Alto Ingredients, Inc. annual report, FY2011

Business context and reporting period

Filing identity: The supplied filing is Pacific Ethanol, Inc.’s Form 10-K for the fiscal year ended December 31, 2011, filed March 8, 2012. It does not identify Alto Ingredients, Inc.; investors should confirm the company and filing match their intended review. This is an annual report, not a standalone fourth-quarter report.

Pacific Ethanol markets ethanol and co-products and operates plants through New PE Holdco, in which it held a 34% interest. The company consolidated New PE Holdco because it determined it was the primary beneficiary. Three plants were operating and the 40-million-gallon-per-year Madera plant was idled; total nameplate capacity was 200 million gallons annually.

Financial performance and liquidity

Net income attributable to Pacific Ethanol was $0.05 per basic and diluted share in 2011; income available to common stockholders was $1.8 million after preferred dividends. The 2010 result included a $119.4 million gain from the plant owners’ bankruptcy exit and is not a straightforward operating comparison.

Sales volume rose 56% to 424.1 million gallons and average sales price rose 42% to $2.79 per gallon. CBOT average corn prices increased 58% to $6.80 per bushel. Net sales also reflect a consolidation difference: New PE Holdco was consolidated for all of 2011 but not for the third quarter of 2010. Management’s pro forma 2010 sales, had it been consolidated for all of that year, were approximately $384.0 million.

Cash used in investing was $11.5 million, mainly for $9.1 million of additional New PE Holdco interests and $2.4 million of capital expenditures. Financing provided $15.6 million, including $10.0 million net borrowing proceeds and $7.4 million from a common-stock-and-warrant placement. Working capital was $57.8 million, versus $9.5 million a year earlier; the increase mainly reflected lower current liabilities after retirement of convertible notes, alongside higher current assets. Reported current assets and liabilities include consolidated variable-interest entities and should be interpreted with that structure in mind.

Year-end debt was $94.4 million, including $20.4 million on Kinergy’s line, $51.3 million of New PE Holdco term debt, $22.0 million on New PE Holdco’s working-capital line, and $0.75 million owed to related parties. The New PE Holdco debt is nonrecourse to Pacific Ethanol, according to the filing. Kinergy’s facility had a $30 million limit and $20.4 million outstanding; the filing reports a $26.6 million borrowing base. New PE Holdco reported $12.2 million of unused line availability. Interest expense increased to $14.8 million from $6.8 million.

Material changes versus the prior comparable period

• Gross margin improved from negative 0.2% to 2.2%, and operating results moved from a $13.8 million loss to $4.0 million of operating income.
• Despite higher sales and improved gross profit, consolidated net income was a $4.0 million loss, compared with 2010 net income of $69.5 million, which was substantially affected by the bankruptcy-exit gain.
• Operating cash use declined to $4.0 million from $36.9 million. Cash nevertheless remained approximately $8.9 million at year-end.
• Convertible notes with $35 million principal were retired in 2011, substantially through share conversions. Common shares outstanding increased from 12.9 million at year-end 2010 to 86.6 million at year-end 2011; the filing also reports a December 2011 equity placement.
• Pacific Ethanol increased its New PE Holdco ownership from 20% to 34% through two additional purchases in November and December.

Outlook, commentary, risks and unusual items

Management said available capital resources, operating revenues and credit facilities were expected to cover anticipated working-capital and capital-expenditure needs for at least the next 12 months. It warned that materially different cash needs, unforeseen events or acquisitions could require more financing. Management intends to restart Madera when market conditions permit and New PE Holdco approves; no restart date or quantified earnings guidance was provided.

• Commodity and margin exposure: Ethanol prices fell approximately 28% over four weeks at the end of 2011, substantially reducing fourth-quarter and full-year profitability. Volatility in ethanol, corn, natural gas and co-product prices can compress or eliminate margins; hedging may not fully protect the business.
• Credit and refinancing: Kinergy’s credit line has financial covenants and is guaranteed by Pacific Ethanol. New PE Holdco’s term and revolving facilities mature in June 2013, and the company said refinancing would be sought. The filing identifies covenant compliance as important to continued borrowing access.
• Operating and ownership structure: The company owns only 34% of New PE Holdco and needs other owners’ consent for certain significant actions. Termination of management or marketing agreements could affect its ability to consolidate the entity.
• Concentration: One customer accounted for 22% of 2011 net sales, and three suppliers represented 64% of ethanol and corn purchases. Customer contracts generally do not require minimum purchases.
• Regulatory uncertainty: California’s low-carbon fuel standard enforcement had been halted by a federal court on constitutional grounds and was under appeal. California’s producer-incentive program was not funded for 2012; Pacific Ethanol received $1.5 million under the program in 2011, recorded as a cost-of-goods-sold reduction, subject to potential reimbursement under specified conditions.
• Preferred stock and dilution: Series B preferred stock carries a 7% cumulative dividend, senior liquidation and dividend rights, voting rights and protective provisions. Accrued unpaid dividends were $7.3 million; common dividends are subordinate and none are planned. Warrants have anti-dilution provisions and are recorded as liabilities at fair value.
• Litigation and controls: The Spiegel state and federal cases were settled confidentially and dismissed with prejudice in November 2011; no accrual was recorded for the described proceedings. Management concluded disclosure controls and internal control over financial reporting were effective at year-end; the auditor did not attest to internal-control effectiveness.

Most important facts for investors to verify

• Confirm the filing is for Pacific Ethanol, Inc. (ticker PEIX), not Alto Ingredients, Inc., and that the annual 2011 reporting period is the one intended.
• Reconcile 2011 sales and margins with the different consolidation periods in 2010, and distinguish consolidated losses from income attributable to Pacific Ethanol.
• Review the cash-flow outlook, borrowing-base availability, Kinergy covenant headroom and the June 2013 maturity/refinancing needs of New PE Holdco debt.
• Assess potential dilution and priority claims from common-stock issuances, outstanding warrants, Series B preferred stock and $7.3 million of unpaid preferred dividends.
• Track ethanol/corn price spreads, the Madera idling decision, California regulatory developments and the continuation of management and marketing agreements.