PEIX Alto Ingredients Inc

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This report and our consolidated financial statements and notes to consolidated 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 generate and profits we might earn if we are successful in implementing our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including:

You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this report, or in the case of a document incorporated by reference, as of the date of that document. We do not undertake to update, revise or correct any forward-looking statements, except as required by law.

Any of the factors described immediately above, or referenced from time to time in our filings with the Securities and Exchange Commission or in the “Risk Factors” section 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

We are a leading producer and marketer of low-carbon renewable fuels in the United States.

We operate nine strategically-located production facilities. Four of our plants are in the Western states of California, Oregon and Idaho, and five of our plants are located in the Midwestern states of Illinois and Nebraska. We are the sixth largest producer of ethanol in the United States based on annualized volumes. Our plants have a combined production capacity of 605 million gallons per year. We market all the ethanol, specialty alcohols and co-products produced at our plants as well as ethanol produced by third parties. On an annualized basis, we market nearly 1.0 billion gallons of ethanol and over 3.0 million tons of co-products on a dry matter basis. Our business consists of two operating segments: a production segment and a marketing segment.

Our mission is to advance our position and significantly increase our market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. We intend to accomplish this goal in part by expanding our ethanol production capacity and distribution infrastructure, accretive acquisitions, lowering the carbon intensity of our ethanol, extending our marketing business into new regional and international markets, and implementing new technologies to promote higher production yields and greater efficiencies.

Production Segment

We produce ethanol, specialty alcohols and co-products at our production facilities described below. Our plants located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. Our plants located in the Midwest are in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets. In addition, our ability to load unit trains from our plants located in the Midwest, and barges from our Pekin, Illinois plants, allows for greater access to international markets.

We wholly-own all of our plants located on the West Coast and the three plants in Pekin, Illinois. We own approximately 74% of the two plants in Aurora, Nebraska as well as the grain elevator adjacent to those properties and related grain handling assets, including the outer rail loop, and the real property on which they are located, through Pacific Aurora, LLC, or Pacific Aurora, an entity owned approximately 26% by Aurora Cooperative Elevator Company.

We produce ethanol co-products at our production facilities such as wet distillers grains, or WDG, dried distillers grains with solubles, or DDGS, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, dried yeast and CO ₂ .

Marketing Segment

We market ethanol, specialty alcohols and co-products produced by our facilities and market ethanol produced by third parties. We have extensive customer relationships throughout the Western and Midwestern United States. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of ethanol, and manage the logistics and timing of delivery with very little effort on their part. Our customers collectively require ethanol volumes in excess of the supplies we produce at our production facilities. We secure additional ethanol supplies from third-party plants in California and other third-party suppliers in the Midwest where a majority of ethanol producers are located. We arrange for transportation, storage and delivery of ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources.

We market our distillers grains and other feed co-products to dairies and feedlots, in many cases located near our ethanol plants. These customers use our feed co-products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers. We do not market co-products from other ethanol producers.

See “Note 2 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments.

Outlook

Our results for the first half of 2018 reflect a compressed and volatile margin environment. Significantly higher corn freight costs and resulting corn basis costs into our Western facilities reduced production margins. In addition, the Environmental Protection Agency’s, or EPA’s, continued practice of granting small refinery exemptions from the Renewable Fuel Standard, or RFS, negatively impacted ethanol margins. Also, escalating trade positioning between the Unites States and China, which resulted in early April in additional tariffs placed on United States ethanol shipped to China, halted United States ethanol exports to China, resulting in higher industry-wide inventory levels which further pressured margins.

Despite a challenging first-half, industry fundamentals remain strong and should support better margins. Ethanol remains a low-cost, high-value, low-carbon renewable fuel and source of octane. Moreover, blending ethanol into gasoline reduces the price of gasoline to consumers. We believe these compelling blend economics will drive higher domestic and international blend rates.

We are actively engaged, including through industry trade associations, with the EPA to achieve Reid vapor pressure (RVP) parity to allow for higher ethanol blends year-round; to maintain the EPA’s renewable volume obligation (RVO) targets consistent with the law; and to be more judicious in granting small refinery economic hardship exemptions and, when granted, to reallocate those gallons to all other obligated parties. While we do not anticipate that any of these outcomes will affect the balance of 2018, we do anticipate positive movement in 2019 to allow for year-round blending of E15.

Domestic gasoline demand remains firm at approximately 1.5% higher year-over-year. At 10% blend ratios, each 1.0% increase in average annual gasoline demand in the United States would result in demand for an additional 140 million gallons of ethanol. Moreover, as the market migrates to higher ethanol blend ratios, each 1.0% increase in aggregate blend ratios across the United States gasoline pool, at current levels of gasoline demand, would result in demand for an additional 1.4 billion gallons of ethanol.

International demand for ethanol set records in 2017 and remains on pace to exceed those records in 2018, with approximately 30 countries having renewable fuel standards or targets. United States ethanol exports from January through June 2018 reached 928 million gallons, up 33% from the same period in 2017 and on pace to significantly exceed the 1.37 billion gallons exported for all of 2017. More countries are importing ethanol from the United States as it represents a low-cost source of high-octane and low-carbon transportation fuel. Japan recently announced its intention to allow United States ethanol to meet up to 44% of a total estimated annual demand of 217 million gallons of ethanol used to make ethyl tert-butyl ether, or ETBE, an oxygenate gasoline additive, or the equivalent of approximately 100 million gallons of United States-sourced ethanol annually. Prior to the halt of United States exports to China, China had returned earlier in the year as a significant buyer of United States-sourced ethanol, supporting its announced 10% blending requirement by 2020. If China continues to pursue this goal, even while rapidly increasing its own domestic ethanol production, it will require significant ethanol imports, ultimately supporting the continued growth in overall international demand for ethanol.

Carbon values in our California and Oregon markets are increasing, resulting in continued and growing premiums for our lower-carbon ethanol. In California, carbon prices currently exceed $185 per metric ton. Over the past year, California carbon prices have risen steadily to an average of $154 per metric ton in June 2018 from $77 per metric ton at the same time last year. Earlier this year, the California Air Resources Board announced changes to extend and increase carbon reduction requirements imposed on refiners through 2030, requiring them to reduce carbon levels to 20% below 2010 levels. Carbon values in Oregon have also improved, with prices currently over $80 per metric ton for our lower-carbon ethanol produced at our Oregon facility. Over the past year, Oregon carbon prices have risen steadily to an average of $69 per metric ton in June 2018 from $45 per metric at the same time last year.

We continue to focus on implementing initiatives and investing in our assets to reduce costs, improve yields and carbon scores, and build our long-term value. We are engaged in several plant-level capital projects with near-term paybacks designed to increase output of high-value co-products such as corn oil, corn gluten meal and yeast. We are also working with our ingredient suppliers to reduce costs and increase ethanol yields.

Our acquisition of ICP in July 2017 provided product diversification, bringing us high-quality alcohol products, which help support stronger margins and reduce our exposure to commodity price fluctuations in the fuel ethanol market. We recently completed our integration of ICP and achieved our goal of $4.5 million in annualized cost synergies in 2018.

Our 3.5 megawatt cogeneration system at our Stockton plant has not yet achieved full commercial operation. The manufacturer of the system’s natural gas fired cogeneration units is handling modifications to meet performance standards. The system converts process waste gas and natural gas into electricity and steam, reducing energy costs by up to $4.0 million per year and lowering carbon and nitrogen oxide emissions.

We completed our 5 megawatt solar photovoltaic power system at our Madera facility. The system is operating at 70% capacity and we anticipate full electricity production by the fourth quarter, once PG&E, our electricity provider, has completed its final upgrades to its adjacent substation. We expect the system to reduce our utility costs by approximately $1.0 million annually and lower our carbon score.

Airgas has begun construction of a liquid CO ₂ production plant adjacent to our Stockton facility. We expect to commence production and begin generating revenues from this arrangement in the fourth quarter of 2018.

We continue to produce commercial levels of cellulosic ethanol and generate D3 RINs at our Stockton plant. However, we continue to suspend production of cellulosic ethanol at our Madera and Magic Valley plants due to delays in EPA approval of our cellulosic ethanol pathways for those plants. We believe these delays result from a negative political environment at the EPA towards advanced biofuels but we are hopeful that we will obtain EPA approval under new regulatory leadership. Once approved, production from these three plants will generate additional combined EBITDA of $2.0 million annually.

Our capital expenditures for the first quarter of 2018 totaled $7.4 million and were primarily related to plant improvement initiatives. We expect our 2018 capital expenditures to remain in-line with our 2017 expenditure level, although we may adjust this amount based on industry economics and our financial performance.

We plan to drive growth by leveraging our diverse base of production and marketing assets to advance our position and significantly increase market share as a leading producer and marketer of low-carbon renewable fuels and high-quality alcohol products in the United States. The foundations of this strategy are our strategically located bio-refineries, which enable us to serve multiple markets; the diversity of our production, geography, technology, feedstocks and logistics, which helps us mitigate exposure to commodity price risks within fuel markets; and our focus on evaluating and investing in plant improvement and other initiatives to increase production and operating efficiencies and yields.  

Critical Accounting Policies

The preparation of our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, requires us to make judgments and estimates that may have a significant impact upon the portrayal of our financial condition and results of operations. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management that can materially impact the portrayal of our financial condition and results of operations: revenue recognition; impairment of long-lived assets; valuation of allowance for deferred taxes; derivative instruments; accounting for business combinations; and allowance for doubtful accounts. These significant accounting principles are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2017.

Results of Operations

The following selected financial information should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report.

Certain performance metrics that we believe are important indicators of our results of operations include:

Net Sales

The increase in our net sales for the three and six months ended June 30, 2018 as compared to the same period in 2017 was primarily due to an increase in our production gallons sold, partially offset by our reduction in third party gallons sold. We increased our production gallons sold primarily due to increased volumes attributed to our ICP facility, which we acquired on July 3, 2017. We sold fewer third party gallons as we deliberately focused our third party ethanol sales in regions where we have either a stronger presence around our own production assets or more favorable margins.

Three Months Ended June 30, 2018

On a consolidated basis, our average sales price per gallon remained flat at $1.66 for the three months ended June 30, 2018 compared to the same period in 2017. The average Chicago Board of Trade, or CBOT, ethanol price per gallon, however, decreased 6.5% to $1.45 for the three months ended June 30, 2018 compared to an average CBOT ethanol price per gallon of $1.55 for the same period in 2017.

Production Segment

Net sales of ethanol from our production segment increased by $36.2 million, or 18%, to $233.9 million for the three months ended June 30, 2018 as compared to $197.7 million for the same period in 2017. Our total volume of production ethanol gallons sold increased by 24.4 million gallons, or 20%, to 144.4 million gallons for the three months ended June 30, 2018 as compared to 120.0 million gallons for the same period in 2017. Our production segment’s average sales price per gallon decreased 1.8% to $1.62 for the three months ended June 30, 2018 compared to our production segment’s average sales price per gallon of $1.65 for the same period in 2017. At our production segment’s average sales price per gallon of $1.62 for the three months ended June 30, 2018, we generated $39.5 million in additional net sales from our production segment from the 24.4 million additional gallons of produced ethanol sold in the three months ended June 30, 2018 as compared to the same period in 2017. The decline of $0.03 in our production segment’s average sales price per gallon for the three months ended June 30, 2018 as compared to the same period in 2017 reduced our net sales of ethanol from our production segment by $3.3 million.

Net sales of co-products increased $20.0 million, or 34%, to $78.5 million for the three months ended June 30, 2018 as compared to $58.5 million for the same period in 2017. Our total volume of co-products sold increased by 59.6 thousand tons, or 8%, to 794.0 thousand tons for three months ended June 30, 2018 from 734.4 thousand tons for the same period in 2017, and our average sales price per ton increased to $98.88 for the three months ended June 30, 2018 from $79.61 for the same period in 2017. At our average sales price per ton of $98.88 for the three months ended June 30, 2018, we generated $5.9 million in additional net sales from the 59.6 thousand tons of additional co-products sold in the three months ended June 30, 2018 as compared to the same period in 2017. The increase of $19.27, or 24%, in our average sales price per ton for the three months ended June 30, 2018 as compared to the same period in 2017 increased net sales of co-products by $14.1 million.

Marketing Segment

Net sales of ethanol from our marketing segment decreased by $51.0 million, or 34%, to $98.1 million for the three months ended June 30, 2018 as compared to $149.1 million for the same period in 2017. Our total volume of ethanol gallons sold by our marketing segment decreased by 8.4 million gallons, or 3.6%, to 227.4 million gallons for the three months ended June 30, 2018 as compared to 235.8 million gallons for the same period in 2017. Of these amounts, we sold 32.8 million fewer third party gallons, which was partially offset by 24.4 million additional production gallons sold by our marketing segment.

The increase in production gallons sold by our marketing segment resulted in an increase of $0.4 million in net sales generated by our marketing segment, which were eliminated upon consolidation.

Our marketing segment’s average sales price per gallon increased $0.05, or 3%, to $1.72 for the three months ended June 30, 2018 as compared to $1.67 for the same period in 2017. At our marketing segment’s average sales price per gallon of $1.72 for the three months ended June 30, 2018, we generated $56.5 million less in net sales from our marketing segment from the 32.8 million fewer third party gallons sold in the three months ended June 30, 2018 as compared to the same period in 2017. The increase of $0.05 in our marketing segment’s average sales price per gallon for the three months ended June 30, 2018 as compared to the same period in 2017 increased our net sales from third party ethanol sold by our marketing segment by $5.5 million.

Six Months Ended June 30, 2018

On a consolidated basis, our average sales price per gallon decreased 1.8% to $1.61 for the six months ended June 30, 2018 compared to our average sales price per gallon of $1.64 for the same period in 2017. The average CBOT ethanol price per gallon decreased 5.9% to $1.44 for the six months ended June 30, 2018 compared to an average CBOT ethanol price per gallon of $1.53 for the same period in 2017.

Production Segment

Net sales of ethanol from our production segment increased by $71.4 million, or 19%, to $453.5 million for the six months ended June 30, 2018 as compared to $382.1 million for the same period in 2017. Our total volume of production ethanol gallons sold increased by 50.2 million gallons, or 21%, to 285.2 million gallons for the six months ended June 30, 2018 as compared to 235.0 million gallons for the same period in 2017. Our production segment’s average sales price per gallon decreased 2% to $1.58 for the six months ended June 30, 2018 compared to our production segment’s average sales price per gallon of $1.61 for the same period in 2017. At our production segment’s average sales price per gallon of $1.58 for the six months ended June 30, 2018, we generated $79.2 million in additional net sales from our production segment from the 50.2 additional gallons of produced ethanol sold in the six months ended June 30, 2018 as compared to the same period in 2017. The decline of $0.03 in our production segment’s average sales price per gallon for the six months ended June 30, 2018 as compared to the same period in 2017 reduced our net sales of ethanol from our production segment by $7.8 million.

Net sales of co-products increased $36.0 million, or 31%, to $153.0 million for the six months ended June 30, 2018 as compared to $117.0 million for the same period in 2017. Our total volume of co-products sold increased by 172.1 thousand tons, or 12%, to 1,592.0 thousand tons for six months ended June 30, 2018 from 1,419.9 thousand tons for the same period in 2017, and our average sales price per ton increased to $96.14 for the six months ended June 30, 2018 from $82.47 for the same period in 2017. At our average sales price per ton of $96.14 for the six months ended June 30, 2018, we generated $16.6 million in additional net sales from the 172.1 thousand tons of additional co-products sold in the six months ended June 30, 2018 as compared to the same period in 2017. The increase of $13.67, or 17%, in our average sales price per ton for the six months ended June 30, 2018 as compared to the same period in 2017 increased net sales of co-products by $19.4 million.

Marketing Segment

Net sales of ethanol from our marketing segment decreased by $88.5 million, or 30%, to $203.1 million for the six months ended June 30, 2018 as compared to $291.6 million for the same period in 2017. Our total volume of ethanol gallons sold by our marketing segment decreased by 1.9 million gallons, or 0.4%, to 460.1 million gallons for the six months ended June 30, 2018 as compared to 462.0 million gallons for the same period in 2017. Of these amounts, we sold 52.1 million fewer third party gallons, which was partially offset by 50.2 million additional production gallons sold by our marketing segment.

The increase in production gallons sold by our marketing segment resulted in an increase of $0.8 million in net sales generated by our marketing segment, which were eliminated upon consolidation.

Our marketing segment’s average sales price per gallon decreased $0.01, or less than 1%, to $1.64 for the six months ended June 30, 2018 as compared to $1.65 for the same period in 2017. At our marketing segment’s average sales price per gallon of $1.64 for the six months ended June 30, 2018, we generated $85.2 million less in net sales from our marketing segment from the 52.1 million fewer third party gallons sold in the six months ended June 30, 2018 as compared to the same period in 2017. Further, the decline of $0.01 in our marketing segment’s average sales price per gallon for the six months ended June 30, 2018 as compared to the same period in 2017 reduced our net sales from third party ethanol sold by our marketing segment by $3.3 million.

Cost of Goods Sold and Gross Profit (Loss)

Our consolidated gross profit declined primarily due to significantly lower commodity margins in the three and six months ended June 30, 2018 compared to the same periods in 2017.

Significantly higher corn freight costs and resulting corn basis costs into our Western facilities compressed production margins. In addition, ethanol margins were negatively impacted by the EPA’s continued practice of granting small refinery exemptions from the Renewable Fuel Standard and trade tariffs that have halted United States ethanol exports to China, resulting in higher industry wide inventory levels which further pressured margins.

Three Months Ended June 30, 2018

Our consolidated gross profit declined to a gross loss of $1.3 million for the three months ended June 30, 2018 as compared to gross profit of $1.7 million for the same period in 2017, representing a negative gross margin of 0.3% for the three months ended June 30, 2018 as compared to a positive gross margin of 0.4% for the same period in 2017.

Production Segment

Our production segment’s gross profit from external sales declined by $9.4 million to a gross loss of $7.7 million for the three months ended June 30, 2018 as compared to a gross profit of $1.7 million for the same period in 2017. Of this amount, $8.1 million is attributable to our production segment’s lower margins for the three months ended June 30, 2018 as compared to the same period in 2017, and $1.3 million is attributable to increased production volumes at negative production margins for the three months ended June 30, 2018 as compared to the same period in 2017.

Gross profit generated by our production segment was negatively impacted by higher than expected repairs and maintenance expense at our Pekin, Illinois wet mill facility. Our results for the second quarter of 2018 include final costs associated with these boilers of approximately $1.5 million. We have experienced larger than anticipated expenses since the second half of 2015 related to the repair, and then replacement, of two package boilers that failed shortly prior to our acquisition of our Midwest assets in 2015. We have resolved these boiler issues, which totaled $11.0 million in 2017, and anticipate that wet mill boiler expenses associated with these issues will be eliminated going forward. We continue to pursue a claim against the boiler manufacturer which will result, however, in ongoing litigation expenses.

Marketing Segment

Our marketing segment’s gross profit improved by $ 6.4 million to $6.4 million for the three months ended June 30, 2018 as compared to breakeven for the same period in 2017. Of this increase, $10.6 million is attributable to our marketing segment’s improved margins per gallon for the three months ended June 30, 2018 as compared to the same period in 2017, partially offset by $4.2 million in lower gross profit attributable to the 32.8 million gallon reduction in third-party marketing volumes for the three months ended June 30, 2018 as compared to the same period in 2017.

Six Months Ended June 30, 2018

Our consolidated gross profit improved by $6.2 million to a gross profit of $2.1 million for the six months ended June 30, 2018 as compared to gross loss of $4.1 million for the same period in 2017, representing a gross margin of 0.3% for the six months ended June 30, 2018 as compared to a negative gross margin of 0.5% for the same period in 2017.

Production Segment

Our production segment’s gross profit from external sales declined by $6.0 million to a gross loss of $11.5 million for the six months ended June 30, 2018 as compared to a gross loss of $5.5 million for the same period in 2017. Of this decline, $4.0 million is attributable to our production segment’s lower margins for the six months ended June 30, 2018 as compared to the same period in 2017, and $2.0 million is attributable to increased production volumes at negative production margins for the six months ended June 30, 2018 as compared to the same period in 2017.

Gross profit generated by our production segment was negatively impacted by $4.1 million in higher than expected repairs and maintenance expense at our Pekin, Illinois wet mill facility for the six months ended June 30, 2018. We have experienced larger than anticipated expenses since the second half of 2015 related initially to the repair, and then replacement, of two package boilers that failed shortly prior to our acquisition of our Midwest assets in 2015. We have resolved these boiler issues, which totaled $11.0 million in 2017, and anticipate that wet mill boiler expenses associated with these issues will be eliminated going forward. We continue to pursue a claim against the boiler manufacturer which will result, however, in ongoing litigation expenses.

Marketing Segment

Our marketing segment’s gross profit improved by $12.2 million to $13.6 million for the six months ended June 30, 2018 as compared to $1.4 million for the same period in 2017. Of this increase, $16.2 million is attributable to our marketing segment’s improved margins for the six months ended June 30, 2018 as compared to the same period in 2017, partially offset by $4.0 million in lower gross profit attributable to the 52.1 million gallon reduction in third-party marketing volumes for the six months ended June 30, 2018 as compared to the same period in 2017.

Our SG&A expenses remained relatively flat for the three months ended June 30, 2018 as compared to the same period in 2017.

Our SG&A expenses increased $4.0 million to $18.2 million for the six months ended June 30, 2018 as compared to $14.2 million for the same period in 2017. The increase in SG&A expenses is primarily due to $3.6 million in one-time gains associated with legal matters resolved in the prior year that reduced our SG&A expenses. In addition, our SG&A expenses for the 2018 periods include expenses related to the operation of our ICP facility that were not present in the prior year periods as the acquisition had not yet occurred. We anticipate SG&A expenses will total approximately $36.0 million for all of 2018.

Interest expense increased $1.5 million to $4.2 million for the three months ended June 30, 2018 from $2.7 million for the same period in 2017. Interest expense increased $3.4 million to $8.7 million for the six months ended June 30, 2018 from $5.3 million for the same period in 2017. The increase in interest expense is primarily due to additional borrowings related to our acquisition of ICP and higher interest rates on our senior notes, which increased in accordance with the note terms. In addition, we realized higher interest expense due to accelerated amortization of deferred financing costs associated with our termination of Pacific Aurora’s line of credit.

The increase in net loss available to common stockholders is primarily due to lower margins and higher interest expense for the three and six months ended June 30, 2018 as compared to the same periods in 2017.

Liquidity and Capital Resources

During the six months ended June 30, 2018, we funded our operations primarily from cash on hand, cash generated from our operations and advances from our revolving credit facilities. These funds were also used to make capital expenditures, capital lease payments and principal payments on term debt.

Our current available capital resources consist of cash on hand and amounts available for borrowing under our credit facilities. We expect that our future available capital resources will consist primarily of our remaining cash balances, cash generated from our operations, and amounts available for borrowing, if any, under our credit facilities.

We believe that current and future available capital resources, including cash generated from our operations, and other existing sources of liquidity, including our credit facilities, will be adequate to meet our anticipated capital requirements for at least the next twelve months.

Quantitative Quarter-End Liquidity Status

We believe that the following amounts provide insight into our liquidity and capital resources. The following selected financial information should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report (dollars in thousands):

Restricted Net Assets

At June 30, 2018, we had approximately $196.0 million of net assets at our subsidiaries that were not available to be transferred to Pacific Ethanol, Inc. in the form of dividends, loans or advances due to restrictions contained in the credit facilities of our subsidiaries.

Changes in Working Capital and Cash Flows

Working capital increased to $121.1 million at June 30, 2018 from $112.5 million at December 31, 2017 as a result of an increase of $17.5 million in current assets, partially offset by an increase of $8.9 million in current liabilities.

Current assets increased primarily due to increases of $13.1 million in cash and cash equivalents, $6.6 million in derivative instruments, $5.8 million in inventories and $1.3 million in other current assets, partially offset by a decrease in accounts receivable of $7.8 million and $1.5 million in other prepaid inventory. Our cash and cash equivalents increased by $13.1 million at June 30, 2018 as compared to December 31, 2017 due to $4.9 million of cash provided by our operations and $15.5 million of cash provided by our financing activities, partially offset by $7.3 million of cash used in our investing activities.

Our current liabilities increased primarily due to increases of $7.9 million in derivative instruments and $1.3 million in accounts payable and accrued liabilities.

Cash provided by our Operating Activities

Cash provided by our operating activities declined by $10.2 million for the six months ended June 30, 2018, as compared to the same period in 2018. We generated $4.9 million in cash from our operating activities during the period. Specific factors that contributed to the decrease in cash provided by our operating activities include:

These amounts were partially offset by:

Cash used in our Investing Activities

Cash used in our investing activities increased by $1.1 million for the six months ended June 30, 2018 as compared to the same period in 2017. The increase in cash used in our investing activities is due to higher spending on capital projects associated with our plant improvement initiatives.

Cash provided by our Financing Activities

Cash provided by our financing activities increased by $1.5 million for the six months ended June 30, 2018 as compared to the same period in 2017. The increase in cash provided by our financing activities is primarily due to $17.3 million in increased net borrowings under Kinergy’s line of credit, partially offset by a decline of $13.5 million in note proceeds from the prior period and $2.0 million in increased principal payments on our term debt.

Kinergy Operating Line of Credit

Kinergy maintains an operating line of credit for an aggregate amount of up to $100.0 million. The credit facility matures on August 2, 2022. Interest accrues under the credit facility at a rate equal to (i) the three-month London Interbank Offered Rate (“LIBOR”), plus (ii) a specified applicable margin ranging from 1.50% to 2.00%. The credit facility’s monthly unused line fee is 0.25% to 0.375% of the amount by which the maximum credit under the facility exceeds the average daily principal balance during the immediately preceding month. Payments that may be made by Kinergy to Pacific Ethanol as reimbursement for management and other services provided by Pacific Ethanol to Kinergy are limited under the terms of the credit facility to $1.5 million per fiscal quarter. The credit facility also includes the accounts receivable of Pacific Ag. Products, LLC, or PAP, as additional collateral. Payments that may be made by PAP to Pacific Ethanol as reimbursement for management and other services provided by Pacific Ethanol to PAP are limited under the terms of the credit facility to $0.5 million per fiscal quarter. PAP, one of our indirect wholly-owned subsidiaries, markets our co-products and also provides raw material procurement services to our subsidiaries.

For all monthly periods in which excess borrowing availability falls below a specified level, Kinergy and PAP must collectively maintain a fixed-charge coverage ratio (calculated as a twelve-month rolling earnings before interest, taxes, depreciation and amortization (EBITDA) divided by the sum of interest expense, capital expenditures, principal payments of indebtedness, indebtedness from capital leases and taxes paid during such twelve-month rolling period) of at least 2.0 and are prohibited from incurring certain additional indebtedness (other than specific intercompany indebtedness). Kinergy’s and PAP’s obligations under the credit facility are secured by a first-priority security interest in all of their assets in favor of the lender. Kinergy and PAP believe they are in compliance with this covenant. The following table summarizes Kinergy’s financial covenants and actual results for the periods presented (dollars in thousands):

For all periods presented above, Kinergy maintained more than the minimum excess borrowing availability required; accordingly, the fixed-charge coverage ratio requirement did not apply.

Pacific Ethanol has guaranteed all of Kinergy’s obligations under the credit facility. As of June 30, 2018, Kinergy had an outstanding balance of $72.0 million with additional borrowing availability under the credit facility of $2.6 million.

Pekin Credit Facilities

On December 15, 2016, our wholly-owned subsidiary, Pacific Ethanol Pekin, LLC, or Pekin, entered into term and revolving credit facilities. Pekin borrowed $64.0 million under a term loan facility that matures on August 20, 2021 and $32.0 million under a revolving credit facility that matures on February 1, 2022. The Pekin credit facilities are secured by a first-priority security interest in all of Pekin’s assets. Interest initially accrued under the Pekin credit facilities at an annual rate equal to the 30-day LIBOR plus 3.75%, payable monthly. Pekin is required to make quarterly principal payments in the amount of $3.5 million on the term loan beginning on May 20, 2017, with the remaining principal balance payable at maturity on August 20, 2021. Pekin is required to pay monthly in arrears a fee on any unused portion of the revolving credit facility at a rate of 0.75% per annum. Prepayment of these facilities is subject to a prepayment penalty. Under the initial terms of the credit facilities, Pekin was required to maintain not less than $20.0 million in working capital and an annual debt service coverage ratio of not less than 1.25 to 1.0.

On August 7, 2017, Pekin amended its term and revolving credit facilities by agreeing to increase the interest rate under the facilities by 25 basis points to an annual rate equal to the 30-day LIBOR plus 4.00%. Pekin and its lender also agreed that Pekin is required to maintain working capital of not less than $17.5 million from August 31, 2017 through December 31, 2017 and working capital of not less than $20.0 million from January 1, 2018 and continuing at all times thereafter. In addition, the required debt service coverage ratio was reduced to 0.15 to 1.00 for the fiscal year ended December 31, 2017. Pekin’s actual debt service coverage ratio was 0.17 to 1.00 for the fiscal year ended December 31, 2017, 0.02 in excess of the required 0.15 to 1.00. For the month ended January 31, 2018, Pekin was not in compliance with its working capital requirement due to larger than anticipated repair and maintenance related expenses to replace faulty equipment. Pekin has received a waiver from its lender for this noncompliance. Further, the lender decreased Pekin’s working capital covenant requirement to $13.0 million for the month ended February 28, 2018, excluding from the calculation a $3.5 million principal payment previously due in May 2018.

On March 30, 2018, Pekin further amended its term loan facility by reducing the amount of working capital it is required to maintain to not less than $13.0 million from March 31, 2018 through November 30, 2018 and not less than $16.0 million from December 1, 2018 and continuing at all times thereafter. In addition, a principal payment in the amount of $3.5 million due for May 2018 was deferred until the maturity date of the term loan. As of the filing of this report, we believe Pekin is in compliance with its working capital requirement.

ICP Credit Facilities

On September 15, 2017, ICP entered into term and revolving credit facilities. ICP borrowed $24.0 million under a term loan facility that matures on September 20, 2021 and $18.0 million under a revolving credit facility that matures on September 1, 2022. The ICP credit facilities are secured by a first-priority security interest in all of ICP’s assets. Interest accrues under the ICP credit facilities at an annual rate equal to the 30-day LIBOR plus 3.75%, payable monthly. ICP is required to make quarterly consecutive principal payments in the amount of $1.5 million. ICP is required to pay monthly in arrears a fee on any unused portion of the revolving credit facility at a rate of 0.75% per annum. Prepayment of these facilities is subject to a prepayment penalty. Under the terms of the credit facilities, ICP is required to maintain not less than $8.0 million in working capital and an annual debt service coverage ratio of not less than 1.5 to 1.0, beginning for the year ended December 31, 2018.

Pacific Ethanol, Inc. Notes Payable

On December 12, 2016, we entered into a Note Purchase Agreement with five accredited investors. On December 15, 2016, under the terms of the Note Purchase Agreement, we sold $55.0 million in aggregate principal amount of our senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold. On June 26, 2017, we entered into a second Note Purchase Agreement with five accredited investors. On June 30, 2017, under the terms of the second Note Purchase Agreement, we sold an additional $13.9 million in aggregate principal amount of our senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold, for a total of $68.9 million in aggregate principal amount of senior secured notes.

The notes mature on December 15, 2019. Interest on the notes accrues at an annual rate equal to (i) the greater of 1% and the three-month LIBOR, plus 7.0% from the closing through December 14, 2017, (ii) the greater of 1% and three-month LIBOR, plus 9% between December 15, 2017 and December 14, 2018, and (iii) the greater of 1% and three-month LIBOR plus 11% between December 15, 2018 and the maturity date. The interest rate increases by an additional 2% per annum above the interest rate otherwise applicable upon the occurrence and during the continuance of an event of default until cured. Interest is payable in cash in arrears on the 15th calendar day of each March, June, September and December. We are required to pay all outstanding principal and any accrued and unpaid interest on the notes on the maturity date. We may, at our option, prepay the outstanding principal amount of the notes at any time without premium or penalty. Pacific Ethanol, Inc. issued the notes, which are secured by a first-priority security interest in the equity interest held by Pacific Ethanol, Inc. in its wholly-owned subsidiary, PE Op. Co., which indirectly owns our plants located on the West Coast.

Contractual Obligations

There have been no material changes in the six months ended June 30, 2018 to the amounts presented in the table under the “Contractual Obligations” section in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation” of our Annual Report on Form 10-K for 2017.

Effects of Inflation

The impact of inflation was not significant to our financial condition or results of operations for the three and six months ended June 30, 2018 and 2017.