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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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 August 15, 2005, there were 28,608,491 shares of Pacific Ethanol,
Inc. common stock, $.001 par value per share, outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No |X|
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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-6
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............................................................................... 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..................................... 25
Item 3. Defaults Upon Senior Securities................................................................. 26
Item 4. Submission of Matters to a Vote of Security Holders............................................. 26
Item 5. Other Information............................................................................... 26
Item 6. Exhibits........................................................................................ 26
Signatures ................................................................................................ 27
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, net 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 11,562,666 --
-------------- --------------
Total other assets 11,620,999 68,333
-------------- --------------
TOTAL ASSETS $ 41,537,605 $ 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 5)
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 (6,692,757) (3,661,246)
--------------- ---------------
Total stockholders' equity 33,604,133 1,355,732
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,537,605 $ 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
$1,849,236 for the three and six months
ended June 30, 2005, respectively, to a
related party) $ 22,814,433 $ 9,442 $ 25,116,430 $ 16,003
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
Non-cash compensation and
consulting fees 918,375 345,000 1,343,636 517,500
--------------- --------------- --------------- ---------------
Loss from operations (2,241,546) (576,825) (2,937,152) (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) (3,026,711) (1,206,288)
Provision for income taxes 3,200 800 4,800 2,400
Net loss $ (2,226,452) $ (714,054) $ (3,031,511) $ (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) $ (0.14) $ (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 $ (3,031,511) $ (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
(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 (695,259) (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 acquisition of Kinergy, ReEnergy and
Accessity (457,808) (202,192)
--------------- ---------------
Net cash provided by (used in) investing activities (2,156,696) (556,846)
--------------- ---------------
Cash flows from Financing Activities:
Proceeds from sale of stock, net 18,879,757 716,339
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
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. 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.
F-7
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
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.
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.............. 11,788,000
--------------
Total assets acquired..................... 18,808,420
Current liabilities.......................... 4,253,177
Other liabilities............................ 83,017
--------------
Total liabilities assumed................. 4,336,194
--------------
Net assets acquired.......................... $ 14,472,226
==============
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.
The Company issued stock valued at $9,803,750 for the acquisition of
Kinergy. In addition, certain stockholders sold stock to the sole
member 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 and ReEnergy acquisitions
therefore totaled $2,952,000.
F-8
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 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 $ 48,704,129 $ 37,842,788
============== ==============
Net loss $ (3,203,375) $ (739,834)
============== ==============
Loss per share of common stock
Basic $ (0.11) $ (0.03)
============== ==============
Diluted $ (0.11) $ (0.03)
============== ==============
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 4), 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 additional goodwill of $506,000.
F-9
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 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 goodwill of $253,000.
3. 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-10
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
4. 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 5) 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
F-11
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
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 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 5)
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 5)
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-12
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
5. 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-13
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
4)
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 4)
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.
6. SUBSEQUENT EVENTS:
------------------
STOCK OPTIONS - On July 19, 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 $6.61 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 $20,475 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.
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 500,000 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.
F-14
PACIFIC ETHANOL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2005
(UNAUDITED)
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.
F-15
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 prospectus. This prospectus 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 our business strategy for expanding, maintaining or
contracting our presence in this market;
o our ability to efficiently and effectively integrate and
operate the businesses of our newly-acquired subsidiaries,
Pacific Ethanol, Inc., a California corporation that was
organized in 2003 ("PEI California"), Kinergy Marketing, LLC,
an Oregon limited liability company that was organized in 2000
("Kinergy") and ReEnergy, LLC, a California limited liability
company that was organized in 2001 ("ReEnergy");
o our ability to consummate the purchase of the membership
interests of Phoenix Bio-Industries, LLC.
o our ability to obtain the necessary financing to construct an
ethanol plant in Madera County;
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.
We are currently in the business of marketing ethanol in the Western
United States. Through third-party service providers, we provide transportation,
storage and delivery of ethanol. 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.
In August 2005, we executed an agreement to acquire Phoenix
Bio-Industries, LLC, or PBI, a company that has completed construction of what
we believe is the first large-scale ethanol production facility in California.
The PBI facility has an annual ethanol production capacity of approximately 25
million gallons, is located in Goshen, California and is currently undergoing
initial start-up testing. The closing of the acquisition of PBI is contingent
upon certain events, including our obtaining all necessary funding to complete
the acquisition, which we currently estimate at approximately $40.0 million, the
satisfactory completion of our due diligence on PBI and on the ethanol
production facility and our ability to purchase all of the membership interests
of PBI. We expect that the closing of this acquisition, if it occurs, will occur
in October 2005. We cannot provide any assurances that the closing of our
acquisition of PBI will not be delayed or that the closing will occur at all.
See "Risk Factors."
2
Unless we are able to complete our acquisition of PBI, we expect that
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
agreement with PBI which provides that we will market and sell PBI's entire
ethanol production from its plant located in Goshen, California. The term of
this agreement is two years from the date that ethanol is first available for
marketing from PBI's plant. This agreement will remain in effect if we are not
successful in acquiring PBI.
We intend in the near-term to construct an ethanol production facility
to begin, or in the event the acquisition of PBI is consummated expand, 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, including through the acquisition of PBI as
discussed above, one or more 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, 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 may build an ethanol production facility.
Historically, Kinergy's gross profit as a percentage of sales has
averaged between 2.0% and 4.4%, primarily due to increases in the value of the
inventory we held for sale during periods in which ethanol prices generally
increased. However, in light of recent overall volatility in ethanol prices, we
anticipate that until we either complete the acquisition of PBI and/or complete
our facility and commence the business of ethanol production thereby obtaining
the benefits of higher profit margins associated with production activities as
compared to marketing and distribution activities, our gross profit as a
percentage of sales will be close to 1.0%. This is also true in light of our
agreement with PBI, which we expect will result in obtaining a 1.0% gross profit
on the sale of PBI's ethanol. We believe that this level of gross profit is more
typical of the ethanol marketing industry.
Ethanol represents only up to 3% of the total annual gasoline supply
in the United States, therefore we believe that the ethanol industry has
substantial room to grow to reach what we believe is an achievable level of 10%
of the total annual gasoline supply in the United States. In California alone,
an increase in the demand for ethanol to 10% of the total annual gasoline supply
would result in annual demand for approximately 650 million additional gallons
of ethanol, which amounts represents an increase in demand of approximately 16%.
The market price of ethanol is volatile and subject to significant
fluctuations, which may cause our results of operations to fluctuate
significantly. The market price of ethanol is somewhat dependent on the price of
gasoline, which is in turn dependent on the price of petroleum. We cannot
predict the future price of gasoline or oil and we may realize 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 has reversed this decline and increased to approximately 25% above its
2004 average price per gallon in only four months from April 2005 through July
2005. If we fail to price our ethanol consistently in a manner that is
profitable, our business, financial condition and results of operations will be
adversely affected.
We typically match ethanol purchase and sale contracts of like
quantities and delivery period, which ordinarily range from one to twelve
months. From time to time, we attempt to take advantage of what we perceive to
be favorable industry trends and maintain net long or short ethanol positions.
This practice does subject us to the risk of prices moving in unanticipated
directions, which may result in losses, but also enables us to benefit from
above normal margins.
3
SHARE EXCHANGE TRANSACTION
On March 23, 2005, we completed a share exchange transaction, or 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 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 may 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.
Unless we are able to complete our acquisition of PBI, 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.
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........... 11,788,000
--------------
Total assets acquired.................. 18,808,420
Current liabilities....................... 4,253,177
Other liabilities......................... 83,017
--------------
Total liabilities assumed.............. 4,336,194
--------------
Net assets acquired....................... $ 14,472,226
==============
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.
4
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 $ 48,704,129 $ 37,842,788
=============== ==============
Net loss $ (3,203,375) $ (739,834)
Loss per share of common stock
Basic $ (0.11) $ (0.03)
=============== ==============
Diluted $ (0.11) $ (0.03)
=============== ==============
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.
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.
5
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 as well as 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. 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
and ReEnergy acquisitions therefore totaled $2,952,000.
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.
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
------------ ------------
6
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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended June 30, 2005 increased by
$1,164,658 (496%) to $1,399,696 as compared to $235,038 for the three months
ended June 30, 2004. This increase was primarily due to additional legal,
accounting and insurance 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. $267,375 of these fees related to non-cash consulting fees for warrants
and $651,000 were related to non-cash compensation from stock grants in
connection with the hiring of two employees. We expect to incur non-cash
consulting fee expense 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 interest income on cash
in seven day investment accounts and decrease in expense related to construction
payables.
7
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
Non-cash compensation for consulting fees 1,343,636 517,500
------------ ------------
Operating loss (2,937,152) (939,344)
Other expense (89,559) (266,944)
------------ ------------
Loss before provision for income taxes (3,026,711) (1,206,288)
Provision for income taxes 4,800 2,400
------------ ------------
Net Loss (3,031,511) (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 as a percentage of sales has
averaged between 2.0% and 4.4%, primarily due to increases in the value of the
inventory held for sale during periods in which ethanol prices generally
increased. However, in light of recent overall volatility in ethanol prices, we
anticipate that until we either complete the acquisition of PBI and/or complete
our facility and commence the business of ethanol production thereby obtaining
the benefits of higher profit margins associated with production activities as
compared to marketing and distribution activities, our gross profit as a
percentage of sales will be closer to 1.0%. This is also true in light of our
agreement with PBI, which we expect will result in obtaining a 1.0% gross profit
on the sale of PBI's ethanol. We believe that this level of gross profit is more
typical of the ethanol marketing industry.
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 primarily due to additional legal, accounting
and insurance 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
8
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.
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. $460,386 of these fees related to non-cash consulting fees for warrants,
$651,000 related to non-cash compensation from stock grants in connection with
the hiring of two employees and 232,250 related to a stock grant that vested
upon closing of the share exchange transaction, March 23, 2005. We expect to
incur non-cash consulting fee expense 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 interest income on cash in
seven day investment accounts and decrease in expense related to construction
payables.
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 $6,692,757 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 $695,259 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 $424,730 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 $2,156,696 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 $457,808 used to acquire Kinergy and ReEnergy, 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 acquisition of Accessity,
Kinergy and ReEnergy.
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 $18,895,354
from a private offering of equity securities on March 23, 2005, as described
below.
9
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
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
10
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 me 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.
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.
11
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.
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 $6.7 million. For the six months ended June
30, 2005, we incurred a net loss of approximately $3.0 million. We expect to
incur losses for the foreseeable future and at least until the completion of our
planned ethanol production facility. Unless we are able to complete our
acquisition of PBI, we estimate that the earliest completion date of our ethanol
production facility in Madera County, 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 cannot assure you that we will
attain, sustain or increase profitability on a quarterly or annual basis in the
future. If we do not achieve, sustain or increase profitability, our business
will be adversely affected and 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. In
addition, some studies, including a study conducted at the University of
California, Berkeley in 2003, suggest that producing ethanol from corn requires
burning as much as twice the amount of gasoline already used in cars, thereby
harming the environment more than pure gasoline. We expect to be completely
focused on the production and marketing of ethanol and its co-products for the
foreseeable future. There can be no assurance that we will be able 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 sale and profitabililty.
12
WE PLAN TO FUND A SUBSTANTIAL MAJORITY OF THE ACQUISITION COST OF PBI AND
CONSTRUCTION COSTS OF OUR PLANNED ETHANOL PRODUCTION FACILITY THROUGH THE
ISSUANCE OF A SUBSTANTIAL AMOUNT OF DEBT, RESULTING IN SUBSTANTIAL DEBT
SERVICE REQUIREMENTS THAT COULD REDUCE THE VALUE OF YOUR INVESTMENT.
We have executed an agreement to acquire PBI, a company that has
constructed an ethanol production facility in Goshen, California. We plan to
fund a substantial majority of the acquisition costs of PBI and construction
costs of our planned ethanol production facility through the issuance of a
substantial amount of debt. We anticipate that we will need to raise
approximately $40.0 million and another $60.0 million in debt financing to
acquire PBI and to construct our first ethanol production facility,
respectively. 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;
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 eliminated 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
our all or a portion of our debt or raise funds through asset sales, sales of
equity or otherwise, our business may be adversely affected, we may be forced to
liquidate and you could lose your entire investment.
FOLLOWING THE CLOSING OF OUR ANTICIPATED DEBT FINANCING, OUR LENDERS MAY
REQUIRE US TO ABIDE BY RESTRICTIVE LOAN COVENANTS THAT MAY HINDER OUR
ABILITY TO OPERATE AND REDUCE OUR PROFITABILITY.
We expect that following the closing of our anticipated debt financing,
the loan agreements governing our debt financing will contain a number of
restrictive affirmative and negative covenants. These covenants may limit our
ability to, among other things:
o incur additional indebtedness;
o make capital expenditures in excess of prescribed thresholds;
o pay dividends to our stockholders;
o make various investments;
o create liens on our assets;
o utilize the proceeds of asset sales; or
o merge or consolidate or dispose of all or substantially all of
our assets.
13
We also will likely be required to maintain specified financial ratios,
including minimum cash flow coverage, minimum working capital and minimum net
worth. We also may be required to utilize a portion of any excess cash flow
generated by operations to prepay our debt. A breach of any of these covenants
or requirements could result in a default under our debt agreements. If we
default, and if such default is not cured or waived, a lender could, among other
remedies, accelerate our debt and declare the debt immediately due and payable.
If this occurs, we may not be able to repay or borrow sufficient funds to
refinance our debt. Even if new financing is available, it may not be on terms
that are acceptable. Such an occurrence could cause us to cease building our
ethanol production facility, or if our facility is already constructed, such an
occurrence could cause us to cease or curtail operations. We cannot assure you
that our future operating results will be sufficient to achieve compliance with
such covenants and requirements, or in the event of a default, to remedy such
default.
GOVERNMENTAL REGULATIONS OR THE REPEAL OR MODIFICATION OF VARIOUS TAX
INCENTIVES FAVORING THE USE OF ETHANOL COULD ADVERSELY AFFECT OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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
business, financial condition and results of operations would be materially and
adversely affected.
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 business and results of operations.
VIOLATIONS OF ENVIRONMENTAL REGULATIONS COULD SUBJECT US TO SEVERE
PENALTIES AND MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
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
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 business, results of operations and financial condition
could be materially and adversely affected.
14
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 significantly delay or prevent the achievement of our business
objectives. Consequently, the loss of Mr. Koehler could adversely affect our
business, financial condition and results of operations.
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.
The ethanol production and marketing industry is extremely competitive.
Many of our significant competitors in the ethanol production and marketing
industry, have substantially greater production, financial, research and
development, personnel and marketing resources than we do. As a result, each of
these companies 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 and sales.
OUR FAILURE TO ATTRACT AND RETAIN KEY PERSONNEL COULD ADVERSELY AFFECT OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Our future success is dependent in part on our ability to attract and
retain certain key personnel. We currently have few employees and need to
attract additional skilled technical, clerical and managerial personnel in all
areas of our business to continue to grow. The competition for such individuals
in the growing ethanol production and marketing industry is intense. There can
be no assurance that we will be able to retain our existing personnel or attract
additional qualified personnel in the future. If we are unable to attract and
retain key personnel, our business, financial condition and results of
operations could be adversely affected.
OUR MANAGEMENT MAY FAIL TO SUCCESSFULLY INTEGRATE THE BUSINESS OF KINERGY
WITH THE PROPOSED ETHANOL PRODUCTION BUSINESS OF PBI OR PEI CALIFORNIA, OR
BOTH, WHICH COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Integrating the business of Kinergy with the proposed ethanol
production businesses of PBI and PEI California will be complex, time-consuming
and expensive, and our management may fail to successfully integrate these
businesses. Each of Kinergy, PBI and PEI California were previously operated
independently, each with its own business or proposed business, culture,
clients, employees and systems. Since March 2005, Kinergy and PEI California
have been be operated as a combined organization, utilizing common information
and communication systems, operating procedures, financial controls and human
resources practices, including benefits, training and professional development
15
programs. If the acquisition of PBI occurs, it will be consolidated with the
businesses of Kinergy and PEI California. We may experience substantial
difficulties, costs and delays relating to our efforts to integrate the business
of Kinergy and the proposed ethanol production business of PBI or PEI
California. These may include the diversion of management resources from our
core ethanol marketing business, the potential incompatibility of business
cultures and the costs and delays in implementing common systems and procedures.
Any one or all of these factors may cause increased operating costs or the loss
of key customers and employees, either of which could adversely affect our
business, financial condition and results of operations.
OUR FAILURE TO MANAGE OUR GROWTH EFFECTIVELY COULD IMPAIR OUR BUSINESS.
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 proposed acquisition of PBI and the
construction of our planned ethanol production facility, will require
significant investments of capital and management's close attention. 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.
There can be no assurance that we will be able 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, our business, financial condition and results of
operations could be materially and adversely affected.
INSURANCE COVERAGE MAY BE INADEQUATE OR UNAVAILABLE TO PROTECT US FROM
LOSSES ASSOCIATED WITH OUR PLANS AND OPERATIONS, WHICH MAY ADVERSELY AFFECT
OUR BUSINESS AND FINANCIAL CONDITION.
Insurance coverage may be inadequate or unavailable to protect us from
losses associated with our plans and operations. Events may occur for which no
insurance is available or for which insurance is not available on terms that are
reasonably acceptable. In addition, events may occur for which our insurance
inadequately covers the associated losses. Losses from an uninsured or
underinsured event, such as, but not limited to, earthquakes, floods, war, riot,
acts of terrorism or other risks may be uninsured or underinsured and such a
loss may adversely affect our business and financial condition. In addition, we
operate in an industry that is subject to heavy environmental regulation and we
are undertaking to acquire PBI, a company that owns an existing ethanol
production facility, and construct an additional ethanol production facility,
all of which subject us to substantial losses upon the occurrence of certain
events such as the discharge of a hazardous substance or a catastrophic event
such as an explosion or fire during or following the acquisition of PBI or
construction of our ethanol production facility. In the event of a loss, any
failure to obtain and maintain insurance, with adequate policy limits and/or
self-retention limits, may adversely affect our business and financial
condition.
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 August 15, 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.
16
We expect to register for resale approximately 16.1 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 such shares of common stock. We cannot predict the
effect, if any, that future sales of shares of our common stock into the public
market will have on the market price of our common stock. However, 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:
o the volume and timing of the receipt of orders for ethanol
from major customers;
o competitive pricing pressures;
o our ability 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 new products and
processes 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 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 business, financial condition and results of operations and
also the price of our common stock.
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 MARGINS AND WHICH
COULD MATERIALLY AND ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Kinergy's purchases and sales of ethanol are not always matched with
sales and purchases of ethanol at established prices. As a standard business
practice, 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. As a standard business practice, 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's inventory of ethanol held for sale subjects us to the risk of a
decline in the price of ethanol. 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 results of operations.
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 RESULTS OF OPERATIONS.
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, we cannot
assure you that, in any future period, Kinergy's sales generated from these
customers, individually or in the aggregate, will equal or exceed historical
levels. We also cannot assure you that, if sales to any of these customers cease
or decline, Kinergy will be able 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 net sales and results of operations.
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, KINERGY MAY BE UNABLE TO
SATISFY THE DEMANDS OF ITS CUSTOMERS AND OUR BUSINESS AND RESULTS OF
OPERATIONS 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. We cannot assure you that, if any of these
suppliers is unable or declines for any reason to continue to supply Kinergy
with ethanol, Kinergy will be able 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 any of these suppliers is unable or decides not to continue to
supply Kinergy with ethanol, Kinergy may be unable to satisfy the demands of its
customers and our business and results of operations will be adversely affected.
INTERRUPTIONS OR DELAYS IN KINERGY'S SUPPLY OF ETHANOL COULD CAUSE KINERGY
TO BE UNABLE TO SATISFY THE DEMANDS OF ITS CUSTOMERS AND ADVERSELY AFFECT
OUR BUSINESS AND RESULTS OF OPERATIONS.
Kinergy sources the ethanol that it sells primarily from suppliers
thousands of miles away 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. The quantity of ethanol in Kinergy's
inventory fluctuates and during periods of low inventory levels, Kinergy is more
vulnerable to the effects of interruptions and delays in its supply of ethanol.
Accordingly, interruptions or delays in Kinergy's supply of ethanol from the
Midwest could cause Kinergy to be unable to satisfy the demands of its customers
and adversely affect our business and results of operations.
RISKS RELATING TO THE BUSINESS OF PEI CALIFORNIA
THE ACQUISITION OF PBI AND THE CONSTRUCTION OF OUR PLANNED ETHANOL
PRODUCTION FACILITY WILL REQUIRE SIGNIFICANT ADDITIONAL FUNDING, WHICH WE
EXPECT TO RAISE THROUGH DEBT FINANCING. WE CANNOT ASSURE YOU THAT WE WILL
BE SUCCESSFUL IN RAISING ADEQUATE CAPITAL.
We anticipate that we will need to raise approximately $40.0 million
and an additional $60.0 million in debt financing to complete the acquisition of
PBI and to construct our first ethanol production facility in Madera County,
respectively. We have no contracts with or binding commitments from any bank,
lender or financial institution for this debt financing. We cannot assure you
that any funding from one or more lenders will be obtained, or if it 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 plans for the construction of an ethanol production
facility.
19
NEITHER PBI NOR PEI CALIFORNIA HAS CONDUCTED ANY SIGNIFICANT BUSINESS
OPERATIONS AND HAVE BEEN UNPROFITABLE TO DATE. IF EITHER PBI OR PEI
CALIFORNIA FAILS TO COMMENCE SIGNIFICANT BUSINESS OPERATIONS, IT WILL BE
UNSUCCESSFUL, WILL FAIL TO CONTRIBUTE POSITIVELY TO OUR PROFITABILITY AND
WILL HAVE AN ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Neither PBI nor PEI California has 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 PBI's or PEI
California's success or its contribution to our profitability. We cannot assure
you that our acquisition of PBI will ever be consummated or, if consummated,
that PBI will ever commence significant business operations or ever be
successful or contribute positively to our profitability. We also cannot assure
you that PEI California will ever complete construction of an ethanol production
facility and commence significant operations or, if PEI California does complete
the construction of an ethanol production facility, that PEI California will
ever be successful or contribute positively to our profitability. If PBI or PEI
California fails to commence significant business operations, it will be
unsuccessful and will fail to contribute positively to our profitability, which
will have an adverse effect on our financial condition and results of
operations.
THE MARKET PRICE OF ETHANOL IS VOLATILE AND SUBJECT TO SIGNIFICANT
FLUCTUATIONS, WHICH MAY CAUSE OUR RESULTS OF OPERATIONS TO FLUCTUATE
SIGNIFICANTLY.
The market price of ethanol is somewhat dependent 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 has 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. If PEI California fails to
price its ethanol consistently in a manner that is profitable, our business,
financial condition and results of operations will be adversely affected.
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. We cannot assure you that
there will be any material or significant increases in the demand for ethanol
commensurate with increasing supplies of ethanol. Accordingly, 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 may
adversely affect our business, financial condition and results of operations.
20
THE CONSTRUCTION AND OPERATION OF OUR PLANNED ETHANOL PRODUCTION FACILITY,
AND, IN THE EVENT WE CONSUMMATE THE ACQUISITION OF PBI, THE OPERATION OF
PBI'S 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. In addition, PBI will be subject to these
regulations in connection with the operation of its ethanol production facility.
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 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, which could have a material and adverse effect on
our business and results of operations.
VARIOUS RISKS ASSOCIATED WITH THE CONSTRUCTION OF OUR PLANNED ETHANOL
PRODUCTION FACILITY AND, IN THE EVENT WE CONSUMMATE THE ACQUISITION OF PBI,
THE OPERATION OF PBI'S ETHANOL PRODUCTION FACILITY, MAY ADVERSELY AFFECT
OUR BUSINESS AND FINANCIAL CONDITION.
We cannot assure you that delays in the construction of our planned
ethanol production facility or defects in materials and/or workmanship will not
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. These risks also apply to
the operation of PBI's ethanol production facility. 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, California
site during the first quarter of 2004. PEI California incurred additional
expenses to repair 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 business and
financial condition.
There can be no assurance that PEI California will not encounter
hazardous conditions at the Madera County, California site. PEI California may
encounter conditions at the site that may delay construction of the facility. If
PEI California encounters a hazardous condition at 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, California 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 business and financial condition 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 million. The estimated cost of the facility
is based on preliminary discussions and estimates, and we cannot assure you that
the final construction cost of the facility will not be significantly higher.
Any significant increase in the final construction cost of the facility may
adversely affect our business, financial condition and results of operations.
21
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 BUSINESS AND FINANCIAL CONDITION.
PEI California will be highly dependent upon W. M. Lyles Co. to design
and build our planned ethanol production facility in Madera County, California.
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. if PEI California terminates
it in favor of another contractor, in addition to payment of all costs incurred
by W. M. Lyles Co. for services rendered through the date of termination.
Consequently, if PEI California terminates these agreements, the requirement
that it pay the termination fee and costs could adversely affect our business
and financial condition. 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 business, financial condition
and results of operations.
THE RAW MATERIALS AND ENERGY NECESSARY TO PRODUCE ETHANOL MAY BE
UNAVAILABLE OR MAY INCREASE IN PRICE, ADVERSELY AFFECTING OUR BUSINESS AND
RESULTS OF OPERATIONS.
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. In
addition, we estimate that PBI's ethanol production facility will require
approximately 9.0 million bushels or more of corn each year and also will
require 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. We cannot assure you that local water, electricity and gas
utilities will be able to reliably supply the water, electricity and natural gas
that our planned ethanol production facility will need or will 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 or PBI'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 or PBI paying
higher prices than its competitors. In addition, PEI California and PBI 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 financial
condition and results of operation will be significantly affected by the prices
and supplies of raw materials and energy.
22
ITEM 3. CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluations as of June 30, 2005, that the design and operation of
our "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended ("Exchange Act")), are effective to
ensure that information required to be disclosed by us in the reports filed or
submitted by us under the Exchange Act is accumulated, recorded, processed,
summarized and reported to our management, including our principal executive
officer and our principal financial officer, as appropriate to allow timely
decisions regarding whether or not disclosure is required.
During the quarter ended June 30, 2005, there were no changes in our
"internal controls over financial reporting" (as defined in Rule 13a-15(f) under
the Exchange Act) that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
23
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.
R.A. DAVIS COMMODITIES
On September 22, 2004, R. A. Davis Commodities, LLC filed a complaint
for breach of contract, promissory estoppel and negligence in the Superior Court
of the State of California for the County of Fresno against PEI California. The
complaint sought actual and consequential damages in the amount of approximately
$700,000 based on PEI California's alleged breach of certain rolled corn
purchase contracts. PEI California responded to the complaint on January 27,
2005. PEI California also filed a cross-complaint against R.A. Davis on that
date, alleging breach of oral and written contract in connection with sales of
feed product as well as "transloading" services performed for R.A Davis. The
cross-complaint sought damages in the amount of $121,435. We settled these
matters with R. A. Davis in July 2005 and paid R.A. Davis $75,000.00 in
connection with such settlement.
INSURANCE CORPORATION OF HANOVER
On November 8, 2004, Insurance Corporation of Hanover and Kruse
Investments d/b/a Western Milling, LLC (collectively, the "Plaintiffs") filed a
complaint for damages in the Superior Court of the State of California for the
County of Madera against PEI California. The complaint sought actual and
consequential damages in the amount of approximately $960,800 based on PEI
California's alleged breach of contract and negligence in connection with losses
suffered by Plaintiffs which arose out of damage caused to Western Milling's
canola meal that was stored at PEI California's grain silos located at PEI
California's Madera County facility, which facility was the subject of a grain
silo fire on January 12, 2004. PEI California's insurance company has settled
this matter. Plaintiffs have dismissed the action against PEI California with
prejudice and have provided PEI California a written release.
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
24
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.
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 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.
25
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.
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
26
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: August 15, 2005 By: /S/ WILLIAM G. LANGLEY
----------------------------
William G. Langley
Chief Financial Officer
(principal financial officer
and duly authorized officer)
27
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
28