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EX-32.1 - EXHIBIT 32.1 - Pacific Ethanol, Inc.s109336_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Pacific Ethanol, Inc.s109336_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Pacific Ethanol, Inc.s109336_ex31-1.htm
EX-23.1 - EXHIBIT 23.1 - Pacific Ethanol, Inc.s109336_ex23-1.htm
EX-21.1 - EXHIBIT 21.1 - Pacific Ethanol, Inc.s109336_ex21-1.htm
EX-10.31 - EXHIBIT 10.31 - Pacific Ethanol, Inc.s109336_ex10-31.htm
EX-10.5 - EXHIBIT 10.5 - Pacific Ethanol, Inc.s109336_ex10-5.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2017

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from                  to               

 

Commission file number: 000-21467

 

PACIFIC ETHANOL, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

41-2170618

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

400 Capitol Mall, Suite 2060, Sacramento, California 95814
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (916) 403-2123

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class

Name of Exchange on Which Registered

Common Stock, $0.001 par value

The Nasdaq Stock Market LLC

(Nasdaq Capital Market)

 

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

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒    No  ☐

 

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

 

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

 

Large accelerated filer  ☐ Accelerated filer  ☒
Non-accelerated filer  ☐ (Do not check if a smaller reporting company) Smaller reporting company  ☐
  Emerging growth company  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The aggregate market value of the voting and non-voting common equity held by nonaffiliates of the registrant computed by reference to the closing sale price of such stock, was approximately $266.3 million as of June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter.

 

As of March 14, 2018, there were 43,959,245 shares of the registrant’s common stock, $0.001 par value per share, and 896 shares of the registrant’s non-voting common stock, $0.001 par value per share, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Part III incorporates by reference certain information from the registrant’s proxy statement (the “Proxy Statement”) for the 2018 Annual Meeting of Stockholders to be filed on or before April 30, 2018

 

 

 

 

TABLE OF CONTENTS

    Page
PART I
Item 1. Business 1
Item 1A. Risk Factors 14
Item 1B. Unresolved Staff Comments 23
Item 2. Properties 23
Item 3. Legal Proceedings 23
Item 4. Mine Safety Disclosures 24
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 25
Item 6. Selected Financial Data 27
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 49
Item 8. Financial Statements and Supplementary Data 50
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 50
Item 9A. Controls and Procedures 50
Item 9B. Other Information 52
PART III
Item 10. Directors, Executive Officers and Corporate Governance 53
Item 11. Executive Compensation 53
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 53
Item 13. Certain Relationships and Related Transactions, and Director Independence 53
Item 14. Principal Accounting Fees and Services 53
PART IV
Item 15. Exhibits, Financial Statement Schedules 53
Index to Consolidated Financial Statements F-1

 

 

 

 

CAUTIONARY STATEMENT

 

All statements included or incorporated by reference in this Annual Report on Form 10-K, other than statements or characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected net sales, costs and expenses and gross margins; our accounting estimates, assumptions and judgments; the demand for ethanol and its co-products; the competitive nature of and anticipated growth in our industry; production capacity and goals; our ability to consummate acquisitions and integrate their operations successfully; and our prospective needs for additional capital. These forward-looking statements are based on our current expectations, estimates, approximations and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under “Risk Factors” in Item 1A of this report. These forward-looking statements speak only as of the date of this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.

 

 

 

 

PART I

 

Item 1.Business.

 

Business Overview

 

We are a leading producer and marketer of low-carbon renewable fuels in the United States.

 

We operate nine strategically-located production facilities. Four of our plants are in the Western states of California, Oregon and Idaho, and five of our plants are located in the Midwestern states of Illinois and Nebraska. We are the sixth largest producer of ethanol in the United States based on annualized volumes. Our plants have a combined production capacity of 605 million gallons per year. We market all the ethanol, specialty alcohols and co-products produced at our plants as well as ethanol produced by third parties. On an annualized basis, we market nearly 1.0 billion gallons of ethanol and over 3.0 million tons of ethanol co-products on a dry matter basis. Our business consists of two operating segments: a production segment and a marketing segment.

 

Our mission is to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. We intend to accomplish this goal in part by expanding our ethanol production capacity and distribution infrastructure, accretive acquisitions, lowering the carbon intensity of our ethanol, extending our marketing business into new regional and international markets, and implementing new technologies to promote higher production yields and greater efficiencies.

 

Production Segment

 

We produce ethanol, specialty alcohols and co-products at our production facilities described below. Our plants located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. Our plants located in the Midwest are in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, our ability to load unit trains from our plants located in the Midwest, and barges from our Pekin, Illinois plants, allows for greater access to international markets.

 

We wholly-own all of our plants located on the West Coast and the three plants in Pekin, Illinois. We own approximately 74% of the two plants in Aurora, Nebraska as well as the grain elevator adjacent to those properties and related grain handling assets, including the outer rail loop, and the real property on which they are located, through Pacific Aurora, LLC, or Pacific Aurora, an entity owned approximately 26% by Aurora Cooperative Elevator Company, or ACEC.

 

Facility Name

Facility Location

Estimated Annual Capacity
(gallons)

Magic Valley Burley, ID 60,000,000
Columbia Boardman, OR 40,000,000
Stockton Stockton, CA 60,000,000
Madera Madera, CA 40,000,000
Aurora West Aurora, NE 110,000,000
Aurora East Aurora, NE 45,000,000
Pekin Wet Pekin, IL 100,000,000
Pekin Dry Pekin, IL 60,000,000
Pekin ICP Pekin, IL 90,000,000

 

-1-

 

 

We produce ethanol co-products at our production facilities such as wet distillers grains, or WDG, dry distillers grains with solubles, or DDGS, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO2.

 

Marketing Segment

 

We market ethanol, specialty alcohols and co-products produced by our facilities and market ethanol produced by third parties. We have extensive customer relationships throughout the Western and Midwestern United States. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of ethanol, and manage the logistics and timing of delivery with very little effort on their part. Our customers collectively require ethanol volumes in excess of the supplies we produce at our production facilities. We secure additional ethanol supplies from third-party plants in California and other third-party suppliers in the Midwest where a majority of ethanol producers are located. We arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources.

 

We market our distillers grains and other feed co-products to dairies and feedlots, in many cases located near our ethanol plants. These customers use our feed co-products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers. We do not market co-products from other ethanol producers.

 

See “Note 4 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments.

 

Acquisition of Illinois Corn Processing LLC

 

On July 3, 2017, we completed our acquisition of Illinois Corn Processing, LLC, or ICP, under the terms of an Agreement and Plan of Merger dated as of June 26, 2017 by and among Pacific Ethanol Central, LLC, ICP Merger Sub, LLC, Illinois Corn Processing Holdings Inc., MGPI Processing, Inc., and ICP. ICP is a 90 million gallon per year fuel and industrial alcohol manufacturing, storage and distribution facility located on the Illinois River adjacent to our facilities in Pekin, Illinois. ICP produces fuel-grade ethanol, beverage and industrial-grade alcohol, DDGS and corn oil. ICP’s facility has direct access to end-markets via barge, rail and truck. We acquired ICP for $76.9 million, of which $30.0 million was paid in cash and $46.9 million was paid through the issuance of non-amortizing secured promissory notes, which have been subsequently repaid.

 

Our acquisition of ICP adds 90 million gallons per year of production capacity, diversifies fuel ethanol production with high-value beverage and industrial grade alcohol, and expands our domestic and international distribution channels. Two-thirds of ICP’s production is currently dedicated to producing high-quality, premium-priced alcohol products for the beverage and industrial markets. The consolidation of the ICP facility with our two Pekin, Illinois plants has integrated our Pekin site into a unique combination of technologies and products with a combined operating capacity of 250 million gallons per year. We expect the acquisition will yield approximately $4.5 million in annual cost savings over the twelve-month period following the acquisition, including economies of scale in purchasing power, managing grain supply and transportation costs for DDGS and ethanol. The acquisition was immediately accretive to earnings. We believe the acquisition will have a continued positive impact on our earnings as ICP’s beverage and industrial grade alcohol products are priced at a premium to fuel ethanol.

 

-2-

 

 

Company History

 

We are a Delaware corporation formed in February 2005. Our common stock trades on The NASDAQ Capital Market under the symbol “PEIX.” Our Internet website address is http://www.pacificethanol.com. Information contained on our website is not part of this Annual Report on Form 10-K. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed with or furnished to the Securities and Exchange Commission and other Securities and Exchange Commission filings are available free of charge through our website as soon as reasonably practicable after the reports are electronically filed with, or furnished to, the Securities and Exchange Commission.

 

Business Strategy

 

Our primary goal is to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. The key elements of our business and growth strategy to achieve this objective include:

 

Expand ethanol production capacity and distribution infrastructure. We believe the United States ethanol production industry is poised for continued consolidation. We evaluate and intend to pursue opportunities to acquire additional ethanol and specialty alcohol production, ethanol storage and distribution facilities, and related infrastructure as financial resources and business prospects make these acquisitions desirable. To this end, we are examining specific opportunities to extend our current production and marketing platform with strategic and synergistic acquisitions. In addition, we plan to expand our distribution infrastructure by increasing our ability to provide transportation, storage and related logistical services to our customers throughout the United States.

 

Lower the carbon intensity of our ethanol. We plan to further reduce the carbon intensity of the ethanol we produce. We are able to sell this lower carbon intensity ethanol in certain regions at premium prices compared to higher carbon intensity ethanol. We are able to charge premium prices for this ethanol based on state laws and regulations, such as Low-Carbon Fuel Standards enacted in California and Oregon that require blenders to use lower carbon intensity ethanol in their gasoline. When available and cost-effective, we intend to use feedstock other than corn, including cellulosic feedstock, as the raw material used in the production of ethanol to further reduce the carbon intensity of our ethanol.

 

Extend our marketing business into new regional and international markets. We have strengthened our market position in the Midwest through our acquisition in mid-2017 of ICP and through our acquisition in mid-2015 of Aventine Renewable Energy Holdings, Inc., now known as Pacific Ethanol Central, LLC, or PE Central. We intend to pursue opportunities to extend our marketing business into new regional markets within reach from our plants in Illinois and Nebraska. We also plan to continue to leverage our relationships with our customers to market and sell additional ethanol sourced from third parties. In addition, we are exploring opportunities to market and sell ethanol internationally.

 

Implement new equipment and technologies. We intend to continue to evaluate and implement new equipment and technologies to increase our production and operating efficiencies, reduce our use of carbon-based fuels and improve our carbon scores, use diverse feedstocks, diversify products and revenues, including through our production of advanced biofuels, and improve our plant profitability as financial resources and market conditions justify these investments.

 

-3-

 

 

Competitive Strengths

 

We believe that our competitive strengths include the following:

 

Our customer and supplier relationships. We have extensive business relationships with customers and suppliers throughout the United States. In addition, we have developed extensive business relationships with major and independent un-branded gasoline suppliers who collectively control the majority of all gasoline sales in those regions.

 

Our ethanol distribution network. We believe we have a competitive advantage due to our experience in marketing to customers in major metropolitan and rural markets in the United States. We have developed an ethanol distribution network for delivery of ethanol by truck to virtually every significant fuel terminal as well as to numerous smaller fuel terminals throughout California and other Western states. Fuel terminals have limited storage capacity and we have successfully secured storage tanks at many of the terminals we service. In addition, we have an extensive network of third-party delivery trucks available to deliver ethanol throughout the Western United States. In the Midwest, we have the ability to sell and deliver products in bulk via unit trains providing us access to Western, gulf coast and international markets. Further, higher value co-products from our Illinois facilities can be sold at premium prices under fixed price, longer-term contracts (up to 12 months) thus providing a more stable source of revenue in what can be a volatile commodity industry.

 

Our strategic locations. We operate our ethanol plants in markets where we believe their individual locations, as well as our overall ethanol production and marketing platform, provide strategic advantages. Our production in both the Western United States and in the Midwest enables us to source ethanol from two different regions, which we believe allows us to address regional inefficiencies and other challenges such as rail congestion and other supply constraints, as well as pricing anomalies.

 

We operate four plants in the Western United States where we believe local characteristics create an opportunity to capture a significant production and shipping cost advantage over competing ethanol production facilities in other regions. We believe a combination of factors enables us to achieve this cost advantage, including:

 

Locations near fuel blending facilities lower our ethanol transportation costs while providing timing and logistical advantages over competing locations that require ethanol to be shipped over much longer distances, and in many cases require double-handling.

 

Locations adjacent to major rail lines allow the efficient delivery of corn in large unit trains from major corn-producing regions and allow for the efficient delivery of ethanol in large unit trains to other markets, including markets with higher demand.

 

Locations near large concentrations of dairy and/or beef cattle enable delivery of WDG, over short distances without the need for costly drying processes.

 

-4-

 

 

We operate five plants in the Midwest which enables us to participate in the largest regional ethanol market in the United States as well as international markets. Our Midwest locations, coupled with our locations in the Western United States, also allow us many advantages over locations solely on the West Coast, including:

 

Locations in diverse markets assist us in spreading commodity and basis price risks across markets and products, supporting our efforts to optimize margin management.

 

Locations in the Midwest enhance our overall hedging opportunities with a greater correlation to the highly-liquid physical and paper markets in Chicago.

 

Locations in diverse markets support heightened flexibility and alternatives in feedstock procurement for our various production facilities.

 

Our Illinois facilities provide excellent logistical access via rail, truck and barge. The relatively unique wet milling process at one of our Illinois facilities allows us to extract the highest use and value from each component of the corn kernel. As a result, the wet milling process generates a higher level of cost recovery from corn than that produced at a dry mill.

 

Locations in the Midwest allow us deeper market insight and engagement in major ethanol and feed markets outside the Western United States, thereby improving pricing opportunities.

 

Our low carbon-intensity ethanol. California and Oregon have enacted Low-Carbon Fuel Standards for transportation fuels. Under these Low-Carbon Fuel Standards, the ethanol we produce in the Western United States has a lower carbon-intensity than most ethanol produced at plants by other producers. This is primarily because our plants located on the West Coast use less energy in their production processes. The ethanol produced in California by other producers, all of which we market, also has a lower carbon-intensity rating than either gasoline or ethanol produced in the Midwest. The lower carbon-intensity rating of ethanol we produce at our plants located on the West Coast or otherwise resell from third-party California producers is valued in the market by our customers due to California’s Low Carbon Fuel Standard program, or LCFS, which has enabled us to capture premium prices for this ethanol.

 

Modern technologies. Our plants use the latest production technologies to take advantage of state-of-the-art technical and operational efficiencies to achieve lower operating costs, higher yields and more efficient production of ethanol and its co-products and reduce our use of carbon-based fuels.

 

Our experienced management. Our senior management team has a proven track record with significant operational and financial expertise and many years of experience in the ethanol, fuel and energy industries. Our senior executives, who average approximately 18 years of industry experience, have successfully navigated a wide variety of business and industry-specific challenges and deeply understand the business of successfully producing and marketing ethanol and its co-products.

 

We believe that these competitive strengths will help us attain our goal to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels in the United States.

 

-5-

 

 

Industry Overview and Market Opportunity

 

Overview of Ethanol Market

 

The primary applications for fuel-grade ethanol in the United States include:

 

Octane enhancer. On average, regular unleaded gasoline has an octane rating of 87 and premium unleaded gasoline has an octane rating of 91. In contrast, pure ethanol has an average octane rating of 113. Adding ethanol to gasoline enables refiners to produce greater quantities of lower octane blend stock with an octane rating of less than 87 before blending. In addition, ethanol is commonly added to finished regular grade gasoline as a means of producing higher octane mid-grade and premium gasoline.

 

Fuel blending. In addition to its performance and environmental benefits, ethanol is used to extend fuel supplies. In light of the need for transportation fuel in the United States and the dependence on foreign crude oil and refined products, the United States is increasingly seeking domestic sources of fuel. Much of the ethanol blending throughout the United States is done for the purpose of extending the volume of fuel sold at the gasoline pump.

 

Renewable fuels. Ethanol is blended with gasoline to enable gasoline refiners to comply with a variety of governmental programs, in particular, the national Renewable Fuel Standard, or RFS, which was enacted to promote alternatives to fossil fuels. See “—Governmental Regulation.”

 

The United States ethanol industry is supported by federal and state legislation and regulation. For example, the Energy Independence and Security Act of 2007, which was signed into law in December 2007, significantly increased the prior RFS. Under the RFS, the mandated use of all renewable fuels rises incrementally in succeeding years and peaks at 36.0 billion gallons by 2022. Under the RFS, approximately 14.0 billion gallons in 2015, 14.5 billion gallons in 2016 and 15.0 billion gallons in 2017 were required from conventional, or corn-based, ethanol. Under the RFS, 15.0 billion gallons are required from conventional ethanol in 2018. The RFS allows the Environmental Protection Agency, or EPA, to adjust the annual requirement based on certain facts.

 

According to the Renewable Fuels Association, the domestic ethanol industry produced a record 15.8 billion gallons of ethanol in 2017. We believe that the ethanol market in California alone represented approximately 10% of the national market. However, the Western United States has relatively few ethanol facilities and local ethanol production levels are substantially below the local demand for ethanol. The balance of ethanol is shipped via rail from the Midwest to the Western United States. Gasoline and diesel fuel that supply the major fuel terminals are shipped in pipelines throughout portions of the Western United States. Unlike gasoline and diesel fuel, however, ethanol is not shipped in these types of pipelines because ethanol has an affinity for mixing with water already present in the pipelines. When mixed, water dilutes ethanol and creates significant quality control issues. Therefore, ethanol must be trucked from rail terminals to regional fuel terminals, or blending racks.

 

We believe that approximately 90% of the ethanol produced in the United States is made in the Midwest from corn. According to the Department of Energy, or DOE, ethanol is generally blended at a rate of 10% by volume, but is also blended at a rate of up to 85% by volume for vehicles designed to operate on 85% ethanol. The EPA has increased the allowable blend of ethanol in gasoline from 10% by volume to 15% by volume for model year 2001 and newer automobiles, pending final approvals by certain state regulatory authorities. Some retailers have begun blending at higher rates in states that have approved higher blend rates.

 

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Compared to gasoline, ethanol is generally considered to be cleaner burning and contains higher octane. We anticipate that the increasing demand for renewable transportation fuels coupled with limited opportunities for gasoline refinery expansions and the growing importance of reducing CO2 emissions through the use of renewable fuels will generate additional growth in the demand for ethanol.

 

According to the DOE, total annual gasoline consumption in the United States is approximately 143 billion gallons and total annual ethanol consumption represented approximately 10% of this amount in 2017. The domestic ethanol industry has substantially reached this 10% blend ratio, and we believe the industry has significant potential for growth in the event the industry can migrate to an up to 15% blend ratio, which would translate into an annual demand of up to 20 billion gallons of ethanol.

 

Overview of Ethanol Production Process

 

Ethanol production from starch- or sugar-based feedstock is a highly-efficient process that we believe yields substantially more energy from ethanol and its co-products than is required to make the products. The modern production of ethanol requires large amounts of corn, or other high-starch grains, and water as well as chemicals, enzymes and yeast, and denaturants including unleaded gasoline or liquid natural gas, in addition to natural gas and electricity.

 

Dry Milling Process

 

In the dry milling process, corn or other high-starch grain is first ground into meal, then slurried with water to form a mash. Enzymes are then added to the mash to convert the starch into the simple sugar, dextrose. Ammonia is also added for acidic (pH) control and as a nutrient for the yeast. The mash is processed through a high temperature cooking procedure, which reduces bacteria levels prior to fermentation. The mash is then cooled and transferred to fermenters, where yeast is added and the conversion of sugar to ethanol and CO2 begins.

 

After fermentation, the resulting “beer” is transferred to distillation, where the ethanol is separated from the residual “stillage.” The ethanol is concentrated to 190 proof using conventional distillation methods and then is dehydrated to approximately 200 proof, representing 100% alcohol levels, in a molecular sieve system. The resulting anhydrous ethanol is then blended with about 2.5% denaturant, which is usually gasoline, and is then ready for shipment to market.

 

The residual stillage is separated into a coarse grain portion and a liquid portion through a centrifugation process. The soluble liquid portion is concentrated to about 40% dissolved solids by an evaporation process. This intermediate state is called condensed distillers solubles, or syrup. The coarse grain and syrup portions are then mixed to produce WDG or can be mixed and dried to produce DDGS. Both WDG and DDGS are high-protein animal feed products.

 

Wet Milling Process

 

In the wet milling process, corn or other high-starch grain is first soaked or “steeped” in water for 24 – 48 hours to separate the grain into its many components. After steeping, the corn slurry is processed first to separate the corn germ, from which the corn oil can be further separated. The remaining fiber, gluten and starch components are further separated and sold.

 

The steeping liquor is concentrated in an evaporator. The concentrated product, called heavy steep water, is co-dried with the fiber component and is then sold as corn gluten feed. The gluten component is filtered and dried to produce corn gluten meal.

 

-7-

 

 

The starch and any remaining water from the mash is then processed into ethanol or dried and processed into corn syrup. The fermentation process for ethanol at this stage is similar to the dry milling process.

 

Overview of Distillers Grains Market

 

Distillers grains are produced as a co-product of ethanol production and are valuable components of feed rations primarily to dairies and beef cattle markets, both nationally and internationally. Our plants produce both WDG and DDGS. WDG is sold to customers proximate to the plants and DDGS is delivered by truck, rail and barge to customers in domestic and international markets.

 

Producing WDG also allows us to use up to one-third less process energy, thus reducing production costs and lowering the carbon footprint of these plants, thereby increasing demand in California where premiums are paid for the low-carbon attributes.

 

Historically, the market price for distillers grains has generally tracked the value of corn. We believe that the market price of WDG and DDGS is determined by a number of factors, including the market value of corn, soybean meal and other competitive ingredients, the performance or value of WDG and DDGS in a particular feed formulation and general market forces of supply and demand, including export markets for these co-products. The market price of distillers grains is also often influenced by nutritional models that calculate the feed value of distillers grains by nutritional content, as well as reliability of consistent supply.

 

Customers

 

We market and sell through our wholly-owned subsidiary, Kinergy Marketing LLC, or Kinergy, all of the ethanol produced by our production facilities. Kinergy also markets ethanol produced by third parties. We have extensive customer relationships throughout the Western and Midwestern United States. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of ethanol, and manage the logistics and timing of delivery with very little effort on their side. Our customers collectively require ethanol volumes in excess of the supplies we produce at our production facilities. We secure additional ethanol supplies from third-party plants in California and other third-party suppliers in the Midwest where a majority of ethanol producers are located. We arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources.

 

We also market all of the co-products produced at our plants. We do not market co-products from other ethanol producers. Our co-products include WDG, DDGS, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO2. We market our distillers grains and other feed co-products to dairies and feedlots, in many cases located near our ethanol plants. These customers use our feed co-products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers.

 

Our production segment generated $838.3 million, $792.6 million and $527.7 million in net sales for the years ended December 31, 2017, 2016 and 2015, respectively, from the sale of ethanol. Our production segment generated $264.4 million, $253.2 million and $182.5 million in net sales for the years ended December 31, 2017, 2016 and 2015, respectively, from the sale of co-products.

 

During 2017, 2016 and 2015, our production segment sold an aggregate of approximately 527.2 million, 484.1 million and 319.2 million gallons of ethanol and 3.0 million, 2.8 million and 2.1 million tons of ethanol co-products, respectively.

 

-8-

 

 

Our marketing segment generated $529.5 million, $579.0 million and $481.0 million in net sales for the years ended December 31, 2017, 2016 and 2015, respectively, from the sale of ethanol.

 

During 2017, 2016 and 2015, we produced or purchased ethanol from third parties and resold an aggregate of approximately 837 million, 816 million and 594 million gallons of fuel-grade ethanol and specialty alcohols to approximately 83, 81 and 69 customers, respectively. Sales to our three largest customers, Valero Energy Corporation, Chevron Products USA and Tesoro Refining and Marketing Company LLC in 2017, 2016 and 2015 represented an aggregate of approximately 33%, 35% and 39%, of our net sales, respectively. Sales to each of our other customers represented less than 10% of our net sales in each of 2017, 2016 and 2015.

 

Suppliers

 

Production Segment

 

Our production operations are dependent upon various raw materials suppliers, including suppliers of corn, natural gas, electricity and water. The cost of corn is the most important variable cost associated with our production. We source corn for our plants using standard contracts, including spot purchase, forward purchase and basis contracts. When resources are available, we seek to limit the exposure of our production operations to raw material price fluctuations by purchasing forward a portion of our corn requirements on a fixed price basis and by purchasing corn and other raw materials futures contracts.

 

During 2017, 2016 and 2015, purchases of corn from our four largest suppliers represented an aggregate of approximately 46%, 38% and 41% of our total corn purchases, respectively, for those periods. Purchases from each of our other corn suppliers represented less than 10% of total corn purchases in each of 2017, 2016 and 2015.

 

Marketing Segment

 

Our marketing operations are dependent upon various third-party producers of fuel-grade ethanol. In addition, we provide ethanol transportation, storage and delivery services through third-party service providers with whom we have contracted to receive ethanol at agreed upon locations from our third-party suppliers and to store and/or deliver the ethanol to agreed-upon locations on behalf of our customers. These contracts generally run from year-to-year, subject to termination by either party upon advance written notice before the end of the then current annual term.

 

During 2017, 2016 and 2015, we purchased and resold from third parties an aggregate of approximately 310 million, 334 million and 274 million gallons, respectively, of fuel-grade ethanol.

 

During 2017, 2016 and 2015, purchases of fuel-grade ethanol from our two largest third-party suppliers represented an aggregate of approximately 35%, 35% and 32% of our total third-party ethanol purchases, respectively, for those periods. Purchases from each of our other third-party ethanol suppliers represented less than 10% of total third-party ethanol purchases in each of 2017, 2016 and 2015.

 

Pacific Ethanol Plants

 

The table below provides an overview of our nine ethanol production facilities. Our plants have an aggregate annual production capacity of up to 605 million gallons. All of our plants are currently operational. As market conditions change, we may increase, decrease or idle production at one or more operational facilities or resume operations at any idled facility.

 

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We wholly-own all of our plants located on the West Coast and the three plants in Pekin, Illinois. We own approximately 74% of the plants in Aurora, Nebraska as well as the grain elevator adjacent to those properties and related grain handling assets, including the outer rail loop, and the real property on which they are located, through Pacific Aurora, an entity owned approximately 26% by ACEC.

 

 

Madera
Facility

Columbia
Facility

Magic Valley
Facility

Stockton
Facility

 
Location Madera, CA Boardman, OR Burley, ID Stockton, CA  
Approximate maximum annual ethanol production capacity (in millions of gallons) 40 40 60 60  
Production milling process Dry Dry Dry Dry  
Primary energy source Natural Gas Natural Gas Natural Gas Natural Gas  
           
 

Pekin
Wet Facility

Pekin
Dry Facility

Pekin
ICP Facility

Aurora West
Facility

Aurora East
Facility

Location Pekin, IL Pekin, IL Pekin, IL Aurora, NE Aurora, NE
Approximate maximum annual ethanol production capacity (in millions of gallons) 100 60 90 110 45
Production milling process Wet Dry Dry Dry Dry
Primary energy source Natural Gas Natural Gas Natural Gas Natural Gas Natural Gas

 

Commodity Risk Management

 

We employ various risk mitigation techniques. For example, we may seek to mitigate our exposure to commodity price fluctuations by purchasing forward a portion of our corn and natural gas requirements through fixed-price or variable-price contracts with our suppliers, as well as entering into derivative contracts for ethanol, corn and natural gas. To mitigate ethanol inventory price risks, we may sell a portion of our production forward under fixed- or index-price contracts, or both. We may hedge a portion of the price risks by selling exchange-traded futures contracts. Proper execution of these risk mitigation strategies can reduce the volatility of our gross profit margins. However, the market price of ethanol is volatile and subject to large fluctuations, and given the nature of our business, we cannot effectively hedge against extreme volatility or certain market conditions. For example, ethanol prices, as reported by the Chicago Board of Trade, or CBOT, ranged from $1.26 to $1.67 per gallon during 2017, from $1.31 to $1.75 per gallon during 2016 and from $1.31 to $1.69 per gallon during 2015; and corn prices, as reported by the CBOT, ranged from $3.30 to $3.92 per bushel during 2017, from $3.02 to $4.38 per bushel during 2016 and from $3.48 to $4.34 per bushel during 2015.

 

Marketing Arrangements

 

We market all the ethanol and specialty alcohols produced at our production facilities. In addition, we have exclusive ethanol marketing agreements with two third-party ethanol producers, Calgren Renewable Fuels, LLC and Aemetis Advanced Fuels Keyes, Inc., to market and sell their entire ethanol production volumes. Calgren Renewable Fuels, LLC owns and operates an ethanol production facility in Pixley, California with annual production capacity of 55 million gallons. Aemetis Advanced Fuels Keyes, Inc. owns and operates an ethanol production facility in Keyes, California with annual production capacity of 55 million gallons. We intend to evaluate and pursue opportunities to enter into marketing arrangements with other third-party ethanol producers as business prospects make these marketing arrangements advisable.

 

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Competition

 

We are the sixth largest producer of ethanol in the United States based on annualized volumes and operate in the highly competitive ethanol production and marketing industry. The largest ethanol producers in the United States are Archer-Daniels-Midland Company, POET, LLC, Green Plains Inc. and Valero Renewable Fuels Company, LLC, collectively with approximately 38% of the total installed ethanol production capacity in the United States. In addition, there are many mid-size producers with several plants under ownership, smaller producers with one or two plants, and several ethanol marketers that create significant competition. Overall, we believe there are over 200 ethanol production facilities in the United States with a total installed production capacity of approximately 16.2 billion gallons and many brokers and marketers with whom we compete for sales of ethanol and its co-products.

 

We believe that our competitive strengths include our customer and supplier relationships, our extensive ethanol distribution network, our strategic locations, our low carbon-intensity ethanol, our use of modern technologies at our production facilities and our experienced management. We believe that these advantages will help us to attain our goal to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels in the United States.

 

Most of the largest metropolitan areas in the United States have fuel terminals served by rail, but other major metropolitan areas and more remote smaller cities and rural areas do not. We believe that we have a competitive advantage in the Western United States in particular due to our experience in marketing to the segment of customers located in major metropolitan and rural markets in the Western United States. We manage the complicated logistics of shipping ethanol to intermediate storage locations throughout the Western United States and trucking the ethanol from these storage locations to blending racks where the ethanol is blended with gasoline. We believe that by establishing an efficient service for truck deliveries to these more remote locations, we have differentiated ourselves from our competitors on the West Coast. In addition, due to our plant locations on the West Coast, we believe that we benefit from our ability to increase spot sales of ethanol from those plants following ethanol price spikes caused from time to time by rail delays in delivering ethanol from the Midwest to the Western United States.

 

Our strategic locations in the Western United States designed to capitalize on cost efficiencies may nevertheless result in higher than expected costs as a result of more expensive raw materials and related shipping costs, including corn, which generally must be transported from the Midwest. If the costs of producing and shipping ethanol and its co-products over short distances are not advantageous relative to the costs of obtaining raw materials from the Midwest, then the benefits of our strategic locations on the West Coast may not be realized.

 

Governmental Regulation

 

Our business is subject to federal, state and local laws and regulations relating to the production of renewable fuels, the protection of the environment and in support of the corn and ethanol industries. These laws, their underlying regulatory requirements and their enforcement, some of which are described below, impact, or may impact, our existing and proposed business operations by imposing:

 

restrictions on our existing and proposed business operations and/or the need to install enhanced or additional controls;

 

the need to obtain and comply with permits and authorizations;

 

liability for exceeding applicable permit limits or legal requirements, in some cases for the remediation of contaminated soil and groundwater at our facilities, contiguous and adjacent properties and other properties owned and/or operated by third parties; and

 

 -11-

 

specifications for the ethanol we market and produce.

 

In addition, some governmental regulations are helpful to our ethanol production and marketing business. The ethanol fuel industry is supported by federal and state mandates and environmental regulations that favor the use of ethanol in motor fuel blends in North America. Some of the governmental regulations applicable to our ethanol production and marketing business are briefly described below.

 

National Energy Legislation

 

The Energy Independence and Security Act of 2007, which was signed into law in December 2007, significantly increased the prior RFS. The RFS significantly increases the mandated use of renewable fuels, rising incrementally each year, to 36.0 billion gallons by 2022.

 

Under the provisions of the Energy Independence and Security Act of 2007, the EPA has the authority to waive the mandated RFS requirements in whole or in part. To grant a waiver, the EPA administrator must determine, in consultation with the Secretaries of Agriculture and Energy, that there is inadequate domestic renewable fuel supply or implementation of the requirement would severely harm the economy or environment of a state, region or the United States as a whole.

 

Legislation aimed at reducing or eliminating the renewable fuel use required by the RFS has been introduced since the 115th United States Congress began on January 3, 2017. On January 3, 2017, the Leave Ethanol Volumes at Existing Levels (LEVEL) Act (H.R. 119) was introduced in the House of Representatives. The bill would freeze renewable fuel blending requirements under the RFS at 7.5 billion gallons per year, prohibit the sale of gasoline containing more than 10% ethanol, and revoke the EPA’s approval of E15 blends. On January 31, 2017, a bill (H.R. 777) was introduced in the House of Representatives that would require the EPA and National Academies of Sciences to conduct a study on “the implications of the use of mid-level ethanol blends”. A mid-level ethanol blend is an ethanol gasoline blend containing 10-20% ethanol by volume, including E15 and E20, that is intended to be used in any conventional gasoline powered motor vehicle or nonroad vehicle or engine. Also on January 31, 2017, a bill (H.R. 776) was introduced in the House of Representatives that would limit the volume of cellulosic biofuel required under the RFS to what is commercially available. On March 2, 2017, a bill (H.R. 1315) was introduced in the House of Representatives that would cap the volume of ethanol in gasoline at 10%. On the same day, the RFS Elimination Act (H.R. 1314) was introduced, which would fully repeal the RFS.

 

All of these bills were referred to a congressional subcommittee, which will consider them before possibly sending any of them on to the House of Representatives as a whole. No legislation affecting the RFS or ethanol has been introduced in the Senate so far this session.

 

E15 (a Blend of Gasoline and Ethanol)

 

The EPA has allowed fuel and fuel-additive manufacturers to introduce into commercial gasoline that contains greater than 10% ethanol by volume, up to 15% ethanol by volume, or E15, for vehicles from model year 2001 and beyond. Additional changes to some states’ laws to allow for the use of E15 are still required; however, commercial sale of E15 has begun in some states. At the end of 2017, there were over 1,200 stations offering E15. We anticipate the number of stations offering E15 fuel will reach over 2,000 in 2018.

 

 -12-

 

State Energy Legislation and Regulations

 

In January 2007, California’s Governor signed an executive order directing the California Air Resources Board to implement California’s LCFS for transportation fuels. California’s LCFS requires fuel suppliers to reduce the carbon intensity of transportation fuels to 10% below 2010 levels by 2020. The Governor’s office estimates that the standard will have the effect of increasing current renewable fuels use in California by three to five times by 2020.

 

The California Air Resources Board has engaged in a comprehensive process to consider extending California’s LCFS through 2030, applying aggressive new carbon intensity reduction targets for the final 10 years. We believe the revised program will be beneficial as we produce among the lowest carbon intensity ethanol commercially available, and we receive a premium for the fuel we sell into the California marketplace, which we expect will increase as the compliance curve steepens, which began in 2016.

 

A program similar to California’s LCFS has also been adopted in Oregon and the Canadian province of British Columbia, and is under discussion in Washington State. These regions, together with California, represent a very large segment of the overall demand for transportation fuels in the United States.

 

Additional Environmental Regulations

 

In addition to the governmental regulations applicable to the ethanol production and marketing industry described above, our business is subject to additional federal, state and local environmental regulations, including regulations established by the EPA, the San Joaquin Valley Regional Water Quality Control Board, the San Joaquin Valley Air Pollution Control District and the California Air Resources Board. We cannot predict the manner or extent to which these regulations will harm or help our business or the ethanol production and marketing industry in general.

 

Employees

 

As of March 15, 2018, we had approximately 560 full-time employees. We believe that our employees are highly-skilled, and our success will depend in part upon our ability to retain our employees and attract new qualified employees, many of whom are in great demand. Approximately 180 of our employees are presently represented by a labor union and covered by a collective bargaining agreement. We have never had a work stoppage or strike and we consider our relations with our employees to be good.

 

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Item 1A.Risk Factors.

 

Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described below in addition to the other information contained in this Report and in our other filings with the Securities and Exchange Commission, including subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on Pacific Ethanol, our business, financial condition, results of operations and/or liquidity could be seriously harmed. In that event, the market price for our common stock will likely decline, and you may lose all or part of your investment.

 

Risks Related to our Business

 

We have incurred significant losses and negative operating cash flow in the past and we may incur losses and negative operating cash flow in the future, which may hamper our operations and impede us from expanding our business.

 

We have incurred significant losses and negative operating cash flow in the past. For the years ended December 31, 2017 and 2015, we incurred consolidated net losses of approximately $38.1 million and $18.9 million, respectively. For the year ended December 31, 2015, we incurred negative operating cash flows of $28.0 million. We may incur losses and negative operating cash flow in the future. We expect to rely on cash on hand, cash, if any, generated from our operations, borrowing availability under our lines of credit and proceeds from future financing activities, if any, to fund all of the cash requirements of our business. Continued losses and negative operating cash flow may hamper our operations and impede us from expanding our business.

 

Our results of operations and our ability to operate at a profit is largely dependent on managing the costs of corn and natural gas and the prices of ethanol, distillers grains and other ethanol co-products, all of which are subject to significant volatility and uncertainty.

 

Our results of operations are highly impacted by commodity prices, including the cost of corn and natural gas that we must purchase, and the prices of ethanol, distillers grains and other ethanol co-products that we sell. Prices and supplies are subject to and determined by market and other forces over which we have no control, such as weather, domestic and global demand, supply shortages, export prices and various governmental policies in the United States and around the world.

 

As a result of price volatility of corn, natural gas, ethanol, distillers grains and other ethanol co-products, our results of operations may fluctuate substantially. In addition, increases in corn or natural gas prices or decreases in ethanol, distillers grains or other ethanol co-product prices may make it unprofitable to operate. In fact, some of our marketing activities will likely be unprofitable in a market of generally declining ethanol prices due to the nature of our business. For example, to satisfy customer demands, we maintain certain quantities of ethanol inventory for subsequent resale. Moreover, we procure much of our inventory outside the context of a marketing arrangement and therefore must buy ethanol at a price established at the time of purchase and sell ethanol at an index price established later at the time of sale that is generally reflective of movements in the market price of ethanol. As a result, our margins for ethanol sold in these transactions generally decline and may turn negative as the market price of ethanol declines.

 

No assurance can be given that corn or natural gas can be purchased at, or near, current or any particular prices or that ethanol, distillers grains or other ethanol co-products will sell at, or near, current or any particular prices. Consequently, our results of operations and financial position may be adversely affected by increases in the price of corn or natural gas or decreases in the price of ethanol, distillers grains or other ethanol co-products.

 

 -14-

 

Over the past several years, the spread between ethanol and corn prices has fluctuated significantly. Fluctuations are likely to continue to occur. A sustained narrow spread, whether as a result of sustained high or increased corn prices or sustained low or decreased ethanol prices, would adversely affect our results of operations and financial position. Further, combined revenues from sales of ethanol, distillers grains and other ethanol co-products could decline below the marginal cost of production, which may force us to suspend production of ethanol, distillers grains and ethanol co-products at some or all of our plants.

 

Increased ethanol production or higher inventory levels may cause a decline in ethanol prices or prevent ethanol prices from rising, and may have other negative effects, adversely impacting our results of operations, cash flows and financial condition.

 

We believe that the most significant factor influencing the price of ethanol has been the substantial increase in ethanol production. According to the Renewable Fuels Association, domestic ethanol production capacity increased from an annualized rate of 1.5 billion gallons per year in January 1999 to a record 16.2 billion gallons in 2017. In addition, if ethanol production margins improve, we anticipate that owners of ethanol production facilities will increase production levels, thereby resulting in more abundant ethanol supplies and inventories. Any increase in the supply of ethanol may not be commensurate with increases in the demand for ethanol, thus leading to lower ethanol prices. Also, demand for ethanol could be impaired due to a number of factors, including regulatory developments and reduced United States gasoline consumption. Reduced gasoline consumption has occurred in the past and could occur in the future as a result of increased gasoline or oil prices or other factors such as increased automobile fuel efficiency. Any of these outcomes could have a material adverse effect on our results of operations, cash flows and financial condition.

 

The market price of ethanol is volatile and subject to large fluctuations, which may cause our profitability or losses to fluctuate significantly.

 

The market price of ethanol is volatile and subject to large fluctuations. The market price of ethanol is dependent upon many factors, including the supply of ethanol and the price of gasoline, which is in turn dependent upon the price of petroleum which is highly volatile and difficult to forecast. For example, ethanol prices, as reported by the CBOT, ranged from $1.26 to $1.67 per gallon during 2017, $1.31 to $1.75 per gallon during 2016 and $1.31 to $1.69 per gallon during 2015. Fluctuations in the market price of ethanol may cause our profitability or losses to fluctuate significantly.

 

Some of our marketing activities will likely be unprofitable in a market of generally declining ethanol prices due to the nature of our business.

 

Some of our marketing activities will likely be unprofitable in a market of generally declining ethanol prices due to the nature of our business. For example, to satisfy customer demands, we maintain certain quantities of ethanol inventory for subsequent resale. Moreover, we procure much of our inventory outside the context of a marketing arrangement and therefore must buy ethanol at a price established at the time of purchase and sell ethanol at an index price established later at the time of sale that is generally reflective of movements in the market price of ethanol. As a result, our margins for ethanol sold in these transactions generally decline and may turn negative as the market price of ethanol declines.

 

 -15-

 

Disruptions in production or distribution infrastructure may adversely affect our business, results of operations and financial condition.

 

Our business depends on the continuing availability of rail, road, port, storage and distribution infrastructure. In particular, due to limited storage capacity at our plants and other considerations related to production efficiencies, our plants depend on just-in-time delivery of corn. The production of ethanol and specialty alcohols also requires a significant and uninterrupted supply of other raw materials and energy, primarily water, electricity and natural gas. Local water, electricity and gas utilities may not be able to reliably supply the water, electricity and natural gas that our plants need or may not be able to supply those resources on acceptable terms. During 2014, poor weather caused disruptions in rail transportation, which slowed the delivery of ethanol by rail, the principle manner by which ethanol from our plants located in the Midwest is transported to market. Disruptions in production or distribution infrastructure, whether caused by labor difficulties, earthquakes, storms, other natural disasters or human error or malfeasance or other reasons, could prevent timely deliveries of corn or other raw materials and energy, and could delay transport of our products to market, and may require us to halt production at one or more plants, any of which could have a material adverse effect on our business, results of operations and financial condition.

 

We may engage in hedging transactions and other risk mitigation strategies that could harm our results of operations and financial condition.

 

In an attempt to partially offset the effects of volatility of ethanol prices and corn and natural gas costs, we may enter into contracts to fix the price of a portion of our ethanol production or purchase a portion of our corn or natural gas requirements on a forward basis. In addition, we may engage in other hedging transactions involving exchange-traded futures contracts for corn, natural gas and unleaded gasoline from time to time. The financial statement impact of these activities is dependent upon, among other things, the prices involved and our ability to sell sufficient products to use all of the corn and natural gas for which forward commitments have been made. Hedging arrangements also expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or, in the case of exchange-traded contracts, where there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices paid or received by us. In addition, our open contract positions may require cash deposits to cover margin calls, negatively impacting our liquidity. As a result, our results of operations and financial condition may be adversely affected by our hedging activities and fluctuations in the price of corn, natural gas, ethanol and unleaded gasoline.

 

Operational difficulties at our plants could negatively impact sales volumes and could cause us to incur substantial losses.

 

Operations at our plants are subject to labor disruptions, unscheduled downtimes and other operational hazards inherent in the ethanol production industry, including equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. Our insurance may not be adequate to fully cover the potential operational hazards described above or we may not be able to renew this insurance on commercially reasonable terms or at all.

 

Moreover, our plants may not operate as planned or expected. All of these facilities are designed to operate at or above a specified production capacity. The operation of these facilities is and will be, however, subject to various uncertainties. As a result, these facilities may not produce ethanol, specialty alcohols and co-products at expected levels. In the event any of these facilities do not run at their expected capacity levels, our business, results of operations and financial condition may be materially and adversely affected.

 

 -16-

 

Future demand for ethanol is uncertain and may be affected by changes to federal mandates, public perception, consumer acceptance and overall consumer demand for transportation fuel, any of which could negatively affect demand for ethanol and our results of operations.

 

Although many trade groups, academics and governmental agencies have supported ethanol as a fuel additive that promotes a cleaner environment, others have criticized ethanol production as consuming considerably more energy and emitting more greenhouse gases than other biofuels and potentially depleting water resources. Some studies have suggested that corn-based ethanol is less efficient than ethanol produced from other feedstock and that it negatively impacts consumers by causing increased prices for dairy, meat and other food generated from livestock that consume corn. Additionally, ethanol critics contend that corn supplies are redirected from international food markets to domestic fuel markets. If negative views of corn-based ethanol production gain acceptance, support for existing measures promoting use and domestic production of corn-based ethanol could decline, leading to reduction or repeal of federal mandates, which could adversely affect the demand for ethanol. These views could also negatively impact public perception of the ethanol industry and acceptance of ethanol as an alternative fuel.

 

There are limited markets for ethanol beyond those established by federal mandates. Discretionary blending and E85 blending are important secondary markets. Discretionary blending is often determined by the price of ethanol versus the price of gasoline. In periods when discretionary blending is financially unattractive, the demand for ethanol may be reduced. Also, the demand for ethanol is affected by the overall demand for transportation fuel. Demand for transportation fuel is affected by the number of miles traveled by consumers and the fuel economy of vehicles. Market acceptance of E15 may partially offset the effects of decreases in transportation fuel demand. A reduction in the demand for ethanol and ethanol co-products may depress the value of our products, erode our margins and reduce our ability to generate revenue or to operate profitably. Consumer acceptance of E15 and E85 fuels is needed before ethanol can achieve any significant growth in market share relative to other transportation fuels.

 

Our future results will suffer if we do not effectively manage our expanded operations.

 

Our business following recent acquisitions is larger than the individual businesses of Pacific Ethanol and the acquired companies prior to the acquisitions. Our future success depends, in part, upon our ability to manage our expanded business, which may pose continued challenges for our management, including challenges related to the management and monitoring of new operations and associated increased costs and complexity. We cannot assure you that we will be successful or that we will realize the expected operating efficiencies, annual net operating synergies, revenue enhancements and other benefits currently anticipated to result from the acquisition.

 

Our plant indebtedness exposes us to many risks that could negatively impact our business, our business prospects, our liquidity and our cash flows and results of operations.

 

Our plants located in the Midwest have significant indebtedness. Unlike traditional term debt, the terms of our plant loans require amortizing payments of principal over the lives of the loans and our borrowing availability under our plant credit facilities periodically and automatically declines through the maturity dates of those facilities. Our plant indebtedness could:

 

make it more difficult to pay or refinance our debts as they become due during adverse economic and industry conditions because any decrease in revenues could cause us to not have sufficient cash flows from operations to make our scheduled debt payments;

 

 -17-

 

limit our flexibility to pursue strategic opportunities or react to changes in our business and the industry in which we operate and, consequently, place us at a competitive disadvantage to our competitors who have less debt;

 

require a substantial portion of our cash flows from operations to be used for debt service payments, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, acquisitions, dividend payments and other general corporate purposes; or

 

limit our ability to procure additional financing for working capital or other purposes.

 

Our term loans and credit facilities also require compliance with numerous financial and other covenants. In addition, our plant indebtedness bears interest at variable rates. An increase in prevailing interest rates would likewise increase our debt service obligations and could materially and adversely affect our cash flows and results of operations.

 

Our ability to generate sufficient cash to make all principal and interest payments when due depends on our business performance, which is subject to a variety of factors beyond our control, including the supply of and demand for ethanol and co-products, ethanol and co-product prices, the cost of key production inputs, and many other factors incident to the ethanol production and marketing industry. We cannot provide any assurance that we will be able to timely satisfy such obligations. Our failure to timely satisfy our debt obligations could have a material adverse effect on our business, business prospects, liquidity, cash flows and results of operations.

 

If Kinergy fails to satisfy its financial covenants under its credit facility, it may experience a loss or reduction of that facility, which would have a material adverse effect on our financial condition and results of operations.

 

We are substantially dependent on Kinergy’s credit facility to help finance its operations. Kinergy must satisfy monthly financial covenants under its credit facility, including fixed-charge coverage ratio covenants. Kinergy will be in default under its credit facility if it fails to satisfy any financial covenant. A default may result in the loss or reduction of the credit facility. The loss of Kinergy’s credit facility, or a significant reduction in Kinergy’s borrowing capacity under the facility, would result in Kinergy’s inability to finance a significant portion of its business and would have a material adverse effect on our financial condition and results of operations.

 

The United States ethanol industry is highly dependent upon certain federal and state legislation and regulation and any changes in legislation or regulation could have a material adverse effect on our results of operations, cash flows and financial condition.

 

The EPA has implemented the RFS pursuant to the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007. The RFS program sets annual quotas for the quantity of renewable fuels (such as ethanol) that must be blended into motor fuels consumed in the United States. The domestic market for ethanol is significantly impacted by federal mandates under the RFS program for volumes of renewable fuels (such as ethanol) required to be blended with gasoline. Future demand for ethanol will be largely dependent upon incentives to blend ethanol into motor fuels, including the price of ethanol relative to the price of gasoline, the relative octane value of ethanol, constraints in the ability of vehicles to use higher ethanol blends, the RFS, and other applicable environmental requirements. Any significant increase in production capacity above the RFS minimum requirements may have an adverse impact on ethanol prices.

 

 -18-

 

Legislation aimed at reducing or eliminating the renewable fuel use required by the RFS has been introduced in the United States Congress. On January 3, 2017, the Leave Ethanol Volumes at Existing Levels (LEVEL) Act (H.R. 119) was introduced in the House of Representatives. The bill would freeze renewable fuel blending requirements under the RFS at 7.5 billion gallons per year, prohibit the sale of gasoline containing more than 10% ethanol, and revoke the EPA’s approval of E15 blends. On January 31, 2017, a bill (H.R. 777) was introduced in the House of Representatives that would require the EPA and National Academies of Sciences to conduct a study on “the implications of the use of mid-level ethanol blends”. A mid-level ethanol blend is an ethanol-gasoline blend containing 10-20% ethanol by volume, including E15 and E20, that is intended to be used in any conventional gasoline-powered motor vehicle or nonroad vehicle or engine. Also on January 31, 2017, a bill (H.R. 776) was introduced in the House of Representatives that would limit the volume of cellulosic biofuel required under the RFS to what is commercially available. On March 2, 2017, a bill (H.R. 1315) was introduced in the House of Representatives that would cap the volume of ethanol in gasoline at 10%. On the same day, the RFS Elimination Act (H.R. 1314) was introduced, which would fully repeal the RFS.

 

All of these bills were referred to a congressional subcommittee, which will consider them before possibly sending any of them on to the House of Representatives as a whole. Our operations could be adversely impacted if any legislation is enacted that reduces or eliminates the RFS volume requirements or that reduces or eliminates corn ethanol as qualifying as a renewable fuel under the RFS.

 

Under the provisions of the Clean Air Act, as amended by the Energy Independence and Security Act of 2007, the EPA has limited authority to waive or reduce the mandated RFS requirements, which authority is subject to consultation with the Secretaries of Agriculture and Energy, and based on a determination that there is inadequate domestic renewable fuel supply or implementation of the applicable requirements would severely harm the economy or environment of a state, region or the United States. Our results of operations, cash flows and financial condition could be adversely impacted if the EPA reduces the RFS requirements from the statutory levels specified in the RFS.

 

The ethanol production and marketing industry is extremely competitive. Many of our significant competitors have greater production and financial resources and one or more of these competitors could use their greater resources to gain market share at our expense.

 

The ethanol production and marketing industry is extremely competitive. Many of our significant competitors in the ethanol production and marketing industry, including Archer-Daniels-Midland Company, POET, LLC, Green Plains, Inc. and Valero Renewable Fuels Company, LLC, have substantially greater production and/or financial resources. As a result, our competitors may be able to compete more aggressively and sustain that competition over a longer period of time. Successful competition will require a continued high level of investment in marketing and customer service and support. Our limited resources relative to many significant competitors may cause us to fail to anticipate or respond adequately to new developments and other competitive pressures. This failure could reduce our competitiveness and cause a decline in market share, sales and profitability. Even if sufficient funds are available, we may not be able to make the modifications and improvements necessary to compete successfully.

 

We also face competition from international suppliers. Currently, international suppliers produce ethanol primarily from sugar cane and have cost structures that are generally substantially lower than our cost structures. Any increase in domestic or foreign competition could cause us to reduce our prices and take other steps to compete effectively, which could adversely affect our business, financial condition and results of operations.

 

Our ability to utilize net operating loss carryforwards and certain other tax attributes may be limited.

 

Federal and state income tax laws impose restrictions on the utilization of net operating loss, or NOL, and tax credit carryforwards in the event that an “ownership change” occurs for tax purposes, as defined by Section 382 of the Internal Revenue Code, or Code. In general, an ownership change occurs when stockholders owning 5% or more of a “loss corporation” (a corporation entitled to use NOL or other loss carryovers) have increased their ownership of stock in such corporation by more than 50 percentage points during any three-year period. The annual base limitation under Section 382 of the Code is calculated by multiplying the loss corporation’s value at the time of the ownership change by the greater of the long-term tax-exempt rate determined by the Internal Revenue Service in the month of the ownership change or the two preceding months.

 

 -19-

 

As of December 31, 2017, of our $154.6 million of federal NOLs, we had $94.9 million of federal NOLs that are limited in their annual use under Section 382 of the Code. Accordingly, our ability to utilize these NOL carryforwards may be substantially limited. These limitations could in turn result in increased future tax obligations, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our business is not diversified. The high concentration of our sales within the ethanol production and marketing industry could result in a significant reduction in sales and negatively affect our profitability if demand for ethanol declines.

 

Our business is not diversified. Our sales are highly concentrated within the ethanol production and marketing industry. We expect to be substantially focused on the production and marketing of ethanol and its co-products for the foreseeable future. An industry shift away from ethanol, or the emergence of new competing products, may significantly reduce the demand for ethanol. However, we may be unable to timely alter our business focus away from the production and marketing of ethanol to other renewable fuels or competing products. A downturn in the demand for ethanol would likely materially and adversely affect our sales and profitability.

 

We may be adversely affected by environmental, health and safety laws, regulations and liabilities.

 

We are subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground, the generation, storage, handling, use, transportation and disposal of hazardous materials and wastes, and the health and safety of our employees. In addition, some of these laws and regulations require us to operate under permits that are subject to renewal or modification. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns. In addition, we have made, and expect to make, significant capital expenditures on an ongoing basis to comply with increasingly stringent environmental laws, regulations and permits.

 

We may be liable for the investigation and cleanup of environmental contamination at each of our plants and at off-site locations where we arrange for the disposal of hazardous substances or wastes. If these substances or wastes have been or are disposed of or released at sites that undergo investigation and/or remediation by regulatory agencies, we may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or other environmental laws for all or part of the costs of investigation and/or remediation, and for damages to natural resources. We may also be subject to related claims by private parties alleging property damage and personal injury due to exposure to hazardous or other materials at or from those properties. Some of these matters may require us to expend significant amounts for investigation, cleanup or other costs.

 

In addition, new laws, new interpretations of existing laws, increased governmental enforcement of environmental laws or other developments could require us to make significant additional expenditures. Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at our plants. Present and future environmental laws and regulations, and interpretations of those laws and regulations, applicable to our operations, more vigorous enforcement policies and discovery of currently unknown conditions may require substantial expenditures that could have a material adverse effect on our results of operations and financial condition.

 

 -20-

 

The hazards and risks associated with producing and transporting our products (including fires, natural disasters, explosions and abnormal pressures and blowouts) may also result in personal injury claims or damage to property and third parties. As protection against operating hazards, we maintain insurance coverage against some, but not all, potential losses. However, we could sustain losses for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Events that result in significant personal injury or damage to our property or third parties or other losses that are not fully covered by insurance could have a material adverse effect on our results of operations and financial condition.

 

If we are unable to attract or retain key personnel, our ability to operate effectively may be impaired, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our ability to operate our business and implement strategies depends, in part, on the efforts of our executive officers and other key personnel. Our future success will depend on, among other factors, our ability to retain our current key personnel and attract and retain qualified future key personnel, particularly executive management. If we are unable to attract or retain key personnel, our ability to operate effectively may be impaired, which could have a material adverse effect on our business, financial condition and results of operations.

 

We depend on a small number of customers for the majority of our sales. A reduction in business from any of these customers could cause a significant decline in our overall sales and profitability.

 

The majority of our sales are generated from a small number of customers. During 2017, 2016 and 2015, three customers accounted for an aggregate of approximately $544 million, $572 million and $467 million in net sales, representing 33%, 35% and 39% of our net sales, respectively, for those periods. We expect that we will continue to depend for the foreseeable future upon a small number of customers for a significant portion of our sales. Our agreements with these customers generally do not require them to purchase any specified volume or dollar value of ethanol or co-products, or to make any purchases whatsoever. Therefore, in any future period, our sales generated from these customers, individually or in the aggregate, may not equal or exceed historical levels. If sales to any of these customers cease or decline, we may be unable to replace these sales with sales to either existing or new customers in a timely manner, or at all. A cessation or reduction of sales to one or more of these customers could cause a significant decline in our overall sales and profitability.

 

We incur significant expenses to maintain and upgrade our operating equipment and plants, and any interruption in the operation of our facilities may harm our operating performance.

 

We regularly incur significant expenses to maintain and upgrade our equipment and facilities. The machines and equipment we use to produce our products are complex, have many parts and some are run on a continuous basis. We must perform routine maintenance on our equipment and will have to periodically replace a variety of parts such as motors, pumps, pipes and electrical parts. In addition, our facilities require periodic shutdowns to perform major maintenance and upgrades. These scheduled facility shutdowns result in decreased sales and increased costs in the periods in which a shutdown occurs and could result in unexpected operational issues in future periods as a result of changes to equipment and operational and mechanical processes made during the shutdown period.

 

 -21-

 

Our lack of long-term ethanol orders and commitments by our customers could lead to a rapid decline in our sales and profitability.

 

We cannot rely on long-term ethanol orders or commitments by our customers for protection from the negative financial effects of a decline in the demand for ethanol or a decline in the demand for our marketing services. The limited certainty of ethanol orders can make it difficult for us to forecast our sales and allocate our resources in a manner consistent with our actual sales. Moreover, our expense levels are based in part on our expectations of future sales and, if our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. Furthermore, because we depend on a small number of customers for a significant portion of our sales, the ramifications of these risks are greater in magnitude than if our sales were less concentrated. As a result of our lack of long-term ethanol orders and commitments, we may experience a rapid decline in our sales and profitability.

 

There are limitations on our ability to receive distributions from our subsidiaries.

 

We conduct most of our operations through subsidiaries and are dependent upon dividends or other intercompany transfers of funds from our subsidiaries to generate free cash flow. Moreover, some of our subsidiaries are limited in their ability to pay dividends or make distributions, loans or advances to us by the terms of their financing arrangements. At December 31, 2017, we had approximately $302.9 million of net assets at our subsidiaries that were not available to be distributed in the form of dividends, distributions, loans or advances due to restrictions contained in their financing arrangements.

 

Risks Related to Ownership of our Common Stock

 

Our stock price is highly volatile, which could result in substantial losses for investors purchasing shares of our common stock and in litigation against us.

 

The market price of our common stock has fluctuated significantly in the past and may continue to fluctuate significantly in the future. The market price of our common stock may continue to fluctuate in response to one or more of the following factors, many of which are beyond our control:

 

fluctuations in the market prices of ethanol and its co-products;

the cost of key inputs to the production of ethanol, including corn and natural gas;

the volume and timing of the receipt of orders for ethanol from major customers;

competitive pricing pressures;

our ability to timely and cost-effectively produce, sell and deliver ethanol;

the announcement, introduction and market acceptance of one or more alternatives to ethanol;

changes in market valuations of companies similar to us;

stock market price and volume fluctuations generally;

the possibility that the anticipated benefits from our acquisition of ICP cannot be fully realized in a timely manner or at all;

regulatory developments or increased enforcement;

fluctuations in our quarterly or annual operating results;

additions or departures of key personnel;

our ability to obtain any necessary financing;

our financing activities and future sales of our common stock or other securities; and

our ability to maintain contracts that are critical to our operations.

 

Demand for ethanol could be adversely affected by a slow-down in the overall demand for oxygenate and gasoline additive products. The levels of our ethanol production and purchases for resale will be based upon forecasted demand. Accordingly, any inaccuracy in forecasting anticipated revenues and expenses could adversely affect our business. The failure to receive anticipated orders or to complete delivery in any quarterly period could adversely affect our results of operations for that period. Quarterly and annual results are not necessarily indicative of future performance for any particular period, and we may not experience revenue growth or profitability on a quarterly or an annual basis.

 

 -22-

 

The price at which you purchase shares of our common stock may not be indicative of the price that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you and which may include the complete loss of your investment. In the past, securities class action litigation has often been brought against a company following periods of high stock price volatility. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and our resources away from our business.

 

Any of the risks described above could have a material adverse effect on our results of operations or the price of our common stock, or both.

 

Item 1B.Unresolved Staff Comments.

 

We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our 2017 fiscal year and that remain unresolved.

 

Item 2.Properties.

 

Our corporate headquarters, located in Sacramento, California, consists of a 10,000 square foot office under a lease expiring in 2018. We have plants located in Madera, California, at a 137 acre facility; Boardman, Oregon, at a 25 acre facility; Burley, Idaho, at a 160 acre facility; and Stockton, California, at a 30 acre facility. We own the land in Madera, California and Burley, Idaho. The land in Boardman, Oregon and Stockton, California are leased under leases expiring in 2026 and 2022, respectively. We also have plants located in Pekin, Illinois at facilities totaling 145 acres and Aurora, Nebraska, at a 96 acre facility. We own the land in Pekin, Illinois and Aurora, Nebraska, as well as the grain handling facility, loop track and the real property on which they are located in Aurora, Nebraska. We also own an idled ethanol production facility in Canton, Illinois on a 289 acre facility, of which a significant portion is farm land. Our production segment includes ethanol production facilities. See “Business—Pacific Ethanol Plants.”

 

Item 3.Legal Proceedings.

 

We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect our quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not adversely affect in any material respect our financial position, results of operations or cash flows.

 

 -23-

 

People of the State of Illinois v. Pacific Ethanol Pekin, LLC, case no. 18-CH-06, was filed on January 8, 2018 in the Circuit Court for the 10th Judicial Circuit in Tazewell County, Illinois. The Illinois Attorney General, on behalf of the People of the State of Illinois, alleges violations of the Pekin facility’s NPDES permit and water pollution associated with the facility’s discharge. Most of the alleged violations relate to thermal limits set forth in the permit. The complaint seeks a cease and desist order and damages for the alleged violations in accordance with statutory limits under the Illinois Environmental Protection Act. We are currently in negotiations with the Illinois Attorney General seeking to resolve this matter.

 

Item 4.Mine Safety Disclosures.

 

Not applicable.

 

 -24-

 

PART II

 

Item 5.Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information

 

Our common stock trades on The NASDAQ Capital Market under the symbol “PEIX”. We also have non-voting common stock outstanding which is not listed on an exchange. The table below shows, for each fiscal quarter indicated, the high and low sales prices of shares of our common stock. The prices shown reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.

 

   Price Range 
         
   High   Low 
Year Ended December 31, 2017:        
         
First Quarter (January 1 – March 31)  $10.05   $6.50 
Second Quarter (April 1 – June 30)  $7.45   $5.63 
Third Quarter (July 1 – September 30)  $7.50   $4.15 
Fourth Quarter (October 1 – December 31)  $6.00   $4.10 
           
Year Ended December 31, 2016:          
           
First Quarter  $5.85   $2.41 
Second Quarter  $6.76   $3.67 
Third Quarter  $7.50   $5.37 
Fourth Quarter  $10.95   $5.75 

 

Security Holders

 

As of March 14, 2018, we had 43,959,245 shares of common stock outstanding held of record by approximately 230 stockholders and 896 shares of non-voting common stock outstanding held of record by one stockholder. These holders of record include depositories that hold shares of stock for brokerage firms which, in turn, hold shares of stock for numerous beneficial owners. On March 14, 2018, the closing sales price of our common stock on The NASDAQ Capital Market was $3.63 per share.

 

Performance Graph

 

The graph below shows a comparison of the cumulative total stockholder return on our common stock with the cumulative total return on The NASDAQ Composite Index and The NASDAQ Clean Edge Green Energy Index, or Peer Group, in each case over the five-year period ended December 31, 2017.

 

The graph assumes $100 invested at the indicated starting date in our common stock and in each of The NASDAQ Composite Index and the Peer Group, with the reinvestment of all dividends. We have not paid or declared any cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. Stockholder returns over the indicated periods should not be considered indicative of future stock prices or stockholder returns. This graph assumes that the value of the investment in our common stock and each of the comparison groups was $100 on December 31, 2012.

 

 -25-

  

( GRAPHIC)

 

   Cumulative Total Return ($)
   12/12 12/13 12/14 12/15 12/16 12/17
PACIFIC ETHANOL, INC.  100.00 107.35 217.86 100.81 200.36 95.96
THE NASDAQ COMPOSITE INDEX  100.00 141.63 162.09 173.33 187.19 242.29
THE NASDAQ CLEAN EDGE GREEN ENERGY INDEX  100.00 196.27 208.69 232.98 222.42 295.91

 

Dividend Policy

 

We have never paid cash dividends on our common stock and do not intend to pay cash dividends on our common stock in the foreseeable future. We anticipate that we will retain any earnings for use in the continued development of our business.

 

Our current and future debt financing arrangements may limit or prevent cash distributions from our subsidiaries to us, depending upon the achievement of specified financial and other operating conditions and our ability to properly service our debt, thereby limiting or preventing us from paying cash dividends. Further, the holders of our outstanding Series B Preferred Stock are entitled to dividends of 7% per annum, payable quarterly in arrears. In 2017, 2016 and 2015, we declared and paid in cash dividends on our outstanding shares of Series B Preferred Stock as they became due. Accrued and unpaid dividends in respect of our Series B Preferred Stock must be paid prior to the payment of any dividends in respect of shares of our common stock.

 

 -26-

 

Recent Sales of Unregistered Securities

 

None.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

 

Item 6.Selected Financial Data.

 

The following table sets forth our selected consolidated financial data. We prepared this information using our consolidated financial statements for each of the years ended December 31, 2017, 2016, 2015, 2014 and 2013.

 

You should read this selected consolidated financial data together with the consolidated financial statements and related notes contained in this report and in our prior and subsequent reports filed with the Securities and Exchange Commission, as well as the section of this report and our other reports entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The historical results that appear below are not necessarily indicative of results to be expected for any future periods.

 

  

Years Ended December 31, 

 
  

2017 

  

2016 

  

2015 

  

2014 

  

2013 

 
   (in thousands, except per share data) 
Consolidated Statements of Operations Data:                    
Net sales  $1,632,255   $1,624,758   $1,191,176   $1,107,412   $908,437 
Cost of goods sold (1)   1,626,324    1,570,400    1,180,810    995,695    872,370 
Gross profit   5,931    54,358    10,366    111,717    36,067 
Selling, general and administrative expenses (1)   31,516    30,849    26,368    20,340    17,158 
Asset impairment           1,970         
Income (loss) from operations   (25,585)   23,509    (17,972)   91,377    18,909 
Fair value adjustments and warrant inducements   473    (557)   1,641    (37,532)   (1,013)
Interest expense   (12,938)   (22,406)   (12,594)   (9,438)   (15,671)
Loss on extinguishments of debt               (2,363)   (3,035)
Other income (expense), net   (345)   (1)   18    (905)   (352)
Income (loss) before provision for income taxes   (38,395)   545    (28,907)   41,139    (1,162)
Provision (benefit) for income taxes   (321)   (981)   (10,034)   15,137    

 
Consolidated net income (loss)   (38,074)   1,526    (18,873)   26,002    (1,162)
Net (income) loss attributed to noncontrolling interests   3,110    (107)   87    (4,713)   381 
Net income (loss) attributed to Pacific Ethanol, Inc.  $(34,964)  $1,419   $(18,786)  $21,289   $(781)
Preferred stock dividends   (1,265)   (1,269)   (1,265)   (1,265)   (1,265)
Income allocated to participating securities       (2)   

    (585)   

 
Income (loss) available to common stockholders  $(36,229)  $148   $(20,051)  $19,439   $(2,046)
Income (loss) per share, basic  $(0.85)  $0.00   $(0.60)  $0.93   $(0.17)
Income (loss) per share, diluted  $(0.85)  $0.00   $(0.60)  $0.86   $(0.17)
                          
Weighted-average shares outstanding, basic   42,745    42,182    33,173    20,810    12,264 
                          
Weighted-average shares outstanding, diluted   42,745    42,251    33,173    22,669    12,264 

  

Consolidated Balance Sheet Data: 

                    
Cash and cash equivalents  $49,489   $64,259   $52,712   $62,084   $5,151 
Working capital  $112,540   $156,360   $125,033   $112,498   $51,161 
Total assets  $720,296   $708,238   $674,680   $297,540   $239,986 
Long-term debt, net of current portion  $221,091   $188,028   $203,861   $34,177   $98,095 
Stockholders’ equity  $383,700   $418,261   $371,544   $217,982   $94,901 
                          

 

(1)Reflects reclassification of co-product selling costs from cost of goods sold to selling, general and administrative expenses of approximately $2.5 million, $3.0 million, $3.2 million and $3.1 million for the years ended December 31, 2016, 2015, 2014 and 2013, respectively, to reflect current year classification.

 

No cash dividends on our common stock were declared during any of the periods presented above.

 

 -27-

 

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This discussion contains forward-looking statements, reflecting our plans and objectives that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors” and elsewhere in this report.

 

Overview

 

We are a leading producer and marketer of low-carbon renewable fuels in the United States.

 

We operate nine strategically-located production facilities. Four of our plants are in the Western states of California, Oregon and Idaho, and five of our plants are located in the Midwestern states of Illinois and Nebraska. We are the sixth largest producer of ethanol in the United States based on annualized volumes. Our plants have a combined production capacity of 605 million gallons per year. We market all the ethanol, specialty alcohols and co-products produced at our plants as well as ethanol produced by third parties. On an annualized basis, we market nearly 1.0 billion gallons of ethanol and over 3.0 million tons of ethanol co-products on a dry matter basis. Our business consists of two operating segments: a production segment and a marketing segment.

 

Our mission is to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. We intend to accomplish this goal in part by expanding our ethanol production capacity and distribution infrastructure, accretive acquisitions, lowering the carbon intensity of our ethanol, extending our marketing business into new regional and international markets, and implementing new technologies to promote higher production yields and greater efficiencies.

 

Production Segment

 

We produce ethanol, specialty alcohols and co-products at our production facilities described below. Our plants located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. Our plants located in the Midwest are in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, our ability to load unit trains from our plants located in the Midwest, and barges from our Pekin, Illinois plants, allows for greater access to international markets.

 

We wholly-own all of our plants located on the West Coast and the three plants in Pekin, Illinois. We own approximately 74% of the two plants in Aurora, Nebraska as well as the grain elevator adjacent to those properties and related grain handling assets, including the outer rail loop, and the real property on which they are located, through Pacific Aurora, LLC, or Pacific Aurora, an entity owned approximately 26% by Aurora Cooperative Elevator Company, or ACEC.

 

-28

 

 

Facility Name

 

Facility Location

 

Estimated Annual
Capacity

(gallons)

Magic Valley   Burley, ID   60,000,000
Columbia   Boardman, OR   40,000,000
Stockton   Stockton, CA   60,000,000
Madera   Madera, CA   40,000,000
Aurora West   Aurora, NE   110,000,000
Aurora East   Aurora, NE   45,000,000
Pekin Wet   Pekin, IL   100,000,000
Pekin Dry   Pekin, IL   60,000,000
Pekin ICP   Pekin, IL   90,000,000

 

We produce ethanol co-products at our production facilities such as wet distillers grains, or WDG, dried distillers grains with solubles, or DDGS, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO2.

 

Marketing Segment

 

We market ethanol, specialty alcohols and co-products produced by our facilities and market ethanol produced by third parties. We have extensive customer relationships throughout the Western and Midwestern United States. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of ethanol, and manage the logistics and timing of delivery with very little effort on their part. Our customers collectively require ethanol volumes in excess of the supplies we produce at our production facilities. We secure additional ethanol supplies from third-party plants in California and other third-party suppliers in the Midwest where a majority of ethanol producers are located. We arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources.

 

We market our distillers grains and other feed co-products to dairies and feedlots, in many cases located near our ethanol plants. These customers use our feed co-products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers. We do not market co-products from other ethanol producers.

 

See “Note 4 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments.

 

Current Initiatives and Outlook

 

Our results for the fourth quarter and full year reflect a difficult production margin environment due to lower average ethanol sales prices throughout the year. The industry’s high inventory levels negatively impacted ethanol sales prices, compressing production margins despite a decline in our average delivered cost of corn. Our results also reflect increased production gallons sold in the second half of the year predominately from increased volumes from our recently acquired ICP facility which, for the second half of the year, performed well and contributed $75.9 million in net sales and $3.7 million in pre-tax income.

 

In response to high industry-wide inventory levels and lower margins, we moderated production in locations most impacted by margin compression and where we were not otherwise contractually committed. We also reduced sales of third party ethanol to focus our sales efforts around our own production volumes where we are best able to maximize profitability and contribute to greater pricing stability. Industry inventory levels have since declined resulting from lower production and higher domestic and export demand. Ethanol inventories, which reached a record high at the beginning of 2018—running twenty percent higher than the same period in 2017—are now slightly lower than the same period last year while ethanol demand remains strong. As a result, margins have improved by approximately fifteen cents per gallon from the lows in December.

 

-29

 

 

We remain confident we are heading into a stronger year supported by an improved supply and demand balance, continued stability in corn prices, a strong export market and increasing adoption of E15 across the United States. Domestic gasoline demand for the first two months of 2018 is more than 5% higher than in the comparable period in 2017. Exports reached a record level of 1.37 billion gallons in 2017, a 17% increase over 2016, and we expect similar if not greater export growth in 2018. We also expect growth in E15 availability and sales. At the beginning of 2018, E15 was available at more than 1,200 stations across 29 states. We expect E15 availability at over 2,000 stations by year end. We continue to work diligently with the industry to enable E15 and higher blends to achieve Reid Vapor Pressure (RVP) parity with the standard 10% blend ratio which will allow E15 sales for the entire year across the United States and further bolster ethanol demand. Ethanol remains a low cost, low carbon, high octane transportation fuel that we believe will continue to attract additional demand.

 

We continue to focus on transactions and initiatives to build long-term value. As a leading innovator in the ethanol industry, we are focused on making appropriate investments in our production facilities to reduce costs, improve our carbon score and support profitable operations. Our acquisition of ICP in July provided product diversification, bringing us high-quality alcohol products, which help support stronger margins and reduce our exposure to commodity price fluctuations in the fuel ethanol market. Our integration of ICP is progressing well and we are on track to achieve our goal of $4.5 million in annualized cost synergies in 2018.

 

Our 3.5 megawatt cogeneration system at our Stockton plant is partially complete. The first natural gas fired cogeneration unit is now fully commissioned, generating power and used in production at the plant. The second of two cogeneration units is still in its commissioning stage. The system converts process waste gas and natural gas into electricity and steam, reducing energy costs by up to $4.0 million per year and lowering carbon and nitrogen oxide emissions.

 

We received an updated LCFS pathway from the California Air Resources Board, incorporating the benefits of our industrial scale membrane system at our Madera facility that separates water from ethanol during the plant’s dehydration process. We are realizing energy savings of a 5% reduction in natural gas costs at the plant. Overall, we estimate the operating efficiencies, energy savings and carbon premium combined will total approximately $1.0 million annually at current market rates. We are in the process of evaluating this technology for potential implementation at other plants.

 

We are producing commercial levels of cellulosic ethanol at our Stockton, Madera and Magic Valley plants and generating D3 RINs at our Stockton plant. We have filed for approval from the EPA to produce D3 RINs at our Madera and Magic Valley plants.

 

Also at our Madera facility, we remain on schedule to begin full-scale operation of our 5 megawatt solar photovoltaic power system pending interconnection with our local utility. We expect the system to reduce our utility costs by over $1.0 million annually and lower our carbon score.

 

Our capital expenditures for 2017 totaled $20.9 million. We expect our 2018 capital expenditures to approximate our 2017 expenditure level, although we may adjust this amount based on industry economics and our financial performance.

 

-30

 

 

We plan to drive growth by leveraging our diverse base of production and marketing assets to advance our position and significantly increase market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. The foundations of this strategy are our strategically located bio-refineries, which enable us to serve multiple markets; the diversity of our production, geography, technology, feedstocks and logistics, which helps us mitigate exposure to commodity price risks within fuel markets; and our focus on evaluating and investing in plant improvement and other initiatives to increase production and operating efficiencies and yields.

 

2017 Financial Performance Summary

 

Summary

 

Our consolidated net sales remained consistent at $1.6 billion compared to 2016. Our net income (loss) available to common stockholders declined by $36.3 million from net income of $0.1 million for 2016 to a net loss of $36.2 million for 2017.

 

Factors that contributed to our results of operations for 2017 include:

 

Net sales. Our net sales for the period remained consistent, the result of an increase in total gallons sold, offset by a decrease in our average sales price per gallon. Our total gallons of ethanol sold increased 3% to 952 million gallons for 2017 from 925 million gallons for 2016. Our production sales volume of ethanol increased 9% to 527 million gallons for 2017 from 484 million gallons for 2016, partially offset by a decrease in our third-party sales volume of 4% to 425 million gallons for 2017 from 440 million gallons for 2016. The increased production sales volume was primarily due to our mid-year acquisition of Illinois Corn Processing, LLC, or ICP. Our decreased third party sales volume was primarily due to an intentional reduction in less profitable third party sales.

 

Gross margin. Our gross margin decreased to 0.4% for 2017 from 3.3% for 2016. The decline in our gross margin was primarily the result of lower corn crush margins compared to 2016, predominately due to lower average ethanol sales prices.

 

Selling, general and administrative expenses. Our selling, general and administrative expenses, or SG&A, increased by $0.7 million to $31.5 million for 2017, as compared to $30.8 million for 2016, primarily as a result of higher employee benefits, non-cash compensation and professional fees related to our acquisition of ICP, and higher overhead and other costs related to ICP’s business. These increased expenses were partially offset by $3.6 million in gains associated with legal matters resolved in the first quarter of 2017.

 

Interest expense. Our interest expense declined by $9.5 million to $12.9 million for 2017 from $22.4 million for 2016. This decline primarily resulted from our refinance of debt balances acquired in connection with our acquisition of our Midwest plants, in which we replaced existing debt with lower cost debt.

 

Sales and Margins

 

We generate sales by marketing all the ethanol produced by our ethanol plants, all the ethanol produced by two other ethanol producers in the Western United States and ethanol purchased from other third-party suppliers throughout the United States. We also market high-quality alcohol products and ethanol co-products, including WDG and DDGS, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO2, for our ethanol plants.

 

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Our profitability is highly dependent on various commodity prices, including the market prices of ethanol, corn and natural gas.

 

Our average ethanol sales price declined by 3% to $1.62 per gallon for 2017 compared to $1.67 per gallon for 2016. The average price of ethanol as reported by the Chicago Board of Options Trade, or CBOT, declined by less than 1% to $1.50 per gallon for 2017 compared to $1.51 per gallon for 2016. Our average cost of corn declined by 2% to $3.82 per bushel for 2017 from $3.90 per bushel for 2016. The average price of corn as reported by the CBOT increased slightly to $3.59 per bushel for 2017 from $3.58 per bushel for 2016.

 

We have three principal methods of selling ethanol: as a merchant, as a producer and as an agent. See “—Critical Accounting Policies—Revenue Recognition” below.

 

When acting as a merchant or as a producer, we generally enter into sales contracts to ship ethanol to a customer’s desired location. We support these sales contracts through purchase contracts with several third-party suppliers or through our own production. We manage the necessary logistics to deliver ethanol to our customers either directly from a third-party supplier or from our inventory via truck or rail. Our sales as a merchant or as a producer expose us to significant price risks resulting from potential fluctuations in the market price of ethanol and corn. Our exposure varies depending on the magnitude of our sales and purchase commitments compared to the magnitude of our existing inventory, as well as the pricing terms—such as market index or fixed pricing—of our contracts. We seek to mitigate our exposure to price risks by implementing appropriate risk management strategies.

 

When acting as an agent for third-party suppliers, we conduct back-to-back purchases and sales in which we match ethanol purchase and sale contracts of like quantities and delivery periods. When acting in this capacity, we receive a predetermined service fee and have little or no exposure to price risks resulting from potential fluctuations in the market price of ethanol. For these sales, we record the marketing fee as net sales.

 

We believe that our gross profit margins depend primarily on five key factors:

 

the market price of ethanol, which we believe is impacted by the degree of competition in the ethanol market; the price of gasoline and related petroleum products; and government regulation, including government mandates;

 

the market price of key production input commodities, including corn and natural gas;

 

the market price of co-products;

 

our ability to anticipate trends in the market price of ethanol, co-products, and key input commodities and implement appropriate risk management and opportunistic strategies; and

 

the proportion of our sales of ethanol produced at our ethanol plants to our sales of ethanol produced by unrelated third-parties.

 

We seek to optimize our gross profit margins by anticipating the factors above and, when resources are available, implementing hedging transactions and taking other actions designed to limit risk and address these factors. For example, we may seek to decrease inventory levels in anticipation of declining ethanol prices and increase inventory levels in anticipation of rising ethanol prices. We may also seek to alter our proportion or timing, or both, of purchase and sales commitments. Furthermore, we may diversify our ethanol feedstock to lower our average costs and/or increase our ethanol sales prices from premiums for low-carbon intensity rated ethanol.

 

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Our limited resources to act upon the anticipated factors described above and/or our inability to anticipate these factors or their relative importance, and adverse movements in the factors themselves, could result in declining or even negative gross profit margins over certain periods of time. Our ability to anticipate these factors or favorable movements in these factors may enable us to generate above-average gross profit margins. However, given the difficulty associated with successfully forecasting any of these factors, we are unable to estimate our future gross profit margins.

 

Results of Operations

 

Accounting for the Results of Illinois Corn Processing, LLC

 

We closed our acquisition of ICP on July 3, 2017 and, as a result, our results of operations include ICP’s results of operations only for the period from July 3, 2017 through December 31, 2017.

 

Selected Financial Information

 

The following selected financial information should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report.

 

Certain performance metrics that we believe are important indicators of our results of operations include:

 

   Years Ended December 31,     Percentage
Change
 
   2017   2016   2015   2017
vs
2016
  

2016

vs

2015

 
Production gallons sold (in millions)   527.2    484.1    319.2    8.9%   51.7%
Third-party gallons sold (in millions)   424.8    440.4    382.3    (3.5)%   15.2%
Total gallons sold (in millions)   952.0    924.5    701.5    3.0%   31.8%
                          
Production capacity utilization
   95%   93%   89%   2.2%   4.5%
                          
Average sales price per gallon  $1.62   $1.67   $1.68    (3.0)%   (0.6)%
                          
Corn cost per bushel—CBOT equivalent
  $3.62   $3.63   $3.77    (0.3)%   (3.7)%
                          
Average basis(1)  $0.20   $0.27   $0.52    (26.0)%   (48.1)%
Delivered cost of corn  $3.82   $3.90   $4.29    (2.1)%   (9.1)%
                          
Total co-product tons sold (in thousands)   3,008.5    2,760.6    2,099.4    9.0%   31.5%
                          
Co-product revenues as % of delivered cost of corn(2)   34.5%   35.1%   35.8%   (1.7)%   (2.0)%
                          
Average CBOT ethanol price per gallon  $1.50   $1.51   $1.52    (0.1)%   %
                          
Average CBOT corn price per bushel  $3.59   $3.58   $3.77    0.3%   (5.0)%


 

(1)Corn basis represents the difference between the immediate cash price of delivered corn and the future price of corn for Chicago delivery.

(2)Co-product revenues as a percentage of delivered cost of corn shows our yield based on sales of co-products, including WDG and corn oil, generated from ethanol we produced.

 

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Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

 

   Years Ended   Dollar
Change
   Percentage
Change
  

Results as a Percentage

of Net Sales for the

Years Ended

 
    December 31,    Favorable    Favorable     December 31,  
   2017   2016   (Unfavorable)   (Unfavorable)   2017   2016 
   (dollars in thousands)     
Net sales  $1,632,255   $1,624,758   $7,497    0.5%   100.0%   100.0%
Cost of goods sold   1,626,324    1,570,400    (55,924)   (3.6)%   99.6%   96.7%
Gross profit   5,931    54,358    (48,427)   (89.1)%   0.4%   3.3%
Selling, general and administrative expenses   31,516    30,849    (667)   2.2%   1.9%   1.9%
Income (loss) from operations    (25,585)   23,509    (49,094)   (208.8)%   (1.6)%   1.4%
Fair value adjustments   473    (557)   1,030    NM    0.0%   (0.0)%
Interest expense   (12,938)   (22,406)   9,468    42.3%   (0.8)%   (1.4)%
Other expense, net   (345)   (1)   (344)   

NM

    (0.0)%   (0.0)%
Income (loss) before provision for income taxes   (38,395)   545    (38,940)   NM    (2.4)%   0.0%
Provision (benefit) for income taxes   (321)   (981)   660    (67.3)%   (0.0)%   (0.1)%
Consolidated net income (loss)   (38,074)   1,526    (39,600)   NM    (2.3)%   0.1%
Net (income) loss attributed to noncontrolling interests   3,110    (107)   3,217    

NM

    0.2%   

%
Net income (loss) attributed to Pacific Ethanol, Inc.  $(34,964)  $1,419   $(36,383)   

NM

    (2.1)%   0.1%
Preferred stock dividends   (1,265)   (1,269)   4    (0.3)%   (0.1)%   (0.1)%
Income allocated to participating securities       (2)   2        

%   

%
Income (loss) available to common stockholders  $(36,229)  $148   $(36,377)   

NM

    (2.2)%   0.0%

 

Net Sales

 

The increase in our consolidated net sales for 2017 as compared to 2016 was primarily due to an increase in our total gallons sold, partially offset by a decrease in our average sales price per gallon.

 

We increased production gallons sold and our volume of co-products sold, for 2017 as compared to 2016, while decreasing third-party gallons sold. The increases in volumes of our production gallons and co-products sold are primarily due to additional volumes from our recently-acquired ICP production facility. We decreased third-party gallons sold due to an intentional reduction in less profitable third party sales.

 

Production Segment

 

Net sales of ethanol from our production segment increased by $45.7 million, or 6%, to $838.3 million for 2017 as compared to $792.6 million for 2016. Our total volume of production ethanol gallons sold increased by 43.1 million gallons, or 9%, to 527.2 million gallons for 2017 as compared to 484.1 million gallons for 2016. At our production segment’s average sales price per gallon of $1.59 for 2017, we generated $68.5 million in additional net sales from our production segment from the 43.1 million additional gallons of produced ethanol sold in 2017 as compared to 2016. The decline of $0.05, or 3%, in our production segment’s average sales price per gallon in 2017 as compared to 2016 reduced our net sales from our production segment by $22.8 million.

 

Net sales of co-products increased $11.2 million, or 4%, to $264.4 million for 2017 as compared to $253.2 million for 2016. Our total volume of co-products sold increased by 0.2 million tons to 3.0 million tons for 2017 from 2.8 million tons for 2016. At our average sales price per ton of $87.90 for 2017, we generated $21.8 million in additional net sales from the 0.2 million additional tons of co-products sold in 2017 as compared to 2016. The decline of $3.84, or 4%, in our average sales price per ton in 2017 as compared to 2016 decreased our net sales from our production segment by $10.6 million.

 

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Marketing Segment

 

Net sales of ethanol from our marketing segment decreased by $49.4 million, or 9%, to $529.5 million for 2017 as compared to $578.9 million for 2016.

 

Our total volume of ethanol gallons sold by our marketing segment increased by 27.5 million gallons, or 3%, to 952.0 million gallons for 2017 as compared to 924.5 million gallons for 2016. Our additional production gallons sold accounted for 43.1 million gallons of this increase, as noted above, and was offset by 15.6 million fewer third-party gallons sold.

 

The increase in production gallons sold by our marketing segment contributed insignificantly to net sales generated by our marketing segment, resulting in an additional $0.4 million in net sales, which were eliminated upon consolidation.

 

At our marketing segment’s average sales price per gallon of $1.67 for 2017, we generated $26.0 million in lower net sales from our marketing segment from the 15.6 million gallon reduction in third-party ethanol sold in 2017 as compared to 2016. Further, the decline of $0.05 per gallon, or 3%, in our marketing segment’s average sales price per gallon in 2017 as compared to 2016 reduced our net sales from third-party ethanol sold by our marketing segment by $23.4 million.

 

Cost of Goods Sold and Gross Profit

 

Our consolidated gross profit declined to $5.9 million for 2017 from $54.4 million for 2016, representing a gross margin of 0.4% for 2017 compared to 3.3% for 2016. Our consolidated gross profit decreased primarily due to significantly lower crush margins during the year resulting from lower ethanol prices. In addition, for the years ended December 31, 2017 and 2016, cost of goods sold included approximately $10.7 million and $7.4 million of larger than anticipated repair and maintenance related expenses to replace faulty equipment. 

 

Production Segment

 

Our production segment’s gross profit declined by $38.7 million to $3.1 million for 2017 as compared to $41.8 million for 2016. Of this decline, $38.9 million is attributable to lower margins, offset slightly by $0.2 million in higher gross profit attributable to the 43.1 million gallon increase in production volumes sold in 2017 as compared to 2016.

 

Marketing Segment

 

Our marketing segment’s gross profit declined by $9.8 million to $2.8 million for 2017 as compared to $12.6 million for 2016. Of this decline, $9.6 million is attributable to lower margins and $0.2 million is attributable to decreased third party marketing volumes in 2017 as compared to 2016.

 

Selling, General and Administrative Expenses

 

Our SG&A increased $0.7 million to $31.5 million for 2017 as compared to $30.8 million for the same period in 2016. The increase in SG&A is due to higher employee benefits, non-cash compensation and professional fees associated with our ICP acquisition, and higher overhead and other costs related to ICP’s business, partially offset by $3.6 million in gains associated with legal matters resolved in the first quarter of 2017.

 

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We expect SG&A of $34.0 million for 2018, or approximately $8.5 million per quarter.

 

Interest Expense

 

Interest expense declined by $9.5 million to $12.9 million for 2017 from $22.4 million for 2016. The decline primarily resulted from the refinance of debt balances acquired in connection with our acquisition of our Midwest plants, in which we replaced existing debt with lower cost debt.

 

Provision (Benefit) for Income Taxes

 

In 2017, we incurred book and tax losses, yet there were no prior years for which to carry back these losses. As a result, we will carry forward these tax losses, however, we must apply a valuation allowance against these net operating loss carryforwards until the realizability of these losses is more likely than not. Further, we revised the amount of our net deferred tax liabilities under the new Federal tax rates, and consequently recognized a gain on the reduction of these net tax liabilities of $0.3 million, resulting in a net tax benefit for 2017.

 

Net (Income) Loss Attributed to Noncontrolling Interests

 

Net (income) loss attributed to noncontrolling interests relates to our consolidated treatment of Pacific Aurora. Beginning in 2016, we consolidated the assets associated with Pacific Aurora before and after the admission of a 26% equity owner of Pacific Aurora. As a result, we reduced our consolidated net income (loss) for the noncontrolling interests, which were the ownership interests that we did not own.

 

Preferred Stock Dividends

 

Shares of our Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in an amount equal to 7% per annum of the purchase price per share of the Series B Preferred Stock. We accrued and paid in cash dividends of $1.3 million for each of 2017 and 2016 in respect of our Series B Preferred Stock.

 

Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015

 

   Years Ended   Dollar
Change
   Percentage
Change
  

Results as a Percentage

of Net Sales for the

Years Ended

 
    December 31,    Favorable    Favorable     December 31,  
   2016   2015   (Unfavorable)   (Unfavorable)   2016   2015 
   (dollars in thousands)     
Net sales  $1,624,758   $1,191,176   $433,582    36.4%   100.0%   100.0%
Cost of goods sold   1,570,400    1,180,810    389,590    33.0%   96.7%   99.1%
Gross profit   54,358    10,366    43,992    424.4%   3.3%   0.9%
Selling, general and administrative expenses   30,849    26,368    (4,481)   (17.0)%   1.9%   2.2%
Asset impairment       1,970    1,970    100.0%   

—%

    0.2%
Income (loss) from operations    23,509    (17,972)   41,481    NM    1.4%   (1.5)%
Fair value adjustments   (557)   1,641    (2,198)   NM    (0.0)%   0.1%
Interest expense   (22,406)   (12,594)   (9,812)   (77.9)%   (1.4)%   (1.1)%
Other income (expense), net   (1)   18    (19)   

NM

    (0.0)%   

%
Income (loss) before provision for income taxes   545    (28,907)   29,452    NM    0.0%   (2.4)%
Provision (benefit) for income taxes   (981)   (10,034)   (9,053)   (90.2)%   (0.1)%   (0.8)%
Consolidated net income (loss)   1,526    (18,873)   20,399    NM    0.1%   (1.6)%
Net (income) loss attributed to noncontrolling interests   (107)   87    (194)   

NM

    

%   

%
Net income (loss) attributed to Pacific Ethanol, Inc.  $1,419   $(18,786)  $20,205    

NM

    0.1%   (1.6)%
Preferred stock dividends   (1,269)   (1,265)   (4)   (0.3)%   (0.1)%   (0.1)%
Income allocated to participating securities   (2)       (2)   

NM

    

—%

    

—%

 
Income (loss) available to common stockholders  $148   $(20,051)  $20,199    

NM

    0.0%   (1.7)%

 

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Net Sales

 

The increase in our consolidated net sales for 2016 as compared to 2015 was primarily due to an increase in our total gallons sold.

 

We increased both production and third-party gallons sold, and our volume of co-products sold, for 2016 as compared to 2015. The increases in volumes of our production gallons and co-products sold are primarily due to additional volumes from our plants located in the Midwest, as well as third-party sales. In addition, we expanded our customer base and our sales to a larger national footprint with the addition of regions we cover with our Midwest plants.

 

Our average sales price per gallon remained relatively flat at $1.67 for 2016 compared to our average sales price per gallon of $1.68 for 2015. Similarly, the average CBOT ethanol price per gallon, remained relatively flat at $1.51 for 2016 compared to $1.52 for 2015.

 

Production Segment

 

Net sales of ethanol from our production segment increased by $264.9 million, or 50%, to $792.6 million for 2016 as compared to $527.7 million for 2015. Our total volume of production ethanol gallons sold increased by 164.9 million gallons, or 52%, to 484.1 million gallons for 2016 as compared to 319.2 million gallons for 2015. At our production segment’s average sales price per gallon of $1.62 for 2016, we generated $267.0 million in additional net sales from our production segment from the 164.9 million additional gallons of produced ethanol sold in 2016 as compared to 2015. The decline of $0.01, or 0.6%, in our production segment’s average sales price per gallon in 2016 as compared to 2015 reduced our net sales from our production segment by $2.1 million.

 

Net sales of co-products increased $70.7 million, or 39%, to $253.2 million for 2016 as compared to $182.5 million for 2015. Our total volume of co-products sold increased by 0.7 million tons to 2.8 million tons for 2016 from 2.1 million tons for 2015. At our average sales price per ton of $91.74 for 2016, we generated $60.6 million in additional net sales from the 0.7 million additional tons of co-products sold in 2016 as compared to 2015. In addition, the increase of $4.82, or 5.5%, in our average sales price per ton in 2016 as compared to 2015 increased our net sales from our production segment by $10.1 million.

 

Marketing Segment

 

Net sales of ethanol from our marketing segment increased by $98.0 million, or 20%, to $579.0 million for 2016 as compared to $481.0 million for 2015.

 

Our total volume of ethanol gallons sold by our marketing segment increased by 223.0 million gallons, or 32%, to 924.5 million gallons for 2016 as compared to 701.5 million gallons for 2015. Our additional production gallons sold accounted for 164.9 million gallons of this increase, as noted above, and our additional third-party gallons sold accounted for 58.1 million gallons of this increase.

 

The increase in production gallons sold by our marketing segment contributed insignificantly to net sales generated by our marketing segment, resulting in an additional $2.6 million in net sales, which were eliminated upon consolidation.

 

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At our marketing segment’s average sales price per gallon of $1.72 for 2016, we generated $99.6 million in additional net sales from our marketing segment from the 58.1 million gallons in additional third-party ethanol sold in 2016 as compared to 2015. However, the decline of less than $0.01, or 0.3%, in our marketing segment’s average sales price per gallon in 2016 as compared to 2015 reduced our net sales from third-party ethanol sold by our marketing segment by $1.6 million.

 

Cost of Goods Sold and Gross Profit

 

Our consolidated gross profit improved significantly to $54.4 million for 2016 from $10.4 million for 2015, representing a gross margin of 3.3% for 2016 compared to 0.9% for 2015. Our consolidated gross profit increased primarily due to a decline of $0.39 in our average delivered cost of corn per bushel in 2016 as compared to 2015.

 

Production Segment

 

Our production segment improved our consolidated gross profit by $40.6 million for 2016 as compared to 2015. Of this amount, $26.4 million is attributable to higher margins resulting primarily from our lower corn costs in 2016 as compared to 2015, and $14.2 million in higher gross profit is attributed to the 164.9 million gallon increase in production volumes sold in 2016 as compared to 2015.

 

Marketing Segment

 

Our marketing segment improved our consolidated gross profit by $3.4 million for 2016 as compared to 2015. Of this amount, $2.2 million is attributable to the 58.1 million gallon increase in third party marketing volumes in 2016 as compared to 2015, and $1.2 million is attributable to higher margins from our marketing segment in 2016 as compared to 2015.

 

Selling, General and Administrative Expenses

 

Our SG&A increased $4.5 million to $30.8 million for 2016 as compared to $26.3 million for the same period in 2015. The increase in SG&A is due to increased professional fees relating to our litigation matters, our costs associated with our transaction with ACEC and refinancing efforts during 2016 and an increase in compensation costs.

 

Interest Expense

 

Interest expense increased by $9.8 million to $22.4 million for 2016 from $12.6 million for 2015. Increased interest expense is primarily related to a full year of debt inherited in the acquisition of our Midwest facilities as well as increased debt discount amortization resulting from our early payoff of the debt. In December 2016, we refinanced our outstanding plant debt with new term and revolving debt at interest rates much lower than the prior debt which should result in lower interest expense in future periods.

 

Provision (Benefit) for Income Taxes

 

In 2016, we generated taxable income, however, we were able to offset taxable income against net operating losses in prior years. Further, we revised our estimate of our valuation allowance related to prior alternative minimum tax credits, which relates to a change in the tax code during the year, resulting in a net tax benefit for 2016.

 

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Net (Income) Loss Attributed to Noncontrolling Interests

 

Net (income) loss attributed to noncontrolling interests relates to our consolidated treatment of Pacific Aurora as previously discussed, and PE Op Co., which indirectly owns our plants located on the West Coast. In 2015, PE Op Co. was not wholly owned for the entire year, but was wholly owned at the end of 2015.

 

Preferred Stock Dividends

 

Shares of our Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in an amount equal to 7% per annum of the purchase price per share of the Series B Preferred Stock. We accrued and paid in cash dividends of $1.3 million for each of 2016 and 2015 in respect of our Series B Preferred Stock.

 

Liquidity and Capital Resources

 

During 2017, we funded our operations primarily from cash on hand, cash generated from our operations, proceeds from new credit facilities, advances from our revolving credit facilities, proceeds from the issuance of additional senior notes, income tax refunds and proceeds from warrant exercises. A portion of these funds were also used to acquire ICP, make payments on our term debt, make capital expenditures, make payments on our capital leases and pay dividends in respect of our Series B Preferred Stock.

 

Our current available capital resources consist of cash on hand and amounts available for borrowing under our credit facilities. We expect that our future available capital resources will consist primarily of our remaining cash balances, amounts available for borrowing, if any, under our credit facilities and cash generated from operations.

 

We believe that current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, including our credit facilities, will be adequate to meet our anticipated capital requirements for at least the next twelve months.

 

Quantitative Year-End Liquidity Status

 

We believe that the following amounts provide insight into our liquidity and capital resources. The following selected financial information should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report (dollars in thousands).

 

  

December 31, 2017

  

December 31, 2016

 
Cash and cash equivalents  $49,489   $64,259 
Current assets  $203,246   $235,201 
Property and equipment, net  $508,352   $465,190 
Current liabilities  $90,706   $78,841 
Long-term debt, noncurrent portion  $221,091   $188,028 
Working capital  $112,540   $156,360 
Working capital ratio   2.24    2.98 

 

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Restricted Net Assets

 

At December 31, 2017, we had approximately $302.9 million of net assets at our subsidiaries that were not available to be transferred to Pacific Ethanol, Inc. in the form of dividends, distributions, loans or advances due to restrictions contained in the credit facilities of these subsidiaries.

 

Changes in Working Capital and Cash Flows

 

Working capital decreased to $112.5 million at December 31, 2017 from $156.4 million at December 31, 2016 as a result of a decrease of $32.0 million in current assets and an increase of $11.9 million in current liabilities.

 

Current assets decreased primarily due to a decrease of $14.8 million in cash, $6.7 million in prepaid inventory, $5.9 million in accounts receivable, $5.0 million in income tax receivables and $1.1 million in derivative and other assets, partially offset by an increase of $1.5 million in inventories.

 

Our cash and cash equivalents decreased by $14.8 million at December 31, 2017 as compared to December 31, 2016 primarily due to $50.4 million used in our investing activities in connection with our plant improvement initiatives and our acquisition of ICP, and an additional $0.8 million used in our net financing activities, partially offset by $36.5 million of cash generated from our operations.

 

Our current liabilities increased by $11.9 million at December 31, 2017 as compared to December 31, 2016 primarily due to an increase of $9.5 million in current portion of long-term debt, $4.1 million in accounts payable and accrued liabilities, partially offset by a decrease of $1.5 million in derivative and other current liabilities.

 

Cash provided by or used in our Operating Activities

 

Cash provided by our operating activities declined by $0.7 million in 2017 as compared to 2016. We generated $36.5 million of cash from our operating activities in 2017. Specific factors that contributed to the decrease in cash provided by our operating activities include:

 

a decrease related to net income (loss) of $36.5 million;

a decrease related to accounts payable and accrued expenses of $14.8 million due to the timing of payments and higher sales volumes;

a decrease related to interest expense added to plant term debt of $9.5 million as we did not add any interest to plant debt balances in 2017; and

a decrease related to prepaid expenses and other assets of $0.5 million due to the collection of income tax refunds.

 

These amounts were partially offset by:

  

an increase related to accounts receivable of $42.8 million primarily due to the timing of collections; and

an increase related to inventories and prepaid inventory of $15.0 million due to the timing of purchases.

 

Cash used in our Investing Activities

 

Cash used in our investing activities increased by $35.8 million in 2017 as compared to 2016. We used $50.4 million of cash in our investing activities in 2017. The increase in cash used in our investing activities is primarily due to $29.6 million of net cash used in our acquisition of ICP and an increase of $1.7 million in capital expenditures.

 

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Cash provided by or used in our Financing Activities

 

Cash used in our financing activities declined by $9.1 million in 2017 as compared to 2016. We used $0.8 million of cash in our financing activities in 2017. The decrease in cash used in our financing activities is primarily due to the following activities:

 

a decrease of $91.3 million in proceeds from credit agreements and assessment financing, in the current year as compared to our debt refinancing transactions in the prior year; and

a decrease of $30.0 million from the sale of a portion of our equity interest in Pacific Aurora in the prior year.

 

These amounts were partially offset by:

 

a decrease of $112.1 million in payments in respect of term and revolving debt; and

a decrease of $6.5 million in payments on capital leases.

 

Kinergy Operating Line of Credit

 

Kinergy maintains an operating line of credit for an aggregate amount of up to $100.0 million. The credit facility matures on August 2, 2022. Interest accrues under the credit facility at a rate equal to (i) the three-month London Interbank Offered Rate (“LIBOR”), plus (ii) a specified applicable margin ranging from 1.50% to 2.00%. The credit facility’s monthly unused line fee is 0.25% to 0.375% of the amount by which the maximum credit under the facility exceeds the average daily principal balance during the immediately preceding month. Payments that may be made by Kinergy to Pacific Ethanol as reimbursement for management and other services provided by Pacific Ethanol to Kinergy are limited under the terms of the credit facility to $1.5 million per fiscal quarter. The credit facility also includes the accounts receivable of Pacific Ag. Products, LLC, or PAP, as additional collateral. Payments that may be made by PAP to Pacific Ethanol as reimbursement for management and other services provided by Pacific Ethanol to PAP are limited under the terms of the credit facility to $0.5 million per fiscal quarter. PAP, one of our indirect wholly-owned subsidiaries, markets our co-products and also provides raw material procurement services to our subsidiaries.

 

For all monthly periods in which excess borrowing availability falls below a specified level, Kinergy and PAP must collectively maintain a fixed-charge coverage ratio (calculated as a twelve-month rolling earnings before interest, taxes, depreciation and amortization (EBITDA) divided by the sum of interest expense, capital expenditures, principal payments of indebtedness, indebtedness from capital leases and taxes paid during such twelve-month rolling period) of at least 2.0 and are prohibited from incurring certain additional indebtedness (other than specific intercompany indebtedness). Kinergy’s and PAP’s obligations under the credit facility are secured by a first-priority security interest in all of their assets in favor of the lender. Kinergy and PAP believe they are in compliance with this covenant. The following table summarizes Kinergy’s financial covenants and actual results for the periods presented (dollars in thousands):

 

   Years
Ended
December 31,
 
   2017   2016 
Fixed Charge Coverage Ratio Requirement   2.00    2.00 
Actual   2.79    7.88 
Excess   0.79    5.88 

 

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Pacific Ethanol has guaranteed all of Kinergy’s obligations under the credit facility. As of December 31, 2017, Kinergy had an outstanding balance of $49.5 million and an unused availability under the credit facility of $27.4 million.

 

Pekin Credit Facilities

 

On December 15, 2016, our wholly-owned subsidiary, Pacific Ethanol Pekin, Inc., or Pekin, entered into term and revolving credit facilities. Pekin borrowed $64.0 million under a term loan facility that matures on August 20, 2021 and $32.0 million under a revolving credit facility that matures on February 1, 2022. The Pekin credit facilities are secured by a first-priority security interest in all of Pekin’s assets. Interest accrues under the Pekin credit facilities at an annual rate equal to the 30-day LIBOR plus 3.75%, payable monthly. Pekin is required to make quarterly principal payments in the amount of $3.5 million on the term loan beginning on May 20, 2017 and a principal payment of $4.5 million at maturity on August 20, 2021. Pekin is required to pay monthly in arrears a fee on any unused portion of the revolving credit facility at a rate of 0.75% per annum. Prepayment of these facilities is subject to a prepayment penalty. Under the terms of the credit facilities, Pekin is required to maintain not less than $20.0 million in working capital and an annual debt coverage ratio of not less than 1.25 to 1.0.

 

On August 7, 2017, Pekin amended its term and revolving credit facilities by agreeing to increase the interest rate under the facilities by 25 basis points to an annual rate equal to the 30-day LIBOR plus 4.00%. Pekin and its lender also agreed that Pekin is required to maintain working capital of not less than $17.5 million from August 31, 2017 through December 31, 2017 and working capital of not less than $20.0 million from January 1, 2018 and continuing at all times thereafter. In addition, the required Debt Service Coverage Ratio was reduced to 0.15 to 1.00 for the fiscal year ended December 31, 2017. Pekin’s actual Debt Service Coverage Ratio was 0.17 to 1.00 for the fiscal year ended December 31, 2017, 0.02 in excess of the required 0.15 to 1.00. For the month ended January 31, 2018, Pekin was not in compliance with its working capital requirement due to larger than anticipated repair and maintenance related expenses to replace faulty equipment. Pekin has received a waiver from its lender for this noncompliance. Further, the lender decreased Pekin’s working capital covenant requirement to $13.0 million for the month ended February 28, 2018, excluding the $3.5 million principal payment due in May 2018 in the calculation. As of the filing of this report, we believe Pekin is in compliance with its working capital requirement.

 

ICP Credit Facilities

 

On September 15, 2017, ICP entered into term and revolving credit facilities. ICP borrowed $24.0 million under term loan facility that matures on September 20, 2021 and $18.0 million under a revolving credit facility that matures on September 1, 2022. The ICP credit facilities are secured by a first-priority security interest in all of ICP’s assets. Interest accrues under the ICP credit facilities at an annual rate equal to the 30-day LIBOR plus 3.75%, payable monthly. ICP is required to make quarterly consecutive principal payments in the amount of $1.5 million. ICP is required to pay monthly in arrears a fee on any unused portion of the revolving credit facility at a rate of 0.75% per annum. Prepayment of these facilities is subject to a prepayment penalty. Under the terms of the credit facilities, ICP is required to maintain not less than $8.0 million in working capital and an annual debt coverage ratio of not less than 1.5 to 1.0, beginning for the year ended December 31, 2018.

 

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Pacific Aurora Credit Facility

 

On December 15, 2016, Pacific Aurora entered into a revolving credit facility for up to $30.0 million that matures on February 1, 2022. The credit facility is secured by a first-priority security interest in all of Pacific Aurora’s assets. Borrowing availability under the credit facility automatically declines by $2.5 million on the first day of each June and December beginning on June 1, 2017 through and including December 1, 2020. Interest accrues under the Pacific Aurora credit facility at an annual rate equal to the 30-day LIBOR plus 4.0%, payable monthly. Pacific Aurora is required to pay monthly in arrears a fee on any unused portion of the credit facility at a rate of 0.75% per annum. Prepayment of the credit facility is subject to a prepayment penalty. Under the terms of the credit facility, Pacific Aurora was required to maintain not less than $22.5 million in working capital through June 30, 2017, not less than $24.0 million in working capital after June 30, 2017 and an annual debt service coverage ratio of not less than 1.50 to 1.00. These covenants were partially amended, as noted below.

 

On September 1, 2017, Pacific Aurora and its lender agreed that Pacific Aurora is required to maintain working capital of not less than $18.0 million from September 30, 2017 through February 28, 2018 and working capital of not less than $20.0 million from March 1, 2018 and continuing at all times thereafter. In addition, the required Debt Service Coverage Ratio was reduced to 0.00 to 1.00 for the fiscal year ending December 31, 2017 and 1.50 to 1.00 for the fiscal year ending December 31, 2018.

 

At December 31, 2017, Pacific Aurora was not in compliance with its working capital and Debt Service Coverage Ratio requirements. We did not utilize the credit facility in 2017 and have no plans to draw on the facility at this time, having addressed the liquidity and capital needs of Pacific Aurora through other means. Consequently, we are in discussions with our lender to either amend the credit facility or terminate it.

  

Pacific Ethanol, Inc. Notes Payable

 

On December 12, 2016, we entered into a Note Purchase Agreement with five accredited investors. On December 15, 2016, under the terms of the Note Purchase Agreement, we sold $55.0 million in aggregate principal amount of our senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold. On June 26, 2017, we entered into a second Note Purchase Agreement with five accredited investors. On June 30, 2017, under the terms of the second Note Purchase Agreement, we sold an additional $13.9 million in aggregate principal amount of our senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold, for a total of $68.9 million in aggregate principal amount of senior secured notes.

 

The notes mature on December 15, 2019. Interest on the notes accrues at an annual rate equal to (i) the greater of 1% and the three-month LIBOR, plus 7.0% from the closing through December 14, 2017, (ii) the greater of 1% and the three-month LIBOR, plus 9% between December 15, 2017 and December 14, 2018, and (iii) the greater of 1% and the three-month LIBOR plus 11% between December 15, 2018 and the maturity date. The interest rate increases by an additional 2% per annum above the interest rate otherwise applicable upon the occurrence and during the continuance of an event of default until cured. Interest is payable in cash in arrears on the 15th calendar day of each March, June, September and December. We are required to pay all outstanding principal and any accrued and unpaid interest on the notes on the maturity date. We may, at our option, prepay the outstanding principal amount of the notes at any time without premium or penalty. Pacific Ethanol, Inc. issued the notes, which are secured by a first-priority security interest in the equity interest held by Pacific Ethanol, Inc. in its wholly-owned subsidiary, PE Op. Co., which indirectly owns our plants located on the West Coast.

 

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Effects of Inflation

 

The impact of inflation was not significant to our financial condition or results of operations for 2017, 2016 or 2015.

 

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Contractual Obligations

 

The following table outlines payments due under our significant contractual obligations (in thousands):

 

Contractual Obligations
At December 31, 2017
 

2018

  

2019

  

2020

  

2021

  

2022

  

Thereafter

  

Total

 
Sourcing commitments(1)  $30,066   $   $   $   $   $   $30,066 
Debt principal   20,000    88,948    20,000    16,000    99,477        244,425 
Debt interest(2)   15,254    14,692    5,971    4,844    1,824    2    42,587 
Capital projects   7,296                        7,296 
Operating leases(3)   11,841    9,236    7,042    4,074    3,894    5,530    41,617 
Capital leases(3)   613    45    45    34            737 
Preferred dividends(4)   1,265    1,265    1,265    1,265    1,265    1,265    7,590 
Total commitments  $86,335   $114,186   $34,323   $26,217   $106,460   $6,797   $374,318 

 

 

(1)Unconditional fixed purchase commitments for production materials incurred in the normal course of business.

(2)Payments based on interest rates and balances as of December 31, 2017 through maturity.

(3)Future minimum payments under capital and non-cancelable operating leases.

(4)Represents dividends on 926,942 shares of Series B Preferred Stock. Dividends accrue until Series B Preferred Stock is converted to common stock or redeemed. The “thereafter” amount includes only one additional year of dividends.

 

The above table outlines our obligations as of December 31, 2017 and does not reflect the changes in our obligations that occurred after that date.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations is 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 recognize revenue when it is realized or realizable and earned. We consider revenue realized or realizable and earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. We derive revenue primarily from sales of ethanol and related co-products. We recognize revenue when title transfers to our customers, which is generally upon the delivery of these products to a customer’s designated location. These deliveries are made in accordance with sales commitments and related sales orders entered into with customers either verbally or in written form. The sales commitments and related sales orders provide quantities, pricing and conditions of sales. In this regard, we engage in three basic types of revenue generating transactions:

 

As a producer. Sales as a producer consist of sales of our inventory produced at our ethanol production facilities.

 

As a merchant. Sales as a merchant consist of sales to customers through purchases from third-party suppliers in which we may or may not obtain physical control of the ethanol in which shipments are directed from our suppliers to our terminals or direct to our customers but for which we accept the risk of loss in the transactions.

 

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As an agent. Sales as an agent consist of sales to customers through purchases from third-party suppliers in which the risks and rewards of inventory ownership remain with third-party suppliers and we receive a predetermined service fee under these transactions.

 

The following table shows our net sales generated as a producer, a merchant and as an agent for the years presented (in thousands):

 

    For the Years Ended December 31, 
    2017   2016   2015 
Producer   $1,102,722   $1,045,807   $710,114 
Merchant    527,869    577,347    479,551 
Agent    1,664    1,604    1,511 
    $1,632,255   $1,624,758   $1,191,176 

 

Revenue from sales of third-party ethanol is recorded net of costs when we are acting as an agent between a customer and a supplier and gross when we are a principal to the transaction. Several factors are considered to determine whether we are acting as an agent or principal, most notably whether we are the primary obligor to the customer, whether we have inventory risk and related risk of loss or whether we add meaningful value to the supplier’s product or service. Consideration is also given to whether we have latitude in establishing the sales price or have credit risk, or both. When we act as an agent, we record revenues on a net basis, or our predetermined fees and any associated freight, based upon the amount of net revenues retained in excess of amounts paid to suppliers.

 

We record revenues based upon the gross amounts billed to our customers in transactions where we act as a producer or a merchant and obtain title to ethanol and therefore own the product and any related unmitigated inventory risk for the ethanol, regardless of whether we actually obtain physical control of the product.

 

Impairment of Long-Lived Assets

 

Our long-lived assets have been primarily associated with our ethanol production facilities, reflecting their original cost, adjusted for depreciation and any subsequent impairment.

 

We assess the impairment of long-lived assets, including property and equipment, when events or changes in circumstances indicate that the fair value of an asset could be less than the net book value of the asset. Generally, we assess long-lived assets for impairment by first determining the forecasted, undiscounted cash flows each asset is expected to generate plus the net proceeds expected from the sale of the asset. If the amount of proceeds is less than the carrying value of the asset, we then determine the fair value of the asset. An impairment loss would be recognized when the fair value is less than the related net book value, and an impairment expense would be recorded in the amount of the difference. Forecasts of future cash flows are judgments based on our experience and knowledge of our operations and the industry in which we operate. These forecasts could be significantly affected by future changes in market conditions, the economic environment, including inflation, and the purchasing decisions of our customers.

 

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We review our intangible assets with indefinite lives at least annually or more frequently if impairment indicators arise. In our review, we determine the fair value of these assets using market multiples and discounted cash flow modeling and compare it to the net book value of the acquired assets.

 

In 2015, we recorded an impairment charge of $2.0 million on our long-lived assets related to the abandonment of certain accounting and information technology systems following our integration of our Midwest plants. We did not recognize any asset impairment charges in 2017 and 2016.

 

Valuation Allowance for Deferred Taxes

 

We account for income taxes under the asset and liability approach, where deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

We evaluate our deferred tax asset balance for realizability. To the extent we believe it is more likely than not that some portion or all of our deferred tax assets will not be realized, we will establish a valuation allowance against the deferred tax assets. Realization of our deferred tax assets is dependent upon future taxable income during the periods in which the associated temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.

 

Our pre-tax consolidated loss was $38.4 million, compared to income of $0.5 million and a loss of $28.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. In 2016, we carried back a portion of our losses to apply to taxable income in 2014, however, based on our current and prior results, we do not have significant evidence to support a conclusion that we will more likely than not be able to benefit from our remaining deferred tax assets. As such, we have recorded a valuation allowance against our net deferred tax assets.

 

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Derivative Instruments

 

We evaluate our contracts to determine whether the contracts are derivative instruments. Management may elect to exempt certain forward contracts that meet the definition of a derivative from derivative accounting as normal purchases or normal sales. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from the fair value accounting and reporting requirements of derivative accounting.

 

We enter into short-term cash, option and futures contracts as a means of securing purchases of corn, natural gas and sales of ethanol and managing exposure to changes in commodity prices. All of our exchange-traded derivatives are designated as non-hedge derivatives for accounting purposes, with changes in fair value recognized in net income. Although the contracts are economic hedges of specified risks, they are not designated as and accounted for as hedging instruments.

 

Realized and unrealized gains and losses related to exchange-traded derivative contracts are included as a component of cost of goods sold in the accompanying financial statements. The fair values of contracts entered through commodity exchanges are presented on the accompanying balance sheet as derivative instruments. The selection of normal purchase or sales contracts, and use of hedge accounting, are accounting policies that can change the timing of recognition of gains and losses in the statement of operations.

 

Accounting for Business Combinations

 

Determining the fair value of assets acquired and liabilities assumed in a business combination is considered a critical accounting estimate because the allocation of the purchase price to assets acquired and liabilities assumed based upon fair values requires significant management judgment and the use of subjective measurements. Variability in industry conditions and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on our financial position, liquidity or results of operations.

 

Allowance for Doubtful Accounts

 

We sell ethanol primarily to gasoline refining and distribution companies, sell corn oil to poultry and biodiesel customers and sell other co-products to dairy operators and animal feed distributors. We had significant concentrations of credit risk from sales of our ethanol as of December 31, 2017 and 2016, as described in Note 1 to our consolidated financial statements included elsewhere in this report. However, historically, those ethanol customers have had good credit ratings and we have collected the amounts billed to those customers. Receivables from customers are generally unsecured. We continuously monitor our customer account balances and actively pursue collections on past due balances.

 

We maintain an allowance for doubtful accounts for balances that appear to have specific collection issues. Our collection process is based on the age of the invoice and requires attempted contacts with the customer at specified intervals. If after a specified number of days, we have been unsuccessful in our collection efforts, we consider recording a bad debt allowance for the balance in question. We would eventually write-off accounts included in our allowance when we have determined that collection is not likely. The factors considered in reaching this determination are the apparent financial condition of the customer, and our success in contacting and negotiating with the customer.

 

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We recognized a bad debt expense of $5,000 and $306,000 and bad debt recoveries of $354,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

 

Impact of New Accounting Pronouncements

 

See “Note 1 – Organization and Significant Accounting Policies – Recent Accounting Pronouncements” of the Notes to Consolidated Financial Statements commencing on page F-19 of this report.

 

Item 7A.Quantitative and Qualitative Disclosures About Market Risk.

 

We are exposed to various market risks, including changes in commodity prices and interest rates as discussed below. Market risk is the potential loss arising from adverse changes in market rates and prices. In the ordinary course of business, we may enter into various types of transactions involving financial instruments to manage and reduce the impact of changes in commodity prices and interest rates. We do not expect to have any exposure to foreign currency risk as we conduct all of our transactions in U.S. dollars.

 

Commodity Risk

 

We produce ethanol, specialty alcohols and co-products. Our business is sensitive to changes in the prices of ethanol and corn. In the ordinary course of business, we may enter into various types of transactions involving financial instruments to manage and reduce the impact of changes in ethanol and corn prices. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

 

We are subject to market risk with respect to ethanol pricing. Ethanol prices are sensitive to global and domestic ethanol supply; crude-oil supply and demand; crude-oil refining capacity; carbon intensity; government regulation; and consumer demand for alternative fuels. Our ethanol sales are priced using contracts that are either based on a fixed price or an indexed price tied to a specific market, such as the CBOT or the Oil Price Information Service. Under these fixed-priced arrangements, we are exposed to risk of a decrease in the market price of ethanol between the time the price is fixed and the time the ethanol is sold.

 

We satisfy our physical corn needs, the principal raw material used to produce ethanol and ethanol co-products, based on supply-guaranteed contracts with our vendors. Generally, we determine the purchase price of our corn at the time we begin to grind that day’s needs. Additionally, we also enter into volume contracts with our vendors to fix the purchase price. As such, we are also subject to market risk with respect to the price of corn. The price of corn is subject to wide fluctuations due to unpredictable factors such as weather conditions, farmer planting decisions, governmental policies with respect to agriculture and international trade and global supply and demand. Under the fixed price arrangements, we assume the risk of a decrease in the market price of corn between the time the price is fixed and the time the corn is utilized.

 

Ethanol co-products are sensitive to various demand factors such as numbers of livestock on feed, prices for feed alternatives and supply factors, primarily production of ethanol co-products by ethanol plants and other sources.

 

As noted above, we may attempt to reduce the market risk associated with fluctuations in the price of ethanol or corn by employing a variety of risk management and hedging strategies. Strategies include the use of derivative financial instruments such as futures and options executed on the CBOT and/or the New York Mercantile Exchange, as well as the daily management of physical corn.

 

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These derivatives are not designated for special hedge accounting treatment, and as such, the changes in the fair values of these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold. We recognized losses of $4.2 million, income of $1.4 million and losses of $0.3 million related to settled non-designated hedges as the change in the fair values of these contracts for the years ended December 31, 2017, 2016 and 2015, respectively.

 

At December 31, 2017, we prepared a sensitivity analysis to estimate our exposure to ethanol and corn. Market risk related to these factors was estimated as the potential change in pre-tax income resulting from a hypothetical 10% adverse change in the prices of our expected ethanol and corn volumes. The results of this analysis as of December 31, 2017, which may differ materially from actual results, are as follows (in millions):

 

Commodity 

Year Ending December 31, 

2017
Volume 

  Unit of Measure  Approximate
Adverse Change to
Pre-Tax Income
Ethanol    952.0    Gallons   $85.8 
Corn    188.3    Bushels   $68.2 

 

Interest Rate Risk

 

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our indebtedness that bears interest at variable rates. At December 31, 2017, $244.4 million of our long-term debt was variable-rate in nature. Based on a 100 basis point (1.00%) increase in the interest rate on our long-term debt, on an annualized basis, our pre-tax income for the year ended December 31, 2017 would have been negatively impacted by approximately $2.4 million.

 

Item 8.Financial Statements and Supplementary Data.

 

Reference is made to the financial statements, which begin at page F-1 of this report.

 

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.Controls and Procedures.

 

We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended, or Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2017 that our disclosure controls and procedures were effective at a reasonable assurance level.

 

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Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:

 

(i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

 

(ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

A material weakness is defined by the Public Company Accounting Oversight Board’s Audit Standards AS 2201 as being a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis by the company’s internal controls.

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework set forth in Internal Control — Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2016.

 

RSM US LLP, an independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting as of December 31, 2017. That report is included in Part IV of this report.

 

Inherent Limitations on the Effectiveness of Controls

 

Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of internal control over financial reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been or will be detected.

 

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These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.Other Information.

 

None.

 

 -52-

 

 

PART III

 

Item 10.Directors, Executive Officers and Corporate Governance.

 

The information under the captions “Information about our Board of Directors, Board Committees and Related Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance,” appearing in the Proxy Statement, is hereby incorporated by reference.

 

Item 11.Executive Compensation.

 

The information under the caption “Executive Compensation and Related Information,” appearing in the Proxy Statement, is hereby incorporated by reference.

 

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The information under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information,” appearing in the Proxy Statement, is hereby incorporated by reference.

 

Item 13.Certain Relationships and Related Transactions, and Director Independence.

 

The information under the captions “Certain Relationships and Related Transactions” and “Information about our Board of Directors, Board Committees and Related Matters—Director Independence” appearing in the Proxy Statement, is hereby incorporated by reference.

 

Item 14.Principal Accounting Fees and Services.

 

The information under the caption “Audit Matters—Principal Accountant Fees and Services,” appearing in the Proxy Statement, is hereby incorporated by reference.

 

PART IV

 

Item 15.Exhibits, Financial Statement Schedules.

 

(a)(1) Financial Statements

 

Reference is made to the financial statements listed on and attached following the Index to Consolidated Financial Statements contained on page F-1 of this report.

 

(a)(2) Financial Statement Schedules

 

None.

 

(a)(3) Exhibits

 

Reference is made to the exhibits listed on the Index to Exhibits.

 

 -53-

 

 

Index to Consolidated Financial Statements

 

Reports of Independent Registered Public Accounting Firm F-2
   
Consolidated Balance Sheets as of December 31, 2017 and 2016 F-5
   
Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016 and 2015 F-7
   
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016 and 2015 F-8
   
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2017, 2016 and  2015 F-9
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015 F-10
   
Notes to Consolidated Financial Statements F-12

 

 F-1

 

  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Stockholders and the Board of Directors of
Pacific Ethanol, Inc.

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Pacific Ethanol, Inc. and its subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of operations, other comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes to the consolidated financial statements (collectively, the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 15, 2018, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ RSM US LLP

 

We have served as the Company’s auditor since 2015.

 

Sioux Falls, South Dakota
March 15, 2018

 


 F-2

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Stockholders and the Board of Directors of
Pacific Ethanol, Inc.

 

Opinion on the Internal Control Over Financial Reporting

We have audited Pacific Ethanol, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets as of December 31, 2017 and 2016, the related consolidated statements of operations, other comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017 of the Company and our report dated March 15, 2018 expressed an unqualified opinion.

 

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

 F-3

 

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ RSM US LLP

 

Sioux Falls, South Dakota 

March 15, 2018

 

 F-4

 

 

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and par value)

 

  

December 31,

 
 

2017

  

2016

 
ASSETS        
           
Current Assets:          
Cash and cash equivalents  $49,489   $64,259 
Accounts receivable, net of allowance for doubtful accounts of $19 and $331, respectively   80,344    86,275 
Inventories   61,550    60,070 
Prepaid inventory   3,281    9,946 
Income tax receivables   743    5,730 
Derivative assets   998    978 
Other current assets   6,841    7,943 
Total current assets   203,246    235,201 
           
Property and equipment, net   508,352    465,190 
           
Other Assets:          
Intangible assets   2,678    2,678 
Other assets   6,020    5,169 
Total other assets   8,698    7,847 
Total Assets  $720,296   $708,238 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-5

 

 

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands, except shares and par value)

 

  

December 31,

 
 

2017

  

2016

 
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Accounts payable – trade  $39,738   $37,051 
Accrued liabilities   21,673    20,280 
Current portion – capital leases   592    794 
Current portion – long-term debt   20,000    10,500 
Derivative liabilities   2,307    4,115 
Other current liabilities   6,396    6,101 
Total current liabilities   90,706    78,841 
           
Long-term debt, net of current portion   221,091    188,028 
Capital leases, net of current portion   123    547 
Warrant liabilities at fair value       651 
Other liabilities   24,676    21,910 
Total Liabilities   336,596    289,977 
Commitments and contingencies (Notes 1, 8, 9 and 14)          
           
Stockholders’ Equity:          
Preferred stock, $0.001 par value; 10,000,000 shares authorized:          
Series A: 1,684,375 shares authorized; no shares issued and outstanding as of December 31, 2017 and 2016        
Series B: 1,580,790 shares authorized; 926,942 shares issued and outstanding as of December 31, 2017 and 2016; liquidation preference of $18,075 as of December 31, 2017   1    1 
Common stock, $0.001 par value; 300,000,000 shares authorized; 43,984,975 and 39,772,238 shares issued and outstanding as of December 31, 2017 and 2016, respectively   44    40 
Non-voting common stock, $0.001 par value; 3,553,000 shares authorized; 896 and 3,540,132 shares issued and outstanding as of December 31, 2017 and 2016, respectively       4 
Additional paid-in capital   927,090    922,698 
Accumulated other comprehensive loss   (2,234)   (2,620)
Accumulated deficit   (568,462)   (532,233)
Total Pacific Ethanol, Inc. stockholders’ equity   356,439    387,890 
Noncontrolling interests   27,261    30,371 
Total stockholders’ equity   383,700    418,261 
Total Liabilities and Stockholders’ Equity  $720,296   $708,238 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-6

 

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

 

  

Years Ended December 31,

 
  

2017

  

 

2016 

 

 

2015

 
Net sales  $1,632,255   $1,624,758   $1,191,176 
Cost of goods sold   1,626,324    1,570,400    1,180,810 
Gross profit   5,931    54,358    10,366 
Selling, general and administrative expenses   31,516    30,849    26,368 
Asset impairment           1,970 
Income (loss) from operations   (25,585)   23,509    (17,972)
Fair value adjustments and warrant inducements   473    (557)   1,641 
Interest expense   (12,938)   (22,406)   (12,594)
Other income (expense), net   (345)   (1)   18 
Income (loss) before provision for income taxes   (38,395)   545    (28,907)
Provision (benefit) for income taxes   (321)   (981)   (10,034)
Consolidated net income (loss)   (38,074)   1,526    (18,873)
Net (income) loss attributed to noncontrolling interests   3,110    (107)   87 
Net income (loss) attributed to Pacific Ethanol, Inc.  $(34,964)  $1,419   $(18,786)
Preferred stock dividends  $(1,265)  $(1,269)  $(1,265)
Income allocated to participating securities       (2)    
Income (loss) available to common stockholders  $(36,229)  $148   $(20,051)
Income (loss) per share, basic and diluted  $(0.85)  $0.00   $(0.60)
Weighted-average shares outstanding, basic   42,745    42,182    33,173 
Weighted-average shares outstanding, diluted   42,745    42,251    33,173 

The accompanying notes are an integral part of these consolidated financial statements.

F-7

 

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)

 

   Years Ended December 31, 
   2017   2016   2015 
Consolidated net income (loss)  $(38,074)  $1,526   $(18,873)
Other comprehensive income (expense) – net gain (loss) arising during the period on defined benefit pension plans   386    (3,660)   1,040 
Total comprehensive loss   (37,688)   (2,134)   (17,833)
Comprehensive (income) loss attributed to noncontrolling interests   3,110    (107)   87 
                
Comprehensive loss attributed to Pacific Ethanol, Inc.  $(34,578)  $(2,241)  $(17,746)

The accompanying notes are an integral part of these consolidated financial statements.

F-8

 

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

   Preferred Stock   Common Stock                     
  

Shares

  

Amount

  

Shares

  

Amount

  

Additional
Paid-In Capital

  

Accumulated Deficit

  

Accum. Other Comprehensive Income (Loss)

  

Non-Controlling Interests

  

 

Total

 
Balances, January 1, 2015   927   $1    24,499   $25   $725,813   $(512,332)  $   $4,475   $217,982 
Stock-based compensation expense – restricted stock issued to employees and directors, net of cancellations and tax           216        1,475                1,475 
Pension plan adjustment                           1,040        1,040 
Warrant exercises           42        440                440 
Shares issued in PE Central acquisition           17,758    18    174,555                174,573 
Purchases of interests in PE Op Co.                   560            (4,388)   (3,828)
Preferred stock dividends                       (1,265)           (1,265)
Net loss                       (18,786)       (87)   (18,873)
Balances, December 31, 2015   927   $1    42,515   $43   $902,843   $(532,383)  $1,040   $   $371,544 
Stock-based compensation expense – restricted stock and options to employees and directors, net of cancellations and tax           659    1    2,281                2,282 
Warrant exercises           138        1,338                1,338 
ACEC contribution to form Pacific Aurora                   5,761            10,739    16,500 
Pension plan adjustment                           (3,660)       (3,660)
Sale of Pacific Aurora interests to ACEC                   10,475            19,525    30,000 
Preferred stock dividends                       (1,269)           (1,269)
Net income                       1,419        107    1,526 
Balances, December 31, 2016   927   $1    43,312   $44   $922,698   $(532,233)  $(2,620)  $30,371   $418,261 
Stock-based compensation expense – restricted stock and options to employees and directors, net of cancellations and tax           473        3,014                3,014 
Warrant and option exercises           201        1,378                1,378 
Pension plan adjustment                           386        386 
Preferred stock dividends                       (1,265)           (1,265)
Net loss                       (34,964)       (3,110)   (38,074)
Balances, December 31, 2017   927   $1    43,986   $44   $927,090   $(568,462)  $(2,234)  $27,261   $383,700 

The accompanying notes are an integral part of these consolidated financial statements.

F-9

 

 

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS 

(in thousands)

 

   For the Years Ended December 31, 
   2017   2016   2015 
Operating Activities:               
Consolidated net income (loss)  $(38,074)  $1,526   $(18,873)
Adjustments to reconcile consolidated net income (loss) to cash provided by (used in) operating activities:               
Depreciation and amortization of intangibles   38,651    35,441    23,632 
Fair value adjustments   (473)   557    (1,641)
Asset impairment           1,970 
Deferred income taxes   169    (1,122)   (2,023)
Inventory valuation   2,678        509 
Change in fair value on commodity derivative instruments   2,077    1,984    542 
Amortization of deferred financing costs   503    137    272 
Amortization of debt discounts   636    2,322    716 
Noncash compensation   3,828    2,616    2,019 
Bad debt expense (recovery)   5    306    (354)
Interest expense added to plant term debt       9,451     
Changes in operating assets and liabilities, net of effects from acquisitions:               
Accounts receivable   17,562    (25,235)   (15,950)
Inventories   5,070    750    (13,296)
Prepaid expenses and other assets   2,677    3,189    (1,093)
Prepaid inventory   6,738    (3,973)   5,622 
Accounts payable and accrued expenses   (5,538)   9,279    (10,045)
Net cash provided by (used in) operating activities  $36,509   $37,228   $(27,993)
Investing Activities:               
Additions to property and equipment  $(20,866)  $(19,171)  $(20,507)
Purchase of ICP, net of cash acquired   (29,574)        
Proceeds (payments) for cash collateralized letters of credit       4,574    (4,574)
Net cash from acquisition of PE Central           18,756 
Net cash used in investing activities  $(50,440)  $(14,597)  $(6,325)
Financing Activities:               
Proceeds from warrant and option exercises  $1,202   $1,164   $368 
Proceeds from plant term and revolving credit agreements   42,000    97,000     
Proceeds from parent notes   13,530    53,350     
Sale of noncontrolling interests       30,000     
Proceeds from assessment financing   5,618    2,096     
Net proceeds (payments) on Kinergy’s line of credit   (385)   (11,141)   43,584 
Payments on plant borrowings   (59,927)   (172,073)   (13,833)
Debt issuance costs   (986)   (1,960)    
Preferred stock dividend payments   (1,265)   (1,269)   (1,265)
Payments on capital leases   (626)   (7,089)   (5,059)
Net cash provided by (used in) financing activities  $(839)  $(9,922)  $23,795 
Net increase (decrease) in cash and cash equivalents   (14,770)   12,709    (10,523)
Cash and cash equivalents at beginning of period   64,259    51,550    62,073 
Cash and cash equivalents at end of period  $49,489   $64,259   $51,550 

 

The accompanying notes are an integral part of these consolidated financial statements.

F-10

 

 

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands) 

 

   For the Years Ended December 31, 
   2017   2016   2015 
Supplemental Information:               
                
Interest paid  $11,133   $11,168   $11,685 
                
Income tax refunds  $5,614   $4,784   $5,710 
Noncash financing and investing activities:               
Accrued payment for ownership positions of PE Op Co.  $   $   $3,828 
Capital leases added to plant and equipment  $180   $   $1,864 
Reclass of warrant liability to equity upon exercises  $178   $179   $72 
Contribution of property and equipment for noncontrolling interest (see Note 2)  $   $16,500   $ 
Debt issued in ICP acquisition (see Note 2)  $46,927   $   $ 
Common stock issued in PE Central acquisition (see Note 2)  $   $   $174,573 

The accompanying notes are an integral part of these consolidated financial statements.

F-11

 

  

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES.

 

Organization and Business – The consolidated financial statements include, for all periods presented, the accounts of Pacific Ethanol, Inc., a Delaware corporation (“Pacific Ethanol”), and its direct and indirect subsidiaries (collectively, the “Company”), including its wholly-owned subsidiaries, Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”), Pacific Ag. Products, LLC, a California limited liability company (“PAP”) and PE Op Co., a Delaware corporation (“PE Op Co.”).

 

The Company’s acquisition of Aventine Renewable Energy Holdings, Inc. (now, Pacific Ethanol Central, LLC, a Delaware limited liability company, “PE Central”) was consummated on July 1, 2015, and as a result, the Company’s consolidated financial statements include the results of PE Central only as of and for the years ended December 31, 2017 and 2016 and for the six months ended December 31, 2015.

 

On December 15, 2016, the Company and Aurora Cooperative Elevator Company, a Nebraska cooperative corporation (“ACEC”), closed a transaction under a contribution agreement under which the Company contributed its Aurora, Nebraska ethanol facilities and ACEC contributed its Aurora grain elevator and related grain handling assets to Pacific Aurora, LLC (“Pacific Aurora”) in exchange for equity interests in Pacific Aurora. On December 15, 2016, concurrently with the closing under the contribution agreement, the Company sold a portion of its equity interest in Pacific Aurora to ACEC. As a result, the Company owned 73.93% of Pacific Aurora and ACEC owned 26.07% of Pacific Aurora as of December 31, 2017 and 2016. Further, the Company has consolidated 100% of the results of Pacific Aurora and recorded ACEC’s 26.07% equity interest as noncontrolling interests in the accompanying financial statements for the year ended December 31, 2017 and for the period December 15, 2016 through December 31, 2016.

 

The Company’s acquisition of Illinois Corn Processing, LLC (“ICP”) was consummated on July 3, 2017, and as a result, the Company’s consolidated financial statements include the results of ICP only for the period from July 3, 2017 through December 31, 2017.

 

The Company is a leading producer and marketer of low-carbon renewable fuels in the United States. The Company’s four ethanol plants in the Western United States (together with their respective holding companies, the “Pacific Ethanol West Plants”) are located in close proximity to both feed and ethanol customers and thus enjoy unique advantages in efficiency, logistics and product pricing. These plants produce among the lowest-carbon ethanol produced in the United States due to low energy use in production.

 

With the addition of four Midwestern ethanol plants in July 2015 as a result of the Company’s acquisition of PE Central and the addition of ICP’s plant in July 2017, the Company now has a combined production capacity of 605 million gallons per year, markets, on an annualized basis, nearly 1.0 billion gallons of ethanol and specialty alcohols, and produces, on an annualized basis, over 3.0 million tons of co-products on a dry matter basis, such as wet and dry distillers grains, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, dried yeast and CO2. The Company’s five ethanol plants in the Midwest (together with their respective holding companies, the “Pacific Ethanol Central Plants”) are located in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, the Company’s ability to load unit trains from these facilities in the Midwest allows for greater access to international markets.

 

 F-12

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2017, all nine facilities were operating. As market conditions change, the Company may increase, decrease or idle production at one or more operational facilities or resume operations at any idled facility.

 

Basis of Presentation – The consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Segments – A segment is a component of an enterprise whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The Company determines and discloses its segments in accordance with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification Section 280, Segment Reporting, which defines how to determine segments. The Company reports its financial and operating performance in two reportable segments: (1) ethanol production, which includes the production and sale of ethanol, specialty alcohols and co-products, with all of the Company’s production facilities aggregated, and (2) marketing and distribution, which includes marketing and merchant trading for Company-produced ethanol, specialty alcohols and co-products and third-party ethanol.

 

Cash and Cash Equivalents – The Company considers all highly-liquid investments with an original maturity of three months or less to be cash equivalents. The Company maintains its accounts at several financial institutions. These cash balances regularly exceed amounts insured by the Federal Deposit Insurance Corporation, however, the Company does not believe it is exposed to any significant credit risk on these balances.

 

Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are presented at face value, net of the allowance for doubtful accounts. The Company sells ethanol to gasoline refining and distribution companies, sells distillers grains and other feed co-products to dairy operators and animal feedlots and sells corn oil to poultry and biodiesel customers generally without requiring collateral. Due to a limited number of ethanol customers, the Company had significant concentrations of credit risk from sales of ethanol as of December 31, 2017 and 2016, as described below.

 

The Company maintains an allowance for doubtful accounts for balances that appear to have specific collection issues. The collection process is based on the age of the invoice and requires attempted contacts with the customer at specified intervals. If, after a specified number of days, the Company has been unsuccessful in its collection efforts, a bad debt allowance is recorded for the balance in question. Delinquent accounts receivable are charged against the allowance for doubtful accounts once uncollectibility has been determined. The factors considered in reaching this determination are the apparent financial condition of the customer and the Company’s success in contacting and negotiating with the customer. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of ability to make payments, additional allowances may be required.

 

Of the accounts receivable balance, approximately $64,501,000 and $64,853,000 at December 31, 2017 and 2016, respectively, were used as collateral under Kinergy’s operating line of credit. The allowance for doubtful accounts was $19,000 and $331,000 as of December 31, 2017 and 2016, respectively. The Company recorded a bad debt expense of $5,000 and $306,000 and a recovery of $354,000 for the years ended December 31, 2017, 2016 and 2015, respectively. The Company does not have any off-balance sheet credit exposure related to its customers.

 

 F-13

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Concentration Risks – 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 Company has not experienced any significant losses in such accounts and believes that it is not exposed to any significant risk of loss of cash.

 

The Company sells fuel-grade ethanol to gasoline refining and distribution companies. The Company sold ethanol to customers representing 10% or more of the Company’s total net sales, as follows.

 

   Years Ended December 31,
   2017  2016  2015
Customer A   16%   17%   12%
Customer B   11%   12%   15%
Customer C   6%   6%   12%

 

The Company had accounts receivable due from these customers totaling $21,584,000 and $21,274,000, representing 27% and 25% of total accounts receivable, as of December 31, 2017 and 2016, respectively.

 

The Company purchases corn, its largest cost component in producing ethanol, from its suppliers. The Company purchased corn from suppliers representing 10% or more of the Company’s total corn purchases, as follows:

 

   Years Ended December 31,
   2017  2016  2015
Supplier A   14%   13%   19%
Supplier B   13%   4%   %
Supplier C   10%   8%   9%
Supplier D   9%   13%   13%

 

Approximately 32% of the Company’s employees are covered by a collective bargaining agreement.

  

 F-14

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Inventories – Inventories consisted primarily of bulk ethanol, specialty alcohols, corn, co-products, low-carbon and Renewable Identification Number (“RIN”) credits and unleaded fuel, and are valued at the lower-of-cost-or-net realizable value, with cost determined on a first-in, first-out basis. Inventory is net of a $2.7 million valuation adjustment as of December 31, 2017. Inventory balances consisted of the following (in thousands):

 

   December 31, 
   2017   2016 
Finished goods  $35,652   $33,773 
Work in progress   8,807    7,092 
Raw materials   7,601    6,571 
Low-carbon and RIN credits   7,952    10,926 
Other   1,538    1,708 
Total  $61,550   $60,070 

 

Property and Equipment – Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives:

 

Buildings 40 years
Facilities and plant equipment 10 – 25 years
Other equipment, vehicles and furniture 5 – 10 years

 

The cost of normal maintenance and repairs is charged to operations as incurred. Significant capital expenditures that increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of property and equipment sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any resulting gains or losses are reflected in current operations.

 

Intangible Asset – The Company assesses indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. If the carrying value of an indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the Company determines that an impairment charge is needed, the charge will be recorded as an asset impairment in the consolidated statements of operations.

 

Derivative Instruments and Hedging Activities – Derivative transactions, which can include exchange-traded forward contracts and futures positions on the New York Mercantile Exchange or the Chicago Board of Trade, are recorded on the balance sheet as assets and liabilities based on the derivative’s fair value. Changes in the fair value of derivative contracts are recognized currently in income unless specific hedge accounting criteria are met. If derivatives meet those criteria, and hedge accounting is elected, effective gains and losses are deferred in accumulated other comprehensive income (loss) and later recorded together with the hedged item in consolidated income (loss). For derivatives designated as a cash flow hedge, the Company formally documents the hedge and assesses the effectiveness with associated transactions. The Company has designated and documented contracts for the physical delivery of commodity products to and from counterparties as normal purchases and normal sales.

 

Revenue Recognition – The Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. The Company derives revenue primarily from sales of ethanol and related co-products. The Company recognizes revenue when title transfers to its customers, which is generally upon the delivery of these products to a customer’s designated location. These deliveries are made in accordance with sales commitments and related sales orders entered into either verbally or in writing with customers. The sales commitments and related sales orders provide quantities, pricing and conditions of sales. In this regard, the Company engages in three basic types of revenue generating transactions:

 

As a producer. Sales as a producer consist of sales of the Company’s inventory produced at its plants.

 

 F-15

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As a merchant. Sales as a merchant consist of sales to customers through purchases from third-party suppliers in which the Company may or may not obtain physical control of the ethanol, in which shipments are directed from the Company’s suppliers to its terminals or direct to its customers but for which the Company accepts the risk of loss in the transactions.

 

As an agent. Sales as an agent consist of sales to customers through purchases from third-party suppliers in which the risks and rewards of inventory ownership remain with third-party suppliers and the Company receives a predetermined service fee under these transactions.

 

Revenue from sales of third-party ethanol is recorded net of costs when the Company is acting as an agent between a customer and a supplier and gross when the Company is a principal to the transaction. The Company recorded $1,663,000, $1,604,000 and $1,510,000 in net sales when acting as an agent for the years ended December 31, 2017, 2016 and 2015, respectively. Several factors are considered to determine whether the Company is acting as an agent or principal, most notably whether the Company is the primary obligor to the customer and whether the Company has inventory risk and related risk of loss or whether the Company adds meaningful value to the supplier’s product or service. Consideration is also given to whether the Company has latitude in establishing the sales price or has credit risk, or both. When the Company acts as an agent, it recognizes revenue on a net basis or recognizes its predetermined fees and any associated freight, based upon the amount of net revenues retained in excess of amounts paid to suppliers.

 

The Company records revenues based upon the gross amounts billed to its customers in transactions where the Company acts as a producer or a merchant and obtains title to ethanol and therefore owns the product and any related, unmitigated inventory risk for the ethanol, regardless of whether the Company actually obtains physical control of the product.

 

Shipping and Handling Costs – Shipping and handling costs are classified as a component of cost of goods sold in the accompanying consolidated statements of operations.

 

Selling Costs – Selling costs associated with the Company’s product sales are classified as a component of selling, general and administrative expenses in the accompanying consolidated statements of operations.

 

Stock-Based Compensation – The Company accounts for the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award, determined on the date of grant. The expense is recognized over the period during which an employee is required to provide services in exchange for the award. The Company accounts for forfeitures as they occur. The Company recognizes stock-based compensation expense as a component of selling, general and administrative expenses in the consolidated statements of operations.

  

 F-16

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impairment of Long-Lived Assets – The Company assesses the impairment of long-lived assets, including property and equipment, internally developed software and purchased intangibles subject to amortization, when events or changes in circumstances indicate that the fair value of assets could be less than their net book value. In such event, the Company assesses long-lived assets for impairment by first determining the forecasted, undiscounted cash flows the asset group is expected to generate plus the net proceeds expected from the sale of the asset group. If this amount is less than the carrying value of the asset, the Company will then determine the fair value of the asset group. An impairment loss would be recognized when the fair value is less than the related asset group’s net book value, and an impairment expense would be recorded in the amount of the difference. Forecasts of future cash flows are judgments based on the Company’s experience and knowledge of its operations and the industries in which it operates. These forecasts could be significantly affected by future changes in market conditions, the economic environment, including inflation, and purchasing decisions of the Company’s customers.

 

Deferred Financing Costs – Deferred financing costs are costs incurred to obtain debt financing, including all related fees, and are amortized as interest expense over the term of the related financing using the straight-line method, which approximates the interest rate method. Amortization of deferred financing costs was $503,000, $137,000 and $272,000 for the years ended December 31, 2017, 2016 and 2015, respectively. Unamortized deferred financing costs were approximately $1,925,000 and $1,708,000 as of December 31, 2017 and 2016, respectively, and are recorded net of long-term debt in the consolidated balance sheets.

 

Provision for Income Taxes – Income taxes are accounted for under the asset and liability approach, where deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

The Company accounts for uncertainty in income taxes using a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. An uncertain tax position is considered effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied. Should the Company incur interest and penalties relating to tax uncertainties, such amounts would be classified as a component of interest expense and other income (expense), net, respectively. Deferred tax assets and liabilities are classified as noncurrent in the Company’s consolidated balance sheets.

 

The Company files a consolidated federal income tax return. This return includes all wholly-owned subsidiaries as well as the Company’s pro-rata share of taxable income from pass-through entities in which the Company owns less than 100%. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to the Company and its subsidiaries.

 

Income (Loss) Per Share – Basic income (loss) per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Preferred dividends are deducted from net income (loss) attributed to Pacific Ethanol, Inc. and are considered in the calculation of income (loss) available to common stockholders in computing basic income (loss) per share. Common stock equivalents to the preferred stock are considered participating securities and are also included in this calculation when dilutive.

 

 F-17

 

 

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables compute basic and diluted earnings per share (in thousands, except per share data):

 

   Year Ended December 31, 2017 
   Loss
Numerator
   Shares
Denominator
   Per-Share
Amount
 
Net loss attributed to Pacific Ethanol  $(34,964)          
Less: Preferred stock dividends   (1,265)          
Basic and Diluted loss per share:               
Loss available to common stockholders  $(36,229)   42,745   $(0.85)

 

   Year Ended December 31, 2016 
   Income
Numerator
   Shares
Denominator
   Per-Share
Amount
 
Net income attributed to Pacific Ethanol  $1,419           
Less: Preferred stock dividends   (1,269)          
Less: Allocated to participating securities   (2)          
Basic income per share:               
Income available to common stockholders  $148    42,182