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Pacific Ethanol 10-Q 2009
pacific_10q-093009.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended September 30, 2009
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from ______ to _______
 
Commission File Number:000-21467
 
PACIFIC ETHANOL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction
of incorporation or organization)
41-2170618
(I.R.S. Employer
Identification No.)
   
400 Capitol Mall, Suite 2060, Sacramento, California
(Address of principal executive offices)
95814
(zip code)
 
(916) 403-2123
(Registrant’s telephone number, including area code)
 
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 x No o
 
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 during the preceding 12 months (or for such shorter periods that the registrant was required to submit and post such files).  Yes o No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
As of November 6, 2009, there were 57,636,828 shares of Pacific Ethanol, Inc. common stock, $0.001 par value per share, outstanding.
 



PART I
FINANCIAL INFORMATION
 
    Page
     
Item 1.
Financial Statements.
 
     
 
Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008
F-1
     
 
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited)
F-3
     
 
Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited)
F-4
     
 
Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited)
F-5
     
 
Notes to Consolidated Financial Statements (unaudited)
F-6
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
3
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
15
     
Item 4.
Controls and Procedures
17
     
Item 4T.
Controls and Procedures
18
     
 
PART II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings 18
     
Item 1A.
Risk Factors
20
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
21
     
Item 3.
Defaults Upon Senior Securities
21
     
Item 4.
Submission of Matters to a Vote of Security Holders
22
     
Item 5.
Other Information
22
     
Item 6.
Exhibits 24
     
  Signatures 25
     
Exhibits Filed with this Report
 
 
2

 

PART I - FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS.
 
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS
 
September 30,
2009
   
December 31,
2008
 
   
(unaudited)
    *  
Current Assets:
             
Cash and cash equivalents
  $ 11,336     $ 11,466  
Investments in marketable securities
    101       7,780  
Accounts receivable, net (net of allowance for doubtful accounts of $1,317 and $2,210, respectively)
    12,440       23,823  
Restricted cash
          2,520  
Inventories
    9,751       18,408  
Prepaid expenses
    1,126       2,279  
Prepaid inventory
    1,905       2,016  
Other current assets
    2,509       3,599  
Total current assets
    39,168       71,891  
                 
Property and equipment, net
    502,649       530,037  
                 
Other Assets:
               
Intangible assets, net
    5,275       5,630  
Other assets
    971       9,276  
Total other assets
    6,246       14,906  
                 
Total Assets
  $ 548,063     $ 616,834  
_______________
*   Amounts derived from the audited financial statements for the year ended December 31, 2008.
 
 
See accompanying notes to consolidated financial statements.
F-1

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

   
September 30,
   
December 31,
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
2009
   
2008
 
   
(unaudited)
      *  
Current Liabilities:
             
Accounts payable – trade
  $ 8,351     $ 14,034  
Accrued liabilities
    4,590       12,334  
Accounts payable and accrued liabilities – construction-related
    14,893       20,304  
Other liabilities – related parties
    5,098       608  
Current portion – long-term notes payable (including $33,500 and $31,500, respectively due to related parties)
    60,803       291,925  
Derivative instruments
    1,091       7,504  
Total current liabilities
    94,826       346,709  
                 
Notes payable, net of current portion
    15,652       14,432  
Other liabilities
    1,893       3,497  
                 
Liabilities subject to compromise (Note 9)
    250,259        
                 
Total Liabilities
    362,630       364,638  
                 
Commitments and Contingencies (Notes 1 and 10)
               
                 
Stockholders’ Equity:
               
Pacific Ethanol Inc. Stockholders’ Equity:
               
Preferred stock, $0.001 par value; 10,000,000 shares authorized; Series A: 7,000,000 shares authorized; 0 shares issued and outstanding as of September 30, 2009 and December 31, 2008; Series B: 3,000,000 shares authorized; 2,346,152 shares issued and outstanding as of September 30, 2009 and December 31, 2008
    2       2  
Common stock, $0.001 par value; 100,000,000 shares authorized; 57,644,585 and 57,750,319 shares issued and outstanding as of September 30, 2009 and December 31, 2008, respectively
    58       58  
Additional paid-in capital
    480,525       479,034  
Accumulated deficit
    (335,439 )     (269,721 )
Total Pacific Ethanol, Inc. Stockholders’ Equity
    145,146       209,373  
                 
Noncontrolling interest in variable interest entity
    40,287       42,823  
Total Stockholders’ Equity
    185,433       252,196  
                 
Total Liabilities and Stockholders’ Equity
  $ 548,063     $ 616,834  
_______________
*           Amounts derived from the audited financial statements for the year ended December 31, 2008.
 
 
See accompanying notes to consolidated financial statements.
F-2

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Net sales
  $ 71,889     $ 183,980     $ 228,685     $ 543,489  
Cost of goods sold
    76,420       204,265       252,123       547,673  
Gross loss
    (4,531 )     (20,285 )     (23,438 )     (4,184 )
Selling, general and administrative expenses
    3,215       6,731       17,143       24,275  
Impairment of asset group
    2,200       40,900       2,200       40,900  
Impairment of goodwill
                      87,047  
Loss from operations
    (9,946 )     (67,916 )     (42,781 )     (156,406 )
Other expense, net
    (1,510 )     (2,774 )     (13,215 )     (4,184 )
Loss before reorganization costs and provision for income taxes
    (11,456 )     (70,690 )     (55,996 )     (160,590 )
Reorganization costs
    401             9,863        
Provision for income taxes
                       
Net loss
    (11,857 )     (70,690 )     (65,859 )     (160,590 )
Net (income) loss attributed to noncontrolling interest in variable interest entity
    (150 )     1,523       2,536       47,939  
Net loss attributed to Pacific Ethanol, Inc.
  $ (12,007 )   $ (69,167 )   $ (63,323 )   $ (112,651 )
Preferred stock dividends
  $ (807 )   $ (807 )   $ (2,395 )   $ (3,296 )
Deemed dividend on preferred stock
                      (761 )
Loss available to common stockholders
  $ (12,814 )   $ (69,974 )   $ (65,718 )   $ (116,708 )
Net loss per share, basic and diluted
  $ (0.22 )   $ (1.23 )   $ (1.15 )   $ (2.44 )
Weighted-average shares outstanding, basic and diluted
    57,001       56,717       56,998       47,791  
 
 
See accompanying notes to consolidated financial statements.
F-3

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Net loss
  $ (11,857 )   $ (70,690 )   $ (65,859 )   $ (160,590 )
                                 
Other comprehensive income (loss), net of tax:
                               
                                 
Net change in the fair value of derivatives
          (626 )           2,854  
                                 
Comprehensive loss
  $ (11,857 )   $ (71,316 )   $ (65,859 )   $ (157,736 )
 
 
See accompanying notes to consolidated financial statements.
F-4

 
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
   
Nine Months Ended
September 30,
 
   
2009
   
2008
 
Operating Activities:
           
Net loss
  $ (65,859 )   $ (160,590 )
Adjustments to reconcile net loss to cash used in operating activities:
               
Non-cash reorganization costs:
               
Write off of unamortized deferred financing fees
    7,545        
Settlement of accrued liability
    (2,008 )      
Impairment of asset group
    2,200       40,900  
Impairment of goodwill
          87,047  
Depreciation and amortization of intangibles
    25,984       17,985  
Inventory valuation
    845       5,608  
Amortization of deferred financing fees
    1,058       1,489  
Non-cash compensation and consulting expense
    1,493       2,154  
(Gain) loss on derivatives
    (2,511 )     4,268  
Bad debt expense (recovery)
    (869 )     307  
Changes in operating assets and liabilities:
               
Accounts receivable
    12,252       (3,108 )
Restricted cash
    2,520       (3,296 )
Inventories
    7,812       (20,347 )
Prepaid expenses and other assets
    2,043       (4,631 )
Prepaid inventory
    111       635  
Accounts payable and accrued expenses
    (5,543 )     (6,153 )
Accounts payable, and accrued expenses-related party
    4,490       (688 )
Net cash used in operating activities
    (8,437 )     (38,420 )
                 
Investing Activities:
               
Additions to property and equipment
    (3,599 )     (139,335 )
Proceeds from sales of available-for-sale investments
    7,679       11,901  
Restricted cash designated for construction projects
          (8,076 )
Proceeds from sales of property and equipment
          206  
Net cash provided by (used in) investing activities
    4,080       (135,304 )
                 
Financing Activities:
               
Proceeds from borrowing under DIP Financing
    12,278        
Proceeds from related party borrowing
    2,000        
Proceeds from other borrowings
          126,609  
Net proceeds from issuance of preferred stock and warrants
          45,469  
Net proceeds from issuance of common stock and warrants
          26,847  
Principal payments paid on borrowings
    (10,051 )     (12,487 )
Cash paid for debt issuance costs
          (838 )
Preferred share dividends paid
          (2,489 )
Dividends paid to noncontrolling interests
          (1,115 )
Net cash provided by financing activities
    4,227       181,996  
                 
Net increase (decrease) in cash and cash equivalents
    (130 )     8,272  
Cash and cash equivalents at beginning of period
    11,466       5,707  
Cash and cash equivalents at end of period
  $ 11,336     $ 13,979  
                 
Supplemental Information:
               
Interest paid ($0 and $9,186 capitalized)
  $ 2,407     $ 13,677  
Non-Cash Financing and Investing activities:
               
Accrued additions to property and equipment
  $     $ 20,895  
Preferred stock dividend declared and unpaid
  $ 2,395     $ 807  
Deemed dividend on preferred stock
  $     $ 761  
 
 
See accompanying notes to consolidated financial statements.
F-5

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1.  ORGANIZATION AND BASIS OF PRESENTATION.
 
Organization and Business – The consolidated financial statements include the accounts of Pacific Ethanol, Inc., a Delaware corporation (“Parent”), and all of its wholly-owned subsidiaries, including Pacific Ethanol California, Inc., a California corporation, Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”) and the consolidated financial statements of Front Range Energy, LLC, a Colorado limited liability company (“Front Range”), a variable interest entity of which Pacific Ethanol, Inc. owns 42% (collectively, the “Company”).
 
The Company produces and sells ethanol and its co-products, including wet distillers grain (“WDG”), and provides transportation, storage and delivery of ethanol through third-party service providers in the Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and Washington. The Company sells ethanol to gasoline refining and distribution companies and WDG to dairy operators and animal feed distributors.
 
The Company’s four ethanol facilities, which produce its ethanol and co-products, are as follows:
 
Facility Name Facility Location
Date Operations
Began
Estimated Annual
Production Capacity
(gallons)
Current
Operating
Status
         
Stockton Stockton, CA September 2008 60,000,000 Idled
Magic Valley Burley, ID April 2008 60,000,000 Idled
Columbia Boardman, OR September 2007 40,000,000 Operating
Madera Madera, CA October 2006 40,000,000 Idled
 
In addition, the Company owns a 42% interest in Front Range, which owns a plant located in Windsor, Colorado, with annual production capacity of up to 50 million gallons.
 
FASB Codification – The Financial Accounting Standards Board (“FASB”) sets generally accepted accounting principles (“GAAP”) that the Company follows to ensure it has consistently reported its financial condition, results of operations and cash flows. Over the years, the FASB and other designated GAAP-setting bodies have issued standards in the form of FASB Statements, Interpretations, Staff Positions, EITF Consensuses and AICPA Statements of Position (“SOP”s), etc. Over the years, many of these standards have been interpreted and amended several times and in many forms.
 
The FASB recognized the complexity of its standard-setting process and embarked on a revised process which resulted in the FASB Accounting Standards Codification (“Codification” or “ASC”). To the Company, this means instead of following the guidance in SOP 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“SOP 90-7”) for its accounting and reporting of its restructuring under the protection of Chapter 11 of the U.S. Bankruptcy Code, it now follows the guidance in FASB ASC 852, Reorganizations. The Codification does not change how the Company accounts for its transactions or the nature of the related disclosures made. However, when referring to guidance issued by the FASB, the Company will now refer to sections in the ASC rather than SOP 90-7, for example. This change was made effective by the FASB for periods ending on or after September 15, 2009. As a result, the Company has updated its references in this Quarterly Report on Form 10-Q to reflect the guidance in the Codification.
 
F-6

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Chapter 11 Filings – On May 17, 2009, five indirect wholly-owned subsidiaries of the Company, namely, Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC and Pacific Ethanol Magic Valley, LLC (collectively, the “Bankrupt Debtors”) each commenced a case by filing voluntary petitions for relief under chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) in an effort to restructure their indebtedness (“Chapter 11 Filings”).
 
Neither Parent nor any of its other direct or indirect subsidiaries, including Kinergy and Pacific Ag. Products, LLC (“PAP”), have filed petitions for relief under the Bankruptcy Code. The Bankrupt Debtors may not be able to confirm a plan of reorganization, and the Company may not be able to restructure its debt and raise sufficient capital in a timely manner, and therefore may need to seek further protection under the U.S. Bankruptcy Code, including at the Parent level. See “Liquidity” immediately below. The Company continues to manage the Bankrupt Debtors pursuant to an asset management agreement and Kinergy and PAP continue to market and sell their ethanol and feed production pursuant to existing marketing agreements. The Bankrupt Debtors continue to operate their businesses as “debtors-in-possession” under jurisdiction of the Bankruptcy Court and in accordance with applicable provisions of the Bankruptcy Code and order of the Bankruptcy Court.
 
Liquidity – The Company’s financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At September 30, 2009, on a consolidated basis, the Company had an aggregate of $11.4 million in cash, cash equivalents and investments in marketable securities, which includes amounts that were held by the Bankrupt Debtors and other consolidated entities. Of this amount, approximately $2.3 million was unrestricted and available to the Parent for its operations and obligations. The Company has suspended operations at three of its four wholly-owned ethanol production facilities due to market conditions and in an effort to conserve capital. The Company has also taken and expects to take additional steps to preserve capital and generate additional cash.
 
A payable in the amount of $1.9 million from a judgment arising out of litigation against the Company in 2008 is due on December 1, 2009. The Company does not believe that it will have sufficient funds to make this payment. As a result, the Company believes it has sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs through the end of November 2009. The Company is communicating with the judgment creditor in an attempt to defer the required $1.9 million payment. If the Company is able to defer the payment to the end of the first quarter of 2010, or later, the Company believes it will have sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs through the end of March 2010. The Company’s expectations above concerning its available liquidity through November 2009 and March 2010 presume that Lyles United, LLC and Lyles Mechanical Co. do not pursue any action against the Company due to its default on an aggregate of $31.5 million of indebtedness to those entities and that the Company maintains its current levels of borrowing availability under its Wachovia line of credit.
 
Although the Company is actively pursuing a number of alternatives, including seeking a confirmed plan of reorganization with respect to the Chapter 11 Filings, seeking to defer the $1.9 million payment owed to its judgment creditor, seeking to restructure its debt with Lyles United, LLC and Lyles Mechanical Co. and seeking to raise additional debt or equity financing, or both, there can be no assurance that it will be successful. If the Company cannot confirm a plan of reorganization with respect to the Chapter 11 Filings, defer the $1.9 million payment owed to the judgment creditor, restructure its debt and raise sufficient capital, in each case in a timely manner, it may need to seek further protection under the U.S. Bankruptcy Code, including at the parent-company level, which could occur prior to the end of the November 2009 and March 2010 periods anticipated above. In addition, the Company could be forced into bankruptcy or liquidation by its creditors, namely, the judgment creditor or Lyles United, LLC and Lyles Mechanical Co., or be forced to substantially restructure or alter its business operations or obligations.
 
F-7

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Subsequent to the Chapter 11 Filings, the Bankrupt Debtors initially obtained debtor-in-possession financing (“DIP Financing”) in the amount of up to $20,000,000 to fund working capital and general corporate needs, including the administrative costs of the Chapter 11 Filings. The DIP Financing provides the Bankrupt Debtors financing to reimburse Parent for certain direct and indirect costs in accordance with an asset management agreement. In October 2009, the DIP Financing amount was increased to $25,000,000 and the maturity date was extended to March 31, 2010, or sooner if certain covenants are not maintained. These covenants include various reporting requirements to the lenders, as well as confirmation of a plan of reorganization prior to the maturity date. The Company believes it is in compliance with the DIP Financing covenants. As of September 30, 2009, the Bankrupt Debtors have utilized $12,278,000 of the DIP Financing. The Company believes that the remaining undrawn amount of $12,722,000 will provide enough cash to allow the Bankrupt Debtors to obtain a confirmed plan of reorganization with their secured and unsecured creditors through the maturity date.
 
The Bankrupt Debtors are in default under their construction-related term loans and working capital lines of credit in the aggregate amount of $246,483,000. In addition, Parent is in default under its aggregate $31,500,000 notes payable to Lyles United, LLC and Lyles Mechanical Co. In February 2009, the Company entered into forbearance agreements with each of these lenders, which were amended in March 2009, under which the lenders agreed to forbear from exercising their rights until April 30, 2009 absent further defaults. These forbearances have not been extended.
 
Kinergy has renegotiated and amended its credit facility with Wachovia. Wachovia has agreed to continue providing up to $10,000,000 for Kinergy’s working capital needs. The term of the amended credit facility extends through October 2010. In addition, the amended credit facility required that Parent obtain certain additional financing by May 31, 2009, a date that was chosen based on the Company’s then foreseeable cash needs. This additional financing was not obtained. In addition, Kinergy must meet certain monthly EBITDA amounts. Kinergy did not meet the required EBITDA amount for the month ended August 31, 2009 but did meet the required EBITDA amount for the month ended September 30, 2009. In November 2009, Wachovia amended the credit facility which removed the additional financing requirement, waived the August 31, 2009 covenant violation and revised the EBITDA calculations for the remainder of 2009. Consequently, the Company believes that Kinergy is in compliance with the Wachovia facility.
 
Except as to the Chapter 11 Filings, the consolidated financial statements do not include any other adjustments that might result from the outcome of these matters.
 
Accounting and Reporting under Chapter 11 – In accordance with FASB ASC 852, Reorganizations, companies operating under the protection of chapter 11 of the Bankruptcy Code, generally do not change the manner in which their financial statements are prepared. However, among other disclosures, it does require that the financial statements for periods subsequent to the filing of the chapter 11 petition distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of the business must be reported separately as reorganization items in the statements of operations. The balance sheet must distinguish prepetition liabilities subject to compromise from both those prepetition liabilities that are not subject to compromise and from postpetition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, reorganization items must be disclosed separately in the statement of cash flows. The Company has applied the provisions of FASB ASC 852 to the Chapter 11 Filings for only the affected Bankrupt Debtors.
 
F-8

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Contractual interest expense represents amounts due under the contractual terms of outstanding debt, including liabilities subject to compromise for which interest expense is not recognized in accordance with the provisions of FASB ASC 852. The Bankrupt Debtors did not record contractual interest expense on certain unsecured prepetition debt subject to compromise from the bankruptcy filing date. The Bankrupt Debtors are however, accruing interest on their DIP Financing and related Rollup Debt as these amounts are likely to be paid in full upon confirmation of a plan of reorganization. For the three and nine months ended September 30, 2009, the Bankrupt Debtors recorded interest expense of approximately $673,000 and $10,648,000, respectively. Had the Bankrupt Debtors accrued interest on all of their liabilities subject to compromise from May 17, 2009 through September 30, 2009, the Bankrupt Debtors’ interest expense for the three and nine months ended September 30, 2009 would have been approximately $7,988,000 and $20,969,000, respectively.
 
Deferred financing fees are typically amortized on a straight-line basis until the date that the debt is due and payable either because of a stated maturity date or full payment of debt. In accordance with FASB ASC 852, upon the Chapter 11 Filings, the Bankrupt Debtors wrote off approximately $7,545,000 of their unamortized deferred financing fees related to their term loans and working capital lines of credit, which are reclassified as liabilities subject to compromise in the Company’s consolidated balance sheet as of September 30, 2009.
 
Basis of PresentationInterim Financial Statements – The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Results for interim periods should not be considered indicative of results for a full year. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Except as discussed above and in Note 2 below, the accounting policies used in preparing these consolidated financial statements are the same as those described in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required as part of determining allowance for doubtful accounts, estimated lives of property and equipment and intangibles, long-lived asset impairments, valuation allowances on deferred income taxes, and the potential outcome of future tax consequences of events recognized in the Company’s financial statements or tax returns. Actual results and outcomes may materially differ from management’s estimates and assumptions.
 
Reclassifications of prior year’s data have been made to conform to 2009 classifications. Such classifications had no effect on net loss reported in the consolidated statements of operations.
 
F-9

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
2.  NEW ACCOUNTING STANDARDS.
 
On June 12, 2009, the FASB amended its guidance to FASB ASC 810, Consolidations, surrounding a company’s analysis to determine whether any of its variable interest entities constitute controlling financial interests in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new guidance also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. The guidance is effective for the first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company will adopt these provisions beginning on January 1, 2010. The Company is currently evaluating whether this guidance will have a material effect on its financial condition or results of operations.
 
On May 28, 2009, the FASB issued FASB ASC 855, Subsequent Events, which provides guidance on management’s assessment of subsequent events. Historically, management had relied on U.S. auditing literature for guidance on assessing and disclosing subsequent events. FASB ASC 855 represents the inclusion of guidance on subsequent events in the accounting literature and is directed specifically to management, since management is responsible for preparing an entity’s financial statements. The guidance clarifies that management must evaluate, as of each reporting period, events or transactions that occur after the balance sheet date through the date that the financial statements are issued. The guidance is effective prospectively for interim and annual financial periods ending after June 15, 2009. The Company adopted the provisions of FASB ASC 855 for its reporting period ending June 30, 2009 and its adoption did not have a material impact on the Company’s financial condition or results of operations. The Company has evaluated subsequent events up through the date of the filing of this report with the Securities and Exchange Commission.
 
On January 1, 2009, the Company adopted the provisions of FASB ASC 810, Consolidations, which amended existing guidance that changed the Company’s classification and reporting for its noncontrolling interests in its variable interest entity to a component of stockholders’ equity and other changes to the format of its financial statements. Except for these changes in classification, the adoption of FASB ASC 810 did not have a material impact on the Company’s financial condition or results of operations.
 
On January 1, 2009, the Company adopted certain provisions of FASB ASC 815, Derivatives and Hedging, which changed the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB ASC 815 and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The adoption of these amended provisions resulted in enhanced disclosures and did not have any impact on the Company’s financial condition or results of operations. (See Note 7.)
 
On January 1, 2009, the Company adopted the provisions of FASB ASC 815-40, Derivatives and Hedging, which mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock. The adoption of these provisions did not have a material impact on the Company’s financial condition or results of operations.
 
F-10

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
On January 1, 2009, the Company adopted certain provisions of FASB ASC 805, Business Combinations, which amended certain of its previous provisions. These amendments provide additional guidance that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. The guidance requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. In addition, the guidance requires acquisition costs and restructuring costs that the acquirer expected but was not obligated to incur to be recognized separately from the business combination, therefore, expensed instead of part of the purchase price allocation. These amended provisions will be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The adoption of these provisions did not have a material impact on the Company’s financial condition or results of operations.
 
3.  REORGANIZATION COSTS.
 
In accordance with FASB ASC 852, revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of the business must be reported separately as reorganization items in the statements of operations. During the three months ended September 30, 2009, the Bankrupt Debtors settled a prepetition accrued liability with a vendor, resulting in a realized gain. Professional fees directly related to the reorganization include fees associated with advisors to the Bankrupt Debtors, unsecured creditors, secured creditors and administrative costs in complying with reporting rules under the Bankruptcy Code. As discussed in Note 1, the Company wrote off a portion of its unamortized deferred financing fees on the debt which is considered to be unlikely to be repaid by the Bankrupt Debtors.
 
The Bankrupt Debtors’ reorganization costs for the three and nine months ended September 30, 2009 consist of the following (in thousands):

   
Three Months Ended
September 30, 2009
   
Nine Months Ended
September 30, 2009
 
             
Write-off of unamortized deferred financing fees
  $     $ 7,545  
Settlement of accrued liability
    (2,008 )     (2,008 )
Professional fees
    2,363       3,648  
DIP financing fees
          600  
Trustee fees
    46       78  
Total
  $ 401     $ 9,863  
 
4.  MARKETABLE SECURITIES.
 
The Company’s marketable securities consisted of short-term marketable securities with carrying values of $101,000 and $7,780,000 as of September 30, 2009 and December 31, 2008, respectively. As of September 30, 2009 and December 31, 2008, there were no gross unrealized gains or losses for these securities.
 
5.  INVENTORIES.
 
Inventories consisted primarily of bulk ethanol, unleaded fuel and corn, and are valued at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis. Inventory balances consisted of the following (in thousands):

   
September 30, 2009
   
December 31, 2008
 
Raw materials
  $ 3,777     $ 9,000  
Work in progress
    1,146       1,895  
Finished goods
    3,377       5,994  
Other
    1,451       1,519  
Total
  $ 9,751     $ 18,408  
 
F-11

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
6.  PROPERTY AND EQUIPMENT.
 
The ethanol industry has experienced significant adverse conditions over the course of the last 12-18 months, including prolonged negative operating margins. The Company has also experienced these adverse conditions as well as severe working capital and liquidity shortages, and in response to such conditions, the Company has reduced its production significantly until market conditions resume to acceptable levels and working capital becomes available. The Company first reduced production in December 2008 and continued to reduce production through the first quarter of 2009. As of the end of February 2009, the Company had ceased production at its Madera, Magic Valley and Stockton facilities. The Company continues to operate its Columbia facility and, indirectly, the Front Range facility. The Company continues to assess market conditions and when appropriate, provided it has adequate available working capital, plans to bring these facilities back to operation.
 
In 2008, the Company completed construction of its ethanol production facilities, with installed capacity of 220 million gallons per year. The carrying value of these facilities at September 30, 2009 was approximately $413.7 million. In accordance with the Company’s policy for evaluating impairment of long-lived assets in accordance with FASB ASC 360, Property, Plant and Equipment, management has evaluated the facilities for possible impairment based on projected future cash flows from operations of these facilities, including the above mentioned suspensions of its facilities in the near term. Management has determined that the undiscounted cash flows from operations of these facilities over their estimated useful lives exceed their carrying values, and therefore, no impairment has been recognized at September 30, 2009. In determining future undiscounted cash flows, the Company has made significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. If the Company were required to compute the fair value in the future, it may use the work of a qualified valuation specialist who would assist in examining replacement costs, recent transactions between third parties and cash flow that can be generated from operations. Since the completion of the last of the facilities occurred in the past year, replacement costs would likely approximate the carrying values of the facilities. However, there have been recent transactions between independent parties to purchase plants at prices substantially below the carrying value of the facilities. Some of the facilities have been in bankruptcy and may not be representative of transactions outside of bankruptcy. Given these circumstances, should management be required to adjust the carrying value of the facilities to fair value at some future point in time, the adjustment could be significant and could significantly impact the Company’s financial position and results of operation. No adjustment has been made in these financial statements for this uncertainty.
 
In 2008, the Company performed its impairment analysis for the asset group associated with its suspended plant construction project in the Imperial Valley near Calipatria, California (“Imperial Project”). In November 2008, the Company began proceedings to liquidate these assets and liabilities. Based on the Company’s original assessment of the estimated undiscounted cash flows, the Company recorded an impairment charge of $40,900,000, thereby reducing its property and equipment by that amount. At September 30, 2009, the Company revised its assessment of the estimated undiscounted cash flows which resulted in an additional impairment charge of $2,200,000. To the extent the Company is relieved of the related liabilities, the Company may record a gain in the period in which the relief occurs.
 
7.  DERIVATIVES.
 
The business and activities of the Company expose it to a variety of market risks, including risks related to changes in commodity prices and interest rates. The Company monitors and manages these financial exposures as an integral part of its risk management program. This program recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effects that market volatility could have on operating results. The Company accounts for its use of derivatives related to its hedging activities pursuant to FASB ASC 815, Derivatives and Hedging, under which the Company recognizes all of its derivative instruments in its balance sheet as either assets or liabilities, depending on the rights or obligations under the contracts, unless the contracts qualify as a normal purchase or normal sale. Derivative instruments are measured at fair value. Changes in the derivative’s fair value are recognized currently in income unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s effective gains and losses to be deferred in accumulated other comprehensive income and later recorded together with the gains and losses to offset related results on the hedged item in income. Companies must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
 
F-12

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Commodity RiskCash Flow Hedges – The Company uses derivative instruments to protect cash flows from fluctuations caused by volatility in commodity prices in order to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sale and purchase commitments where the prices are set at a future date and/or if the contracts specify a floating or index-based price for ethanol. In addition, the Company hedges anticipated sales of ethanol to minimize its exposure to the potentially adverse effects of price volatility. These derivatives are designated and documented as cash flow hedges and effectiveness is evaluated by assessing the probability of the anticipated transactions and regressing commodity futures prices against the Company’s purchase and sales prices. Ineffectiveness, which is defined as the degree to which the derivative does not offset the underlying exposure, is recognized immediately in cost of goods sold.
 
For the three months ended September 30, 2009 and 2008, gains from effectiveness in the amount of $1,000 and $0, respectively, were recorded in cost of goods sold. For the nine months ended September 30, 2009 and 2008, losses from effectiveness in the amount of $113,000 and gains of $5,277,000, respectively, were recorded in cost of goods sold. For the three months ended September 30, 2009 and 2008, there were no gains or losses from ineffectiveness. For the nine months ended September 30, 2009 and 2008, losses from ineffectiveness in the amount of $85,000 and $1,033,000, respectively, were recorded in cost of goods sold. There were no notional balances remaining on these derivatives as of September 30, 2009 and December 31, 2008.
 
Commodity Risk – Non-Designated Hedges – As part of the Company’s risk management strategy, it uses forward contracts on corn, crude oil and reformulated blendstock for oxygenate blending gasoline to lock in prices for certain amounts of corn, denaturant and ethanol, respectively. These derivatives are not designated under FASB ASC 815, for special hedge accounting treatment. The changes in fair value of these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold. For the three months ended September 30, 2009 and 2008, the Company recognized losses of $154,000 and $1,681,000, respectively, and for the nine months ended September 30, 2009 and 2008, the Company recognized losses of $19,000 and $4,614,000, respectively, as the change in the fair value of these contracts. The notional balances remaining on these contracts as of September 30, 2009 and December 31, 2008 were $569,000 and $4,215,000, respectively.
 
Interest Rate Risk – As part of the Company’s interest rate risk management strategy, the Company uses derivative instruments to minimize significant unanticipated income fluctuations that may arise from rising variable interest rate costs associated with existing and anticipated borrowings. To meet these objectives the Company purchased interest rate caps and swaps. The rate for notional balances of interest rate caps ranging from $4,268,000 to $16,821,000 is 5.50%-6.00% per annum. The rate for notional balances of interest rate swaps ranging from $543,000 to $38,000,000 is 5.01%-8.16% per annum.
 
These derivatives are designated and documented as cash flow hedges and effectiveness is evaluated by assessing the probability of anticipated interest expense and regressing the historical value of the rates against the historical value in the existing and anticipated debt. Ineffectiveness, reflecting the degree to which the derivative does not offset the underlying exposure, is recognized immediately in other income (expense). For the three months ended September 30, 2009 and 2008, losses from effectiveness in the amount of $0 and $26,000, gains from ineffectiveness in the amount of $0 and $723,000 and gains of $447,000 and losses of $38,000 from undesignated hedges, respectively, were recorded in other expense. For the nine months ended September 30, 2009 and 2008, losses from effectiveness in the amount of $0 and $77,000, gains from ineffectiveness in the amount of $0 and $905,000 and gains of $1,920,000 and losses of $4,187,000 from undesignated hedges, respectively, were recorded in other expense.
 
F-13

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The classification and amounts of the Company’s derivatives not designated as hedging instruments are as follows (in thousands):
 
    As of September 30, 2009  
    Assets   Liabilities  
Type of Instrument   Balance Sheet Location   Fair Value   Balance Sheet Location   Fair Value  
                       
Interest rate contracts   Other current assets   $ 28   Derivative instruments   $ 1,091  
Commodity contract   Other current assets     83   Liabilities subject to compromise     3,561  
        $ 111       $ 4,652  
 
The classification and amounts of the Company’s recognized gains (losses) for its derivatives not designated as hedging instruments are as follow (in thousands):
 
        Gain (Loss) Recognized  
       
For the Three Months
Ended September 30,
   
For the Nine Months
Ended September 30,
 
Type of Instrument   Statement of Operations Location   2009     2008     2009     2008  
Interest rate contracts   Other expense, net   $ 447     $ 659     $ 1,920     $ (3,359 )
 
The gains for the three and nine months ended September 30, 2009 resulted primarily from the Company’s efforts to restructure its debt financing and, therefore, making it not probable that the related borrowings would be paid as designated. As such the Company de-designated certain of its interest rate caps and swaps. The losses for the nine months ended September 30, 2008 resulted primarily from the Company’s deferral of constructing its Imperial Valley facility.
 
F-14

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
8.  DEBT.
 
Long-term borrowings are summarized in the table below (in thousands):

   
September 30, 2009
   
December 31, 2008
 
Notes payable to related party
  $ 31,500     $ 31,500  
DIP Financing
    24,556        
Notes payable to related parties
    2,000        
Kinergy operating line of credit
    2,493       10,482  
Swap note
    13,876       14,987  
Variable rate note
          582  
Front Range operating line of credit
    1,000       1,200  
Water rights capital lease obligations
    1,030       1,123  
Term loans and working capital lines of credit
          246,483  
      76,455       306,357  
Less short-term portion
    (60,803 )     (291,925 )
Long-term debt
  $ 15,652     $ 14,432  
 
Notes Payable to Related Party – The Company has certain notes payable in favor of Lyles United, LLC and Lyles Mechanical Co. (collectively, “Lyles”) in the amounts of $30,000,000 and $1,500,000, which were due March 15, 2009 and March 31, 2009, respectively. In February 2009, the Company notified Lyles that it would not be able to pay these notes and entered into a forbearance agreement with Lyles. Under the terms of the forbearance agreement, Lyles agreed to forbear from exercising its rights and remedies against the Company through April 30, 2009. These forbearances have not been extended.
 
DIP Financing – Certain of the Bankrupt Debtors’ existing lenders (the “DIP Lenders”) entered into a credit agreement for up to a total of $20,000,000 (“DIP Financing”), not including the DIP Rollup (as defined below) amount. In October 2009, the DIP Financing amount was increased to a total of $25,000,000. The DIP Financing was initially approved by the Bankruptcy Court on June 3, 2009, and the Bankruptcy Court approved the October 2009 increase on October 23, 2009. The DIP Financing provides for a first priority lien in the Chapter 11 Filings. Proceeds of the DIP Financing will be used, among other things, to fund the working capital and general corporate needs of the Company and the costs of the Chapter 11 Filings in accordance with an approved budget. The DIP Financing matures on March 31, 2010, or sooner if certain covenants are not maintained. These covenants include various reporting requirements to the DIP Lenders, as well as confirmation of a plan of reorganization prior to the maturity date. The Company believes it is in compliance with the DIP Financing covenants. The DIP Financing allows the DIP Lenders a first priority lien on a dollar-for-dollar basis of their term loans and working capital lines of credit funded prior to the Chapter 11 Filings for each dollar of DIP Financing. As the Bankrupt Debtors draw down on their DIP Financing, an equivalent amount is reclassified from “Liabilities subject to compromise” to “DIP financing” (the “DIP Rollup”). As of September 30, 2009, the Bankrupt Debtors have received proceeds in the amount of $12,278,000 from the DIP Financing. After accounting for the DIP Rollup, the DIP Financing has a total balance of $24,556,000. The interest rate at September 30, 2009, was approximately 14% per annum.
 
Notes Payable to Related Parties – On March 31, 2009, the Company’s Chairman of the Board and its Chief Executive Officer provided funds totaling $2,000,000 for general cash and operating purposes, in exchange for two unsecured notes payable from the Company. Interest on the unpaid principal amount accrues at a rate per annum of 8.00%. All principal and accrued and unpaid interest on the notes is due and payable on March 31, 2010.
 
F-15

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Kinergy Operating Line of Credit – In February 2009, Kinergy determined it had violated certain of its covenants, including its EBITDA covenant for 2008 in its operating line of credit of up to $40,000,000 (“Line of Credit”), and as a result, entered into an amendment and forbearance agreement (“Forbearance Agreement”) which was extended in March 2009 with its lender. The Forbearance Agreement identified certain defaults under the Line of Credit, as to which Kinergy’s lender agreed to forebear from exercising its rights and remedies under the Line of Credit commencing February 13, 2009 through April 30, 2009. The Forbearance Agreement reduced the aggregate amount of the credit facility from up to $40,000,000 to $10,000,000.
 
The Forbearance Agreement also increased the applicable interest rates. Kinergy may borrow under the Line of Credit based upon (i) a rate equal to (a) the London Interbank Offered Rate (“LIBOR”), divided by 0.90 (subject to change based upon the reserve percentage in effect from time to time under Regulation D of the Board of Governors of the Federal Reserve System), plus (b) 4.50% depending on the amount of Kinergy’s EBITDA for a specified period, or (ii) a rate equal to (a) the greater of the prime rate published by Wachovia Bank from time to time, or the federal funds rate then in effect plus 0.50%, plus (b) 2.25% depending on the amount of Kinergy’s EBITDA for a specified period. Kinergy’s obligations under the Line of Credit are secured by a first-priority security interest in all of its assets in favor of its lender.
 
On May 17, 2009, Kinergy and the Company entered into an Amendment and Waiver Agreement (“Amendment”) with Kinergy’s lender. Under the Amendment, Kinergy’s monthly unused line fee increased from 0.375% to 0.500% of the amount by which the maximum credit under the Line of Credit exceeds the average daily principal balance. In addition, the Amendment imposed a new $5,000 monthly servicing fee. The Amendment also limited most payments that may be made by Kinergy to the Company as reimbursement for management and other services provided by the Company to Kinergy to $600,000 in any three month period and $2,400,000 in any twelve month period. The Amendment amends the definition of “Material Adverse Effect” to exclude the Chapter 11 Filings and certain other matters and clarifies that certain events of default do not extend to the Bankrupt Debtors. However, the Amendment further made many events of default that previously were applicable only to Kinergy now applicable to the Company and its subsidiaries except for certain specified subsidiaries including the Bankrupt Debtors. Under the Amendment, the term of the Line of Credit was reduced from three years to a term expiring on October 31, 2010. The Amendment also removed the early termination fee that would be payable in the event Kinergy terminated the Line of Credit prior to the conclusion of the term. In addition, the Amendment amended and restated Kinergy’s EBITDA covenants. The Amendment also prohibited Kinergy from incurring any additional indebtedness (other than certain intercompany indebtedness) or making any capital expenditures in excess of $100,000 absent the lender’s prior consent. Further, under the Amendment, the lender waived all existing defaults under the Line of Credit. Kinergy was required to pay an amendment fee of $200,000 to the lender.
 
The Amendment also required that, on or before May 31, 2009, the lender shall have received copies of financing agreements, in form and substance reasonably satisfactory to the lender, among the Company and certain of its subsidiaries and Lyles United, LLC, which agreements shall provide, among other things, for (i) a credit facility available to the Company of up to $2,500,000 over a term of eighteen months (or such shorter term but in no event prior to the maturity date of the Loan Agreement), (ii) the grant by the Company to Lyles United, LLC of a security interest in substantially all of the Company’s assets, including a pledge by the Company to Lyles United, LLC of the equity interest of the Company in Kinergy, and (iii) the use by the Company of borrowings thereunder for general corporate and other purposes in accordance with the terms thereof. As of September 30, 2009, the Company had not obtained the aforementioned financing with Lyles United, LLC. In addition, Kinergy did not meet the required EBITDA amount for the month ended August 31, 2009, but did meet the required EBITDA amount for the month ended September 30, 2009. In November 2009, Kinergy obtained an amendment from its lender, which removed the aforementioned financing requirement, waived the August 31, 2009 covenant violation and revised the EBITDA calculations for the remainder of 2009. Consequently, the Company believes that Kinergy is in compliance with the credit facility.
 
F-16

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Swap Note – Front Range is subject to certain loan covenants under the terms of its Swap Note. Under these covenants, Front Range was required to maintain, on a quarterly basis, a certain fixed-charge coverage ratio, a minimum level of working capital and a minimum level of net worth. The covenants also set a maximum amount of additional debt that may be incurred by Front Range. The covenants also limit annual distributions that may be made to owners of Front Range, including the Company, based on Front Range’s leverage ratio. As of December 31, 2008 and March 31, 2009, Front Range was out of compliance with certain of its covenants and has since obtained a waiver from its lender. Under the terms of the waiver, the lender changed the covenant to an annual calculation from a quarterly calculation. Further, the available long term revolving note was reduced from $5,000,000 to $2,500,000, with an August 10, 2011 maturity date. The interest rate was adjusted to the greater of 5% or the 30 day LIBOR rate plus 3.25%-4.00% depending on Front Range’s debt-to-net worth ratio. As of September 30, 2009, the Company believes it is in compliance with its revised covenants with its lender.
 
Term Loans & Working Capital Lines of Credit – In connection with financing the Company’s construction of its four ethanol production facilities, in 2007, the Company entered into a debt financing transaction through its wholly-owned indirect subsidiaries. These subsidiaries are now the Bankrupt Debtors and these loans are discussed in more detail in Note 9.
 
9.  LIABILITIES SUBJECT TO COMPROMISE.
 
Liabilities subject to compromise refers to prepetition obligations which may be impacted by the Chapter 11 Filings. These amounts represent the Company’s current estimate of known or potential prepetition obligations to be resolved in connection with the Chapter 11 Filings.
 
Differences between liabilities estimated and the claims filed, or to be filed, will be investigated and resolved in connection with the claims resolution process. The Company will continue to evaluate these liabilities during the Chapter 11 Filings and adjust amounts as necessary.
 
Liabilities subject to compromise are as follows (in thousands):

   
September 30, 2009
 
Term loans
  $ 216,435  
Working capital lines of credit
    17,770  
Accounts payable trade and accrued expenses
    12,493  
Derivative instruments – interest rate swaps
    3,561  
Total liabilities subject to compromise
  $ 250,259  
 
Term Loans & Working Capital Lines of Credit – In connection with financing the Company’s construction of its four ethanol production facilities, in 2007, the Company entered into a debt financing transaction (the “Debt Financing”) in the aggregate amount of up to $250,769,000 through its wholly-owned indirect subsidiaries. These subsidiaries are now the Bankrupt Debtors. The Debt Financing included four term loans and four working capital lines of credit. In addition, the subsidiaries utilized approximately $825,000 of the working capital and letter of credit facility to obtain a letter of credit, which was also outstanding at September 30, 2009 and December 31, 2008. The obligations under the Debt Financing are secured by a first-priority security interest in all of the equity interests in the subsidiaries and substantially all their assets. The Chapter 11 Filings constituted an event of default under the Debt Financing. Under the terms of the Debt Financing, upon the Chapter 11 Filings, the outstanding principal amount of, and accrued interest on, the amounts owed in respect of the Debt Financing became immediately due and payable.
 
As discussed above in Note 8, the DIP Lenders provided DIP Financing for up to a total of $25,000,000. The DIP Financing has been approved by the Bankruptcy Court and provides for a first priority lien in the Chapter 11 Filings. The DIP Financing also allows the DIP Lenders a first priority lien on a dollar-for-dollar basis of their term loans and working capital lines of credit funded prior to the Chapter 11 Filings for each dollar of DIP Financing. As the Bankrupt Debtors draw down on their DIP Financing, an equivalent amount is reclassified from “Liabilities subject to compromise” to “DIP financing.” As of September 30, 2009, the Bankrupt Debtors have received funds in the amount of $12,278,000 from the DIP Financing, therefore reducing an equal amount owed under the Debt Financing that has been reclassified and reported as DIP Financing.
 
F-17

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
10.  COMMITMENTS AND CONTINGENCIES.
 
Purchase Commitments – At September 30, 2009, the Company had purchase contracts with its suppliers to purchase certain quantities of ethanol, corn and denaturant. These fixed- and indexed-price commitments will be delivered throughout the remainder of 2009. Outstanding balances on fixed-price contracts for the purchases of materials are indicated below and volumes indicated in the indexed-price portion of the table are additional purchase commitments at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

   
Fixed-Price Contracts
 
Ethanol
  $ 4,878  
Corn
    5,406  
Denaturant
    91  
Total
  $ 10,375  

   
Indexed-Price Contracts
(Volume)
 
Ethanol (gallons)
    30,898  
Corn (bushels)
    4,970  
 
Sales Commitments – At September 30, 2009, the Company had entered into sales contracts with its major customers to sell certain quantities of ethanol, WDG and syrup. The volumes indicated in the indexed price contracts table will be sold at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

   
Fixed-Price Contracts
 
Ethanol
  $ 1,644  
WDG
    2,751  
Syrup
    242  
Total
  $ 4,637  

   
Indexed-Price Contracts
(Volume)
 
Ethanol (gallons)
    34,157  
 
Litigation – General The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect the Company’s quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes that such matters will not adversely affect the Company’s financial position, results of operations or cash flows.
 
F-18

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Litigation – Western Ethanol Company – On January 9, 2009, Western Ethanol Company, LLC (“Western Ethanol”) filed a complaint in the Superior Court of the State of California (the “Superior Court”) naming Kinergy as defendant. In the complaint, Western Ethanol alleges that Kinergy breached an alleged agreement to buy and accept delivery of a fixed amount of ethanol. On January 12, 2009, Western Ethanol filed an application for issuance of right to attach order and order for issuance of writ of attachment. On February 10, 2009, the Superior Court granted the right to attach order and order for issuance of writ of attachment against Kinergy in the amount of approximately $3,700,000. On February 11, 2009, Kinergy filed an answer to the complaint. On May 14, 2009, Kinergy entered into an Agreement with Western Ethanol under which Western Ethanol agreed to terminate all notices, writs of attachment issued to the Sheriff of any county other than Contra Costa County, and all notices of levy, liens, and similar claims or actions except as to a levy against a specified Kinergy receivable in the amount of $1,350,000. Kinergy agreed to have the $1,350,000 receivable paid over to the Contra Costa County Sheriff in compliance with and in satisfaction of the levy on the receivable to be held pending final outcome of the litigation. In September 2009, the Company entered into a confidential settlement agreement with Western Ethanol, under which the Company paid an amount less than $1,350,000 and received payment on the balance of the $1,350,000 receivable.
 
Litigation – Barry Spiegel – On December 22, 2005, Barry J. Spiegel, a former shareholder and director of Accessity, filed a complaint in the Circuit Court of the 17th Judicial District in and for Broward County, Florida (Case No. 05018512) (the “State Court Action”) against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce Udell (collectively, the “Individual Defendants”). Messrs. Udell and Friedman are former directors of Accessity and Pacific Ethanol. Mr. Kart is a former executive officer of Accessity and Pacific Ethanol. Mr. Siegel was a former director and executive officer of Accessity and Pacific Ethanol.
 
The State Court Action relates to the Share Exchange Transaction and purports to state the following five counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the Florida Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his Accessity common stock to diminish and is seeking approximately $22.0 million in damages. On March 8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his response in opposition on May 30, 2006. The Court granted the motion to dismiss by Order dated December 1, 2006, on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a derivative action.
 
On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The amended complaint included Pacific Ethanol as a defendant. On March 30, 2007, Pacific Ethanol filed a motion to dismiss the amended complaint. Before the Court could decide that motion, on June 4, 2007, Mr. Spiegel amended his complaint, which purports to state two counts: (i) breach of fiduciary duty and (ii) fraudulent inducement. The first count is alleged against the Individual Defendants and the second count is alleged against the Individual Defendants and Pacific Ethanol. The amended complaint was, however, voluntarily dismissed on August 27, 2007, by Mr. Spiegel as to Pacific Ethanol. In March 2009, Mr. Spiegel sought and obtained leave to file another amended complaint which renewed his case against Pacific Ethanol, and the amended pleading named three additional individual defendants, and asserted the following three counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, and (iii) aiding and abetting breach of fiduciary duty. The first two counts are alleged against the Individual Defendants. With respect to the third count, the pleading alleged claims a claim against Pacific Ethanol California, Inc. (formerly known as Pacific Ethanol, Inc.), as well as against individual William Jones, Neil Koehler and Ryan Turner. Messrs. Jones, Koehler and Turner are current and former officers and directors of Pacific Ethanol. The Court, however, dismissed the claims for aiding and abetting a breach of fiduciary duty brought against Messrs. Jones, Koehler and Turner and Pacific Ethanol California with leave to Mr. Spiegel to file an amended claim by no later than November 2, 2009.
 
F-19

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Litigation – Delta-T Corporation – On August 18, 2008, Delta-T Corporation filed suit in the United States District Court for the Eastern District of Virginia (the “Virginia Federal Court case”), naming Pacific Ethanol, Inc. as a defendant, along with its subsidiaries Pacific Ethanol Stockton, LLC, Pacific Ethanol Imperial, LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Magic Valley, LLC and Pacific Ethanol Madera, LLC. The suit alleges breaches of the parties’ Engineering, Procurement and Technology License Agreements, breaches of a subsequent term sheet and letter agreement and breaches of indemnity obligations. The complaint seeks specified contract damages of approximately $6.5 million, along with other unspecified damages. All of the defendants moved to dismiss the Virginia Federal Court case for lack of personal jurisdiction and on the ground that all disputes between the parties must be resolved through binding arbitration, and, in the alternative, moving to stay the Virginia Federal Court Case pending arbitration. In January 2009, these motions were granted by the Court, compelling the case to arbitration with the American Arbitration Association (“AAA”). By letter dated June 10, 2009, the AAA notified the parties to the arbitration that the matter was automatically stayed as a result of the Chapter 11 Filings. Delta-T Corporation subsequently sought to continue the arbitration as to Pacific Ethanol, Inc.
 
On March 18, 2009 Delta-T Corporation filed a cross-complaint against Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC in the Superior Court of the State of California in and for the County of Imperial. The cross-complaint arises out of a suit by OneSource Distributors, LLC against Delta-T Corporation. On March 31, 2009, Delta-T Corporation and Bateman Litwin N.V, a foreign corporation, filed a third-party complaint in the United States District Court for the District of Minnesota naming Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC as defendants. The third-party complaint arises out of a suit by Campbell-Sevey, Inc. against Delta-T Corporation. On April 6, 2009 Delta-T Corporation filed a cross-complaint against Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC in the Superior Court of the State of California in and for the County of Imperial. The cross-complaint arises out of a suit by GEA Westfalia Separator, Inc. against Delta-T Corporation. Each of these actions allegedly relate to the aforementioned Engineering, Procurement and Technology License Agreements and Delta-T Corporation’s performance of services thereunder. The third-party suit and the cross-complaints assert many of the factual allegations in the Virginia Federal Court case and seek unspecified damages.
 
In connection with the Chapter 11 Filings, the Bankrupt Debtors moved the United States Bankruptcy Court for the District of Delaware to enter a preliminary injunction in favor of the Bankrupt Debtors and Parent staying and enjoining all of the aforementioned litigation and arbitration proceedings commenced by Delta-T Corporation. On August 6, 2009, the Delaware court ordered that the litigation and arbitration proceedings commenced by Delta-T Corporation be stayed and enjoined until September 21, 2009 or further order of the court, and that the Bankrupt Debtors, Parent and Delta-T Corporation complete mediation by September 20, 2009 for purposes of settling all disputes between the parties. Following a mediation, the parties reached an agreement pursuant to which a stipulated order was entered in the bankruptcy court on September 21, 2009, providing for a complete mutual release and settlement of any and all claims between Delta-T Corporation and the Bankrupt Debtors, a complete reservation of rights as between Parent and Delta-T Corporation, and a stay of all proceedings by Delta-T Corporation against Parent until December 31, 2009. As a result of the complete mutual release and settlement, the Company recorded a gain of approximately $2,008,000 in reorganization costs for the three months ended September 30, 2009. In the event Delta-T Corporation chooses to proceed with its remaining claims against Parent, the Company intends to continue to vigorously defend against Delta-T Corporation’s claims.
 
F-20

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
11.  FAIR VALUE MEASUREMENTS.
 
The fair value hierarchy established by FASB ASC 820, Fair Value Measurements and Disclosures, prioritizes the inputs used in valuation techniques into three levels as follows:
 
·
Level 1 – Observable inputs – unadjusted quoted prices in active markets for identical assets and liabilities;
 
·
Level 2 – Observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with market data; and
 
·
Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable.
 
In accordance with FASB ASC 820, the Company has classified its investments in marketable securities and derivative instruments into these levels depending on the inputs used to determine their fair values. The Company’s investments in marketable securities consist of money market funds which are based on quoted prices and are designated as Level 1. The Company’s derivative instruments consist of commodity positions and interest rate caps and swaps. The fair value of the interest rate caps and certain swaps are based on quoted prices on similar assets or liabilities in active markets and discounts to reflect potential credit risk to lenders and are designated as Level 2; and certain interest rate swaps are based on a combination of observable inputs and material unobservable inputs and are designated as Level 3.
 
The following table summarizes fair value measurements by level at September 30, 2009 (in thousands):

   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
Investments in marketable securities
  $ 101     $     $     $ 101  
Commodity derivative securities
    83           $       83  
Interest rate caps and swaps
          28             28  
Total assets
  $ 184     $ 28     $     $ 212  
 
                               
Liabilities:
                               
Interest rate caps and swaps
  $     $ 1,091     $ 3,561     $ 4,652  
Total liabilities
  $     $ 1,091     $ 3,561     $ 4,652  
 
For fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs is required along with a reconciliation of Level 3 values from the prior reporting period. The Company has five pay-fixed and receive variable interest rate swaps in liability positions at September 30, 2009. The value of these swaps at September 30, 2009 was materially affected by the Company’s credit. A pre-credit fair value of each swap was determined using conventional present value discounting based on the 3-year Euro dollar futures curves and the LIBOR swap curve beyond 3 years, resulting in a liability of approximately $8,903,000. To reflect the Company’s current financial condition and Chapter 11 Filings, a recovery rate of 40% was applied to that value. Management elected the 40% recovery rate in the absence of any other company-specific information. As the recovery rate is a material unobservable input, these swaps are considered Level 3. It is the Company’s understanding that 40% reflects the standard market recovery rate provided by Bloomberg in probability of default calculations. The Company applied their interpretation of the 40% recovery rate to the swap liability reducing the liability by 60% to approximately $3,561,000 to reflect the credit risk to counterparties. The changes in the Company’s fair value of its Level 3 inputs are as follows (in thousands):
 
F-21

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
   
Level 3
 
Beginning balance, June 30, 2009
  $ (4,005 )
Adjustments to fair value for the period
    444  
Ending balance, September 30, 2009
  $ (3,561 )
 
12.  EARNINGS PER SHARE.
 
The following table computes basic and diluted earnings per share (in thousands, except per share data):

   
Three Months Ended September 30, 2009
 
   
Income Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (12,007 )            
Less:  Preferred stock dividends
    (807 )            
Basic and diluted loss per share:
                   
Loss available to common stockholders
  $ (12,814 )     57,001     $ (0.22 )

 
   
Three Months Ended September 30, 2008
 
   
Income Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (69,167 )            
Less:  Preferred stock dividends
    (807 )            
Basic and diluted loss per share:
                   
Loss available to common stockholders
  $ (69,974 )     56,717     $ (1.23 )

 
   
Nine Months Ended September 30, 2009
 
   
Income Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (63,323 )            
Less:  Preferred stock dividends
    (2,395 )            
Basic and diluted loss per share:
                   
Loss available to common stockholders
  $ (65,718 )    
56,998
    $ (1.15 )
 
F-22

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
   
Nine Months Ended September 30, 2008
 
   
Income Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (112,651 )            
Less:  Preferred stock dividends
    (3,296 )            
Less:  Deemed dividend on preferred stock
   
(761
)            
Basic and diluted loss per share:
                   
Loss available to common stockholders
  $ (116,708 )    
47,791
    $ (2.44 )
 
There were an aggregate of 7,038,000 of potentially dilutive weighted-average shares from convertible securities outstanding as of September 30, 2009 and 2008. These convertible securities were not considered in calculating diluted net loss per share for the three and nine months ended September 30, 2009 and 2008 as their effect would be anti-dilutive.
 
13.  VARIABLE INTEREST ENTITY.
 
On October 17, 2006, the Company entered into a Membership Interest Purchase Agreement with Eagle Energy to acquire Eagle Energy’s 42% interest in Front Range. Front Range was formed on July 29, 2004 to construct and operate a 50 million gallon dry mill ethanol plant in Windsor, Colorado. Front Range began producing ethanol in June 2006.
 
The Company has determined that Front Range meets the definition of a variable interest entity under FASB ASC 810, Consolidations. The Company has also determined that it is the primary beneficiary and is therefore required to treat Front Range as a consolidated subsidiary for financial reporting purposes rather than use equity investment accounting treatment. As a result, the Company consolidates the financial results of Front Range, including its entire balance sheet with the balance of the noncontrolling interest displayed as a component of equity, and the income statement after intercompany eliminations with an adjustment for the noncontrolling interest in net income, in each case since its acquisition on October 17, 2006. As long as the Company is deemed the primary beneficiary of Front Range, it must treat Front Range as a consolidated subsidiary for financial reporting purposes.
 
Prior to the Company’s acquisition of its ownership interest in Front Range, the Company, directly or through one of its subsidiaries, had entered into four marketing and management agreements with Front Range.
 
The Company entered into a marketing agreement with Front Range on August 19, 2005 that provided the Company with the exclusive right to act as an agent to market and sell all of Front Range’s ethanol production. The marketing agreement was amended on August 9, 2006 to extend the Company’s relationship with Front Range to allow the Company to act as a merchant under the agreement. The marketing agreement was amended again on October 17, 2006 to provide for a term of six and a half years with provisions for annual automatic renewal thereafter.
 
The Company entered into a grain supply agreement with Front Range on August 20, 2005 (amended October 17, 2006) under which the Company is to negotiate on behalf of Front Range all grain purchase, procurement and transport contracts. The Company is to receive a $1.00 per ton fee related to this service. The grain supply agreement expired in May 2009.
 
The Company entered into a WDG marketing and services agreement with Front Range on August 19, 2005 (amended October 17, 2006) that provided the Company with the exclusive right to market and sell all of Front Range’s WDG production. The Company is to receive the greater of a 5% fee of the amount sold or $2.00 per ton. The WDG marketing and services agreement had a term of two and a half years with provisions for annual automatic renewal thereafter. In February 2009, the Company and Front Range terminated this agreement and entered into a new agreement with similar terms. The revised WDG marketing and services agreement expired in May 2009.
 
F-23

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The Company’s acquisition of its ownership interest in Front Range does not impact the Company’s rights or obligations under any of these agreements.
 
Included in the Company’s consolidated balance sheets are certain notes and lines of credit that are obligations of Front Range. These notes represent permanent financing and are collateralized by a perfected, first-priority security interest in all of the assets of Front Range, including inventories and all rights, title and interest in all tangible and intangible assets of Front Range; a pledge of 100% of the ownership interest in Front Range; an assignment of all revenues produced by Front Range; a pledge and assignment of Front Range’s material contracts and documents, to the extent assignable; all contractual cash flows associated with such agreements; and any other collateral security as the lender may reasonably request.
 
The carrying values and classification of assets that are collateral for the obligations of Front Range at September 30, 2009 are as follows (in thousands):

Current assets
  $ 13,673  
Property and equipment
    45,804  
Other assets
    292  
Total collateralized assets
  $ 59,769  

These collateralizations restrict the assets and revenues as well as future financing strategies of Front Range, but do not apply to, nor have bearing upon any financing strategies that the Company may choose to undertake in the future.
 
14.  RELATED PARTY TRANSACTIONS.
 
The Company contracted for transportation services for its products sold from its Madera, Magic Valley and Stockton facilities with a transportation company. At the time these contracts were entered, a senior officer of the transportation company was a member of the Company’s Board of Directors. Subsequently, the senior officer has retired from the transportation company but remains a member of the Company’s Board of Directors. For the three and nine months ended September 30, 2009, the Company purchased transportation services of $138,000 and $1,057,000, respectively. For the three and nine months ended September 30, 2008, the Company purchased transportation services of $899,500 and $1,479,000, respectively. As of September 30, 2009 and December 31, 2008, the Company had outstanding accounts payable to this vendor of $1,228,000 and $608,000, respectively.
 
As discussed in Note 8, on September 30, 2009, the Company had certain notes payable to Lyles of $31,500,000 and accrued interest payable of $1,385,000.
 
Also as discussed in Note 8, on September 30, 2009, the Company had certain notes payable to its Chairman of the Board and its Chief Executive Officer totaling $2,000,000 and accrued interest payable of $80,000.
 
The Company has issued its Series B Preferred Stock to certain related parties. As of September 30, 2009 and December 31, 2008, the Company had outstanding unpaid preferred dividends of $2,395,000 and $0, respectively.
 
The Company entered into a consulting agreement with a relative of the Company’s Chairman of the Board for consulting services related to the Company’s restructuring efforts. Compensation payable under the agreement is $10,000 per month plus expenses. For the three and nine months ended September 30, 2009, the Company paid a total of $20,600 and $26,700, respectively. There were no payments for the three and nine months ended September 30, 2008. As of September 30, 2009 and December 31, 2008, the Company had outstanding accounts payable to this vendor of $20,000 and $0, respectively.
 
F-24

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
15.  BANKRUPT DEBTORS’ CONDENSED COMBINED FINANCIAL STATEMENTS.
 
Since the consolidated financial statements of the Company include entities other than the Bankrupt Debtors, the following presents the condensed combined financial statements of the Bankrupt Debtors. Pacific Ethanol Holding Co. LLC is the direct parent company of the other Bankrupt Debtors. These condensed combined financial statements have been prepared in all material respects, on the same basis as the consolidated financial statements of the Company. The condensed combined financial statements of the Bankrupt Debtors are as follows (unaudited, in thousands):
 
PACIFIC ETHANOL HOLDING CO. LLC AND SUBSIDIARIES
CONDENSED COMBINED BALANCE SHEET
As of September 30, 2009

ASSETS
     
Current Assets:
     
Cash and cash equivalents
  $ 3,061  
Accounts receivable trade
    689  
Accounts receivable related parties
    1,795  
Inventories
    3,881  
Other current assets
    1,620  
Total current assets
    11,046  
         
Property and equipment, net
    413,702  
         
Other Assets:
       
Other assets
    609  
Total other assets
    609  
         
Total Assets
  $ 425,357  

       
LIABILITIES AND MEMBER’S EQUITY
     
Current Liabilities:
     
Accounts payable – trade
  $ 1,615  
Accrued liabilities
    187  
Other liabilities – related parties
    372  
Current portion – long-term notes payable
    24,556  
Other current liabilities
    1,720  
Total current liabilities
    28,450  
         
Other liabilities
    49  
         
Liabilities subject to compromise
    250,259  
         
Total Liabilities
    278,758  
         
Member’s Equity:
       
Member’s equity
    257,485  
Accumulated deficit
    (110,886 )
Total Member’s Equity
    146,599  
         
Total Liabilities and Member’s Equity
  $ 425,357  
 
F-25

 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
PACIFIC ETHANOL HOLDING CO. LLC AND SUBSIDIARIES
CONDENSED COMBINED STATEMENTS OF OPERATIONS

   
Three Months Ended
September 30, 2009
   
May 17, 2009 to
September 30, 2009
 
Net sales
  $ 18,226     $ 26,984  
Cost of goods sold
    25,091       37,961  
Gross loss
    (6,865 )     (10,977 )
Selling, general and administrative expenses
    988       1,520  
Loss from operations
    (7,853 )     (12,497 )
Other expense, net
    (286 )     (87 )
Reorganization costs
    (401 )     (9,863 )
Net loss
  $ (8,540 )   $ (22,447 )
 
PACIFIC ETHANOL HOLDING CO. LLC AND SUBSIDIARIES
CONDENSED COMBINED STATEMENT OF CASH FLOWS
May 17, 2009 to September 30, 2009
 
Operating Activities:
     
Net cash used in operating activities
  $ (9,269 )
Financing Activities:
       
Proceeds from DIP Financing
    12,278  
Net cash provided by financing activities
    12,278  
Net increase in cash and cash equivalents
    3,009  
Cash and cash equivalents at beginning of period
    52  
Cash and cash equivalents at end of period
  $ 3,061  
 
16.  SUBSEQUENT EVENTS.
 
As discussed in Note 8, in October 2009, the Bankrupt Debtors’ entered into an amendment to the DIP Financing, increasing the amount to $25,000,000 and extending the maturity date to March 31, 2010.
 
Also, as discussed in Note 8, in November 2009, Kinergy and its lender amended the terms of its credit facility.
 
F-26

 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This report and our consolidated financial statements and notes to consolidated financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:

·  
our ability to continue as a going concern;
·  
our ability to operate our subsidiaries pursuant to the terms and conditions of our DIP financing and any cash collateral order entered by the Bankruptcy Court in connection with the Chapter 11 Filings;
·  
our ability to obtain Court approval with respect to motions in the chapter 11 proceedings prosecuted by us from time to time;
·  
our ability to develop, prosecute, confirm and consummate one or more plans of reorganization with respect to the Chapter 11 Filings;
·  
our ability to obtain and maintain normal terms with vendors and service providers;
·  
our ability to maintain contracts that are critical to our operations;
·  
fluctuations in the market price of ethanol and its co-products;
·  
the projected growth or contraction in the ethanol and co-product markets in which we operate;
·  
our strategies for expanding, maintaining or contracting our presence in these markets;
·  
our ability to successfully develop, finance, construct and operate our current and any future ethanol production facilities;
·  
anticipated trends in our financial condition and results of operations; and
·  
our ability to distinguish ourselves from our current and future competitors.
 
You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Form 10-Q, or in the case of a document incorporated by reference, as of the date of that document. We do not undertake to update, revise or correct any forward-looking statements, except as required by law.
 
Any of the factors described immediately above, or referenced from time to time in our filings with the SEC or in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2008 or the “Risk Factors” section below, could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.
 
Recent Developments
 
On May 17, 2009, five of our indirect wholly-owned subsidiaries, namely, Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC and Pacific Ethanol Magic Valley, LLC, collectively, the Bankrupt Debtors, each commenced a case by filing voluntary petitions for relief under chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the District of Delaware in an effort to restructure their indebtedness. We refer to these filings as the Chapter 11 Filings.
 
3

 
Neither Pacific Ethanol, Inc., nor any of its other direct or indirect subsidiaries, including Kinergy Marketing LLC, or Kinergy, and Pacific Ag. Products, LLC, or PAP, have filed petitions for relief under the Bankruptcy Code. We continue to manage the Bankrupt Debtors pursuant to an asset management agreement and Kinergy and PAP continue to market and sell their ethanol and feed production pursuant to existing marketing agreements.  Subsequent to the Chapter 11 Filings, the Bankrupt Debtors obtained additional financing in the amount of up to $25,000,000 to fund working capital and general corporate needs, including the administrative costs of the Chapter 11 Filings.
 
Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At September 30, 2009, on a consolidated basis, we had an aggregate of $11.4 million in cash, cash equivalents and investments in marketable securities, which includes amounts that were held by the Bankrupt Debtors and other consolidated entities. Of this amount, approximately $2.3 million was unrestricted and available to Pacific Ethanol, Inc. for its operations and obligations. We have suspended operations at three of our four wholly-owned ethanol production facilities due to market conditions and in an effort to conserve capital. We have also taken and expect to take additional steps to preserve capital and generate additional cash.
 
A payable in the amount of $1.9 million from a judgment arising out of litigation against us in 2008 is due on December 1, 2009. We do not believe that we will have sufficient funds to make this payment. As a result, we believe we have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity needs through the end of November 2009. We are communicating with the judgment creditor in an attempt to defer the required $1.9 million payment. If we are able to defer the payment to the end of the first quarter of 2010, or later, we believe we will have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity needs through the end of March 2010. Our expectations above concerning our available liquidity through November 2009 and March 2010 presume that Lyles United, LLC and Lyles Mechanical Co. do not pursue any action against us due to our default on an aggregate of $31.5 million of indebtedness to those entities and that we maintain our current levels of borrowing availability under our Wachovia line of credit.
 
Although we are actively pursuing a number of alternatives, including seeking a confirmed plan of reorganization with respect to the Chapter 11 Filings, seeking to defer the $1.9 million payment owed to our judgment creditor, seeking to restructure our debt with Lyles United, LLC and Lyles Mechanical Co. and seeking to raise additional debt or equity financing, or both, there can be no assurance that we will be successful. If we cannot confirm a plan of reorganization with respect to the Chapter 11 Filings, defer the $1.9 million payment owed to our judgment creditor, restructure our debt and raise sufficient capital, in each case in a timely manner, we may need to seek further protection under the U.S. Bankruptcy Code, including at the parent-company level, which could occur prior to the end of the November 2009 and March 2010 periods anticipated above. In addition, we could be forced into bankruptcy or liquidation by our creditors, namely, our judgment creditor or Lyles United, LLC and Lyles Mechanical Co., or be forced to substantially restructure or alter our business operations or obligations. See “—Liquidity and Capital Resources” below.
 
Overview
 
Our primary goal is to be the leading marketer and producer of low carbon renewable fuels in the Western United States.
 
We produce and sell ethanol and its co-products, including wet distillers grain, or WDG, and provide transportation, storage and delivery of ethanol through third-party service providers in the Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and Washington. We have extensive customer relationships throughout the Western United States and extensive supplier relationships throughout the Western and Midwestern United States.
 
4

 
Our four ethanol facilities, which produce our ethanol and co-products, are as follows:
 
Facility Name Facility Location
Date Operations
Began
Estimated Annual
Production Capacity
(gallons)
Current
Operating
Status
         
Stockton Stockton, CA September 2008 60,000,000 Idled
Magic Valley Burley, ID April 2008 60,000,000 Idled
Columbia Boardman, OR September 2007 40,000,000 Operating
Madera Madera, CA October 2006 40,000,000 Idled
 
In addition, we own a 42% interest in Front Range, which owns a plant located in Windsor, Colorado, with annual production capacity of up to 50 million gallons.
 
Critical Accounting Policies
 
The preparation of our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, requires us to make judgments and estimates that may have a significant impact upon the portrayal of our financial condition and results of operations. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management that can materially impact the portrayal of our financial condition and results of operations: going concern assumptions; revenue recognition; consolidation of variable interest entities; impairment of intangible and long-lived assets; derivative instruments and hedging activities; allowance for doubtful accounts; and costs of start-up activities. These significant accounting principles are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2008.
 
Results of Operations
 
The following selected financial data should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report.
 
Certain performance metrics that we believe are important indicators of our results of operations include:
 
   
Three Months Ended
September 30,
         
Nine Months Ended
September 30,
       
   
2009
   
2008
   
Variance
   
2009
   
2008
   
Variance
 
Gallons sold (in millions)
    36.6       65.0       (43.7)%       116.2       191.0       (39.2)%  
Average sales price per gallon
  $ 1.73     $ 2.45       (29.4)%     $ 1.70     $ 2.43       (30.0)%  
Corn cost per bushel—CBOT equivalent (1)
  $ 3.33     $ 6.28       (47.0)%     $ 3.91     $ 5.75       (32.0)%  
Co-product revenues as % of delivered cost of corn
    25.7%       21.6%       19.0%       24.4%       22.6%       8.0%  
                                                 
Average CBOT ethanol price per gallon
  $ 1.59     $ 2.34       (32.1)%     $ 1.61     $ 2.40       (32.9)%  
Average CBOT corn price per bushel
  $ 3.27     $ 5.78       (43.4)%     $ 3.70     $ 5.76       (35.8)%  
_____________
                                               
 
(1)
We exclude transportation—or “basis”—costs in our corn costs to calculate a Chicago Board of Trade, or CBOT, equivalent price to compare our corn costs to average CBOT corn prices.
 
5

 
Net Sales, Cost of Goods Sold and Loss
 
The following table presents our net sales, cost of goods sold and gross loss in dollars and gross loss as a percentage of net sales (in thousands, except percentages):

   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2009
   
2008
   
Dollars
   
Percent
   
2009
   
2008
   
Dollars
   
Percent
 
                                                 
Net sales                          
  $ 71,889     $ 183,980     $ (112,091 )     (60.9)%     $ 228,685     $ 543,489     $ (314,804 )     (57.9)%  
Cost of goods sold
    76,420       204,265       (127,845 )     (62.6)%       252,123       547,673       (295,550 )     (54.0)%  
Gross loss                          
  $ (4,531 )   $ (20,285 )