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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2005
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to _______
Commission File Number: 0-21467
PACIFIC ETHANOL, INC.
(Name of small business issuer as specified in its charter)
DELAWARE 41-2170618
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
5711 N. WEST AVENUE
FRESNO, CALIFORNIA 93711
(Address of principal executive offices)
(559) 435-1771
(Issuer's telephone number, including area code)
NOT APPLICABLE.
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
Indicate by check whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
As of November 14, 2005, there were 28,667,185 shares of Pacific
Ethanol, Inc. common stock, $.001 par value per share, outstanding.
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PART I
FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2005 (unaudited) and
December 31, 2004........................................................................... F-2
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2005 and 2004 (unaudited)............................................... F-4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004 (unaudited)..................................................... F-5
Notes to Condensed Consolidated Financial Statements (unaudited)................................ F-7
Item 2. Management's Discussion and Analysis or Plan of Operation ...................................... 2
Item 3. Controls and Procedures......................................................................... 25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..................................... 29
Item 3. Defaults Upon Senior Securities................................................................. 29
Item 4. Submission of Matters to a Vote of Security Holders............................................. 29
Item 5. Other Information............................................................................... 29
Item 6. Exhibits........................................................................................ 30
Signatures ................................................................................................ 31
F-1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004
September 30,
2005 December 31,
(unaudited) 2004
--------------- ---------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 11,344,034 $ 42
Accounts receivable (including $396,129 and $0 as
of September 30, 2005 and December 31, 2004,
respectively, from a related party) 2,418,598 8,464
Inventories 633,691 --
Prepaid expenses 1,303,150 --
Prepaid inventory 593,636 293,115
Other current assets 59,811 484,485
--------------- ---------------
Total current assets 16,352,920 786,106
PROPERTY AND EQUIPMENT, NET 13,416,453 6,324,824
OTHER ASSETS:
Debt issuance costs, net 53,333 68,333
Deposits 14,086 --
Intangible assets, net 10,508,082 --
--------------- ---------------
Total other assets 10,575,501 68,333
--------------- ---------------
TOTAL ASSETS $ 40,344,874 $ 7,179,263
=============== ===============
See accompanying notes to condensed consolidated financial statements.
F-2
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004 (CONTINUED)
September 30,
2005 December 31,
(unaudited) 2004
--------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable - trade $ 2,400,739 $ 383,012
Accounts payable - related party 1,294,566 846,211
Accrued retention - related party 505,385 --
Accrued payroll -- 18,963
Accrued interest payable -- 30,864
Other accrued liabilities 845,306 531,803
--------------- ---------------
Total current liabilities 5,045,996 1,810,853
RELATED-PARTY NOTE PAYABLE 2,948,081 4,012,678
COMMITMENTS AND CONTINGENCIES (NOTES 4 AND 5)
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value; 10,000,000 shares
authorized, no shares issued and outstanding as of
September 30, 2005 and December 31, 2004 -- --
Common stock, $0.001 par value; 100,000,000 shares
authorized, 28,667,185 and 13,445,866 shares issued and
outstanding as of September 30, 2005 and December 31,
2004, respectively 28,667 13,446
Additional paid-in capital 42,374,060 5,071,632
Unvested consulting expense (1,583,739) --
Due from stockholders (600) (68,100)
Accumulated deficit (8,467,591) (3,661,246)
--------------- ---------------
Total stockholders' equity 32,350,797 1,355,732
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 40,344,874 $ 7,179,263
=============== ===============
See accompanying notes to condensed consolidated financial statements.
F-3
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net sales (including $2,165,315 and $ 26,414,305 $ 829 $ 51,530,735 $ 16,832
$4,017,322 for the three and nine months
ended September 30, 2005, respectively,
to a related party)
Cost of goods sold 24,778,592 -- 49,695,870 10,789
------------ ------------ ------------ ------------
Gross profit 1,635,713 829 1,834,865 6,043
Operating expenses:
Selling, general and administrative
expenses 2,206,985 287,672 3,999,653 714,730
Services rendered in connection with
feasibility study -- -- 852,250 --
Non-cash compensation and consulting
fees 406,331 345,000 1,749,967 862,500
------------ ------------ ------------ ------------
Loss from operations (977,603) (631,843) (4,767,005) (1,571,187)
Other income (expense):
Other income 872 2,317 27,267 2,368
Interest income (expense) 54,947 (148,731) (61,007) (415,726)
------------ ------------ ------------ ------------
Loss before provision for income taxes (921,784) (778,257) (4,800,745) (1,984,545)
Provision for income taxes 800 6,000 5,600 8,400
------------ ------------ ------------ ------------
Net loss $ (922,584) $ (784,257) $ (4,806,345) $ (1,992,945)
============ ============ ============ ============
Weighted Average Shares Outstanding 28,614,819 12,334,591 23,841,380 12,064,684
============ ============ ============ ============
Net Loss Per Share $ (0.03) $ (0.06) $ (0.20) $ (0.10)
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
F-4
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
Nine Months Ended
September 30,
2005 2004
------------ ------------
Net loss $ (4,806,345) $ (1,992,945)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization of intangibles 488,861 58,894
Amortization of debt issuance costs 15,000 15,000
Interest expense relating to amortization of debt discount 180,403 180,402
Non-cash compensation expense 951,706 --
Non-cash consulting expense 798,261 862,500
Services rendered in connection with feasibility study 702,250 --
(Increase) decrease in:
Accounts receivable 101,525 15,551
Inventories (52,126) --
Prepaid expenses and other assets (1,181,449) (13,558)
Prepaid inventory (286,074) --
Other receivable (319) 224,490
Increase (decrease) in:
Accounts payable 177,564 (106,141)
Accounts payable, related party 448,355 325,035
Accrued retention, related party 505,385 --
Accrued payroll (18,963) (3,579)
Accrued interest payable (31,315) (131,574)
Accrued liabilities 277,993 444,934
------------ ------------
Net cash used in operating activities (1,729,288) (120,991)
------------ ------------
Cash flows from Investing Activities:
Additions to property, plant and equipment (7,146,598) (688,727)
Payment on related party notes receivable -- 199,812
Payment on deposit (4,086) --
Payment on option to acquire site (10,000) --
Net cash acquired in acquisition of Kinergy, ReEnergy
and Accessity 1,146,854 --
Costs associated with share exchange transaction (307,808) (265,217)
------------ ------------
Net cash used in investing activities (6,321,638) (754,132)
------------ ------------
Cash flows from Financing Activities:
Proceeds from sale of stock, net 18,879,749 846,855
Proceeds from exercise of stock options 447,669 92
Receipt of stockholder receivable 67,500 --
------------ ------------
Net cash provided by financing activities 19,394,918 846,947
------------ ------------
Net increase (decrease) in cash and cash equivalents 11,343,992 (28,176)
Cash and cash equivalents at beginning of period 42 249,084
------------ ------------
Cash and cash equivalents at end of period $ 11,344,034 $ 220,908
============ ============
See accompanying notes to condensed consolidated financial statements.
F-5
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (CONTINUED)
(UNAUDITED)
Nine Months Ended
September 30,
2005 2004
------------ ------------
Non-Cash Financing and Investing activities:
Conversion of debt to equity $ 1,245,000 $ 240,000
============ ============
Issuance of stock for receivable $ -- $ 68,100
============ ============
Purchase of ReEnergy with Stock $ 316,250 $ --
============ ============
Shares contributed by stockholder in purchase
of ReEnergy $ 506,000 $ --
============ ============
Shares contributed by stockholder in purchase
of Kinergy $ 1,012,000 $ --
============ ============
Purchase of Kinergy with Stock $ 9,803,750 $ --
============ ============
Stock returned to the Company as payment for
stock option exercise $ 1,213,314 $ --
============ ============
See accompanying notes to condensed consolidated financial statements.
F-6
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
1. REPORT BY MANAGEMENT:
---------------------
The condensed consolidated financial statements include the accounts of
Pacific Ethanol, Inc., a Delaware corporation, and its wholly-owned
subsidiaries (collectively, the "Company"). All significant
transactions among the consolidated entities have been eliminated upon
consolidation.
The condensed consolidated financial statements have been prepared by
the Company and include all adjustments consisting of only normal
recurring adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position of the
Company as of September 30, 2005 and the results of operations and the
cash flows of the Company for the three and nine months ended September
30, 2005 and 2004, pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, the condensed
consolidated financial statements do not include all of the information
and footnotes required by accounting principles generally accepted in
the United States of America for annual consolidated financial
statements. The Company's results of operations for the nine months
ended September 30, 2005 are not necessarily indicative of the results
of operations to be expected for the full fiscal year ending December
31, 2005.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION - As permitted under Statement of Financial
Accounting Standards No. 123 ( FAS 123), Accounting for Stock-Based
Compensation, the Company has elected to follow Accounting Principles
Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to
Employees in accounting for stock-based awards to its employees and
directors. Accordingly, the Company accounts for grants of stock
options to its employees and directors according to the intrinsic value
method and, thus, recognizes no stock-based compensation expense for
options granted with exercise prices equal to or greater than the fair
value of the Company's common stock on the date of grant. The Company
records deferred stock-based compensation when the market of the
Company's common stock exceeds the exercise price of the stock options
or purchase rights on the measurement date (generally, the date of
grant). Any such deferred stock-based compensation is amortized ratably
over the vesting period of the individual options.
Options granted to non-employees are accounted for at fair value using
the Black-Scholes Option Valuation Model in accordance with FAS 123 and
Emerging Issues Task Force Consensus No. 96-18, and are subject to
periodic revaluation over their vesting terms. The resulting
stock-based compensation expense is recorded over the service period in
which the non-employee provides services to the Company.
Pro forma net loss information using the fair value based method of
accounting for grants of stock options to employees and directors is
included in the table shown below for the three months and nine months
ended September 30, 2005 and 2004:
F-7
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- ----------------------------
2005 2004 2005 2004
----------- ------------ ----------- -----------
Net loss attributable to common
stockholders, as reported $ (922,584) $ (784,257) $(4,806,345) $(1,992,945)
=========== ============ =========== ===========
Add: stock-based employee
compensation cost included in
determination of net loss 68,456 -- 68,456 --
Deduct: fair value compensation cost
under FAS 123 (507,825) -- (507,825) --
----------- ------------ ----------- -----------
Pro forma net loss $(1,361,953) $ (784,257) $(5,245,714) $(1,992,945)
=========== ============ =========== ===========
Loss per share:
Weighted average shares outstanding,
as reported $ (0.03) $ (0.06) $ (0.20) $ (0.17)
=========== ============ =========== ===========
Weighted average shares outstanding,
pro forma $ (0.05) $ (0.06) $ (0.22) $ (0.17)
=========== ============ =========== ===========
Fair market value of stock-based compensation has been estimated using
the Black-Scholes option pricing model. Inputs into the pricing model
include the underlying stock price at the time of fair market value
measurement, the exercise price of the granted options, the remaining
time to expiration from the date of grant, the underlying stock's
estimated annualized volatility, and a discount rate based on the ten
year treasury note yield. Annualized volatility has been estimated
under the guidelines of FAS 123 and is based on the variance of
historical returns of an appropriate proxy company.
REVENUE RECOGNITION - The Company recognizes revenue in accordance with
SEC Staff Accounting Bulletin No. 104, Revenue Recognition, and the
related Emerging Task Force Issue No. EITF 99-19, Reporting Revenue
Gross as a Principal Versus Net as an Agent, or EITF 99-19.
The Company derives revenue primarily from sales of ethanol. The
Company's sales are based upon written agreements or purchase orders
that identify the amount of ethanol to be purchased and the purchase
price. Revenue is recognized, gross, upon delivery of ethanol to a
customer's designated ethanol tank. Shipments are made to customers,
variously, directly from suppliers and from the Company's inventory to
the Company's customers by truck or rail. Ethanol that is shipped by
rail originates primarily in the Midwest and takes from 10 to 14 days
from date of shipment to be delivered to the customer or to one of four
terminals in California and Oregon. For local deliveries the product is
shipped by truck and delivered the same day as shipment
In accordance with the criteria outlined in EITF 99-19, the Company
records ethanol sales revenue at gross. The Company generally takes
title to the ethanol, has the contractual obligation to deliver ethanol
that meets certain specifications (hence to determine the nature, type,
characteristics, or specifications of the product or services ordered
by the customer), negotiates the price of the ethanol, is responsible
for assuring fulfillment of the amount to be delivered, selects the
F-8
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
supplier and makes the decision as to which available inventory is
matched to which sales fulfillment (not always the same customer) and
assumes credit risk for the amount billed to the customer. The presence
of the combination of these factors indicates that the Company has the
risks and rewards of a principal in these transactions and therefore
the Company records revenue at the gross amount.
2. ORGANIZATION AND NATURE OF OPERATIONS:
--------------------------------------
SHARE EXCHANGE TRANSACTION - On March 23, 2005, the Company completed a
share exchange transaction with the shareholders of Pacific Ethanol,
Inc., a California corporation that was incorporated on January 30,
2003 ("PEI California"), and the holders of the membership interests of
each of Kinergy Marketing, LLC, an Oregon limited liability company
that was organized on September 13, 2000 ("Kinergy") and ReEnergy, LLC,
a California limited liability company that was organized on March 7,
2001 ("ReEnergy"), pursuant to which the Company acquired all of the
issued and outstanding capital stock of PEI California and all of the
outstanding membership interests of Kinergy and ReEnergy (the "Share
Exchange Transaction"). In connection with the Share Exchange
Transaction, the Company issued an aggregate of 20,610,987 shares of
common stock to the shareholders of PEI California, 3,875,000 shares of
common stock to the sole limited liability company member of Kinergy
and an aggregate of 125,000 shares of common stock to the limited
liability company members of ReEnergy.
Immediately prior to the consummation of the Share Exchange
Transaction, the Company's predecessor, Accessity Corp., a New York
corporation ("Accessity"), reincorporated in the State of Delaware
under the name "Pacific Ethanol, Inc" through a merger of Accessity
with and into its then-wholly-owned Delaware subsidiary named Pacific
Ethanol, Inc., which was formed for the purpose of effecting the
reincorporation (the "Reincorporation Merger"). In connection with the
Reincorporation Merger, the shareholders of Accessity became
stockholders of the Company and the Company succeeded to the rights,
properties and assets and assumed the liabilities of Accessity.
Immediately prior to the consummation of the share exchange
transaction, Accessity divested its two operating subsidiaries.
Accordingly, effective as of the closing of the share exchange
transaction, Accessity did not have any ongoing business operations.
Assets consisting primarily of cash and cash equivalents totaling
approximately $3.7 million were acquired and certain current
liabilities of approximately $300,000 were assumed from Accessity.
Since Accessity had no operations and only net monetary assets, the
Share Exchange Transaction is being treated as a capital transaction,
whereby Pacific Ethanol acquired the net monetary assets of Accessity,
accompanied by a recapitalization of Pacific Ethanol. As such, no fair
value adjustments were necessary for any of the assets acquired or
liabilities assumed.
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting
acquiror. As a result, the Company's results of operations for the
three and nine months ended September 30, 2004 consist only of the
operations of PEI California. The Company has consolidated the results
of PEI California, Kinergy and ReEnergy beginning March 23, 2005, the
date of the Share Exchange Transaction. Accordingly, the Company's
F-9
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
results of operations for the three and nine months ended September 30,
2005 consist of the operations of PEI California for the entire nine
month period and the operations of the Company, Kinergy and ReEnergy
from March 23, 2005 through September 30, 2005.
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with the Share Exchange Transaction:
Current assets............................. $ 7,014,196
Property, plant and equipment.............. 6,224
Intangibles, including goodwill............ 10,935,750
--------------
Total assets acquired................... 17,956,170
Current liabilities........................ 4,253,177
Other liabilities.......................... 83,017
--------------
Total liabilities assumed............... 4,336,194
--------------
Net assets acquired........................ $ 13,619,976
==============
Shares of common stock issued.............. 6,489,414
==============
The purchase price represented a significant premium over the recorded
net worth of the acquired entities' assets. In deciding to pay this
premium, the Company considered various factors, including the value of
Kinergy's trade name, Kinergy's extensive market presence and history,
Kinergy's industry knowledge and expertise, Kinergy's extensive
customer relationships and expected synergies among Kinergy's and
ReEnergy's businesses and assets and the Company's planned entry into
the ethanol production business.
In connection with the Share Exchange Transaction and the Company's
acquisition of Kinergy and ReEnergy, the Company engaged a valuation
firm to determine what portion of the purchase price should be
allocated to identifiable intangible assets. Through that process, the
Company has estimated that for Kinergy, the distribution backlog is
valued at $136,000, the customer relationships are valued at $5,600,000
and the trade name is valued at $3,100,000. The Company made a $150,000
cash payment and issued stock valued at $316,250 for the acquisition of
ReEnergy. In addition, certain stockholders sold stock to the members
of ReEnergy, increasing the purchase price by $506,000 (see further
discussion below). The purchase price for ReEnergy totaled $972,250. Of
this amount, $120,000 was recorded as an intangible asset for the fair
value of a favorable option to acquire land and because the acquisition
of ReEnergy was not deemed to be an acquisition of a business, the
remaining purchase price of $852,250 was recorded as an expense for
services rendered in connection with a feasibility study. The Company
issued stock valued at $9,803,750 for the acquisition of Kinergy. In
addition, certain stockholders sold stock to the sole member of Kinergy
and a related party, increasing the purchase price by $1,012,000. The
purchase price for Kinergy totaled $10,815,750. Goodwill directly
associated with the Kinergy acquisition therefore totaled $1,979,750.
The Kinergy trade name is determined to have an indefinite life and
therefore, rather than being amortized, will be periodically tested for
impairment. The distribution backlog has an estimated life of six
months and customer relationships were estimated to have a ten-year
F-10
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
life and, as a result, will be amortized accordingly, unless otherwise
impaired at an earlier time. The ReEnergy land option expires on
December 15, 2005 and will be expensed at that time if not extended.
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of the Company, as though the
acquisitions occurred as of January 1, 2004. The pro forma amounts give
effect to appropriate adjustments for amortization of intangible assets
and income taxes. The pro forma amounts presented are not necessarily
indicative of future operating results.
Nine Months
Ended September 30,
----------------------------
2005 2004
------------ ------------
Net sales $ 75,135,987 $ 56,545,947
============ ============
Net loss $ (5,312,481) $ (3,273,338)
============ ============
Loss per share of common stock
Basic and diluted $ (0.19) $ (0.13)
============ ============
On April 1, 2004, certain founders of the Company agreed to sell an
aggregate of 500,000 shares of the Company's common stock owned by them
to Cagan McAfee Capital Partners, LLC ("CMCP") at $0.01 per share for
securing financing to close the Share Exchange Transaction on or prior
to March 31, 2005. Immediately prior to the closing of the Share
Exchange Transaction, the founders sold these shares at the agreed upon
price to CMCP. The contribution of these shares is accounted for as a
capital contribution. However, because the shares were issued as a
finder's fee in a private offering (see note 5), the related expense is
offset against the proceeds received, resulting in no effect on equity.
Immediately prior to the closing of the Share Exchange Transaction,
certain stockholders of the Company sold an aggregate of 250,000 shares
of the Company's common stock owned by them to the then-Chief Executive
Officer of Accessity at $0.01 per share to compensate him for
facilitating the closing of the Share Exchange Transaction. The
contribution of these shares is accounted for as a capital
contribution. However, because the shares are deemed issued to
Accessity in connection with the Share Exchange Transaction, the
related expense is offset against the cash received from Accessity,
resulting in no effect on equity.
Immediately prior to the closing of the Share Exchange Transaction,
William Jones, the Company's Chairman of the Board of Directors, sold
200,000 shares of the Company's common stock to the individual members
of ReEnergy at $0.01 per share, to compensate them for facilitating the
F-11
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
closing of the Share Exchange Transaction. The contribution of these
shares resulted in an additional expense of $506,000 for services
rendered in connection with a feasibility study.
Immediately prior to the closing of the Share Exchange Transaction,
William Jones sold 300,000 shares of the Company's common stock to Neil
Koehler, the sole member of Kinergy and an officer and director of the
Company, at $0.01 per share to compensate him for facilitating the
closing of the Share Exchange Transaction. The contribution of these
shares resulted in additional Kinergy goodwill of $759,000.
Immediately prior to the closing of the Share Exchange Transaction,
William Jones sold 100,000 shares of the Company's common stock to Tom
Koehler, a member of ReEnergy and a related party of the sole member of
Kinergy, at $0.01 per share to compensate him for facilitating the
closing of the Share Exchange Transaction. The contribution of these
shares resulted in additional Kinergy goodwill of $253,000.
3. RELATED PARTY NOTES PAYABLE:
----------------------------
On January 10, 2005 and February 22, 2005, William Jones advanced the
Company $60,000 and $20,000, respectively, at 5% interest, due and
payable upon the closing of the Share Exchange Transaction. The
accumulated principal due was repaid on March 24, 2005 and the related
accrued interest was paid on April 15, 2005.
On January 10, 2005, Neil Koehler advanced the Company $100,000 at 5%
interest, due and payable upon the closing of the Share Exchange
Transaction. The principal was repaid on March 24, 2005 and the related
accrued interest was paid on April 15, 2005.
On January 31, 2005, Eric McAfee, a principal of CMCP, advanced the
Company $100,000 at 5% interest, due and payable upon close of the
Share Exchange Transaction. The principal was repaid on March 24, 2005
and the related accrued interest was paid on April 15, 2005.
During 2004, on July 31, September 24, and November 15, Lyles
Diversified, Inc. ("LDI") converted $150,000, $90,000 and $15,000 of
debt into 100,000, 60,000 and 10,000 shares of common stock,
respectively, at a conversion price equal to $1.50 per share. During
2005, on January 14, February 4, March 10, and May 27, LDI converted
$36,000, $114,000, $97,682 and $997,318 of debt into 24,000, 76,000,
65,121 and 664,879 shares of the Company's common stock, respectively,
at a conversion price equal to $1.50 per share. The total debt
converted by LDI as of September 30, 2005 was $1,500,000 for 1,000,000
shares of the Company's common stock, at a conversion price equal to
$1.50 per share.
Pursuant to the terms of the Share Exchange Transaction, Kinergy
distributed to its sole member in the form of a promissory note in the
amount of $2,095,614, Kinergy's net worth as set forth on Kinergy's
balance sheet prepared in accordance with GAAP, as of March 23, 2005.
A holdback amount of $100,000 for 30 days was provided to allow
Kinergy to settle its accounts. In April 2005, Kinergy paid the
balance of its net worth, up to the holdback amount of $100,000. The
remaining holdback amount was paid in May 2005.
Pursuant to the terms of the Share Exchange Transaction, ReEnergy
distributed to its members in the form of a promissory note in the
amount of $1,439 ReEnergy's net worth as set forth on ReEnergy's
balance sheet prepared in accordance with GAAP, as of March 23, 2005.
The note balance was paid in April 2005.
F-12
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
4. COMMON STOCK:
-------------
SHARE EXCHANGE TRANSACTION - In connection with the Share Exchange
Transaction, the Company issued an aggregate of 20,610,987 shares of
common stock to the shareholders of PEI California, 3,875,000 shares of
common stock to the sole limited liability company member of Kinergy
and an aggregate of 125,000 shares of common stock to the limited
liability company members of ReEnergy.
PRIVATE OFFERING - On March 23, 2005, PEI California issued to 63
accredited investors in a private offering an aggregate of 7,000,000
shares of common stock at a purchase price of $3.00 per share, two-year
investor warrants to purchase 1,400,000 shares of common stock at an
exercise price of $3.00 per share and two-year investor warrants to
purchase 700,000 shares of common stock at an exercise price of $5.00
per share, for total gross proceeds of approximately $21,000,000. PEI
California paid cash placement agent fees and expenses of approximately
$1,850,400 and issued five-year placement agent warrants to purchase
678,000 shares of common stock at an exercise price of $3.00 per share
in connection with the offering. Additional costs related to the
financing include legal, accounting, consulting, and stock certificate
issuance fees that totaled approximately $272,366 through September 30,
2005.
The Company is obligated under a Registration Rights Agreement to file,
on the 151st day following March 23, 2005, a Registration Statement
with the Securities and Exchange Commission registering for resale
shares of common stock, and shares of common stock underlying investor
warrants and certain of the placement agent warrants, issued in
connection with the private offering. If the Company (i) does not file
the Registration Statement within the time period prescribed, or (ii)
fails to file with the Securities and Exchange Commission a request for
acceleration in accordance with Rule 461 promulgated under the
Securities Act of 1933, within five trading days of the date that the
Company is notified (orally or in writing, whichever is earlier) by the
Securities and Exchange Commission that the Registration Statement will
not be "reviewed," or is not subject to further review, or (iii) the
Registration Statement filed or required to be filed under the
Registration Rights Agreement is not declared effective by the
Securities and Exchange Commission on or before 225 days following
March 23, 2005, or (iv) after the Registration Statement is first
declared effective by the Securities and Exchange Commission, it ceases
for any reason to remain continuously effective as to all securities
registered thereunder, or the holders of such securities are not
permitted to utilize the prospectus contained in the Registration
Statement to resell such securities, for more than an aggregate of 45
trading days during any 12-month period (which need not be consecutive
trading days) (any such failure or breach being referred to as an
"Event," and for purposes of clause (i) or (iii) the date on which such
Event occurs, or for purposes of clause (ii) the date on which such
five-trading day period is exceeded, or for purposes of clause (iv) the
date on which such 45-trading day-period is exceeded being referred to
as "Event Date"), then in addition to any other rights the holders of
such securities may have under the Registration Statement or under
applicable law, then, on each such Event Date and on each monthly
anniversary of each such Event Date (if the applicable Event shall not
have been cured by such date) until the applicable Event is cured, the
Company is required to pay to each such holder an amount in cash, as
partial liquidated damages and not as a penalty, equal to 2.0% of the
F-13
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
aggregate purchase price paid by such holder pursuant to the Securities
Purchase Agreement relating to such securities then held by such
holder. If the Company fails to pay any partial liquidated damages in
full within seven days after the date payable, the Company is required
to pay interest thereon at a rate of 18% per annum (or such lesser
maximum amount that is permitted to be paid by applicable law) to such
holder, accruing daily from the date such partial liquidated damages
are due until such amounts, plus all such interest thereon, are paid in
full. The partial liquidated damages are to apply on a daily pro-rata
basis for any portion of a month prior to the cure of an Event.
The Registration Rights Agreement also provides for customary
piggy-back registration rights whereby holders of shares of the
Company's common stock, or warrants to purchase shares of common stock,
can cause the Company to register such shares for resale in connection
with the Company's filing of a Registration Statement with the
Securities and Exchange Commission to register shares in another
offering. The Registration Rights Agreement also contains customary
representations and warranties, covenants and limitations.
The Registration Statement was not declared effective by the Securities
and Exchange Commission on or before 225 days following March 23, 2005.
The Company endeavored to have all security holders entitled to these
registration rights execute amendments to the Registration Rights
Agreement reducing the penalty from 2.0% to 1.0% of the aggregate
purchase price paid by such holder pursuant to the Securities Purchase
Agreement relating to such securities then held by such holder. This
penalty reduction applies to penalties accrued on or prior to January
31, 2006 as a result of the related Registration Statement not being
declared effective by the Securities and Exchange Commission. Certain
of the security holders executed this amendment. However, not all
security holders executed this amendment and as a result, the Company
paid an aggregate of $298,050 in penalties on November 8, 2005, which
will be recorded in the quarterly period ending December 31, 2005.
STOCK OPTIONS - One outstanding option granted to an employee of the
Company to acquire 25,000 shares of common stock vested on March 23,
2005 and was converted into a warrant. Non-cash compensation expense of
$232,250 was recognized to record the fair value of the warrant.
On July 26, 2005, the Company issued options to purchase an aggregate
of 17,500 shares of the Company's common stock at an exercise price
equal to $7.01 per share, which exercise price equals 85% of the
closing price per share of the Company's common stock on that date. The
options vested upon issuance and expire 10 years following the date of
grant. A non-cash charge of $21,656 will be recorded in the quarter
ended September 30, 2005.
On July 26, 2005, the Company granted options to purchase an aggregate
of 115,000 shares of the Company's common stock at an exercise price
equal to $8.25, the closing price per share of the Company's common
stock on that date, to various non-employee directors. The options vest
one year following the date of grant and expire 10 years following the
date of grant.
On July 28, 2005, the Company granted options to purchase an aggregate
of 30,000 shares of the Company's common stock at an exercise price
equal to $8.30, the closing price per share of the Company's common
F-14
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
stock on that date, to two new non-employee directors. The options vest
one year following the date of grant and expire 10 years following the
date of grant.
On August 10, 2005, the Company granted options to purchase an
aggregate of 425,000 shares of the Company's common stock at an
exercise price equal to $8.03, the closing price per share of the
Company's common stock on the day immediately preceding that date, to
its Chief Financial Officer. The options vested as to 85,000 shares
immediately and 85,000 shares will vest on each of the next four
anniversaries of the date of grant. The options expire 10 years
following the date of grant.
On August 10, 2005, the Company granted options to purchase an
aggregate of 75,000 shares of the Company's common stock at an exercise
price equal to $8.03, the closing price per share of the Company's
common stock on the day immediately preceding that date, to a
consultant. The options vested as to 15,000 shares immediately and
15,000 shares will vest on each of the next four anniversaries of the
date of grant. The options expire 10 years following the date of grant.
A non-cash charge of $70,500 was recorded in the quarter ended
September 30, 2005.
On September 1, 2005, the Company granted options to purchase an
aggregate of 160,000 shares of the Company's common stock at an
exercise price equal to $6.63 per share, which exercise price equals
85% of the closing price per share of the Company's common stock on the
day immediately preceding that date. A non-cash charge of $46,800 was
recorded in the quarter ended September 30, 2005 and will be recorded
on the dates of additional vesting occurring on each of the next three
anniversaries of the date of grant. The options expire 10 years
following the date of grant.
STOCK ISSUANCE - The Company issued an aggregate of 70,000 shares of
common stock to two employees of the Company on their date of hire on
June 23, 2005. Non-cash compensation expense of $651,000 was recognized
to record the fair value of shares of common stock.
NON-CASH COMPENSATION - On February 12, 2004, the Company entered into
a consulting agreement with an unrelated party to represent the Company
in investors' communications and public relations with existing
shareholders, brokers, dealers and other investment professionals as to
the Company's current and proposed activities. As compensation for such
services, the Company issued warrants to the consultant to purchase
920,000 shares of the Company's common stock. These warrants vested
upon the effective date of the agreement and were recognized at the
fair value on the date of issuance in the amount of $1,380,000. The
Company recorded non-cash expense of $172,500 and $517,500 for
consulting services during the nine months ended September 30, 2005 and
2004, respectively.
Pursuant to the consulting agreement, upon completion of the Share
Exchange Transaction, the Company issued warrants to the consultant to
purchase 230,000 additional shares of common stock that will vest
ratably over a period of two years. The warrants were recognized at the
fair value as of the start of business on March 24, 2005 in the amount
of $2,139,000 and recorded as contra-equity. The Company recorded
non-cash expense of $555,261 for consulting services vested during the
period from March 24, 2005 to September 30, 2005. The unvested warrants
in the amount of $1,583,739 will vest ratably at $89,125 per month over
the remainder of the two year period.
F-15
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
5. COMMITMENTS AND CONTINGENCIES:
------------------------------
OPERATING LEASES - The Company leases shared office space in Fresno,
California on a month-to-month basis at $4,132 per month. The related
office rent expense was $32,076 and $17,648 for the nine months ended
September 30, 2005 and 2004, respectively.
The Company leases office space in Davis, California at a rate of
$1,100 per month. The lease term expires on November 30, 2005.
The Company entered into a lease for office space in Portland, Oregon
on August 3, 2005. The term of the lease is three years, commencing
December 1, 2005 through November 30, 2008 with monthly lease payments
of $1,290 through May 31, 2007 and $1,362 from June 1, 2007 through the
end of the lease term.
ADVISORY FEE - On April 14, 2004, the Company entered into an agreement
with CMCP in connection with raising funding for an ethanol production
facility. The agreement provided that upon raising a minimum of
$15,000,000 the Company would pay CMCP a fee, through that date, equal
to $10,000 per month starting from April 15, 2003. In addition, the
agreement provided for payment of $25,000 per month for a minimum of 12
months upon the completion of a merger between the Company and a public
company, starting from the date of close of such merger, as well as an
advisory fee of 3% of any equity amount raised through the efforts of
CMCP, including cash amounts received through a merger with another
corporate entity. The Company paid an advisory fee to CMCP in the
amount of $235,000 on March 24, 2005, pursuant to the terms of the
agreement between CMCP and the Company and in connection with the
private placement transaction described above. In addition, $83,017 was
paid related to cash received from Accessity in connection with the
Share Exchange Transaction.
The Company terminated the consulting agreement on November 1, 2005 and
paid CMCP $150,000 for the remainder of their contract for a total of
$300,000 paid in 2005 related to this consulting agreement.
On January 5, 2005, the Company entered into an agreement with
Northeast Securities, Inc. ("NESC") and Chadbourn Securities, Inc.
("Chadbourn"), a related party, in connection with the private offering
on March 23, 2005 described above. The agreement provides that upon
completion of a financing within the time-frame of the engagement
covered by the agreement, the Company will pay NESC 6% (plus a 1%
non-accountable expense allowance) of gross proceeds received by the
Company, and warrants exercisable at the offering price in an amount
equal to 7% of the aggregate number of shares of common stock sold in
the financing. In addition, the agreement provides that Chadbourn will
receive 2% (plus a 1% non-accountable expense allowance) of gross
proceeds and warrants exercisable at the offering price in an amount
equal to 3% of the aggregate number of shares of common stock sold in
the financing. Pursuant to the terms of the agreement and in connection
with the completion of the private offering described above, the
F-16
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
Company paid NESC $1,168,800, (net of a reduction of $183,600, as
agreed on March 18, 2005), and issued to NESC placement warrants to
purchase 450,800 shares of the Company's common stock exercisable at
$3.00 per share. The Company also paid Chadbourn $627,600 and issued to
Chadbourn placement warrants to purchase 212,700 shares of the
Company's common stock exercisable at $3.00 per share.
In April 2005, the Company entered into a consulting agreement in the
amount of $180,000 with NESC. Under the terms of the agreement, the
Company paid an initial payment of $30,000 and will continue to make
monthly payments of $12,500 through April 1, 2006.
CASUALTY LOSS - In January 2004, canola stored in one of the silos at
the Company's Madera County, California facility caught on fire. The
facility was fully insured with $10 million of property and general
liability insurance. The canola was owned by a third party who was also
insured. The insurance company has paid $1,000,000 to date and has
estimated that an additional $3,000,000 of payments will be made to the
Company. The Company has received a detailed engineering estimate for
full restoration and is proceeding with the restoration.
ETHANOL PURCHASE AND MARKETING AGREEMENT - On March 4, 2005, Kinergy
entered into an Ethanol Purchase and Marketing Agreement with the owner
of an ethanol production facility. The agreement is effective for two
years with automatic renewals for additional one-year periods
thereafter unless a party to the agreement delivers written notice of
termination at least 60 days prior to the end of the original or
renewal term. Under the agreement, Kinergy is to provide denatured fuel
ethanol marketing services for the production facility. Kinergy is to
have the exclusive right to market and sell all of the ethanol from the
facility, an estimated 20 million gallons-per-year. Kinergy is to pay
the owner the gross payments received by Kinergy from third parties for
forward sales of ethanol less certain transaction costs and fees. From
the gross payments, Kinergy may deduct transportation costs and
expenses incurred by or on behalf of Kinergy in connection with the
marketing of ethanol pursuant to the agreement, including truck, rail
and terminal fees for the transportation of the facility's ethanol to
third parties and may also deduct and retain a 1.0% marketing fee
calculated after deducting these costs and expenses.
CONSULTING AGREEMENT- On April 27, 2005, the Company engaged a
consulting firm to explore capital raising alternatives. The Company
paid the consulting firm an initial engagement fee of $300,000 upon
execution of its engagement agreement. The engagement agreement also
requires an additional engagement fee, the amount of which is dependent
upon the number of the Company's projects to be financed. The
additional engagement fee has a range of a minimum of $300,000 and a
maximum of one-half of one percent (1/2%) of the capital raised, and is
payable upon the occurrence of certain events. In addition, the Company
is obligated to pay to the consulting firm an arrangement fee of three
percent (3%) of the capital raised, which amount is payable upon the
closing of the financing transaction. If, however, the capital raised
finances only one Company project and the consulting firm arranges
additional financing to finance another Company project, the
arrangement fee under the second financing is to be three and one-half
percent (3.5%) but there shall be no additional engagement fee for the
second financing. The Company is also to pay to the consulting firm an
annual administration fee of $75,000 if one Company project is financed
and $100,000 if two Company projects are financed, which amounts are
payable for each year during which debt financing raised by the
consulting firm is outstanding.
F-17
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
EMPLOYMENT AGREEMENT - On August 10, 2005, the Company entered into an
Executive Employment Agreement with William Langley, its Chief
Financial Officer, that provides for a four-year term and automatic
one-year renewals thereafter, unless either Mr. Langley or the Company
provides written notice to the other at least 90 days prior to the
expiration of the then-current term. Mr. Langley is to receive a base
salary of $185,000 per year. Mr. Langley is entitled to six months of
severance pay effective throughout the entire term of his agreement and
is also entitled to reimbursement of his costs associated with his
relocation to Fresno, California. Mr. Langley is obligated to relocate
to Fresno, California within six months of the date of his Executive
Employment Agreement.
RESOURCES AGREEMENT - Effective August 10, 2005, the Company entered
into a resources agreement with Tatum CFO Partners ("Tatum") relating
to the Executive Employment Agreement with William Langley, its Chief
Financial Officer, whereby the Company agreed to pay as compensation
for resources to be provided by Tatum, a lump sum signing fee of
$69,375 and $1,000 per month during the term of the Resources
Agreement, which remains in effect for the duration of Mr. Langley's
employment with the Company. In addition, on August 10, 2005, the
Company granted options to purchase an aggregate of 75,000 shares of
the Company's common stock at an exercise price equal to $8.03, the
closing price per share of the Company's common stock on the day
immediately preceding that date, to Tatum CFO Partners. The agreement
requires that of the options to be issued in the future, if any, to
William G. Langley, the Company's Chief Financial Officer, 15% of such
options are to be issued to Tatum.
ETHANOL MARKETING AGREEMENT - On August 31, 2005, Kinergy entered into
an Ethanol Marketing Agreement with the owner of an ethanol production
facility. The agreement is effective for three years with automatic
renewals for additional one-year periods thereafter unless a party to
the agreement delivers written notice of termination at least 60 days
prior to the end of the original or renewal term. Under the agreement,
Kinergy is to provide denatured fuel ethanol marketing services for the
production facility. Kinergy is to have the exclusive right to market
and sell all of the ethanol from the facility, an estimated 40 million
gallons-per-year. Kinergy is to pay the owner the gross payments
received by Kinergy from third parties for forward sales of ethanol
(the "Purchase Price") less certain transaction costs and fees. From
the Purchase Price, Kinergy may deduct all reasonable out-of-pocket and
documented costs and expenses incurred by or on behalf of Kinergy in
connection with the marketing of ethanol pursuant to the agreement,
including truck, rail and terminal costs for the transportation and
storage of the facility's ethanol to third parties and reasonable,
documented out-of-pocket expenses incurred in connection with the
negotiation and documentation of sales agreements between Kinergy and
third parties (the "Transaction Costs"). From the Purchase Price,
Kinergy may also deduct and retain the product of 1.0% multiplied by
the difference between the Purchase Price and the Transaction Costs. In
addition, Kinergy is to split the profit from any logistical arbitrage
associated with ethanol supplied by the facility.
F-18
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
OPTION TO ACQUIRE LAND - On August 22, 2005, the Company entered into
an Option Agreement to acquire approximately 60 acres of unimproved
real property at a purchase price of $7,500 per acre, for the purpose
of developing an ethanol plant. The Company paid $50,000 as option
consideration on the grant date and an additional $100,000 will be due
on the 1st and 2nd anniversary dates of the grant date. The option
payments will be applied to the purchase price in the event the option
is exercised. The Company must make additional quarterly non-refundable
option payments of 2.5% of the total anticipated purchase price less
option payment(s) made to date until the option is exercised or
expired. This option expires on August 21, 2008.
OPTION TO LEASE - On August 17, 2005, the Company entered into a Letter
of Intent for an option to lease approximately 25 acres for the purpose
of developing an ethanol plant. The term of the option is for a period
of one year, beginning August 10, 2005. The Company paid $10,000 as
consideration for the option.
6. SUBSEQUENT EVENTS:
------------------
PURCHASE AGREEMENT - On August 10, 2005, the Company entered into a
Membership Interest Purchase Agreement with certain holders of a
limited liability company under which the Company intended to purchase
all of the outstanding membership interests of the limited liability
company. The limited liability company is the owner of a
newly-constructed ethanol production facility in Goshen, California
that is undergoing initial start-up testing. The purchase price,
subject to certain adjustments, was $48 million, payable in
approximately $31 million in cash, the assumption of approximately $9
million in debt and the issuance by the Company to the members of the
limited liability company of an aggregate of $8 million in convertible
subordinated promissory notes. To the extent that debt actually assumed
by the Company was greater or less than $9 million, the cash payment of
approximately $31 million was to be reduced or increased, respectively,
by an equal amount. The closing of the transaction was subject to the
satisfaction of certain conditions, including the securing by the
Company of all funding necessary to finance the transaction,
satisfactory results of the Company's due diligence and the Company's
ability to obtain the agreement of all members of the limited liability
company. The agreement was to terminate automatically in the event that
the closing of the purchase transaction did not occur by the earlier of
October 15, 2005 and the sixtieth day following the satisfaction of a
certain ethanol production milestone.
The deadline for the closing of the transaction contemplated by the
agreement was October 15, 2005. This deadline was not met and was not
waived by any party to the agreement; accordingly, the agreement
terminated automatically on October 15, 2005.
OPTION TO LEASE - On October 5, 2005, the Company entered into an
Agreement of Option to Lease approximately 15 acres for the purpose of
developing an ethanol plant. The Company paid a $5,000 refundable
option deposit and $5,000 non-refundable option payment to be credited
to the first payment(s) of base rent payable under the lease. The
parties have 60 days from the date of the option agreement to finalize
the terms and conditions of the lease. The option expires on January
30, 2006 if the Company does not extend the option per the terms of the
agreement.
F-19
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
LOAN REVISION/EXTENSION AGREEMENT - On November 1, 2005, Kinergy
executed a Loan Revision/Extension Agreement (the "Agreement") dated
October 4, 2005 with Comerica Bank. The Agreement is effective as of
June 20, 2005 and relates to a Master Revolving Note dated September
24, 2004 in the amount of $2 million, as further described below. Under
the Agreement, the maturity date of the Master Revolving Note was
extended from October 5, 2005 to October 5, 2006. As of the execution
date of the Agreement, no amounts were owed to Comerica under the
Master Revolving Note. Principal amounts outstanding under the Note
accrue interest, on a per annum basis, at the prime rate of interest
plus 1.0%.
In connection with the Revision/Extension Agreement, certain other
agreements were also entered into with Comerica by Kinergy and the
Company. A Letter Agreement provides for the delivery by Kinergy of
certain financial documents and includes certain financial covenants
and limitations. In addition, Kinergy is obligated to provide to
Comerica annual audited financial statements and quarterly financial
statements as well as quarterly accounts receivable and accounts
payable ageing reports. A Guaranty dated October 4, 2005 in favor of
Comerica was executed by the Company and relates to the Agreement and
the Master Revolving Note described above and any other obligations of
Kinergy to Comerica. Under the Guaranty, the Company guarantees payment
and performance of all indebtedness and obligations of Kinergy to
Comerica. A Security Agreement dated as of September 24, 2004 was
executed by Kinergy in favor of Comerica in connection with Kinergy's
indebtedness and obligations under the Master Revolving Note and other
agreements with Comerica. The Security Agreement grants a continuing
security interest and lien to Comerica in certain collateral comprising
essentially all of Kinergy's assets. Kinergy is obligated to keep the
collateral free of all liens, claims and encumbrances other than those
in favor of Comerica.
AMENDED AND RESTATED PHASE 1 DESIGN-BUILD AGREEMENT - On November 2,
2005, Pacific Ethanol Madera LLC ("PEI Madera"), a wholly-owned
subsidiary of the Company, entered into an Amended and Restated Phase 1
Design-Build Agreement (the "Amended Agreement") with a builder
("Builder"). The Amended Agreement amended and restated that certain
Standard Form of Design-Build Agreement and General Conditions dated
July 7, 2003 between Builder and PEI California. The Amended Agreement
provides for design and build services to be rendered by Builder to PEI
Madera with respect to an ethanol production facility currently under
construction in Madera County, California (the "Project"). Under the
Amended Agreement, Builder is to operate in a general contractor
capacity and procure engineering and construction services from third
parties. The Amended Agreement stipulates that the engineer for the
Project is to be Delta-T Corporation. The Amended Agreement provides
for a guaranteed maximum price proposal of $15.0 million. However, PEI
Madera is liable for additional costs to the extent that the scope of
work actually performed by Builder exceeds the scope of work that is
the basis for the guaranteed maximum price. In addition, the cost of
services performed directly by the engineer for the Project, Delta-T
Corporation, is not included in such guaranteed maximum price. The
completion date of the work contemplated by the Amended Agreement is to
be November 20, 2005.
PEI Madera may terminate the Amended Agreement but must pay Builder for
all costs associated with the work on the Project. If PEI Madera
terminates the Amended Agreement and selects another design-builder,
then PEI Madera is to pay for all costs associated with the work on the
F-20
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
Project as well as a $5.0 million premium. PEI Madera is also required
to pay Builder fair compensation for all equipment retained by Builder
and PEI Madera is required to assume all obligations, commitments and
unsettled claims that Builder has undertaken or incurred in good faith
in connection with the work on the Project. In the event that Builder
fails to perform any of its material obligations under the Amended
Agreement, PEI Madera may terminate the Amended Agreement without the
obligation to pay the $5.0 million premium but only after such failure
continues for forty-five days following receipt by Builder of written
notice of such failure.
PHASE 2 DESIGN-BUILD AGREEMENT - On November 2, 2005, PEI Madera
entered into a Phase 2 Design-Build Agreement (the "Phase 2 Agreement")
with Builder. The Phase 2 Agreement covers additional work to be
performed by Builder for the completion of the Project. The final
completion date of the work contemplated by the Phase 2 Agreement is
five hundred forty-five days after PEI Madera's notice to Builder to
proceed. As of the date of this report, PEI Madera has not yet
delivered its notice to proceed to Builder. The Phase 2 Agreement
provides for a guaranteed maximum price proposal of approximately $34.0
million. However, PEI Madera is liable for additional costs to the
extent that the scope of work actually performed by Builder exceeds the
scope of work that is the basis for the guaranteed maximum price. In
the event that the total costs and fees for Phase 2 of the Project are
less than the guaranteed maximum price of approximately $34.0 million,
then Builder and PEI Madera are to share such difference equally.
Delays in work beyond the substantial completion date not caused by PEI
Madera will result in PEI Madera being entitled to liquidated damages.
These liquidated damages are to be calculated as $23,000 per day
multiplied by one minus the daily operating rate for such day. The
daily operating rate is calculated based on the actual operating
capacity for that day (expressed in millions of gallons per year)
divided by thirty-five million gallons. As an incentive bonus for
achieving substantial completion prior to the specified date, PEI
Madera is to pay to Builder $12,500 per day for each day in advance of
such date. Fifty percent of any bonus is payable within thirty days
after substantial completion and the remaining fifty percent is payable
once final completion is achieved. The aggregate amount of any
liquidated damages or incentive bonus is not to exceed $2.5 million.
LETTER AGREEMENT - On November 2, 2005, PEI California entered into a
Letter Agreement (the "Letter Agreement") with Builder. The Letter
Agreement relates to the Amended Agreement and the Phase 2 Agreement
described above. Under the Letter Agreement, in the event that Builder
pays performance liquidated damages to PEI Madera under the Phase 2
Agreement as a result of a defect attributable Delta-T Corporation, the
engineer for the Project, or in the event that Builder pays liquidated
damages to PEI Madera under the Phase 2 Agreement as a result of a
delay that is attributable to Delta-T Corporation, then PEI California
agrees to reimburse Builder for such liquidated damages. However, PEI
California is not responsible for the first $2.0 million of
reimbursement. In addition, in the event that Builder recovers amounts
from Delta-T Corporation for such defect or delay, then Builder will
not seek reimbursement from PEI California. The aggregate reimbursement
obligations of PEI California under the Letter Agreement are not to
exceed $8.1 million.
F-21
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
CONTINUING GUARANTY (JONES) - On November 3, 2005, William L. Jones, a
related party and the Chairman of the Board of Directors of the
Company, executed a Continuing Guaranty (the "Jones Guaranty") in favor
of Builder. Under the Jones Guaranty, Mr. Jones guarantees to Builder
the payment obligations of PEI California under the Letter Agreement.
Under the Jones Guaranty, Builder is to seek payment on a pro rata
basis from Mr. Jones and Neil Koehler (as described below), but in the
event that Mr. Koehler fails to make payment, then Mr. Jones is
responsible for any shortfall. However, the full extent of Mr. Jones'
liability under the Jones Guaranty, including for any shortfall for
non-payment by Mr. Koehler, is limited to $4.0 million plus any
attorneys' fees, costs and expenses.
CONTINUING GUARANTY (KOEHLER) - On November 3, 2005, Neil Koehler, a
related party and Chief Executive Officer and President and a member of
the Board of Directors of the Company, executed a Continuing Guaranty
(the "Koehler Guaranty") in favor of Builder. Under the Koehler
Guaranty, Mr. Koehler guarantees to Builder the payment obligations of
PEI California under the Letter Agreement. Under the Koehler Guaranty,
Builder is to seek payment on a pro rata basis from Messrs. Jones (as
described above) and Koehler, but in the event that Mr. Jones fails to
make payment, then Mr. Koehler is responsible for any shortfall.
However, the full extent of Mr. Koehler's liability under the Koehler
Guaranty, including for any shortfall for non-payment by Mr. Jones, is
limited to $4.0 million plus any attorneys' fees, costs and expenses.
F-22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes to financial
statements included elsewhere in this report. This report and our condensed
consolidated financial statements and notes to 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
earn if we are successful in implementing our business strategies. The
forward-looking statements and associated risks may include, relate to or be
qualified by other important factors, including, without limitation:
o the projected growth or contraction in the ethanol market in
which we operate;
o fluctuations in the market price of ethanol;
o our business strategy for expanding, maintaining or
contracting our presence in this market;
o our ability to obtain the necessary financing to complete
construction of our planned ethanol production facilities,
including our facility in Madera County, California;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and
future competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
Any of the factors described above or in the "Risk Factors" section
could cause our financial results, including our net income or loss or growth in
net income or loss to differ materially from prior results, which in turn could,
among other things, cause the price of our common stock to fluctuate
substantially.
OVERVIEW
Our primary goal is to become a leader in the production, marketing
and sale of ethanol and other renewable fuels in the Western United States.
Through our wholly-owned subsidiary, Kinergy Marketing, LLC, or
Kinergy, we are currently engaged in the business of marketing ethanol in the
Western United States. We provide transportation, storage and delivery of
ethanol through third-party service providers. We sell ethanol primarily in
California, Nevada, Arizona and Oregon and have extensive customer relationships
throughout the Western United States and extensive supplier relationships
throughout the Western and Midwestern United States. We do not currently produce
any ethanol that we sell. Until we commence the production of ethanol, if at
all, we expect our operations to consist primarily of the marketing and sale of
ethanol produced by third-parties. Accordingly, we expect that unless and until
we complete the construction of our initial ethanol production facility in
Madera County our consolidated net sales will consist solely of net sales
generated by Kinergy. We anticipate that our net sales will grow in the
long-term as demand for ethanol increases and as a result of our marketing
agreements with third-party ethanol producers.
We believe that we have a competitive advantage due to the market
niche that we have developed by supplying ethanol to customers in several major
metropolitan and rural markets in California and other Western states. We also
believe that the experience of our management over the past two decades and the
operations Kinergy has conducted over the past four years have enabled us to
establish valuable relationships in the ethanol marketing industry.
2
Through our wholly-owned subsidiary, Pacific Ethanol California, Inc.,
or PEI California, we are constructing an ethanol production facility in Madera
County to begin the production and sale of ethanol and its co-products if we are
able to secure all the necessary financing to complete construction of this
facility. To date, we have not obtained all of this financing. See "Risk Factors
- - Risks Relating to the Business of PEI California." We also intend to construct
or otherwise acquire additional ethanol production facilities as financing
resources and business prospects make the construction or acquisition of these
facilities advisable. PEI California has, to date, not conducted any significant
business operations other than the acquisition of real property located in
Madera County, on which we are constructing our first ethanol production
facility.
Our wholly-owned subsidiary, ReEnergy, LLC, or ReEnergy, does not
presently have any significant business operations or plans but does hold an
option to acquire real property in Visalia, California, on which we intend to
build an ethanol production facility.
Currently, ethanol represents only up to 3% of the total annual
gasoline supply in the United States. We believe that the ethanol industry has
substantial room to grow to reach what we estimate is an achievable level of at
least 10% of the total annual gasoline supply in the United States. An increase
in the demand for ethanol from California's current level of 5.7% to at least
10% of total annual gasoline supply would result in demand for approximately 700
million additional gallons of ethanol, representing an increase in annual demand
in California of approximately 75%. An additional 700 million gallons of ethanol
would represent an increase in annual demand of approximately 18% for the entire
United States.
Kinergy has two principal methods of conducting its ethanol marketing
and sales activities: direct sales and inventory sales. Kinergy's first method
of marketing and selling ethanol involves direct sales through which suppliers
deliver ethanol directly via rail to Kinergy's customers. For direct sales,
Kinergy typically matches ethanol purchase and sale contracts of like quantities
and delivery periods. These back-to-back direct sales typically involve no price
risks to Kinergy that otherwise may result from fluctuations in the market price
of ethanol. Kinergy's second method of marketing and selling ethanol involves
truck deliveries from inventory purchased by Kinergy in advance. For inventory
sales, as with direct sales, Kinergy typically matches ethanol purchase and sale
contracts of like quantities. However, timing differences do exist and
consequently, a back-to-back inventory sale may lag by up to two or more weeks.
This time lag results from inventory transit and turnover times. As a result,
Kinergy may supply ethanol under new inventory sales contracts from existing
inventory. These back-to-back inventory sales therefore involve some price risks
to Kinergy resulting from potential fluctuations in the market price of ethanol.
We believe that the only consistent price risk to Kinergy is currently
inventory risk. Management seeks to optimize transitions to new inventory sales
contracts and reduce the effects of declining ethanol prices by managing
inventory as carefully as possible to decrease inventory levels in anticipation
of declining ethanol prices. In addition, management seeks to increase inventory
levels in anticipation of rising ethanol prices. Because Kinergy increases
inventory levels in anticipation of rising ethanol prices and decreases
inventory levels in anticipation of declining ethanol prices, it is subject to
the risk of ethanol prices moving in unanticipated directions, which could
result in declining or even negative gross profit margins over certain periods
of time, but also enables Kinergy to potentially benefit from above-normal gross
profit margins.
Over the past few years, the market price of ethanol has experienced
significant fluctuations. More recently, the price of ethanol declined by
approximately 25% from its 2004 average price per gallon in five months from
January 2005 through May 2005 and reversed this decline and increased to
approximately 55% above its 2004 average price per gallon in four months from
June 2005 through September 2005. Since September 2005, the price of ethanol has
generally trended downward and the average price of ethanol during October 2005
3
and through mid-November 2005 was approximately 24% above its 2004 average price
per gallon. We believe that the market price of ethanol will, for the
foreseeable future, continue to experience significant fluctuations which may
cause our future results of operations to fluctuate significantly. As a result,
our historical results of operations may not be predictive of our future results
of operations.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and we believe will
continue to reduce margins, as compared to historical levels. Second, Kinergy is
emphasizing direct sales to a greater degree. Direct sales ordinarily have gross
profit margins of approximately 1.0% over periods of one year or more, a level
that is consistent with our recent ethanol marketing agreements with Front Range
Energy, LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol
marketing industry as a whole. Inventory sales ordinarily have base gross profit
margins of approximately 1.0% to 2.0%, assuming stability in the price of
ethanol, over periods of one year or more. We believe that, for our inventory
sales, gross profit margins above or below this range likely result from
fluctuations in the market price of ethanol. Historically, Kinergy's sales were
comprised to a greater degree of inventory sales that often involved the buying
and selling of ethanol based on anticipated trends in the market price of
ethanol. These inventory sales represented higher-risk positions but enabled
Kinergy to achieve higher margin levels, as compared to direct sales, as a
result of correctly anticipating fluctuations in the market price of ethanol. As
a result of highly-volatile ethanol prices, we are unable to estimate Kinergy's
future gross profit margins from inventory sales. However, we believe that over
longer periods of up to a year or more, our gross profit margin from inventory
sales is unlikely to exceed our historic high average gross profit margin of
4.4%.
If we are able to complete our ethanol production facility in Madera
County and commence producing ethanol, we expect our gross profit margins for
ethanol that we produce to be substantially higher than our gross profit margins
for Kinergy's direct sales and inventory sales activities. However, any gross
profits that we realize from the production of ethanol will be highly dependent
upon the prevailing market price of ethanol at the time of sale. Moreover, in
light of the recent and expected future volatility in the price of ethanol, we
are now, and expect for the foreseeable future to be, unable to estimate our
gross profit margins resulting from the sale of ethanol that we may produce.
Kinergy's gross profit margin declined by 56% from 3.9% in 2004 to
1.7% in the first quarter of 2005, declined further by 82% from 3.9% in 2004 to
0.7% in the second quarter of 2005 and increased by 59% from 3.9% in 2004 to
6.2% in the third quarter of 2005. Kinergy's gross profit margin for the full
nine months ended September 30, 2005 declined by 8% from 3.9% in 2004 to 3.6%.
Kinergy's gross profit margin in the first quarter of 2005 is generally
reflective of the contracted margins for that period. The decline in Kinergy's
gross profit margin in the second quarter of 2005 resulted primarily from the
transition from inventory sales contracts ending in the first quarter of 2005 to
new inventory sales contracts beginning in the second quarter of 2005 during a
period of rapidly declining market prices. As discussed above, because of the
time lag in delivering ethanol under new inventory sales contracts, Kinergy sold
ethanol under these contracts from existing inventory that was purchased at
levels higher than the prevailing market price at the time of sale. The increase
in Kinergy's gross profit margin in the third quarter of 2005 is generally
reflective of opportunistic buying and selling during a period of rapidly
increasing market prices. As noted above, the price of ethanol declined during
the first and second quarters of 2005 by approximately 25% from its 2004 average
price per gallon in five months from January 2005 through May 2005 and reversed
this decline and increased during the third quarter of 2005 to approximately 55%
above its 2004 average price per gallon in four months from June 2005 through
September 2005. Since September 2005, the price of ethanol has generally trended
downward and the average price of ethanol during October 2005 and through
mid-November 2005 was approximately 24% above its 2004 average price per gallon.
4
Management correctly anticipated a softening in the price ethanol in
early 2005, but neither management nor, we believe, the ethanol industry as a
whole, anticipated the speed and the extent of the decline in the price of
ethanol from January 2005 through May 2005. As a result, Kinergy was forced to
sell some ethanol at negative gross profit levels following the rapid and
extensive decline in the price of ethanol. In the second quarter of 2005, and
before ethanol prices increased to levels significantly higher than their recent
lows, Kinergy sold much of this ethanol inventory that was acquired at prices
higher than those prevailing at the time of sale. Accordingly, despite the
general increase in ethanol prices during the second quarter of 2005, this
inventory and these sales still had the effect of depressing Kinergy's gross
profit margin to 0.7% for the entire second quarter of 2005 and to 0.8% for the
six months ended June 30, 2005. However, as a result of the substantial increase
in the price of ethanol during the third quarter of 2005, and the opportunistic
buying and selling of ethanol during that period, Kinergy's gross profit margin
increased to 6.2% for the third quarter of 2005, a level significantly higher
than our gross profit margins for either the first or second quarters of 2005.
As noted above, our results in the third quarter of 2005 raised Kinergy's gross
profit margin to 3.6% for the nine months ended September 30, 2005.
Management decided to maintain net long ethanol positions in the first
and second quarters of 2005 as a result of a confluence of factors, including
its expectation of increased prices of gasoline and petroleum and anticipated
favorable federal legislation that we expected would increase the demand for and
price of ethanol over the short- and longer-terms. We believe that these factors
were, however, outweighed by a sudden but short-lived excess of ethanol supplied
to the market by a number of new ethanol production facilities. We believe that
the sudden and short-lived excess of ethanol supplied to the market coupled with
higher market-wide inventory levels caused the rapid and steep decline in the
price of ethanol. Following its rapid decline during January 2005 through May
2005, the price of ethanol reversed and subsequently increased to unprecedented
high levels from June 2005 through September 2005. We believe that this increase
in the price of ethanol demonstrates that the fundamental factors considered by
management in deciding to maintain net long ethanol positions ultimately were
the prevailing forces in driving the price of ethanol to unprecedented high
levels. In addition, we believe that these factors contributed and will continue
to contribute to the market's relatively quick absorption of the additional
supply of ethanol that was, and that continues to be, supplied to the market by
new ethanol production facilities.
SHARE EXCHANGE TRANSACTION
On March 23, 2005, we completed a share exchange transaction, or the
Share Exchange Transaction, with the shareholders of PEI California, and the
holders of the membership interests of each of Kinergy and ReEnergy, pursuant to
which we acquired all of the issued and outstanding shares of capital stock of
PEI California and all of the outstanding membership interests of each of
Kinergy and ReEnergy. Immediately prior to the consummation of the share
exchange, our predecessor, Accessity, reincorporated in the State of Delaware
under the name "Pacific Ethanol, Inc." through a merger of Accessity with and
into its then-wholly-owned Delaware subsidiary named Pacific Ethanol, Inc.,
which was formed for the purpose of effecting the reincorporation. We are the
surviving entity resulting from the reincorporation merger and have three
principal wholly-owned subsidiaries: Kinergy, PEI California and ReEnergy.
In connection with the Share Exchange Transaction, we issued an
aggregate of 20,610,987 shares of common stock to the shareholders of PEI
California, 3,875,000 shares of common stock to the limited liability company
member of Kinergy and an aggregate of 125,000 shares of common stock to the
limited liability company members of ReEnergy. In addition, holders of options
5
and warrants to acquire an aggregate of 3,157,587 shares of common stock of PEI
California were, following the consummation of the Share Exchange Transaction,
deemed to hold warrants to acquire an equal number of our shares of common
stock. Also, a holder of a promissory note convertible into an aggregate of
664,879 shares of common stock of PEI California was, following the consummation
of the Share Exchange Transaction, entitled to convert the note into an equal
number of shares of our common stock.
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting acquiror. As a
result, our results of operations for the nine months ended September 30, 2004
and the fiscal years 2004 and 2003 consist of the operations of PEI California
only. We have consolidated the results of PEI California, Kinergy and ReEnergy
beginning March 23, 2005, the date of the Share Exchange Transaction.
Accordingly, our results of operations for the nine months ended September 30,
2005 consist of the operations of PEI California for the entire nine month
period and the operations of the Company, Kinergy and ReEnergy from March 23,
2005 through September 30, 2005.
PEI California has, to date, not conducted any significant business
operations other than the acquisition of real property located in Madera County
on which we are constructing our first ethanol production facility. ReEnergy
does not presently have any significant business operations or plans but does
hold an option to acquire real property in Visalia, California, on which we
intend to build an ethanol production facility.
We have consolidated the results of operations of Kinergy beginning
from March 23, 2005, the date of the closing of the Share Exchange Transaction.
We expect that, until we complete construction of our ethanol production
facility in Madera County, our operations will consist solely of operations
conducted by Kinergy.
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with the Share Exchange Transaction (as
restated):
Current assets............................. $ 7,014,196
Property, plant and equipment.............. 6,224
Intangibles, including goodwill............ 10,935,750
--------------
Total assets acquired................... 17,956,170
Current liabilities........................ 4,253,177
Other liabilities.......................... 83,017
--------------
Total liabilities assumed............... 4,336,194
--------------
Net assets acquired........................ $ 13,619,976
==============
Shares of common stock issued.............. 6,489,414
==============
The purchase price represented a significant premium over the recorded
net worth of the acquired entities' assets. In deciding to pay this premium, we
considered various factors, including the value of Kinergy's trade name,
Kinergy's extensive market presence and history, Kinergy's industry knowledge
and expertise, Kinergy's extensive customer relationships and expected synergies
with Kinergy's business and assets and our planned entry into the ethanol
production business.
6
The following table summarizes, on an unaudited pro forma basis, our
combined results of operations, as though the acquisitions occurred as of
January 1, 2004. The pro forma amounts give effect to appropriate adjustments
for amortization of intangibles and income taxes. The pro forma amounts
presented are not necessarily indicative of future operating results.
Nine Months
Ended September 30,
-------------------------------
2005 2004
------------- ------------
Net sales $ 75,135,987 $ 56,545,947
============= ============
Net loss $ (5,312,481) $ (3,273,338)
============= ============
Loss per share of common stock
Basic and diluted $ (0.19) $ (0.13)
============= ============
Prior to the Share Exchange Transaction, through its wholly-owned
subsidiary Sentaur Corp., Accessity was in the business of providing medical
billing recovery services for hospitals. Sentaur Corp.'s services were designed
to help hospitals recoup discounts improperly taken by insurance companies and
other institutional payors of medical treatments. In addition, through its
wholly-owned subsidiary DriverShield CRM Corp., Accessity was in the business of
providing internet-based vehicle repair management services, including collision
and general repair programs, estimating and auditing services and vehicle
rentals for insurance companies and affinity group members.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of net sales and expenses for
each period. The following represents a summary of our critical accounting
policies, defined as those policies that we believe are the most important to
the portrayal of our financial condition and results of operations and that
require management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effects of matters that are
inherently uncertain.
REVENUE RECOGNITION
We recognize revenue in accordance with SEC Staff Accounting Bulletin
No. 104, Revenue Recognition, and the related Emerging Task Force Issue No. EITF
99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, or EITF
99-19.
We derive revenue primarily from sales of ethanol. Our sales are based
upon written agreements or purchase orders that identify the amount of ethanol
to be purchased and the purchase price. Revenue is recognized, gross, upon
delivery of ethanol to a customer's designated ethanol tank. Shipments are made
to customers, variously, directly from suppliers and from our inventory to our
customers by truck or rail. Ethanol that is shipped by rail originates primarily
in the Midwest and takes from 10 to 14 days from date of shipment to be
delivered to the customer or to one of four terminals in California and Oregon.
For local deliveries the product is shipped by truck and delivered the same day
as shipment
In accordance with the criteria outlined in EITF 99-19, we record
ethanol sales revenue at gross. We generally take title to the ethanol, have
the contractual obligation to deliver ethanol that meets certain specifications
7
(hence to determine the nature, type, characteristics, or specifications of the
product or services ordered by the customer), negotiate the price of the
ethanol, are responsible for assuring fulfillment of the amount to be delivered,
select the supplier and make the decision as to which available inventory is
matched to which sales fulfillment (not always the same customer) and assume
credit risk for the amount billed to the customer. The presence of the
combination of these factors indicates that we have the risks and rewards of a
principal in these transactions and therefore we record revenue at the gross
amount.
INVENTORY
Inventory consists of fuel ethanol and is valued at the lower of cost
or market, cost being determined on a first-in first-out basis. Shipping,
handling and storage costs are classified as a component of cost of goods sold.
Title to ethanol transfers from the producer to us when the ethanol passes
through the inlet flange of our receiving tank.
INTANGIBLES, INCLUDING GOODWILL
We periodically evaluate our intangibles, including goodwill, for
potential impairment. Our judgments regarding the existence of impairment are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment of goodwill, we consider these
factors and forecast financial performance of the acquired businesses. If
forecasts are not met, we may have to record additional impairment charges not
previously recognized. In assessing the recoverability of our goodwill and other
intangibles, we must make assumptions regarding estimated future cash flows and
other factors to determine the fair value of those respective assets. If these
estimates or their related assumptions change in the future, we may be required
to record impairment charges for these assets that were not previously recorded.
If that were the case, we would have to record an expense in order to reduce the
carrying value of our goodwill.
In connection with the Share Exchange Transaction and our acquisition
of Kinergy and ReEnergy, we engaged a valuation firm to determine what portion
of the purchase price should be allocated to identifiable intangible assets.
Through that process, we have estimated that for Kinergy, the distribution
backlog is valued at $136,000, the customer relationships are valued at
$5,600,000 and the trade name is valued at $3,100,000. We issued stock valued at
$9,803,750 for the acquisition of Kinergy. In addition, certain stockholders
sold stock to the sole member of Kinergy and a related party, increasing the
purchase price by $1,012,000. The purchase price for Kinergy totaled
$10,815,750. Goodwill directly associated with the Kinergy acquisition therefore
totaled $1,979,750. The Kinergy trade name is determined to have an indefinite
life and therefore, rather than being amortized, is being periodically tested
for impairment. The distribution backlog has an estimated life of six months and
customer relationships were estimated to have a ten-year life and, as a result,
will be amortized accordingly, unless otherwise impaired at an earlier time.
We made a $150,000 cash payment and issued stock valued at $316,250 for
the acquisition of ReEnergy. In addition, certain stockholders sold stock to the
members of ReEnergy, increasing the purchase price by $506,000. The purchase
price for ReEnergy totaled $972,250. Of this amount, $120,000 was recorded as an
intangible asset for the fair value of a favorable option to acquire land and
because the acquisition of ReEnergy was not deemed to be an acquisition of a
business, the remaining purchase price of $852,250 was recorded as an expense
for services rendered in connection with a feasibility study. The ReEnergy land
option will expire on December 15, 2005 and will be expensed at that time if not
extended.
8
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2005 TO THE THREE MONTHS
ENDED SEPTEMBER 30, 2004
The following table sets forth certain of our operating data for the
three months ended September 30, 2005 and 2004:
Three Months Ended
---------------------------------
September 30,
2005 2004
--------------- --------------
Net sales (including $2,165,315 for the three months
ended September 30, 2005 to a related party).................... $ 26,414,305 $ 829
Cost of goods sold................................................. 24,778,592 0
--------------- --------------
Gross profit....................................................... 1,635,713 829
Selling, general and administrative expenses....................... 2,206,985 287,672
Non-cash compensation for consulting fees.......................... 406,331 345,000
--------------- --------------
Operating loss..................................................... (977,603) (631,843)
Other income/(expense)............................................. 55,819 (146,414)
--------------- --------------
Loss before provision for income taxes............................. (921,784) (778,257)
Provision for income taxes......................................... 800 6,000
--------------- --------------
Net loss........................................................... $ (922,584) $ (784,257)
=============== ==============
NET SALES. Net sales for the three months ended September 30, 2005
increased by $26,413,476 to $26,414,305 as compared to $829 for the three months
ended September 30, 2004. Sales attributable to the acquisition of Kinergy on
March 23, 2005 contributed $26,413,476 of this increase. Without the acquisition
of Kinergy, our net sales for the three months ended September 30, 2005 would
have been $0. This was due to ceasing our transloading services in order to
begin construction of our Madera County ethanol plant on this site.
GROSS PROFIT. Gross profit for the three months ended September 30,
2005 increased by $1,634,884 to $1,635,713 as compared to $829 for the three
months ended September 30, 2004, primarily due to the acquisition of Kinergy on
March 23, 2005. Gross profit as a percentage of net sales increased to 6.2% for
the three months ended September 30, 2005 as compared to 100% for the three
months ended September 30, 2004. This difference is attributable to the
acquisition of Kinergy on March 23, 2005.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and will continue to
reduce margins, as compared to historical levels. Second, Kinergy is emphasizing
direct sales to a greater degree. Direct sales ordinarily have gross profit
margins of approximately 1.0% over periods of one year or more, a level that is
consistent with our recent ethanol marketing agreements with Front Range Energy,
LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol marketing
industry as a whole.
Kinergy's gross profit margin increased by 59% from 3.9% in 2004 to
6.2% in the third quarter of 2005. The increase in Kinergy's gross profit margin
in the third quarter of 2005 is generally reflective of opportunistic buying and
selling during a period of rapidly increasing market prices.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended September 30, 2005 increased
by $1,919,313 (667%) to $2,206,985 as compared to $287,672 for the three months
9
ended September 30, 2004. This increase was primarily due to $588,332 in
additional legal, accounting and consulting fees, $202,304 from amortization of
intangibles and $293,068 in additional payroll expense related to three
executive employment agreements that became effective upon the consummation of
the Share Exchange Transaction on March 23, 2005, the addition of two staff
positions in May and June 2005, an employee promotion in May 2005, the addition
of two executive positions in June 2005 and the addition of two ethanol plant
management positions in September 2005. The increase in selling, general and
administrative expenses also was due to a $300,000 increase from the accrual of
a bonus due Neil Koehler under his employment agreement, a $154,918 increase
from expenses related to the termination of the proposed acquisition of Phoenix
Bio-Industries, LLC, $97,401 in additional research and development expenses, a
$40,423 increase in insurance expense related to the addition of a directors and
officers insurance policy in October 2004 and an insurance premium increase
effective June 2004 related to a silo fire that occurred in January 2004 at our
Madera County grain facility, a $78,725 increase in business travel expense, a
$30,581 increase in market and filing fees, a $27,212 increase in policy and
investor relations expenses, a $27,266 increase in marketing expense, a $19,633
increase in rents, a $12,944 increase in telephone expense, $11,790 related to
Kinergy LLC gross receipts fee, and the net balance of $34,715 related to
various increases in other selling, general and administrative expenses.
We expect that over the near term, our selling, general and
administration expenses will increase as a result of, among other things,
increased legal and accounting fees associated with increased corporate
governance activities in response to the Sarbanes-Oxley Act of 2002, recently
adopted rules and regulations of the Securities and Exchange Commission, the
filing of a registration statement with the Securities and Exchange Commission
to register for resale, in addition to other shares of our common stock, the
shares of common stock and shares of common stock underlying warrants PEI
California issued in its private offering in March 2005, increased employee
costs associated with planned staffing increases, increased sales and marketing
expenses, increased activities related to the construction of our Madera County,
California ethanol production facility and increased activity in searching for
and analyzing potential acquisitions.
NON-CASH COMPENSATION AND CONSULTING FEES. Non-cash compensation and
consulting fees for the three months ended September 30, 2005 increased by
$61,331 (18%) to $406,331 as compared to $345,000 for the three months ended
September 30, 2004. Of this increase, $70,500 was related to non-cash consulting
fees for stock options granted to a consulting firm in connection with the
employment of our Chief Financial Officer, $46,800 related to non-cash
compensation from stock options granted in connection with the hiring of two
ethanol plant managers, $21,656 related to non-cash compensation from stock
options granted to reward employees for past performance, and $77,625 was a
decrease in fees related to non-cash consulting fees for warrants that were
granted in February 2004 and that vested over one year. We expect to incur
non-cash consulting fee expenses for warrants that vest ratably over two years
in connection with the consummation of the Share Exchange Transaction in the
amount of $89,125 per month for the remainder of the two-year term ending on
March 23, 2007.
OTHER INCOME/(EXPENSE). Other income/(expense) increased by $202,233
to $55,819 for the three months ended September 30, 2005, as compared to
($146,414) for the three months ended September 30, 2004, primarily due to
approximately $110,950 in interest income on cash held in seven day investment
accounts and a net decrease of $91,283 in interest expense related to long-term
debt, amortization of discount, and construction payables, net of capitalized
interest related to our planned Madera County ethanol plant.
10
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2005 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2004
The following table sets forth certain of our operating data for the
nine months ended September 30, 2005 and 2004
Nine Months Ended
September 30,
---------------------------------
2005 2004
-------------- --------------
Net sales (including $4,017,322 for the nine months ended
September 30, 2005 to a related party).......................... $ 51,530,735 $ 16,832
Cost of goods sold................................................. 49,695,870 10,789
-------------- --------------
Gross profit....................................................... 1,834,865 6,043
Selling, general and administrative expenses....................... 3,999,653 714,730
Services rendered in connection with feasibility study............. 852,250 --
Non-cash compensation for consulting fees.......................... 1,749,967 862,500
-------------- --------------
Operating loss..................................................... (4,767,005) (1,571,187)
Other expense...................................................... (33,740) (413,358)
-------------- --------------
Loss before provision for income taxes............................. (4,800,745) (1,984,545)
Provision for income taxes......................................... 5,600 8,400
-------------- --------------
Net Loss........................................................... $ (4,806,345) $ (1,992,945)
-------------- --------------
NET SALES. Net sales for the nine months ended September 30, 2005
increased by $51,513,903 to $51,530,735 as compared to $16,832 for the nine
months ended September 30, 2004. Sales attributable to the acquisition of
Kinergy on March 23, 2005 contributed $51,513,903 of this increase. Without the
acquisition of Kinergy, our net sales would have been $0. This was due to
ceasing our transloading services in order to begin construction of our Madera
County ethanol plant on this site.
GROSS PROFIT. Gross profit for the nine months ended September 30,
2005 increased by $1,828,822 to $1,834,865 as compared to $6,043 for the nine
months ended September 30, 2004, primarily due to the acquisition of Kinergy on
March 23, 2005. Gross profit as a percentage of net sales decreased to 3.6% for
the nine months ended September 30, 2005 as compared to 36% for the nine months
ended September 30, 2004. This difference is attributable to the acquisition of
Kinergy on March 23, 2005.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and will continue to
reduce margins, as compared to historical levels. Second, Kinergy is emphasizing
direct sales to a greater degree. Direct sales ordinarily have gross profit
margins of approximately 1.0% over periods of one year or more, a level that is
consistent with our recent ethanol marketing agreements with Front Range Energy,
LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol marketing
industry as a whole.
Kinergy's gross profit margin declined by 8% from 3.9% in 2004 to 3.6%
for the nine months ended September 30, 2005. The decline in Kinergy's gross
profit margin for the first nine months of 2005 resulted primarily from a
combination of factors. The transition from inventory sales contracts ending in
the first quarter of 2005 to new inventory sales contracts beginning in the
second quarter of 2005 during a period of rapidly declining market prices
reduced gross profit margins for the first and second quarters of 2005. This
reduction was offset by rapidly increasing market prices during the third
quarter of 2005 resulting in a gross profit margin of 6.2% for that period and a
combined gross profit margin of 3.6% for the nine months ended September 30,
11
2005. Kinergy sold ethanol under these contracts from existing inventory that
was purchased at levels higher than the prevailing market price at the time of
sale in the second quarter of 2005 and conversely sold ethanol under these
contracts from existing inventory that was purchase at levels lower than the
prevailing market price at the time of sale in the third quarter. Accordingly,
the fluctuation in ethanol prices during the nine months ended September 30,
2005, had the net effect of reducing Kinergy's gross profit margin by 8% from
3.9% in 2004 to 3.6% for the nine months ended September 30, 2005.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the nine months ended September 30, 2005 increased
by $3,284,923 (460%) to $3,999,653 as compared to $714,730 for the nine months
ended September 30, 2004. This increase was primarily due to $1,227,250 in
additional legal, accounting and consulting fees, $427,668 for amortization of
intangibles and $506,292 in additional payroll expense related to the three
executive employment agreements that became effective upon the consummation of
the Share Exchange Transaction on March 23, 2005, the addition of two staff
positions in May and June 2005, an employee promotion in May 2005, the addition
of two executive positions in June 2005, the addition of two high-level ethanol
plant management positions in September 2005. The increase in selling, general
and administrative expenses also was due to a $300,000 increase from the accrual
of a bonus due Neil Koehler under his employment agreement, $143,998 in
additional insurance expense related to the addition of a directors and officers
insurance policy in October 2004, the addition of a property and general
liability policy for Kinergy in April, and an insurance premium increase
effective June 2004 related to a silo fire that occurred in January 2004 at our
Madera County grain facility, a $154,918 increase for expenses related to the
termination of the proposed acquisition of Phoenix Bio-Industries, LLC, a
$128,259 increase in business travel expenses, a $97,401 increase in research
and development expense, a $63,818 increase in market and filing fees, a $61,300
increase in policy and investor relations expenses, a $41,281 increase in rents,
a $35,909 increase in marketing expense, an $18,665 increase in dues and trade
memberships, a $15,260 increase in telephone expense, a $7,158 increase in bad
debt expense, and the net balance of $55,746 related to various increases in
other selling, general and administrative expenses.
We expect that over the near term, our selling, general and
administration expenses will increase as a result of, among other things,
increased legal and accounting fees associated with increased corporate
governance activities in response to the Sarbanes-Oxley Act of 2002, recently
adopted rules and regulations of the Securities and Exchange Commission, the
filing of a registration statement with the Securities and Exchange Commission
to register for resale the shares of common stock and shares of common stock
underlying warrants issued in various private offerings, increased employee
costs associated with planned staffing increases, increased sales and marketing
expenses, increased activities related to the construction of our Madera County
ethanol production facility and increased activity in searching for and
analyzing potential acquisitions.
SERVICES RENDERED IN CONNECTION WITH FEASIBILITY STUDY. Services
rendered in connection with feasibility study for the nine months ended
September 30, 2005 increased by $852,250 (100%) as compared to $0 for the nine
months ended September 30, 2004. This expense arose in connection with the
acquisition of ReEnergy and relates to a feasibility study for an ethanol plant
in Visalia, California. Based on this study, ReEnergy entered into an option to
buy land for the ethanol plant site at a fixed price of $12,000 per acre.
NON-CASH COMPENSATION AND CONSULTING FEES. Non-cash compensation and
consulting fees for the nine months ended September 30, 2005 increased by
$887,467 (103%) to $1,749,967 as compared to $862,500 for the nine months ended
September 30, 2004. Of this amount, $651,000 related to non-cash compensation
from stock grants in connection with the hiring of two employees, $232,250
related to a stock grant that vested upon closing of the Share Exchange
Transaction on March 23, 2005, $70,500 related to non-cash consulting fees for
12
stock options granted to a consulting firm in connection with the employment of
our Chief Financial Officer, $46,800 related to non-cash compensation for stock
options granted in connection with the hiring of two ethanol plant managers,
$21,656 related to non-cash compensation for stock options granted to reward
employees for past performance, and $134,739 related to a decrease in non-cash
consulting fees for warrants that were granted in February 2004 and that vested
over one year. We expect to incur non-cash consulting fee expenses for warrants
granted in connection with the consummation of the Share Exchange Transaction
that vest ratably over two years in the amount of $89,125 per month for the
remainder of the two-year term ending on March 23, 2007.
OTHER INCOME/(EXPENSE). Other income/(expense) increased by $379,618
to $(33,740) for the nine months ended September 30, 2005 as compared to
($413,358) for the nine months ended September 30, 2004, primarily due to
approximately $255,688 of interest income on cash held in seven day investment
accounts and a net decrease of $123,930 in interest expense related to long-term
debt, amortization of discount, and construction payables, net of capitalized
interest related to our planned Madera County ethanol plant.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2005, we funded our
operations primarily from net income of $1,377,138 from Kinergy and $18,879,749
in net proceeds we received in connection with a private offering of equity
securities on March 23, 2005, as described below. As of September 30, 2005, we
had working capital of $11,306,924, which represented a $12,331,671 increase
from negative working capital of $1,024,747 at December 31, 2004, primarily due
to the proceeds from the private offering. As of September 30, 2005 and December
31, 2004, we had accumulated deficits of $8,467,591 and $3,661,246,
respectively, and cash and cash equivalents of $11,344,034 and $42,
respectively.
Our current available capital resources consist primarily of
approximately $11.3 million in cash as of September 30, 2005. This amount was
primarily raised through the private offering by PEI California described below.
We expect that our future available capital resources will consist primarily of
any balance of the $11.3 million in cash as of September 30, 2005, cash
generated from Kinergy's ethanol marketing business, if any, and future debt
and/or equity financings, if any.
Accounts receivable increased $2,410,134 during the nine months ended
September 30, 2005 from $8,464 as of December 31, 2004 to $2,418,598 as of
September 30, 2005. Sales attributable to the acquisition of Kinergy contributed
substantially all of this increase.
Inventory balances increased $633,691 during the nine months ended
September 30, 2005, from $0 as of December 31, 2004 to $633,691 as of September
30, 2005 because of the acquisition of Kinergy. Inventory represented 1.6% of
our total assets as of September 30, 2005.
Cash used in our operating activities totaled $1,729,288 for the nine
months ended September 30, 2005 as compared to cash used by operating activities
of $120,991 for the nine months ended September 30, 2004. This $1,608,297
increase in cash used in operating activities primarily resulted from an
increase in pre-paid expenses.
Cash used in our investing activities totaled $6,321,638 for the nine
months ended September 30, 2005 as compared to $754,132 of cash used for the
nine months ended September 30, 2004. Included in the results for the nine
months ended September 30, 2005 are net cash of $307,808 used in connection with
the Share Exchange Transaction, net cash of $7,146,598 used to purchase
property, plant and equipment, $10,000 used for an option to acquire land,
$4,086 used for a security deposit, and net cash of $1,146,854 that we acquired
in connection with the Share Exchange Transaction.
13
Cash provided by our financing activities totaled $19,394,918 for the
nine months ended September 30, 2005 as compared to $846,947 for the nine months
ended September 30, 2004. The change is primarily due to the net proceeds of
$18,879,749 from a private offering of equity securities on March 23, 2005, as
further described below.
We have used a portion of the net proceeds from the private offering
that occurred in March 2005 to fund our working capital requirements and begin
site preparation at our Madera County site. We expect to use the remainder of
the net proceeds from this offering to fund our working capital requirements
over the next 12 months and to continue construction of our first ethanol
production facility in Madera County. These net proceeds, and additional debt
and/or equity capital that we intend to raise, are expected to be used as
follows for a total cost of completion of our Madera County ethanol production
facility estimated at approximately $55.0 million: grain and WDG handling ($1.2
million); site work ($2.3 million); building and concrete ($7.7 million); site
utilities ($3.3 million); process utilities ($3.9 million); mash preparation,
fermentation and carbon dioxide scrubbing ($2.4 million); distillation,
dehydration, separation and evaporation ($4.9 million); equipment installation
($1.8 million); piping ($5.7 million); electrical ($3.6 million); engineering
and general conditions ($12.5 million); and miscellaneous ($5.6 million). The
above amounts do not include up to $5.0 million in additional funding required
for capital raising costs and expenses. Significant additional funding is
required to complete construction of this ethanol facility and we may not be
successful in obtaining these additional funds.
See "Risk Factors."
On March 23, 2005, prior to the consummation of the Share Exchange
Transaction, PEI California issued to 63 accredited investors in a private
offering an aggregate of 7,000,000 shares of common stock at a purchase price of
$3.00 per share, two-year investor warrants to purchase 1,400,000 shares of
common stock at an exercise price of $3.00 per share and two-year investor
warrants to purchase 700,000 shares of common stock at an exercise price of
$5.00 per share, for total gross proceeds of approximately $21,000,000. PEI
California paid cash placement agent fees and expenses of approximately
$1,850,400 and issued five-year placement agent warrants to purchase 678,000
shares of common stock at an exercise price of $3.00 per share in connection
with the offering. Additional costs related to the financing include legal,
accounting and consulting fees that totaled approximately $272,366 through
September 30, 2005 and continue to be incurred in connection with various
securities filings and the registration statement described below.
We are obligated under a Registration Rights Agreement related to the
above financing to file, on the 151st day following March 23, 2005, a
Registration Statement with the Securities and Exchange Commission, or the
14
Commission, registering for resale shares of common stock, and shares of common
stock underlying investor warrants and certain of the placement agent warrants,
issued in connection with the private offering. If we (i) do not file the
Registration Statement within the time period prescribed, or (ii) fail to file
with the Commission a request for acceleration in accordance with Rule 461
promulgated under the Securities Act of 1933, within five trading days of the
date that we are notified (orally or in writing, whichever is earlier) by the
Commission that the Registration Statement will not be "reviewed," or is not
subject to further review, or (iii) the Registration Statement filed or required
to be filed under the Registration Rights Agreement is not declared effective by
the Commission on or before November 3, 2005, or (iv) after the Registration
Statement is first declared effective by the Commission, it ceases for any
reason to remain continuously effective as to all securities registered
thereunder, or the holders of such securities are not permitted to utilize the
prospectus contained in the Registration Statement to resell such securities,
for more than an aggregate of 45 trading days during any 12-month period (which
need not be consecutive trading days) (any such failure or breach being referred
to as an "Event," and for purposes of clause (i) or (iii) the date on which such
Event occurs, or for purposes of clause (ii) the date on which such five-trading
day period is exceeded, or for purposes of clause (iv) the date on which such
45-trading day-period is exceeded being referred to as "Event Date"), then in
addition to any other rights the holders of such securities may have under the
Registration Statement or under applicable law, then, on each such Event Date
and on each monthly anniversary of each such Event Date (if the applicable Event
shall not have been cured by such date) until the applicable Event is cured, we
are required to pay to each such holder an amount in cash, as partial liquidated
damages and not as a penalty, equal to 2.0% of the aggregate purchase price paid
by such holder pursuant to the Securities Purchase Agreement relating to such
securities then held by such holder. If we fail to pay any partial liquidated
damages in full within seven days after the date payable, we are required to pay
interest thereon at a rate of 18% per annum (or such lesser maximum amount that
is permitted to be paid by applicable law) to such holder, accruing daily from
the date such partial liquidated damages are due until such amounts, plus all
such interest thereon, are paid in full. The partial liquidated damages are to
apply on a daily pro-rata basis for any portion of a month prior to the cure of
an Event.
The Registration Rights Agreement also provides for customary
piggy-back registration rights whereby certain holders of shares of our common
stock, or warrants to purchase shares of our common stock, can cause us to
register such shares for resale in connection with our filing of a Registration
Statement with the Commission to register shares in another offering. The
Registration Rights Agreement also contains customary representations and
warranties, covenants and limitations.
The Registration Statement was not declared effective by the
Securities and Exchange Commission on or before 225 days following March 23,
2005. We endeavored to have all security holders entitled to these registration
rights execute amendments to the Registration Rights Agreement reducing the
penalty from 2.0% to 1.0% of the aggregate purchase price paid by such holder
pursuant to the Securities Purchase Agreement relating to such securities then
held by such holder. This penalty reduction applies to penalties accrued on or
prior to January 31, 2006 as a result of the related Registration Statement not
being declared effective by the Securities and Exchange Commission. Certain of
the security holders executed this amendment. However, not all security holders
executed this amendment and as a result, we paid an aggregate of $298,050 in
penalties on November 8, 2005, which will be recorded in the quarterly period
ending December 31, 2005.
We believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including the credit facilities we have and the remaining proceeds we have from
PEI California's March 2005 private offering, will be adequate to meet our
anticipated working capital and capital expenditure requirements for at least
the next twelve months. If, however, our capital requirements or cash flow vary
materially from our current projections, if unforeseen circumstances occur, or
if we require a significant amount of cash to fund future acquisitions, we may
require additional financing. Our failure to raise capital, if needed, could
restrict our growth, limit our development of new products or hinder our ability
to compete.
15
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant
on the financial condition or results of operations of either our company or our
operating subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4,"
SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle
facilities, excess freight and handling costs, and wasted materials (spoilage)
are required to be recognized as current period costs. The provisions of SFAS
No. 151 are effective for our fiscal 2006. We are currently evaluating the
provisions of SFAS No. 151 and do not expect that adoption will have a material
effect on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS 123R, SHARE-BASED PAYMENT
("SFAS 123R") which is a revision of SFAS 123 and supersedes Accounting
Principles Board ("APB") 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB
25"). Among other items, SFAS 123R eliminates the use of APB 25 and the
intrinsic value method of accounting, and requires companies to recognize the
cost of employee services received in exchange for awards of equity instruments,
based on the grant date fair value of those awards, in the financial statements.
The effective date of SFAS 123R is the first reporting period beginning after
December 15, 2005. SFAS 123R permits companies to adopt its requirements using
either a "modified prospective" method, or a "modified retrospective" method.
Under the "modified prospective" method, compensation cost is recognized in the
financial statements beginning with the effective date, based on the
requirements of SFAS 123R for all share-based payments granted after that date,
and based on the requirements of SFAS 123 for all unvested awards granted prior
to the effective date of SFAS 123R. Under the "modified retrospective" method,
the requirements are the same as under the "modified prospective" method, but
also permits entities to restate financial statements of previous periods based
on pro forma disclosures made in accordance with SFAS 123.
We currently utilize a standard option pricing model (i.e.,
Black-Scholes) to measure the fair value of stock options granted to employees.
While SFAS 123R permits entities to continue to use such a model, the standard
also permits the use of a "lattice" model. We have not yet determined which
model we will use to measure the fair value of employee stock options upon the
adoption of SFAS 123R.
We currently expect to adopt SFAS 123R effective January 1, 2006.
However, because we have not yet determined which of the aforementioned adoption
methods we will use, we have not yet determined the impact of adopting SFAS
123R.
RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN
ADDITION TO THE OTHER INFORMATION IN THIS REPORT AND IN OUR OTHER FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING OUR SUBSEQUENT REPORTS ON
FORMS 10-QSB AND 8-K, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS
BEFORE DECIDING TO INVEST IN SHARES OF OUR COMMON STOCK OR TO MAINTAIN OR
INCREASE YOUR INVESTMENT IN SHARES OF OUR COMMON STOCK. IF ANY OF THE FOLLOWING
RISKS ACTUALLY OCCUR, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. AS A RESULT, THE TRADING PRICE
OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL OF YOUR
INVESTMENT.
16
RISKS RELATED TO OUR COMBINED OPERATIONS
WE HAVE INCURRED SIGNIFICANT LOSSES IN THE PAST AND WE MAY INCUR
SIGNIFICANT LOSSES IN THE FUTURE. IF WE CONTINUE TO INCUR LOSSES, WE WILL
EXPERIENCE NEGATIVE CASH FLOW, WHICH MAY HAMPER OUR OPERATIONS, MAY PREVENT
US FROM EXPANDING OUR BUSINESS AND MAY CAUSE OUR STOCK PRICE TO DECLINE.
We have incurred losses in the past. As of September 30, 2005, we had
an accumulated deficit of approximately $8.5 million. For the nine months ended
September 30, 2005, we incurred a net loss of approximately $4.8 million. We
expect to incur losses for the foreseeable future and at least until the
completion of our initial ethanol production facility in Madera County,
California. We estimate that the earliest completion date of this facility and,
as a result, our earliest date of ethanol production, will not occur until the
fourth quarter of 2006. We expect to rely on cash from operations and debt and
equity financing to fund all of the cash requirements of our business. If our
net losses continue, we will experience negative cash flow, which may hamper
current operations and may prevent us from expanding our business. We may be
unable to attain, sustain or increase profitability on a quarterly or annual
basis in the future. If we do not achieve, sustain or increase profitability our
stock price may decline.
THE HIGH CONCENTRATION OF OUR SALES WITHIN THE ETHANOL PRODUCTION AND
MARKETING INDUSTRY COULD RESULT IN A SIGNIFICANT REDUCTION IN SALES AND
NEGATIVELY AFFECT OUR PROFITABILITY IF DEMAND FOR ETHANOL DECLINES.
Our revenue is and will continue to be derived primarily from sales of
ethanol. Currently, the predominant oxygenate used to blend with gasoline is
ethanol. Ethanol competes with several other existing products and other
alternative products could also be developed for use as fuel additives. We
expect to be completely focused on the production and marketing of ethanol and
its co-products for the foreseeable future. We may be unable to shift our
business focus away from the production and marketing of ethanol to other
renewable fuels or competing products. Accordingly, an industry shift away from
ethanol or the emergence of new competing products may reduce the demand for
ethanol. A downturn in the demand for ethanol would significantly and adversely
affect our sales and profitability.
WE PLAN TO FUND A SUBSTANTIAL MAJORITY OF THE CONSTRUCTION COSTS OF OUR
PLANNED ETHANOL PRODUCTION FACILITIES THROUGH THE ISSUANCE OF A SIGNIFICANT
AMOUNT OF DEBT, RESULTING IN SUBSTANTIAL DEBT SERVICE REQUIREMENTS THAT
COULD REDUCE THE VALUE OF YOUR INVESTMENT.
We plan to fund a substantial majority of the construction costs of
our planned ethanol production facilities through the issuance of a significant
amount of debt. For example, we anticipate that we will need to raise an
additional $60.0 million in debt financing to complete construction of our first
ethanol production facility in Madera County. As a result, our capital structure
will be highly leveraged. Our debt levels and debt service requirements could
have important consequences which could reduce the value of your investment,
including:
o limiting our ability to borrow additional amounts for
operating capital or other purposes and causing us to be able
to borrow additional funds only on unfavorable terms;
o reducing funds available for operations and distributions
because a substantial portion of our cash flow will be used to
pay interest and principal on our debt;
o making us vulnerable to increases in prevailing interest
rates;
o placing us at a competitive disadvantage because we may be
substantially more leveraged than some of our competitors;
o subjecting all or substantially all of our assets to liens,
which means that there may be no assets left for our
stockholders in the event of a liquidation; and
17
o limiting our ability to adjust to changing market conditions,
which could increase our vulnerability to a downturn in our
business or general economic conditions.
If we are unable to pay our debt service obligations, we could be
forced to reduce or eliminate dividends to our stockholders, if they were to
commence, and/or reduce or eliminate needed capital expenditures. It is possible
that we could be forced to sell assets, seek to obtain additional equity capital
or refinance or restructure all or a portion of our debt on substantially less
favorable terms. In the event that we are unable to refinance all or a portion
of our debt or raise funds through asset sales, sales of equity or otherwise, we
may be forced to liquidate and you could lose your entire investment.
GOVERNMENTAL REGULATIONS OR THE REPEAL OR MODIFICATION OF VARIOUS TAX
INCENTIVES FAVORING THE USE OF ETHANOL COULD REDUCE THE DEMAND FOR ETHANOL
AND CAUSE OUR SALES AND PROFITABILITY TO DECLINE.
Our business is subject to extensive regulation by federal, state and
local governmental agencies. We cannot predict in what manner or to what extent
governmental regulations will harm our business or the ethanol production and
marketing industry in general. For example the recent energy bill signed into
law by President Bush includes a national renewable fuels standard that requires
refiners to blend a percentage of renewable fuels into gasoline. This
legislation replaces the current oxygenate requirements in the State of
California and may potentially decrease the demand for ethanol in the State of
California. If the demand for ethanol in the State of California decreases, our
sales and profitability would decline.
The fuel ethanol business benefits significantly from tax incentive
policies and environmental regulations that favor the use of ethanol in motor
fuel blends in the United States. Currently, a gasoline marketer that sells
gasoline without ethanol must pay a federal tax of $0.18 per gallon compared to
$0.13 per gallon for gasoline that is blended with 10% ethanol. Smaller credits
are available for gasoline blended with lesser percentages of ethanol. The
repeal or substantial modification of the federal excise tax exemption for
ethanol-blended gasoline or, to a lesser extent, other federal or state policies
and regulations that encourage the use of ethanol could have a detrimental
effect on the ethanol production and marketing industry and materially and
adversely affect our sales and profitability.
VIOLATIONS OF ENVIRONMENTAL REGULATIONS COULD SUBJECT US TO SEVERE
PENALTIES AND MATERIALLY AND ADVERSELY AFFECT OUR SALES AND PROFITABILITY.
The production and sale of ethanol is subject to regulation by
agencies of the federal government, including, but not limited to, the EPA, as
well as other agencies in each jurisdiction in which ethanol is produced, sold,
stored or transported. Environmental laws and regulations that affect our
operations, and that are expected to affect our planned operations, are
extensive and have become progressively more stringent. Applicable laws and
regulations are subject to change, which could be made retroactively. Violations
of environmental laws and regulations or permit conditions can result in
substantial penalties, injunctive orders compelling installation of additional
controls, civil and criminal sanctions, permit revocations and/or facility
shutdowns. If significant unforeseen liabilities arise for corrective action or
other compliance, our sales and profitability could be materially and adversely
affected.
WE RELY HEAVILY ON OUR PRESIDENT AND CHIEF EXECUTIVE OFFICER, NEIL KOEHLER.
THE LOSS OF HIS SERVICES COULD ADVERSELY AFFECT OUR ABILITY TO SOURCE
ETHANOL FROM OUR KEY SUPPLIERS AND OUR ABILITY TO SELL ETHANOL TO OUR
CUSTOMERS.
Our success depends, to a significant extent, upon the continued
services of Neil Koehler, who is our President and Chief Executive Officer. For
example, Mr. Koehler has developed key personal relationships with our ethanol
18
suppliers and customers. We greatly rely on these relationships in the conduct
of our operations and the execution of our business strategies. The loss of Mr.
Koehler could, therefore, result in the loss of our favorable relationships with
one or more of our ethanol suppliers and customers. In addition, Mr. Koehler has
considerable experience in the construction, start-up and operation of ethanol
production facilities and in the ethanol marketing business. Although we have
entered into an employment agreement with Mr. Koehler, that agreement is of
limited duration and is subject to early termination by Mr. Koehler under
certain circumstances. In addition, we do not maintain "key person" life
insurance covering Mr. Koehler or any other executive officer. The loss of Mr.
Koehler could also significantly delay or prevent the achievement of our
business objectives.
THE ETHANOL PRODUCTION AND MARKETING INDUSTRY IS EXTREMELY COMPETITIVE.
MANY OF OUR SIGNIFICANT COMPETITORS HAVE GREATER FINANCIAL AND OTHER
RESOURCES THAN WE DO AND ONE OR MORE OF THESE COMPETITORS COULD USE THEIR
GREATER RESOURCES TO GAIN MARKET SHARE AT OUR EXPENSE. IN ADDITION, CERTAIN
OF OUR SUPPLIERS MAY CIRCUMVENT OUR MARKETING SERVICES, CAUSING OUR SALES
AND PROFITABILITY TO DECLINE.
The ethanol production and marketing industry is extremely
competitive. Many of our significant competitors in the ethanol production and
marketing industry, such as Archer-Daniels-Midland Company, or ADM, have
substantially greater production, financial, research and development, personnel
and marketing resources than we do. In addition, we are not currently producing
any ethanol that we sell and therefore are unable to capture the higher gross
profit margins generally associated with production activities. As a result, our
competitors, who are presently producing ethanol, may have greater relative
advantages resulting from greater capital resources due to higher gross profit
margins. As a result, our competitors may be able to compete more aggressively
and sustain that competition over a longer period of time than we could. Our
lack of resources relative to many of our significant competitors may cause us
to fail to anticipate or respond adequately to new developments and other
competitive pressures. This failure could reduce our competitiveness and cause a
decline in our market share, sales and profitability.
In addition, some of our suppliers are potential competitors and,
especially if the price of ethanol remains at historically high levels, they may
seek to capture additional profits by circumventing our marketing services in
favor of selling directly to our customers. If one or more of our major
suppliers, or numerous smaller suppliers, circumvent our marketing services, our
sales and profitability will decline.
OUR FAILURE TO MANAGE OUR GROWTH EFFECTIVELY COULD PREVENT US FROM
ACHIEVING OUR GOALS.
Our strategy envisions a period of rapid growth that may impose a
significant burden on our administrative and operational resources. The growth
of our business, and in particular, the completion of construction of our
planned ethanol production facilities, will require significant investments of
capital and management's close attention. In addition to our plans to construct
additional ethanol production facilities after the completion of our first
facility in Madera County, we have recently entered into significant marketing
agreements with Front Range Energy, LLC and Phoenix Bio-Industries, LLC, and we
are seeking to enter into additional similar agreements with companies that
currently, or expect to, produce ethanol, all of which may result in a
substantial growth in our marketing business. Our ability to effectively manage
our growth will require us to substantially expand the capabilities of our
administrative and operational resources and to attract, train, manage and
retain qualified management, technicians and other personnel. We may be unable
to do so. In addition, our failure to successfully manage our growth could
result in our sales not increasing commensurately with our capital investments.
If we are unable to successfully manage our growth, we may be unable to achieve
our goals.
19
RISKS RELATING TO THE BUSINESS OF KINERGY
KINERGY'S PURCHASE AND SALE COMMITMENTS AS WELL AS ITS INVENTORY OF ETHANOL
HELD FOR SALE SUBJECT US TO THE RISK OF FLUCTUATIONS IN THE PRICE OF
ETHANOL, WHICH MAY RESULT IN LOWER OR EVEN NEGATIVE GROSS PROFIT MARGINS
AND WHICH COULD MATERIALLY AND ADVERSELY AFFECT OUR PROFITABILITY.
Kinergy's purchases and sales of ethanol are not always matched with
sales and purchases of ethanol at prevailing market prices. Kinergy commits from
time to time to the sale of ethanol to its customers without corresponding and
commensurate commitments for the supply of ethanol from its suppliers, which
subjects us to the risk of an increase in the price of ethanol. Kinergy also
commits from time to time to the purchase of ethanol from its suppliers without
corresponding and commensurate commitments for the purchase of ethanol by its
customers, which subjects us to the risk of a decline in the price of ethanol.
In addition, Kinergy increases inventory levels in anticipation of rising
ethanol prices and decreases inventory levels in anticipation of declining
ethanol prices. As a result, Kinergy is subject to the risk of ethanol prices
moving in unanticipated directions, which could result in declining or even
negative gross profit margins. Accordingly, our business is subject to
fluctuations in the price of ethanol and these fluctuations may result in lower
or even negative gross margins and which could materially and adversely affect
our profitability.
KINERGY DEPENDS ON A SMALL NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF ITS
SALES. A REDUCTION IN BUSINESS FROM ANY OF THESE CUSTOMERS COULD CAUSE A
SIGNIFICANT DECLINE IN OUR OVERALL SALES AND PROFITABILITY.
The vast majority of Kinergy's sales are generated from a small number
of customers. During the first nine months of 2005, sales to Kinergy's two
largest customers that provided 10% or more of total sales represented
approximately 17% and 12%, respectively, representing an aggregate of
approximately 29%, of our total sales. During 2004, sales to Kinergy's four
largest customers that provided 10% or more of the total sales represented
approximately 13%, 12%, 12% and 12%, respectively, representing an aggregate of
approximately 49%, of our total sales. We expect that Kinergy will continue to
depend for the foreseeable future upon a small number of customers for a
significant majority of its sales. Kinergy's agreements with these customers
generally do not require them to purchase any specified amount of ethanol or
dollar amount of sales or to make any purchases whatsoever. Therefore, in any
future period, Kinergy's sales generated from these customers, individually or
in the aggregate, may not equal or exceed historical levels. If sales to any of
these customers cease or decline, Kinergy may be unable to replace these sales
with sales to either existing or new customers in a timely manner, or at all. A
cessation or reduction of sales to one or more of these customers could cause a
significant decline in our overall sales and profitability.
KINERGY'S LACK OF LONG-TERM ETHANOL ORDERS AND COMMITMENTS BY ITS CUSTOMERS
COULD LEAD TO A RAPID DECLINE IN OUR SALES AND PROFITABILITY.
Kinergy cannot rely on long-term ethanol orders or commitments by its
customers for protection from the negative financial effects of a decline in the
demand for ethanol or a decline in the demand for Kinergy's services. The
limited certainty of ethanol orders can make it difficult for us to forecast our
sales and allocate our resources in a manner consistent with our actual sales.
Moreover, our expense levels are based in part on our expectations of future
sales and, if our expectations regarding future sales are inaccurate, we may be
unable to reduce costs in a timely manner to adjust for sales shortfalls.
Furthermore, because Kinergy depends on a small number of customers for the vast
majority of its sales, the magnitude of the ramifications of these risks is
greater than if Kinergy's sales were less concentrated within a small number of
customers. As a result of Kinergy's lack of long-term ethanol orders and
commitments, we may experience a rapid decline in our sales and profitability.
20
KINERGY DEPENDS ON A SMALL NUMBER OF SUPPLIERS FOR THE VAST MAJORITY OF THE
ETHANOL THAT IT SELLS. IF ANY OF THESE SUPPLIERS IS UNABLE OR DECIDES NOT
TO CONTINUE TO SUPPLY KINERGY WITH ETHANOL IN ADEQUATE AMOUNTS, KINERGY MAY
BE UNABLE TO SATISFY THE DEMANDS OF ITS CUSTOMERS AND OUR SALES,
PROFITABILITY AND RELATIONSHIPS WITH OUR CUSTOMERS WILL BE ADVERSELY
AFFECTED.
Kinergy depends on a small number of suppliers for the vast majority
of the ethanol that it sells. During the first nine months of 2005, Kinergy's
four largest suppliers that provided 10% or more of total purchases made
represented approximately 28%, 21%, 19% and 11%, respectively, representing an
aggregate of approximately 80%, of the total ethanol Kinergy purchased for
resale. During 2004, Kinergy's three largest suppliers that provided 10% or more
of the total purchases made represented approximately 27%, 23% and 14%,
respectively, representing an aggregate of approximately 64% of the total
ethanol Kinergy purchased for resale. We expect that Kinergy will continue to
depend for the foreseeable future upon a small number of suppliers for a
significant majority of the ethanol that it purchases. In addition, Kinergy
sources the ethanol that it sells primarily from suppliers in the Midwestern
United States. The delivery of the ethanol that Kinergy sells is therefore
subject to delays resulting from inclement weather and other conditions. Also,
there is currently a substantial demand for ethanol which has, for most of 2005,
far exceeded ethanol production capacities and Kinergy's management has, from
time to time, found it very difficult to satisfy all the demands for ethanol by
Kinergy's customers. If any of these suppliers is unable or declines for any
reason to continue to supply Kinergy with ethanol in adequate amounts, Kinergy
may be unable to replace that supplier and source other supplies of ethanol in a
timely manner, or at all, to satisfy the demands of its customers. If this
occurs, our sales and profitability and Kinergy's relationships with its
customers will be adversely affected.
RISKS RELATING TO THE BUSINESS OF PEI CALIFORNIA
THE COMPLETION OF CONSTRUCTION OF OUR PLANNED ETHANOL PRODUCTION FACILITIES
WILL REQUIRE SIGNIFICANT ADDITIONAL FUNDING, WHICH WE EXPECT TO RAISE
THROUGH DEBT AND EQUITY FINANCING. WE MAY NOT BE SUCCESSFUL IN RAISING
ADEQUATE CAPITAL WHICH MAY FORCE US TO ABANDON CONSTRUCTION OF ONE OR MORE,
OR EVEN ALL, OF OUR PLANNED ETHANOL PRODUCTION FACILITIES.
In order to complete the construction of the various planned ethanol
production facilities, we will require significant additional funding. For
example, we anticipate that we will need to raise an additional $60.0 million in
debt financing to complete construction of our first ethanol production facility
in Madera County. We have no contracts with or binding commitments from any
bank, lender or financial institution for this debt financing. We may not be
able to obtain any funding from one or more lenders, or if funding is obtained,
that it will be on terms that we have anticipated or that are otherwise
acceptable to us. If we are unable to secure adequate debt financing, or debt
financing on acceptable terms is unavailable for any reason, we may be forced to
abandon our construction of one or more, or even all, of our planned ethanol
production facilities.
PEI CALIFORNIA HAS NOT CONDUCTED ANY SIGNIFICANT BUSINESS OPERATIONS AND
HAS BEEN UNPROFITABLE TO DATE. IF PEI CALIFORNIA FAILS TO COMMENCE
SIGNIFICANT BUSINESS OPERATIONS, IT WILL BE UNSUCCESSFUL, WILL DECREASE OUR
OVERALL PROFITABILITY AND WE WILL HAVE FAILED TO ACHIEVE ONE OF OUR
SIGNIFICANT GOALS.
PEI California has not conducted any significant business operations
and has been unprofitable to date. Accordingly, there is no prior operating
history by which to evaluate the likelihood of PEI California's success or its
contribution to our overall profitability. PEI California may never complete
construction of an ethanol production facility and commence significant
operations or, if PEI California does complete the construction of an ethanol
production facility, PEI California may not be successful or contribute
21
positively to our profitability. If PEI California fails to commence significant
business operations, it will be unsuccessful and will decrease our overall
profitability and we will have failed to achieve one of our significant goals.
THE MARKET PRICE OF ETHANOL IS VOLATILE AND SUBJECT TO SIGNIFICANT
FLUCTUATIONS, WHICH MAY CAUSE OUR PROFITABILITY TO FLUCTUATE SIGNIFICANTLY.
The market price of ethanol is dependent on many factors, including on
the price of gasoline, which is in turn dependent on the price of petroleum.
Petroleum prices are highly volatile and difficult to forecast due to frequent
changes in global politics and the world economy. The distribution of petroleum
throughout the world is affected by incidents in unstable political
environments, such as Iraq, Iran, Kuwait, Saudi Arabia, the former U.S.S.R. and
other countries and regions. The industrialized world depends critically on oil
from these areas, and any disruption or other reduction in oil supply can cause
significant fluctuations in the prices of oil and gasoline. We cannot predict
the future price of oil or gasoline and may establish unprofitable prices for
the sale of ethanol due to significant fluctuations in market prices. For
example, the price of ethanol declined by approximately 25% from its 2004
average price per gallon in only five months from January 2005 through May 2005.
In recent years, the prices of gasoline, petroleum and ethanol have all reached
historically unprecedented high levels. If the prices of gasoline and petroleum
decline, we believe that the demand for and price of ethanol may be adversely
affected. Fluctuations in the market price of ethanol may cause our
profitability to fluctuate significantly.
We believe that the production of ethanol is expanding rapidly. There
are a number of new plants under construction and planned for construction, both
inside and outside California. We expect existing ethanol plants to expand by
increasing production capacity and actual production. Increases in the demand
for ethanol may not be commensurate with increasing supplies of ethanol. Thus,
increased production of ethanol may lead to lower ethanol prices. The increased
production of ethanol could also have other adverse effects. For example,
increased ethanol production could lead to increased supplies of co-products
from the production of ethanol, such as wet distillers grain, or WDG. Those
increased supplies could lead to lower prices for those co-products. Also, the
increased production of ethanol could result in increased demand for corn. This
could result in higher prices for corn and cause higher ethanol production costs
and, in the event that PEI California is unable to pass increases in the price
of corn to its customers, will result in lower profits. We cannot predict the
future price of ethanol or WDG. Any material decline in the price of ethanol or
WDG will adversely affect our sales and profitability.
THE CONSTRUCTION AND OPERATION OF OUR PLANNED ETHANOL PRODUCTION FACILITIES
MAY BE ADVERSELY AFFECTED BY ENVIRONMENTAL REGULATIONS AND PERMIT
REQUIREMENTS.
The production of ethanol involves the emission of various airborne
pollutants, including particulates, carbon monoxide, oxides of nitrogen and
volatile organic compounds. PEI California will be subject to extensive air,
water and other environmental regulations in connection with the construction
and operation of our planned ethanol production facilities. PEI California also
may be required to obtain various other water-related permits, such as a water
discharge permit and a storm-water discharge permit, a water withdrawal permit
and a public water supply permit. If for any reason PEI California is unable to
obtain any of the required permits, construction costs for our planned ethanol
production facilities are likely to increase; in addition, the facilities may
not be fully constructed at all. It is also likely that operations at the
facilities will be governed by the federal regulations of the Occupational
Safety and Health Administration, or OSHA, and other regulations. Compliance
with OSHA and other regulations may be time-consuming and expensive and may
delay or even prevent sales of ethanol in California or in other states.
22
VARIOUS RISKS ASSOCIATED WITH THE CONSTRUCTION OF OUR PLANNED ETHANOL
PRODUCTION FACILITIES MAY ADVERSELY AFFECT OUR SALES AND PROFITABILITY.
Delays in the construction of our planned ethanol production
facilities or defects in materials and/or workmanship may occur. Any defects
could delay the commencement of operations of the facilities, or, if such
defects are discovered after operations have commenced, could halt or
discontinue operation of a particular facility indefinitely. In addition,
construction projects often involve delays in obtaining permits and encounter
delays due to weather conditions, fire, the provision of materials or labor or
other events. For example, PEI California experienced a fire at its Madera
County site during the first quarter of 2004 which required repairs to areas and
equipment damaged by the fire. In addition, changes in interest rates or the
credit environment or changes in political administrations at the federal, state
or local levels that result in policy change towards ethanol or our project in
particular, could cause construction and operation delays. Any of these events
may adversely affect our sales and profitability.
PEI California may encounter hazardous conditions at or near each of
its planned facility sites, including the Madera County site that may delay or
prevent construction of a particular facility. If PEI California encounters a
hazardous condition at or near a site, work may be suspended and PEI California
may be required to correct the condition prior to continuing construction. The
presence of a hazardous condition would likely delay construction of a
particular facility and may require significant expenditure of resources to
correct the condition. For example, W. M. Lyles Co., the company we have
selected to construct our Madera County ethanol production facility, may be
entitled to an increase in its fees and afforded additional time for performance
if it has been adversely affected by the hazardous condition. If PEI California
encounters any hazardous condition during construction, our sales and
profitability may be adversely affected.
We have based our estimated capital resource needs on a design for our
first ethanol production facility in Madera County that we estimate will cost an
additional $60.0 million. The estimated cost of the facility is based on
preliminary discussions and estimates, but the final construction cost of the
facility may be significantly higher. Any significant increase in the final
construction cost of the facility will adversely affect our profitability,
liquidity and available capital resources.
PEI CALIFORNIA'S DEPENDENCE ON AND AGREEMENTS WITH W. M. LYLES CO. FOR THE
CONSTRUCTION OF OUR ETHANOL PRODUCTION FACILITY IN MADERA COUNTY COULD
ADVERSELY AFFECT OUR LIQUIDITY AND AVAILABLE CAPITAL RESOURCES, OUR SALES
AND OUR PROFITABILITY.
PEI California will be highly dependent upon W. M. Lyles Co. to design
and build our ethanol production facility in Madera County. PEI California has
entered into agreements with W. M. Lyles Co. for the construction of this
facility. These agreements contain a number of provisions that are favorable to
W. M. Lyles Co. and unfavorable to PEI California. These agreements also include
a provision that requires PEI California to pay a termination fee of $5.0
million to W. M. Lyles Co. in addition to payment of all costs incurred by W. M.
Lyles Co. for services rendered through the date of termination, if PEI
California terminates it in favor of another contractor. Consequently, if PEI
California terminates these agreements, the requirement that it pay the
termination fee and costs could adversely affect our liquidity and available
capital resources. In addition, if W. M. Lyles Co. has entered into or enters
into a construction contract with one or more other parties, it may be under
pressure to complete another project or projects and may prioritize the
completion of another project or projects ahead of our Madera County facility.
As a result, PEI California's ability to commence production of and sell ethanol
would be delayed, which would adversely affect our overall sales and
profitability.
23
THE RAW MATERIALS AND ENERGY NECESSARY TO PRODUCE ETHANOL MAY BE
UNAVAILABLE OR MAY INCREASE IN PRICE, ADVERSELY AFFECTING OUR SALES AND
PROFITABILITY.
The production of ethanol requires a significant amount of raw
materials and energy, primarily corn, water, electricity and natural gas. In
particular, we estimate that our Madera County ethanol production facility will
require approximately 12.5 million bushels or more of corn each year and
significant and uninterrupted supplies of water, electricity and natural gas.
The prices of corn, electricity and natural gas have fluctuated significantly in
the past and may fluctuate significantly in the future. In addition, droughts,
severe winter weather in the Midwest, where we expect to source corn, and other
problems may cause delays or interruptions of various durations in the delivery
of corn to California, reduce corn supplies and increase corn prices. Local
water, electricity and gas utilities may not be able to reliably supply the
water, electricity and natural gas that our Madera County facility will need or
may not be able to supply such resources on acceptable terms. In addition, if
there is an interruption in the supply of water or energy for any reason, we may
be required to halt ethanol production. We may not be able to successfully
anticipate or mitigate fluctuations in the prices of raw materials and energy
through the implementation of hedging and contracting techniques. PEI
California's hedging and contracting activities may not lower its prices of raw
materials and energy, and in a period of declining raw materials or energy
prices, these hedging and contracting strategies may result in PEI California
paying higher prices than its competitors. In addition, PEI California may be
unable to pass increases in the prices of raw materials and energy to its
customers. Higher raw materials and energy prices will generally cause lower
profit margins and may even result in losses. Accordingly, our sales and
profitability may be significantly and adversely affected by the prices and
supplies of raw materials and energy.
RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK HAS A SMALL PUBLIC FLOAT AND SHARES OF OUR COMMON STOCK
ELIGIBLE FOR PUBLIC SALE COULD CAUSE THE MARKET PRICE OF OUR STOCK TO DROP,
EVEN IF OUR BUSINESS IS DOING WELL, AND MAKE IT DIFFICULT FOR US TO RAISE
ADDITIONAL CAPITAL THROUGH SALES OF EQUITY SECURITIES.
As of November 14, 2005, we had outstanding approximately 28.7 million
shares of our common stock. Approximately 25.3 million of these shares were
restricted under the Securities Act of 1933, including approximately 9.3 million
shares beneficially owned, in the aggregate, by our executive officers,
directors and 10% stockholders. Accordingly, our common stock has a public float
of approximately 3.4 million shares held by a relatively small number of public
investors.
We are in the process of registering for resale approximately 11.8
million shares of our common stock, including shares of our common stock
underlying warrants. If and when a registration statement covering these shares
of common stock is declared effective, holders of these shares will be
permitted, subject to few limitations, to freely sell these shares of common
stock. As a result of our small public float, sales of substantial amounts of
common stock, including shares issued upon the exercise of stock options or
warrants, or an anticipation that such sales could occur, may materially and
adversely affect prevailing market prices for our common stock. Any adverse
effect on the market price of our common stock could make it difficult for us to
raise additional capital through sales of equity securities at a time and at a
price that we deem appropriate.
OUR STOCK PRICE IS HIGHLY VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN
LITIGATION AGAINST US.
The market price of our common stock has fluctuated significantly in
the past and may continue to fluctuate significantly in the future. The market
price of our common stock may continue to fluctuate in response to one or more
of the following factors, many of which are beyond our control:
24
o the volume and timing of the receipt of orders for ethanol
from major customers;
o competitive pricing pressures;
o our ability to produce, sell and deliver ethanol on a
cost-effective and timely basis;
o our inability to obtain construction, acquisition, capital
equipment and/or working capital financing;
o the introduction and announcement of one or more new
alternatives to ethanol by our competitors;
o changing conditions in the ethanol and fuel markets;
o changes in market valuations of similar companies;
o stock market price and volume fluctuations generally;
o regulatory developments or increased enforcement;
o fluctuations in our quarterly or annual operating results;
o additions or departures of key personnel; and
o future sales of our common stock or other securities.
Furthermore, we believe that the economic conditions in California and
other states, as well as the United States as a whole, could have a negative
impact on our results of operations. Demand for ethanol could also be adversely
affected by a slow-down in overall demand for oxygenate and gasoline additive
products. The levels of our ethanol production and purchases for resale will be
based upon forecasted demand. Accordingly, any inaccuracy in forecasting
anticipated revenues and expenses could adversely affect our business.
Furthermore, we recognize revenues from ethanol sales at the time of delivery.
The failure to receive anticipated orders or to complete delivery in any
quarterly period could adversely affect our results of operations for that
period. Quarterly results are not necessarily indicative of future performance
for any particular period, and we may not experience revenue growth or
profitability on a quarterly or an annual basis.
The price at which you purchase shares of our common stock may not be
indicative of the price that will prevail in the trading market. You may be
unable to sell your shares of common stock at or above your purchase price,
which may result in substantial losses to you and which may include the complete
loss of your investment. In the past, securities class action litigation has
often been brought against a company following periods of stock price
volatility. We may be the target of similar litigation in the future. Securities
litigation could result in substantial costs and divert management's attention
and our resources away from our business. Any of the risks described above could
adversely affect our sales and profitability and also the price of our common
stock.
ITEM 3. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, as of September 30, 2005, to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the Securities Exchange Commission's rules
and forms, including to ensure that information required to be disclosed by us
in the reports filed or submitted by us under the Exchange Act is accumulated
and communicated to our management, including our principal executive and
principal financial officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. Based on
25
that evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of September 30, 2005, our disclosure controls and procedures
were not effective at the reasonable assurance level due to the material
weakness described below.
In light of the material weakness described below, we performed
additional analyses and other post-closing procedures to ensure that our
consolidated financial statements were prepared in accordance with generally
accepted accounting principles. Accordingly, we believe that the consolidated
financial statements included in this report fairly present, in all material
respects, our financial condition, results of operations and cash flows for the
periods presented.
A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. Management has identified the
following material weakness which has caused management to conclude that, as of
September 30, 2005, our disclosure controls and procedures were not effective at
the reasonable assurance level.
In conjunction with preparing our Registration Statement on Form S-1,
and after receiving comments from the Staff of the Securities and Exchange
Commission relating to our Registration Statement on Form S-1, management
reviewed, during the third and fourth quarters of 2005, our purchase accounting
methodology for the acquisition of ReEnergy. As a result of this review,
management concluded, during the fourth quarter of 2005, that our controls over
the selection of appropriate assumptions and factors affecting our purchase
accounting methodology for the acquisition of ReEnergy were not in accordance
with generally accepted accounting principles and that, of the $972,250 purchase
price for ReEnergy, all of which was previously recorded as goodwill and was
being capitalized, $852,250 should have been recorded as an expense for services
rendered in connection with a feasibility study that was conducted with respect
to real property that was subject to a purchase option held by ReEnergy and
$120,000 should have been recorded as an intangible asset for the fair value of
a favorable option. Based upon this conclusion, our Audit Committee and senior
management decided, in the fourth quarter of 2005, to restate our financial
statements as of and for the three months ended March 31, 2005 and the six
months ended June 30, 2005 to reflect the correction in our purchase accounting
methodology.
Management evaluated, in the fourth quarter of 2005 and as of
September 30, 2005, the impact of this restatement on our assessment of our
disclosure controls and procedures and concluded, as of September 30, 2005, that
the control deficiency that resulted in the use of an incorrect purchase
accounting methodology represented a material weakness.
To address this material weakness, management performed additional
analyses and other procedures to ensure that the financial statements included
herein fairly present, in all material respects, our financial position, results
of operations and cash flows for the periods presented.
REMEDIATION OF MATERIAL WEAKNESS
To remediate the material weakness in our disclosure controls and
procedures identified above, we have done the following subsequent to September
30, 2005:
We have revised our purchase accounting methodology as it relates to
the acquisition of ReEnergy. Upon further examination of our purchase accounting
methodology for the acquisition of ReEnergy, we determined that we made an error
in our application of the relevant accounting principles under SFAS 141,
paragraph 9 (with reference to EITF No. 98-3) and determined that we should have
expensed $852,250 and capitalized $120,000 of the $972,250 purchase price for
ReEnergy. Under SFAS 141, paragraph 9 (with reference to EITF No. 98-3), only
26
the acquisition of an ongoing business can result in the recordation and
capitalization of goodwill. At the time of the acquisition, ReEnergy did not
have sufficient activities to qualify it as an ongoing business under SFAS 141,
paragraph 9 (with reference to EITF No. 98-3) and accordingly, no amount of the
$972,250 purchase price for ReEnergy should have been recorded as goodwill. We
have determined the effect of the correction on our previously issued financial
statements and have restated the financial statements for the three months ended
March 31, 2005 and for the six months ended June 30, 2005. Of the $972,250
purchase price for ReEnergy, $852,250 has been recorded as an expense for
services rendered in connection with a feasibility study that was conducted with
respect to real property that was subject to a purchase option held by ReEnergy
and $120,000 has been recorded as an intangible asset for the fair value of a
favorable option. The revision of our purchase accounting methodology as it
relates to the acquisition of ReEnergy was completed in the fourth quarter of
2005. This methodology applies to the three months ended March 31, 2005 and all
subsequent periods. In addition, management will use more care in the selection
of appropriate assumptions and factors affecting our purchase accounting
methodology for future acquisitions, if any.
Management believes that the remediation described above has remediated
the material weakness also described above. Management believes that our
expenditures associated with this remediation, not including the
reclassification as an expense of part of the purchase price for ReEnergy,
totaled approximately $20,000. These expenditures consisted primarily of legal
and accounting fees related to the filing of amendments to our Forms 10-QSB for
the quarterly periods ended March 31, 2005 and June 30, 2005.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The changes in our controls over the selection of appropriate
assumptions and factors affecting our purchase accounting methodology for the
acquisition of ReEnergy and our commitment to use more care in the selection of
appropriate assumptions and factors affecting our purchase accounting
methodology for future acquisitions, if any, are the only changes during our
most recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect, our internal control over financial
reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are subject to legal proceedings, claims and litigation arising in
the ordinary course of business. While the amounts claimed may be substantial,
the ultimate liability cannot presently be determined because of considerable
uncertainties that exist. Therefore, it is possible that the outcome of those
legal proceedings, claims and litigation could adversely affect our quarterly or
annual operating results or cash flows when resolved in a future period.
However, based on facts currently available, management believes such matters
will not adversely affect our financial position, results of operations or cash
flows.
GERALD ZUTLER
In January 2003, DriverShield CRM Corp., or DriverShield, then a
wholly-owned subsidiary of our predecessor, Accessity, was served with a
complaint filed by Mr. Gerald Zutler, its former President and Chief Operating
Officer, alleging, among other things, that DriverShield breached his employment
contract, that there was fraudulent concealment of DriverShield's intention to
terminate its employment agreement with Mr. Zutler, and discrimination on the
basis of age and aiding and abetting violation of the New York State Human
Rights Law. Mr. Zutler is seeking damages aggregating $3.0 million, plus
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punitive damages and reasonable attorneys' fees. DriverShield's management
believes that DriverShield properly terminated Mr. Zutler's employment for
cause, and intends to vigorously defend this suit. An Answer to the complaint
was served by DriverShield on February 28, 2003. In 2003, Mr. Zutler filed a
motion to have DriverShield's attorney removed from the case. The motion was
granted by the court, but was subsequently overturned by an appellate court.
DriverShield has filed a claim with its insurance carrier under its directors
and officers and employment practices' liability policy. The carrier has agreed
to cover certain portions of the claim as they relate to Mr. Siegel,
DriverShield's former Chief Executive Officer. The policy has a $50,000
deductible and a liability limit of $3.0 million per policy year. At the present
time, the carrier has agreed to cover the portion of the claim that relates to
Mr. Siegel and has agreed to a fifty percent allocation of expenses.
MERCATOR GROUP, LLC
We filed a Demand for Arbitration against Presidion Solutions, Inc., or
Presidion, alleging that Presidion breached the terms of the Memorandum of
Understanding, or the MOU, between Accessity and Presidion dated January 17,
2003. We sought a break-up fee of $250,000 pursuant to the terms of the MOU
alleging that Presidion breached the MOU by wrongfully terminating the MOU.
Additionally, we sought out of pocket costs of its due diligence amounting to
approximately $37,000. Presidion filed a counterclaim against us alleging that
we had breached the MOU and therefore owe Presidion a break-up fee of $250,000.
The dispute was heard by a single arbitrator before the American Arbitration
Association in Broward County, Florida in late February 2004. During June 2004,
the arbitrator awarded us the $250,000 break-up fee set forth in the MOU between
us and Presidion, as well as our share of the costs of the arbitration and
interest from the date of the termination by Presidion of the MOU, aggregating
approximately $280,000. During the third quarter of 2004, Presidion paid us the
full amount of the award with accrued interest. The arbitrator dismissed
Presidion's counterclaim against us.
In 2003, we filed a lawsuit seeking damages in excess of $100 million
as a result of information obtained during the course of the arbitration
discussed above, against: (i) Presidion Corporation, f/k/a MediaBus Networks,
Inc., Presidion's parent corporation, (ii) Presidion's investment bankers,
Mercator Group, LLC, or Mercator, and various related and affiliated parties and
(iii) Taurus Global LLC, or Taurus, (collectively referred to as the "Mercator
Action"), alleging that these parties committed a number of wrongful acts,
including, but not limited to tortuously interfering in the transaction between
us and Presidion. In 2004, we dismissed this lawsuit without prejudice, which
was filed in Florida state court. We recently refiled this action in the State
of California, for a similar amount, as we believe this to be the proper
jurisdiction. On August 18, 2005, the court stayed the action and ordered the
parties to arbitration. The parties have agreed to mediate the matter. Mediation
is scheduled to take place on December 9, 2005. The final outcome of the
Mercator Action will most likely take an indefinite time to resolve. We
currently have limited information regarding the financial condition of the
defendants and the extent of their insurance coverage. Therefore, it is possible
that we may prevail, but may not be able to collect any judgment. The share
exchange agreement relating to the Share Exchange Transaction provides that
following full and final settlement or other final resolution of the Mercator
Action, after deduction of all fees and expenses incurred by the law firm
representing us in this action and payment of the 25% contingency fee to the law
firm, shareholders of record of Accessity on the date immediately preceding the
closing date of the Share Exchange Transaction will receive two-thirds and we
will retain the remaining one-third of the net proceeds from any Mercator Action
recovery.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
UNREGISTERED SALES OF EQUITY SECURITIES
On July 26, 2005 we issued options to purchase an aggregate of 115,000
shares of our common stock to five of our non-employee directors at a per share
exercise price of $8.25.
On July 28, 2005 we issued options to purchase an aggregate of 30,000
shares of our common stock to two of our non-employee directors at a per share
exercise price of $8.30.
On August 10, 2005 we issued options to purchase an aggregate of
425,000 shares of our common stock to an executive officer at a per share
exercise price of $8.03.
On August 10, 2005 we issued options to purchase an aggregate of
75,000 shares of our common stock to an executive placement and consultancy firm
at a per share exercise price of $8.03.
On September 1, 2005 we issued options to purchase an aggregate of
160,000 shares of our common stock to two employees at a per share exercise
price of $6.63.
On September 9, 2005, we issued an aggregate of 6,906 shares of common
stock to three transferees of a placement agent upon cashless exercises of
outstanding warrants, which cashless exercises resulted in the cancellation of
2,094 shares of common stock.
On September 23, 2005, we issued 28,750 shares of common stock to a
consultant and three transferees of that consultant upon exercise of outstanding
warrants with exercise prices of $.0001 per share for total gross proceeds of
approximately $2.88.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were sophisticated or
accredited with access to the kind of information registration would provide.
DIVIDENDS
We have never paid cash dividends on our common stock and do not
currently intend to pay cash dividends on our common stock in the foreseeable
future. We currently anticipate that we will retain any earnings for use in the
continued development of our business.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
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ITEM 6. EXHIBITS.
Exhibit
Number Description
------ -----------
10.1 Description of Non-Employee Director Compensation (1)
10.2 Form of Indemnification Agreement between the Company and Charles
W. Bader (1)
10.3 Form of Indemnification Agreement between the Company and John L.
Prince (1)
10.4 Form of Membership Interest Purchase Agreement between the
Company and the Holders of the Membership Interests of Phoenix
Bio-Industries, LLC (2)
10.5 Executive Employment Agreement dated August 10, 2005 between the
Company and William G. Langley (2)
10.6 Form of Indemnification Agreement between the Company and William
G. Langley (2)
10.7 Ethanol Marketing Agreement dated as of August 31, 2005 by and
between Kinergy Marketing, LLC and Front Range Energy, LLC (3)
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (*)
32 Certification of President and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (*)
- ----------
* Filed herewith.
(1) Filed as an exhibit to the Registrant's current report on Form 8-K for
July 26, 2005 filed with the Securities and Exchange Commission on
August 1, 2005 and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's current report on Form 8-K for
August 10, 2005 filed with the Securities and Exchange Commission on
August 16, 2005 and incorporated herein by reference.
(3) Filed as an exhibit to the Registrant's current report on Form 8-K for
August 31, 2005 filed with the Securities and Exchange Commission on
September 7, 2005 and incorporated herein by reference.
30
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PACIFIC ETHANOL, INC.
Dated: November 14, 2005 By: /S/ WILLIAM G. LANGLEY
----------------------------
William G. Langley
Chief Financial Officer
(principal financial officer
and duly authorized officer)
31
EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-QSB
Exhibit
Number Description
------ -----------
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification of President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32