will float at a rate equal to the 30-day LIBOR, plus 2.75-
3.50%, depending on a debt-to-net worth ratio. As of December 31, 2008, the interest rate was 5.39%.
Repayment terms are included above in the description of the variable rate note.
The swap note, variable rate note and long-term revolving note are due in 2011, and include an
accelerated principal reduction provision based on excess net cash flow. Excess net cash flow is measured
on an annual basis and is defined as net income before interest expense, income taxes, depreciation and
amortization and after giving effect to scheduled loan payments and capital expenditures. The provision
requires the Company to pay 20% of its excess net cash flow within 120 days of its year end; however,
this amount is not to exceed $4,000,000 per fiscal year. The accelerated payment for the year ended
December 31, 2008 and 2007 is $0 and $4,000,000, respectively, and had the effect of increasing the
maturities of long-term debt due in 2008 and 2007 and decreasing the future maturities of long-term debt
that would have been due in 2011.
The three notes listed above represent permanent financing and are collateralized by a perfected, first-
priority security interest in all of the assets of Front Range, including inventories and all rights, title and
interest in all tangible and intangible assets of Front Range; a pledge of 100% of the ownership interest in
Front Range; an assignment of all revenues produced by Front Range; a pledge and assignment of Front
Range’s material contracts and documents, to the extent assignable; all contractual cash flows associated
with such agreements; and any other collateral security as the lender may reasonably request.
These collateralizations restrict the assets and revenues as well as future financing strategies of Front
Range, the Company’s variable interest entity, but do not apply to, nor have bearing upon any financing
strategies that the Company may choose to undertake in the future.
The carrying values and classification of assets that are collateral for the obligations of Front Range at
December 31, 2008 are as follows (in thousands):
Current assets
Property and equipment
Other assets
Total collateralized assets
$ 19,369
49,231
388
$ 69,988
Front Range is subject to certain loan covenants. Under these covenants, Front Range is required to
maintain a certain fixed-charge coverage ratio, a minimum level of working capital and a minimum level
of net worth. The covenants also set a maximum amount of additional debt that may be incurred by Front
Range. The covenants also limit annual distributions that may be made to owners of Front Range,
including the Company, based on Front Range’s leverage ratio. Front Range is currently out of
F-33
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
compliance with certain of its covenants and is currently seeking a waiver from its lender. Until a waiver
is obtained, the Company has reclassified the related outstanding balance on the loan to current.
Water Rights Capital Lease – The water rights lease obligation relates to a lease agreement with the Town
of Windsor for augmentation water for use in Front Range’s production processes. The lease required an
initial payment of $400,000, paid in 2006, and annual payments of $160,000 per year for the following
ten years. The future payments were discounted using a 5.25% interest rate which was comparable to
available borrowing rates at the time of execution of the agreement. The obligation has been recorded as a
capital lease and included in long-term obligations and the related asset has been included in property and
equipment.
Interest Expense on Borrowings – Interest expense on all borrowings discussed above was $12,271,000,
$1,882,000 and $720,000, for the years ended December 31, 2008, 2007 and 2006, respectively. These
amounts were net of capitalized interest and deferred financing fees of $9,186,000, $8,494,000 and
$671,000 for the years ended December 31, 2008, 2007 and 2006, respectively, and included the
Company’s construction costs of plant and equipment.
The amounts of long-term debt maturing, including current debt in forbearance, due in each of the next
five years are included below (in thousands):
Years Ended
December 31,
2009
2010
2011
2012
2013
Thereafter
Total
Amount
$ 305,420
130
122
123
130
432
$ 306,357
8. INCOME TAXES.
The asset and liability method is used to account for income taxes. Under this method, deferred tax assets
and liabilities are recognized for tax credits and for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be recovered or settled. A
valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more
likely than not that such assets will be realized.
The Company files a consolidated federal income tax return. This return includes all corporate companies
80% or more owned by the Company as well as the Company’s pro-rata share of taxable income from
pass-through entities in which the Company holds an ownership interest. State tax returns are filed on a
consolidated, combined or separate basis depending on the applicable laws relating to the Company and
its subsidiaries.
The Company recorded no provision for income taxes for each of the years ended December 31, 2008,
2007 and 2006.
F-34
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the differences between the United States statutory federal income tax rate and the
effective tax rate as provided in the consolidated statements of operations is as follows:
Statutory rate
State income taxes, net of federal benefit
Change in valuation allowance
Impairment of Kinergy goodwill
Valuation allowance relating to equity items
Non-deductible items
Prior year purchase accounting adjustment
Other
Effective rate
Years Ended December 31,
2008
2007
2006
(35.0)%
(4.3)
37.6
1.1
0.7
—
—
(0.1)
0.0%
(35.0)%
(5.9)
49.1
—
(8.3)
0.8
—
(0.7)
0.0%
(35.0)%
—
(2,091.8)
—
369.8
15.6
1,599.9
141.5
0.0%
Deferred income taxes are provided using the asset and liability method to reflect temporary differences
between the financial statement carrying amounts and tax bases of assets and liabilities using presently
enacted tax rates and laws. The components of deferred income taxes included in the consolidated balance
sheets were as follows (in thousands):
Deferred tax assets:
Net operating loss carryforward
Impairment of asset group
Investment in partnerships
Derivative instruments mark-to-market
Stock option compensation
Other accrued liabilities
Available-for-sale securities
Other
Total deferred tax assets
Deferred tax liabilities:
Fixed assets
Intangibles
Investment in partnerships
Total deferred tax liabilities
Valuation allowance
Net deferred tax liabilities
Classified in balance sheet as:
Deferred income tax benefit (current assets)
Deferred income taxes (long-term liability)
December 31,
2008
2007
$ 61,474
16,188
8,852
2,452
2,494
124
—
1,920
93,504
(26,952)
(2,265)
—
(29,217)
(65,378)
(1,091)
—
(1,091)
(1,091)
$
$
$
$ 23,218
—
—
2,341
1,339
189
970
132
28,189
(15,318)
(2,513)
(995)
(18,826)
(10,454)
(1,091)
—
(1,091)
(1,091)
$
$
$
At December 31, 2008 and 2007, the Company had federal net operating loss carryforwards of
approximately $169,157,000 and $71,466,000, and state net operating
loss carryforwards of
approximately $149,124,000 and $67,392,000, respectively. These net operating loss carryforwards
expire at various dates beginning in 2013. The deferred tax asset for the Company’s net operating loss
F-35
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
carryforwards at December 31, 2008 does not include $5,442,000 which relates to the tax benefits
associated with warrants and non-statutory options exercised by employees, members of the board and
others under the various incentive plans. These tax benefits will be recognized in stockholders’ equity
rather than in the statements of operations in accordance with SFAS No. 109 but not until the period that
these amounts decrease taxes payable.
A portion of the Company’s net operating loss carryforwards will be subject to provisions of the tax law
that limit the use of losses incurred by a company prior to becoming a member of a consolidated group as
well as losses that existed at the time there is a change in control of an enterprise. The amount of the
Company’s net operating loss carryforwards that would be subject to these limitations was approximately
$7,728,000 at December 31, 2008.
In assessing whether the deferred tax assets are realizable, SFAS No. 109 establishes a more likely than
not standard. If it is determined that it is more likely than not that deferred tax assets will not be realized,
a valuation allowance must be established against the deferred tax assets. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income during the periods in which
the associated temporary differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income and tax planning strategies in making this
assessment.
A valuation allowance has been established in the amount of $65,378,000 and $10,454,000 at December
31, 2008 and 2007, respectively, based on Company’s assessment of the future realizability of certain
deferred tax assets. For the years ending December 31, 2008 and 2007, the Company recorded an increase
in the valuation allowance of $54,924,000 and $7,062,000, respectively. The valuation allowance on
deferred tax assets is related to future deductible temporary differences and net operating loss
carryforwards (exclusive of net operating losses associated with items recorded directly to equity) for
which the Company has concluded it is more likely than not that these items will not be realized in the
ordinary course of operations.
On January 1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in the entity’s financial statements in
accordance with SFAS No. 109. The adoption of FIN 48 did not result in a cumulative effect adjustment
to the Company’s retained earnings. As of the date of adoption, the Company had no unrecognized
income tax benefits. Accordingly, the annual effective tax rate was not affected by the adoption of FIN
48. Should the Company incur interest and penalties relating to tax uncertainties, such amounts would be
classified as a component of interest expense and operating expense, respectively.
At December 31, 2008, the Company had no increase or decrease in unrecognized income tax benefits for
the year. There was no accrued interest or penalties relating to tax uncertainties at December 31, 2008.
Unrecognized tax benefits are not expected to increase or decrease within the next twelve months.
The Company is subject to income tax in the U.S. federal jurisdiction and various state jurisdictions and
has identified its federal tax return and tax returns in state jurisdictions below as ―major‖ tax filings.
These jurisdictions, along with the years still open to audit under the applicable statutes of limitation, are
as follows:
F-36
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Jurisdiction
Tax Years
Federal
California
Colorado
Florida
Idaho
Nebraska
Oregon
Wisconsin
2005 – 2007
2004 – 2007
2006 – 2007
2005
2006 – 2007
2006 – 2007
2006 – 2007
2006 – 2007
However, because the Company had net operating losses and credits carried forward in several of the
jurisdictions, including the U.S. federal and California jurisdictions, certain items attributable to closed
tax years are still subject to adjustment by applicable taxing authorities through an adjustment to tax
attributes carried forward to open years.
9. PREFERRED STOCK.
Series A Preferred Stock – On April 13, 2006, the Company issued to Cascade Investment, L.L.C.
(―Cascade‖), 5,250,000 shares of Series A Cumulative Redeemable Convertible Preferred Stock (―Series
A Preferred Stock‖) at a price of $16.00 per share, for an aggregate purchase price of $84,000,000. The
Company used $4,000,000 of the proceeds for general working capital and the remaining $80,000,000 for
the construction of its ethanol production facilities.
The Series A Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s
common stock. Holders of Series A Preferred Stock are entitled to quarterly cumulative dividends
payable in arrears in cash in an amount equal to 5% per annum of the purchase price per share of the
Series A Preferred Stock. Prior to March 27, 2008, and at the Company’s option, it could have made
dividend payments in additional shares of Series A Preferred Stock based on the value of the purchase
price per share of the Series A Preferred Stock.
The holders of the Series A Preferred Stock have conversion rights initially equivalent to two shares of
common stock for each share of Series A Preferred Stock, subject to customary antidilution adjustments.
Certain specified issuances will not result in antidilution adjustments. The shares of Series A Preferred
Stock are also subject to forced conversion upon the occurrence of a transaction that would result in an
internal rate of return to the holders of the Series A Preferred Stock of 25% or more. Accrued but unpaid
dividends on the Series A Preferred Stock are to be paid in cash upon any conversion of the Series A
Preferred Stock.
The holders of Series A Preferred Stock have a liquidation preference over the holders of the Company’s
common stock equivalent to the purchase price per share of the Series A Preferred Stock plus any accrued
and unpaid dividends on the Series A Preferred Stock. A liquidation will be deemed to occur upon the
happening of customary events, including transfer of all or substantially all of the Company’s capital
stock or assets or a merger, consolidation, share exchange, reorganization or other transaction or series of
related transaction, unless holders of 66 2/3% of the Series A Preferred Stock vote affirmatively in favor
of or otherwise consent to such transaction.
Under the provisions of SFAS No. 133, the Series A Preferred Stock’s redemption feature was likely a
derivative instrument that required bifurcation from the host contract. SFAS No. 133 requires all
derivative instruments to be measured at fair value. However, because the underlying events that would
cause the redemption feature to be exercisable (i.e., redemption events) are in the Company’s control and
F-37
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
were not probable of occurrence in the foreseeable future, the Company believed that the fair value of the
embedded derivative was de minimis at the date of issuance of the Series A Preferred Stock. As of
December 31, 2007, the redemption events were no longer applicable, as the funds have been fully used
for construction.
During 2008, Cascade converted all of its Series A Preferred Stock into shares of the Company’s common
stock. In the aggregate, Cascade converted 5,315,625 shares of Series A Preferred Stock into 10,631,250
shares of the Company’s common stock. Accordingly, as of December 31, 2008, no shares of Series A
Preferred Stock were outstanding.
Series B Preferred Stock – On March 18, 2008, the Company entered into a Securities Purchase
Agreement (the ―Purchase Agreement‖) with Lyles United, LLC. The Purchase Agreement provided for
the sale by the Company and the purchase by Lyles United, LLC of (i) 2,051,282 shares of the
Company’s Series B Cumulative Convertible Preferred Stock (the ―Series B Preferred Stock‖), all of
which are initially convertible into an aggregate of 6,153,846 shares of the Company’s common stock
based on an initial three-for-one conversion ratio, and (ii) a warrant to purchase an aggregate of 3,076,923
shares of the Company’s common stock at an exercise price of $7.00 per share. On March 27, 2008, the
Company consummated the purchase and sale of the Series B Preferred Stock. Upon issuance, the
Company recorded $39,898,000, net of issuance costs, in stockholders’ equity. The warrant is exercisable
at any time during the period commencing on the date that is six months and one day from the date of the
warrant and ending ten years from the date of the warrant.
On May 20, 2008, the Company entered into a Securities Purchase Agreement (the ―May Purchase
Agreement‖) with Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (the ―May
Purchasers‖). The May Purchase Agreement provided for the sale by the Company and the purchase by
the May Purchasers of (i) an aggregate of 294,870 shares of the Company’s Series B Preferred Stock, all
of which are initially convertible into an aggregate of 884,610 shares of the Company’s common stock
based on an initial three-for-one conversion ratio, and (ii) warrants to purchase an aggregate of 442,305
shares of the Company’s common stock at an exercise price of $7.00 per share. On May 22, 2008, the
Company consummated the purchase and sale under the May Purchase Agreement. Upon issuance, the
Company recorded $5,745,000, net of issuance costs, in stockholders’ equity. The warrants are
exercisable at any time during the period commencing on the date that is six months and one day from the
date of the warrants and ending ten years from the date of the warrants.
The Series B Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s
common stock. Holders of Series B Preferred Stock are entitled to quarterly cumulative dividends payable
in arrears in cash in an amount equal to 7.00% per annum of the purchase price per share of the Series B
Preferred Stock; however, subject to the provisions of the Letter Agreement described below, such
dividends may, at the option of the Company, be paid in additional shares of Series B Preferred Stock
based initially on liquidation value of the Series B Preferred Stock. The holders of Series B Preferred
Stock have a liquidation preference over the holders of the Company’s common stock initially equivalent
to $19.50 per share of the Series B Preferred Stock plus any accrued and unpaid dividends on the Series B
Preferred Stock. A liquidation will be deemed to occur upon the happening of customary events,
including the transfer of all or substantially all of the capital stock or assets of the Company or a merger,
consolidation, share exchange, reorganization or other transaction or series of related transaction, unless
holders of 66 2/3% of the Series B Preferred Stock vote affirmatively in favor of or otherwise consent that
such transaction shall not be treated as a liquidation. The Company believes that such liquidation events
are within its control and therefore, in accordance with Emerging Issues Task Force Issue D-98,
Classification and Measurement of Redeemable Securities, the Company has classified the Series B
Preferred Stock in stockholders’ equity.
F-38
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The holders of the Series B Preferred Stock have conversion rights initially equivalent to three shares of
common stock for each share of Series B Preferred Stock. The conversion ratio is subject to customary
antidilution adjustments. In addition, antidilution adjustments are to occur in the event that the Company
issues equity securities at a price equivalent to less than $6.50 per share, including derivative securities
convertible into equity securities (on an as-converted or as-exercised basis). The shares of Series B
Preferred Stock are also subject to forced conversion upon the occurrence of a transaction that would
result in an internal rate of return to the holders of the Series B Preferred Stock of 25% or more. The
forced conversion is to be based upon the conversion ratio as last adjusted. Accrued but unpaid dividends
on the Series B Preferred Stock are to be paid in cash upon any conversion of the Series B Preferred
Stock.
The holders of Series B Preferred Stock vote together as a single class with the holders of the Company’s
common stock on all actions to be taken by the Company’s stockholders. Each share of Series B Preferred
Stock entitles the holder to the number of votes equal to the number of shares of common stock into
which each share of Series B Preferred Stock is convertible on all matters to be voted on by the
stockholders of the Company. Notwithstanding the foregoing, the holders of Series B Preferred Stock are
afforded numerous customary protective provisions with respect to certain actions that may only be
approved by holders of a majority of the shares of Series B Preferred Stock. As long as 50% of the shares
of Series B Preferred Stock remain outstanding, the holders of the Series B Preferred Stock are afforded
preemptive rights with respect to certain securities offered by the Company.
In connection with the closing of the above mentioned sales of its Series B Preferred Stock, the Company
entered into Letter Agreements with Lyles United, LLC and the May Purchasers under which the
Company expressly waived its rights under the Certificate of Designations to make dividend payments in
additional shares of Series B Preferred Stock in lieu of cash dividend payments without the prior written
consent of Lyles United, LLC and the May Purchasers.
Registration Rights Agreement – In connection with the closing of the sale of its Series A and B
Preferred Stock, the Company entered into Registration Rights Agreements with holders of the Preferred
Stock. The Registration Rights Agreements are to be effective until the holders of the Preferred Stock,
and their affiliates, as a group, own less than 10% for each of the series issued, including common stock
into which such Preferred Stock has been converted (the ―Termination Date‖). The Registration Rights
Agreements provide that holders of a majority of the Preferred Stock, including common stock into which
such Preferred Stock has been converted, may demand and cause the Company, at any time after the first
anniversary of the Closing, to register on their behalf the shares of common stock issued, issuable or that
may be issuable upon conversion of the Preferred Stock and as payment of dividends thereon, and, in the
case of the Series B Preferred Stock, upon exercise of the related warrants as well as upon exercise of a
warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $8.00 per
share and issued in connection with the extension of the maturity date of an unrelated loan (collectively,
the ―Registrable Securities‖). The Company is required to keep such registration statement effective until
such time as all of the Registrable Securities are sold or until such holders may avail themselves of Rule
144 for sales of Registrable Securities without registration under the Securities Act of 1933, as amended.
The holders are entitled to two demand registrations on Form S-1 and unlimited demand registrations on
Form S-3; provided, however, that the Company is not obligated to effect more than one demand
registration on Form S-3 in any calendar year. In addition to the demand registration rights afforded the
holders under the Registration Rights Agreement, the holders are entitled to unlimited ―piggyback‖
registration rights. These rights entitle the holders who so elect to be included in registration statements to
be filed by the Company with respect to other registrations of equity securities. The Company is
responsible for all costs of registration, plus reasonable fees of one legal counsel for the holders, which
fees are not to exceed $25,000 per registration. The Registration Rights Agreements include customary
F-39
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
representations and warranties on the part of both the Company and the holders and other customary
terms and conditions.
Under its obligations described above, in connection with the Series A Preferred Stock, the Company
filed a registration statement with the Commission, registering for resale shares of the common stock up
to 10,500,000, which was declared effective in November 2007.
Deemed Dividend on Preferred Stock – In accordance with EITF Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, and EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the
Series A Preferred Stock and Series B Preferred Stock issued to the May Purchasers is considered to have
an embedded beneficial conversion feature because the conversion price (as adjusted for the value
allocated to the warrants) was less than the fair value of the Company’s common stock at the issuance
date. As a result, the Company has recorded a deemed dividend on preferred stock of $761,000, $28,000
and $84,000,000 for the years ended December 31, 2008, 2007 and 2006, respectively. These non-cash
dividends are to reflect the implied economic value to the preferred stockholder of being able to convert
its shares into common stock at a price (as adjusted for the value allocated to any warrants) which was in
excess of the fair value of the Preferred Stock at the time of issuance. The fair value allocated to the
Preferred Stock together with the original conversion terms (as adjusted for the value allocated to any
warrants) were used to calculate the value of the deemed dividend on the Preferred Stock on the date of
issuance.
For the year ended December 31, 2008, the deemed dividend on the Series B Preferred Stock was
calculated using the difference between the conversion price of the Series B Preferred Stock into shares of
common stock, adjusted for the value allocated to the warrants, of $4.79 per share and the fair market
value of the Company’s common stock of $5.65 on the date of issuance of the Series B Preferred Stock.
These amounts have been charged to accumulated deficit with the offsetting credit to additional paid-in-
capital. The Company has treated the deemed dividend on preferred stock as a reconciling item on the
consolidated statements of operations to adjust its reported net loss, together with any preferred stock
dividends recorded during the applicable period, to loss available to common stockholders in the
consolidated statements of operations.
For the year ended December 31, 2007, the deemed dividend on the Series A Preferred Stock was
calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock
into shares of common stock of $8.00 per share and the fair market value of the Company’s common
stock of $8.21 on the date of issuance of the Series A Preferred Stock.
For the year ended December 31, 2006, the deemed dividend on the Series A Preferred Stock was
calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock
into shares of common stock of $8.00 per share and the fair market value of the Company’s common
stock of $29.27 on the date of issuance of the Series A Preferred Stock. The fair value allocated to the
Series A Preferred Stock was in excess of the gross proceeds received of $84,000,000 in connection with
the sale of the Series A Preferred Stock; however, the deemed dividend on the Series A Preferred Stock is
limited to the gross proceeds received of $84,000,000.
The Company recorded preferred stock dividends of $4,104,000, $4,200,000 and $2,998,000 for the years
ended December 31, 2008, 2007 and 2006, respectively. For all periods except for the three months ended
December 31, 2007, the Company declared cash dividends for payment of the preferred stock dividends.
For the three months ended December 31, 2007, the Company elected to issue an additional 65,625 shares
of Series A Preferred Stock as a payment-in-kind of dividends.
F-40
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. COMMON STOCK AND WARRANTS.
In March 2008, in connection with the Company’s issuance of the Series B Preferred Stock, as discussed
in Note 9, the Company issued warrants to purchase an aggregate of 3,076,923 shares of common stock at
an exercise price of $7.00 per share.
In March 2008, in connection with the Company’s extension of its related party note, as discussed in Note
7, it issued warrants to purchase 100,000 of common stock at an exercise price of $8.00 per share.
In May 2008, in connection with the Company’s issuance of additional Series B Preferred Stock, as
discussed in Note 9, the Company issued warrants to purchase an aggregate of 442,305 shares of common
stock at an exercise price of $7.00 per share.
In May 2008, the Company entered into a Placement Agent Agreement with Lazard Capital Markets LLC
(the ―Placement Agent‖), relating to the sale by the Company of an aggregate of 6,000,000 shares of
common stock and warrants to purchase an aggregate of 3,000,000 shares of common stock at an exercise
price of $7.10 per share of common stock for an aggregate purchase price of $28,500,000. The warrants
are exercisable at any time during the period commencing on the date that is six months and one day from
the date of the warrants and ending five years from the date of the warrants. On May 29, 2008, the
Company consummated the offering. Upon issuance, the Company recorded $26,648,000, net of issuance
costs, in stockholders’ equity.
In May 2006, the Company issued to 45 accredited investors an aggregate of 5,496,583 shares of common
stock at a price of $26.38 per share, for an aggregate purchase price of $145.0 million in cash. The
Company designated the net proceeds of approximately $138.0 million, net of capital raising fees and
expenses, for construction of additional ethanol plants and working capital. The Company also issued to
the investors warrants to purchase an aggregate of 2,748,297 shares of common stock at an exercise price
of $31.55 per share. These warrants expired unexercised in February 2007.
In February 2004, upon completion of the Share Exchange Transaction, the Company issued warrants to
purchase 230,000 additional shares of common stock at an exercise price of $0.0001 and expiring on
March 23, 2009 that vested ratably over a period of two years from the date of the Share Exchange
Transaction. The fair value of the warrants were amortized over two years, resulting in non-cash expense
of $0 for the years ended December 31, 2008 and 2007 and $1,316,364 for the year ended December 31,
2006.
The following table summarizes warrant activity for the years ended December 31, 2008, 2007 and 2006
(number of shares in thousands):
Balance at December 31, 2005
Warrants granted
Warrants exercised
Balance at December 31, 2006
Warrants exercised
Warrants expired
Balance at December 31, 2007
Warrants granted
Balance at December 31, 2008
Number of
Shares
2,905
3,442
(2,747)
3,600
(128)
(3,472)
—
6,619
6,619
Price per
Share
$0.0001 - $5.00
$14.41 – $31.55
$0.0001 - $5.00
$0.0001 – $31.55
$0.0001 – $5.00
$3.00 – $31.00
$7.00 – $8.00
$7.00 – $8.00
F-41
Weighted
Average
Exercise Price
$ 3.26
27.66
3.28
27.57
2.84
27.45
—
7.06
$ 7.06
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. STOCK-BASED COMPENSATION.
The Company has three equity incentive compensation plans: an Amended 1995 Incentive Stock Plan, a
2004 Stock Option Plan and a 2006 Stock Incentive Plan.
Amended 1995 Incentive Stock Plan – The Amended 1995 Incentive Stock Plan was carried over from
Accessity as a result of the Share Exchange Transaction. The plan authorized the issuance of incentive
stock options (―ISOs‖) and non-qualified stock options (―NQOs‖), to the Company’s employees, directors
or consultants for the purchase of up to an aggregate of 1,200,000 shares of the Company’s common
stock. On July 19, 2006, the Company terminated the Amended 1995 Incentive Stock Plan, except to the
extent of issued and outstanding options then existing under the plan. The Company had 20,000, 40,000
and 63,000 stock options outstanding under its Amended 1995 Incentive Stock Plan at December 31,
2008, 2007 and 2006, respectively.
2004 Stock Option Plan – The 2004 Stock Option Plan authorized the issuance of ISOs and NQOs to the
Company’s officers, directors or key employees or to consultants that do business with the Company for
up to an aggregate of 2,500,000 shares of common stock. On September 7, 2006, the Company terminated
the 2004 Stock Option Plan, except to the extent of issued and outstanding options then existing under the
plan. The Company had 110,000, 185,000 and 405,000 stock options outstanding under its 2004 Stock
Option Plan at December 31, 2008, 2007 and 2006, respectively.
On August 10, 2005, the Company granted options to purchase an aggregate of 425,000 shares of the
Company’s common stock at an exercise price equal to $8.03, the closing price per share of the
Company’s common stock on the day immediately preceding that date, to its Chief Financial Officer. The
options vested as to 85,000 shares immediately and 85,000 shares were to vest on each of the next four
anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Since
the options were granted at par with the market price of the stock, no non-cash charge was recorded.
Upon the retirement of the Chief Financial Officer on December 14, 2006, the unvested stock options
related to this grant were forfeited, except for the options allotted under a consulting agreement entered
into with the retired Chief Financial Officer on December 14, 2006. The consulting agreement provided
for the immediate vesting of 42,500 stock options on December 14, 2006, and an additional 42,500 stock
options vested on August 15, 2007, the last day of the term of the consulting agreement, provided the
obligations under the consulting agreement were fulfilled by the retired Chief Financial Officer. The
Company accounted for these options under the provisions of SFAS No. 123(R) and EITF Issue No. 96-
18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services, and accordingly, recorded compensation expense for the
unvested stock options based on the fair value of those options at the end of the reporting period based on
the Black-Scholes option-pricing model with inputs of: the closing stock price on the last day of the
reporting period, an exercise price of $8.03, the remaining contractual term through August 15, 2007, and
volatility of 73.1%. The Company recorded $151,000 and $312,000 in stock-based compensation expense
relating to these options for the years ended December 31, 2007 and 2006, respectively.
On August 10, 2005, the Company granted options to purchase an aggregate of 75,000 shares of the
Company’s common stock at an exercise price equal to $8.03, the closing price per share of the
Company’s common stock on the day immediately preceding that date, to a consultant. The options
vested as to 15,000 shares immediately and 15,000 shares were to vest on each of the next four
anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Under
the guidelines of EITF Issue No. 96-18, based on the consultant meeting its obligations under the
consulting agreement, the Company recorded compensation expense based on the fair value of the stock
options at the vesting dates and on the last day of the reporting period for the unvested stock options,
F-42
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
based on the Black-Scholes option-pricing model with inputs of: an exercise price of $8.03, the closing
stock price, a contractual term of 10 years, and volatility of 53.6%. Beginning in December 2006 the
consultant stopped providing services and will not be providing services in the future under the existing
consulting agreement. As a result, the unvested stock options were forfeited. The Company recorded
share-based compensation expense of $174,000 for the year ended December 31, 2006 relating to these
options.
A summary of the status of Company’s stock option plans as of December 31, 2008, 2007 and 2006 and
of changes in options outstanding under the Company’s plans during those years are as follows (in
thousands, except exercise prices):
2008
Years Ended December 31,
2007
2006
Weighted
Average
Exercise
Price
$7.03
—
—
6.55
7.37
$7.37
Weighted
Average
Exercise
Price
$7.42
—
7.79
—
7.03
$7.11
Number of
Shares
468
—
(243)
—
225
185
Number
of Shares
225
—
—
(95)
130
130
Weighted
Average
Exercise
Price
$7.53
—
7.06
8.04
7.42
Number
of Shares
927
—
(196)
(263)
468
297
$7.36
Outstanding at beginning of year
Granted
Exercised
Terminated
Outstanding at end of year
Options exercisable at end of year
Stock options outstanding as of December 31, 2008, were as follows (number of shares in thousands):
Options Outstanding
Options Exercisable
Range of
Exercise
Prices
$4.88-$6.63
$8.25-$8.30
Number
Outstanding
50
80
130
Weighted
Average
Remaining
Contractual
Life
Weighted
Average
Exercise
Price
4.30
6.57
$5.95
$8.26
Weighted
Average
Exercise
Price
$5.95
$8.26
Number
Exercisable
50
80
130
The total intrinsic value of options outstanding was approximately $0 and $267,000 at December 31,
2008 and 2007, respectively. The intrinsic value for exercisable options was $0 and $203,000 at
December 31, 2008 and 2007, respectively. The total intrinsic value for stock options exercised was
approximately $0, $101,000 and $3,833,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.
There were 40,000 and 66,034 unvested options with weighted-average grant-date fair values of $6.63
and $7.56, at December 31, 2007 and 2006, respectively. There were no unvested options at December
31, 2008.
2006 Stock Incentive Plan – The 2006 Stock Incentive Plan authorizes the issuance of options, restricted
stock, restricted stock units, stock appreciation rights, direct stock issuances and other stock-based awards
F-43
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to the Company’s officers, directors or key employees or to consultants that do business with the
Company for up to an aggregate of 2,000,000 shares of common stock.
The Company grants to certain employees and directors shares of restricted stock under its 2006 Stock
Incentive Plan pursuant to restricted stock agreements. A summary of unvested restricted stock activity is
as follows (shares in thousands):
Unvested at January 1, 2006
Issued
Vested
Unvested at December 31, 2006
Issued
Vested
Canceled
Unvested at December 31, 2007
Issued
Vested
Canceled
Unvested at December 31, 2008
Weighted
Average
Grant Date
Fair Value
$ —
13.06
13.06
13.06
15.11
13.14
13.72
13.07
3.65
7.78
13.06
7.11
$
Number of
Shares
—
946
(281)
665
19
(140)
(36)
508
630
(275)
(111)
752
Adoption of SFAS No. 123(R) – Upon the Company’s adoption of SFAS No. 123(R) in 2006, the
Company used the modified prospective method which requires that share-based compensation expense
be recorded for any employee options granted after the adoption date and for the unvested portion of any
employee options outstanding as of the adoption date.
The Company’s determination of fair value is affected by the Company’s common stock price as well as
the assumptions discussed above that require management’s judgment. As permitted under SFAS
No. 123(R), the Company continued to use the Black-Scholes option-pricing model in order to calculate
the compensation costs of employee stock-based compensation. Such model requires the use of subjective
assumptions, including the expected life of the option, the expected volatility of the underlying stock, and
the expected dividend on the stock. For the years ended December 31, 2008, 2007 and 2006, the
Company did not grant any options.
SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. Based on historical experience, the
Company estimated future unvested option forfeitures at 3% as of December 31, 2008.
Stock-based compensation expense related to employee and non-employee stock grants, options and
warrants recognized in income were as follows (in thousands):
Years Ended December 31,
2008
2007
2006
Employees
Non-employees
Total stock-based compensation expense
$
$
2,232
783
3,015
$
$
1,671
554
2,225
$
$
4,466
1,782
6,248
F-44
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective with the adoption of SFAS No. 123(R), stock-based compensation expense related to the
Company’s stock-based compensation arrangements attributable to employees is recorded as a component
of general and administrative expense in the consolidated statements of operations.
SFAS No. 123(R) requires that cash flows resulting from tax deductions in excess of the cumulative
compensation cost recognized for options exercised (i.e., excess tax benefits) be classified as cash inflows
from financing activities and cash outflows from operating activities. The aggregate amount of cash the
Company received from the exercise of stock options was $1,894,000 and $1,303,000 for the years ended
December 31, 2007 and 2006, respectively, which shares, consistent with prior periods, were newly
issued common stock. There were no options exercised during the year ended December 31, 2008. Prior
to the adoption of SFAS No. 123(R), the Company reported the full tax benefits resulting from the
exercise of stock options as operating cash flows. Prior to adopting SFAS No. 123(R), the Company
accounted for its employee stock-based compensation in accordance with Accounting Principles Board
Opinion (―APB‖) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Pursuant
to APB No. 25, the Company did not record share-based compensation, but followed the disclosure
requirements of SFAS No. 123. The Company’s financial results for prior periods have not been restated.
At December 31, 2008, the total compensation cost related to unvested awards which had not been
recognized was $5,972,000 and the associated weighted-average period over which the compensation cost
attributable to those unvested awards would be recognized is 2.5 years.
12. CUMULATIVE EFFECT ADJUSTMENT.
In September 2006, the Commission issued SAB No. 108, Topic 1N, Financial Statements —
Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year
Financial Statements. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding
how public companies quantify financial statement misstatements.
SAB No. 108 permits existing public companies to initially apply its provisions either by (i) restating
prior financial statements or (ii) recording the cumulative effect to the carrying values of assets and
liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained
earnings. The Company elected to record the effects of applying SAB No. 108 using the cumulative effect
transition method.
In allocating the purchase price with respect to the Kinergy acquisition, no adjustment was made to record
a deferred tax liability for the difference between the recorded value of the assets acquired and their
corresponding tax basis. Such an adjustment would have increased goodwill by the amount of the
deferred tax liability recorded. In addition, goodwill would have been reduced by the amount of any
valuation allowance attributable to any pre-acquisition deferred tax asset of the Company that could more
likely than not have been utilized against the recorded deferred tax liability. As a result of applying the
guidance in SAB No. 108 to this adjustment, the Company recorded an adjustment of $1,043,000 to
beginning retained earnings as of January 1, 2006.
13. COMMITMENTS AND CONTINGENCIES.
Commitments – The following is a description of significant commitments at December 31, 2008:
Operating Leases–Future minimum lease payments required by non-cancelable operating leases in effect
at December 31, 2008 are as follows (in thousands):
F-45
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended
December 31,
2009
2010
2011
2012
2013
Total
Amount
$ 3,103
3,082
2,701
2,035
1,657
$ 12,578
Total rent expense during the years ended December 31, 2008, 2007 and 2006 was $2,967,000,
$1,793,000 and $714,000, respectively. Included in the amounts above is approximately $1.5 million in
which the Company has been notified that it is in violation of certain of its lease covenants, which the
Company disputes. The Company continues to be current on its payments to the lessor.
Purchase Commitments – At December 31, 2008, the Company had purchase contracts with its suppliers
to purchase certain quantities of ethanol, corn and denaturant. These fixed- and indexed-price
commitments will be delivered throughout 2009. Outstanding balances on fixed-price contracts for the
purchases of materials are indicated below and volumes indicated in the indexed-price portion of the table
are additional purchase commitments at publicly-indexed sales prices determined by market prices in
effect on their respective transaction dates (in thousands):
Corn
Ethanol
Denaturant
Total
Ethanol (gallons)
Corn (bushels)
Fixed-Price
Contracts
$
$
19,611
8,056
1,292
28,959
Indexed-Price
Contracts
(Volume)
46,922
12,035
Sales Commitments – At December 31, 2008, the Company had entered into sales contracts with its major
customers to sell certain quantities of ethanol, WDG and syrup. The volumes indicated in the indexed
price contracts table will be sold at publicly-indexed sales prices determined by market prices in effect on
their respective transaction dates (in thousands):
Ethanol
WDG
Syrup
Total
Fixed-Price
Contracts
$
$
4,888
13,642
2,995
21,525
F-46
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Ethanol (gallons)
WDG (tons)
Indexed-Price
Contracts
(Volume)
60,617
24
The Company recorded in cost of goods sold estimated losses on its fixed-price purchase and sale
commitments of approximately $4,687,000 for the year ended December 31, 2008. There were no
estimated losses recorded for the years ended December 31, 2007 and 2006.
Contingencies – The following is a description of significant contingencies at December 31, 2008:
Litigation – General – The Company is subject to legal proceedings, claims and litigation arising in the
ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot
presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the
outcome of those legal proceedings, claims and litigation could adversely affect the Company’s quarterly
or annual operating results or cash flows when resolved in a future period. However, based on facts
currently available, management believes such matters will not adversely affect the Company’s financial
position, results of operations or cash flows.
Litigation – Western Ethanol Company – On January 9, 2009, Western Ethanol Company, LLC
(―Western Ethanol‖) filed a complaint in the Superior Court of the State of California (the ―Superior
Court‖) naming Kinergy as defendant. In the complaint, Western Ethanol alleges that Kinergy breached
an alleged agreement to buy and accept delivery of a fixed amount of ethanol. On January 12, 2009,
Western Ethanol filed an application for issuance of right to attach order and order for issuance of writ of
attachment. On February 10, 2009, the Superior Court granted the right to attach order and order for
issuance of writ of attachment against Kinergy in the amount of approximately $3.7 million. On February
11, 2009, Kinergy filed an answer to the complaint. Kinergy intends to vigorously defend against Western
Ethanol’s claims.
Litigation – Delta-T Corporation – On August 18, 2008, Delta-T Corporation filed suit in the United
States District Court for the Eastern District of Virginia (the ―Virginia Federal Court case‖), naming The
Company as a defendant, along with its subsidiaries Pacific Ethanol Stockton, LLC, Pacific Ethanol
Imperial, LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Magic Valley, LLC, and Pacific Ethanol
Madera, LLC. The suit alleges breaches of the parties’ Engineering, Procurement and Technology
License Agreements, breaches of a subsequent term sheet and letter agreement and breaches of indemnity
obligations.
All of the defendants have moved to dismiss the Virginia Federal Court Case for lack of personal
jurisdiction and on the ground that all disputes between the parties must be resolved through binding
arbitration, and, in the alternative, moving to stay the Virginia Federal Court Case pending arbitration. In
January 2009, these motions were granted by the Court, compelling the case to arbitration. The complaint
seeks specified contract damages of approximately $6.5 million, along with other unspecified damages.
The Company intends to vigorously defend against Delta-T Corporation’s claims.
Litigation – Barry Spiegel – State Court Action – On December 23, 2005, Barry J. Spiegel, a former
shareholder and director of Accessity, filed a complaint in the Circuit Court of the 17th Judicial District in
and for Broward County, Florida (Case No. 05018512) (the ―State Court Action‖) against Barry Siegel,
Philip Kart, Kenneth Friedman and Bruce Udell (collectively, the ―Individual Defendants‖). Messrs.
F-47
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Siegel, Udell and Friedman are former directors of Accessity and Pacific Ethanol. Mr. Kart is a former
executive officer of Accessity and the Company.
The State Court Action relates to the Share Exchange Transaction and purports to state the following five
counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the Florida
Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of
Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the
actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his
Accessity common stock to diminish and is seeking approximately $22.0 million in damages. On March
8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his
response in opposition on May 30, 2006. The Court granted the motion to dismiss by Order dated
December 1, 2006, on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a
derivative action.
On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the following five
counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and
Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The
amended complaint included the Company as a defendant, but it was subsequently voluntarily dismissed
on August 27, 2007, by Mr. Spiegel as to the Company. On March 23, 2009, Mr. Spiegel filed an
amended complaint which renewed his previously voluntarily dismissed case against the Company.
Further Mr. Spiegel seeks depositions of Barry Siegel and Philip B. Kart on or around April 30, 2009.
The Company intends to vigorously defend against Mr. Spiegel’s claims.
Litigation – Barry Spiegel – Federal Court Action – On December 28, 2006, Barry J. Spiegel, filed a
complaint in the United States District Court, Southern District of Florida (Case No. 06-61848) (the
―Federal Court Action‖) against the Individual Defendants and the Company. The Federal Court Action
relates to the Share Exchange Transaction and purports to state the following three counts: (i) violations
of Section 14(a) of the Exchange Act and SEC Rule 14a-9 promulgated thereunder, (ii) violations of
Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (iii) violation of Section
20(A) of the Exchange Act. The first two counts are alleged against the Individual Defendants and the
Company and the third count is alleged solely against the Individual Defendants. Mr. Spiegel bases his
claims on, among other things, allegations that the actions of the Individual Defendants and the Company
in connection with the Share Exchange Transaction resulted in a share exchange ratio that was unfair and
resulted in the preparation of a proxy statement seeking shareholder approval of the Share Exchange
Transaction that contained material misrepresentations and omissions. Mr. Spiegel is seeking in excess of
$15.0 million in damages.
Mr. Spiegel amended the Federal Court Action on March 5, 2007, and the Company and the Individual
Defendants filed a Motion to Dismiss the amended pleading on April 23, 2007. Plaintiff Spiegel sought to
stay his own federal case, but the Motion was denied on July 17, 2007. The Court required Mr. Spiegel to
respond to the Company’s Motion to Dismiss. On January 15, 2008, the Court rendered an Order
dismissing the claims under Section 14(a) of the Exchange Act on the basis that they were time barred
and that more facts were needed for the claims under Section 10(b) of the Exchange Act. The Court,
however, stayed the entire case pending resolution of the State Court Action.
F-48
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUE MEASUREMENTS.
The fair value hierarchy established by SFAS No. 157 prioritizes the inputs used in valuation techniques
into three levels as follows:
Level 1 – Observable inputs – unadjusted quoted prices in active markets for identical assets and
liabilities;
Level 2 – Observable inputs other than quoted prices included in Level 1 that are observable for
the asset or liability through corroboration with market data; and
Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or
more significant inputs are unobservable.
In accordance with SFAS No. 157, the Company has classified its investments in marketable securities
and derivative instruments into these levels depending on the inputs used to determine their fair values.
The Company’s investments in marketable securities consist of money market funds which are based on
quoted prices and are designated as Level 1. The Company’s derivative instruments consist of commodity
positions and interest rate caps and swaps. The fair value of the commodity positions are based on quoted
prices on the commodity exchanges and are designated as Level 1; the fair value of the interest rate caps
and certain swaps are based on quoted prices on similar assets or liabilities in active markets and
discounts to reflect potential credit risk to lenders and are designated as Level 2; and certain interest rate
swaps are based on a combination of observable inputs and material unobservable inputs.
The following table summarizes fair value measurements by level at December 31, 2008 (in thousands):
Assets:
Investments in marketable securities
Interest rate caps and swaps
Total Assets
Assets::
Liabilities:
Commodity derivative liabilities
Interest rate caps and swaps
Total Liabilities
Level 1
Level 2
Level 3
Total
$
7,780
$
—
$
7,780
$
—
7
7
$
$
951
—
951
$
$
—
1,307
1,307
$
$
$
$
—
—
—
$
7,780
7
$
7,787
—
5,245
5,245
$
$
951
6,552
7,503
For fair value measurements using significant unobservable inputs (Level 3), a description of the inputs
and the information used to develop the inputs is required along with a reconciliation of Level 3 values
from the prior reporting period. The Company has five pay-fixed and receive variable interest rate swaps
in liability positions at December 31, 2008. The value of these swaps at December 31, 2008 was
materially affected by the Company’s credit. A pre-credit fair value of each swap was determined using
conventional present value discounting based on the 3-year Euro dollar futures curves and the LIBOR
swap curve beyond 3 years, resulting in a liability of approximately $13,111,000. To reflect the
Company’s current financial condition and debt restructuring efforts, a recovery rate of 40% was applied
to that value. Management elected the 40% recovery rate in the absence of any other company-specific
information. As the recovery rate is a material unobservable input, these swaps are considered Level 3. It
is the Company’s understanding that 40% reflects the standard market recovery rate provided by
F-49
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Bloomberg in probability of default calculations. The Company applied their interpretation of the 40%
recovery rate to the swap liability reducing the liability by 60% to approximately $5,245,000 to reflect the
credit risk to counterparties, resulting in a gain of approximately $7,866,000 in other income (expense) in
the consolidated statements of operations. Further, due to the current financial status of the Company and
the remote chance of it making its anticipated LIBOR-based interest payments under SFAS No. 133, all
hedge accounting was disallowed as of December 31, 2008, and the amount in accumulated other
comprehensive income was recorded as a loss of approximately $4,565,000 in other income (expense) in
the consolidated statements of operations. At September 30, 2008, the Company’s last reporting period,
the Company had discounted these swaps 435 basis points over LIBOR reflecting the then current
borrowing rate.
Beginning balance, September 30, 2008
Transfers to Level 3 (from Level 2)
Ending balance, December 31, 2008
Level 3
$
$
—
(5,245)
(5,245)
At September 30, 2008, the credit-affected swap liability totaled approximately $7,464,000, during the
three months ended December 31, 2008, approximately $719,000 of losses were realized in other income
(expense). At December 31, 2008, the unrealized liability value was approximately $5,245,000.
15. RELATED PARTY TRANSACTIONS.
Related Customers – The Company entered into three consecutive six-month sales contracts with
Southern Counties Oil Co., an entity owned by a former director and stockholder of the Company. The
contract periods were from October 1, 2005 through March 31, 2007 for fuel grade ethanol to be
delivered ratably per month at varying prices based on delivery destinations in California, Nevada and
Arizona. Under these contracts, the Company sold a total of 13,944,000 gallons. Sales to Southern
Counties Oil Co. under these contracts totaled $6,039,000 and $16,985,000 for the years ended December
31, 2007 and 2006, respectively. There were no sales under these contracts during the year ended
December 31, 2008 and there were no accounts receivable from Southern Counties Oil Co. related to
these contracts at December 31, 2008 and 2007.
The Company sells corn and WDG to Tri J Land and Cattle (―Tri J‖), an entity owned by a director of the
Company. The Company is not under contract with Tri J, but currently sells corn on a spot basis as
needed. Sales to Tri J totaled $1,300, $166,000 and $0 for the years ended December 31, 2008, 2007 and
2006, respectively. Accounts receivable from Tri J totaled $1,300 and $7,000 at December 31, 2008 and
2007, respectively.
Related Vendors – The Company contracts for certain transportation services for its products to a
transportation company, in which a senior officer of the transportation company became a member of the
Company’s Board of Directors. For the year ended December 31, 2008, the Company purchased
transportation services of $1,487,000. As of December 31, 2008, the Company had $608,000 of
outstanding accounts payable to this vendor. There were no additional purchases during the years ended
December 31, 2007 and 2006.
The Company purchased 18,628 bushels of corn from Jones Villere Farms (―JVF‖), a company owned by
a director of the Company. Purchases from JVF totaled $95,000 for the year ended December 31, 2007.
There were no additional purchases during the years ended December 31, 2008 and 2006. There were no
accounts payable due to JVF at December 31, 2008 and 2007.
F-50
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company purchased 35,219 bushels of corn from Llanada Farms (―Llanada‖), an affiliate of a
director of the Company for the year ended December 31, 2006. Purchases from Llanada under this
contract totaled $112,000 for the year ended December 31, 2006. There were no additional purchases
during the years ended December 31, 2008 and 2007.
Plant Development and Construction – In 2006, the Company entered into an agreement with a
construction company to build an ethanol production facility in Madera, California. An officer of the
construction company was a former member of the board of directors of PEI California. The Company
had outstanding liabilities to the construction company in the amount of $900,000 as of December 31,
2007.
Financing Activities – During the year ended December 31, 2008, the Company sold $33,500 of its
business energy tax credits to certain employees of the Company on the same terms and conditions as
others to whom the Company sold credits.
As discussed in Note 9, on March 27, 2008, the Company consummated the sale of its Series B Preferred
Stock with Lyles United, LLC. In addition, as of December 31, 2008, the Company had notes payable of
$31,500,000 and accrued interest payable of $243,000 to Lyles United, LLC and its affiliates.
Also as discussed in Note 9, on May 22, 2008, the Company consummated the sale of additional shares of
its Series B Preferred Stock to Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler.
16. QUARTERLY FINANCIAL DATA.
The Company’s unaudited quarterly results of operations for the years ended December 31, 2008 and
2007 are as follows (in thousands):
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
December 31, 2008:
Net sales
Gross profit (loss)
Loss from operations
Net loss
Preferred stock dividends
Deemed dividend on preferred stock
Loss available to common stockholders
$ 161,535
$ 15,658
$ (81,254)
$ (35,151)
$ (1,101)
$ —
$ (36,252)
$
197,974
$ 443
$ (7,235)
$ (8,333)
$ (1,388)
$ (761)
$ (10,482)
$ 183,980
$ (20,285)
$ (67,916)
$ (69,167)
$ (807)
$ —
$ (69,974)
$
160,437
$ (29,221)
$ (36,743)
$ (33,896)
$ (808)
$ —
$ (34,704)
Loss per common share:
Basic and diluted
$ (0.90)
$
(0.23)
$
(1.23)
$ (0.61)
F-51
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$
99,242
$ 15,341
$ 5,839
$ 2,975
$ (1,050)
$ —
$
113,763
$ 11,121
$ 2,801
$ 2,156
$ (1,050)
$ —
$ 118,118
$ 4,759
$ (1,161)
$ (4,842)
$ (1,050)
$ —
$
130,390
$ 1,678
$ (5,402)
$ (14,689)
$ (1,050)
$ (28)
$ 1,925
$ 1,106
$ (5,892)
$ (15,767)
$
0.05
$
0.03
$
(0.15)
$ (0.39)
December 31, 2007:
Net sales
Gross profit
Income (loss) from operations
Net income (loss)
Preferred stock dividend
Deemed dividend on preferred stock
Income (loss) available to common
stockholders
Income (loss) per common share:
Basic and diluted
17. SUBSEQUENT EVENTS.
Forbearance Agreements
As discussed in Note 7, in February 2009, the Company entered into three separate forbearance
agreements with its lenders which were extended in March 2009. These forbearance agreements provide
that the lenders will forbear from exercising their rights under their respective loan agreements. The
Company is attempting to negotiate new terms with its lenders. The outcome of these negotiations is
uncertain at this time.
Notes Payable
On March 31, 2009, the Company’s Chairman of the Board and Chief Executive Officer provided funds
totaling approximately $2.0 million for general operating purposes, in exchange for two unsecured notes
payable from the Company. Interest on the unpaid principal amount accrues at a rate per annum of 8.00%.
All principal and accrued and unpaid interest on the notes are due and payable on March 31, 2010.
F-52
Exhibit
Number
INDEX TO EXHIBITS
Description
2.1
2.2
2.3
2.4
2.5
2.6
2.7
3.1
3.2
3.3
3.4
10.1
10.2
10.3
10.4
10.5
10.6
10.7
Agreement and Plan of Merger dated March 23, 2005 between the Registrant and Accessity
Corp. (1)
Share Exchange Agreement dated as of May 14, 2004 by and among Accessity Corp., Pacific
Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named
therein (1)
Amendment No. 1 to Share Exchange Agreement dated as of July 29, 2004 by and among
Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the
other parties named therein (1)
Amendment No. 2 to Share Exchange Agreement dated as of October 1, 2004 by and among
Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the
other parties named therein (1)
Amendment No. 3 to Share Exchange Agreement dated as of January 7, 2005 by and among
Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the
other parties named therein (1)
Amendment No. 4 to Share Exchange Agreement dated as of February 16, 2005 by and
among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and
the other parties named therein (1)
Amendment No. 5 to Share Exchange Agreement dated as of March 3, 2005 by and among
Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the
other parties named therein (1)
Certificate of Incorporation of the Registrant (1)
Certificate of Designations, Powers, Preferences and Rights of the Series A Cumulative
Redeemable Convertible Preferred Stock (14)
Certificate of Designations, Powers, Preferences and Rights of the Series B Cumulative
Convertible Preferred Stock (29)
Bylaws of the Registrant (1)
Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a
California corporation and the investors who are parties thereto (7)
Form of Placement Warrant dated effective of various dates issued by Pacific Ethanol, Inc., a
California corporation, to certain placement agents (7)
Form of Registration Rights Agreement dated effective May 14, 2004 between Pacific
Ethanol, Inc., a California corporation and the investors who are parties thereto (6)
Form of Placement Warrant dated effective May 14, 2004 issued by Pacific Ethanol, Inc., a
California corporation, to certain placement agents (7)
Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a
California corporation and the investors who are parties thereto (6)
Form of Warrant of various dates issued to subscribers to a private placement of securities of
Pacific Ethanol, Inc., a California corporation (7)
Form of Registration Rights Agreement dated effective March 23, 2005 between Pacific
Ethanol, Inc., a California corporation and the investors who are parties thereto (1)
Exhibit
Number
Description
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
Form of Warrant dated March 23, 2005 issued by the Registrant to subscribers to a private
placement of securities by Pacific Ethanol, Inc., a California corporation (1)
Form of Placement Warrant dated March 23, 2005 issued by the Registrant to certain
placement agents (1)
Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March
23, 2005 between the Registrant and Barry Siegel (1)
Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March
23, 2005 between the Registrant and Philip B. Kart (1)
Form of Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23,
2005 between the Registrant and each of Neil M. Koehler, Tom Koehler, William L. Jones,
Andrea Jones and Ryan W. Turner (1)
Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23, 2005
between the Registrant and Neil M. Koehler (1)
Form of Indemnification Agreement between the Registrant and each of its Executive Officers
and Directors (#) (14)
Executive Employment Agreement dated March 23, 2005 between the Registrant and Neil M.
Koehler (#)(1)
Executive Employment Agreement dated March 23, 2005 between the Registrant and Ryan
W. Turner (#)(1)
Stock Purchase Agreement and Assignment and Assumption Agreement dated March 23,
2005 between the Registrant and Barry Siegel (1)
10.18
Letter Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (1)
10.19
Ethanol Purchase and Marketing Agreement dated March 4, 2005 between Kinergy
Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific Ethanol, Inc. and Western Milling,
LLC (2)
10.20
Pacific Ethanol Inc. 2004 Stock Option Plan (3)
10.21
First Amendment to Pacific Ethanol, Inc. 2004 Stock Option Plan (13)
10.22
Amended 1995 Stock Option Plan (4)
10.23 Warrant dated March 23, 2005 issued by the Registrant to Liviakis Financial
Communications, Inc. (1)
10.24
10.25
Executive Employment Agreement dated August 10, 2005 between the Registrant and
William G. Langley (#)(5)
Ethanol Marketing Agreement dated as of August 31, 2005 by and between Kinergy
Marketing, LLC and Front Range Energy, LLC (8)
10.26 Master Revolving Note dated September 24, 2004 of Kinergy Marketing, LLC in favor of
Comerica Bank (9)
10.27
Loan Revision/Extension Agreement dated October 4, 2005 and effective as of June 20, 2005
between Kinergy Marketing, LLC and Comerica Bank (9)
Exhibit
Number
10.28
Description
Letter Agreement dated as of October 4, 2005 between Kinergy Marketing, LLC and
Comerica Bank (9)
10.29
Guaranty dated October 4, 2005 by Pacific Ethanol, Inc. in favor of Comerica Bank (9)
10.30
10.31
10.32
10.33
10.34
10.35
Security Agreement dated as of September 24, 2004 executed by Kinergy Marketing, LLC in
favor of Comerica Bank (12)
Amended and Restated Phase 1 Design-Build Agreement dated November 2, 2005 by and
between Pacific Ethanol Madera LLC and W.M. Lyles Co. (10)
Phase 2 Design-Build Agreement dated November 2, 2005 by and between Pacific Ethanol
Madera LLC and W.M. Lyles Co. (10)
Letter Agreement dated November 2, 2005 by and between Pacific Ethanol California, Inc.
and W.M. Lyles Co. (10)
Continuing Guaranty dated as of November 3, 2005 by William L. Jones in favor of
W.M. Lyles Co. (10)
Continuing Guaranty dated as of November 3, 2005 by Neil M. Koehler in favor of
W.M. Lyles Co. (10)
10.36
Description of Non-Employee Director Compensation (11)
10.37
10.38
10.39
10.40
10.41
10.42
10.43
10.44
Purchase Agreement dated November 14, 2005 between Pacific Ethanol, Inc. and Cascade
Investment, L.L.C. (11)
Deposit Agreement dated April 13, 2006 by and between Pacific Ethanol, Inc. and Comerica
Bank (14)
Registration Rights and Stockholders Agreement dated as of April 13, 2006 by and between
Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (14)
Amendment No. 1 to Ethanol Purchase and Marketing Agreement dated effective as of
March 4, 2005 between Kinergy Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific
Ethanol, Inc. and Western Milling, LLC (14)
Construction and Term Loan Agreement dated April 10, 2006 by and among Pacific Ethanol
Madera LLC, Comerica Bank and Hudson United Capital, a division of TD Banknorth, N.A.
(14)
Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of
Comerica Bank (14)
Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of
Hudson United Capital, a division of TD Banknorth, N.A. (14)
Assignment and Security Agreement dated April 13, 2006 by and between Pacific Ethanol
Madera LLC and Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.45 Member Interest Pledge Agreement dated April 13, 2006 by Pacific Ethanol Madera LLC in
favor of Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.46
Disbursement Agreement dated April 13, 2006 by and among Pacific Ethanol Madera LLC,
Hudson United Capital, a division of TD Banknorth, N.A., Comerica Bank and Wealth
Management Group of TD Banknorth, N.A. (14)
Exhibit
Number
10.47
10.48
10.49
10.50
Description
Amended and Restated Term Loan Agreement effective as of April 13, 2006 by and between
Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
Letter Agreement dated as of April 13, 2006 by and among Pacific Ethanol California, Inc.,
Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing dated
April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division
of TD Banknorth, N.A. (15)
Deed of Trust (Non-Construction) Security Agreement and Fixture Filing with Assignment of
Rents dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Lyles Diversified, Inc.
(15)
10.51
Securities Purchase Agreement dated as of May 25, 2006 by and among Pacific Ethanol, Inc.
and the investors listed on the Schedule of Investors attached thereto as Exhibit A (16)
10.52
Form of Warrant dated May 31, 2006 (16)
10.53
10.54
10.55
10.56
10.57
10.58
10.59
10.60
Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol,
Inc. and John T. Miller (17)
Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol,
Inc. and Christopher W. Wright (17)
Amended and Restated Ethanol Purchase and Sale Agreement dated as of August 9, 2006 by
and between Kinergy Marketing, LLC and Front Range Energy, LLC (18)
Construction Agreement for the Boardman Project between Pacific Ethanol Columbia, LLC
and Parsons RCIE Inc. dated as of August 28, 2006 (19)
Engineering, Procurement and Technology License Agreement dated September 6, 2006 by
and between Delta-T Corporation and PEI Columbia, LLC (*)(21)
Engineering, Procurement and Technology License Agreement (Plant No. 3) dated September
6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
Engineering, Procurement and Technology License Agreement (Plant No. 4) dated September
6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
Engineering, Procurement and Technology License Agreement (Plant No. 5) dated September
6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.61
Pacific Ethanol, Inc. 2006 Stock Incentive Plan (#)(20)
10.62
Form of Employee Restricted Stock Agreement (#)(22)
10.63
Form of Non-Employee Director Restricted Stock Agreement (#)(22)
10.64
Amendment No. 1 to Construction and Term Loan Agreement and Agreement as to Future
Financing Transactions dated September 29, 2006 by and among Pacific Ethanol Madera
LLC, TD Banknorth, N.A., Comerica Bank and Pacific Ethanol, Inc. (23)
10.65 Membership Interest Purchase Agreement dated as of October 17, 2006 by and among Eagle
Energy, LLC, Pacific Ethanol California, Inc. and Pacific Ethanol, Inc. (24)
Exhibit
Number
Description
10.66 Warrant to Purchase Common Stock dated October 17, 2006 issued to Eagle Energy, LLC by
Pacific Ethanol, Inc. (24)
10.67
10.68
10.69
10.70
10.71
10.72
10.73
10.74
10.75
10.76
10.77
10.78
10.79
10.80
Registration Rights Agreement dated as of October 17, 2006 by and between Pacific Ethanol,
Inc. and Eagle Energy, LLC (24)
Second Amended and Restated Operating Agreement of Front Range Energy, LLC among the
members identified therein (as amended by Amendment No. 1 described below) (24)
Amendment No. 1, dated as of October 17, 2006, of the Second Amended and Restated
Operating Agreement of Front Range Energy, LLC to Add a Substitute Member and for
Certain Other Purposes (24)
Form of Non-Competition Agreement dated as of October 17, 2006 by and among Pacific
Ethanol, Inc., Front Range Energy, LLC and each of the members of Eagle Energy, LLC (24)
Amendment to Amended and Restated Ethanol Purchase and Sale Agreement dated October
17, 2006 between Kinergy Marketing, LLC and Front Range Energy, LLC (24)
Separation and Consulting Agreement dated December 14, 2006 between Pacific Ethanol, Inc.
and William G. Langley (25)
Credit Agreement, dated as of February 27, 2007, by and among Pacific Ethanol Holding Co.
LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol
Stockton, LLC, Pacific Ethanol Imperial, LLC, and Pacific Ethanol Magic Valley, LLC, as
borrowers, the lenders party thereto, WestLB AG, New York Branch, as administrative agent,
lead arranger and sole book runner, WestLB AG, New York Branch, as collateral agent,
Union Bank of California, N.A., as accounts bank, Mizuho Corporate Bank, Ltd., as lead
arranger and co-syndication agent, CIT Capital Securities LLC, as lead arranger and co-
syndication agent, Cooperative Centrale Raiffeisen-Boerenleenbank BA., ―Rabobank
Nederland‖, New York Branch, and Banco Santander Central Hispano S.A., New York
Branch (26)
Sponsor Support Agreement, dated as of February 27, 2007, by and among Pacific Ethanol,
Inc., Pacific Ethanol Holding Co. LLC and WestLB AG, New York Branch, as administrative
agent (26)
Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol,
Inc. and Joseph W. Hansen (#) (27)
Indemnification Agreement as of January 2, 2008 by and between Pacific Ethanol, Inc. and
Joseph W. Hansen (#) (27)
Amended and Restated Executive Employment Agreement dated December 11, 2007 by and
between Pacific Ethanol, Inc. and Neil M. Koehler (#) (27)
Amended and Restated Executive Employment Agreement dated December 11, 2007 by and
between Pacific Ethanol, Inc. and John T. Miller (#) (27)
Amended and Restated Executive Employment Agreement dated December 11, 2007 by and
between Pacific Ethanol, Inc. and Christopher W. Wright (#) (27)
Securities Purchase Agreement dated March 18, 2008 by and between Pacific Ethanol, Inc.
and Lyles United, LLC (28)
10.81 Warrant dated March 27, 2008 issued by Pacific Ethanol, Inc. to Lyles United, LLC (29)
Exhibit
Number
10.82
10.83
10.84
10.85
10.86
10.87
10.88
Description
Registration Rights Agreement dated as of March 27, 2008 by and between Pacific Ethanol,
Inc. and Lyles United, LLC (29)
Letter Agreement dated March 27, 2008 by and between Pacific Ethanol, Inc. and Lyles
United, LLC (29)
Series A Preferred Stockholder Consent and Waiver dated March 27, 2008 by and between
Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (29)
Form of Waiver and Third Amendment to Credit Agreement dated as of March 25, 2008 by
and among Pacific Ethanol, Inc. and the parties thereto (29)
Forbearance Agreement and Release dated as of May 12, 2008 by and among Kinergy
Marketing LLC, Pacific Ethanol, Inc. and Comerica Bank (30)
Reaffirmation of Guaranty dated May 12, 2008 by Pacific Ethanol, Inc. and Neil M. Koehler,
Bill Jones, Paul P. Koehler and Thomas D. Koehler (30)
Securities Purchase Agreement dated May 20, 2008 by and among Pacific Ethanol, Inc. and
Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (31)
10.89
Form of Warrant dated May 22, 2008 issued by Pacific Ethanol, Inc. (31)
10.90
10.91
Letter Agreement dated May 22, 2008 by and among Pacific Ethanol, Inc. and Neil M.
Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (31)
Form of Subscription Agreement dated May 22, 2008 between Pacific Ethanol, Inc. and each
of the purchasers (31)
10.92
Form of Warrant to purchase shares of Pacific Ethanol, Inc. Common Stock (31)
10.93
10.94
10.95
10.96
10.97
10.98
10.99
Form of Placement Agent Agreement dated May 22, 2008, by and between Pacific Ethanol,
Inc. and Lazard Capital Markets LLC (31)
Loan and Security Agreement dated July 28, 2008 by and among Kinergy Marketing LLC, the
parties thereto from time to time as Lenders, Wachovia Capital Finance Corporation
(Western) and Wachovia Bank, National Association (32)
Guarantee dated July 28, 2008 by and between Pacific Ethanol, Inc. in favor of Wachovia
Capital Finance Corporation (Western) for and on behalf of Lenders (32)
Loan Restructuring Agreement dated as of November 7, 2008 by and among Pacific Ethanol,
Inc., Pacific Ethanol Imperial, LLC, Pacific Ethanol California, Inc. and Lyles United, LLC
(33)
Amended and Restated Promissory Note dated November 7, 2008 by Pacific Ethanol, Inc. in
favor of Lyles United, LLC (33)
Security Agreement dated as of November 7, 2008 by and between Pacific Ag. Products, LLC
and Lyles United, LLC (33)
Limited Recourse Guaranty dated November 7, 2008 by Pacific Ethanol California, Inc. in
favor of Lyles United, LLC (33)
10.100 Unconditional Guaranty dated November 7, 2008 by Pacific Ag. Products, LLC in favor of
Lyles United, LLC (33)
10.101
Irrevocable Joint Instruction Letter dated November 7, 2008 executed by Pacific Ethanol, Inc.,
Lyles United, LLC and Pacific Ethanol California, Inc. (33)
Exhibit
Number
Description
10.102 Amendment and Forbearance Agreement dated February 13, 2009 by and among Pacific
Ethanol, Inc., Kinergy Marketing LLC and Wachovia Capital Finance Corporation (Western)
(34)
10.103 Limited Waiver and Forbearance Agreement dated as of February 17, 2009 by and among
Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia,
LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Magic Valley, LLC, WestLB AG, New
York Branch, Amarillo National Bank and the Lenders identified therein (34)
10.104 Amendment No. 1 to Letter re: Amendment and Forbearance Agreement dated February 26,
2009 by and among Pacific Ethanol, Inc., Kinergy Marketing LLC and Wachovia Capital
Finance Corporation (Western) (35)
10.105 Second Limited Waiver and Forbearance Agreement dated as of February 27, 2009 by and
among Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol
Columbia, LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Magic Valley, LLC, WestLB
AG, New York Branch, Amarillo National Bank and the Lenders identified therein (35)
10.106 Forbearance Agreement dated February 26, 2009 by and among Pacific Ethanol, Inc., Pacific
Ag Products, LLC, Pacific Ethanol California, Inc. and Lyles United, LLC. (35)
21.1
23.1
31.1
31.2
32.1
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
_______________
(#)
(*)
(1)
(2)
(3)
(4)
Management contract or compensatory plan, contract or arrangement required to be filed as an
exhibit.
Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed
with the Securities and Exchange Commission.
Filed as an exhibit to the Registrant’s current report on Form 8-K for March 23, 2005 filed with
the Securities and Exchange Commission on March 29, 2005 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s quarterly report on Form 10-QSB for March 31, 2005 (File
No. 0-21467) filed with the Securities and Exchange Commission on May 23, 2005 and
incorporated herein by reference.
Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-123538)
filed with the Securities and Exchange Commission on March 24, 2005 and incorporated herein
by reference.
Filed as an exhibit to the Registrant’s annual report Form 10-KSB for December 31, 2002 (File
No. 0-21467) filed with the Securities and Exchange Commission on March 31, 2003 and
incorporated herein by reference.
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
(20)
(21)
(22)
(23)
(24)
Filed as an exhibit to the Registrant’s current report on Form 8-K for August 10, 2005 filed with
the Securities and Exchange Commission on August 16, 2005 and incorporated herein by
reference.
The Form of the Registration Rights Agreement was filed as Exhibit 4.4 to the Registrant’s
Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and
Exchange Commission on August 19, 2005 and incorporated herein by reference.
Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (Reg. No. 333-127714)
filed with the Securities and Exchange Commission on August 19, 2005 and incorporated herein
by reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for August 31, 2005 filed with
the Securities and Exchange Commission on September 7, 2005 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for November 1, 2005 filed
with the Securities and Exchange Commission on November 7, 2005 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for November 2, 2005 filed
with the Securities and Exchange Commission on November 8, 2005 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for November 10, 2005 filed
with the Securities and Exchange Commission on November 15, 2005 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1
(Reg. No. 333-127714) filed with the Securities and Exchange Commission on November 22,
2005 and incorporated herein by reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for January 26, 2006 filed with
the Securities and Exchange Commission on February 1, 2006 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s annual report on Form 10-KSB for December 31, 2005
filed with the Securities and Exchange Commission on April 14, 2006 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for April 13, 2006 filed with the
Securities and Exchange Commission on April 19, 2006 and incorporated herein by reference.
Filed as an exhibit to the Registrant’s current report on Form 8-K for May 25, 2006 filed with the
Securities and Exchange Commission on May 31, 2006 and incorporated herein by reference.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for June 26, 2006 filed with
the Securities and Exchange Commission on June 27, 2006.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 9, 2006 filed with
the Securities and Exchange Commission on August 15, 2006.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 23, 2006 filed with
the Securities and Exchange Commission on August 29, 2006.
Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-137663)
filed with the Securities and Exchange Commission on September 29, 2006.
Filed as an exhibit to the Registrant’s quarterly report on Form 10-Q for September 30, 2006 filed
with the Securities and Exchange Commission on November 20, 2006 and incorporated herein by
reference.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 4, 2006 filed with
the Securities and Exchange Commission on October 10, 2006.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 2, 2006 filed with
the Securities and Exchange Commission on October 12, 2006.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 17, 2006 filed
with the Securities and Exchange Commission on October 23, 2006.
(25)
(26)
(27)
(28)
(29)
(30)
(31)
(32)
(33)
(34)
(35)
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 14, 2006 filed
with the Securities and Exchange Commission on December 15, 2006.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 27, 2007 filed
with the Securities and Exchange Commission on March 5, 2007.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 11, 2007 filed
with the Securities and Exchange Commission on December 17, 2007.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for March 18, 2008 filed with
the Securities and Exchange Commission on March 18, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for March 26, 2008 filed with
the Securities and Exchange Commission on March 27, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for May 13, 2008 filed with
the Securities and Exchange Commission on May 19, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for May 22, 2008 filed with
the Securities and Exchange Commission on May 23, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for July 28, 2008 filed with
the Securities and Exchange Commission on August 1, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for November 7, 2008 filed
with the Securities and Exchange Commission on November 10, 2008.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 13, 2009 filed
with the Securities and Exchange Commission on February 20, 2009.
Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 26, 2009 filed
with the Securities and Exchange Commission on March 4, 2009.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized on this 31st day of March, 2009.
PACIFIC ETHANOL, INC.
/s/ NEIL M. KOEHLER
Neil M. Koehler
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the capacities and on the dates
indicated.
Signature
Title
Date
/s/ WILLIAM L. JONES
William L. Jones
/s/ NEIL M. KOEHLER
Neil M. Koehler
Chairman of the Board and Director
March 31, 2009
President, Chief Executive Officer
(Principal Executive Officer) and Director
March 31, 2009
/s/ JOSEPH W. HANSEN
Joseph W. Hansen
Chief Financial Officer (Principal
Financial and Accounting Officer)
March 31, 2009
/s/ TERRY L. STONE
Terry L. Stone
/s/ JOHN L. PRINCE
John L. Prince
/s/ DOUGLAS L. KIETA
Douglas L. Kieta
/s/ LARRY D. LAYNE
Larry D. Layne
/s/ MICHAEL D. KANDRIS
Michael D. Kandris
Director
Director
Director
Director
Director
March 31, 2009
March 31, 2009
March 31, 2009
March 31, 2009
March 31, 2009
EXHIBITS FILED WITH THIS REPORT
Exhibit
Number Description
21.1
23.1
31.1
31.2
32.1
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EXHIBIT 21.1
Subsidiary Name
SUBSIDIARIES OF THE REGISTRANT
Names Under Which
Subsidiary Does Business
State or Jurisdiction of
Incorporation or
Organization
Pacific Ethanol California, Inc.
Pacific Ethanol California
Kinergy Marketing, LLC
Kinergy Marketing/Kinergy
Pacific Ag. Products, LLC
Pacific Ag Products/PAP
Pacific Ethanol Madera LLC
Pacific Ethanol Madera
Pacific Ethanol Holding Co. LLC
Pacific Ethanol Holding Co.
Pacific Ethanol Imperial, LLC
Pacific Ethanol Imperial
Pacific Ethanol Stockton LLC
Pacific Ethanol Stockton
Pacific Ethanol Columbia, LLC
Pacific Ethanol Columbia
Pacific Ethanol Magic Valley, LLC
Pacific Ethanol Magic Valley
Pacific Ethanol Plymouth, LLC
Pacific Ethanol Plymouth
Pacific BioGasol, LLC
Pacific BioGasol
Stockton Ethanol Receiving Company, LLC
Stockton Ethanol Receiving
Company
California
Oregon
California
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Oregon
Delaware
EXHIBIT 23.1
Consent of Independent Registered Public Accounting Firm
To the Board of Directors
Pacific Ethanol, Inc.
Sacramento, California
We consent to the incorporation by reference in Registration Statements (Nos. 333-106554, 333-123538
and 333-137663) on Form S-8 and (Nos. 333-127714, 333-135270, 333-138260, 333-143617 and 333-
147471) on Form S-3 of Pacific Ethanol, Inc. of our reports dated March 31, 2009 relating to our audits of
the consolidated financial statements and internal control over financial reporting, which appear in this
Annual Report on Form 10-K of Pacific Ethanol, Inc. for the year ended December 31, 2008.
/s/ HEIN & ASSOCIATES LLP
Irvine, California
March 31, 2009
EXHIBIT 31.1
I, Neil M. Koehler, certify that:
CERTIFICATION
1. I have reviewed this Annual Report on Form 10-K of Pacific Ethanol, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal
control over financial reporting.
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 31, 2009
/s/ NEIL M. KOEHLER
Neil M. Koehler
President and Chief Executive Officer (Principal
Executive Officer)
EXHIBIT 31.2
I, Joseph W. Hansen, certify that:
CERTIFICATION
1. I have reviewed this Annual Report on Form 10-K of Pacific Ethanol, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal
control over financial reporting.
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 31, 2009
/s/ JOSEPH W. HANSEN
Joseph W. Hansen
Chief Financial Officer (Principal Financial and
Accounting Officer)
EXHIBIT 32.1
CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Pacific Ethanol, Inc. (the ―Company‖) for the year
ended December 31, 2008 (the ―Report‖), the undersigned hereby certify in their capacities as Chief Executive
Officer and Chief Financial Officer of the Company, respectively, pursuant to 18 U.S.C. section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to their knowledge:
1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended; and
2. the information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
Date: March 31, 2009
By: /s/ NEIL M. KOEHLER
Neil M. Koehler
Chief Executive Officer
(Principal Executive Officer)
Date: March 31, 2009
By: /s/ JOSEPH W. HANSEN
Joseph W. Hansen
Chief Financial Officer (Principal Financial and
Accounting Officer)
A signed original of this written statement required by Section 906, or other document authenticating,
acknowledging, or otherwise adopting the signatures that appear in typed form within the electronic version of this
written statement required by Section 906, has been provided to the Company and will be retained by the Company
and furnished to the Securities and Exchange Commission or its staff upon request.