UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
  
(Mark One)
  
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
For the quarterly period ended September 30, 2010
  
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
For the transition period from ______ to _______
 
Commission File Number: 000-21467
  
  
PACIFIC ETHANOL, INC.
(Exact name of registrant as specified in its charter)
  
Delaware
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)
  
(916) 403-2123
(Registrant’s telephone number, including area code)
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter periods that the registrant was required to submit and post such files).  Yes o  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
As of November 12, 2010, there were 89,229,004 shares of Pacific Ethanol, Inc. common stock, $0.001 par value per share, outstanding.


 
 
 
 
 
PART I
FINANCIAL INFORMATION
  
    Page
     
Item 1.
Financial Statements.
F-1
     
 
Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009 (unaudited)
F-1
     
 
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)
F-3
     
 
Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)
F-4
     
 
Notes to Consolidated Financial Statements (unaudited)
F-5
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
2
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
15
     
Item 4.
Controls and Procedures
15
     
PART II
OTHER INFORMATION
     
Item 1.
Legal Proceedings
16
     
Item 1A.
Risk Factors
16
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
29
     
Item 3.
Defaults Upon Senior Securities
30
     
Item 4.
(Removed and Reserved)
30
     
Item 5.
Other Information
30
     
Item 6. Exhibits 30
     
Signature 31
     
Exhibits Filed with this Report
 
  
 
 

 
 
PART I - FINANCIAL INFORMATION
  
ITEM 1.    FINANCIAL STATEMENTS.
   
PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
   
   
September 30,
2010
   
December 31,
2009
 
   
(unaudited)
    *  
 ASSETS              
Current Assets:
             
Cash and cash equivalents
  $ 1,644     $ 17,545  
Accounts receivable, net (net of allowance for doubtful accounts of $285 and $1,016, respectively)
    17,465       12,765  
Inventories
    4,619       12,131  
Prepaid inventory
    4,443       3,192  
Investment in Front Range, held for sale
    18,500        
Other current assets
    2,292       3,143  
Total current assets
    48,963       48,776  
                 
Property and equipment, net
    1,115       243,733  
                 
Other Assets:
               
Intangible assets, net
    4,801       5,156  
Other assets
    592       1,154  
Total other assets
    5,393       6,310  
                 
Total Assets
  $ 55,471     $ 298,819  
_______________
*  Amounts derived from the audited financial statements for the year ended December 31, 2009.
      
See accompanying notes to these unaudited consolidated financial statements.
  
 
F-1

 

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands, except par value and shares)
   
   
September 30,
   
December 31,
 
 
 
2010
   
2009
 
   
(unaudited)
    *  
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
             
               
Current Liabilities:
             
Accounts payable – trade
  $ 13,858     $ 8,182  
Accrued liabilities
    6,163       7,062  
Other liabilities – related parties
    8,256       6,053  
Current portion – long-term notes payable (including $13,250 and $33,500, respectively, due to related parties)
    13,250       77,365  
Derivative instruments
          971  
Total current liabilities
    41,527       99,633  
                 
Notes payable, net of current portion (including $1,250 and $0, respectively, due to related parties)
    8,399       12,739  
Other liabilities
    1,617       1,828  
                 
Liabilities subject to compromise
          242,417  
                 
Total Liabilities
    51,543       356,617  
                 
Commitments and Contingencies (Notes 1 and 7)
               
                 
Stockholders’ Equity (Deficit):
               
Pacific Ethanol, Inc. Stockholders’ Equity (Deficit):
               
Preferred stock, $0.001 par value; 10,000,000 shares authorized; Series A: 1,684,375 shares authorized; 0 shares issued and outstanding as of September 30, 2010 and December 31, 2009;
           
Series B: 3,000,000 shares authorized; 2,203,554 and 2,346,152 shares issued and outstanding as of September 30, 2010 and December 31, 2009, respectively; liquidation preference of $48,518 as of September 30, 2010
    2       2  
Common stock, $0.001 par value; 300,000,000 shares authorized; 82,971,365 and 57,469,598 shares issued and outstanding as of September 30, 2010 and December 31, 2009, respectively
    83       57  
Additional paid-in capital
    503,489       480,948  
Accumulated deficit
    (499,646 )     (581,076 )
Total Pacific Ethanol, Inc. Stockholders’ Equity (Deficit)
    3,928       (100,069 )
                 
Noncontrolling interest in variable interest entity
          42,271  
Total Stockholders’ Equity (Deficit)
    3,928       (57,798 )
                 
Total Liabilities and Stockholders’ Equity (Deficit)
  $ 55,471     $ 298,819  
_______________
*  Amounts derived from the audited financial statements for the year ended December 31, 2009.
   
See accompanying notes to these unaudited consolidated financial statements.
     
 
F-2

 
 
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share data)
    
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net sales
  $ 46,039     $ 71,889     $ 194,087     $ 228,685  
Cost of goods sold
    42,058       76,420       195,883       252,123  
Gross profit (loss)
    3,981       (4,531 )     (1,796 )     (23,438 )
Selling, general and administrative expenses
    2,732       3,215       9,065       17,143  
Impairment of asset group
          2,200             2,200  
Income (loss) from operations
    1,249       (9,946 )     (10,861 )     (42,781 )
Loss on investment in Front Range, held for sale
    (12,146 )           (12,146 )      
Loss on extinguishments of debt
                (2,159 )      
Other expense, net
    (1,221 )     (1,510 )     (4,550 )     (13,215 )
Loss before reorganization costs, gain from bankruptcy exit and income taxes
    (12,118 )     (11,456 )     (29,716 )     (55,996 )
Reorganization costs
          (401 )     (4,153 )     (9,863 )
Gain from bankruptcy exit
                119,408        
Provision for income taxes
                       
Net income (loss)
    (12,118 )     (11,857 )     85,539       (65,859 )
Net income (loss) attributed to noncontrolling interest in variable interest entity
          150             (2,536 )
Net income (loss) attributed to Pacific Ethanol
  $ (12,118 )   $ (12,007 )   $ 85,539     $ (63,323 )
Preferred stock dividends
  $ (758 )   $ (807 )   $ (2,346 )   $ (2,395 )
Income (loss) available to common stockholders
  $ (12,876 )   $ (12,814 )   $ 83,193     $ (65,718 )
Net income (loss) per share, basic
  $ (0.16 )   $ (0.22 )   $ 1.19     $ (1.15 )
Net income (loss) per share, diluted
  $ (0.16 )   $ (0.22 )   $ 1.10     $ (1.15 )
Weighted-average shares outstanding, basic
    81,901       57,001       69,630       56,998  
Weighted-average shares outstanding, diluted
    81,901       57,001       77,692       56,998  

See accompanying notes to these unaudited consolidated financial statements.
  
 
F-3

 
 
PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
    
   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
Operating Activities:
           
Net income (loss)
  $ 85,539     $ (65,859 )
Adjustments to reconcile net income (loss) to cash used in operating activities:
               
Non-cash reorganization costs:
               
Gain on bankruptcy exit
    (119,408 )      
Write-off of deferred financing fees
          7,545  
Settlement of accrued liability
          (2,008 )
Loss on investment in Front Range, held for sale
    12,146        
Impairment of asset group
          2,200  
Loss on extinguishments of debt
    2,159        
Depreciation and amortization of intangibles
    5,957       25,984  
Inventory valuation
    136       845  
Amortization of deferred financing fees
    360       1,058  
Non-cash compensation and consulting expense
    1,399       1,493  
Gain on derivatives
    (1,206 )     (2,511 )
Bad debt recovery
    (165 )     (869 )
Equity earnings in Front Range
    929        
Changes in operating assets and liabilities:
               
Accounts receivable
    (13,100 )     12,252  
Restricted cash
          2,520  
Inventories
    (786 )     7,812  
Prepaid expenses and other assets
    (2,367 )     2,043  
Prepaid inventory
    (1,251 )     111  
Accounts payable and accrued expenses
    14,563       (5,543 )
Accounts payable and accrued expenses – related parties
    1,444       4,490  
Net cash used in operating activities
    (13,651 )     (8,437 )
                 
Investing Activities:
               
Net cash impact of deconsolidation of Front Range
    (10,486 )      
Net cash impact of bankruptcy exit
    (1,301 )      
Additions to property and equipment
    (333 )     (3,599 )
Proceeds from sales of available-for-sale investments
          7,679  
Net cash provided by (used in) investing activities
    (12,120 )     4,080  
                 
Financing Activities:
               
Proceeds from borrowings under DIP Financing
    5,173       12,278  
Proceeds from (payments on) other borrowings
    4,697       (10,051 )
Proceeds from related party borrowing
          2,000  
Net cash provided by financing activities
    9,870       4,227  
                 
Net decrease in cash and cash equivalents
    (15,901 )     (130 )
                 
Cash and cash equivalents at beginning of period
    17,545       11,466  
                 
Cash and cash equivalents at end of period
  $ 1,644     $ 11,336  
                 
Supplemental Information:
               
Interest paid
  $ 3,784     $ 2,407  
                 
Non-cash financing and investing activities:
               
Preferred stock dividend declared
  $ 2,346     $ 2,395  
Value of common stock issued in debt extinguishments
  $ 21,159     $  
    
See accompanying notes to these unaudited consolidated financial statements.
  
 
F-4

 
   
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
   
1.  ORGANIZATION AND BASIS OF PRESENTATION.
 
Organization – The consolidated financial statements include the accounts of Pacific Ethanol, Inc., a Delaware corporation, and its wholly-owned subsidiaries, including Pacific Ethanol California, Inc., a California corporation (“PECA”), Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”) and Pacific Ag. Products, LLC (“PAP”) for all periods presented, and for the periods specified below, the Plant Owners (as defined below), and Front Range Energy, LLC, a Colorado limited liability company (“Front Range”) (collectively, the “Company”).
 
The Company produces and sells low-carbon renewable fuels and co-products, including wet distillers grain (“WDG”), a nutritional animal feed. The Company sells ethanol to integrated oil companies and gasoline marketers who blend ethanol into gasoline, 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.
 
Effective June 29, 2010, under a new asset management agreement, the Company manages the production and operation of the Pacific Ethanol Plants (as defined below). These four facilities have an aggregate annual production capacity of up to 200 million gallons. Two of the facilities are operating and two of the facilities are idled. The Company is in the process of re-starting the Stockton, California facility and expects to resume production of ethanol at that facility in December 2010. In addition, if market conditions continue to improve, the Company may re-start the Madera, California facility as early as the first quarter of 2011, subject to the approval of New PE Holdco (as defined below). In addition, as of September 30, 2010, the Company owned a 42% interest in Front Range, which owns a plant located in Windsor, Colorado, with an annual production capacity of up to 50 million gallons. On October 6, 2010, the Company sold its entire interest in Front Range. See “Note 12—Subsequent Events.”
 
Chapter 11 Filings – On May 17, 2009, five indirect wholly-owned subsidiaries of Pacific Ethanol, Inc., namely, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC and Pacific Ethanol Magic Valley, LLC (collectively, the “Pacific Ethanol Plants”) and Pacific Ethanol Holding Co. LLC (“PEHC”) (together with the Pacific Ethanol Plants, the “Plant Owners”) each commenced a case by filing voluntary petitions for relief under chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) in an effort to restructure their indebtedness (“Chapter 11 Filings”).
 
On June 29, 2010 (the “Effective Date”), the Plant Owners declared effective their amended joint plan of reorganization (the “Plan”) with the Bankruptcy Court, which was structured in cooperation with certain of the Plant Owners’ secured lenders. Under the Plan, on the Effective Date, 100% of the ownership interests in the Plant Owners was transferred to a newly-formed limited liability company (“New PE Holdco”) which was wholly-owned by certain prepetition lenders, resulting in each of the Plant Owners becoming direct or indirect wholly-owned subsidiaries of New PE Holdco. On October 6, 2010, the Company purchased a 20% ownership interest in New PE Holdco from a number of the existing owners. See “Note 12—Subsequent Events.”
 
Basis of PresentationInterim Financial Statements – The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10−Q and Rule 10-01 of Regulation S-X. Results for interim periods should not be considered indicative of results for a full year. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Except as disclosed in Note 4, the accounting policies used in preparing these consolidated financial statements are the same as those described in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included. All significant intercompany accounts and transactions have been eliminated in consolidation.
  
 
F-5

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required as part of determining allowance for doubtful accounts, estimated lives of property and equipment and intangibles, long-lived asset impairments, valuation allowances on deferred income taxes, and the potential outcome of future tax consequences of events recognized in the Company’s financial statements or tax returns. Actual results and outcomes may materially differ from management’s estimates and assumptions.
 
For the periods through June 29, 2010, the consolidated financial statements include the financial statements of the Plant Owners. On June 29, 2010, the Plant Owners emerged from bankruptcy and the ownership of the Plant Owners was transferred to New PE Holdco.
 
For periods through December 31, 2009, the consolidated financial statements include the financial statements of Front Range, a variable interest entity of which PECA owned a 42% interest. Beginning January 1, 2010, the consolidated financial statements do not include the financial statements of Front Range as the Company is no longer the primary beneficiary. See “Note 4—Deconsolidation and Sale of Front Range.”
 
Reclassifications of prior year’s data have been made to conform to 2010 classifications. Such classifications had no effect on net loss reported in the consolidated statements of operations.
 
Liquidity – The Company’s financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
 
The Company believes that current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, including its credit facility and its remaining proceeds from its private offering of senior convertible notes and warrants on October 6, 2010, will be adequate to meet its anticipated working capital and capital expenditure requirements for at least the next twelve months. If, however, the Company is unable to service the principal and/or interest payments under the senior convertible notes through the issuance of shares of its common stock, if the Company’s capital requirements or cash flow vary materially from its current projections, if unforeseen circumstances occur, or if the Company requires a significant amount of cash to fund future acquisitions, the Company may require additional financing. The Company’s failure to raise capital, if needed, could restrict its growth, or hinder its ability to compete.
 
The consolidated financial statements do not include any other adjustments that might result from the outcome of these matters.
  
 
F-6

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
    
2.  NEW OPERATING AGREEMENTS AND CALL OPTION AGREEMENT.
 
Asset Management Agreement – As contemplated by the Plan, on the Effective Date, the Company entered into an Asset Management Agreement (“AMA”) with the Plant Owners under which the Company agreed to operate and maintain the Pacific Ethanol Plants on behalf of the Plant Owners. These services generally include, but are not limited to, administering the Plant Owners’ compliance with their credit agreements and performing billing, collection, record keeping and other administrative and ministerial tasks. The Company agreed to supply all labor and personnel required to perform its services under the AMA, including the labor and personnel required to operate and maintain the production facilities.
 
The costs and expenses associated with the Company’s provision of services under the AMA are prefunded by the Plant Owners under a preapproved budget. The Company’s obligation to provide services is limited to the extent there are sufficient funds advanced by the Plant Owners to cover the associated costs and expenses.
 
As compensation for providing the services under the AMA, the Company is to be paid $75,000 per month for each production facility that is operational and $40,000 per month for each production facility that is idled. In addition to the monthly fee, if during any six-month period (measured on September 30 and March 31 of each year commencing March 31, 2011) a production facility has annualized earnings before interest, income taxes, depreciation and amortization (“EBITDA”) per gallon of operating capacity of $0.20 or more, the Company will be paid a performance bonus equal to 3% of the increment by which EBITDA exceeds such amount. The aggregate performance bonus for all plants is capped at $2.2 million for each six-month period. The performance bonus is to be reduced by 25% if all production facilities then operating do not operate at a minimum average yield of 2.70 gallons of denatured ethanol per bushel of corn. In addition, no performance bonus is to be paid if there is a default or event of default under the Plant Owners’ credit agreement resulting from their failure to pay any amounts then due and owing.
 
The AMA also provides the Company with an incentive fee upon any sale of a production facility to the extent the sales price is above $0.60 per gallon of annual capacity.
 
The AMA has an initial term of six months and may be extended for additional six-month periods at the option of the Plant Owners. In addition to typical conditions for a party to terminate the agreement prior to its expiration, the Company may terminate the AMA, and the Plant Owners may terminate the AMA with respect to any facility, at any time by providing at least 60 days prior notice of such termination.
 
Ethanol Marketing Agreements – As contemplated by the Plan, on the Effective Date, Kinergy entered into separate ethanol marketing agreements with each of the two Plant Owners whose facilities were operating, which granted Kinergy the exclusive right to purchase, market and sell the ethanol produced at those facilities. Kinergy has also entered into an ethanol marketing agreement with the Plant Owner whose facility is currently being restarted. If the remaining idled facility becomes operational, it is contemplated that Kinergy would enter into a substantially identical ethanol marketing agreement with the applicable Plant Owner. Under the terms of the ethanol marketing agreements, within ten days after delivering ethanol to Kinergy, an amount is to be paid equal to (i) the estimated purchase price payable by the third-party purchaser of the ethanol, minus (ii) the estimated amount of transportation costs to be incurred by Kinergy, minus (iii) the estimated incentive fee payable to Kinergy, which equals 1% of the aggregate third-party purchase price. To facilitate Kinergy’s ability to pay amounts owing, the ethanol marketing agreements require that Kinergy maintain one or more lines of credit of at least $5.0 million in the aggregate. Each of the ethanol marketing agreements has an initial term of one year and may be extended for additional one-year periods at the option of the individual Plant Owner.
  
 
F-7

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
Corn Procurement and Handling Agreements – As contemplated by the Plan, on the Effective Date, PAP entered into separate corn procurement and handling agreements with each of the two Plant Owners whose facilities were operating. Kinergy has also entered into a corn procurement and handling agreement with the Plant Owner whose facility is currently being restarted. If the remaining idled facility becomes operational, it is contemplated that PAP would enter into a substantially identical corn procurement and handling agreement with the applicable Plant Owner. Under the terms of the corn procurement and handling agreements, each facility appointed PAP as its exclusive agent to solicit, negotiate, enter into and administer, on its behalf, corn supply arrangements to procure the corn necessary to operate its facility. PAP will also provide grain handling services including, but not limited to, receiving, unloading and conveying corn into the facility’s storage and, in the case of whole corn delivered, processing and hammering the whole corn.
 
PAP is to receive a fee of $0.50 per ton of corn delivered to each facility as consideration for its procurement services and a fee of $1.50 per ton of corn delivered as consideration for its grain handling services, each payable monthly. The Company agreed to enter into an agreement guaranteeing the performance of PAP’s obligations under the corn procurement and handling agreement upon the request of a Plant Owner. Each corn procurement and handling agreement has an initial term of one year and may be extended for additional one-year periods at the option of the applicable Plant Owner.
 
Distillers Grains Marketing Agreements – Under the Plan, on the Effective Date, PAP entered into separate distillers grains marketing agreements with each of the two Plant Owners whose facilities were operating, which granted PAP the exclusive right to market, purchase and sell the WDG produced at the facility. Kinergy has also entered into a distillers grains marketing agreement with the Plant Owner whose facility is currently being restarted. If the remaining idled facility becomes operational, it is contemplated that PAP would enter into a substantially identical WDG marketing agreement with the applicable Plant Owner. Under the terms of the distillers grains marketing agreements, within ten days after a Plant Owner delivers WDG to PAP, the Plant Owner is to be paid an amount equal to (i) the estimated purchase price payable by the third-party purchaser of the WDG, minus (ii) the estimated amount of transportation costs to be incurred by PAP, minus (iii) the estimated amount of fees and taxes payable to governmental authorities in connection with the tonnage of WDG produced or marketed, minus (iv) the estimated incentive fee payable to PAP, which equals the greater of (a) 5% of the aggregate third-party purchase price, and (b) $2.00 for each ton of WDG sold in the transaction. Within the first five business days of each calendar month, the parties will reconcile and “true up” the actual purchase price, transportation costs, governmental fees and taxes, and incentive fees for all transactions entered into since the previous true-up date. Each distillers grains marketing agreement has an initial term of one year and may be extended for additional one-year periods at the option of the applicable Plant Owner.
 
Call Option Agreement – Under the Plan, on the Effective Date, the Company entered into a Call Option Agreement with New PE Holdco and a number of owners of New PE Holdco under which the Company had the option to acquire up to 25% of the equity in New PE Holdco for a total price of $30,000,000 in cash. On September 28, 2010, the Company exercised this option. On October 6, 2010, the Company paid $14,400,000 in cash to purchase 12% of the equity in New PE Holdco under the option. In addition, on October 6, 2010, the Company also paid $8,800,000 in cash to purchase an additional 8% of the equity in New PE Holdco from an owner. See “Note 12—Subsequent Events.”
 
F-8

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
    
3.  ACCOUNTING FOR EMERGENCE FROM BANKRUPTCY.
 
Gain on Bankruptcy Exit – On the Effective Date, the Company ceased to own the Plant Owners. As a result, the Company removed the related assets and liabilities from its consolidated financial statements, resulting in a net gain from the bankruptcy exit of $119,408,000. The classification and amounts of the net liabilities removed at June 29, 2010 are as follows (in thousands):
  
Current Assets:
     
Cash and cash equivalents
  $ 1,302  
Accounts receivable – trade
    562  
Accounts receivable – Kinergy and PAP
    5,212  
Inventories
    4,841  
Other current assets
    2,166  
Total current assets
    14,083  
         
Property and equipment, net
    160,402  
Other assets
    585  
         
Total Assets
  $ 175,070  

Current Liabilities:
     
Accounts payable and other liabilities
  $ 21,368  
DIP Financing and rollup
    50,000  
         
Liabilities subject to compromise
    223,110  
         
Total Liabilities
  $ 294,478  
         
Net Gain
  $ 119,408  
  
Liabilities Subject to Compromise – Liabilities subject to compromise refers to prepetition obligations which may be impacted by the Chapter 11 Filings. These amounts represented the Company’s estimate of known or potential prepetition obligations to be resolved in connection with the Chapter 11 Filings. On June 29, 2010, the liabilities subject to compromise were removed from the Company’s balance sheet as discussed above.
 
Contractual interest expense represents amounts due under the contractual terms of outstanding debt, including liabilities subject to compromise for which interest expense may not be recognized in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 852, Reorganizations. The Plant Owners did not record contractual interest expense on certain unsecured prepetition debt subject to compromise from the date of the Chapter 11 Filings. The Plant Owners did, however, accrue interest on their debtor-in-possession credit agreement (“DIP Financing”) and related rollup as these amounts were likely to be paid in full upon confirmation of a plan of reorganization. On the Effective Date, the DIP Financing was converted to a term loan of the Plant Owners. For the nine months ended September 30, 2010, the Company recorded interest expense related to the Plant Owners of approximately $2,356,000. Had the Company accrued interest on all of the Plant Owners’ liabilities subject to compromise for the nine months ended September 30, 2010, interest expense would have been approximately $14,932,000. For the three and nine months ended September 30, 2009, the Company recorded interest expense related to the Plant Owners of approximately $673,000 and $10,648,000, respectively. Had the Company accrued interest on all of their liabilities subject to compromise for the three and nine months ended September 30, 2009, interest expense would have been approximately $7,988,000 and $20,969,000, respectively.
  
 
F-9

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
Reorganization Costs – The Plant Owners’ reorganization costs consisted of the following (in thousands):
   
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Professional fees
  $     $ 2,363     $ 4,036     $ 3,648  
Write-off of unamortized deferred financing fees
                      7,545  
Settlement of accrued liability
          (2,008 )           (2,008 )
DIP Financing fees
                      600  
Trustee fees
          46       117       78  
Total
  $     $ 401     $ 4,153     $ 9,863  
  
4.  DECONSOLIDATION AND SALE OF FRONT RANGE.
 
Deconsolidation of Front Range – On October 17, 2006, the Company entered into a Membership Interest Purchase Agreement with Eagle Energy, LLC 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 facility in Windsor, Colorado. Front Range began producing ethanol in June 2006. Upon initial acquisition of the 42% interest in Front Range, the Company determined that it was the primary beneficiary and from that point, consolidated the financial results of Front Range. Except for the marketing agreement discussed below, certain contracts and arrangements between the Company and Front Range have since terminated.
 
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 one-half years with provisions for annual automatic renewal thereafter.
 
On June 12, 2009, the FASB amended its guidance to ASC 810, Consolidations, surrounding a company’s analysis to determine whether any of its variable interest entities constitute controlling financial interests in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new guidance also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. The guidance was effective for the first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter.
 
Effective January 1, 2010, the Company adopted these provisions, which resulted in the Company concluding that the Company was no longer the primary beneficiary and, effective January 1, 2010, the Company had prospectively adopted the FASB’s guidance resulting in a deconsolidation of the financial results of Front Range. In making this conclusion, the Company determined that Front Range continued to be a variable interest entity; however, the Company did not have the power to direct most of the activities that most significantly impact the entity’s economic performance. Some of these activities included efficient management and operation of its facility, procurement of feedstock, sale of co-products and effectiveness of risk management strategies. Further, the Company’s maximum exposure was limited to its investment in Front Range. Upon deconsolidation, the Company removed $62,617,000 of assets and $18,584,000 of liabilities from its consolidated balance sheet and recorded a cumulative debit adjustment to retained earnings of $1,762,000. The periods presented in this report prior to the effective date of the deconsolidation continue to include related balances associated with Front Range. Effective January 1, 2010, the Company accounted for its investment in Front Range under the equity method, with equity earnings recorded in other income (expense) in the consolidated statements of operations.
  
 
F-10

 

PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
Sale of Front Range – On September 27, 2010, PECA entered into an agreement with Daniel A. Sanders under which PECA agreed to sell its entire interest in Front Range to Mr. Sanders for $18,500,000 in cash. The Company’s carrying value of its investment in Front Range prior to the sale was $30,646,000. As a result of the sale, the Company reduced its carrying value of its investment in Front Range to fair value, resulting in a charge of $12,146,000 to record a carrying value equal to the $18,500,000 sale price. The Company closed the sale of its interest in Front Range on October 6, 2010.
  
5.  INVENTORIES.
  
Inventories consisted primarily of bulk ethanol, unleaded fuel and corn, and are valued at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis. The inventory held by the Plant Owners was removed from the Company’s consolidated financial statements on the Effective Date. Remaining inventory balances at September 30, 2010 primarily represent inventory held by Kinergy. Inventory balances consisted of the following (in thousands):
  
   
September 30, 2010
   
December 31, 2009
 
Finished goods
  $ 4,619     $ 2,483  
Raw materials
          5,957  
Work in progress
          2,230  
Other
          1,461  
Total
  $ 4,619     $ 12,131  
   
6.  DEBT.
    
Long-term borrowings are summarized in the following table (in thousands):
   
   
September 30, 2010
   
December 31, 2009
 
Notes payable to related party
  $ 12,500     $ 31,500  
Notes payable to related parties
    2,000       2,000  
Kinergy operating line of credit
    7,149       2,452  
DIP Financing and rollup
          39,654  
Swap note
          13,495  
Water rights capital lease obligations
          1,003  
      21,649       90,104  
Less short-term portion
    (13,250 )     (77,365 )
Long-term debt
  $ 8,399     $ 12,739  

Notes Payable to Related Party – The Company was a party to certain agreements designed to satisfy the Company’s outstanding debt to Lyles United, LLC, a significant shareholder, and Lyles Mechanical Co. (collectively, “Lyles”). In March 2010, Socius CG II, Ltd. (“Socius”) entered into purchase agreements with Lyles under which Socius would purchase claims in respect of the Company’s indebtedness in up to $5,000,000 tranches, which claims Socius would then settle in exchange for shares of the Company’s common stock. Each tranche was to be settled in exchange for the Company’s common stock valued at a 20% discount to the volume weighted average price (“VWAP”) of the Company’s common stock over a predetermined trading period, which ranged from 5 to 20 trading days, immediately following the date on which the shares were first issued to Socius.
  
 
F-11

 

PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
   
Under this arrangement, the Company issued shares to Socius which settled outstanding debt previously owed to Lyles in four successive transactions. For the nine months ended September 30, 2010, the Company issued an aggregate of 24,088,000 shares with an aggregate fair value of $21,159,000 in exchange for $19,000,000 in debt extinguishment, resulting in an aggregate loss of $2,159,000. The Company determined fair value based on the closing price of its shares on the last day of the applicable trading period, which was the date the net shares to be issued were determinable by the Company. There were no additional issuances during the three months ended September 30, 2010.

On October 6, 2010, the Company paid in full all remaining principal, accrued interest and fees owed to Lyles.
 
Notes Payable to Related Parties – On March 31, 2009, the Company’s Chairman of the Board and its Chief Executive Officer provided funds totaling $2,000,000 for general working capital purposes in exchange for two unsecured promissory notes issued by the Company. Interest on the unpaid principal amounts accrues at a rate per annum of 8.00%. All principal and accrued and unpaid interest on the promissory notes was due and payable in January 2011. On October 29, 2010, the Company paid all accrued interest and $750,000 in principal under these notes. On November 5, 2010, the Company entered into amendments to these notes, extending the maturity date to March 31, 2012.
 
Kinergy Operating Line of Credit – On October 27, 2010 and September 22, 2010, Kinergy and the Company entered into amendments (the “Amendments”) to Kinergy’s working capital line of credit with Wells Fargo Capital Finance, LLC, successor by merger to Wachovia Capital Finance Corporation (Western) (“Wells Fargo”). Under the Amendments, the maturity date of the credit facility was extended by 60 days to December 31, 2010 to accommodate ongoing discussions between Kinergy and Wells Fargo regarding a renewal and upsizing of the credit facility. In addition, the maximum amount of the credit facility was increased to $15,000,000 from $10,000,000.
 
DIP Financing and Rollup – The DIP Financing and rollup balances were removed from the Company’s consolidated financial statements as discussed in Note 3.
 
7.  COMMITMENTS AND CONTINGENCIES.
 
Purchase Commitments – At September 30, 2010, the Company had purchase contracts with its suppliers to purchase certain quantities of ethanol. The Company had $10,825,000 in fixed-price commitments and 6,893,000 gallons of indexed-price commitments. These fixed- and indexed-price commitments are to be delivered throughout the remainder of 2010. The volumes of indexed-price contracts are to be purchased at pre-established prices based on publicly-indexed prices in effect on their respective transaction dates.
 
Sales Commitments – At September 30, 2010, the Company had sales contracts with its customers to sell certain quantities of ethanol. The Company had $8,371,000 in fixed-price commitments and 98,732,000 gallons in indexed-price commitments. The volumes of indexed price contracts will be sold at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates.
  
 
F-12

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
Litigation – General The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect the Company’s quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes that such matters will not adversely affect the Company’s financial position, results of operations or cash flows.
 
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 “First Virginia Federal Court case”), naming Pacific Ethanol, Inc. as a defendant, along with its former 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 alleged breaches of the parties’ Engineering, Procurement and Technology License Agreements, breaches of a subsequent term sheet and letter agreement and breaches of indemnity obligations. The complaint sought specified contract damages of approximately $6,500,000, along with other unspecified damages. All of the defendants moved to dismiss the First 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, moved to stay the First Virginia Federal Court case pending arbitration. In January 2009, these motions were granted by the Court, compelling the case to arbitration with the American Arbitration Association (“AAA”). By letter dated June 10, 2009, the AAA notified the parties to the arbitration that the matter was automatically stayed as a result of the Chapter 11 Filings.
 
On March 18, 2009, Delta-T Corporation filed a cross-complaint against Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC in the Superior Court of the State of California in and for the County of Imperial. The cross-complaint arose out of a suit by OneSource Distributors, LLC against Delta-T Corporation. On March 31, 2009, Delta-T Corporation and Bateman Litwin N.V, a foreign corporation, filed a third-party complaint in the United States District Court for the District of Minnesota naming Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC as defendants. The third-party complaint arose out of a suit by Campbell-Sevey, Inc. against Delta-T Corporation. On April 6, 2009, Delta-T Corporation filed a cross-complaint against Pacific Ethanol, Inc. and Pacific Ethanol Imperial, LLC in the Superior Court of the State of California in and for the County of Imperial. The cross-complaint arose out of a suit by GEA Westfalia Separator, Inc. against Delta-T Corporation. Each of these actions allegedly related to the aforementioned Engineering, Procurement and Technology License Agreements and Delta-T Corporation’s performance of services thereunder. The third-party suit and the cross-complaints asserted many of the factual allegations in the First Virginia Federal Court case and sought unspecified damages.
 
On June 19, 2009, Delta-T Corporation filed suit in the United States District Court for the Eastern District of Virginia (the “Second Virginia Federal Court case”), naming Pacific Ethanol, Inc. as the sole defendant. The suit alleged breaches of the parties’ Engineering, Procurement and Technology License Agreements, breaches of a subsequent term sheet and letter agreement, and breaches of indemnity obligations. The complaint sought specified contract damages of approximately $6,500,000, along with other unspecified damages.
 
In connection with the Chapter 11 Filings, the Plant Owners moved the United States Bankruptcy Court for the District of Delaware to enter a preliminary injunction in favor of the Plant Owners and Pacific Ethanol, Inc. staying and enjoining all of the aforementioned litigation and arbitration proceedings commenced by Delta-T Corporation. On August 6, 2009, the Delaware court ordered that the litigation and arbitration proceedings commenced by Delta-T Corporation be stayed and enjoined until September 21, 2009 or further order of the court, and that the Plant Owners, Pacific Ethanol, Inc. and Delta-T Corporation complete mediation by September 20, 2009 for purposes of settling all disputes between the parties. Following a mediation, the parties reached an agreement under which a stipulated order was entered in the bankruptcy court on September 21, 2009, providing for a complete mutual release and settlement of any and all claims between Delta-T Corporation and the Plant Owners, a complete reservation of rights as between Pacific Ethanol, Inc. and Delta-T Corporation, and a stay of all proceedings by Delta-T Corporation against Pacific Ethanol, Inc. until December 31, 2009.
  
 
F-13

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
On March 1, 2010, Delta-T Corporation resumed active litigation of the Second Virginia Federal Court case by filing a motion for entry of a default judgment. Also on March 1, 2010, Pacific Ethanol, Inc. filed a motion for extension of time for its first appearance in the Second Virginia Federal Court case and also filed a motion to dismiss Delta-T Corporation’s complaint based on the mandatory arbitration clause in the parties’ contracts, and alternatively to stay proceedings during the pendency of arbitration. These motions were argued on March 31, 2010. The Court ruled on the motions in May 2010, denying Delta-T’s Corporation’s motion for entry of a default judgment, and compelling the case to arbitration with the AAA. 
 
On May 25, 2010, Delta-T Corporation filed a Voluntary Petition in the Bankruptcy Court for the Eastern District of Virginia under Chapter 7 of the Bankruptcy Code. After reviewing Delta-T Corporation’s Voluntary Petition, the Company believes that Delta-T Corporation intends to liquidate and abandon its claims against the Company.
 
8.  FAIR VALUE MEASUREMENTS.
 
In accordance with FASB ASC 820, Fair Value Measurements and Disclosures, the Company, prior to the Effective Date, classified the Plant Owners’ interest rate caps and swaps into the following levels depending on the inputs used to determine their fair values. The fair value of the interest rate caps were designated as Level 2, based on quoted prices on similar assets or liabilities in active markets. The fair values of the interest rate swaps were designated as Level 3 and were based on a combination of observable inputs and material unobservable inputs.
 
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 Plant Owners had five pay-fixed and receive variable interest rate swaps in liability positions which were extinguished as part of the emergence from bankruptcy. The value of these swaps was materially affected by the Plant Owners’ 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 $4,070,000 at June 29, 2010. To reflect the Plant Owners’ current financial condition and Chapter 11 Filings, a recovery rate of 40% was applied to that value. Management elected the 40% recovery rate in the absence of any other company-specific information. As the recovery rate is a material unobservable input, these swaps were considered Level 3. It is the Company’s understanding that a 40% recovery rate reflects the standard market recovery rate provided by Bloomberg in probability of default calculations. The Company applied its interpretation of the 40% recovery rate to the swap liability, reducing the liability by 60% to approximately $1,628,000 to reflect the credit risk to counterparties. On June 29, 2010, the liability balance was removed from the Company’s consolidated financial statements as discussed in Note 3.

The carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and current portion of long-term notes payable are reasonable estimates of their fair value because of the short maturity of these items.
  
 
F-14

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
9.  EARNINGS PER SHARE.
 
The following table computes basic and diluted earnings per share (in thousands, except per share data):
   
   
Three Months Ended September 30, 2010
 
   
Loss
Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (12,118 )            
Less:  Preferred stock dividends
    (758 )            
Basic and diluted earnings per share:
                   
Loss available to common stockholders
  $ (12,876 )     81,901     $ (0.16 )
  
     
   
Three Months Ended September 30, 2009
 
   
Loss
Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (12,007 )            
Less:  Preferred stock dividends
    (807 )            
Basic and diluted earnings per share:
                   
Loss available to common stockholders
  $ (12,814 )     57,001     $ (0.22 )
  
    
   
Nine Months Ended September 30, 2010
 
   
Income Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net income
  $ 85,539              
Less:  Preferred stock dividends
    (2,346 )            
Basic income per share:
                   
Income available to common stockholders
  $ 83,193       69,630     $ 1.19  
Add:  Preferred stock dividends
    2,346       8,062          
Diluted income per share:
                       
Income available to common stockholders
  $ 85,539       77,692     $ 1.10  
   
   
   
Nine Months Ended September 30, 2009
 
   
Loss
Numerator
   
Shares Denominator
   
Per-Share Amount
 
Net loss
  $ (63,323 )            
Less:  Preferred stock dividends
    (2,395 )            
Basic and diluted earnings per share:
                   
Loss available to common stockholders
  $ (65,718 )     56,998     $ (1.15 )
       
 
There were an aggregate of 8,832,000 and 7,038,000 potentially dilutive weighted-average shares from convertible securities outstanding as of September 30, 2010 and 2009, respectively. These convertible securities were not considered in calculating diluted net loss per share for the three months ended September 30, 2010 and the three and nine months ended September 30, 2009 as their effect would have been anti-dilutive. On October 6, 2010, the Company issued $35,000,000 of senior convertible notes and warrants to purchase an aggregate of 20,588,235 shares of the Company’s common stock. See “Note 12—Subsequent Events.”
   
 
F-15

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
10.  RELATED PARTY TRANSACTIONS.
 
The Company had accrued and unpaid dividends in respect of its Series B Cumulative Convertible Preferred Stock (“Series B Preferred Stock”) of $5,549,000 and $3,202,000 as of September 30, 2010 and December 31, 2009, respectively. In August 2010, 142,598 shares of the Company’s Series B Preferred Stock were converted into 560,003 shares of the Company’s common stock.
 
The Company had notes payable to Lyles in the aggregate principal amount of $12,500,000 and $31,500,000 and accrued and unpaid interest and fees in respect of these notes of $4,505,000 and $2,731,000 as of September 30, 2010 and December 31, 2009, respectively. On October 6, 2010, the Company paid in full all amounts owed under its notes payable to Lyles, consisting of $12,500,000 in principal and $4,537,000 in accrued interest and fees.
 
The Company had notes payable to its Chairman of the Board and its Chief Executive Officer totaling $2,000,000 and accrued and unpaid interest in respect of these notes of $240,000 and $120,000 as of September 30, 2010 and December 31, 2009, respectively. On October 29, 2010, the Company paid all accrued interest and $750,000 in principal under these notes. On November 5, 2010, the Company entered into amendments to these notes, extending the maturity date to March 31, 2012.
 
 
   
 
F-16

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
     
11.  PLANT OWNERS’ CONDENSED COMBINED FINANCIAL STATEMENTS.
 
Since the consolidated financial statements of the Company include entities other than the Plant Owners, the following presents the condensed combined financial statements of the Plant Owners for the periods included in these condensed combined financial statements. The Company did not consolidate any of the Plant Owners’ results for the three months ended September 30, 2010. These condensed combined financial statements have been prepared, in all material respects, on the same basis as the consolidated financial statements of the Company. The condensed combined financial statements of the Plant Owners are as follows (unaudited, in thousands):
  
PACIFIC ETHANOL HOLDING CO. LLC AND SUBSIDIARIES
CONDENSED COMBINED STATEMENTS OF OPERATIONS
       
   
Nine Months Ended
September 30, 2010
   
Three Months Ended
September 30, 2009
   
May 17, 2009 to
September 30, 2009
 
                   
Net sales
  $ 89,737     $ 18,226     $ 26,984  
Cost of goods sold
    98,140       25,091       37,961  
Gross loss
    (8,403 )     (6,865 )     (10,977 )
Selling, general and administrative expenses
    1,829       988       1,520  
Loss from operations
    (10,232 )     (7,853 )     (12,497 )
Other expense, net
    (1,253 )     (286 )     (87 )
Loss before reorganization costs and gain from bankruptcy exit
    (11,485 )     (8,139 )     (12,584 )
Reorganization costs
    (4,153 )     (401 )     (9,863 )
Gain from bankruptcy exit
    119,408              
Net income (loss)
  $ 103,770     $ (8,540 )   $ (22,447 )
   
PACIFIC ETHANOL HOLDING CO. LLC AND SUBSIDIARIES
CONDENSED COMBINED STATEMENT OF CASH FLOWS
    
   
Nine Months Ended
September 30, 2010
   
May 17, 2009 to
September 30, 2009
 
Operating Activities:
           
Net cash used in operating activities
  $ (6,808 )   $ (9,269 )
Investing Activities:
               
Net cash impact of bankruptcy exit
    (1,301 )      
Additions to property and equipment
    (310 )      
Net cash used in investing activities
    (1,611 )      
Financing Activities:
               
Proceeds from borrowing
    5,173       12,278  
Net cash provided by financing activities
    5,173       12,278  
Net (decrease) increase in cash and cash equivalents
    (3,246 )     3,009  
Cash and cash equivalents at beginning of period
    3,246       52  
Cash and cash equivalents at end of period
  $     $ 3,061  
   
 
F-17

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
12.  SUBSEQUENT EVENTS.

Debt and Plant Ownership TransactionsOn October 6, 2010, the Company entered into the following transactions which restructured its debt and plant ownership positions:

Issuance of Senior Convertible Notes and Warrants – On September 27, 2010, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with seven accredited investors (the “Investors”). Under the terms of the Purchase Agreement, the Company agreed to sell $35,000,000 of senior convertible notes (the “Notes”) and warrants (the “Warrants”) to purchase an aggregate of 20,588,235 shares of the Company’s common stock to the Investors in a private offering (the “Financing Transaction”). The sale of the Notes and the Warrants to the Investors closed on October 6, 2010 (the “Closing”). In connection with the sale of the Notes and the Warrants, the Company entered into a registration rights agreement with the Investors on October 6, 2010. The Company paid Lazard Capital Markets LLC $2,450,000 plus out of pocket fees upon the Closing in consideration of placement agent services provided to the Company.

On October 26, 2010, the Company filed a registration statement on Form S-1 with the Securities and Exchange Commission to register for resale 99,120,272 shares of common stock issuable upon conversion of the Notes or otherwise under the terms of the Notes and/or upon exercise of the Warrants, which is based on 150% of (i) the maximum number of shares of common stock initially issuable upon conversion of the Notes, (ii) the maximum number of other shares of common stock issuable under the Notes (i.e., shares of common stock issuable as interest in lieu of cash payments) on October 25, 2010, and (iii) the maximum number of shares of common stock issuable upon exercise of Warrants on October 25, 2010, in each case, determined as if the outstanding Notes and Warrants were converted or exercised (as the case may be) in full, without regard to any limitation on conversion, issuance of common stock or exercise contained in the Notes and Warrants. For purposes of the calculation of the maximum number of shares of common stock initially issuable upon conversion of the Notes and the maximum number of other shares of common stock issuable under the Notes, the Company assumed a conversion price of $0.85, which represents the initial conversion price and the conversion price under the Notes on October 25, 2010.

Exercise of Call Option – On September 28, 2010, the Company exercised its option to purchase an aggregate of 12% of the equity of New PE Holdco from the owners of New PE Holdco for an aggregate purchase price of $14,400,000. On October 6, 2010, using proceeds from the Financing Transaction, the Company closed the purchase of 12% of the equity in New PE Holdco under the option.

Purchase of Units in New PE Holdco – On September 28, 2010, the Company entered into an Agreement for Purchase and Sale of Units (the “Units Purchase Agreement”) in New PE Holdco with Candlewood Special Situations Fund, L.P. (“Candlewood”) under which the Company agreed to purchase 8% of the equity of New PE Holdco from Candlewood for an aggregate purchase price of $8,800,000 in cash. On October 6, 2010, using proceeds from the Financing Transaction, the Company closed the purchase of 8% of the equity in New PE Holdco under the Units Purchase Agreement.

Sale of Front Range – On September 27, 2010, PECA entered into an agreement under which PECA agreed to sell its entire interest in Front Range for an aggregate cash consideration of $18,500,000. The Company closed this transaction on October 6, 2010.
  
 
F-18

 

PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
Lyles Payoff – On October 6, 2010, the Company paid all amounts owed to Lyles United LLC and Lyles Mechanical Co., in the aggregate amount of $17,037,000, using proceeds received from the sale of its interest in Front Range.

Pro Forma Condensed Balance Sheet (unaudited) – The following unaudited condensed consolidated pro forma balance sheet presents the Company’s balance sheet as of September 30, 2010. The pro forma balance sheet gives effect to the above transactions, including the consolidation of the New PE Holdco, as if they occurred on September 30, 2010 (amounts in thousands).
   
ASSETS
 
Reported
Amounts
   
Pro Forma Adjustments
 
 
Notes
 
Pro Forma Amounts
 
Cash and cash equivalents
  $ 1,644     $ 16,952  
(a)
  $ 18,596  
Accounts receivable, net
    17,465               17,465  
Inventories
    4,619       5,385  
(b)
    10,004  
Investment in Front Range, held for sale
    18,500       (18,500 )
(c)
     
Other current assets
    6,735       3,665  
(b)
    10,400  
Total current assets
    48,963       7,502         56,465  
                           
Property and equipment, net
    1,115       157,370  
(b)
    158,485  
Other assets
    5,393       1,196  
(b)
    6,589  
Total Assets
  $ 55,471     $ 166,068       $ 221,539  
    
LIABILITIES AND STOCKHOLDERS’ EQUITY:
               
Accounts payable and accrued liabilities
  $ 20,021     $ (2,761 )
(b)
  $ 17,260  
Other liabilities - related parties
    8,256       (4,537 )
(d)
    3,719  
Current portion of long-term debt
    13,250       (12,500 )
(d)
    750  
Total current liabilities
    41,527       (19,798 )       21,729  
                           
Senior convertible notes
          35,000  
(e)
    35,000  
New PE Holdco debt and working capital facility
          63,756  
(f)
    63,756  
Notes payable, net of current portion
    8,399               8,399  
Other liabilities
    1,617       98  
(b)
    1,715  
Total Liabilities
    51,543       79,056         130,599  
                           
Stockholders’ Equity:
                         
Pacific ethanol stockholders’ equity
    3,928               3,928  
Noncontrolling interest equity
          87,012  
(b)
    87,012  
Total Stockholders' Equity
    3,928       87,012         90,940  
Total Liabilities and Stockholders' Equity
  $ 55,471     $ 166,068       $ 221,539  
 
Notes to Unaudited Pro Forma Condensed Balance Sheet
 
 
(a)
Amounts represent cash sources and uses as follows (in thousands):
    
Cash proceeds from Notes and Warrants   $ 35,000  
Cash proceeds from sale of interest in Front Range     18,500  
Cash balances at New PE Holdco     3,789  
Purchase of 20% in New PE Holdco     (23,300 )
Payments in satisfaction of Lyles loans     (17,037 )
  Net adjustment   $ 16,952  
    
 
F-19

 
 
PACIFIC ETHANOL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  
 
(b) 
Amounts represent the assets and liabilities of New PE Holdco at September 30, 2010. The Company has determined that New PE Holdco is a variable interest entity. In addition, because of its ownership interest in New PE Holdco, in relation to the other members’ position and involvement, as well as its asset management and marketing agreements with subsidiaries of New PE Holdco, the Company believes that it is the primary beneficiary and, accordingly, has consolidated the results of New PE Holdco in the balance sheet. The Company has made a preliminary allocation of the estimated purchase price of its 20% interest in New PE Holdco to the assets acquired and liabilities assumed based on estimates of their fair value. Final estimates of these items are dependent upon valuations and other analyses which could not be completed prior to the completion of the transactions described above.
   
 
(c) 
Removal of the Company’s investment in Front Range as a result of the sale.
   
 
(d) 
Represents the payment in satisfaction of accrued interest and notes payable to Lyles United, LLC and Lyles Mechanical Co.
   
 
(e) 
Represents the Notes issued as part of the transactions described above. Allocations regarding any Warrant and Note exercise or conversion feature liabilities are not included in these amounts. The valuation of the components could not be completed prior to the completion of the transactions described above.
   
 
(f) 
Represents New PE Holdco’s reorganized debt consisting of $50.0 million in 3-year term debt and amounts outstanding under its $35.0 million working capital facility at September 30, 2010.
 
Extension of Kinergy Line of Credit – On October 27, 2010 and September 22, 2010, Kinergy and the Company, entered into Amendments to Kinergy’s working capital line of credit with Wells Fargo. Under the Amendments, the maturity date of the credit facility was extended by 60 days to December 31, 2010 to accommodate ongoing discussions between Kinergy and Wells Fargo regarding a renewal and upsizing of the credit facility. In addition, the maximum amount of the credit facility was increased to $15,000,000 from $10,000,000.
 
Payment on Notes Payable to Related Parties – On October 29, 2010, the Company paid all accrued interest and $750,000 in principal under its notes to its Chairman of the Board and its Chief Executive Officer. In addition, on November 5, 2010, the Company entered into amendments to those notes, extending their maturity date to March 31, 2012.
 
Stock Grants – In October 2010, the Company granted an aggregate amount of 3,135,000 shares of restricted stock under the Company’s 2006 Stock Incentive Plan to members of its Board of Directors, executive officers and a number of employees.
 
Series B Conversions – In October 2010, 338,770 shares of the Company’s Series B Preferred Stock were converted into 1,988,579 shares of the Company’s common stock. In November 2010, 204,430 shares of the Company’s Series B Preferred Stock were converted into 1,200,001 shares of the Company’s common stock.
 
The Company performed an evaluation of subsequent events through the date of filing this Quarterly Report on Form 10-Q and has determined that there are no other subsequent events that require disclosure.
  
 
F-20

 
  
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This report and our consolidated financial statements and notes to consolidated financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:
  
 
our ability to obtain and maintain normal terms with vendors and service providers;
 
our ability to maintain contracts that are critical to our operations;
 
fluctuations in the market price of ethanol and its co-products;
 
the projected growth or contraction in the ethanol and co-product markets in which we operate;
 
our strategies for expanding, maintaining or contracting our presence in these markets;
 
our ability to successfully manage and operate third party ethanol production facilities;
 
anticipated trends in our financial condition and results of operations; and
 
our ability to distinguish ourselves from our current and future competitors.
     
You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q, or in the case of a document incorporated by reference, as of the date of that document. We do not undertake to update, revise or correct any forward-looking statements, except as required by law.
  
Any of the factors described immediately above, or referenced from time to time in our filings with the SEC or in the “Risk Factors” section below could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.
  
Overview
  
We are the leading marketer and producer of low carbon renewable fuels in the Western United States.
  
Since our inception in 2005, we have conducted ethanol marketing operations through our subsidiary, Kinergy, through which we market and sell ethanol produced by third parties. In 2006, we began constructing the first of our four then wholly-owned ethanol production facilities, or Pacific Ethanol Plants, and were continuously engaged in plant construction until the fourth facility was completed in 2008. We funded, and until recently directly operated, the Pacific Ethanol Plants through a subsidiary holding company and four other indirect subsidiaries, or Plant Owners.
  
In late 2008 and early 2009, we idled production at three of the Pacific Ethanol Plants due to adverse market conditions and lack of adequate working capital. Adverse market conditions and our financial constraints continued, resulting in an inability to meet our debt service requirements, and in May 2009, the subsidiary holding company and the Plant Owners, collectively referred to as the Bankrupt Debtors, each commenced a case by filing voluntary petitions for relief under chapter 11 of Title 11 of the United States Code, or Bankruptcy Code, in the United States Bankruptcy Court for the District of Delaware.
  
 
2

 
On March 26, 2010, the Bankrupt Debtors filed a joint plan of reorganization with the Bankruptcy Court, which was structured in cooperation with a number of the Bankrupt Debtors’ secured lenders. On June 29, 2010, referred to as the Effective Date, the Bankrupt Debtors declared effective their amended joint plan of reorganization, or the Plan, and emerged from bankruptcy. Under the Plan, on the Effective Date, all of the ownership interests in the Bankrupt Debtors were transferred to a newly-formed holding company, New PE Holdco, LLC, or New PE Holdco, wholly-owned as of that date by some of the prepetition lenders and new lenders of the Bankrupt Debtors. As a result, the Pacific Ethanol Plants are now wholly-owned by New PE Holdco. We hold a 20% ownership interest in New PE Holdco. See “—Recent Developments” below.
 
We currently manage the production of ethanol at the Pacific Ethanol Plants under the terms of an asset management agreement with the Plant Owners. We also market ethanol and its co-products, including WDG, produced by the Pacific Ethanol Plants under the terms of separate marketing agreements with the Plant Owners whose facilities are operational and a Plant Owner whose facility is in the process of being re-started. We also market ethanol and its co-products to other third parties, and provide transportation, storage and delivery of ethanol through third-party service providers in the Western United States, primarily in California, Nevada, Arizona, Oregon, Colorado, Idaho and Washington.
 
We have extensive customer relationships throughout the Western United States and extensive supplier relationships throughout the Western and Midwestern United States. Our customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. We supply ethanol to our customers either from the Pacific Ethanol Plants located within the regions we serve, or with ethanol procured in bulk from other producers. In some cases, we have marketing agreements with ethanol producers to market all of the output of their facilities. Additionally, we have customers who purchase our co-products for animal feed and other uses.
 
The Pacific Ethanol Plants have an aggregate annual capacity of up to 200 million gallons. As of the filing of this report, two of the facilities were operating and two of the facilities were idled. We are in the process of re-starting the Stockton, California facility and expect to resume production of ethanol at that facility in December 2010. In addition, if market conditions continue to improve, we may re-start the Madera, California facility as early as the first quarter of 2011, subject to the approval of New PE Holdco.
 
Under the asset management agreement and marketing agreements, we manage the production and operations of the Pacific Ethanol Plants, market their ethanol and WDG and earn fees as follows:
  
 
Ethanol marketing fees of approximately 1% of the net sales price;
     
 
Corn procurement and handling fees of approximately $2.00 per ton;
     
 
WDG fees of approximately the greater of 5% of the third-party purchase price or $2.00 per ton; and
     
 
Asset management fees of $75,000 per month for each operating facility and $40,000 per month for each idled facility.
        
We intend to maintain our position as the leading marketer and producer of low-carbon renewable fuels in the Western United States, in part by expanding our relationships with customers and third-party ethanol producers to market higher volumes of ethanol and by expanding the market for ethanol by continuing to work with state governments to encourage the adoption of policies and standards that promote ethanol as a fuel additive and transportation fuel. Further, we may seek to provide management services for other third-party ethanol production facilities in the Western United States.
  
 
3

 
  
Recent Developments
 
On October 6, 2010, we raised $35.0 million through the issuance of $35.0 million in principal amount of senior convertible notes, or Notes, and warrants, or Warrants, to purchase an aggregate of 20,588,235 shares of our common stock. On that same date we sold our 42% interest in Front Range Energy, LLC, or Front Range, for $18.5 million in cash, paid off our outstanding indebtedness to Lyles United, LLC and Lyles Mechanical Co. in the aggregate amount of approximately $17.0 million and purchased a 20% ownership interest in New PE Holdco for an aggregate purchase price of $23.3 million.
 
Critical Accounting Policies
 
The preparation of our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, requires us to make judgments and estimates that may have a significant impact upon the portrayal of our financial condition and results of operations. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management that can materially impact the portrayal of our financial condition and results of operations: going concern assumption; revenue recognition; consolidation of variable interest entities; and allowance for doubtful accounts. These significant accounting principles are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2009.
 
Results of Operations
 
The following selected financial data should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report.
 
Accounting for the results of New PE Holdco
 
For the periods through June 29, 2010, our consolidated financial statements include the financial statements of the Plant Owners. On June 29, 2010, the Plant Owners emerged from bankruptcy, and the ownership of the Plant Owners was transferred to New PE Holdco. Accordingly, for the three months ended September 30, 2010, we did not consolidate the Plant Owners’ financial statements as we had no ownership interest in the Plant Owners during the period. Also, under the Plan, we removed the Plant Owners’ assets of $175.0 million and liabilities of $294.4 million from our balance sheet, resulting in a net gain of $119.4 million for the three months ended June 30, 2010. On October 6, 2010, we purchased 20% ownership interest in New PE Holdco, which gives us the largest equity position. Based on our ownership interest as well as our asset management and marketing agreements with New PE Holdco, we believe we will consolidate its financial results with ours beginning in the fourth quarter of 2010.
 
Accounting for the results of Front Range
 
Effective January 1, 2010, we adopted the new guidance to Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 810, Consolidations, which resulted in our conclusion that, under the FASB’s guidance, we are no longer the primary beneficiary and, effective January 1, 2010, we prospectively adopted the guidance resulting in a deconsolidation of the financial results of Front Range. Upon deconsolidation, on January 1, 2010, we removed $62.6 million of assets and $18.6 million of liabilities from our consolidated balance sheet and recorded a cumulative debit adjustment to retained earnings of $1.8 million. The periods presented in this report prior to the effective date of the deconsolidation continue to include related balances associated with our prior ownership interest in Front Range. Effective January 1, 2010, we began accounting for our investment in Front Range under the equity method, with equity earnings recorded in other income (expense) in the consolidated statements of operations. On October 6, 2010, we sold our ownership interest in Front Range, resulting in a loss on the sale in the amount of $12.1 million for the three months ended September 30, 2010, as we reduced the carrying value of our investment in Front Range to its fair value equal to the $18.5 million sale price.
 
4

 
Certain performance metrics that we believe are important indicators of our results of operations include the following:
  
   
Three Months Ended
September 30,
         
Nine Months Ended
September 30,
       
   
2010
   
2009
   
Variance
   
2010
   
2009
   
Variance
 
Production gallons sold (in millions)
    --       20.2       (100.0 )%     43.2       64.6       (33.1 )%
Third party gallons sold (in millions)
    71.5       21.9       226.5 %     152.4       57.0       167.4 %
Total gallons sold (in millions)
    71.5       42.1       69.8 %     195.6       121.6       60.9 %
                                                 
Average sales price per gallon
  $ 1.93     $ 1.73       11.6 %   $ 1.81     $ 1.70       6.5 %
Corn cost per bushel – CBOT equivalent (1)
  $ --     $ 3.33    
NA
    $ 3.62     $ 3.91       (7.4 )%
Co-product revenues as % of delivered cost of corn
    -- %     25.7 %  
NA
      21.9 %     24.4 %     (10.2 )%
                                                 
Average CBOT ethanol price per gallon
  $ 1.80     $ 1.59       13.2 %   $ 1.70     $ 1.61       5.6 %
Average CBOT corn price per bushel
  $ 4.22     $ 3.27       29.1 %   $ 3.83     $ 3.70       3.5 %
                                                 
(1)
We exclude transportation—or “basis”—costs in our corn costs to calculate a Chicago Board of Trade, or CBOT, equivalent price to compare our corn costs to average CBOT corn prices.
  
Net Sales, Cost of Goods Sold and Gross Profit (Loss)
  
The following table presents our net sales, cost of goods sold and gross profit (loss) in dollars and gross profit (loss) as a percentage of net sales (in thousands, except percentages):
   
   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
                                                 
Net sales                          
  $ 46,039     $ 71,889     $ (25,850 )     (36.0 )%   $ 194,087     $ 228,685     $ (34,598 )     (15.1 )%
Cost of goods sold
    42,058       76,420       (34,362 )     (45.0 )%     195,883       252,123       (56,240 )     (22.3 )%
Gross profit (loss)
  $ 3,981     $ (4,531 )   $ 8,512       187.9 %   $ (1,796 )   $ (23,438 )   $ 21,642       92.3 %
Percentage of net sales
    8.6 %     (6.3 )%                     (0.9 )%     (10.2 )%                
  
Net Sales
  
The decrease in our net sales for the three months ended September 30, 2010 as compared to the same period in 2009 was primarily due to a decrease in production gallons sold, which was partially offset by an increase in third party gallons sold and an increase in our average sales price per gallon.
 
For the three months ended September 30, 2010, we did not consolidate the financial results, including production gallon sales from the Pacific Ethanol Plants and for all of 2010, we did not consolidate the financial results of Front Range, including its production gallon sales. As a result, we did not record any production gallons sold during the three months ended September 30, 2010. Total volume of ethanol production gallons for the three months ended September 30, 2009 was related to production gallons of the Columbia, Magic Valley and Front Range facilities. We did, however, continue to sell as an agent during the three months ended September 30, 2010, the ethanol produced by the Columbia, Magic Valley and Front Range facilities. These sales are reflected in our third party gallons sold.
  
 
5

 
  
Third party gallons sold increased by 49.6 million gallons, or 227%, to 71.5 million gallons for the three months ended September 30, 2010 as compared to 21.9 million gallons for the same period in 2009. Of this increase, 14.2 million gallons was due to the operation of the Magic Valley facility in 2010 that was idled in 2009. The balance of the increase in third party gallons sold is primarily from increased sales under our other third-party ethanol marketing arrangements.
 
Our average sales price per gallon increased 12% to $1.93 for the three months ended September 30, 2010 from an average sales price per gallon of $1.73 for the three months ended September 30, 2009. This increase in average sales price per gallon is consistent with the average CBOT price per gallon, which increased 13% to $1.80 for the three months ended September 30, 2010 from $1.59 for the three months ended September 30, 2009.
 
The decrease in our net sales for the nine months ended September 30, 2010 as compared to the same period in 2009 was primarily due to the decrease in production gallons sold, which was partially offset by an increase in our third party gallons sold and an increase in our average sales price per gallon.
 
Total volume of ethanol production gallons sold decreased by 21.4 million gallons, or 33%, to 43.2 million gallons for the nine months ended September 30, 2010 as compared to 64.6 million gallons for the same period in 2009. The decrease in production sales volume is primarily due to our deconsolidation of the Columbia, Magic Valley and Front Range facilities for the three months ended September 30, 2010, which was partially offset by an increase in gallons sold from the Magic Valley facility for the six months ended June 30, 2010. Third-party ethanol gallons sold increased by 95.4 million gallons, or 167%, to 152.4 million gallons for the nine months ended September 30, 2010 as compared to 57.0 million gallons for the same period in 2009. The increase in third-party sales volume is primarily due to increased sales under our third-party ethanol marketing arrangements, including gallons sold for the Columbia, Magic Valley and Front Range facilities.
 
Our average sales price per gallon increased 7% to $1.81 for the nine months ended September 30, 2010 from an average sales price per gallon of $1.70 for the nine months ended September 30, 2009. This increase in average sales price per gallon is also consistent with the average CBOT price per gallon, which increased 6% to $1.70 for the nine months ended September 30, 2010 from $1.61 for the nine months ended September 30, 2009.
 
Cost of Goods Sold and Gross Profit (Loss)
 
Our gross margin improved to positive 8.6% for the three months ended September 30, 2010 from negative 6.3% for the same period in 2009 due to decreased depreciation expense and a higher average sales price per gallon. Included in cost of goods sold for the three months ended September 30, 2009 are depreciation expenses for the Pacific Ethanol Plants and Front Range of approximately $8.3 million, whereas depreciation expenses for these facilities are not included for the three months ended September 30, 2010.
 
Our gross margin improved to negative 0.9% for the nine months ended September 30, 2010 from negative 10.2% for the same period in 2009 primarily due to decreased corn costs and lower depreciation expense. Total depreciation expense for the nine months ended September 30, 2010 was approximately $5.2 million, as compared to approximately $25.0 million for the same period in 2009.
  
 
6

 
   
Selling, General and Administrative Expenses
 
The following table presents our selling, general and administrative expenses in dollars and as a percentage of net sales (in thousands, except percentages):

   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
    Variance in  
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
    Dollars    
Percent
 
Selling, general and administrative expenses
  $ 2,732     $ 3,215     $ (483 )     (15.0 )%   $ 9,065     $ 17,143     $
(8,078
)     (47.1 )%
Percentage of net sales
    5.9 %     4.5 %                     4.7 %     7.5 %                
  
Our selling, general and administrative expenses, or SG&A, decreased for the three and nine months ended September 30, 2010.
  
SG&A decreased $0.5 million to $2.7 million for the three months ended September 30, 2010 as compared to $3.2 million for the same period in 2009, primarily due to the following factors:
       
 
professional fees decreased by $0.6 million due to cost saving efforts;
     
 
SG&A associated with Front Range decreased by $0.6 million as we no longer consolidate its financial results with our own; and
     
 
SG&A associated with the Pacific Ethanol Plants decreased by $0.3 million as we did not include their financial results with our own.
        
These decreases were partially offset by an increase in bad debt expense of $1.0 million due to a significant recovery of a trade receivable in 2009 that did not recur in 2010.
     
 
7

 
    
SG&A decreased $8.1 million to $9.1 million for the nine months ended September 30, 2010 as compared to $17.1 million for the same period in 2009, primarily due to the following factors:
          
 
professional fees decreased by $3.8 million due to cost saving efforts and a reduction of $2.1 million in professional fees associated with our debt restructuring efforts;
     
 
payroll and benefits decreased by $1.7 million due to a reduction in employees as we reduced the number of administrative positions in 2009 due to reduced ethanol production and related support needs;
     
 
other general corporate expenses, including rent, decreased by $1.3 million due to a reduction in office space and other cost saving efforts;
     
 
SG&A associated with Front Range decreased by $1.7 million as we no longer consolidate its financial results with our own; and
     
 
SG&A associated with the Pacific Ethanol Plants decreased by $0.3 million as we did not include their financial results with our own for the three months ended September 30, 2010.
   
These decreases were partially offset by an increase in bad debt expense of $0.7 million due to a significant recovery of a trade receivable in 2009 that did not recur in 2010.
     
Impairment of Asset Group
  
The following table presents our impairment of asset group in dollars and as a percentage of net sales (in thousands, except percentages):
  
   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Impairment of asset group
  $     $ 2,200     $ (2,200 )     (100.0 )%   $     $ 2,200     $ (2,200 )     (100.0 )%
Percentage of net sales
    %     3.1 %                     %     1.0 %                
  
We performed an impairment analysis for our asset group associated with our suspended plant construction project in the Imperial Valley near Calipatria, California. In November 2008, we began proceedings to liquidate these assets and liabilities. Based on our original assessment of the estimated undiscounted cash flows at September 30, 2008, we recorded an impairment charge of $40.9 million, thereby reducing our property and equipment at September 30, 2008 by that amount. At September 30, 2009, our revised assessment of the estimated undiscounted cash flows resulted in an additional impairment charge of $2.2 million.
   
Loss on Investment in Front Range, Held for Sale
    
The following table presents our loss on investment in Front Range, held for sale in dollars and as a percentage of net sales (in thousands, except percentages):
  
   
Three Months Ended
September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Loss on investment in Front Range, held for sale
  $ 12,146     $     $ 12,146       *     $ 12,146     $     $ 12,146       *  
Percentage of net sales
    26.4 %     %                     6.3 %     %                
* Not meaningful
                                                               
  
On September 27, 2010, we entered into an agreement to sell our entire interest in Front Range for $18.5 million in cash. The carrying value of our interest in Front Range prior to the sale was $30.6 million. As a result, we reduced our investment in Front Range to fair value, resulting in charge of $12.1 million. We closed the sale of our interest in Front Range on October 6, 2010.
 
Loss on Extinguishments of Debt
 
The following table presents our loss on extinguishments of debt in dollars and as a percentage of net sales (in thousands, except percentages):

   
Three Months Ended
September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Loss on extinguishments of debt
  $     $     $           $ 2,159     $     $ 2,159       *  
Percentage of net sales
    %     %                     1.1 %     %                
* Not meaningful
                                                               
 
We were party to agreements designed to satisfy our then outstanding debt to Lyles United, LLC and Lyles Mechanical Co., or collectively, Lyles. Under these agreements, we issued shares to a third party which acquired outstanding debt owed to Lyles in successive tranches. Under these transactions, we issued an aggregate of 24.1 million shares in the nine months ended September 30, 2010, resulting in an aggregate loss of $2.2 million for that period. We did not issue any shares under these arrangements during the three months ended September 30, 2010.
  
 
8

 
  
Other Expense, net
    
The following table presents our other expense, net in dollars and our other expense, net as a percentage of net sales (in thousands, except percentages):

   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Other expense, net
  $ 1,221     $ 1,510     $ (289 )     (19.1 )%   $ 4,550     $ 13,215     $ (8,665 )     (65.6 )%
Percentage of net sales
    2.7 %     2.1 %                     2.3 %     5.8 %                
  
Other expense, net decreased by $0.3 million to $1.2 million for the three months ended September 30, 2010 from $1.5 million for the same period in 2009, primarily due to a reduction in expenses associated with the Pacific Ethanol Plants of $0.3 million as we did not consolidate the Plant Owners’ results with our own for the three months ended September 30, 2010. Most of these expenses related to interest expense on the Plant Owners’ indebtedness.
  
Other expense, net decreased by $8.6 million to $4.6 million for the nine months ended September 30, 2010 from $13.2 million for the same period in 2009, primarily due to the following factors:
          
 
interest expense for the period in which we consolidated the results of the Plant Owners decreased by $7.8 million as we ceased fully accruing interest on our debt due to the Plant Owners’ bankruptcy;
     
 
amortization of deferred financing fees decreased by $0.7 million; and
     
 
other expense associated with Front Range decreased by $0.2 million as we no longer consolidate its financial results with our own.
      
Reorganization Costs and Gain from Bankruptcy Exit
 
The following table presents our reorganization costs and gain from bankruptcy exit in dollars and as a percentage of net sales (in thousands, except percentages):

   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Reorganization costs
  $     $ (401 )   $ (401 )     (100.0 )%   $ (4,153 )   $ (9,863 )   $ (5,710 )     (57.9 )%
Percentage of net sales
    %     0.6 %                     2.1 %     4.3 %                
Gain from bankruptcy exit
  $     $     $           $ 119,408     $     $ 119,408       *  
Percentage of net sales
    %     %                     61.5 %     %                
* Not meaningful
                                                               
 
In accordance with FASB ASC 852, Reorganizations, revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of a business must be reported separately as reorganization items in the statements of operations.
  
 
9

 
  
Professional fees directly related to the reorganization include fees associated with advisors to the Plant Owners, unsecured creditors, secured creditors and administrative costs in complying with reporting rules under the Bankruptcy Code. Reorganization costs consisted of the following (in thousands):

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Professional fees
  $     $ 2,363     $ 4,036     $ 3,648  
Write-off of unamortized deferred financing fees
                      7,545  
Settlement of accrued liability
          (2,008 )           (2,008 )
DIP financing fees
                      600  
Trustee fees
          46       117       78  
Total
  $     $ 401     $ 4,153     $ 9,863  
 
On the Effective Date, we no longer owned the Plant Owners. As a result, we removed the net liabilities from our consolidated financial statements, resulting in a net gain from bankruptcy exit of $119.4 million.
 
Net Income (Loss) Attributed to Noncontrolling Interest in Variable Interest Entity
 
The following table presents the proportionate share of the net income (loss) attributed to noncontrolling interest in Front Range, a variable interest entity, and net income (loss) attributed to noncontrolling interest in variable interest entity as a percentage of net sales (in thousands, except percentages):
   
   
Three Months Ended September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Net income (loss) attributed to noncontrolling interest in variable interest entity
  $     $ 150     $ (150 )     (100.0 )%   $     $ 2,536     $ (2,536 )     (100.0 )%
Percentage of net sales
    %     0.2 %                     %     1.1 %                
  
Net income (loss) attributed to noncontrolling interest in variable interest entity relates to our consolidated treatment of Front Range, a variable interest entity, prior to January 1, 2010. We subsequently determined that we are no longer the primary beneficiary in Front Range. For the three and nine months ended September 30, 2009, we consolidated the entire income statement of Front Range for the period covered. However, because we owned 42% of Front Range, we reduced our net loss for the controlling interest, which was the 58% ownership interest that we did not own.
    
Net Income (Loss) Attributed to Pacific Ethanol
    
The following table presents our net income (loss) attributed to Pacific Ethanol in dollars and our net income (loss) attributed to Pacific Ethanol as a percentage of net sales (in thousands, except percentages):
  
   
Three Months Ended
September 30,
   
Variance in
   
Nine Months Ended
September 30,
   
Variance in
 
   
2010
   
2009
   
Dollars
   
Percent
   
2010
   
2009
   
Dollars
   
Percent
 
Net income (loss) attributed to Pacific Ethanol.
  $ (12,118 )   $ (12,007 )   $ (111 )     (0.9 )%   $ 85,539     $ (63,323 )   $ 148,862       *