UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to _______

Commission File Number: 000-21467

(Exact name of registrant as specified in its charter)

(916) 403-2123
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

As of August 6, 2019, there were 49,771,412 shares of Pacific Ethanol, Inc. common stock, $0.001 par value per share, and 896 shares of Pacific Ethanol, Inc. non-voting common stock, $0.001 par value per share, outstanding.

PART I - FINANCIAL INFORMATION

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share data)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(unaudited, in thousands)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Organization and Business – The consolidated financial statements include, for all periods presented, the accounts of Pacific Ethanol, Inc., a Delaware corporation (“Pacific Ethanol”), and its direct and indirect subsidiaries (collectively, the “Company”), including its subsidiaries, Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”), Pacific Ag. Products, LLC, a California limited liability company (“PAP”), PE Op Co., a Delaware corporation (“PE Op Co.”) and all nine of the Company’s ethanol production facilities.

The Company is a leading producer and marketer of low-carbon renewable fuels in the United States.

The Company’s four ethanol plants in the Western United States (together with their respective holding companies, the “Pacific Ethanol West Plants”) are located in close proximity to both feed and ethanol customers and thus enjoy unique advantages in efficiency, logistics and product pricing.

The Company’s five ethanol plants in the Midwest (together with their respective holding companies, the “Pacific Ethanol Central Plants”) are located in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, the Company’s ability to load unit trains from these facilities in the Midwest allows for greater access to international markets.

The Company has a combined production capacity of 605 million gallons per year, markets, on an annualized basis, nearly 1.0 billion gallons of ethanol and specialty alcohols, and produces, on an annualized basis, nearly 3.0 million tons of co-products on a dry matter basis, such as wet and dry distillers grains, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, dried yeast and CO₂.

As of June 30, 2019, all but one of the Company’s production facilities, specifically, the Company’s Aurora East facility, were operating. As market conditions change, the Company may increase, decrease or idle production at one or more operating facilities or resume operations at any idled facility.

Basis of Presentation–Interim Financial Statements – The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Results for interim periods should not be considered indicative of results for a full year. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The accounting policies used in preparing these consolidated financial statements are the same as those described in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, with the exception of new lease accounting, as discussed further below. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included. All significant intercompany accounts and transactions have been eliminated in consolidation.

Liquidity – The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company and the ethanol industry as a whole experienced significant adverse conditions throughout most of 2018 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. In response to the low-margin environment, the Company initiated and expects to complete over the next four months strategic initiatives focused on the potential sale of certain production assets, a reduction of its debt levels, a strengthening of its cash and liquidity position, and opportunities for strategic partnerships and capital raising activities, positioning the Company to optimize its business performance. The most significant challenge to the Company in meeting these objectives would be a continued adverse margin environment.

In implementing these strategic initiatives, the Company, as of June 30, 2019, had the following available liquidity and capital resources to achieve its objectives:

The Company also will continue working with its lenders to pursue other options to increase liquidity and extend the maturity dates of its debt.

The Company believes that its strategic initiatives will provide sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs through the next twelve months.

Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are presented at face value, net of the allowance for doubtful accounts. The Company sells ethanol to gasoline refining and distribution companies, sells distillers grains and other feed co-products to dairy operators and animal feedlots and sells corn oil to poultry and biodiesel customers generally without requiring collateral.

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

Of the accounts receivable balance, approximately $61,986,000 and $54,820,000 at June 30, 2019 and December 31, 2018, respectively, were used as collateral under Kinergy’s operating line of credit. The allowance for doubtful accounts was $39,000 and $12,000 as of June 30, 2019 and December 31, 2018, respectively. The Company recorded a bad debt expense of $1,000 and a bad debt recovery of $2,000 for the three months ended June 30, 2019 and 2018, respectively. The Company recorded a bad debt expense of $27,000 and $45,000 for the six months ended June 30, 2019 and 2018, respectively.

Financial Instruments – The carrying values of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, derivative assets and derivative liabilities are reasonable estimates of their fair values because of the short maturity of these items. The Company believes the carrying value of its long-term debt approximates fair value because the interest rates on these instruments are variable, and are considered Level 2 fair value measurements.

Recent Accounting Pronouncements – In February 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance on accounting for leases under Accounting Standards Codification 842 (“ASC 842”). Under the new guidance, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted cash flow basis; and (2) a “right of use” asset, which is an asset that represents the lessee’s right to use the specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged, with some minor exceptions. Lease expense under the new guidance is substantially the same as prior to the adoption. See Note 5 for further information.

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

The Company reports its financial and operating performance in two segments: (1) ethanol production, which includes the production and sale of ethanol, specialty alcohols and co-products, with all of the Company’s production facilities aggregated, and (2) marketing and distribution, which includes marketing and merchant trading for Company-produced ethanol, specialty alcohols and co-products and third-party ethanol.

The following tables set forth certain financial data for the Company’s operating segments (in thousands):

The following table sets forth the Company’s total assets by operating segment (in thousands): 

Inventories consisted primarily of bulk ethanol, specialty alcohols, corn, co-products, low-carbon and Renewable Identification Number (“RIN”) credits and unleaded fuel, and are valued at the lower-of-cost-or-net realizable value, with cost determined on a first-in, first-out basis. Inventory is net of a $1,285,000 and $2,328,000 valuation adjustment as of June 30, 2019 and December 31, 2018, respectively. Inventory balances consisted of the following (in thousands):

The business and activities of the Company expose it to a variety of market risks, including risks related to changes in commodity prices. The Company monitors and manages these financial exposures as an integral part of its risk management program. This program recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effects that market volatility could have on operating results.

Commodity Risk – Cash Flow Hedges – The Company uses derivative instruments to protect cash flows from fluctuations caused by volatility in commodity prices for periods of up to twelve months in order to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sale and purchase commitments where the prices are set at a future date and/or if the contracts specify a floating or index-based price for ethanol. In addition, the Company hedges anticipated sales of ethanol to minimize its exposure to the potentially adverse effects of price volatility. These derivatives may be designated and documented as cash flow hedges and effectiveness is evaluated by assessing the probability of the anticipated transactions and regressing commodity futures prices against the Company’s purchase and sales prices. Ineffectiveness, which is defined as the degree to which the derivative does not offset the underlying exposure, is recognized immediately in cost of goods sold. For the three and six months ended June 30, 2019 and 2018, the Company did not designate any of its derivatives as cash flow hedges.

Commodity Risk – Non-Designated Hedges – The Company uses derivative instruments to lock in prices for certain amounts of corn and ethanol by entering into exchange-traded forward contracts for those commodities. These derivatives are not designated for hedge accounting treatment. The changes in fair value of these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold. The Company recognized gains of $4,971,000 and losses of $2,909,000 as the changes in the fair values of these contracts for the three months ended June 30, 2019 and 2018, respectively. The Company recognized gains of $4,885,000 and losses of $3,370,000 as the changes in the fair values of these contracts for the six months ended June 30, 2019 and 2018, respectively.

Non Designated Derivative Instruments – The classification and amounts of the Company’s derivatives not designated as hedging instruments, and related cash collateral balances, are as follows (in thousands):

The classification and amounts of the Company’s recognized gains (losses) for its derivatives not designated as hedging instruments are as follows (in thousands):

As discussed in Note 1, on January 1, 2019, the Company adopted the provisions of ASC 842 using the prospective transition approach, which applies the provisions of ASC 842 upon adoption, with no change to prior periods. This adoption resulted in the Company recognizing initial right of use assets and lease liabilities of $43,753,000. The adoption did not have a significant impact on the Company’s consolidated statements of operations.

Upon the initial adoption of ASC 842, the Company elected the following practical expedients allowable under the guidance: not to reassess whether any expired or existing contracts are or contain leases; not to reassess the lease classification for any expired or existing leases; not to reassess initial direct costs for any existing leases; not to separately identify lease and nonlease components; and not to evaluate historical land easements. Additionally, the Company elected the short-term lease exemption policy, applying the requirements of ASC 842 to only long-term (greater than 1 year) leases.

The Company leases railcar equipment, office equipment and land for certain of its facilities. Operating lease right of use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company uses its estimated incremental borrowing rate, unless an implicit rate is readily determinable, as the discount rate for each lease in determining the present value of lease payments. For the three and six months ended June 30, 2019, the Company’s weighted average discount rate was 6.01%. Operating lease expense is recognized on a straight-line basis over the lease term.

The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s leases have remaining lease terms of approximately 1 year to 57 years, which may include options to extend the lease when it is reasonably certain the Company will exercise those options. For the three and six months ended June 30, 2019, the weighted average remaining lease terms of equipment and land-related leases were 2.85 years and 12.86 years, respectively. The Company does not have lease arrangements with residual value guarantees, sale leaseback terms or material restrictive covenants. The Company does not have any material finance lease obligations nor sublease agreements.

The following table summarizes the remaining maturities of the Company’s operating lease liabilities, assuming all land lease extensions are taken, as of June 30, 2019 (in thousands):

For the three and six months ended June 30, 2019, the Company recorded operating lease costs of $2,069,000 and $4,332,000 in cost of goods sold, respectively, and $118,000 and $236,000 in selling, general and administrative expenses, respectively, in the Company’s statements of operations

Long-term borrowings are summarized as follows (in thousands):

Kinergy Operating Line of Credit – On July 31, 2019, Kinergy amended its credit facility to continue, until November 30, 2019 or earlier on ten days prior notice from the lender, the borrowing base under the credit facility at 90% of eligible accounts receivable, plus the lesser of (a) $50,000,000, (b) 80% of eligible inventory, or (c) 95% of the estimated recovery value of eligible inventory. The amendment extends to November 30, 2019 prior credit accommodations that were set to expire September 30, 2019. With respect to these additional borrowings, to the extent outstanding, the additional borrowings will accrue interest at an annual rate equal to the daily three month LIBOR plus an applicable margin of 4.00%. As of June 30, 2019, Kinergy had additional borrowing availability under its credit facility of $12,641,000, including $7,804,000 of incremental availability under the aforementioned temporary increase.

Pekin Term Loan – On March 30, 2018, Pacific Ethanol Pekin, LLC (“PE Pekin”), one of the Company’s subsidiaries, amended its term loan facility by reducing the amount of working capital it is required to maintain to not less than $13.0 million from March 31, 2018 through November 30, 2018 and not less than $16.0 million from December 1, 2018 and continuing at all times thereafter. In addition, a principal payment in the amount of $3.5 million due for May 2018 was deferred until the maturity date of the term loan.

On March 21, 2019, PE Pekin amended its term and revolving credit facilities by agreeing to increase the interest rate under the facilities by 125 basis points to an annual rate equal to the 30-day LIBOR plus 5.00%. PE Pekin and its lender also agreed that it is required to maintain working capital of not less than $15,000,000 from March 21, 2019 through July15, 2019 and working capital of not less than $30,000,000 from July 15, 2019 and continuing at all times thereafter. On July 15, 2019, PE Pekin and its lender agreed to a further amendment extending the aforementioned July 15, 2019 dates to November 15, 2019. As of the filing of this report, the Company believes PE Pekin is in compliance with its working capital requirement.

Under these amendments, the lenders also agreed to temporarily waive financial covenant violations, working capital maintenance violations and intercompany accounts receivable collections violations that occurred with respect to PE Pekin’s credit agreement. In addition, the lenders agreed to defer scheduled principal payments, including further deferral of principal payments in the amount of $3,500,000 each due on February 20, 2019 and May 20, 2019. On August 6, 2019, the Company paid its $3,500,000 principal payment scheduled for August 20, 2019.

The waivers and principal deferrals expire on November 15, 2019, or earlier in the case of an event of default, at which time the waivers will become permanent if Pacific Ethanol Central, LLC (“PE Central”), PE Pekin’s parent, has made a contribution to PE Pekin in an amount equal to $30,000,000, minus the then-existing amount of PE Pekin’s working capital, plus the amount of any accounts receivable owed by PE Central to PE Pekin, plus $12,000,000 (the “PE Central Contribution Amount”). In addition, if the PE Central Contribution Amount is timely received, the lenders agreed to waive PE Pekin’s debt service coverage ratio financial covenant for the year ended December 31, 2019. If the PE Central Contribution Amount is not timely made, then the temporary waivers will automatically expire.

PE Pekin is also required to pay by November 15, 2019 the aggregate amount of $10,500,000 representing all deferred and unpaid scheduled principal payments and all additional scheduled principal payments for the remainder of 2019.

Restrictions – At June 30, 2019, there were approximately $195.5 million of net assets at the Company’s subsidiaries that were not available to be transferred to Pacific Ethanol, Inc. in the form of dividends, loans or advances due to restrictions contained in the credit facilities of the Company’s subsidiaries.

Sales Commitments – At June 30, 2019, the Company had entered into sales contracts with its major customers to sell certain quantities of ethanol and co-products. The Company had open ethanol indexed-price contracts for 223,958,000 gallons of ethanol as of June 30, 2019 and open fixed-price ethanol sales contracts totaling $97,055,000 as of June 30, 2019. The Company had open fixed-price co-product sales contracts totaling $28,789,000 and open indexed-price co-product sales contracts for 260,000 tons as of June 30, 2019. These sales contracts are scheduled to be completed throughout 2019.

Purchase Commitments – At June 30, 2019, the Company had indexed-price purchase contracts to purchase 13,794,000 gallons of ethanol and fixed-price purchase contracts to purchase $8,847,000 of ethanol from its suppliers. The Company had fixed-price purchase contracts to purchase $14,823,000 of corn from its suppliers as of June 30, 2019. These purchase commitments are scheduled to be satisfied throughout 2019.

Litigation – General – The Company is subject to various claims and contingencies in the ordinary course of its business, including those related to litigation, business transactions, employee-related matters, environmental regulations, and others. When the Company is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, the Company will record a liability for the loss. If the loss is not probable or the amount of the loss cannot be reasonably estimated, the Company discloses the claim if the likelihood of a potential loss is reasonably possible and the amount involved could be material. While there can be no assurances, the Company does not expect that any of its pending legal proceedings will have a material impact on the Company’s financial condition or results of operations.

The Company sponsors a defined benefit pension plan (the “Retirement Plan”) and a health care and life insurance plan (the “Postretirement Plan”). The Company assumed the Retirement Plan and the Postretirement Plan as part of its acquisition of PE Central on July 1, 2015.

The Retirement Plan is noncontributory, and covers only “grandfathered” unionized employees at the Company’s Pekin, Illinois facility who fulfill minimum age and service requirements. Benefits are based on a prescribed formula based upon the employee’s years of service. The Retirement Plan, which is part of a collective bargaining agreement, covers only union employees hired prior to November 1, 2010.

The Company uses a December 31 measurement date for its Retirement Plan. The Company’s funding policy is to make the minimum annual contribution required by applicable regulations. As of December 31, 2018, the Retirement Plan’s accumulated projected benefit obligation was $ $18,690,000, with a fair value of plan assets of $13,257,000. The underfunded amount of $5,433,000 is recorded on the Company’s consolidated balance sheet in other liabilities.

The Company’s net periodic Retirement Plan costs are as follows (in thousands):

The Postretirement Plan provides postretirement medical benefits and life insurance to certain “grandfathered” unionized employees. Employees hired after December 31, 2000 are not eligible to participate in the Postretirement Plan. The Postretirement Plan is contributory, with contributions required at the same rate as active employees. Benefit eligibility under the plan reduces at age 65 from a defined benefit to a defined dollar cap based upon years of service. As of December 31, 2018, the Postretirement Plan’s accumulated projected benefit obligation was $5,711,000 and is recorded on the Company’s consolidated balance sheet in other liabilities. The Company’s funding policy is to make the minimum annual contribution required by applicable regulations.

The Company’s net periodic Postretirement Plan costs are as follows (in thousands):

The fair value hierarchy prioritizes the inputs used in valuation techniques into three levels, as follows:

Pooled separate accounts – Pooled separate accounts invest primarily in domestic and international stocks, commercial paper or single mutual funds. The net asset value is used as a practical expedient to determine fair value for these accounts. Each pooled separate account provides for redemptions by the Retirement Plan at reported net asset values per share, with little to no advance notice requirement, therefore these funds are classified within Level 2 of the valuation hierarchy.

Other Derivative Instruments – The Company’s other derivative instruments consist of commodity positions. The fair values of the commodity positions are based on quoted prices on the commodity exchanges and are designated as Level 1 inputs.

The following table summarizes recurring fair value measurements by level at June 30, 2019 (in thousands):

The following table summarizes recurring fair value measurements by level at December 31, 2018 (in thousands):

The following tables compute basic and diluted earnings per share (in thousands, except per share data):

There were an aggregate of 635,000 potentially dilutive weighted-average shares from convertible securities outstanding for the three and six months ended June 30, 2019. There were an aggregate of 1,606,000 and 721,000 potentially dilutive weighted-average shares from convertible securities outstanding for the three and six months ended June 30, 2018, respectively. These convertible securities were not considered in calculating diluted net loss per share for the three and six months ended June 30, 2019, as their effect would have been anti-dilutive.

Restricted Net Assets – At March 31, 2019, the Company had approximately $195,549,000 of net assets at its subsidiaries that were not available to be transferred to Pacific Ethanol in the form of dividends, distributions, loans or advances due to restrictions contained in the credit facilities of these subsidiaries.

Parent company financial statements for the periods covered in this report are set forth below (in thousands):

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This report and our consolidated financial statements and notes to consolidated financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including:

You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this report, or in the case of a document incorporated by reference, as of the date of that document. We do not undertake to update, revise or correct any forward-looking statements, except as required by law.

Any of the factors described immediately above, or referenced from time to time in our filings with the Securities and Exchange Commission or in the “Risk Factors” section below could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

Overview

We are a leading producer and marketer of low-carbon renewable fuels in the United States.

We operate nine strategically-located production facilities. Four of our plants are in the Western states of California, Oregon and Idaho, and five of our plants are located in the Midwestern states of Illinois and Nebraska. We are the sixth largest producer of ethanol in the United States based on annualized volumes. Our plants have a combined production capacity of 605 million gallons per year. We market all the ethanol, specialty alcohols and co-products produced at our plants as well as ethanol produced by third parties. On an annualized basis, we market nearly 1.0 billion gallons of ethanol and nearly 3.0 million tons of co-products on a dry matter basis. Our business consists of two operating segments: a production segment and a marketing segment.

Our mission is to be a leading producer and marketer of low-carbon renewable fuels, high-value animal feed and high-quality alcohol products in the United States. We intend to accomplish this goal in part by investing in our ethanol production and distribution infrastructure, lowering the carbon intensity of our ethanol, extending our marketing business into new regional and international markets, and implementing new technologies to promote higher production yields and greater efficiencies.

Production Segment

We produce ethanol, specialty alcohols and co-products at our production facilities described below. Our plants located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. Our plants located in the Midwest are in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, our ability to load unit trains from our plants located in the Midwest, and barges from our Pekin, Illinois plants, allows for greater access to international markets.

We wholly-own all of our plants located on the West Coast and the three plants in Pekin, Illinois. We own approximately 74% of the two plants in Aurora, Nebraska as well as the grain elevator adjacent to those properties and related grain handling assets, including the outer rail loop, and the real property on which they are located, through Pacific Aurora, LLC, or Pacific Aurora, an entity owned approximately 26% by Aurora Cooperative Elevator Company.

All of our plants, with the exception of our Aurora East facility, are currently operating. As market conditions change, we may increase, decrease or idle production at one or more operating facilities or resume operations at any idled facility.

We produce ethanol co-products at our production facilities such as wet distillers grains, or WDG, dried distillers grains with solubles, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO₂.

Marketing Segment

We market ethanol, specialty alcohols and co-products produced by our facilities and market ethanol produced by third parties. We have extensive customer relationships throughout the Western and Midwestern United States. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of ethanol, and manage the logistics and timing of delivery with very little effort on their part. Our customers collectively require ethanol volumes in excess of the supplies we produce at our production facilities. We secure additional ethanol supplies from third-party plants in California and other third-party suppliers in the Midwest where a majority of ethanol producers are located. We arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources.

We market our distillers grains and other feed co-products to dairies and feedlots, in many cases located near our ethanol plants. These customers use our feed co-products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers. We do not market co-products from other ethanol producers.

See “Note 2 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments.

Current Initiatives and Outlook

Our second quarter 2019 results reflect slightly improved crush margins as well as our successful efforts to reduce costs and efficiently operate our production facilities.

We continue to moderate production volumes in locations most impacted by high ethanol inventory levels as well as at our Pekin facilities that experienced temporary logistics constraints due to seasonal river flooding. We also continue to use Kinergy’s marketing platform to source third-party ethanol to help meet our contractual commitments and support our decision to reduce production. Overall, we are operating at approximately 80% of production capacity across our plants. The ethanol supply-demand balance has somewhat tightened recently due to seasonal increases in demand and marginally lower industry ethanol levels. We believe ethanol’s compelling cost, octane and carbon benefits will drive additional demand over the longer-term.

United States trade disputes with China are a significant ongoing industry challenge. A trade dispute resolution should reopen a large market for United States ethanol as China continues on its path toward 10% ethanol blend rates, which would require over 4.0 billion gallons of ethanol annually. China’s current domestic production capacity is only 1.0 billion gallons, therefore the region represents a significant market opportunity for United States ethanol producers.

The Environmental Protection Agency’s, or EPA’s, ongoing practice of granting small refinery exemptions from the Renewable Fuel Standard, or RFS, continues to negatively impact the ethanol industry. During the past two years, the EPA’s exemptions resulted in 2.6 billion fewer gallons of ethanol sold industry-wide. We are working as a company and with industry groups to address what we believe are EPA violations of the RFS in granting these exemptions, including the EPA’s failure to reallocate exempted gallons to satisfy the RFS’s annual volume requirements.

The EPA recently enacted a rule that allows for year-round use of E15, resulting in modest additional demand this summer. We expect year-round demand for E15 will increase in future years as E15 adoption accelerates.

Carbon values in our West Coast markets remain strong, resulting in robust premiums for our lower-carbon ethanol as a result of government programs such as California’s Low Carbon Fuel Standard and Oregon’s Clean Fuels Program.

Commercial operations of the CO₂ plant at our Stockton facility have commenced and we expect the CO₂ plant will contribute approximately $1.0 million in operating income annually. We have also made changes to our arrangements with the contractor responsible for our cogeneration system at our Stockton facility. System improvements should allow for greater operating ranges and system durability. In addition, we implemented new milestones for the system’s commercial operations with corresponding future payments, resulting in a positive cash flow impact of approximately $8.0 million in 2019. We are confident that once fully operational, the cogeneration system will contribute over $4.0 million in value annually through a combination of energy savings and carbon reductions.

We are pursuing a number of strategic initiatives focused on the potential sale of certain production assets, a reduction of our debt levels, a strengthening of our cash and liquidity position, and opportunities for strategic partnerships and capital raising activities, positioning us to optimize our business performance. Our most significant challenge in meeting these objectives would be a continued adverse margin environment. We continue to make progress on our plans and in July we further amended credit agreements to provide us with ongoing flexibility and liquidity as we pursue our strategic initiatives. We believe we have excellent production assets with values well in excess of our near-term liquidity needs. We are also confident in our strong relationships with our financial and commercial partners and believe we are taking appropriate steps to increase shareholder value to benefit our stakeholders long-term and to provide greater financial flexibility to execute future strategic initiatives.

We remain focused on implementing initiatives and investing in our assets to reduce costs, both at the operating and corporate levels; further diversifying our sales through additional high-protein animal feed and high-quality alcohol products; and improving our production yields and carbon scores.

Critical Accounting Policies

The preparation of our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, requires us to make judgments and estimates that may have a significant impact upon the portrayal of our financial condition and results of operations. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management that can materially impact the portrayal of our financial condition and results of operations: revenue recognition; impairment of long-lived assets; valuation of allowance for deferred taxes; derivative instruments; accounting for business combinations; and allowance for doubtful accounts. These significant accounting principles are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018.

Results of Operations

The following selected financial information should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report.

Certain performance metrics that we believe are important indicators of our results of operations include:

Net Sales, Cost of Goods Sold and Gross Profit (Loss)

The following table presents our net sales, cost of goods sold and gross profit (loss) in dollars and gross profit (loss) as a percentage of net sales (in thousands, except percentages):

Net Sales

The decline in our net sales for the three and six months ended June 30, 2019 as compared to the same periods in 2018 was primarily due to both a decline in our ethanol production gallons sold and a decline in our average sales price per gallon.

We sold fewer production gallons and co-products for the three and six months ended June 30, 2019 as compared to the same periods in 2018. These declines are primarily due to lower production capacity utilization at our plants in response to a lower ethanol crush margin environment. Our production capacity utilization declined to 80% and 81% for the three and six months ended June 30, 2019 and 2018, respectively, compared to 95% and 94% for the same periods in 2018, respectively. Our third-party gallons sold remained relatively flat over the same periods and we continued to focus our third-party ethanol sales in regions where we have a stronger presence around our own production assets or more favorable margins, as well as to compensate for lower production levels and meet our contractual commitments.

Three Months Ended June 30, 2019 and 2018

On a consolidated basis, our average sales price per gallon declined 3.0% to $1.61 for the three months ended June 30, 2019 compared to $1.66 for the same period in 2018. The average Chicago Board of Trade, or CBOT, ethanol price per gallon, declined 2.8% to $1.41 for the three months ended June 30, 2019 compared to $1.45 for the same period in 2018.

Production Segment

Net sales of ethanol from our production segment declined by $39.5 million, or 17%, to $194.4 million for the three months ended June 30, 2019 as compared to $233.9 million for the same period in 2018. Our total volume of production ethanol gallons sold declined by 14.6 million gallons, or 10%, to 129.8 million gallons for the three months ended June 30, 2019 as compared to 144.4 million gallons for the same period in 2018. Our production segment’s average sales price per gallon declined 7% to $1.50 for the three months ended June 30, 2019 compared to $1.62 for the same period in 2018. At our production segment’s average sales price per gallon of $1.50 for the three months ended June 30, 2019, we generated $21.9 million less in net sales from our production segment from the 14.6 million fewer gallons of produced ethanol sold in the three months ended June 30, 2019 as compared to the same period in 2018. The decline of $0.12 in our production segment’s average sales price per gallon for the three months ended June 30, 2019 as compared to the same period in 2018 reduced our net sales of ethanol from our production segment by $17.6 million.

Net sales of co-products declined $13.8 million, or 18%, to $64.7 million for the three months ended June 30, 2019 as compared to $78.5 million for the same period in 2018. Our total volume of co-products sold declined by 102.5 thousand tons, or 13%, to 691.5 thousand tons for the three months ended June 30, 2018 from 794.0 thousand tons for the same period in 2018, and our average sales price per ton declined to $93.53 for the three months ended June 30, 2019 from $98.88 for the same period in 2018. At our average sales price per ton of $93.53 for the three months ended June 30, 2019, we generated $9.6 million less in net sales from the 102.5 thousand ton decline in co-products sold in the three months ended June 30, 2019 as compared to the same period in 2018. The decline in our average sales price per ton of $5.35, or 5%, for the three months ended June 30, 2019 as compared to the same period in 2018 reduced our net sales of co-products by $4.2 million.

Marketing Segment

Net sales of ethanol from our marketing segment, excluding intersegment sales, declined by $10.9 million, or 11%, to $87.2 million for the three months ended June 30, 2019 as compared to $98.1 million for the same period in 2018. Our total volume of ethanol gallons sold by our marketing segment declined by 14.4 million gallons, or 6%, to 213.0 million gallons for the three months ended June 30, 2019 as compared to 227.4 million gallons for the same period in 2018. As noted above, 14.6 million fewer production gallons sold, slightly offset by 0.2 million additional third party gallons sold, accounted for this decline. The additional 0.2 million gallons in third party ethanol sold is comprise of 1.0 million additional gallons sold on a gross basis offset by 0.8 million fewer gallons sold on a net basis.

Our marketing segment’s average sales price per gallon declined 13% to $1.62 for the three months ended June 30, 2019 compared to $1.86 for the same period in 2018. At our marketing segment’s average sales price per gallon of $1.62 for the three months ended June 30, 2019, we generated $1.6 million in additional net sales from our marketing segment from the additional 0.2 million gallons in third party ethanol sold in the three months ended June 30, 2019 as compared to the same period in 2018. The decline of $0.24 in our marketing segment’s average sales price per gallon for the three months ended June 30, 2019 as compared to the same period in 2018 reduced our net sales from third party ethanol sold by our marketing segment by $12.5 million.

Six Months Ended June 30, 2019 and 2018

On a consolidated basis, our average sales price per gallon declined 2.5% to $1.57 for the six months ended June 30, 2019 compared to $1.61 for the same period in 2018. The average CBOT ethanol price per gallon declined 5.6% to $1.36 for the six months ended June 30, 2019 compared to $1.44 for the same period in 2018.

Production Segment

Net sales of ethanol from our production segment declined by $79.7 million, or 18%, to $373.8 million for the six months ended June 30, 2019 as compared to $453.5 million for the same period in 2018. Our total volume of production ethanol gallons sold declined by 38.5 million gallons, or 13%, to 246.7 million gallons for the six months ended June 30, 2019 as compared to 285.2 million gallons for the same period in 2018. Our production segment’s average sales price per gallon declined 4% to $1.52 for the six months ended June 30, 2019 compared to $1.59 for the same period in 2018. At our production segment’s average sales price per gallon of $1.52 for the six months ended June 30, 2019, we generated $58.3 million less in net sales from our production segment from the 38.5 million fewer gallons of produced ethanol sold in the six months ended June 30, 2019 as compared to the same period in 2018. The decline of $0.07 in our production segment’s average sales price per gallon for the six months ended June 30, 2019 as compared to the same period in 2018 reduced our net sales of ethanol from our production segment by $21.4 million.

Net sales of co-products declined $19.5 million, or 13%, to $133.5 million for the six months ended June 30, 2019 as compared to $153.0 million for the same period in 2018. Our total volume of co-products sold declined by 216.4 thousand tons, or 14%, to 1,375.6 thousand tons for the six months ended June 30, 2019 from 1,592.0 thousand tons for the same period in 2018, and our average sales price per ton increased to $97.04 for the six months ended June 30, 2019 from $96.14 for the same period in 2018. At our average sales price per ton of $97.04 for the six months ended June 30, 2019, we generated $20.9 million less in net sales from the 216.4 thousand ton decline in co-products sold in the six months ended June 30, 2019 as compared to the same period in 2018. The increase in our average sales price per ton of $0.90, or 1%, for the six months ended June 30, 2019 as compared to the same period in 2018 increased our net sales of co-products by $1.4 million.

Marketing Segment

Net sales of ethanol from our marketing segment, excluding intersegment sales, declined by $9.1 million, or 4%, to $194.8 million for the six months ended June 30, 2019 as compared to $203.9 million for the same period in 2018. Our total volume of ethanol gallons sold by our marketing segment declined by 35.4 million gallons, or 8%, to 424.7 million gallons for the six months ended June 30, 2019 as compared to 460.1 million gallons for the same period in 2018. As noted above, 38.5 million fewer production gallons sold, partially offset by 3.1 million additional third party gallons sold, accounted for this decline. The additional 3.1 million gallons in third party ethanol sold is comprise of 3.7 million additional gallons sold on a gross basis offset by 0.6 million fewer gallons sold on a net basis.

Our marketing segment’s average sales price per gallon declined 7% to $1.63 for the six months ended June 30, 2019 as compared to $1.76 for the same period in 2018. At our marketing segment’s average sales price per gallon of $1.63 for the six months ended June 30, 2019, we generated $6.0 million in additional net sales from our marketing segment from the additional 3.1 million gallons in third party ethanol sold in the six months ended June 30, 2019 as compared to the same period in 2018. The decline of $0.13 in our marketing segment’s average sales price per gallon for the six months ended June 30, 2019 as compared to the same period in 2018 reduced our net sales from third party ethanol sold by our marketing segment by $15.1 million.

Cost of Goods Sold and Gross Profit (Loss)

Our consolidated gross profit (loss) improved to a gross profit of $4.0 million, representing a gross profit margin of 1.1%, for the three months ended June 30, 2019 compared to a gross loss of $1.3 million, representing a negative gross profit margin of 0.3%, for the same period in 2018. Our gross profit and gross profit margin improved due primarily to boiler-related repair costs that occurred in 2018 but did not recur in 2019.

Our consolidated gross profit (loss) declined to a gross profit of $1.7 million, representing a gross profit margin of 0.2%, for the six months ended June 30, 2019 compared to a gross profit of $2.1 million, representing a gross profit margin of 0.3%, for the same period in 2018. Our gross profit and gross profit margin declined primarily due to significantly lower commodity margins in the first quarter of 2019 compared to the same period in 2018, which was partially offset by lower boiler-related repair costs that occurred in 2018 but did not recur in 2019.

Three Months Ended June 30, 2019 and 2018

Production Segment

Our production segment’s gross profit from external sales improved by $10.0 million to a gross profit of $2.3 million for the three months ended June 30, 2019 as compared to a gross loss of $7.7 million for the same period in 2018. Of this improvement, $10.2 million is attributable to our production segment’s lower boiler-related repair costs for the three months ended June 30, 2019 as compared to the same period in 2018, partially offset by $0.2 million in lower gross profit attributable to decreased production volumes for the three months ended June 30, 2019 as compared to the same period in 2018.

Marketing Segment

Our marketing segment’s gross profit declined by $4.8 million to $1.6 million for the three months ended June 30, 2019 as compared to $6.4 million for the same period in 2018. Of this decline, $4.9 million is attributable to our marketing segment’s lower margins per gallon, partially offset by less than $0.1 million in higher gross profit from the 0.2 million gallon increase in third party marketing volumes for the three months ended June 30, 2019 as compared to the same period in 2018.

Six Months Ended June 30, 2019 and 2018

Production Segment

Our production segment’s gross profit (loss) from external sales improved by $3.8 million to a gross loss of $7.7 million for the six months ended June 30, 2019 as compared to a gross loss of $11.5 million for the same period in 2018. Of this improvement, $2.6 million is attributable to our production segment’s lower boiler-related repair costs for the six months ended June 30, 2019 as compared to the same period in 2018, and $1.2 million is attributable to lower production volumes for the six months ended June 30, 2019 as compared to the same period in 2018.

Marketing Segment

Our marketing segment’s gross profit declined by $4.2 million to $9.4 million for the six months ended June 30, 2019 as compared to $13.6 million for the same period in 2018. Of this decline, $4.4 million is attributable to our marketing segment’s lower margins per gallon, partially offset by $0.2 million in gross profit attributable to the increase in third-party marketing volumes for the six months ended June 30, 2019 as compared to the same period in 2018.

Selling, General and Administrative Expenses

The following table presents our selling, general and administrative, or SG&A, expenses in dollars and as a percentage of net sales (in thousands, except percentages):

Our SG&A expenses declined for the three and six months ended June 30, 2019 as compared to the same period in 2018. The decrease in SG&A expenses is primarily due to reductions in compensation and health insurance costs.

Net Loss Available to Common Stockholders

The following table presents our net loss available to common stockholders in dollars and as a percentage of net sales (in thousands, except percentages):

The improvement in net loss available to common stockholders is primarily due to lower boiler-related repair costs and lower SG&A expenses, slightly offset by higher interest expense for the three and six months ended June 30, 2019 as compared to the same periods in 2018.

Liquidity and Capital Resources

During the six months ended June 30, 2019, we funded our operations primarily from cash on hand and advances from our revolving credit facilities. These funds were also used to make capital expenditures, capital lease payments and principal payments on term debt.

Both we and the ethanol industry as a whole experienced significant adverse conditions throughout most of 2018 and into 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels primarily related to United States and China trade disputes and domestic ethanol demand destruction caused by EPA exemptions for small refineries. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses.

In response to these adverse conditions, we have initiated and expect to complete over the next four months strategic initiatives focused on the potential sale of certain production assets, a reduction of our debt levels, a strengthening of our cash and liquidity position, and opportunities for strategic partnerships and capital raising activities, positioning us to optimize our business performance. Our most significant challenge in meeting these objectives would be a continued adverse margin environment. We believe we have excellent production assets with values well in excess of our near term liquidity needs. We are also confident in our strong relationships with our financial and commercial partners and believe we are taking the appropriate steps to increase our shareholder value to benefit all of our stakeholders long-term and to provide greater financial flexibility to execute future strategic initiatives.

Our current available capital resources consist of cash on hand and amounts available for borrowing under our credit facilities. We expect that our future available capital resources will consist primarily of our current cash balances, availability under our lines of credit, any cash generated from operations, net cash proceeds from any sale of production assets and net cash proceeds from any equity sales or debt financing transactions.

At June 30, 2019, on a consolidated basis, we had an aggregate of $16.5 million in cash and Kinergy had $12.6 million in excess availability under its credit facility.

As of June 30, 2019, our current liabilities of $226.3 exceeded our current assets of $174.4 million, resulting in a working capital deficit of $51.9 million. This working capital deficit arises from the following: