Alto Ingredients, Inc. - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to _______

Commission File Number: 000-21467

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [   ] No [X]

As of November 6, 2015, there were 38,978,689 shares of Pacific Ethanol, Inc. common stock, $0.001 par value per share, and 3,540,132 shares of Pacific Ethanol, Inc. non-voting common stock, $0.001 par value per share, outstanding.

PART I
FINANCIAL INFORMATION

PART II

OTHER INFORMATION

PART I – FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS.

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

_______________

* Amounts derived from the audited financial statements for the year ended December 31, 2014.

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands, except par value and shares)

_______________
* Amounts derived from the audited financial statements for the year ended December 31, 2014.

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share data)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.     ORGANIZATION AND BASIS OF PRESENTATION.

Organization and Business – The consolidated financial statements include, for all periods presented, the accounts of Pacific Ethanol, Inc., a Delaware corporation (“Pacific Ethanol”), and its direct and indirect subsidiaries (collectively, the “Company”), including its wholly-owned subsidiaries, Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”), Pacific Ag. Products, LLC, a California limited liability company (“PAP”) and PE Op Co., a Delaware corporation (“PE Op Co.”). The Company’s acquisition of Aventine Renewable Energy Holdings, Inc. (now, Pacific Ethanol Central, LLC, a Delaware limited liability company, “Aventine”) was consummated on July 1, 2015, and as a result, the Company’s consolidated financial statements include the results of Aventine only as of and for the three months ended September 30, 2015 and the same three month period within the nine months ended September 30, 2015.

The Company is a leading producer and marketer of low-carbon renewable fuels in the United States. The Company’s four ethanol plants in the Western United States (together with their respective holding companies, the “Pacific Ethanol West Plants”) are located in close proximity to both feed and ethanol customers and thus enjoy unique advantages in efficiency, logistics and product pricing. These plants produce among the lowest-carbon ethanol produced in the United States due to low energy use in production.

With the addition of four Midwestern ethanol plants in July 2015 as a result of the Company’s acquisition of Aventine, the Company now has a combined ethanol production capacity of 515 million gallons per year, markets, on an annualized basis, over 800 million gallons of ethanol and produces, on an annualized basis, over 1 million tons of co-products such as wet and dry distillers grains, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, distillers yeast and CO₂. The Company’s four ethanol plants in the Midwest (together with their respective holding companies, the “Pacific Ethanol Central Plants”) are located in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets; and the Company’s ability to load unit trains from these facilities in the Midwest allows for greater access to international markets.

Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are presented at face value, net of the allowance for doubtful accounts. The Company sells ethanol to gasoline refining and distribution companies, sells co-products to dairy operators, animal feed distributors and poultry and biodiesel customers generally without requiring collateral.

The Company maintains an allowance for doubtful accounts for balances that appear to have specific collection issues. The collection process is based on the age of the invoice and requires attempted contacts with the customer at specified intervals. If, after a specified number of days, the Company has been unsuccessful in its collection efforts, a bad debt allowance is recorded for the balance in question. Delinquent accounts receivable are charged against the allowance for doubtful accounts once uncollectibility has been determined. The factors considered in reaching this determination are the apparent financial condition of the customer and the Company’s success in contacting and negotiating with the customer. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of ability to make payments, additional allowances may be required.

Of the accounts receivable balance, approximately $35,541,000 and $28,475,000 at September 30, 2015 and December 31, 2014, respectively, were used as collateral under Kinergy’s operating line of credit. The allowance for doubtful accounts was $21,700 and $6,000 as of September 30, 2015 and December 31, 2014, respectively. The Company recorded bad debt recoveries of $360,000 and $357,000 for the three and nine months ended September 30, 2015, respectively, and bad debt recoveries of $6,000 and $40,000 for the three and nine months ended September 30, 2014, respectively. The Company does not have any off-balance sheet credit exposure related to its customers.

Employment-related Benefits – Employment-related benefits associated with pensions and postretirement health care are expensed based on actuarial analysis. The recognition of expense is affected by estimates made by management, such as discount rates used to value certain liabilities, investment rates of return on plan assets, increases in future wage amounts and future health care costs. Discount rates are determined based on a spot yield curve that includes bonds with maturities that match expected benefit payments under the plan.

Provision for Income Taxes – For the three and nine months ended September 30, 2015, the Company recognized a tax benefit for losses incurred to the extent they are able to be carried back to prior taxable years, however, losses from the Pacific Ethanol Central Plants are not eligible to be carried back to prior taxable years and as such, were not recognized as an income tax benefit. In addition, for the three and nine months ended September 30, 2015, the Company recognized $1.5 million in tax benefit related to adjustments to its tax asset valuation allowance from a prior period. This adjustment is considered to be immaterial. For the three and nine months ended September 30, 2014, expenses related to warrant fair value adjustments are not tax deductible and as such, those expenses were excluded from a tax benefit, resulting in a higher effective tax rate.

The resulting effective tax rates for the three months ended September 30, 2015 and 2014 were 21.1% and 40.0% of pre-tax income, respectively. The resulting effective tax rates for the nine months ended September 30, 2015 and 2014 were 25.2% and 51.4% of pre-tax income, respectively.

Recent Accounting Pronouncements – In May 2014, the Financial Accounting Standards Board (“FASB”) issued new guidance on the recognition of revenue. The guidance states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard was originally effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, but has been further deferred one year. The Company’s adoption begins with the first fiscal quarter of fiscal year 2018. The Company is currently evaluating the impact of the adoption of this accounting standard update on its consolidated results of operations and financial position.

In April 2015, the FASB issued new guidance on presentation of debt issuance costs. Historically, entities have presented debt issuance costs as an asset. Under the new guidance, effective for fiscal years beginning after December 31, 2015, debt issuance costs will be reclassified as a deduction to the carrying amount of the related debt balance. The guidance does not change any of the Company’s other debt recognition or disclosure. The Company will adopt the guidance beginning March 31, 2016.

In July 2015, the FASB issued new guidance on simplifying the measurement of inventory. Under the new guidance, entities are required to measure most inventory at the lower of cost and net realizable value, thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. This guidance is effective prospectively for fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company has adopted the guidance with no material impact on its results of operations or financial condition.

In September 2015, the FASB issued new guidance on simplifying the accounting for measurement-period adjustments. Under the new guidance, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The guidance also requires acquirers to present separately on the face of the statement of operations or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The guidance is effective for fiscal years beginning after December 31, 2015, applied prospectively. Early adoption is permitted. The Company will consider early adoption in future periods related to its current measurement period for its acquisition of Aventine.

Basis of Presentation–Interim Financial Statements – The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Results for interim periods should not be considered indicative of results for a full year. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The accounting policies used in preparing these consolidated financial statements are the same as those described in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included. All significant intercompany accounts and transactions have been eliminated in consolidation.

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions 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 amounts of revenues and expenses during the reporting period. Significant estimates are required as part of determining the fair value of assets acquired and liabilities assumed from the acquisition of Aventine, warrants and conversion features, pension and postretirement benefit plan obligations, allowance for doubtful accounts, estimated lives of property and equipment and intangibles, long-lived asset impairments, valuation allowances on deferred income taxes and the potential outcome of future tax consequences of events recognized in the Company’s financial statements or tax returns. Actual results and outcomes may materially differ from management’s estimates and assumptions.

2.     PACIFIC ETHANOL WEST PLANTS.

As of September 30, 2015, the Company owned 100% of its four Pacific Ethanol West Plants located in the Western United States through its holding company, PE Op Co., namely, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton LLC and Pacific Ethanol Magic Valley, LLC, and their holding company, Pacific Ethanol Holding Co. LLC (together with the Pacific Ethanol West Plants, the “Plant Owners”).

Prior to December 2013, PE Op Co. was consolidated as a variable interest entity because the Company, through its contractual arrangements with PE Op Co., had the power to direct the activities that most significantly impacted PE Op Co.’s economic performance. Since December 2013, as a result of owning 91% of PE Op Co., the Company continued to consolidate PE Op Co.’s financial results under the voting rights model.

In May 2015, the Company purchased the remaining 4% ownership interest in PE Op Co. that it did not own, giving it 100% ownership of PE Op Co.

For the prior periods in which the Company did not wholly-own PE Op Co., it adjusted its consolidated net income (loss) for the income (loss) attributed to PE Op Co.’s other owners. The remaining amount after this adjustment resulted in net income (loss) attributed to Pacific Ethanol.

Noncontrolling interest decreased from $4,475,000 at December 31, 2014 to $0 at September 30, 2015 due to the Company’s purchase of the remaining 4% ownership interest in PE Op Co. for $3,828,000, resulting in a reduction of noncontrolling interest of $4,388,000, and loss attributed to noncontrolling interest of $87,000 for the nine months ended September 30, 2015.

The Company’s acquisition of its ownership interest in PE Op Co. does not impact the Company’s rights or obligations under any of its contractual arrangements. Further, creditors of PE Op Co. do not have recourse to Pacific Ethanol, Inc. Since its acquisition, the Company has not provided any additional support to PE Op Co. beyond the terms of its contractual arrangements.

3.     ACQUISITION OF AVENTINE.

On December 30, 2014, the Company entered into a definitive merger agreement with Aventine, a Midwest ethanol producer, under which the Company agreed to acquire Aventine through a stock-for-stock merger. The merger agreement was amended effective March 31, 2015 to address certain conditions to closing and other matters. The acquisition closed on July 1, 2015 and the Company issued an aggregate of 17.8 million shares of common stock and non-voting common stock for 100% of the outstanding shares of common stock of Aventine. The common stock and non-voting common stock issued as consideration had an aggregate fair value of $174.6 million, based on the closing market price of the Company’s common stock on the acquisition date.

The Company believes the Aventine acquisition will result in a number of synergies and strategic advantages. The Company believes the acquisition will spread commodity and basis price risks across diverse markets and products, assisting in its efforts to optimize margin management; improve its hedging opportunities with a greater correlation to the liquid physical and paper markets in Chicago; and increase its flexibility and alternatives in feedstock procurement for its Midwestern and Western production facilities. The acquisition also expands the Company’s marketing reach into new markets and extends its mix of co-products. The Company believes the acquisition will enable it to have deeper market insight and engagement in major ethanol and feed markets outside the Western United States, thereby improving pricing opportunities; allows the Company to establish access to markets in 48 states for ethanol sales and access many markets with ethanol and co-product sales reaching domestic and international customers; and enable it to use its more diverse mix of co-products to generate strong co-product returns. In addition, the acquisition also increases the Company’s combined annual ethanol production capacity to 515 million gallons per year and annualized ethanol marketing volume to over 800 million gallons, including Aventine’s historical volumes.

The Company has recognized the following allocation of the purchase price at fair values. The following fair value allocation for all assets and liabilities is provisional and incomplete as the Company is in the process of completing its valuation of the assets acquired and liabilities assumed, most significantly its valuation of property and equipment, deferred taxes and environmental remediation. The fair values of property and equipment and deferred taxes are based on the Company’s draft valuations, and represent its best estimates at the time of the filing of this report. The Company expects to conclude its valuations during the fourth quarter of 2015. The Company has included in the following allocation its estimated fair values for certain operating lease agreements and open commitments. The fair-value determination of long-term debt is based on the interest rate environment at the acquisition date.

Based upon these fair value estimates, the purchase price consideration allocation is as follows (in thousands):

The contractual amount due on the accounts receivable acquired was $10.8 million, of which $0.4 million is expected to be uncollectible. Any changes to the initial estimates of the fair value of the acquired assets and assumed liabilities will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill if the net assets acquired are less than the purchase price. If the net assets acquired exceed the purchase price, the residual amount will result in a bargain purchase gain. As discussed in Note 9, the Company recognized $3.7 million, included in other noncurrent liabilities above, as a litigation contingency related to certain legal cases for amounts that were probable and estimable as of the acquisition date. Subsequent to the acquisition date, the Company paid approximately $0.4 million of this amount.

The following table presents unaudited pro forma financial information assuming the acquisition occurred on January 1, 2014 (in thousands, except per share).

The effects of the initial step-up of inventories and open contracts in the aggregate of $8.7 million recorded during the three months ended September 30, 2015 were excluded in the above amounts, and instead recorded for the nine months ended September 30, 2014, as if the acquisition had occurred on January 1, 2014. For the three months ended September 30, 2015, Aventine contributed $143.6 million in net revenues and $16.6 million in pre-tax loss. For the three and nine months ended September 30, 2015, the Company recorded approximately $0.1 million and $1.4 million, respectively, in costs associated with the Aventine acquisition. These costs are reflected in selling, general and administrative expenses on the Company’s consolidated statements of operations, but were excluded from the amounts above.

4.     INVENTORIES.

Inventories consisted primarily of bulk ethanol, corn, co-products and unleaded fuel, and are valued at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis. Inventory balances consisted of the following (in thousands):

5.     DERIVATIVES.

The business and activities of the Company expose it to a variety of market risks, including risks related to changes in commodity prices and interest rates. The Company monitors and manages these financial exposures as an integral part of its risk management program. This program recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effects that market volatility could have on operating results.

Commodity Risk – Cash Flow Hedges – The Company uses derivative instruments to protect cash flows from fluctuations caused by volatility in commodity prices for periods of up to twelve months in order to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sale and purchase commitments where the prices are set at a future date and/or if the contracts specify a floating or index-based price for ethanol. In addition, the Company hedges anticipated sales of ethanol to minimize its exposure to the potentially adverse effects of price volatility. These derivatives may be designated and documented as cash flow hedges and effectiveness is evaluated by assessing the probability of the anticipated transactions and regressing commodity futures prices against the Company’s purchase and sales prices. Ineffectiveness, which is defined as the degree to which the derivative does not offset the underlying exposure, is recognized immediately in cost of goods sold. For the three and nine months ended September 30, 2015 and 2014, the Company did not designate any of its derivatives as cash flow hedges.

Commodity Risk – Non-Designated Hedges – The Company uses derivative instruments to lock in prices for certain amounts of corn and ethanol by entering into exchange-traded forward contracts for those commodities. These derivatives are not designated for special hedge accounting treatment. The changes in fair value of these contracts are recorded on the balance sheet and recognized immediately in cost of goods sold.

The classification and amounts of the Company’s derivatives not designated as hedging instruments are as follows (in thousands):

The classification and amounts of the Company’s recognized gains (losses) for its derivatives not designated as hedging instruments are as follows (in thousands):

6.     DEBT.

Long-term borrowings are summarized as follows (in thousands):

Kinergy Operating Line of Credit – As of September 30, 2015, Kinergy had an outstanding balance of $47,137,000 and an available borrowing base under the credit facility of $4,576,000.

Effective, July 1, 2015, Kinergy amended its line of credit to:

Pacific Ethanol West Plants’ Term Debt and Operating Lines of Credit – As of September 30, 2015, the Pacific Ethanol West Plants’ term debt had an outstanding balance of $17,003,000. As of September 30, 2015, the Pacific Ethanol West Plants had no outstanding balances on their revolving credit facilities, with an aggregate of $19,473,000 of borrowing availability. The outstanding balance matures in June 2016 and has been classified as current.

All of the term loans and revolving credit facilities represent permanent financing and are secured by a perfected, first-priority security interest in all of the assets, including inventories and all rights, title and interest in all tangible and intangible assets, of the Pacific Ethanol West Plants. The creditors under the term loans and revolving credit facilities for the Pacific Ethanol West Plants do not have recourse to Pacific Ethanol, Inc. or any of its other direct or indirect subsidiaries.

Pacific Ethanol Central Plants’ Term Debt – As of September 30, 2015, the Pacific Ethanol Central Plants’ term debt had an outstanding balance of $145,619,000. On July 1, 2015, upon effectiveness of the Aventine acquisition, Aventine became a wholly-owned subsidiary of the Company and, on a consolidated basis, the combined company became obligated with respect to the Pacific Ethanol Central Plants’ term loan and revolving credit facilities. The creditors under the term loan for the Pacific Ethanol Central Plants have recourse solely against the Pacific Ethanol Central Plants and their subsidiaries but not against Pacific Ethanol, Inc. or its other direct or indirect subsidiaries. In connection with the Company’s allocation of purchase price, the debt was recorded at $142,744,000, net of a discount of $2,875,000.

The term loan facility matures on September 24, 2017. The term loan facility is secured through a first-priority lien on substantially all of the Pacific Ethanol Central Plants’ assets and contains customary financial covenants, including the requirement that Aventine maintain a cash balance of at least $2.0 million. Interest on the term loan facility accrues and may be paid in cash at a rate of 10.5% per annum or may be paid in-kind at a rate of 15.0% per annum by adding such interest to the outstanding principal balance. If the Company were to elect to pay interest in-kind, the interest would be capitalized at the end of each quarter. The Company paid interest in cash for the three months ended September 30, 2015.

On July 1, 2015, the Company repaid in full $14.5 million, including approximately $0.7 million in termination fees, representing all amounts owed under Aventine’s revolving credit facility.

At September 30, 2015, there were approximately $320.9 million of net assets of the Company’s subsidiaries that were not available to be transferred to the parent company in the form of dividends, loans or advances due to restrictions contained in the credit facilities of these subsidiaries.

7.     PENSION AND RETIREMENT BENEFIT PLANS

The Company, through its acquisition of Aventine, has assumed a defined benefit pension plan (the “Pension Plan”) and a health care and life insurance plan (the “Postretirement Plan”).

The Pension Plan is noncontributory, and covers unionized employees at the Company’s Pekin, Illinois facility, who fulfill minimum age and service requirements. Benefits are based on a prescribed formula based upon the employee’s years of service. The Pension Plan, part of a collective bargaining agreement, covers only Union employees hired after November 1, 2010. The Company uses a December 31 measurement date for its Pension Plan. The Company’s funding policy is to make the minimum annual contributions that are required by applicable regulations. As of September 30, 2015, the Pension Plan’s accumulated projected benefit obligation was $18.0 million, with a fair value of plan assets of $13.2 million. The underfunded amount of $4.8 million is recorded on the Company’s consolidated balance sheet in other noncurrent liabilities. For the three months ended September 30, 2015, the Pension Plan’s net periodic expense was $24,000, comprised of $169,000 in interest cost and $106,000 in service cost, partially offset by a $251,000 expected return on plan assets. The Company expects approximately $0.5 million to be paid out of the Pension Plan for the remainder of 2015.

The Postretirement Plan provides postretirement medical benefits and life insurance to certain “grandfathered” unionized employees. Employees hired after December 31, 2000 are not eligible to participate in the Postretirement Plan. The Postretirement Plan is contributory, with contributions required at the same rate as active employees. Benefit eligibility under the plan reduces at age 65 from a defined benefit to a defined collar cap based upon years of service. As of September 30, 2015, the Postretirement Plan’s accumulated projected benefit obligation was $3.7 million and is recorded on the Company’s consolidated balance sheet in other noncurrent liabilities. The Company’s funding policy is to make the minimum annual contributions that are required by applicable regulations. For the three months ended September 30, 2015, the Postretirement Plan’s net periodic expense was $49,000, comprised of $33,000 of interest cost and $16,000 of service cost. The Company expects approximately $0.1 million to be paid out of the Postretirement Plan for the remainder of 2015.

8.     COMMON STOCK AND WARRANTS.

Warrant Exercises – There were no warrants exercised during the three months ended September 30, 2015. During the nine months ended September 30, 2015, certain holders exercised warrants and received an aggregate of 42,000 shares of the Company’s common stock upon payment of an aggregate of $368,000 in cash. During the three months ended September 30, 2015, approximately 432,000 warrants expired unexercised. As of September 30, 2015, there were warrants outstanding to purchase 349,000 shares of the Company’s common stock at an average exercise price of $7.02 per share.

During the three and nine months ended September 30, 2014, certain holders exercised warrants and received an aggregate of 3,095,000 and 5,942,000 shares of the Company’s common stock upon payment of an aggregate of $24,417,000 and $42,575,000 in cash, respectively. During the three and nine months ended September 30, 2014, the Company paid an aggregate of $1,471,000 and $2,271,000, respectively, in cash to certain warrant holders as an inducement to exercise their warrants and recorded an expense of $1,471,000 and $2,271,000, respectively. During the nine months ended September 30, 2014, certain warrant holders exercised warrants on a cashless basis and received 291,000 shares of the Company’s common stock.

Grants of Stock – In August 2015, the Company granted an aggregate of 5,000 shares of restricted stock to certain of the Company’s eligible employees that vest in equal amounts on each of April 1, 2016, 2017 and 2018, which had a grant date fair value of $7.03 per share. In July 2015, the Company granted an aggregate of 67,000 shares of restricted stock to certain of the Company’s eligible employees that vest in equal amounts on each of April 1, 2016, 2017 and 2018, which had a grant date fair value of $9.83 per share. In June 2015, the Company granted an aggregate of approximately 41,000 shares of restricted stock to non-employee members of the Company’s Board of Directors that vest on the earlier of (i) the date of the Company’s 2016 annual meeting of stockholders, or (ii) July 1, 2016, which had a grant date fair value of $10.87 per share. In March 2015, the Company granted an aggregate of 194,000 shares of restricted stock to the Company’s executive officers and other eligible employees that vest in equal amounts on each of April 1, 2016, 2017 and 2018, which had a grant date fair value of $10.20 per share. As of September 30, 2015, there was $4.4 million of total unrecognized costs related to nonvested restricted stock. That cost is expected to be recognized over a weighted-average period of 2.5 years.

9.     COMMITMENTS AND CONTINGENCIES.

Sales Commitments – At September 30, 2015, the Company had sales contracts with its major customers to sell certain quantities of ethanol and co-products. The Company had fixed-price sales contracts to sell $6,593,000 of ethanol and indexed-price contracts to sell 176,108,000 gallons of ethanol. At September 30, 2015, the Company had fixed-price sales contracts to sell $18,778,000 of co-products and indexed-price sales contracts to sell 13,000 tons of co-products. These sales contracts are scheduled to be completed throughout 2015.

Purchase Commitments – At September 30, 2015, the Company had fixed-price purchase contracts with its suppliers to purchase $7,749,000 of ethanol, $10,625,000 of corn and indexed-price contracts to purchase 23,892,000 gallons of ethanol. These contracts are scheduled to be satisfied throughout the remainder of 2015. 

Litigation – The Company is subject to various claims and contingencies in the ordinary course of its business, including those related to litigation, business transactions, employee-related matters, and others. When the Company is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, the Company will record a liability for the loss. If the loss is not probable or the amount of the loss cannot be reasonably estimated, the Company discloses the claim if the likelihood of a potential loss is reasonably possible and the amount involved could be material. While there can be no assurances, the Company does not expect that any of its pending legal proceedings will have a material financial impact on the Company’s operating results.

Pacific Ethanol, Inc., through a subsidiary acquired in its acquisition of Aventine, became involved in a pending lawsuit with Western Sugar Cooperative (“Western Sugar”) that pre-dated the Aventine acquisition.

On February 27, 2015, Western Sugar filed a complaint in the United States District Court for the District of Colorado (Case No. 1:15-cv-00415) naming Aventine Renewable Energy, Inc. (“ARE, Inc.”), one of Aventine’s subsidiaries, as defendant. Western Sugar amended its complaint on April 21, 2015. ARE, Inc. purchased surplus sugar through a United States Department of Agriculture program. Western Sugar was one of the entities that warehoused this sugar for ARE, Inc. The suit alleges that ARE, Inc. breached its contract with Western Sugar by failing to pay certain penalty rates for the storage of its sugar or alternatively failing to pay a premium rate for storage. Western Sugar alleges that the penalty rates apply because ARE, Inc. failed to take timely delivery or otherwise cause timely shipment of the sugar. Western Sugar claims “expectation damages” in the amount of approximately $8.6 million. ARE, Inc. filed answers to Western Sugar’s complaint and amended complaint generally denying Western Sugar’s allegations and asserting various defenses. The case is currently in its discovery phase.

The Company, through subsidiaries acquired in its acquisition of Aventine, became involved in various pending lawsuits with Aurora Cooperative Elevator Company (“Aurora Coop”) that pre-dated the Aventine acquisition.

On July 26, 2015, the Company settled all outstanding litigation with Aurora Coop. The Company and Aurora Coop agreed to dismiss all lawsuits with prejudice with no admission of fault or liability by the parties, and to release the alleged option held by Aurora Coop to repurchase the land upon which the Company’s 110 million gallon ethanol production facility in Aurora, Nebraska is located (the “Aurora West Facility”). In addition, the parties agreed to terminate the grain supply, marketing and various other agreements between them or their subsidiaries. Under the terms of the settlement, the Company and Aurora Coop will each bear its own costs and fees associated with the lawsuits and the settlement. The Company and Aurora Coop agreed to continue to work together to amend or replace certain real property easements currently in place to ensure continued mutual access by both parties to a system of rails, rail switches, roads, electrical improvements, and utilities already constructed near the Aurora West Facility.

On May 24, 2013, GS CleanTech Corporation (“GS CleanTech”), filed a suit in the United States District Court for the Eastern District of California, Sacramento Division (Case No.: 2:13-CV-01042-JAM-AC), naming Pacific Ethanol, Inc. as a defendant. On August 29, 2013, the case was transferred to the United States District Court for the Southern District of Indiana and made part of the pre-existing multi-district litigation involving GS CleanTech and multiple defendants. The suit alleged infringement of a patent assigned to GS CleanTech by virtue of certain corn oil separation technology in use at one or more of the ethanol production facilities in which the Company has an interest, including Pacific Ethanol Stockton LLC (“PE Stockton”), located in Stockton, California. The complaint sought preliminary and permanent injunctions against the Company, prohibiting future infringement on the patent owned by GS CleanTech and damages in an unspecified amount adequate to compensate GS CleanTech for the alleged patent infringement, but in any event no less than a reasonable royalty for the use made of the inventions of the patent, plus attorneys’ fees. The Company answered the complaint, counterclaimed that the patent claims at issue, as well as the claims in several related patents, are invalid and unenforceable and that the Company is not infringing. Pacific Ethanol, Inc. does not itself use any corn oil separation technology and may seek a dismissal on those grounds.

On March 17 and March 18, 2014, GS CleanTech filed suit naming as defendants two Company subsidiaries: PE Stockton and Pacific Ethanol Magic Valley, LLC (“PE Magic Valley”). The claims were similar to those filed against Pacific Ethanol, Inc. in May 2013. These two cases were transferred to the multi-district litigation division in United States District Court for the Southern District of Indiana, where the case against Pacific Ethanol, Inc. was pending. Although PE Stockton and PE Magic Valley do separate and market corn oil, Pacific Ethanol, Inc., PE Stockton and PE Magic Valley strongly disagree that either of the subsidiaries use corn oil separation technology that infringes the patent owned by GS CleanTech. In a January 16, 2015 decision, the District Court for the Southern District of Indiana ruled in favor of a stipulated motion for partial summary judgment for Pacific Ethanol, Inc., PE Stockton and PE Magic Valley finding that all of the GS Cleantech patents in the suit were invalid and, therefore, not infringed. GS Cleantech has said it will appeal this decision when the remaining claim in the suit has been decided. The only remaining claim alleges that GS Cleantech inequitably conducted itself before the United States Patent Office when obtaining the patents at issue.

A trial in the District Court for the Southern District of Indiana was conducted last month on that single issue as well as whether GS Cleantech’s behavior during prosecution of the patents renders this an exceptional case. The Company is awaiting the court’s decision. If the Defendants, including Pacific Ethanol, Inc., PE Stockton and PE Magic Valley, succeed in proving inequitable conduct, and that GS Cleantech’s behavior makes this an “exceptional case” such a finding would allow the Court to award to Pacific Ethanol, Inc., PE Stockton and PE Magic Valley the attorneys’ fees expended to date for defense in this case. It is unknown whether GS Cleantech would appeal such a ruling. The Company did not record a provision for these matters as of June 30, 2015 as Company management intends to vigorously defend these allegations and believes a material adverse ruling against Pacific Ethanol, Inc., PE Stockton and/or PE Magic Valley is not probable. The Company believes that any liability Pacific Ethanol, Inc., PE Stockton and/or PE Magic Valley may incur would not have a material adverse effect on the Company’s financial condition or its results of operations.

The Company has evaluated the above cases as well as other pending cases. The Company currently has recognized $3.3 million as a litigation contingency liability with respect to these cases for amounts that are probable and estimable.

10.  FAIR VALUE MEASUREMENTS.

The fair value hierarchy prioritizes the inputs used in valuation techniques into three levels, as follows:

The Company recorded its warrants issued from 2010 through 2013 at fair value and designated them as Level 3 on their issuance dates.

Warrants – Except for the warrants issued September 26, 2012, the Company’s warrants were valued using a Monte Carlo Binomial Lattice-Based valuation methodology, adjusted for marketability restrictions. The warrants issued September 26, 2012, due to no anti-dilution protection features, were valued using the Black-Scholes Valuation Model.

Significant assumptions used and related fair values for the warrants as of September 30, 2015 were as follows:

Significant assumptions used and related fair values for the warrants as of December 31, 2014 were as follows:

The estimated fair value of the warrants is affected by the above underlying inputs. Observable inputs include the values of exercise price, stock price, term and risk-free interest rate. As separate inputs, an increase (decrease) in either the term or risk free interest rate will result in an increase (decrease) in the estimated fair value of the warrant.

Unobservable inputs include volatility and market discount. An increase (decrease) in volatility will result in an increase (decrease) in the estimated warrant value and an increase (decrease) in the market discount will result in a decrease (increase) in the estimated warrant fair value.

The volatility utilized was a blended average of the Company’s historical volatility and implied volatilities derived from a selected peer group. The implied volatility component has remained relatively constant over time given that implied volatility is a forward-looking assumption based on observable trades in public option markets. Should the Company’s historical volatility increase (decrease) on a go-forward basis, the resulting value of the warrants would increase (decrease).

The market discount, or a discount for lack of marketability, is quantified using a Black-Scholes option pricing model, with a primary model input of assumed holding period restriction. As the assumed holding period increases (decreases), the market discount increases (decreases), conversely impacting the value of the warrant fair value.

Other Derivative Instruments – The Company’s other derivative instruments consist of commodity positions. The fair values of the commodity positions are based on quoted prices on the commodity exchanges and are designated as Level 1 inputs.

The following table summarizes fair value measurements by level at September 30, 2015 (in thousands):

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(1) Included in other current assets in the consolidated balance sheets.

(2) Included in warrant liabilities at fair value in the consolidated balance sheets.

(3) Included in accrued liabilities in the consolidated balance sheets.

The following table summarizes fair value measurements by level at December 31, 2014 (in thousands):

__________

(1) Included in other current assets in the consolidated balance sheets.

(2) Included in warrant liabilities at fair value in the consolidated balance sheets.

(3) Included in accrued liabilities in the consolidated balance sheets.

For fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs is required along with a reconciliation of Level 3 values from the prior reporting period. The changes in the Company’s fair value of its Level 3 inputs with respect to its warrants were as follows (in thousands):

11.     EARNINGS PER SHARE.

The following tables compute basic and diluted earnings per share (in thousands, except per share data):

There were an aggregate of 897,000 and 786,000 potentially dilutive weighted-average shares from the Company’s warrants and shares of Series B Cumulative Convertible Preferred Stock outstanding for the three and nine months ended September 30, 2015, respectively. These convertible securities were not considered in calculating diluted net income (loss) per share for the three and nine months ended September 30, 2015, as their effect would have been anti-dilutive.

ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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.

Recent Development

On July 1, 2015, we consummated our acquisition of Aventine Renewable Energy Holdings, Inc., now known as Pacific Ethanol Central, LLC, or Aventine, under the terms of an Agreement and Plan of Merger dated as of December 30, 2014 by and among Pacific Ethanol, Inc., AVR Merger Sub, Inc., one of our wholly-owned subsidiaries, and Aventine. Under the terms of the acquisition, Aventine became one of our wholly-owned subsidiaries.

In connection with the acquisition, each issued and outstanding share of Aventine common stock as of July 1, 2015, the effective date of the acquisition, was automatically cancelled and converted into the right to receive consideration equal to (i) 1.25 shares of our non-voting common stock, plus cash in lieu of fractional shares, for each issued and outstanding share of Aventine’s common stock, (ii) 1.25 shares of our voting common stock plus cash in lieu of fractional shares, for each issued and outstanding share of Aventine’s common stock, or (iii) a combination of non-voting common stock and voting common stock at the ratios provided above, in each case at the election or deemed election of each Aventine stockholder.

We issued approximately 14.2 million shares of our voting common stock and approximately 3.6 million shares of our non-voting common stock to the Aventine stockholders in connection with the acquisition.

We believe the Aventine acquisition will result in a number of synergies and strategic advantages. We believe the acquisition will spread commodity and basis price risks across diverse markets and products, assisting in our efforts to optimize margin management; improve our hedging opportunities with a greater correlation to the liquid physical and paper markets in Chicago; and increase our flexibility and alternatives in feedstock procurement for our Midwest and Western production facilities. The acquisition also expands our marketing reach into new markets and extends our mix of co-products. We believe the acquisition will enable us to have deeper market insight and engagement in major ethanol and feed markets outside the Western United States, thereby improving pricing opportunities; allow us to establish access to markets in 48 states for ethanol sales and access many markets with ethanol and co-product sales reaching domestic and international customers; and enable us to use our more diverse mix of co-products to generate strong co-product returns. In addition, the acquisition also increases our combined ethanol production capacity to 515 million gallons per year and our annualized ethanol marketing volume to over 800 million gallons, including Aventine’s historical volumes.

Overview

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

We own and operate eight strategically-located ethanol production facilities, four in the Western states of California, Oregon and Idaho, and four in the Midwestern states of Illinois and Nebraska. Our ethanol plants have a combined ethanol production capacity of 515 million gallons per year. We are the sixth largest producer of ethanol in the United States based on annualized volumes, including Aventine’s historical volumes.

We have extensive customer relationships throughout the United States and market and distribute ethanol and co-products domestically and internationally. Our ethanol customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline.

Our customers collectively require ethanol volumes in excess of the supplies we produce, and depend on us to provide a reliable supply of product, and manage the logistics and timing of delivery with very little effort on their side. We secure ethanol supplies from a variety of sources, including our eight ethanol production facilities, other plants in California for which we market ethanol, and other suppliers in the Midwest, where a majority of ethanol manufacturers are located. In 2014, we obtained approximately 42% of our ethanol supplies from Midwest producers to supplement ethanol produced by our plants in the Western United States. 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 also produce and market, on an annualized basis, over 1.0 million tons of ethanol co-products such as wet and dry distillers grains, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, corn oil, distillers yeast and CO₂. Customers for our distillers grains and other feed co-products include 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.

Our subsidiary, Kinergy Marketing LLC, or Kinergy, markets all the ethanol produced at our ethanol plants as well as for third parties, with an annualized marketing volume of over 800 million gallons of ethanol, including Aventine’s historical volumes.

Our ethanol plants are comprised of the eight production facilities described immediately below. The Pacific Ethanol West facilities are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. The Pacific Ethanol Central facilities are located in the heart of the Corn Belt, benefit from low-cost and abundant feedstock production and allow for access to many additional domestic markets; and our ability to load unit trains from these facilities in the Midwest allows for greater access to international markets.

Our mission is to be the leading producer and marketer of low-carbon renewable fuels in the United States. We intend to accomplish this goal in part by expanding our relationships with our current customers and establishing relationships with new customers. As we develop new customer relationships, we will seek new suppliers, including through the acquisition of additional production facilities.

Current Initiatives and Outlook

We experienced a compressed margin environment in the third quarter and throughout most of the first nine months of 2015. Overall crush and commodity margins, which reflect ethanol and co-product sales prices relative to production inputs such as corn and natural gas, remained low in 2015 compared to 2014 due to lower ethanol prices predominantly caused by higher industry-wide inventory levels. As 2015 has progressed, ethanol demand has increased and inventory levels have moderated. The ethanol stock-to-use ratio is now at its lowest level in a year, which is contributing to improved production margins in the fourth quarter of 2015. A better supply and demand balance now exists in part due to higher overall demand for gasoline as low oil prices have led to higher consumption of transportation fuels. In addition, exports continue to grow as global markets react to the economic, environmental and octane benefits of ethanol.

We remain confident in the long-term demand for renewable fuels and our ability to execute and create value. Ethanol continues to trade at a significant discount to the wholesale price of gasoline. We believe this underscores the value of ethanol as a high-octane, cleaner-burning and cheapest available liquid transportation fuel.

We expect our acquisition of Aventine to result in significant synergies in multiple areas of our business. Our goal is to achieve at least $12.0 million annualized in synergistic benefits. We believe our larger, more diversified platform yields significant benefits, including enhanced purchasing power, increased revenues, new product sales and an overall strengthened position as a low-cost producer and marketer of ethanol and high-value co-products.

On July 26, 2015, we settled all outstanding litigation with Aurora Cooperative Elevator Company, or Aurora Coop. Pacific Ethanol and Aurora Coop agreed to dismiss all lawsuits with prejudice with no admission of fault or liability by the parties, and to release the alleged option held by Aurora Coop to repurchase the land upon which Pacific Ethanol’s 110 million gallon ethanol production facility in Aurora, Nebraska is located. See “Legal Proceedings”.

In July, we began producing and selling corn oil at our Boardman, Oregon facility which completes our two-year initiative to add this high-value co-product. We now produce and sell corn oil at all of our dry mill ethanol plants, further diversifying our revenue and providing immediate incremental operating income. Production and sale of corn oil adds approximately $0.05 per gallon of incremental operating income.

The regulatory environment continues to support the long-term demand for renewable fuels. California’s Low-Carbon Fuel Standard requires refiners to reduce the carbon intensity of their fuels by 10% between 2011 and 2020, which we believe is an aggressive requirement that will necessitate a significant amount of low-carbon fuel to displace gasoline in the California fuel supply. Currently, we receive a $0.04 to $0.07 per gallon premium over Midwest ethanol on each California production gallon sold into the California market. We expect this premium to increase as the compliance curve steepens beginning in 2016.

We have undertaken a number of plant improvement initiatives. We are working on cogeneration technology at our Stockton, California plant, and are examining the feasibility of implementing the technology at our Madera, California facility. We are commercially producing cellulosic ethanol at our Stockton plant and we are working with our technology provider and the U.S. Environmental Protection Agency to qualify this ethanol for special premiums over conventional ethanol.

Our goals for the remainder of 2015 include further integrating and optimizing our Pacific Ethanol Central plants to maximize the synergies from our acquisition of Aventine; continuing to reinvest in our ethanol production business through initiatives focused on further improving operating efficiencies and yields, diversifying our feedstock, creating new revenue streams and furthering our advanced biofuels initiatives; and leveraging our state-of-the-art, strategically-located ethanol plants to expand market share, all of which are directed at expanding our share of the renewable fuels market and delivering long-term, profitable growth.

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; warrants and conversion features carried at fair value; pension and postretirement benefit plan obligations; impairment of long-lived and intangible assets; and allowance for doubtful accounts. These significant accounting principles, other than with respect to our pension and postretirement benefit plan obligations, 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, 2014. In addition, the accounting for our acquisition of assets acquired and liabilities assumed in the acquisition of Aventine involves significant estimates of their fair values.

Pension and Postretirement Benefit Plan Obligations

Liabilities associated with pension and postretirement benefit plans are primarily based on actuarial analysis. The recognition of obligations and associated expense are affected by estimates made by management, such as discount rates, investment rates of return on plan assets, increases in future wage amounts and future health care costs. Discount rates are determined based on a spot yield curve that includes bonds with maturities that match expected benefit payments under the plan.

Results of Operations

Our acquisition of Aventine was consummated on July 1, 2015, and as a result, our results of operations include Aventine’s results of operations only as of and for the three months ended September 30, 2015 and the same three month period within the nine months ended September 30, 2015. The three and nine months ended September 30, 2014 exclude Aventine’s results of operations for those periods.

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:

___________

The disparity between our average ethanol sales price per gallon and the Chicago Board of Trade, or CBOT, average reflects both the additional basis costs for West Coast delivery of ethanol as well as the premiums we receive by selling lower-carbon intensity ethanol in the Western United States.

Net Sales, Cost of Goods Sold and Gross Profit (Loss)

The following table presents our net sales, cost of goods sold and gross profit (loss) in dollars and gross profit (loss) as a percentage of net sales (in thousands, except percentages):

Net Sales

The increase in our net sales for the three months ended September 30, 2015 as compared to the same period in 2014 was primarily due to increased gallons sold from new volumes from our Pacific Ethanol Central Plants resulting from our acquisition of Aventine, partially offset by our lower average sales price. The decrease in our net sales for the nine months ended September 30, 2015 as compared to 2014 was primarily due to our lower average sales price, partially offset by an increase in gallons sold due to new volumes from our Pacific Ethanol Central plants resulting from our acquisition of Aventine.

Three Months ended September 30, 2015

Net sales of ethanol increased by $65.7 million, or 26%, to $315.6 million for the three months ended September 30, 2015 as compared to $249.9 million for the three months ended September 30, 2014. Our total volume of ethanol gallons sold increased by 77.9 million gallons, or 33%, to 211.6 million gallons for the three months ended September 30, 2015 as compared to 133.7 million gallons for the same period in 2014. Total gallons sold as a producer or merchant increased 62.8 million gallons and 16.2 million gallons, respectively, for the three months ended September 30, 2015 as compared to the same period in 2014. At our average sales price per gallon of $1.67 for the three months ended September 30, 2015, we generated $134.8 million in additional net sales from the 79.0 million additional gallons of ethanol sold as a producer or merchant for the period as compared to the same period in 2014. In addition, we sold 1.1 million fewer gallons as an agent during the period. The 1.1 million fewer gallons of ethanol sold as an agent had an immaterial impact on our net sales for the three months ended September 30, 2015. The decline of $0.65, or 28%, in our average sales price per gallon for the three months ended September 30, 2015 as compared to the same period in 2014 reduced our net sales by $69.1 million.

Net sales of co-products increased by $39.3 million, or 153%, to $65.0 million for the three months ended September 30, 2015 as compared to $25.7 million for the same period in 2014. Our total volume of co-products sold increased by 285,000 tons to 670,000 tons for the three months ended September 30, 2015 from 385,000 tons for the same period in 2014. Our average sales price per ton of co-products increased by $28.68, or 45%, to $93.02 for the three months ended September 30, 2015 as compared to $64.34 per ton of co-product for the three months ended September 30, 2014. At our average sales price per ton of $93.02 for the three months ended September 30, 2015, we generated $11.0 million in additional net sales from the 285,000 additional tons of co-products sold in the third quarter of 2015 as compared to the same period in 2014. The increase of $28.68 in our average sales price per ton for the three months ended September 30, 2015 as compared to the same period in 2014 increased our net sales by $28.3 million.

We increased both production and third party gallons sold, as well as our volume of co-products sold, for the three months ended September 30, 2015 as compared to the same period in 2014 primarily due to new volumes from our Pacific Ethanol Central plants resulting from our acquisition of Aventine.

Nine Months ended September 30, 2015

Net sales of ethanol declined by $65.5 million, or 9%, to $698.8 million for the nine months ended September 30, 2015 as compared to $764.3 million for the nine months ended September 30, 2014. Our total volume of ethanol gallons sold increased by 109.4 million gallons, or 29%, to 488.0 million gallons for the nine months ended September 30, 2015 as compared to 378.6 million gallons for the same period in 2014. Total gallons sold as a producer or merchant increased 68.6 million gallons and 47.1 million gallons, respectively, for the nine months ended September 30, 2015 as compared to the same period in 2014. At our average sales price per gallon of $1.69 for the nine months ended September 30, 2015, we generated $197.1 million in additional net sales from the 115.7 million additional gallons of ethanol sold as a producer or merchant for the period as compared to the same period in 2014. In addition, we sold 6.3 million fewer gallons as an agent during the period. The 6.3 million fewer gallons of ethanol sold as an agent had an immaterial impact on our net sales for the nine months ended September 30, 2015. The decline of $0.90, or 35%, in our average sales price per gallon for the nine months ended September 30, 2015 as compared to the same period in 2014 reduced our net sales by $262.6 million.

Net sales of co-products increased $28.6 million, or 33%, to $115.6 million for the nine months ended September 30, 2015 as compared to $87.0 million for the same period in 2014. Our total volume of co-products sold increased by 297,300 tons to 1,398,100 tons for the nine months ended September 30, 2015 from 1,100,800 tons for the same period in 2014. Our average sales price per ton of co-products increased by $2.39, or 3%, to $79.84 for the nine months ended September 30, 2015 as compared to $77.45 per ton of co-product for the nine months ended September 30, 2014. At our average sales price per ton of $79.84 for the nine months ended September 30, 2015, we generated $26.0 million in additional net sales from the 297,300 additional tons of co-products sold in the first nine months of 2015 as compared to the same period in 2014. The increase of $2.39 in our average sales price per ton for the nine months ended September 30, 2015 as compared to the same period in 2014 increased our net sales by $2.6 million.

We increased both production and third party gallons sold, as well as our volume of co-products sold, for the nine months ended September 30, 2015 as compared to the same period in 2014 primarily due to new volumes from our Pacific Ethanol Central plants resulting from our acquisition of Aventine as well as a result of the restart of production at our Madera plant in the second quarter of 2014.

Cost of Goods Sold and Gross Profit (Loss)

Three Months ended September 30, 2015

Our gross profit declined to a gross loss of $7.4 million for the three months ended September 30, 2015 from a gross profit of $18.0 million for the same period in 2014. Our gross margin declined to negative 1.9% for the three months ended September 30, 2015 from a gross margin of 6.5% for the same period in 2014. Our gross profit and gross margin declined primarily due to significantly lower crush and commodity margins realized at our plants, predominantly related to lower ethanol sales prices relative to corn costs caused by industry-wide excess ethanol supply relative to demand. In addition, we realized approximately $8.7 million in purchase accounting adjustments in our costs of goods sold for the three months ended September 30, 2015 related to our acquisition of Aventine.

Of the $25.4 million decline in gross profit for the three months ended September 30, 2015 as compared to the same period in 2014, gross loss of $28.6 million related to our total production gallons sold and gross profit of $3.2 million related to our merchant sales. Our production gallons sold increased by 62.8 million gallons in the three months ended September 30, 2015 as compared to the same period in 2014. Of the $28.6 million in gross loss resulting from our total production gallons sold, $21.8 million is attributable to our lower gross margins in the third quarter of 2015 and $6.8 million is attributable to the 62.8 million gallon increase in production gallons sold in the third quarter of 2015 as compared to the same period in 2014. Of the $3.2 million in higher gross profit resulting from our merchant sales, $2.2 million is attributable to our higher gross margins for these sales in the third quarter of 2015 and $1.0 million is attributable to the 16.2 million gallon increase in merchant gallons sold in the third quarter of 2015 as compared to the same period in 2014.

Nine Months ended September 30, 2015

Our gross profit declined to a gross loss of $2.1 million for the nine months ended September 30, 2015 from a gross profit of $90.1 million for the same period in 2014. Our gross margin declined to negative 0.3% for the nine months ended September 30, 2015 from a gross margin of 10.6% for the same period in 2014. Our gross profit and gross margin declined primarily due to significantly lower crush and commodity margins realized at our plants, predominantly related to lower ethanol sales prices relative to corn costs caused by industry-wide excess ethanol supply relative to demand. In addition, we realized approximately $8.7 million in purchase accounting adjustments in our costs of goods sold for the nine months ended September 30, 2015 related to our acquisition of Aventine.

Of the $92.2 million decline in gross profit for the nine months ended September 30, 2015 as compared to the same period in 2014, gross loss of $93.5 million related to our total production gallons sold and gross profit of $1.3 million related to our merchant sales. Our production gallons sold increased by 68.6 million gallons in the nine months ended September 30, 2015 as compared to the same period in 2014. Of the $93.5 million in lower gross profit resulting from our total production gallons sold, $90.3 million is attributable to our lower gross margins in the first nine months of 2015 and $3.2 million is attributable to the 68.6 million gallon increase in production gallons sold in the first nine months of 2015 as compared to the same period in 2014. Of the $1.3 million in higher gross profit resulting from our merchant sales, $1.7 million is attributable to the 47.1 million gallon increase in merchant gallons sold in the first nine months of 2015 as compared to the same period in 2014, partially offset by $0.4 million in lower gross profit related to our lower gross margins for these sales in the first nine months of 2015 as compared to the same period in 2014.

Selling, General and Administrative Expenses

The following table presents our selling, general and administrative, or SG&A, expenses in dollars and as a percentage of net sales (in thousands, except percentages):

Our SG&A expenses increased $3.1 million to $7.5 million for the three months ended September 30, 2015 as compared to $4.4 million for the same period in 2014, and increased as a percentage of net sales for the three months ended September 30, 2015 as compared to the same period in 2014. The increase in SG&A expenses is primarily due to additional SG&A expenses of $3.0 million associated with our new Pacific Ethanol Central operations resulting from our acquisition of Aventine.

Our SG&A expenses increased $4.0 million to $16.4 million for the nine months ended September 30, 2015 as compared to $12.4 million for the same period in 2014. The increase in SG&A expenses is due to additional SG&A expenses of $3.0 million associated with our new Pacific Ethanol Central operations resulting from our acquisition of Aventine and an increase in professional fees of $1.0 million due to costs largely associated with our acquisition of Aventine, which were partially offset by a reduction in compensation costs of $0.5 million due to a decline in incentive compensation compared to the prior year.

At current operating levels, including our Pacific Ethanol Central operations, we are targeting our SG&A expenses at approximately $7.0 million for the fourth quarter of 2015.

Fair Value Adjustments and Warrant Inducements

The following table presents our fair value adjustments and warrant inducements in dollars and as a percentage of net sales (in thousands, except percentages):

We issued warrants in various financing transactions from 2010 through 2013. These warrants were initially recorded at fair value and are adjusted quarterly. As a result of quarterly fair value adjustments and warrant inducements, we recorded income of $1.2 million and expense of $4.4 million for the three months ended September 30, 2015 and 2014, respectively, and we recorded income of $1.4 million and expense of $39.7 million for the nine months ended September 30, 2015 and 2014, respectively.

These changes in fair value are primarily due to the volatility in the market price of our common stock from period to period. The substantial change in fair value for the nine months ended September 30, 2014 occurred because the exercise prices of our warrants were, as of September 30, 2014, well below the market price of our common stock. At December 31, 2013, the market price of our common stock was $5.09 per share and our outstanding warrants had a weighted-average exercise price of $7.27 per share. At September 30, 2014, the market price of our common stock had increased to $13.96 per share, and our outstanding warrants were in-the-money and had significant intrinsic value.

These fair value adjustments will continue in future periods until all of our warrants are exercised or expire. These adjustments will generally reduce our net income or increase our net loss if the market price of our common stock increases from the prior quarter through the date of a warrant’s exercise, if exercised during the quarter, or if our common stock increases on a quarter over quarter basis for warrants outstanding at the end of a quarter. Conversely, the adjustments will generally increase our net income or reduce our net loss if the market price of our common stock declines on a quarter over quarter basis.

We paid an aggregate of $1.5 million and $2.3 million in cash to certain warrant holders as an inducement to exercise their warrants and recorded an equivalent expense for the three and nine months ended September 30, 2014, respectively.

Interest Expense, net

The following table presents our interest expense, net in dollars and as a percentage of net sales (in thousands, except percentages):

Interest expense, net increased $4.0 million to $5.2 million for the three months ended September 30, 2015 from $1.1 million for the same period in 2014. The increase in interest expense, net is primarily related to our increased term debt outstanding due to Aventine’s $145.6 million in term debt. Interest expense, net declined by $1.2 million to $7.2 million for the nine months ended September 30, 2015 from $8.4 million for the same period in 2014. The decrease in interest expense, net is primarily due to decreased average debt balances, partially offset by accelerations of debt discount and deferred financing fees of an aggregate of $2.5 million for the nine months ended September 30, 2014, due to the early retirement of the indebtedness associated with our Pacific Ethanol West plants and our senior unsecured notes.

Loss on Extinguishments of Debt

The following table presents our loss on extinguishments of debt in dollars and as a percentage of net sales (in thousands, except percentages):

For the nine months ended September 30, 2014, we extinguished certain PE Op Co. debt by paying $2.4 million in cash in excess of the amount of the debt, and as such, recorded a loss on extinguishments of debt. We retired a total of $64.8 million in debt in the nine months ended September 30, 2014, eliminating all parent level debt and reducing our consolidated third-party debt at the plant level to $17.0 million as of September 30, 2014.

Other Income (Expense), net

The following table presents our other income (expense), net in dollars and as a percentage of net sales (in thousands, except percentages):

Other income (expense), net increased by $0.4 million to income of $0.2 million for the three months ended September 30, 2015 from an expense of $0.2 million for the same period in 2014. Other income (expense), net increased by $0.8 million to income of $0.1 million for the nine months ended September 30, 2015 from an expense of $0.7 million for the same period in 2014. These increases in other income (expense), net are primarily due to a payment received from a one-time settlement of a claim.

Provision (Benefit) for Income Taxes

The following table presents our provision (benefit) for income taxes in dollars and as a percentage of net sales (in thousands, except percentages):

For the three and nine months ended September 30, 2015, we recorded a benefit for income taxes of $2.4 million and $4.6 million, respectively, at an estimated effective tax rate. In addition, for the three and nine months ended September 30, 2015, we recognized $1.5 million in tax benefit related to adjustments to our tax asset valuation allowance from a prior period. For the three and nine months ended September 30, 2014, we generated income subject to income tax, partially as a result of the non-tax deductible nature of our fair value adjustments for the period. As a result, we recorded a gross provision for income taxes of $13.6 million for the nine months ended September 30, 2014.

Net (Income) Loss Attributed to Noncontrolling Interests

The following table presents the portion of our net (income) loss attributed to noncontrolling interests in dollars and as a percentage of net sales (in thousands, except percentages):

Net (income) loss attributed to noncontrolling interests relates to our consolidated treatment of PE Op Co., which indirectly owns our plants located in the Western United States. For the three and nine months ended September 30, 2015 and 2014, we consolidated the entire income statement of PE Op Co. However, because we owned less than 100% of PE Op Co. for portions of the three and nine months ended September 30, 2015 and 2014, respectively, we reduced our consolidated net income (loss) for the noncontrolling interests, which were the ownership interests that we did not own. The decreases in net income attributed to noncontrolling interests for the periods are primarily due to lower operating income from lower commodity margins, much of which was generated at the plant level. Going forward, given our 100% ownership of PE Op Co., no amounts will be recorded for noncontrolling interests.

Net Income (Loss) Attributed to Pacific Ethanol

The following table presents our net income (loss) attributed to Pacific Ethanol in dollars and as a percentage of net sales (in thousands, except percentages):

Net income attributed to Pacific Ethanol decreased substantially during the three and nine months ended September 30, 2015 as compared to the same periods in 2014, primarily due to significantly lower crush and commodity margins in 2015 resulting predominantly from lower ethanol sales prices.

Preferred Stock Dividends and Income (Loss) Available to Common Stockholders

The following table presents our preferred stock dividends in dollars for our Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock, these preferred stock dividends as a percentage of net sales, and our income (loss) available to common stockholders in dollars and as a percentage of net sales (in thousands, except percentages):