A significant amount of our revenues are derived from an asset management agreement with a number of subsidiaries of New PE Holdco under which we manage the production and operations of the Pacific Ethanol Plants. The asset management agreement has a term of six months and automatically renews for successive six month terms unless terminated by either party by giving notice 60 days prior to the end of any six month period. We also derive revenues from our activities related to the marketing of the ethanol and 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 . If the asset management agreement or the marketing agreements are terminated for any reason, our revenues and financial condition will decline.
We recognized impairment charges in 2009 and 2008 and may recognize additional impairment charges in the future.
For the years ended December 31, 2009 and 2008, we recognized asset and goodwill impairment charges in the aggregate amounts of $252.4 million and $127.9 million, respectively. These impairment charges primarily related to our previously owned ethanol facilities and goodwill attributed to our acquisition of Kinergy and our 42% ownership interest in Front Range. We performed our forecast of expected future cash flows of our facilities over their estimated useful lives. The forecasts of expected future cash flows are heavily dependent upon management’s estimates and probability analysis of various scenarios including market prices for ethanol, our primary product, and corn, our primary production input. Both ethanol and corn costs have fluctuated significantly in the past year, therefore these estimates are highly subjective and are management’s best estimates at this time. During 2010, as a result of the sale of our 42% ownership interest in Front Range, we expect to incur an additional loss on the difference between our cost basis of the investment in Front Range and the price at which we sold our investment. We may also incur additional impairments in the future on current or future long-lived assets and goodwill.
The results of operations of the Pacific Ethanol Plants and their ability to operate at a profit is largely dependent on managing the spread among the prices of corn, natural gas, ethanol and WDG, the prices of which are subject to significant volatility and uncertainty.
The results of operations of the Pacific Ethanol Plants are highly impacted by commodity prices, including the spread between the cost of corn and natural gas that they must purchase, and the price of ethanol and WDG that they sell. Prices and supplies are subject to and determined by market forces over which we have no control, such as weather, domestic and global demand, shortages, export prices, and various governmental policies in the United States and around the world. As a result of price volatility for these commodities, our operating results may fluctuate substantially. Increases in corn prices or natural gas or decreases in ethanol or WDG prices may make it unprofitable to operate the Pacific Ethanol Plants. No assurance can be given that corn and natural gas can be purchased at, or near, current prices and that ethanol or WDG will sell at, or near, current prices. Consequently, our results of operations and financial position may be adversely affected by increases in the price of corn or natural gas or decreases in the price of ethanol or WDG.
In early 2006, the spread between ethanol and corn prices was at historically high levels, driven in large part by oil companies removing a competitive product, methyl tertiary butyl ether, or MTBE, from the fuel stream and replacing it with ethanol in a relatively short time period. However, since that time, this spread has fluctuated widely and narrowed significantly. Fluctuations are likely to continue to occur. A sustained narrow spread or any further reduction in the spread between ethanol and corn prices, whether as a result of sustained high or increased corn prices or sustained low or decreased ethanol prices, would adversely affect our results of operations and financial position. Further, combined revenues from sales of ethanol and WDG could decline below the marginal cost of production, which could cause us to suspend production of ethanol and WDG at all or some of the Pacific Ethanol Plants.
Increased ethanol production may cause a decline in ethanol prices or prevent ethanol prices from rising, and may have other negative effects, adversely impacting our results of operations, cash flows and financial condition.
We believe that the most significant factor influencing the price of ethanol has been the substantial increase in ethanol production in recent years. Domestic ethanol production capacity has increased steadily from an annualized rate of 1.5 billion gallons per year in January 1999 to 10.8 billion gallons in 2009 according to the RFA. See “Business—Governmental Regulation.” However, increases in the demand for ethanol may not be commensurate with increases in the supply of ethanol, thus leading to lower ethanol prices. Demand for ethanol could be impaired due to a number of factors, including regulatory developments and reduced United States gasoline consumption. Reduced gasoline consumption has occurred in the past and could occur in the future as a result of increased gasoline or oil prices.
The market price of ethanol is volatile and subject to large fluctuations, which may cause our profitability or losses to fluctuate significantly.
The market price of ethanol is volatile and subject to large fluctuations. The market price of ethanol is dependent upon many factors, including the supply of ethanol and the price of gasoline, which is in turn dependent upon the price of petroleum which is highly volatile and difficult to forecast. For example, our average sales price of ethanol decreased by 20% in 2009, and increased by 5% in 2008 from the prior year’s average sales price per gallon. Fluctuations in the market price of ethanol may cause our profitability or losses to fluctuate significantly.
Disruptions in ethanol production infrastructure may adversely affect our business, results of operations and financial condition.
Our business depends on the continuing availability of rail, road, port, storage and distribution infrastructure. In particular, due to limited storage capacity at the Pacific Ethanol Plants and other considerations related to production efficiencies, the Pacific Ethanol Plants depend on just-in-time delivery of corn. The production of ethanol also requires a significant and uninterrupted supply of other raw materials and energy, primarily water, electricity and natural gas. The prices of electricity and natural gas have fluctuated significantly in the past and may fluctuate significantly in the future. Local water, electricity and gas utilities may not be able to reliably supply the water, electricity and natural gas that the Pacific Ethanol Plants will need or may not be able to supply those resources on acceptable terms. Any disruptions in the ethanol production infrastructure, whether caused by labor difficulties, earthquakes, storms, other natural disasters or human error or malfeasance or other reasons, could prevent timely deliveries of corn or other raw materials and energy and may require the Pacific Ethanol Plants to halt production which could have a material adverse effect on our business, results of operations and financial condition.
We and the Pacific Ethanol Plants may engage in hedging transactions and other risk mitigation strategies that could harm our results of operations.
In an attempt to partially offset the effects of volatility of ethanol prices and corn and natural gas costs, the Pacific Ethanol Plants may enter into contracts to fix the price of a portion of their ethanol production or purchase a portion of their corn or natural gas requirements on a forward basis. In addition, we may engage in other hedging transactions involving exchange-traded futures contracts for corn, natural gas and unleaded gasoline from time to time. The financial statement impact of these activities is dependent upon, among other things, the prices involved and our ability to sell sufficient products to use all of the corn and natural gas for which forward commitments have been made. We may also engage in hedging transactions involving interest rate swaps related to our debt financing activities, the financial statement impact of which is dependent upon, among other things, fluctuations in prevailing interest rates. Hedging arrangements also expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or, in the case of exchange-traded contracts, where there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices paid or received by us. As a result, our results of operations and financial position may be adversely affected by fluctuations in the price of corn, natural gas, ethanol, unleaded gasoline and prevailing interest rates.
Operational difficulties at the Pacific Ethanol Plants could negatively impact sales volumes and could cause us to incur substantial losses.
Operations at the Pacific Ethanol Plants are subject to labor disruptions, unscheduled downtimes and other operational hazards inherent in the ethanol production industry, including equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. Insurance obtained by the Pacific Ethanol Plants may not be adequate to fully cover the potential operational hazards described above or the Pacific Ethanol Plants may not be able to renew this insurance on commercially reasonable terms or at all.
Moreover, the production facilities at the Pacific Ethanol Plants may not operate as planned or expected. All of these facilities are designed to operate at or above a specified production capacity. The operation of these facilities is and will be, however, subject to various uncertainties. As a result, these facilities may not produce ethanol and its co-products at expected levels. In the event any of these facilities do not run at their expected capacity levels, our business, results of operations and financial condition may be materially and adversely affected.
The United States ethanol industry is highly dependent upon myriad federal and state legislation and regulation and any changes in legislation or regulation could have a material adverse effect on our results of operations and financial condition.
The elimination or reduction of federal excise tax incentives could have a material adverse effect on our results of operations and our financial condition.
The amount of ethanol production capacity in the United States exceeds the mandated usage of renewable biofuels. Ethanol consumption above mandated amounts is primarily based upon the economic benefit derived by blenders, including benefits received from federal excise tax incentives. Therefore, the production of ethanol is made significantly more competitive by federal tax incentives. The federal excise tax incentive program, which is scheduled to expire on December 31, 2010, allows gasoline distributors who blend ethanol with gasoline to receive a federal excise tax rate reduction for each blended gallon they sell regardless of the blend rate. The current federal excise tax on gasoline is $0.184 per gallon, and is paid at the terminal by refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.45 per gallon tax credit for each gallon of ethanol used in the mixture. The 2008 Farm Bill enacted into law reduced federal excise tax incentives from $0.51 per gallon in 2008 to $0.45 per gallon in 2009. The federal excise tax incentive program might not be renewed prior to its expiration in 2010, or if renewed, it may be renewed on terms significantly less favorable than current tax incentives. The elimination or significant reduction in the federal excise tax incentive program could reduce discretionary blending and have a material adverse effect on our results of operations and our financial condition.
Various studies have criticized the efficiency of ethanol in general, and corn-based ethanol in particular, which could lead to the reduction or repeal of incentives and tariffs that promote the use and domestic production of ethanol or otherwise negatively impact public perception and acceptance of ethanol as an alternative fuel.
Although many trade groups, academics and governmental agencies have supported ethanol as a fuel additive that promotes a cleaner environment, others have criticized ethanol production as consuming considerably more energy and emitting more greenhouse gases than other biofuels and as potentially depleting water resources. Other studies have suggested that ethanol negatively impacts consumers by causing higher prices for dairy, meat and other foodstuffs from livestock that consume corn. If these views gain acceptance, support for existing measures promoting the use and domestic production of corn-based ethanol could decline, leading to a reduction or repeal of these measures. These views could also negatively impact public perception of the ethanol industry and acceptance of ethanol as a component for blending in transportation fuel.
Waivers or repeal of the national Renewable Fuel Standard program’s minimum levels of renewable fuels included in gasoline could have a material adverse affect on our results of operations.
Shortly after passage of the Energy Independence and Security Act of 2007, which increased the minimum mandated required usage of ethanol, a Congressional sub-committee held hearings on the potential impact of the national Renewable Fuel Standard, or RFS, program on commodity prices. While no action was taken by the sub-committee towards repeal of the national RFS, any attempt by Congress to re-visit, repeal or grant waivers of the national RFS could adversely affect demand for ethanol and could have a material adverse effect on our results of operations and financial condition.
While the Energy Independence and Security Act of 2007 imposes the national RFS, it does not mandate only the use of ethanol.
The Energy Independence and Security Act of 2007 imposes the national RFS, but does not mandate only the use of ethanol. While the RFA expects that ethanol should account for the largest share of renewable fuels produced and consumed under the national RFS, the national RFS is not limited to ethanol and also includes biodiesel and any other liquid fuel produced from biomass or biogas.
The ethanol production and marketing industry is extremely competitive. Many of the significant competitors of the Pacific Ethanol Plants have greater production and financial resources than New PE Holdco does and one or more of these competitors could use their greater resources to gain market share at the expense of New PE Holdco. In addition, a number of of New PE Holdco’s suppliers may circumvent the marketing services we provide to New PE Holdco, causing our sales and profitability to decline.
The ethanol production and marketing industry is extremely competitive. Many of New PE Holdco’s and our significant competitors in the ethanol production and marketing industry, including ADM, Valero and Green Plains Renewable Energy, have substantially greater production and/or financial resources than we do. As a result, our competitors may be able to compete more aggressively and sustain that competition over a longer period of time than New PE Holdco or we could. Successful competition will require a continued high level of investment in marketing and customer service and support. New PE Holdco’s and our limited resources relative to many significant competitors may cause New PE Holdco to fail to anticipate or respond adequately to new developments and other competitive pressures. This failure could reduce New PE Holdco’s and our competitiveness and cause a decline in market share, sales and profitability. Even if sufficient funds are available, we and New PE Holdco may not be able to make the modifications and improvements necessary to compete successfully.
We and New PE Holdco also face increasing competition from international suppliers. Currently, international suppliers produce ethanol primarily from sugar cane and have cost structures that are generally substantially lower than the cost structures of the Pacific Ethanol Plants. Any increase in domestic or foreign competition could cause the Pacific Ethanol Plants to reduce their prices and take other steps to compete effectively, which could adversely affect their and our results of operations and financial condition.
In addition, some of New PE Holdco’s and our suppliers are potential competitors and, especially if the price of ethanol reaches historically high levels, they may seek to capture additional profits by circumventing our marketing services in favor of selling directly to our customers. If one or more of our major suppliers, or numerous smaller suppliers, circumvent our marketing services, our sales and profitability may decline.
The high concentration of our sales within the ethanol marketing and production industry could result in a significant reduction in sales and negatively affect our profitability if demand for ethanol declines.
We expect to be completely focused on the marketing and production of ethanol and its co-products for the foreseeable future. We may be unable to shift our business focus away from the marketing and production of ethanol to other renewable fuels or competing products. Accordingly, an industry shift away from ethanol or the emergence of new competing products may reduce the demand for ethanol. A downturn in the demand for ethanol would likely materially and adversely affect our sales and profitability.
The volatility in the financial and commodities markets and sustained weakening of the economy could further significantly impact our business and financial condition and may limit our ability to raise additional capital.
As widely reported, financial markets in the United States and the rest of the world have experienced extreme disruption, including, among other things, extreme volatility in securities and commodities prices, as well as severely diminished liquidity and credit availability. As a result, we believe that our ability to access capital markets and raise funds required for our operations is severely restricted at a time when we need to do so, which continues to have a material adverse effect on our ability to meet our current and future funding requirements and on our ability to react to changing economic and business conditions. Significant declines in the price of crude oil have resulted in reduced demand for our products. We are not able to predict the duration or severity of any current or future disruption in financial markets, fluctuations in the price of crude oil or other adverse economic conditions in the United States. However, if economic conditions worsen, it is likely that these factors would have a further adverse effect on our results of operations and future prospects and may limit our ability to raise additional capital.
In addition to the ethanol produced by the Pacific Ethanol Plants, we also depend on a small number of third-party suppliers for a significant portion of the total amount of ethanol that we sell. If any of these suppliers does not continue to supply us with ethanol in adequate amounts, we may be unable to satisfy the demands of our customers and our sales, profitability and relationships with our customers will be adversely affected.
In addition to the ethanol produced by the Pacific Ethanol Plants, we also depend on a small number of third-party suppliers for a significant portion of the ethanol that we sell. We expect to continue to depend for the foreseeable future upon a small number of third-party suppliers for a significant portion of the total amount of the ethanol that we sell. Our third-party suppliers are primarily located in the Midwestern United States. The delivery of ethanol from these suppliers is therefore subject to delays resulting from inclement weather and other conditions. If any of these suppliers is unable or declines for any reason to continue to supply us with ethanol in adequate amounts, we may be unable to replace that supplier and source other supplies of ethanol in a timely manner, or at all, to satisfy the demands of our customers. If this occurs, our sales, profitability and our relationships with our customers will be adversely affected.
We and New PE Holdco may be adversely affected by environmental, health and safety laws, regulations and liabilities.
We and New PE Holdco are subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground, the generation, storage, handling, use, transportation and disposal of hazardous materials, and the health and safety of our employees and the employees of the Pacific Ethanol Plants. In addition, some of these laws and regulations require the Pacific Ethanol Plants to operate under permits that are subject to renewal or modification. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns. In addition, we have made, and expect to make, significant capital expenditures on an ongoing basis to comply with increasingly stringent environmental laws, regulations and permits.
We and New PE Holdco may be liable for the investigation and cleanup of environmental contamination at each of the properties that New PE Holdco owns or that we operate and at off-site locations where we arrange for the disposal of hazardous substances. If these substances have been or are disposed of or released at sites that undergo investigation and/or remediation by regulatory agencies, we may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or other environmental laws for all or part of the costs of investigation and/or remediation, and for damages to natural resources. We may also be subject to related claims by private parties alleging property damage and personal injury due to exposure to hazardous or other materials at or from those properties. Some of these matters may require us to expend significant amounts for investigation, cleanup or other costs.
In addition, new laws, new interpretations of existing laws, increased governmental enforcement of environmental laws or other developments could require us to make significant additional expenditures. Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at the Pacific Ethanol Plants. Present and future environmental laws and regulations (and interpretations thereof) applicable to New PE Holdco’s and our operations, more vigorous enforcement policies and discovery of currently unknown conditions may require substantial expenditures that could have a material adverse effect on our results of operations and financial condition.
The hazards and risks associated with producing and transporting our products (including fires, natural disasters, explosions and abnormal pressures and blowouts) may also result in personal injury claims or damage to property and third parties. As protection against operating hazards, we maintain insurance coverage against some, but not all, potential losses. However, we could sustain losses for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Events that result in significant personal injury or damage to our property or third parties or other losses that are not fully covered by insurance could have a material adverse effect on our results of operations and financial condition.
If we are unable to attract and retain key personnel, our ability to operate effectively may be impaired.
Our ability to operate our business and implement strategies depends, in part, on the efforts of our executive officers and other key employees. Our future success will depend on, among other factors, our ability to attract and retain our current key personnel and qualified future key personnel, particularly executive management. Failure to attract or retain qualified key personnel could have a material adverse effect on our business and results of operations.
We depend on a small number of customers for the majority of our sales. A reduction in business from any of these customers could cause a significant decline in our overall sales and profitability.
The majority of our sales are generated from a small number of customers. During each of 2009 and 2008, sales to our two largest customers, each of whom accounted for 10% or more of total net sales, represented an aggregate of approximately 32% of our total net sales for those years. We expect that we will continue to depend for the foreseeable future upon a small number of customers for a significant portion of our sales. Our agreements with these customers generally do not require them to purchase any specified amount of ethanol or dollar amount of sales or to make any purchases whatsoever. Therefore, in any future period, our sales generated from these customers, individually or in the aggregate, may not equal or exceed historical levels. If sales to any of these customers cease or decline, we may be unable to replace these sales with sales to either existing or new customers in a timely manner, or at all. A cessation or reduction of sales to one or more of these customers could cause a significant decline in our overall sales and profitability.
Our lack of long-term ethanol orders and commitments by our customers could lead to a rapid decline in our sales and profitability.
We cannot rely on long-term ethanol orders or commitments by our customers for protection from the negative financial effects of a decline in the demand for ethanol or a decline in the demand for our marketing services. The limited certainty of ethanol orders can make it difficult for us to forecast our sales and allocate our resources in a manner consistent with our actual sales. Moreover, our expense levels are based in part on our expectations of future sales and, if our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. Furthermore, because we depend on a small number of customers for a significant portion of our sales, the magnitude of the ramifications of these risks is greater than if our sales were less concentrated. As a result of our lack of long-term ethanol orders and commitments, we may experience a rapid decline in our sales and profitability.
Risks Related to this Offering and Ownership of our Common Stock
We have received a delisting notice from The NASDAQ Stock Market. Our common stock may be involuntarily delisted from trading on The NASDAQ Capital Market if we fail to regain compliance with the minimum closing bid price requirement of $1.00 per share. A delisting of our common stock is likely to reduce the liquidity of our common stock and may inhibit or preclude our ability to raise additional financing and may also materially and adversely impact our credit terms with our vendors.
NASDAQ’s quantitative listing standards require, among other things, that listed companies maintain a minimum closing bid price of $1.00 per share. We failed to satisfy this threshold for 30 consecutive trading days and on June 30, 2010, we received a letter from The NASDAQ Stock Market, or NASDAQ, indicating that we have been provided an initial period of 180 calendar days, or until December 27, 2010, in which to regain compliance. The letter states that the NASDAQ staff will provide written notification that we have achieved compliance if at any time before December 27, 2010, the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive business days unless the NASDAQ staff exercises its discretion to extend this 10 day period. We may be eligible to receive an additional 180 day compliance period if we meet some of the initial listing requirements of The NASDAQ Capital Market, notify NASDAQ of our intent to cure the deficiency and it appears to the staff of NASDAQ that it is possible for us to cure the deficiency. If we receive the additional 180 day compliance period, we will have until June 25, 2011 to regain compliance. If we do not regain compliance by December 27, 2010, or, if we receive an additional compliance period, by June 25, 2011, the NASDAQ staff will provide written notice that our common stock is subject to delisting. Given the increased market volatility arising in part from economic turmoil resulting from the ongoing credit crisis, the challenging environment in the biofuels industry and our lack of liquidity, we may be unable to regain compliance with the closing bid price requirement by December 27, 2010 or June 25, 2011. A delisting of our common stock is likely to reduce the liquidity of our common stock and may inhibit or preclude our ability to raise additional financing and may also materially and adversely impact our credit terms with our vendors.
The conversion of convertible securities (including the Notes and our Series B Preferred Stock) and the exercise of outstanding options and warrants (including the Warrants) to purchase our common stock could substantially dilute your investment, impede our ability to obtain additional financing, and cause us to incur additional expenses.
Under the terms of our Notes and Series B Preferred Stock that are convertible into our common stock, warrants (including the Warrants) to purchase our common stock, and outstanding options to acquire our common stock issued to employees, directors and others, the holders of these securities are given an opportunity to profit from a rise in the market price of our common stock that, upon the conversion of the Notes or the Series B Preferred Stock or the exercise of these warrants (including the Warrants) and/or options, could result in dilution in the interests of our other stockholders. The terms on which we may obtain additional financing may be adversely affected by the existence and potentially dilutive impact of the Notes, Series B Preferred Stock, options and warrants (including the Warrants). In addition, holders of the Notes, Series B Preferred Stock, and warrants (including the Warrants) have registration rights with respect to the common stock underlying the Notes and Warrants, the registration of which will cause us to incur a substantial expense.
The voting power and value of your investment could decline if our Notes are converted and our Warrants are exercised at a reduced price due to our issuance of lower-priced shares or market declines which trigger rights of the holders of our Notes to receive additional shares of our common stock.
We have issued a significant amount of Notes and Warrants, the conversion or exercise of which could have a substantial negative impact on the price of our common stock and could result in a dramatic decrease in the value of your investment. The initial conversion price of our Notes is subject to market-price protection that may cause the conversion price of the Notes to be reduced in the event of a decline in the market price of our common stock. In addition, the conversion price of our Notes and the exercise price of the Warrants will be subject to downward anti-dilution adjustments in most cases, from time to time, if we issue securities at a purchase, exercise or conversion price that is less than the then-applicable conversion price of our outstanding Notes or exercise price of the Warrants. Consequently, the voting power and value of your investment in each of these events would decline if the Notes or the Warrants are converted or exercised for shares of our common stock at lower prices as a result of the declining market-price or sales of our securities are made below the conversion price of the Notes and/or the exercise price of the Warrants.
The market-price protection feature of our Notes could also allow the Notes to become convertible into a greatly increased number of additional shares of our common stock, particularly if a holder of the Notes sequentially converts portions of the Note into shares of our common stock at alternate conversion prices and resells those shares into the market. If a holder of the Notes sequentially converts portions of the Notes into shares of our common stock or if we issue shares of common stock in lieu of cash payments of principal and interest on the Notes, each at alternate conversion prices, and the holder of the Notes resells those shares into the market, then the market price of our common stock could decline due to the additional shares available in the market, particularly in the event of any thin trading volume of our common stock. Consequently, if a holder of the Notes repeatedly converts portions of the Notes or we repeatedly issue shares of common stock in lieu of cash payments of principal and interest on the Notes at alternate conversion prices and then the holder resells those underlying shares into the market, a continuous downward spiral of the market price of our common stock could occur that would benefit a holder of our Notes at the expense of other existing or potential holders of our common stock, potentially creating a divergence of interests between a holder of our Notes and investors who purchase the shares of common stock resold by a holder of the Notes following conversion of the Notes.
The market price of our common stock and the value of your investment could substantially decline if our Notes or Series B Preferred Stock are converted into shares of our common stock, if we issue shares of our common stock in payment of principal and interest on our Notes and if our options and warrants (including the Warrants) are exercised for shares of our common stock and all of these shares of common stock are resold into the market, or if a perception exists that a substantial number of shares will be issued upon conversion of our Notes or Series B Preferred Stock, upon the payment of principal and interest on the Notes or upon exercise of our warrants (including the Warrants) or options and then resold into the market.
If the conversion prices at which the principal balances of the Notes or Series B Preferred Stock are converted, the issuance prices at which shares of common stock in payment of principal and interest on the Notes are issued, and the exercise prices at which our warrants (including the Warrants) and options are exercised are lower than the price at which you made your investment, immediate dilution of the value of your investment will occur. In addition, sales of a substantial number of shares of common stock issued upon conversion of the Notes or Series B Preferred Stock, in lieu of cash payments of principal and interest on the Notes and upon exercise of our warrants (including the Warrants) and options, or even the perception that these sales could occur, could adversely affect the market price of our common stock, which would mean that the Notes would be convertible into an increased number of shares of our common stock in cases where, as described elsewhere in these risk factors, the conversion price is based upon a discount from the market price of our common stock. You could, therefore, experience a substantial decline in the value of your investment as a result of both the actual and potential conversion of our outstanding Notes or Series B Preferred Stock, issuance of shares of common stock in lieu of cash payments of principal and interest on the Notes and exercise of our outstanding warrants (including the Warrants) or options.
The issuance of shares upon the conversion of the Notes or Series B Preferred Stock, upon the payment of principal and interest on the Notes and upon the exercise of outstanding options and warrants (including the Warrants) could result in a change of control of Pacific Ethanol.
As of December 8 , 2010, we had outstanding options, warrants (including the Warrants), Notes (including shares issuable as interest in lieu of cash payments calculated at an interest rate of 8% per annum, compounded monthly, from the closing date of the issuance of the Notes through the maturity date of the Notes) and Series B Preferred Stock that were exercisable for or convertible into approximately 82,443,675 shares of common stock based upon an assumed conversion price of $0.85 for the Notes and existing exercise prices for the warrants (including the Warrants) and options. In addition, as discussed elsewhere in these Risk Factors, the number of shares exercisable under outstanding warrants and convertible under outstanding Notes and Series B Preferred Stock may be subject to increase in the event of our future issuance of securities or a decline in the market price of our common stock. A change of control of Pacific Ethanol could occur if a significant number of shares are issued to the holders of our outstanding options, warrants (including the Warrants), Notes or Series B Preferred Stock. If a change of control occurs, then the stockholders who historically have controlled our company would no longer have the ability to exert significant control over matters that could include the election of our directors, changes in the size and composition of our board of directors, and mergers and other business combinations involving our company. Instead, one or more other stockholders could gain the ability to exert this type of control and may also, through control of our board of directors and voting power, be able to control a number of decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third-party lenders and the issuance of additional equity securities), and the acquisition or disposition of our assets.
If we are unsuccessful in maintaining compliance with or modifying our registration obligations with regard to our Notes and Warrants, we may incur substantial monetary penalties.
The registration rights agreements we entered into in connection with the issuance of the Notes and Warrants require us to, among other things, register for resale the shares of common stock issued or issuable under our Notes (including shares issued in payment of interest on the Notes) and the Warrants, and maintain the effectiveness of the registration for an extended period of time. We will be required to file a number of registration statements, including the registration statement of which this prospectus is a part, to ensure that all shares of common stock to be issued in connection with the issuance of the Notes and Warrants will be registered. If we are unable to have any one of these registration statements declared effective by the Securities and Exchange Commission, or SEC, or maintain effectiveness of the required registration statements, or to modify our registration obligations, then we may be required to pay registration delay payments in an amount up to approximately $700,000 on the date of failure and monthly thereafter until the failure is cured. The payment of registration delay payments would adversely affect our business, operating results, financial condition, and ability to service our other indebtedness by adversely affecting our cash flows.
In addition, failure to meet our registration requirements may result in an event of default under the Notes. Among other things, upon an event of default the Note holders are entitled to demand that we immediately pay the entire principal balance of the Notes in full in cash. If we are required to redeem the Notes upon an event of default, it would have a significant negative impact on our financial condition and would likely render us insolvent.
As a result of our issuance of shares of Series B Preferred Stock, our common stockholders may experience numerous negative effects and most of the rights of our common stockholders will be subordinate to the rights of the holders of our Series B Preferred Stock.
As a result of our issuance of shares of Series B Preferred Stock, our common stockholders may experience numerous negative effects, including dilution from any dividends paid in preferred stock and antidilution adjustments. In addition, rights in favor of the holders of our Series B Preferred Stock include: seniority in liquidation and dividend preferences; substantial voting rights; numerous protective provisions; and preemptive rights. Also, our outstanding Series B Preferred Stock could have the effect of delaying, deferring and discouraging another party from acquiring control of Pacific Ethanol.
Our stock price is highly volatile, which could result in substantial losses for investors purchasing shares of our common stock and in litigation against us.
The market price of our common stock has fluctuated significantly in the past and may continue to fluctuate significantly in the future. The market price of our common stock may continue to fluctuate in response to one or more of the following factors, many of which are beyond our control:
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our ability to maintain contracts that are critical to our operations, including the asset management agreement with a number of subsidiaries of New PE Holdco that provide us with the ability to operate the Pacific Ethanol Plants;
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our ability to obtain and maintain normal terms with vendors and service providers;
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fluctuations in the market price of ethanol and its co-products;
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the volume and timing of the receipt of orders for ethanol from major customers;
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competitive pricing pressures;
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our ability to produce, sell and deliver ethanol on a cost-effective and timely basis;
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the introduction and announcement of one or more new alternatives to ethanol by our competitors;
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changes in market valuations of similar companies;
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stock market price and volume fluctuations generally;
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|
·
|
the relative small public float of our common stock;
|
|
|
·
|
regulatory developments or increased enforcement;
|
|
|
·
|
fluctuations in our quarterly or annual operating results;
|
|
|
·
|
additions or departures of key personnel;
|
|
|
·
|
our inability to obtain financing; and
|
|
|
·
|
future sales of our common stock or other securities.
|
Furthermore, we believe that the economic conditions in California and other Western states, as well as the United States as a whole, could have a negative impact on our results of operations. Demand for ethanol could also be adversely affected by a slow-down in overall demand for oxygenate and gasoline additive products. The levels of our ethanol production and purchases for resale will be based upon forecasted demand. Accordingly, any inaccuracy in forecasting anticipated revenues and expenses could adversely affect our business. The failure to receive anticipated orders or to complete delivery in any quarterly period could adversely affect our results of operations for that period. Quarterly results are not necessarily indicative of future performance for any particular period, and we may not experience revenue growth or profitability on a quarterly or an annual basis.
The price at which you purchase shares of our common stock may not be indicative of the price that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you and which may include the complete loss of your investment. In the past, securities class action litigation has often been brought against a company following periods of high stock price volatility. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and our resources away from our business.
Any of the risks described above could have a material adverse effect on our sales and profitability and the price of our common stock.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements, including statements concerning future conditions in the industries within which we operate, and concerning our future business, financial condition, operating strategies, and operational and legal risks. Words like “believe,” “expect,” “may,” “will,” “could,” “seek,” “estimate,” “continue,” “anticipate,” “intend,” “future,” “plan” or variations of those terms and other similar expressions, including their use in the negative, are used in this prospectus to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as to our expectations, as of the date of this prospectus. These forward-looking statements are subject to a number of risks and uncertainties, including those identified under “Risk Factors” and elsewhere in this prospectus. Although we believe that the expectations reflected in these forward-looking statements are reasonable, actual conditions in the industries within which we operate, and actual conditions and results in our business, could differ materially from those expressed in these forward-looking statements. In addition, none of the events anticipated in the forward-looking statements may actually occur. Any of these different outcomes could cause the price of our common stock to decline substantially. Except as required by law, we undertake no duty to update any forward-looking statement after the date of this prospectus, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events.
USE OF PROCEEDS
We will not receive any of the proceeds from the sale of the shares of common stock offered under this prospectus by the selling security holders. Rather, the selling security holders will receive those proceeds directly.
Upon exercise of the Warrants, the underlying shares of common stock of which are offered for sale hereunder, we may receive aggregate proceeds of approximately $17.5 million if the security holders elect to exercise the Warrants for cash rather than electing to exercise the Warrants using the cashless exercise provisions contained in the Warrants. We expect to use any cash proceeds from the exercise of Warrants for general working capital purposes.
DIVIDEND POLICY
We have never paid cash dividends on our common stock and do not intend to pay cash dividends on our common stock in the foreseeable future. We anticipate that we will retain any earnings for use in the continued development of our business.
Several of our current and future debt financing arrangements may limit or prevent cash distributions from our subsidiaries to us, depending upon the achievement of specified financial and other operating conditions and our ability to properly service our debt, thereby limiting or preventing us from paying cash dividends. Further, under the terms of the Notes we are prohibited from paying any cash dividends on either our common stock or Series B Preferred Stock. In addition, the holders of our outstanding Series B Preferred Stock are entitled to dividends of 7% per annum, payable quarterly in arrears, none of which have been paid for the year ended December 31, 2009 or thereafter through the date of this prospectus. Accumulated and unpaid dividends in respect of our Series B Preferred Stock must be paid prior to the payment of any dividends to our common stockholders. Under the terms of the Notes, accrued and unpaid dividends in respect of our Series B Preferred Stock may only be paid in-kind while the Notes remain outstanding. As of September 30, 2010, we had accrued and unpaid dividends of approximately $5.5 million on our Series B Preferred Stock.
PRICE RANGE OF COMMON STOCK
Our common stock has traded on The NASDAQ Capital Market since May 3, 2010. Between October 10, 2005 and May 3, 2010, our common stock traded on The NASDAQ Global Market (formerly, The NASDAQ National Market). The table below shows, for each fiscal quarter indicated, the high and low sales prices for shares of our common stock. This information has been obtained from The NASDAQ Stock Market. The prices shown reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
| |
Price Range
|
| |
High
|
|
Low
|
| |
|
|
|
|
Year Ending December 31, 2010:
|
|
|
|
|
First Quarter (January 1 – March 31)
|
$ 2.75
|
|
$ 0.71
|
|
Second Quarter (April 1 – June 30)
|
$ 1.60
|
|
$ 0.45
|
|
Third Quarter (July 1 – September 30)
|
$ 1.25
|
|
$ 0.37
|
|
Fourth Quarter (October 1 – December 8 )
|
$ 1.14
|
|
$ 0.58
|
| |
|
|
|
|
Year Ended December 31, 2009:
|
|
|
|
|
First Quarter (January 1 – March 31)
|
$ 0.68
|
|
$ 0.20
|
|
Second Quarter (April 1 – June 30)
|
$ 0.84
|
|
$ 0.28
|
|
Third Quarter (July 1 – September 30)
|
$ 0.67
|
|
$ 0.30
|
|
Fourth Quarter (October 1 – December 31)
|
$ 1.06
|
|
$ 0.35
|
| |
|
|
|
|
Year Ended December 31, 2008:
|
|
|
|
|
First Quarter (January 1 – March 31)
|
$ 9.20
|
|
$ 4.25
|
|
Second Quarter (April 1 – June 30)
|
$ 6.86
|
|
$ 1.81
|
|
Third Quarter (July 1 – September 30)
|
$ 2.40
|
|
$ 1.24
|
|
Fourth Quarter (October 1 – December 31)
|
$ 1.65
|
|
$ 0.35
|
As of December 8 , 2010, we had 89,227,006 shares of common stock outstanding and held of record by approximately 500 stockholders. These holders of record include depositories that hold shares of stock for brokerage firms which, in turn, hold shares of stock for numerous beneficial owners. On December 8 , 2010, the last reported price of our common stock on The NASDAQ Capital Market was $0.60 per share.
Equity Compensation Plan Information
The following table provides information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans as of December 31, 2009.
|
|
|
Number of
Securities to be
Issued Upon Exercise of Outstanding
Options, Warrants
or Stock Rights
|
|
|
Weighted-Average
Exercise Price of Outstanding Options, Warrants and Rights
|
|
|
Number of
Securities Remaining Available
for Future Issuance Under Equity Compensation Plans(1)(2)
|
|
|
Equity Compensation Plans Approved by Security Holders:
|
|
|
|
|
|
|
|
|
|
|
2004 Plan(1)
|
|
|
80,000 |
|
|
$ |
8.26 |
|
|
|
— |
|
|
2006 Plan
|
|
|
— |
|
|
$ |
— |
|
|
|
922,259 |
(2) |
|
(1)
|
Our 2004 Plan was terminated effective September 7, 2006, except to the extent of then-outstanding options.
|
|
(2)
|
Excludes an additional 4,000,000 shares of common stock available for future issuance under an amendment to the 2006 Plan that was approved by our stockholders on June 3, 2010.
|
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
The following unaudited condensed consolidated pro forma financial information presents our balance sheet as of September 30, 2010 and the statements of operations for the year ended December 31, 2009 and for the nine months ended September 30, 2010. The pro forma statement of operations for the year ended December 31, 2009 is based on our audited consolidated statement of operations for the year ended December 31, 2009, and the unaudited balance sheet as of September 30, 2010 and the statement of operations for the nine months ended September 30, 2010 are based on our unaudited balance sheet and statement of operations and other costs related to the transactions described below. The pro forma statements of operations give effect to the transactions as if each of the transactions occurred on January 1, 2009. The pro forma balance sheet gives effect to the transactions as if each of the transactions occurred on September 30, 2010.
The unaudited pro forma condensed combined financial statements should be read in conjunction with our historical audited financial statements and the unaudited interim financial information appearing elsewhere in this prospectus.
On October 6, 2010, we raised $35 million through the issuance of $35 million in principal amount of Notes and 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 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 million and purchased a 20% ownership interest in New PE Holdco for an aggregate purchase price of $23.3 million.
For purposes of the unaudited pro forma condensed combined financial information, we have made a preliminary allocation of the estimated purchase price of our 20% interest in New PE Holdco to the assets acquired and liabilities assumed based on estimates of their fair value. Prior to our acquisition of our interest in New PE Holdco, and for the periods presented in the historical financial statements, we indirectly owned 100% of the assets and liabilities of the entities that were transferred to New PE Holdco on the Effective Date. Therefore, the estimates of the assets, liabilities and their subsequent allocations were derived from prior estimates made by management. Final estimates of these are dependent upon valuations and other analyses which could not be completed prior to the completion of the transactions described above. These final allocations may differ materially from the preliminary allocations used in these unaudited pro forma condensed combined financial statements and these differences may result in material changes in the pro forma information contained in this prospectus.
The Notes and Warrants have features that we believe would require us to bifurcate the Notes from the fair value of the liabilities attributed to the Warrants and the conversion features of the Notes, separately. Estimated valuations of these components could not be completed prior to the completion of the transactions. The result of the allocation will result in a debt discount. Therefore, amortization of the debt discount is excluded from the pro forma results for the year ended December 31, 2009 and for the nine months ended September 30, 2010. In addition, liabilities recorded relating to the Warrants and the conversion features of the Notes would be marked-to-market at each reporting period. The pro forma results do not include these mark-to-market adjustments.
We also consolidated the results of Front Range for the year ended December 31, 2009 within the historical amounts, with us deconsolidating these amounts on January 1, 2010, resulting in accounting for Front Range under the equity method for the nine months ended September 30, 2010.
The unaudited pro forma condensed combined financial information has been prepared for illustrative purposes only and is not necessarily indicative of the consolidated financial position at any future date or consolidated results of operations in future periods or the results that actually would have been realized had these transactions during the specified periods presented. The pro forma adjustments are based on the preliminary information available as of the date of this prospectus.
The unaudited pro forma condensed combined financial information does not give effect to any potential cost savings or other operating efficiencies that could result from the transactions described above, had they occurred on January 1, 2009.
Any reference in the following tables and notes to PEH and PEI means New PE Holdco and Pacific Ethanol, respectively.
PACIFIC ETHANOL, INC.
Unaudited Pro Forma Condensed Consolidated Balance Sheet
As of September 30, 2010
(in thousands)
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
18,500 |
|
|
|
(18,500 |
) |
(d)
|
|
|
— |
|
|
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 |
|
(c) |
|
|
158,485 |
|
|
Other Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
|
4,801 |
|
|
|
— |
|
|
|
|
4,801 |
|
|
Other assets
|
|
|
592 |
|
|
|
1,196 |
|
(b)
|
|
|
1,788 |
|
|
Total other assets
|
|
|
5,393 |
|
|
|
1,196 |
|
|
|
|
6,589 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$ |
55,471 |
|
|
$ |
166,068 |
|
|
|
$ |
221,539 |
|
See accompanying notes to these unaudited pro forma condensed consolidated financial statements.
PACIFIC ETHANOL, INC.
Unaudited Pro Forma Condensed Consolidated Balance Sheet
(Continued)
As of September 30, 2010
(in thousands)
|
LIABILITIES AND
STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable, trade
|
|
$ |
13,858 |
|
|
$ |
(3,121 |
) |
(b)
|
|
$ |
10,737 |
|
|
Accrued liabilities
|
|
|
6,163 |
|
|
|
360 |
|
(b)
|
|
|
6,523 |
|
|
Other liabilities - related parties
|
|
|
8,256 |
|
|
|
(4,537 |
) |
(e)
|
|
|
3,719 |
|
|
Current portion of long-term debt
|
|
|
13,250 |
|
|
|
(12,500 |
) |
(e)
|
|
|
750 |
|
|
Total current liabilities
|
|
|
41,257 |
|
|
|
(19,798 |
) |
|
|
|
21,729 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior convertible notes
|
|
|
— |
|
|
|
35,000 |
|
(f)
|
|
|
35,000 |
|
|
PEH term debt
|
|
|
— |
|
|
|
50,000 |
|
(g)
|
|
|
50,000 |
|
|
PEH working capital line of credit
|
|
|
— |
|
|
|
13,756 |
|
(g)
|
|
|
13,756 |
|
|
Kinergy working capital line of credit
|
|
|
8,399 |
|
|
|
— |
|
|
|
|
8,399 |
|
|
Other Liabilities
|
|
|
1,617 |
|
|
|
98 |
|
(b)
|
|
|
1,715 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
51,543 |
|
|
|
79,056 |
|
|
|
|
130,599 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ Equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pacific Ethanol, Inc. Stockholders’ Equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock
|
|
|
2 |
|
|
|
— |
|
|
|
|
2 |
|
|
Common stock
|
|
|
83 |
|
|
|
— |
|
|
|
|
83 |
|
|
Additional paid-in capital
|
|
|
503,489 |
|
|
|
— |
|
|
|
|
503,489 |
|
|
Accumulated deficit
|
|
|
(499,646 |
) |
|
|
— |
|
|
|
|
(499,646 |
) |
|
Total PEI equity
|
|
|
3,928 |
|
|
|
— |
|
|
|
|
3,928 |
|
|
Noncontrolling interest equity
|
|
|
— |
|
|
|
87,012 |
|
(h)
|
|
|
87,012 |
|
|
Total Stockholders’ Equity
|
|
|
3,928 |
|
|
|
87,012 |
|
|
|
|
90,940 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders’ Equity
|
|
$ |
55,471 |
|
|
$ |
166,068 |
|
|
|
$ |
221,539 |
|
See accompanying notes to these unaudited pro forma condensed consolidated financial statements.
PACIFIC ETHANOL, INC.
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Year ended December 31, 2009
(in thousands, except per share data)
| |
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
316,560 |
|
|
$ |
(95,656 |
) |
(i)
|
|
$ |
220,904 |
|
|
Cost of goods sold
|
|
|
338,607 |
|
|
|
(92,796 |
) |
(i)
|
|
|
|
|
| |
|
|
|
|
|
|
(15,710 |
) |
(j)
|
|
|
230,101 |
|
|
Gross profit (loss)
|
|
|
(22,047 |
) |
|
|
12,850 |
|
|
|
|
(9,197 |
) |
|
Selling, general and administrative expenses
|
|
|
21,458 |
|
|
|
(2,569 |
) |
(i)
|
|
|
18,889 |
|
|
Asset impairments
|
|
|
252,388 |
|
|
|
(252,388 |
) |
(k)
|
|
|
— |
|
|
Income (loss) from operations
|
|
|
(295,893 |
) |
|
|
267,807 |
|
|
|
|
(28,086 |
) |
|
Gain from write-off of liabilities
|
|
|
14,232 |
|
|
|
— |
|
|
|
|
14,232 |
|
|
Other expense, net
|
|
|
(15,437 |
) |
|
|
(2,085 |
) |
(l)
|
|
|
|
|
| |
|
|
|
|
|
|
1,348 |
|
(i)
|
|
|
(16,174 |
) |
|
Loss before reorganization costs and provision for income taxes
|
|
|
(297,098 |
) |
|
|
267,070 |
|
|
|
|
(30,028 |
) |
|
Reorganization costs
|
|
|
(11,607 |
) |
|
|
11,607 |
|
(k)
|
|
|
— |
|
|
Provision for income taxes
|
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
Net income (loss)
|
|
|
(308,705 |
) |
|
|
278,677 |
|
|
|
|
(30,028 |
) |
|
Net income (loss) attributed to noncontrolling interests in variable interest entity
|
|
|
552 |
|
|
|
19,996 |
|
(m)
|
|
|
20,548 |
|
|
Net income (loss) attributed to PEI
|
|
$ |
(308,153 |
) |
|
$ |
298,673 |
|
|
|
$ |
(9,480 |
) |
|
Preferred stock dividends
|
|
|
(3,202 |
) |
|
|
— |
|
|
|
|
(3,202 |
) |
|
Income (loss) available to common stockholders
|
|
$ |
(311,355 |
) |
|
$ |
298,673 |
|
|
|
$ |
(12,682 |
) |
|
Net income (loss) per share, basic and diluted
|
|
$ |
(5.45 |
) |
|
|
|
|
|
|
$ |
(0.19 |
) |
|
Weighted average shares outstanding, basic and diluted
|
|
|
57,084 |
|
|
|
8,306 |
|
(n)
|
|
|
65,390 |
|
See accompanying notes to these unaudited pro forma condensed consolidated financial statements.
PACIFIC ETHANOL, INC.
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Nine months ended September 30, 2010
(in thousands, except per share data)
| |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
194,087 |
|
|
$ |
54,748 |
|
(b)
|
|
$ |
248,835 |
|
|
Cost of goods sold
|
|
|
195,883 |
|
|
|
55,780 |
|
(b)
|
|
|
251,663 |
|
|
Gross loss
|
|
|
(1,796 |
) |
|
|
(1,032 |
) |
|
|
|
(2,828 |
) |
|
Selling, general and administrative expenses
|
|
|
9,065 |
|
|
|
152 |
|
(b)
|
|
|
9,217 |
|
|
Loss from operations
|
|
|
(10,861 |
) |
|
|
(1,184 |
) |
|
|
|
(12,045 |
) |
|
Loss on investment in Front Range
|
|
|
(12,146 |
) |
|
|
12,146 |
|
|
|
|
— |
|
|
Loss on extinguishment of debt
|
|
|
(2,159 |
) |
|
|
— |
|
|
|
|
(2,159 |
) |
|
Other expense, net
|
|
|
(4,550 |
) |
|
|
(5,017 |
) |
(l)
|
|
|
|
|
| |
|
|
|
|
|
|
929 |
|
(i)
|
|
|
(8,638 |
) |
|
Loss before reorganization costs, gain from bankruptcy exit and provision for income taxes
|
|
|
(29,716 |
) |
|
|
(6,874 |
) |
|
|
|
(22,842 |
) |
|
Reorganization costs
|
|
|
(4,153 |
) |
|
|
4,153 |
|
(k)
|
|
|
— |
|
|
Gain from bankruptcy exit
|
|
|
119,408 |
|
|
|
(119,408 |
) |
(k)
|
|
|
— |
|
|
Provision for income taxes
|
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
Net income (loss)
|
|
|
85,539 |
|
|
|
(108,381 |
) |
|
|
|
(22,842 |
) |
|
Net income (loss) attributed to noncontrolling interests in variable interest entity
|
|
|
— |
|
|
|
14,338 |
|
(m)
|
|
|
14,338 |
|
|
Net income (loss) attributed to PEI
|
|
$ |
85,539 |
|
|
$ |
(94,043 |
) |
|
|
$ |
(8,504 |
) |
|
Preferred stock dividends
|
|
|
(2,346 |
) |
|
|
— |
|
|
|
|
(2,346 |
) |
|
Income (loss) available to common stockholders
|
|
$ |
83,193 |
|
|
$ |
(94,043 |
) |
|
|
$ |
(10,850 |
) |
|
Net income (loss) per share, basic
|
|
$ |
1.19 |
|
|
|
|
|
|
|
$ |
(0.10 |
) |
|
Net income (loss) per share, diluted
|
|
$ |
1.10 |
|
|
|
|
|
|
|
$ |
(0.10 |
) |
|
Weighted average shares outstanding, basic
|
|
|
69,630 |
|
|
|
39,923 |
|
(n)
|
|
|
109,553 |
|
|
Weighted average shares outstanding, diluted
|
|
|
77,692 |
|
|
|
39,923 |
|
(n)
|
|
|
109,553 |
|
See accompanying notes to these unaudited pro forma condensed consolidated financial statements.
Notes to Unaudited Pro Forma Financial Information
|
|
(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 PEH
|
|
|
3,789 |
|
|
Purchase of 20% in PEH
|
|
|
(23,300 |
) |
|
Payments in satisfaction of Lyles loans
|
|
|
(17,037 |
) |
|
Net adjustment
|
|
$ |
16,952 |
|
|
|
(b)
|
Management has determined that PEH is a variable interest entity. In addition, because of our ownership interest in PEH, in relation to the other members’ position and involvement, as well as our asset management and marketing agreements with subsidiaries of PEH, management believes that we are the primary beneficiary and, accordingly, we have consolidated the results of PEH in these pro forma results. Amounts represent the assets, liabilities and operations of PEH at September 30, 2010.
|
|
|
(c)
|
Amounts represent the fixed assets of the Pacific Ethanol Plants. The amounts represent management’s best estimate of the fair value of the fixed assets based on a previously conducted analyses in connection with our assessment of these assets for impairment at December 31, 2009, less cumulative depreciation expense. Management has not completed its final purchase price allocation and amounts are subject to change from these pro form adjustments upon completion of the valuation and allocation.
|
|
|
(d)
|
Adjustment for the removal of our investment in Front Range, which was sold as part of the transactions described above, resulting in a loss on our investment.
|
|
|
(e)
|
Represents the payment in satisfaction of accrued interest and notes payable to Lyles United, LLC and Lyles Mechanical Co.
|
|
|
(f)
|
Represents the Notes issued as part of the transactions described above. Allocations regarding any Warrant and Note exercise or conversion feature liabilities, as well as their resulting income statement impacts to interest expense, are not included in these amounts. The valuation of the components could not be completed prior to the completion of the transactions described above.
|
|
|
(g)
|
Represents PEH’s reorganized debt consisting of $50.0 million in 3-year term debt and a $35.0 million working capital facility.
|
|
|
(h)
|
Adjustment for noncontrolling interest equity, as we own only 20% of PEH.
|
|
|
(i)
|
Amounts represent the removal of the previously consolidated results of Front Range, assuming that the sale of Front Range and the other transactions described above occurred on January 1, 2009.
|
|
|
(j)
|
The historical financial results include results from the entities transferred to PEH upon completion of its bankruptcy proceedings. These amounts represent the adjustment to depreciation expense using the most recent assessment of the property and equipment valuation.
|
|
|
(k)
|
Historical amounts include the consolidated results of the entities transferred to PEH prior to completion of its bankruptcy proceedings. These adjustments are intended to adjust the pro forma amounts for PEH to amounts assuming PEH had emerged from bankruptcy protection prior to our acquisition of PEH on January 1, 2009, therefore these amounts adjust for the bankruptcy accounting specific items.
|
|
|
(l)
|
Amounts represent interest expense and amortization of deferred financing fees on the Notes and Warrants and a reduction of interest expense associated with the repayment of the notes to Lyles United, LLC and Lyles Mechanical Co. in connection with the above transactions, as they were assumed to be paid on January 1, 2009. Further, the amounts do not include any mark-to-market adjustments on derivative liabilities and any amortization of debt discount on the Notes.
|
|
|
(m)
|
Amounts represent the removal of the Front Range component of noncontrolling interest as Front Range was assumed sold on January 1, 2009 for the year ended December 31, 2009 and adjustment for the PEH income of noncontrolling interests.
|
|
|
(n)
|
Share amounts represent the issuance of the common stock in satisfaction of the principal and interest on the Notes, beginning in the sixth month and continuing monthly over the remainder of the 15 month term. These shares assume there were no Warrant exercises during the period.
|
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 prospectus. This prospectus 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:
|
|
·
|
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 prospectus, 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 above, elsewhere in this prospectus or in the “Risk Factors” section of this prospectus 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.
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 currently manage the production of ethanol at the Pacific Ethanol Plants under the terms of an asset management agreement with a number of subsidiaries of New PE Holdco. 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 date of this prospectus, 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;
|
|
|
·
|
Distillers grain 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.
Recent Developments
On October 6, 2010, we raised $35.0 million through the issuance of $35.0 million in principal amount of Notes and Warrants to purchase an aggregate of 20,588,235 shares of our common stock. See “Description of Note and Warrant Financing.” 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.
Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009
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.
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 prospectus 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.
Results of Operations
Specific performance metrics that we believe are important indicators of our results of operations include the following:
| |
|
Nine Months Ended
|
|
|
|
|
|
| |
|
September 30,
|
|
|
|
|
|
| |
|
2010
|
|
|
2009
|
|
|
Variance
|
|
|
Production gallons sold (in millions)
|
|
|
43.2 |
|
|
|
64.6 |
|
|
|
(33.1 |
)% |
|
|
Third party gallons sold (in millions)
|
|
|
152.4 |
|
|
|
57.0 |
|
|
|
167.4 |
% |
|
|
Total gallons sold (in millions)
|
|
|
195.6 |
|
|
|
121.6 |
|
|
|
60.9 |
% |
|
|
Average sales price per gallon
|
|
$ |
1.81 |
|
|
$ |
1.70 |
|
|
|
6.5 |
% |
|
|
Corn cost per bushel – CBOT equivalent (1)
|
|
$ |
3.62 |
|
|
$ |
3.91 |
|
|
|
(7.4 |
)% |
|
|
Co-product revenues as % of delivered cost of corn
|
|
|
21.9% |
|
|
|
24.4% |
|
|
|
(10.2 |
)% |
|
|
Average CBOT price per gallon
|
|
$ |
1.70 |
|
|
$ |
1.61 |
|
|
|
5.6 |
% |
|
|
Average CBOT corn price per bushel
|
|
$ |
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 Loss
The following table presents our net sales, cost of goods sold and gross loss in dollars and gross loss as a percentage of net sales (in thousands, except percentages):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
194,087 |
|
|
$ |
228,685 |
|
|
$ |
(34,598 |
) |
|
|
(15.1 |
)% |
|
|
Cost of goods sold
|
|
|
195,883 |
|
|
|
252,123 |
|
|
|
(56,240 |
) |
|
|
(22.3 |
)% |
|
|
Gross loss
|
|
$ |
(1,796 |
) |
|
$ |
(23,438 |
) |
|
$ |
21,642 |
|
|
|
92.3 |
% |
|
|
Percentage of net sales
|
|
|
(0.9)% |
|
|
|
(10.2)% |
|
|
|
|
|
|
|
|
|
|
Net Sales
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 a decrease in production gallons sold, which was partially offset by an increase in our average sales price per gallon.
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 prospectus, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this prospectus.
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 Loss
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.
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
$ |
9,065 |
|
|
$ |
17,143 |
|
|
$ |
(8,078 |
) |
|
|
(47.1)% |
|
|
Percentage of net sales
|
|
|
4.7% |
|
|
|
7.5% |
|
|
|
|
|
|
|
|
|
Our selling, general and administrative expenses, or SG&A, decreased for the nine months ended September 30, 2010.
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of asset group
|
|
$ |
— |
|
|
$ |
2,200 |
|
|
$ |
(2,200 |
) |
|
|
(100.0)% |
|
|
Percentage of net sales
|
|
|
–% |
|
|
|
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss on investment in Front Range, held for sale
|
|
$ |
12,146 |
|
|
$ |
— |
|
|
$ |
12,146 |
|
|
|
* |
|
|
Percentage of net sales
|
|
|
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss on extinguishments of debt
|
|
$ |
2,159 |
|
|
$ |
— |
|
|
$ |
2,159 |
|
|
|
* |
|
|
Percentage of net sales
|
|
|
1.51% |
|
|
|
—% |
|
|
|
|
|
|
|
|
|
|
_______________
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Not meaningful
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We were party to agreements designed to satisfy our 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 24.0 million shares in the nine months ended September 30, 2010, resulting in aggregate losses of $2.2 million for the nine months ended September 30, 2010.
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense, net
|
|
$ |
4,550 |
|
|
$ |
13,215 |
|
|
$ |
(8,665 |
) |
|
|
(65.6)% |
|
|
Percentage of net sales
|
|
|
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Reorganization costs
|
|
$ |
(4,153 |
) |
|
$ |
(9,863 |
) |
|
$ |
(5,710 |
) |
|
|
(57.9)% |
|
|
Percentage of net sales
|
|
|
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.
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):
| |
|
Nine Months Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
Professional fees
|
|
$ |
4,036 |
|
|
$ |
3,648 |
|
|
Write-off of unamortized deferred financing fees
|
|
|
— |
|
|
|
7,545 |
|
|
Settlement of accrued liability
|
|
|
— |
|
|
|
(2,008 |
) |
|
DIP financing fees
|
|
|
— |
|
|
|
600 |
|
|
Trustee fees
|
|
|
117 |
|
|
|
78 |
|
|
Total
|
|
$ |
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):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributed to noncontrolling interest in variable interest entity
|
|
$ |
— |
|
|
$ |
2,536 |
|
|
$ |
(2,536 |
) |
|
|
(100.0)% |
|
|
Percentage of net sales
|
|
|
—% |
|
|
|
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 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, Inc.
The following table presents our net income (loss) attributed to Pacific Ethanol, Inc. in dollars and our net income (loss) attributed to Pacific Ethanol, Inc. as a percentage of net sales (in thousands, except percentages):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributed to Pacific Ethanol, Inc.
|
|
$ |
85,539 |
|
|
$ |
(63,323 |
) |
|
$ |
148,862 |
|
|
|
* |
|
|
Percentage of net sales
|
|
|
44.1% |
|
|
|
(27.7)% |
|
|
|
|
|
|
|
|
|
|
_______________
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Not meaningful
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributed to Pacific Ethanol, Inc. increased for the nine months ended September 30, 2010 as compared to the same period in 2009 primarily due to a net gain from bankruptcy exit of $119.4 million and decreases in gross losses and SG&A and other expenses, which were partially offset by our loss on extinguishments of debt and reorganization costs.
Preferred Stock Dividends and Income (Loss) Available to Common Stockholders
The following table presents the preferred stock dividends in dollars for our Series B Preferred Stock, these preferred stock dividends as a percentage of net sales, and our income (loss) available to common stockholders in dollars and our income (loss) available to common stockholders as a percentage of net sales (in thousands, except percentages):
| |
|
Nine Months Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock dividends
|
|
$ |
(2,346 |
) |
|
$ |
(2,395 |
) |
|
$ |
(49 |
) |
|
|
(2.0)% |
|
|
Percentage of net sales
|
|
|
(1.2)% |
|
|
|
(1.0)% |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) available to common stockholders
|
|
$ |
83,193 |
|
|
$ |
(65,718 |
) |
|
$ |
148,911 |
|
|
|
226.6% |
|
|
Percentage of net sales
|
|
|
42.9% |
|
|
|
(28.7)% |
|
|
|
|
|
|
|
|
|
Shares of our Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in an amount equal to 7% per annum of the purchase price per share of the Series B Preferred Stock. We declared, but did not pay, cash dividends on our Series B Preferred Stock in the aggregate amount of $2.3 million and $2.4 million for each of the nine months ended September 30, 2010 and 2009, respectively. We are currently in arrears and have not paid approximately $5.5 million in Series B Preferred Stock dividends as of September 30, 2010.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Financial Performance Summary
Our net sales decreased by $387.3 million, or 55%, to $316.6 million for the year ended December 31, 2009 from $703.9 million for the year ended December 31, 2008. Our net loss increased by $109.5 million to $308.7 million for the year ended December 31, 2009 from $199.2 million for the year ended December 31, 2008.
Factors that contributed to our results of operations for 2009 include:
|
|
·
|
Net sales. The decrease in our net sales in 2009 as compared to 2008 was primarily due to the following combination of factors:
|
|
|
o
|
Lower sales volumes. Total volume of ethanol sold decreased by 36% to 172.7 million gallons in 2009 from 268.4 million gallons in 2008. The decrease in sales volume is primarily due to both decreased gallons sold from the Pacific Ethanol Plants and from our third party marketing arrangements. In 2008, two new facilities commenced operations, and in 2009, we produced ethanol at only one facility for most of the year; and
|
|
|
o
|
Lower ethanol prices. Our average sales price of ethanol decreased 20% to $1.80 per gallon in 2009 as compared to $2.25 per gallon in 2008.
|
|
|
·
|
Gross margins. Our gross margins decreased to negative 7.0% for 2009 as compared to a gross margin of negative 4.7% for 2008. The drop in gross margin was a result of lower ethanol prices and higher depreciation expense in 2009, partially offset by a reduction in corn costs. Depreciation on the ethanol facilities was $33.3 million for 2009 as compared to $25.3 million in 2008. Our average price of corn decreased by 27.9% to $3.98 per bushel in 2009 from $5.52 per bushel in 2008.
|
|
|
·
|
Selling, general and administrative expenses. Our selling, general and administrative expenses decreased by $10.3 million to $21.5 million in 2009 as compared to $31.8 million in 2008 primarily as a result of decreases in payroll and benefits, bad debt expense, derivatives commissions, noncash compensation expense and travel expenses, which were partially offset by increases in professional fees. Our selling, general and administrative expenses, however, increased as a percentage of net sales due to our significant sales decline.
|
|
|
·
|
Impairments. Our impairments increased by $124.5 million to $252.4 million in 2009 as compared to $127.9 million in 2008. In 2009, we recognized $252.4 million in asset impairments. In 2008, we recognized $87.0 million in impairment of goodwill and $40.9 million in asset impairment. The asset impairments in 2009 primarily relate to our ethanol production facilities. The impairment of goodwill related to our annual goodwill review, mostly reflecting a decline in the valuation of our prior purchase of our 42% interest in Front Range. The asset impairment in 2008 reflects our decision to abandon construction of our Imperial Valley ethanol production facility due to adverse market conditions. In 2009, we further impaired our assets related to an ethanol production facility we were constructing in the Imperial Valley, California by an additional $2.2 million, prior to their disposal.
|
|
|
·
|
Gain from write-off of liabilities. Gain from write-off of liabilities was $14.2 million in 2009, with no corresponding gain in 2008. This gain was due to a write-off of the liabilities related to the Imperial Valley facility.
|
|
|
·
|
Other expense. Our other expense increased by $9.4 million to $15.4 million in 2009 from $6.0 million in 2008. This increase is primarily due to decreased sales of our business energy tax credits, decreased interest income, where were partially offset by decreased mark-to-market losses, decreased interest expense and decreased finance cost amortization.
|
Sales and Margins
Over the past three years, our sales mix has shifted significantly from sales generated solely as a marketer of ethanol produced by third parties to include sales generated as a producer of our own ethanol. Our production facility cost structure also changed significantly, beginning in 2007, as the Madera and Front Range facilities were in full production and continuing in 2008 as the Columbia facility was in full production and the Magic Valley and Stockton facilities commenced operations. The shift in our sales mix greatly altered our dependency on specified market conditions from that based primarily on the market price of ethanol to that based significantly on the cost of corn, the principal input commodity for our production of ethanol.
Average ethanol sales prices declined in 2009 as compared to 2008. The average CBOT ethanol price decreased by 23% in 2009 as compared to 2008. The decrease in the prevailing market price of ethanol was primarily due to the decline in crude oil prices that commenced in mid-2008.
Average corn prices also decreased significantly in 2009 as compared to 2008. Specifically, the average CBOT corn price decreased by 29% in 2009 as compared to 2008. The decrease in the prevailing market price of corn was the primary cause of the decrease in our average corn price. The average CBOT corn price decreased to $3.74 for 2009 from $5.27 for 2008.
We have three principal methods of selling ethanol: as a merchant, as a producer and as an agent. See “Critical Accounting Policies—Revenue Recognition” below.
When acting as a merchant or as a producer, we generally entered into sales contracts to ship ethanol to a customer’s desired location. We supported these sales contracts through purchase contracts with several third-party suppliers or through our own production. We managed the necessary logistics to deliver ethanol to our customers either directly from a third-party supplier or from our inventory via truck or rail. Our sales as a merchant or as a producer exposed us to price risks resulting from potential fluctuations in the market price of ethanol and corn. Our exposure varied depending on the magnitude of our sales and purchase commitments compared to the magnitude of our existing inventory, as well as the pricing terms—including market index or fixed pricing—of our contracts. We mitigated our exposure to price risks by implementing appropriate risk management strategies.
When acting as an agent for third-party suppliers, we conducted back-to-back purchases and sales in which we matched ethanol purchase and sale contracts of like quantities and delivery periods. When acting as an agent for third-party suppliers, we receive a predetermined service fee and we had little or no exposure to price risks resulting from potential fluctuations in the market price of ethanol.
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 prospectus, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this prospectus.
Performance metrics that we believe are important indicators of our results of operations include:
| |
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Gallons sold (in millions)
|
|
|
172.7 |
|
|
|
268.4 |
|
|
|
(35.7 |
)% |
|
Average sales price per gallon
|
|
$ |
1.80 |
|
|
$ |
2.25 |
|
|
|
(20.0 |
)% |
|
Corn cost per bushel—CBOT equivalent(1)
|
|
$ |
3.98 |
|
|
$ |
5.52 |
|
|
|
(27.9 |
)% |
|
Co-product revenues as % of delivered cost of corn(2)
|
|
|
24.6% |
|
|
|
22.5% |
|
|
|
9.3 |
% |
|
Average CBOT ethanol price per gallon
|
|
$ |
1.70 |
|
|
$ |
2.22 |
|
|
|
(23.4 |
)% |
|
Average CBOT corn price per bushel
|
|
$ |
3.74 |
|
|
$ |
5.27 |
|
|
|
(29.0 |
)% |
|
|
(1)
|
We exclude transportation—or “basis”—costs in our corn costs to calculate a CBOT equivalent in order to more appropriately compare our corn costs to average CBOT corn prices.
|
|
|
(2)
|
Co-product revenues as % of delivered cost of corn shows our yield based on sales of WDG generated from ethanol we produced.
|
2008/2009 Year-Over-Year Comparison
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results as a Percentage
|
|
| |
|
|
|
|
|
|
|
|
|
|
Dollar
|
|
|
|
Percentage
|
|
|
|
of Net Sales for the
|
|
| |
|
|
Years Ended
|
|
|
|
Variance
|
|
|
|
Variance
|
|
|
|
Years Ended
|
|
| |
|
|
|
|
|
|
Favorable
|
|
|
|
Favorable
|
|
|
|
December 31,
|
|
| |
|
|
2009
|
|
|
|
2008
|
|
|
|
(Unfavorable)
|
|
|
|
(Unfavorable)
|
|
|
|
2009
|
|
|
|
2008
|
|
| |
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
316,560 |
|
|
$ |
703,926 |
|
|
$ |
(387,366 |
) |
|
|
(55.0 |
)% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
Cost of goods sold
|
|
|
338,607 |
|
|
|
737,331 |
|
|
|
398,724 |
|
|
|
54.1 |
|
|
|
107.0 |
|
|
|
104.7 |
|
|
Gross loss
|
|
|
(22,047 |
) |
|
|
(33,405 |
) |
|
|
11,358 |
|
|
|
34.0 |
|
|
|
(7.0 |
) |
|
|
(4.7 |
) |
|
Selling, general and administrative expenses
|
|
|
21,458 |
|
|
|
31,796 |
|
|
|
10,338 |
|
|
|
32.5 |
|
|
|
6.8 |
|
|
|
4.5 |
|
|
Asset impairments
|
|
|
252,388 |
|
|
|
40,900 |
|
|
|
(211,488 |
) |
|
|
(517.1 |
) |
|
|
79.7 |
|
|
|
5.8 |
|
|
Goodwill impairments
|
|
|
— |
|
|
|
87,047 |
|
|
|
87,047 |
|
|
|
100.0 |
|
|
|
— |
|
|
|
12.4 |
|
|
Loss from operations
|
|
|
(295,893 |
) |
|
|
(193,148 |
) |
|
|
(102,745 |
) |
|
|
(53.2 |
) |
|
|
(93.5 |
) |
|
|
(27.4 |
) |
|
Gain from write-off of liabilities
|
|
|
14,232 |
|
|
|
— |
|
|
|
14,232 |
|
|
NM
|
|
|
|
4.5 |
|
|
|
— |
|
|
Other expense, net
|
|
|
(15,437 |
) |
|
|
(6,068 |
) |
|
|
(9,369 |
) |
|
|
(154.4 |
) |
|
|
(4.9 |
) |
|
|
(0.9 |
) |
|
Loss before noncontrolling interest in variable interest entity and provision for income taxes
|
|
|
(297,098 |
) |
|
|
(199,216 |
) |
|
|
(97,882 |
) |
|
|
(49.1 |
) |
|
|
(93.9 |
) |
|
|
(28.3 |
) |
|
Reorganization costs
|
|
|
11,607 |
|
|
|
— |
|
|
|
(11,607 |
) |
|
NM
|
|
|
|
3.6 |
|
|
|
— |
|
|
Provision for income taxes
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Net loss
|
|
|
(308,705 |
) |
|
|
(199,216 |
) |
|
|
(109,489 |
) |
|
|
(55.0 |
) |
|
|
(97.5 |
) |
|
|
(28.3 |
) |
|
Net loss attributed to noncontrolling interest in variable interest entity
|
|
|
552 |
|
|
|
52,669 |
|
|
|
52,117 |
|
|
|
99.0 |
|
|
|
0.2 |
|
|
|
7.5 |
|
|
Net loss attributed to Pacific Ethanol, Inc.
|
|
$ |
(308,153 |
) |
|
$ |
(146,547 |
) |
|
$ |
(161,606 |
) |
|
|
(110.3 |
)% |
|
|
(97.3 |
)% |
|
|
(20.8 |
)% |
|
Preferred stock dividends
|
|
$ |
(3,202 |
) |
|
$ |
(4,104 |
) |
|
$ |
902 |
|
|
|
22.0 |
% |
|
|
(1.0 |
)% |
|
|
(0.6 |
)% |
|
Deemed dividend on preferred stock
|
|
|
— |
|
|
|
(761 |
) |
|
|
761 |
|
|
|
100.0 |
|
|
|
— |
|
|
|
(0.1 |
) |
|
Loss available to common stockholders
|
|
$ |
(311,355 |
) |
|
$ |
(151,412 |
) |
|
$ |
(159,943 |
) |
|
|
(105.6 |
)% |
|
|
(98.3 |
)% |
|
|
(21.5 |
)% |
Net Sales
The decrease in our net sales in 2009 as compared to 2008 was primarily due to a significant decrease in the total volume of ethanol sold and lower average sales prices.
Total volume of ethanol sold decreased by 95.7 million gallons, or 36%, to 172.7 million gallons in 2009 as compared to 268.4 million gallons in 2008. This decrease in sales volume is primarily due to idled operations at three of the Pacific Ethanol Plants for nearly all of 2009, as well as decreased sales volume from our third party ethanol marketing arrangements. During 2008, we completed construction of the Stockton and Magic Valley facilities, and all of the Pacific Ethanol Plants were in operation during the last quarter of 2008.
Our average sales price per gallon decreased 20% to $1.80 in 2009 from an average sales price per gallon of $2.25 in 2008. The average CBOT ethanol price per gallon decreased 23% to $1.70 in 2009 from an average CBOT ethanol price per gallon of $2.22 in 2008. Our average sales price per gallon did not decrease as much as the average CBOT ethanol price per gallon for 2009 due to both the timing of our sales and the proportion of our fixed-price contracts during a period of rising ethanol prices.
Cost of Goods Sold and Gross Loss
Our gross loss improved to negative $22.0 million for 2009 from negative $33.4 million for 2008 due to lower corn costs. Our gross margin decreased to negative 7.0% for 2009 as compared to negative 4.7% for 2008.
The drop in gross margin was a result of lower ethanol prices and higher depreciation expense in 2009, which were partially offset by a reduction in corn costs. Increased costs to manage the Pacific Ethanol Plants in relation to the volume they produced contributed to the drop in gross margins, particularly as it relates to the three Pacific Ethanol Plants which were not producing ethanol for most of 2009 but still incurring maintenance costs and depreciation expense. Total depreciation for 2009 was $33.3 million up 32% from $25.3 million for 2008. Our 2008 depreciation expense was lower because the Stockton and Magic Valley facilities began operations during 2008.
These factors were partially offset by lower corn costs. Corn is the single largest component of the cost of ethanol production and our average price of corn decreased by 27.9% to $3.98 per bushel in 2009 from $5.52 per bushel in 2008. Overall, the price of corn had a significant impact on our production costs due to the timing of the corn and the related ethanol pricing from the time we purchased corn to the sale of ethanol. Generally, we fixed our corn price upon shipment from the vendor, and in a falling market, our margins were compressed as both corn and ethanol prices continued to fall from transit to processing of the corn. Further, during 2008 we experienced unprecedented volatility in the price of corn ranging from the CBOT low for the year of $2.94 to the CBOT high for the year of $7.55. These prices moved in a short period of time that it became difficult to sell the related ethanol production before the prices of both corn and ethanol changed dramatically primarily downward-from the time of the corn purchase. Further, due to falling market prices toward the end of 2008, corn and ethanol ending inventories had been purchased and produced, respectively, at prices higher than prevailing spot prices for the commodities at the end of 2008. As a result, we recorded additional losses from this market adjustment of approximately $1.7 million in 2008.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses, or SG&A, decreased by $10.3 million to $21.5 million for 2009 as compared to $31.8 million for 2008. SG&A, however, increased as a percentage of net sales due to our significant sales decline. The decrease in the amount of SG&A is primarily due to the following factors:
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|
·
|
payroll and benefits decreased by $3.8 million due primarily to a reduction in employees, largely near the end of the first quarter of 2009, as we reduced the number of administrative positions as a result of reduced production and related support needs;
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|
|
·
|
bad debt expense decreased by $3.1 million due primarily to a high provision for bad debt in 2008 and a significant recovery from a trade receivable during the third quarter of 2009;
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|
|
·
|
derivative commissions decreased by $1.6 million due primarily to a significant amount of trades during 2008 and relatively little activity in 2009;
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|
|
·
|
noncash compensation expense decreased by $1.1 million due primarily to a reduction in the value of share grants to our Board of Directors in 2009;
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|
|
·
|
travel expenses decreased by $1.0 million due primarily to the cessation of our construction-related activities.
|
These items were partially offset by:
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|
·
|
professional fees, which increased by $1.0 million due primarily to increased legal fees and other legal matters associated with the Bankrupt Debtors’ bankruptcy proceedings. Costs associated with our Chapter 11 Filings after the filing date on May 17, 2009 are recorded as reorganization costs.
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Asset Impairments
Our asset impairments increased by $124.5 million to $252.4 million in 2009 as compared to $127.9 million in 2008. In accordance with FASB ASC 360, Property, Plant and Equipment, we performed an impairment analysis on our long-lived assets, including our ethanol production facilities and assets associated with our suspended plant construction project in the Imperial Valley near Calipatria, California, or Imperial Project. Based on our probability-weighted cash flows for our long-lived assets, including the current status of the Bankrupt Debtors’ restructuring efforts as they prepared to file a plan of reorganization, we determined that these assets must be assessed for impairment. These assessments resulted in a noncash impairment charge of $250.2 million, thereby initially reducing our property and equipment by that amount. Also in accordance with FASB ASC 360, we assessed for impairment our assets associated with our Imperial Project in 2009 and 2008. In November 2008, we began proceedings to liquidate these assets and liabilities. Based on our original assessment of the estimated undiscounted cash flows, we recorded an impairment charge of $40.9 million, thereby initially reducing our property and equipment by that amount. At the end of the third quarter in 2009, our revised assessment of the estimated undiscounted cash flows resulted in an additional impairment charge of $2.2 million.
Goodwill Impairments
In accordance with FASB ASC 350, Intangibles-Goodwill and Other, we conducted an impairment test of goodwill as of March 31, 2008. As a result, we recorded a non-cash impairment charge of $87.0 million, requiring us to write-off our entire goodwill balances from our previous acquisitions of Kinergy and Front Range.
Gain from Write-Off of Liabilities
In connection with our Imperial Project, discussed above, in the fourth quarter of 2009, the assets were sold and the resulting cash proceeds and the settlement of the remaining liabilities were deemed out of our control as they had been assigned to a trustee. As a result, we wrote-off the remaining liabilities, resulting in a gain of $14.2 million for the year ended December 31, 2009.
Other Expense, Net
Other expense increased by $9.4 million to $15.4 million in 2009 from other expense of $6.0 million in 2008. The increase in other expense is primarily due to the following factors:
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|
·
|
other income decreased by $10.1 million primarily related to sales, which did not recur in 2009, of our business energy tax credits sold in 2008 as pass through investments to interested purchasers; and
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·
|
interest income decreased by $0.4 million due to lower average cash balances.
|
These items were partially offset by:
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|
·
|
mark-to-market losses decreased by $4.1 million related to our interest rate swaps which we de-designated in 2008 associated with our Bankrupt Debtors’ credit facility; and
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|
|
·
|
interest expense decreased by $4.0 million, as we ceased fully accruing interest on our debt due to the Chapter 11 Filings. Since May 17, 2009, we only accrue interest on our debt that is probable to be repaid as part of a plan of reorganization; and
|
|
|
·
|
amortization of deferred financing fees decreased by $0.8 million, as we wrote-off a significant amount of deferred financing fees at the time of the Chapter 11 Filings.
|
Reorganization Costs
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 the business must be reported separately as reorganization items in the statements of operations. We wrote-off a portion of our unamortized deferred financing fees on the debt which is considered to be unlikely to be repaid. During 2009, the Bankrupt Debtors settled a prepetition accrued liability with a vendor, resulting in a realized gain. Professional fees directly related to the reorganization include fees associated with advisors to the Bankrupt Debtors, unsecured creditors, secured creditors and administrative costs in complying with reporting rules under the Bankruptcy Code.
The Bankrupt Debtors’ reorganization costs for the year ended December 31, 2009 consist of the following (in thousands):
|
Write-off of unamortized deferred financing fees
|
|
$ |
7,545 |
|
|
Settlement of accrued liability
|
|
|
(2,008 |
) |
|
Professional fees
|
|
|
5,198 |
|
|
DIP financing fees
|
|
|
750 |
|
|
Trustee fees
|
|
|
122 |
|
|
Total
|
|
$ |
11,607 |
|
Net Loss Attributed to Noncontrolling Interest in Variable Interest Entity
Net loss attributed to noncontrolling interest in variable interest entity relates to the consolidated treatment of Front Range, a variable interest entity, and represents the noncontrolling interest of others in the earnings of Front Range. We consolidate the entire income statement of Front Range for the periods covered. However, because we only owned 42% of Front Range, we were required to reduce our net income or increase our net loss for the noncontrolling interest, which is the 58% ownership interest that we did not own. For 2009, this amount decreased by $52.1 million from the same period in 2008 due to fluctuations in net loss of Front Range.
Preferred Stock Dividends
Shares of our Series A Cumulative Redeemable Convertible Preferred Stock, or Series A Preferred Stock, and Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in an amount equal to 5% and 7% per annum, respectively, of the purchase price per share of the preferred stock. For our Series A Preferred Stock, we declared and paid cash dividends of $1.7 million for 2008. During 2008, the former holder of our Series A Preferred Stock converted all of its shares of Series A Preferred Stock into shares of our common stock. We did not pay any dividends on our Series A Preferred Stock in 2009 as there was none outstanding during that period. For our Series B Preferred Stock, we declared cash dividends of $3.2 million and $2.4 million for 2009 and 2008, respectively. We are currently in arrears and have not paid the $3.2 million of preferred dividends declared in 2009.
Deemed Dividend on Preferred Stock
During 2008, we recorded a deemed dividend on preferred stock of $0.8 million in connection with a subsequent issuance of shares of Series B Preferred Stock. This non-cash dividend reflects the implied economic value to the preferred stockholder of being able to convert the shares into common stock at a price (as adjusted for the value allocated to the warrants) which was in excess of the fair value of the Series B Preferred Stock at the time of issuance. The fair value was calculated using the difference between the conversion price of the Series B Preferred Stock into shares of common stock, adjusted for the value allocated to the warrants, of $4.79 per share and the fair market value of our common stock of $5.65 on the date of issuance of the Series B Preferred Stock. The deemed dividend on preferred stock is a reconciling item and adjusts our reported net loss, together with the preferred stock dividends discussed above, to loss available to common stockholders.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of net sales and expenses for each period. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.
Going Concern Assumption
We have based our financial statements on the assumption of our operations continuing as a going concern. Our consolidated financial statements do not include any adjustments relating to the recoverability and classification of the recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue our existence.
Revenue Recognition
We recognize revenue when it is realized or realizable and earned. We consider revenue realized or realizable and earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured.
We derive revenue primarily from sales of ethanol and related co-products. We recognize revenue when title transfers to our customers, which is generally upon the delivery of these products to a customer’s designated location. These deliveries are made in accordance with sales commitments and related sales orders entered into with customers either verbally or in written form. The sales commitments and related sales orders provide quantities, pricing and conditions of sales. In this regard, we engage in three basic types of revenue generating transactions:
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·
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As a producer. Sales as a producer consist of sales of our inventory produced at the Pacific Ethanol Plants.
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·
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As a merchant. Sales as a merchant consist of sales to customers through purchases from third-party suppliers in which we may or may not obtain physical control of the ethanol or co-products, though ultimately titled to us, in which shipments are directed from our suppliers to our terminals or direct to our customers but for which we accept the risk of loss in the transactions.
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As an agent. Sales as an agent consist of sales to customers through purchases from third-party suppliers in which, depending upon the terms of the transactions, title to the product may technically pass to us, but the risks and rewards of inventory ownership remain with third-party suppliers as we receive a predetermined service fee under these transactions and therefore act predominantly in an agency capacity.
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Revenue from sales of third-party ethanol and its co-products is recorded net of costs when we are acting as an agent between the customer and supplier and gross when we are a principal to the transaction. Several factors are considered to determine whether we are acting as an agent or principal, most notably whether we are the primary obligor to the customer, whether we have inventory risk and related risk of loss or whether we add meaningful value to the vendor’s product or service. Consideration is also given to whether we have latitude in establishing the sales price or have credit risk, or both.
We record revenues based upon the gross amounts billed to our customers in transactions where we act as a producer or a merchant and obtain title to ethanol and its co-products and therefore own the product and any related, unmitigated inventory risk for the ethanol, regardless of whether we actually obtain physical control of the product. When we act in an agency capacity, we record revenues on a net basis, or our predetermined agency fees and any associated freight only, based upon the amount of net revenues retained in excess of amounts paid to suppliers. Through the six months ended June 30, 2010, in which we owned ethanol production facilities, we recorded revenue from their production on a gross basis and to the extent we either do not own the Pacific Ethanol Plants or consolidate them, we will record revenue from their production on a net basis in much the same way as other third-party sales.
Consolidation of Variable Interest Entities
We have determined that our prior ownership interest in Front Range met the definition of a variable interest entity. Since our initial acquisition of our ownership interests in Front Range through December 31, 2009, we determined that we were the primary beneficiary and we were therefore required to treat Front Range as a consolidated subsidiary for financial reporting purposes rather than use equity investment accounting treatment. As a result, we consolidated the financial results of Front Range, including its entire balance sheet with the balance of the noncontrolling interest displayed as a component of equity, and its income statement after intercompany eliminations with an adjustment for the noncontrolling interest as net income (loss) attributed to noncontrolling interest in variable interest entity, through December 31, 2009.
Effective January 1, 2010, we adopted new accounting guidance which resulted in our conclusion that under the new 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. In making this conclusion, we determined that we did not have the power to direct most of the activities that most significantly impact the entity’s economic performance. Some of those activities include efficient management and operations of its ethanol production facility, procurement of feedstock, sale of co-products and effectiveness of risk management strategies.
On October 6, 2010, we acquired a 20% ownership interest of New PE Holdco. We will consider the same accounting guidance in determining if it is a variable interest entity and if so, if we are the primary beneficiary. As a result, we may conclude that we will consolidate all of New PE Holdco effective October 6, 2010. This determination will be continuously reviewed for appropriateness at each future reporting period.
Impairment of Long-Lived and Intangible Assets
Our long-lived assets have been primarily associated with the Pacific Ethanol Plants, reflecting the original cost of construction, adjusted for any prior impairments. Our intangible assets, including goodwill, were derived from the acquisition of our interest in Front Range in 2006 and our acquisition of Kinergy in 2005 in connection with the Share Exchange Transaction. In accounting for the Share Exchange Transaction, we allocated the respective purchase prices to the tangible assets, liabilities and intangible assets acquired based upon their estimated fair values. The excess purchase prices over the fair values of the assets acquired and liabilities assumed were recorded as goodwill.
We evaluate impairment of long-lived assets in accordance with FASB ASC 360. We assess the impairment of long-lived assets, including property and equipment and purchased intangibles subject to amortization, when events or changes in circumstances indicate that the fair value of each asset (or asset group) could be less than the net book value of the asset (or asset group). We assess long-lived assets for impairment by first determining the forecasted, undiscounted cash flows each asset (or asset group) is expected to generate plus the net proceeds expected from the sale of the asset (or asset group). If the amount of proceeds is less than the asset (or asset group’s) carrying value, we then determine the fair value of the asset (or asset group). An impairment loss would be recognized when the fair value is less than the related net book value, and an impairment expense would be recorded in the amount of the difference. Forecasts of future cash flows are judgments based on our experience and knowledge of our operations and the industries in which we operate. These forecasts could be significantly affected by future changes in market conditions, the economic environment, including inflation, and purchasing decisions of our customers.
During the years ended December 31, 2009 and 2008, we recognized asset impairment charges associated with our ethanol production facilities and our Imperial Project in the aggregate amounts of $252.4 million and $40.9 million, respectively.
We review our goodwill and intangible assets with indefinite lives at least annually or more frequently if impairment indicators arise. In our review, we determine the fair value of these assets using market multiples and discounted cash flow modeling and compare it to the net book value of the acquired assets. During the year ended December 31, 2008, we performed our annual review of our goodwill and intangible assets and recognized an impairment loss of $87.0 million, the entire amount of our goodwill.
Allowance for Doubtful Accounts
We primarily sell ethanol to gasoline refining and distribution companies and WDG to dairy operators and animal feed distributors. We had significant concentrations of credit risk from sales of our ethanol as of December 31, 2009, as described in Note 1 to our consolidated financial statements. However, those ethanol customers historically have had good credit ratings and historically we have collected amounts that were billed to those customers. Receivables from customers are generally unsecured. We continuously monitor our customer account balances and actively pursue collections on past due balances.
We maintain an allowance for doubtful accounts for balances that appear to have specific collection issues. Our collection process is based on the age of the invoice and requires attempted contacts with the customer at specified intervals. If after a specified number of days, we have been unsuccessful in our collection efforts, we consider recording a bad debt allowance for the balance in question. We would eventually write-off accounts included in our allowance when we have determined that collection is not likely. The factors considered in reaching this determination are the apparent financial condition of the customer, and our success in contacting and negotiating with the customer.
For the year ended December 31, 2009, we recognized a recovery of bad debt expense of $1.0 million and for the year ended December 31, 2008, we recognized a bad debt expense of $2.2 million.
Impact of New Accounting Pronouncements
On June 12, 2009, the Financial Accounting Standards Board, or FASB, amended its guidance to FASB Accounting Standards Codification, or 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. Effective January 1, 2010, we adopted these provisions, which resulted in us concluding that, under the FASB’s guidance, we are no longer the primary beneficiary and, effective January 1, 2010, we have prospectively adopted the FASB’s guidance resulting in a deconsolidation of the financial results of Front Range. In making this conclusion, we determined that at that time Front Range continued to be a variable interest entity; however, we did not have the power to direct most of the activities that most significantly impact the entity’s economic performance. Some of these activities include efficient management and operation of its facility, procurement of feedstock, sale of co-products and effectiveness of risk management strategies. Further, our maximum exposure was limited to our investment in Front Range. Upon deconsolidation, we removed $62,617,000 of assets and $18,584,000 of liabilities from our consolidated balance sheet and recorded a cumulative debit adjustment to retained earnings of $1,762,000. The periods presented in this prospectus prior to the effective date of the deconsolidation continue to include related balances associated with Front Range. Effective January 1, 2010, we began accounting for our prior investment in Front Range under the equity method, with equity earnings recorded in other income (expense) in the consolidated statements of operations.
On May 28, 2009, the FASB issued FASB ASC 855, Subsequent Events, which provides guidance on management’s assessment of subsequent events. Historically, management had relied on United States auditing literature for guidance on assessing and disclosing subsequent events. FASB ASC 855 represents the inclusion of guidance on subsequent events in the accounting literature and is directed specifically to management, since management is responsible for preparing an entity’s financial statements. The guidance clarifies that management must evaluate, as of each reporting period, events or transactions that occur after the balance sheet date through the date that the financial statements are issued. The guidance is effective prospectively for interim and annual financial periods ending after June 15, 2009. We adopted the provisions of FASB ASC 855 for our reporting period ending June 30, 2009 and its adoption did not have a material impact on our financial condition or results of operations. We have evaluated subsequent events up through the date of the filing of this prospectus.
On January 1, 2009, we adopted the provisions of FASB ASC 810, Consolidations, which amended existing guidance that changed our classification and reporting for our noncontrolling interests in our variable interest entity to a component of stockholders’ equity (deficit) and other changes to the format of our financial statements. Except for these changes in classification, the adoption of FASB ASC 810 did not have a material impact on our financial condition or results of operations.
On January 1, 2009, we adopted a number of provisions of FASB ASC 815, Derivatives and Hedging, which changed the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB ASC 815 and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The adoption of these amended provisions resulted in enhanced disclosures and did not have any impact on our financial condition or results of operations.
On January 1, 2009, we adopted the provisions of FASB ASC 815, Derivatives and Hedging, which mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock. The adoption of these provisions did not have a material impact on our financial condition or results of operations.
On January 1, 2009, we adopted a number of provisions of FASB ASC 805, Business Combinations, which amended a number of its previous provisions. These amendments provide additional guidance that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. The guidance requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. In addition, the guidance requires acquisition costs and restructuring costs that the acquirer expected but was not obligated to incur to be recognized separately from the business combination, therefore, expensed instead of part of the purchase price allocation. These amended provisions will be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The adoption of these provisions did not have a material impact on our financial condition or results of operations.
Liquidity and Capital Resources
During the nine months ended September 30, 2010, we funded our operations primarily from cash provided by operations and borrowings under our credit facility. As of September 30, 2010, we had positive working capital of $7.4 million. As of September 30, 2010 and December 31, 2009, we had cash and cash equivalents of $1.6 million and $17.5 million, respectively.
Our current available capital resources consist of cash, which includes the remainder of amounts raised through our private offering of Notes and Warrants for $35.0 million and the sale of our 42% interest in Front Range for $18.5 million, both of which occurred on October 6, 2010. On that date, we 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. We expect that our future available capital resources will consist primarily of our existing cash balances, cash generated from Kinergy’s ethanol marketing business, fees paid under our asset management agreement relating to operating the Pacific Ethanol Plants and any future debt and/or equity financings.
On June 30, 2010, we received a letter from NASDAQ indicating that the bid price of our common stock for the last 30 consecutive business days had closed below the minimum $1.00 per share required for continued listing. We have been provided an initial period of 180 calendar days, or until December 27, 2010, in which to regain compliance. We may be eligible for an additional grace period if we meet the initial listing standards, with the exception of the minimum bid price, of The NASDAQ Capital Market contained in NASDAQ Listing Rule 5505. A delisting of our common stock is likely to reduce the liquidity of our common stock and may inhibit or preclude our ability to raise additional financing and may also materially and adversely impact our credit terms with our vendors. See “Risk Factors.”
We believe that current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, including our credit facility and the remaining net proceeds from our private offering of Notes and Warrants on October 6, 2010, will be adequate to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months. If, however, we are unable to service the principal and/or interest payments under the Notes through the issuance of shares of our common stock, if our capital requirements or cash flow vary materially from our current projections, if unforeseen circumstances occur, or if we require a significant amount of cash to fund future acquisitions, we may require additional financing. Our failure to raise capital, if needed, could restrict our growth, or hinder our ability to compete.
Change in Working Capital and Cash Flows
Nine Months Ended September 30, 2010 as Compared to Year Ended December 31, 2009
Working capital increased to $7.4 million at September 30, 2010 from a deficit of $50.9 million at December 31, 2009 primarily as a result of a decrease in current liabilities of $58.1 million.
Current liabilities decreased due to our deconsolidation of Front Range and the Plant Owners’ exit from bankruptcy, resulting in decreases in current portion of long-term notes payable of $64.1 million, which were partially offset by an increase in accounts payable and accrued liabilities of $4.8 million and an increase in other liabilities-related parties of $2.2 million.
Current assets remained relatively flat, with a decrease in cash and inventories of $15.9 million and $7.5 million, respectively, offset by an increase in accounts receivable of $4.7 million and the reclassification of our investment in Front Range as a current asset valued at $18.5 million.
Cash used in operating activities of $13.7 million resulted primarily from net income of $85.5 million, which was partially offset by a gain from bankruptcy exit of $119.4 million, an increase in accounts receivable of $13.1 million, which was partially offset by an increase in accounts payable and accrued expenses of $14.6 million, loss on investment in Front Range of $12.1 million, depreciation expense of $6.0 million, increase in prepaid expense of $2.4 million and a loss on extinguishments of debt of $2.2 million.
Cash used in investing activities of $12.1 million resulted primarily from the net impact of our deconsolidation of Front Range of $10.5 million and the net impact of the Plant Owners’ exit from bankruptcy of $1.3 million.
Cash provided by financing activities of $9.9 million resulted primarily from proceeds from borrowings under the Plant Owners’ debtor-in-possession credit agreement of $5.2 million and net proceeds from Kinergy’s line of credit of $4.7 million.
Year Ended December 2009 as Compared to Year Ended December 31, 2008
Our working capital decreased to a deficit of $50.9 million at December 31, 2009 from a deficit of $274.8 million at December 31, 2008 as a result of a significant decrease in current liabilities of $247.1 million, which was partially offset by a decrease in current assets of $23.1 million.
Current liabilities decreased significantly primarily due to the Chapter 11 Filings, which reclassified our prepetition debt to liabilities subject to compromise, which was $242.4 million at December 31, 2009. Current liabilities also decreased due to a decrease in construction-related liabilities from our write-off of the liabilities of our Imperial Project.
Current assets decreased primarily due to net decreases in accounts receivable and inventories, as we idled operations at three of our facilities for most of 2009. At December 31, 2009, our Columbia and Front Range facilities were operating, whereas, at December 31, 2008, most of our facilities were operating at near full capacity.
Cash used in our operating activities of $6.3 million resulted primarily from a loss of $308.7 million, gain on our write-off of the liabilities of our Imperial Project of $14.2 million, gains on derivative instruments of $3.7 million and a decrease in accounts payable and accrued expenses of $3.1 million, which were partially offset by noncash asset impairment charges of $252.4 million, depreciation and amortization of intangibles of $34.9 million, a decrease in accounts receivable of $12.0 million, write-off of unamortized deferred financing fees of $7.5 million, decrease in inventory of $5.4 million and an increase in related party accounts payable and accrued expenses of $6.6 million.
Cash provided by our investing activities of $3.4 million resulted primarily from proceeds from sales of marketable securities of $7.7 million, which was partially offset by additions to property and equipment of $4.3 million.
Cash provided by our financing activities of $9.0 million resulted primarily from proceeds from borrowings under our debtor-in-possession financing of $19.8 million and proceeds from related party borrowings of $2.0 million, which were partially offset by principal debt payments of $12.8 million.
Notes Payable to Related Parties
On March 31, 2009, our Chairman of the Board and our Chief Executive Officer provided funds totaling $2,000,000 for general cash and operating purposes, in exchange for two unsecured promissory notes payable by us. 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 March 2010. The maturity date of these notes was initially extended to January 5, 2011. On October 29, 2010, we paid $750,000 of principal on these notes and all accrued and unpaid interest. On November 5, 2010, we further extended the maturity date of these notes to March 31, 2012.
Kinergy Operating Line of Credit
Kinergy maintains a credit facility in the aggregate amount of up to $15.0 million. The term of the credit facility expires on December 31, 2010. Kinergy may borrow under the credit facility based upon (i) a rate equal to (a) the London Interbank Offered Rate, or LIBOR, divided by 0.90 (subject to change based upon the reserve percentage in effect from time to time under Regulation D of the Board of Governors of the Federal Reserve System), plus (b) 4.50% depending on the amount of Kinergy’s earnings before interest, taxes, depreciation and amortization, or EBITDA, for a specified period, or (ii) a rate equal to (a) the greater of the prime rate published by Wachovia Bank from time to time, or the federal funds rate then in effect plus 0.50%, plus (b) 2.25% depending on the amount of Kinergy’s EBITDA for a specified period. The credit facility’s monthly unused line fee is 0.50% of the amount by which the maximum credit under the facility exceeds the average daily principal balance. Kinergy is also required to pay customary fees and expenses associated with the credit facility and issuances of letters of credit. In addition, Kinergy is responsible for a $5,000 monthly servicing fee. Payments that may be made by Kinergy to Pacific Ethanol as reimbursement for management and other services provided by Pacific Ethanol to Kinergy are limited to $0.6 million in any three month period and $2.4 million in any twelve month period. Kinergy is required to meet specified EBITDA financial covenants under the credit facility and is prohibited from incurring any additional indebtedness (other than specific intercompany indebtedness) or making any capital expenditures in excess of $100,000 absent the lender’s prior consent. Kinergy’s obligations under the credit facility are secured by a first-priority security interest in all of its assets in favor of the lender.
Completion of Chapter 11 Filings
On the Effective Date, we ceased to directly or indirectly own the membership interests in the Plant Owners and their holding company. As a result, we removed the following assets and liabilities from our consolidated financial statements at June 29, 2010, resulting in a gain from the exit from bankruptcy of $119.4 million (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 Liabilities
|
|
$ |
119,408 |
|
Registration Rights Agreements
In connection with the sale of the Notes and Warrants, we entered into registration rights agreements with the investors to file a registration statement on Form S-1 with the SEC. See “Selling Security Holders – Registration Rights Agreement.”
Effects of Inflation
The impact of inflation was not significant to our financial condition or results of operations for the nine months ended September 30, 2010 and 2009 and the years ended December 31, 2009 and 2008.
Business Overview
Background
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 Marketing, LLC, or 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, four wholly-owned production facilities through a subsidiary holding company and the Plant Owners.
In 2006, we completed our Madera, California facility and began producing ethanol and its co-products at the facility, and also acquired a 42% interest in Front Range, which owns a fully operational production facility in Windsor, Colorado. In 2007, we entered into credit agreements to borrow up to $325.0 million to fund the construction of, or refinance indebtedness in respect of, up to five ethanol production facilities and provide working capital as each production facility became operational. Later in 2007, the credit facility was reduced to $250.8 million for up to four ethanol production facilities. A portion of this indebtedness was used to refinance outstanding indebtedness in respect of the Madera facility as well as other facilities under construction. In 2007, we began production at the Columbia facility in Boardman, Oregon and in 2008, we began production at the Magic Valley facility in Burley, Idaho and another facility in Stockton, California. See “—Pacific Ethanol Plants” below.
Our net sales increased significantly from $87.6 million in 2005 to $703.9 million in 2008 as the Pacific Ethanol Plants began production in 2006, 2007 and 2008, with all facilities producing and selling ethanol in the last quarter of 2008. During these periods, we also sold additional volume under ethanol marketing arrangements with third party suppliers. However, our net sales dropped considerably to $316.6 million in 2009 as we idled production at three of the Pacific Ethanol Plants for most of 2009, as discussed further below.
Our average ethanol sales price peaked at $2.28 per gallon in 2006, stayed relatively stable for 2007 and 2008, but declined to $1.80 per gallon in 2009. In 2007, our average price of corn, the primary raw material for our ethanol production, began increasing dramatically, ultimately rising by over 125% from $2.44 per bushel in 2006 to $5.52 per bushel in 2008. As a result, our gross margins, which peaked at 11.0% in 2006, began declining in 2007, reaching negative 4.7% in 2008. Our average price of corn declined to $3.98 per bushel in 2009, but lower ethanol prices and overhead and depreciation expenses with no corresponding sales from the idled facilities resulted in a gross margin of negative 7.0% in 2009.
From 2006 until the fourth quarter of 2008, when the fourth Pacific Ethanol Plant was completed, we maintained a cost structure commensurate with our construction activities, including substantial project overhead and staffing. Upon completion of the fourth Pacific Ethanol Plant, we sought to alter our cost structure to one more suitable for an operating company. However, beginning in 2008, we began experiencing significant financial constraints and adverse market conditions, and our working capital lines of credit for the Pacific Ethanol Plants were insufficient given substantially higher corn prices and other input costs in the production process.
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. Both we and the ethanol industry experienced significant adverse conditions through most of 2009 as a result of elevated corn prices, reduced demand for transportation fuel and declining ethanol prices, resulting in prolonged negative operating margins. In response to these adverse conditions, as well as severe working capital and liquidity constraints, we reduced production significantly and implemented many cost-saving initiatives. Market conditions improved in the last quarter of 2009 and in response, in January 2010, we resumed operations at the Magic Valley facility. However, margins began deteriorating in late February 2010 and continued to deteriorate in March 2010.
On May 17, 2009, each of the Bankrupt Debtors 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, or Bankruptcy Court, in an effort to restructure their indebtedness. The Plant Owners continued to operate their businesses and manage their properties as debtors and debtors-in-possession during the pendency of the bankruptcy proceedings.
On June 3, 2009, the Bankruptcy Court approved the Bankrupt Debtors’ post petition financing facility provided by WestLB, AG, New York Branch and the banks and financial institutions that are from time to time lender parties to the Amended and Restated Debtor-in-Possession Credit Agreement dated June 3, 2009, or as amended, the Post petition Credit Agreement. The post petition credit facility was intended to fund the Bankrupt Debtors’ working capital and general corporate needs in the ordinary course of business and allow them to pay these other amounts as required or permitted to be paid under the terms of the Post petition Credit Agreement, including the administrative costs associated with the Chapter 11 Filings.
On March 26,2010, the Bankrupt Debtors filed a joint plan of reorganization with the Bankruptcy Court. On April 16, 2010, the Bankrupt Debtors filed an amended joint plan of reorganization, or the Plan, with the Bankruptcy Court, which was structured in cooperation with a number of the Bankrupt Debtors’ secured lenders. The Bankruptcy Court confirmed the Plan at a hearing on June 8, 2010. On June 29, 2010, or Effective Date, the Bankrupt Debtors emerged from bankruptcy under the terms of the Plan.
On the Effective Date, approximately $294.4 million in prepetition and post petition secured indebtedness of the Bankrupt Debtors was restructured under a credit agreement entered into on June 25, 2010 among Bankrupt Debtors, as borrowers, and WestLB, AG, New York Branch, or WestLB, and other lenders, or Credit Agreement. Under the Plan, the Bankrupt Debtors’ existing prepetition and post petition secured indebtedness of approximately $294.4 million was restructured to consist of approximately $50.0 million in three-year term loans and a new three-year revolving credit facility of up to $35.0 million to fund working capital requirements (the revolver is initially capped at $15.0 million but may be increased to up to $35.0 million if more than two of the Pacific Ethanol Plants cease operations).
Under the Plan, on the Effective Date, all of the ownership interests in the Plant Owners were transferred to New PE Holdco, wholly-owned as of that date by some of the prepetition lenders of the Bankrupt Debtors and the new lenders to the post emergence companies under the Credit Agreement. As a result, the Pacific Ethanol Plants are now wholly-owned by New PE Holdco.
Also on the Effective Date, we entered into a Call Option Agreement with New PE Holdco and a number of owners of membership interests in New PE Holdco, or New PE Holdco Option Agreement, whereby we had the right to acquire from the owners membership interests in New PE Holdco in an amount up to 25% of the total membership interests in New PE Holdco for a total price of $30 million in cash (or $1,200,000 for each one percent of membership interest in New PE Holdco). On October 6, 2010, we purchased 12% of the outstanding membership interests in New PE Holdco for a total price of $14.4 million in cash under the New PE Holdco Option Agreement.
On the Effective Date, we also entered into an Asset Management Agreement with the Bankrupt Debtors under which we have agreed to provide management services to the Plant Owners whereby we will effectively operate and maintain the production facilities on behalf of the Plant Owners. These services generally include, but are not limited to, administering each Plant Owners’ compliance with the Credit Agreement and related financing documents and performing billing, collection, record keeping and other administrative and ministerial responsibilities for each facility. We have agreed to supply all labor and personnel required to perform its services under the agreement, including, but not limited to, the labor and personnel required to operate and maintain the production facilities.
Recent Developments
On October 6, 2010, we raised $35 million through the issuance of $35 million in principal amount of Notes and Warrants to purchase an aggregate of 20,588,235 shares of our common stock. See “Description of Note and Warrant Financing.” On that same date we sold our 42% interest in 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. Of the 20% ownership interest in New PE Holdco we acquired on October 6, 2010, a 12% ownership interest in New PE Holdco was acquired under the New PE Holdco Option Agreement described above.
Current Operations
We currently manage the production of ethanol at the Pacific Ethanol Plants under the terms of an asset management agreement with a number of subsidiaries of New PE Holdco. 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 produce ethanol and co-products and are comprised of the four facilities described below. The Stockton California facility is in the process of becoming operational. We expect to re-start the facility by the end of December 2010. In addition, if market conditions continue to improve, we may re-start the Madera, California facility during the first quarter of 2011,subject to the approval of New PE Holdco.
| |
|
Estimated Annual
|
Current
|
| |
|
Production Capacity
|
Operating
|
|
Facility Name
|
Facility Location
|
(gallons)
|
Status
|
| |
|
|
|
|
Magic Valley
|
Burley, ID
|
60,000,000
|
Operating
|
|
Columbia
|
Boardman, OR
|
40,000,000
|
Operating
|
|
Stockton
|
Stockton, CA
|
60,000,000
|
Idled
|
|
Madera
|
Madera, CA
|
40,000,000
|
Idled
|
Company History
We are a Delaware corporation formed in February 2005. Our main Internet address is http://www.pacificethanol.net. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other SEC filings are available free of charge through our website as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC. Our common stock trades on The NASDAQ Capital Market under the symbol “PEIX.” The inclusion of our Internet website address in this prospectus does not include or incorporate by reference into this prospectus any information contained on our website.
Business Strategy
Our primary goal is to maintain and advance our position as the leading marketer and producer of low carbon renewable fuels in the Western United States. We view the key elements of our business and growth strategy to achieve this objective in short- and long-term perspectives, which include:
Short-Term Strategy
· Expand ethanol production and marketing revenues, ethanol markets and distribution infrastructure. We plan to increase our ethanol production and marketing revenues by expanding our relationships with third-party ethanol producers and our ethanol customers to increase sales volumes of ethanol throughout the Western United States at profitable margins. In addition, we plan to maintain and increase sales to animal feed customers in the local markets we serve for WDG. We also plan to expand the market for ethanol by continuing to work with the federal government and state governments to encourage the adoption of policies and standards that promote ethanol as a component in transportation fuels. In addition, we plan to expand our distribution infrastructure by increasing our ability to provide transportation, storage and related logistical services to our customers throughout the Western United States.
· Operation of Pacific Ethanol Plants. We provide day-to-day operational expertise to manage the Pacific Ethanol Plants under an asset management agreement. We intend to continue operating the Pacific Ethanol Plants in a part owner-operator capacity. Further, as idle Pacific Ethanol Plants and other third party facilities become operational, we intend to expand our business by providing management services to those facilities.
· Focus on cost efficiencies. We operate the Pacific Ethanol Plants in markets where we believe local characteristics create an opportunity to capture a significant production and shipping cost advantage over competing ethanol production facilities. We believe a combination of factors will enable us to achieve this cost advantage, including:
|
|
o
|
Locations near fuel blending facilities will enable lower ethanol transportation costs and allow timing and logistical advantages over competing locations which require ethanol to be shipped over much longer distances.
|
|
|
o
|
Locations adjacent to major rail lines will enable the efficient delivery of corn in large unit trains from major corn-producing regions.
|
|
|
o
|
Locations near large concentrations of dairy and/or beef cattle will enable delivery of WDG over short distances without the need for costly drying processes.
|
In addition to these location-related efficiencies, we believe that we can continue to increase operating efficiencies by incorporating advanced design elements into the production facilities to take advantage of state-of-the-art technical and operational efficiencies.
Long-Term Strategy
· Increase our ownership interest in New PE Holdco. We intend to increase our ownership interest in New PE Holdco as opportunities arise to purchase additional interests from other members and as financial resources and business prospects make the acquisition of additional ownership interests in New PE Holdco advisable.
· Explore new technologies and renewable fuels. We are evaluating a number of technologies that may increase the efficiency of our ethanol production facilities and reduce our use of carbon-based fuels. In addition, we are exploring the feasibility of using different and potentially abundant and cost-effective feedstocks, including cellulosic feed stock, to supplement corn as the raw material used in the production of ethanol. As capital resources become available, we intend to continue pursuing these opportunities, including continuing our efforts to build a cellulosic ethanol demonstration facility in the Northwest United States at the Columbia site. On January 29, 2008, the DOE awarded us $24.3 million in matching funds to assist in this project.
· Evaluate and pursue acquisition opportunities. We intend to evaluate and pursue opportunities to acquire additional ethanol production, storage and distribution facilities and related infrastructure as financial resources and business prospects make the acquisition of these facilities advisable. In addition, we may also seek to acquire facility sites under development.
Competitive Strengths
We believe that our competitive strengths include the following:
· Our customer and supplier relationships. We have developed extensive business relationships with our customers and suppliers. In particular, we have developed extensive business relationships with major and independent un-branded gasoline suppliers who collectively control the majority of all gasoline sales in California and other Western states. In addition, we have developed extensive business relationships with ethanol and grain suppliers throughout the Western and Midwestern United States.
· Our ethanol distribution network. We believe that we have a competitive advantage due to our experience in marketing to the segment of customers in major metropolitan and rural markets in the Western United States. We have developed an ethanol distribution network for delivery of ethanol by truck to virtually every significant fuel terminal as well as to numerous smaller fuel terminals throughout California and other Western states. Fuel terminals have limited storage capacity and we have been successful in securing storage tanks at many of the terminals we service. In addition, we have an extensive network of third-party delivery trucks available to deliver ethanol throughout the Western United States.
· Our operational expertise. We began managing ethanol production facilities in 2006. We believe that we have obtained operational expertise and know-how that can be used to continue operating the Pacific Ethanol Plants and provide operational services to third party facilities.
· Our strategic locations. We believe that our focus on developing and acquiring ethanol production facilities in markets where local characteristics create the opportunity to capture a significant production and shipping cost advantage over competing ethanol production facilities provides us with competitive advantages, including transportation cost, delivery timing and logistical advantages as well as higher margins associated with the local sale of WDG and other co-products.
· Our California production. With the recent California enacted Low Carbon Fuels Standard for transportation fuels, carbon emission standards placed on ethanol produced in California are currently higher than in other states. As a result, the ethanol produced at the Pacific Ethanol Plants and marketed through Kinergy provides added benefits to our customers in meeting their own emission requirements.
· Modern technologies. The Pacific Ethanol Plants use the latest production technologies to take advantage of state-of-the-art technical and operational efficiencies in order to achieve lower operating costs and more efficient production of ethanol and its co-products and reduce our use of carbon-based fuels.
· Our experienced management. Neil M. Koehler, our President and Chief Executive Officer, has over 20 years of experience in the ethanol production, sales and marketing industry. Mr. Koehler is a Director of the California Renewable Fuels Partnership, a Director of the Renewable Fuels Association, or RFA, and is a frequent speaker on the issue of renewable fuels and ethanol marketing and production. In addition to Mr. Koehler, we have seasoned managers with many years of experience in the ethanol, fuel and energy industries, leading our various departments. We believe that the experience of our management over the past two decades and our ethanol marketing operations have enabled us to establish valuable relationships in the ethanol industry and understand the business of marketing and producing ethanol and its co-products.
We believe that these advantages will allow us to capture an increasing share of the total market for ethanol and its co-products.
Industry Overview and Market Opportunity
Overview of Ethanol Market
The primary applications for fuel-grade ethanol in the United States include:
· Octane enhancer. On average, regular unleaded gasoline has an octane rating of 87 and premium unleaded has an octane rating of 91. In contrast, pure ethanol has an average octane rating of 113. Adding ethanol to gasoline enables refiners to produce greater quantities of lower octane blend stock with an octane rating of less than 87 before blending. In addition, ethanol is commonly added to finished regular grade gasoline as a means of producing higher octane mid-grade and premium gasoline.
· Renewable fuels. Ethanol is blended with gasoline in order to enable gasoline refiners to comply with a variety of governmental programs, in particular, the national RFS program which was enacted to promote alternatives to fossil fuels. See “—Governmental Regulation.”
· Fuel blending. In addition to its performance and environmental benefits, ethanol is used to extend fuel supplies. As the need for automotive fuel in the United States increases and the dependence on foreign crude oil and refined products grows, the United States is increasingly seeking domestic sources of fuel. Much of the ethanol blending throughout the United States is done for the purpose of extending the volume of fuel sold at the gasoline pump.
The ethanol fuel industry is greatly dependent upon tax policies and environmental regulations that favor the use of ethanol in motor fuel blends in the United States. See “—Governmental Regulation.” Ethanol blends have been either wholly or partially exempt from the federal excise tax on gasoline since 1978. The current federal excise tax on gasoline is $0.184 per gallon and is paid at the terminal by refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.45 per gallon tax credit for each gallon of ethanol used in the mixture. Federal law also requires the sale of oxygenated fuels in a number of carbon monoxide non-attainment Metropolitan Statistical Areas, or MSAs, during at least four winter months, typically November through February.
In addition, the Energy Independence and Security Act of 2007, which was signed into law in December 2007, significantly increased the prior national RFS. The national RFS significantly increases the mandated use of renewable fuels to 12.95 billion gallons in 2010 and 13.95 billion gallons in 2011, and rises incrementally and peaks at 36.0 billion gallons by 2022. We believe that these increases will bolster demand for ethanol.
Effective January 1, 2010, the State of California implemented a Low Carbon Fuels Standard for transportation fuels. The California Governor’s office estimates that the standard will have the effect of increasing current renewable fuels use in California by three to five times by 2020. The State of Oregon implemented a state-wide renewable fuels standard effective January 2008. This standard requires a 10% ethanol blend in every gallon of gasoline and is expected to cause the use of approximately 160 million gallons of ethanol per year in Oregon.
According to the RFA, the domestic ethanol industry produced approximately 10.8 billion gallons of ethanol in 2009, an increase of approximately 20% from the approximately 9.0 billion gallons of ethanol produced in 2008. We believe that the ethanol market in California alone represented approximately 10% of the national market. However, the Western United States has relatively few ethanol facilities and local ethanol production levels are substantially below the local demand for ethanol. The balance of ethanol is shipped via rail from the Midwest to the Western United States. Gasoline and diesel fuel that supply the major fuel terminals are shipped in pipelines throughout portions of the Western United States. Unlike gasoline and diesel fuel, however, ethanol is not shipped in these pipelines because ethanol has an affinity for mixing with water already present in the pipelines. When mixed, water dilutes ethanol and creates significant quality control issues. Therefore, ethanol must be trucked from rail terminals to regional fuel terminals, or blending racks.
We believe that approximately 90% of the ethanol produced in the United States is made in the Midwest from corn. According to the DOE, ethanol is typically blended at 5.7% to 10% by volume, but is also blended at up to 85% by volume for vehicles designed to operate on 85% ethanol. The Environmental Protection Agency, or EPA, recently increased the allowable blend of ethanol in gasoline from 10% to 15%. Compared to gasoline, ethanol is generally considered to be cleaner burning and contains higher octane. We anticipate that the increasing demand for transportation fuels coupled with limited opportunities for gasoline refinery expansions and the growing importance of reducing CO2 emissions through the use of renewable fuels will generate additional growth in the demand for ethanol in the Western United States.
Ethanol prices, net of tax incentives offered by the federal government, are generally positively correlated to fluctuations in gasoline prices. In addition, we believe that ethanol prices in the Western United States are typically $0.15 to $0.20 per gallon higher than in the Midwest due to the freight costs of delivering ethanol from Midwest production facilities.
According to the DOE, total annual gasoline consumption in the United States is approximately 138 billion gallons and total annual ethanol consumption represented less than 8% of this amount in 2009. We believe that the domestic ethanol industry has substantial potential for growth to initially reach what we estimate is an achievable level of at least 10% of the total annual gasoline consumption in the United States, or approximately 14 billion gallons of ethanol annually and thereafter up to 36 billion gallons of ethanol annually required under the national RFS by 2022.
While we believe that the overall national market for ethanol will grow, we believe that the market for ethanol in specific geographic areas including California could experience either increases or decreases in demand depending on, among other factors, the preferences of petroleum refiners and state policies. See “Risk Factors.”
Overview of Ethanol Production Process
The production of ethanol from starch- or sugar-based feedstocks has been refined considerably in recent years, leading to a highly-efficient process that we believe now yields substantially more energy in the ethanol and co-products than is required to make the products. The modern production of ethanol requires large amounts of corn, or other high-starch grains, and water as well as chemicals, enzymes and yeast, and denaturants including unleaded gasoline or liquid natural gas, in addition to natural gas and electricity.
In the dry milling process, corn or other high-starch grains are first ground into meal and then slurried with water to form a mash. Enzymes are then added to the mash to convert the starch into the simple sugar, dextrose. Ammonia is also added for acidic (pH) control and as a nutrient for the yeast. The mash is processed through a high temperature cooking procedure, which reduces bacteria levels prior to fermentation. The mash is then cooled and transferred to fermenters, where yeast is added and the conversion of sugar to ethanol and CO2 begins.
After fermentation, the resulting “beer” is transferred to distillation, where the ethanol is separated from the residual “stillage.” The ethanol is concentrated to 190 proof using conventional distillation methods and then is dehydrated to approximately 200 proof, representing 100% alcohol levels, in a molecular sieve system. The resulting anhydrous ethanol is then blended with about 5% denaturant, which is usually gasoline, and is then ready for shipment to market.
The residual stillage is separated into a coarse grain portion and a liquid portion through a centrifugation process. The soluble liquid portion is concentrated to about 40% dissolved solids by an evaporation process. This intermediate state is called condensed distillers solubles, or syrup. The coarse grain and syrup portions are then mixed to produce WDG or can be mixed and dried to produce dried distillers grains with solubles, or DDGS. Both WDG and DDGS are high-protein animal feed products.
Overview of Distillers Grains Market
Most distillers grains are produced in the Midwest, where producers dry the grains before shipping. Successful and profitable delivery of DDGS from the Midwest to markets in the Western United States faces a number of challenges, including drying of distiller grains which may increase the energy cost to dry the grains and reduce the quality of the feed product, and longer distance to market, which may increase the handling and transportation costs to deliver the grains to market. By not drying the distillers grains and by shipping WDG locally, we believe that we will be able to better preserve the feed value of this product, as the WDG retains a higher percentage of nutrients than DDGS.
Historically, the market price for distillers grains has generally tracked the value of corn. We believe that the market price of DDGS is determined by a number of factors, including the market value of corn, soybean meal and other competitive ingredients, the performance or value of DDGS in a particular feed formulation and general market forces of supply and demand. The market price of distillers grains is also often influenced by nutritional models that calculate the feed value of distillers grains by nutritional content, as well as reliability of consistent supply.
Customers
We purchase ethanol from the Pacific Ethanol Plants and other third-parties and resell ethanol to various customers in the Western United States. We also arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers. In addition, we purchase WDG from the Pacific Ethanol Plants and sell WDG to customers comprised of dairies and feedlots located near the Pacific Ethanol Plants.
During 2009 and 2008, we produced or purchased ethanol from third parties and resold an aggregate of approximately 173 million and 268 million gallons of fuel-grade ethanol to approximately 60 and 66 customers, respectively. Sales to our two largest customers in 2009 and 2008 represented approximately 32% of our net sales for each of those years. These customers who accounted for 10% or more of our net sales in 2009 and 2008 were Chevron Products USA and Valero Marketing. Sales to each of our other customers represented less than 10% of our net sales in each of 2009 and 2008.
Most of the major metropolitan areas in the Western United States have fuel terminals served by rail, but other major metropolitan areas and more remote smaller cities and rural areas do not. We believe that we have a competitive advantage due to our experience in marketing to the segment of customers in major metropolitan and rural markets in the Western United States. We manage the complicated logistics of shipping ethanol purchased from third-parties from the Midwest by rail to intermediate storage locations throughout the Western United States and trucking the ethanol from these storage locations to blending racks where the ethanol is blended with gasoline. We believe that by establishing an efficient service for truck deliveries to these more remote locations, we have differentiated ourselves from our competitors. In addition, by producing ethanol in the Western United States, we believe that we will benefit from our ability to increase spot sales of ethanol from this additional supply following ethanol price spikes caused from time to time by rail delays in delivering ethanol from the Midwest to the Western United States. In addition to producing ethanol, we produce ethanol co-products including WDG. We endeavor to position WDG as the protein feed of choice for cattle based on its nutritional composition, consistency of quality and delivery, ease of handling and its mixing ability with other feed ingredients. We are one of the few WDG producers with production facilities located in the Western United States and we primarily sell our WDG to dairy farmers in close proximity to the Pacific Ethanol Plants.
Suppliers
Our marketing operations are dependent upon various third-party producers of fuel-grade ethanol. In addition, we provide ethanol transportation, storage and delivery services through third-party service providers with whom we have contracted to receive ethanol at agreed upon locations from our suppliers and to store and/or deliver the ethanol to agreed upon locations on behalf of our customers. These contracts generally run from year-to-year, subject to termination by either party upon advance written notice before the end of the then-current annual term.
During 2009 and 2008, we purchased fuel-grade ethanol and corn, the largest component in producing ethanol, from our suppliers. Purchases from our three largest suppliers in 2009 represented approximately 45% of our total ethanol and corn purchases. Purchases from our two largest suppliers in 2008 represented approximately 49% of our total ethanol and corn purchases. Purchases from each of our other suppliers represented less than 10% of total ethanol and corn purchases in each of 2009 and 2008.
The ethanol production operations of the Pacific Ethanol Plants are dependent upon various raw materials suppliers, including suppliers of corn, natural gas, electricity and water. The cost of corn is the most important variable cost associated with the production of ethanol. An ethanol facility must be able to efficiently ship corn from the Midwest via rail and cheaply and reliably truck ethanol to local markets. We believe that our existing grain receiving facilities at the Pacific Ethanol Plants are some of the most efficient grain receiving facilities in the United States. We source corn for the Pacific Ethanol Plants using standard contracts, including spot purchase, forward purchase and basis contracts. When resources are available to do so, we seek to limit the exposure of the Pacific Ethanol Plants to raw material price fluctuations by purchasing forward a portion of their corn requirements on a fixed price basis and by purchasing corn and other raw materials future contracts. In addition, to help protect against supply disruptions, the Pacific Ethanol Plants may maintain inventories of corn.
Pacific Ethanol Plants
The table below provides an overview of the Pacific Ethanol Plants owned by New PE Holdco and operated by us. 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.
| |
|
|
|
|
|
Location
|
Madera, CA
|
Boardman, OR
|
Burley, ID
|
Stockton, CA
|
|
Quarter/Year operations began
|
4th Qtr., 2006
|
3rd Qtr., 2007
|
2nd Qtr., 2008
|
3rd Qtr., 2008
|
|
Operating status
|
Idled
|
Operating
|
Operating
|
Idled
|
|
Annual design basis ethanol production capacity (in millions of gallons)
|
35
|
35
|
50
|
50
|
|
Approximate maximum annual ethanol production capacity (in millions of gallons)
|
40
|
40
|
60
|
60
|
|
Ownership by New PE Holdco
|
100%
|
100%
|
100%
|
100%
|
|
Primary energy source
|
Natural Gas
|
Natural Gas
|
Natural Gas
|
Natural Gas
|
|
Estimated annual WDG production capacity (in thousands of tons)
|
293
|
293
|
418
|
418
|
Commodity Risk Management
We may seek to employ one or more risk mitigation techniques when sufficient working capital is available. We may seek to mitigate our exposure to commodity price fluctuations by purchasing forward a portion of our corn and natural gas requirements through fixed-price or variable-price contracts with our suppliers, as well as entering into derivative contracts for ethanol, corn and natural gas prices. To mitigate ethanol inventory price risks, we may sell a portion of our production forward under fixed- or index-price contracts, or both. We may hedge a portion of the price risks by selling exchange-traded futures contracts. Proper execution of these risk mitigation strategies can reduce the volatility of our gross profit margins.
Marketing Arrangements
In addition to our marketing agreements with the Plant Owners whose facilities are operational and a Plant Owner whose facility is in the process of being re-started to market all of the ethanol produced at those Pacific Ethanol Plants, we have exclusive ethanol marketing agreements with third-party ethanol producers, including Calgren Renewable Fuels, LLC and Front Range, to market and sell their entire ethanol production volumes. Calgren Renewable Fuels, LLC owns and operates an ethanol production facility in Pixley, California with annual production capacity of 55 million gallons. Front Range owns and operates an ethanol production facility in Windsor, Colorado with annual production capacity of 50 million gallons. We intend to evaluate and pursue opportunities to enter into marketing arrangements with other ethanol producers as business prospects make these marketing arrangements advisable.
Competition
We operate in the highly competitive ethanol marketing and production industry. The largest ethanol producers in the United States are ADM and Valero with over 18% of the total installed capacity of ethanol in the United States. In addition, there are many mid-size producers with several plants under ownership, smaller producers with one or two plants, and several ethanol marketers that create significant competition. Overall, we believe there are over 200 ethanol facilities in the United States with an installed capacity of approximately 13.2 billion gallons and many brokers and marketers with whom we compete for sales of ethanol and its co-products.
We believe that our competitive strengths include our strategic locations in the Western United States, our extensive ethanol distribution network, our extensive customer and supplier relationships, our use of modern technologies at our production facilities and our experienced management. We believe that these advantages will allow us to capture an increasing share of the total market for ethanol and its co-products and earn favorable margins on ethanol and its co-products that we produce.
Our strategic focus on particular geographic locations designed to exploit cost efficiencies may nevertheless result in higher than expected costs as a result of more expensive raw materials and related shipping costs, including corn, which generally must be transported from the Midwest. If the costs of producing and shipping ethanol and its co-products over short distances are not advantageous relative to the costs of obtaining raw materials from the Midwest, then the planned benefits of our strategic locations may not be realized.
Governmental Regulation
Our business is subject to federal, state and local laws and regulations relating to the protection of the environment and in support of the corn and ethanol industries. These laws, their underlying regulatory requirements and their enforcement, some of which are described below, impact, or may impact, our existing and proposed business operations by imposing:
· restrictions on our existing and proposed business operations and/or the need to install enhanced or additional controls;
· the need to obtain and comply with permits and authorizations;
· liability for exceeding applicable permit limits or legal requirements, in some cases for the remediation of contaminated soil and groundwater at our facilities, contiguous and adjacent properties and other properties owned and/or operated by third parties; and
· specifications for the ethanol we market and produce.
In addition, some of the governmental regulations to which we are subject are helpful to our ethanol marketing and production business. The ethanol fuel industry is greatly dependent upon tax policies and environmental regulations that favor the use of ethanol in motor fuel blends in North America. Some of the governmental regulations applicable to our ethanol marketing and production business are briefly described below.
Federal Excise Tax Exemption
Ethanol blends have been either wholly or partially exempt from the federal excise tax on gasoline since 1978. The exemption has ranged from $0.04 to $0.06 per gallon of gasoline during that 25-year period. The current federal excise tax on gasoline is $0.184 per gallon, and is paid at the terminal by refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.45 per gallon tax credit for each gallon of ethanol used in the mixture. The federal excise tax exemption was revised and its expiration date was extended for the sixth time since its inception as part of the American Jobs Creation Act of 2004. The new expiration date of the federal excise tax exemption is December 31, 2010.
Clean Air Act Amendments of 1990
In November 1990, a comprehensive amendment to the Clean Air Act of 1977 established a series of requirements and restrictions for gasoline content designed to reduce air pollution in identified problem areas of the United States. The two principal components affecting motor fuel content are the oxygenated fuels program, which is administered by states under federal guidelines, and a federally supervised reformulated gasoline, or RFG, program.
Oxygenated Fuels Program
Federal law requires the sale of oxygenated fuels in a number of carbon monoxide non-attainment MSAs during at least four winter months, typically November through February. Any additional MSAs not in compliance for a period of two consecutive years in subsequent years may also be included in the program. The Environmental Protection Agency, or EPA, Administrator is afforded flexibility in requiring a shorter or longer period of use depending upon available supplies of oxygenated fuels or the level of non-attainment. This law currently affects the Los Angeles area, where over 150 million gallons of ethanol are blended with gasoline each winter.
Reformulated Gasoline Program
The Clean Air Act Amendments of 1990 established special standards effective January 1, 1995 for the most polluted ozone non-attainment areas: Los Angeles Area, Baltimore, Chicago Area, Houston Area, Milwaukee Area, New York City Area, Hartford, Philadelphia Area and San Diego, with provisions to add other areas in the future if conditions warrant. California’s San Joaquin Valley, the location of both our Madera and Stockton facilities, was added in 2002. At the outset of the RFG program there were a total of 96 MSAs not in compliance with clean air standards for ozone, which represents approximately 60% of the national market.
The RFG program also includes a provision that allows individual states to “opt into” the federal program by request of the governor, to adopt standards promulgated by California that are stricter than federal standards, or to offer alternative programs designed to reduce ozone levels. Nearly the entire Northeast and middle Atlantic areas from Washington, D.C. to Boston not under the federal mandate have “opted into” the federal standards.
These state mandates in recent years have created a variety of gasoline grades to meet different regional environmental requirements. The RFG program accounts for about 30% of nationwide gasoline consumption. California refiners blend a minimum of 2.0% oxygen by weight, which is the equivalent of 5.7% ethanol in every gallon of gasoline, or roughly 1.0 billion gallons of ethanol per year in California alone.
National Energy Legislation
In addition, the Energy Independence and Security Act of 2007, which was signed into law in December 2007, significantly increased the prior national RFS. The national RFS significantly increases the mandated use of renewable fuels to 12.95 billion gallons in 2010 and 13.95 billion gallons in 2011, and rises incrementally and peaks at 36.0 billion gallons by 2022.
E15 (a blend of gasoline and ethanol)
On October 13, 2010, the EPA partially granted a waiver request application submitted under Section 211(f)(4) of the Clean Air Act. This partial waiver will allow fuel and fuel additive manufacturers to introduce into commerce gasoline that contains greater than 10 volume percent of ethanol, up to 15 volume percent of ethanol, or E15, for use in some motor vehicles once other conditions are fulfilled. This waiver only applies to vehicles from model year 2007 and beyond. It is expected that the EPA will make a determination of waiver for earlier model year cars by the end of 2010. It is important to remember that there are a number of additional steps that must be completed – some of which are not under EPA control – to allow the sale and distribution of E15. These include, but are not limited to, submission of a complete E15 fuels registration application by industry, and changes to some states’ laws to allow for the use of E15.
State Energy Legislation and Regulations
State energy legislation and regulations may affect the demand for ethanol. California recently passed legislation regulating the total emissions of CO2 from vehicles and other sources. In 2006, the State of Washington passed a statewide renewable fuel standard effective December 1, 2008. The State of Oregon implemented a state-wide renewable fuels standard effective January 2008. This standard requires a 10% ethanol blend in every gallon of gasoline and is expected to cause the use of approximately 160 million gallons of ethanol per year in Oregon. We believe other states may also enact their own renewable fuel standards.
In January 2007, California’s Governor signed an executive order directing the California Air Resources Board to implement a Low Carbon Fuels Standard for transportation fuels. The Governor’s office estimates that the standard will have the effect of increasing current renewable fuels use in California by three to five times by 2020.
The State of California has established a policy to support ethanol produced in California with the California Ethanol Producer Incentive Program, or CEPIP, a producer incentive which offers up to $0.25 per gallon when ethanol production profitability is less than prescribed levels determined by the California Energy Commission, or CEC. The Pacific Ethanol Plants located in California are eligible for the CEPIP. This program is scheduled to start in the Fall of 2010 and continue for four years. No assurances can be given that that the California legislation will fund the CEPIP or that the CEC will not alter the program thresholds, participant eligibility or other policy choices that may impact the ability of the Pacific Ethanol Plants located in California to be eligible for the CEPIP.
Additional Environmental Regulations
In addition to the governmental regulations applicable to the ethanol marketing and production industries described above, our business is subject to additional federal, state and local environmental regulations, including regulations established by the EPA, the Regional Water Quality Control Board, the San Joaquin Valley Air Pollution Control District and the California Air Resources Board. We cannot predict the manner or extent to which these regulations will harm or help our business or the ethanol production and marketing industry in general.
Employees
As of December 8 , 2010, we had approximately 144 full-time employees. We believe that our employees are highly-skilled, and our success will depend in part upon our ability to retain our employees and attract new qualified employees who are in great demand. We have never had a work stoppage or strike, and no employees are presently represented by a labor union or covered by a collective bargaining agreement. We consider our relations with our employees to be good.
Legal Proceedings
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect our quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes these matters will not adversely affect our financial position, results of operations or cash flows.
Delta-T Corporation
On August 18, 2008, Delta-T Corporation filed suit in the United States District Court for the Eastern District of Virginia, or 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 $6.5 million, 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, or the 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, or 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 $6.5 million, along with other unspecified damages.
In connection with the Chapter 11 Filings, the Plant Owners moved the Bankruptcy Court 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 Bankruptcy 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 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.
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 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, we believe that Delta-T Corporation intends to liquidate and abandon its claims against us.
Barry Spiegel – State Court Action
On December 22, 2005, Barry J. Spiegel, a former shareholder and director of Accessity, filed a complaint in the Circuit Court of the 17th Judicial District in and for Broward County, Florida (Case No. 05018512), or the State Court Action, against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce Udell, or collectively, the Individual Defendants. Messrs. Udell and Friedman are former directors of Accessity and Pacific Ethanol. Mr. Kart is a former executive officer of Accessity and Pacific Ethanol. Mr. Siegel is a former director and former executive officer of Accessity and Pacific Ethanol.
The State Court Action relates to the Share Exchange Transaction and purports to state the following five counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the Florida Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his Accessity common stock to diminish and is seeking approximately $22.0 million in damages. On March 8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his response in opposition on May 30, 2006. The court granted the motion to dismiss by Order dated December 1, 2006, on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a derivative action.
On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The amended complaint included Pacific Ethanol as a defendant. On March 30, 2007, Pacific Ethanol filed a motion to dismiss the amended complaint. Before the court could decide that motion, on June 4, 2007, Mr. Spiegel amended his complaint, which purports to state two counts: (a) breach of fiduciary duty, and (b) fraudulent inducement. The first count is alleged against the Individual Defendants and the second count is alleged against the Individual Defendants and Pacific Ethanol. The amended complaint was, however, voluntarily dismissed on August 27, 2007, by Mr. Spiegel as to Pacific Ethanol.
Mr. Spiegel sought and obtained leave to file another amended complaint on June 25, 2009, which renewed his case against Pacific Ethanol, and named three additional individual defendants, and asserted the following three counts: (x) breach of fiduciary duty, (y) fraudulent inducement, and (z) aiding and abetting breach of fiduciary duty. The first two counts are alleged solely against the Individual Defendants. With respect to the third count, Mr. Spiegel has named Pacific Ethanol California, Inc. (formerly known as Pacific Ethanol, Inc.), as well as William L. Jones, Neil M. Koehler and Ryan W. Turner. Messrs. Jones and Turner are directors of Pacific Ethanol. Mr. Turner is a former officer of Pacific Ethanol. Mr. Koehler is a director and officer of Pacific Ethanol. Pacific Ethanol and the Individual Defendants filed a motion to dismiss the count against them, and the court granted the motion. Plaintiff then filed another amended complaint, and Defendants once again moved to dismiss. The motion was heard on February 17, 2010, and the court, on March 22, 2010, denied the motion requiring Pacific Ethanol and Messrs. Jones, Koehler and Turner to answer the Complaint and respond to discovery requests.
Barry Spiegel – Federal Court Action
On December 28, 2006, Barry J. Spiegel, filed a complaint in the United States District Court, Southern District of Florida (Case No. 06-61848), or the Federal Court Action, against the Individual Defendants and Pacific Ethanol. The Federal Court Action relates to the Share Exchange Transaction and purports to state the following three counts: (i) violations of Section 14(a) of the Securities Exchange Act of 1934, as amended, or Exchange Act, and SEC Rule 14a-9 promulgated thereunder, (ii) violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (iii) violation of Section 20(A) of the Exchange Act. The first two counts are alleged against the Individual Defendants and Pacific Ethanol and the third count is alleged solely against the Individual Defendants. Mr. Spiegel bases his claims on, among other things, allegations that the actions of the Individual Defendants and Pacific Ethanol in connection with the Share Exchange Transaction resulted in a share exchange ratio that was unfair and resulted in the preparation of a proxy statement seeking shareholder approval of the Share Exchange Transaction that contained material misrepresentations and omissions. Mr. Spiegel is seeking in excess of $15.0 million in damages.
Mr. Spiegel amended the Federal Court Action on March 5, 2007, and Pacific Ethanol and the Individual Defendants filed a Motion to Dismiss the amended pleading on April 23, 2007. Plaintiff Spiegel sought to stay his own federal case, but the Motion was denied on July 17, 2007. The court required Mr. Spiegel to respond to our Motion to Dismiss. On January 15, 2008, the court rendered an Order dismissing the claims under Section 14(a) of the Exchange Act on the basis that they were time barred and that more facts were needed for the claims under Section 10(b) of the Exchange Act. The court, however, stayed the entire case pending resolution of the State Court Action.
MANAGEMENT
Directors and Executive Officers
The following table sets forth information regarding our current directors and executive officers as of December 8 , 2010:
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William L. Jones
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60
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Chairman of the Board and Director
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Neil M. Koehler
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52
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Chief Executive Officer, President and Director
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Bryon T. McGregor
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46
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Chief Financial Officer
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Christopher W. Wright
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57
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Vice President, General Counsel and Secretary
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Terry L. Stone (1)
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60
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Director
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John L. Prince (1)
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67
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Director
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Douglas L. Kieta (2)
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67
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Director
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Larry D. Layne (3)
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69
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Director
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Michael D. Kandris
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62
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Director
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Ryan W. Turner
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35
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Director
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(1) Member of the Audit, Compensation and Nominating and Governance Committees.
(2) Member of the Compensation and Nominating and Governance Committees.
(3) Member of the Audit and Compensation Committees.
Our officers are appointed by and serve at the discretion of our Board of Directors, or Board. There are no family relationships among our executive officers and directors other than Mr. Turner is the son-in-law of Mr. Jones.
Following is a brief description of the business experience and educational background of each of our directors and executive officers, including the capacities in which they served during the past five years:
William L. Jones has served as Chairman of the Board and as a director since March 2005. Mr. Jones is a co-founder of Pacific Ethanol California, Inc., or PEI California, which is now one of our wholly-owned subsidiaries, and served as Chairman of the Board of PEI California since its formation in January 2003 through March 2004, when he stepped off the board of PEI California to focus on his candidacy for one of California’s United States Senate seats. Mr. Jones was California’s Secretary of State from 1995 to 2003. Since May 2002, Mr. Jones has also been the owner of Tri-J Land & Cattle, a diversified farming and cattle company in Fresno County, California. Mr. Jones has a B.A. degree in Agribusiness and Plant Sciences from California State University, Fresno.
Mr. Jones’s qualifications to serve on our Board include:
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co-founder of PEI California;
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knowledge gained through his extensive work as our Chairman since our inception in 2005;
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extensive knowledge of and experience in the agricultural and feed industries, as well as a deep understanding of operations in political environments; and
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background as an owner of a farming company in California, and his previous role in the California state government.
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Neil M. Koehler has served as Chief Executive Officer, President and as a director since March 2005. Mr. Koehler served as Chief Executive Officer of PEI California since its formation in January 2003 and as a member of its board of directors since March 2004. Prior to his association with PEI California, Mr. Koehler was the co-founder and General Manager of Parallel Products, one of the first ethanol production facilities in California, which was sold to a public company in 1997. Mr. Koehler was also the sole manager and sole limited liability company member of Kinergy Marketing, LLC, which he founded in September 2000, and which is now one of our wholly-owned subsidiaries. Mr. Koehler has over 20 years of experience in the ethanol production, sales and marketing industry in the Western United States. Mr. Koehler is a Director of the California Renewable Fuels Partnership, a Director of the RFA and is a nationally-recognized speaker on the production and marketing of renewable fuels. Mr. Koehler has a B.A. degree in Government from Pomona College.
Mr. Koehler’s qualifications to serve on our Board include:
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day-to-day leadership experience as our current President and Chief Executive Officer provides Mr. Koehler with intimate knowledge of our operations;
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extensive knowledge of and experience in the ethanol production, sales and marketing industry, particularly in the Western United States;
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prior leadership experience with other companies in the ethanol industry; and
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day-to-day leadership experience affords a deep understanding of business operations, challenges and opportunities.
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Bryon T. McGregor has served as our Chief Financial Officer since November 19, 2009. Mr. McGregor served as Vice President, Finance at Pacific Ethanol from September 2008 until he became Interim Chief Financial Officer in April 2009. Prior to joining Pacific Ethanol, Mr. McGregor was employed as Senior Director for E*TRADE Financial from February 2002 to August 2008, serving in various capacities including International Treasurer based in London England from 2006 to 2008, Brokerage Treasurer and Director from 2003 to 2006 and Assistant Treasurer and Director of Finance and Investor Relations from 2002 to 2003. Prior to joining E*TRADE, Mr. McGregor served as Manager of Finance and Head of Project Finance for BP (formerly Atlantic Richfield Company – ARCO) from 1998 to 2001. Mr. McGregor has extensive experience in banking and served as a Director of International Project Finance for Credit Suisse from 1992 to 1998, as Assistant Vice President for Sumitomo Mitsubishi Banking Corp (formerly The Sumitomo Bank Limited) from 1989 to 1992, and as Commercial Banking Officer for Bank of America from 1987 to 1989. Mr. McGregor has a B.S. degree in Business Management from Brigham Young University with an emphasis in International Finance and a minor in Japanese.
Christopher W. Wright has served as Vice President, General Counsel and Secretary since June 2006. From April 2004 until he joined Pacific Ethanol in June 2006, Mr. Wright operated an independent consulting practice, advising companies on complex transactions, including acquisitions and financings. Prior to that time, from January 2003 to April 2004, Mr. Wright was a partner with Orrick, Herrington & Sutcliffe, LLP, and from July 1998 to December 2002, Mr. Wright was a partner with Cooley Godward LLP, where he served as Partner-in-Charge of the Pacific Northwest office. Mr. Wright has extensive experience advising boards of directors on compliance, securities matters and strategic transactions, with a particular focus on guiding the development of rapidly growing companies. He has acted as general counsel for numerous technology enterprises in all aspects of corporate development, including fund-raising, business and technology acquisitions, mergers and strategic alliances. Mr. Wright holds an A.B. in History from Yale College and a J.D. from the University of Chicago Law School.
Terry L. Stone has served as a director since March 2005. Mr. Stone is a Certified Public Accountant with over thirty years of experience in accounting and taxation. He has been the owner of his own accountancy firm since 1990 and has provided accounting and taxation services to a wide range of industries, including agriculture, manufacturing, retail, equipment leasing, professionals and not-for-profit organizations. Mr. Stone has served as a part-time instructor at California State University, Fresno, teaching classes in taxation, auditing and financial and management accounting. Mr. Stone is also a financial advisor and franchisee of Ameriprise Financial Services, Inc. Mr. Stone has a B.S. degree in Accounting from California State University, Fresno.
Mr. Stone’s qualifications to serve on our Board include:
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extensive experience with financial accounting and tax matters;
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recognized expertise as an instructor of taxation, auditing and financial and management accounting;
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“audit committee financial expert,” as defined by the SEC, and satisfies the “financial sophistication” requirements of the NASDAQ listing standards; and
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ability to communicate and encourage discussion, together with his experience as a senior independent director of all Board committees on which he serves make him an effective chairman of our Audit Committee.
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John L. Prince has served as a director since July 2005. Mr. Prince is retired but also works as a consultant to Ruan Transport Corp. and other companies. Mr. Prince was an Executive Vice President with Land O’ Lakes, Inc. from July 1998 until his retirement in 2004. Prior to that time, Mr. Prince was President and Chief Executive Officer of Dairyman’s Cooperative Creamery Association, or the DCCA, located in Tulare, California, until its merger with Land O’ Lakes, Inc. in July 1998. Land O’ Lakes, Inc. is a farmer-owned, national branded organization based in Minnesota with annual sales in excess of $6 billion and membership and operations in over 30 states. Prior to joining the DCCA, Mr. Prince was President and Chief Executive Officer for nine years until 1994, and was Operations Manager for the preceding ten years commencing in 1975, of the Alto Dairy Cooperative in Waupun, Wisconsin. Mr. Prince has a B.A. degree in Business Administration from the University of Northern Iowa.
Mr. Prince’s qualifications to serve on our Board include:
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extensive experience in various executive leadership positions;
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day-to-day leadership experience affords a deep understanding of business operations, challenges and opportunities; and
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ability to communicate and encourage discussion help Mr. Prince discharge his duties effectively as chairman of our Nominating and Governance Committee.
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Douglas L. Kieta has served as a director since April 2006. Mr. Kieta is currently retired. Prior to retirement in January 2009, Mr. Kieta was employed by BE&K, Inc., a large engineering and construction company headquartered in Birmingham, Alabama, where he served as the Vice President of Power since May 2006. From April 1999 to April 2006, Mr. Kieta was employed at Calpine Corporation where he was the Senior Vice President of Construction and Engineering. Calpine Corporation is a major North American power company which leases and operates integrated systems of fuel-efficient natural gas-fired and renewable geothermal power plants and delivers clean, reliable and fuel-efficient electricity to customers and communities in 21 U.S. states and three Canadian provinces. Mr. Kieta has a B.S. degree in Civil Engineering from Clarkson University and a Master’s degree in Civil Engineering from Cornell University.
Mr. Kieta’s qualifications to serve on our Board include:
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extensive experience in various leadership positions;
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day-to-day leadership experience affords a deep understanding of business operations, challenges and opportunities; and
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service with Calpine affords a deep understanding of large-scale construction and engineering projects as well as plant operations, which is particularly relevant to our ethanol production facility operations.
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Larry D. Layne has served as a director since December 2007. Mr. Layne joined First Western Bank in 1963 and served in various capacities with First Western Bank and its acquiror, Lloyds Bank of California, and Lloyd’s acquiror, Sanwa Bank, until his retirement in 2000. Sanwa Bank was subsequently acquired by Bank of the West. From 1999 to 2000, Mr. Layne was Vice Chairman of Sanwa Bank in charge of its Commercial Banking Group which encompassed all of Sanwa Bank’s 38 commercial and business banking centers and 12 Pacific Rim branches as well as numerous internal departments. From 1997 to 2000, Mr. Layne was also Chairman of the Board of The Eureka Funds, a mutual fund family of five separate investment funds with total assets of $900 million. From 1996 to 2000, Mr. Layne was Group Executive Vice President of the Relationship Banking Group of Sanwa Bank in charge of its 107 branches and 13 commercial banking centers as well as numerous internal departments. Mr. Layne has also served in various capacities with many industry and community organizations, including as Director and Chairman of the Board of the Agricultural Foundation at California State University, Fresno, or CSUF; Chairman of the Audit Committee of the Ag. Foundation at CSUF; board member of the Fresno Metropolitan Flood Control District; and Chairman of the Ag Lending Committee of the California Bankers Association. Mr. Layne has a B.S. degree in Dairy Husbandry from CSUF and is a graduate of the California Agriculture Leadership Program.
Mr. Layne’s qualifications to serve on our Board include:
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extensive experience in various leadership positions;
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day-to-day leadership experience affords a deep understanding of business operations, challenges and opportunities.
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experience and involvement in California industry and community organizations provides a useful perspective; and
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ability to communicate and encourage discussion help Mr. Layne discharge his duties effectively as chairman of our Compensation Committee.
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Michael D. Kandris has served as a director since June 2008. Mr. Kandris was President, Western Division of Ruan Transportation Management Systems, or RTMS, until his retirement in September 2009. Prior to that time, Mr. Kandris served as President and Chief Operating Officer of RTMS. Mr. Kandris has 30 years of experience in all modes of transportation and logistics. As President for RTMS, Mr. Kandris held responsibilities in numerous operations and administrative functions. Mr. Kandris serves as a board member for the National Tank Truck Organization. Mr. Kandris has a B.S. degree in Business from California State University, Hayward.
Mr. Kandris’ qualifications to serve on our Board include:
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extensive experience in various executive leadership positions;
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extensive experience in rail and truck transportation and logistics; and
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day-to-day leadership experience affords a deep understanding of business operations, challenges and opportunities.
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Ryan W. Turner has served as a director since February 2010. From May 2009 until February 2010, Mr. Turner acted as a consultant to the independent members of the Board, advising on our restructuring efforts. In July 2007, Mr. Turner co-founded and is currently Managing Partner of 6th Street Investments, LLC, a private investment group based in Fresno, California with investments primarily in energy and real estate. Mr. Turner previously served as our Chief Operating Officer and Secretary from March 2005 until April 2006 and as a director from March 2005 until July 2005. Mr. Turner is a co-founder of PEI California and served as its Chief Operating Officer and Secretary and as a director and led all business development efforts of PEI California since its inception in January 2003. Prior to co-founding and joining PEI California, Mr. Turner served as Chief Operating Officer of Bio-Ag, LLC from March 2002 until January 2003. Mr. Turner has a B.A. degree in Public Policy from Stanford University, an M.B.A. from California State University, Fresno and was a member of Class XXIX of the California Agricultural Leadership Program.
Mr. Turner’s qualifications to serve on our Board include:
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·
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co-founder of PEI California;
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·
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knowledge gained through his early work as our Chief Operating Officer and as one of our directors; and
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·
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experience and knowledge gained through his work as a consultant advising our Board and a special committee on our restructuring efforts.
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Director Independence
Our corporate governance guidelines provide that a majority of the Board and all members of the Audit, Compensation and Nominating and Governance Committees of the Board will be independent. On an annual basis, each director and executive officer is obligated to complete a Director and Officer Questionnaire that requires disclosure of any transactions with Pacific Ethanol in which a director or executive officer, or any member of his or her immediate family, have a direct or indirect material interest. Following completion of these questionnaires, the Board, with the assistance of the Nominating and Governance Committee, makes an annual determination as to the independence of each director using the current standards for “independence” established by the SEC and NASDAQ, additional criteria contained in our corporate governance guidelines and consideration of any other material relationship a director may have with Pacific Ethanol.
The Board has determined that all of its directors are independent under these standards, except for (i) Mr. Jones, who is the father-in-law of Ryan W. Turner, one of our current directors and a former executive officer who resigned from his officer position in April 2006, and who was a consultant to Pacific Ethanol during 2009 and 2010 until his appointment as one of our directors in February 2010, (ii) Ryan W. Turner, for the reasons noted above, and (iii) Mr. Koehler, who serves full-time as our Chief Executive Officer and President.
Compensation of Directors
We use a combination of cash and stock-based incentive compensation to attract and retain qualified candidates to serve on our Board. In setting the compensation of directors, we consider the significant amount of time that Board members spend in fulfilling their duties to Pacific Ethanol as well as the experience level we require to serve on our Board. The Board, through its Compensation Committee, annually reviews the compensation and compensation policies for Board members. In recommending director compensation, the Compensation Committee is guided by the following three goals:
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·
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compensation should fairly pay directors for work required in a company of our size and scope;
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·
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compensation should align directors’ interests with the long-term interests of our stockholders; and
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·
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the structure of the compensation should be clearly disclosed to our stockholders.
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In addition, as with our executive compensation, in making compensation decisions as to our directors, our Compensation Committee compared our cash and equity compensation payable to directors against market data obtained by Hewitt Associates. The data included a general industry survey of 235 companies with less than $1,000,000,000 in annual revenues and a general industry survey of 51 companies with between $500,000,000 and $1,000,000,000 in annual revenues. The Compensation Committee set compensation for our directors at approximately the median of compensation paid to directors of the companies comprising the market data provided to us by Hewitt Associates.
Cash Compensation
Our cash compensation plan for directors provides the Chairman of our Board annual compensation of $80,000, the Chairman of our Audit Committee annual compensation of $42,000, the Chairman of our Compensation Committee annual compensation of $36,000, the Chairman of our Nominating and Governance Committee annual compensation of $36,000, the Chairman of our Transportation Committee annual compensation of $36,000 and the Chairman of our Strategic Transactions Committee annual compensation of $36,000. All other directors, except employee directors, receive annual compensation of $24,000. These amounts are paid in advance in bi-weekly installments. In addition, directors are reimbursed for specified reasonable and documented expenses in connection with attendance at meetings of our Board and its committees. Employee directors do not receive director compensation in connection with their service as directors.
Equity Compensation
Our Compensation Committee or our full Board typically grants equity compensation to our newly elected or reelected directors which normally vests as to 100% of the grants no later than one year after the date of grant. Vesting is normally subject to continued service on our Board during the full year.
In determining the amount of equity compensation, the Compensation Committee determines the value of total compensation, approximately targeting the median of compensation paid to directors of the companies comprising the market data provided to us by Hewitt Associates. The Compensation Committee then determines the cash component based on this market data. The balance of the total compensation target is then allocated to equity awards, and the number of shares to be granted to our directors is based on the estimated value of the underlying shares on the expected grant date.
In addition, the Compensation Committee may, from time to time, grant additional equity compensation to directors at the discretion of the Compensation Committee.
Compensation of Employee Director
Mr. Koehler was compensated as a full-time employee and officer but received no additional compensation for service as a Board member during 2009. Information regarding the compensation awarded to Mr. Koehler is included in “—Summary Compensation Table” below.
Director Compensation Table – 2009
The following table summarizes the compensation of our non-employee directors for the year ended December 31, 2009:
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Fees Earned
or Paid in Cash
($)(1)
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William L. Jones
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$80,000
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$—(3)
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$80,000
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Terry L. Stone
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$42,000
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$—(4)
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$42,000
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John L. Prince
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$36,000
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$—(5)
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$36,000
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Douglas L. Kieta
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$36,000
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$—(6)
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$36,000
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Larry D. Layne
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$36,000
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$—(7)
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$36,000
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Michael D. Kandris
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$36,000
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$—(8)
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$36,000
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(1)
|
For a description of annual director fees and fees for chair positions, see the disclosure above under “Compensation of Directors—Cash Compensation.” The value of perquisites and other personal benefits was less than $10,000 in aggregate for each director.
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(2)
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No grants were awarded to our directors in 2009.
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(3)
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At December 31, 2009, Mr. Jones held 75,500 shares from stock awards, including 9,360 unvested shares, and also held options to purchase an aggregate of 50,000 shares of common stock. Mr. Jones was granted 31,200 and 44,300 shares of our common stock on October 4, 2006 and June 12, 2008, having aggregate grant date fair values of $407,472 and $104,991, respectively, calculated based on the fair market value of our common stock on the applicable grant date.
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(4)
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At December 31, 2009, Mr. Stone held 34,600 shares from stock awards and also held options to purchase an aggregate of 15,000 shares of common stock. Mr. Stone was granted 15,600 and 44,300 shares of our common stock on October 4, 2006 and June 12, 2008, having aggregate grant date fair values of $203,736 and $104,991, respectively, calculated based on the fair market value of our common stock on the applicable grant date. On December 28, 2009, Mr. Stone voluntarily relinquished 25,300 unvested shares of restricted stock.
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(5)
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At December 31, 2009, Mr. Prince held 34,600 shares from stock awards and also held options to purchase an aggregate of 15,000 shares of common stock. Mr. Prince was granted 15,600 and 44,300 shares of our common stock on October 4, 2006 and June 12, 2008, having aggregate grant date fair values of $203,736 and $104,991, respectively, calculated based on the fair market value of our common stock on the applicable grant date. On December 28, 2009, Mr. Prince voluntarily relinquished 25,300 unvested shares of restricted stock.
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(6)
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At December 31, 2009, Mr. Kieta held 34,600 shares from stock awards. Mr. Kieta was granted 15,600 and 44,300 shares of our common stock on October 4, 2006 and June 12, 2008, having aggregate grant date fair values of $203,736 and $104,991, respectively, calculated based on the fair market value of our common stock on the applicable grant date. On December 28, 2009, Mr. Kieta voluntarily relinquished 25,300 unvested shares of restricted stock.
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(7)
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At December 31, 2009, Mr. Layne held 34,600 shares from stock awards, including 5,200 unvested shares. Mr. Layne was granted 15,600 and 44,300 shares of our common stock on January 17, 2008 and June 12, 2008, having aggregate grant date fair values of $86,112 and $104,991, respectively, calculated based on the fair market value of our common stock on the applicable grant date. On December 28, 2009, Mr. Layne voluntarily relinquished 25,300 unvested shares of restricted stock.
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(8)
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At December 31, 2009, Mr. Kandris held no shares from stock awards. Mr. Kandris was granted 25,300 shares of our common stock on June 12, 2008, having an aggregate grant date fair value of $59,961, calculated based on the fair market value of our common stock on the grant date. On December 28, 2009, Mr. Kandris voluntarily relinquished 25,300 unvested shares of restricted stock.
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Ryan W. Turner, who was appointed as one of our directors on February 18, 2010, received compensation in 2009 in his capacity as one of our consultants. See “Certain Relationships and Related Transactions” below.
Summary Compensation Table
The following table sets forth summary information concerning the compensation of our (i) Chief Executive Officer and President, who serves as our principal executive officer, (ii) Chief Financial Officer, who serves as our principal financial officer, (iii) Vice President, General Counsel and Secretary, (iv) former Chief Operating Officer, and (v) former Chief Financial Officer, who served as our principal financial officer, or collectively, the named executive officers, for all services rendered in all capacities to us for the years ended December 31, 2009 and 2008.
Name and
Principal Position
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All Other Compensation
($)(2)
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Neil M. Koehler
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2009
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$ |
389,423 |
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$ |
— |
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$ |
— |
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$ |
15,542 |
(3) |
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$ |
404,965 |
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Chief Executive Officer and President
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2008
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$ |
359,135 |
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$ |
— |
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$ |
342,805 |
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$ |
14,071 |
(3) |
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$ |
716,011 |
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Bryon T. McGregor
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2009
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$ |
197,827 |
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$ |
40,000 |
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$ |
— |
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$ |
— |
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$ |
237,827 |
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Chief Financial Officer(4)
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2008
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$ |
61,192 |
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$ |
20,000 |
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$ |
7,450 |
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$ |
— |
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$ |
88,642 |
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Christopher W. Wright
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2009
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$ |
249,231 |
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$ |
— |
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$ |
— |
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$ |
— |
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$ |
249,231 |
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Vice President, General Counsel and Secretary
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2008
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$ |
236,827 |
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$ |
— |
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$ |
95,984 |
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$ |
— |
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$ |
332,811 |
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John T. Miller
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2009
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$ |
308,942 |
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$ |
— |
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$ |
— |
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$ |
30,531 |
(6) |
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$ |
339,473 |
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former Chief Operating Officer(5)
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2008
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$ |
301,250 |
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$ |
— |
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$ |
137,121 |
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$ |
12,050 |
(3) |
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$ |
450,421 |
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Joseph W. Hansen
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2009
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$ |
76,923 |
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$ |
— |
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$ |
— |
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$ |
190,358 |
(8) |
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$ |
267,281 |
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former Chief Financial Officer(7)
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2008
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$ |
238,461 |
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$ |
— |
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$ |
386,612 |
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$ |
— |
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$ |
625,073 |
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(1)
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The amounts shown are the fair value of stock awards on the date of grant. Fair value is calculated by multiplying the number of shares of stock granted by the closing price of our common stock on the date of grant. The shares of common stock were issued under our 2006 Plan. Information regarding the vesting schedules for the named executive officers is included in the footnotes to the “Outstanding Equity Awards at Fiscal Year-End-2009” table below. No stock awards were made to the named executive officers in 2009.
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(2)
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Except as contained in the table, the value of perquisites and other personal benefits was less than $10,000 in aggregate for each of the named executive officers.
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(3)
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Amount represents matching 401K funds.
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(4)
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Mr. McGregor was appointed as our Chief Financial Officer on November 19, 2009 and as our Interim Chief Financial Officer on April 21, 2009.
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(5)
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Mr. Miller’s employment ended on December 4, 2009. Mr. Miller was previously our Acting Chief Financial Officer from July 19, 2007 through January 1, 2008.
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(6)
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Amount includes $18,173 in severance paid for 2009 under Mr. Miller’s Amended and Restated Executive Employment Agreement and $12,358 in matching 401K funds. Mr. Miller’s employment ended on December 4, 2009.
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(7)
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Joseph W. Hansen was appointed as our Chief Financial Officer effective January 2, 2008 and was terminated on April 3, 2009.
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(8)
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Amount includes $187,500 in severance paid for 2009 under Mr. Hansen’s Executive Employment Agreement and $3,038 in matching 401K funds. Mr. Hansen was terminated on April 3, 2009.
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Executive Employment Agreements
Neil M. Koehler
Our Amended and Restated Executive Employment Agreement with Mr. Koehler dated as of December 11, 2007 provides for at-will employment as our President and Chief Executive Officer. Mr. Koehler was to receive a base salary of $300,000 per year, which was increased to $375,000 effective March 1, 2008, and is eligible to receive an annual discretionary cash bonus of up to 70% of his base salary, to be paid based upon performance criteria set by the Board and an additional cash bonus not to exceed 50% of the net free cash flow of Kinergy (defined as revenues of Kinergy, less Mr. Koehler’s salary and performance bonus, less capital expenditures and all expenses incurred specific to Kinergy), subject to a maximum of $300,000 in any given year; provided, that this bonus will be reduced by ten percentage points each year, commencing in 2005. As a result, 2009 was the final year of the bonus at 10% of net free cash flow.
Upon termination by Pacific Ethanol without cause, resignation by Mr. Koehler for good reason or upon Mr. Koehler’s disability, Mr. Koehler is entitled to receive (i) severance equal to twelve months of base salary, (ii) continued health insurance coverage for twelve months, and (iii) accelerated vesting of 25% of all shares or options subject to any equity awards granted to Mr. Koehler prior to Mr. Koehler’s termination which are unvested as of the date of termination. However, if Mr. Koehler is terminated without cause or resigns for good reason within three months before or twelve months after a change in control, Mr. Koehler is entitled to (a) severance equal to eighteen months of base salary, (b) continued health insurance coverage for eighteen months, and (c) accelerated vesting of 100% of all shares or options subject to any equity awards granted to Mr. Koehler prior to Mr. Koehler’s termination that are unvested as of the date of termination.
The term “for good reason” is defined in the Executive Employment Agreement as (i) the assignment to Mr. Koehler of any duties or responsibilities that result in the material diminution of Mr. Koehler’s authority, duties or responsibility, (ii) a material reduction by Pacific Ethanol in Mr. Koehler’s annual base salary, except to the extent the base salaries of all other executive officers of Pacific Ethanol are accordingly reduced, (iii) a relocation of Mr. Koehler’s place of work, or Pacific Ethanol’s principal executive offices if Mr. Koehler’s principal office is at these offices, to a location that increases Mr. Koehler’s daily one-way commute by more than thirty-five miles, or (iv) any material breach by Pacific Ethanol of any material provision of the Executive Employment Agreement.
The term “cause” is defined in the Executive Employment Agreement as (i) Mr. Koehler’s indictment or conviction of any felony or of any crime involving dishonesty, (ii) Mr. Koehler’s participation in any fraud or other act of willful misconduct against Pacific Ethanol, (iii) Mr. Koehler’s refusal to comply with any lawful directive of Pacific Ethanol, (iv) Mr. Koehler’s material breach of his fiduciary, statutory, contractual, or common law duties to Pacific Ethanol, or (v) conduct by Mr. Koehler which, in the good faith and reasonable determination of the Board, demonstrates gross unfitness to serve; provided, however, that in the event that any of the foregoing events is reasonably capable of being cured, Pacific Ethanol shall, within twenty days after the discovery of the event, provide written notice to Mr. Koehler describing the nature of the event and Mr. Koehler shall thereafter have ten business days to cure the event.
A “change in control” of Pacific Ethanol is deemed to have occurred if, in a single transaction or series of related transactions (i) any person (as the term is used in Section 13(d) and 14(d) of the Exchange Act), or persons acting as a group, other than a trustee or fiduciary holding securities under an employee benefit program, is or becomes a “beneficial owner” (as defined in Rule 13-3 under the Exchange Act), directly or indirectly of securities of Pacific Ethanol representing a majority of the combined voting power of Pacific Ethanol, (ii) there is a merger, consolidation or other business combination transaction of Pacific Ethanol with or into another corporation, entity or person, other than a transaction in which the holders of at least a majority of the shares of voting capital stock of Pacific Ethanol outstanding immediately prior to the transaction continue to hold (either by the shares remaining outstanding or by their being converted into shares of voting capital stock of the surviving entity) a majority of the total voting power represented by the shares of voting capital stock of Pacific Ethanol (or the surviving entity) outstanding immediately after the transaction, or (iii) all or substantially all of our assets are sold.
Bryon T. McGregor
Our Amended and Restated Executive Employment Agreement with Mr. McGregor effective as of November 25, 2009 provides for at-will employment as our Chief Financial Officer. Mr. McGregor receives a base salary of $240,000 per year and is eligible to receive an annual discretionary cash bonus of up to 50% of his base salary, to be paid based upon performance criteria set by the Board. All other terms and conditions of Mr. McGregor’s Amended and Restated Executive Employment Agreement are substantially the same as those contained in Mr. Koehler’s Amended and Restated Executive Employment Agreement, except that Mr. McGregor is not entitled to any bonus based on the net free cash flow of Kinergy.
Christopher W. Wright
Our Amended and Restated Executive Employment Agreement with Mr. Wright dated as of December 11, 2007 provides for at-will employment as our Vice President, General Counsel and Secretary. Mr. Wright was to receive a base salary of $225,000 per year, which was increased to $240,000, effective March 1, 2008, and is eligible to receive an annual discretionary cash bonus of up to 50% of his base salary, to be paid based upon performance criteria set by the Board. All other terms and conditions of Mr. Wright’s Amended and Restated Executive Employment Agreement are substantially the same as those contained in Mr. Koehler’s Amended and Restated Executive Employment Agreement, except that Mr. Wright is not entitled to any bonus based on the net free cash flow of Kinergy.
John T. Miller
Our Amended and Restated Executive Employment Agreement with Mr. Miller dated as of December 11, 2007 provided for at-will employment as our Chief Operating Officer. Mr. Miller was to receive a base salary of $250,000 per year, which was increased to $315,000 effective March 1, 2008, and was eligible to receive an annual discretionary cash bonus of up to 50% of his base salary, to be paid based upon performance criteria set by the Board. All other terms and conditions of Mr. Miller’s Executive Employment Agreement were substantially the same as those contained in Mr. Koehler’s Executive Employment Agreement, except that Mr. Miller was not entitled to any bonus based on the net free cash flow of Kinergy. Mr. Miller’s employment ended on December 4, 2009.
Joseph W. Hansen
Our Executive Employment Agreement with Mr. Hansen dated as of December 11, 2007 provided for at-will employment as our Chief Financial Officer commencing January 2, 2008. Mr. Hansen was to receive a base salary of $250,000 per year and was eligible to receive an annual discretionary cash bonus of up to 50% of his base salary, to be paid based upon performance criteria set by the Board. All other terms and conditions of Mr. Hansen’s Executive Employment Agreement were substantially the same as those contained in Mr. Koehler’s Executive Employment Agreement, except that Mr. Hansen was not entitled to any bonus based on the net free cash flow of Kinergy. Mr. Hansen was terminated on April 3, 2009.
Outstanding Equity Awards at Fiscal Year-End – 2009
The following table sets forth information about outstanding equity awards held by our named executive officers as of December 31, 2009.
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Number of Shares
or Units of Stock
That Have Not Vested (#)(1)
|
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|
Market Value of Shares
or Units of Stock
That Have Not Vested($)(2)
|
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Neil M. Koehler
|
|
|
28,080 |
(3) |
|
|
$ |
19,937 |
|
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| |
|
|
59,931 |
(4) |
|
|
$ |
42,551 |
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|
Bryon T. McGregor
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|
|
2,500 |
(5) |
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|
$ |
1,775 |
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Christopher W. Wright
|
|
|
21,060 |
(6) |
|
|
$ |
14,953 |
|
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| |
|
|
16,780 |
(7) |
|
|
$ |
11,914 |
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|
|
John T. Miller
|
|
|
15,795 |
(8) |
|
|
$ |
11,214 |
|
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| |
|
|
17,979 |
(8) |
|
|
$ |
12,765 |
|
|
|
Joseph W. Hansen
|
|
|
— |
|
|
|
$ |
— |
|
|
|
|
(1)
|
The stock awards reported in the above table represent shares of stock granted under our 2006 Plan.
|
|
|
(2)
|
Represents the fair market value per share of our common stock on December 31, 2009, which was $0.71, multiplied by the number of shares that had not vested as of that date.
|
|
|
(3)
|
Represents shares granted on October 4, 2006. Mr. Koehler’s grant vests as to 14,040 shares on each of October 4, 2010 and 2011.
|
|
|
(4)
|
Represents shares granted on April 8, 2008. Mr. Koehler’s grant vests as to 19,977 shares on each of April 1, 2010, 2011 and 2012.
|
|
|
(5)
|
Represents shares granted on September 18, 2008. Mr. McGregor’s grant vests on September 1, 2010.
|
|
|
(6)
|
Represents shares granted on October 4, 2006. Mr. Wright’s grant vests as to 14,040 shares on each of October 4, 2010 and 2011.
|
|
|
(7)
|
Represents shares granted on April 8, 2008. Mr. Wright’s grant vests as to 5,594 shares on each of April 1, 2010, 2011 and 2012.
|
|
|
(8)
|
Mr. Miller’s grants terminated without vesting on March 4, 2010.
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2006 Stock Incentive Plan
In 2006, our Board adopted and our stockholders ratified and approved the adoption of our 2006 Plan. On March 5, 2010, our Board approved an increase in the number of shares of common stock authorized for issuance under our 2006 Plan from 2,000,000 shares to 6,000,000 shares, subject to stockholder approval. Our stockholders approved the amendment to the 2006 Plan on June 3, 2010.
The 2006 Plan is intended to promote our interests by providing eligible persons in our service with the opportunity to acquire a proprietary or economic interest, or otherwise increase their proprietary or economic interest, in us as an incentive for them to remain in their service and render superior performance during their service. The 2006 Plan consists of two equity-based incentive programs, the Discretionary Grant Program and the Stock Issuance Program. Principal features of each program are summarized below.
A total of 6,000,000 shares of common stock are authorized for issuance under the 2006 Plan. As of the date of this prospectus, equity awards totaling 4,657,158 shares of common stock, net of forfeitures and shares withheld to satisfy tax withholding obligations, have been issued under the 2006 Plan.
The following is a summary of the principal features of our 2006 Plan as amended to reflect the recent amendment. The summary does not purport to be a complete description of all provisions of our 2006 Plan and is qualified in its entirety by the text of the 2006 Plan.
Administration
The Compensation Committee of our Board has the exclusive authority to administer the Discretionary Grant and Stock Issuance Programs with respect to option grants, restricted stock awards, restricted stock units, stock appreciation rights, direct stock issuances and other stock-based awards, or equity awards, made to executive officers and non-employee Board members, and also has the authority to make equity awards under those programs to all other eligible individuals. However, the Board may retain, reassume or exercise from time to time the power to administer those programs. Equity awards made to members of the Compensation Committee must be authorized and approved by a disinterested majority of the Board.
The term “plan administrator,” as used in this summary, means the Compensation Committee or the Board, to the extent either entity is acting within the scope of its administrative jurisdiction under the 2006 Plan.
Share Reserve
Initially, 2,000,000 shares of common stock were authorized for issuance under the 2006 Plan. Currently, a total of 6,000,000 shares of common stock are authorized for issuance under the 2006 Plan.
No participant in the 2006 Plan may be granted equity awards for more than 250,000 shares of common stock per calendar year for purposes of Internal Revenue Code Section 162(m), or Section 162(m). This share limitation is intended to assure that any deductions to which we would otherwise be entitled, either upon the exercise of stock options or stock appreciation rights granted under the Discretionary Grant Program with an exercise price per share equal to the fair market value per share of our common stock on the grant date or upon the subsequent sale of the shares purchased under those options, will not be subject to the $1,000,000 limitation on the income tax deductibility of compensation paid per covered executive officer imposed under Section 162(m). In addition, shares issued under the Stock Issuance Program may qualify as performance-based compensation that is not subject to the Section 162(m) limitation, if the issuance of those shares is approved by the Compensation Committee and the vesting is tied solely to the attainment of the corporate performance milestones discussed below in the summary description of that program.
The shares of common stock issuable under the 2006 Plan may be drawn from shares of our authorized but unissued shares or from shares reacquired by us, including shares repurchased on the open market. Shares subject to any outstanding equity awards under the 2006 Plan that expire or otherwise terminate before those shares are issued will be available for subsequent awards. Unvested shares issued under the 2006 Plan and subsequently repurchased by us at the option exercise or direct issue price paid per share, under our repurchase rights under the 2006 Plan, will be added back to the number of shares reserved for issuance under the 2006 Plan and will be available for subsequent reissuance.
If the exercise price of an option under the 2006 Plan is paid with shares of common stock, then the authorized reserve of common stock under the 2006 Plan will be reduced only by the net number of new shares issued under the exercised stock option. If shares of common stock otherwise issuable under the 2006 Plan are withheld in satisfaction of the withholding taxes incurred in connection with the issuance, exercise or vesting of an equity award, then the number of shares of common stock available for issuance under the 2006 Plan will be reduced only by the net number of shares issued under that equity award. The withheld shares will not reduce the share reserve. Upon the exercise of any stock appreciation right granted under the 2006 Plan, the share reserve will only be reduced by the net number of shares actually issued upon exercise, and not by the gross number of shares as to which the stock appreciation right is exercised.
We have registered the issuance of the additional 4,000,000 shares of common stock under the 2006 Plan on Form S-8 under the Securities Act of 1933, as amended, or Securities Act.
Eligibility
Officers, employees, non-employee directors, and consultants and independent advisors who are under written contract and whose securities issued under the 2006 Plan could be registered on Form S-8, all of whom are in our service or the service of any parent or subsidiary of ours, whether now existing or subsequently established, are eligible to participate in the Discretionary Grant and Stock Issuance Programs.
As of October 25, 2010, three executive officers, approximately 110 other employees, seven non-employee members of our Board and an indeterminate number of consultants and advisors were eligible to participate in the 2006 Plan.
Valuation
The fair market value per share of our common stock on any relevant date under the 2006 Plan will be deemed to be equal to the closing selling price per share of our common stock at the close of regular hours trading on The NASDAQ Capital Market on that date. If there is no closing selling price for our common stock on the date in question, the fair market value will be the closing selling price on the last preceding date for which a quotation exists. On October 25, 2010, the fair market value determined on that basis was $0.905 per share.
Discretionary Grant Program
The plan administrator has complete discretion under the Discretionary Grant Program to determine which eligible individuals are to receive equity awards under that program, the time or times when those equity awards are to be made, the number of shares subject to each award, the time or times when each equity award is to vest and become exercisable, the maximum term for which the equity award is to remain outstanding and the status of any granted option as either an incentive stock option or a non-statutory option under the federal tax laws.
Stock Options. Each granted option will have an exercise price per share determined by the plan administrator, provided that the exercise price will not be less than 85% or 100% of the fair market value of a share on the grant date in the case of non-statutory or incentive options, respectively. No granted option will have a term in excess of ten years. Incentive options granted to an employee who beneficially owns more than 10% of our outstanding common stock must have exercise prices not less than 110% of the fair market value of a share on the grant date and a term of not more than five years measured from the grant date. Options generally will become exercisable in one or more installments over a specified period of service measured from the grant date. However, options may be structured so that they will be immediately exercisable for any or all of the option shares. Any unvested shares acquired under immediately exercisable options will be subject to repurchase, at the exercise price paid per share, if the optionee ceases service with us prior to vesting in those shares.
An optionee who ceases service with us other than due to misconduct will have a limited time within which to exercise outstanding options for any shares for which those options are vested and exercisable at the time of cessation of service. The plan administrator has complete discretion to extend the period following the optionee’s cessation of service during which outstanding options may be exercised (but not beyond the expiration date) and/or to accelerate the exercisability or vesting of options in whole or in part. Discretion may be exercised at any time while the options remain outstanding, whether before or after the optionee’s actual cessation of service.
Stock Appreciation Rights. The plan administrator has the authority to issue the following three types of stock appreciation rights under the Discretionary Grant Program:
Tandem stock appreciation rights, which provide the holders with the right, upon approval of the plan administrator, to surrender their options for an appreciation distribution in an amount equal to the excess of the fair market value of the vested shares of common stock subject to the surrendered option over the aggregate exercise price payable for those shares.
Standalone stock appreciation rights, which allow the holders to exercise those rights as to a specific number of shares of common stock and receive in exchange an appreciation distribution in an amount equal to the excess of the fair market value on the exercise date of the shares of common stock as to which those rights are exercised over the aggregate base price in effect for those shares. The base price per share may not be less than the fair market value per share of the common stock on the date the standalone stock appreciation right is granted, and the right may not have a term in excess of ten years.
Limited stock appreciation rights, which may be included in one or more option grants made under the Discretionary Grant Program to executive officers or directors who are subject to the short-swing profit liability provisions of Section 16 of the Exchange Act. Upon the successful completion of a hostile takeover for more than 50% of our outstanding voting securities or a change in a majority of our Board as a result of one or more contested elections for Board membership over a period of up to 36 consecutive months, each outstanding option with a limited stock appreciation right may be surrendered in return for a cash distribution per surrendered option share equal to the excess of the fair market value per share at the time the option is surrendered or, if greater and the option is a non-statutory option, the highest price paid per share in the transaction, over the exercise price payable per share under the option.
Payments with respect to exercised tandem or standalone stock appreciation rights may, at the discretion of the plan administrator, be made in cash or in shares of common stock. All payments with respect to exercised limited stock appreciation rights will be made in cash. Upon cessation of service with us, the holder of one or more stock appreciation rights will have a limited period within which to exercise those rights as to any shares as to which those stock appreciation rights are vested and exercisable at the time of cessation of service. The plan administrator will have complete discretion to extend the period following the holder’s cessation of service during which his or her outstanding stock appreciation rights may be exercised and/or to accelerate the exercisability or vesting of the stock appreciation rights in whole or in part. Discretion may be exercised at any time while the stock appreciation rights remain outstanding, whether before or after the holder’s actual cessation of service.
Repricing. The plan administrator has the authority, with the consent of the affected holders, to effect the cancellation of any or all outstanding options or stock appreciation rights under the Discretionary Grant Program and to grant in exchange one or more of the following: (i) new options or stock appreciation rights covering the same or a different number of shares of common stock but with an exercise or base price per share not less than the fair market value per share of common stock on the new grant date, or (ii) cash or shares of common stock, whether vested or unvested, equal in value to the value of the cancelled options or stock appreciation rights. The plan administrator also has the authority with or, if the affected holder is not subject to the short-swing profit liability of Section 16 of the Exchange Act, then without, the consent of the affected holders, to reduce the exercise or base price of one or more outstanding stock options or stock appreciation rights to the then current fair market value per share of common stock or to issue new stock options or stock appreciation rights with a lower exercise or base price in immediate cancellation of outstanding stock options or stock appreciation rights with a higher exercise or base price.
Stock Issuance Program
Shares of common stock may be issued under the Stock Issuance Program for valid consideration under the Delaware General Corporation Law as the plan administrator deems appropriate, including cash, past services or other property. In addition, restricted shares of common stock may be issued under restricted stock awards that vest in one or more installments over the recipient’s period of service or upon attainment of specified performance objectives. Shares of common stock may also be issued under the program under restricted stock units or other stock-based awards that entitle the recipients to receive the shares underlying those awards upon the attainment of designated performance goals, the satisfaction of specified service requirements and/or upon the expiration of a designated time period following the vesting of those awards or units, including a deferred distribution date following the termination of the recipient’s service with us.
The plan administrator will have complete discretion under the Stock Issuance Program to determine which eligible individuals are to receive equity awards under the program, the time or times when those equity awards are to be made, the number of shares subject to each equity award, the vesting schedule to be in effect for the equity award and the consideration, if any, payable per share. The shares issued under an equity award may be fully vested upon issuance or may vest upon the completion of a designated service period and/or the attainment of pre-established performance goals.
To assure that the compensation attributable to one or more equity awards under the Stock Issuance Program will qualify as performance-based compensation that will not be subject to the $1,000,000 limitation on the income tax deductibility of the compensation paid per covered executive officer imposed under Section 162(m), the Compensation Committee will also have the discretionary authority to structure one or more equity awards under the Stock Issuance Program so that the shares subject to those particular awards will vest only upon the achievement of pre-established corporate performance goals. Goals may be based on one or more of the following criteria: (i) return on total stockholders’ equity; (ii) net income per share; (iii) net income or operating income; (iv) earnings before interest, taxes, depreciation, amortization and stock-based compensation costs, or operating income before depreciation and amortization; (v) sales or revenue targets; (vi) return on assets, capital or investment; (vii) cash flow; (viii) market share; (ix) cost reduction goals; (x) budget comparisons; (xi) implementation or completion of projects or processes strategic or critical to our business operations; (xii) measures of customer satisfaction; (xiii) any combination of, or a specified increase in, any of the foregoing; and (xiv) the formation of joint ventures, research and development collaborations, marketing or customer service collaborations, or the completion of other corporate transactions intended to enhance our revenue or profitability or expand our customer base; provided, however, that for purposes of items (ii), (iii) and (vii) above, the Compensation Committee may, at the time the equity awards are made, specify adjustments to those items as reported in accordance with generally accepted accounting principles in the United States, or GAAP, which will exclude from the calculation of those performance goals one or more of the following: specific charges related to acquisitions, stock-based compensation, employer payroll tax expense on specific stock option exercises, settlement costs, restructuring costs, gains or losses on strategic investments, non-operating gains, other non-cash charges, valuation allowance on deferred tax assets, and the related income tax effects, purchases of property and equipment, and any extraordinary non-recurring items as described in Accounting Principles Board Opinion No. 30 or its successor, provided that those adjustments are in conformity with those reported by us on a non-GAAP basis. In addition, performance goals may be based upon the attainment of specified levels of our performance under one or more of the measures described above relative to the performance of other entities and may also be based on the performance of any of our business groups or divisions thereof or any parent or subsidiary. Performance goals may include a minimum threshold level of performance below which no award will be earned, levels of performance at which specified portions of an award will be earned, and a maximum level of performance at which an award will be fully earned. The Compensation Committee may provide that, if the actual level of attainment for any performance objective is between two specified levels, the amount of the award attributable to that performance objective shall be interpolated on a straight-line basis.
The plan administrator will have the discretionary authority at any time to accelerate the vesting of any and all shares of restricted stock or other unvested shares outstanding under the Stock Issuance Program. However, no vesting requirements tied to the attainment of performance objectives may be waived with respect to shares that were intended at the time of issuance to qualify as performance-based compensation under Section 162(m), except in the event of specified involuntary terminations or changes in control or ownership.
Outstanding restricted stock units or other stock-based awards under the Stock Issuance Program will automatically terminate, and no shares of common stock will actually be issued in satisfaction of those awards, if the performance goals or service requirements established for those awards are not attained. The plan administrator, however, will have the discretionary authority to issue shares of common stock in satisfaction of one or more outstanding restricted stock units or other stock-based awards as to which the designated performance goals or service requirements are not attained. However, no vesting requirements tied to the attainment of performance objectives may be waived with respect to awards that were intended at the time of issuance to qualify as performance-based compensation under Section 162(m), except in the event of specified involuntary terminations or changes in control or ownership.
General Provisions
Acceleration. If a change in control occurs, each outstanding equity award under the Discretionary Grant Program will automatically accelerate in full, unless (i) that award is assumed by the successor corporation or otherwise continued in effect, (ii) the award is replaced with a cash retention program that preserves the spread existing on the unvested shares subject to that equity award (the excess of the fair market value of those shares over the exercise or base price in effect for the shares) and provides for subsequent payout of that spread in accordance with the same vesting schedule in effect for those shares, or (iii) the acceleration of the award is subject to other limitations imposed by the plan administrator. In addition, all unvested shares outstanding under the Discretionary Grant and Stock Issuance Programs will immediately vest upon the change in control, except to the extent our repurchase rights with respect to those shares are to be assigned to the successor corporation or otherwise continued in effect or accelerated vesting is precluded by other limitations imposed by the plan administrator. Each outstanding equity award under the Stock Issuance Program will vest as to the number of shares of common stock subject to that award immediately prior to the change in control, unless that equity award is assumed by the successor corporation or otherwise continued in effect or replaced with a cash retention program similar to the program described in clause (ii) above or unless vesting is precluded by its terms. Immediately following a change in control, all outstanding awards under the Discretionary Grant Program will terminate and cease to be outstanding except to the extent assumed by the successor corporation or its parent or otherwise expressly continued in full force and effect under the terms of the change in control transaction.
The plan administrator will have the discretion to structure one or more equity awards under the Discretionary Grant and Stock Issuance Programs so that those equity awards will vest in full either immediately upon a change in control or in the event the individual’s service with us or the successor entity is terminated (actually or constructively) within a designated period following a change in control transaction, whether or not those equity awards are to be assumed or otherwise continued in effect or replaced with a cash retention program.
A change in control will be deemed to have occurred if, in a single transaction or series of related transactions:
(i) any person (as that term is used in Section 13(d) and 14(d) of the Exchange Act), or persons acting as a group, other than a trustee or fiduciary holding securities under an employment benefit program, is or becomes a beneficial owner (as defined in Rule 13-3 under the Exchange Act), directly or indirectly of securities representing 51% or more of the combined voting power of our company, or
(ii) there is a merger, consolidation, or other business combination transaction of us with or into another corporation, entity or person, other than a transaction in which the holders of at least a majority of the shares of our voting capital stock outstanding immediately prior to the transaction continue to hold (either by the shares remaining outstanding or by their being converted into shares of voting capital stock of the surviving entity) a majority of the total voting power represented by the shares of voting capital stock of our company (or the surviving entity) outstanding immediately after the transaction, or
(iii) all or substantially all of our assets are sold.
Stockholder Rights and Option Transferability. The holder of an option or stock appreciation right will have no stockholder rights with respect to the shares subject to that option or stock appreciation right unless and until the holder exercises the option or stock appreciation right and becomes a holder of record of shares of common stock distributed upon exercise of the award. Incentive options are not assignable or transferable other than by will or the laws of inheritance following the optionee’s death, and during the optionee’s lifetime, may only be exercised by the optionee. However, non-statutory options and stock appreciation rights may be transferred or assigned during the holder’s lifetime to one or more members of the holder’s family or to a trust established for the benefit of the holder and/or one or more family members or to the holder’s former spouse, to the extent the transfer is in connection with the holder’s estate plan or under a domestic relations order.
A participant will have a number of rights with respect to shares of common stock issued to the participant under the Stock Issuance Program, whether or not the participant’s interest in those shares is vested. Accordingly, the participant will have the right to vote the shares and to receive any regular cash dividends paid on the shares, but will not have the right to transfer the shares prior to vesting. A participant will not have any stockholder rights with respect to the shares of common stock subject to restricted stock units or other stock-based awards until the awards vest and the shares of common stock are actually issued. However, dividend-equivalent units may be paid or credited, either in cash or in actual or phantom shares of common stock, on outstanding restricted stock units or other stock-based awards, subject to terms and conditions the plan administrator deems appropriate.
Changes in Capitalization. If any change is made to the outstanding shares of common stock by reason of any recapitalization, stock dividend, stock split, combination of shares, exchange of shares or other change in corporate structure effected without our receipt of consideration, appropriate adjustments will be made to (i) the maximum number and/or class of securities issuable under the 2006 Plan, (ii) the maximum number and/or class of securities for which any one person may be granted equity awards under the 2006 Plan per calendar year, (iii) the number and/or class of securities and the exercise price or base price per share in effect under each outstanding option or stock appreciation right, and (iv) the number and/or class of securities subject to each outstanding restricted stock unit or other stock-based award under the 2006 Plan and the cash consideration, if any, payable per share. All adjustments will be designed to preclude any dilution or enlargement of benefits under the 2006 Plan and the outstanding equity awards thereunder.
Special Tax Election. Subject to applicable laws, rules and regulations, the plan administrator may permit any or all holders of equity awards to utilize any or all of the following methods to satisfy all or part of the federal and state income and employment withholding taxes to which they may become subject in connection with the issuance, exercise or vesting of those equity awards.
Stock Withholding: The election to have us withhold, from the shares otherwise issuable upon the issuance, exercise or vesting of an equity award, a portion of those shares with an aggregate fair market value equal to the percentage of the withholding taxes (not to exceed 100%) designated by the holder and make a cash payment equal to the fair market value directly to the appropriate taxing authorities on the individual’s behalf.
Stock Delivery: The election to deliver to us shares of common stock previously acquired by the holder (other than in connection with the issuance, exercise or vesting that triggered the withholding taxes) with an aggregate fair market value equal to the percentage of the withholding taxes (not to exceed 100%) designated by the holder.
Sale and Remittance: The election to deliver to us, to the extent the award is issued or exercised for vested shares, through a special sale and remittance procedure under which the optionee or participant will concurrently provide irrevocable instructions to a brokerage firm to effect the immediate sale of the purchased or issued shares and remit to us, out of the sale proceeds available on the settlement date, sufficient funds to cover the withholding taxes we are required to withhold by reason of the issuance, exercise or vesting.
Amendment, Suspension and Termination
Our Board may suspend or terminate the 2006 Plan at any time. Our Board may amend or modify the 2006 Plan, subject to any required stockholder approval. Stockholder approval will be required for any amendment that materially increases the number of shares available for issuance under the 2006 Plan, materially expands the class of individuals eligible to receive equity awards under the 2006 Plan, materially increases the benefits accruing to optionees and other participants under the 2006 Plan or materially reduces the price at which shares of common stock may be issued or purchased under the 2006 Plan, materially extends the term of the 2006 Plan, expands the types of awards available for issuance under the 2006 Plan, or as to which stockholder approval is required by applicable laws, rules or regulations.
Unless sooner terminated by our Board, the 2006 Plan will terminate on the earliest to occur of: July 19, 2016; the date on which all shares available for issuance under the 2006 Plan have been issued as fully-vested shares; and the termination of all outstanding equity awards upon enumerated changes in control or ownership. If the 2006 Plan terminates on July 19, 2016, then all equity awards outstanding at that time will continue to have force and effect in accordance with the provisions of the documents evidencing those awards.
Federal Income Tax Consequences
The following discussion summarizes income tax consequences of the 2006 Plan under current federal income tax law and is intended for general information only. In addition, the tax consequences described below are subject to the limitations of Section 162(m), as discussed in further detail below. Other federal taxes and foreign, state and local income taxes are not discussed, and may vary depending upon individual circumstances and from locality to locality.
Option Grants. Options granted under the 2006 Plan may be either incentive stock options, which satisfy the requirements of Internal Revenue Code Section 422, or non-statutory stock options, which are not intended to meet those requirements. The federal income tax treatment for the two types of options differs as follows:
Incentive Stock Options. No taxable income is recognized by the optionee at the time of the option grant, and, if there is no disqualifying disposition at the time of exercise, no taxable income is recognized for regular tax purposes at the time the option is exercised, although taxable income may arise at that time for alternative minimum tax purposes equal to the excess of the fair market value of the purchased shares at the time over the exercise price paid for those shares.
The optionee will recognize taxable income in the year in which the purchased shares are sold or otherwise made the subject of some dispositions. For federal tax purposes, dispositions are divided into two categories: qualifying and disqualifying. A qualifying disposition occurs if the sale or other disposition is made more than two years after the date the option for the shares involved in the sale or disposition was granted and more than one year after the date the option was exercised for those shares. If either of these two requirements is not satisfied, a disqualifying disposition will result.
Upon a qualifying disposition, the optionee will recognize long-term capital gain in an amount equal to the excess of the amount realized upon the sale or other disposition of the purchased shares over the exercise price paid for the shares. If there is a disqualifying disposition of the shares, the excess of the fair market value of those shares on the exercise date over the exercise price paid for the shares will be taxable as ordinary income to the optionee. Any additional gain or any loss recognized upon the disposition will be taxable as a capital gain or capital loss.
If the optionee makes a disqualifying disposition of the purchased shares, we will be generally entitled to an income tax deduction, for our taxable year in which the disposition occurs, equal to the excess of the fair market value of the shares on the option exercise date over the exercise price paid for the shares. If the optionee makes a qualifying disposition, we will not be entitled to any income tax deduction.
Non-Statutory Stock Options. No taxable income is generally recognized by an optionee upon the grant of a non-statutory option. The optionee will, in general, recognize ordinary income, in the year in which the option is exercised, equal to the excess of the fair market value of the purchased shares on the exercise date over the exercise price paid for the shares, and we will be required to collect withholding taxes applicable to the income from the optionee.
We will generally be entitled to an income tax deduction equal to the amount of any ordinary income recognized by the optionee with respect to an exercised non-statutory option. The deduction will in general be allowed for our taxable year in which the ordinary income is recognized by the optionee.
If the shares acquired upon exercise of the non-statutory option are unvested and subject to repurchase in the event of the optionee’s cessation of service prior to vesting in those shares, the optionee will not recognize any taxable income at the time of exercise but will have to report as ordinary income, as and when our repurchase right lapses, an amount equal to the excess of the fair market value of the shares on the date the repurchase right lapses over the exercise price paid for the shares. The optionee may elect under Internal Revenue Code Section 83(b), or Section 83(b), to include as ordinary income in the year of exercise of the option an amount equal to the excess of the fair market value of the purchased shares on the exercise date over the exercise price paid for the shares. If a timely Section 83(b) election is made, the optionee will not recognize any additional income as and when the repurchase right lapses.
Stock Appreciation Rights. No taxable income is generally recognized upon receipt of a stock appreciation right. The holder will recognize ordinary income in the year in which the stock appreciation right is exercised, in an amount equal to the excess of the fair market value of the underlying shares of common stock on the exercise date over the base price in effect for the exercised right, and we will be required to collect withholding taxes applicable to the income from the holder.
We will generally be entitled to an income tax deduction equal to the amount of any ordinary income recognized by the holder in connection with the exercise of a stock appreciation right. The deduction will in general be allowed for our taxable year in which the ordinary income is recognized by the holder.
Direct Stock Issuances. Stock granted under the 2006 Plan may include issuances including unrestricted stock grants, restricted stock grants and restricted stock units. The federal income tax treatment for the stock issuances are as follows:
Unrestricted Stock Grants. The holder will recognize ordinary income in the year in which shares are actually issued to the holder. The amount of that income will be equal to the fair market value of the shares on the date of issuance, and we will be required to collect withholding taxes applicable to the income from the holder.
We will be entitled to an income tax deduction equal to the amount of ordinary income recognized by the holder at the time the shares are issued. The deduction will in general be allowed for our taxable year in which the ordinary income is recognized by the holder.
Restricted Stock Grants. No taxable income is recognized upon receipt of stock that qualifies as performance-based compensation unless the recipient elects to have the value of the stock (without consideration of any effect of the vesting conditions) included in income on the date of receipt. The recipient may elect under Section 83(b) to include as ordinary income in the year the shares are actually issued an amount equal to the fair market value of the shares. If a timely Section 83(b) election is made, the holder will not recognize any additional income when the vesting conditions lapse and will not be entitled to a deduction in the event the stock is forfeited as a result of failure to vest.
If the holder does not file an election under Section 83(b), he will not recognize income until the shares vest. At that time, the holder will recognize ordinary income in an amount equal to the fair market value of the shares on the date the shares vest. We will be required to collect withholding taxes applicable to the income of the holder at that time.
We will be entitled to an income tax deduction equal to the amount of ordinary income recognized by the holder at the time the shares are issued, if the holder elects to file an election under Section 83(b), or we will be entitled to an income tax deduction at the time the vesting conditions occur, if the holder does not elect to file an election under Section 83(b).
Restricted Stock Units. No taxable income is generally recognized upon receipt of a restricted stock unit award. The holder will recognize ordinary income in the year in which the shares subject to that unit are actually issued to the holder. The amount of that income will be equal to the fair market value of the shares on the date of issuance, and we will be required to collect withholding taxes applicable to the income from the holder.
We will generally be entitled to an income tax deduction equal to the amount of ordinary income recognized by the holder at the time the shares are issued. The deduction will in general be allowed for our taxable year in which the ordinary income is recognized by the holder.
Section 409A. A number of awards, including non-statutory stock options and stock appreciation rights granted with an exercise price that is less than fair market value, and some restricted stock units, can be considered “non-qualified deferred compensation” and subject to Internal Revenue Code Section 409A, or Section 409A. Awards that are subject to but do not meet the requirements of Section 409A will result in an additional 20% tax obligation, plus penalties and interest to the recipient, and may result in accelerated imposition of income tax and the related withholding.
Deductibility of Executive Compensation
We anticipate that any compensation deemed paid by us in connection with disqualifying dispositions of incentive stock option shares or the exercise of non-statutory stock options or stock appreciation rights with exercise prices or base prices equal to or greater than the fair market value of the underlying shares on the grant date will qualify as performance-based compensation for purposes of Section 162(m) and will not have to be taken into account for purposes of the $1,000,000 limitation per covered individual on the deductibility of the compensation paid to some executive officers. Accordingly, all compensation deemed paid with respect to those options or stock appreciation rights should remain deductible without limitation under Section 162(m). However, any compensation deemed paid by us in connection with shares issued under the Stock Issuance Program will be subject to the $1,000,000 limitation on deductibility per covered individual, except to the extent the vesting of those shares is based solely on one or more of the performance milestones specified above in the summary of the terms of the Stock Issuance Program.
Accounting Treatment
In accordance with accounting standards established by the Financial Accounting Standards Board’s Accounting Standards Codification Topic 718, Stock Compensation, we are required to recognize all share-based payments, including grants of stock options, restricted stock and restricted stock units, in our financial statements. Accordingly, stock options are valued at fair value as of the grant date under an appropriate valuation formula, and that value will be charged as stock-based compensation expense against our reported earnings over the designated vesting period of the award. For shares issuable upon the vesting of restricted stock units that may be awarded under the 2006 Plan, we are required to expense over the vesting period a compensation cost equal to the fair market value of the underlying shares on the date of the award. Restricted stock issued under the 2006 Plan results in a direct charge to our reported earnings equal to the excess of the fair market value of those shares on the issuance date over the cash consideration (if any) paid for the shares. If the shares are unvested at the time of issuance, then any charge to our reported earnings is amortized over the vesting period. This accounting treatment for restricted stock units and restricted stock issuances is applicable whether vesting is tied to service periods or performance criteria.
New Plan Benefits
No additional awards under the 2006 Plan are determinable at this time because awards under the 2006 Plan are discretionary and no specific additional awards have been approved by the plan administrator beyond currently outstanding unvested restricted stock grants in respect of 2,885,636 shares of common stock.
Other Arrangements Not Subject to Stockholder Action
Information regarding our equity compensation plan arrangements that existed as of the end of 2009 is included in this prospectus at “Price Range of Common Stock – Equity Compensation Plan Information.”
Interests of Related Parties
The 2006 Plan provides that our officers, employees, non-employee directors, and some consultants and independent advisors will be eligible to receive awards under the 2006 Plan. As discussed above, we may be eligible in some circumstances to receive a tax deduction for some executive compensation resulting from awards under the 2006 Plan that would otherwise be disallowed under Section 162(m).
Possible Anti-Takeover Effects
Although not intended as an anti-takeover measure by our Board, one of the possible effects of the 2006 Plan could be to place additional shares, and to increase the percentage of the total number of shares outstanding, or to place other incentive compensation, in the hands of the directors and officers of Pacific Ethanol, Inc. Those persons may be viewed as part of, or friendly to, incumbent management and may, therefore, under some circumstances be expected to make investment and voting decisions in response to a hostile takeover attempt that may serve to discourage or render more difficult the accomplishment of the attempt.
In addition, options or other incentive compensation may, in the discretion of the plan administrator, contain a provision providing for the acceleration of the exercisability of outstanding, but unexercisable, installments upon the first public announcement of a tender offer, merger, consolidation, sale of all or substantially all of our assets, or other attempted changes in the control of Pacific Ethanol, Inc. In the opinion of our Board, this acceleration provision merely ensures that optionees under the 2006 Plan will be able to exercise their options or obtain their incentive compensation as intended by our Board and stockholders prior to any extraordinary corporate transaction which might serve to limit or restrict that right. Our Board is, however, presently unaware of any threat of hostile takeover involving Pacific Ethanol, Inc.
Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law, or DGCL, permits a corporation to indemnify its directors and officers against expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred in connection with a pending or completed action, suit or proceeding if the officer or director acted in good faith and in a manner the officer or director reasonably believed to be in the best interests of the corporation.
Our certificate of incorporation provides that, except in specified instances, our directors shall not be personally liable to us or our stockholders for monetary damages for breach of their fiduciary duty as directors, except liability for the following:
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any breach of their duty of loyalty to Pacific Ethanol or our stockholders;
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acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;
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unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the DGCL; and
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any transaction from which the director derived an improper personal benefit.
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In addition, our certificate of incorporation and bylaws obligate us to indemnify our directors and officers against expenses and other amounts reasonably incurred in connection with any proceeding arising from the fact that the person is or was an agent of ours. Our bylaws also authorize us to purchase and maintain insurance on behalf of any of our directors or officers against any liability asserted against that person in that capacity, whether or not we would have the power to indemnify that person under the provisions of the DGCL. We have entered and expect to continue to enter into agreements to indemnify our directors and officers as determined by our Board. These agreements provide for indemnification of related expenses including attorneys’ fees, fines and settlement amounts incurred by any of these individuals in any action or proceeding. We believe that these bylaw provisions and indemnification agreements are necessary to attract and retain qualified persons as directors and officers. We also maintain directors’ and officers’ liability insurance.
The limitation of liability and indemnification provisions in our certificate of incorporation and bylaws may discourage stockholders from bringing a lawsuit against our directors for breach of their fiduciary duty. They may also reduce the likelihood of derivative litigation against our directors and officers, even though an action, if successful, might benefit us and other stockholders. Furthermore, a stockholder’s investment may be adversely affected to the extent that we pay the costs of settlement and damage awards against directors and officers as required by these indemnification provisions.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons under the foregoing provisions of our certificate of incorporation or bylaws, or otherwise, we have been advised that in the opinion of the SEC that indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Policies and Procedures for Approval of Related Party Transactions
Our Board has the responsibility to review and discuss with management and approve, and has adopted written policies and procedures relating to approval or ratification of, interested transactions with related parties. During this process, the material facts as to the related party’s interest in a transaction are disclosed to all Board members or an applicable committee. Under the policies and procedures, the Board is to review each interested transaction with a related party that requires approval and either approve or disapprove of the entry into the interested transaction. An interested transaction is any transaction in which we are a participant and any related party has or will have a direct or indirect interest. Transactions that are in the ordinary course of business and would not require either disclosure required by Item 404(a) of Regulation S-K under the Securities Act or approval of the Board or an independent committee of the Board as required by applicable NASDAQ rules would not be deemed interested transactions. No director may participate in any approval of an interested transaction with respect to which he or she is a related party. Our Board intends to approve only those related party transactions that are in the best interests of Pacific Ethanol and our stockholders.
Other than as described below or elsewhere in this prospectus, since January 1, 2007, there has not been a transaction or series of related transactions to which Pacific Ethanol was or is a party involving an amount in excess of $120,000 and in which any director, executive officer, holder of more than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons, had or will have a direct or indirect material interest. All of the below transactions, except as to any transactions with Front Range prior to October 17, 2006, were separately approved by our Board. Daniel A. Sanders became a member of our Board on October 17, 2006, and is no longer a member of our Board.
Certain Relationships and Related Transactions
Miscellaneous
We are or have been a party to employment and compensation arrangements with related parties, as more particularly described above in “Management—Executive Employment Agreements.” We have entered into an indemnification agreement with each of our directors and executive officers. The indemnification agreements and our certificate of incorporation and bylaws require us to indemnify our directors and officers to the fullest extent permitted by Delaware law.
Neil M. Koehler
Series B Preferred Stock
On May 20, 2008, we sold to Neil M. Koehler, who is our President and Chief Executive Officer and one of our directors, 256,410 shares our Series B Preferred Stock, all of which were initially convertible into an aggregate of 769,230 shares of our common stock based on an initial three-for-one conversion ratio and warrants to purchase an aggregate of 384,615 shares of our common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $5,000,000. For the year ended December 31, 2008, we declared and paid cash dividends to Mr. Koehler in respect of our Series B Preferred Stock in the aggregate amount of $214,794. For the year ended December 31, 2009, we declared cash dividends to Mr. Koehler in respect of our Series B Preferred Stock in the aggregate amount of $350,000, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to Mr. Koehler in respect of our Series B Preferred Stock in the aggregate amount of $261,781 , which dividends have not been paid.
Loan Transaction
On March 30, 2009, we entered into an unsecured promissory note in favor of Mr. Koehler. The promissory note is for the principal amount of $1,000,000. Interest on the unpaid principal amount of the promissory note accrues at a rate per annum of 8.00%. On October 29, 2010, the Company paid all accrued interest under the Note. In addition, on November 5, 2010, the Company entered into an amendment to this Note, extending its maturity date to March 31, 2012.
Common Stock
On January 28, 2010, we granted 250,000 shares of our restricted common stock to Mr. Koehler in consideration of services provided. The value of the common was determined be $535,000.
On October 20, 2010, we granted 750,000 shares of our restricted common stock to Mr. Koehler in consideration of services provided. The value of the common stock was determined to be $712,500.
Paul P. Koehler
Paul P. Koehler, a brother of Neil M. Koehler, is employed by us as Vice President of Corporate Development, at an annual salary of $190,000.
On May 20, 2008, we sold to Mr. Paul Koehler 12,820 shares our Series B Preferred Stock, all of which were initially convertible into an aggregate of 38,460 shares of our common stock based on an initial three-for-one conversion ratio and warrants to purchase an aggregate of 19,230 shares of our common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $250,000. For the year ended December 31, 2008, we declared and paid cash dividends to Mr. Paul Koehler in respect of our Series B Preferred Stock in the aggregate amount of $10,739. For the year ended December 31, 2009, we declared cash dividends to Mr. Paul Koehler in respect of our Series B Preferred Stock in the aggregate amount of $17,500, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to Mr. Paul Koehler in respect of our Series B Preferred Stock in the aggregate amount of $13,089 , which dividends have not been paid.
Thomas D. Koehler
Thomas D. Koehler, a brother of Neil M. Koehler, who is our President and Chief Executive Officer and one of our directors, was employed by us as Vice President of Public Policy and Markets, at an annual salary of $175,000 through March 31, 2008, his last day of employment with us.
Effective as of April 1, 2008, we entered into an Independent Contractor Services Agreement with Thomas D. Koehler, a brother of Neil M. Koehler, for the provision of strategic consulting services, including in connection with promoting Pacific Ethanol and ethanol as a fuel additive and transportation fuel with governmental agencies. Mr. Thomas Koehler is compensated at a rate of $12,500 per month under this arrangement from April 1, 2008 April 30, 2009. Mr. Thomas Koehler has been compensated at a rate of $5,000 per month under this arrangement since May 1, 2009.
On May 20, 2008, we sold to Mr. Thomas Koehler 12,820 shares our Series B Preferred Stock, all of which were initially convertible into an aggregate of 38,460 shares of our common stock based on an initial three-for-one conversion ratio and warrants to purchase an aggregate of 19,230 shares of our common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $250,000. For the year ended December 31, 2008, we declared and paid cash dividends to Mr. Thomas Koehler in respect of our Series B Preferred Stock in the aggregate amount of $10,739. For the year ended December 31, 2009, we declared cash dividends to Mr. Thomas Koehler in respect of our Series B Preferred Stock in the aggregate amount of $17,500, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to Mr. Thomas Koehler in respect of our Series B Preferred Stock in the aggregate amount of $13,089 , which dividends have not been paid.
William L. Jones
Sales of Corn
During 2007 and 2008, we sold corn to Tri-J Land & Cattle, an entity owned by William L. Jones, our Chairman of the Board and a director. We were not under contract with Tri-J Land & Cattle, but we sold rolled corn to Tri-J Land & Cattle on a spot basis as needed. Sales of rolled corn to Tri-J Land & Cattle totaled $166,000 for the year ended December 31, 2007. Sales of rolled corn to Tri-J Land & Cattle totaled $1,300 for the year ended December 31, 2008.
Series B Preferred Stock
On May 20, 2008, we sold to Mr. Jones 12,820 shares our Series B Preferred Stock, all of which were initially convertible into an aggregate of 38,460 shares of our common stock based on an initial three-for-one conversion ratio and warrants to purchase an aggregate of 19,230 shares of our common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $250,000. For the year ended December 31, 2008, we declared and paid cash dividends to Mr. Jones in respect of our Series B Preferred Stock in the aggregate amount of $10,739. For the year ended December 31, 2009, we declared cash dividends to Mr. Jones in respect of our Series B Preferred Stock in the aggregate amount of $17,500, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to Mr. Jones in respect of our Series B Preferred Stock in the aggregate amount of $13,089 , which dividends have not been paid.
Loan Transaction
On March 30, 2009, we entered into an unsecured promissory note in favor of Mr. Jones. The promissory note is for the principal amount of $1,000,000. Interest on the unpaid principal amount of the promissory note accrues at a rate per annum of 8.00%. On October 29, 2010, the Company paid all accrued interest and $750,000 in principal under the Note. In addition, on November 5, 2010, the Company entered into an amendment to this Note, extending its maturity date to March 31, 2012.
Common Stock
On October 1, 2010, we granted 57,142 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 1, 2010 was determined to be $58,856. On October 20, 2010, we granted 90,000 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 20, 2010 was determined to be $85,500.
Ryan W. Turner
On May 13, 2009, we entered into a consulting agreement with Ryan W. Turner, who is the son-in-law of William L. Jones, for consulting services relating to a potential capital raising transaction and reorganization of us or our bankrupt subsidiaries, or both, at $10,000 per month. In November 2009, we executed a new consulting agreement with Mr. Turner for similar consulting services at $20,000 per month. In 2009 and 2010, we paid Mr. Turner an aggregate of $86,500 and $23,100, respectively, under these arrangements. Our consulting relationship with Mr. Turner was terminated in connection with his appointment to our Board in February 2010.
Common Stock
On October 1, 2010, we granted 57,142 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 1, 2010 was determined to be $58,856. On October 20, 2010, we granted 90,000 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 20, 2010 was determined to be $85,500.
Michael D. Kandris
During 2009 and 2008, we contracted with Ruan, an entity with which Michael D. Kandris, one of our directors, was a senior officer until his retirement in September 2009, for transportation services for our products. For the year ended December 31, 2008, we purchased transportation services for $2,840,000. As of December 31, 2008, we had $608,000 of outstanding accounts payable to Ruan. For the year ended December 31, 2009, we purchased transportation services for $860,000. As of September 30, 2010 and December 31, 2009, we had $1,234,000 and $1,171,000 of outstanding accounts payable to Ruan, respectively.
Common Stock
On October 1, 2010, we granted 57,142 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 1, 2010 was determined to be $58,856. On October 20, 2010, we granted 90,000 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 20, 2010 was determined to be $85,500.
Terry L. Stone, John L. Prince, Douglas L. Kieta and Larry D. Layne
Mr. Stone, Prince, Kieta and Layne currently serve on our Board. On October 1, 2010, we granted 57,142 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 1, 2010 was determined to be $58,856. On October 20, 2010, we granted 90,000 shares of our restricted common stock to each of our non-employee directors in consideration of services provided. The value of the common stock granted to each non-employee director on October 20, 2010 was determined to be $85,500.
Christopher W. Wright
Mr. Wright is our Vice President, General Counsel and Secretary. On January 28, 2010, we granted 700,000 shares of our restricted common stock to Mr. Wright in consideration of services provided. The value of the common stock granted on January 28, 2010 was determined to be $149,800. On October 20, 2010, we granted 210,000 shares of our restricted common stock to Mr. Wright in consideration of services provided. The value of the common stock granted on October 20, 2010 was determined to be $199,500.
Bryon T. McGregor
Mr. McGregor is our Chief Financial Officer. On January 28, 2010, we granted 700,000 shares of our restricted common stock to Mr. McGregor in consideration of services provided. The value of the common stock granted on January 28, 2010 was determined to be $149,800. On October 20, 2010, we granted 210,000 shares of our restricted common stock to each of Mr. McGregor in consideration of services provided. The value of the common stock granted on October 20, 2010 was determined to be $199,500.
Lyles United, LLC
Series B Preferred Stock
On March 27, 2008, we sold Lyles United, LLC, or Lyles United, 2,051,282 shares our Series B Preferred Stock, all of which were initially convertible into an aggregate of 6,153,846 shares of our common stock based on an initial three-for-one conversion ratio and warrants to purchase an aggregate of 3,076,923 shares of our common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $40,000,000. For the year ended December 31, 2008, we declared and paid cash dividends to Lyles United in respect of our Series B Preferred Stock in the aggregate amount of $2,186,000. For the year ended December 31, 2009, we declared cash dividends to Lyles United in respect of our Series B Preferred Stock in the aggregate amount of $2,270,000, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to Lyles United in respect of our Series B Preferred Stock in the aggregate amount of $523,561 , which dividends have not been paid.
Construction Relationship
We contracted with the W.M. Lyles Company, or W.M. Lyles for construction services associated with the construction of some of our ethanol production facilities. These agreements resulted in payments of approximately $216,297 and $43,143,000 to W. M. Lyles during 2009 and 2008, respectively, with approximately $18,636 and $3,575,000 outstanding as of December 31, 2009 and 2008, respectively.
Lyles United Loan Transactions
In November and December 2007, one of our wholly-owned subsidiaries borrowed, in two loan transactions of equal amount, an aggregate of $30,000,000 from Lyles United. The loans were due in the amount of $15,000,000 in each of February and March 2009 and were secured by substantially all of the assets of the subsidiary. We guaranteed the repayment of the loan. The first loan accrued interest at the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 2% and the second loan accrued interest at the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 4%. In connection with the extension of the maturity date of the first loan, we issued to Lyles United a warrant to purchase 100,000 shares of our common stock at an exercise price of $8.00 per share. This warrant expired unexercised in September 2009.
In connection with the first loan in November 2007, our subsidiary entered into a Letter Agreement with Lyles United under which it committed to award the primary construction and mechanical contract to Lyles United or one of its affiliates for the construction of an ethanol production facility at the Imperial Valley site near Calipatria, California, or the Project, conditioned upon the subsidiary electing, in its sole discretion, to proceed with the Project and Lyles United or its affiliate having all necessary licenses and being otherwise ready, willing and able to perform the primary construction and mechanical contract. In the event the foregoing conditions were satisfied and the subsidiary awarded the contract to a party other than Lyles United or one of its affiliates, the subsidiary would have been required to pay to Lyles United, as liquidated damages, an amount equal to $5.0 million. We have ceased any construction activity at the Imperial Valley site.
In November 2008, we restructured the loans from Lyles United. We assumed all of the subsidiary’s obligations under the loans and issued a single promissory note in favor of Lyles United in the principal amount of $30,000,000, or the Lyles United Note. The new loan was due March 15, 2009 and accrues interest at the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus 3%. We also terminated Lyles United’s security interest in our subsidiary’s assets. We also entered into a joint instruction letter with Lyles United instructing a subsidiary to remit directly to Lyles United any cash distributions received on account of the subsidiary’s ownership interests in the initial obligor subsidiary or Front Range until the time as the loan is repaid in full. In addition, the subsidiary entered into a limited recourse guaranty in favor of Lyles United to the extent of the cash distributions. Another subsidiary also guaranteed our obligations as to the loan and pledged all of its assets as security therefor. Finally, the initial obligor subsidiary paid all accrued and unpaid interest on the initial loans through November 6, 2008 in the aggregate amount of $2,205,000.
We paid Lyles United an aggregate of $332,000 and $146,000 in interest on the loans for the years ended December 31, 2009 and 2008, respectively. As of December 31, 2009, we owed Lyles United accrued and unpaid interest of $2,644,000 in respect of this loan, subject to amounts that may be satisfied on account of the transactions described below with Socius CG II, Ltd. On October 6, 2010, we paid $15,214,700 in principal, interest and fees to Lyles United, fully satisfying the amounts owed to Lyles United under these loans.
Lyles Mechanical Co. Loan Transaction
In October 2008, we issued an unsecured promissory note, or the Lyles Mechanical Note, to Lyles Mechanical Co., or Lyles Mechanical, an affiliate of Lyles United. The promissory note is for the principal amount of $1,500,000 for final payment due to Lyles Mechanical for final construction our ethanol production facility in Stockton, California. Interest on the unpaid principal amount of the promissory note accrues at an annual rate equal to the Prime Rate as reported from time to time in The Wall Street Journal plus 2%. All principal and unpaid interest on the promissory note was due on March 31, 2009.
We did not pay Lyles Mechanical any principal or interest on the loans for the years ended December 31, 2009 and 2008. As of December 31, 2009, we owed Lyles Mechanical accrued and unpaid interest of $87,000 in respect of this loan, subject to amounts that may be satisfied on account of the transactions described below with Socius CG II, Ltd. On October 6, 2010, we paid $1,822,630 in principal and interest to Lyles Mechanical, fully satisfying the amounts owed to Lyles Mechanical under these loans.
Forbearance Agreements
In February 2009 we and some of our subsidiaries and Lyles United and Lyles Mechanical entered into a forbearance agreement relating to the loans described above. In March 2009, we and some of our subsidiaries as well as Lyles United and Lyles Mechanical entered into an amended forbearance agreement relating to the loans described above. The amended forbearance agreement provided that Lyles United and Lyles Mechanical would forbear from exercising their rights and remedies under their promissory notes until the earliest to occur of April 30, 2009; the date of termination of the forbearance period due to a default under the amended forbearance agreement; and the date on which all of the obligations under the promissory notes and related documents have been paid and discharged in full and the promissory notes have been canceled. On October 6, 2010, we paid all amounts due to Lyles United and Lyles Mechanical under the loans described above.
Socius CG II, Ltd.
Between March 5, 2010 and July 21, 2010, under the terms of Orders Approving Stipulation for Settlement of Claim, or Orders, entered by the Superior Court of the State of California for the County of Los Angeles, we issued an aggregate of 24,088,218 shares of our common stock to Socius GC II, Ltd., or Socius, in consideration of the full and final settlement of an aggregate of $19,000,000 in claims against us held by Socius, or the Claims and legal fees and expenses incurred by Socius. Socius purchased the Claims from Lyles United under the terms of a Purchase and Option Agreement dated effective as of March 2, 2010 between Socius and Lyles United, or Lyles United Purchase Agreement. The Claims consisted of the right to receive an aggregate of $19,000,000 of principal amount of and under a loan made by Lyles United to us under the terms of an Amended and Restated Promissory Note dated November 7, 2008 in the original principal amount of $30,000,000.
Lyles United Purchase Agreement. On March 2, 2010, Socius and Lyles United entered into the Lyles United Purchase Agreement described above. We are a party to the Lyles United Purchase Agreement through our execution of an acknowledgment contained in that agreement. The Lyles United Purchase Agreement provided for the sale by Lyles United to Socius of Lyles United’s right to receive payment on a portion of the total amount of our indebtedness to Lyles United, specifically $5,000,000 principal amount of and under the Lyles United Note. The Lyles United Purchase Agreement also provides that if specified conditions are met with respect to the sale and purchase of the $5,000,000 portion of the total indebtedness owed to Lyles United, then Lyles United will have successive options, to be exercised at the sole and absolute discretion of Lyles United, if at all, to sell, transfer and assign to Socius one or more additional claims (which may include any combination of principal, interest or reimbursable fees or expenses comprising part of the then-outstanding indebtedness) in the amount of up to $5,000,000 each. On October 6, 2010, we paid in full all amounts due under the Lyles United Note.
Lyles Mechanical Option/Purchase Agreement. On March 2, 2010, Socius and Lyles Mechanical entered into an Option/Purchase Agreement, or Option Agreement. We are a party to the Option Agreement through our execution of an acknowledgment contained in that agreement. The Option Agreement grants Lyles Mechanical an option in the future, to be exercised at the sole and absolute discretion of Lyles Mechanical, if at all, to sell, transfer and assign to Socius the right of Lyles Mechanical to receive payment of all amounts due Lyles Mechanical by us under the terms of the Lyles Mechanical Note in the principal amount of $1,500,000. On October 6, 2010, we paid in full all amounts due under the Lyles Mechanical Note.
Frank P. Greinke
Series B Preferred Stock
For the year ended December 31, 2009, we declared cash dividends to the Greinke Personal Living Trust Dated April 20, 1999 in respect of our Series B Preferred Stock in the aggregate amount of $530,000, which dividends have not been paid. For the nine months ended September 30, 2010, we declared cash dividends to the Greinke Personal Living Trust Dated April 20, 1999 in respect of our Series B Preferred Stock in the aggregate amount of $1,310,260 , which dividends have not been paid. Frank P. Greinke is one of our former directors and the trustee of the holder of a majority of our issued and outstanding shares of Series B Preferred Stock. The Greinke Personal Living Trust Dated April 20, 1999 acquired its shares of Series B Preferred Stock from Lyles United in December 2009. On July 27, 2010, The Greinke Personal Living Trust Dated April 20, 1999 converted 91,670 shares of Series B Preferred Stock into 360,001 shares of our common stock. On October 13, 2010, The Greinke Personal Living Trust Dated April 20, 1999 converted 282,308 shares of Series B Preferred Stock into 1,657,147 shares of our common stock. On November 11, 2010, The Greinke Personal Living Trust Dated April 20, 1999 converted 170,358 shares of Series B Preferred Stock into 1,000,001 shares of our common stock .
Sales of Ethanol
During 2009 and 2008, we contracted with Southern Counties Oil Co., an entity controlled by Mr. Greinke, for the purchase of ethanol. For the years ended December 31, 2009 and 2008, we sold ethanol to Southern Counties Oil Co. for an aggregate of $2,482,000 and $12,095,000, respectively, and as of December 31, 2009 and 2008, we had outstanding accounts receivable due from Southern Counties Oil Co. of $138,000 and $152,000, respectively. For the nine months ended September 30, 2010, we sold ethanol to Southern Counties Oil Co. for an aggregate of $3,414,000 and as of September 30, 2010, we had outstanding accounts receivable of $109,000.
Front Range Energy, LLC – Daniel A. Sanders
On October 17, 2006, we acquired approximately 42% of the outstanding membership interests of Front Range, which owns and operates an ethanol production facility located in Windsor, Colorado. Daniel A. Sanders, one of our former directors, is the majority owner of Front Range. Mr. Sanders resigned as a director on October 8, 2007.
On August 9, 2006, Kinergy, one of our wholly-owned subsidiaries, entered into an Amended and Restated Ethanol Purchase and Sale Agreement dated as of August 9, 2006 with Front Range. The agreement amended an underlying agreement first signed on August 31, 2005. The agreement is effective for three years with automatic renewals for additional one-year periods thereafter unless a party to the agreement delivers written notice of termination at least 60 days prior to the end of the original or renewal term. Under the agreement, Kinergy is to provide denatured fuel ethanol marketing services for Front Range. Kinergy is to have the exclusive right to market and sell all of the ethanol from the ethanol production facility owned by Front Range, an estimated 40 million gallons per year. Under the terms of the agreement, the purchase price of the ethanol may be negotiated from time to time between Kinergy and Front Range without regard to the price at which Kinergy will re-sell the ethanol to its customers. Alternatively, Kinergy may pay to Front Range the gross payments received by Kinergy from third parties for forward sales of ethanol, referred to as the purchase price, less transaction costs and fees. From the purchase price, Kinergy may deduct all reasonable out-of-pocket and documented costs and expenses incurred by or on behalf of Kinergy in connection with the marketing of ethanol under the agreement, including truck, rail and terminal costs for the transportation and storage of the facility’s ethanol to third parties and reasonable, documented out-of-pocket expenses incurred in connection with the negotiation and documentation of sales agreements between Kinergy and third parties, collectively referred to as the transaction costs. From the purchase price, Kinergy may also deduct and retain the product of 1.0% multiplied by the difference between the purchase price and the transaction costs. In addition, Kinergy is to split the profit from any logistical arbitrage associated with ethanol supplied by Front Range.
During the years ended December 31, 2007, 2008, 2009 and for the nine months ended September 30, 2010, revenues from Front Range totaled $2,740,600, $3,069,700, $1,663,000 and $1,403,200 , respectively. Accounts receivable from Front Range at December 31, 2007, 2008, 2009 and September 30, 2010, totaled $303,300, $56,000, $21,600 and $54,800 , respectively.
On October 6, 2010, we sold our 42% ownership interest in Front Range to Mr. Sanders for $18.5 million in cash.
Cascade Investment, L.L.C.
For the year ended December 31, 2007, we declared and paid dividends to Cascade Investment, L.L.C. in respect of our Series A Preferred Stock in the aggregate amount of $4,200,000 comprised of cash dividends in the aggregate amount of $3,150,000 for the first three quarters and a dividend payment-in-kind in the amount of $1,050,000 that was issued as 65,625 shares of Series A Preferred Stock for the fourth quarter. At December 31, 2007, Cascade Investment, L.L.C. held more than 5% of our then outstanding shares of common stock.
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial ownership of our voting securities as of December 8 , 2010, the date of the table, by:
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each person known by us to beneficially own more than 5% of the outstanding shares of our common stock;
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each of our directors and director nominees;
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each of our current executive officers; and
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all of our directors and executive officers as a group.
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Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with respect to the securities. To our knowledge, except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Shares of common stock underlying derivative securities, if any, that currently are exercisable or convertible or are scheduled to become exercisable or convertible for or into shares of common stock within 60 days after the date of the table are deemed to be outstanding in calculating the percentage ownership of each listed person or group but are not deemed to be outstanding as to any other person or group. Percentage of beneficial ownership is based on 89,227,006 shares of common stock and 1,660,354 shares of Series B Preferred Stock outstanding as of the date of the table.
Name and Address of Beneficial Owner(1)
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Amount and Nature
of Beneficial Ownership
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William L. Jones
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Common
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668,182(2)
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*
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Series B Preferred
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12,820
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*
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Neil M. Koehler
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Common
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5,382,154(3)
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5.91%
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Series B Preferred
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256,410
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15.44%
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Bryon T. McGregor
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Common
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277,900
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*
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Christopher W. Wright
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Common
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287,715
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*
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Terry L. Stone
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Common
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192,142(4)
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*
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John L. Prince
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Common
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201,142(5)
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*
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Douglas L. Kieta
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Common
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211,742
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*
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Larry D. Layne
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Common
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181,742
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*
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Michael D. Kandris
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Common
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177,142
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*
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Ryan W. Turner
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Common
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159,642(6)
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*
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Capital Ventures International
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Common
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5,186,272(7)
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5.49%
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The Goldman Sachs Group, Inc.
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Common
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9,903,097(8)
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9.99%
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Mimi S. Taylor
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Common
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588,032(9)
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*
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Series B Preferred
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96,493
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5.81%
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Robert W. Bollar and Christina N. Bollar
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Common
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588,032(10)
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*
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Series B Preferred
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96,493
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5.81%
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Frank P. Greinke
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Common
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4,245,245(11)
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4.56%
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Series B Preferred
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659,678
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39.73%
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Lyles United, LLC
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Common
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6,093,175(12)
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6.39%
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Series B Preferred
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512,820
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30.89%
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All executive officers and directors
as a group (10 persons)
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Common
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7,798,503(13)
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8.54%
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Series B Preferred
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269,230
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16.22%
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(1)
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Messrs. Jones, Koehler, Stone, Prince, Kieta, Layne, Kandris and Turner are directors of Pacific Ethanol. Messrs. Koehler, McGregor and Wright are executive officers of Pacific Ethanol. The address of each of these persons is c/o Pacific Ethanol, Inc., 400 Capitol Mall, Suite 2060, Sacramento, California 95814. The address for each of Frank P. Greinke, Mimi S. Taylor Robert W. Bollar and Christina N. Bollar is P.O. Box 4159, 1800 W. Katella, Suite 400, Orange, California 92863. The address for Lyles United, LLC is c/o Howard Rice Nemerovski Canady Falk & Rabkin, Three Embarcadero Center, Suite 700, San Francisco, California 94111-4024. The address for Capital Ventures International is c/o Heights Capital Management, 101 California Street, Suite 3250, San Francisco, CA 94111. The address for The Goldman Sachs Group, Inc. is c/o Goldman Sachs Asset Management, 200 West Street, New York NY 10282.
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(2)
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Amount of common stock represents 523,699 shares of common stock held by William L. Jones and Maurine Jones, husband and wife, as community property, 50,000 shares of common stock underlying options issued to Mr. Jones, 19,230 shares of common stock underlying a warrant issued to Mr. Jones and 75,253 shares of common stock underlying our Series B Preferred Stock held by Mr. Jones.
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(3)
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Amount of common stock represents 3,492,413 shares of common stock held directly, 384,615 shares of common stock underlying a warrant and 1,505,126 shares of common stock underlying our Series B Preferred Stock.
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(4)
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Includes 15,000 shares of common stock underlying options.
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(5)
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Includes 15,000 shares of common stock underlying options.
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(6)
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Excludes 7,500 shares of common stock held by a Trust, the sole beneficiary of which is Mr. Turner’s son. Also excludes 7,500 shares of common stock held by a Trust, the sole beneficiary of which is Mr. Turner’s daughter. Neither Mr. Turner nor his spouse is a trustee of either Trust. Mr. Turner disclaims beneficial ownership of all shares owned by the Trusts.
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(7)
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Based solely on a representation by the selling security holder of the number of shares of our common stock beneficially held by the selling security holder and represents 500,000 shares of common stock underlying a warrant issued on May 29, 2008 and 4,686,272 shares of common stock issuable pursuant to the Notes and the Warrants held by the selling security holder. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 4.99%.
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(8)
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Represents shares of common stock issuable under the Notes and the Warrants held by Liberty Harbor Master Fund I, L.P., Liberty Harbor Distressed Credit, and Goldman Sachs TC Master Partnership, L.P., each a selling security holder and an affiliate of The Goldman Sachs Group, Inc. The number of shares beneficially owned is limited to 9.99% of our outstanding common stock under the terms of the Notes and the Warrants.
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(9)
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Includes 566,414 shares of common stock underlying our Series B Preferred Stock.
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(10)
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Includes 566,414 shares of common stock underlying our Series B Preferred Stock. The shares are beneficially owned by Robert W. Bollar and Christina N. Bollar, as trustees of the Bollar Living Trust dated November 5, 2004.
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(11)
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Includes 3,872,308 shares of common stock underlying our Series B Preferred Stock. The shares are beneficially owned by Frank P. Greinke, as trustee under the Greinke Personal Living Trust Dated April 20, 1999.
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(12)
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Amount of common stock represents 6,000 shares of common stock held directly, 3,076,923 shares of common stock underlying warrants and 3,010,352 shares of common stock underlying our Series B Preferred Stock.
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(13)
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Amount of common stock represents 5,734,279 shares of common stock held directly, 80,000 shares of common stock underlying options, 403,845 shares of common stock underlying warrants and 1,580,379 shares of common stock underlying our Series B Preferred Stock.
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SELLING SECURITY HOLDERS
Selling Security Holder Table
The shares of common stock being offered by the selling security holders are those issuable to the selling security holders upon conversion of the Notes, or Conversion Shares, and otherwise under the terms of the Notes with respect to the Notes, or Interest Shares. We are registering the shares of common stock in order to permit the selling security holders to offer the shares for resale from time to time. Except for the ownership of the Notes and the Warrants, the selling security holders have not had any material relationship with us within the past three years except as disclosed under the heading “Our Relationships with the Selling Security Holders” below.
The table below lists the selling security holders and other information regarding the beneficial ownership of the shares of common stock held by each of the selling security holders. The second column lists the number of shares of common stock beneficially owned by the selling security holders, based on their respective ownership of shares of common stock, Notes, Warrants and other warrants to purchase shares of common stock, as of December 8, 2010, assuming conversion of the Notes and exercise of the Warrants held by each selling security holder on that date but taking account of any limitations on conversion and issuance of common stock and exercise contained in the Notes and Warrants. The number of shares of common stock issuable upon conversion of the Notes and exercise of the Warrants held by each selling security holder on December 8, 2010 is of the sum of (i) the maximum number of shares of common stock issuable upon conversion of the Notes on December 8, 2010, (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 December 8, 2010 and (iii) the maximum number of shares of common stock issuable upon exercise of the Warrants on December 8, 2010. For purposes of calculating the maximum number of shares of common stock issuable upon conversion of the Notes or otherwise under the Notes, we used a conversion price of $0.85, the initial conversion price and the conversion price on December 8, 2010.
The third column lists the shares of common stock being offered by this prospectus by the selling security holders and does not take in account any limitations on (i) conversion of the Notes or issuance of common stock contained in the Notes or (ii) exercise of the Warrants contained in the Warrants. This prospectus generally covers the resale of up to 24,445,485 shares of common stock issuable upon conversion of the Notes and up to 3,333,475 shares of common stock otherwise issuable under the Notes (i.e., shares of common stock issuable as interest in lieu of cash payments). We are not registering the shares of common stock issuable to the selling security holders upon exercise of the Warrants, or Warrant Shares. We are only registering a portion of the total number of shares that may be issued upon conversion of the Notes and otherwise under the Notes on December 8, 2010. The number of shares of common stock that will actually be issued upon conversion of the Notes, otherwise under the Notes (i.e., shares of common stock issuable as interest in lieu of cash payments) and/or upon exercise of the Warrants may be more or less than the number of shares being offered by this prospectus.
The fourth column assumes the sale of all of the shares offered by the selling security holders under this prospectus and takes into account any limitations on conversion and issuance of common stock and exercise contained in the Notes and Warrants.
Under the terms of the Notes and the Warrants, a selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 4.99% or 9.99% (which percentage has been established at the election of each selling security holder) of our outstanding shares of common stock, or Blocker. The Blocker applicable to the conversion of the Notes may be raised or lowered to any other percentage not in excess of 9.99% or less than 4.99% at the option of the selling security holder, except that any increase will only be effective upon 61-days’ prior notice to us. The Blocker applicable to the exercise of the Warrants may be raised or lowered to any other percentage not in excess of 9.99%, except that any increase will only be effective upon 61-days’ prior notice to us. The number of shares in the second column reflects these limitations. The selling security holders may sell all, some or none of their shares in this offering. See “Plan of Distribution.”
Except as disclosed in the footnotes to the table below, each of the selling security holders have represented to us that they are not a broker-dealer, or affiliated with or associated with a broker-dealer, registered with the SEC or designated as a member of the Financial Industry Regulatory Authority. The shares of common stock being offered under this prospectus may be offered for sale from time to time during the period the registration statement of which this prospectus is a part remains effective, by or for the accounts of the selling security holders listed below.
Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with respect to the securities. To our knowledge, except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Except as indicated by footnote, all shares of common stock underlying derivative securities, if any, that are currently exercisable or convertible or are scheduled to become exercisable or convertible for or into shares of common stock within 60 days after the date of the table are deemed to be outstanding for the purpose of calculating the percentage ownership of each listed person or group but are not deemed to be outstanding as to any other person or group. Percentage of beneficial ownership is based on 89,227,006 shares of common stock outstanding as of December 8, 2010. Shares shown as beneficially owned after the offering assume that all shares being offered are sold.
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Shares of Common Stock Beneficially Owned Prior to
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Maximum Number of Shares of Common Stock to be Sold Pursuant to this
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Shares of Common Stock Beneficially Owned After Offering (#)
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Name of Beneficial Owner
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Offering
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Prospectus
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Number
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Percentage
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Hudson Bay Master Fund Ltd. (1)
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4,686,272 |
(2) |
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7,936,846 |
(3) |
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4,686,272 |
(2) |
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4.99% |
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J.P. Morgan Omni SPC, Ltd. – BIOV1 Segregated Portfolio (4)
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4,686,272 |
(2) |
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3,968,423 |
(5) |
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4,686,272 |
(2) |
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4.99% |
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Capital Ventures International (6)
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5,186,272 |
(7) |
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2,381,054 |
(8) |
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3,782,926 |
(9) |
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4.07% |
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Liberty Harbor Master Fund I, L.P. (10)
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9,903,097 |
(11) |
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6,349,476 |
(12) |
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8,754,564 |
(13) |
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8.93% |
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Liberty Harbor Distressed Credit Aggregator I, L.P. (10)
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6,608,019 |
(14) |
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2,777,896 |
(15) |
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3,380,123 |
(16) |
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4.12% |
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Goldman Sachs TC Master Partnership, L.P. (10)
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4,720,013 |
(17) |
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1,984,211 |
(18) |
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2,735,802 |
(19) |
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2.97% |
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Iroquois Master Fund Ltd. (20)
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4,686,267 |
(21) |
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2,381,054 |
(22) |
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3,238,062 |
(23) |
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3.55% |
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____________________
* Less than 1.00%
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(#)
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Assumes all shares being offered under this prospectus are sold. The percentage of share ownership indicated is based on 89,227,006 shares of our common stock outstanding as of December 8, 2010.
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(1)
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Hudson Bay Capital Management LP, the investment manager of Hudson Bay Master Fund Ltd., has voting and investment power over these securities. Sander Gerber is the managing member of Hudson Bay Capital GP LLC, which is the general partner of Hudson Bay Capital Management LP. Sander Gerber disclaims beneficial ownership over these securities.
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(2)
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Represents shares of common stock issuable under the Notes and the Warrants held by the selling security holder. The number of shares beneficially owned is limited to 4.99% of our outstanding common stock under the terms of the Notes and the Warrants.
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(3)
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Represents (i) 6,984,425 shares of common stock issuable upon conversion of the Notes and (ii) 952,421 shares of common stock otherwise issuable under the Notes.
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(4)
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Hudson Bay Capital Management LP, the investment manager of J.P. Morgan Omni SPC, Ltd. – BIOVI Segregated Portfolio, has voting and investment power over these securities. Sander Gerber is the managing member of Hudson Bay Capital GP LLC, which is the general partner of Hudson Bay Capital Management LP. Sander Gerber disclaims beneficial ownership over these securities. J.P. Morgan Omni SPC, Ltd. – BIOVI Segregated Portfolio is an “affiliate” of a U.S. registered broker-dealer and has represented that it acquired the securities offered for its own account in the ordinary course of business, and at the time it acquired the securities, it had no agreements, plans or understandings, directly or indirectly, to distribute the securities.
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(5)
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Represents (i) 3,492,212 shares of common stock issuable upon conversion of the Notes and (ii) 476,211 shares of common stock otherwise issuable under the Notes.
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(6)
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Heights Capital Management, Inc., the authorized agent of Capital Ventures International, has discretionary authority to vote and dispose of the shares held by Capital Ventures International and may be deemed to be the beneficial owner of these shares. Martin Kobinger, in his capacity as investment Manger of Heights Capital Management, Inc., may also be deemed to have investment discretion and voting power over the shares held by Capital Ventures International. Mr. Kobinger disclaims any beneficial ownership of the shares. The selling security holder is an “affiliate” of a U.S. registered broker-dealer and has represented that it acquired the securities offered for its own account in the ordinary course of business, and at the time it acquired the securities, it had no agreements, plans or understandings, directly or indirectly, to distribute the securities.
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(7)
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The number of shares disclosed is based solely on a representation by the selling security holder of the number of shares of our common stock beneficially held by the selling security holder and represents 500,000 shares of common stock underlying a warrant issued on May 29, 2008 and 4,686,272 shares of common stock issuable under the Notes and the Warrants held by the selling security holder. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 4.99%.
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(8)
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Represents (i) 2,095,328 shares of common stock issuable upon conversion of the Notes and (ii) 285,726 shares of common stock otherwise issuable under the Notes.
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(9)
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Represents (i) 1,434,084 shares of common stock issuable upon conversion of the Notes, (ii) 84,172 shares of common stock otherwise issuable under the Notes, (iii) 1,764,706 shares of common stock issuable upon exercise of the Warrants and (iv) 500,000 shares of common stock underlying a warrant issued on May 29, 2008.
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(10)
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The general partner and investment manager of the selling security holder are indirect, wholly owned subsidiaries of The Goldman Sachs Group, Inc., a publicly traded corporation (NYSE:GS). Certain subsidiaries of The Goldman Sachs Group, Inc. are registered broker dealers. The selling security holder is not a broker-dealer, registered with the SEC or designated as a member of the Financial Industry Regulatory Authority. The selling security holder has represented that it acquired the securities offered for its own account in the ordinary course of business, and at the time it acquired the securities, it had no agreements, plans or understandings, directly or indirectly, to distribute the securities.
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(11)
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Represents shares of common stock issuable under the Notes and the Warrants held by the selling security holder. The number of shares beneficially owned is limited to 9.99% of our outstanding common stock under the terms of the Notes and the Warrants.
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(12)
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Represents (i) 5,587,539 shares of common stock issuable upon conversion of the Notes and (ii) 761,937 shares of common stock otherwise issuable under the Notes.
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(13)
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Represents (i) 3,824,226 shares of common stock issuable upon conversion of the Notes, (ii) 224,456 shares of common stock otherwise issuable under the Notes, and (iii) 4,705,882 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 9.99%.
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(14)
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Represents (i) 4,117,648 shares of common stock issuable upon conversion of the Notes, (ii) 431,547 shares of common stock otherwise issuable under the Notes, and (iii) 2,058,824 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 9.99%.
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(15)
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Represents (i) 2,444,548 shares of common stock issuable upon conversion of the Notes and (ii) 333,348 shares of common stock otherwise issuable under the Notes.
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(16)
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Represents (i) 1,673,100 shares of common stock issuable upon conversion of the Notes, (ii) 98,199 shares of common stock otherwise issuable under the Notes, and (iii) 2,058,824 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 9.99%.
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(17)
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Represents (i) 2,941,177 shares of common stock issuable upon conversion of the Notes, (ii) 308,248 shares of common stock otherwise issuable under the Notes, and (iii) 1,470,588 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 9.99%.
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(18)
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Represents (i) 1,746,106 shares of common stock issuable upon conversion of the Notes and (ii) 238,105 shares of common stock otherwise issuable under the Notes.
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(19)
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Represents (i) 1,195,071 shares of common stock issuable upon conversion of the Notes, (ii) 70,143 shares of common stock otherwise issuable under the Notes, and (iii) 1,470,588 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 9.99%.
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(20)
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Iroquois Capital Management L.L.C. is the investment manager of the selling security holder. Consequently, Iroquois Capital Management L.L.C. has voting control and investment discretion over securities held by the selling security holder. As managing members of Iroquois Capital Management L.L.C., Joshua Silverman and Richard Abbe make voting and investment decisions on behalf of Iroquois Capital Management L.L.C. in its capacity as investment manager to the selling security holder. As a result of the foregoing, Mr. Silverman and Mr. Abbe may be deemed to have beneficial ownership (as determined under Section 13(d) of the Exchange Act) of the securities held by the selling security holder. Notwithstanding the foregoing, Mr. Silverman and Mr. Abbe disclaim beneficial ownership.
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(21)
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Represents 100 shares of common stock and 4,686,167 shares of common stock issuable under the Notes and the Warrants held by the selling security holder. The number of shares beneficially owned is limited to 4.99% of our outstanding common stock under the terms of the Notes and the Warrants.
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(22)
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Represents (i) 2,095,327 shares of common stock issuable upon conversion of the Notes and (ii) 285,727 shares of common stock otherwise issuable under the Notes.
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(23)
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Includes (i) 1,434,085 shares of common stock issuable upon conversion of the Notes, (ii) 84,171 shares of common stock otherwise issuable under the Notes, and (iii) 1,764,706 shares of common stock issuable upon exercise of the Warrants. Under the terms of the Notes and the Warrants held by the selling security holder, the selling security holder may not convert the Notes or exercise the Warrants to the extent (but only to the extent) the selling security holder or any of its affiliates would beneficially own a number of shares of our common stock which would exceed 4.99%.
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Private Placement Through Which the Selling Security Holders Obtained Beneficial Ownership of the Offered Shares
All shares of common stock offered by the selling security holders underlie Notes and Warrants acquired from us in connection with the transaction described below in “Description of Note and Warrant Financing.”
On October 6, 2010, or Closing Date, we consummated a private placement, or Financing, of $35,000,000 in aggregate principal amount of Notes and Warrants to purchase an aggregate of 20,588,235 shares of our common stock at an initial exercise price of $0.85 per share in a private placement to seven accredited investors under the terms of a Securities Purchase Agreement, dated as of September 27, 2010, or Purchase Agreement as more fully described below. See “Description of Note and Warrant Financing.”
Under the Purchase Agreement, each investor purchased a Note and a Warrant. The Notes are convertible into shares of our common stock, or as converted, the Conversion Shares, and are entitled to earn interest which may be paid in cash or in shares of our common stock, or Interest Shares. The Warrants are exercisable into shares of our common stock, or as exercised, the Warrant Shares). The Conversion Shares, the Interest Shares and the Warrant Shares are all subject to standard anti-dilution provisions.
In connection with the issuance of the Notes and Warrants, we paid commissions to Lazard Capital Markets LLC in the amount of $2,450,000 and expenses of approximately $50,600.
Registration Rights Agreement
In connection with the sale of the Notes and Warrants, we entered into a registration rights agreement with all of the investors in the Financing to file a registration statement on Form S-1 with the SEC covering the resale of the Conversion Shares, any Interest Shares, and the Warrant Shares, or Registration Rights Agreement. The Registration Rights Agreement requires that we file a registration statement with the SEC for the resale by the selling security holders of 150% of the sum of (i) the maximum number of Conversion Shares initially issuable upon conversion of the Notes, (ii) the maximum number of Interest Shares issuable under the Notes on October 25, 2010 and (iii) the maximum number of Warrant Shares issuable upon exercise of the 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 limitations on conversion, issuance of common stock or exercise contained in the Notes and Warrants). We have agreed to use our best efforts to have the registration statement declared effective on or before December 26, 2010, or January 25, 2011 in the event the registration statement is subject to a limited or full review by the SEC. We are obligated to amend the registration statement or file a new registration statement in the event the number of shares available under any registration statement is insufficient to cover 150% of the securities issuable under the Notes and the Warrants.
Subject to grace periods, we are required to keep a registration statement (and the prospectus contained in that registration statement available for use) for resales by the investors on a delayed or continuous basis at then-prevailing market prices at all times until the earlier of (i) the date as of which all of the investors may sell all of the shares of common stock required to be covered by the registration statement without restriction under Rule 144 under the Securities Act (including volume restrictions) and without the need for current public information required by Rule 144(c), if applicable) or (ii) the date on which the investors shall have sold all of the shares of common stock covered by the registration statement.
We must pay registration delay payments of 2% of each selling security holders initial investment in the Notes and Warrants sold in the Financing per month if the registration statement is not filed or declared effective within the foregoing time periods or ceases to be effective prior to the expiration of deadlines provided for in the registration rights agreement. However, no registration delay payments, shall be paid (i) with respect to any securities being registered that we are not permitted to include in the registration statement due to the SEC’s application of Rule 415 under the Securities Act, or (ii) with respect to any selling security holder, solely because the selling security holder is required to be described as an underwriter under applicable securities laws, and the selling security holder elects not to have its shares registered.
The Registration Rights Agreement contains various indemnification provisions in connection with the registration of the shares of common stock underlying the Notes and the shares of common stock underlying the Warrants.
Our Relationships with the Selling Security Holders
In the past three years, we have not had any relationship or arrangement with any of the selling security holders, their affiliates, or any person with whom the selling security holders have a contractual relationship regarding the Financing other than as follows: Capital Ventures International purchased 1,000,000 shares of our common stock and warrants to purchase 500,000 shares of our common stock on May 29, 2008 in a public offering of our common stock described in our registration statement on Form S-3 (File No. 333-143617).
PLAN OF DISTRIBUTION
We are registering the shares of common stock issuable upon conversion of the Notes and otherwise under the terms of the Notes to permit the resale of these shares of common stock by the holders of the Notes or Holders, from time to time after the date of this prospectus. We will not receive any of the proceeds from the sale by the selling security holders of the shares of common stock. We will bear all fees and expenses incident to our obligation to register the shares of common stock.
The selling security holders may sell all or a portion of the shares of common stock held by them and offered hereby from time to time directly or through one or more underwriters, broker-dealers or agents. If the shares of common stock are sold through underwriters or broker-dealers, the selling security holders will be responsible for underwriting discounts or commissions or agent’s commissions. The shares of common stock may be sold in one or more transactions at fixed prices, at prevailing market prices at the time of the sale, at varying prices determined at the time of sale or at negotiated prices. These sales may be effected in transactions, which may involve crosses or block transactions, under one or more of the following methods:
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on any national securities exchange or quotation service on which the securities may be listed or quoted at the time of sale;
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in the over-the-counter market;
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in transactions otherwise than on these exchanges or systems or in the over-the-counter market;
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through the writing or settlement of options, whether the options are listed on an options exchange or otherwise;
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ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers;
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block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction;
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purchases by a broker-dealer as principal and resale by the broker-dealer for its account;
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an exchange distribution in accordance with the rules of the applicable exchange;
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privately negotiated transactions;
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short sales made after the date the registration statement, of which this prospectus forms a part, is declared effective by the SEC;
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broker-dealers may agree with the selling security holders to sell a specified number of shares at a stipulated price per share;
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a combination of any of these methods of sale; and
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any other method permitted under applicable law.
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The selling security holders may also sell shares of common stock under Rule 144 promulgated under the Securities Act, if available, rather than under this prospectus. In addition, the selling security holders may transfer the shares of common stock by other means not described in this prospectus. If the selling security holders effect these transactions by selling shares of common stock to or through underwriters, broker-dealers or agents, these underwriters, broker-dealers or agents may receive commissions in the form of discounts, concessions or commissions from the selling security holders or commissions from purchasers of the shares of common stock for whom they may act as agent or to whom they may sell as principal (which discounts, concessions or commissions as to particular underwriters, broker-dealers or agents may be in excess of those customary in the types of transactions involved). In connection with sales of the shares of common stock or otherwise, the selling security holders may enter into hedging transactions with broker-dealers, which may in turn engage in short sales of the shares of common stock in the course of hedging in positions they assume. The selling security holders may also sell shares of common stock short and deliver shares of common stock covered by this prospectus to close out short positions and to return borrowed shares in connection with short sales. The selling security holders may also loan or pledge shares of common stock to broker-dealers that in turn may sell these shares.
The selling security holders may pledge or grant a security interest in some or all of the notes, warrants or shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time under this prospectus or any amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending, if necessary, the list of selling security holders to include the pledgee, transferee or other successors in interest as selling security holders under this prospectus. The selling security holders also may transfer and donate the shares of common stock in other circumstances in which case the transferees, donees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus.
To the extent required by the Securities Act and the rules and regulations thereunder, the selling security holders and any broker-dealer participating in the distribution of the shares of common stock may be deemed to be “underwriters” within the meaning of the Securities Act, and any commission paid, or any discounts or concessions allowed to, any broker-dealer may be deemed to be underwriting commissions or discounts under the Securities Act. At the time a particular offering of the shares of common stock is made, a prospectus supplement, if required, will be distributed, which will contain the aggregate amount of shares of common stock being offered and the terms of the offering, including the name or names of any broker-dealers or agents, any discounts, commissions and other terms constituting compensation from the selling security holders and any discounts, commissions or concessions allowed or re-allowed or paid to broker-dealers.
Under the securities laws of some states, the shares of common stock may be sold in these states only through registered or licensed brokers or dealers. In addition, in some states the shares of common stock may not be sold unless the shares have been registered or qualified for sale in the state or an exemption from registration or qualification is available and is complied with.
There can be no assurance that any selling security holder will sell any or all of the shares of common stock registered under the registration statement, of which this prospectus forms a part.
The selling security holders and any other person participating in this distribution will be subject to applicable provisions of the Exchange Act and the rules and regulations thereunder, including to the extent applicable, Regulation M of the Exchange Act, which may limit the timing of purchases and sales of any of the shares of common stock by the selling security holders and any other participating person. To the extent applicable, Regulation M may also restrict the ability of any person engaged in the distribution of the shares of common stock to engage in market-making activities with respect to the shares of common stock. All of the foregoing may affect the marketability of the shares of common stock and the ability of any person or entity to engage in market-making activities with respect to the shares of common stock.
We will pay all expenses of the registration of the shares of common stock under the registration rights agreement, estimated to be $100,000 in total, including, SEC filing fees and expenses of compliance with state securities or “blue sky” laws; provided, however, a selling security holder will pay all underwriting discounts and selling commissions, if any. We will indemnify the selling security holders against liabilities, including some liabilities under the Securities Act in accordance with the registration rights agreements or the selling security holders will be entitled to contribution. We may be indemnified by the selling security holders against civil liabilities, including liabilities under the Securities Act that may arise from any written information furnished to us by the selling security holder specifically for use in this prospectus, in accordance with the related registration rights agreements or we may be entitled to contribution.
Once sold under the registration statement, of which this prospectus forms a part, the shares of common stock will be freely tradable in the hands of persons other than our affiliates.
DESCRIPTION OF NOTE AND WARRANT FINANCING
Notes
The Notes were issued on October 6, 2010, and have an aggregate principal amount of $35 million. The Notes will mature on January 6, 2012, or Maturity Date, subject to the right of the investors to extend the date (i) if an event of default under the Notes has occurred and is continuing or any event shall have occurred and be continuing that with the passage of time and the failure to cure would result in an event of default under the Notes and (ii) for a period of 20 business days after the consummation of specific types of transactions involving a change of control. The Notes bear interest at the rate of 8% per annum and are compounded monthly. The interest rate will increase to 15% per annum upon the occurrence of an event of default (as described below).
The Notes are entitled to interest, amortization payments and other amounts. We are required to pay a late charge of 15% on any amount of principal or other amounts due which are not paid when due.
Interest on the Notes is payable in arrears on each Installment Date (as defined below). If a holder elects to convert or redeem all or any portion of a Note prior to the Maturity Date, all interest that would have accrued on the amount being converted or redeemed through the Maturity Date will also be payable. If we elects to redeem all or any portion of a Note prior to the Maturity Date, all interest that would have accrued on the amount being redeemed through the Maturity Date will also be payable.
Conversion
All amounts due under the Notes are convertible at any time, in whole or in part, at the option of the holders into shares of our common stock at a conversion price, or Conversion Price, which is subject to adjustment as described below. The Notes are initially convertible into shares of our common stock at the initial Conversion Price of $0.85 per share, or Fixed Conversion Price. If an event of default has occurred and is continuing or if we have elected to make an amortization payment in shares of our common stock, the Notes are convertible at a price determined as follows:
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If an event of default has occurred and is continuing, the Conversion Price will be equal to the lesser of (i) the Fixed Conversion Price and (ii) the closing bid price of the common stock on the trading date immediately before the date of conversion.
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If we have elected to make an amortization payment in shares of common stock and the date of conversion occurs during the 15 calendar day period following (and including) the applicable Installment Date (as defined below), or Initial Period, the Conversion Price will be equal to the lesser of (i) the Fixed Conversion Price and (ii) the average of the volume weighted average prices of our common stock for each of the 5 lowest trading days during the 20 trading day period immediately prior to the Initial Period.
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To the extent we have elected to make an amortization payment in shares of common stock and the date of conversion occurs during the period beginning on the 16th calendar day after the applicable Installment Date and ending on the day immediately prior to the next Installment Date or the Maturity Date, the Conversion Price will be equal to the lesser of (i) the Fixed Conversion Price and (ii) the closing bid price of our common stock on the trading date immediately before the date of conversion.
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The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. The Fixed Conversion Price is also subject to a “full ratchet” anti-dilution adjustment where if we issue or are deemed to have issued specified securities at a price lower than the then applicable Fixed Conversion Price, the Fixed Conversion Price will immediately reduce to equal the price at which we issue or are deemed to have issued our common stock.
If a holder elects to convert all or any portion of a Note prior to the Maturity Date, all interest that would have accrued on the amount being converted through the Maturity Date will also be payable.
If we sell or issue any securities with “floating” conversion prices based on the market price of our common stock, a holder of a Note will have the right to substitute the “floating” conversion price for the Fixed Conversion Price upon conversion of all or part of the Note.
The Notes may not be converted if, after giving effect to the conversion, the investor together with its affiliates would beneficially own in excess of 4.99% or 9.99% (which percentage has been established at the election of each selling security holder and is contained in the footnotes to the table in the Selling Security Holders section of this prospectus) of our outstanding shares of common stock. The Blocker applicable to the conversion of the Notes may be raised or lowered to any other percentage not in excess of 9.99% or less than 4.99% at the option of the selling security holder, except that any raise will only be effective upon 61-days’ prior notice to us. The number of shares in the second column reflects these limitations. The selling security holders may sell all, some or none of their shares in this offering. See “Plan of Distribution.”
If we fail to timely deliver common stock upon conversion of the Notes, we have agreed to pay “buy-in” damages of the converting holder.
Payment of Principal and Interest
We have agreed to make amortization payments with respect to the principal amount of each Note on each of the following dates, collectively, the Installment Dates:
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the 22nd trading day immediately following the earlier of April 6, 2011 and the date the registration statement of which this prospectus is a part is declared effective;
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the first trading day of the calendar month at least thirty calendar days after the date in the item immediately above; and
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the first trading day of each calendar month thereafter.
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The amortizing portion of the principal of each Note, or Monthly Amortization Amount, will equal the fraction of each Note with a numerator of which is equal to the original outstanding principal amount of the Note and the denominator of which is equal to the number of Installment Dates remaining until the Maturity Date.
We may elect to pay the Monthly Amortization Amount and applicable interest, or collectively, the Monthly Payment Amount, in cash or shares of our common stock, at our election, subject to the satisfaction of a Equity Conditions (as defined below).
Monthly Amortization Payment Procedures
Installment Notices
On or prior to the 21st trading day prior to each Installment Date we are required to deliver a notice electing to effect a redemption in cash or a conversion of the Monthly Payment Amount, in whole or in part (a failure to deliver a notice is deemed to be a delivery of a conversion notice in full).
Pre-Installment Share Delivery
No later than 2 trading days after delivery (or deemed delivery) of the notice, we are required to deliver to the holders of Notes an amount of shares of common stock equal to that portion of the Monthly Payment Amount being converted divided by the lesser of the then existing Conversion Price and 85% of the average of the volume weighted average prices of the 5 lowest trading days during the 20 day period ending on the trading day immediately prior to the date of the notice, which we refer to in this prospectus as the Pre-Installment Price.
Installment Date “True-Up” Share Delivery
On the applicable Installment Date, we are required to “true-up” the amount of common stock to reflect a conversion price equal to the lesser of the then existing Conversion Price and 85% of the average of the volume weighted average prices of the 5 lowest trading days during the 20 day period ending on the trading day immediately prior to the applicable Installment Date, which we refer to in this prospectus as the Post-Installment Price.
Blocker Deferral Rights
If any holder of Notes is unable to receive shares of common stock due to the Blocker, the holder of Notes may deliver a notice and either cause the portion of the applicable Monthly Payment Amount to become payable on the immediately subsequent Installment Date or withdraw the notice and receive the applicable shares of common stock at a price equal to the closing bid price on the trading day immediately preceding the date of the withdrawal.
Equity Conditions Failure Rights
If we are not permitted to deliver shares of common stock with respect to an Installment Date due to our failure to satisfy any of the Equity Conditions (as defined below), the holder of the Note, at its option at any time prior to the 3rd trading day after any applicable Installment Date, may (x) cause that portion of the applicable Monthly Payment Amount to become payable on the immediately subsequent Installment Date or (y) elect to receive the applicable shares of common stock at a price equal to lower of (A) the closing bid price on the trading day immediately preceding the date of the election and (B) the applicable Pre-Installment Price or Post-Installment Price.
Share Delivery Failure Rights
If we fail to deliver shares of our common stock in connection with an amortization payment as required under a Note, the holder of the Note may, in lieu of receiving the shares of common stock, require us to pay a cash payment of 125% of that portion of the Monthly Payment Amount subject to conversion (or 150% if we falsely certified that no Equity Conditions failure had occurred).
Equity Conditions
We will have the option to pay a Monthly Payment Amount in shares of common stock only if all of the following equity conditions are satisfied at the time of the payment (or waived by the investors), which we refer to in this prospectus as the Equity Conditions:
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The shares of common stock issuable under the terms of the Notes and the Warrants are either covered by an effective registration statement or are eligible for sale without restriction and without the need for registration under any applicable federal or state securities laws;
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During the 30 day period immediately before the payment date, our common stock shall have been listed or designated for quotation on an exchange or market permitted by the Notes, and shall not have been suspended from trading on the exchange or market (other than suspensions of not more than two days due to business announcements by us) nor shall delisting or suspension by the exchange or market been threatened or pending either in writing by the exchange or market;
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During the 30 day period immediately before the payment date, we shall have delivered shares of common stock upon conversion of the Notes and upon exercise of the Warrants on a timely basis;
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The common stock used to make the payment may be issued without violating the Blocker;
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The common stock used to make the payment may be issued without violating the regulations of the eligible exchange or market on which the common stock is listed or designated for quotation;
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During the 30 day period immediately before the payment date, we shall not have publicly announced that specified types of transactions involving a change of control are pending, proposed or intended that have not been abandoned, terminated or consummated;
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During the 30 day period immediately before the payment date, we shall not have had knowledge of any fact that would cause:
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Any effective registration statement required to be filed under the terms of the Registration Rights Agreement not to be effective and available for the resale of the shares of common stock required to registered on the registration statement, or
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Any shares of common stock issuable under the terms of the Notes or the Warrants not to be eligible for sale under Rule 144 of the Securities Act and any applicable state securities laws;
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During the 30 day period immediately before the payment date, no event shall have occurred that constitutes, or with the passage of time or giving of notice would constitute, an event of default under the Notes;
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The investors must not be in possession of any material, non-public information provided by us;
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The average of the volume-weighted average price of our common stock for each of the 5 trading days ending on the payment date is less than $0.20 (as adjusted for stock splits, stock dividends, stock combinations and other similar transactions); and
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The aggregate dollar trading volume (as reported by Bloomberg) of our common stock on over the 5 trading day period ending on the payment date is less than $1,000,000.
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If we cannot pay the Monthly Payment Amount in shares of common stock because one of the Equity Conditions described above is not satisfied and the holders of the Notes do not elect to exercise their rights described under the heading “Equity Conditions Failure Rights” above, we must make the payment in cash.
Events of Default
The Notes contain a variety of events of default which are typical for transactions of this type, as well as the following events:
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Any time after the earlier of the day the registration statement of which this prospectus is a part is declared effective by the SEC and the April 6, 2011, if for five consecutive days or for more than 10 days in any 365-day period (other than allowable grace periods) we are not in compliance with the current public information requirements of Rule 144(c) under the Securities Act and a registration statement required to be filed under the Registration Rights Agreement is not effective.
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Our common stock is not trading or listed on an eligible market or exchange for more than 5 consecutive trading days.
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We have not issued shares of common stock due upon conversion of a Note or exercise of a Warrant for more than 5 trading days.
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We have notified an investor of our intention not to comply with a request for conversion or exercise.
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We have not removed a restrictive legend on any certificate or any shares of common stock issued upon conversion or exercise within five days of a request for the removal when required by the terms of the Financing.
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If there is an event of default, holders of at least 20% of the outstanding principal amount of the Notes may force us to redeem all or any portion of the Notes (including all accrued and unpaid interest and all interest that would have accrued through the Maturity Date), in cash, at a price equal to the greater of up to 125% of the amount being redeemed, depending on the nature of the default, and the product of the following: the amount being converted multiplied by the closing bid price of our common stock on the trading date immediately before the date of redemption multiplied by the highest closing sale price of our common stock during the period beginning on the date immediately before the event of default and ending on the trading day immediately before the date of redemption.
Fundamental Transactions
The Notes prohibit us from entering into specified transactions involving a change of control, unless the successor entity is a publicly traded corporation that assumes in writing all of our obligations under the Notes under a written agreement that is approved by the holders of at least 75% of the outstanding principal amount of the Notes before the transaction is completed.
In the event of these transactions involving a change of control, the holder of a Note will have the right to force us to redeem all or any portion of the Note they hold (including all accrued and unpaid interest and all interest that would have accrued through the Maturity Date) at a price equal to the greater of (i) 125% of the amount being redeemed, (ii) the product of (m) the amount being redeemed multiplied by (n) the quotient of (A) the highest closing sale price of our common stock during the period beginning on the date immediately before the earlier to occur of (q) the completion of the change of control and (r) the public announcement of the change of control and ending on the trading day immediately before the trading day on which we pay the redemption price divided by (B) the Conversion Price then in effect, and (iii) the product of (x) the amount being redeemed multiplied by (y) the quotient of (M) the aggregate cash consideration and the aggregate cash value of any non-cash consideration per share of our common stock to be paid to the holders of the shares of common stock upon the completion of the change of control divided by (N) the Conversion Price then in effect.
Purchase Rights
If we issue options, convertible securities, warrants or similar securities to holders of our common stock, each holder of a Note has the right to acquire the same as if it had converted its Notes into common stock.
Optional Redemption at our Election
If at any time after the 30th calendar day immediately following the date that the registration statement of which this prospectus is part is declared effective, the closing sale price of our common stock exceeds 200% of the Fixed Conversion Price (as adjusted for stock splits, stock dividends, stock combinations or other similar transactions) for 15 consecutive trading days, and all of the Equity Conditions are met, we will have the right to redeem all, but not less than all (subject to exceptions in connection with the Blocker), of the principal, accrued and unpaid interest, all interest that would have accrued through the Maturity Date and all other charges remaining under the Notes by paying that amount in its entirety in cash.
Covenants
The Notes contain a variety of obligations on our part not to engage in specified activities, which are typical for transactions of this type, as well as the following covenants:
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We will initially reserve out of our authorized and unissued common stock an aggregate of 150% number of shares of common stock issuable under the Notes on October 6, 2010.
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We will, for as long as any Notes are outstanding, reserve out of our authorized and unissued common stock a number of shares equal to 125% of the number of shares of common stock issuable under the Notes.
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We will take all action reasonably necessary to reserve the required number of shares of common stock, including holding a meeting of our stockholders for the approval of an increase in the number of shares of common stock within 90 days after the date on which we do not have the required number authorized and unissued shares reserved for issuance.
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The payments due under the Notes will rank senior to all of other indebtedness and the indebtedness of our subsidiaries, other than permitted senior indebtedness.
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We and our subsidiaries will not incur other indebtedness, except for permitted indebtedness.
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We and our subsidiaries will not incur any liens, except for permitted liens.
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We and our subsidiaries will not, directly or indirectly, redeem or repay all or any portion of any indebtedness (except for permitted indebtedness) if at the time the payment is due or is made or, after giving effect to the payment, an event constituting, or that with the passage of time and without being cured would constitute, an event of default has occurred and is continuing.
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We and our subsidiaries will not redeem, repurchase or pay any dividend or distribution on our respective capital stock (other than dividends by our wholly-owned subsidiaries) without the prior consent of the investors, other than the distribution that was made by Pacific Ethanol California, Inc. to us upon the closing of the sale of Pacific Ethanol California Inc.’s interest in Front Range.
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We and our subsidiaries will not sell, lease, assign, transfer or otherwise dispose of any of our assets or any assets of any subsidiary, except for permitted dispositions (including the sales of inventory or receivables in the ordinary course of business).
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We and our subsidiaries will not permit any indebtedness to mature or accelerate prior to the maturity date, other than permitted indebtedness.
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Participation Rights
The holders of the Notes are entitled to receive any dividends paid or distributions made to the holders of our common stock on an “as if converted to common stock” basis.
Warrants
The Warrants are immediately exercisable and, in the aggregate, entitle the holders of the Warrants to purchase up to an aggregate of 20,588,235 shares of our common stock for a period of 7 years at an exercise price of $0.85 per share, or Warrant Exercise Price, which price is subject to adjustment. The Warrants include both cash and cashless exercise provisions.
The Warrant Exercise Price is subject to adjustment for stock splits, combinations or similar events, and, in this event, the number of shares issuable upon the exercise of the Warrant will also be adjusted so that the aggregate Warrant Exercise Price shall be the same immediately before and immediately after the adjustment. In addition, the Warrant Exercise Price is also subject to a “full ratchet” anti-dilution adjustment where if we issue or are deemed to have issued securities at a price lower than the then applicable Warrant Exercise Price, the Warrant Exercise Price will immediately reduce to equal the price at which we issue or are deemed to have issued our common stock.
If we sell or issue any securities with “floating” conversion prices based on the market price of our common stock, a holder of a Warrant have the right to substitute the “floating” conversion price for the Warrant Exercise Price upon exercise of all or part the Warrant.
Similar to the Notes, the Warrants require payments to be made by us for failure to deliver the shares of common stock issuable upon exercise.
The Warrants may not be converted if, after giving effect to the conversion, the investor together with its affiliates would beneficially own in excess of 4.99% or 9.99% (which percentage has been established at the election of each selling security holder and is contained in the footnotes to the table in the Selling Security Holders section of this prospectus) of our outstanding shares of common stock. The Blocker applicable to the exercise of the Warrants may be raised or lowered to any other percentage not in excess of 9.99%, except that any increase will only be effective upon 61-days’ prior notice to us.
Purchase Rights
If we issue options, convertible securities, warrants, stock, or similar securities to holders of our common stock, each holder of a Warrant has the right to acquire the same as if the holder had exercised its Warrant.
Fundamental Transactions
The Warrants prohibit us from entering into specified transactions involving a change of control, unless the successor entity is a publicly traded corporation that assumes all of our obligations under the Warrants under a written agreement approved by all of the holders of the Warrants before the transaction is completed. When there is a transaction involving a permitted change of control, a holder of a Warrant a will have the right to force us to repurchase the holder’s Warrant for a purchase price in cash equal to the Black Scholes value (as calculated under the Warrants) of the then unexercised portion of the Warrant.
Mandatory Exercise
If at any time after the date we have initially satisfied all of the Equity Conditions, (i) our common stock trades at a price equal to or greater than $2.12 per share for 20 trading days in any 30 consecutive trading day period, or Mandatory Exercise Measuring Period, (ii) the average daily dollar trading volume (as reported on Bloomberg) of our common stock for each trading day during the Mandatory Exercise Measuring Period exceeds $250,000 per day and (iii) all Equity Conditions are satisfied, we will have the right to require the holders of the Warrants to fully exercise all, but not less than all, of the Warrants (subject to the Blocker).
Summary of Economic Terms of the Note and Warrant Financing and Potential Negative Implications to Us and Our Other Investors
The following provides a summary of some of the economic and financial information and the potential effects to us as a result of the Financing.
Investing in our common stock involves substantial risks. As part of the Financing, we issued a significant amount of Notes and Warrants, the conversion or exercise of which could have a substantial negative impact on the price of our common stock and could result in a dramatic decrease in the value of an investment in our common stock. We urge potential investors to review the report of our independent certified public accountants and our consolidated financial statements and related notes beginning on page F-2 of this prospectus, the cautionary statements included in the “Risk Factor” section, including but not limited to the “Risks Related to This Offering,” beginning on page 14 of this prospectus, and to seek independent advice concerning these substantial risks before making a decision to invest in our common stock.
The selling security holders are offering for resale an aggregate of 27,778,960 shares of common stock under this prospectus, which represents only a portion of the good faith estimate of the number of shares of common stock that are issuable upon the conversion of principal of the Notes or issuable as interest in lieu of cash payments on the Notes.
Based on the Fixed Conversion Price of the Notes of $0.85, the conversion in full of the aggregate principal amount of Notes of approximately $35.0 million would result in our issuance of approximately 41,176,473 shares of our common stock. However, as discussed below, various factors, including the future market price of our common stock and our ability to issue shares of common stock in lieu of interest subject to the satisfaction of the Equity Conditions, could result in us issuing significantly more shares of common stock upon conversion in full of the Notes.
Value of the Common Stock Covered By This Prospectus
Based on the closing price of a share of our common stock on The NASDAQ Capital Market of $1.00 on the Closing Date of the Financing, the total dollar value of the 27,778,960 shares of common stock being offered for resale by the selling security holders under this prospectus was $27,778,960 . The foregoing calculation does not include the value of the shares of common stock that may be issuable under Notes and the Warrants that are not covered by this prospectus.
Payments to Selling Security Holders in Connection with the Financing
Aggregate Payments to Selling Security Holders
The following table discloses all payments that have been made or we may be required to make to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing.
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A.
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Interest payments on the Notes
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$ |
2,473,542
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(1)
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B.
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Total possible payments to selling security holders
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$ |
2,473,542
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(1)(2)
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C.
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Total possible payments to our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing
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$ |
2,619,600
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(3)
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D.
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Total possible payments to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing
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$ |
5,093,142
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(4)
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(1)
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Represents interest payments due under the Notes. The Notes bear interest at the rate of 8% per annum and are compounded monthly. The interest rate will increase to 15% per annum upon the occurrence of an event of default. The payment amount represents the amount of interest that will be paid to the holders assuming that (i) the first Installment Date occurs on April 6, 2011, the six month anniversary of the Closing Date, (ii) an event of default will not occur and (iii) all interest will be paid in cash when it becomes due, calculated at a rate of 8% per annum, compounded monthly, through the Maturity Date. As described above, we may elect to pay accrued interest on the Notes in cash or shares of our common stock, at our election, subject to the satisfaction of the Equity Conditions.
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(2)
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Represents interest payments due under the Notes, calculated as contained in footnote 1 to Row A. In addition to the interest payments, we may be required to make other payments to the selling security holders in connection with the Financing. Holders of the Notes are entitled to receive any dividends paid and distributions made to holders of our common stock to the same extent as if the holders of the Notes had converted the Notes into common stock and had held the shares of common stock on the record date for the dividends and distributions. We are required to pay a late charge of 15% on any amount of principal or other amounts due which are not paid when due. In the event of any delay in effectiveness of a registration statement required to be filed under the Registration Rights Agreement, or in the event any selling security holder of securities is unable to sell any securities underlying the Notes or Warrants because of a failure by us to maintain the effectiveness of a registration statement required to be filed under the Registration Rights Agreement or to file with the SEC any required reports that lead to us not being in compliance with Rule 144 of the Securities Act, we will be required to pay to each selling security holder, as partial relief for damages, an amount in cash equal to 2% of that selling security holder’s original principal amount of the Notes per month, until the failure is cured.
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(3)
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Represents (i) legal fees totaling approximately $119,000 paid to selling security holders’ legal counsel, and (ii) payments made to Lazard Capital Markets LLC totaling $2,500,600 (including expenses incurred by Lazard Capital Markets LLC in connection with the Financing). Lazard Capital Markets LLC acted as our placement agent for the Financing. As part of the Financing, we agreed to reimburse the selling security holders for all reasonable costs and expenses incurred by them in connection with the Financing (including all reasonable legal fees), including costs and expenses in connection with the selling security holders’ review of this prospectus and future prospectuses. The amount paid by us for legal fees could increase as a result of the selling security holders’ legal counsel’s review of this and future prospectuses. This amount does not include legal fees paid to our legal counsel and other costs and expenses incurred by us in connection with Financing.
|
|
(4)
|
Represents the sum of the values of Rows B and C.
|
Payments to be made to Selling Security Holders in the First Year following the Closing Date.
The following table discloses payments we may be required to make to the selling security holders, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing in the first year following the Closing Date.
|
Interest payments on the Notes
|
|
$ |
2,333,542
|
(1)
|
| |
|
|
|
|
|
Total possible payments to Holders
|
|
$ |
2,333,542
|
(1)(2)
|
|
(1)
|
Represents interest payments due under the Notes. The Notes bear interest at the rate of 8% per annum and are compounded monthly. The interest rate will increase to 15% per annum upon the occurrence of an event of default. The payment amount represents the amount of interest that will be paid to the holders assuming that (i) the first Installment Date occurs on April 6, 2011, the six month anniversary of the Closing Date, (ii) an event of default will not occur and (iii) all interest will be paid in cash when it becomes due, calculated at a rate of 8% per annum, compounded monthly, through October 6, 2011. As described above, we may elect to pay accrued interest on the Notes in cash or shares of our common stock, at our election, subject to the satisfaction of the Equity Conditions.
|
|
(2)
|
Represents interest payments due under the Notes, calculated as contained in footnote 1 above. In addition to the interest payments, we may be required to make other payments to the selling security holders in connection with the Financing. Holders of the Notes are entitled to receive any dividends paid and distributions made to holders of our common stock to the same extent as if the holders of the Notes had converted the Notes into common stock and had held the shares of common stock on the record date for the dividends and distributions. We are required to pay a late charge of 15% on any amount of principal or other amounts due which are not paid when due. In the event of any delay in effectiveness of a registration statement required to be filed under the Registration Rights Agreement, or in the event any selling security holder of securities is unable to sell any securities underlying the Notes or Warrants because of a failure by us to maintain the effectiveness of a registration statement required to be filed under the Registration Rights Agreement or to file with the SEC any required reports that lead to us not being in compliance with Rule 144 of the Securities Act, we will be required to pay to each selling security holder, as partial relief for damages, an amount in cash equal to 2% of that selling security holder’s original principal amount of the Notes per month, until the failure is cured.
|
Cost of Financing, Net Proceeds and Total Possible Profit to Selling Security Holders
The following table discloses the gross proceeds we received in the Financing, all payments that have been made or we may be required to make to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing, and the resulting net proceeds we received in connection with the Financing.
The following table also sets forth an example of the total possible profit to the selling security holders resulting from the sale of common stock underlying the Notes and Warrants issued in the Financing. This total possible profit calculation is based on various assumptions and is for example purposes only. The actual profits to the selling security holders may be materially less or materially more than the amount reported.
|
A.
|
Gross proceeds to Pacific Ethanol from the sale of the Notes and Warrants
|
|
$ |
35,000,000
|
|
| |
|
|
|
|
|
|
B.
|
Total possible payments to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing
|
|
$ |
5,093,142
|
(1)
|
| |
|
|
|
|
|
|
C.
|
Net proceeds to Pacific Ethanol from the sale of the Notes and Warrants after deducting the total possible payments to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing
|
|
$ |
29,906,858
|
(2)
|
| |
|
|
|
|
|
|
D.
|
Total possible profit that could be realized by the selling security holders as a result of the sale of common stock underlying the Notes and Warrants issued in the Financing (assuming that payments of interest will be made in cash and not in shares of our common stock), assuming a conversion price of $0.85
|
|
$ |
9,246,706
|
(3)
|
| |
|
|
|
|
|
|
E.
|
Total possible profit that could be realized by the selling security holders as a result of the sale of common stock underlying the Notes and Warrants issued in the Financing (assuming that payments of interest will be made in cash and not in shares of our common stock), assuming a conversion price of $0.20
|
|
$ |
156,470,588
|
(4)
|
|
(1)
|
Represents the value depicted in Row D from the table above captioned “Aggregate Payments to Selling Security Holders” under the description of “Payments to Selling Security Holders in Connection with the Financing” above. The value represented is based on various assumptions described above.
|
|
(2)
|
Represents the value in Row A less the value in Row B.
|
|
(3)
|
Represents the value depicted in Row F from the table captioned “Assuming a Conversion Price $0.85” under the description of “Total Possible Profit That the Selling Security Holders Could Realize as a Result of the Conversion Discount for the shares of Common Stock underlying the Notes and Warrants” below. The value represented is based on various assumptions described below and is for example purposes only. The actual profits to the selling security holders may be materially less or materially more than this amount.
|
|
(4)
|
Represents the value depicted in Row F from the table captioned “Assuming a Conversion Price $0.20” under the description of “Total Possible Profit That the Selling Security Holders Could Realize as a Result of the Conversion Discount for the shares of Common Stock underlying the Notes and Warrants” below. The value represented is based on various assumptions described below and is for example purposes only. The actual profits to the selling security holders may be materially less or materially more than this amount.
|
Based on the numbers presented in the table above, assuming a Conversion Price of $0.85, the sum of (i) the total possible payments to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing (Row B above) and (ii) the total possible profit that could be realized by the selling security holders as a result of the sale of common stock underlying the Notes and Warrants issued in the Financing (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row D above) represents approximately 48% of the net proceeds received by us in the Financing (Row C above). If spread over the fifteen month term of the Notes, this would equal approximately 3.2% per month. If spread over the seven year term of the Warrants, this would equal approximately 0.6% per month.
Based on the numbers presented in the table below, assuming a Conversion Price of $0.20, the sum of the total possible payments to the selling security holders, our placement agent, any affiliate of any selling security holder, or any person with whom any selling security holder has a contractual relationship regarding the Financing (Row B above) and the total possible profit that could be realized by the selling security holders as a result of the sale of common stock underlying the Notes and Warrants issued in the Financing (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row E above) represents approximately 540% of the net proceeds received by us in the Financing (Row C above). If spread over the fifteen month term of the Notes, this would equal approximately 36% per month. If spread over the seven year term of the Warrants, this would equal approximately 6.4% per month.
Total Possible Profit That the Selling Security Holders Could Realize as a Result of the Conversion Discount for the shares of Common Stock underlying the Notes and Warrants
We anticipate that we will pay the entire principal balance of the Notes in shares of our common stock. We also anticipate that, to the fullest extent permitted by the Notes, we will pay interest payments under the notes in shares of our common stock.
Our ability to make amortization payments in shares of our common stock is subject to the Equity Conditions discussed in more detail above in our description of the Notes under the caption “Payment of Principal and Interest.” If these Equity Conditions are not satisfied, the amortization payments must be made in cash unless a waiver is obtained from the selling security holders. If these Equity Conditions are satisfied, we are permitted to pay all principal and interest due under the Notes in shares of our common stock, subject to the Blocker.
As discussed in more detail above in our description of the Notes, the Notes are convertible into shares of our common stock based on the Conversion Price. The Notes are initially convertible into shares of our common stock at the Fixed Conversion Price of $0.85 per share. As discussed above, the Conversion Price will be adjusted if an event of default has occurred and is continuing or if we have elected to make an amortization payment in shares of our common stock, and will be determined as follows:
|
|
·
|
If an event of default has occurred and is continuing, the Conversion Price will be equal to the lesser of the Fixed Conversion Price and the closing bid price of the common stock on the trading date immediately before the date of conversion.
|
|
|
·
|
If we have elected to make an amortization payment in shares of common stock and the date of conversion occurs during the Initial Period, the Conversion Price will be equal to the lesser of the Fixed Conversion Price and the average of the volume weighted average prices of our common stock for each of the 5 lowest trading days during the 20 trading day period immediately prior to the Initial Period.
|
|
|
·
|
To the extent we have elected to make an amortization payment in shares of common stock and the date of conversion occurs during the period beginning on the 16th calendar day after the applicable Installment Date and ending on the day immediately prior to the next Installment Date or the Maturity Date, the Conversion Price will be equal to the lesser of the Fixed Conversion Price and the closing bid price of our common stock on the trading date immediately before the date of conversion.
|
Unless we obtain a waiver from the holders of the Notes, we cannot use shares of common stock to make an amortization payment if the Conversion Price is less than $0.20. For purposes of a conversion of the Notes by the selling security holders, there is no minimum number to which the Conversion Price could fall.
The following tables contains estimates of the potential profit to the selling security holders upon selling the shares of common stock issuable to them under the Notes and the Warrants. The following tables assume a Conversion Price of $0.85 and $0.20, respectively, and are for example purposes only. The Conversion Price could fall to lower than $0.20. Actual results may be materially less or materially more than the amounts contained in the tables below.
Assuming a Conversion Price of $0.85
|
A.
|
Market Price of a share of our common stock on the Closing Date
|
|
$ |
1.00
|
(1)
|
| |
|
|
|
|
|
|
B.
|
Conversion Price on the Closing Date
|
|
$ |
0.85
|
(2)
|
| |
|
|
|
|
|
|
C.
|
Total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock)
|
|
|
61,764,708
|
(3)
|
| |
|
|
|
|
|
|
D.
|
Combined market price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by using the market price per share of our common stock on the Closing Date (Row A) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row C)
|
|
$ |
61,764,708
|
|
| |
|
|
|
|
|
|
E.
|
Combined Conversion Price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by using the Conversion Price on the Closing Date (Row B) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row C)
|
|
$ |
52,500,002
|
|
| |
|
|
|
|
|
|
F.
|
Total possible discount to the market price as of the Closing Date of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by subtracting Row E from Row D
|
|
$ |
9,264,706
|
|
| |
|
|
|
|
|
|
G.
|
Total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock)
|
|
|
66,080,179
|
(3)(4)
|
| |
|
|
|
|
|
|
H.
|
Combined market price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of Interest Shares), calculated by using the market price per share of our common stock on the Closing Date (Row A) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock) (Row G)
|
|
$ |
66,080,179
|
|
| |
|
|
|
|
|
|
I.
|
Combined Conversion Price of the total number of shares of common stock issuable under the Notes and Warrants on the Closing Date (assuming that payments of interest will be made in shares of our common stock), calculated by using the Conversion Price on the Closing Date (Row B) the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock) (Row G)
|
|
$ |
56,168,152
|
|
| |
|
|
|
|
|
|
J.
|
Total possible discount to the market price as of the Closing Date of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock), calculated by subtracting Row I from Row H
|
|
$ |
9,912,027
|
|
|
(1)
|
Represents the closing price of our common stock on The NASDAQ Capital Market on the Closing Date.
|
|
(2)
|
The Conversion Price is subject to adjustment as described above.
|
|
(3)
|
The total number of shares issuable under the Notes is calculated based on a Conversion Price of $0.85, which represents the Conversion Price on the Closing Date and on December 8 , 2010.
|
|
(4)
|
The number of Interest Shares issuable under the Notes is based on the amount of interest due if all of the Notes had been converted immediately upon issuance on the Closing Date (calculated at a rate of 8% per annum, compounded monthly, through the Maturity Date) and is calculated using a Conversion Price of $0.85, the Conversion Price on the Closing Date and on December 8 , 2010.
|
Assuming a Conversion Price of $0.20
|
A.
|
Market Price of a share of our common stock on the Closing Date
|
|
$ |
1.00
|
(1)
|
| |
|
|
|
|
|
|
B.
|
Conversion Price
|
|
$ |
0.20
|
(2)
|
| |
|
|
|
|
|
|
C.
|
Total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in Interest Shares)
|
|
|
195,588,235
|
(3)
|
| |
|
|
|
|
|
|
D.
|
Combined market price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by using the market price per share of our common stock on the Closing Date (Row A) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row C)
|
|
$ |
195,588,235
|
|
| |
|
|
|
|
|
|
E.
|
Combined Conversion Price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by using the Conversion Price on the Closing Date (Row B) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock) (Row C)
|
|
$ |
39,117,647
|
|
| |
|
|
|
|
|
|
F.
|
Total possible discount to the market price as of the Closing Date of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in cash and not in shares of our common stock), calculated by subtracting Row E from Row D
|
|
$ |
156,470,588
|
|
| |
|
|
|
|
|
|
G.
|
Total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock)
|
|
|
213,928,976
|
(3)(4)
|
| |
|
|
|
|
|
|
H.
|
Combined market price of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock), calculated by using the market price per share of our common stock on the Closing Date (Row A) and the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock) (Row G)
|
|
$ |
213,928,976
|
|
| |
|
|
|
|
|
|
I.
|
Combined Conversion Price of the total number of shares of common stock issuable under the Notes and Warrants on the Closing Date (assuming that payments of interest will be made in shares of our common stock), calculated by using the Conversion Price on the Closing Date (Row B) the total number of shares of common stock that may be issued under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock) (Row G)
|
|
$ |
42,785,795
|
|
| |
|
|
|
|
|
|
J.
|
Total possible discount to the market price as of the Closing Date of the total number of shares of common stock issuable under the Notes and Warrants (assuming that payments of interest will be made in shares of our common stock), calculated by subtracting Row I from Row H
|
|
$ |
171,143,181
|
|
|
(1)
|
Represents the closing price of our common stock on The NASDAQ Capital Market on the Closing Date.
|
|
(2)
|
Represents the lowest Conversion Price at which we are allowed to make amortization payments in shares of our common stock without a waiver from the holders of the Notes, subject to the other Equity Conditions described above. The Conversion Price is subject to resetting provisions as described above. For purposes of a conversion of the Notes by the selling security holders, there is no minimum number to which the Conversion Price could fall.
|
|
(3)
|
The total number of shares issuable under the Notes is calculated based on a Conversion Price of $0.20, which represents the lowest Conversion Price at which we are allowed to make amortization payments in shares of our common stock without a waiver from the holders of the Notes, subject to the other equity conditions described above.
|
|
(4)
|
The number of Interest Shares issuable under the Notes is based on the amount of interest due if all of the Notes had been converted on the Closing Date (calculated at a rate of 8% per annum, compounded monthly, through the Maturity Date) and is calculated using a Conversion Price of $0.20, the lowest Conversion Price at which we are allowed to make amortization payments in shares of our common stock without a waiver from the holders of the Notes, subject to the other equity conditions described above.
|
Information Regarding Prior Securities Transactions between us and the Selling Security Holders
The following tables contain information regarding all securities transactions completed after March 23, 2005 and before October 6, 2010 between us and the selling security holders, any affiliates of the selling security holders, or any person with whom any selling security holder had a contractual relationship regarding the transaction (or any predecessors of those persons).
Registered Direct Transaction Completed on May 29, 2008
On May 29, 2008, Capital Ventures International purchased 1,000,000 shares of our common stock and warrants to purchase 500,000 shares of our common stock in a public offering of our common stock described in our registration statement on Form S-3 (File No. 333-143617).
|
A.
|
Date of Transaction
|
|
|
May 29, 2008
|
|
| |
|
|
|
|
|
|
B.
|
Number of shares of common stock outstanding immediate prior to the transaction
|
|
|
44,131,065
|
|
| |
|
|
|
|
|
|
C.
|
Approximate number of shares of our common stock outstanding immediately prior to the transaction, excluding the approximate number of shares of common stock held by our affiliates and the selling security holders immediately prior to the completion of the transaction
|
|
|
37,500,000
|
(1)
|
| |
|
|
|
|
|
|
D.
|
Number of shares of common stock subject to the transaction
|
|
|
9,000,000
|
(2)
|
| |
|
|
|
|
|
|
E.
|
Percentage of total outstanding securities that were issued in the transaction
|
|
|
24.0%
|
(3)
|
| |
|
|
|
|
|
|
F.
|
Market price per share of our common stock on May 29, 2008
|
|
$ |
3.50
|
(4)
|
| |
|
|
|
|
|
|
G.
|
Market price per share of our common stock on December 8 , 2010
|
|
$ |
0.60
|
(5)
|
|
(1)
|
Calculated by deducting the approximate number of shares of common stock held by our affiliates and the selling security holders immediately prior to the completion of the transaction from the value in Row B.
|
|
(2)
|
Includes 6,000,000 shares of common stock and 3,000,000 shares of common stock underlying warrants.
|
|
(3)
|
The percentage was calculated by taking the number in Row D and dividing that number by the number in Row C.
|
|
(4)
|
Represents the closing price of our common stock on The NASDAQ Global Market on May 29, 2008.
|
|
(5)
|
Represents the closing price of our common stock on The NASDAQ Capital Market on December 8 , 2010.
|
Private Placement Transaction Completed on May 25, 2006
On May 25, 2006, we completed private placement transaction in which (i) Capital Ventures International purchased 379,075 shares of our common stock and warrants to purchase 189,538 shares of our common stock, (ii) Hudson Bay Fund, LP purchased 199,014 shares of our common stock and warrants to purchase 99,507 shares of our common stock and (iii) Iroquois Master Fund, Ltd. purchased 189,537 shares of our common stock and warrants to purchase 94,769 shares of our common stock.
|
A.
|
Date of Transaction
|
|
|
May 25, 2006
|
|
| |
|
|
|
|
|
|
B.
|
Approximate number of shares of common stock outstanding immediate prior to the transaction
|
|
|
31,500,000
|
|
| |
|
|
|
|
|
|
C.
|
Approximate number of shares of our common stock outstanding immediately prior to the transaction, excluding the approximate number of shares of common stock held by our affiliates and the selling security holders immediately prior to the completion of the transaction
|
|
|
22,800,000
|
(1)
|
| |
|
|
|
|
|
|
D.
|
Number of shares of common stock subject to the transaction
|
|
|
8,244,880
|
(2)
|
| |
|
|
|
|
|
|
E.
|
Percentage of total outstanding securities that were issued in the transaction
|
|
|
36.2%
|
(3)
|
| |
|
|
|
|
|
|
F.
|
Market price per share of our common stock on May 25, 2006
|
|
$ |
31.52
|
(4)
|
| |
|
|
|
|
|
|
G.
|
Market price per share of our common stock on December 8 , 2010
|
|
$ |
0.60
|
(5)
|
|
(1)
|
Calculated by deducting the approximate number of shares of common stock held by our affiliates and the selling security holders immediately prior to the completion of the transaction from the value in Row B.
|
|
(2)
|
Includes 5,496,583 shares of common stock and 2,748,297 shares of common stock underlying warrants.
|
|
(3)
|
The percentage was calculated by taking the number in Row D and dividing that number by the number in Row C.
|
|
(4)
|
Represents the closing price of our common stock on the NASDAQ Capital Market on May 25, 2006.
|
|
(5)
|
Represents the closing price of our common stock on the NASDAQ Capital Market on December 8 , 2010.
|
Total Possible Profit Selling Security Holders Could Realize as a Result of the Conversion Discount for the shares of Common Stock underlying Other Convertible Securities Held
Except for a warrant, or Capital Warrant, to purchase 500,000 shares of our common stock purchased by Capital Ventures International on May 29, 2008 in a public offering of our common stock describe in our registration statement on Form S-3 (File No. 333-143617), neither the selling security holders nor any of their affiliates hold any warrants, options, notes or other securities to purchase shares of our common stock other than for the Notes and the Warrants held by the selling security holders. The exercise price of common stock purchasable upon exercise of the Capital Warrant is $7.10 per share. The exercise price and the number of shares issuable upon exercise of the Capital Warrant are subject to adjustment for stock splits, combinations or similar events.
The following table sets forth estimates of the potential profit to Capital Ventures International upon selling the shares of common stock issuable to Capital Ventures International upon exercise of the Capital Warrant.
|
A.
|
Market Price of a share of our common stock on May 29, 2008
|
|
$ |
3.50
|
(1)
|
| |
|
|
|
|
|
|
B.
|
Exercise price on May 29, 2008
|
|
$ |
7.10
|
(2)
|
| |
|
|
|
|
|
|
C.
|
Total number of shares of common stock that may be issued to Capital Ventures International under the Capital Warrant
|
|
|
500,000
|
|
| |
|
|
|
|
|
|
D.
|
Combined market price of the total number of shares of common stock issuable to Capital Ventures International under the Capital Warrant, calculated by using the market price per share of our common stock on the May 29, 2008 (Row A) and the total number of shares of common stock that may be issued to Capital Ventures International under the Capital Warrant (Row C)
|
|
$ |
1,750,000
|
|
| |
|
|
|
|
|
|
E.
|
Combined Conversion Price of the total number of shares of common stock issuable to Capital Ventures International under the Capital Warrant, calculated by using the exercise price of the Capital Warrant on May 29, 2008 (Row B) and the total number of shares of common stock that may be issued to Capital Ventures International under the Capital Warrant (Row C)
|
|
$ |
3,550,000
|
|
| |
|
|
|
|
|
|
F.
|
Total possible discount to the market price as of May 29, 2008 of the total number of shares of common stock issuable to Capital Ventures International under the Capital Warrant, calculated by subtracting Row E from line D
|
|
|
N/A
|
(3)
|
|
(1)
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Represents the closing price of our common stock on The NASDAQ Global Market on May 29, 2008.
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(2)
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The exercise price had not been subject to adjustment since May 29, 2008.
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(3)
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The Capital Warrant was not sold at a discount to market.
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Information Regarding Our Outstanding Common Stock and the Selling Security Holders’ Resale of Our Common Stock
The following tables provides information regarding our outstanding common stock as of the Closing Date.
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A.
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Number of shares of our common stock outstanding immediately prior to the Financing
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83,371,359
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Number of shares of our common stock outstanding immediately prior to the Financing, excluding shares of common stock held by our affiliates and the selling security holders
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79,211,980
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(1) |
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B.
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Number of shares of our common stock registered for resale by the selling security holders in prior registration statements
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None
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C.
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Common stock being offered for resale by the selling security holders to the public under this prospectus
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27,778,960
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(1)
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(1)
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Calculated by excluding 100 shares of common stock held by Iroquois Master Fund Ltd. and 4,159,279 shares of common stock held by our affiliates, from our 83,371,359 total shares of common stock outstanding as of the Closing Date. Except for 100 shares of common stock held by Iroquois Master Fund Ltd., neither the selling security holders nor any of their respective affiliates held any of our outstanding common stock on the Closing Date.
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Our Financial Ability to Make Payments Due Under the Notes
We intend, and have a reasonable basis to believe that we will have the financial ability, to make all payments with respect to the Financing.
Method of Determining the Number of Shares Being Registered
We seek to register 27,778,960 shares of common stock on the registration statement of which this prospectus is a part.
We initially agreed to register 99,120,272 shares of common stock. This figure represents 150% of the sum of (i) the maximum number of shares of common stock initially issuable upon conversion of the Notes (assuming an initial Conversion Price of $0.85), (ii) the maximum number of shares of common stock payable as interest under the Notes (assuming all interest became due and payable on October 25, 2010, calculated using an interest rate of 8% per annum compounded monthly through the Maturity Date and a Conversion Price of $0.85, which was the closing price of our common stock on October 25, 2010), and (iii) the maximum number of shares of common stock issuable upon exercise of the Warrants. The calculation is illustrated in the table below:
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Shares Issuable Under Notes
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Principal Amount of Notes sold in Financing
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$ |
35,000,000 |
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Fixed Conversion Price
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$ |
0.85 |
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Total number of Conversion Shares initially issuable upon conversion of the Notes
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41,176,473 |
(1) |
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150% of Conversion Shares
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61,764,711 |
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Interest Rate on Notes
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8% |
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Total Amount of interest
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$ |
3,666,148 |
(2) |
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Conversion Price on October 25, 2010
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$ |
0.85 |
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Interest Shares
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4,315,471 |
(1), (2) |
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150% of Interest Shares
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6,473,208 |
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Shares Issuable Under Warrants
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Warrant Shares
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20,588,235 |
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150% of Warrant Shares
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30,882,353 |
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