Business context and reporting period
The supplied filing is Pacific Ethanol, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2018; the filing does not identify the registrant as Alto Ingredients, Inc. Pacific Ethanol operated nine ethanol facilities with combined annual capacity of 605 million gallons and reported production and marketing segments. Illinois Corn Processing (ICP), acquired July 3, 2017, contributed to 2018 results but not the 2017 comparison, limiting comparability.
Financial performance and position
Amounts below are in millions of dollars unless noted otherwise.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $410.5 | $405.2 | $810.5 | $791.5 |
| Gross profit (loss) | $(1.3) | $1.7 | $2.1 | $(4.1) |
| Operating loss | $(10.2) | $(7.1) | $(16.1) | $(18.3) |
| Consolidated net loss | $(14.6) | $(9.9) | $(24.1) | $(23.4) |
| Loss available to common stockholders | $(13.2) | $(9.2) | $(21.4) | $(22.1) |
| Basic and diluted loss per share | $(0.31) | $(0.22) | $(0.50) | $(0.52) |
Gross margin was negative 0.3% in Q2 and positive 0.3% for the first half. SG&A was $8.9 million in Q2 and $18.2 million year to date. Interest expense rose to $4.2 million in Q2 and $8.7 million for the first half.
For the first half, operating cash flow was $4.9 million, investing cash flow $(7.3) million, and financing cash flow $15.5 million. Cash increased $13.1 million from year-end to $62.6 million. The filing separately states that Q2 operating cash flow was negative $4.0 million. At June 30, working capital was $121.1 million and the current ratio was 2.21. Total debt before discounts and current portion was $260.5 million; reported current debt was $20.0 million and long-term debt, net of current portion, was $237.8 million. Kinergy’s $100 million credit facility had $72.0 million outstanding and $2.6 million available. About $196 million of subsidiary net assets were restricted from transfer to the parent.
Material changes versus prior comparable periods
- Q2 sales rose 1.3%, but the company moved from gross profit to gross loss and reported a larger net loss attributable to the company. First-half sales rose 2.4%, and gross results improved from a loss to a small profit.
- Production gallons sold increased 20.3% in Q2 and 21.4% for the first half, mainly reflecting ICP. Third-party gallons sold declined; total gallons sold fell 3.6% in Q2 and 0.4% in the first half.
- Production segment margins weakened, while marketing segment gross profit improved. Management attributed pressure to higher corn freight and basis costs, industry ethanol-margin weakness, and negative-margin production volumes.
- Interest expense increased 55% in Q2 and 63% for the first half, primarily due to acquisition-related borrowing, higher rates on senior notes, and accelerated financing-fee amortization. SG&A increased year to date partly because prior-year results included a $3.6 million legal settlement gain.
Outlook, management commentary, risks and contingencies
Management described first-half margins as compressed and volatile, citing higher corn costs, EPA small-refinery exemptions under the Renewable Fuel Standard, and U.S.-China trade tariffs that halted U.S. ethanol exports to China and raised inventories. Management expected industry fundamentals to support better margins but did not provide earnings or revenue guidance. It anticipated approximately $36 million of SG&A for 2018 and capital expenditures broadly in line with 2017, subject to industry economics and performance.
Management noted ICP integration was complete and the targeted $4.5 million of annualized cost synergies had been achieved. The Stockton cogeneration system had not reached full commercial operation; Madera’s solar system was operating at 70%, with full production expected in Q4; and an adjacent CO2 plant was expected to begin production and generate revenue in Q4. Cellulosic ethanol production continued at Stockton but remained suspended at Madera and Magic Valley pending EPA pathway approvals; management estimated $2.0 million in combined annual EBITDA potential after approvals.
- Commodity prices and production spreads are major risks; the company recorded $3.4 million of non-designated derivative losses for the first half. All long-term debt was variable-rate; a 100-basis-point rate increase was estimated to reduce first-half pretax income by about $1.3 million.
- The company cited liquidity and covenant risks. Pekin had received a waiver after January working-capital noncompliance; its covenant was amended and a $3.5 million principal payment deferred to maturity. Parent senior notes mature December 15, 2019, with interest rates scheduled to step up.
- An Illinois Attorney General lawsuit alleges NPDES permit and water pollution violations at the Pekin facility. The parties were negotiating; an agreed interim order would allow operations under specified thermal limits while a permit amendment was pursued. Management said ordinary-course proceedings were not expected to materially affect the company, while acknowledging outcomes could affect future results or cash flows.
- Other material risks include ethanol demand and policy changes, customer concentration, operational or distribution disruptions, debt service, and limits on upstreaming subsidiary cash. The filing states disclosure controls were effective at a reasonable assurance level and no material quarterly change in internal control occurred.
Important facts for investors to verify
- Confirm the issuer and filing identity: the supplied 10-Q is for Pacific Ethanol, Inc., despite the request naming Alto Ingredients, Inc.
- Assess whether ethanol and co-product margins recover, particularly given corn basis and freight costs, EPA exemptions, export conditions, and inventory levels.
- Review debt maturities, variable-rate exposure, facility borrowing availability, covenant compliance, Pekin’s amended requirements, and the parent notes’ 2019 maturity and rate step-ups.
- Track execution and timing of the cogeneration, solar, CO2, and cellulosic projects, including whether expected savings, revenues, and EBITDA are realized.
- Monitor the Pekin environmental matter and boiler-manufacturer litigation, along with the restrictions on subsidiary distributions.