Alto Ingredients, Inc. - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2020

☐ 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

PACIFIC ETHANOL, INC.

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒

As of August 12, 2020, there were 56,985,217 shares of Pacific Ethanol, Inc. common stock, $0.001 par value per share, and 896 shares of Pacific Ethanol, Inc. non-voting common stock, $0.001 par value per share, outstanding.

PART I - FINANCIAL INFORMATION

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

See accompanying notes to consolidated financial statements.

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

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.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(unaudited, in thousands)

See accompanying notes to consolidated financial statements.

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 subsidiaries, Kinergy Marketing LLC, an Oregon limited liability company (“Kinergy”), Pacific Ag. Products, LLC, a California limited liability company (“PAP”), PE Op Co., a Delaware corporation (“PE Op Co.”) and all nine of the Company’s ethanol production facilities through April 15, 2020. As discussed in Note 2, on April 15, 2020, the Company completed the sale of its ownership interests in Pacific Aurora, LLC (“Pacific Aurora”), thereby divesting the Company’s two ethanol production facilities located in Nebraska.

The Company is a leading producer and marketer of high quality alcohol products and low-carbon renewable fuels in the United States. The Company’s plants in Illinois and Nebraska (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. In addition, the Company’s ability to load unit trains from these facilities in the Midwest allows for greater access to international markets. The Company’s four ethanol plants in California, Oregon and Idaho (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.

Following the Company’s sale of its interest in Pacific Aurora, the Company has a combined production capacity of 450 million gallons per year, markets, on an annualized basis, nearly 1.0 billion gallons combined of high quality alcohol and ethanol, based on historical volumes, and produces, on an annualized basis, nearly 3.0 million tons of co-products on a dry matter basis, such as wet and dry distillers grains, wet and dry corn gluten feed, condensed distillers solubles, corn gluten meal, corn germ, dried yeast and CO₂, based on historical volumes.

As of June 30, 2020, the Company was operating at approximately 50% of its 450 million gallon annual production capacity. As market conditions change, the Company may increase, decrease or idle production at one or more operating facilities or resume operations at any idled facility.

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, 2019. 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, 2019. 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.

Liquidity – The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. During the three months ended June 30, 2020, the Company continued to experience significant adverse conditions in the ethanol fuel market as demand and pricing were at record lows due to reduced domestic transportation and resulting lower gasoline demand. In response, the Company reduced production at its facilities by more than 50% in an effort to conserve capital as a result of the substantial reduction in fuel ethanol demand due to stay-at-home orders issued in response to the coronavirus pandemic. The Company, however, has not only continued producing and selling its high quality alcohol, but also converted a portion of its fuel-grade ethanol production to higher quality alcohol to respond to increased demand from the sanitizer and disinfectant markets. These sales of high quality alcohol were at a mix of fixed and spot pricing, both of which resulted in positive net income and cash flows from operations during the quarter. The Company expects robust demand for its high quality alcohol to continue for at least the next twelve months as the Company continues to enter fixed-price contracts and hedge corn input costs, locking in profit margins on sales of high quality alcohol.

At June 30, 2020, the Company had $29.8 million in cash and $10.0 million available under Kinergy’s operating line of credit. During the first half of 2020, the Company generated $45.7 million in cash from its operations and realized $19.9 million in net cash proceeds from the sale of its interest in Pacific Aurora. These positive cash flows have allowed the Company to make net payments totaling $52.3 million on its debt. Further, subsequent to June 30, 2020, the Company made an additional $9.2 million in payments on its term debt.

The Company, as previously agreed with its lenders, has presented and continues to negotiate a comprehensive plan to restructure its assets and liabilities. The Company has appointed a chief restructuring officer to facilitate the development of such a plan and to assist in the Company’s current strategic initiatives. The Company expects the negotiated plan may include additional assets sales, soliciting new investments in its assets, further debt payments and further reductions to overhead expenses.

The Company believes that as of the date of this report, it is in compliance with all debt covenants contained in its credit facilities, except the Company’s obligation to obtain lender approval of a comprehensive plan to restructure its assets and liabilities with respect to its Pekin and ICP lenders. The Company has appointed a chief restructuring officer to facilitate the development of such a plan and has presented and continues to negotiate the plan with its lenders. As a result, the Company is not in compliance with its obligations to its lenders, which could result in their acceleration of the Company’s debt. Although the Company does not expect such an outcome, especially in light of its financial performance and debt prepayments during the second quarter and thereafter, the Company does not have sufficient liquidity or capital resources to immediately repay its debt if accelerated. Even though the Company doesn’t believe acceleration is probable, it has classified its related debt as current on the Company’s consolidated balance sheets. Given the above noted projected cash flows from operations and debt repayments, the Company believes it has alleviated substantial doubt about its ability to continue as a going concern. Therefore, the Company believes it has sufficient liquidity to meet its anticipated working capital, debt service and other liquidity needs for the next twelve months.

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 distillers grains and other feed co-products to dairy operators and animal feedlots and sells corn oil to 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 $40,772,000 and $63,736,000 at June 30, 2020 and December 31, 2019, respectively, were used as collateral under Kinergy’s operating line of credit. The allowance for doubtful accounts was $16,000 and $39,000 as of June 30, 2020 and December 31, 2019, respectively. The Company recorded a bad debt recovery of $18,000 and a bad debt expense of $1,000 for the three months ended June 30, 2020 and 2019, respectively. The Company recorded a bad debt expense of $1,000 and $27,000 for the six months ended June 30, 2020 and 2019, respectively.

Financial Instruments – The carrying values of cash and cash equivalents, accounts receivable, derivative assets, accounts payable, accrued liabilities and derivative liabilities are reasonable estimates of their fair values because of the short maturity of these items. The carrying value of the Company’s senior secured notes were recorded at fair value at December 31, 2019 and are considered Level 2 fair value measurements. The Company believes their carrying value approximates fair value at June 30, 2020. The Company believes the carrying value of its notes receivable are not considered materially different than fair value due to their recent issuances, and other long-term debt instruments are not considered materially different than fair value because the interest rates on these instruments are variable, and are considered Level 2 fair value measurements.

Estimates and Assumptions – The preparation of the consolidated financial statements in conformity with GAAP 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 allowance for doubtful accounts, net realizable value of inventory, estimated lives of property and equipment, 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, and the valuation of assets acquired and liabilities assumed as a result of business combinations. Actual results and outcomes may materially differ from management’s estimates and assumptions.

On December 19, 2019, Pacific Ethanol Central, LLC (“PE Central”) entered into a term sheet covering the proposed sale of its 73.93% ownership interest in Pacific Aurora to Aurora Cooperative Elevator Company (“ACEC”) for $52.8 million, and as a result, the Company determined that as of December 31, 2019, the long-lived assets of Pacific Aurora should be classified as held-for-sale.

On April 15, 2020, the Company closed the sale of its ownership interest in Pacific Aurora and preliminarily received total consideration of $52.8 million, subject to working capital adjustments of approximately $35.3 million, resulting in cash proceeds of $19.9 million and the balance of $16.5 million in long-term ACEC promissory notes, resulting in a net loss on sale of approximately $1.4 million, recorded as other income (expense) in the Company’s consolidated statements of operations. Approximately $14.5 million of the cash proceeds were used to repay a portion of the Company’s term debt.

The Company received two promissory notes in the amounts of $8.6 million and $7.9 million as part consideration for the sale, both maturing on April 15, 2025. The $8.6 million note accrues interest at an annual rate of 5.00%. Interest payments are due quarterly beginning July 1, 2020 and principal payments of $0.4 million are due quarterly beginning July 1, 2021. The $7.9 million note accrues interest at an annual rate of 4.50%. Interest payments are due quarterly beginning July 1, 2020 and principal payments of $0.4 million are due quarterly beginning January 3, 2022.

In addition, upon the sale, the Company no longer has noncontrolling interests on its balance sheet and no longer records income (loss) of noncontrolling interests for future periods.

For the three months ended June 30, 2020 and 2019, Pacific Aurora contributed less than $0.1 million and $45.4 million in net sales, $0.5 million and $2.5 million in pre-tax loss, and $0.1 million and $0.6 million in net loss attributed to noncontrolling interests, respectively. For the six months ended June 30, 2020 and 2019, Pacific Aurora contributed $39.6 million and $81.9 million in net sales, $8.4 million and $7.4 million in pre-tax loss, and $2.2 million and $1.9 million in net loss attributed to noncontrolling interests, respectively.

The Company reports its financial and operating performance in two segments: (1) ethanol production, which includes the production and sale of high quality alcohol, ethanol and co-products, with all of the Company’s production facilities aggregated, and (2) marketing and distribution, which includes marketing and merchant trading for Company-produced high quality alcohol, ethanol and co-products and third-party ethanol.

The following tables set forth certain financial data for the Company’s operating segments (in thousands):

The following table sets forth the Company’s total assets by operating segment (in thousands): 

Inventories consisted primarily of bulk high quality alcohol, ethanol, corn, co-products, low-carbon and Renewable Identification Number (“RIN”) credits and unleaded fuel, and are valued at the lower-of-cost-or-net realizable value, with cost determined on a first-in, first-out basis. Inventory is net of a $0 and $1,290,000 valuation adjustment as of June 30, 2020 and December 31, 2019, respectively. Inventory balances consisted of the following (in thousands):

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

PE Pekin Credit Facilities – On March 20, 2020, Pacific Ethanol Pekin, LLC (“PE Pekin”) and its lender agreed to defer $1.0 million in aggregate interest payments due March 20, 2020 and April 20, 2020 until May 20, 2020. On that same date, the Company granted to the lender a security interest in all of the Company’s equity interests in PE Op Co., which indirectly owns the Company’s plants located on the West Coast. The Company and certain subsidiaries also entered into intercreditor agreements with the PE Pekin and Illinois Corn Processing, LLC (“ICP”) lenders, and the agent for the Company’s senior secured noteholders, to address issues of priority and the allocation of proceeds from asset sales. In July 2020, the Company reached a confidential settlement of an outstanding dispute resulting in a gain and cash proceeds of approximately $11.8 million. The Company used a portion of these funds to make approximately $7.4 million in additional principal payments on PE Pekin’s term debt.

ICP Credit Facilities – On March 20, 2020, ICP and its lender agreed to defer a $1.5 million principal payment due March 20, 2020 and $0.3 million in aggregate interest payments due March 20, 2020 and April 20, 2020 until May 20, 2020. On that same date, the Company granted to the lender a security interest in all of the Company’s equity interests in PE Op Co. The Company and certain of its subsidiaries also entered into intercreditor agreements with the PE Pekin and ICP lenders, and the agent for the Company’s senior secured noteholders, to address issues of priority and the allocation of proceeds from asset sales. The Company used a portion of the proceeds from the settlement noted above, in July 2020, to make approximately $1.8 million in additional principal payments on ICP’s term debt.

CARES Act Loans – On May 4, 2020, Pacific Ethanol, Inc. and PE Pekin received loan proceeds from Bank of America, NA under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), through the Paycheck Protection Program administered by the U.S. Small Business Administration. Pacific Ethanol, Inc. received $6.0 million and PE Pekin received $3.9 million in loan proceeds. The loans mature in two years and bear interest at a rate of 1.00% per annum. Under the terms of the loans, certain amounts may be forgiven if they are used for qualifying expenses as described in the CARES Act, but the Company can provide no assurance that it will be able to obtain forgiveness of all or any portion of the loans.

Restrictions – At June 30, 2020, there were approximately $204.4 million of net assets at the Company’s 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 the Company’s subsidiaries.

Sales Commitments – At June 30, 2020, the Company had entered into sales contracts with its major customers to sell certain quantities of ethanol and co-products. The Company had open ethanol indexed-price contracts for 5,169,000 gallons of ethanol as of June 30, 2020 and open fixed-price ethanol and high quality alcohol sales contracts totaling $226,845,000 as of June 30, 2020. The Company had open fixed-price co-product sales contracts totaling $9,320,000 and open indexed-price co-product sales contracts for 179,000 tons as of June 30, 2020. These sales contracts are scheduled to be completed throughout 2020 and 2021.

Purchase Commitments – At June 30, 2020, the Company had indexed-price purchase contracts to purchase 35,476,000 gallons of ethanol and fixed-price purchase contracts to purchase $7,766,000 of ethanol from its suppliers. The Company had fixed-price purchase contracts to purchase $7,669,000 of corn from its suppliers as of June 30, 2020. These purchase commitments are scheduled to be satisfied throughout 2020. In July 2020, the Company entered into derivative contracts to hedge its corn costs for its fixed sales contracts.

Litigation – General – 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, environmental regulations, 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 impact on the Company’s financial condition or results of operations.

The Company sponsors a defined benefit pension plan (the “Retirement Plan”) and a health care and life insurance plan (the “Postretirement Plan”). The Company assumed the Retirement Plan and the Postretirement Plan as part of its acquisition of PE Central on July 1, 2015.

The Retirement Plan is noncontributory, and covers only “grandfathered” 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 Retirement Plan, which is part of a collective bargaining agreement, covers only union employees hired prior to November 1, 2010.

The Company uses a December 31 measurement date for its Retirement Plan. The Company’s funding policy is to make the minimum annual contribution required by applicable regulations. As of December 31, 2019, the Retirement Plan’s accumulated projected benefit obligation was $21.6 million, with a fair value of plan assets of $15.7 million. The underfunded amount of $5.9 million is recorded on the Company’s consolidated balance sheet in other liabilities.

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 dollar cap based upon years of service. As of December 31, 2019, the Postretirement Plan’s accumulated projected benefit obligation was $5.3 million and is recorded on the Company’s consolidated balance sheet in other liabilities. The Company’s funding policy is to make the minimum annual contribution required by applicable regulations.

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

Pooled separate accounts – Pooled separate accounts invest primarily in domestic and international stocks, commercial paper or single mutual funds. The net asset value is used as a practical expedient to determine fair value for these accounts. Each pooled separate account provides for redemptions by the Retirement Plan at reported net asset values per share, with little to no advance notice requirement, therefore these funds are classified within Level 2 of the valuation hierarchy.

Warrants – The Company’s warrants issued December 22, 2019, were valued using the Black-Scholes Valuation Model.

Significant assumptions used and related fair value for the warrants as of June 30, 2020 were as follows:

Significant assumptions used and related fair value for the warrants as of December 31, 2019 were as follows:

The fair values of the warrants are based on unobservable inputs and are designated as Level 3 inputs.

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 recurring and nonrecurring fair value measurements by level at June 30, 2020 (in thousands):

The following table summarizes recurring and nonrecurring fair value measurements by level at December 31, 2019 (in thousands):

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

There were an aggregate of 635,000 potentially dilutive weighted-average shares from convertible securities outstanding for the three and six months ended June 30, 2020 and 2019. These convertible securities were not considered in calculating diluted net income (loss) per share for the periods presented, as their effect would have been anti-dilutive.

Restricted Net Assets – At June 30, 2020, the Company had approximately $204,432,000 of net assets at its subsidiaries that were not available to be transferred to Pacific Ethanol in the form of dividends, distributions, loans or advances due to restrictions contained in the credit facilities of these subsidiaries.

Parent company financial statements for the periods covered in this report are set forth below (in thousands):

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 high quality alcohol products and low-carbon renewable fuels in the United States.

We operate seven strategically-located production facilities. Three of our plants are located in the Midwestern state of Illinois and four of our plants are in the Western states of California, Oregon and Idaho. We are the seventh largest ethanol producer in the United States based on annualized production capacity. Our plants have a combined high quality alcohol and fuel ethanol production capacity of 450 million gallons per year. We market all the high quality alcohol, ethanol and co-products produced at our plants as well as ethanol produced by third parties. In 2019, we marketed nearly 1.0 billion gallons combined of high quality alcohol and ethanol, and nearly 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 be a leading producer and marketer of high quality alcohol products, low-carbon renewable fuels and high-value animal feed in the United States. We intend to accomplish this goal in part by investing in our production and distribution infrastructure, lowering the carbon intensity of our products, 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 high quality alcohol, ethanol and co-products at our production facilities described below. 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 and barges from our Pekin, Illinois plants, allows for greater access to international markets. Our plants located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages.

Currently, we are operating at approximately 52% of production capacity. As market conditions change, we may increase, decrease or idle production at one or more operating facilities or resume operations at any idled facility.

We produce high quality alcohol and 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 CO₂.

Marketing Segment

We market high quality alcohol products, low-carbon ethanol, high protein feed and co-products produced by our facilities. We also market fuel ethanol produced by third parties.

We have extensive and long-standing customer relationships, both domestic and international, for our high quality alcohol products. These customers include producers and distributors of ingredients for cosmetics, sanitizers and related products, distilled spirits producers, food products manufacturers, producers of personal health/consumer health and personal care hygiene products, and global trading firms.

Our fuel ethanol customers are located throughout the Western and Midwestern United States and consist of integrated oil companies and gasoline marketers who blend ethanol into gasoline. Our customers depend on us to provide a reliable supply of fuel 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 Western 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 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 producers.

See “Note 3 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments.

Current Initiatives and Outlook

In the second quarter, we experienced an excellent margin environment for our high quality alcohol, reflecting the benefits of our diversification strategy, expanded production and robust demand for our products used in sanitizers and disinfectants due to the ongoing coronavirus pandemic. To meet increased demand, we focused on debottlenecking production and other process improvements to generate additional production capacity for high quality alcohol of 25 million gallons per year at our Pekin campus. In addition, we continue to modify and refurbish existing equipment to further increase production capacity of USP-grade alcohol by an additional 30 million gallons per year by the end of 2020. As we move into 2021, our Pekin campus will have total production capacity for high quality alcohol of 140 million gallons per year, the majority of which will meet or exceed USP specifications.

Our high quality alcohol products consistently achieve significantly better margins than fuel ethanol. Moreover, high-quality alcohol is typically sold at fixed prices and volumes with longer-term commitments than fuel ethanol, allowing us to lock in our input costs over the contract term and better secure favorable margins. The majority of our high quality alcohol production is contracted through 2020, and we are building a strong book of sales for 2021 as we add new customers and renew existing contracts.

The market for high quality alcohol requires that manufacturers have specialized equipment and systems, and also strong quality controls, experience and operational capabilities to produce alcohol products that meet customers’ precise and unique specifications. The coronavirus pandemic significantly increased demand for sanitizers and disinfectants, which quickly outstripped available supplies. In response, the federal government temporarily loosened quality-control requirements, which had the unintended consequence of allowing questionable third-party products into the marketplace. We expect that quality-control requirements will be retightened, highlighting a competitive advantage we hold over various third-party producers.

Our Pekin campus has produced industrial, chemical and beverage grade alcohol for over 100 years. We have new as well as many long-standing relationships with key domestic and international customers who benefit from our quality products, service and logistics advantages, including our ability to ship products via truck, rail or barge. Given our quality control capabilities, we intend to continue to meet or exceed our stringent customer and regulatory standards.

We also continue to enjoy strong demand for our high protein meal and dried yeast products, which our Pekin facilities have manufactured for over 20 years. For example, we offer a high quality yeast used in pet and human food and a high protein corn meal used in poultry, pet food and aquaculture. Despite the slowdown in our production of fuel ethanol co-products as a result of the coronavirus pandemic, we have been able to consistently maintain production of these high value products at our Pekin campus, resulting in strong co-product returns.

With regard to our fuel grade ethanol operations, we continued to experience a poor margin environment in the second quarter resulting from low demand from the impact of the coronavirus pandemic. Industry-wide ethanol production had declined by more than 50% at the beginning of the second quarter. Most of our fuel ethanol commitments for the quarter were met through our third party marketing business.

Although we have seen some resurgence in both production and demand, the current market environment for fuel ethanol remains volatile and uncertain, with overall demand off by more than 10% from a year ago. In addition, fuel ethanol production crush margins remain variable and unpredictable over the longer term. Given these market conditions, we do not intend to restart our idled fuel ethanol plants in the Western states until we can better secure positive forward operating margins for the facilities. We anticipate that reopening may also entail either repurposing certain facilities or restarting with high value complementary or differentiated products. We are considering all options for maximizing or monetizing the value of our fuel ethanol plants, and we are in discussions with various parties in this regard.

We continue to pursue a number of strategic initiatives focused on the sale of additional production assets, a reduction of our debt levels, a strengthening of our cash and liquidity position, and opportunities for strategic partnerships and capital raising activities, positioning us to optimize our business performance.

We remain focused on implementing initiatives and investing in our assets to further diversify our sales through additional products and revenue streams, improve our production yields and other operating efficiencies, and reduce costs, both at the operating and corporate levels.

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 and held-for-sale classification; valuation of allowance for deferred taxes and derivative instruments. 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, 2019.

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, Cost of Goods Sold and Gross Profit (Loss)

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

Net Sales

The decline in our net sales for the three and six months ended June 30, 2020 as compared to the same periods in 2019 was primarily due to a significant decline in our ethanol production gallons sold.

We sold fewer ethanol production gallons and co-products for the three and six months ended June 30, 2020 as compared to the same periods in 2019. These declines are primarily due to significantly reduced transportation fuel demand from the effects of stay-at-home orders as a result of the coronavirus pandemic. As a result, we reduced our production capacity utilization to 40% on a consolidated basis in the second quarter. Demand for our high quality alcohol, however, increased significantly in the sanitizer and disinfectant markets. These markets have historically, and even more so in the second quarter, provided a premium price over fuel ethanol markets. Our third-party gallons sold declined in the quarter, but less than the decline in overall ethanol demand, as most of our fuel ethanol commitments for the quarter were met through our third party marketing business.

Three Months Ended June 30, 2020 and 2019

On a consolidated basis, our average sales price per gallon declined 1.2% to $1.59 for the three months ended June 30, 2020 compared to $1.61 for the same period in 2019. The average Chicago Board of Trade, or CBOT, ethanol price per gallon, declined 23.4% to $1.08 for the three months ended June 30, 2020 compared to $1.41 for the same period in 2019.

Production Segment

Net sales of alcohol and ethanol from our production segment declined by $89.1 million, or 46%, to $105.3 million for the three months ended June 30, 2020 as compared to $194.4 million for the same period in 2019. Our total volume of production gallons sold declined by 61.7 million gallons, or 52%, to 56.9 million gallons for the three months ended June 30, 2020 as compared to 118.6 million gallons for the same period in 2019. Our production segment’s average sales price per gallon increased 13% to $1.85 for the three months ended June 30, 2020 compared to $1.64 for the same period in 2019. At our production segment’s average sales price per gallon of $1.85 for the three months ended June 30, 2020, we generated $114.3 million less in net sales from our production segment from the 61.7 million fewer gallons of produced alcohol and ethanol sold in the three months ended June 30, 2020 as compared to the same period in 2019. The increase of $0.21 in our production segment’s average sales price per gallon for the three months ended June 30, 2020 as compared to the same period in 2019 increased our net sales of alcohol and ethanol from our production segment by $25.2 million.

Net sales of co-products declined $29.4 million, or 45%, to $35.3 million for the three months ended June 30, 2020 as compared to $64.7 million for the same period in 2019. Our total volume of co-products sold declined by 441.4 thousand tons, or 64%, to 250.1 thousand tons for the three months ended June 30, 2020 from 691.5 thousand tons for the same period in 2019, however, our average sales price per ton improved to $141.26 for the three months ended June 30, 2020 from $93.53 for the same period in 2019. At our average sales price per ton of $141.26 for the three months ended June 30, 2020, we generated $62.4 million less in net sales from the 441.4 thousand ton decline in co-products sold in the three months ended June 30, 2020 as compared to the same period in 2019. The increase in our average sales price per ton of $47.73, or 51%, for the three months ended June 30, 2020 as compared to the same period in 2019 increased our net sales of co-products by $33.0 million.

Marketing Segment

Net sales of alcohol and ethanol from our marketing segment, excluding intersegment sales, declined by $15.8 million, or 18%, to $71.4 million for the three months ended June 30, 2020 as compared to $87.2 million for the same period in 2019. Our total volume of alcohol and ethanol gallons sold by our marketing segment declined by 71.0 million gallons, or 35%, to 130.8 million gallons for the three months ended June 30, 2020 as compared to 201.8 million gallons for the same period in 2019. The 71.0 million decline in gallons sold by our marketing segment is comprised of 61.7 million fewer production gallons sold and 9.3 million fewer third party gallons sold. The 9.3 million gallon decline in third party gallons sold is comprised of 0.3 million fewer gallons sold on a gross basis and 9.0 million fewer gallons sold on a net basis.