Business context and reporting period
This is Pacific Ethanol, Inc.’s Form 10-Q for the quarter and nine months ended September 30, 2020. The filing identifies the registrant as Pacific Ethanol; the request metadata names Alto Ingredients, Inc. The company produces and markets specialty and fuel-grade alcohols and essential ingredients. After selling its interest in Pacific Aurora in April 2020, it operated seven distilleries with combined annual capacity of 450 million gallons.
Fuel-grade ethanol demand fell sharply amid pandemic-related reductions in transportation. The company reduced production, converted some fuel-grade capacity to specialty alcohols, and reported operating at about 51% of capacity as of September 30; third-quarter capacity utilization was 40%.
Key financial results
Amounts below are in millions of dollars except per-share data and where noted.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $204.7 | $365.2 | $728.2 | $1,067.3 |
| Gross profit (loss) | $20.9 | $(14.8) | $39.2 | $(13.1) |
| Gross margin | 10.2% | (4.1%) | 5.4% | (1.2%) |
| Income (loss) from operations | $26.3 | $(23.5) | $25.7 | $(36.8) |
| Net income (loss) attributable to Pacific Ethanol | $15.2 | $(27.3) | $5.1 | $(47.9) |
| Net income (loss) available to common stockholders | $14.9 | $(27.6) | $4.1 | $(48.8) |
| Diluted earnings (loss) per share | $0.24 | $(0.58) | $0.07 | $(1.04) |
- Revenue fell 43.9% year over year in Q3 and 31.8% for the nine-month period, primarily reflecting sharply lower production and sales volumes. In Q3, production gallons sold fell 66.6% and total gallons sold fell 42.8%. Higher specialty-alcohol and essential-ingredient margins partly offset the volume decline.
- Management attributed improved gross profit mainly to specialty-alcohol margins. Q3 results also included an $11.75 million litigation-settlement gain. Fair-value adjustments were a $6.9 million expense in Q3 and a $7.5 million expense year to date; the filing links the improvement in net income partly to these adjustments’ offsetting effect on results.
- Net interest expense was $4.2 million in Q3 and $14.2 million year to date. No income-tax benefit or expense was reported for the periods shown.
- Operating cash flow was $75.7 million for the first nine months, versus cash used of $27.2 million in 2019. Investing activities provided $15.0 million, including $19.9 million of Pacific Aurora sale proceeds, while financing activities used $71.0 million. Cash increased by $19.7 million to $38.7 million.
- At September 30, current assets were $137.7 million and current liabilities $115.1 million, yielding working capital of $22.6 million and a 1.20 current ratio. Working capital was $71.7 million and the ratio 1.45 at December 31, 2019.
- Debt was $163.8 million before unamortized debt adjustments; the balance sheet reported $74.9 million current and $88.0 million long-term debt. This compares with $245.5 million of gross borrowings at year-end 2019. Subsequent to quarter-end, the company reported repaying $25.3 million of parent-note principal.
Material changes versus the prior comparable period
- Results turned profitable from substantial losses in 2019, with gross margins improving from negative to positive. The main stated driver was improved specialty-alcohol margins, including strong sanitizer and disinfectant demand; the litigation-settlement gain also contributed to reported income.
- Volumes and sales contracted significantly as the company curtailed fuel-grade ethanol production in response to reduced transportation-fuel demand. The sales mix shifted toward specialty alcohols, helping lift the average sales price per gallon despite lower benchmark fuel-ethanol prices.
- The April sale of the company’s 73.93% interest in Pacific Aurora reduced assets, debt, and reported sales; the divestiture also eliminated noncontrolling interests. The company received $19.9 million in cash and $15.6 million in promissory notes after purchase-price adjustments.
- Debt reduction and liquidity were supported by operating cash flow, asset-sale proceeds, and equity financing. The company’s share count increased during 2020, and the October offering added substantial potential dilution.
Outlook, risks, and unusual items
- Management expected specialty-alcohol demand to remain robust for at least the next 12 months and said most 2021 specialty-alcohol production was already contracted at fixed prices. It also cited improved fuel-ethanol spot prices, expected growth in sanitizer and spirits markets, and plans to add 30 million gallons of grain-neutral-spirit capacity in Q4 2020. These are management expectations, not guarantees.
- The company planned a 15% yeast-facility capacity expansion, with a $5.5 million investment and targeted completion by Q3 2021. It was also evaluating Western distillery repurposing or sales. A separate $10 million sale of Magic Valley grain-handling assets was expected to close by November 30, 2020, subject to conditions; the company planned to retain the alcohol facility and terminal.
- Management said the company believed it had alleviated substantial doubt about continuing as a going concern and expected sufficient liquidity for the next 12 months, citing projected operating cash flow, a subsequent equity raise, and planned asset-sale proceeds. However, the company was not in compliance with obligations to obtain lender approval of a restructuring plan for its Pekin and ICP debt, and disputed whether part of required principal payments came from an approved source. Lenders could accelerate debt; management said acceleration was not considered probable, but related debt was classified as current. The filing warns the company lacked sufficient liquidity to repay debt immediately if accelerated.
- On October 28, 2020, the company completed an equity offering and concurrent warrant issuance that generated approximately $75 million gross and $70 million net. It reported using proceeds to make the subsequent $25.3 million debt payment. The offering and warrants may materially dilute existing shareholders.
- Other material risks include pandemic-related demand and pricing uncertainty, commodity-price and margin volatility, customer concentration, dependence on fuel mandates and ethanol markets, operational and logistics disruptions, variable-rate debt, and limits on transferring subsidiary assets or cash to the parent. Approximately $291.3 million of subsidiary net assets were restricted from transfer at quarter-end.
- The filing reports $9.9 million of CARES Act Paycheck Protection Program loans at 1% interest; some amounts might be forgiven, but forgiveness was not assured. The company accrued $0.9 million in Series B preferred dividends year to date but did not pay cash dividends during 2020 through the reporting date.
Important facts for investors to verify
- Progress and lender acceptance of the Pekin and ICP restructuring plan, resolution of the payment-source dispute, covenant status, and any risk of debt acceleration.
- Actual closing and net proceeds from the announced $10 million Magic Valley asset sale, and how proceeds are applied to debt.
- Whether specialty-alcohol demand, fixed-price contracts, and margins persist as pandemic-driven sanitizer demand changes; also verify production levels and utilization.
- Debt balances and liquidity after the October equity offering and subsequent principal repayment, including the effect of subsidiary cash-transfer restrictions and upcoming maturities.
- Potential dilution from the common-stock offering, pre-funded warrants, and additional warrants, as well as the terms and status of the preferred-stock dividends.
- Reported earnings quality: distinguish recurring operating performance from the $11.75 million settlement gain and fair-value adjustments.