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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended MARCH 31, 2006
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______ to _______
Commission File Number: 0-21467
PACIFIC ETHANOL, INC.
(Name of small business issuer as specified in its charter)
DELAWARE 41-2170618
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
5711 N. WEST AVENUE
FRESNO, CALIFORNIA 93711
(Address of principal executive offices)
(559) 435-1771
(Registrant's telephone number, including Area Code)
NOT APPLICABLE.
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check 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 |X| No | |
Indicate by check whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer | | Accelerated filer | | Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
As of May 10, 2006, there were 31,447,705 shares of Pacific Ethanol,
Inc. common stock, $.001 par value per share, outstanding.
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PART I
FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2006 (unaudited) and
December 31, 2005..................................................... F-2
Consolidated Statements of Operations and Other Comprehensive Income
for the three months ended March 31, 2006 and 2005 (unaudited)........ F-4
Consolidated Statements of Cash Flows for the three months ended
March 31, 2006 and 2005 (unaudited)................................... F-5
Notes to Consolidated Financial Statements (unaudited).................... F-7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation.................................................. 2
Item 3. Quantitative and Qualitative Disclosures About Market Risk................ 14
Item 4. Controls and Procedures................................................... 15
PART II
OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 17
Item 1A. Risk Factors.............................................................. 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............... 19
Item 3. Defaults Upon Senior Securities........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders....................... 19
Item 5. Other Information......................................................... 19
Item 6. Exhibits.................................................................. 20
Signatures .......................................................................... 21
Exhibits Filed with this Report
F-1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
March 31, December 31,
2006 2005
----------- -----------
ASSETS (unaudited)
------ -----------
CURRENT ASSETS:
Cash and cash equivalents $ 4,200,902 $ 4,521,111
Investments in marketable securities -- 2,750,000
Accounts receivable (including $1,611,120 and $937,713
as of March 31, 2006 and December 31, 2005,
respectively, from a related party) 7,955,170 4,947,538
Notes receivable - related party 240,336 135,995
Inventories 644,464 362,972
Prepaid expenses 872,906 626,575
Prepaid inventory 824,056 1,349,427
Derivative instruments 680,904 --
Other current assets 603,841 86,054
----------- -----------
Total current assets 16,022,579 14,779,672
----------- -----------
PROPERTY AND EQUIPMENT, NET 36,945,250 23,208,248
----------- -----------
OTHER ASSETS:
Goodwill 2,565,750 2,565,750
Intangible assets, net 7,392,281 7,568,723
Other assets 606,952 62,419
----------- -----------
Total other assets 10,564,983 10,196,892
----------- -----------
TOTAL ASSETS $63,532,812 $48,184,812
=========== ===========
See accompanying notes to consolidated financial statements.
F-2
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
LIABILITIES AND STOCKHOLDERS' EQUITY March 31, December 31,
------------------------------------ 2006 2005
------------ ------------
(unaudited)
------------
CURRENT LIABILITIES:
Current portion - related party note payable $ 1,200,000 $ 1,200,000
Accounts payable - trade 5,701,705 4,755,235
Accounts payable - related party 13,244,401 6,411,618
Accrued retention - related party 2,674,079 1,450,500
Accrued payroll 187,848 433,887
Other accrued liabilities 3,583,860 3,422,565
------------ ------------
Total current liabilities 26,591,893 17,673,805
RELATED-PARTY NOTES PAYABLE, NET OF CURRENT PORTION 2,059,778 1,995,576
------------ ------------
Total Liabilities 28,651,671 19,669,381
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 7)
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value; 10,000,000 shares
authorized, no shares issued and outstanding as of
March 31, 2006 and December 31, 2005 -- --
Common stock, $0.001 par value; 100,000,000 shares
authorized, 30,549,888 and 28,874,442 shares issued and
outstanding as of March 31, 2006 and December 31, 2005,
respectively 30,550 28,874
Additional paid-in capital 49,710,101 43,697,486
Unvested consulting expense (1,336,989) (1,625,964)
Accumulated other comprehensive income 674,208 --
Due from stockholders (600) (600)
Accumulated deficit (14,196,129) (13,584,365)
------------ ------------
Total stockholders' equity 34,881,141 28,515,431
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,532,812 $ 48,184,812
============ ============
See accompanying notes to consolidated financial statements.
F-3
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)
2006 2005
------------ ------------
Net sales (including $5,859,853 and $353,058 for
the three months ended March 31, 2006 and 2005,
respectively, to a related party) $ 38,239,167 $ 2,301,997
Cost of goods sold 35,913,920 2,254,370
------------ ------------
Gross profit 2,325,247 47,627
Operating expenses:
Selling, general and administrative expenses 2,984,084 743,233
Services rendered in connection with feasibility
study -- 852,250
------------ ------------
Loss from operations (658,837) (1,547,856)
Other income (expense), net 51,779 (107,853)
------------ ------------
Loss before provision for income taxes (607,058) (1,655,709)
Provision for income taxes 4,705 1,600
------------ ------------
Net loss $ (611,763) $ (1,657,309)
============ ============
Other comprehensive income, net of tax:
Cash flow hedges:
Net change in the fair value of derivatives, net of
tax 674,208 --
------------ ------------
Comprehensive income (loss) $ 62,445 $ (1,657,309)
============ ============
Weighted Average Shares Outstanding 29,587,193 16,257,942
============ ============
Net Loss Per Share $ (0.02) $ (0.10)
============ ============
See accompanying notes to consolidated financial statements.
F-4
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)
2006 2005
------------ ------------
OPERATING ACTIVITIES:
Net loss $ (611,763) $ (1,657,309)
Adjustments to reconcile net loss to
cash provided by (used in) operating activities:
Depreciation and amortization 274,172 85,174
Non-cash compensation expense 333,752 232,250
Non-cash consulting expense 267,375 193,011
Non-cash services rendered in connection with feasibility study -- 702,250
Changes in operating assets and liabilities:
Accounts receivable (3,007,632) 299,823
Note receivable, related party (104,341) --
Inventories (281,492) 37,752
Prepaid expenses and other assets (1,315,347) 10,057
Prepaid inventory 525,371 (40,147)
Accounts payable and accrued expenses 861,726 (1,341,644)
Accounts payable and accrued retention, related party 8,056,362 282,703
------------ ------------
Net cash provided by (used in) operating activities 4,998,183 (1,196,080)
============ ============
INVESTING ACTIVITIES:
Additions to property, plant and equipment (13,770,530) (42,379)
Proceeds from sale of available-for-sale investment 2,750,000 --
Net cash acquired in acquisition of Kinergy, ReEnergy and Accessity -- 3,326,924
Costs associated with share exchange transaction -- (307,808)
------------ ------------
Net cash provided by (used in) investing activities (11,020,530) 2,976,737
------------ ------------
FINANCING ACTIVITIES:
Proceeds from sale of stock, net -- 18,895,354
Proceeds from exercise of warrants and stock options 5,702,138 --
Receipt of stockholder receivable -- 67,500
------------ ------------
Net cash provided by financing activities 5,702,138 18,962,854
------------ ------------
Net increase (decrease) in cash and cash equivalents (320,209) 20,743,511
Cash and cash equivalents at beginning of period 4,521,111 42
------------ ------------
Cash and cash equivalents at end of period $ 4,200,902 $ 20,743,553
============ ============
See accompanying notes to consolidated financial statements.
F-5
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005(CONTINUED)
(UNAUDITED)
Supplemental Information:
Cash paid for interest $ 176,533 $ 128,719
============ ============
Cash paid for taxes $ 4,705 $ 1,600
============ ============
Non-Cash Financing and Investing activities:
Conversion of debt to equity $ -- $ 247,682
============ ============
Purchase of ReEnergy with stock $ -- $ 316,250
============ ============
Shares contributed by stockholder in purchase of ReEnergy $ -- $ 506,000
============ ============
Shares contributed by stockholder in purchase of Kinergy $ -- $ 1,012,000
============ ============
Purchase of Kinergy with stock $ -- $ 9,803,750
============ ============
See accompanying notes to consolidated financial statements.
F-6
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
------------------------------------------------------------
BASIS OF PRESENTATION - The accompanying unaudited interim consolidated
financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and reflect all
adjustments, consisting solely of normal recurring adjustments, needed
to fairly present the financial results for these interim periods.
These financial statements include some amounts that are based on
management's best estimates and judgments. These estimates may be
adjusted as more information becomes available, and any adjustment
could be significant. The impact of any change in estimates is included
in the determination of earnings in the period in which the change in
estimate is identified. The results of the operations for the three
months ended March 31, 2006 are not necessarily indicative of the
results that may be expected for the entire 2006 fiscal year.
The Company has omitted footnote disclosures that would substantially
duplicate the disclosures contained in the audited financial statements
of the Company and the accompanying unaudited interim consolidated
financial statements should be read in conjunction with the financial
statements for the fiscal years ended December 31, 2005 and 2004 and
notes thereto in the Company's Form 10-KSB for the year ended December
31, 2005, filed with the Securities and Exchange Commission on April
14, 2006.
LIQUIDITY - The Company believes that current and future available
capital resources, revenues generated from operations, and other
existing sources of liquidity, including the credit facilities the
Company has and the Company's offering of Series A Preferred Stock and
the available proceeds from its debt financing, will be adequate to
meet the Company's anticipated working capital and capital expenditure
requirements for at least the next twelve months. (See "Preferred Stock
Financing" and "Debt Financing" in Note 10.)
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.
The accounts maintained by the Company at the financial institution are
insured by the Federal Deposit Insurance Corporation (FDIC) up to
$100,000. At March 31, 2006, the uninsured balance was $3,949,208 and
at December 31, 2005 the uninsured balance was $4,048,476. The Company
has not experienced any losses in such accounts and believes that it is
not exposed to any significant risk of loss on cash.
F-7
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
During the three months ended March 31, 2006 and 2005, the Company had
sales to gasoline refining and distribution companies representing 10%
or more of total sales as follows:
Three Months Ended March 31,
----------------------------
2006 2005
------- -------
Customer A 22% 18%
Customer B 15% 10%
Customer C 11% 11%
As of March 31, 2006, the Company had receivables of approximately
$3,572,590 from these customers, representing 45% of total accounts
receivable.
During the three months ended March 31, 2006 and 2005, the Company had
purchases from ethanol suppliers representing 10% or more of total
purchases as follows:
Three Months Ended March 31,
----------------------------
2006 2005
------- -------
Vendor A 29% --
Vendor B 24% 23%
Vendor C 16% --
Vendor D -- 30%
Vendor E -- 12%
INVENTORIES - Inventories consist of bulk ethanol fuel and is valued at
the lower-of-cost-or-market, cost being determined on a first-in,
first-out basis. Shipping and handling costs are classified as a
component of cost of goods sold in the accompanying Statements of
Operations and Other Comprehensive Income and Stockholders' Equity.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - The Company attempts to
minimize its exposure to price risk by using derivative instruments. In
2006 the Company entered into derivative instruments to minimize its
exposure to market volatility associated with certain purchase
commitments. The Company accounts for its derivative transactions in
accordance with Statement of Financial Accounting Standards ("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 ("NYMEX"), 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 earnings
unless specific hedge accounting criteria are met. If derivatives meet
those criteria, the derivative's gains and losses offset related
results on the hedged item in the Statements of Operations and Other
Comprehensive Income. The Company formally designates the derivative as
a hedge and documents and assesses the effectiveness of derivatives
associated with transactions that receive hedge accounting.
F-8
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 ASSET. The Company assesses the
impairment of long-lived assets, including property and equipment and
purchased intangibles subject to amortization, which are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. The asset
impairment review assesses the fair value of the assets based on the
future cash flows the assets are expected to generate. An impairment
loss is recognized when estimated undiscounted future cash flows
expected to result from the use of the asset plus net proceeds expected
from the disposition of the asset (if any) are less than the related
asset's carrying amount. Impairment losses are measured as the amount
by which the carrying amounts of the assets exceed their fair values.
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
affected by future changes in market conditions, the economic
environment, and capital spending decisions of the Company's customers
and inflation.
The Company believes the future cash flows to be received from its
long-lived assets will exceed the assets' carrying values, and,
accordingly, the Company has not recognized any impairment losses
through March 31, 2006.
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
impairment indicators arise. This review would include the
determination of each reporting unit's fair value using market
multiples and discounted cash flow modeling. The Company has adopted
SFAS No. 142 guidelines for annual review of impairment of goodwill and
has performed its annual review of impairment, and accordingly, the
Company has not recognized any impairment losses through March 31,
2006.
STOCK-BASED COMPENSATION - On January 1, 2006 the Company adopted SFAS
No. 123 (revised), SHARE-BASED PAYMENT ("SFAS No. 123R") which requires
the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on
estimated fair values. SFAS No. 123R supersedes the Company's previous
accounting under Accounting Principles Board ("APB") Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, for periods beginning in
fiscal 2006. In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin ("SAB") No. 107 relating to SFAS No.
123R. The Company has applied the provisions of SAB No. 107 in its
adoption of SFAS 123R.
SFAS No. 123R requires companies to estimate the fair value of
share-based payment awards to employees and directors on the date of
grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as expense over
the requisite service periods in the Company's Statements of Operations
and Other Comprehensive Income.
The Company adopted SFAS No. 123R using the modified prospective
method, which requires the application of the accounting standard as of
January 1, 2006, the first day of the Company's fiscal year 2006. The
Company's financial statements as of and for the three months ended
March 31, 2006 reflect the impact of SFAS No. 123R. In accordance with
the modified prospective transition method, the Company's financial
statements for prior periods have not been restated to reflect, and do
not include, the impact of SFAS No. 123R. The stock-based compensation
F-9
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
expense related to employees or directors stock options and
non-employees for the three months ended March 31, 2005
was $232,250 and $193,011, respectively. Stock-based compensation
expense recognized under SFAS No. 123R for employees and directors and
non-employees for the three months ended March 31, 2006 was $333,752
and $267,375, respectively.
The following table illustrates the effect on net loss per share if the
Company had applied the fair value recognition provisions of SFAS No.
123R to stock-based awards granted under the Company's stock option
plans for the three months ended March 31, 2005.
Net loss, as reported $(1,657,309)
Compensation cost included in reported net
income under the intrinsic value method 232,250
Total compensation cost under the fair
value method for all awards (232,250)
-----------
Pro forma net loss $(1,657,309)
-----------
Basic and diluted net loss per share:
-------------------------------------
As reported $ (0.10)
-----------
Pro forma $ (0.10)
-----------
The intrinsic value and fair value results are the same due to a
weighted average exercise price of $0.01 for the awards.
There were no options granted during the quarter ended March 31, 2006.
Previously granted options have been valued using the Black-Scholes
option valuation model. Assumptions used in the Black-Scholes model
(depending on the particular option grant being valued and its
respective measurement date) were: expected volatility of 53.6% to
55.0%, risk-free interest rate of 3.9% to 4.5%, weighted average
expected term of 5.5 to 10.0 years, and expected dividend yield of
zero.
Stock-based compensation expense recognized in the Statement of
Operations and Other Comprehensive Income for the quarter ended March
31, 2006 includes compensation expense for share-based payment awards
granted prior to, but not yet vested as of January 1, 2006 based on the
fair value on the date of grant estimated in accordance with the pro
forma provisions of SFAS No. 123. For stock-based awards issued to
employees and directors, stock-based compensation is attributed to
expense using the straight-line single option method, which is
consistent with how the prior-period pro formas were provided. The
stock-based compensation expense recognized in the Statement of
Operations and Other Comprehensive Income for the three months ended
March 31, 2006 reflects the Company's estimate of no forfeitures.
SFAS No. 123R requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.
F-10
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company's determination of the fair value of share-based payment
awards to employees and directors on the date of grant using the
Black-Scholes model is affected by the Company's stock price as well as
assumptions regarding a number of complex variables. These variables
include, but are not limited to the Company's expected stock price
volatility over the term of the awards. The Company estimates the
expected term of the awards using the simplified method provided in SAB
No. 107.
As of March 31, 2006, the Company had two stock option plans: the
Amended 1995 Incentive Stock Plan and the 2004 Stock Option Plan, both
of which were carried over from Accessity as a result of the Share
Exchange Transaction. Following is a summary of the status of the
share-based payment plans for the three months ended March 31, 2006:
2004 Plan 1995 Plan
---------------------------- ---------------------------
Number of Weighted Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Balance at January 1, 2006 822,500 $ 7.78 105,000 $ 5.53
Granted -- -- -- --
Exercised (27,500) $ 7.57 -- --
Forfeited -- -- -- --
-------- -------- -------- ---------
Balance at March 31, 2006 795,000 $ 7.78 105,000 $ 5.53
Options exercisable at March 31, 2006 130,000 $ 7.56 105,000 $ 5.53
Weighted average fair value of options
granted during the three months ended
March 31, 2006 -- --
The total proceeds to the Company from options exercised during the
three months ended March 31, 2006 and March 31, 2005 was $208,075 and
$0, respectively.
Following is a summary of non-vested shares as of March 31, 2006 and
changes during the quarter:
Weighted Average
Number Fair Value
------ ----------
Balance at December 31, 2005 665,000 $4.64
Granted during the quarter -- --
Vested during the quarter -- --
Forfeited during the quarter -- --
------------------------------
Balance at March 31, 2006 665,000 $4.64
==============================
As of March 31, 2006, there was $3,088,350 of total unrecognized
compensation cost related to non-vested share-based compensation
arrangements, which is expected to be recognized over a weighted
average period of 2.6 years.
F-11
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Compensation cost recorded as non-cash compensation expense for the
three months ended March 31, 2006 and March 31, 2005 was $601,127 and
$425,261, respectively.
Following is a summary of the status of all options outstanding at
March 31, 2006 under the 1995 and 2004 Plans:
Weighted Average Weighted
Remaining Average Weighted
Contractual Life Exercise Number Average
Exercise Price Range Number (Years) Price Exercisable Exercise Price
- --------------------- -------------------- ------------------- -------------- ---------------- ----------------
$3.75 - $7.45 105,000 2.04 $ 5.53 105,000 $ 5.53
6.63 160,000 9.43 6.63 40,000 6.63
7.01 5,000 9.27 7.01 5,000 7.01
8.03 485,000 9.37 8.03 85,000 8.03
8.25 115,000 9.27 8.25 -- --
8.30 30,000 9.33 8.30 -- --
-------------------- ------------------- -------------- ---------------- ----------------
900,000 8.52 $ 7.52 235,000 $ 6.65
==================== =================== ============== ================ ================
The aggregate intrinsic value of options outstanding and exercisable at
March 31, 2006 and March 31, 2005 was $12,661,750 and $3,509,750,
respectively.
The Company accounts for stock options granted to non-employees in
accordance with Emerging Issues Task Force ("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 SFAS No. 123R. Options granted to non-employees are
analyzed under the guidelines of EITF Issue No. 96-18 to determine the
appropriate date of measurement of fair value and method of recording
the non-cash equity compensation expense.
REVENUE RECOGNITION - The Company derives revenue primarily from sales
of ethanol. The Company's sales are based upon written agreements or
purchase orders that identify the amount of ethanol to be purchased and
the purchase price. Shipments are made to customers, either, directly
from suppliers or from the Company's inventory to the customers by
truck or rail. Ethanol that is shipped by rail originates primarily in
the Midwest and takes from 10 to 14 days from date of shipment to be
delivered to the customer or to one of four terminals in California and
Oregon. For local deliveries, the product is shipped by truck and
delivered the same day as shipment. Revenue is recognized upon delivery
of ethanol to a customer's designated ethanol tank in accordance with
SAB No. 104, REVENUE RECOGNITION, and the related EITF Issue No. 99-19,
REPORTING REVENUE GROSS AS A PRINCIPAL VERSUS NET AS AN AGENT.
Revenues on the sale of ethanol that are shipped from the Company's
stock of inventory are recognized when the ethanol has been delivered
to the customer provided that appropriate signed documentation of the
arrangement, such as a signed contract, purchase order or letter of
agreement, has been received, the fee is fixed or determinable and
collectibility is reasonably assured.
F-12
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In accordance with EITF Issue No. 99-19, revenue from drop shipments of
third-party ethanol sales are recognized upon delivery, and recorded at
the gross amount when the Company is responsible for fulfillment of the
customer order, has latitude in pricing, incurs credit risk on the
receivable and has discretion in the selection of the supplier.
Shipping and handling costs are included in cost of goods sold.
The Company has entered into certain contracts under which the Company
may pay the owner of the ethanol the gross payments received by the
Company from third parties for forward sales of ethanol less certain
transaction costs and fees. From the gross payments, the Company may
deduct transportation costs and expenses incurred by or on behalf of
the Company in connection with the marketing of ethanol pursuant to the
agreement, including truck, rail and terminal fees for the
transportation of the facility's ethanol to third parties and may also
deduct and retain a marketing fee calculated after deducting these
costs and expenses. (See Note 7.) For the three months ended March 31,
2006, the Company did not record revenues under these terms. If and
when the Company does purchase and sell ethanol under these terms, the
Company will evaluate the proper recording of the sales under EITF
Issue No. 99-19.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified
to conform to the current presentation. Such reclassification had no
effect on net loss.
2. SHARE EXCHANGE TRANSACTION:
---------------------------
On March 23, 2005, the Company completed a share exchange transaction
("Share Exchange Transaction"), with the shareholders of Pacific
Ethanol California, Inc. ("PEI California") and the holders of the
membership interests of each of Kinergy Marketing, LLC ("Kinergy") and
ReEnergy, LLC ("ReEnergy"), pursuant to which the Company 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, 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 sole purpose of effecting the
reincorporation (the "Reincorporation Merger"). In connection with the
Reincorporation Merger, the shareholders of Accessity became
stockholders of the Company and the Company succeeded to the rights,
properties, and assets and assumed the liabilities of Accessity.
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting
acquiror. The Company has consolidated the results of PEI California,
Kinergy, and ReEnergy beginning March 23, 2005, the date of the Share
Exchange Transaction. Accordingly, the Company's results of operations
for the quarter ended March 31, 2005 consist of the operations of PEI
California for that entire period and the operations of Kinergy and
ReEnergy from March 23, 2005 through March 31, 2005. The Company's
results of operations for the quarter ended March 31, 2006 consist of
the Company's operations and the operations of all of its wholly-owned
subsidiaries, including PEI California, Kinergy and ReEnergy.
F-13
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In connection with the Share Exchange Transaction, the Company issued
an aggregate of 20,610,987 shares of common stock to the shareholders
of PEI California, 3,875,000 shares of common stock to the limited
liability company member of Kinergy and an aggregate of 125,000 shares
of common stock to the limited liability company members of ReEnergy.
On March 23, 2005, prior to the consummation of the Share Exchange
Transaction, PEI California issued to 63 accredited investors in a
private offering an aggregate of 7,000,000 shares of common stock at a
purchase price of $3.00 per share, two-year investor warrants to
purchase 1,400,000 shares of common stock at an exercise price of $3.00
per share and two-year investor warrants to purchase 700,000 shares of
common stock at an exercise price of $5.00 per share, for total gross
proceeds of approximately $21,000,000. PEI California paid cash
placement agent fees and expenses of approximately $1,850,400 and
issued five-year placement agent warrants to purchase 678,000 shares of
common stock at an exercise price of $3.00 per share in connection with
the offering. Additional costs related to the financing include legal,
accounting and consulting fees that totaled approximately $274,415.
3. PROPERTY AND EQUIPMENT:
-----------------------
Property and equipment consisted of the following:
March 31, 2006 December 31, 2005
-------------- -----------------
Land $ 515,298 $ 515,298
Facilities 4,234,703 4,234,703
Equipment and vehicles 373,520 373,520
Office furniture, fixtures and equipment 404,700 378,149
------------- - -----------
5,528,221 5,501,670
Accumulated depreciation (244,204) (210,675)
------------- - -----------
5,284,017 5,290,995
Construction in progress, Madera 30,727,935 17,917,253
Construction in progress, other 933,298 --
------------- - -----------
$ 36,945,250 $ 23,208,248
============= =============
As of March 31, 2006 and December 31, 2005, the Company had incurred
costs of $30,727,935 and $17,917,253, respectively, under its Amended
and Restated Phase 1 Design-Build Agreement and its Phase 2 Design-
Build Agreement both dated November 2, 2005 with W.M. Lyles Co., a
subsidiary of Lyles Diversified, Inc. ("LDI"), which has been included
in construction in progress at March 31, 2006 and December 31, 2005,
respectively. Included in this amount is a total of $1,701,202 and
$1,306,499 related to the construction management fee of W.M. Lyles
Co., of which $478,155 and $195,901 had not been paid at March 31, 2006
and December 31, 2005, respectively.
As of March 31, 2006 and December 31, 2005, the Company had accounts
payable due to W.M. Lyles Co. of $13,244,402 and $6,411,618,
respectively, related to the construction in progress of an ethanol
plant. As of March 31, 2006 and December 31, 2005, the Company had
accrued retention due to W.M. Lyles Co. of $2,674,079 and $1,450,500,
respectively, related to the construction in progress of an ethanol
plant. Included in construction in progress at March 31, 2006 and
December 31, 2005 is capitalized interest of $572,158 and $343,793,
respectively.
F-14
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Madera ethanol production facility is estimated to have a
construction cost of approximately $55.3 million as follows: site work
($1.7 million); building and concrete ($7.0 million); site utilities
($1.1 million); equipment and tanks ($19.2 million); piping ($5.7
million); electrical ($3.7 million); and engineering, general
conditions, and other ($16.9 million). In addition to the construction
cost, the Madera project will require up to $10.2 million in additional
funding for capital raising expenses, interest during construction, and
working capital for a total project cost of approximately $65.5
million.
Other construction in progress consists of engineering, site design,
permitting, and other development costs related to preparation for the
construction of additional ethanol production facilities.
As of March 31, 2006 and December 31, 2005, property and equipment
totaling $4,114,391 had not been placed in service. Depreciation
expense was $33,529 for the three months ended March 31, 2006 and
$85,250 for the year ended December 31, 2005.
4. ACCRUED LIABILITIES:
--------------------
Accrued liabilities as of March 31, 2006 and December 31, 2005
consisted of the following:
March 31, December 31,
2006 2005
------------- ------------
Fire damage restoration in progress $ 2,144,385 $ 3,157,969
Insurance policy premium financing 413,688 209,469
Bank overdraft 168,553 --
Other accrued liabilities 857,234 55,127
------------- -------------
Total accrued liabilities $ 3,583,860 $ 3,422,565
============= ============
5. RELATED PARTY NOTES PAYABLE:
----------------------------
In connection with the acquisition of the grain facility in March 2003,
on June 16, 2003 PEI California entered into a Term Loan Agreement (the
"Loan Agreement") with LDI whereby LDI
loaned PEI California $5,100,000. On April 13, 2006, Pacific Ethanol
Madera, LLC ("PEI Madera"), a second-tier subsidiary of the Company,
and LDI entered into an Amended and Restated Loan Agreement (the
"Amended and Restated Loan Agreement") whereby the Loan Agreement was
assigned by the Company to PEI Madera. The Amended and Restated Loan
Agreement currently carries a variable interest rate based on The Wall
Street Journal Prime Rate (7.75% as of March 31, 2006) plus 2%.
Principal payments are due annually in three equal installments
beginning June 20, 2006 and ending June 20, 2008. The amounts owing
under the Amended and Restated Loan Agreement are collateralized by a
lien created by a deed of trust on the grain facility. The Amended and
Restated Loan Agreement is described in further detail in the Company's
Form 10-KSB for the year ended December 31, 2005.
F-15
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. STOCKHOLDERS' EQUITY:
---------------------
PREFERRED STOCK - The Company has 10,000,000 shares of preferred stock
authorized, 7,000,000 of which have been designated Series A Cumulative
Redeemable Convertible Preferred Stock. As of March 31, 2006, no shares
of preferred stock were issued and outstanding. (See "Preferred Stock
Financing" in Note 10.)
COMMON STOCK - The Company has 100,000,000 shares of common stock
authorized. As of March 31, 2006, 30,549,888 shares of common stock
were issued and outstanding.
WARRANTS - The following table summarizes warrant activity for the
three months ended March 31, 2006 and the year ended December 31, 2005:
Weighted
Number of Price per Average
Shares Share Exercise Price
-------------------- -------------------- --------------------
Balance at January 1, 2005 124,587 $1.5000 - 5.00 $2.24
Warrants granted 3,058,000 0.0001 - 5.00 $3.21
Warrants exercised (277,769) 0.0001 - 5.00 $2.01
Warrants forfeited -- -- --
Balance at December 31, 2005 2,904,818 0.0001 - 5.00 $3.26
Warrants granted -- -- --
Warrants exercised (1,655,117) 0.0001 - 5.00 $3.38
Warrants canceled -- -- --
Warrants forfeited -- -- --
-------------------- -------------------- --------------------
Balance at March 31, 2006 1,249,701 $0.0001 - 5.00 $3.16
==================== ==================== ====================
The weighted average remaining contractual life and weighted average
exercise price of all warrants outstanding and of warrants exercisable
as of March 31, 2006 were as follows:
Warrants Outstanding Warrants Exercisable
-------------------------------------------------- -------------------------------
Weighted
Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
$0.0001 115,001 2.98 $0.0001 -- --
$1.50 1,000 2.87 $1.50 1,000 $1.50
$3.00 863,534 1.75 $3.00 863,534 $3.00
$5.00 270,166 0.98 $5.00 270,166 $5.00
--------- ---------
1,249,701 1,134,700
========= =========
F-16
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. COMMITMENTS AND CONTINGENCIES:
------------------------------
PURCHASE COMMITMENTS - During the three months ended March 31, 2006,
the Company entered into purchase contracts with its major suppliers to
acquire certain quantities of ethanol, at specified prices. The
contracts generally run for six months from April through September,
and from October through March. As of March 31, 2006, the outstanding
balance on fixed price purchase contracts commencing April 1, 2006 or
thereafter was $81,383,490. The Company has also entered into purchase
contracts for delivery beginning April 2006 through March 2007 for
16,716,000 gallons of ethanol for which the purchase price will be
determined by the market price at the transaction date.
SALES COMMITMENTS - During the three months ended March 31, 2006, the
Company entered into sales contracts with its major customers to sell
certain quantities of ethanol at specified prices. The contracts
generally run for six months from April through September and from
October through March. As of March 31, 2006, the outstanding balance on
fixed price sales contracts with delivery commencing April 1, 2006 or
thereafter was $74,960,115. The Company has also entered into sales
contracts for delivery beginning April 2006 through December 2006 for
9,744,000 gallons of ethanol for which the sales price will be
determined by the market price at the transaction date.
ETHANOL PURCHASE AND MARKETING AGREEMENT - On March 4, 2005, Kinergy
entered into an Ethanol Purchase and Marketing Agreement with the owner
of an ethanol production facility. The agreement was amended in April
2006 effective as of March 4, 2005. The
agreement is effective for two years with automatic renewals for
additional one-year periods. Kinergy has the exclusive right to market
and sell all of the ethanol from the facility. Pursuant to the terms of
the agreement, the purchase price of the ethanol may be negotiated
monthly between Kinergy and the owner of the ethanol production
facility without regard to the price at which Kinergy will re-sell the
ethanol to its customers or Kinergy may pay the owner the gross
payments received by Kinergy from third parties for forward sales of
ethanol less certain transaction costs and fees and retain a 1.0%
marketing fee calculated after deducting these costs and expenses.
During the three months ended March 31, 2006, all purchases of ethanol
from this facility were based on the monthly negotiated prices.
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 - BARRY SPIEGEL - On December 23, 2005, Barry J. Spiegel, a
stockholder of the Company and former 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 "Spiegel Action"),
against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce Udell
(collectively, the "Defendants"). Messrs. Siegel, Udell and Friedman
are former directors of Accessity and the Company. Mr. Kart is a former
executive officer of Accessity and the Company. The Spiegel Action
relates to the Share Exchange Transaction and purports to state five
counts against the Defendants: (i) breach of fiduciary duty, (ii)
violation of Florida's Deceptive and Unfair Trade Practices Act, (iii)
conspiracy to defraud, (iv) fraud, and (v) violation of Florida
Securities and Investor Protection Act. Mr. Spiegel is seeking $22.0
million in damages. On March 8, 2006, Defendants filed a motion to
dismiss the Spiegel Action. The Company has agreed with Messrs.
Friedman, Siegel, Kart and Udell to advance the costs of defense in
connection with the Spiegel Action. Under applicable provisions of
Delaware law, the Company may be responsible to indemnify each of the
Defendants in connection with the Spiegel Action.
F-17
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
LITIGATION - GERALD ZUTLER - In January 2003, DriverShield CRM Corp.,
or DriverShield, then a wholly-owned subsidiary of the Company's
predecessor, Accessity, was served with a complaint filed by Mr. Gerald
Zutler, its former President and Chief Operating Officer, alleging,
among other things, that DriverShield breached his employment contract,
that there was fraudulent concealment of DriverShield's intention to
terminate its employment agreement with Mr. Zutler, and discrimination
on the basis of age and aiding and abetting violation of the New York
State Human Rights Law. The complaint was filed in the Supreme Court of
the State of New York, County of Nassau, Index No.: 654/03. Mr. Zutler
is seeking damages aggregating $2.225 million, plus punitive damages
and reasonable attorneys' fees. DriverShield's management believes that
DriverShield properly terminated Mr. Zutler's employment for cause, and
intends to vigorously defend this suit. An Answer to the complaint was
served by DriverShield on February 28, 2003. In 2003, Mr. Zutler filed
a motion to have DriverShield's attorney removed from the case. The
motion was granted by the court, but was subsequently overturned by an
appellate court. DriverShield has filed a claim with its insurance
carrier under its directors and officers and employment practices'
liability policy. The carrier has agreed to cover certain portions of
the claim as they relate to Mr. Siegel, DriverShield's former Chief
Executive Officer. The policy has a $50,000 deductible and a liability
limit of $3.0 million per policy year. At the present time, the carrier
has agreed to cover the portion of the claim that relates to Mr. Siegel
and has agreed to a fifty percent allocation of expenses.
LITIGATION - MERCATOR - In 2003, Accessity filed a lawsuit seeking
damages in excess of $100 million against: (i) Presidion Corporation,
f/k/a MediaBus Networks, Inc., Presidion's parent corporation, (ii)
Presidion's investment bankers, Mercator Group, LLC, or Mercator, and
various related and affiliated parties and (iii) Taurus Global LLC, or
Taurus, (collectively referred to as the "Mercator Action"), alleging
that these parties committed a number of wrongful acts, including, but
not limited to tortuously interfering in a transaction between
Accessity and Presidion. In 2004, Accessity dismissed this lawsuit
without prejudice, which was filed in Florida state court. The Company
recently refiled this action in the State of California, for a similar
amount, as the Company believes that this is the proper jurisdiction.
On August 18, 2005, the court stayed the action and ordered the parties
to arbitration. The parties agreed to mediate the matter. Mediation
took place on December 9, 2005 and was not successful. On December 5,
2005, the Company filed a Demand for Arbitration with the American
Arbitration Association. On April 6, 2006, a single arbitrator was
appointed. The share exchange agreement relating to the Share Exchange
Transaction provides that following full and final settlement or other
final resolution of the Mercator Action, after deduction of all fees
and expenses incurred by the law firm representing the Company in this
action and payment of the 25% contingency fee to the law firm,
shareholders of record of Accessity on the date immediately preceding
the closing date of the Share Exchange Transaction will receive
two-thirds and the Company will retain the remaining one-third of the
net proceeds from any Mercator Action recovery.
8. DERIVATIVES:
------------
The Company from time to time conducts hedging activities using
derivative instruments. The hedging activities are conducted to
appropriately manage risk by minimizing the Company's exposure to price
volatility on purchase contracts with suppliers where the price is to
be set at a future date and/or if the purchase contract specifies a
F-18
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
floating or "index-based" price for ethanol that is based on either the
NYMEX price of gasoline or, to a lesser extent, the Chicago Board of
Trade price of ethanol.
The Company may utilize NYMEX unleaded gasoline futures contracts and
other derivatives to reduce its exposure to unfavorable changes in
NYMEX unleaded gasoline futures associated with its purchase
commitments. The Company accounts for its use of these derivatives
related to its hedging activities pursuant to SFAS No. 133, ACCOUNTING
FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, in 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 obligations under the contracts. Derivate 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 earning unless
specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset
related results on the hedged item in the income statement. Companies
must formally document, designate and assess the effectiveness of
transacts that receive hedge accounting.
The Company marked its derivative instruments to fair value at each
period end. According to the Company's designation of the derivative,
changes in the fair value of derivatives are reflected in net income or
other comprehensive income.
The Company reviews its contracts to determine if the contracts meet
the definition of derivatives pursuant to SFAS No. 133. At March 31,
2006, the company had futures contracts that qualified as derivatives
and were formally documented and designated as cash flow hedges of
specified purchases commitments anticipated to occur between April 2006
and September 2006. During the three months ended March 31, 2006, the
Company recognized unrealized gains of $680,904 which were included in
other comprehensive income. For the three months ended March 31, 2006,
the Company recognized $6,696 in other income for the change in fair
value of the ineffective portion of a derivative designated as a cash
flow hedge. The consolidated balance sheet at March 31, 2006 includes
an increase in other current assets of $680,904 as a result of
unrealized gains.
The Company determined that the remainder of its derivative contracts
qualified for the normal purchase and sale exemption and were
designated and documented as such at March 31, 2006 and December 31,
2005.
9. RELATED PARTY TRANSACTIONS:
---------------------------
NOTES RECEIVABLE - On January 19, 2006, a management employee was
advanced $91,699 at 5% interest, due and payable on or before July 19,
2006, for the withholding taxes due on the reportable gross taxable
income related to a warrant exercise of 25,000 shares.
VOTING AGREEMENT - On November 14, 2005, William L. Jones, Neil M.
Koehler, Ryan W. Turner, Kenneth J. Friedman and Frank P. Greinke, each
of whom is, with the exception of Mr. Turner, who resigned in April
2006, a director and/or executive officer of the Company (the
"Stockholders"), and the Company, entered into a Voting Agreement (the
"Voting Agreement") with Cascade Investment, L.L.C. ("Cascade" or
"Purchaser"). The Stockholders collectively hold an aggregate of
F-19
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9,162,704 shares of the Company's common stock. The Voting Agreement
provides that the Stockholders may not transfer their shares of the
Company's common stock, and must keep their shares free of all liens,
proxies, voting trusts or agreements, until the Voting Agreement is
terminated. The Voting Agreement provides that the Stockholders will
each vote or execute a written consent in favor of the transactions
contemplated by the Purchase Agreement between the Company and
Purchaser (the "Transactions"). In addition, under the Voting
Agreement, each Stockholder grants an irrevocable proxy to Neil M.
Koehler to act as such Stockholder's proxy and attorney-in-fact to vote
or execute a written consent in favor of the Transactions. The Voting
Agreement is effective until the earlier of the approval of the
Transactions by the Company's stockholders or the termination of the
Purchase Agreement in accordance with its terms. The Transactions were
approved by the stockholders on December 30, 2005.
RELATED CUSTOMER - On August 10, 2005, the Company entered into a
6-month sales contract with Southern Counties Oil Co., a company owned
by a director of the Company. The contract
period is from October 1, 2005 through March 31, 2006 for 5,544,000
gallons of fuel grade ethanol to be delivered ratably at approximately
924,000 gallons per month at varying prices based on delivery
destinations in Arizona, Nevada and California. During the three months
ended March 31, 2006, sales to Southern Counties Oil Co. totaled
$5,859,853 and accounts receivable from Southern Counties Oil Co. at
March 31, 2006 totaled $1,611,120.
10. SUBSEQUENT EVENTS:
------------------
AMENDMENT TO LDI TERM LOAN - On April 13, 2006, PEI Madera and LDI
entered into an Amended and Restated Loan Agreement whereby the Loan
Agreement was assigned by the Company to PEI Madera. The lien created
by a deed of trust on PEI Madera's grain facility is subject and
subordinate to the lien created by a deed of trust in favor of the
lender under the construction loan with Hudson United Capital and
Comerica Bank described below.
WARRANT EXERCISES - From April 1, 2006 through May 10, 2006, the
Company issued 744,816 shares of common stock for the exercise of
warrants and received proceeds of $2,300,832. Of these shares, 12,684
shares were issued pursuant to cashless exercises.
OPTION EXERCISES - From April 1, 2006 through May 10, 2006, the Company
issued 153,000 shares of common stock for the exercise of options and
received proceeds of $1,076,250.
ADVISORY FEE - On April 14, 2004, the Company entered into an agreement
with Cagan-McAfee Capital Partners ("CMCP") and Chadbourn Securities,
Inc., a related entity to CMCP, in connection with raising funding for
and ethanol production facility. The Company terminated the consulting
agreement on November 1, 2005 and pursuant to the terms of a Settlement
Agreement, the Company paid Chadbourn $960,000 on April 13, 2006 in
connection with the closing of the Company's offering of Series A
Preferred Stock.
CONSULTING AGREEMENT - On April 27, 2005, the Company engaged a
consulting firm to explore capital raising alternatives. The Company
paid the consulting firm an initial engagement fee of $300,000 upon
execution of its engagement agreement. The engagement agreement also
requires an additional engagement fee, the amount of which is dependent
F-20
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
upon the number of the Company's projects to be financed. The
additional engagement fee has a range of a minimum of $300,000 and a
maximum of one-half of one percent (1/2%) of the capital raised, and is
payable upon the occurrence of certain events. In addition, the Company
is obligated to pay to the consulting firm an arrangement fee of 3% to
3.5% of the capital raised. For the three months ended March 31, 2006,
the Company paid the consulting firm $56,599 in additional expenses. On
April 3, 2006, the consulting firm waived any rights it may have had,
if any, to be paid a fee in connection with the Closing of the
Company's debt financing with Hudson United Capital and Comerica Bank
and no additional fees were due to the consulting firm.
PREFERRED STOCK FINANCING - On April 13, 2006, the Company issued to
Cascade, 5,250,000 shares of the Company's Series A Cumulative
Redeemable Convertible Preferred Stock (the "Series A Preferred
Stock"), at a price of $16.00 per share, for an aggregate purchase
price of $84.0 million. Of the $84.0 million aggregate purchase price,
$4.0 million was paid to the Company at closing and $80.0 million was
deposited into a restricted cash account and will be disbursed in
accordance with the Deposit Agreement described below. The Company is
entitled to use the initial $4.0 million of proceeds for general
working capital and must use the remaining $80.0 million for the
construction or acquisition of one or more ethanol production
facilities in accordance with the terms of the Deposit Agreement.
The Certificate of Designations, Powers, Preferences and Rights of the
Series A Cumulative Redeemable Convertible Preferred Stock (the
"Certificate of Designations"), provides for 7,000,000 shares of the
Company's preferred stock to be designated as Series A Cumulative
Redeemable Convertible Preferred Stock. 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% of the purchase price per share of the Series A Preferred
Stock; however, such dividends may, at the Company's option, be paid 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 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.
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. 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 $8.00 per share, including derivative
securities convertible into equity securities (on an as-converted or
as-exercised basis). 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.
F-21
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The holders of Series A 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 A Preferred
Stock entitles the holder to the number of votes equal to the number of
shares of the Company's common stock into which each share of Series A
Preferred Stock is convertible. However, the number of votes for each
share of Series A Preferred Stock may not exceed the number of shares
of common stock into which each share of Series A Preferred Stock would
be convertible if the applicable conversion price were $8.99. In
addition, the holders of Series A 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 A
Preferred Stock. In addition, the holders of the Series A Preferred
Stock are afforded preemptive rights with respect to certain securities
offered by the Company and are entitled to certain redemption rights.
The Deposit Agreement between the Company and Comerica Bank provides
for a restricted cash account into which $80.0 million of the aggregate
purchase price for the Series A Preferred Stock has been deposited. The
Company may not withdraw funds from the restricted cash account except
in accordance with the terms of the Deposit Agreement. Under the
Deposit Agreement, the Company may, with certain prescribed
limitations, requisition funds from the restricted cash account for the
payment of construction costs in connection with the construction of
ethanol production facilities. Of the $80.0 million deposited into the
restricted cash account, $20.0 million has been advanced to the Company
for use in the construction of its Madera County ethanol plant.
In connection with the issuance of the Series A Preferred Stock, the
Company entered into a Registration Rights and Stockholders Agreement
(the "Rights Agreement") with Cascade. The Rights Agreement is to be
effective until the holders of the Series A Preferred Stock, and their
affiliates, as a group, own less than 10% of the Series A Preferred
Stock issued under the purchase agreement with Cascade, including
common stock into which such Series A Preferred Stock has been
converted (the "Termination Date"). The Rights Agreement provides that
holders of a majority of the Series A Preferred Stock, including common
stock into which the Series A Preferred Stock has been converted, may
demand and cause the Company, at any time after April 13, 2007, to
register on their behalf the shares of common stock issued, issuable or
that may be issuable upon conversion of the Series A Preferred Stock
(the "Registrable Securities"). Following such demand, the Company is
required to notify any other holders of the Series A Preferred Stock or
Registrable Securities of the Company's intent to file a registration
statement and, to the extent requested by such holders, include them in
the related registration statement. 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(k) under the Securities Act of 1933, which
requires, among other things, a minimum two-year holding period and
requires that any holder availing itself of Rule 144(k) not be an
affiliate of the Company. The holders are entitled to three demand
registrations on Form S-1 and unlimited demand registrations on
Form S-3; however, the Company is not obligated to effect more than
two demand registrations on Form S-3 in any 12-month period.
F-22
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In addition to the demand registration rights afforded the holders
under the Rights Agreement, the holders are entitled to "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 holders are
entitled to unlimited "piggyback" registration rights.
The Rights Agreement provides for the initial appointment of two
persons designated by Cascade to the Company's Board of Directors, and
the appointment of one of such persons as the Chairman of the
Compensation Committee of the Board of Directors. Following the
Termination Date, Cascade is required to cause its director designees,
and all other designees, to resign from all applicable committees and
boards of directors, effective as of the Termination Date.
The Company is in the process of evaluating the proper accounting
treatment for the above factors and resulting impact on its
consolidated financial statements.
DEBT FINANCING - On April 13, 2006, PEI Madera entered into a
Construction and Term Loan Agreement (the "Construction Loan") with
Comerica Bank ("Comerica") and Hudson United Capital ("Hudson") for a
debt financing (the "Debt Financing"), from Hudson and Comerica
(collectively, the "Lender"), in the aggregate amount of up to $34.0
million. The Debt Financing will provide a portion of the total
financing necessary for the completion of the Company's ethanol
production facility in Madera County, California (the "Project"). The
Project cost is not to exceed approximately $65.5 million (the "Project
Cost").
The Company has contributed assets to PEI Madera having a value of
approximately $13.9 million (the "Contributed Assets"). The Company is
responsible for arranging cash equity (the "Contributed Amount") in an
amount that, when combined with the Contributed Assets would be equal
to no less than the difference between the Debt Financing amount of
$34.0 million and the total Project Cost. The Contributed Amount was
approximately $31.5 million and has been satisfied through the
application of $17.7 million of Cascade's investment in the Company's
Series A Preferred Stock.
The Debt Financing will initially be in the form the Construction Loan
that will mature on or before the Final Completion Date, after which
the Debt Financing will be converted to a term loan (the "Term Loan"),
that will mature on the seventh anniversary of the closing of the Term
Loan. If the conversion does not occur and PEI Madera elects to repay
the Construction Loan, then PEI Madera must pay a termination fee equal
to 5.00% of the amount of the Construction Loan. The closing of the
Term Loan is expected to be the Final Completion Date. The Construction
Loan interest rate will float at a rate equal to the 30-day London
Inter Bank Offered Rate ("LIBOR"), plus 3.75%. PEI Madera will be
required to pay the Construction Loan interest monthly during the term
of the Construction Loan. The Term Loan interest rate will float at a
rate equal to the 90-day LIBOR plus 4.00%. PEI Madera will be required
to purchase interest rate protection in the form of a LIBOR rate cap of
no more than 5.50% from a provider on terms and conditions reasonably
acceptable to Lender, and in an amount covering no less than 70% of the
principal outstanding on any loan payment date commencing on the
closing date through the fifth anniversary of the Term Loan. Loan
repayments on the Term Loan are to be due quarterly in arrears for a
F-23
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
total of 28 payments beginning on the closing of the Term Loan and
ending on its maturity date. The loan amortization for the Project will
be established on the closing of the Term Loan based upon the operating
cash projected to be available to PEI Madera from the Project as
determined by closing pro forma projections. The Debt Financing will be
the only indebtedness permitted on the Project. The Debt Financing will
be senior to all obligations of the Project and PEI Madera other than
direct Project operating expenses and expenses incurred in the ordinary
course of business. All direct and out-of-pocket expenses of the
Company or the Company's direct and indirect subsidiaries will be
reimbursed only after the repayment of the Debt Financing obligations.
The Term Loan amount is to be the lesser of (i) $34.0 Million, (ii)
52.25% of the total Project cost as of the Term Loan Conversion Date,
and (iii) an amount equal to the present value (discounted at an
interest rate of 9.5% per annum) of 43.67% of the operating cash
distributable to and received by PEI Madera supported by the closing
pro forma projections, from the closing of Term Loan through the
seventh anniversary of such closing.
The Debt Financing is secured by: (a) a perfected first priority
security interest in all of the assets of PEI Madera, including
inventories and all right title and interest in all tangible and
intangible assets of the Project; (b) a perfected first priority
security interest in the Project's grain facility, including all of PEI
Madera's and the Company's and its affiliates' right title and interest
in all tangible and intangible assets of the Project's grain facility;
(c) a pledge of 100% of the ownership interest in PEI Madera; (d) a
pledge of the PEI Madera's ownership interest in the Project; (e) an
assignment of all revenues produced by the Project and PEI Madera; (f)
the pledge and assignment of the material Project documents, to the
extent assignable; (g) all contractual cash flows associated with such
agreements; and (h) any other collateral security as Lender may
reasonably request. In addition, the Construction Loan is secured by a
completion bond provided by W.M. Lyles Co.
F-24
ITEM 2. 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 strategies. The forward-looking statements and associated risks may
include, relate to or be qualified by other important factors, including,
without limitation:
o the projected growth or contraction in the ethanol market in
which we operate;
o fluctuations in the market price of ethanol;
o our business strategy for expanding, maintaining or
contracting our presence in this market;
o our ability to obtain the necessary financing to complete
construction of our planned ethanol production facilities
other than our facility in Madera County, California;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and
future competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
Any of the factors described above or in the "Risk Factors" section of
our Annual Report on Form 10-KSB for the year ended December 31, 2005 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.
OVERVIEW
Our primary goal is to become a leader in the production, marketing
and sale of ethanol and other renewable fuels in the Western United States.
Through our wholly-owned subsidiary, Kinergy Marketing, LLC, or
Kinergy, we are currently engaged in the business of marketing ethanol in the
Western United States. We provide transportation, storage and delivery of
ethanol through third-party service providers. We sell ethanol primarily in
California, Nevada, Arizona, Washington and Oregon and have extensive customer
relationships throughout the Western United States and extensive supplier
relationships throughout the Western and Midwestern United States. We do not
currently produce any ethanol that we sell. Until we commence the production of
ethanol, if at all, we expect our operations to consist primarily of the
marketing and sale of ethanol produced by third-parties. Accordingly, we expect
that unless and until we complete the construction of our initial ethanol
production facility in Madera County our consolidated net sales will consist
solely of net sales generated by Kinergy. We anticipate that our net sales will
grow in the long-term as demand for ethanol increases and as a result of our
marketing agreements with third-party ethanol producers.
We believe that we have a competitive advantage due to the market
niche that we have developed by supplying ethanol to customers in several major
metropolitan and rural markets in California and other Western states. We also
believe that the experience of our management over the past two decades and the
operations Kinergy has conducted over the past five years have enabled us to
establish valuable relationships in the ethanol marketing industry and
understand the business of marketing ethanol.
2
Through Pacific Ethanol Madera, LLC, or PEI Madera, a second-tier
subsidiary of our wholly-owned subsidiary, Pacific Ethanol California, Inc., or
PEI California, we are constructing an ethanol production facility in Madera
County to begin the production and sale of ethanol and its co-products. In April
2006, we secured all the necessary financing to complete construction of this
facility. See "Preferred Stock Financing" and "Debt Financing" below. We also
intend to construct or otherwise acquire additional ethanol production
facilities as financing resources and business prospects make the construction
or acquisition of these facilities advisable.
Currently, ethanol represents only up to 3% of the total annual
gasoline supply in the United States. We believe that the ethanol industry has
substantial room to grow to reach what we estimate is an achievable level of at
least 10% of the total annual gasoline supply in the United States. An increase
in the demand for ethanol from California's current level of 5.7% to at least
10% of total annual gasoline supply would result in demand for approximately 700
million additional gallons of ethanol, representing an increase in annual demand
in California of approximately 75%. An additional 700 million gallons of ethanol
would represent an increase in annual demand of approximately 18% for the entire
United States.
Kinergy has two principal methods of conducting its ethanol marketing
and sales activities: direct sales and inventory sales. Kinergy's first method
of marketing and selling ethanol involves direct sales through which suppliers
deliver ethanol directly via rail to Kinergy's customers. For direct sales,
Kinergy typically matches ethanol purchase and sale contracts of like quantities
and delivery periods. These back-to-back direct sales typically involve no price
risks to Kinergy that otherwise may result from fluctuations in the market price
of ethanol. Kinergy's second method of marketing and selling ethanol involves
truck deliveries from inventory purchased by Kinergy in advance. For inventory
sales, as with direct sales, Kinergy typically matches ethanol purchase and sale
contracts of like quantities. However, timing differences do exist and
consequently, a back-to-back inventory sale may lag by up to two or more weeks.
This time lag results from inventory transit and turnover times. As a result,
Kinergy may supply ethanol under new inventory sales contracts from existing
inventory. These back-to-back inventory sales therefore involve some price risks
to Kinergy resulting from potential fluctuations in the market price of ethanol.
We believe that the only consistent price risk to Kinergy is currently
inventory risk. Management seeks to optimize transitions to new inventory sales
contracts and reduce the effects of declining ethanol prices by managing
inventory as carefully as possible to decrease inventory levels in anticipation
of declining ethanol prices. In addition, management seeks to increase inventory
levels in anticipation of rising ethanol prices. Because Kinergy decreases
inventory levels in anticipation of declining ethanol prices and increases
inventory levels in anticipation of rising ethanol prices, it is subject to the
risk of ethanol prices moving in unanticipated directions, which could result in
declining or even negative gross profit margins over certain periods of time,
but also enables Kinergy to potentially benefit from above-normal gross profit
margins.
Over the past few years, the market price of ethanol has experienced
significant fluctuations. The price of ethanol declined by approximately 25%
from its 2004 average price per gallon in five months from January 2005 through
May 2005 and reversed this decline and increased to approximately 55% above its
2004 average price per gallon in four months from June 2005 through September
2005. From September through December 2005, the price of ethanol trended
downward, but reversed its trend in the first quarter of 2006 by rising
approximately 16% above its 2005 average price per gallon.
3
We believe that the market price of ethanol will, for the foreseeable
future, continue to experience significant fluctuations which may cause our
future results of operations to fluctuate significantly. As a result, our
historical results of operations may not be predictive of our future results of
operations.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margins in the first quarter of 2006 and
2005 were 6.0% and 1.7%, respectively. We believe that Kinergy's future gross
profit margins may be lower than average historical levels for two principal
reasons. First, increased competition in the ethanol market may reduce margins.
Second, Kinergy may, in some cases, engage in direct sale arrangements that
typically result in lower gross margins. Historically, Kinergy's sales were
comprised to a greater degree of inventory sales that often involved the buying
and selling of ethanol based on anticipated trends in the market price of
ethanol. These inventory sales represented higher-risk positions but enabled
Kinergy to achieve higher margin levels, as compared to direct sales, as a
result of correctly anticipating fluctuations in the market price of ethanol.
As a result of highly-volatile ethanol prices, we are unable to estimate
Kinergy's future gross profit margins from inventory sales. However, we
believe that over longer periods of up to a year or more, our gross profit
margin from inventory sales is unlikely to exceed our historic high average
gross profit margin of 4.4%.
If we are able to complete our ethanol production facility in Madera
County and commence producing ethanol, we expect our gross profit margins for
ethanol that we produce to be substantially higher than our gross profit margins
for Kinergy's direct sales and inventory sales activities. However, any gross
profits that we realize from the production of ethanol will be highly dependent
upon the prevailing market price of ethanol at the time of sale. Moreover, in
light of the recent and expected future volatility in the price of ethanol, we
are now, and expect for the foreseeable future to be, unable to estimate our
gross profit margins resulting from the sale of ethanol that we may produce.
Kinergy's gross profit margin increased by 253% from 1.7% in the first
quarter of 2005 to 6.0% in the first quarter of 2006. Kinergy's gross profit
margin in the first quarter of 2005 is generally reflective of the contracted
margins for that period. The increase in Kinergy's gross profit margin in the
first quarter of 2006 is generally reflective of opportunistic buying and
selling during a period of rapidly increasing market prices. Kinergy entered
into fixed-price purchase contracts for the October 2005 through March 2006
contracting period and maintained a net long ethanol position going into the
first quarter of 2006. The decision to maintain a net long ethanol position was
based on a confluence of factors, including management's expectation of
increased prices of gasoline and petroleum and the acceleration of the phase-out
of MTBE blending which we believed would result in a significant increase in
demand for blending ethanol with gasoline.
SHARE EXCHANGE TRANSACTION
On March 23, 2005, we completed a share exchange transaction, or the
Share Exchange Transaction, with the shareholders of PEI California, and the
holders of the membership interests of each of Kinergy and ReEnergy, LLC, or
ReEnergy, pursuant to which 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., or
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, or the Reincorporation Merger. We are
the surviving entity resulting from the reincorporation merger and Kinergy, PEI
California and ReEnergy are three of our wholly-owned subsidiaries.
4
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting acquiror. We
have consolidated the results of PEI California, Kinergy, and ReEnergy beginning
March 23, 2005, the date of the Share Exchange Transaction. Accordingly, our
results of operations for the quarter ended March 31, 2005 consist of the
operations of PEI California for that entire period and the operations of
Kinergy and ReEnergy from March 23, 2005 through March 31, 2005. Our results of
operations for the quarter ended March 31, 2006 consist of our operations and
the operations of all of our wholly-owned subsidiaries, including PEI
California, Kinergy and ReEnergy for that entire period.
In connection with the Share Exchange Transaction, we issued an
aggregate of 20,610,987 shares of common stock to the shareholders of PEI
California, 3,875,000 shares of common stock to the limited liability company
member of Kinergy and an aggregate of 125,000 shares of common stock to the
limited liability company members of ReEnergy. In addition, holders of options
and warrants to acquire an aggregate of 3,157,587 shares of common stock of PEI
California were, following the consummation of the Share Exchange Transaction,
deemed to hold warrants to acquire an equal number of our shares of common
stock. Also, a holder of a promissory note, a portion of which was convertible
into an aggregate of 664,879 shares of common stock of PEI California was,
following the consummation of the Share Exchange Transaction, entitled to
convert the note into an equal number of shares of our common stock.
On March 23, 2005, prior to the consummation of the Share Exchange
Transaction, PEI California issued to 63 accredited investors in a private
offering an aggregate of 7,000,000 shares of common stock at a purchase price of
$3.00 per share, two-year investor warrants to purchase 1,400,000 shares of
common stock at an exercise price of $3.00 per share and two-year investor
warrants to purchase 700,000 shares of common stock at an exercise price of
$5.00 per share, for total gross proceeds of approximately $21,000,000. PEI
California paid cash placement agent fees and expenses of approximately
$1,850,400 and issued five-year placement agent warrants to purchase 678,000
shares of common stock at an exercise price of $3.00 per share in connection
with the offering. Additional costs related to the financing include legal,
accounting and consulting fees that totaled approximately $274,415.
PREFERRED STOCK FINANCING
GENERAL
On April 13, 2006, we issued to one investor, Cascade Investment,
L.L.C., or Cascade, 5,250,000 shares of our Series A Cumulative Redeemable
Convertible Preferred Stock, or Series A Preferred Stock, at a price of $16.00
per share, for an aggregate purchase price of $84.0 million. Of the $84.0
million aggregate purchase price, $4.0 million was paid to us at closing and
$80.0 million was deposited into a restricted cash account and will be disbursed
in accordance with the Deposit Agreement described below. We are entitled to use
the initial $4.0 million of proceeds for general working capital purposes and
must use the remaining $80.0 million for the construction or acquisition of one
or more ethanol production facilities in accordance with the terms of the
Deposit Agreement described below.
CERTIFICATE OF DESIGNATIONS
The Certificate of Designations, Powers, Preferences and Rights of the
Series A Cumulative Redeemable Convertible Preferred Stock, or Certificate of
Designations, provides for 7,000,000 shares of preferred stock to be designated
as Series A Cumulative Redeemable Convertible Preferred Stock. The Series A
Preferred Stock ranks senior in liquidation and dividend preferences to our
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% of the
purchase price per share of the Series A Preferred Stock; however, such
dividends may, at our option, be paid in additional shares of Series A Preferred
5
Stock based on the value of the purchase price per share of the Series A
Preferred Stock. The holders of Series A Preferred Stock have a liquidation
preference over the holders of our 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
our 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.
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. The conversion ratio is subject to customary antidilution
adjustments. In addition, antidilution adjustments are to occur in the event
that we issue equity securities at a price equivalent to less than $8.00 per
share, including derivative securities convertible into equity securities (on an
as-converted or as-exercised basis). 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 vote together as a single
class with the holders of our common stock on all actions to be taken by our
stockholders. Each share of Series A Preferred Stock entitles the holder to the
number of votes equal to the number of shares of our common stock into which
each share of Series A Preferred Stock is convertible. However, the number of
votes for each share of Series A Preferred Stock may not exceed the number of
shares of common stock into which each share of Series A Preferred Stock would
be convertible if the applicable conversion price were $8.99. The holders of
Series A 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 A Preferred Stock. The holders of the Series A
Preferred Stock are also afforded preemptive rights with respect to certain
securities offered by us and are entitled to certain redemption rights.
DEPOSIT AGREEMENT
The Deposit Agreement between us and Comerica Bank provides for a
restricted cash account into which $80.0 million of the aggregate purchase price
for the Series A Preferred Stock has been deposited. We may not withdraw funds
from the restricted cash account except in accordance with the terms of the
Deposit Agreement. Under the Deposit Agreement, we may, with certain prescribed
limitations, requisition funds from the restricted cash account for the payment
of construction costs in connection with the construction of ethanol production
facilities. Of the $80.0 million deposited into the restricted cash account,
$20.0 million has been advanced to us for use in the construction of our Madera
County ethanol plant.
REGISTRATION RIGHTS AND STOCKHOLDERS AGREEMENT
In connection with the issuance of the Series A Preferred Stock, we
entered into a Registration Rights and Stockholders Agreement, or Rights
Agreement, with Cascade. The Rights Agreement is to be effective until the
holders of the Series A Preferred Stock, and their affiliates, as a group, own
less than 10% of the Series A Preferred Stock issued under the purchase
agreement with Cascade, including common stock into which such Series A
Preferred Stock has been converted (the "Termination Date"). The Rights
Agreement provides that holders of a majority of the Series A Preferred Stock,
including common stock into which the Series A Preferred Stock has been
converted, may demand and cause us, at any time after April 13, 2007, to
register on their behalf the shares of common stock issued, issuable or that may
6
be issuable upon conversion of the Series A Preferred Stock, or Registrable
Securities. Following such demand, we are required to notify any other holders
of the Series A Preferred Stock or Registrable Securities of our intent to file
a registration statement and, to the extent requested by such holders, include
them in the related registration statement. We are 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(k),
which requires, among other things, a minimum two-year holding period and
requires that any holder availing itself of Rule 144(k) not be an affiliate of
Pacific Ethanol. The holders are entitled to three demand registrations on Form
S-1 and unlimited demand registrations on Form S-3; however, we are not
obligated to effect more than two demand registrations on Form S-3 in any
12-month period.
In addition to the demand registration rights afforded the holders
under the Rights Agreement, the holders are entitled to "piggyback" registration
rights. These rights entitle the holders who so elect to be included in
registration statements to be filed by us with respect to other registrations of
equity securities. The holders are entitled to unlimited "piggyback"
registration rights.
The Rights Agreement provides for the initial appointment of two
persons designated by Cascade to our Board of Directors, and the appointment of
one of such persons as the Chairman of the Compensation Committee of the Board
of Directors. Following the Termination Date, Cascade is required to cause its
director designees, and all other designees, to resign from all applicable
committees and boards of directors, effective as of the Termination Date.
DEBT FINANCING
OVERVIEW
On April 13, 2006, PEI California's second-tier subsidiary, Pacific
Ethanol Madera LLC, or PEI Madera, entered into a Construction and Term Loan
Agreement, or Construction Loan, with Hudson United Capital, or Hudson, and
Comerica Bank, or Comerica. This debt financing, or Debt Financing, is in the
aggregate amount of up to approximately $34.0 million and will provide a portion
of the total financing necessary for the completion of our ethanol production
facility in Madera County, or Project. The Project cost is not to exceed
approximately $65.5 million, or Project Cost.
We have contributed assets to PEI Madera having a value of
approximately $13.9 million (the "Contributed Assets"). We are responsible
for arranging cash equity (the "Contributed Amount") in an amount that, when
combined with the Contributed Assets would be equal to no less than the
difference between the Debt Financing amount of $34.0 million and the total
Project Cost. The Contributed Amount was approximately $31.5 million and has
been satisfied through the application of $17.7 million of Cascade's investment
in our Series A Preferred Stock.
CONSTRUCTION LOAN AND TERM LOAN
The Debt Financing will initially be in the form of a construction
loan, or Construction Loan, that will mature on or before the Final Completion
Date, after which the Debt Financing will be converted to a term loan, or Term
Loan, that will mature on the seventh anniversary of the closing of the Term
Loan. If the conversion does not occur and PEI Madera elects to repay the
Construction Loan, then PEI Madera must pay a termination fee equal to 5.00% of
the amount of the Construction Loan. The closing of the Term Loan is expected to
be the Final Completion Date. The Construction Loan interest rate will float at
a rate equal to the 30-day London Inter Bank Offered Rate, or LIBOR, plus 3.75%.
PEI Madera will be required to pay the Construction Loan interest monthly during
the term of the Construction Loan. The Term Loan interest rate will float at a
rate equal to the 90-day LIBOR plus 4.00%. PEI Madera will be required to
purchase interest rate protection in the form of a LIBOR rate cap of no more
than 5.50% from a provider on terms and conditions reasonably acceptable to
Lender, and in an amount covering no less than 70% of the principal outstanding
7
on any loan payment date commencing on the first draw down date through the
fifth anniversary of the Term Loan. Loan repayments on the Term Loan are to be
due quarterly in arrears for a total of 28 payments beginning on the closing of
the Term Loan and ending on its maturity date. The loan amortization for the
Project will be established on the closing of the Term Loan based upon the
operating cash projected to be available to PEI Madera from the Project as
determined by closing pro forma projections. The Debt Financing will be the only
secured indebtedness permitted on the Project. The Debt Financing will be senior
to all obligations of the Project and PEI Madera other than direct Project
operating expenses and expenses incurred in the ordinary course of business. All
direct and out-of-pocket expenses of Pacific Ethanol or our direct and indirect
subsidiaries will be reimbursed only after the repayment of the Debt Financing
obligations.
The Term Loan amount is to be the lesser of (i) $34.0 Million, (ii)
52.25% of the total Project cost as of the Term Loan Conversion Date, and (iii)
an amount equal to the present value (discounted at an interest rate of 9.5% per
annum) of 43.67% of the operating cash distributable to and received by PEI
Madera supported by the closing pro forma projections, from the closing of Term
Loan through the seventh anniversary of such closing.
LENDER'S SECURITY INTEREST
The Debt Financing is secured by: (i) a perfected first priority
security interest in all of the assets of PEI Madera, including inventories and
all right title and interest in all tangible and intangible assets of the
Project; (ii) a perfected first priority security interest in the Project's
grain facility, including all of PEI Madera's and Pacific Ethanol's and its
affiliates' right title and interest in all tangible and intangible assets of
the Project's grain facility; (iii) a pledge of 100% of the ownership interest
in PEI Madera; (iv) a pledge of the PEI Madera's ownership interest in the
Project; (v) an assignment of all revenues produced by the Project and PEI
Madera; (vi) the pledge and assignment of the material Project documents, to the
extent assignable; (vii) all contractual cash flows associated with such
agreements; and (viii) any other collateral security as Lender may reasonably
request. In addition, the Construction Loan is secured by a completion bond
provided by W.M. Lyles Co.
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.
REVENUE RECOGNITION
We derive revenue primarily from sales of ethanol. Our sales are based
upon written agreements or purchase orders that identify the amount of ethanol
to be purchased and the purchase price. Shipments are made to customers, either,
directly from suppliers or from our inventory to our customers by truck or rail.
Ethanol that is shipped by rail originates primarily in the Midwest and takes
from 10 to 14 days from date of shipment to be delivered to the customer or to
one of four terminals in California and Oregon. For local deliveries the product
is shipped by truck and delivered the same day as shipment. Revenue is
recognized upon delivery of ethanol to a customer's designated ethanol tank in
accordance with Staff Accounting Bulletin ("SAB") No. 104, REVENUE Recognition,
and the related Emerging Issues Task Force ("EITF") Issue No. 99-19, REPORTING
REVENUE GROSS AS A PRINCIPAL VERSUS NET AS AN AGENT.
8
Revenues on the sale of ethanol, which is shipped from our stock of
inventory, are recognized when the ethanol has been delivered to the customer,
provided that appropriate signed documentation of the arrangement, such as a
signed contract, purchase order or letter of agreement, has been received, the
fee is fixed or determinable and collectibility is reasonably assured.
In accordance with EITF Issue No. 99-19, revenue from drop shipments
of third-party ethanol sales are recognized upon delivery, and recorded at the
gross amount when we are responsible for fulfillment of the customer order, have
latitude in pricing, incur credit risk on the receivable and have discretion in
the selection of the supplier. Shipping and handling costs are included in cost
of goods sold.
We have entered into certain contracts under which we may pay the
owner of the ethanol the gross payments received by us from third parties for
forward sales of ethanol less certain transaction costs and fees. From the gross
payments, we may deduct transportation costs and expenses incurred by or on
behalf of Pacific Ethanol in connection with the marketing of ethanol pursuant
to the agreement, including truck, rail and terminal fees for the transportation
of the facility's ethanol to third parties and may also deduct and retain a
marketing fee calculated after deducting these costs and expenses. During 2005,
we did not record revenues under these terms. If and when we do purchase and
sell ethanol under these terms, we will evaluate the proper recording of the
sales under EITF Issue No. 99-19.
INVENTORIES
Inventories consist of fuel ethanol and is valued at the lower of cost
or market, cost being determined on a first-in, first-out basis. Shipping,
handling and storage costs are classified as a component of cost of goods sold.
Title to ethanol transfers from the producer to us when the ethanol passes
through the inlet flange of our receiving tank.
INTANGIBLES, INCLUDING GOODWILL
We evaluate impairment of long-lived assets in accordance with
Statement of Financial Accounting Standards, or SFAS, No. 144, ACCOUNTING FOR
THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSET. We assess the impairment of
long-lived assets, including property and equipment and purchased intangibles
subject to amortization, which are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The asset impairment review assesses the fair value of the
assets based on the future cash flows the assets are expected to generate. An
impairment loss is recognized when estimated undiscounted future cash flows
expected to result from the use of the asset plus net proceeds expected from the
disposition of the asset (if any) are less than the related asset's carrying
amount. Impairment losses are measured as the amount by which the carrying
amounts of the assets exceed their fair values. Estimates of future cash flows
are judgments based on management's experience and knowledge of our operations
and the industries in which we operate. These estimates can be significantly
affected by future changes in market conditions, the economic environment, and
capital spending decisions of our customers and inflation.
We believe the future cash flows to be received from its long-lived
assets will exceed the assets' carrying value, and, accordingly, we have not
recognized any impairment losses through March 31, 2006.
9
Goodwill represents the excess of cost of an acquired entity over the
net of the amounts assigned to net assets acquired and liabilities assumed. We
account for our goodwill in accordance with SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS, which requires an annual review for impairment or more
frequently if impairment indicators arise. This review would include the
determination of each reporting unit's fair value using market multiples and
discounted cash flow modeling. We have adopted SFAS No. 142 guidelines for
annual review of impairment of goodwill and has performed its annual review of
impairment and accordingly, we have not recognized any impairment losses through
March 31, 2006.
STOCK-BASED COMPENSATION
During the first quarter of 2006, effective as of the beginning of the
year, we adopted the fair value method of accounting for employee stock
compensation cost pursuant to SFAS No. 123R. Prior to that date, we used the
intrinsic value method under Accounting Policy Board ("APB") Opinion No. 25 to
recognize compensation cost. Under the method of accounting for the change to
the fair value method, compensation cost recognized in 2006 is the same amount
that would have been recognized if the fair value method would have been used
for all awards granted. The effects on net income and earnings per share had the
fair value method been applied to all outstanding and unvested awards in each
period are reflected in Note 1 of the financial statements.
Our assumptions made for purposes of estimating the fair value of its
stock options, as well as a summary of the activity under our stock option plan
are included in Note 1 of the financial statements.
We account for the stock options granted to non-employees in
accordance with 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 SFAS No. 123R.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We attempt to minimize our exposure to price risk by using derivative
instruments. In 2006, we entered into derivative instruments in an attempt to
minimize our exposure to market volatility associated with certain purchase
commitments. We account for our 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 ("NYMEX"),
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 earnings unless specific hedge accounting criteria
are met. If derivatives meet those criteria, the derivative's gains and losses
offset related results on the hedged item in the income statement. We formally
designate each derivative as a hedge and document and assess the effectiveness
of derivatives associated with transactions that receive hedge accounting.
RESULTS OF OPERATIONS
The table presented below, which compare our results of operations from
one period to another, present the results for each period, the change in those
results from one period to another in both dollars and percentage change, and
the results for each period as a percentage of net sales. The columns present
the following:
o The first two data columns in the table show the absolute
results for each period presented.
o The columns entitled "Dollar Variance" and "Percentage
Variance" show the change in results, both in dollars and
percentages. These two columns show favorable changes as a
positive and unfavorable changes as negative. For example,
when our net sales increase from one period to the next, that
change is shown as a positive number in both columns.
Conversely, when expenses increase from one period to the
next, that change is shown as a negative in both columns.
10
o The last two columns in the table show the results for each
period as a percentage of net sales.
THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2005
RESULTS AS A
PERCENTAGE
DOLLAR PERCENTAGE OF NET SALES FOR THE
THREE MONTHS ENDED VARIANCE VARIANCE THREE MONTHS ENDED
MARCH 31, ------------ ------------- MARCH 31,
------------------------------ FAVORABLE FAVORABLE ----------------------
2006 2005 (UNFAVORABLE) (UNFAVORABLE) 2006 2005
------------ ------------ ------------ ------------- -------- ---------
Net sales ................................. $ 38,239,167 $ 2,301,997 $ 35,937,170 1,561.1% 100.0% 100.0%
Cost of sales ............................. 35,913,920 2,254,370 33,659,550 1,493.1 93.9 97.9
------------ ------------ ------------ --------- -------- ---------
Gross profit .............................. 2,325,247 47,627 2,277,620 4,782.1 6.1 2.1
Selling, general and administrative
expenses ................................ 2,984,084 743,233 2,240,851 (301.5) 7.8 32.3
Feasibility study expensed in connection
with acquisition of ReEnergy ............ -- 852,250 (852,250) 100.0 -- 37.0
------------ ------------ ------------ --------- -------- ---------
Loss from operations ...................... (658,837) (1,547,856) 889,019 57.4 (1.7) (67.2)
Total other income (expense) .............. 51,779 (107,853) 159,632 148.0 0.1 (4.7)
------------ ------------ ------------ --------- -------- ---------
Loss from operations before income taxes... (607,058) (1,655,709) 1,048,651 63.3 (1.6) (71.9)
Provision for income taxes ................ 4,705 1,600 (3,105) (194.1) 0.0 0.1
------------ ------------ ------------ --------- -------- ---------
Net loss .................................. $ (611,763) $ (1,657,309) $ 1,045,546 63.1% (1.6)% (72.0)%
============ ============ ============ ========= ========= =========
NET SALES. Net sales for the three months ended March 31, 2006
increased by $35,937,170 to $38,239,167 as compared to $2,301,997 for the three
months ended March 31, 2005. We completed our acquisition of Kinergy on March
23, 2005. Accordingly, our results of operations for the quarter ended March 31,
2005 consist of the operations of PEI California for that entire period and the
operations of Kinergy and ReEnergy from March 23, 2005 through March 31, 2005.
Our results of operations for the quarter ended March 31, 2006 consist of our
operations and the operations of all of our wholly-owned subsidiaries, including
PEI California, Kinergy and ReEnergy for that entire period.
GROSS PROFIT. Gross profit for 2005 increased by $2,277,620 to
$2,325,247 as compared to $47,627 for the three months ended March 31, 2005.
Gross profit as a percentage of net sales increased to 6.1% for the three months
ended March 31, 2006 as compared to 2.1% for the three months ended March 31,
2005. This difference is almost entirely attributable to higher gross margins
achieved by Kinergy.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin was 6.0% in the first quarter of
2006 as compared to 1.7% in the first quarter of 2005. Kinergy's gross profit
margin in the first quarter of 2005 is generally reflective of the contracted
margins for that period. The increase in Kinergy's gross profit margin in the
first quarter of 2006 is generally reflective of opportunistic buying and
selling during a period of rapidly increasing market prices. Kinergy entered
into fixed-price purchase contracts for the October 2005 through March 2006
contracting period and maintained a net long ethanol position going into the
first quarter of 2006. The decision to maintain a net long ethanol position was
based on a confluence of factors, including management's expectation of
increased prices of gasoline and petroleum and the acceleration of the phase-out
of MTBE blending which we believed would result in a significant increase in
demand for blending ethanol with gasoline.
We believe that Kinergy's future gross profit margins may be lower
than historical levels for two principal reasons. First, increased competition
in the ethanol market may reduce margins. Second, Kinergy may, in some cases,
engage in direct sales arrangements that typically result in lower gross
margins.
11
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended March 31, 2006 increased by
$2,240,851 to $2,984,084 as compared to $743,233 for the three months ended
March 31, 2005. This increase was primarily due to $885,094 in additional legal,
accounting and consulting fees, $176,442 in additional amortization of
intangibles, $175,866 in additional non-cash compensation and non-cash
consulting expenses, $555,831 in additional payroll expense related to the
three executive employment agreements that became effective upon the
consummation of the Share Exchange Transaction on March 23, 2005, the addition
of two staff positions in May and June 2005, an employee promotion in May 2005,
the addition of two executive positions in June 2005, the addition of two
high-level ethanol plant management positions in September 2005, the addition of
three staff positions in the fourth quarter of 2005, and the addition
of three staff positions in the first quarter of 2006. The increase
in selling, general and administrative expenses was also due to $22,482 in
additional insurance expense related primarily to liability and property
coverage for our Madera County construction site, a $88,121 increase in business
travel expenses, a $95,602 increase in policy and investor relations expenses, a
$17,496 increase in rents, a $9,044 increase in advertising and marketing
expense, an $34,007 increase in dues and trade memberships, a $10,512 increase
in telephone expense, a $44,324 increase in terminated project development
expense, and the net balance of $126,030 related to various increases in other
selling, general and administrative expenses.
We expect that over the near-term, our selling, general and
administration expenses will increase as a result of, among other things,
increased legal and accounting fees associated with increased corporate
governance activities in response to the Sarbanes-Oxley Act of 2002, recently
adopted rules and regulations of the Securities and Exchange Commission,
increased employee costs associated with planned staffing increases, increased
sales and marketing expenses, increased activities related to the construction
of our Madera County ethanol production facility and increased activity in
searching for and analyzing potential acquisitions.
FEASIBILITY STUDY EXPENSED IN CONNECTION WITH ACQUISITION OF REENERGY.
Feasibility study expenses in connection with acquisition of ReEnergy for the
three months ended March 31, 2006 were $0 as compared to $852,250 for the three
months ended March 31, 2005. This amount arose in the connection with the
acquisition of ReEnergy and relates to a feasibility study for an ethanol plant
in Visalia, California. Based on this study, ReEnergy entered into an option to
buy land for the ethanol plant. The option expired unexercised on December 15,
2005.
OTHER INCOME/(EXPENSE). Other income/(expense) increased by $159,632
to $51,779 for the three months ended March 31, 2006 as compared to ($107,853)
for the three months ended March 31, 2005, primarily due to a $49,080 increase
in interest income, a $19,595 decrease in other income, a net decrease of
$138,492 in interest expense related to long-term debt, amortization of
discount, and construction payables, net of capitalized interest related to our
planned Madera County ethanol plant, and an increase of $8,345 in bank charges,
finance charges, and short-term interest.
LIQUIDITY AND CAPITAL RESOURCES
During the three months ended March 31, 2006, we funded our operations
primarily from our cash on hand, net income from the operations of Kinergy and
net proceeds from the exercise of warrants and options to purchase shares of our
common stock. As of March 31, 2006, we had negative working capital of
$10,569,314, representing a decrease in working capital of $7,675,181 from
negative working capital of $2,894,133 as of December 31, 2005. This decrease in
working capital is primarily due to an increase in accounts payable to W.M.
Lyles Co., a related party, for the construction of our Madera County ethanol
production facility as well as an increase in accounts payable of Kinergy.
12
Our current available capital resources consist primarily of
approximately $4.2 million in cash as of March 31, 2006. This amount was
primarily raised through the exercise of outstanding warrants and options. We
expect that our future available capital resources will consist primarily of any
balance of the $4.2 million in cash as of March 31, 2006, cash generated from
Kinergy's ethanol marketing business, if any, restricted and unrestricted
proceeds from the issuance of our Series A Preferred Stock to Cascade, and any
future debt and/or equity financings.
Accounts receivable increased $3,007,632 during the three months ended
March 31, 2006 from $4,947,538 as of December 31, 2005 to $7,955,170 as of March
31, 2006. Kinergy's sales growth contributed substantially all of this increase.
Inventory balances increased $281,492 during the three months ended
March 31, 2006, from $362,972 as of December 31, 2005 to $644,464 as of March
31, 2006. As of December 31, 2005, there was significant inventory in transit
(prepaid inventory) due to logistical delays in delivery to our inventory
terminal locations. The increased inventory balance as of March 31, 2006
reflects a return to a more typical balance between inventory in transit and
actual inventory on hand.
Other current assets increased $517,787 during the three months ended
March 31, 2006, from $86,054 as of December 31, 2005 to $603,841 as of March 31,
2006. The increase is primarily related to deposits for derivative instruments.
Total other assets increased $368,091 during the three months ended
March 31, 2006 from $10,196,892 as of December 31, 2005 to $10,564,983 as of
March 31, 2006. The increase is primarily due to deferred financing fees related
to our debt financing for the completion of our ethanol production facility in
Madera County. See "Debt Financing" above.
Cash provided by our operating activities totaled $4,998,183 for the
three months ended March 31, 2006 compared to cash used in our operating
activities of $1,196,080 for the three months ended March 31, 2005. This
$5,694,263 increase in cash provided by operating activities primarily resulted
from an increase in accounts payable and accrued expenses.
Cash used in our investing activities totaled $11,020,530 for the
three months ended March 31, 2006 as compared to $2,976,737 of cash provided in
the three months ended March 31, 2005. Included in the results for the three
months ended March 31, 2006 are $13,770,530 in cash used for additions to
property, plant, and equipment primarily reflecting the Madera County plant
construction and $2,750,000 in proceeds from sale of marketable securities.
Cash provided by our financing activities totaled $5,702,138 for the
three months ended March 31, 2006 as compared to $18,962,854 for the three
months ended March 31, 2005. The entire amount for the three months ended March
31, 2006 is related to gross proceeds from the exercise of warrants and stock
options. The amount for the three months ended March 31, 2005 includes the
proceeds from PEI California's private placement transaction in March 2005. See
"Share Exchange Transaction" above.
On April 13, 2006, we issued to Cascade 5,250,000 shares of our Series
A Preferred Stock at a price of $16.00 per share for an aggregate purchase price
of $84.0 million. Of the $84.0 million aggregate purchase price, $4.0 million
was paid to us at closing and $80.0 million has been deposited into a restricted
cash account and will be disbursed in accordance with a Deposit Agreement. We
are entitled to use the initial $4.0 million of proceeds for general working
capital and must use the remaining $80.0 million for the construction or
acquisition of one or more ethanol production facilities in accordance with the
terms of the Deposit Agreement. Of the $80.0 million deposited into the
restricted cash account, $20.0 million has been advanced to us for use in the
construction of our Madera County ethanol plant. See "Preferred Stock Financing"
above.
On April 13, 2006, PEI Madera entered into a Construction Loan with
Hudson and Comerica for debt financing in the aggregate amount of up to
approximately $34.0 million. We must use these loan proceeds for the
construction of our Madera County ethanol production facility.
13
A portion of the proceeds from the Series A Preferred Stock financing
and the entire amount of the approximately $34.0 million in Debt Financing are
expected to be used as follows for a total cost of completion of our Madera
County ethanol production facility estimated at approximately $55.3 million:
site work ($1.7 million); building and concrete ($7.0 million); site utilities
($1.1 million); equipment and tanks ($19.2 million); piping ($5.7 million);
electrical ($3.7 million); and engineering, general conditions, and other ($16.9
million). The above amounts do not include up to $10.2 million in additional
funding required for capital raising expenses, interest expense during
construction and working capital for a total project cost of approximately
$65.5 million.
We have a $2.0 million revolving line of credit with Comerica Bank, or
Comerica, that we use from time to time in connection with the operations of
Kinergy. Principal amounts outstanding under the line of credit accrue interest,
on a per annum basis, at Comerica's "base rate" of interest plus 1.0%.
Comerica's "base rate" of interest is currently the prime rate of interest and
is subject to adjustment from time to time by Comerica. As of March 31, 2006,
the interest rate on principal amounts outstanding under the line of credit
would have been 8.75%. There were no balances outstanding on the line of
credit as of March 31, 2006 and December 31, 2005.
On October 1, 2005, we issued an Irrevocable Standby Letter of Credit
by Comerica Bank for any sum not to exceed a total of $400,000, leaving funds
available of $1.6 million on the line of credit. The designated beneficiary of
the letter of credit is one of our vendors, and the letter was initially valid
through March 31, 2006. On April 1, 2006, the Irrevocable Standby Letter of
Credit was extended to September 30, 2006.
We believe that current and future available capital resources,
revenues generated from operations and other existing sources of liquidity,
including the credit facilities we have, and our offering of Series A Preferred
Stock and the available proceeds from the Debt Financing, will be adequate to
meet our anticipated working capital and capital expenditure requirements for at
least the next twelve months. If, however, our capital requirements or cash flow
vary materially from our current projections, if unforeseen circumstances occur,
or if we require a significant amount of cash to fund future acquisitions, we
may require additional financing. Our failure to raise capital, if needed, could
restrict our growth or hinder our ability to compete.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant
on the financial condition or results of operations of either our company or our
operating subsidiaries.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INDEXED PURCHASE COMMITMENTS
We are exposed to market risks primarily related to volatility in
unleaded gasoline prices associated with purchase commitments for ethanol. We
utilize NYMEX commodity-based futures contracts to attempt to hedge our exposure
to these market price fluctuations. As of March 31, 2006, we had entered into
NYMEX futures contracts that will settle from April 2006 through September 2006.
These contracts qualify as cash flow hedges, therefore, unrealized gains and
losses in the fair value of these instruments are recognized in other
comprehensive income. This accounting treatment is discussed further under Note
1 "Organization and Summary of Significant Accounting Policies" in our
consolidated financial statements contained elsewhere in this report.
14
The fair value estimate is based on the difference between NYMEX
market data available on March 31, 2006 and the applicable contract price,
multiplied by the number of gallons stated in the futures contract. The time
value component of the derivative value was not significant, and was therefore
excluded from the calculation of fair value.
ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, as of March 31, 2006, to ensure that information
required to be disclosed by us in the reports filed or submitted by us under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities Exchange Commission's rules and forms,
including to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is accumulated and
communicated to management, including our principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that as
of March 31, 2006, our disclosure controls and procedures were not effective at
the reasonable assurance level due to the material weakness described below.
A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected.
On April 7, 2006, in connection with its audit of our consolidated
financial statements for the year ended December 31, 2005, Hein & Associates
LLP, our independent registered public accounting firm ("Hein"), advised
management and our audit committee of the following matter that Hein considered
to be a material weakness: The organization of our accounting department at that
time did not provide us with the appropriate resources and adequate technical
skills to accurately account for and disclose our activities.
Hein stated that this matter is evidenced by the following issues
encountered in connection with its audit of our consolidated financial
statements for the year ended December 31, 2005: (i) we were unable to provide
accurate accounting for and disclosure of the Share Exchange Transaction, (ii)
our closing procedures were not adequate and resulted in significant accounting
adjustments, and (iii) we were unable to adequately perform the financial
reporting process as evidenced by a significant number of suggested revisions
and comments by Hein to our consolidated financial statements and related
disclosures for the year ended December 31, 2005.
As a result of the identification of this matter by Hein, management
evaluated, with consultation from our audit committee, in the second quarter of
2006 and as of March 31, 2006, the impact of our lack of appropriate resources
and adequate technical skills in our accounting department and concluded, in the
second quarter of 2006 and as of March 31, 2006, that the control deficiency
that resulted in our lack of appropriate resources and adequate technical skills
in our accounting department represented a material weakness and concluded that,
as of March 31, 2006, our disclosure controls and procedures were not effective
at the reasonable assurance level.
15
To initially address this material weakness, management performed
additional analyses and other procedures to ensure that the financial statements
included herein fairly present, in all material respects, our financial
position, results of operations and cash flows for the periods presented.
REMEDIATION OF MATERIAL WEAKNESS
To remediate the material weakness in our disclosure controls and
procedures identified above, we have done or intend to do the following
subsequent to March 31, 2006, in the periods specified below:
In the second quarter of 2006, we developed plans to alter the current
organization of our accounting department to hire additional personnel to assist
in our financial reporting processes, including a Director of Financial
Reporting who has expertise in public company financial reporting compliance and
at least one additional accounting supervisory support staff member who will
report to our Controller and/or our Director of Financial Reporting.
In the second quarter of 2006, we successfully hired a Director of
Financial Reporting who has expertise in public company financial reporting
compliance. We also replaced one support staff member with a more well-qualified
individual. We continue to seek to hire an additional accounting supervisory
support staff member who will report to our Controller and/or our Director of
Financial Reporting.
Our remediation plans also include exploring the advisability of
seeking guidance from financial consultants who are certified public accountants
with the requisite background and experience to assist us in identifying and
evaluating complex accounting and reporting matters. In addition, we intend to
define new internal processes for identifying and disclosing both routine and
non-routine transactions and for researching and determining proper accounting
treatment for those transactions. We plan to assign individuals with appropriate
knowledge and skills to perform these processes and plan to provide those
individuals with adequate technical and other resources to help ensure the
proper application of accounting principles and the timely and appropriate
disclosure of routine and non-routine transactions. We also intend to hire a
General Counsel who will work with our Chief Financial Officer and Director of
Financial Reporting to help ensure that our disclosures are timely and
appropriate.
We believe that our current Director of Financial Reporting and our
additional accounting supervisory support staff member, once hired, will
contribute additional expertise to our team of finance and accounting personnel.
In addition, we believe that, by replacing one support staff member with a more
well-qualified individual, we have added an individual who will contribute
additional expertise to our team of finance and accounting personnel. We also
believe that our new position of General Counsel, once it is filled with a
suitable candidate, will contribute additional expertise to help ensure that our
reporting obligations are satisfied.
Management is unsure, at the time of the filing of this report, when
the actions described above will remediate the material weakness also described
above. Although management intends to hire one additional accounting supervisory
support staff member and a General Counsel as soon as practicable, it may take
an extended period of time until suitable candidates can be located and hired.
Management is, however, optimistic that these personnel can be located and hired
by the third quarter of 2006 and that the material weakness described above can
be fully remediated by the fourth quarter of 2006. Until we hire an additional
accounting supervisory support staff member, as planned, management may hire
outside consultants to assist us in satisfying our financial reporting
obligations.
Our Director of Financial Reporting has an annual base salary of
$85,000, not including benefits and other costs of employment. Management
believes that a suitable candidate for General Counsel will have an annual base
salary in the range of $150,000 to $200,000, not including benefits and other
costs of employment. Management also believes that a suitable candidate for our
additional accounting supervisory support staff member will have an annual base
salary in the range of $40,000 to $50,000, not including benefits and other
costs of employment. Management is unable, however, to estimate our expenditures
16
related to fees, if any, that may be paid to financial consultants in connection
with their guidance in identifying and evaluating complex accounting and
reporting matters. Management is also unable to estimate our expenditures
related to the development of new internal processes for identifying and
disclosing both routine and non-routine transactions and for researching and
determining proper accounting treatment for those transactions. Management is
also unable to estimate our expenditures related to the hiring of other outside
consultants, if any, to assist us in satisfying our financial reporting
obligations. In addition, management is unable to estimate our expenditures
related to higher fees to be paid to our independent auditors in connection with
their review of this remediation.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes during our most recently completed fiscal
quarter that have materially affected or are reasonably likely to materially
affect, our internal control over financial reporting, as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act.
PART II - OTHER INFORMATION
ITEM 1. 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 adversely affect our financial position, results of operations or cash
flows.
BARRY SPIEGEL
On December 23, 2005, Barry J. Spiegel, a stockholder of Pacific
Ethanol and former director of Accessity, filed a complaint in the Circuit Court
of the 17th Judicial District in and for Broward County, Florida (Case No.
05018512), or the Spiegel Action, against Barry Siegel, Philip Kart, Kenneth
Friedman and Bruce Udell, or collectively, the 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 Spiegel Action relates to the Share Exchange Transaction and
purports to state the following five counts against the Defendants: (i) breach
of fiduciary duty, (ii) violation of Florida's Deceptive and Unfair Trade
Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of
Florida Securities and Investor Protection Act. Mr. Spiegel is seeking $22.0
million in damages. On March 8, 2006, Defendants filed a motion to dismiss the
Spiegel Action.
We have agreed with Messrs. Friedman, Siegel, Kart and Udell to advance
the costs of defense in connection with the Spiegel Action. Under applicable
provisions of Delaware law, we may be responsible to indemnify each of the
Defendants in connection with the Spiegel Action. The final outcome of the
Spiegel Action will most likely take an indefinite time to resolve.
17
GERALD ZUTLER
In January 2003, DriverShield CRM Corp., or DriverShield, then a
wholly-owned subsidiary of our predecessor, Accessity, was served with a
complaint filed by Mr. Gerald Zutler, its former President and Chief Operating
Officer, alleging, among other things, that DriverShield breached his employment
contract, that there was fraudulent concealment of DriverShield's intention to
terminate its employment agreement with Mr. Zutler, and discrimination on the
basis of age and aiding and abetting violation of the New York State Human
Rights Law. The complaint was filed in the Supreme Court of the State of New
York, County of Nassau, Index No.: 654/03. Mr. Zutler is seeking damages
aggregating $2.225 million, plus punitive damages and reasonable attorneys'
fees. DriverShield's management believes that DriverShield properly terminated
Mr. Zutler's employment for cause, and intends to vigorously defend this suit.
An Answer to the complaint was served by DriverShield on February 28, 2003. In
2003, Mr. Zutler filed a motion to have DriverShield's attorney removed from the
case. The motion was granted by the court, but was subsequently overturned by an
appellate court. DriverShield has filed a claim with its insurance carrier under
its directors and officers and employment practices' liability policy. The
carrier has agreed to cover certain portions of the claim as they relate to Mr.
Siegel, DriverShield's former Chief Executive Officer. The policy has a $50,000
deductible and a liability limit of $3.0 million per policy year. At the present
time, the carrier has agreed to cover the portion of the claim that relates to
Mr. Siegel and has agreed to a fifty percent allocation of expenses.
MERCATOR GROUP, LLC
We filed a Demand for Arbitration against Presidion Solutions, Inc., or
Presidion, alleging that Presidion breached the terms of the Memorandum of
Understanding, or the MOU, between Accessity and Presidion dated January 17,
2003. We sought a break-up fee of $250,000 pursuant to the terms of the MOU
alleging that Presidion breached the MOU by wrongfully terminating the MOU.
Additionally, we sought out of pocket costs of its due diligence amounting to
approximately $37,000. Presidion filed a counterclaim against us alleging that
we had breached the MOU and therefore owe Presidion a break-up fee of $250,000.
The dispute was heard by a single arbitrator before the American Arbitration
Association in Broward County, Florida in late February 2004. During June 2004,
the arbitrator awarded us the $250,000 break-up fee set forth in the MOU between
us and Presidion, as well as our share of the costs of the arbitration and
interest from the date of the termination by Presidion of the MOU, aggregating
approximately $280,000. During the third quarter of 2004, Presidion paid us the
full amount of the award with accrued interest. The arbitrator dismissed
Presidion's counterclaim against us.
In 2003, we filed a lawsuit seeking damages in excess of $100 million
as a result of information obtained during the course of the arbitration
discussed above, against: (i) Presidion Corporation, f/k/a MediaBus Networks,
Inc., Presidion's parent corporation, (ii) Presidion's investment bankers,
Mercator Group, LLC, or Mercator, and various related and affiliated parties and
(iii) Taurus Global LLC, or Taurus, (collectively referred to as the "Mercator
Action"), alleging that these parties committed a number of wrongful acts,
including, but not limited to tortuously interfering in the transaction between
us and Presidion. In 2004, we dismissed this lawsuit without prejudice, which
was filed in Florida state court. We recently refiled this action in the State
of California, for a similar amount, as we believe this to be the proper
jurisdiction. On August 18, 2005, the court stayed the action and ordered the
parties to arbitration. The parties agreed to mediate the matter. Mediation took
place on December 9, 2005 and was not successful. On December 5, 2005, we filed
a Demand for Arbitration with the American Arbitration Association. On April 6,
2006, a single arbitrator was appointed. The final outcome of the Mercator
Action will most likely take an indefinite time to resolve. We currently have
limited information regarding the financial condition of the defendants and the
extent of their insurance coverage. Therefore, it is possible that we may
prevail, but may not be able to collect any judgment. The share exchange
agreement relating to the Share Exchange Transaction provides that following
full and final settlement or other final resolution of the Mercator Action,
after deduction of all fees and expenses incurred by the law firm representing
us in this action and payment of the 25% contingency fee to the law firm,
shareholders of record of Accessity on the date immediately preceding the
closing date of the Share Exchange Transaction will receive two-thirds and we
will retain the remaining one-third of the net proceeds from any Mercator Action
recovery.
18
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you
should carefully consider the factors discussed under "Risk Factors" in our
Annual Report on Form 10-KSB for the year ended December 31, 2005, which could
materially affect our business, financial condition and results of operations.
The risks described in our Annual Report on Form 10-KSB are not the only risks
we face. Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
UNREGISTERED SALES OF EQUITY SECURITIES
From January through March 2006, we issued an aggregate of 1,647,946
shares of our common stock upon the exercise of outstanding warrants, net of
7,171 shares of common stock deemed tendered back to us upon cashless exercises
of certain of those warrants. In connection with the warrant exercises, other
than cashless exercises, we received aggregate gross proceeds of $5,494,065.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were sophisticated or
accredited with access to the kind of information registration would provide.
DIVIDENDS
We have never paid cash dividends on our common stock and do not
currently intend to pay cash dividends on our common stock in the foreseeable
future. We currently anticipate that we will retain any earnings for use in the
continued development of our business.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
19
ITEM 6. EXHIBITS.
Exhibit
Number Description
------ -----------
10.1 First Amendment to Pacific Ethanol, Inc. 2004 Stock Option Plan (1)
31.1 Certifications 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 (*)
31.2 Certifications 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 (*)
32.1 Certification of President 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 (*)
__________
* Filed herewith.
(1) Filed as an exhibit to the Registrant's Current Report on Form 8-K for
January 26, 2006 (File No. 0-21467) filed with the Commission on
February 1, 2006.
20
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PACIFIC ETHANOL, INC.
Dated: May 15, 2006 By: /S/ WILLIAM G. LANGLEY
--------------------------------------
William G. Langley
Chief Financial Officer
(principal financial officer and duly
authorized officer)
21
EXHIBITS FILED WITH THIS REPORT
Exhibit
Number Description
------ -----------
31.1 Certifications 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 (*)
31.2 Certifications 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 (*)
32.1 Certification of President and Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as Adopted
22