peix_10k-123108.htm

Index to Financial Statements

Report of Independent Registered Public Accounting Firm	F-2

Consolidated Balance Sheets as of December 31, 2008 and 2007	F-3

Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006	F-5

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2008, 2007 and 2006	F-6

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006	F-7

Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006	F-10

Notes to Consolidated Financial Statements	F-12

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

Pacific Ethanol, Inc.

Sacramento, California

We have audited the accompanying consolidated balance sheets of Pacific Ethanol, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pacific Ethanol, Inc. at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1, the Company is in default under its loan agreements and has entered into forbearance agreements with each of the lenders under which the lenders agreed to forbear from exercising their rights until April 30, 2009 absent further defaults. In addition, the Company does not currently have sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs in the very near term-term. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Pacific Ethanol, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 31, 2009 expressed an unqualified opinion on the effectiveness of Pacific Ethanol, Inc’s internal control over financial reporting.

/s/ HEIN & ASSOCIATES LLP

Irvine, California

March 31, 2009

F-2

PACIFIC ETHANOL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

	December 31,
ASSETS	2008		2007
Current Assets:
Cash and cash equivalents	$	11,466	$	5,707
Investments in marketable securities		7,780		19,353
Accounts receivable, net of allowance for doubtful accounts of $2,210 and $58, respectively		23,823		28,034
Restricted cash		2,520		780
Inventories		18,408		18,540
Prepaid expenses		2,279		1,498
Prepaid inventory		2,016		3,038
Derivative instruments		7		1,613
Other current assets		3,592		3,630
Total current assets		71,891		82,193
Property and equipment, net		530,037		468,704
Other Assets:
Goodwill		—		88,168
Intangible assets, net		5,630		6,324
Other assets		9,276		6,211
Total other assets		14,906		100,703
Total Assets	$	616,834	$	651,600

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

F-3

PACIFIC ETHANOL, INC.

CONSOLIDATED BALANCE SHEETS (CONTINUED)

(in thousands, except shares and par value)

	December 31,
LIABILITIES AND STOCKHOLDERS’ EQUITY	2008			2007
Current Liabilities:
Accounts payable – trade	$	14,034		$	22,641
Accrued liabilities		12,335			8,526
Accounts payable and accrued liabilities – construction-related		20,198			55,203
Contract retentions		106			5,358
Other liabilities – related parties		608			900
Current portion – long-term notes payable (including $31,500 and $0 due to a related party, respectively)		305,420			11,098
Short-term note payable		—			6,000
Derivative instruments		7,503			10,353
Total current liabilities		360,204			120,079

Notes payable, net of current portion (including $0 and $30,000 due to a related party, respectively)		937			151,188
Other liabilities		3,497			1,965

Total Liabilities		364,638			273,232

Commitments and contingencies (Notes 1, 6, 7 and 13)

Noncontrolling interest in variable interest entity		42,823			96,082

Stockholders’ Equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized:
Series A: 7,000,000 shares authorized; 0 and 5,315,625 shares issued and outstanding as of December 31, 2008 and 2007, respectively		—			5
Series B: 3,000,000 shares authorized; 2,346,152 and 0 shares issued and outstanding as of December 31, 2008 and 2007, respectively		2			—
Common stock, $0.001 par value; 100,000,000 shares authorized; 57,750,319 and 40,606,214 shares issued and outstanding as of December 31, 2008 and 2007, respectively		58			41
Additional paid-in capital		479,034			402,932
Accumulated other comprehensive loss		—			(2,383	)
Accumulated deficit		(269,721	)		(118,309	)
Total stockholders’ equity		209,373			282,286

Total Liabilities and Stockholders’ Equity	$	616,834		$	651,600

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

F-4

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Years Ended December 31,
	2008			2007			2006
Net sales (including $1, $6,205 and $16,985 to a related party, respectively)	$	703,926		$	461,513		$	226,356
Cost of goods sold		737,331			428,614			201,527
Gross profit (loss)		(33,405	)		32,899			24,829
Selling, general and administrative expenses		31,796			30,822			24,641
Impairment of goodwill		87,047			—			—
Impairment of asset group		40,900			—			—
Income (loss) from operations		(193,148	)		2,077			188
Other income (expense), net		(6,068	)		(6,801	)		3,426
Income (loss) before noncontrolling interest in variable interest entity and provision for income taxes		(199,216	)		(4,724	)		3,614
Noncontrolling interest in variable interest entity		52,669			(9,676	)		(3,756	)
Loss before provision for income taxes		(146,547	)		(14,400	)		(142	)
Provision for income taxes		—			—			—
Net loss	$	(146,547	)	$	(14,400	)	$	(142	)
Preferred stock dividends	$	(4,104	)	$	(4,200	)	$	(2,998	)
Deemed dividend on preferred stock		(761	)		(28	)		(84,000	)
Loss available to common stockholders	$	(151,412	)	$	(18,628	)	$	(87,140	)
Loss per share, basic and diluted	$	(3.02	)	$	(0.47	)	$	(2.50	)
Weighted-average shares outstanding, basic and diluted		50,147			39,895			34,855

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

F-5

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

	For the Years Ended December 31,
	2008			2007			2006
Net loss	$	(146,547	)	$	(14,400	)	$	(142	)
Other comprehensive income (loss), net of tax:
Cash flow hedges:
Net change in the fair value of derivatives, net of tax		2,383			(2,579	)		196
Unrealized gain (loss) on restricted available-for-sale securities		—			(349	)		349
Comprehensive income (loss)	$	(144,164	)	$	(17,328	)	$	403

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

F-6

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

(in thousands)

	Preferred Stock				Common Stock				Additional Paid-In		Accumulated Other Comprehensive		Accumulated
	Shares		Amount		Shares		Amount		Capital		Income (Loss)		Deficit			Total
Balances, January 1, 2006		—	$	—		28,874	$	29	$	42,071	$	—	$	(13,584	)	$	28,516
Cumulative effect adjustment (Note 12)		—		—		—		—		—		—		1,043			1,043
Issuance of preferred stock, net of offering costs of $1,434		5,250		5		—		—		82,561		—		—			82,566
Beneficial conversion feature on issuance of preferred stock and preferred dividend declared		—		—		—		—		84,000		—		(86,998	)		(2,998	)
Issuance of common stock for private investment in public equity, net of offering costs of $7,381		—		—		5,497		5		137,614		—		—			137,619
Exercise of warrants and Accessity options		—		—		71		—		89		—		—			89
Share-based compensation expense – restricted stock to employees and directors, net of cancellations		—		—		894		1		3,047		—		—			3,048
Common stock issued for purchase of 42% interest in Front Range		—		—		2,082		2		30,006		—		—			30,008
Fair value of warrants issued for purchase of 42% interest in Front Range		—		—		—		—		5,087		—		—			5,087
Collection of stockholder receivable		—		—		—		—		1		—		—			1
Share-based compensation expense – options and warrants to employees and consultants		—		—		—		—		3,201		—		—			3,201
Stock issued for exercise of warrants for cash		—		—		2,518		3		8,556		—		—			8,559
Stock issued for cashless exercise of warrants		—		—		150		—		—		—		—			—
Stock issued for exercise of stock options for cash		—		—		183		—		1,303		—		—			1,303
Comprehensive income		—		—		—		—		—		545		(142	)		403
Balances, December 31, 2006		5,250	$	5		40,269	$	40	$	397,536	$	545	$	(99,681	)	$	298,445

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

F-7

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006 (CONTINUED)

(in thousands)

	Preferred Stock				Common Stock					Additional Paid-In		Accumulated Other Comprehensive			Accumulated
	Shares		Amount		Shares			Amount		Capital		Income (Loss)			Deficit			Total
Balances, January 1, 2007		5,250	$	5		40,269		$	40	$	397,536	$	545		$	(99,681	)	$	298,445
Share-based compensation expense – restricted stock to employees and directors, net of cancellations		—		—		(34	)		—		1,729		—			—			1,729
Share-based compensation expense – options and warrants to employees and consultants		—		—		—			—		333		—			—			333
Stock issued for exercise of warrants for cash		—		—		128			—		363		—			—			363
Stock issued for exercise of stock options for cash		—		—		243			1		1,893		—			—			1,894
Beneficial conversion feature on issuance of preferred stock and preferred dividends declared		66		—		—			—		1,078		—			(4,228	)		(3,150	)
Comprehensive loss		—		—		—			—		—		(2,928	)		(14,400	)		(17,328	)
Balances, December 31, 2007		5,316	$	5		40,606		$	41	$	402,932	$	(2,383	)	$	(118,309	)	$	282,286

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

F-8

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006 (CONTINUED)

(in thousands)

	Preferred Stock						Common Stock				Additional Paid-In			Accumulated Other Comprehensive			Accumulated
	Shares			Amount			Shares		Amount		Capital			Income (Loss)			Deficit			Total
Balances, January 1, 2008		5,316		$	5			40,606	$	41	$	402,932		$	(2,383	)	$	(118,309	)	$	282,286
Issuance of preferred stock, net of offering costs of $156		2,346			2			—		—		45,641			—			—			45,643
Conversion of preferred stock to common stock		(5,316	)		(5	)		10,632		10		(5	)		—			—			—
Issuance of common, net of offering costs of $62		—			—			6,000		6		26,642			—			—			26,648
Share-based compensation expense – restricted stock to employees and directors, net of cancellations		—			—			512		1		2,981			—			—			2,982
Fair value of warrant issued		—			—			—		—		82			—			—			82
Deemed dividend and preferred stock dividends declared		—			—			—		—		761			—			(4,865	)		(4,104	)
Comprehensive loss		—			—			—		—		—			2,383			(146,547	)		(144,164	)
Balances, December 31, 2008		2,346		$	2			57,750	$	58	$	479,034		$	—		$	(269,721	)	$	209,373

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

F-9

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	For the Years Ended December 31,
	2008			2007			2006
Operating Activities:
Net loss	$	(146,547	)	$	(14,400	)	$	(142	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Impairment of goodwill		87,047			—			—
Impairment of asset group		40,900			—			—
Depreciation and amortization of intangibles		26,635			17,513			4,402
Inventory valuation		6,415			144			159
Noncontrolling interest in variable interest entity		(52,669	)		9,676			3,756
Loss on derivative instruments		1,138			6,617			162
Amortization of deferred financing fees		2,018			4,726			1,069
Non-cash compensation and consulting expense		3,015			2,225			6,248
(Gain) loss on disposal of equipment		(27	)		81			—
Bad debt expense		2,191			58			83
Changes in operating assets and liabilities:
Accounts receivable		2,020			1,230			(20,939	)
Restricted cash		(1,740	)		787			(1,570	)
Notes receivable, related party		—			—			136
Inventories		(1,596	)		(11,089	)		(3,856	)
Prepaid expenses and other assets		(4,126	)		(1,649	)		(1,030	)
Prepaid inventory		1,022			(1,009	)		(679	)
Accounts payable and accrued expenses		(20,579	)		10,332			2,498
Accounts payable and accrued expenses, related party		(292	)		(8,524	)		1,559
Net cash provided by (used in) operating activities	$	(55,175	)	$	16,718		$	(8,144	)
Investing Activities:
Additions to property and equipment	$	(152,635	)	$	(210,482	)	$	(82,454	)
Proceeds from sales of available-for-sale investments		11,573			19,417			—
Restricted cash designated for construction projects		—			24,851			(24,851	)
Advances on equipment		—			—			(9,041	)
Purchases of available-for-sale investments		—			—			(28,962	)
Acquisition of 42% interest in Front Range, net of cash received		—			—			(29,514	)
Proceeds from sale of equipment		206			—			—
Net cash used in investing activities	$	(140,856	)	$	(166,214	)	$	(174,822	)
Financing Activities:
Proceeds from borrowings	$	157,322		$	137,725		$	1,950
Net proceeds from issuance of preferred stock and warrants		45,643			—			82,566
Net proceeds from issuance of common stock and warrants		26,649			—			137,619
Proceeds from exercise of warrants and stock options		—			2,257			9,951
Cash paid for debt issuance costs		(1,818	)		(10,261	)		(3,036	)
Principal payments paid on borrowings		(20,787	)		(8,737	)		(1,005	)
Principal payments paid on borrowings (related party)		—			—			(3,600	)
Preferred share dividend paid		(4,104	)		(4,200	)		(1,948	)
Dividend payments to noncontrolling interests		(1,115	)		(5,634	)		—
Receipt of stockholder receivable		—			—			1
Net cash provided by financing activities	$	201,790		$	111,150		$	222,498
Net increase (decrease) in cash and cash equivalents		5,759			(38,346	)		39,532
Cash and cash equivalents at beginning of period		5,707			44,053			4,521
Cash and cash equivalents at end of period	$	11,466		$	5,707		$	44,053

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

F-10

PACIFIC ETHANOL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(in thousands)

	For the Years Ended December 31,
	2008		2007			2006

Supplemental Information:
Interest paid ($9,186, $8,494 and $671 capitalized)	$	20,602	$	9,467		$	966
Non-cash financing and investing activities:
Preferred stock dividend declared	$	—	$	1,050		$	1,050
Deemed dividend on preferred stock (Note 9)	$	761	$	28		$	84,000
Unrealized gain on restricted available-for-sale securities	$	—	$	(349	)	$	349
Accrued additions to construction in progress	$	—	$	52,172		$	3,031
Accounts payable converted to short-term note payable	$	1,500	$	6,000		$	—
Transaction costs associated with acquisition of 42% interest in Front Range	$	—	$	—		$	304
Issuance of common stock associated with acquisition of 42% interest in Front Range	$	—	$	—		$	30,008
Issuance of warrant associated with acquisition of 42% interest in Front Range	$	—	$	—		$	5,087
Cumulative effect adjustment (Note 12)	$	—	$	—		$	2,134
Capital lease obligations	$	810	$	203		$	—

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

F-11

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	ORGANIZATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS.

Organization and Business – The consolidated financial statements include the accounts of Pacific Ethanol, Inc., a Delaware corporation (“Pacific Ethanol”), and all of its wholly-owned subsidiaries, including Pacific Ethanol California, Inc., a California corporation (“PEI California”), Kinergy Marketing, LLC, an Oregon limited liability company (“Kinergy”) and ReEnergy, LLC, a California limited liability company (“ReEnergy”), and, effective October 17, 2006, the consolidated financial statements of Front Range Energy, LLC, a Colorado limited liability company (“Front Range”), a variable-interest entity of which Pacific Ethanol, Inc. owns 42% (collectively, the “Company”).

The Company produces and sells ethanol and its co-products, including wet distillers grain (“WDG”), and provides transportation, storage and delivery of ethanol through third-party service providers in the Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and Washington.

In September 2008, the Company completed construction of its fourth ethanol plant. The Company’s four ethanol plants, which produce ethanol and its co-products, are as follows:

Facility Name	Facility Location	Date Operations Began	Estimated Annual Production Capacity (gallons)

Stockton	Stockton, CA	September 2008	60,000,000
Magic Valley	Burley, ID	April 2008	60,000,000
Columbia	Boardman, OR	September 2007	40,000,000
Madera	Madera, CA	October 2006	40,000,000

In addition, the Company owns a 42% interest in Front Range, which owns a plant located in Windsor, Colorado, with annual production capacity of up to 50 million gallons. The Company also intends to either construct or acquire additional production facilities as financial resources and business prospects make the construction or acquisition of these facilities advisable.

On October 17, 2006, Pacific Ethanol and PEI California entered into an agreement with Eagle Energy, LLC (“Eagle Energy”) to acquire Eagle Energy’s 42% ownership interest in Front Range by paying cash and issuing common stock and a warrant to purchase common stock of the Company in a transaction valued at $65,612,000. The results of operations for the year ended December 31, 2006 consist of the Company’s operations for the twelve months and the operations of Front Range from October 18, 2006 through December 31, 2006. (See Note 2)

On March 23, 2005, the Company completed a share exchange transaction with the shareholders of PEI California and the holders of the membership interests of each of Kinergy and ReEnergy, pursuant to which the Company acquired all of the issued and outstanding capital stock of PEI California and all of the outstanding membership interests of Kinergy and ReEnergy (the “Share Exchange Transaction”). Immediately prior to the consummation of the Share Exchange Transaction, the Company’s predecessor, Accessity Corp., a New York corporation (“Accessity”), reincorporated in the State of Delaware under the name “Pacific Ethanol, Inc” through a merger of Accessity with and into its then-wholly-owned Delaware subsidiary named Pacific Ethanol, Inc., which was formed for the purpose of effecting the reincorporation (the “Reincorporation Merger”). In connection with the Reincorporation Merger, the shareholders of Accessity became stockholders of the Company and the Company succeeded to the rights, properties and assets and assumed the liabilities of Accessity. (See Note 2)

F-12

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Basis of Presentation and Liquidity – The consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of Pacific Ethanol, each of its wholly-owned subsidiaries, and effective October 17, 2006, Front Range. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company’s financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As a result of ethanol industry conditions that have negatively affected the Company’s business, the Company does not currently have sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs in the very near term. The Company has suspended operations at three of its four wholly-owned ethanol production facilities due to market conditions and in an effort to conserve capital. The Company has also taken and expects to take additional steps to preserve liquidity. However, despite any additional cost-saving steps the Company may take, the Company believes that it has sufficient working capital to continue operations only until approximately April 30, 2009 at the latest unless it successfully restructures its debt, experiences a significant improvement in margins and obtains other sources of liquidity.

The Company is in default under its construction-related term loans in the aggregate amount of approximately $246.5 million and under Kinergy’s revolving line of credit as well as $31.5 million in notes payable to another lender. In February 2009, the Company entered into forbearance agreements with each of the lenders, which were amended in March 2009, under which the lenders agreed to forbear from exercising their rights until April 30, 2009 absent further defaults. The Company classified these debt obligations as current liabilities in its consolidated financial statements and of and for the year ended December 31, 2008. Although the Company is actively pursuing a number of alternatives, including seeking to restructure its debt and seeking to raise additional debt or equity financing, or both, there can be no assurance that the Company will be successful. If the Company cannot restructure its debt and obtain sufficient liquidity in the very near term, it may need to seek protection under the U.S. Bankruptcy Code.

The consolidated financial statements do not include any other adjustments that might result from the outcome of these negotiations. (See Note 7.)

Cash and Cash Equivalents – The Company considers all highly-liquid investments with an original maturity of three months or less to be cash equivalents.

Investments in Marketable Securities – The Company’s short-term investments consists of amounts held in money market portfolio funds and United States Treasury Securities, which represents funds available for current operations. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, these short-term investments are classified as available-for-sale and are carried at their fair market value. These securities have stated maturities beyond three months but were priced and traded as short-term instruments. Available-for-sale securities are marked-to-market based on quoted market values of the securities, with the unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income (loss). Realized gains and losses on sales of available-for-sale securities are computed based upon the initial cost adjusted for any other-than-temporary declines in fair value. The cost of investments sold is determined on the specific identification method.

F-13

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are presented at face value, net of the allowance for doubtful accounts. The Company sells ethanol to gasoline refining and distribution companies and WDG to dairy operators and animal feed distributors generally without requiring collateral. Due to a limited number of ethanol customers, the Company had significant concentrations of credit risk from sales of ethanol as of December 31, 2008 and 2007, as described below.

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

The allowance for doubtful accounts was $2,210,000 and $58,000 as of December 31, 2008 and 2007, respectively. The Company recorded bad debt expense of $2,191,000, $58,000 and $83,000 for the years ended December 31, 2008, 2007 and 2006, respectively. The Company does not have any off-balance sheet credit exposure related to its customers.

Concentrations of Credit Risk – Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk, whether on- or off-balance sheet, that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions described below.

Financial instruments that subject the Company to credit risk consist of cash balances maintained in excess of federal depository insurance limits and accounts receivable, which have no collateral or security. Some of the accounts maintained by the Company at financial institutions are insured by the Federal Deposit Insurance Corporation. The Company’s uninsured balance was $10,422,000 and $8,460,000 as of December 31, 2008 and 2007, respectively. The Company has not experienced any losses in such accounts and believes that it is not exposed to any significant risk of loss of cash.

The Company sells fuel-grade ethanol to gasoline refining and distribution companies. The Company had sales from customers representing 10% or more of total net sales as follows:

	Years Ended December 31,
	2008		2007		2006
Customer A	19	%	16	%	12	%
Customer B	13	%	16	%	9	%
Customer C	3	%	6	%	13	%

As of December 31, 2008, the Company had receivables from these customers of approximately $6,829,000, representing 29% of total accounts receivable. As of December 31, 2007, the Company had receivables from these customers of approximately $4,983,000, representing 18% of total accounts receivable.

F-14

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company purchases fuel-grade ethanol and corn, its largest cost component in producing ethanol, from its suppliers. The Company had purchases from ethanol and corn suppliers representing 10% or more of total purchases in the purchase and production of ethanol as follows:

	Years Ended December 31,
	2008		2007		2006
Supplier A	27	%	14	%	6	%
Supplier B	22	%	20	%	0	%
Supplier C	5	%	9	%	17	%
Supplier D	5	%	9	%	11	%
Supplier E	0	%	13	%	22	%

Restricted Cash – Current Asset – The restricted cash balance of $2,520,000 and $780,000 as of December 31, 2008 and 2007, respectively, was the balance of deposits held at the Company’s trade broker in connection with trading instruments entered into as part of the Company’s hedging strategy.

Inventories – Inventories consist primarily of bulk ethanol, unleaded fuel and corn, and are valued at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis. Inventory balances consisted of the following (in thousands):

	December 31,
	2008		2007
Raw materials	$	9,000	$	3,647
Work in progress		1,895		1,809
Finished goods		5,994		12,064
Other		1,519		1,020
Total	$	18,408	$	18,540

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

Buildings	40 years
Facilities and plant equipment	10 – 25 years
Other equipment, vehicles and furniture	5 – 10 years
Water rights	99 years

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

Goodwill – Goodwill represents the excess of cost of an acquired entity over the net of the amounts assigned to net assets acquired and liabilities assumed. The Company accounts for its goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which requires an annual review for impairment, or more frequently if indications of impairment arise. This review includes the determination of each reporting unit’s fair value using market multiples and discounted cash flow modeling. The Company is operating as a single-segmented, single-reporting unit. The estimates of future cash flows are judgments based on management’s experience and knowledge of the Company’s operations and the industries in which the Company operates. These estimates can be significantly affected by future changes in market conditions, the economic environment, including inflation, and capital spending decisions of the Company’s customers. Any assessed impairments will be permanent and expensed in the period in which the impairment is determined. If the Company determines through its assessment process that any of its goodwill requires impairment charges, the charges will be recorded in selling, general and administrative expenses in the consolidated statements of operations.

F-15

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Intangible Assets – Intangible assets have been identified as assets with definite lives. The Company will amortize these assets using the straight-line method over their established lives, generally 2-10 years. Additionally, the Company will test these assets with established lives for impairment if conditions exist that indicates that carrying values may not be recoverable. Possible conditions leading to the unrecoverability of these assets include changes in market conditions, changes in future economic conditions or changes in technological feasibility that impact the Company’s assessments of future operations. If the Company determines that an impairment charge is needed, the charge will be recorded in selling, general and administrative expenses in the consolidated statements of operations.

Deferred Financing Costs – Deferred financing costs, which are included in other assets, are costs incurred to obtain debt financing, including all related fees, and are amortized as interest expense over the term of the related financing using the straight-line method which approximates the interest rate method. To the extent these fees relate to facility construction, a portion is capitalized with the related interest expense into construction in progress until such time as the facility is placed into operation.

Derivative Instruments and Hedging Activities – Beginning in 2006, the Company implemented a policy to minimize its exposure to commodity price risk associated with certain anticipated commodity purchases and sales and interest rate risk associated with anticipated corporate borrowings by using derivative instruments. The Company accounts for its derivative transactions in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted. Derivative transactions, which can include forward contracts and futures positions on the New York Mercantile Exchange and the Chicago Board of Trade and interest rate caps and swaps are recorded on the balance sheet as assets and liabilities based on the derivative’s fair value. Changes in the fair value of the derivative contracts are recognized currently in income unless specific hedge accounting criteria are met. If derivatives meet those criteria, effective gains and losses are deferred in accumulated other comprehensive income (loss) and later recorded together with the hedged item in income. For derivatives designated as a cash flow hedge, the Company formally documents the hedge and assesses the effectiveness with associated transactions. The Company has designated and documented contracts for the physical delivery of commodity products to and from counterparties as normal purchases and normal sales.

Consolidation of Variable-Interest Entities – In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 46, Consolidation of Variable Interest Entities, and in December 2003, amended it by issuing FIN 46(R). FIN 46(R) addresses consolidation by business enterprises of variable interest entities that either: (i) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (ii) have equity investors that lack an essential characteristic of a controlling financial interest. Under FIN 46(R), the primary beneficiary of a variable interest entity is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests, which can be ownership, contractual, or other financial interests that change with the fair value of the entity’s net assets.

The Company has determined that Front Range meets the definition of a variable interest entity under FIN 46(R). The Company has also determined that it is the primary beneficiary and is therefore required to treat Front Range as a consolidated subsidiary for financial reporting purposes rather than use equity investment accounting treatment. As a result, the Company consolidates the financial results of Front Range, including its entire balance sheet with the balance of the noncontrolling interest displayed between liabilities and equity, and the income statement after intercompany eliminations with an adjustment for the noncontrolling interest in net income, in each case since its acquisition on October 17, 2006. Under FIN 46(R), and as long as the Company is deemed the primary beneficiary of Front Range, it must treat Front Range as a consolidated subsidiary for financial reporting purposes.

F-16

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenue Recognition – The Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when it has persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured in conformity with the Securities and Exchange Commission’s (“Commission”) Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition.

The Company derives revenue primarily from sales of ethanol and related co-products. The Company recognizes revenue when title transfers to its customers, which is generally upon the delivery of these products to a customer’s designated location. These deliveries are made in accordance with sales commitments and related sales orders entered into with customers either verbally or in written form. The sales commitments and related sales orders provide quantities, pricing and conditions of sales. In this regard, the Company engages in three basic types of revenue generating transactions:

·	As a producer. Sales as a producer consist of sales of the Company’s inventory produced at its ethanol production facilities.

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

As an agent. Sales as an agent consist of sales to customers through purchases from third-party suppliers in which, depending upon the terms of the transactions, title to the product may technically pass to the Company, but the risks and rewards of inventory ownership remains with third-party suppliers as the Company receives a predetermined service fee under these transactions and therefore acts predominantly in an agency capacity.

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

When the Company acts in an agency capacity, it records revenues based on the principles of Emerging Issues Task Force (“EITF”) Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent. The Company recognizes revenue on a net basis or recognizes its predetermined agency fees only, based upon the amount of net revenues retained in excess of amounts paid to suppliers. Revenue from sales of third-party ethanol and its co-products is recorded net of costs when the Company is acting as an agent between the customer and supplier and gross when the Company is a principal to the transaction. Several factors are considered to determine whether the Company is acting as an agent or principal, most notably whether the Company is the primary obligor to the customer, whether the Company has inventory risk and related risk of loss. Consideration is also given to whether the Company has latitude in establishing the sales price or has credit risk, or both.

F-17

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Costs of Start-Up Activities – Start-up activities are defined broadly in American Institute of Certified Public Accountants Statement of Position 98-5, Reporting on the Costs of Start-Up Activities, as those one-time activities related to opening a new facility, introducing a new product or service, conducting business in a new territory, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility, commencing some new operation or activities related to organizing a new entity. The Company’s start-up activities consist primarily of costs associated with new or potential sites for ethanol production facilities. All the costs associated with a potential site are expensed, until the site is considered viable by management, at which time costs would be considered for capitalization based on authoritative accounting literature. These costs are included in selling, general and administrative expenses in the consolidated statements of operations.

Stock-Based Compensation – On January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payments. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award on the date of grant. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award.

Impairment of Long-Lived Assets – The Company evaluates impairment of long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company assesses the impairment of long-lived assets, including property and equipment and purchased intangibles subject to amortization, when events or changes in circumstances indicate that the fair value of assets could be less then their net book value. In such event, the Company assesses long-lived assets for impairment by determining their fair value based on the forecasted, undiscounted cash flows the assets are expected to generate plus the net proceeds expected from the sale of the asset. An impairment loss would be recognized when the fair value is less than the related asset’s net book value, and an impairment expense would be recorded in the amount of the difference. Forecasts of future cash flows are judgments based on the Company’s experience and knowledge of its operations and the industries in which it operates. These forecasts could be significantly affected by future changes in market conditions, the economic environment, including inflation, and capital spending decisions of the Company’s customers.

Income Taxes – Income taxes are accounted for under SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Income (Loss) Per Share – The Company computes income (loss) per common share in accordance with the provisions of SFAS No. 128, Earnings Per Share. SFAS No. 128 requires companies with complex capital structures to present basic and diluted earnings per share. Basic income (loss) per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Preferred dividends are deducted from net income and are considered in the calculation of income (loss) available to common stockholders in computing basic income (loss) per share. In periods in which there is a loss available to common stockholders, diluted income per share is equal to basic income per share.

F-18

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table computes basic and diluted net loss per share (in thousands, except per share data):

	Years Ended December 31,
	2008			2007			2006
Numerator (basic and diluted):
Net loss	$	(146,547	)	$	(14,400	)	$	(142	)
Preferred stock dividends		(4,104	)		(4,200	)		(2,998	)
Deemed dividend on preferred stock		(761	)		(28	)		(84,000	)
Loss available to common stockholders	$	(151,412	)	$	(18,628	)	$	(87,140	)
Denominator:
Weighted-average common shares outstanding – basic and diluted		50,147			39,895			34,855
Loss per share – basic and diluted	$	(3.02	)	$	(0.47	)	$	(2.50	)

There were an aggregate of 10,930,000, 10,750,000 and 14,568,000 of potentially dilutive shares from stock options, common stock warrants and convertible securities outstanding as of December 31, 2008, 2007 and 2006, respectively. These options, warrants and convertible securities were not considered in calculating diluted loss per common share for the years ended December 31, 2008, 2007 and 2006, as their effect would be anti-dilutive. As a result, for each of the years ended December 31, 2008, 2007 and 2006, the Company’s basic and diluted loss per share are the same.

Financial Instruments – SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. The carrying value of cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued expenses are reasonable estimates of their fair value because of the short maturity of these items. Except as noted below, the Company believes the carrying values of its notes payable and long-term debt approximate fair value because the interest rates on these instruments are variable.

The Company believes the carrying values and estimated fair values of its notes payable and long-term debt are as follows at December 31, 2008 (in thousands):

Carrying Value		$	306,357
Estimated Fair Value		$	139,568

The Company estimated the fair value of its notes payable and long-term debt associated with its Debt Financing currently in forbearance consistent with its related interest rate caps and swaps. As discussed in Note 14, the Company applied a 40% standard market recovery rate to its caps and swaps, and accordingly, applied the rate to its related debt carrying value. For all other notes payable and long-term debt, fair value approximates carrying value. As of December 31, 2008 and 2007, the fair value of the Company’s other financial instruments approximated their carrying values.

Fair Value Measurements – On January 1, 2008, the Company adopted SFAS No. 157 Fair Value Measurements, which defines a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value, but does not require any new fair value measurement. The SFAS No. 157 requirements for certain nonfinancial assets and liabilities have been deferred until the first quarter of 2009 in accordance with FASB Staff Position 157-2. The adoption of SFAS No. 157 did not have a material impact on the Company’s financial position, results of operations or cash flows. See Note 14.

F-19

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On January 1, 2008, the Company also adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets and liabilities and certain other items including insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense upfront costs and fees associated with the item for which the fair value option is elected. The adoption of SFAS No. 159 did not have a material impact on the Company’s financial position, results of operations or cash flows for the year ended December 31, 2008.

Estimates and Assumptions – The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required as part of determining allowance for doubtful accounts, estimated lives of property and equipment and intangibles, goodwill and long-lived asset impairments, valuation allowances on deferred income taxes, and the potential outcome of future tax consequences of events recognized in the Company’s financial statements or tax returns. Actual results and outcomes may materially differ from management’s estimates and assumptions.

Reclassifications – Certain prior year amounts have been reclassified to conform to the current presentation. Such reclassification had no effect on the net loss reported in the consolidated statements of operations.

Recently Issued Accounting Pronouncements – In June 2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock. EITF No. 07-5 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock. EITF No. 07-5 is effective for the Company beginning with its first quarter ended March 31, 2009. The Company does not expect the adoption of EITF No. 07-5 will have a material impact on its financial condition or results of operations.

In March 2008, the FASB issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not expect the adoption of SFAS No. 161 to have a material impact to its financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141, Business Combinations, that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in SFAS No. 141(R). In addition, SFAS No. 141(R) requires acquisition costs and restructuring costs that the acquirer expected but was not obligated to incur to be recognized separately from the business combination, therefore, expensed instead of part of the purchase price allocation. SFAS No. 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. The Company will adopt SFAS No. 141(R) to any business combinations after January 1, 2009.

F-20

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51. SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. Upon adoption on January 1, 2009, the Company will present its Noncontrolling Interest in Variable Interest Entity within Stockholders’ Equity in its consolidated balance sheets. The Company does not expect the adoption of SFAS No. 160 to have a material impact to its financial condition or results of operations.

2.	ACQUISITION OF INTEREST IN FRONT RANGE.

On October 17, 2006, the Company entered into a Membership Interest Purchase Agreement with Eagle Energy to acquire Eagle Energy’s 42% interest in Front Range. Front Range was formed on July 29, 2004 to construct and operate a 50 million gallon dry mill ethanol plant in Windsor, Colorado. Front Range began producing ethanol in June 2006.

As consideration for the acquisition of Eagle Energy’s interest in Front Range, the Company paid to Eagle Energy $30,000,000 in cash, 2,081,888 shares of common stock valued at $30,008,000 under the valuation provisions of the agreement and a warrant to purchase up to 693,963 shares of common stock at an exercise price of $14.41 per share. The warrant expired unexercised on October 17, 2007. The Company utilized EITF Issue No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination, to establish the market price of the securities issued in the transaction where the measurement date was determined to be the date at which the number of acquirer shares and the amount of consideration becomes fixed and determinable without subsequent revision. In the transaction, the measurement date on which the shares to be issued became fixed and determinable was October 17, 2006 and the common stock valuation price was $14.41 per share, pursuant to the terms of the Front Range acquisition agreement, whereby the 10-day volume-weighted-average trading price prior to closing was used in determining the number of exercisable shares in the warrant. Using the Black-Scholes option-pricing model, the value of this warrant on the measurement date was $5,087,000. The total value of the consideration paid to Eagle Energy was $65,095,000. The Company incurred, and has capitalized, transaction costs associated with this acquisition of $517,000. The following summarizes the Company’s estimated fair values of the Front Range tangible and intangible assets and liabilities acquired, which have been revised for activity in 2007 as discussed in Note 4 (in thousands):

F-21

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Total Current Assets	$	15,090
Property and Equipment		92,376
Other Assets		584
Intangible Assets:
Customer backlogs		3,900
Non-compete covenants		400
Goodwill		83,468
Total Intangible Assets		87,768
Total Assets		195,818

Total Current Liabilities		(10,847	)
Long Term Debt		(28,753	)
Total Liabilities		(39,600	)
Noncontrolling interest in variable interest entity		(90,606	)
Net Assets	$	65,612

Cash issued to Eagle Energy	$	30,000
Stock issued to Eagle Energy		30,008
Value of warrant issued to Eagle Energy		5,087
Acquisition expenses		517
Transaction value	$	65,612

Prior to the Company’s acquisition of its ownership interest in Front Range, the Company, directly or through one of its subsidiaries, had entered into four marketing and management agreements with Front Range.

The Company entered into a marketing agreement with Front Range on August 19, 2005 that provided the Company with the exclusive right to act as an agent to market and sell all of Front Range’s ethanol production. The marketing agreement was amended on August 9, 2006 to extend the Company’s relationship with Front Range to allow the Company to act as a merchant under the agreement. The marketing agreement was amended again on October 17, 2006 to provide for a term of six and a half years with provisions for annual automatic renewal thereafter.

The Company entered into a grain supply agreement with Front Range on August 20, 2005 (amended October 17, 2006) under which the Company is to negotiate on behalf of Front Range all grain purchase, procurement and transport contracts. The Company is to receive a $1.00 per ton fee related to this service. The grain supply agreement has a term of two and a half years with provisions for annual automatic renewal thereafter.

The Company entered into a WDG marketing and services agreement with Front Range on August 19, 2005 (amended October 17, 2006) that provided the Company with the exclusive right to market and sell all of Front Range’s WDG production. The Company is to receive the greater of a 5% fee of the amount sold or $2.00 per ton. The WDG marketing and services agreement has a term of two and a half years with provisions for annual automatic renewal thereafter. In February 2009, the Company and Front Range terminated this agreement and entered into a new agreement with similar terms. The revised WDG marketing and services agreement continues through May 2009.

The Company entered into a management agreement with Front Range on August 30, 2005 under which the Company is to provide management services to Front Range relating to construction management and operational support. These services are advisory in nature as Front Range management retains ultimate decision making authority. The Company is to receive an annual management fee of $150,000 under this agreement. The management agreement has a term of three years with provisions for annual automatic renewal thereafter. This agreement was terminated by mutual agreement on February 28, 2007.

F-22

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company’s acquisition of its ownership interest in Front Range does not impact the Company’s rights or obligations under any of these agreements.

3.	PROPERTY AND EQUIPMENT.

Property and equipment consisted of the following (in thousands):

	December 31,
	2008			2007
Facilities and plant equipment	$	549,829		$	262,235
Land		5,778			5,848
Other equipment, vehicles and furniture		4,787			3,703
Water rights – capital lease		1,613			1,613
Construction in progress		11,655			213,157
		573,662			486,556
Accumulated depreciation		(43,625	)		(17,852	)
	$	530,037		$	468,704

In connection with the Company’s construction of its four ethanol production facilities, it has recorded capitalized interest during their construction and is included in property and equipment. At December 31, 2008, capitalized interest of $16,270,000 is included in facilities and plant equipment and $1,410,000 is included in construction in progress. At December 31, 2007, capitalized interest of $5,961,000 is included in construction in progress. Depreciation expense was $25,940,000, $13,682,000 and $2,284,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

In 2008, the Company performed its impairment analysis for the asset group associated with its suspended plant construction project in the Imperial Valley near Calipatria, California (“Imperial Project”). The asset group consisted of construction in progress of $43,751,000. In addition, the Imperial Project had construction-related accounts payable and accrued expenses of $17,245,000. The Company does not intend to resume construction of its Imperial Project. In November, 2008, the Company began proceedings to liquidate these assets and liabilities. After assessing the estimated undiscounted cash flows, the Company recorded an impairment charge of $40,900,000, thereby reducing its property and equipment by that amount. To the extent the Company is relieved of the related liabilities, the Company may record a gain in the period in which the relief occurs.

The ethanol industry has experienced significant adverse conditions over the course of the last 12 months, including prolonged negative operating margins. The Company has also experienced these adverse conditions as well as severe working capital and liquidity shortages, and in response to such conditions, the Company has reduced its production significantly until market conditions resume to acceptable levels and working capital becomes available. The Company first reduced production in December 2008 and continued to reduce production through the first quarter of 2009. As of the end of February 2009, the Company has ceased production at its Madera, Magic Valley and Stockton facilities. The Company continues to operate its Columbia and Front Range facilities. The Company continues to assess market conditions and when appropriate, provided it has adequate available working capital, the Company plans to bring these facilities back to operation.

F-23

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In 2008, the Company completed construction of its ethanol production facilities, with installed capacity of 220 million gallons per year, its goal since 2005. The carrying value of these facilities at December 31, 2008 was approximately $436.0 million. In accordance with the Company’s policy for evaluating impairment of long-lived assets in accordance with SFAS No. 144, management has evaluated the facilities for possible impairment based on projected future cash flows from operations of these facilities, including the above mentioned suspensions of its facilities in the near term. Management has determined that the undiscounted cash flows from operations of these facilities over their estimated useful lives exceed their carrying values, and therefore, no impairment has been recognized at December 31, 2008. In determining future undiscounted cash flows, the Company has made significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. If the Company were required to compute the fair value in the future, it may use the work of a qualified valuation specialist who would assist it in examining replacement costs, recent transactions between third parties and cash flow that can be generated from operations. Given the recent completion of the facilities, replacement cost would likely approximate the carrying value of the facilities. However, there have been recent transactions between independent parties to purchase plants at prices substantially below the carrying value of the facilities. Some of the facilities have been in bankruptcy and may not be representative of transactions outside of bankruptcy. Given these circumstances, should management be required to adjust the carrying value of the facilities to fair value at some future point in time, the adjustment could be significant and could significantly impact the Company’s financial position and results of operation. No adjustment has been made in these financial statements for this uncertainty.

4.	GOODWILL AND OTHER INTANGIBLE ASSETS.

The table below represents the net balances for goodwill and intangible assets (in thousands):

		December 31, 2008						December 31, 2007
	Useful Life (Years)	Gross		Accumulated Amortization/ Impairment		Net Book Value		Gross		Accumulated Amortization/ Impairment		Net Book Value
Non-Amortizing:
Goodwill recognized in business combinations		$	88,168	$	88,168	$	—	$	88,168	$	—	$	88,168
Tradename			2,678		—		2,678		2,678		—		2,678
Amortizing:
Customer relationships	10		4,741		1,789		2,952		4,741		1,314		3,427
Non-compete covenants	2-3		1,095		1,095		—		1,095		876		219
Total goodwill and intangible assets		$	96,682	$	91,052	$	5,630	$	96,682	$	2,190	$	94,492

Goodwill – The Company recorded goodwill of $2,566,000 as part of the Share Exchange Transaction. The Company originally recorded goodwill of $80,607,000 as part of the Company’s purchase of ownership interests in Front Range for the year ended December 31, 2006. During the year ended December 31, 2007, the Company adjusted the purchase price allocation, increasing goodwill and accrued liabilities in the aggregate amount of $2,861,000, due to recognition of additional liabilities that existed at the time of the acquisition.

In 2008, the Company adjusted its goodwill associated with its acquisition of ownership interests in Front Range resulting in a decrease of goodwill of $1,121,000. Additionally, the Company performed its annual review of impairment of goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, as of March 31, 2008. The Company’s annual review estimated the fair value of its single reporting unit to be below its carrying value. As a result, the Company recognized an impairment charge on its remaining goodwill of $87,047,000, reducing its goodwill balance to zero. The Company did not record any goodwill impairments for the years ended December 31, 2007 and 2006.

F-24

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Tradename – The Company recorded tradename of $2,678,000 as part of the Share Exchange Transaction. The Company determined that the tradename has an indefinite life and therefore, rather than being amortized, will, be tested annually for impairment. The Company did not record any impairment on its tradename for the years ended December 31, 2008, 2007 and 2006.

Customer Relationships – The Company recorded customer relationships of $4,741,000 as part of the Share Exchange Transaction. The Company has established a useful life of ten years for these customer relationships.

Non-Compete Covenants – The Company recorded non-compete covenants of $400,000 as part of the Company’s purchase of ownership interest in Front Range and $695,000 as part of the Share Exchange Transaction. The Company has established estimated useful lives of two and three years, respectively, for these non-compete covenants.

Amortization expense associated with intangible assets totaled $693,000, $3,831,000 and $1,714,000 for the years ended December 31, 2008, 2007 and 2006, respectively. The weighted-average unamortized life of the customer relationships is 6.2 years.

The expected amortization expense relating to amortizable intangible assets in each of the five years after December 31, 2008, are (in thousands):

Years Ended December 31,	Amount
2009	$	474
2010		474
2011		474
2012		474
2013		474
Thereafter		582
Total	$	2,952

5.	SHORT-TERM NOTE PAYABLE.

In November 2007, the Company issued an unsecured note payable for $6,000,000 to finance short-term cash needs related to its plant construction activities. This note was for final construction costs related to its Columbia facility and did not result in any cash proceeds to the Company. The note required monthly principal payments of $500,000 and accrued interest. The note was paid in full at December 31, 2008.

6.	DERIVATIVES.

The business and activities of the Company expose it to a variety of market risks, including risks related to changes in commodity prices and interest rates. The Company monitors and manages these financial exposures as an integral part of its risk management program. This program recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effects that market volatility could have on operating results. The Company accounts for its use of derivatives related to its hedging activities pursuant to SFAS No. 133, under which the Company recognizes all of its derivative instruments in its statement of financial position as either assets or liabilities, depending on the rights or obligations under the contracts, unless the contracts qualify as a normal purchase or normal sale as further discussed below. The Company has designated and documented contracts for the physical delivery of commodity products to and from counterparties as normal purchases and normal sales. Derivative instruments are measured at fair value. Changes in the derivative’s fair value are recognized currently in income unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s effective gains and losses to be deferred in accumulated other comprehensive income (loss) and later recorded together with the gains and losses to offset related results on the hedged item in income. Companies must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. Contracts designated and documented as normal purchases or normal sales are not recorded at fair value.

F-25

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Commodity Risk – Cash Flow Hedges – The Company uses derivative instruments to protect cash flows from fluctuations caused by volatility in commodity prices for periods of up to twelve months in order to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sale and purchase commitments where the prices are set at a future date and/or if the contracts specify a floating or index-based price for ethanol. In addition, the Company hedges anticipated sales of ethanol to minimize its exposure to the potentially adverse effects of price volatility. These derivatives are designated and documented as SFAS No. 133 cash flow hedges and effectiveness is evaluated by assessing the probability of the anticipated transactions and regressing commodity futures prices against the Company’s purchase and sales prices. Ineffectiveness, which is defined as the degree to which the derivative does not offset the underlying exposure, is recognized immediately in cost of goods sold.

For the year ended December 31, 2008, a loss from ineffectiveness in the amount of $991,000 and an effective gain in the amount of $566,000 were recorded in cost of goods sold. For the year ended December 31, 2007, a gain from ineffectiveness in the amount of $2,832,000 and an effective loss in the amount of $1,680,000 were recorded in cost of goods sold. For the year ended December 31, 2006, losses of ineffectiveness in the amount of $239,000 and an effective loss in the amount of $438,000 was recorded in cost of goods sold. For the year ended December 31, 2006, an effective gain in the amount of $1,281,000 was recorded in net sales. The notional balances remaining on these derivatives as of December 31, 2008 and 2007 were $0 and $2,427,000, respectively.

Commodity Risk – Non-Designated Hedges – As part of the Company’s risk management strategy, it uses forward contracts on corn, crude oil and reformulated blendstock for oxygenate blending gasoline to lock in prices for certain amounts of corn, denaturant and ethanol, respectively. These derivatives are not designated under SFAS No. 133 for special hedge accounting treatment. The changes in fair value of these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold. The Company recognized a loss of $2,395,000 (of which $1,131,000 is related to settled non-designated hedges), $6,484,000 and $0 as the change in the fair value of these contracts for the years ended December 31, 2008, 2007 and 2006, respectively. The notional balances remaining on these contracts as of December 31, 2008 and 2007 were $4,215,000 and $29,999,000, respectively.

Interest Rate Risk – As part of the Company’s interest rate risk management strategy, the Company uses derivative instruments to minimize significant unanticipated income fluctuations that may arise from rising variable interest rate costs associated with existing and anticipated borrowings. To meet these objectives the Company purchased interest rate caps and swaps. The rate for notional balances of interest rate caps ranging from $4,268,000 to $18,990,000 is 5.50%-6.00% per annum. The rate for notional balances of interest rate swaps ranging from $543,000 to $57,654,000 is 5.01%-8.16% per annum.

These derivatives are designated and documented as SFAS No. 133 cash flow hedges and effectiveness is evaluated by assessing the probability of anticipated interest expense and regressing the historical value of the rates against the historical value in the existing and anticipated debt. Ineffectiveness, reflecting the degree to which the derivative does not offset the underlying exposure, is recognized immediately in other income (expense). For the year ended December 31, 2008, gains from ineffectiveness in the amount of $4,999,000, gains from effectiveness in the amount of $75,000 and losses from undesignated hedges in the amount of $6,456,000 were recorded in other income (expense). These gains and losses resulted primarily from the Company’s efforts to restructure its debt financing and, therefore, making it not probable that the related borrowings would be paid as designated. As such the Company de-designated certain of its interest rate caps and swaps.

F-26

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the year ended December 31, 2007, losses from ineffectiveness in the amount of $4,836,000, losses from effectiveness in the amount of $147,000 and losses from undesignated hedges in the amount of $606,000 were recorded in other income (expense). These losses resulted primarily from the Company’s deferral of constructing its Imperial Valley facility. (See Note 3.) During the year ended December 31, 2006, ineffectiveness in the amount of $24,000 was recorded in other income (expense). Amounts remaining in accumulated other comprehensive income (loss) were reclassified to income upon the recognition of the hedged interest expense.

The Company marked its derivative instruments to fair value at each period end, except for those derivative contracts that qualified for the normal purchase and sale exemption under SFAS No. 133.

Accumulated Other Comprehensive Income – Accumulated other comprehensive income relative to derivatives is as follows (in thousands):

	Commodity Derivatives			Interest Rate Derivatives
	Gain/(Loss)*			Gain/(Loss)*
Beginning balance, January 1, 2008	$	(455	)	$	(1,928	)
Net changes		—			(2,637	)
Less: Amount reclassified to cost of goods sold		455			—
Less: Amount reclassified to other income (expense)		—			4,565
Ending balance, December 31, 2008	$	—		$	—

__________

*Calculated on a pretax basis

F-27

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DEBT.

Long-term borrowings are summarized in the table below (in thousands):

	December 31,
	2008			2007
Plant term loans, in forbearance	$	227,308		$	92,308
Plant working capital lines of credit, in forbearance		19,175			9,200
Kinergy operating line of credit, in forbearance		10,482			6,217
Notes payable to related party, in forbearance		31,500			30,000
Swap note, due 2011		14,987			16,370
Variable rate note, due 2011		582			6,930
Long-term revolving note		—			—
Front Range operating line of credit		1,200			—
Water rights capital lease obligations		1,123			1,261
		306,357			162,286
Less short-term portion		(305,420	)		(11,098	)
Long-term debt	$	937		$	151,188

Plant Term Loans & Working Capital Lines of Credit – On February 27, 2007, the Company closed a debt financing transaction in the aggregate amount of up to $325,000,000 through certain of its wholly-owned indirect subsidiaries (the “Borrowers”). The primary purpose of the debt financing (the “Debt Financing”) was to provide debt financing for the development, construction, installation, engineering, procurement, design, testing, start-up, operation and maintenance of five ethanol production facilities. On November 27, 2007, the Company amended the agreement to apply to four ethanol production facilities, thereby reducing the aggregate amount of available financing to up to $250,769,000. During 2008, the Company completed construction of its Magic Valley and Stockton plants, each resulting in total draws on the Company’s plant term loans and working capital lines of $69,231,000 and $5,000,000, respectively. In addition, the Company utilized approximately $825,000 of its working capital and letter of credit facility to obtain a letter of credit, which was outstanding at December 31, 2008.

The Debt Financing, as amended, included:

four construction loan facilities in an aggregate amount of up to $230,769,000. Loans made under the construction loan facilities do not amortize, but require payment of accrued interest, and were fully due and payable on the earlier of October 27, 2008 or the date the construction loans made thereunder were converted into term loans (the “Conversion Date”), the latter of which was the date the last of the four plants achieved commercial operations. On October 27, 2008, the Company achieved commercial operations of its last plant, and at that time converted its construction loans into term loans;

four term loan facilities in an aggregate amount of up to $230,769,000, which were intended to refinance the loans made under the construction loan facilities. The term loans are to be repaid ratably by each Borrower on a quarterly basis from and after the Conversion Date in an amount equal to 1.5% of the aggregate original principal amount of the corresponding term loan. The remaining principal balance and all accrued and unpaid interest on the term loans are fully due and payable on the date that is 84 months after the Conversion Date; and

F-28

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

a working capital and letter of credit facility in an aggregate amount of up to $20,000,000 ($5,000,000 per facility) that is fully due and payable on the date that is 12 months after the Conversion Date. During the term of the working capital and letter of credit facility, the Borrowers may borrow, repay and re-borrow amounts available under the facility.

Loans and letters of credit under the Debt Financing are subject to conditions precedent, including, among others, the absence of a material adverse effect; the absence of defaults or events of defaults; the accuracy of certain representations and warranties; the maintenance of a debt-to-equity ratio that is not in excess of 65:35; the contribution of all required equity by the Company to the Borrowers; and the attainment of at least a 1.5-to-1.0 debt service coverage ratio. Loans made under the construction and term loan facilities may not be re-borrowed once repaid or re-borrowed once prepaid.

In addition to scheduled principal payments, starting after the Conversion Date, the term loan facilities require mandatory repayments of principal in amounts based on the Borrowers’ free cash flow. The percentage of the Borrowers’ free cash flow to be applied to principal repayments is to vary from 50% in the first two years following the Conversion Date to 75-100% in succeeding years, based upon repayment amounts measured against targeted balances.

Borrowings and the Borrowers’ obligations under the Debt Financing are secured by a first-priority security interest in all of the equity interests in the Borrowers and substantially all the assets of the Borrowers. The security interests granted by the Borrowers under the Debt Financing restrict the assets and revenues of the Borrowers and therefore may inhibit the Company’s ability to obtain other debt financing.

In connection with the Debt Financing, the Company also entered into a Sponsor Support Agreement under which the Company is to provide limited contingent equity support in connection with the development, construction, installation, engineering, procurement, design, testing, start-up and maintenance of the four ethanol production facilities. In particular, the Company has agreed to provide a warranty with respect to all ethanol plants other than its Madera facility, which is under standard warranty through the contractor. The warranty obligations of the Company with respect to the other three facilities extend one year beyond the commercial operations start date of each facility. The warranty obligations will cease in October 2009, one year from the date the final ethanol plant started commercial operations. The Company’s obligations under the warranty are capped at approximately $28,000,000. Until the Company’s contingent equity obligations have been fully performed or the warranty period has expired, the Company may not incur any secured indebtedness for borrowed money, grant liens on its assets or provide any secured credit enhancements in an aggregate amount in excess of $10,000,000 unless the Company provides the lenders under the Debt Financing with the same liens or credit support.

The Company incurred $13,317,000 of costs associated with the completion of the Debt Financing arrangement and has capitalized these costs in other assets, except the portion amortizing during the next twelve months, which is classified in other current assets. In connection with the amendment discussed above, the Company recognized a write-off of the corresponding facility’s related unamortized financing costs of approximately $1,962,000 for the year ended December 31, 2007. For the other facilities, the Company recognized amortization of financing costs of approximately $2,018,000 and $2,764,000 for the years ended December 31, 2008 and 2007. The remaining unamortized financing costs continue to be amortized over a seven-year life.

In March 2008, the Company became aware of various events or circumstances which constituted defaults under its credit agreement. On March 26, 2008, the Company obtained waivers from its lenders as to these defaults and was required to pay the lenders a consent fee in an aggregate amount of $521,000. In addition to the waivers, the Company’s lenders agreed to amend the Debt Financing. These amendments include an increase in the frequency with which the Company is to deposit certain revenues into a restricted account each month, an increase of allowable Eurodollar loans from a maximum of seven to a maximum of ten, and the Company was required to pay all remaining project costs on its Madera and Columbia plants by May 16, 2008.

F-29

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In February, 2009, the Company became aware of new and potential events which constituted defaults under its credit agreement. In February 2009, the Company obtained a waiver and forbearance agreement with its lenders which was extended in March 2009. The waiver and forbearance agreement, as extended, provides that the lenders will forbear from exercising their rights and remedies under the Debt Financing commencing February 17, 2009 and ending on April 30, 2009. Further the waiver and forbearance agreement provides that the Company may withdraw funds otherwise required to be reserved in two accounts designated solely for the Stockton facility and the other for future debt service payments. The use of these funds provides approximately $5,385,000 million to the Company for operating activities. Further, the lenders have allowed the Company to cease payments of principal and interest due during the forbearance period. Finally, under the terms of the forbearance agreement, the Company’s obligations will accrue interest at a rate that is based on the Prime Rate as published by the Wall Street Journal plus applicable spreads, resulting in rates ranging from 8.29% to 9.35%. Upon expiration of the forbearance period, or the Company’s earlier default under the terms of the forbearance, the Company will be required to repay all outstanding amounts owed to its lenders. The Company is presently attempting to negotiate debt restructuring terms with its lenders. However, the Company cannot provide any assurance that it will be able to successfully negotiate satisfactory terms with its lenders.

Kinergy Operating Line of Credit – Kinergy was originally a party to a $17,500,000 credit facility dated as of August 17, 2007 with Comerica Bank. Kinergy’s obligations to Comerica Bank were secured by substantially all of its assets, subject to certain customary exclusions and permitted liens, and were guaranteed by the Company. On May 12, 2008, Kinergy and Comerica entered into a forbearance agreement. The forbearance agreement identified certain existing defaults under the credit facility and provided that Comerica Bank would forbear for a period of time (the “Forbearance Period”) commencing on May 12, 2008 and ending on the earlier to occur of (i) August 15, 2008, and (ii) the date that any new default occurred under the Loan Documents, from exercising its rights and remedies under the Loan Documents and under applicable law.

On July 28, 2008, Kinergy entered into a new Loan and Security Agreement (the “Loan Agreement”) dated July 28, 2008 with Wachovia Capital Finance Corporation (Western) (“Agent”) and Wachovia Bank, National Association (“Wachovia”). Kinergy initially used the proceeds from the closing of this credit facility to repay all amounts outstanding under its credit facility with Comerica Bank and to pay certain closing fees.

The original terms of the Loan Agreement provided for a credit facility in an aggregate amount of up to $40,000,000 based on Kinergy’s eligible accounts receivable and inventory levels, subject to any reserves established by Agent. Kinergy could also obtain letters of credit under the credit facility, subject to a letter of credit sublimit of $10,000,000. The credit facility was subject to certain other sublimits, including as to inventory loan limits. Kinergy could have requested an increase in the amount of the facility in increments of not less than $2,500,000, up to a maximum aggregate credit limit of $45,000,000, but Wachovia had no obligation to agree to any such request. The Loan Agreement also contained restrictions on distributions of funds from Kinergy to the Company. In addition, the Loan Agreement contained a single financial covenant requiring that Kinergy generate EBITDA in specified amounts during 2008 and 2009. For subsequent periods, the minimum EBITDA covenant amounts were to be determined based upon financial projections to be delivered by Kinergy and shall be mutually agreed upon by Kinergy and Agent.

F-30

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Kinergy paid customary closing fees, including a closing fee of 0.50% of the maximum credit, or $200,000, to Wachovia, and $150,000 in legal fees to legal counsel to Agent and Wachovia. On July 28, 2008, the Company entered into a Guarantee dated July 28, 2008 in favor of Agent for and on behalf of Wachovia. The Guarantee provides for the unconditional guarantee by the Company of, and the Company agreed to be liable for, the payment and performance when due of Kinergy’s obligations under the Loan Agreement.

In February 2009, Kinergy determined it had violated certain of its covenants, including its EBITDA covenant for 2008, and as a result, entered into an amendment and forbearance agreement which was extended in March 2009 (“Amendment”) with Agent and Wachovia. The Amendment identified certain defaults under the Loan Agreement, as to which Agent and Wachovia agreed to forebear from exercising their rights and remedies under the Loan Agreement commencing February 13, 2009 through April 30, 2009. The Amendment reduced the aggregate amount of the credit facility from up to $40,000,000 to $10,000,000.

The Amendment also increased the interest rates. Kinergy may borrow under the credit facility based upon (i) a rate equal to (a) the London Interbank Offered Rate (“LIBOR”), divided by 0.90 (subject to change based upon the reserve percentage in effect from time to time under Regulation D of the Board of Governors of the Federal Reserve System), plus (b) 4.50% depending on the amount of Kinergy’s EBITDA for a specified period, or (ii) a rate equal to (a) the greater of the prime rate published by Wachovia Bank from time to time, or the federal funds rate then in effect plus 0.50%, plus (b) 2.25% depending on the amount of Kinergy’s EBITDA for a specified period. In addition, Kinergy is required to pay an unused line fee at a rate equal to 0.375% as well as other customary fees and expenses associated with the credit facility and issuances of letters of credit. Kinergy’s obligations under the Loan Agreement are secured by a first-priority security interest in all of its assets in favor of Agent and Wachovia.

The credit facility originally matured on July 28, 2011, unless sooner terminated. Kinergy is permitted to terminate the credit facility early upon ten days prior written notice. Agent and Wachovia may terminate the credit facility early at any time on or after an event of default has occurred and is continuing. In the event the credit facility is for any reason terminated prior to the maturity date, Kinergy will be required to pay an early termination fee ranging from 0.50% to 1.00% of the maximum credit, based on the date of termination if the credit facility is terminated on or before July 29, 2010.

Upon expiration of the Amendment, Kinergy will be required to repay all outstanding amounts to Agent and Wachovia, and as such, the Company has reclassified all amounts to current on its consolidated balance sheet. The Company is attempting to negotiate new terms satisfactory to Kinergy, Agent and Wachovia.

Notes Payable to Related Party – In November 2007, Pacific Ethanol Imperial, LLC (“PEI Imperial”), an indirect subsidiary of the Company, borrowed $15,000,000 from Lyles United, LLC under a Secured Promissory Note containing customary terms and conditions. The loan accrued interest at a rate equal to the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 2.00%, computed on the basis of a 360-day year of twelve 30-day months. The loan was due 90-days after issuance or, if extended at the option of PEI Imperial, 365-days after the end of such 90-day period. This loan was extended by PEI Imperial to February 25, 2009. The Secured Promissory Note provided that if the loan was extended, the Company was to issue a warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $8.00 per share. The Company issued this warrant simultaneously with the closing of the issuance of the Company’s Series B Preferred Stock on March 27, 2008. The warrant is exercisable at any time during the 18-month period after the date of issuance.

F-31

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In December 2007, PEI Imperial borrowed an additional $15,000,000 from Lyles United, LLC under a second Secured Promissory Note containing customary terms and conditions. The loan accrued interest at a rate equal to the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 4.00%, computed on the basis of a 360-day year of twelve 30-day months. The loan was due on March 31, 2008, but was extended at the option of PEI Imperial, to March 31, 2009. As a result of the extension, the interest rate increased by 2.00% to the rate indicated above.

In November 2008, PEI Imperial restructured its aggregate $30,000,000 loan from Lyles United, LLC by paying all accrued and unpaid interest thereon and assigning the aforementioned two Secured Promissory Notes to the Company. The Company issued an Amended and Restated Promissory Note in the principal amount of $30,000,000 and Lyles United, LLC cancelled the two Secured Promissory Notes. The Amended and Restated Promissory Note is due March 15, 2009 and accrues interest at the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 3.00%, computed on the basis of a 360-day year of twelve 30-day months. The Company and Lyles United, LLC (“Lyles United”) jointly instructed Pacific Ethanol California, Inc. (“PEI California”) pursuant to an Irrevocable Joint Instruction Letter to remit directly to Lyles United, LLC any cash distributions received by PEI California on account of its ownership interests in PEI Imperial and Front Range until such time as the Amended and Restated Promissory Note is repaid in full. In addition, PEI California entered into a Limited Recourse Guaranty to the extent of such cash distributions in favor of Lyles United, LLC. Finally, Pacific Ag. Products, LLC entered into an Unconditional Guaranty as to all of the Company’s obligations under the Amended and Restated Promissory Note and pledged all of its assets as security therefore pursuant to a Security Agreement.

In October 2008, upon completion of the Stockton facility, the Company converted final unpaid construction costs to an unsecured note payable. The note payable is between the Company and Lyles Mechanical Co. in the principal amount of $1,500,000 and is due with accrued interest on March 31, 2009. Interest accrues at the Prime Rate of interest as reported from time to time in the Wall Street Journal, plus 2.00%, computed on the basis of a 360-day year of twelve 30-day months.

In February 2009, the Company notified Lyles United and Lyles Mechanical that it would not be able to pay off its notes due March 15, and March 31, 2009 and as a result, entered into a forbearance agreement, which was extended in March 2009. Under the terms of the forbearance agreement, as extended, Lyles United and Lyles Mechanical agreed to forbear from exercising their rights and remedies against the Company through April 30, 2009. Upon expiration of the forbearance agreement, the Company will be required to repay the amounts due to Lyles United and Lyles Mechanical, and as such, the Company has classified all amounts in current liabilities on its consolidated balance sheet.

Swap Note – The swap note is a term loan, with a floating interest rate, established on a quarterly basis, equal to the 90-day LIBOR plus 3.00%. The Company has entered into a swap contract with the lender to provide a fixed rate of 8.16%. The loan matures in five years, but has required principal payments due based on a ten-year amortization schedule. Quarterly payments are approximately $678,000, including interest with final payment due November 10, 2011.

Variable Rate Note – The variable rate note is a term loan that carries an interest rate that will float at a rate equal to the 90-day LIBOR plus 2.75-3.50%, depending on a debt-to-net worth ratio. As of December 31, 2008, the interest rate was 5.39%. The variable loan matures in five years but is amortized over 10 years with a final payment due November 10, 2011. Quarterly payments of approximately $654,000 which are applied in a cascading order, as follows: long-term revolving note interest, variable rate note interest, variable rate note principal and long-term revolving note principal.

F-32

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Front Range Operating Line of Credit – Front Range has a line of credit of $3,500,000 with a commercial bank to support working capital, specifically inventories and accounts receivable. The line of credit expires November 24, 2009 and bears interest at a rate equal to the 30-day LIBOR plus 3.75%. The line of credit is secured by substantially all of the assets of Front Range.

Long-Term Revolving Note – The long-term revolving note is a revolving loan in the amount of $5,000,000 and carries an interest rate that will float at a rate equal to the 30-day LIBOR, plus 2.75-3.50%, depending on a debt-to-net worth ratio. As of December 31, 2008, the interest rate was 5.39%. Repayment terms are included above in the description of the variable rate note.

The swap note, variable rate note and long-term revolving note are due in 2011, and include an accelerated principal reduction provision based on excess net cash flow. Excess net cash flow is measured on an annual basis and is defined as net income before interest expense, income taxes, depreciation and amortization and after giving effect to scheduled loan payments and capital expenditures. The provision requires the Company to pay 20% of its excess net cash flow within 120 days of its year end; however, this amount is not to exceed $4,000,000 per fiscal year. The accelerated payment for the year ended December 31, 2008 and 2007 is $0 and $4,000,000, respectively, and had the effect of increasing the maturities of long-term debt due in 2008 and 2007 and decreasing the future maturities of long-term debt that would have been due in 2011.

The three notes listed above represent permanent financing and are collateralized by a perfected, first-priority security interest in all of the assets of Front Range, including inventories and all rights, title and interest in all tangible and intangible assets of Front Range; a pledge of 100% of the ownership interest in Front Range; an assignment of all revenues produced by Front Range; a pledge and assignment of Front Range’s material contracts and documents, to the extent assignable; all contractual cash flows associated with such agreements; and any other collateral security as the lender may reasonably request.

These collateralizations restrict the assets and revenues as well as future financing strategies of Front Range, the Company’s variable interest entity, but do not apply to, nor have bearing upon any financing strategies that the Company may choose to undertake in the future.

The carrying values and classification of assets that are collateral for the obligations of Front Range at December 31, 2008 are as follows (in thousands):

Current assets	$	19,369
Property and equipment		49,231
Other assets		388
Total collateralized assets	$	69,988

Front Range is subject to certain loan covenants. Under these covenants, Front Range is required to maintain a certain fixed-charge coverage ratio, a minimum level of working capital and a minimum level of net worth. The covenants also set a maximum amount of additional debt that may be incurred by Front Range. The covenants also limit annual distributions that may be made to owners of Front Range, including the Company, based on Front Range’s leverage ratio. Front Range is currently out of compliance with certain of its covenants and is currently seeking a waiver from its lender. Until a waiver is obtained, the Company has reclassified the related outstanding balance on the loan to current.

F-33

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Water Rights Capital Lease – The water rights lease obligation relates to a lease agreement with the Town of Windsor for augmentation water for use in Front Range’s production processes. The lease required an initial payment of $400,000, paid in 2006, and annual payments of $160,000 per year for the following ten years. The future payments were discounted using a 5.25% interest rate which was comparable to available borrowing rates at the time of execution of the agreement. The obligation has been recorded as a capital lease and included in long-term obligations and the related asset has been included in property and equipment.

Interest Expense on Borrowings – Interest expense on all borrowings discussed above was $12,271,000, $1,882,000 and $720,000, for the years ended December 31, 2008, 2007 and 2006, respectively. These amounts were net of capitalized interest and deferred financing fees of $9,186,000, $8,494,000 and $671,000 for the years ended December 31, 2008, 2007 and 2006, respectively, and included the Company’s construction costs of plant and equipment.

The amounts of long-term debt maturing, including current debt in forbearance, due in each of the next five years are included below (in thousands):

Years Ended December 31,	Amount
2009	$	305,420
2010		130
2011		122
2012		123
2013		130
Thereafter		432
Total	$	306,357

8.	INCOME TAXES.

The asset and liability method is used to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax credits and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.

The Company files a consolidated federal income tax return. This return includes all corporate companies 80% or more owned by the Company as well as the Company’s pro-rata share of taxable income from pass-through entities in which the Company holds an ownership interest. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to the Company and its subsidiaries.

The Company recorded no provision for income taxes for each of the years ended December 31, 2008, 2007 and 2006.

F-34

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A reconciliation of the differences between the United States statutory federal income tax rate and the effective tax rate as provided in the consolidated statements of operations is as follows:

	Years Ended December 31,
	2008			2007			2006
Statutory rate		(35.0	)%		(35.0	)%		(35.0	)%
State income taxes, net of federal benefit		(4.3	)		(5.9	)		—
Change in valuation allowance		37.6			49.1			(2,091.8	)
Impairment of Kinergy goodwill		1.1			—			—
Valuation allowance relating to equity items		0.7			(8.3	)		369.8
Non-deductible items		—			0.8			15.6
Prior year purchase accounting adjustment		—			—			1,599.9
Other		(0.1	)		(0.7	)		141.5
Effective rate		0.0	%		0.0	%		0.0	%

Deferred income taxes are provided using the asset and liability method to reflect temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using presently enacted tax rates and laws. The components of deferred income taxes included in the consolidated balance sheets were as follows (in thousands):

	December 31,
	2008			2007
Deferred tax assets:
Net operating loss carryforward	$	61,474		$	23,218
Impairment of asset group		16,188			—
Investment in partnerships		8,852			—
Derivative instruments mark-to-market		2,452			2,341
Stock option compensation		2,494			1,339
Other accrued liabilities		124			189
Available-for-sale securities		—			970
Other		1,920			132
Total deferred tax assets		93,504			28,189

Deferred tax liabilities:
Fixed assets		(26,952	)		(15,318	)
Intangibles		(2,265	)		(2,513	)
Investment in partnerships		—			(995	)
Total deferred tax liabilities		(29,217	)		(18,826	)

Valuation allowance		(65,378	)		(10,454	)
Net deferred tax liabilities	$	(1,091	)	$	(1,091	)

Classified in balance sheet as:
Deferred income tax benefit (current assets)	$	—		$	—
Deferred income taxes (long-term liability)		(1,091	)		(1,091	)
	$	(1,091	)	$	(1,091	)

At December 31, 2008 and 2007, the Company had federal net operating loss carryforwards of approximately $169,157,000 and $71,466,000, and state net operating loss carryforwards of approximately $149,124,000 and $67,392,000, respectively. These net operating loss carryforwards expire at various dates beginning in 2013. The deferred tax asset for the Company’s net operating loss carryforwards at December 31, 2008 does not include $5,442,000 which relates to the tax benefits associated with warrants and non-statutory options exercised by employees, members of the board and others under the various incentive plans. These tax benefits will be recognized in stockholders’ equity rather than in the statements of operations in accordance with SFAS No. 109 but not until the period that these amounts decrease taxes payable.

F-35

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A portion of the Company’s net operating loss carryforwards will be subject to provisions of the tax law that limit the use of losses incurred by a company prior to becoming a member of a consolidated group as well as losses that existed at the time there is a change in control of an enterprise. The amount of the Company’s net operating loss carryforwards that would be subject to these limitations was approximately $7,728,000 at December 31, 2008.

In assessing whether the deferred tax assets are realizable, SFAS No. 109 establishes a more likely than not standard. If it is determined that it is more likely than not that deferred tax assets will not be realized, a valuation allowance must be established against the deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

A valuation allowance has been established in the amount of $65,378,000 and $10,454,000 at December 31, 2008 and 2007, respectively, based on Company’s assessment of the future realizability of certain deferred tax assets. For the years ending December 31, 2008 and 2007, the Company recorded an increase in the valuation allowance of $54,924,000 and $7,062,000, respectively. The valuation allowance on deferred tax assets is related to future deductible temporary differences and net operating loss carryforwards (exclusive of net operating losses associated with items recorded directly to equity) for which the Company has concluded it is more likely than not that these items will not be realized in the ordinary course of operations.

On January 1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the entity’s financial statements in accordance with SFAS No. 109. The adoption of FIN 48 did not result in a cumulative effect adjustment to the Company’s retained earnings. As of the date of adoption, the Company had no unrecognized income tax benefits. Accordingly, the annual effective tax rate was not affected by the adoption of FIN 48. Should the Company incur interest and penalties relating to tax uncertainties, such amounts would be classified as a component of interest expense and operating expense, respectively.

At December 31, 2008, the Company had no increase or decrease in unrecognized income tax benefits for the year. There was no accrued interest or penalties relating to tax uncertainties at December 31, 2008. Unrecognized tax benefits are not expected to increase or decrease within the next twelve months.

F-36

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company is subject to income tax in the U.S. federal jurisdiction and various state jurisdictions and has identified its federal tax return and tax returns in state jurisdictions below as “major” tax filings. These jurisdictions, along with the years still open to audit under the applicable statutes of limitation, are as follows:

Jurisdiction	Tax Years

Federal	2005 – 2007
California	2004– 2007
Colorado	2006– 2007
Florida	2005
Idaho	2006– 2007
Nebraska	2006– 2007
Oregon	2006– 2007
Wisconsin	2006– 2007

However, because the Company had net operating losses and credits carried forward in several of the jurisdictions, including the U.S. federal and California jurisdictions, certain items attributable to closed tax years are still subject to adjustment by applicable taxing authorities through an adjustment to tax attributes carried forward to open years.

9.	PREFERRED STOCK.

Series A Preferred Stock – On April 13, 2006, the Company issued to Cascade Investment, L.L.C. (“Cascade”), 5,250,000 shares of Series A Cumulative Redeemable Convertible Preferred Stock (“Series A Preferred Stock”) at a price of $16.00 per share, for an aggregate purchase price of $84,000,000. The Company used $4,000,000 of the proceeds for general working capital and the remaining $80,000,000 for the construction of its ethanol production facilities.

The Series A Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s common stock. Holders of Series A Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in cash in an amount equal to 5% per annum of the purchase price per share of the Series A Preferred Stock. Prior to March 27, 2008, and at the Company’s option, it could have made dividend payments in additional shares of Series A Preferred Stock based on the value of the purchase price per share of the Series A Preferred Stock.

The holders of the Series A Preferred Stock have conversion rights initially equivalent to two shares of common stock for each share of Series A Preferred Stock, subject to customary antidilution adjustments. Certain specified issuances will not result in antidilution adjustments. The shares of Series A Preferred Stock are also subject to forced conversion upon the occurrence of a transaction that would result in an internal rate of return to the holders of the Series A Preferred Stock of 25% or more. Accrued but unpaid dividends on the Series A Preferred Stock are to be paid in cash upon any conversion of the Series A Preferred Stock.

The holders of Series A Preferred Stock have a liquidation preference over the holders of the Company’s common stock equivalent to the purchase price per share of the Series A Preferred Stock plus any accrued and unpaid dividends on the Series A Preferred Stock. A liquidation will be deemed to occur upon the happening of customary events, including transfer of all or substantially all of the Company’s capital stock or assets or a merger, consolidation, share exchange, reorganization or other transaction or series of related transaction, unless holders of 66 2/3% of the Series A Preferred Stock vote affirmatively in favor of or otherwise consent to such transaction.

Under the provisions of SFAS No. 133, the Series A Preferred Stock’s redemption feature was likely a derivative instrument that required bifurcation from the host contract. SFAS No. 133 requires all derivative instruments to be measured at fair value. However, because the underlying events that would cause the redemption feature to be exercisable (i.e., redemption events) are in the Company’s control and were not probable of occurrence in the foreseeable future, the Company believed that the fair value of the embedded derivative was de minimis at the date of issuance of the Series A Preferred Stock. As of December 31, 2007, the redemption events were no longer applicable, as the funds have been fully used for construction.

F-37

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

During 2008, Cascade converted all of its Series A Preferred Stock into shares of the Company’s common stock. In the aggregate, Cascade converted 5,315,625 shares of Series A Preferred Stock into 10,631,250 shares of the Company’s common stock. Accordingly, as of December 31, 2008, no shares of Series A Preferred Stock were outstanding.

Series B Preferred Stock – On March 18, 2008, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Lyles United, LLC. The Purchase Agreement provided for the sale by the Company and the purchase by Lyles United, LLC of (i) 2,051,282 shares of the Company’s Series B Cumulative Convertible Preferred Stock (the “Series B Preferred Stock”), all of which are initially convertible into an aggregate of 6,153,846 shares of the Company’s common stock based on an initial three-for-one conversion ratio, and (ii) a warrant to purchase an aggregate of 3,076,923 shares of the Company’s common stock at an exercise price of $7.00 per share. On March 27, 2008, the Company consummated the purchase and sale of the Series B Preferred Stock. Upon issuance, the Company recorded $39,898,000, net of issuance costs, in stockholders’ equity. The warrant is exercisable at any time during the period commencing on the date that is six months and one day from the date of the warrant and ending ten years from the date of the warrant.

On May 20, 2008, the Company entered into a Securities Purchase Agreement (the “May Purchase Agreement”) with Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (the “May Purchasers”). The May Purchase Agreement provided for the sale by the Company and the purchase by the May Purchasers of (i) an aggregate of 294,870 shares of the Company’s Series B Preferred Stock, all of which are initially convertible into an aggregate of 884,610 shares of the Company’s common stock based on an initial three-for-one conversion ratio, and (ii) warrants to purchase an aggregate of 442,305 shares of the Company’s common stock at an exercise price of $7.00 per share. On May 22, 2008, the Company consummated the purchase and sale under the May Purchase Agreement. Upon issuance, the Company recorded $5,745,000, net of issuance costs, in stockholders’ equity. The warrants are exercisable at any time during the period commencing on the date that is six months and one day from the date of the warrants and ending ten years from the date of the warrants.

The Series B Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s common stock. Holders of Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in cash in an amount equal to 7.00% per annum of the purchase price per share of the Series B Preferred Stock; however, subject to the provisions of the Letter Agreement described below, such dividends may, at the option of the Company, be paid in additional shares of Series B Preferred Stock based initially on liquidation value of the Series B Preferred Stock. The holders of Series B Preferred Stock have a liquidation preference over the holders of the Company’s common stock initially equivalent to $19.50 per share of the Series B Preferred Stock plus any accrued and unpaid dividends on the Series B Preferred Stock. A liquidation will be deemed to occur upon the happening of customary events, including the transfer of all or substantially all of the capital stock or assets of the Company or a merger, consolidation, share exchange, reorganization or other transaction or series of related transaction, unless holders of 66 2/3% of the Series B Preferred Stock vote affirmatively in favor of or otherwise consent that such transaction shall not be treated as a liquidation. The Company believes that such liquidation events are within its control and therefore, in accordance with Emerging Issues Task Force Issue D-98, Classification and Measurement of Redeemable Securities, the Company has classified the Series B Preferred Stock in stockholders’ equity.

F-38

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The holders of the Series B Preferred Stock have conversion rights initially equivalent to three shares of common stock for each share of Series B Preferred Stock. The conversion ratio is subject to customary antidilution adjustments. In addition, antidilution adjustments are to occur in the event that the Company issues equity securities at a price equivalent to less than $6.50 per share, including derivative securities convertible into equity securities (on an as-converted or as-exercised basis). The shares of Series B Preferred Stock are also subject to forced conversion upon the occurrence of a transaction that would result in an internal rate of return to the holders of the Series B Preferred Stock of 25% or more. The forced conversion is to be based upon the conversion ratio as last adjusted. Accrued but unpaid dividends on the Series B Preferred Stock are to be paid in cash upon any conversion of the Series B Preferred Stock.

The holders of Series B Preferred Stock vote together as a single class with the holders of the Company’s common stock on all actions to be taken by the Company’s stockholders. Each share of Series B Preferred Stock entitles the holder to the number of votes equal to the number of shares of common stock into which each share of Series B Preferred Stock is convertible on all matters to be voted on by the stockholders of the Company. Notwithstanding the foregoing, the holders of Series B Preferred Stock are afforded numerous customary protective provisions with respect to certain actions that may only be approved by holders of a majority of the shares of Series B Preferred Stock. As long as 50% of the shares of Series B Preferred Stock remain outstanding, the holders of the Series B Preferred Stock are afforded preemptive rights with respect to certain securities offered by the Company.

In connection with the closing of the above mentioned sales of its Series B Preferred Stock, the Company entered into Letter Agreements with Lyles United, LLC and the May Purchasers under which the Company expressly waived its rights under the Certificate of Designations to make dividend payments in additional shares of Series B Preferred Stock in lieu of cash dividend payments without the prior written consent of Lyles United, LLC and the May Purchasers.

Registration Rights Agreement – In connection with the closing of the sale of its Series A and B Preferred Stock, the Company entered into Registration Rights Agreements with holders of the Preferred Stock. The Registration Rights Agreements are to be effective until the holders of the Preferred Stock, and their affiliates, as a group, own less than 10% for each of the series issued, including common stock into which such Preferred Stock has been converted (the “Termination Date”). The Registration Rights Agreements provide that holders of a majority of the Preferred Stock, including common stock into which such Preferred Stock has been converted, may demand and cause the Company, at any time after the first anniversary of the Closing, to register on their behalf the shares of common stock issued, issuable or that may be issuable upon conversion of the Preferred Stock and as payment of dividends thereon, and, in the case of the Series B Preferred Stock, upon exercise of the related warrants as well as upon exercise of a warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $8.00 per share and issued in connection with the extension of the maturity date of an unrelated loan (collectively, the “Registrable Securities”). The Company is required to keep such registration statement effective until such time as all of the Registrable Securities are sold or until such holders may avail themselves of Rule 144 for sales of Registrable Securities without registration under the Securities Act of 1933, as amended. The holders are entitled to two demand registrations on Form S-1 and unlimited demand registrations on Form S-3; provided, however, that the Company is not obligated to effect more than one demand registration on Form S-3 in any calendar year. In addition to the demand registration rights afforded the holders under the Registration Rights Agreement, the holders are entitled to unlimited “piggyback” registration rights. These rights entitle the holders who so elect to be included in registration statements to be filed by the Company with respect to other registrations of equity securities. The Company is responsible for all costs of registration, plus reasonable fees of one legal counsel for the holders, which fees are not to exceed $25,000 per registration. The Registration Rights Agreements include customary representations and warranties on the part of both the Company and the holders and other customary terms and conditions.

F-39

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Under its obligations described above, in connection with the Series A Preferred Stock, the Company filed a registration statement with the Commission, registering for resale shares of the common stock up to 10,500,000, which was declared effective in November 2007.

Deemed Dividend on Preferred Stock – In accordance with EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the Series A Preferred Stock and Series B Preferred Stock issued to the May Purchasers is considered to have an embedded beneficial conversion feature because the conversion price (as adjusted for the value allocated to the warrants) was less than the fair value of the Company’s common stock at the issuance date. As a result, the Company has recorded a deemed dividend on preferred stock of $761,000, $28,000 and $84,000,000 for the years ended December 31, 2008, 2007 and 2006, respectively. These non-cash dividends are to reflect the implied economic value to the preferred stockholder of being able to convert its shares into common stock at a price (as adjusted for the value allocated to any warrants) which was in excess of the fair value of the Preferred Stock at the time of issuance. The fair value allocated to the Preferred Stock together with the original conversion terms (as adjusted for the value allocated to any warrants) were used to calculate the value of the deemed dividend on the Preferred Stock on the date of issuance.

For the year ended December 31, 2008, the deemed dividend on the Series B Preferred Stock was calculated using the difference between the conversion price of the Series B Preferred Stock into shares of common stock, adjusted for the value allocated to the warrants, of $4.79 per share and the fair market value of the Company’s common stock of $5.65 on the date of issuance of the Series B Preferred Stock. These amounts have been charged to accumulated deficit with the offsetting credit to additional paid-in-capital. The Company has treated the deemed dividend on preferred stock as a reconciling item on the consolidated statements of operations to adjust its reported net loss, together with any preferred stock dividends recorded during the applicable period, to loss available to common stockholders in the consolidated statements of operations.

For the year ended December 31, 2007, the deemed dividend on the Series A Preferred Stock was calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock into shares of common stock of $8.00 per share and the fair market value of the Company’s common stock of $8.21 on the date of issuance of the Series A Preferred Stock.

For the year ended December 31, 2006, the deemed dividend on the Series A Preferred Stock was calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock into shares of common stock of $8.00 per share and the fair market value of the Company’s common stock of $29.27 on the date of issuance of the Series A Preferred Stock. The fair value allocated to the Series A Preferred Stock was in excess of the gross proceeds received of $84,000,000 in connection with the sale of the Series A Preferred Stock; however, the deemed dividend on the Series A Preferred Stock is limited to the gross proceeds received of $84,000,000.

The Company recorded preferred stock dividends of $4,104,000, $4,200,000 and $2,998,000 for the years ended December 31, 2008, 2007 and 2006, respectively. For all periods except for the three months ended December 31, 2007, the Company declared cash dividends for payment of the preferred stock dividends. For the three months ended December 31, 2007, the Company elected to issue an additional 65,625 shares of Series A Preferred Stock as a payment-in-kind of dividends.

F-40

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.	COMMON STOCK AND WARRANTS.

In March 2008, in connection with the Company’s issuance of the Series B Preferred Stock, as discussed in Note 9, the Company issued warrants to purchase an aggregate of 3,076,923 shares of common stock at an exercise price of $7.00 per share.

In March 2008, in connection with the Company’s extension of its related party note, as discussed in Note 7, it issued warrants to purchase 100,000 of common stock at an exercise price of $8.00 per share.

In May 2008, in connection with the Company’s issuance of additional Series B Preferred Stock, as discussed in Note 9, the Company issued warrants to purchase an aggregate of 442,305 shares of common stock at an exercise price of $7.00 per share.

In May 2008, the Company entered into a Placement Agent Agreement with Lazard Capital Markets LLC (the “Placement Agent”), relating to the sale by the Company of an aggregate of 6,000,000 shares of common stock and warrants to purchase an aggregate of 3,000,000 shares of common stock at an exercise price of $7.10 per share of common stock for an aggregate purchase price of $28,500,000. The warrants are exercisable at any time during the period commencing on the date that is six months and one day from the date of the warrants and ending five years from the date of the warrants. On May 29, 2008, the Company consummated the offering. Upon issuance, the Company recorded $26,648,000, net of issuance costs, in stockholders’ equity.

In May 2006, the Company issued to 45 accredited investors an aggregate of 5,496,583 shares of common stock at a price of $26.38 per share, for an aggregate purchase price of $145.0 million in cash. The Company designated the net proceeds of approximately $138.0 million, net of capital raising fees and expenses, for construction of additional ethanol plants and working capital. The Company also issued to the investors warrants to purchase an aggregate of 2,748,297 shares of common stock at an exercise price of $31.55 per share. These warrants expired unexercised in February 2007.

In February 2004, upon completion of the Share Exchange Transaction, the Company issued warrants to purchase 230,000 additional shares of common stock at an exercise price of $0.0001 and expiring on March 23, 2009 that vested ratably over a period of two years from the date of the Share Exchange Transaction. The fair value of the warrants were amortized over two years, resulting in non-cash expense of $0 for the years ended December 31, 2008 and 2007 and $1,316,364 for the year ended December 31, 2006.

The following table summarizes warrant activity for the years ended December 31, 2008, 2007 and 2006 (number of shares in thousands):

	Number of Shares			Price per Share	Weighted Average Exercise Price
Balance at December 31, 2005		2,905		$0.0001 - $5.00	$	3.26
Warrants granted		3,442		$14.41 – $31.55		27.66
Warrants exercised		(2,747	)	$0.0001 - $5.00		3.28
Balance at December 31, 2006		3,600		$0.0001 – $31.55		27.57
Warrants exercised		(128	)	$0.0001 – $5.00		2.84
Warrants expired		(3,472	)	$3.00 – $31.00		27.45
Balance at December 31, 2007		—				—
Warrants granted		6,619		$7.00 – $8.00		7.06
Balance at December 31, 2008		6,619		$7.00 – $8.00	$	7.06

F-41

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.	STOCK-BASED COMPENSATION.

The Company has three equity incentive compensation plans: an Amended 1995 Incentive Stock Plan, a 2004 Stock Option Plan and a 2006 Stock Incentive Plan.

Amended 1995 Incentive Stock Plan – The Amended 1995 Incentive Stock Plan was carried over from Accessity as a result of the Share Exchange Transaction. The plan authorized the issuance of incentive stock options (“ISOs”) and non-qualified stock options (“NQOs”), to the Company’s employees, directors or consultants for the purchase of up to an aggregate of 1,200,000 shares of the Company’s common stock. On July 19, 2006, the Company terminated the Amended 1995 Incentive Stock Plan, except to the extent of issued and outstanding options then existing under the plan. The Company had 20,000, 40,000 and 63,000 stock options outstanding under its Amended 1995 Incentive Stock Plan at December 31, 2008, 2007 and 2006, respectively.

2004 Stock Option Plan – The 2004 Stock Option Plan authorized the issuance of ISOs and NQOs to the Company’s officers, directors or key employees or to consultants that do business with the Company for up to an aggregate of 2,500,000 shares of common stock. On September 7, 2006, the Company terminated the 2004 Stock Option Plan, except to the extent of issued and outstanding options then existing under the plan. The Company had 110,000, 185,000 and 405,000 stock options outstanding under its 2004 Stock Option Plan at December 31, 2008, 2007 and 2006, respectively.

On August 10, 2005, the Company granted options to purchase an aggregate of 425,000 shares of the Company’s common stock at an exercise price equal to $8.03, the closing price per share of the Company’s common stock on the day immediately preceding that date, to its Chief Financial Officer. The options vested as to 85,000 shares immediately and 85,000 shares were to vest on each of the next four anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Since the options were granted at par with the market price of the stock, no non-cash charge was recorded. Upon the retirement of the Chief Financial Officer on December 14, 2006, the unvested stock options related to this grant were forfeited, except for the options allotted under a consulting agreement entered into with the retired Chief Financial Officer on December 14, 2006. The consulting agreement provided for the immediate vesting of 42,500 stock options on December 14, 2006, and an additional 42,500 stock options vested on August 15, 2007, the last day of the term of the consulting agreement, provided the obligations under the consulting agreement were fulfilled by the retired Chief Financial Officer. The Company accounted for these options under the provisions of SFAS No. 123(R) and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and accordingly, recorded compensation expense for the unvested stock options based on the fair value of those options at the end of the reporting period based on the Black-Scholes option-pricing model with inputs of: the closing stock price on the last day of the reporting period, an exercise price of $8.03, the remaining contractual term through August 15, 2007, and volatility of 73.1%. The Company recorded $151,000 and $312,000 in stock-based compensation expense relating to these options for the years ended December 31, 2007 and 2006, respectively.

On August 10, 2005, the Company granted options to purchase an aggregate of 75,000 shares of the Company’s common stock at an exercise price equal to $8.03, the closing price per share of the Company’s common stock on the day immediately preceding that date, to a consultant. The options vested as to 15,000 shares immediately and 15,000 shares were to vest on each of the next four anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Under the guidelines of EITF Issue No. 96-18, based on the consultant meeting its obligations under the consulting agreement, the Company recorded compensation expense based on the fair value of the stock options at the vesting dates and on the last day of the reporting period for the unvested stock options, based on the Black-Scholes option-pricing model with inputs of: an exercise price of $8.03, the closing stock price, a contractual term of 10 years, and volatility of 53.6%. Beginning in December 2006 the consultant stopped providing services and will not be providing services in the future under the existing consulting agreement. As a result, the unvested stock options were forfeited. The Company recorded share-based compensation expense of $174,000 for the year ended December 31, 2006 relating to these options.

F-42

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A summary of the status of Company’s stock option plans as of December 31, 2008, 2007 and 2006 and of changes in options outstanding under the Company’s plans during those years are as follows (in thousands, except exercise prices):

	Years Ended December 31,
	2008					2007					2006
	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Outstanding at beginning of year		225		$	7.03		468		$	7.42		927		$	7.53
Granted		—			—		—			—		—			—
Exercised		—			—		(243	)		7.79		(196	)		7.06
Terminated		(95	)		6.55		—			—		(263	)		8.04
Outstanding at end of year		130			7.37		225			7.03		468			7.42
Options exercisable at end of year		130		$	7.37		185		$	7.11		297		$	7.36

Stock options outstanding as of December 31, 2008, were as follows (number of shares in thousands):

	Options Outstanding					Options Exercisable
Range of Exercise Prices	Number Outstanding		Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price

$4.88-$6.63		50	4.30	$	5.95		50	$	5.95
$8.25-$8.30		80	6.57	$	8.26		80	$	8.26
		130					130

The total intrinsic value of options outstanding was approximately $0 and $267,000 at December 31, 2008 and 2007, respectively. The intrinsic value for exercisable options was $0 and $203,000 at December 31, 2008 and 2007, respectively. The total intrinsic value for stock options exercised was approximately $0, $101,000 and $3,833,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

There were 40,000 and 66,034 unvested options with weighted-average grant-date fair values of $6.63 and $7.56, at December 31, 2007 and 2006, respectively. There were no unvested options at December 31, 2008.

2006 Stock Incentive Plan – The 2006 Stock Incentive Plan authorizes the issuance of options, restricted stock, restricted stock units, stock appreciation rights, direct stock issuances and other stock-based awards to the Company’s officers, directors or key employees or to consultants that do business with the Company for up to an aggregate of 2,000,000 shares of common stock.

F-43

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company grants to certain employees and directors shares of restricted stock under its 2006 Stock Incentive Plan pursuant to restricted stock agreements. A summary of unvested restricted stock activity is as follows (shares in thousands):

	Number of Shares			Weighted Average Grant Date Fair Value
Unvested at January 1, 2006		—		$	—
Issued		946			13.06
Vested		(281	)		13.06
Unvested at December 31, 2006		665			13.06
Issued		19			15.11
Vested		(140	)		13.14
Canceled		(36	)		13.72
Unvested at December 31, 2007		508			13.07
Issued		630			3.65
Vested		(275	)		7.78
Canceled		(111	)		13.06
Unvested at December 31, 2008		752		$	7.11

Adoption of SFAS No. 123(R) – Upon the Company’s adoption of SFAS No. 123(R) in 2006, the Company used the modified prospective method which requires that share-based compensation expense be recorded for any employee options granted after the adoption date and for the unvested portion of any employee options outstanding as of the adoption date.

The Company’s determination of fair value is affected by the Company’s common stock price as well as the assumptions discussed above that require management’s judgment. As permitted under SFAS No. 123(R), the Company continued to use the Black-Scholes option-pricing model in order to calculate the compensation costs of employee stock-based compensation. Such model requires the use of subjective assumptions, including the expected life of the option, the expected volatility of the underlying stock, and the expected dividend on the stock. For the years ended December 31, 2008, 2007 and 2006, the Company did not grant any options.

SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on historical experience, the Company estimated future unvested option forfeitures at 3% as of December 31, 2008.

Stock-based compensation expense related to employee and non-employee stock grants, options and warrants recognized in income were as follows (in thousands):

	Years Ended December 31,
	2008		2007		2006

Employees	$	2,232	$	1,671	$	4,466
Non-employees		783		554		1,782
Total stock-based compensation expense	$	3,015	$	2,225	$	6,248

F-44

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Effective with the adoption of SFAS No. 123(R), stock-based compensation expense related to the Company’s stock-based compensation arrangements attributable to employees is recorded as a component of general and administrative expense in the consolidated statements of operations.

SFAS No. 123(R) requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (i.e., excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities. The aggregate amount of cash the Company received from the exercise of stock options was $1,894,000 and $1,303,000 for the years ended December 31, 2007 and 2006, respectively, which shares, consistent with prior periods, were newly issued common stock. There were no options exercised during the year ended December 31, 2008. Prior to the adoption of SFAS No. 123(R), the Company reported the full tax benefits resulting from the exercise of stock options as operating cash flows. Prior to adopting SFAS No. 123(R), the Company accounted for its employee stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Pursuant to APB No. 25, the Company did not record share-based compensation, but followed the disclosure requirements of SFAS No. 123. The Company’s financial results for prior periods have not been restated.

At December 31, 2008, the total compensation cost related to unvested awards which had not been recognized was $5,972,000 and the associated weighted-average period over which the compensation cost attributable to those unvested awards would be recognized is 2.5 years.

12.	CUMULATIVE EFFECT ADJUSTMENT.

In September 2006, the Commission issued SAB No. 108, Topic 1N, Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

SAB No. 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements or (ii) recording the cumulative effect to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. The Company elected to record the effects of applying SAB No. 108 using the cumulative effect transition method.

In allocating the purchase price with respect to the Kinergy acquisition, no adjustment was made to record a deferred tax liability for the difference between the recorded value of the assets acquired and their corresponding tax basis. Such an adjustment would have increased goodwill by the amount of the deferred tax liability recorded. In addition, goodwill would have been reduced by the amount of any valuation allowance attributable to any pre-acquisition deferred tax asset of the Company that could more likely than not have been utilized against the recorded deferred tax liability. As a result of applying the guidance in SAB No. 108 to this adjustment, the Company recorded an adjustment of $1,043,000 to beginning retained earnings as of January 1, 2006.

13	COMMITMENTS AND CONTINGENCIES.

Commitments – The following is a description of significant commitments at December 31, 2008:

F-45

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Operating Leases–Future minimum lease payments required by non-cancelable operating leases in effect at December 31, 2008 are as follows (in thousands):

Years Ended December 31,	Amount
2009	$	3,103
2010		3,082
2011		2,701
2012		2,035
2013		1,657
Total	$	12,578

Total rent expense during the years ended December 31, 2008, 2007 and 2006 was $2,967,000, $1,793,000 and $714,000, respectively. Included in the amounts above is approximately $1.5 million in which the Company has been notified that it is in violation of certain of its lease covenants, which the Company disputes. The Company continues to be current on its payments to the lessor.

Purchase Commitments – At December 31, 2008, the Company had purchase contracts with its suppliers to purchase certain quantities of ethanol, corn and denaturant. These fixed- and indexed-price commitments will be delivered throughout 2009. Outstanding balances on fixed-price contracts for the purchases of materials are indicated below and volumes indicated in the indexed-price portion of the table are additional purchase commitments at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

	Fixed-Price Contracts
Corn	$	19,611
Ethanol		8,056
Denaturant		1,292
Total	$	28,959

	Indexed-Price Contracts (Volume)
Ethanol (gallons)		46,922
Corn (bushels)		12,035

Sales Commitments – At December 31, 2008, the Company had entered into sales contracts with its major customers to sell certain quantities of ethanol, WDG and syrup. The volumes indicated in the indexed price contracts table will be sold at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

	Fixed-Price Contracts
Ethanol	$	4,888
WDG		13,642
Syrup		2,995
Total	$	21,525

	Indexed-Price Contracts (Volume)
Ethanol (gallons)		60,617
WDG (tons)		24

F-46

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company recorded in cost of goods sold estimated losses on its fixed-price purchase and sale commitments of approximately $4,687,000 for the year ended December 31, 2008. There were no estimated losses recorded for the years ended December 31, 2007 and 2006.

Contingencies – The following is a description of significant contingencies at December 31, 2008:

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

Litigation – Western Ethanol Company – On January 9, 2009, Western Ethanol Company, LLC (“Western Ethanol”) filed a complaint in the Superior Court of the State of California (the “Superior Court”) naming Kinergy as defendant. In the complaint, Western Ethanol alleges that Kinergy breached an alleged agreement to buy and accept delivery of a fixed amount of ethanol. On January 12, 2009, Western Ethanol filed an application for issuance of right to attach order and order for issuance of writ of attachment. On February 10, 2009, the Superior Court granted the right to attach order and order for issuance of writ of attachment against Kinergy in the amount of approximately $3.7 million. On February 11, 2009, Kinergy filed an answer to the complaint. Kinergy intends to vigorously defend against Western Ethanol’s claims.

Litigation – Delta-T Corporation – On August 18, 2008, Delta-T Corporation filed suit in the United States District Court for the Eastern District of Virginia (the “Virginia Federal Court case”), naming The Company as a defendant, along with its subsidiaries Pacific Ethanol Stockton, LLC, Pacific Ethanol Imperial, LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Magic Valley, LLC, and Pacific Ethanol Madera, LLC. The suit alleges breaches of the parties’ Engineering, Procurement and Technology License Agreements, breaches of a subsequent term sheet and letter agreement and breaches of indemnity obligations.

All of the defendants have moved to dismiss the Virginia Federal Court Case for lack of personal jurisdiction and on the ground that all disputes between the parties must be resolved through binding arbitration, and, in the alternative, moving to stay the Virginia Federal Court Case pending arbitration. In January 2009, these motions were granted by the Court, compelling the case to arbitration. The complaint seeks specified contract damages of approximately $6.5 million, along with other unspecified damages. The Company intends to vigorously defend against Delta-T Corporation’s claims.

Litigation – Barry Spiegel – State Court Action – On December 23, 2005, Barry J. Spiegel, a former shareholder and director of Accessity, filed a complaint in the Circuit Court of the 17th Judicial District in and for Broward County, Florida (Case No. 05018512) (the “State Court Action”) against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce Udell (collectively, the “Individual Defendants”). Messrs. Siegel, Udell and Friedman are former directors of Accessity and Pacific Ethanol. Mr. Kart is a former executive officer of Accessity and the Company.

The State Court Action relates to the Share Exchange Transaction and purports to state the following five counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the Florida Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his Accessity common stock to diminish and is seeking approximately $22.0 million in damages. On March 8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his response in opposition on May 30, 2006. The Court granted the motion to dismiss by Order dated December 1, 2006, on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a derivative action.

F-47

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The amended complaint included the Company as a defendant, but it was subsequently voluntarily dismissed on August 27, 2007, by Mr. Spiegel as to the Company. On March 23, 2009, Mr. Spiegel filed an amended complaint which renewed his previously voluntarily dismissed case against the Company. Further Mr. Spiegel seeks depositions of Barry Siegel and Philip B. Kart on or around April 30, 2009. The Company intends to vigorously defend against Mr. Spiegel’s claims.

Litigation – Barry Spiegel – Federal Court Action – On December 28, 2006, Barry J. Spiegel, filed a complaint in the United States District Court, Southern District of Florida (Case No. 06-61848) (the “Federal Court Action”) against the Individual Defendants and the Company. The Federal Court Action relates to the Share Exchange Transaction and purports to state the following three counts: (i) violations of Section 14(a) of the Exchange Act and SEC Rule 14a-9 promulgated thereunder, (ii) violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (iii) violation of Section 20(A) of the Exchange Act. The first two counts are alleged against the Individual Defendants and the Company and the third count is alleged solely against the Individual Defendants. Mr. Spiegel bases his claims on, among other things, allegations that the actions of the Individual Defendants and the Company in connection with the Share Exchange Transaction resulted in a share exchange ratio that was unfair and resulted in the preparation of a proxy statement seeking shareholder approval of the Share Exchange Transaction that contained material misrepresentations and omissions. Mr. Spiegel is seeking in excess of $15.0 million in damages.

Mr. Spiegel amended the Federal Court Action on March 5, 2007, and the Company and the Individual Defendants filed a Motion to Dismiss the amended pleading on April 23, 2007. Plaintiff Spiegel sought to stay his own federal case, but the Motion was denied on July 17, 2007. The Court required Mr. Spiegel to respond to the Company’s Motion to Dismiss. On January 15, 2008, the Court rendered an Order dismissing the claims under Section 14(a) of the Exchange Act on the basis that they were time barred and that more facts were needed for the claims under Section 10(b) of the Exchange Act. The Court, however, stayed the entire case pending resolution of the State Court Action.

14.	FAIR VALUE MEASUREMENTS.

The fair value hierarchy established by SFAS No. 157 prioritizes the inputs used in valuation techniques into three levels as follows:

·	Level 1 – Observable inputs – unadjusted quoted prices in active markets for identical assets and liabilities;

·	Level 2 – Observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with market data; and

F-48

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

·	Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable.

In accordance with SFAS No. 157, the Company has classified its investments in marketable securities and derivative instruments into these levels depending on the inputs used to determine their fair values. The Company’s investments in marketable securities consist of money market funds which are based on quoted prices and are designated as Level 1. The Company’s derivative instruments consist of commodity positions and interest rate caps and swaps. The fair value of the commodity positions are based on quoted prices on the commodity exchanges and are designated as Level 1; the fair value of the interest rate caps and certain swaps are based on quoted prices on similar assets or liabilities in active markets and discounts to reflect potential credit risk to lenders and are designated as Level 2; and certain interest rate swaps are based on a combination of observable inputs and material unobservable inputs.

The following table summarizes fair value measurements by level at December 31, 2008 (in thousands):

	Level 1		Level 2		Level 3		Total
Assets:
Investments in marketable securities	$	7,780	$	—	$	—	$	7,780
Interest rate caps and swaps		—		7		—		7
Total Assets	$	7,780	$	7	$	—	$	7,787

Liabilities:
Commodity derivative liabilities	$	951	$	—	$	—	$	951
Interest rate caps and swaps		—		1,307		5,245		6,552
Total Liabilities	$	951	$	1,307	$	5,245	$	7,503

For fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs is required along with a reconciliation of Level 3 values from the prior reporting period. The Company has five pay-fixed and receive variable interest rate swaps in liability positions at December 31, 2008. The value of these swaps at December 31, 2008 was materially affected by the Company’s credit. A pre-credit fair value of each swap was determined using conventional present value discounting based on the 3-year Euro dollar futures curves and the LIBOR swap curve beyond 3 years, resulting in a liability of approximately $13,111,000. To reflect the Company’s current financial condition and debt restructuring efforts, a recovery rate of 40% was applied to that value. Management elected the 40% recovery rate in the absence of any other company-specific information. As the recovery rate is a material unobservable input, these swaps are considered Level 3. It is the Company’s understanding that 40% reflects the standard market recovery rate provided by Bloomberg in probability of default calculations. The Company applied their interpretation of the 40% recovery rate to the swap liability reducing the liability by 60% to approximately $5,245,000 to reflect the credit risk to counterparties, resulting in a gain of approximately $7,866,000 in other income (expense) in the consolidated statements of operations. Further, due to the current financial status of the Company and the remote chance of it making its anticipated LIBOR-based interest payments under SFAS No. 133, all hedge accounting was disallowed as of December 31, 2008, and the amount in accumulated other comprehensive income was recorded as a loss of approximately $4,565,000 in other income (expense) in the consolidated statements of operations. At September 30, 2008, the Company’s last reporting period, the Company had discounted these swaps 435 basis points over LIBOR reflecting the then current borrowing rate.

F-49

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Level 3
Beginning balance, September 30, 2008	$	—
Transfers to Level 3 (from Level 2)		(5,245	)
Ending balance, December 31, 2008	$	(5,245	)

At September 30, 2008, the credit-affected swap liability totaled approximately $7,464,000, during the three months ended December 31, 2008, approximately $719,000 of losses were realized in other income (expense). At December 31, 2008, the unrealized liability value was approximately $5,245,000.

15.	RELATED PARTY TRANSACTIONS.

Related Customers – The Company entered into three consecutive six-month sales contracts with Southern Counties Oil Co., an entity owned by a former director and stockholder of the Company. The contract periods were from October 1, 2005 through March 31, 2007 for fuel grade ethanol to be delivered ratably per month at varying prices based on delivery destinations in California, Nevada and Arizona. Under these contracts, the Company sold a total of 13,944,000 gallons. Sales to Southern Counties Oil Co. under these contracts totaled $6,039,000 and $16,985,000 for the years ended December 31, 2007 and 2006, respectively. There were no sales under these contracts during the year ended December 31, 2008 and there were no accounts receivable from Southern Counties Oil Co. related to these contracts at December 31, 2008 and 2007.

The Company sells corn and WDG to Tri J Land and Cattle (“Tri J”), an entity owned by a director of the Company. The Company is not under contract with Tri J, but currently sells corn on a spot basis as needed. Sales to Tri J totaled $1,300, $166,000 and $0 for the years ended December 31, 2008, 2007 and 2006, respectively. Accounts receivable from Tri J totaled $1,300 and $7,000 at December 31, 2008 and 2007, respectively.

Related Vendors – The Company contracts for certain transportation services for its products to a transportation company, in which a senior officer of the transportation company became a member of the Company’s Board of Directors. For the year ended December 31, 2008, the Company purchased transportation services of $1,487,000. As of December 31, 2008, the Company had $608,000 of outstanding accounts payable to this vendor. There were no additional purchases during the years ended December 31, 2007 and 2006.

The Company purchased 18,628 bushels of corn from Jones Villere Farms (“JVF”), a company owned by a director of the Company. Purchases from JVF totaled $95,000 for the year ended December 31, 2007. There were no additional purchases during the years ended December 31, 2008 and 2006. There were no accounts payable due to JVF at December 31, 2008 and 2007.

The Company purchased 35,219 bushels of corn from Llanada Farms (“Llanada”), an affiliate of a director of the Company for the year ended December 31, 2006. Purchases from Llanada under this contract totaled $112,000 for the year ended December 31, 2006. There were no additional purchases during the years ended December 31, 2008 and 2007.

Plant Development and Construction – In 2006, the Company entered into an agreement with a construction company to build an ethanol production facility in Madera, California. An officer of the construction company was a former member of the board of directors of PEI California. The Company had outstanding liabilities to the construction company in the amount of $900,000 as of December 31, 2007.

F-50

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Financing Activities – During the year ended December 31, 2008, the Company sold $33,500 of its business energy tax credits to certain employees of the Company on the same terms and conditions as others to whom the Company sold credits.

As discussed in Note 9, on March 27, 2008, the Company consummated the sale of its Series B Preferred Stock with Lyles United, LLC. In addition, as of December 31, 2008, the Company had notes payable of $31,500,000 and accrued interest payable of $243,000 to Lyles United, LLC and its affiliates.

Also as discussed in Note 9, on May 22, 2008, the Company consummated the sale of additional shares of its Series B Preferred Stock to Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler.

16.	QUARTERLY FINANCIAL DATA.

The Company’s unaudited quarterly results of operations for the years ended December 31, 2008 and 2007 are as follows (in thousands):

	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
December 31, 2008:
Net sales	$	161,535		$	197,974		$	183,980		$	160,437
Gross profit (loss)	$	15,658		$	443		$	(20,285	)	$	(29,221	)
Loss from operations	$	(81,254	)	$	(7,235	)	$	(67,916	)	$	(36,743	)
Net loss	$	(35,151	)	$	(8,333	)	$	(69,167	)	$	(33,896	)
Preferred stock dividends	$	(1,101	)	$	(1,388	)	$	(807	)	$	(808	)
Deemed dividend on preferred stock	$	—		$	(761	)	$	—		$	—
Loss available to common stockholders	$	(36,252	)	$	(10,482	)	$	(69,974	)	$	(34,704	)
Loss per common share:
Basic and diluted	$	(0.90	)	$	(0.23	)	$	(1.23	)	$	(0.61	)

	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
December 31, 2007:
Net sales	$	99,242		$	113,763		$	118,118		$	130,390
Gross profit	$	15,341		$	11,121		$	4,759		$	1,678
Income (loss) from operations	$	5,839		$	2,801		$	(1,161	)	$	(5,402	)
Net income (loss)	$	2,975		$	2,156		$	(4,842	)	$	(14,689	)
Preferred stock dividend	$	(1,050	)	$	(1,050	)	$	(1,050	)	$	(1,050	)
Deemed dividend on preferred stock	$	—		$	—		$	—		$	(28	)
Income (loss) available to common stockholders	$	1,925		$	1,106		$	(5,892	)	$	(15,767	)
Income (loss) per common share:
Basic and diluted	$	0.05		$	0.03		$	(0.15	)	$	(0.39	)

17.	SUBSEQUENT EVENTS.

Forbearance Agreements

As discussed in Note 7, in February 2009, the Company entered into three separate forbearance agreements with its lenders which were extended in March 2009. These forbearance agreements provide that the lenders will forbear from exercising their rights under their respective loan agreements. The Company is attempting to negotiate new terms with its lenders. The outcome of these negotiations is uncertain at this time.

Notes Payable

On March 31, 2009, the Company’s Chairman of the Board and Chief Executive Officer provided funds totaling approximately $2.0 million for general operating purposes, in exchange for two unsecured notes payable from the Company. Interest on the unpaid principal amount accrues at a rate per annum of 8.00%. All principal and accrued and unpaid interest on the notes are due and payable on March 31, 2010.

F-51

INDEX TO EXHIBITS

Exhibit Number	Description

2.1	Agreement and Plan of Merger dated March 23, 2005 between the Registrant and Accessity Corp. (1)
2.2	Share Exchange Agreement dated as of May 14, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.3	Amendment No. 1 to Share Exchange Agreement dated as of July 29, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.4	Amendment No. 2 to Share Exchange Agreement dated as of October 1, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.5	Amendment No. 3 to Share Exchange Agreement dated as of January 7, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.6	Amendment No. 4 to Share Exchange Agreement dated as of February 16, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.7	Amendment No. 5 to Share Exchange Agreement dated as of March 3, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
3.1	Certificate of Incorporation of the Registrant (1)
3.2	Certificate of Designations, Powers, Preferences and Rights of the Series A Cumulative Redeemable Convertible Preferred Stock (14)
3.3	Certificate of Designations, Powers, Preferences and Rights of the Series B Cumulative Convertible Preferred Stock (29)
3.4	Bylaws of the Registrant (1)
10.1	Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (7)
10.2	Form of Placement Warrant dated effective of various dates issued by Pacific Ethanol, Inc., a California corporation, to certain placement agents (7)
10.3	Form of Registration Rights Agreement dated effective May 14, 2004 between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (6)
10.4	Form of Placement Warrant dated effective May 14, 2004 issued by Pacific Ethanol, Inc., a California corporation, to certain placement agents (7)
10.5	Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (6)
10.6	Form of Warrant of various dates issued to subscribers to a private placement of securities of Pacific Ethanol, Inc., a California corporation (7)
10.7	Form of Registration Rights Agreement dated effective March 23, 2005 between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (1)

Exhibit Number	Description

10.8	Form of Warrant dated March 23, 2005 issued by the Registrant to subscribers to a private placement of securities by Pacific Ethanol, Inc., a California corporation (1)
10.9	Form of Placement Warrant dated March 23, 2005 issued by the Registrant to certain placement agents (1)
10.10	Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March 23, 2005 between the Registrant and Barry Siegel (1)
10.11	Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March 23, 2005 between the Registrant and Philip B. Kart (1)
10.12	Form of Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23, 2005 between the Registrant and each of Neil M. Koehler, Tom Koehler, William L. Jones, Andrea Jones and Ryan W. Turner (1)
10.13	Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (1)
10.14	Form of Indemnification Agreement between the Registrant and each of its Executive Officers and Directors (#) (14)
10.15	Executive Employment Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (#)(1)
10.16	Executive Employment Agreement dated March 23, 2005 between the Registrant and Ryan W. Turner (#)(1)
10.17	Stock Purchase Agreement and Assignment and Assumption Agreement dated March 23, 2005 between the Registrant and Barry Siegel (1)
10.18	Letter Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (1)
10.19	Ethanol Purchase and Marketing Agreement dated March 4, 2005 between Kinergy Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific Ethanol, Inc. and Western Milling, LLC (2)
10.20	Pacific Ethanol Inc. 2004 Stock Option Plan (3)
10.21	First Amendment to Pacific Ethanol, Inc. 2004 Stock Option Plan (13)
10.22	Amended 1995 Stock Option Plan (4)
10.23	Warrant dated March 23, 2005 issued by the Registrant to Liviakis Financial Communications, Inc. (1)
10.24	Executive Employment Agreement dated August 10, 2005 between the Registrant and William G. Langley (#)(5)
10.25	Ethanol Marketing Agreement dated as of August 31, 2005 by and between Kinergy Marketing, LLC and Front Range Energy, LLC (8)
10.26	Master Revolving Note dated September 24, 2004 of Kinergy Marketing, LLC in favor of Comerica Bank (9)
10.27	Loan Revision/Extension Agreement dated October 4, 2005 and effective as of June 20, 2005 between Kinergy Marketing, LLC and Comerica Bank (9)

Exhibit Number	Description

10.28	Letter Agreement dated as of October 4, 2005 between Kinergy Marketing, LLC and Comerica Bank (9)
10.29	Guaranty dated October 4, 2005 by Pacific Ethanol, Inc. in favor of Comerica Bank (9)
10.30	Security Agreement dated as of September 24, 2004 executed by Kinergy Marketing, LLC in favor of Comerica Bank (12)
10.31	Amended and Restated Phase 1 Design-Build Agreement dated November 2, 2005 by and between Pacific Ethanol Madera LLC and W.M. Lyles Co. (10)
10.32	Phase 2 Design-Build Agreement dated November 2, 2005 by and between Pacific Ethanol Madera LLC and W.M. Lyles Co. (10)
10.33	Letter Agreement dated November 2, 2005 by and between Pacific Ethanol California, Inc. and W.M. Lyles Co. (10)
10.34	Continuing Guaranty dated as of November 3, 2005 by William L. Jones in favor of W.M. Lyles Co. (10)
10.35	Continuing Guaranty dated as of November 3, 2005 by Neil M. Koehler in favor of W.M. Lyles Co. (10)
10.36	Description of Non-Employee Director Compensation (11)
10.37	Purchase Agreement dated November 14, 2005 between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (11)
10.38	Deposit Agreement dated April 13, 2006 by and between Pacific Ethanol, Inc. and Comerica Bank (14)
10.39	Registration Rights and Stockholders Agreement dated as of April 13, 2006 by and between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (14)
10.40	Amendment No. 1 to Ethanol Purchase and Marketing Agreement dated effective as of March 4, 2005 between Kinergy Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific Ethanol, Inc. and Western Milling, LLC (14)
10.41	Construction and Term Loan Agreement dated April 10, 2006 by and among Pacific Ethanol Madera LLC, Comerica Bank and Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.42	Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Comerica Bank (14)
10.43	Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.44	Assignment and Security Agreement dated April 13, 2006 by and between Pacific Ethanol Madera LLC and Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.45	Member Interest Pledge Agreement dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.46	Disbursement Agreement dated April 13, 2006 by and among Pacific Ethanol Madera LLC, Hudson United Capital, a division of TD Banknorth, N.A., Comerica Bank and Wealth Management Group of TD Banknorth, N.A. (14)

Exhibit Number	Description

10.47	Amended and Restated Term Loan Agreement effective as of April 13, 2006 by and between Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
10.48	Letter Agreement dated as of April 13, 2006 by and among Pacific Ethanol California, Inc., Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
10.49	Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (15)
10.50	Deed of Trust (Non-Construction) Security Agreement and Fixture Filing with Assignment of Rents dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Lyles Diversified, Inc. (15)
10.51	Securities Purchase Agreement dated as of May 25, 2006 by and among Pacific Ethanol, Inc. and the investors listed on the Schedule of Investors attached thereto as Exhibit A (16)
10.52	Form of Warrant dated May 31, 2006 (16)
10.53	Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol, Inc. and John T. Miller (17)
10.54	Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol, Inc. and Christopher W. Wright (17)
10.55	Amended and Restated Ethanol Purchase and Sale Agreement dated as of August 9, 2006 by and between Kinergy Marketing, LLC and Front Range Energy, LLC (18)
10.56	Construction Agreement for the Boardman Project between Pacific Ethanol Columbia, LLC and Parsons RCIE Inc. dated as of August 28, 2006 (19)
10.57	Engineering, Procurement and Technology License Agreement dated September 6, 2006 by and between Delta-T Corporation and PEI Columbia, LLC (*)(21)
10.58	Engineering, Procurement and Technology License Agreement (Plant No. 3) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.59	Engineering, Procurement and Technology License Agreement (Plant No. 4) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.60	Engineering, Procurement and Technology License Agreement (Plant No. 5) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.61	Pacific Ethanol, Inc. 2006 Stock Incentive Plan (#)(20)
10.62	Form of Employee Restricted Stock Agreement (#)(22)
10.63	Form of Non-Employee Director Restricted Stock Agreement (#)(22)
10.64	Amendment No. 1 to Construction and Term Loan Agreement and Agreement as to Future Financing Transactions dated September 29, 2006 by and among Pacific Ethanol Madera LLC, TD Banknorth, N.A., Comerica Bank and Pacific Ethanol, Inc. (23)
10.65	Membership Interest Purchase Agreement dated as of October 17, 2006 by and among Eagle Energy, LLC, Pacific Ethanol California, Inc. and Pacific Ethanol, Inc. (24)

Exhibit Number	Description

10.66	Warrant to Purchase Common Stock dated October 17, 2006 issued to Eagle Energy, LLC by Pacific Ethanol, Inc. (24)
10.67	Registration Rights Agreement dated as of October 17, 2006 by and between Pacific Ethanol, Inc. and Eagle Energy, LLC (24)
10.68	Second Amended and Restated Operating Agreement of Front Range Energy, LLC among the members identified therein (as amended by Amendment No. 1 described below) (24)
10.69	Amendment No. 1, dated as of October 17, 2006, of the Second Amended and Restated Operating Agreement of Front Range Energy, LLC to Add a Substitute Member and for Certain Other Purposes (24)
10.70	Form of Non-Competition Agreement dated as of October 17, 2006 by and among Pacific Ethanol, Inc., Front Range Energy, LLC and each of the members of Eagle Energy, LLC (24)
10.71	Amendment to Amended and Restated Ethanol Purchase and Sale Agreement dated October 17, 2006 between Kinergy Marketing, LLC and Front Range Energy, LLC (24)
10.72	Separation and Consulting Agreement dated December 14, 2006 between Pacific Ethanol, Inc. and William G. Langley (25)
10.73	Credit Agreement, dated as of February 27, 2007, by and among Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Imperial, LLC, and Pacific Ethanol Magic Valley, LLC, as borrowers, the lenders party thereto, WestLB AG, New York Branch, as administrative agent, lead arranger and sole book runner, WestLB AG, New York Branch, as collateral agent, Union Bank of California, N.A., as accounts bank, Mizuho Corporate Bank, Ltd., as lead arranger and co-syndication agent, CIT Capital Securities LLC, as lead arranger and co-syndication agent, Cooperative Centrale Raiffeisen-Boerenleenbank BA., “Rabobank Nederland”, New York Branch, and Banco Santander Central Hispano S.A., New York Branch (26)
10.74	Sponsor Support Agreement, dated as of February 27, 2007, by and among Pacific Ethanol, Inc., Pacific Ethanol Holding Co. LLC and WestLB AG, New York Branch, as administrative agent (26)
10.75	Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Joseph W. Hansen (#) (27)
10.76	Indemnification Agreement as of January 2, 2008 by and between Pacific Ethanol, Inc. and Joseph W. Hansen (#) (27)
10.77	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Neil M. Koehler (#) (27)
10.78	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and John T. Miller (#) (27)
10.79	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Christopher W. Wright (#) (27)
10.80	Securities Purchase Agreement dated March 18, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (28)
10.81	Warrant dated March 27, 2008 issued by Pacific Ethanol, Inc. to Lyles United, LLC (29)

Exhibit Number	Description

10.82	Registration Rights Agreement dated as of March 27, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (29)
10.83	Letter Agreement dated March 27, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (29)
10.84	Series A Preferred Stockholder Consent and Waiver dated March 27, 2008 by and between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (29)
10.85	Form of Waiver and Third Amendment to Credit Agreement dated as of March 25, 2008 by and among Pacific Ethanol, Inc. and the parties thereto (29)
10.86	Forbearance Agreement and Release dated as of May 12, 2008 by and among Kinergy Marketing LLC, Pacific Ethanol, Inc. and Comerica Bank (30)
10.87	Reaffirmation of Guaranty dated May 12, 2008 by Pacific Ethanol, Inc. and Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (30)
10.88	Securities Purchase Agreement dated May 20, 2008 by and among Pacific Ethanol, Inc. and Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (31)
10.89	Form of Warrant dated May 22, 2008 issued by Pacific Ethanol, Inc. (31)
10.90	Letter Agreement dated May 22, 2008 by and among Pacific Ethanol, Inc. and Neil M. Koehler, Bill Jones, Paul P. Koehler and Thomas D. Koehler (31)
10.91	Form of Subscription Agreement dated May 22, 2008 between Pacific Ethanol, Inc. and each of the purchasers (31)
10.92	Form of Warrant to purchase shares of Pacific Ethanol, Inc. Common Stock (31)
10.93	Form of Placement Agent Agreement dated May 22, 2008, by and between Pacific Ethanol, Inc. and Lazard Capital Markets LLC (31)
10.94	Loan and Security Agreement dated July 28, 2008 by and among Kinergy Marketing LLC, the parties thereto from time to time as Lenders, Wachovia Capital Finance Corporation (Western) and Wachovia Bank, National Association (32)
10.95	Guarantee dated July 28, 2008 by and between Pacific Ethanol, Inc. in favor of Wachovia Capital Finance Corporation (Western) for and on behalf of Lenders (32)
10.96	Loan Restructuring Agreement dated as of November 7, 2008 by and among Pacific Ethanol, Inc., Pacific Ethanol Imperial, LLC, Pacific Ethanol California, Inc. and Lyles United, LLC (33)
10.97	Amended and Restated Promissory Note dated November 7, 2008 by Pacific Ethanol, Inc. in favor of Lyles United, LLC (33)
10.98	Security Agreement dated as of November 7, 2008 by and between Pacific Ag. Products, LLC and Lyles United, LLC (33)
10.99	Limited Recourse Guaranty dated November 7, 2008 by Pacific Ethanol California, Inc. in favor of Lyles United, LLC (33)
10.100	Unconditional Guaranty dated November 7, 2008 by Pacific Ag. Products, LLC in favor of Lyles United, LLC (33)
10.101	Irrevocable Joint Instruction Letter dated November 7, 2008 executed by Pacific Ethanol, Inc., Lyles United, LLC and Pacific Ethanol California, Inc. (33)

Exhibit Number	Description

10.102	Amendment and Forbearance Agreement dated February 13, 2009 by and among Pacific Ethanol, Inc., Kinergy Marketing LLC and Wachovia Capital Finance Corporation (Western) (34)
10.103	Limited Waiver and Forbearance Agreement dated as of February 17, 2009 by and among Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Magic Valley, LLC, WestLB AG, New York Branch, Amarillo National Bank and the Lenders identified therein (34)
10.104	Amendment No. 1 to Letter re: Amendment and Forbearance Agreement dated February 26, 2009 by and among Pacific Ethanol, Inc., Kinergy Marketing LLC and Wachovia Capital Finance Corporation (Western) (35)
10.105	Second Limited Waiver and Forbearance Agreement dated as of February 27, 2009 by and among Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Magic Valley, LLC, WestLB AG, New York Branch, Amarillo National Bank and the Lenders identified therein (35)
10.106	Forbearance Agreement dated February 26, 2009 by and among Pacific Ethanol, Inc., Pacific Ag Products, LLC, Pacific Ethanol California, Inc. and Lyles United, LLC. (35)
21.1	Subsidiaries of the Registrant
23.1	Consent of Independent Registered Public Accounting Firm
31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

_______________

(#)	Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit.

(*)	Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission.

(1)	Filed as an exhibit to the Registrant’s current report on Form 8-K for March 23, 2005 filed with the Securities and Exchange Commission on March 29, 2005 and incorporated herein by reference.

(2)	Filed as an exhibit to the Registrant’s quarterly report on Form 10-QSB for March 31, 2005 (File No. 0-21467) filed with the Securities and Exchange Commission on May 23, 2005 and incorporated herein by reference.

(3)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-123538) filed with the Securities and Exchange Commission on March 24, 2005 and incorporated herein by reference.

(4)	Filed as an exhibit to the Registrant’s annual report Form 10-KSB for December 31, 2002 (File No. 0-21467) filed with the Securities and Exchange Commission on March 31, 2003 and incorporated herein by reference.

(5)	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.

(6)	The Form of the Registration Rights Agreement was filed as Exhibit 4.4 to the Registrant’s Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on August 19, 2005 and incorporated herein by reference.

(7)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on August 19, 2005 and incorporated herein by reference.

(8)	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.

(9)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 1, 2005 filed with the Securities and Exchange Commission on November 7, 2005 and incorporated herein by reference.

(10)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 2, 2005 filed with the Securities and Exchange Commission on November 8, 2005 and incorporated herein by reference.

(11)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 10, 2005 filed with the Securities and Exchange Commission on November 15, 2005 and incorporated herein by reference.

(12)	Filed as an exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on November 22, 2005 and incorporated herein by reference.

(13)	Filed as an exhibit to the Registrant’s current report on Form 8-K for January 26, 2006 filed with the Securities and Exchange Commission on February 1, 2006 and incorporated herein by reference.

(14)	Filed as an exhibit to the Registrant’s annual report on Form 10-KSB for December 31, 2005 filed with the Securities and Exchange Commission on April 14, 2006 and incorporated herein by reference.

(15)	Filed as an exhibit to the Registrant’s current report on Form 8-K for April 13, 2006 filed with the Securities and Exchange Commission on April 19, 2006 and incorporated herein by reference.

(16)	Filed as an exhibit to the Registrant’s current report on Form 8-K for May 25, 2006 filed with the Securities and Exchange Commission on May 31, 2006 and incorporated herein by reference.

(17)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for June 26, 2006 filed with the Securities and Exchange Commission on June 27, 2006.

(18)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 9, 2006 filed with the Securities and Exchange Commission on August 15, 2006.

(19)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 23, 2006 filed with the Securities and Exchange Commission on August 29, 2006.

(20)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-137663) filed with the Securities and Exchange Commission on September 29, 2006.

(21)	Filed as an exhibit to the Registrant’s quarterly report on Form 10-Q for September 30, 2006 filed with the Securities and Exchange Commission on November 20, 2006 and incorporated herein by reference.

(22)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 4, 2006 filed with the Securities and Exchange Commission on October 10, 2006.

(23)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 2, 2006 filed with the Securities and Exchange Commission on October 12, 2006.

(24)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 17, 2006 filed with the Securities and Exchange Commission on October 23, 2006.

(25)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 14, 2006 filed with the Securities and Exchange Commission on December 15, 2006.

(26)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 27, 2007 filed with the Securities and Exchange Commission on March 5, 2007.

(27)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 11, 2007 filed with the Securities and Exchange Commission on December 17, 2007.

(28)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for March 18, 2008 filed with the Securities and Exchange Commission on March 18, 2008.

(29)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for March 26, 2008 filed with the Securities and Exchange Commission on March 27, 2008.

(30)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for May 13, 2008 filed with the Securities and Exchange Commission on May 19, 2008.

(31)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for May 22, 2008 filed with the Securities and Exchange Commission on May 23, 2008.

(32)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for July 28, 2008 filed with the Securities and Exchange Commission on August 1, 2008.

(33)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for November 7, 2008 filed with the Securities and Exchange Commission on November 10, 2008.

(34)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 13, 2009 filed with the Securities and Exchange Commission on February 20, 2009.

(35)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 26, 2009 filed with the Securities and Exchange Commission on March 4, 2009.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 31st day of March, 2009.

	PACIFIC ETHANOL, INC.


	/s/ NEIL M. KOEHLER
	Neil M. Koehler President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date

/s/ WILLIAM L. JONES	Chairman of the Board and Director	March 31, 2009
William L. Jones

/s/ NEIL M. KOEHLER	President, Chief Executive Officer	March 31, 2009
Neil M. Koehler	(Principal Executive Officer) and Director

/s/ JOSEPH W. HANSEN	Chief Financial Officer (Principal Financial and	March 31, 2009
Joseph W. Hansen	Accounting Officer)

/s/ TERRY L. STONE	Director	March 31, 2009
Terry L. Stone

/s/ JOHN L. PRINCE	Director	March 31, 2009
John L. Prince

/s/ DOUGLAS L. KIETA	Director	March 31, 2009
Douglas L. Kieta

/s/ LARRY D. LAYNE	Director	March 31, 2009
Larry D. Layne

/s/ MICHAEL D. KANDRIS	Director	March 31, 2009
Michael D. Kandris

EXHIBITS FILED WITH THIS REPORT

Exhibit Number	Description

21.1	Subsidiaries of the Registrant
23.1	Consent of Independent Registered Public Accounting Firm
31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Delaware	41-2170618
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

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

Large accelerated filer ¨	Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

		Page
PART I

Item 1.	Business	1
Item 1A.	Risk Factors.	13
Item 1B.	Unresolved Staff Comments.	24
Item 2.	Properties.	24
Item 3.	Legal Proceedings.	24
Item 4.	Submission of Matters to a Vote of Security Holders.	26

PART II

Item 5.	Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	27
Item 6.	Selected Financial Data.	30
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	31
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	51
Item 8.	Financial Statements and Supplementary Data.	53
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	53
Item 9A.	Controls and Procedures	53
Item 9A(T)	Controls and Procedures	56
Item 9B.	Other Information.	56

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	57
Item 11.	Executive Compensation	57
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	57
Item 13.	Certain Relationships and Related Transactions, and Director Independence	57
Item 14.	Principal Accounting Fees and Services	57

PART IV

Item 15.	Exhibits, Financial Statement Schedules	57
Index to Financial Statements		F-1

	Madera Facility	Front Range Facility(1)	Columbia Facility	Magic Valley Facility	Stockton Facility
Location	Madera, CA	Windsor, CO	Boardman, OR	Burley, ID	Stockton, CA
Quarter/Year operations began	4th Qtr., 2006	2nd Qtr., 2006	3rd Qtr., 2007	2nd Qtr., 2008	3rd Qtr., 2008
Annual design basis ethanol production capacity (in millions of gallons)	35	40	35	50	50
Approximate maximum annual ethanol production capacity (in millions of gallons)	40	50	40	60	60
Ownership	100%	42%	100%	100%	100%
Primary energy source	Natural Gas	Natural Gas	Natural Gas	Natural Gas	Natural Gas
Estimated annual WDG production capacity (in thousands of tons)	293	335	293	418	418

			Estimated Annual
		Date Operations	Production Capacity
Facility Name	Facility Location	Began	(gallons)
Stockton	Stockton, CA	September 2008	60,000,000
Magic Valley	Burley, ID	April 2008	60,000,000
Columbia	Boardman, OR	September 2007	40,000,000
Madera	Madera, CA	October 2006	40,000,000

	Price Range
	High		Low

Year Ended December 31, 2008:
First Quarter (January 1 – March 31)	$	8.85	$	4.25
Second Quarter (April 1 – June 30)	$	5.65	$	1.81
Third Quarter (July 1 – September 30)	$	2.37	$	1.37
Fourth Quarter (October 1 – December 31)	$	1.41	$	0.36

Year Ended December 31, 2007:
First Quarter	$	17.85	$	14.22
Second Quarter	$	16.50	$	12.25
Third Quarter	$	14.86	$	8.58
Fourth Quarter	$	9.46	$	4.22

	Cumulative Total Return ($)
	12/03	12/04	3/23/05	12/05	12/06	12/07	12/08
PACIFIC ETHANOL, INC.	100.00	252.34	385.11	460.43	654.89	349.36	18.72
THE NASDAQ STOCK MARKET (U.S.) INDEX	100.00	110.08	104.15	112.88	126.51	138.13	80.47
SIC 2860—INDUSTRIAL ORGANIC CHEMICALS	100.00	126.07	118.68	105.11	152.61	122.81	52.96

	Years Ended December 31,									Percentage Variance From Prior Year
		2008			2007			2006		2008		2007
Gallons sold (in millions)		268.4			190.6			101.7		40.8	%	87.4	%
Average sales price per gallon	$	2.25		$	2.15		$	2.28		4.7	%	(5.7	)%
Corn cost per bushel—CBOT equivalent(1)	$	5.52		$	3.61		$	2.44		52.9	%	48.0	%
Co-product revenues as % of delivered cost of corn(2)		22.5	%		24.8	%		33.4	%	(9.3	)%	(25.7	)%

Average CBOT ethanol price per gallon	$	2.22		$	1.98		$	2.52		12.1	%	(21.4	)%
Average CBOT corn price per bushel	$	5.27		$	3.74		$	2.60		40.9	%	43.9	%
_____________

												Results as a Percentage
							Dollar			Percentage		of Net Sales for the
	Years Ended						Variance			Variance		Years Ended
	December 31,						Favorable			Favorable		December 31,
	2008			2007			(Unfavorable)			(Unfavorable)		2008			2007
	(dollars in thousands)
Net sales	$	703,926		$	461,513		$	242,413		52.5	%		100.0	%		100.0	%
Cost of goods sold		737,331			428,614			(308,717	)	(72.0	)		104.7			92.9
Gross profit (loss)		(33,405	)		32,899			(66,304	)	(201.5	)		(4.7	)		7.1
Selling, general and administrative expenses		31,796			30,822			(974	)	(3.2	)		4.5			6.6
Impairment of goodwill		87,047			—			(87,047	)	NM			12.4			—
Impairment of asset group		40,900			—			(40,900	)	NM			5.8			—
Income (loss) from operations		(193,148	)		2,077			(195,225	)	NM			(27.4	)		0.5
Other income (expense), net		(6,068	)		(6,801	)		733		10.8			(0.9	)		(1.5	)
Loss before noncontrolling interest in variable interest entity and provision for income taxes		(199,216	)		(4,724	)		(194,492	)	NM			(28.3	)		(1.0	)
Noncontrolling interest in variable interest entity		52,669			(9,676	)		(62,345	)	(644.3	)		7.5			(2.1	)
Loss before provision for income taxes		(146,547	)		(14,400	)		(132,147	)	(917.7	)		(20.8	)		(3.1	)
Provision for income taxes		—			—			—		—			—			—
Net loss	$	(146,547	)	$	(14,400	)	$	(132,147	)	(917.7	)%		(20.8	)%		(3.1	)%
Preferred stock dividends	$	(4,104	)	$	(4,200	)	$	96		2.3	%		(0.6	)%		(0.9	)%
Deemed dividend on preferred stock		(761	)		(28	)		(733	)	NM			(0.1	)		(0.0	)
Loss available to common stockholders	$	(151,412	)	$	(18,628	)	$	(132,784	)	(712.8	)%		(21.5	)%		(4.0	)%

	As of and for the Year Ended December 31,
	2008			2007			Variance
Current assets	$	71,891		$	82,193			(12.5	)%
Current liabilities	$	360,204		$	120,079			200.0	%
Property and equipment, net	$	530,037		$	468,704			13.1	%
Notes payable, net of current portion	$	937		$	151,188			(99.4	)%
Cash provided by (used in) operating activities	$	(55,175	)	$	16,718			(430.0	)%
Working capital	$	(288,313	)	$	(37,886	)		(661.0	)%
Working capital ratio		0.20			0.68			(70.6	)%

Contractual Obligations At December 31, 2008	2009		2010		2011		2012		2013		Thereafter		Total
Sourcing commitments(1)	$	28,959	$	—	$	—	$	—	$	—	$	—	$	28,959
Debt principal(2)		67,981		15,581		26,176		24,134		13,976		158,509		306,357
Debt interest(2)		17,728		15,762		13,462		12,073		10,415		19,132		88,572
Operating leases(3)		3,103		3,082		2,701		2,035		1,657		8,794		21,372
Preferred dividends(4)		3,202		3,202		3,202		3,202		3,202		3,202		19,212
Total commitments	$	120,973	$	37,627	$	45,541	$	41,444	$	29,250	$	189,637	$	464,472

	Year Ended December 31,
	2008			2007			2006
Commodity futures	$	(2,791	)	$	(5,331	)	$	622
Interest rate options		1,382			(5,590	)		(17	)
Total	$	(1,409	)	$	(10,921	)	$	605

	Commodity Derivatives			Interest Rate Derivatives
	Gain/(Loss)*			Gain/(Loss)*
Beginning balance, January 1, 2008	$	(455	)	$	(1,928	)
Net changes		—			(2,637	)
Less: Amount reclassified to cost of goods sold		455			—
Less: Amount reclassified to other income (expense)		—			4,565
Ending balance, December 31, 2008	$	—		$	—