U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended JUNE 30, 2005
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ______ to _______
Commission File Number: 0-21467
PACIFIC ETHANOL, INC.
(Name of small business issuer as specified in its charter)
DELAWARE 41-2170618
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
5711 N. WEST AVENUE
FRESNO, CALIFORNIA 93711
(Address of principal executive offices)
(559) 435-1771
(Issuer's telephone number, including area code)
NOT APPLICABLE.
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
As of October 25, 2005, there were 28,664,146 shares of Pacific
Ethanol, Inc. common stock, $.001 par value per share, outstanding.
Transitional Small Business Disclosure Format: Yes | | No |X|
PART I
FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2005 (unaudited) and
December 31, 2004........................................................................... F-2
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 2005 and 2004 (unaudited).................................................... F-4
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2005 and 2004 (unaudited).......................................................... F-5
Notes to Condensed Consolidated Financial Statements (unaudited)................................ F-7
Item 2. Management's Discussion and Analysis or Plan of Operation ...................................... 2
Item 3. Controls and Procedures......................................................................... 23
PART II
OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..................................... 27
Item 3. Defaults Upon Senior Securities................................................................. 27
Item 4. Submission of Matters to a Vote of Security Holders............................................. 27
Item 5. Other Information............................................................................... 27
Item 6. Exhibits........................................................................................ 28
Signatures ................................................................................................ 29
F-1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2005 AND DECEMBER 31, 2004
June 30,
2005 December 31,
(unaudited) 2004
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $16,427,839 $ 42
Accounts receivable (including $50,545 and $0 as
of June 30, 2005 and December 31, 2004, respectively,
from a related party) 2,112,200 8,464
Inventories 1,111,960 --
Prepaid expenses 785,151 293,115
Deposits 5,400 --
Related party notes receivable 5,410 5,286
Business acquisition costs -- 430,393
Other receivables 52,313 48,806
Restricted cash 280,000 --
----------- -----------
Total current assets 20,780,273 786,106
PROPERTY AND EQUIPMENT, NET 9,136,333 6,324,824
OTHER ASSETS:
Debt issuance costs, net 58,333 68,333
Intangible assets, net 10,710,416 --
----------- -----------
Total other assets 10,768,749 68,333
----------- -----------
TOTAL ASSETS $40,685,355 $ 7,179,263
=========== ===========
See accompanying notes to condensed consolidated financial statements.
F-2
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2005 AND DECEMBER 31, 2004 (CONTINUED)
June 30,
2005 December 31,
(unaudited) 2004
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable - trade $ 2,511,831 $ 383,012
Accounts payable - related party 1,700,240 846,211
Accrued payroll -- 18,963
Accrued interest payable -- 30,864
Other accrued liabilities 833,454 531,803
------------ ------------
Total current liabilities 5,045,525 1,810,853
RELATED-PARTY NOTE PAYABLE 2,887,947 4,012,678
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value; 10,000,000 shares authorized, no shares
issued and outstanding as of June 30, 2005 and
December 31, 2004 -- --
Common stock, $0.001 par value; 100,000,000 shares
authorized, 28,608,491 and 13,445,866 shares issued and
outstanding as of June 30, 2005 and December 31, 2004,
respectively 28,608 13,446
Additional paid-in capital 42,119,996 5,071,632
Unvested consulting expense (1,851,114) --
Due from stockholders (600) (68,100)
Accumulated deficit (7,545,007) (3,661,246)
------------ ------------
Total stockholders' equity 32,751,883 1,355,732
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 40,685,355 $ 7,179,263
============ ============
See accompanying notes to condensed consolidated financial statements.
F-3
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net sales (including $1,496,178 and $ 22,814,433 $ 9,442 $ 25,116,430 $ 16,003
$1,849,236 for the three and six months
ended June 30, 2005, respectively, to a
related party)
Cost of goods sold 22,662,908 6,229 24,917,278 10,789
------------ ------------ ------------ ------------
Gross profit 151,525 3,213 199,152 5,214
Operating expenses:
Selling, general and administrative
expenses 1,474,696 235,038 1,792,668 427,058
Services rendered in connection with
feasibility study -- -- 852,250 --
Non-cash compensation and consulting
fees 918,375 345,000 1,343,636 517,500
------------ ------------ ------------ ------------
Loss from operations (2,241,546) (576,825) (3,789,402) (939,344)
Other income (expense):
Other income 104 310 26,395 51
Interest income (expense) 18,190 (136,739) (115,954) (266,995)
------------ ------------ ------------ ------------
Loss before provision for income taxes (2,223,252) (713,254) (3,878,961) (1,206,288)
Provision for income taxes 3,200 800 4,800 2,400
------------ ------------ ------------ ------------
Net loss $ (2,226,452) $ (714,054) $ (3,883,761) $ (1,208,688)
============ ============ ============ ============
Weighted Average Shares Outstanding 27,977,127 12,106,596 21,415,102 11,927,493
============ ============ ============ ============
Net Loss Per Share $ (0.08) $ (0.06) $ (0.18) $ (0.10)
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
F-4
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(UNAUDITED)
Six Months Ended
June 30,
----------------------------
2005 2004
------------ ------------
Net loss $ (3,883,761) $ (1,208,688)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 40,457 39,537
Amortization of debt issuance costs 235,334 10,000
Interest expense relating to amortization of debt discount 120,268 120,268
Non-cash compensation expense 883,250 --
Non-cash consulting expense 460,386 517,500
Services rendered in connection with feasibility study 702,250 --
(Increase) decrease in:
Accounts receivable 407,923 15,525
Inventories (530,395) --
Prepaid expenses and other assets (663,450) (68,766)
Prepayments on product in transit 307,562 --
Other receivable (3,631) 217,096
Increase (decrease) in:
Accounts payable 288,656 (144,169)
Accounts payable, related party 854,029 247,556
Accrued payroll (18,963) 141,259
Accrued interest payable (31,315) 4,420
Accrued liabilities (13,859) (162,067)
------------ ------------
Net cash used in operating activities (845,259) (270,529)
------------ ------------
Cash flows from Investing Activities:
Additions to property, plant and equipment (2,845,742) (521,038)
Payment on related party notes receivable -- 199,875
Issuance of related party notes receivable -- (33,491)
Net cash acquired in acquisition of Kinergy, ReEnergy and
Accessity 1,146,854 --
Costs associated with share exchange transaction (307,808) (202,192)
------------ ------------
Net cash provided by (used in) investing activities (2,006,696) (556,846)
------------ ------------
Cash flows from Financing Activities:
Proceeds from sale of stock, net 18,879,749 716,339
Proceeds from exercise of stock options 332,503 --
Receipt of stockholder receivable 67,500 --
------------ ------------
Net cash provided by financing activities 19,279,752 716,339
------------ ------------
Net increase (decrease) in cash and cash equivalents 16,427,797 (111,036)
Cash and cash equivalents at beginning of period 42 249,084
------------ ------------
Cash and cash equivalents at end of period $ 16,427,839 $ 138,048
============ ============
See accompanying notes to condensed consolidated financial statements.
F-5
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (CONT'D)
(UNAUDITED)
Non-Cash Financing and Investing activities:
Conversion of debt to equity $1,245,000 $ --
========== ==========
Issuance of stock for receivable $ 0 $ 199,750
========== ==========
Issuance of warrants for consulting services $2,139,000 $1,380,000
========== ==========
Issuance of warrants for employee compensation $ 883,250 $ 0
========== ==========
Purchase of ReEnergy with Stock $ 316,250 $ --
========== ==========
Shares contributed by stockholder in purchase of ReEnergy $ 506,000 $ --
========== ==========
Shares contributed by stockholder in purchase of Kinergy $1,012,000 $ --
========== ==========
Purchase of Kinergy with Stock $9,803,750 $ --
========== ==========
Stock returned to the Company as payment for stock option
exercise $1,195,314 $ --
========== ==========
See accompanying notes to condensed consolidated financial statements.
F-6
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2005
(UNAUDITED)
1. REPORT BY MANAGEMENT:
--------------------
The condensed consolidated financial statements include the accounts of
Pacific Ethanol, Inc., a Delaware corporation, and its wholly-owned
subsidiaries (collectively, the "Company"). All significant transactions
among the consolidated entities have been eliminated upon consolidation.
The condensed consolidated financial statements have been prepared by the
Company and include all adjustments consisting of only normal recurring
adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position of the Company as of June 30, 2005
and the results of operations and the cash flows of the Company for the six
months ended June 30, 2005 and 2004, pursuant to the rules and regulations
of the Securities and Exchange Commission. Accordingly, the condensed
consolidated financial statements do not include all of the information and
footnotes required by accounting principles generally accepted in the
United States of America for annual consolidated financial statements. The
Company's results of operations for the six months ended June 30, 2005 are
not necessarily indicative of the results of operations to be expected for
the full fiscal year ending December 31, 2005.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
2. RESTATEMENT OF JUNE 30, 2005 FINANCIAL STATEMENTS
-------------------------------------------------
The Company previously accounted for its acquisition of ReEnergy that
resulted from the share exchange transaction that occurred in March 2005 by
recording the $972,250 purchase price for ReEnergy as goodwill. Upon
further examination of its purchase accounting methodology for the
acquisition of ReEnergy, the Company determined that it made an error in
its application of the relevant accounting principles under SFAS 141,
paragraph 9 (with reference to EITF No. 98-3) and determined that it should
have expensed $852,250 and capitalized $120,000 of the $972,250 purchase
price for ReEnergy. The Company has determined the effect of the correction
on its previously issued financial statements and has restated the
accompanying financial statements for the six months ended June 30, 2005.
Of the $972,250 purchase price for ReEnergy, $852,250 has been recorded as
an expense for services rendered in connection with a feasibility study
that was conducted with respect to real property that was subject to a
purchase option held by ReEnergy and $120,000 has been recorded as an
intangible asset for the fair value of a favorable option.
The effects of the restatement on net sales, cost of goods sold, gross
profit, services rendered in connection with feasibility study, net loss,
basic and diluted net loss per common share, intangible assets (net), total
assets and stockholders' equity as of and for the six months ended June 30,
2005 are as follows:
F-7
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
AS ORIGINALLY RESTATEMENT
REPORTED ADJUSTMENTS AS RESTATED
------------ ------------ ------------
Net sales .......................... $ 25,116,430 $ -- $ 25,116,430
Cost of goods sold ................. 24,917,278 -- 24,917,278
Gross profit ....................... 199,152 -- 199,152
Services rendered in connection with
feasibility study ............... -- 852,250 852,250
Net loss ........................... $ (3,031,511) $ (852,250) $ (3,883,761)
NET LOSS PER COMMON SHARE:
Basic and diluted ............... $ (0.14) $ (0.04) $ (0.18)
Intangible assets, net ............. 11,562,666 (852,250) 10,710,416
Total assets ....................... 41,537,605 (852,250) 40,685,355
Stockholders' equity ............... $ 33,604,133 $ (852,250) $ 32,751,883
3. ORGANIZATION AND NATURE OF OPERATIONS:
--------------------------------------
SHARE EXCHANGE TRANSACTION - On March 23, 2005, the Company completed a
share exchange transaction with the shareholders of Pacific Ethanol, Inc.,
a California corporation that was incorporated on January 30, 2003 ("PEI
California"), and the holders of the membership interests of each of
Kinergy Marketing, LLC, an Oregon limited liability company that was
organized on September 13, 2000 ("Kinergy") and ReEnergy, LLC, a California
limited liability company that was organized on March 7, 2001 ("ReEnergy"),
pursuant to which the Company acquired all of the issued and outstanding
capital stock of PEI California and all of the outstanding membership
interests of Kinergy and ReEnergy (the "Share Exchange Transaction"). In
connection with the Share Exchange Transaction, the Company issued an
aggregate of 20,610,987 shares of common stock to the shareholders of PEI
California, 3,875,000 shares of common stock to the sole limited liability
company member of Kinergy and an aggregate of 125,000 shares of common
stock to the limited liability company members of ReEnergy.
Immediately prior to the consummation of the Share Exchange Transaction,
the Company's predecessor, Accessity Corp., a New York corporation
("Accessity"), reincorporated in the State of Delaware under the name
"Pacific Ethanol, Inc" through a merger of Accessity with and into its
then-wholly-owned Delaware subsidiary named Pacific Ethanol, Inc., which
was formed for the purpose of effecting the reincorporation (the
"Reincorporation Merger"). In connection with the Reincorporation Merger,
the shareholders of Accessity became stockholders of the Company and the
Company succeeded to the rights, properties and assets and assumed the
liabilities of Accessity.
Immediately prior to the consummation of the share exchange transaction,
Accessity divested its two operating subsidiaries. Accordingly, effective
as of the closing of the share exchange transaction, Accessity did not have
any ongoing business operations. Assets consisting primarily of cash and
cash equivalents totaling approximately $3.7 million were acquired and
certain current liabilities of approximately $300,000 were assumed from
Accessity. Since Accessity had no operations and only net monetary assets,
the share exchange transaction is being treated as a capital transaction,
whereby Pacific Ethanol acquired the net monetary assets of Accessity,
accompanied by a recapitalization of Pacific Ethanol. As such, no fair
value adjustments were necessary for any of the assets acquired or
liabilities assumed.
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting acquiror.
As a result, the Company's results of operations for the three and six
months ended June 30, 2004 consist only of the operations of PEI
California. The Company has consolidated the results of Accessity, Kinergy
and ReEnergy beginning March 23, 2005, the date of the Share Exchange
Transaction. Accordingly, the Company's results of operations for the three
and six months ended June 30, 2005 consist of the operations of PEI
California for the entire six month period and the operations of Accessity,
Kinergy and ReEnergy from March 23, 2005 through June 30, 2005.
F-8
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with the Share Exchange Transaction:
Current assets............................... $ 7,014,196
Property, plant and equipment................ 6,224
Intangibles, including goodwill.............. 10,935,750
--------------
Total assets acquired..................... 17,956,170
Current liabilities.......................... 4,253,177
Other liabilities............................ 83,017
--------------
Total liabilities assumed................. 4,336,194
--------------
Net assets acquired.......................... $ 13,619,976
==============
Shares of common stock issued................ 6,489,414
==============
The purchase price represented a significant premium over the recorded net
worth of the acquired entities' assets. In deciding to pay this premium,
the Company considered various factors, including the value of Kinergy's
trade name, Kinergy's extensive market presence and history, Kinergy's
industry knowledge and expertise, Kinergy's extensive customer
relationships and expected synergies among Kinergy's and ReEnergy's
businesses and assets and the Company's planned entry into the ethanol
production business.
In connection with the Share Exchange Transaction and the Company's
acquisition of Kinergy and ReEnergy, the Company engaged a valuation firm
to determine what portion of the purchase price should be allocated to
identifiable intangible assets. Through that process, the Company has
estimated that for Kinergy, the distribution backlog is valued at $136,000,
the customer relationships are valued at $5,600,000 and the trade name is
valued at $3,100,000. The Company made a $150,000 cash payment and issued
stock valued at $316,250 for the acquisition of ReEnergy. In addition,
certain stockholders sold stock to the members of ReEnergy, increasing the
purchase price by $506,000 (see further discussion below). The purchase
price for ReEnergy totaled $972,250. Of this amount, $120,000 was recorded
as an intangible asset for the fair value of a favorable option to acquire
land and because the acquisition of ReEnergy was not deemed to be an
acquisition of a business, the remaining purchase price of $852,250 was
recorded as an expense for services rendered in connection with a
feasibility study. The Company issued stock valued at $9,803,750 for the
acquisition of Kinergy. In addition, certain stockholders sold stock to the
sole member of Kinergy and a related party, increasing the purchase price
by $1,012,000. The purchase price for Kinergy totaled $10,815,750. Goodwill
directly associated with the Kinergy acquisition therefore totaled
$1,979,750.
F-9
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
The Kinergy trade name is determined to have an indefinite life and
therefore, rather than being amortized, will be periodically tested for
impairment. The distribution backlog has an estimated life of six months
and customer relationships were estimated to have a ten-year life and, as a
result, will be amortized accordingly, unless otherwise impaired at an
earlier time. The ReEnergy land option expires on December 31, 2005 and
will be expensed at that time if not extended.
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of the Company, as though the acquisitions
occurred as of January 1, 2004. The pro forma amounts give effect to
appropriate adjustments for amortization of intangible assets and income
taxes. The pro forma amounts presented are not necessarily indicative of
future operating results.
Six Months
Ended June 30,
----------------------------
2005 2004
------------ ------------
Net sales $ 48,721,682 $ 37,842,788
============ ============
Net loss $ (4,126,026) $ (2,227,084)
============ ============
Loss per share of common stock
Basic and diluted $ (0.14) $ (0.09)
============ ============
On April 1, 2004, certain founders of the Company agreed to sell an
aggregate of 500,000 shares of the Company's common stock owned by them to
Cagan McAfee Capital Partners, LLC ("CMCP") at $0.01 per share for securing
financing to close the Share Exchange Transaction on or prior to March 31,
2005. Immediately prior to the closing of the Share Exchange Transaction,
the founders sold these shares at the agreed upon price to CMCP. The
contribution of these shares is accounted for as a capital contribution.
However, because the shares were issued as a finder's fee in a private
offering (see note 5), the related expense is offset against the proceeds
received, resulting in no effect on equity.
Immediately prior to the closing of the Share Exchange Transaction, certain
stockholders of the Company sold an aggregate of 250,000 shares of the
Company's common stock owned by them to the then-Chief Executive Officer of
Accessity at $0.01 per share to compensate him for facilitating the closing
of the Share Exchange Transaction. The contribution of these shares is
accounted for as a capital contribution. However, because the shares are
deemed issued to Accessity in connection with the Share Exchange
Transaction, the related expense is offset against the cash received from
Accessity, resulting in no effect on equity.
Immediately prior to the closing of the Share Exchange Transaction, William
Jones, the Company's Chairman of the Board of Directors, sold 200,000
shares of the Company's common stock to the individual members of ReEnergy
at $0.01 per share, to compensate them for facilitating the closing of the
Share Exchange Transaction. The contribution of these shares resulted in an
additional expense of $506,000 for services rendered in connection with a
feasibility study.
F-10
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
Immediately prior to the closing of the Share Exchange Transaction, William
Jones sold 300,000 shares of the Company's common stock to Neil Koehler,
the sole member of Kinergy and an officer and director of the Company, at
$0.01 per share to compensate him for facilitating the closing of the Share
Exchange Transaction. The contribution of these shares resulted in
additional Kinergy goodwill of $759,000.
Immediately prior to the closing of the Share Exchange Transaction, William
Jones sold 100,000 shares of the Company's common stock to Tom Koehler, a
member of ReEnergy and a related party of the sole member of Kinergy, at
$0.01 per share to compensate him for facilitating the closing of the Share
Exchange Transaction. The contribution of these shares resulted in
additional Kinergy goodwill of $253,000.
4. RELATED PARTY NOTES PAYABLE:
---------------------------
On January 10, 2005 and February 22, 2005, William Jones advanced the
Company $60,000 and $20,000, respectively, at 5% interest, due and payable
upon the closing of the Share Exchange Transaction. The accumulated
principal due was repaid on March 24, 2005 and the related accrued interest
was paid on April 15, 2005.
On January 10, 2005, Neil Koehler advanced the Company $100,000 at 5%
interest, due and payable upon the closing of the Share Exchange
Transaction. The principal was repaid on March 24, 2005 and the related
accrued interest was paid on April 15, 2005.
On January 31, 2005, Eric McAfee, a principal of CMCP, advanced the Company
$100,000 at 5% interest, due and payable upon close of the Share Exchange
Transaction. The principal was repaid on March 24, 2005 and the related
accrued interest was paid on April 15, 2005.
On January 14, 2005, February 4, 2005, March 10, 2005 and May 27, 2005,
Lyles Diversified, Inc. ("LDI") converted $36,000, $114,000, $97,682 and
$997,318 of debt into 24,000, 76,000, 65,121 and 664,879 shares of the
Company's common stock, respectively, at a conversion price equal to $1.50
per share. The total debt converted by LDI as of June 30, 2005 was
$1,500,000 for 1,000,000 shares of the Company's common stock, at a
conversion price equal to $1.50 per share.
Pursuant to the terms of the Share Exchange Transaction, Kinergy
distributed to its sole member in the form of a promissory note, in the
amount of $2,095,614 Kinergy's net worth as set forth on Kinergy's balance
sheet prepared in accordance with GAAP, as of March 23, 2005. A holdback
amount of $100,000 for 30 days was provided to allow Kinergy to settle its
accounts. In April 2005, Kinergy paid the balance of its net worth, up to
the holdback amount of $100,000. The remaining holdback amount was paid in
May 2005.
Pursuant to the terms of the Share Exchange Transaction, ReEnergy
distributed to its members in the form of a promissory note in the amount
of $1,439 ReEnergy's net worth as set forth on ReEnergy's balance sheet
prepared in accordance with GAAP, as of March 23, 2005. The note balance
was paid in April 2005.
F-11
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
5. COMMON STOCK:
-------------
SHARE EXCHANGE TRANSACTION - In connection with the Share Exchange
Transaction, the Company issued an aggregate of 20,610,987 shares of common
stock to the shareholders of PEI California, 3,875,000 shares of common
stock to the sole limited liability company member of Kinergy and an
aggregate of 125,000 shares of common stock to the limited liability
company members of ReEnergy.
PRIVATE OFFERING - On March 23, 2005, the Company issued to 63 accredited
investors in a private offering an aggregate of 7,000,000 shares of common
stock at a purchase price of $3.00 per share, two-year investor warrants to
purchase 1,400,000 shares of common stock at an exercise price of $3.00 per
share and two-year investor warrants to purchase 700,000 shares of common
stock at an exercise price of $5.00 per share, for total gross proceeds of
approximately $21,000,000. The Company paid cash placement agent fees and
expenses of approximately $1,850,400 and issued five-year placement agent
warrants to purchase 678,000 shares of common stock at an exercise price of
$3.00 per share in connection with the offering. (See Note 6) Additional
costs related to the financing include legal, accounting, consulting, and
stock certificate issuance fees that totaled approximately $270,658 through
June 30, 2005.
The Company is obligated under a Registration Rights Agreement to file, on
the 151st day following March 23, 2005, a Registration Statement with the
Securities and Exchange Commission registering for resale shares of common
stock, and shares of common stock underlying investor warrants and certain
of the placement agent warrants, issued in connection with the private
offering. If the Company (i) does not file the Registration Statement
within the time period prescribed, or (ii) fails to file with the
Securities and Exchange Commission a request for acceleration in accordance
with Rule 461 promulgated under the Securities Act of 1933, within five
trading days of the date that the Company is notified (orally or in
writing, whichever is earlier) by the Securities and Exchange Commission
that the Registration Statement will not be "reviewed," or is not subject
to further review, or (iii) the Registration Statement filed or required to
be filed under the Registration Rights Agreement is not declared effective
by the Securities and Exchange Commission on or before 225 days following
March 23, 2005, or (iv) after the Registration Statement is first declared
effective by the Securities and Exchange Commission, it ceases for any
reason to remain continuously effective as to all securities registered
thereunder, or the holders of such securities are not permitted to utilize
the prospectus contained in the Registration Statement to resell such
securities, for more than an aggregate of 45 trading days during any
12-month period (which need not be consecutive trading days) (any such
failure or breach being referred to as an "Event," and for purposes of
clause (i) or (iii) the date on which such Event occurs, or for purposes of
clause (ii) the date on which such five-trading day period is exceeded, or
for purposes of clause (iv) the date on which such 45-trading day-period is
exceeded being referred to as "Event Date"), then in addition to any other
rights the holders of such securities may have under the Registration
Statement or under applicable law, then, on each such Event Date and on
each monthly anniversary of each such Event Date (if the applicable Event
shall not have been cured by such date) until the applicable Event is
cured, the Company is required to pay to each such holder an amount in
F-12
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
cash, as partial liquidated damages and not as a penalty, equal to 2.0% of
the aggregate purchase price paid by such holder pursuant to the Securities
Purchase Agreement relating to such securities then held by such holder. If
the Company fails to pay any partial liquidated damages in full within
seven days after the date payable, the Company is required to pay interest
thereon at a rate of 18% per annum (or such lesser maximum amount that is
permitted to be paid by applicable law) to such holder, accruing daily from
the date such partial liquidated damages are due until such amounts, plus
all such interest thereon, are paid in full. The partial liquidated damages
are to apply on a daily pro-rata basis for any portion of a month prior to
the cure of an Event.
The Registration Rights Agreement also provides for customary piggy-back
registration rights whereby holders of shares of the Company's common
stock, or warrants to purchase shares of common stock, can cause the
Company to register such shares for resale in connection with the Company's
filing of a Registration Statement with the Securities and Exchange
Commission to register shares in another offering. The Registration Rights
Agreement also contains customary representations and warranties, covenants
and limitations.
STOCK OPTIONS - One outstanding option granted to an employee of the
Company to acquire 25,000 shares of common stock vested on March 23, 2005
and was converted into a warrant. Non-cash compensation expense of $232,250
was recognized to record the fair value of the warrant. (See Note 6)
STOCK ISSUANCE - The Company issued an aggregate of 70,000 shares of common
stock to two employees of the Company on their date of hire on June 23,
2005. Non-cash compensation expense of $651,000 was recognized to record
the fair value of shares of common stock. (See Note 6)
NON-CASH COMPENSATION - On February 12, 2004, the Company entered into a
consulting agreement with an unrelated party to represent the Company in
investors' communications and public relations with existing shareholders,
brokers, dealers and other investment professionals as to the Company's
current and proposed activities. As compensation for such services, the
Company issued warrants to the consultant to purchase 920,000 shares of the
Company's common stock. These warrants vested upon the effective date of
the agreement and were recognized at the fair value on the date of issuance
in the amount of $1,380,000. The Company recorded non-cash expense of
$172,500 and $517,500 for consulting services during the six months ended
June 30, 2005 and 2004, respectively.
Pursuant to the consulting agreement, upon completion of the Share Exchange
Transaction, the Company issued warrants to the consultant to purchase
230,000 additional shares of common stock that will vest ratably over a
period of two years. The warrants were recognized at the fair value as of
the start of business on March 24, 2005 in the amount of $2,139,000 and
recorded as contra-equity. The Company recorded non-cash expense of
$287,886 for consulting services vested during the period from March 24,
2005 to June 30, 2005. The unvested warrants in the amount of $1,851,114
will vest ratably at $89,125 per month over the remainder of the two year
period.
F-13
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
6. COMMITMENTS AND CONTINGENCIES:
------------------------------
OPERATING LEASES - The Company leases shared office space in Fresno,
California on a month-to-month basis at $4,132 per month. The related
office rent expense was $19,680 and $11,780 for the six months ended June
30, 2005 and 2004, respectively.
ADVISORY FEE - On April 14, 2004, the Company entered into an agreement
with CMCP in connection with raising funding for an ethanol production
facility. The agreement provided that upon raising a minimum of $15,000,000
the Company would pay CMCP a fee, through that date, equal to $10,000 per
month starting from April 15, 2003. In addition, the agreement provided for
payment of $25,000 per month for a minimum of 12 months upon the completion
of a merger between the Company and a public company, starting from the
date of close of such merger, as well as an advisory fee of 3% of any
equity amount raised through the efforts of CMCP, including cash amounts
received through a merger with another corporate entity. The Company paid
an advisory fee to CMCP in the amount of $235,000 on March 24, 2005,
pursuant to the terms of the agreement between CMCP and the Company and in
connection with the private placement transaction described above. In
addition, $83,017 was paid related to cash received from Accessity in
connection with the Share Exchange Transaction. Pursuant to the terms of
the consulting agreement, CMCP will continue to receive payments of $25,000
per month until at least March 2006.
On January 5, 2005, the Company entered into an agreement with Northeast
Securities, Inc. ("NESC") and Chadbourn Securities, Inc. ("Chadbourn"), a
related party, in connection with the private placement described above.
The agreement provides that upon completion of a financing within the
time-frame of the engagement covered by the agreement, the Company will pay
NESC 6% (plus a 1% non-accountable expense allowance) of gross proceeds
received by the Company, and warrants exercisable at the offering price in
an amount equal to 7% of the aggregate number of shares of common stock
sold in the financing. In addition, the agreement provides that Chadbourn
will receive 2% (plus a 1% non-accountable expense allowance) of gross
proceeds and warrants exercisable at the offering price in an amount equal
to 3% of the aggregate number of shares of common stock sold in the
financing. Pursuant to the terms of the agreement and in connection with
the completion of the private placement described above, the Company paid
NESC $1,168,800, (net of a reduction of $183,600, as agreed on March 18,
2005), and issued to NESC placement warrants to purchase 450,800 shares of
the Company's common stock exercisable at $3.00 per share. The Company also
paid Chadbourn $627,600 and issued to Chadbourn placement warrants to
purchase 212,700 shares of the Company's common stock exercisable at $3.00
per share.
In April 2005, the Company entered into a consulting agreement in the
amount of $180,000 with NESC. Under the terms of the agreement, the Company
paid an initial payment of $30,000 and will continue to make monthly
payments of $12,500 through April 1, 2006.
F-14
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
CASUALTY LOSS - In January 2004, canola stored in one of the silos at the
Company's Madera County, California facility caught on fire. The facility
was fully insured with $10 million of property and general liability
insurance. The canola was owned by a third party who was also insured. The
insurance company has paid $1,000,000 to date and has estimated that an
additional $4,000,000 of payments will be made to the Company. The Company
has received a detailed engineering estimate for full restoration and is
proceeding with the restoration.
NON-CASH COMPENSATION - In December 2003, PEI California issued to an
employee stock options to acquire up to 25,000 shares of common stock at an
exercise price of $0.01 per share. In February 2004, the board of directors
of PEI California ratified the options, contingent upon the Company's
success in closing the Share Exchange Transaction. The stock options vested
in full on March 23, 2005 and were converted into a warrant to acquire up
to 25,000 shares of common stock of the Company. Non-cash compensation
expense was recognized in March 2005 in the amount of $232,250 to record
the fair value of the warrant. (See Note 5)
The Company issued an aggregate of 70,000 shares of common stock to two
employees of the Company on their date of hire on June 23, 2005. Non-cash
compensation expense of $651,000 was recognized to record the fair value of
shares of common stock. (See Note 5)
ETHANOL PURCHASE AND MARKETING AGREEMENT - On March 4, 2005, Kinergy
entered into an Ethanol Purchase and Marketing Agreement with the owner of
an ethanol production facility. The agreement is effective for two years
with automatic renewals for additional one-year periods thereafter unless a
party to the agreement delivers written notice of termination at least 60
days prior to the end of the original or renewal term. Under the agreement,
Kinergy is to provide denatured fuel ethanol marketing services for the
production facility. Kinergy is to have the exclusive right to market and
sell all of the ethanol from the facility, an estimated 20 million gallons-
per-year. Kinergy is to pay the owner the gross payments received by
Kinergy from third parties for forward sales of ethanol less certain
transaction costs and fees. From the gross payments, Kinergy may deduct
transportation costs and expenses incurred by or on behalf of Kinergy in
connection with the marketing of ethanol pursuant to the agreement,
including truck, rail and terminal fees for the transportation of the
facility's ethanol to third parties and may also deduct and retain a 1.0%
marketing fee calculated after deducting these costs and expenses.
CONSULTING AGREEMENT - On April 27, 2005, the Company engaged a consulting
firm to explore capital raising alternatives. The Company paid the
consulting firm an initial engagement fee of $300,000 upon execution of its
engagement agreement. The engagement agreement also requires an additional
engagement fee, the amount of which is dependent upon the number of the
Company's projects to be financed. The additional engagement fee has a
range of a minimum of $300,000 and a maximum of one-half of one percent
(1/2%) of the capital raised, and is payable upon the occurrence of certain
events. In addition, the Company is obligated to pay to the consulting firm
an arrangement fee of three percent (3%) of the capital raised, which
amount is payable upon the closing of the financing transaction. If,
however, the capital raised finances only one Company project and the
consulting firm arranges additional financing to finance another Company
project, the arrangement fee under the second financing is to be three and
one-half percent (3.5%) but there shall be no additional engagement fee for
the second financing. The Company is also to pay to the consulting firm an
annual administration fee of $75,000 if one Company project is financed and
$100,000 if two Company projects are financed, which amounts are payable
for each year during which debt financing raised by the consulting firm is
outstanding.
7. SUBSEQUENT EVENTS:
-----------------
STOCK OPTIONS - On July 26, 2005, the Company issued options to purchase an
aggregate of 17,500 shares of the Company's common stock at an exercise
price equal to $7.01 per share, which exercise price equals 85% of the
closing price per share of the Company's common stock on that date. A
non-cash charge of $21,656 will be recorded in the quarter ended September
30, 2005.
On July 26, 2005, the Company granted options to purchase an aggregate of
115,000 shares of the Company's common stock at an exercise price equal to
$8.25, the closing price per share of the Company's common stock on that
date, to various non-employee directors.
F-15
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
On July 28, 2005, the Company granted options to purchase an aggregate of
30,000 shares of the Company's common stock at an exercise price equal to
$8.30, the closing price per share of the Company's common stock on that
date, to two new non-employee directors.
On August 10, 2005, the Company granted options to purchase an aggregate of
425,000 shares of the Company's common stock at an exercise price equal to
$8.03, the closing price per share of the Company's common stock on the day
immediately preceding that date, to its Chief Financial Officer.
On August 10, 2005, the Company granted options to purchase an aggregate of
75,000 shares of the Company's common stock at an exercise price equal to
$8.03, the closing price per share of the Company's common stock on the day
immediately preceding that date, to a consultant.
On September 1, 2005, the Company granted options to purchase an aggregate
of 160,000 shares of the Company's common stock at an exercise price equal
to $6.63 per share, which exercise price equals 85% of the closing price
per share of the Company's common stock on the day immediately preceding
that date. A non-cash charge of $46,800 will be recorded in the quarter
ended September 30, 2005 and on the dates of additional vesting occurring
on each of the next three anniversaries of the date of grant.
EMPLOYMENT AGREEMENT - On August 10, 2005, the Company entered into an
Executive Employment Agreement with William Langley, its Chief Financial
Officer, that provides for a four-year term and automatic one-year renewals
thereafter, unless either Mr. Langley or the Company provides written
notice to the other at least 90 days prior to the expiration of the
then-current term. Mr. Langley is to receive a base salary of $185,000 per
year. Mr. Langley is entitled to six months of severance pay effective
throughout the entire term of his agreement and is also entitled to
reimbursement of his costs associated with his relocation to Fresno,
California. Mr. Langley is obligated to relocate to Fresno, California
within six months of the date of his Executive Employment Agreement.
PURCHASE AGREEMENT - On August 10, 2005, the Company entered into a
Membership Interest Purchase Agreement with certain holders of a limited
liability company under which the Company intends to purchase all of the
outstanding membership interests of the limited liability company. The
limited liability company is the owner of a newly-constructed ethanol
production facility in Goshen, California that is undergoing initial
start-up testing. The purchase price, subject to certain adjustments, is
$48 million, payable in approximately $31 million in cash, the assumption
of approximately $9 million in debt and the issuance by the Company to the
members of the limited liability company of an aggregate of $8 million in
convertible subordinated promissory notes. To the extent that debt actually
assumed by the Company is greater or less than $9 million, the cash payment
of approximately $31 million is to be reduced or increased, respectively,
by an equal amount. The closing of the transaction is subject to the
satisfaction of certain conditions, including the securing by the Company
of all funding necessary to finance the transaction, satisfactory results
of the Company's due diligence and the Company's ability to obtain the
agreement of all members of the limited liability company. The agreement
terminates automatically in the event that the closing of the purchase
transaction does not occur by the earlier of October 15, 2005 and the
sixtieth day following the satisfaction of a certain ethanol production
milestone.
On October 15, 2005, the Membership Interest Purchase Agreement terminated
automatically in accordance with its terms. The deadline for the closing of
the transaction contemplated by the agreement was October 15, 2005. This
deadline was not met and was not waived by any party to the agreement;
accordingly, the agreement terminated automatically on October 15, 2005.
ETHANOL MARKETING AGREEMENT - On August 31, 2005, Kinergy entered into an
Ethanol Marketing Agreement with the owner of an ethanol production
facility. The agreement is effective for three years with automatic
renewals for additional one-year periods thereafter unless a party to the
agreement delivers written notice of termination at least 60 days prior to
the end of the original or renewal term. Under the agreement, Kinergy is to
provide denatured fuel ethanol marketing services for the production
facility. Kinergy is to have the exclusive right to market and sell all of
the ethanol from the facility, an estimated 40 million gallons-per-year.
Kinergy is to pay the owner the gross payments received by Kinergy from
third parties for forward sales of ethanol (the "Purchase Price") less
certain transaction costs and fees. From the Purchase Price, Kinergy may
deduct all reasonable out-of-pocket and documented costs and expenses
incurred by or on behalf of Kinergy in connection with the marketing of
ethanol pursuant to the agreement, including truck, rail and terminal costs
for the transportation and storage of the facility's ethanol to third
parties and reasonable, documented out-of-pocket expenses incurred in
connection with the negotiation and documentation of sales agreements
between Kinergy and third parties (the "Transaction Costs"). From the
Purchase Price, Kinergy may also deduct and retain the product of 1.0%
multiplied by the difference between the Purchase Price and the Transaction
Costs. In addition, Kinergy is to split the profit from any logistical
arbitrage associated with ethanol supplied by the facility.
F-16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes to financial
statements included elsewhere in this report. This report and our condensed
consolidated financial statements and notes to financial statements contain
forward-looking statements, which generally include the plans and objectives of
management for future operations, including plans and objectives relating to our
future economic performance and our current beliefs regarding revenues we might
earn if we are successful in implementing our business strategies. The
forward-looking statements and associated risks may include, relate to or be
qualified by other important factors, including, without limitation:
o the projected growth or contraction in the ethanol market in
which we operate;
o fluctuations in the market price of ethanol;
o our business strategy for expanding, maintaining or contracting
our presence in this market;
o our ability to obtain the necessary financing to complete
construction of an ethanol plant in Madera County, California;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and future
competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
Any of the factors described above or in the "Risk Factors" section
set forth 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
Our primary goal is to become a leader in the production, marketing
and sale of ethanol and other renewable fuels in the Western United States.
Through our wholly-owned subsidiary, Kinergy Marketing, LLC, or
Kinergy, we are currently in the business of marketing ethanol in the Western
United States. We provide transportation, storage and delivery of ethanol
through third-party service providers. We sell ethanol primarily into
California, Nevada, Arizona and Oregon and have extensive customer relationships
throughout the Western United States and extensive supplier relationships
throughout the Western and Midwestern United States. We do not currently produce
any ethanol that we sell. Until we commence the production of ethanol, if at
all, we expect our operations to consist primarily of the marketing and sale of
ethanol produced by third-parties. Accordingly, we expect that unless and until
we complete the construction of our planned ethanol production facility in
Madera County our consolidated net sales will consist solely of net sales
generated by Kinergy. We anticipate that our net sales will grow in the
long-term as demand for ethanol increases and as a result of our marketing
agreements with third-party ethanol producers.
We believe that we have a competitive advantage due to the market
niche that we have developed by supplying ethanol to customers in several major
metropolitan and rural markets in California and other Western states. We also
believe that the experience of our management over the past two decades and the
operations Kinergy has conducted over the past four years have enabled us to
establish valuable relationships in the ethanol marketing industry.
2
Through our wholly-owned subsidiary, Pacific Ethanol California, Inc.,
or PEI California, we are constructing an ethanol production facility in Madera
County to begin the production and sale of ethanol and its co-products if we are
able to secure all the necessary financing to complete construction of this
facility. To date, we have not obtained all of this financing. See "Risk
Factors." We also intend to construct or otherwise acquire additional ethanol
production facilities as financing resources and business prospects make the
construction or acquisition of these facilities advisable. PEI California has,
to date, not conducted any significant business operations other than the
acquisition of real property located in Madera County, on which we are
constructing our first ethanol production facility.
Our wholly-owned subsidiary, ReEnergy, LLC, or ReEnergy, does not
presently have any significant business operations or plans but does hold an
option to acquire real property in Visalia, California, on which we intend to
build an ethanol production facility.
Currently, ethanol represents only up to 3% of the total annual
gasoline supply in the United States. We believe that the ethanol industry has
substantial room to grow to reach what we estimate is an achievable level of at
least 10% of the total annual gasoline supply in the United States. An increase
in the demand for ethanol from California's current level of 5.7% to at least
10% of total annual gasoline supply would result in demand for approximately 700
million additional gallons of ethanol, representing an increase in annual demand
in California of approximately 75%. An additional 700 million gallons of ethanol
would represent an increase in annual demand of approximately 18% for the entire
United States.
Kinergy has two principal methods of conducting its ethanol marketing
and sales activities: direct sales and inventory sales. Kinergy's first method
of marketing and selling ethanol involves direct sales through which suppliers
deliver ethanol directly via rail to Kinergy's customers. For direct sales,
Kinergy typically matches ethanol purchase and sale contracts of like quantities
and delivery periods. These back-to-back direct sales typically involve no price
risks to Kinergy that otherwise may result from fluctuations in the market price
of ethanol. Kinergy's second method of marketing and selling ethanol involves
truck deliveries from inventory purchased by Kinergy in advance. For inventory
sales, as with direct sales, Kinergy typically matches ethanol purchase and sale
contracts of like quantities. However, timing differences do exist and
consequently, a back-to-back inventory sale may lag by up to two or more weeks.
This time lag results from inventory transit and turnover times. As a result,
Kinergy may supply ethanol under new inventory sales contracts from existing
inventory. These back-to-back inventory sales therefore involve some price risks
to Kinergy resulting from potential fluctuations in the market price of ethanol.
We believe that the only consistent price risk to Kinergy is currently
inventory risk. Management seeks to optimize transitions to new inventory sales
contracts and reduce the effects of declining ethanol prices by managing
inventory as carefully as possible to minimize inventory levels in anticipation
of declining ethanol prices. In addition, management seeks to maximize inventory
levels in anticipation of rising ethanol prices. Because Kinergy increases
inventory levels in anticipation of rising ethanol prices and decreases
inventory levels in anticipation of declining ethanol prices, it is subject to
the risk of ethanol prices moving in unanticipated directions, which could
result in declining or even negative gross profit margins over certain periods
of time, but also enables Kinergy to potentially benefit from above-normal gross
profit margins.
Over the past few years, the market price of ethanol has experienced
significant fluctuations. More recently, the price of ethanol declined by
approximately 25% from its 2004 average price per gallon in five months from
January 2005 through May 2005 and reversed this decline and increased to
approximately 55% above its 2004 average price per gallon in four months from
June 2005 through September 2005. We believe that the market price of ethanol
will, for the foreseeable future, continue to experience significant
fluctuations which may cause our future results of operations to fluctuate
significantly. As a result, our historical results of operations may not be
predictive of our future results of operations.
3
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and will continue to
reduce margins, as compared to historical levels. Second, Kinergy is emphasizing
direct sales to a greater degree. Direct sales ordinarily have gross profit
margins of approximately 1.0% over periods of one year or more, a level that is
consistent with our recent ethanol marketing agreements with Front Range Energy,
LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol marketing
industry as a whole. Historically, Kinergy's sales were comprised to a greater
degree of inventory sales that often involved the buying and selling of ethanol
based on anticipated trends in the market price of ethanol. These inventory
sales represented higher-risk positions but enabled Kinergy to achieve higher
margin levels, as compared to direct sales, as a result of correctly
anticipating fluctuations in the market price of ethanol. As a result of
highly-volatile ethanol prices, we are unable to estimate Kinergy's future gross
profit margins from inventory sales. However, we believe that over longer
periods of up to a year or more, our gross profit margin from inventory sales is
unlikely to exceed our historic high average gross profit margin of 4.4%.
If we are able to complete our planned ethanol production facility in
Madera County and commence producing ethanol, we expect our gross profit margins
for ethanol that we produce to be substantially higher than our gross profit
margins for Kinergy's direct sales and inventory sales activities. However, any
gross profits that we realize from the production of ethanol will be highly
dependent upon the prevailing market price of ethanol at the time of sale.
Moreover, in light of the recent and expected future volatility in the price of
ethanol, we are now, and expect for the foreseeable future to be, unable to
estimate our gross profit margins resulting from the sale of ethanol that we may
produce.
Kinergy's gross profit margin declined by 56% from 3.9% in 2004 to
1.7% in the first quarter of 2005 and declined further by 82% from 3.9% in 2004
to 0.7% in the second quarter of 2005. Kinergy's gross profit margin for the
full six months ended June 30, 2005 declined by 79% from 3.9% in 2004 to 0.8%.
Kinergy's gross profit margin in the first quarter of 2005 is generally
reflective of the contracted margins for that period. The decline in Kinergy's
gross profit margin in the second quarter of 2005 resulted primarily from the
transition from inventory sales contracts ending in the first quarter of 2005 to
new inventory sales contracts beginning in the second quarter of 2005 during a
period of rapidly declining market prices. As discussed above, because of the
time lag in delivering ethanol under new inventory sales contracts, Kinergy sold
ethanol under these contracts from existing inventory that was purchased at
levels higher than the prevailing market price at the time of sale.
Management correctly anticipated a softening in the price ethanol in
early 2005, but neither management nor, we believe, the ethanol industry as a
whole, anticipated the speed and the extent of the decline in the price of
ethanol from January 2005 through May 2005. As a result, Kinergy was forced to
sell some ethanol at negative gross profit levels following the rapid and
extensive decline in the price of ethanol. In the second quarter of 2005, and
before ethanol prices increased to levels significantly higher than their recent
lows, Kinergy sold much of this ethanol inventory that was acquired at prices
higher than those prevailing at the time of sale. Accordingly, despite the
general increase in ethanol prices during the second quarter of 2005, this
inventory and these sales still had the effect of depressing Kinergy's gross
profit margin to 0.7% for the entire second quarter of 2005 and to 0.8% for the
six months ended June 30, 2005. However, we believe that, as a result of the
substantial increase in the price of ethanol during the third quarter of 2005,
our gross profit margin for the third quarter of 2005 will be significantly
higher than our gross profit margins for either the first or second quarters of
2005.
4
Management decided to maintain net long ethanol positions in the first
and second quarters of 2005 as a result of a confluence of factors, including
its expectation of increased prices of gasoline and petroleum and anticipated
favorable federal legislation that we expected may increase the demand for and
price of ethanol over the short- and longer-terms. We believe that these factors
were, however, outweighed by a sudden but short-lived excess of ethanol supplied
to the market by a number of new ethanol production facilities. We believe that
the sudden and short-lived excess of ethanol supplied to the market coupled with
higher market-wide inventory levels caused the rapid and steep decline in the
price of ethanol. Following its rapid decline during January 2005 through May
2005, the price of ethanol reversed and subsequently increased to unprecedented
high levels from June 2005 through September 2005. We believe that this increase
in the price of ethanol demonstrates that the fundamental factors considered by
management in deciding to maintain net long ethanol positions ultimately were
the prevailing forces in driving the price of ethanol to unprecedented high
levels. In addition, we believe that these factors contributed and will continue
to contribute to the market's relatively quick absorption of the additional
supply of ethanol that was, and that continues to be, supplied to the market by
new ethanol production facilities.
SHARE EXCHANGE TRANSACTION
On March 23, 2005, we completed a share exchange transaction, or the
Share Exchange Transaction, with the shareholders of PEI California, and the
holders of the membership interests of each of Kinergy and ReEnergy, pursuant to
which we acquired all of the issued and outstanding shares of capital stock of
PEI California and all of the outstanding membership interests of each of
Kinergy and ReEnergy. Immediately prior to the consummation of the share
exchange, our predecessor, Accessity Corp., a New York corporation, or
Accessity, reincorporated in the State of Delaware under the name Pacific
Ethanol, Inc. through a merger of Accessity with and into its then-wholly-owned
Delaware subsidiary named Pacific Ethanol, Inc., which was formed for the
purpose of effecting the reincorporation. We are the surviving entity resulting
from the reincorporation merger and have three principal wholly-owned
subsidiaries: Kinergy, PEI California and ReEnergy.
The Share Exchange Transaction has been accounted for as a reverse
acquisition whereby PEI California is deemed to be the accounting acquiror. As a
result, our results of operations for the six months ended June 30, 2004 consist
of the operations of PEI California only. We have consolidated the results of
Accessity, Kinergy and ReEnergy beginning March 23, 3005, the date of the Share
Exchange Transaction. Accordingly, our results of operations for the six months
ended June 30, 2005 consist of the operations of PEI California for the entire
six month period and the operations of Accessity, Kinergy and ReEnergy from
March 23, 2005 through June 30, 2005.
PEI California has, to date, not conducted any significant business
operations other than the acquisition of real property located in Madera County,
California, on which it intends to construct its first ethanol production
facility. ReEnergy does not presently have any significant business operations
or plans but does hold an option to acquire real property in Visalia,
California, on which we intend to build an ethanol production facility.
We have consolidated the results of operations of Kinergy beginning
from March 23, 2005, the date of the closing of the Share Exchange Transaction.
We expect that, until we complete construction of our planned ethanol production
facility in Madera County, our operations will consist solely of operations
conducted by Kinergy.
5
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with the Share Exchange Transaction:
Current assets............................... $ 7,014,196
Property, plant and equipment................ 6,224
Intangibles, including goodwill.............. 10,935,750
--------------
Total assets acquired..................... 17,956,170
Current liabilities.......................... 4,253,177
Other liabilities............................ 83,017
--------------
Total liabilities assumed................. 4,336,194
--------------
Net assets acquired.......................... $ 13,619,976
==============
Shares of common stock issued................ 6,489,414
==============
The purchase price represented a significant premium over the recorded
net worth of the acquired entities' assets. In deciding to pay this premium, we
considered various factors, including the value of Kinergy's trade name,
Kinergy's extensive market presence and history, Kinergy's industry knowledge
and expertise, Kinergy's extensive customer relationships and expected synergies
among Kinergy's and ReEnergy's businesses and assets and the our planned entry
into the ethanol production business.
The following table summarizes, on an unaudited pro forma basis, our
combined results of operations, as though the acquisitions occurred as of
January 1, 2004. The pro forma amounts give effect to appropriate adjustments
for amortization of intangibles and income taxes. The pro forma amounts
presented are not necessarily indicative of future operating results.
Six Months
Ended June 30,
---------------------------
2005 2004
------------ ------------
Net sales $ 48,721,682 $ 37,842,788
============ ============
Net loss $ (4,126,026) $ (2,227,084)
============ ============
Loss per share of common stock
Basic and diluted $ (0.14) $ (0.09)
============ ============
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.
6
REVENUE RECOGNITION
We derive revenues primarily from sales of ethanol. Our sales are
based upon written agreements or purchase orders that identify the amount of
ethanol to be purchased and the purchase price. We recognize revenue upon
delivery of ethanol to a customer's designated ethanol tank. Shipments are made
to customers directly from suppliers and from our inventory. We ship ethanol to
our customers by truck or rail. Ethanol that is shipped by rail originates
primarily in the Midwest and takes from 10 to 14 days from date of shipment to
be delivered to the customer or to one of four terminals in California and
Oregon. For local deliveries we ship by truck and deliver the product the same
day as shipment.
INVENTORY
Inventory consists of fuel ethanol and is valued at the lower of cost
or market, cost being determined on a first-in first-out basis. Shipping,
handling and storage costs are classified as a component of cost of goods sold.
Title to ethanol transfers from the producer to us when the ethanol passes
through the inlet flange of our receiving tank.
INTANGIBLES, INCLUDING GOODWILL
We periodically evaluate our intangibles, including goodwill, for
potential impairment. Our judgments regarding the existence of impairment are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment of goodwill, we consider these
factors and forecast financial performance of the acquired businesses. If
forecasts are not met, we may have to record additional impairment charges not
previously recognized. In assessing the recoverability of our goodwill and other
intangibles, we must make assumptions regarding estimated future cash flows and
other factors to determine the fair value of those respective assets. If these
estimates or their related assumptions change in the future, we may be required
to record impairment charges for these assets that were not previously recorded.
If that were the case, we would have to record an expense in order to reduce the
carrying value of our goodwill.
In connection with the Share Exchange Transaction and our acquisition
of Kinergy and ReEnergy, we engaged a valuation firm to determine what portion
of the purchase price should be allocated to identifiable intangible assets.
Through that process, we have estimated that for Kinergy, the distribution
backlog is valued at $136,000, the customer relationships are valued at
$5,600,000 and the trade name is valued at $3,100,000. We made a $150,000 cash
payment and issued stock valued at $316,250 for the acquisition of ReEnergy. In
addition, certain stockholders sold stock to the members of ReEnergy, increasing
the purchase price by $506,000. The purchase price for ReEnergy totaled
$972,250. Of this amount, $120,000 was recorded as an intangible asset for the
fair value of a favorable option to acquire land and because the acquisition of
ReEnergy was not deemed to be an acquisition of a business, the remaining
purchase price of $852,250 was recorded as an expense for services rendered in
connection with a feasibility study. We issued stock valued at $9,803,750 for
the acquisition of Kinergy. In addition, certain stockholders sold stock to the
sole member of Kinergy and a related party, increasing the purchase price by
$1,012,000. The purchase price for Kinergy totaled $10,815,750. Goodwill
directly associated with the Kinergy acquisition therefore totaled $1,979,750.
The Kinergy trade name is determined to have an indefinite life and
therefore, rather than being amortized, is being periodically tested for
impairment. The distribution backlog has an estimated life of six months and
customer relationships were estimated to have a ten-year life and, as a result,
will be amortized accordingly, unless otherwise impaired at an earlier time. The
ReEnergy land option will expire on December 31, 2005 and will be expensed at
that time if not extended.
7
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2005 TO THE THREE MONTHS ENDED
JUNE 30, 2004
The following table sets forth certain of our operating data for the
three months ended June 30, 2005 and 2004:
Three Months Ended
June 30,
----------------------------
2005 2004
------------ ------------
Net sales (including $1,496,178 for the three months
ended June 30, 2005 to a related party) $ 22,814,433 $ 9,442
Cost of goods sold 22,662,908 6,229
------------ ------------
Gross profit 151,525 3,213
Selling, general and administrative expenses 1,474,696 235,038
Non-cash compensation for consulting fees 918,375 345,000
------------ ------------
Operating loss (2,241,546) (576,825)
Other income/(expense) 18,294 (136,429)
------------ ------------
Loss before provision for income taxes (2,223,252) (713,254)
Provision for income taxes 3,200 800
------------ ------------
Net loss $ (2,226,452) $ (714,054)
============ ============
NET SALES. Net sales for the three months ended June 30, 2005
increased by $22,804,991 to $22,814,433 as compared to $9,442 for the three
months ended June 30, 2004. Sales attributable to the acquisition of Kinergy on
March 23, 2005 contributed $22,808,380 of this increase. Without the acquisition
of Kinergy, our net sales for the three months ended June 30, 2005 would have
decreased by $3,389 to $6,053. This decrease was due to a decrease in our
transloading services.
GROSS PROFIT. Gross profit for the three months ended June 30, 2005
increased by $148,312 to $151,525 as compared to $3,213 for the three months
ended June 30, 2004, primarily due to the acquisition of Kinergy on March 23,
2005. Gross profit as a percentage of net sales decreased to 0.7% for the three
months ended June 30, 2005 as compared to 34% for the three months ended June
30, 2004. This difference is attributable to the acquisition of Kinergy on March
23, 2005.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and will continue to
reduce margins, as compared to historical levels. Second, Kinergy is emphasizing
direct sales to a greater degree. Direct sales ordinarily have gross profit
margins of approximately 1.0% over periods of one year or more, a level that is
consistent with our recent ethanol marketing agreements with Front Range Energy,
LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol marketing
industry as a whole.
Kinergy's gross profit margin declined by 82% from 3.9% in 2004 to
0.7% in the second quarter of 2005. The decline in Kinergy's gross profit margin
in the second quarter of 2005 resulted primarily from the transition from
inventory sales contracts ending in the first quarter of 2005 to new inventory
sales contracts beginning in the second quarter of 2005 during a period of
rapidly declining market prices. Kinergy sold ethanol under these contracts from
existing inventory that was purchased at levels higher than the prevailing
market price at the time of sale. Accordingly, despite the general increase in
ethanol prices during the second quarter of 2005, this inventory and these sales
still had the effect of depressing Kinergy's gross profit margin to 0.7% for the
second quarter of 2005.
8
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended June 30, 2005 increased by
$1,239,658 (527%) to $1,474,696 as compared to $235,038 for the three months
ended June 30, 2004. This increase was due to approximately $580,000 in
additional legal, accounting and consulting fees, $225,000 for amortization of
intangibles, $220,000 in additional payroll expense related to the three
executive employment agreements that became effective upon the consummation of
the Share Exchange Transaction on March 23, 2005, the addition of two staff
positions in May and June 2005, an employee promotion in May 2005, and the
addition of two executive positions in June 2005, a $65,000 increase in
insurance expense related to the addition of a directors and officers insurance
policy in October 2004 and an insurance premium increase effective June 2004
related to a silo fire that occurred in January 2004 at our Madera County grain
facility, $42,000 in business travel expense, $35,000 in market and filing fees,
$35,000 in policy and investor relations expenses, $20,000 in rents, and the net
balance of $17,000 related to immaterial increases in other selling, general and
administrative expenses. We expect that over the near term, our selling, general
and administration expenses will increase as a result of, among other things,
increased legal and accounting fees associated with increased corporate
governance activities in response to the Sarbanes-Oxley Act of 2002, recently
adopted rules and regulations of the Securities and Exchange Commission, the
filing of a registration statement with the Securities and Exchange Commission
to register for resale, in addition to other shares of common stock, the shares
of common stock and shares of common stock underlying warrants we issued in our
private offering in March 2005, increased employee costs associated with planned
staffing increases, increased sales and marketing expenses, increased activities
related to the construction of our Madera County, California ethanol production
facility and increased activity in searching for and analyzing potential
acquisitions.
NON-CASH COMPENSATION AND CONSULTING FEES. Non-cash compensation and
consulting fees for the three months ended June 30, 2005 increased by $573,375
(166%) to $918,375 as compared to $345,000 for the three months ended June 30,
2004. Of this increase, $651,000 was related to non-cash compensation from stock
grants in connection with the hiring of two employees and $77,625 was a decrease
in fees related to non-cash consulting fees for warrants that were granted in
February 2004 and that vested over one year. We expect to incur non-cash
consulting fee expense for warrants that vest ratably over two years in
connection with the consummation of the Share Exchange transaction in the amount
of $89,125 per month for the remainder of the two-year term ending on March 23,
2007.
OTHER INCOME/(EXPENSE). Other income/(expense) reversed by $154,723 to
$18,294 for the three months ended June 30, 2005, as compared to ($136,429) for
the three months ended June 30, 2004, primarily due to approximately $135,000 in
interest income on cash in seven day investment accounts and $20,000 net
decrease in interest expense related to long-term debt, amortization of
discount, construction payables, and capitalized interest related to our planned
Madera County ethanol plant.
9
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2005 TO THE SIX MONTHS ENDED JUNE
30, 2004
The following table sets forth certain of our operating data for the
six months ended June 30, 2005 and 2004
Six Months Ended
June 30,
----------------------------
2005 2004
------------ ------------
Net sales (including $1,849,236 for the six
months ended June 30, 2005 to a related party) $ 25,116,430 $ 16,003
Cost of goods sold 24,917,278 10,789
------------ ------------
Gross profit 199,152 5,214
Selling, general and administrative expenses 1,792,668 427,058
Services rendered in connection with feasibility
study 852,250 --
Non-cash compensation for consulting fees 1,343,636 517,500
------------ ------------
Operating loss (3,789,402) (939,344)
Other expense (89,559) (266,944)
------------ ------------
Loss before provision for income taxes (3,878,961) (1,206,288)
Provision for income taxes 4,800 2,400
------------ ------------
Net Loss (3,883,761) (1,208,688)
============ ============
NET SALES. Net sales for the six months ended June 30, 2005 increased
by $25,110,427 to $25,116,430 as compared to $16,003 for the six months ended
June 30, 2004. Sales attributable to the acquisition of Kinergy on March 23,
2005 contributed $25,100,522 of this increase. Without the acquisition of
Kinergy, our net sales would have decreased by $95 to $15,908.
GROSS PROFIT. Gross profit for the six months ended June 30, 2005
increased by $193,938 to $199,152 as compared to $5,214 for the six months ended
June 30, 2004, primarily due to the acquisition of Kinergy on March 23, 2005.
Gross profit as a percentage of net sales decreased to 0.8% for the six months
ended June 30, 2005 as compared to 33% for the six months ended June 30, 2004.
This difference is attributable to the acquisition of Kinergy on March 23, 2005.
Historically, Kinergy's gross profit margins have averaged between
2.0% and 4.4%. Kinergy's gross profit margin in 2004 was 3.9%. We believe that
Kinergy's future gross profit margins will be lower than historical levels for
two principal reasons. First, higher ethanol sales volumes and increased
competition in the ethanol market have reduced margins, and will continue to
reduce margins, as compared to historical levels. Second, Kinergy is emphasizing
direct sales to a greater degree. Direct sales ordinarily have gross profit
margins of approximately 1.0% over periods of one year or more, a level that is
consistent with our recent ethanol marketing agreements with Front Range Energy,
LLC and Phoenix Bio-Industries, LLC, and, we believe, with the ethanol marketing
industry as a whole.
Kinergy's gross profit margin declined by 79% from 3.9% in 2004 to
0.8% for the six months ended June 30, 2005. The decline in Kinergy's gross
profit margin for the first six months of 2005 resulted primarily from the
transition from inventory sales contracts ending in the first quarter of 2005 to
new inventory sales contracts beginning in the second quarter of 2005 during a
period of rapidly declining market prices. Kinergy sold ethanol under these
contracts from existing inventory that was purchased at levels higher than the
prevailing market price at the time of sale. Accordingly, despite the general
increase in ethanol prices during the second quarter of 2005, this inventory and
these sales still had the effect of depressing Kinergy's gross profit margin to
0.7% for the entire second quarter of 2005 and to 0.8% for the six months ended
June 30, 2005.
10
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the six months ended June 30, 2005 increased by
$1,365,610 (313%) to $1,792,668 as compared to $427,058 for the six months ended
June 30, 2004. This increase was due to approximately $640,000 in additional
legal, accounting and consulting fees, $225,000 for amortization of intangibles,
$215,000 in additional payroll expense related to the three executive employment
agreements that became effective upon the consummation of the Share Exchange
Transaction on March 23, 2005, the addition of two staff positions in May and
June 2005, an employee promotion in May 2005, and the addition of two executive
positions in June 2005, $104,000 in additional insurance expense related to the
addition of a directors and officers insurance policy in October 2004 and an
insurance premium increase effective June 2004 related to a silo fire that
occurred in January 2004 at our Madera County grain facility, $50,000 in
business travel expense, $35,000 in market and filing fees, $35,000 in policy
and investor relations expenses, $21,000 in rents, $7,000 in bad debt expense
related to a receivable from R.A. Davis Commodities, and the net balance of
$34,000 related to immaterial increases in other selling, general and
administrative expenses. We expect that over the near term, our selling, general
and administration expenses will increase as a result of, among other things,
increased legal and accounting fees associated with increased corporate
governance activities in response to the Sarbanes-Oxley Act of 2002, recently
adopted rules and regulations of the Securities and Exchange Commission, the
filing of a registration statement with the Securities and Exchange Commission
to register for resale the shares of common stock and shares of common stock
underlying warrants we issued in our private offering in March 2005, increased
employee costs associated with planned staffing increases, increased sales and
marketing expenses, increased activities related to the construction of our
Madera County, California ethanol production facility and increased activity in
searching for and analyzing potential acquisitions.
SERVICES RENDERED IN CONNECTION WITH FEASIBILITY STUDY. Services
rendered in connection with feasibility study for the three months ended March
31, 2005 increased by $852,250 (100%) as compared to $0 for the three months
ended March 31, 2004. This expense arose in connection with the acquisition of
ReEnergy and relates to a feasibility study for an ethanol plant in Visalia,
California. Based on this study, ReEnergy entered into an option to buy land
for the ethanol plant site at a fixed price of $12,000 per acre.
NON-CASH COMPENSATION AND CONSULTING FEES. Non-cash compensation and
consulting fees for the six months ended June 30, 2005 increased by $826,136
(166%) to $1,343,636 as compared to $517,500 for the six months ended June 30,
2004. Of this amount, $651,000 related to non-cash compensation from stock
grants in connection with the hiring of two employees, $232,250 related to a
stock grant that vested upon closing of the share exchange transaction on March
23, 2005 and $57,114 related to a decrease in non-cash consulting fees for
warrants that were granted in February 2004 and that vested over one year. We
expect to incur non-cash consulting fee expense for warrants granted in
connection with the consummation of the Share Exchange transaction that vest
ratably over two years in the amount of $89,125 per month for the remainder of
the two-year term ending on March 23, 2007.
OTHER INCOME/(EXPENSE). Other income/(expense) decreased by $177,385
to $(89,559) for the six months ended June 30, 2005 as compared to ($266,944)
for the six months ended June 30, 2004, primarily due to approximately $148,000
of interest income on cash in seven day investment accounts and a net decrease
of $29,000 in interest expense related to long-term debt, amortization of
discount, construction payables, and capitalized interest related to our planned
Madera County ethanol plant.
11
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 2005, we funded our operations
primarily from the approximately $19,212,252 in net proceeds we received in
connection with a private offering of equity securities on March 23, 2005, as
described below. As of June 30, 2005, we had working capital of $15,734,748,
which represented a $16,759,495 increase from negative working capital of
$1,024,747 at December 31, 2004, primarily due to the proceeds from the private
offering. As of June 30, 2005 and December 31, 2004, we had accumulated deficits
of $7,545,007 and $3,661,246, respectively, and cash and cash equivalents of
$16,427,839 and $42, respectively.
Accounts receivable increased $2,103,736 (250%) during the six months
ended June 30, 2005 from $8,464 as of December 31, 2004 to $2,112,200 as of June
30, 2005. Sales attributable to the acquisition of Kinergy contributed
substantially all of this increase.
Inventory balances increased $1,111,960 (100%) during the six months
ended June 30, 2005, from $0 as of December 31, 2004 to $1,111,960 as of June
30, 2005 because of the acquisition of Kinergy. Inventory represented 2.7% of
our total assets as of June 30, 2005.
Cash used in our operating activities totaled $845,259 for the six
months ended June 30, 2005 as compared to cash used by operating activities of
$270,529 for the six months ended June 30, 2004. This $574,730 increase in cash
used in operating activities primarily resulted from an increase in inventories
and pre-paid expenses.
Cash used in our investing activities totaled $2,006,696 for the six
months ended June 30, 2005 as compared to $556,846 of cash used for the six
months ended June 30, 2004. Included in the results for the six months ended
June 30, 2005 are net cash of $307,808 used in connection with the share
exchange transaction, net cash of $2,845,742 used to purchase property, plant
and equipment and net cash of $1,146,854 that we acquired in connection with the
share exchange transaction.
Cash provided by our financing activities totaled $19,279,752 for the
six months ended June 30, 2005 as compared to $716,339 for the six months ended
June 30, 2004. The change is primarily due to the net proceeds of $18,879,757
from a private offering of equity securities on March 23, 2005, as described
below.
On March 23, 2005, we issued to 63 accredited investors in a private
offering an aggregate of 7,000,000 shares of common stock at a purchase price of
$3.00 per share, two-year investor warrants to purchase 1,400,000 shares of
common stock at an exercise price of $3.00 per share and two-year investor
warrants to purchase 700,000 shares of common stock at an exercise price of
$5.00 per share, for total gross proceeds of approximately $21,000,000. We paid
cash placement agent fees and expenses of approximately $1,850,400 and issued
five-year placement agent warrants to purchase 678,000 shares of common stock at
an exercise price of $3.00 per share in connection with the offering. Additional
costs related to the financing include legal, accounting and consulting fees
that totaled approximately $270,658 through June 30, 2005 and continue to be
incurred in connection with various securities filings and the resale
registration statement described below.
We are obligated under a Registration Rights Agreement to file, on the
151st day following March 23, 2005, a Registration Statement with the Securities
and Exchange Commission registering for resale shares of common stock, and
shares of common stock underlying investor warrants and certain of the placement
agent warrants, issued in connection with the private offering. If we (i) do not
file the Registration Statement within the time period prescribed, or (ii) fail
to file with the Securities and Exchange Commission a request for acceleration
in accordance with Rule 461 promulgated under the Securities Act of 1933, within
12
five trading days of the date that we are notified (orally or in writing,
whichever is earlier) by the Securities and Exchange Commission that the
Registration Statement will not be "reviewed," or is not subject to further
review, or (iii) the Registration Statement filed or required to be filed under
the Registration Rights Agreement is not declared effective by the Securities
and Exchange Commission on or before 225 days following March 23, 2005, or (iv)
after the Registration Statement is first declared effective by the Securities
and Exchange Commission, it ceases for any reason to remain continuously
effective as to all securities registered thereunder, or the holders of such
securities are not permitted to utilize the prospectus contained in the
Registration Statement to resell such securities, for more than an aggregate of
45 trading days during any 12-month period (which need not be consecutive
trading days) (any such failure or breach being referred to as an "Event," and
for purposes of clause (i) or (iii) the date on which such Event occurs, or for
purposes of clause (ii) the date on which such five-trading day period is
exceeded, or for purposes of clause (iv) the date on which such 45-trading
day-period is exceeded being referred to as "Event Date"), then in addition to
any other rights the holders of such securities may have under the Registration
Statement or under applicable law, then, on each such Event Date and on each
monthly anniversary of each such Event Date (if the applicable Event shall not
have been cured by such date) until the applicable Event is cured, we are
required to pay to each such holder an amount in cash, as partial liquidated
damages and not as a penalty, equal to 2.0% of the aggregate purchase price paid
by such holder pursuant to the Securities Purchase Agreement relating to such
securities then held by such holder. If we fail to pay any partial liquidated
damages in full within seven days after the date payable, we are required to pay
interest thereon at a rate of 18% per annum (or such lesser maximum amount that
is permitted to be paid by applicable law) to such holder, accruing daily from
the date such partial liquidated damages are due until such amounts, plus all
such interest thereon, are paid in full. The partial liquidated damages are to
apply on a daily pro-rata basis for any portion of a month prior to the cure of
an Event.
The Registration Rights Agreement also provides for customary
piggy-back registration rights whereby holders of shares of our common stock, or
warrants to purchase shares of our common stock, can cause us to register such
shares for resale in connection with our filing of a Registration Statement with
the Securities and Exchange Commission to register shares in another offering.
The Registration Rights Agreement also contains customary representations and
warranties, covenants and limitations.
We have used a portion of the net proceeds from the March 2005 private
placement to fund our working capital requirements and begin site preparation at
the Madera County, California facility. We expect to use the remainder of the
net proceeds to fund our working capital requirements over the next 12 months
and to initiate construction of our first ethanol production facility in Madera
County, California. We expect that the proceeds used to initiate construction
will be used primarily for site preparation, acquisition of equipment and
engineering services. Significant additional funding is required to complete
construction of our first ethanol facility in Madera County, California. No
assurances can be made that we will be successful in obtaining these additional
funds. See "Risk Factors."
We believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including the credit facilities we have and the remaining proceeds we have from
the March 2005 private offering, will be adequate to meet our anticipated
working capital and capital expenditure requirements for at least the next
twelve months. If, however, our capital requirements or cash flow vary
materially from our current projections, if unforeseen circumstances occur, or
if we require a significant amount of cash to fund future acquisitions, we may
require additional financing. Our failure to raise capital, if needed, could
restrict our growth, limit our development of new products or hinder our ability
to compete.
13
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant
on the financial condition or results of operations of either our company or our
operating subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4,"
SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle
facilities, excess freight and handling costs, and wasted materials (spoilage)
are required to be recognized as current period costs. The provisions of SFAS
No. 151 are effective for our fiscal 2006. We are currently evaluating the
provisions of SFAS No. 151 and do not expect that adoption will have a material
effect on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS 123R, SHARE-BASED PAYMENT
("SFAS 123R") which is a revision of SFAS 123 and supersedes Accounting
Principles Board ("APB") 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB
25"). Among other items, SFAS 123R eliminates the use of APB 25 and the
intrinsic value method of accounting, and requires companies to recognize the
cost of employee services received in exchange for awards of equity instruments,
based on the grant date fair value of those awards, in the financial statements.
The effective date of SFAS 123R is the first reporting period beginning after
December 15, 2005. SFAS 123R permits companies to adopt its requirements using
either a "modified prospective" method, or a "modified retrospective" method.
Under the "modified prospective" method, compensation cost is recognized in the
financial statements beginning with the effective date, based on the
requirements of SFAS 123R for all share-based payments granted after that date,
and based on the requirements of SFAS 123 for all unvested awards granted prior
to the effective date of SFAS 123R. Under the "modified retrospective" method,
the requirements are the same as under the "modified prospective" method, but
also permits entities to restate financial statements of previous periods based
on pro forma disclosures made in accordance with SFAS 123.
We currently utilize a standard option pricing model (i.e.,
Black-Scholes) to measure the fair value of stock options granted to employees.
While SFAS 123R permits entities to continue to use such a model, the standard
also permits the use of a "lattice" model. We have not yet determined which
model we will use to measure the fair value of employee stock options upon the
adoption of SFAS 123R.
We currently expect to adopt SFAS 123R effective January 1, 2006.
However, because we have not yet determined which of the aforementioned adoption
methods we will use, we have not yet determined the impact of adopting SFAS
123R.
RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN
ADDITION TO THE OTHER INFORMATION IN THIS REPORT AND IN OUR OTHER FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING OUR SUBSEQUENT REPORTS ON
FORMS 10-QSB AND 8-K, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS
BEFORE DECIDING TO INVEST IN SHARES OF OUR COMMON STOCK OR TO MAINTAIN OR
INCREASE YOUR INVESTMENT IN SHARES OF OUR COMMON STOCK. IF ANY OF THE FOLLOWING
RISKS ACTUALLY OCCUR, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. AS A RESULT, THE TRADING PRICE
OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL OF YOUR
INVESTMENT.
14
RISKS RELATED TO OUR COMBINED OPERATIONS
WE HAVE INCURRED SIGNIFICANT LOSSES IN THE PAST AND WE MAY INCUR
SIGNIFICANT LOSSES IN THE FUTURE. IF WE CONTINUE TO INCUR LOSSES, WE WILL
EXPERIENCE NEGATIVE CASH FLOW, WHICH MAY HAMPER OUR OPERATIONS, MAY PREVENT
US FROM EXPANDING OUR BUSINESS AND MAY CAUSE OUR STOCK PRICE TO DECLINE.
We have incurred losses in the past. As of June 30, 2005, we had an
accumulated deficit of approximately $7.5 million. For the six months ended June
30, 2005, we incurred a net loss of approximately $3.9 million. We expect to
incur losses for the foreseeable future and at least until the completion of our
planned ethanol production facility. We estimate that the earliest completion
date of our ethanol production facility in Madera County, California and, as a
result, our earliest date of ethanol production, will not occur until the fourth
quarter of 2006. We expect to rely on cash from operations and debt and equity
financing to fund all of the cash requirements of our business. If our net
losses continue, we will experience negative cash flow, which may hamper current
operations and may prevent us from expanding our business. We may be unable to
attain, sustain or increase profitability on a quarterly or annual basis in the
future. If we do not achieve, sustain or increase profitability our stock price
may decline.
THE HIGH CONCENTRATION OF OUR SALES WITHIN THE ETHANOL PRODUCTION AND
MARKETING INDUSTRY COULD RESULT IN A SIGNIFICANT REDUCTION IN SALES AND
NEGATIVELY AFFECT OUR PROFITABILITY IF DEMAND FOR ETHANOL DECLINES.
Our revenue is and will continue to be derived primarily from sales of
ethanol. Currently, the predominant oxygenate used to blend with gasoline is
ethanol. Ethanol competes with several other existing products and other
alternative products could also be developed for use as fuel additives. We
expect to be completely focused on the production and marketing of ethanol and
its co-products for the foreseeable future. We may be unable to shift our
business focus away from the production and marketing of ethanol to other
renewable fuels or competing products. Accordingly, an industry shift away from
ethanol or the emergence of new competing products may reduce the demand for
ethanol. A downturn in the demand for ethanol would significantly and adversely
affect our sales and profitability.
WE PLAN TO FUND A SUBSTANTIAL MAJORITY OF THE CONSTRUCTION COSTS OF OUR
PLANNED ETHANOL PRODUCTION FACILITY THROUGH THE ISSUANCE OF A SIGNIFICANT
AMOUNT OF DEBT, RESULTING IN SUBSTANTIAL DEBT SERVICE REQUIREMENTS THAT
COULD REDUCE THE VALUE OF YOUR INVESTMENT.
We plan to fund a substantial majority of the construction costs of
our planned ethanol production facility through the issuance of a significant
amount of debt. We anticipate that we will need to raise approximately $60.0
million in debt financing to complete construction of our first ethanol
production facility in Madera County. As a result, our capital structure will be
highly leveraged. Our debt levels and debt service requirements could have
important consequences which could reduce the value of your investment,
including:
o limiting our ability to borrow additional amounts for operating
capital or other purposes and causing us to be able to borrow
additional funds only on unfavorable terms;
o reducing funds available for operations and distributions because
a substantial portion of our cash flow will be used to pay
interest and principal on our debt;
o making us vulnerable to increases in prevailing interest rates;
o placing us at a competitive disadvantage because we may be
substantially more leveraged than some of our competitors;
15
o subjecting all or substantially all of our assets to liens, which
means that there may be no assets left for our stockholders in
the event of a liquidation; and
o limiting our ability to adjust to changing market conditions,
which could increase our vulnerability to a downturn in our
business or general economic conditions.
If we are unable to pay our debt service obligations, we could be
forced to reduce or eliminate dividends to our stockholders, if they were to
commence, and/or reduce or eliminate needed capital expenditures. It is possible
that we could be forced to sell assets, seek to obtain additional equity capital
or refinance or restructure all or a portion of our debt on substantially less
favorable terms. In the event that we are unable to refinance all or a portion
of our debt or raise funds through asset sales, sales of equity or otherwise, we
may be forced to liquidate and you could lose your entire investment.
GOVERNMENTAL REGULATIONS OR THE REPEAL OR MODIFICATION OF VARIOUS TAX
INCENTIVES FAVORING THE USE OF ETHANOL COULD REDUCE THE DEMAND FOR ETHANOL
AND CAUSE OUR SALES AND PROFITABILITY TO DECLINE.
Our business is subject to extensive regulation by federal, state and
local governmental agencies. We cannot predict in what manner or to what extent
governmental regulations will harm our business or the ethanol production and
marketing industry in general. For example the recent energy bill signed into
law by President Bush includes a national renewable fuels standard that requires
refiners to blend a percentage of renewable fuels into gasoline. This
legislation replaces the current oxygenate requirements in the State of
California and may potentially decrease the demand for ethanol in the State of
California. If the demand for ethanol in the Sate of California decreases, our
sales and profitability would decline.
The fuel ethanol business benefits significantly from tax incentive
policies and environmental regulations that favor the use of ethanol in motor
fuel blends in the United States. Currently, a gasoline marketer that sells
gasoline without ethanol must pay a federal tax of $0.18 per gallon compared to
$0.13 per gallon for gasoline that is blended with 10% ethanol. Smaller credits
are available for gasoline blended with lesser percentages of ethanol. The
repeal or substantial modification of the federal excise tax exemption for
ethanol-blended gasoline or, to a lesser extent, other federal or state policies
and regulations that encourage the use of ethanol could have a detrimental
effect on the ethanol production and marketing industry and materially and
adversely affect our sales and profitability.
VIOLATIONS OF ENVIRONMENTAL REGULATIONS COULD SUBJECT US TO SEVERE
PENALTIES AND MATERIALLY AND ADVERSELY AFFECT OUR SALES AND PROFITABILITY.
The production and sale of ethanol is subject to regulation by
agencies of the federal government, including, but not limited to, the EPA, as
well as other agencies in each jurisdiction in which ethanol is produced, sold,
stored or transported. Environmental laws and regulations that affect our
operations, and that are expected to affect our planned operations, are
extensive and have become progressively more stringent. Applicable laws and
regulations are subject to change, which could be made retroactively. Violations
of environmental laws and regulations or permit conditions can result in
substantial penalties, injunctive orders compelling installation of additional
controls, civil and criminal sanctions, permit revocations and/or facility
shutdowns. If significant unforeseen liabilities arise for corrective action or
other compliance, our sales and profitability could be materially and adversely
affected.
16
WE RELY HEAVILY ON OUR PRESIDENT AND CHIEF EXECUTIVE OFFICER, NEIL KOEHLER.
THE LOSS OF HIS SERVICES COULD ADVERSELY AFFECT OUR ABILITY TO SOURCE
ETHANOL FROM OUR KEY SUPPLIERS AND OUR ABILITY TO SELL ETHANOL TO OUR
CUSTOMERS.
Our success depends, to a significant extent, upon the continued
services of Neil Koehler, who is our President and Chief Executive Officer. For
example, Mr. Koehler has developed key personal relationships with our ethanol
suppliers and customers. We greatly rely on these relationships in the conduct
of our operations and the execution of our business strategies. The loss of Mr.
Koehler could, therefore, result in the loss of our favorable relationships with
one or more of our ethanol suppliers and customers. In addition, Mr. Koehler has
considerable experience in the construction, start-up and operation of ethanol
production facilities and in the ethanol marketing business. Although we have
entered into an employment agreement with Mr. Koehler, that agreement is of
limited duration and is subject to early termination by Mr. Koehler under
certain circumstances. In addition, we do not maintain "key person" life
insurance covering Mr. Koehler or any other executive officer. The loss of Mr.
Koehler could also significantly delay or prevent the achievement of our
business objectives.
THE ETHANOL PRODUCTION AND MARKETING INDUSTRY IS EXTREMELY COMPETITIVE.
MANY OF OUR SIGNIFICANT COMPETITORS HAVE GREATER FINANCIAL AND OTHER
RESOURCES THAN WE DO AND ONE OR MORE OF THESE COMPETITORS COULD USE THEIR
GREATER RESOURCES TO GAIN MARKET SHARE AT OUR EXPENSE. IN ADDITION, CERTAIN
OF OUR SUPPLIERS MAY CIRCUMVENT OUR MARKETING SERVICES, CAUSING OUR SALES
AND PROFITABILITY TO DECLINE.
The ethanol production and marketing industry is extremely
competitive. Many of our significant competitors in the ethanol production and
marketing industry, such as Archer-Daniels-Midland Company, or ADM, have
substantially greater production, financial, research and development, personnel
and marketing resources than we do. In addition, we are not currently producing
any ethanol that we sell and therefore are unable to capture the higher gross
profit margins generally associated with production activities. As a result, our
competitors, who are presently producing ethanol, may have greater relative
advantages resulting from greater capital resources due to higher gross profit
margins. As a result, our competitors may be able to compete more aggressively
and sustain that competition over a longer period of time than we could. Our
lack of resources relative to many of our significant competitors may cause us
to fail to anticipate or respond adequately to new developments and other
competitive pressures. This failure could reduce our competitiveness and cause a
decline in our market share, sales and profitability.
In addition, some of our suppliers are potential competitors and,
especially if that the price of ethanol remains at historically high levels,
they may seek to capture additional profits by circumventing our marketing
services in favor of selling directly to our customers. If one or more of our
major suppliers, or numerous smaller suppliers, circumvent our marketing
services, our sales and profitability will decline.
OUR FAILURE TO MANAGE OUR GROWTH EFFECTIVELY COULD PREVENT US FROM
ACHIEVING OUR GOALS.
Our strategy envisions a period of rapid growth that may impose a
significant burden on our administrative and operational resources. The growth
of our business, and in particular, the completion of construction of our
planned ethanol production facility, will require significant investments of
capital and management's close attention. In addition, we may construct
additional ethanol production facilities. Also, we have recently entered into
significant marketing agreements with Front Range Energy, LLC and Phoenix
Bio-Industries, LLC, and we are seeking to enter into additional similar
agreements with other ethanol producers that may result in a substantial growth
in our marketing business. Our ability to effectively manage our growth will
require us to substantially expand the capabilities of our administrative and
operational resources and to attract, train, manage and retain qualified
management, technicians and other personnel. We may be unable to do so. In
addition, our failure to successfully manage our growth could result in our
sales not increasing commensurately with our capital investments. If we are
unable to successfully manage our growth, we may be unable to achieve our goals.
17
RISKS RELATING TO THE BUSINESS OF KINERGY
KINERGY'S PURCHASE AND SALE COMMITMENTS AS WELL AS ITS INVENTORY OF ETHANOL
HELD FOR SALE SUBJECT US TO THE RISK OF FLUCTUATIONS IN THE PRICE OF
ETHANOL, WHICH MAY RESULT IN LOWER OR EVEN NEGATIVE GROSS PROFIT MARGINS
AND WHICH COULD MATERIALLY AND ADVERSELY AFFECT OUR PROFITABILITY.
Kinergy's purchases and sales of ethanol are not always matched with
sales and purchases of ethanol at prevailing market prices. Kinergy commits from
time to time to the sale of ethanol to its customers without corresponding and
commensurate commitments for the supply of ethanol from its suppliers, which
subjects us to the risk of an increase in the price of ethanol. Kinergy also
commits from time to time to the purchase of ethanol from its suppliers without
corresponding and commensurate commitments for the purchase of ethanol by its
customers, which subjects us to the risk of a decline in the price of ethanol.
In addition, Kinergy increases inventory in anticipation of rising ethanol
prices and decreases inventory levels in anticipation of declining ethanol
prices. As a result, Kinergy is subject to the risk of ethanol prices moving in
unanticipated directions, which could result in declining or even negative gross
profit margins. Accordingly, our business is subject to fluctuations in the
price of ethanol and these fluctuations may result in lower or even negative
gross margins and which could materially and adversely affect our profitability.
KINERGY DEPENDS ON A SMALL NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF ITS
SALES. A REDUCTION IN BUSINESS FROM ANY OF THESE CUSTOMERS COULD CAUSE A
SIGNIFICANT DECLINE IN OUR SALES AND PROFITABILITY.
The vast majority of Kinergy's sales are generated from a small number
of customers. During the first six months of 2005, sales to Kinergy's two
largest customers that provided 10% or more of total sales represented
approximately 18% and 11%, respectively, representing an aggregate of
approximately 29%, of our total sales. During 2004, sales to Kinergy's four
largest customers that provided 10% or more of the total sales represented
approximately 13%, 12%, 12% and 12%, respectively, representing an aggregate of
approximately 49%, of our total sales. We expect that Kinergy will continue to
depend for the foreseeable future upon a small number of customers for a
significant majority of its sales. Kinergy's agreements with these customers
generally do not require them to purchase any specified amount of ethanol or
dollar amount of sales or to make any purchases whatsoever. Therefore, in any
future period, Kinergy's sales generated from these customers, individually or
in the aggregate, may not equal or exceed historical levels. If sales to any of
these customers cease or decline, Kinergy may be unable to replace these sales
with sales to either existing or new customers in a timely manner, or at all. A
cessation or reduction of sales to one or more of these customers could cause a
significant decline in our overall sales and profitability.
KINERGY'S LACK OF LONG-TERM ETHANOL ORDERS AND COMMITMENTS BY ITS CUSTOMERS
COULD LEAD TO A RAPID DECLINE IN OUR SALES AND PROFITABILITY.
Kinergy cannot rely on long-term ethanol orders or commitments by its
customers for protection from the negative financial effects of a decline in the
demand for ethanol or a decline in the demand for Kinergy's services. The
limited certainty of ethanol orders can make it difficult for us to forecast our
sales and allocate our resources in a manner consistent with our actual sales.
Moreover, our expense levels are based in part on our expectations of future
sales and, if our expectations regarding future sales are inaccurate, we may be
unable to reduce costs in a timely manner to adjust for sales shortfalls.
Furthermore, because Kinergy depends on a small number of customers for the vast
majority of its sales, the magnitude of the ramifications of these risks is
greater than if Kinergy's sales were less concentrated within a small number of
customers. As a result of Kinergy's lack of long-term ethanol orders and
commitments, we may experience a rapid decline in our sales and profitability.
18
KINERGY DEPENDS ON A SMALL NUMBER OF SUPPLIERS FOR THE VAST MAJORITY OF THE
ETHANOL THAT IT SELLS. IF ANY OF THESE SUPPLIERS IS UNABLE OR DECIDES NOT
TO CONTINUE TO SUPPLY KINERGY WITH ETHANOL IN ADEQUATE AMOUNTS, KINERGY MAY
BE UNABLE TO SATISFY THE DEMANDS OF ITS CUSTOMERS AND OUR SALES,
PROFITABILITY AND RELATIONSHIPS WITH OUR CUSTOMERS WILL BE ADVERSELY
AFFECTED.
Kinergy depends on a small number of suppliers for the vast majority
of the ethanol that it sells. During the first six months of 2005, Kinergy's
four largest suppliers that provided 10% or more of total purchases made
represented approximately 26%, 21%, 21% and 11%, respectively, representing an
aggregate of approximately 79%, of the total ethanol Kinergy purchased for
resale. During 2004, Kinergy's three largest suppliers that provided 10% or more
of the total purchases made represented approximately 27%, 23% and 14%,
respectively, representing an aggregate of approximately 64% of the total
ethanol Kinergy purchased for resale. We expect that Kinergy will continue to
depend for the foreseeable future upon a small number of suppliers for a
significant majority of the ethanol that it purchases. In addition, Kinergy
sources the ethanol that it sells primarily from suppliers in the Midwestern
United States. The delivery of the ethanol that Kinergy sells is therefore
subject to delays resulting from inclement weather and other conditions. Also,
there is currently a substantial demand for ethanol which has, for most of 2005,
far exceeded ethanol production capacities and Kinergy's management has, from
time to time, found it very difficult to satisfy all the demands for ethanol by
Kinergy's customers. If any of these suppliers is unable or declines for any
reason to continue to supply Kinergy with ethanol in adequate amounts, Kinergy
may be unable to replace that supplier and source other supplies of ethanol in a
timely manner, or at all, to satisfy the demands of its customers. If this
occurs, our sales and profitability and Kinergy's relationships with its
customers will be adversely affected.
RISKS RELATING TO THE BUSINESS OF PEI CALIFORNIA
THE COMPLETION OF CONSTRUCTION OF OUR PLANNED ETHANOL PRODUCTION FACILITY
WILL REQUIRE SIGNIFICANT ADDITIONAL FUNDING, WHICH WE EXPECT TO RAISE
THROUGH DEBT FINANCING. WE MAY NOT BE SUCCESSFUL IN RAISING ADEQUATE
CAPITAL WHICH MAY FORCE US TO ABANDON CONSTRUCTION OF AN ETHANOL PRODUCTION
FACILITY.
We anticipate that we will need to raise approximately $60.0 million
in debt financing to complete construction of our first ethanol production
facility in Madera County. We have no contracts with or binding commitments from
any bank, lender or financial institution for this debt financing. We may not be
able to obtain any funding from one or more lenders, or if funding is obtained,
that it will be on terms that we have anticipated or that are otherwise
acceptable to us. If we are unable to secure adequate debt financing, or debt
financing on acceptable terms is unavailable for any reason, we may be forced to
abandon our construction of an ethanol production facility.
PEI CALIFORNIA HAS NOT CONDUCTED ANY SIGNIFICANT BUSINESS OPERATIONS AND
HAS BEEN UNPROFITABLE TO DATE. IF PEI CALIFORNIA FAILS TO COMMENCE
SIGNIFICANT BUSINESS OPERATIONS, IT WILL BE UNSUCCESSFUL, WILL DECREASE OUR
PROFITABILITY AND WE WILL HAVE FAILED TO ACHIEVE ONE OF OUR SIGNIFICANT
GOALS.
PEI California has not conducted any significant business operations
and has been unprofitable to date. Accordingly, there is no prior operating
history by which to evaluate the likelihood of PEI California's success or its
contribution to our profitability. PEI California may never complete
construction of an ethanol production facility and commence significant
19
operations or, if PEI California does complete the construction of an ethanol
production facility, PEI California may not be successful or contribute
positively to our profitability. If PEI California fails to commence significant
business operations, it will be unsuccessful and will decrease our profitability
and we will have failed to achieve one of our significant goals.
THE MARKET PRICE OF ETHANOL IS VOLATILE AND SUBJECT TO SIGNIFICANT
FLUCTUATIONS, WHICH MAY CAUSE OUR PROFITABILITY TO FLUCTUATE SIGNIFICANTLY.
The market price of ethanol is dependent on many factors, including on
the price of gasoline, which is in turn dependent on the price of petroleum.
Petroleum prices are highly volatile and difficult to forecast due to frequent
changes in global politics and the world economy. The distribution of petroleum
throughout the world is affected by incidents in unstable political
environments, such as Iraq, Iran, Kuwait, Saudi Arabia, the former U.S.S.R. and
other countries and regions. The industrialized world depends critically on oil
from these areas, and any disruption or other reduction in oil supply can cause
significant fluctuations in the prices of oil and gasoline. We cannot predict
the future price of oil or gasoline and may establish unprofitable prices for
the sale of ethanol due to significant fluctuations in market prices. For
example, the price of ethanol declined by approximately 25% from its 2004
average price per gallon in only three months from January 2005 through March
2005 and reversed this decline and increased by approximately 25% from its 2004
average price per gallon in only four months from April 2005 through July 2005.
In recent years, the prices of gasoline, petroleum and ethanol have all reached
historically unprecedented high levels. In the event that the prices of gasoline
and petroleum decline, we believe that the demand for and price of ethanol may
be adversely affected. Fluctuations in the market price of ethanol may cause our
profitability to fluctuate significantly.
We believe that the production of ethanol is expanding rapidly. There
are a number of new plants under construction and planned for construction, both
inside and outside California. We expect existing ethanol plants to expand by
increasing production capacity and actual production. Increases in the demand
for ethanol may not be commensurate with increasing supplies of ethanol. Thus,
increased production of ethanol may lead to lower ethanol prices. The increased
production of ethanol could also have other adverse effects. For example,
increased ethanol production could lead to increased supplies of co-products
from the production of ethanol, such as wet distillers grain, or WDG. Those
increased supplies could lead to lower prices for those co-products. Also, the
increased production of ethanol could result in increased demand for corn. This
could result in higher prices for corn and cause higher ethanol production costs
and, in the event that PEI California is unable to pass increases in the price
of corn to its customers, will result in lower profits. We cannot predict the
future price of ethanol or WDG. Any material decline in the price of ethanol or
WDG will adversely affect our sales and profitability.
THE CONSTRUCTION AND OPERATION OF OUR PLANNED ETHANOL PRODUCTION FACILITY
MAY BE ADVERSELY AFFECTED BY ENVIRONMENTAL REGULATIONS AND PERMIT
REQUIREMENTS.
The production of ethanol involves the emission of various airborne
pollutants, including particulates, carbon monoxide, oxides of nitrogen and
volatile organic compounds. PEI California will be subject to extensive air,
water and other environmental regulations in connection with the construction
and operation of our planned ethanol production facility. PEI California also
may be required to obtain various other water-related permits, such as a water
discharge permit and a storm-water discharge permit, a water withdrawal permit
and a public water supply permit. If for any reason PEI California is unable to
obtain any of the required permits, construction costs for our planned ethanol
production facility are likely to increase; in addition, the facility may not be
fully constructed at all. It is also likely that operations at the facility will
be governed by the federal regulations of the Occupational Safety and Health
Administration, or OSHA, and other regulations. Compliance with OSHA and other
regulations may be time-consuming and expensive and may delay or even prevent
sales of ethanol in California or in other states.
20
VARIOUS RISKS ASSOCIATED WITH THE CONSTRUCTION OF OUR PLANNED ETHANOL
PRODUCTION FACILITY MAY ADVERSELY AFFECT OUR SALES AND PROFITABILITY.
Delays in the construction of our planned ethanol production facility
or defects in materials and/or workmanship may occur. Any defects could delay
the commencement of operations of the facility, or, if such defects are
discovered after operations have commenced, could halt or discontinue operation
of the facility indefinitely. In addition, construction projects often involve
delays in obtaining permits and encounter delays due to weather conditions,
fire, the provision of materials or labor or other events. For example, PEI
California experienced a fire at its Madera County site during the first quarter
of 2004 which required repairs to areas and equipment damaged by the fire. In
addition, changes in interest rates or the credit environment or changes in
political administrations at the federal, state or local levels that result in
policy change towards ethanol or our project in particular, could cause
construction and operation delays. Any of these events may adversely affect our
sales and profitability.
PEI California may encounter hazardous conditions at or near the
Madera County site that may delay or prevent construction of the facility. If
PEI California encounters a hazardous condition at or near the site, work may be
suspended and PEI California may be required to correct the condition prior to
continuing construction. The presence of a hazardous condition would likely
delay construction of the facility and may require significant expenditure of
resources to correct the condition. In addition, W. M. Lyles Co., the company we
have selected to construct our Madera County ethanol production facility, may be
entitled to an increase in its fees and afforded additional time for performance
if it has been adversely affected by the hazardous condition. If PEI California
encounters any hazardous condition during construction, our sales and
profitability may be adversely affected.
We have based our estimated capital resource needs on a design for the
planned ethanol production facility and related co-generation facility that we
estimate will cost approximately $60.0 million. The estimated cost of the
facility is based on preliminary discussions and estimates, but the final
construction cost of the facility may be significantly higher. Any significant
increase in the final construction cost of the facility will adversely affect
our profitability, liquidity and available capital resources.
PEI CALIFORNIA'S DEPENDENCE ON AND AGREEMENTS WITH W. M. LYLES CO. FOR THE
CONSTRUCTION OF OUR PLANNED ETHANOL PRODUCTION FACILITY COULD ADVERSELY
AFFECT OUR LIQUIDITY AND AVAILABLE CAPITAL RESOURCES, OUR SALES AND OUR
PROFITABILITY.
PEI California will be highly dependent upon W. M. Lyles Co. to design
and build our planned ethanol production facility in Madera County, California.
Through a subsidiary, PEI California has entered into agreements with W. M.
Lyles Co. for the construction of this facility. These agreements contain a
number of provisions that are favorable to W. M. Lyles Co. and unfavorable to
PEI California. These agreements also include a provision that requires PEI
California to pay a termination fee of $5.0 million to W. M. Lyles Co. in
addition to payment of all costs incurred by W. M. Lyles Co. for services
rendered through the date of termination, if PEI California terminates it in
favor of another contractor. Consequently, if PEI California terminates these
agreements, the requirement that it pay the termination fee and costs could
adversely affect our liquidity and available capital resources. In addition, if
W. M. Lyles Co. has entered into or enters into a construction contract with one
or more other parties, it may be under pressure to complete another project or
projects and may prioritize the completion of another project or projects ahead
of our planned facility. As a result, PEI California's ability to commence
production of and sell ethanol would be delayed, which would adversely affect
our sales and profitability.
21
THE RAW MATERIALS AND ENERGY NECESSARY TO PRODUCE ETHANOL MAY BE
UNAVAILABLE OR MAY INCREASE IN PRICE, ADVERSELY AFFECTING OUR SALES AND
PROFITABILITY.
The production of ethanol requires a significant amount of raw
materials and energy, primarily corn, water, electricity and natural gas. In
particular, we estimate that our planned ethanol production facility will
require approximately 12.5 million bushels or more of corn each year and
significant and uninterrupted supplies of water, electricity and natural gas.
The prices of corn, electricity and natural gas have fluctuated significantly in
the past and may fluctuate significantly in the future. In addition, droughts,
severe winter weather in the Midwest, where we expect to source corn, and other
problems may cause delays or interruptions of various durations in the delivery
of corn to California, reduce corn supplies and increase corn prices. Local
water, electricity and gas utilities may not be able to reliably supply the
water, electricity and natural gas that our planned ethanol production facility
will need or may not be able to supply such resources on acceptable terms. In
addition, if there is an interruption in the supply of water or energy for any
reason, we may be required to halt ethanol production. We may not be able to
successfully anticipate or mitigate fluctuations in the prices of raw materials
and energy through the implementation of hedging and contracting techniques. PEI
California's hedging and contracting activities may not lower its prices of raw
materials and energy, and in a period of declining raw materials or energy
prices, these hedging and contracting strategies may result in PEI California
paying higher prices than its competitors. In addition, PEI California may be
unable to pass increases in the prices of raw materials and energy to its
customers. Higher raw materials and energy prices will generally cause lower
profit margins and may even result in losses. Accordingly, our sales and
profitability may be significantly and adversely affected by the prices and
supplies of raw materials and energy.
RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK HAS A SMALL PUBLIC FLOAT AND SHARES OF OUR COMMON STOCK
ELIGIBLE FOR PUBLIC SALE COULD CAUSE THE MARKET PRICE OF OUR STOCK TO DROP,
EVEN IF OUR BUSINESS IS DOING WELL, AND MAKE IT DIFFICULT FOR US TO RAISE
ADDITIONAL CAPITAL THROUGH SALES OF EQUITY SECURITIES.
As of October 17, 2005, we had outstanding approximately 28.6 million
shares of our common stock. Approximately 25.2 million of these shares were
restricted under the Securities Act of 1933, including 9.3 million shares
beneficially owned, as a group, by our executive officers, directors and 10%
stockholders. Accordingly, our common stock has a public float of approximately
3.4 million shares held by a relatively small number of public investors.
We are in the process of registering for resale approximately 11.5
million shares of our common stock, including shares of our common stock
underlying warrants. If and when a registration statement covering these shares
of common stock is declared effective, holders of these shares will be
permitted, subject to few limitations, to freely sell these shares of common
stock. As a result of our small public float, sales of substantial amounts of
common stock, including shares issued upon the exercise of stock options or
warrants, or an anticipation that such sales could occur, may materially and
adversely affect prevailing market prices for our common stock. Any adverse
effect on the market price of our common stock could make it difficult for us to
raise additional capital through sales of equity securities at a time and at a
price that we deem appropriate.
OUR STOCK PRICE IS HIGHLY VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN
LITIGATION AGAINST US.
The market price of our common stock has fluctuated significantly in
the past and may continue to fluctuate significantly in the future. The market
price of our common stock may continue to fluctuate in response to one or more
of the following factors, many of which are beyond our control:
22
o the volume and timing of the receipt of orders for ethanol from
major customers;
o competitive pricing pressures;
o our ability to produce, sell and deliver ethanol on a
cost-effective and timely basis;
o our inability to obtain construction, acquisition, capital
equipment and/or working capital financing;
o the introduction and announcement of one or more new alternatives
to ethanol by our competitors;
o changing conditions in the ethanol and fuel markets;
o changes in market valuations of similar companies;
o stock market price and volume fluctuations generally;
o regulatory developments or increased enforcement;
o fluctuations in our quarterly or annual operating results;
o additions or departures of key personnel; and
o future sales of our common stock or other securities.
Furthermore, we believe that the economic conditions in California and
other states, as well as the United States as a whole, could have a negative
impact on our results of operations. Demand for ethanol products could also be
adversely affected by a slow-down in overall demand for oxygenate and gasoline
additive products. The levels of our ethanol production and purchases for resale
will be based upon forecasted demand. Accordingly, any inaccuracy in forecasting
anticipated revenues and expenses could adversely affect our business.
Furthermore, we recognize revenues from ethanol sales at the time of delivery.
The failure to receive anticipated orders or to complete delivery in any
quarterly period could adversely affect our results of operations for that
period. Quarterly results are not necessarily indicative of future performance
for any particular period, and we may not experience revenue growth or
profitability on a quarterly or an annual basis.
The price at which you purchase shares of our common stock may not be
indicative of the price that will prevail in the trading market. You may be
unable to sell your shares of common stock at or above your purchase price,
which may result in substantial losses to you and which may include the complete
loss of your investment. In the past, securities class action litigation has
often been brought against a company following periods of stock price
volatility. We may be the target of similar litigation in the future. Securities
litigation could result in substantial costs and divert management's attention
and our resources away from our business. Any of the risks described above could
adversely affect our sales and profitability and also the price of our common
stock.
ITEM 3. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, as of June 30, 2005, to ensure that information
required to be disclosed by us in the reports filed or submitted by us under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities Exchange Commission's rules and forms,
including to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is accumulated and
communicated to our management, including our principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that as
of June 30, 2005, our disclosure controls and procedures were not effective at
the reasonable assurance level due to the material weakness described below.
23
In light of the material weakness described below, we performed
additional analyses and other post-closing procedures to ensure that our
consolidated financial statements were prepared in accordance with generally
accepted accounting principles. Accordingly, we believe that the consolidated
financial statements included in this report fairly present, in all material
respects, our financial condition, results of operations and cash flows for the
periods presented.
A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. Management has identified the
following material weakness which has caused management to conclude that, as of
June 30, 2005, our disclosure controls and procedures were not effective at the
reasonable assurance level.
In conjunction with preparing our Registration Statement on Form S-1,
and after receiving comments from the Staff of the Securities and Exchange
Commission relating to our Registration Statement on Form S-1, management
reviewed, during the third and fourth quarters of 2005, our purchase accounting
methodology for the acquisition of ReEnergy. As a result of this review,
management concluded, during the fourth quarter of 2005, that our controls over
the selection of appropriate assumptions and factors affecting
our purchase accounting methodology for the acquisition of ReEnergy were not in
accordance with generally accepted accounting principles and that, of the
$972,250 purchase price for ReEnergy, all of which was previously recorded as
goodwill and was being capitalized, $852,250 should have been recorded as an
expense for services rendered in connection with a feasibility study that was
conducted with respect to real property that was subject to a purchase option
held by ReEnergy and $120,000 should have been recorded as an intangible asset
for the fair value of a favorable option. Based upon this conclusion, our Audit
Committee and senior management decided, in the fourth quarter of 2005, to
restate our financial statements as of and for the three months ended March 31,
2005 and the six months ended June 30, 2005 to reflect the correction in our
purchase accounting methodology.
Management evaluated, in the fourth quarter of 2005 and as of June 30,
2005, the impact of this restatement on our assessment of our disclosure
controls and procedures and concluded, as of June 30, 2005, that the control
deficiency that resulted in the use of an incorrect purchase accounting
methodology represented a material weakness.
To address this material weakness, management performed additional
analyses and other procedures to ensure that the financial statements included
herein fairly present, in all material respects, our financial position, results
of operations and cash flows for the periods presented.
REMEDIATION OF MATERIAL WEAKNESS
To remediate the material weakness in our disclosure controls and
procedures identified above, we have done the following subsequent to June 30,
2005:
24
We have revised our purchase accounting methodology as it relates to
the acquisition of ReEnergy. Upon further examination of our purchase accounting
methodology for the acquisition of ReEnergy, we determined that we made an error
in our application of the relevant accounting principles under SFAS 141,
paragraph 9 (with reference to EITF No. 98-3) and determined that we should have
expensed $852,250 and capitalized $120,000 of the $972,250 purchase price for
ReEnergy. Under SFAS 141, paragraph 9 (with reference to EITF No. 98-3), only
the acquisition of an ongoing business can result in the recordation and
capitalization of goodwill. At the time of the acquisition, ReEnergy did not
have sufficient activities to qualify it as an ongoing business under SFAS 141,
paragraph 9 (with reference to EITF No. 98-3) and accordingly, no amount of the
$972,250 purchase price for ReEnergy should have been recorded as goodwill. We
have determined the effect of the correction on our previously issued financial
statements and have restated the accompanying financial statements for the six
months ended June 30, 2005. Of the $972,250 purchase price for ReEnergy,
$852,250 has been recorded as an expense for services rendered in connection
with a feasibility study that was conducted with respect to real property that
was subject to a purchase option held by ReEnergy and $120,000 has been recorded
as an intangible asset for the fair value of a favorable option. The revision of
our purchase accounting methodology as it relates to the acquisition of ReEnergy
was completed in the fourth quarter of 2005. This methodology applies to the
three months ended March 31, 2005 and all subsequent periods. In addition,
management will use more care in the selection of appropriate assumptions and
factors affecting our purchase accounting methodology for future acquisitions,
if any.
Management believes that the remediation described above has remediated
the material weakness also described above. Management believes that our
expenditures associated with this remediation, not including the
reclassification as an expense of part of the purchase price for ReEnergy,
totaled approximately $20,000. These expenditures consisted primarily of legal
and accounting fees related to the filing of amendments to our Forms 10-QSB for
the periods ended March 31, 2005 and June 30, 2005.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The changes in our controls over the selection of appropriate
assumptions and factors affecting our purchase accounting methodology for the
acquisition of ReEnergy and our commitment to use more care in the selection of
appropriate assumptions and factors affecting our purchase accounting
methodology for future acquisitions, if any, are the only changes during our
most recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect, our internal control over financial
reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are subject to legal proceedings, claims and litigation arising in
the ordinary course of business. While the amounts claimed may be substantial,
the ultimate liability cannot presently be determined because of considerable
uncertainties that exist. Therefore, it is possible that the outcome of those
legal proceedings, claims and litigation could adversely affect our quarterly or
annual operating results or cash flows when resolved in a future period.
However, based on facts currently available, management believes such matters
will not adversely affect our financial position, results of operations or cash
flows.
GERALD ZUTLER
In January 2003, DriverShield CRM Corp. ("DriverShield"), then a
wholly-owned subsidiary of our predecessor, Accessity, was served with a
complaint filed by Mr. Gerald Zutler, its former President and Chief Operating
Officer, alleging, among other things, that DriverShield breached his employment
contract, that there was fraudulent concealment of DriverShield's intention to
terminate its employment agreement with Mr. Zutler, and discrimination on the
basis of age and aiding and abetting violation of the New York State Human
Rights Law. Mr. Zutler is seeking damages aggregating $3.0 million, plus
punitive damages and reasonable attorneys' fees. DriverShield's management
believes that DriverShield properly terminated Mr. Zutler's employment for
cause, and intends to vigorously defend this suit. An Answer to the complaint
was served by DriverShield on February 28, 2003. In 2003, Mr. Zutler filed a
motion to have DriverShield's attorney removed from the case. The motion was
granted by the court, but was subsequently overturned by an appellate court.
DriverShield has filed a claim with its insurance carrier under its directors
and officers and employment practices' liability policy. The carrier has agreed
to cover certain portions of the claim as they relate to Mr. Siegel,
DriverShield's former Chief Executive Officer. The policy has a $50,000
deductible and a liability limit of $3.0 million per policy year. At the present
time, the carrier has agreed to cover the portion of the claim that relates to
Mr. Siegel and has agreed to a fifty percent allocation of expenses.
MERCATOR GROUP, LLC
We filed a Demand for Arbitration against Presidion Solutions, Inc.
("Presidion") alleging that Presidion breached the terms of the Memorandum of
Understanding (the "MOU") between Accessity and Presidion dated January 17,
2003. We sought a break-up fee of $250,000 pursuant to the terms of the MOU
alleging that Presidion breached the MOU by wrongfully terminating the MOU.
Additionally, we sought out of pocket costs of its due diligence amounting to
approximately $37,000. Presidion filed a counterclaim against us alleging that
we had breached the MOU and therefore owe Presidion a break-up fee of $250,000.
The dispute was heard by a single arbitrator before the American Arbitration
Association in Broward County, Florida in late February 2004. During June 2004,
the arbitrator awarded us the $250,000 break-up fee set forth in the MOU between
us and Presidion, as well as our share of the costs of the arbitration and
interest from the date of the termination by Presidion of the MOU, aggregating
approximately $280,000. During the third quarter of 2004, Presidion paid us the
full amount of the award with accrued interest. The arbitrator dismissed
Presidion's counterclaim against us.
26
In 2003, we filed a lawsuit seeking damages in excess of $100 million
as a result of information obtained during the course of the arbitration
discussed above, against: (i) Presidion Corporation, f/k/a MediaBus Networks,
Inc., Presidion's parent corporation, (ii) Presidion's investment bankers,
Mercator Group, LLC ("Mercator") and various related and affiliated parties and
(iii) Taurus Global LLC ("Taurus"), (collectively referred to as the "Mercator
Action"), alleging that these parties committed a number of wrongful acts,
including, but not limited to tortuously interfering in the transaction between
us and Presidion. In 2004, we dismissed this lawsuit without prejudice, which
was filed in Florida state court. We recently refiled this action in the State
of California, for a similar amount, as we believe this to be the proper
jurisdiction. The final outcome of the Mercator Action will most likely take an
indefinite time to resolve. We currently have limited information regarding the
financial condition of the defendants and the extent of their insurance
coverage. Therefore, it is possible that we may prevail, but may not be able to
collect any judgment. The Share Exchange Agreement provides that following full
and final settlement or other final resolution of the Mercator Action, after
deduction of all fees and expenses incurred by the law firm representing us in
this action and payment of the twenty-five percent (25%) contingency fee to the
law firm, shareholders of record on the closing date of the share exchange
transaction will receive two-thirds of the net proceeds from any Mercator Action
recovery and we will retain the remaining one-third for the benefit of the
shareholders at that time.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES
On May 27, 2005, a creditor converted $997,318 of debt into 664,879
shares of common stock at a conversion price of $1.50 per share.
On June 23, 2005, we issued an aggregate of 70,000 shares of common
stock to two officers as signing bonuses in connection with their acceptance of
employment.
On June 30, 2005, we issued 28,749 shares of common stock to a
consultant upon exercise of an outstanding warrant with an exercise price of
$.0001 per share for total gross proceeds of approximately $2.87.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were sophisticated or
accredited with access to the kind of information registration would provide.
DIVIDENDS
We have never paid cash dividends on our common stock and do not
currently intend to pay cash dividends on our common stock in the foreseeable
future. We currently anticipate that we will retain any earnings for use in the
continued development of our business.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
27
ITEM 6. EXHIBITS.
Exhibit
Number Description
------ -----------
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification of President and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
28
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PACIFIC ETHANOL, INC.
Dated: October 25, 2005
By: /S/ WILLIAM G. LANGLEY
-----------------------------------
William G. Langley
Chief Financial Officer
(principal financial officer and
duly authorized officer)
EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-QSB
Exhibit
Number Description
------ -----------
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification of President and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002