paceth_10k-123107.htm

F-19

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Recently Issued Accounting Pronouncements – In March 2008, the FASB issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact SFAS No. 161 may have on its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141, Business Combinations, that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in SFAS No. 141(R). In addition, SFAS No. 141(R) requires acquisition costs and restructuring costs that the acquirer expected but was not obligated to incur to be recognized separately from the business combination, therefore, expensed instead of part of the purchase price allocation. SFAS No. 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. The Company expects to adopt SFAS No. 141(R) to any business combinations with an acquisition date on or after January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51. SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the impact SFAS No. 160 may have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets and liabilities and certain other items including insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense upfront cost and fees associated with the item for which the fair value option is elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157, Fair Value Measurements. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 157. SFAS No. 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. The original required effective date of SFAS No. 157 for the Company was the first quarter of 2008, however, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement No. 157, which deferred the adoption date by one year for all nonfinancial assets and nonfinancial liabilities. The Company is currently evaluating the impact SFAS No. 157 may have on its consolidated financial statements.

F-20

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.	BUSINESS COMBINATIONS.

Acquisition of Interest in Front Range – On October 17, 2006, the Company entered into a Membership Interest Purchase Agreement with Eagle Energy to acquire Eagle Energy’s 42% interest in Front Range. Front Range was formed on July 29, 2004 to construct and operate a 50 million gallon dry mill ethanol plant in Windsor, Colorado. Front Range began producing ethanol in June 2006.

As consideration for the acquisition of Eagle Energy’s interest in Front Range, the Company paid to Eagle Energy $30,000,000 in cash, 2,081,888 shares of common stock valued at $30,008,000 under the valuation provisions of the agreement and a warrant to purchase up to 693,963 shares of common stock at an exercise price of $14.41 per share. The warrant expired unexercised on October 17, 2007. The Company utilized EITF Issue No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination, to establish the market price of the securities issued in the transaction where the measurement date was determined to be the date at which the number of acquirer shares and the amount of consideration becomes fixed and determinable without subsequent revision. In the transaction, the measurement date on which the shares to be issued became fixed and determinable was October 17, 2006 and the common stock valuation price was $14.41 per share, pursuant to the terms of the Front Range acquisition agreement, whereby the 10-day volume-weighted-average trading price prior to closing was used in determining the number of exercisable shares in the warrant. Using the Black-Scholes option-pricing model, the value of this warrant on the measurement date was $5,087,000. The total value of the consideration paid to Eagle Energy was $65,095,000. The Company incurred, and has capitalized, transaction costs associated with this acquisition of $517,000. The following summarizes the Company’s estimated fair values of the Front Range tangible and intangible assets and liabilities acquired, which have been revised for activity in 2007 as discussed in Note 6 (in thousands):

Total Current Assets	$	15,090
Property and Equipment		92,376
Other Assets		584
Intangible Assets:
Customer backlogs		3,900
Non-compete covenants		400
Goodwill		83,468
Total Intangible Assets		87,768
Total Assets		195,818

Total Current Liabilities		(10,847	)
Long Term Debt		(28,753	)
Total Liabilities		(39,600	)
Noncontrolling interest in variable interest entity		(90,606	)
Net Assets	$	65,612

Cash issued to Eagle Energy	$	30,000
Stock issued to Eagle Energy		30,008
Value of warrant issued to Eagle Energy		5,087
Acquisition expenses		517
Transaction value	$	65,612

F-21

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Prior to the Company’s acquisition of its ownership interest in Front Range, the Company, directly or through one of its subsidiaries, had entered into four marketing and management agreements with Front Range.

The Company entered into a marketing agreement with Front Range on August 19, 2005 that provided the Company with the exclusive right to act as an agent to market and sell all of Front Range’s ethanol production. The marketing agreement was amended on August 9, 2006 to extend the Company’s relationship with Front Range to allow the Company to act as a merchant under the agreement. The marketing agreement was amended again on October 17, 2006 to provide for a term of six and a half years with provisions for annual automatic renewal thereafter.

The Company entered into a grain supply agreement with Front Range on August 20, 2005 (amended October 17, 2006) under which the Company is to negotiate on behalf of Front Range all grain purchase, procurement and transport contracts. The Company is to receive a $1.00 per ton fee related to this service. The grain supply agreement has a term of two and a half years with provisions for annual automatic renewal thereafter.

The Company entered into a WDG marketing and services agreement with Front Range on August 19, 2005 (amended October 17, 2006) that provided the Company with the exclusive right to market and sell all of Front Range’s WDG production. The Company is to receive the greater of a 5% fee of the amount sold or $2.00 per ton. The WDG marketing and services agreement has a term of two and a half years with provisions for annual automatic renewal thereafter.

The Company entered into a management agreement with Front Range on August 30, 2005 under which the Company is to provide management services to Front Range relating to construction management and operational support. These services are advisory in nature as Front Range management retains ultimate decision making authority. The Company is to receive an annual management fee of $150,000 under this agreement. The management agreement has a term of three years with provisions for annual automatic renewal thereafter. This agreement was terminated by mutual agreement on February 28, 2007.

The Company’s acquisition of its ownership interest in Front Range does not impact the Company’s rights or obligations under any of these agreements.

Share Exchange Transaction – On March 23, 2005, the shareholders of PEI California and the holders of the membership interests of each of Kinergy and ReEnergy, completed the Share Exchange Transaction. The Share Exchange Transaction has been accounted for as a reverse acquisition whereby PEI California is deemed to be the accounting acquiror.

The following table summarizes the assets acquired and liabilities assumed in connection with the Share Exchange Transaction (in thousands):

F-22

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Accessity March 23, 2005			Kinergy March 23, 2005			ReEnergy March 23, 2005			Total

Total Current Assets	$	2,870		$	3,861		$	3		$	6,734
Property and Equipment		—			7			—			7
Other Assets - Land option		—			—			120			120
Total Intangible Assets (Note 6)		—			10,816			—			10,816
Total Assets		2,870			14,684			123			17,677
Total Current Liabilities		(222	)		(3,868	)		(3	)		(4,093	)
Net Assets	$	2,648		$	10,816		$	120		$	13,584

Expense for services rendered in connection with feasibility study	$	—		$	—		$	852		$	852
Stock Issued		2,339			3,875			125			6,339
Stock issued to Accessity officers		600			—			—			600
Stock Issued as finders fee		150			—			—			150
Total Stock Issued		3,089			3,875			125			7,089

Reverse Acquisition – Immediately prior to the consummation of the Share Exchange Transaction, Accessity reincorporated in the State of Delaware under the name “Pacific Ethanol, Inc” through a merger of Accessity with and into its then-wholly-owned Delaware subsidiary named Pacific Ethanol, Inc., which was formed for the purpose of effecting the Reincorporation Merger. In connection with the Reincorporation Merger, the shareholders of Accessity became stockholders of the Company and the Company succeeded to the rights, properties and assets and assumed the liabilities of Accessity.

In addition, Accessity divested its two operating subsidiaries. Accordingly, effective as of the closing of the Share Exchange Transaction, Accessity did not have any ongoing business operations. Assets consisting primarily of cash and cash equivalents totaling $2,870,000 were acquired and certain current liabilities of $222,000 were assumed from Accessity. Because Accessity had no operations and only net monetary assets, the Share Exchange Transaction is being treated as a capital transaction, whereby PEI California acquired the net monetary assets of Accessity, accompanied by a recapitalization of PEI California. As such, no fair value adjustments were necessary for any of the assets acquired or liabilities assumed.

The former shareholders of Accessity, who collectively held 2,339,452 shares of common stock of Accessity, became the stockholders of an equal number of shares of common stock of the Company and holders of options and warrants to acquire shares of common stock of Accessity, who collectively held options and warrants to acquire 402,667 shares of common stock of Accessity, became holders of options and warrants to acquire an equal number of shares of common stock of the Company.

In connection with the reverse acquisition, the Company issued to Accessity’s and the Company’s former Chairman of the Board, President and Chief Executive Officer, 400,000 shares of the Company’s common stock in consideration of his obligations under a Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement that was entered into with the Company in connection with the Share Exchange Transaction. These shares, valued at $1,012,000, are accounted for as transaction costs of the reverse acquisition.

F-23

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In connection with the reverse acquisition, the Company issued to Accessity’s and the Company’s former Senior Vice President, Secretary, Treasurer and Chief Financial Officer, 200,000 shares of the Company’s common stock in consideration of his obligations under a Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement that was entered into with the Company in connection with the Share Exchange Transaction. These shares, valued at $506,000, are accounted for as transaction costs of the reverse acquisition.

On March 23, 2005, the Company issued 150,000 shares of common stock to an independent contractor for services rendered by her as a finder in connection with the Share Exchange Transaction. These shares, valued at $380,000, are accounted for as transaction costs of the reverse acquisition.

Immediately prior to the closing of the Share Exchange Transaction, certain shareholders of PEI California sold an aggregate of 250,000 shares of PEI California’s common stock owned by them to the then-Chief Executive Officer of Accessity at $0.01 per share to compensate him for facilitating the closing of the Share Exchange Transaction. These shares, valued at $633,000, are accounted for as transaction costs of the reverse acquisition.

In addition to the value of the shares transferred as discussed above totaling $2,530,000, the Company incurred $821,000 in legal fees, finder’s fees and valuation services in connection with the reverse acquisition, resulting in total transaction costs of $3,351,000. The Company has recorded an expense with a corresponding increase in paid in capital in the amount of $481,000 for transaction costs incurred in excess of the cash acquired from Accessity.

Kinergy Acquisition – In connection with the Share Exchange Transaction, the Company issued 3,875,000 shares of common stock to the sole limited liability company member of Kinergy to acquire Kinergy. This stock was valued at $9,804,000.

Immediately prior to the closing of the Share Exchange Transaction, the Chairman of the Board of Directors of the Company and PEI California sold 300,000 shares of PEI California’s common stock to the sole member of Kinergy and an officer and director of the Company and PEI California, at $0.01 per share to compensate him for facilitating the closing of the Share Exchange Transaction. The transfer of these shares resulted in additional purchase price of $759,000.

Immediately prior to the closing of the Share Exchange Transaction, the Chairman of the Board of Directors of the Company and PEI California sold 100,000 shares of PEI California’s common stock to a member of ReEnergy and a related party of the sole member of Kinergy, at $0.01 per share to compensate him for facilitating the closing of the Share Exchange Transaction. The transfer of these shares resulted in additional purchase price of $253,000.

The transfer of these shares increased the purchase price by $1,012,000 resulting in a total purchase price for Kinergy of $10,816,000.

Pursuant to the terms of the Share Exchange Transaction, Kinergy distributed to its sole member in the form of a promissory note in the amount of $2,096,000, Kinergy’s net worth as set forth on Kinergy’s balance sheet prepared in accordance with generally accepted accounting principles, as of March 23, 2005. As a result, there was no value to the net assets acquired, resulting in a significant premium paid to acquire Kinergy. In deciding to pay this premium, the Company considered various factors, including the value of Kinergy’s trade name, Kinergy’s extensive market presence and history, Kinergy’s industry knowledge and expertise, Kinergy’s extensive customer relationships and expected synergies among Kinergy’s businesses and assets and the Company’s planned entry into the ethanol production business. The purchase price has been allocated as follows (in thousands):

F-24

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	March 23, 2005

Backlog	$	136
Customer relationships		4,741
Non-compete		695
Kinergy trade name		2,678
Goodwill (Note 11)		2,566
Total assets acquired	$	10,816

The Company has determined that the Kinergy trade name has an indefinite life and therefore, rather than being amortized, it will be periodically tested for impairment. The distribution backlog had an estimated life of six months, the customer relationships were estimated to have a ten-year life and the non-compete had an estimated life of three years and, as a result, will be amortized accordingly, unless otherwise impaired at an earlier time.

ReEnergy Acquisition – The Company made a $150,000 cash payment and issued 125,000 shares of stock valued at $316,000 for the acquisition of ReEnergy. In addition, immediately prior to the closing of the Share Exchange Transaction, the Company’s and PEI California’s Chairman of the Board of Directors, sold 200,000 shares of PEI California’s common stock to the individual members of ReEnergy at $0.01 per share, to compensate them for facilitating the closing of the Share Exchange Transaction. The contribution of these shares increased the purchase price by $506,000 for a total of $972,000. Of this amount, $120,000 was recorded as an asset for an option to acquire land and because the acquisition of ReEnergy was not deemed to be an acquisition of a business, the remaining purchase price of $852,000 was recorded as an expense for services rendered in connection with a feasibility study. Upon expiration of ReEnergy’s option on December 15, 2005, the Company expensed the $120,000 asset associated with the fair value of the option.

The following table summarizes, on an unaudited pro forma basis, the combined results of operations of the Company, as though the acquisitions of Kinergy and Front Range occurred as of January 1, 2005. The pro forma amounts give effect to appropriate adjustments for amortization of intangible assets and income taxes. The pro forma amounts presented are not necessarily indicative of future operating results (in thousands, except per share data):

	December 31,
	2006			2005(1)
Net sales	$	244,046		$	111,187
Net income (loss)	$	7,026		$	(13,095	)
Preferred stock dividends	$	(2,998	)	$	—
Deemed dividend on preferred stock		(84,000	)		—
Loss available to common stockholders		(79,972	)		(13,095	)
Basic loss per share of common stock	$	(2.30	)	$	(0.52	)

___________

(1)	Front Range’s ethanol production facility became operational in June 2006 and accordingly, no sales revenues and only administrative expenses were incurred during 2005.

F-25

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.	INVESTMENTS IN MARKETABLE SECURITIES.

The cost, gross unrealized gains (losses) and fair value of the available-for-sale securities by security type are as follows (in thousands):

	Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Fair Value
As of December 31, 2007:
Available-for-sale:
Short-term marketable securities	$	19,353	$	—	$	—	$	19,353
Total marketable securities	$	19,353	$	—	$	—	$	19,353

As of December 31, 2006:
Available-for-sale:
U.S. Treasury securities	$	27,651	$	349	$	—	$	28,000
Other short-term marketable securities		11,119		—		—		11,119
Total marketable securities	$	38,770	$	349	$	—	$	39,119

4.	RELATED PARTY NOTES RECEIVABLE.

On December 30, 2005, an employee was advanced $40,000 at 5% interest, due and payable on or before June 30, 2006, to cover withholding taxes due on reportable gross taxable income related to a stock grant of 25,000 shares on June 23, 2005. The loan was repaid in full on June 20, 2006.

On December 30, 2005, an employee was advanced $96,000 at 5% interest, due and payable on or before June 30, 2006, to cover withholding taxes due on reportable gross taxable income related to a stock grant of 45,000 shares on June 23, 2005. The loan was repaid in full on June 29, 2006.

5.	PROPERTY AND EQUIPMENT.

Property and equipment consisted of the following (in thousands):

	December 31,
	2007			2006
Land	$	5,848		$	4,350
Water rights – capital lease		1,613			1,613
Facilities		71,383			43,928
Equipment and vehicles		192,045			125,489
Office furniture, fixtures and equipment		2,510			1,368
Construction in progress		213,157			23,612
		486,556			200,360
Accumulated depreciation		(17,852	)		(4,204	)
	$	468,704		$	196,156

F-26

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2007, the Company had completed construction of two ethanol production facilities in Madera, California and Boardman, Oregon, which were completed in October 2006 and September 2007, respectively. Additionally, the Company is continuing construction on two additional facilities in Burley, Idaho and Stockton, California, which had a balance of $91,150,000 and $74,012,000 of construction in progress costs, respectively, as of December 31, 2007. The Burley, Idaho facility is expected to be completed in the second quarter of 2008, with estimated additional costs to be capitalized of $12,687,000. The Stockton, California facility is expected to be completed in the third quarter of 2008, with estimated additional costs to be capitalized of $47,843,000. Although the Company has suspended construction of its Imperial Valley, California facility, approximately $32,636,000 remains in construction in progress as of December 31, 2007.

Included in construction in progress at December 31, 2007 and 2006 was capitalized interest of $5,961,000 and $0, respectively. Depreciation expense was $13,682,000, $2,284,000 and $85,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

6.	GOODWILL AND OTHER INTANGIBLE ASSETS.

The table below represents the net balances for goodwill and intangible assets (in thousands):

		December 31, 2007						December 31, 2006
	Useful Life (Years)	Gross		Accumulated Amortization/ Impairment		Net Book Value		Gross		Accumulated Amortization/ Impairment		Net Book Value
Non-Amortizing:
Goodwill recognized in business combinations		$	88,168	$	—	$	88,168	$	85,307	$	—	$	85,307
Trademarks, brand names			2,678		—		2,678		2,678		—		2,678
Amortizing:
Customer relationships	10		4,741		1,314		3,427		4,741		840		3,901
Non-compete covenants	2-3		1,095		876		219		1,095		444		651
Customer backlogs	<1		4,036		4,036		—		4,036		1,111		2,925
Total goodwill and intangible assets		$	100,718	$	6,226	$	94,492	$	97,857	$	2,395	$	95,462

Goodwill – The Company recorded goodwill of $2,566,000 as part of the Share Exchange Transaction. The Company originally recorded goodwill of $80,607,000 as part of the Company’s purchase of ownership interests in Front Range for the year ended December 31, 2006. During the year ended December 31, 2007, the Company adjusted the purchase price allocation, increasing goodwill and accrued liabilities in the aggregate amount of $2,861,000, due to recognition of additional liabilities that existed at the time of the acquisition.

Trademarks – The Company recorded trademarks of $2,678,000 as part of the Share Exchange Transaction for the year ended December 31, 2005. The Company determined that the trademarks have an indefinite life and therefore, rather than being amortized, will, along with the recorded goodwill, be tested annually for impairment.

Customer Relationships – The Company recorded customer relationships of $4,741,000 as part of the Share Exchange Transaction. The Company has established a useful life of ten years for these customer relationships.

Non-Compete Covenants – The Company recorded non-compete covenants of $400,000 as part of the Company’s purchase of ownership interest in Front Range and $695,000 as part of the Share Exchange Transaction. The Company has established estimated useful lives of two and three years, respectively, for these non-compete covenants.

Customer Backlogs – The Company recorded customer backlogs of $3,900,000 as part of the Company’s purchase of its ownership interest in Front Range and $136,000 as part of the Share Exchange Transaction. The Company had established estimated useful lives of eight and six months, respectively, for these customer backlogs.

F-27

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Amortization expense associated with intangible assets totaled $3,831,000, $1,714,000 and $681,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The weighted-average unamortized lives of the amortizing intangible assets are 7.2 and 0.7 years for customer relationships and non-compete covenants, respectively.

The expected amortization expense relating to amortizable intangible assets in each of the five years after December 31, 2007, are (in thousands):

Years Ended December 31,		Amount
2008	$	693
2009		474
2010		474
2011		474
2012		474
Thereafter		1,057
Total	$	3,646

7.	SHORT-TERM NOTE PAYABLE.

In November 2007, the Company issued an unsecured note payable for $6,000,000 to finance short-term cash needs related to its plant construction activities. This note was for final construction costs related to its Boardman facility and did not result in any cash proceeds to the Company. The note requires monthly principal payments of $500,000 and accrued interest. The remaining balance is due in full on December 15, 2008. The note bears interest at the Prime Rate.

8.	LINE OF CREDIT.

The Company has a line of credit of $3,500,000 with a commercial bank to support working capital, specifically inventories and accounts receivable. The line of credit expires November 25, 2008 and bears interest at a rate equal to the 30-day London Interbank Offered Rate (“LIBOR”) plus 3.50%. As of December 31, 2007, the interest rate was 8.1%. The line of credit is secured by substantially all of the assets of Front Range. There was no outstanding balance on this line of credit as of December 31, 2007.

F-28

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DEBT

Long-term borrowings are summarized in the table below (in thousands):

	December 31,
	2007			2006
Plant construction term loans, due 2015	$	92,308		$	—
Plant construction lines of credit, due 2009		9,200			—
Operating line of credit, due 2009		6,217			—
Notes payable, due 2009		30,000			—
Swap note, due 2011		16,370			17,658
Variable rate note, due 2011		6,930			12,607
Long-term revolving note		—			1,617
Water rights capital lease obligations		1,261			1,213
		162,286			33,095
Less short-term portion		(11,098	)		(4,125	)
Long-term debt	$	151,188		$	28,970

Plant Construction Term Loans & Lines of Credit

On February 27, 2007, the Company closed a debt financing transaction in the aggregate amount of up to $325,000,000 through certain of its wholly-owned indirect subsidiaries (the “Borrowers”). The primary purpose of the debt financing (the “Debt Financing”) was to provide debt financing for the development, construction, installation, engineering, procurement, design, testing, start-up, operation and maintenance of five ethanol production facilities. On November 27, 2007, the Company amended the agreement to apply to four ethanol production facilities, thereby reducing the aggregate amount of available financing to up to $250,769,000. As of December 31, 2007, two of the four plants have been funded, with the remaining two expected to be funded in 2008. As of December 31, 2007, the outstanding balance under the Debt Financing was $101,508,000, comprised of $92,308,000 in construction loans and $9,200,000 in used lines of credit.

The Debt Financing, as amended, includes:

four construction loan facilities in an aggregate amount of up to $230,800,000. Loans made under the construction loan facilities do not amortize, but require payment of accrued interest, and are fully due and payable on the earlier of October 27, 2008 or the date the construction loans made thereunder are converted into term loans (the “Conversion Date”), the latter of which is to be the date the last of the four plants achieves commercial operations. On the Conversion Date, the construction loans are to be converted into term loans;

four term loan facilities in an aggregate amount of up to $230,800,000, which are intended to refinance the loans made under the construction loan facilities. The term loans are to be repaid ratably by each Borrower on a quarterly basis from and after the Conversion Date in an amount equal to 1.5% of the aggregate original principal amount of the corresponding term loan. The remaining principal balance and all accrued and unpaid interest on the term loans are fully due and payable on the date that is 84 months after the Conversion Date; and

a working capital and letter of credit facility in an aggregate amount of up to $20,000,000 ($5,000,000 per facility) that is fully due and payable on the date that is 12 months after the Conversion Date, but is expected to be renewed on similar terms and conditions. During the term of the working capital and letter of credit facility, the Borrowers may borrow, repay and re-borrow amounts available under the facility.

F-29

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and letters of credit under the Debt Financing are subject to conditions precedent, including, among others, the absence of a material adverse effect; the absence of defaults or events of defaults; the accuracy of certain representations and warranties; the maintenance of a debt-to-equity ratio that is not in excess of 65:35; the contribution of all required equity by the Company to the Borrowers, which is expected to be approximately $227,000,000 in the aggregate; and the attainment of at least a 1.5-to-1.0 debt service coverage ratio. Also, the Borrowers may not be able to fully utilize the Debt Financing if the completed ethanol plants fail to meet certain minimum performance standards. Loans made under the construction and term loan facilities may not be re-borrowed once repaid or re-borrowed once prepaid. Finally, loan amounts under the construction and term loan facilities are limited to a percentage of project costs of the corresponding plant but are not to exceed approximately $1.15 per gallon of annual production capacity of the plant.

The Borrowers have the option to select from multiple interest rates that float with common interest rate indices, such as the LIBOR, with reset periods of differing durations. Depending upon the floating interest rate selected, the type of loan and whether the loan is made under a construction loan facility, a term loan facility or the working capital and letter of credit facility, loans under the Debt Financing bear interest at rates ranging from 3.75% to 4.35% over the selected interest rate index.

In addition to scheduled principal payments, starting after the Conversion Date, the term loan facilities require mandatory repayments of principal in amounts based on the Borrowers’ free cash flow. The percentage of the Borrowers’ free cash flow to be applied to principal repayments is to vary from 50% in the first two years following the Conversion Date to 75-100% in succeeding years, based upon repayment amounts measured against targeted balances.

Borrowings and the Borrowers’ obligations under the Debt Financing are secured by a first-priority security interest in all of the equity interests in the Borrowers and substantially all the assets of the Borrowers. The security interests granted by the Borrowers under the Debt Financing restrict the assets and revenues of the Borrowers and therefore may inhibit the Company’s ability to obtain other debt financing.

In connection with the Debt Financing, the Company also entered into a Sponsor Support Agreement under which the Company is to provide limited contingent equity support in connection with the development, construction, installation, engineering, procurement, design, testing, start-up and maintenance of the four ethanol production facilities. In particular, the Company has agreed to contribute to the Borrowers up to an aggregate of approximately $28,083,000 (the “Sponsor Funding Cap”) of contingent equity in the event the Borrowers have insufficient funds to either pay their project costs as they become due and payable or, by delay in payment, cause the ethanol production facilities to fail to be completed by the Conversion Date. The Company has agreed to provide a warranty with respect to all ethanol plants other than its Madera facility, which is under standard warranty through the contractor. The warranty obligations of the Company with respect to the other three facilities extend one year beyond final completion of each facility. The warranty obligation will cease one year from the date the third ethanol plant achieves final completion. The Company’s obligations under the warranty are capped at the Sponsor Funding Cap. Until the Company’s contingent equity obligations have been fully performed or the warranty period has expired, the Company may not incur any secured indebtedness for borrowed money, grant liens on its assets or provide any secured credit enhancements in an aggregate amount in excess of $10,000,000 unless the Company provides the lenders under the Debt Financing with the same liens or credit support.

F-30

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company incurred $11,048,000 of costs associated with the completion of the Debt Financing arrangement and has capitalized these costs in other assets, except the portion amortizing during the next twelve months, which is classified in other current assets. In connection with the amendment discussed above, the Company recognized a write-off of the corresponding facility’s related unamortized financing costs of approximately $1,962,000 for the year ended December 31, 2007. For the other facilities, the Company recognized amortization of financing costs of approximately $2,764,000 for the year ended December 31, 2007. The remaining unamortized financing costs continue to be amortized over a six-year life.

In March 2008, the Company became aware of various events or circumstances which constituted defaults under its Credit Agreement. (See Note 9.) These events or circumstances included the existence of material weaknesses in the Company’s internal control over financial reporting as of December 31, 2007, cash management activities that violated covenants in its Credit Agreement, failure to maintain adequate amounts in a designated debt service reserve account, the existence of a number of Eurodollar loans in excess of the maximum number permitted under the Company’s Credit Agreement, and the Company’s failure to pay all remaining project costs on its Madera and Boardman facilities by certain stipulated deadlines. On March 26, 2008, the Company obtained waivers from its lenders as to these defaults and was required to pay the lenders a consent fee in an aggregate amount of up to approximately $600,000. In addition to the waivers, the Company’s lenders agreed to amend the Credit Agreement. These amendments include an increase in the frequency with which the Company is to deposit certain revenues into a restricted account each month, an increase the allowable Eurodollar loans from a maximum of seven to a maximum of ten, and the Company is required to pay all remaining project costs on its Madera and Boardman facilities by May 16, 2008.

Operating Line of Credit

In addition to the Debt Financing, in August 2007, a subsidiary of the Company entered into an operating line of credit facility that allows for borrowings not to exceed the lesser of $25,000,000 or the sum of 80% of eligible accounts receivable and 70% of eligible inventory of the subsidiary. Advances under the operating line of credit bear interest at spreads typical in the industry for this type of financing over standard indices, such as the prime rate and/or LIBOR. Interest payments are due monthly or at the applicable LIBOR period. As of December 31, 2007, the outstanding balance under the line of credit was $6,217,000 and accrues interest at two separate variable interest rates ranging from 6.19% to 6.75%. The line of credit expires in July 2009, at which time the outstanding balance becomes due and payable. Borrowings under the line of credit are secured by substantially all of the assets of the subsidiary and are also secured by a limited guaranty by the Company. Under the terms of the line of credit, the subsidiary is required to maintain certain financial and non-financial covenants. The financial covenants became effective beginning with the three months ended December 31, 2007. The Company believes that the subsidiary is in compliance with the covenants as of December 31, 2007.

F-31

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Notes Payable

In November 2007, Pacific Ethanol Imperial, LLC (“PEI Imperial”), an indirect subsidiary of the Company, borrowed $15,000,000 from Lyles United, LLC under a Secured Promissory Note containing customary terms and conditions. The loan accrues interest at a rate equal to the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus two percent (2.00%), computed on the basis of a 360-day year of twelve 30-day months. The loan was due 90-days after issuance or, if extended at the option of PEI Imperial, 365-days after the end of such 90-day period. This loan was extended by PEI Imperial and is due February 25, 2009. The Secured Promissory Note provided that if the loan was extended, the Company was to issue a warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $8.00 per share. The Company is to issue this warrant simultaneously with the closing of the transactions contemplated by the Purchase Agreement, or alternatively, not later than April 30, 2008. The warrant will be exercisable at any time during the 18-month period after the date of issuance. The loan is secured by substantially all of the assets of PEI Imperial pursuant to a Security Agreement dated November 28, 2007 by and between PEI Imperial and Lyles United, LLC that contains customary terms and conditions and an Amendment No. 1 to Security Agreement dated December 27, 2007 by and between PEI Imperial and Lyles United, LLC (collectively, the “Security Agreement”). The Company has guaranteed the repayment of the loan pursuant to an Unconditional Guaranty dated November 28, 2007 containing customary terms and conditions. In connection with the loan, PEI Imperial entered into a Letter Agreement dated November 28, 2007 with Lyles United, LLC under which PEI Imperial committed to award the primary construction and mechanical contract to Lyles United, LLC or one of its affiliates for the construction of an ethanol production facility at the Company’s Imperial Valley site near Calipatria, California (the “Project”), conditioned upon PEI Imperial electing, in its sole discretion, to proceed with the Project and Lyles United, LLC or its affiliate having all necessary licenses and is otherwise ready, willing and able to perform the primary construction and mechanical contract. In the event the foregoing conditions are satisfied and PEI Imperial awards such contract to a party other than Lyles United, LLC or one of its affiliates, PEI Imperial will be required to pay to Lyles United, LLC, as liquidated damages, an amount equal to $5,000,000.

In December 2007, PEI Imperial borrowed an additional $15,000,000 from Lyles United, LLC under a second Secured Promissory Note containing customary terms and conditions. The loan accrues interest at a rate equal to the Prime Rate of interest as reported from time to time in The Wall Street Journal, plus two percent (2.00%), computed on the basis of a 360-day year of twelve 30-day months. The loan is due on March 31, 2008 or, if extended at the option of PEI Imperial, on March 31, 2009. If the loan is extended, the interest rate increases by 2.00%. The loan is secured by substantially all of the assets of PEI Imperial pursuant to the Security Agreement. The Company has guaranteed the repayment of the loan pursuant to an Unconditional Guaranty dated December 27, 2007 containing customary terms and conditions. The Company intends to extend the due date of the second Secured Promissory Note.

Since the Company either has extended or has the intent and ability to extend the term of these notes to 2009, it has classified these notes payable as noncurrent.

Swap Note, due 2011

The swap note is a term loan, with a floating interest rate, established on a quarterly basis, equal to the 90-day LIBOR, plus 3.00%. The Company has entered into a swap contract with the lender to provide a fixed rate of 8.16%. The loan matures in five years, but has required principal payments due based on a ten-year amortization schedule. Quarterly payments are approximately $678,000, including interest with final payment due November 10, 2011.

Variable Rate Note, due 2011

The variable rate note is a term loan that carries an interest rate that will float at a rate equal to the 90-day LIBOR, plus 2.75-3.50%, depending on a debt-to-net worth ratio. As of December 31, 2007, the interest rate was 7.45%. The variable loan matures in five years but is amortized over 10 years with a final payment due November 10, 2011. Quarterly payments of approximately $654,000 which are applied in a cascading order, as follows: long-term revolving note interest, variable rate note interest, variable rate note principal and long-term revolving note principal.

F-32

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Long-Term Revolving Note, due 2011

The long-term revolving note is a revolving loan in the amount of $5,000,000 and carries an interest rate that will float at a rate equal to the 30-day LIBOR, plus 2.75-3.50%, depending on a debt-to-net worth ratio. As of December 31, 2007, the interest rate was 7.45%. Repayment terms are included above in the description of the variable rate note.

The swap note, variable rate note and long-term revolving note are due in 2011, and include an accelerated principal reduction provision based on excess net cash flow. Excess net cash flow is measured on an annual basis and is defined as net income before interest expense, income taxes, depreciation and amortization and after giving effect to scheduled loan payments and capital expenditures. The provision requires the Company to pay 20% of its excess net cash flow within 120 days of its year end; however, this amount is not to exceed $4,000,000 per fiscal year. The accelerated payment for the year ended December 31, 2007, estimated at $4,000,000, is expected to be paid prior to April 30, 2008 and will have the effect of increasing the maturities of long-term debt due in 2008 and decreasing the future maturities of long-term debt that would have been due in 2011.

The three notes listed above represent permanent financing and are collateralized by a perfected, first-priority security interest in all of the assets of Front Range, including inventories and all rights, title and interest in all tangible and intangible assets of Front Range; a pledge of 100% of the ownership interest in Front Range; an assignment of all revenues produced by Front Range; a pledge and assignment of Front Range’s material contracts and documents, to the extent assignable; all contractual cash flows associated with such agreements; and any other collateral security as the lender may reasonably request.

These collateralizations restrict the assets and revenues as well as future financing strategies of Front Range, the Company’s variable interest entity, but do not apply to, nor have bearing upon any financing strategies that the Company may choose to undertake in the future.

The carrying values and classification of assets that are collateral for the obligations of Front Range at December 31, 2007 are as follows (in thousands):

Current assets	$	31,120
Property and equipment		50,519
Other assets		433
Total collateralized assets	$	82,072

Front Range is subject to certain loan covenants that were effective beginning in the fourth quarter of 2006. Under these covenants, Front Range is required to maintain a certain fixed-charge coverage ratio, a minimum level of working capital and a minimum level of net worth. The covenants also set a maximum amount of additional debt that may be incurred by Front Range. The covenants also limit annual distributions that may be made to owners of Front Range, including the Company, based on Front Range’s leverage ratio. The Company believes that as of December 31, 2007, Front Range was in compliance with all terms and conditions of the above credit facilities.

Water Rights Capital Lease

The water rights lease obligation relates to a lease agreement with the Town of Windsor for augmentation water for use in Front Range’s production processes. The lease requires an initial payment of $400,000 and annual payments of $160,000 per year for the next nine years. The future payments were discounted using a 5.25% interest rate which was comparable to available borrowing rates at the time of execution of the agreement. The obligation has been recorded as a capital lease and included in long-term obligations and the related asset has been included in property and equipment.

F-33

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Interest Expense on Borrowings

Interest expense on all borrowings was $1,882,000, $720,000 and $495,000, for the years ended December 31, 2007, 2006 and 2005, respectively. These amounts were net of capitalized interest and deferred financing fees of $8,494,000, $671,000 and $298,000 for the years ended December 31, 2007, 2006 and 2005, respectively, and included the Company’s construction costs of plant and equipment.

The amounts of long-term debt maturing in each of the next five years are included below (in thousands):

Years Ended December 31,	Amount
2008	$	7,637
2009		53,465
2010		7,260
2011		17,546
2012		5,661
Thereafter		70,717
Total	$	162,286

10.	RELATED PARTY NOTES PAYABLE.

On December 28, 2004, January 10, 2005 and February 22, 2005, the chairman of the board of directors of each of the Company and PEI California advanced the Company $20,000, $60,000 and $20,000, respectively, at 5% interest, due and payable upon the closing of the Share Exchange Transaction. The accumulated principal due was repaid on March 24, 2005 and the related interest of $921 was paid on April 15, 2005.

On January 10, 2005, a shareholder and officer of PEI California advanced the Company $100,000 at 5% interest, due and payable upon the closing of the Share Exchange Transaction. The principal was repaid on March 24, 2005 and the related interest of $1,003 was paid on April 15, 2005.

On January 31, 2005, a principal of Cagan-McAfee Capital Partners, LLC, a founding shareholder of PEI California, advanced the Company $100,000 at 5% interest, due and payable upon close of the Share Exchange Transaction. The principal was repaid on March 24, 2005 and the related interest of $714 was paid on April 15, 2005.

In connection with the acquisition of a grain facility in March 2003, on June 16, 2003, PEI California entered into a Term Loan Agreement (the “Loan Agreement”) with W.M. Lyles Co., a subsidiary of Lyles Diversified, Inc. (“LDI”), whereby LDI loaned PEI California $5,100,000. In addition, PEI California agreed to engage LDI at the appropriate time, on mutually acceptable terms substantially similar to the Design-Build Agreement for the Madera facility, under a design-build agreement for a second ethanol production facility. On March 23, 2005 the Loan Agreement was assigned by PEI California to the Company. On April 13, 2006, the Company and LDI entered into an Amended and Restated Loan Agreement (the “Amended and Restated Loan Agreement”) whereby the Loan Agreement was assigned by the Company to PEI Madera.

F-34

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Amended and Restated Loan Agreement provided for a fixed interest rate of 5% per annum on the unpaid principal balance through June 19, 2004, at which time the loan converted to a variable interest rate based on the Prime Rate, as reported in The Wall Street Journal, which was 7.25% as of December 31, 2005, plus 2%. The first payment, consisting of interest only, was due June 19, 2004, after which interest was due and payable monthly. Principal payments were due annually in three equal installments beginning June 20, 2006 and ending June 20, 2008. As of December 31, 2005, $3,195,000 was outstanding on the above loan, of which $1,200,000 was a current liability and $1,995,000 was a non-current liability. The loan balance was paid off in full on July 21, 2006.

In partial consideration for entering into the Loan Agreement, PEI California issued 1,000,000 shares of common stock to LDI. The fair value of the common stock on the date of issuance, $1,203,000, was recorded as a debt discount and was amortized over the life of the loan and recorded as interest expense. As of December 31, 2006 and 2005, the unamortized debt discount was $0 and $404,000, respectively.

LDI also had the option to convert up to $1,500,000 of the debt into PEI California’s and/or the Company’s common stock, as the case may be, at a conversion price of $1.50 per share originally through March 31, 2005. On December 28, 2004, the Company and LDI amended the Loan Agreement to extend the conversion option through June 30, 2005. During 2004, LDI converted $255,000 of debt into 170,000 shares of common stock, at a conversion price equal to $1.50 per share. Prior to June 30, 2005, LDI converted $1,245,000 of debt into 830,000 shares of the Company’s common stock, at a conversion price equal to $1.50 per share.

11.	CUMULATIVE EFFECT ADJUSTMENT.

In September 2006, the Commission issued SAB No. 108, Topic 1N, Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

Traditionally, there have been two widely recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the statements of operations, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the statements of operations. The Company historically used the roll-over method for quantifying identified financial statement misstatements.

In SAB No. 108, the Commission established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods.

SAB No. 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been applied or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. The Company elected to record the effects of applying SAB No. 108 using the cumulative effect transition method.

F-35

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the effects (up to January 1, 2006) of applying the guidance in SAB No. 108 (in thousands):

	Period in Which Misstatement Originated(1)
	Year Ended December 31, 2005			Adjustment Recorded as of January 1, 2006
Goodwill(2)	$	2,134		$	2,134
Deferred tax liability(2)	$	(1,091	)	$	(1,091	)
Impact on net income (loss)(3)	$	1,043		$	—
Retained earnings(4)				$	1,043

__________

(1)

The Company previously quantified these errors under the roll-over method and concluded that they were immaterial individually and in the aggregate.

(2)

In allocating the purchase price with respect to the Kinergy acquisition, no adjustment was made to record a deferred tax liability for the difference between the recorded value of the assets acquired and their corresponding tax basis. Such an adjustment would have increased goodwill by the amount of the deferred tax liability recorded. In addition, goodwill would have been reduced by the amount of any valuation allowance attributable to any pre-acquisition deferred tax asset of the Company that could more likely than not have been utilized against the recorded deferred tax liability.

(3)

Represents the net overstatement of net loss for the indicated period resulting from the misstatements

(4)

Represents the increase in retained earnings recorded as of January 1, 2006 to record the initial application of SAB No. 108.

12.	INCOME TAXES.

The asset and liability method is used to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax credits and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.

The Company files a consolidated federal income tax return. This return includes all corporate companies 80% or more owned by the Company as well as the Company’s pro-rata share of taxable income from pass-through entities in which Company holds an ownership interest. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to the Company and its subsidiaries.

Income taxes for each of the years ended December 31, 2007, 2006 and 2005 were $0.

A reconciliation of the differences between the United States statutory federal income tax rate and the effective tax rate as provided in the consolidated statements of operations is as follows:

F-36

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Years Ended December 31,
	2007			2006			2005
Statutory rate		(35.0	)%		(35.0	)%		(35.0	)%
State income taxes, net of federal benefit		(5.9	)		—			(5.7	)
Non-deductible items		0.8			15.6			10.7
Valuation allowance relating to equity items		(8.3	)		369.8			(4.7	)
Prior year purchase accounting adjustment		—			1,599.9			—
Change in valuation allowance		49.1			(2,091.8	)		34.7
Other		(0.7	)		141.5			—
Effective rate		0.0	%		0.0	%		0.0	%

Deferred income taxes are provided using the asset and liability method to reflect temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using presently enacted tax rates and laws. The components of deferred income taxes included in the consolidated balance sheets were as follows (in thousands):

	December 31,
	2007			2006
Deferred tax assets:
Other accrued liabilities	$	189		$	140
Stock option compensation		1,339			569
Derivative instruments mark-to-market		2,341			—
Available-for-sale securities		970			—
Net operating loss carryforward(1)		23,218			6,623
Other		132			2
Total deferred tax assets		28,189			7,334

Deferred tax liabilities:
Fixed assets		(15,318	)		(1,228	)
Investment in partnerships		(995	)		(586	)
Intangibles		(2,513	)		(2,997	)
Available-for-sale securities		—			(142	)
Derivative instruments		—			(80	)
Total deferred tax liabilities		(18,826	)		(5,033	)

Valuation allowance		(10,454	)		(3,392	)
Net deferred tax liabilities	$	(1,091	)	$	(1,091	)

Classified in balance sheet as:
Deferred income tax benefit (current assets)	$	—		$	—
Deferred income taxes (long-term liability)		(1,091	)		(1,091	)
	$	(1,091	)	$	(1,091	)

_______________

(1)

The deferred tax asset for the Company’s net operating loss carryforwards at December 31, 2007 does not include $5,667,000 which relates to the tax benefits associated with warrants and non-statutory options exercised by employees, members of the board and others under the various incentive plans. These tax benefits will be recognized in stockholders’ equity rather than in the statements of operations in accordance with SFAS No. 109 but not until the period that these amounts decrease taxes payable.

F-37

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At December 31, 2007 and 2006, the Company had federal net operating loss carryforwards of approximately $71,466,000 and $27,560,000, and state net operating loss carryforwards of approximately $67,392,000 and $23,464,000, respectively. These net operating loss carryforwards expire at various dates beginning in 2013.

A portion of the Company’s net operating loss carryforwards will be subject to provisions of the tax law that limit the use of losses incurred by a company prior to becoming a member of a consolidated group as well as losses that existed at the time there is a change in control of an enterprise. The amount of the Company’s net operating loss carryforwards that would be subject to these limitations was approximately $7,728,000 at December 31, 2007.

In assessing whether the deferred tax assets are realizable, SFAS No. 109 establishes a more likely than not standard. If it is determined that it is more likely than not that deferred tax assets will not be realized, a valuation allowance must be established against the deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

A valuation allowance has been established in the amount of $10,454,000 in 2007 and $3,392,000 in 2006 based on Company’s assessment of the future realizability of certain deferred tax assets. For the years ending December 31, 2007 and 2006, the Company recorded an increase in the valuation allowance of $7,062,000 and a decrease in the valuation allowance of $2,968,000, respectively. The reduction in the valuation allowance for 2006 was partially attributable to a cumulative effect adjustment. (See Note 11.) The valuation allowance on deferred tax assets is related to future deductible temporary differences and net operating loss carryforwards (exclusive of net operating losses associated with items recorded directly to equity) for which the Company has concluded it is more likely than not that these items will not be realized in the ordinary course of operations.

On January 1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the entity’s financial statements in accordance with SFAS No. 109. The adoption of FIN 48 did not result in a cumulative effect adjustment to the Company’s retained earnings. As of the date of adoption, the Company had no unrecognized income tax benefits. Accordingly, the annual effective tax rate was not affected by the adoption of FIN 48. Should the Company incur interest and penalties relating to tax uncertainties, such amounts would be classified as a component of interest expense and operating expense, respectively.

At December 31, 2007, the Company had no increase or decrease in unrecognized income tax benefits for the year. There was no accrued interest or penalties relating to tax uncertainties at December 31, 2007. Unrecognized tax benefits are not expected to increase or decrease within the next twelve months.

The Company is subject to income tax in the U.S. federal jurisdiction and various state jurisdictions and has identified its federal tax return and tax returns in state jurisdictions below as “major” tax filings. These jurisdictions, along with the years still open to audit under the applicable statutes of limitation, are as follows:

Jurisdiction		Tax Years
Federal		2004 – 2006
California		2003 – 2006
Oregon		2006
Colorado		2006
Idaho		2006

However, because the Company had net operating losses and credits carried forward in several of the jurisdictions, including the U.S. federal and California jurisdictions, certain items attributable to closed tax years are still subject to adjustment by applicable taxing authorities through an adjustment to tax attributes carried forward to open years.

F-38

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.	PREFERRED STOCK.

Issuances of Preferred Stock – On April 13, 2006, the Company issued to Cascade Investment, L.L.C. (“Cascade”), 5,250,000 shares of Series A Cumulative Redeemable Convertible Preferred Stock (“Series A Preferred Stock”) at a price of $16.00 per share, for an aggregate purchase price of $84,000,000. The Company was entitled to use $4,000,000 of the proceeds for general working capital and was required to use the remaining $80,000,000 for the construction or acquisition of one or more ethanol production facilities in accordance with the terms of a deposit agreement.

Under the Certificate of Designations, Powers, Preferences and Rights of the Series A Cumulative Redeemable Convertible Preferred Stock, the Series A Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s common stock. Holders of Series A Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in cash in an amount equal to 5% per annum of the purchase price per share of the Series A Preferred Stock; however, such dividends may, at the Company’s option, be paid in additional shares of Series A Preferred Stock based on the value of the purchase price per share of the Series A Preferred Stock.

The Company recorded preferred stock dividends of $4,200,000 and $2,998,000 for the years ended December 31, 2007 and 2006, respectively. For all periods except for the three months ended December 31, 2007, the Company declared cash dividends for payment of the preferred stock dividends. For the three months ended December 31, 2007, the Company elected to issue an additional 65,625 shares of Series A Preferred Stock as a payment-in-kind of dividends.

The holders of the Series A Preferred Stock have conversion rights initially equivalent to two shares of common stock for each share of Series A Preferred Stock. The conversion ratio is subject to customary antidilution adjustments, including in the event that the Company issues equity securities at a price equivalent to less than $8.00 per share, including derivative securities convertible into equity securities (on an as-converted or as-exercised basis). Certain specified issuances will not result in antidilution adjustments. The shares of Series A Preferred Stock are also subject to forced conversion upon the occurrence of a transaction that would result in an internal rate of return to the holders of the Series A Preferred Stock of 25% or more. Accrued but unpaid dividends on the Series A Preferred Stock are to be paid in cash upon any conversion of the Series A Preferred Stock.

The holders of Series A Preferred Stock have a liquidation preference over the holders of the Company’s common stock equivalent to the purchase price per share of the Series A Preferred Stock plus any accrued and unpaid dividends on the Series A Preferred Stock. A liquidation will be deemed to occur upon the happening of customary events, including transfer of all or substantially all of the Company’s capital stock or assets or a merger, consolidation, share exchange, reorganization or other transaction or series of related transaction, unless holders of 66 2/3% of the Series A Preferred Stock vote affirmatively in favor of or otherwise consent to such transaction.

In connection with the issuance of the Series A Preferred Stock, the Company entered into a Registration Rights and Stockholders Agreement (the “Rights Agreement”) with Cascade. The Rights Agreement is to be effective until the holders of the Series A Preferred Stock, and their affiliates, as a group, own less than 10% of the Series A Preferred Stock issued under the purchase agreement with Cascade, including common stock into which such Series A Preferred Stock has been converted (the “Termination Date”). The Rights Agreement provides that holders of a majority of the Series A Preferred Stock, including common stock into which the Series A Preferred Stock has been converted, may demand and cause the Company, at any time after April 13, 2007, to register on their behalf the shares of common stock issued, issuable or that may be issuable upon conversion of the Series A Preferred Stock (the “Registrable Securities”). Following such demand, the Company is required to notify any other holders of the Series A Preferred Stock or Registrable Securities of the Company’s intent to file a registration statement and, to the extent requested by such holders, include them in the related registration statement. The Company is required to keep such registration statement effective until such time as all of the Registrable Securities are sold or until such holders may avail themselves of Rule 144(k) under the Securities Act of 1933, which requires, among other things, a minimum two-year holding period and requires that any holder availing itself of Rule 144(k) not be an affiliate of the Company. The holders are entitled to three demand registrations on Form S-1 and unlimited demand registrations on Form S-3; however, the Company is not obligated to effect more than two demand registrations on Form S-3 in any 12-month period.

F-39

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In addition to the demand registration rights afforded the holders under the Rights Agreement, the holders are entitled to “piggyback” registration rights. These rights entitle the holders who so elect to be included in registration statements to be filed by the Company with respect to other registrations of equity securities. The holders are entitled to unlimited “piggyback” registration rights.

Under its obligations in the Rights Agreement, the Company filed a registration statement with the Commission, registering for resale shares of the common stock up to 10,500,000. The Company filed the registration statement with the Commission and was declared effective in November 2007.

The Rights Agreement also provides for the initial appointment of two persons designated by Cascade to the Company’s board of directors, and the appointment of one of such persons as the chairman of the compensation committee of the Company’s board of directors. Following a specified termination date, Cascade is required to cause its director designees, and all other designees, to resign from all applicable committees and boards of directors, effective as of the termination date.

Deemed Dividend on Preferred Stock – In accordance with EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the Series A Preferred Stock is considered to have an embedded beneficial conversion feature because the conversion price was less than the fair value of the Company’s common stock at the issuance date. The Company has recorded a deemed dividend on preferred stock of $28,000 and $84,000,000 for the years ended December 31, 2007 and 2006, respectively. These non-cash dividends are to reflect the implied economic value to the preferred stockholder of being able to convert its shares into common stock at a price which was in excess of the fair value of the Series A Preferred Stock at the time of issuance. The fair value allocated to the Series A Preferred Stock together with the original conversion terms were used to calculate the value of the deemed dividend on the Series A Preferred Stock on the date of issuance.

For the year ended December 31, 2007, the fair value was calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock into shares of common stock of $8.00 per share and the fair market value of the Company’s common stock of $8.21 on the date of issuance of the Series A Preferred Stock.

For the year ended December 31, 2006, the fair value was calculated using the difference between the agreed-upon conversion price of the Series A Preferred Stock into shares of common stock of $8.00 per share and the fair market value of the Company’s common stock of $29.27 on the date of issuance of the Series A Preferred Stock. The fair value allocated to the Series A Preferred Stock was in excess of the gross proceeds received of $84,000,000 in connection with the sale of the Series A Preferred Stock; however, the deemed dividend on the Series A Preferred Stock is limited to the gross proceeds received of $84,000,000.

These amounts have been charged to accumulated deficit with the offsetting credit to additional paid-in-capital. The Company has treated the deemed dividend on preferred stock as a reconciling item on the consolidated statements of operations to adjust its reported net loss, together with any preferred stock dividends recorded during the applicable period, to loss available to common stockholders in the consolidated statements of operations.

F-40

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Likely Embedded Derivative – Under the provisions of SFAS No. 133, the Series A Preferred Stock’s redemption feature was likely a derivative instrument that required bifurcation from the host contract. SFAS No. 133 requires all derivative instruments to be measured at fair value. However, because the underlying events that would cause the redemption feature to be exercisable (i.e., redemption events) are in the Company's control and were not probable of occurrence in the foreseeable future, the Company believed that the fair value of the embedded derivative was de minimis at the date of issuance of the Series A Preferred Stock. As of December 31, 2007, the redemption events are no longer applicable, as the funds have been fully used for construction.

14.	COMMON STOCK.

In May 2006, the Company issued to 45 accredited investors an aggregate of 5,496,583 shares of common stock at a price of $26.38 per share, for an aggregate purchase price of $145.0 million in cash. The Company designated the net proceeds of approximately $138.0 million, net of capital raising fees and expenses, for construction of additional ethanol plants and working capital. The Company also issued to the investors warrants to purchase an aggregate of 2,748,297 shares of common stock at an exercise price of $31.55 per share. These warrants expired unexercised in February 2007.

The Company was obligated under a securities purchase agreement related to the above private offering to file, by June 30, 2006, a registration statement with the Commission, registering for resale shares of common stock, and shares of common stock underlying the warrants, issued in connection with the private offering. The Company filed the registration statement with the Commission on June 23, 2006. The registration statement was declared effective by the Commission on July 10, 2006.

On March 23, 2005, PEI California issued to 63 accredited investors in a private offering an aggregate of 7,000,000 shares of common stock at a purchase price of $3.00 per share, two-year investor warrants to purchase 1,400,000 shares of common stock at an exercise price of $3.00 per share and two-year investor warrants to purchase 700,000 shares of common stock at an exercise price of $5.00 per share, for total gross proceeds of approximately $21,000,000. PEI California paid cash placement agent fees and expenses of approximately $1,850,000 and issued five-year placement agent warrants to purchase 678,000 shares of common stock at an exercise price of $3.00 per share in connection with the offering. Additional costs related to the financing include legal, accounting, consulting and stock certificate issuance fees that totaled approximately $275,000.

The Company was obligated under a registration rights agreement to file, on the 151st day following March 23, 2005, a Registration Statement with the Commission registering for resale shares of common stock, and shares of common stock underlying investor warrants and certain of the placement agent warrants, issued in connection with the private offering. If (i) the Company did not file the Registration Statement within the time period prescribed, or (ii) the Company failed to file with the Commission a request for acceleration in accordance with Rule 461 promulgated under the Securities Act of 1933, within five trading days of the date that the Company is notified (orally or in writing, whichever is earlier) by the Commission that the Registration Statement will not be “reviewed,” or is not subject to further review, or (iii) the Registration Statement filed or required to be filed under the registration rights agreement was not declared effective by the Commission on or before 225 days following March 23, 2005, or (iv) after the Registration Statement is first declared effective by the Commission, it ceases for any reason to remain continuously effective as to all securities registered thereunder, or the holders of such securities are not permitted to utilize the prospectus contained in the Registration Statement to resell such securities, for more than an aggregate of 45 trading days during any 12-month period (which need not be consecutive trading days) (any such failure or breach being referred to as an “Event,” and for purposes of clause (i) or (iii) the date on which such Event occurs, or for purposes of clause (ii) the date on which such five-trading day period is exceeded, or for purposes of clause (iv) the date on which such 45-trading day-period is exceeded being referred to as “Event Date”), then in addition to any other rights the holders of such securities may have under the Registration Statement or under applicable law, then, on each such Event Date and on each monthly anniversary of each such Event Date (if the applicable Event shall not have been cured by such date) until the applicable Event is cured and except as disclosed below, the Company is required to pay to each such holder an amount in cash, as partial liquidated damages and not as a penalty, equal to 2.0% of the aggregate purchase price paid by such holder pursuant to the Securities Purchase Agreement relating to such securities then held by such holder. If the Company fails to pay any partial liquidated damages in full within seven days after the date payable, the Company is required to pay interest thereon at a rate of 18% per annum (or such lesser maximum amount that is permitted to be paid by applicable law) to such holder, accruing daily from the date such partial liquidated damages are due until such amounts, plus all such interest thereon, are paid in full. The partial liquidated damages are to apply on a daily pro-rata basis for any portion of a month prior to the cure of an Event.

F-41

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Registration Rights Agreement also provides for customary piggy-back registration rights whereby holders of shares of the Company’s common stock, or warrants to purchase shares of common stock, can cause the Company to register such shares for resale in connection with the Company’s filing of a Registration Statement with the commission to register shares in another offering. The Registration Rights Agreement also contains customary representations and warranties, covenants and limitations.

The Registration Statement was not declared effective by the commission on or before 225 days following March 23, 2005. The Company endeavored to have all security holders entitled to these registration rights execute amendments to the Registration Rights Agreement reducing the penalty from 2.0% to 1.0% of the aggregate purchase price paid by such holder pursuant to the Securities Purchase Agreement relating to such securities then held by such holder. This penalty reduction applies to penalties accrued on or prior to January 31, 2006 as a result of the related Registration Statement not being declared effective by the Commission. Certain of the security holders executed this amendment. However, not all security holders executed this amendment and as a result, the Company paid an aggregate of $298,000 in penalties on November 8, 2005. The Registration Statement was declared effective by the Commission on December 1, 2005.

The Company has evaluated the classification of common stock and warrants issued in the private offerings discussed above in accordance with EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and EITF Issue No. D-98, Classification and Measurement of Redeemable Securities. The Company has determined, based on a valuation performed by an independent appraiser that the maximum potential liquidated damages are less than the difference in fair value between registered and unregistered shares of the Company’s stock and, therefore, has classified the common stock and warrants as equity.

15.	STOCK-BASED COMPENSATION.

The Company has three equity incentive compensation plans: an Amended 1995 Incentive Stock Plan, a 2004 Stock Option Plan and a 2006 Stock Incentive Plan.

Amended 1995 Incentive Stock Plan

The Amended 1995 Incentive Stock Plan was carried over from Accessity as a result of the Share Exchange Transaction. The plan authorized the issuance of incentive stock options (“ISOs”) and non-qualified stock options (“NQOs”), to the Company’s employees, directors or consultants for the purchase of up to an aggregate of 1,200,000 shares of the Company’s common stock. On July 19, 2006, the Company terminated the Amended 1995 Incentive Stock Plan, except to the extent of issued and outstanding options then existing under the plan. The Company had 40,000, 63,000 and 105,000 stock options outstanding under its Amended 1995 Incentive Stock Plan at December 31, 2007, 2006 and 2005, respectively.

F-42

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2004 Stock Option Plan

The 2004 Stock Option Plan authorized the issuance of ISOs and NQOs to the Company’s officers, directors or key employees or to consultants that do business with the Company for up to an aggregate of 2,500,000 shares of common stock. On September 7, 2006, the Company terminated the 2004 Stock Option Plan, except to the extent of issued and outstanding options then existing under the plan. The Company had 185,000, 405,000 and 822,500 stock options outstanding under its 2004 Stock Option Plan at December 31, 2007, 2006 and 2005, respectively.

On August 10, 2005, the Company granted options to purchase an aggregate of 425,000 shares of the Company’s common stock at an exercise price equal to $8.03, the closing price per share of the Company’s common stock on the day immediately preceding that date, to its Chief Financial Officer. The options vested as to 85,000 shares immediately and 85,000 shares were to vest on each of the next four anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Since the options were granted at par with the market price of the stock, no non-cash charge was recorded. Upon the retirement of the Chief Financial Officer on December 14, 2006, the unvested stock options related to this grant were forfeited, except for the options allotted under a consulting agreement entered into with the retired Chief Financial Officer on December 14, 2006. The consulting agreement provided for the immediate vesting of 42,500 stock options on December 14, 2006, and an additional 42,500 stock options vested on August 15, 2007, the last day of the term of the consulting agreement, provided the obligations under the consulting agreement were fulfilled by the retired Chief Financial Officer. The Company accounted for these options under the provisions of SFAS No. 123(R) and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and accordingly, has recorded compensation expense for the unvested stock options based on the fair value of those options at the end of the reporting period based on the Black-Scholes option-pricing model with inputs of: the closing stock price on the last day of the reporting period, an exercise price of $8.03, the remaining contractual term through August 15, 2007, and volatility of 73.1%. The Company recorded $151,000 and $312,000 in stock-based compensation expense relating to these options for the years ended December 31, 2007 and 2006, respectively.

On August 10, 2005, the Company granted options to purchase an aggregate of 75,000 shares of the Company’s common stock at an exercise price equal to $8.03, the closing price per share of the Company’s common stock on the day immediately preceding that date, to a consultant. The options vested as to 15,000 shares immediately and 15,000 shares were to vest on each of the next four anniversaries of the date of grant. The options were to expire 10 years following the date of grant. Under the guidelines of EITF Issue No. 96-18, based on the consultant meeting its obligations under the consulting agreement, the Company recorded compensation expense based on the fair value of the stock options at the vesting dates and on the last day of the reporting period for the unvested stock options, based on the Black-Scholes option-pricing model with inputs of: an exercise price of $8.03, the closing stock price, a contractual term of 10 years, and volatility of 53.6%. Beginning in December 2006 the consultant stopped providing services and will not be providing services in the future under the existing consulting agreement. As a result, the unvested stock options were forfeited. The Company recorded share-based compensation expense of $0, $174,000 and $104,000 for the years ended December 31, 2007, 2006 and 2005, respectively, relating to these options.

F-43

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

One outstanding option granted to an employee of the Company to acquire 25,000 shares of common stock vested on March 23, 2005 and was converted into a warrant. A non-cash charge of $232,000 to compensation expense was recorded for the year ended December 31, 2005 in connection with this warrant.

The Company issued an aggregate of 70,000 shares of common stock to two employees on their date of hire on June 23, 2005. A non-cash charge of $651,000 was recorded for the year ended December 31, 2005 in connection with these issuances.

On July 26, 2005, the Company issued options to purchase an aggregate of 17,500 shares of the Company’s common stock at an exercise price equal to $7.01 per share, which exercise price equals 85% of the closing price per share of the Company’s common stock on that date. The options vested upon issuance and expire 10 years following the date of grant. A non-cash charge of $22,000 to compensation expense was recorded for the year ended December 31, 2005 in connection with these issuances.

On September 1, 2005, the Company granted options to purchase an aggregate of 160,000 shares of the Company’s common stock at an exercise price equal to $6.63 per share, which exercise price equals 85% of the closing price per share of the Company’s common stock on the day immediately preceding that date. The options expire 10 years following the date of grant. A non-cash charge of $59,000 was recorded to compensation expense for the year ended December 31, 2005. The options will be amortized ratably over the dates of additional vesting occurring on each of the three anniversaries following the date of grant.

2006 Stock Incentive Plan

The 2006 Stock Incentive Plan authorizes the issuance of options, restricted stock, restricted stock units, stock appreciation rights, direct stock issuances and other stock-based awards to the Company’s officers, directors or key employees or to consultants that do business with the Company for up to an aggregate of 2,000,000 shares of common stock.

The Company grants to certain employees and directors shares of restricted stock under its 2006 Stock Incentive Plan pursuant to Restricted Stock Agreements. A summary of unvested restricted stock activity is as follows (shares in thousands):

	Number of Shares			Weighted Average Grant Date Fair Value
Unvested at January 1, 2006		—		$	—
Issued		946			13.06
Vested		(281	)		13.06
Unvested at December 31, 2006		665			13.06
Issued		19			15.11
Vested		(140	)		13.14
Canceled		(36	)		13.72
Unvested at December 31, 2007		508		$	13.07

A summary of the status of Company’s stock option plans as of December 31, 2007, 2006 and 2005 and of changes in options outstanding under the Company’s plans during those years are as follows (in thousands, except exercise prices):

F-44

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Years Ended December 31,
	2007					2006					2005
	Number of Shares			Weighted-Average Exercise Price		Number of Shares			Weighted-Average Exercise Price		Number of Shares			Weighted- Average Exercise Price
Outstanding at beginning of year		468		$	7.42		927		$	7.53		25		$	0.01
Granted		—			—		—			—		822			7.78
Acquired in Share Exchange Transaction		—			—		—			—		378			5.98
Exercised		(243	)		7.79		(196	)		7.06		(270	)		6.10
Terminated		—			—		(263	)		8.04		(28	)		0.01
Outstanding at end of year		225			7.03		468			7.42		927			7.53
Options exercisable at end of year		185		$	7.11		297		$	7.36		262		$	7.57

Stock options outstanding as of December 31, 2007, were as follows (number of shares in thousands):

	Options Outstanding			Options Exercisable
Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted- Average Exercise Price	Number Exercisable	Weighted Average Exercise Price

$4.88-$6.63	145	5.98	$6.34	105	$6.24
$8.25-$8.30	80	7.68	$8.26	80	$8.26
	225			185

The total intrinsic value of options outstanding was approximately $267,000 and $7,388,000 at December 31, 2007 and 2006, respectively. The intrinsic value for exercisable options was $203,000 and $2,104,000 at December 31, 2007 and 2006, respectively. The total intrinsic value for stock options exercised was approximately $101,000 and $3,833,000 for the years ended December 31, 2007 and 2006, respectively.

Warrants

In February 2004, the Company entered into a consulting agreement with a consultant to represent the Company in investors’ communications and public relations with existing shareholders, brokers, dealers and other investment professionals as to the Company’s current and proposed activities.

Pursuant to the consulting agreement, upon completion of the Share Exchange Transaction, the Company issued warrants to the consultant to purchase 230,000 additional shares of common stock at an exercise price of $0.0001 and expiring on March 23, 2009 that vested ratably over a period of two years from the date of the Share Exchange Transaction. The warrants were recognized at the fair value as of the start of business on March 24, 2005 in the amount of $2,139,000 and recorded as contra-equity. The fair value was amortized over two years, resulting in non-cash expense of $822,636 during the period from March 24, 2005 to December 31, 2005. The unvested warrants in the amount of $1,316,364 vested ratably at $89,125 per month over the remainder of the two year period.

As of December 31, 2007, there were no outstanding warrants, as all warrants issued were either exercised or expired.

F-45

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes warrant activity for the years ended December 31, 2007, 2006 and 2005 (number of shares in thousands):

	Number of Shares			Price per Share	Weighted Average Exercise Price
Balance at December 31, 2004		125		$1.50 - $5.00	$	2.24
Warrants granted		3,058		$0.0001 - $5.00		3.21
Warrants exercised		(278	)	$0.0001 - $5.00		2.01
Balance at December 31, 2005		2,905		$0.0001 - $5.00		3.26
Warrants granted		3,442		$14.41 – $31.55		27.66
Warrants exercised		(2,747	)	$0.0001 - $5.00		3.28
Balance at December 31, 2006		3,600		$0.0001 – $31.55		27.57
Warrants exercised		(128	)	$0.0001 – $5.00		2.84
Warrants expired		(3,472	)	$3.00 – $31.00		27.45
Balance at December 31, 2007		—			$	—

Adoption of SFAS No. 123(R)

On January 1, 2006, the Company adopted SFAS No. 123(R), which requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award on the date of grant. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award.

SFAS No. 123(R) provides for two transition methods. The “modified prospective” method requires that share-based compensation expense be recorded for any employee options granted after the adoption date and for the unvested portion of any employee options outstanding as of the adoption date. The “modified retrospective” method requires that, beginning in the first quarter of 2006, all prior periods presented be restated to reflect the impact of share-based compensation expense consistent with the pro forma disclosures previously required under SFAS No. 123. The Company has elected to use the “modified prospective” method in adopting this standard.

The Company’s determination of fair value is affected by the Company’s common stock price as well as the assumptions discussed above that require management’s judgment. As permitted under SFAS No. 123(R), the Company continued to use the Black-Scholes option-pricing model in order to calculate the compensation costs of employee stock-based compensation. Such model requires the use of subjective assumptions, including the expected life of the option, the expected volatility of the underlying stock, and the expected dividend on the stock.

In computing the stock-based compensation, the following is a weighted-average of the assumptions used:

Options Granted in Years Ended December 31,	Risk-Free Interest Rate	Expected Life at Issuance	Expected Volatility	Expected Dividends

2007	None	None	None	None
2006	None	None	None	None
2005	3.9 to 4.5%	5.5 to 10 years	53.6%	None

The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of the stock options. The expected volatility is based on the historical volatility of the common stock of an appropriate proxy company. The Company has not paid any dividends on its common stock since its inception and does not anticipate paying dividends on its common stock for the foreseeable future. The computation of the expected option term is based on expectations regarding future exercises of options which generally vest over 5.5 to 10 years.

F-46

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

There were 40,000, 66,034 and 693,502 unvested options with weighted–average grant-date fair values of $6.63, $7.56 and $5.61, at December 31, 2007, 2006 and 2005, respectively.

At December 31, 2007, the total compensation cost related to unvested awards which had not been recognized was $6,187,000 and the associated weighted-average period over which the compensation cost attributable to those unvested awards would be recognized is 2.12 years.

SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on historical experience, the Company estimated future unvested option forfeitures at 3% as of December 31, 2007.

Stock-based compensation expense related to employee and non-employee stock grants, options and warrants recognized in income were as follows (in thousands):

	Years Ended December 31,
	2007		2006		2005

Employees – included in general and administrative	$	1,671	$	4,466	$	963
Non-employees – included in general and administrative		554		1,782		1,099
Total stock-based compensation expense	$	2,225	$	6,248	$	2,062

Effective with the adoption of SFAS No. 123(R), stock-based compensation expense related to the Company’s stock-based compensation arrangements attributable to employees is recorded as a component of general and administrative expense in the consolidated statements of operations.

SFAS No. 123(R) requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (i.e., excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities. The aggregate amount of cash the Company received from the exercise of stock options was $1,894,000, $1,303,000 and $450,000 for the years ended December 31, 2007, 2006 and 2005, respectively, which shares, consistent with prior periods, were newly issued common stock. Prior to the adoption of SFAS No. 123(R), the Company reported the full tax benefits resulting from the exercise of stock options as operating cash flows. In accordance with SFAS No. 123(R), the Company now presents a portion of such tax benefits as financing cash flows, which amount was $0 for the year ended December 31, 2006 due to the Company’s accumulated deficit position. Prior to adopting SFAS No. 123(R), the Company accounted for its employee stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Pursuant to APB No. 25, the Company did not record share-based compensation, but followed the disclosure requirements of SFAS No. 123. The Company’s financial results for prior periods have not been restated.

The following table sets forth the theoretical pro forma costs and effect on net loss as if the Company had applied the fair value recognition provisions of SFAS No. 123(R) to employee stock-based compensation plans for the year ended December 31, 2005 (in thousands, except per share data):

F-47

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Net loss, as reported	$	(9,923	)
Stock-based employee compensation expense included in reported net loss		964
Stock-based compensation awards, fair value method		(1,909	)
Net loss, pro forma	$	(10,868	)
Net loss per share, basic and diluted	$	(0.43	)
Weighted-average shares outstanding, basic and diluted		25,066

16.	COMMITMENTS AND CONTINGENCIES.

Commitments – The following is a description of significant commitments at December 31, 2007:

Operating Leases–Future minimum lease payments required by non-cancelable operating leases in effect at December 31, 2007 are as follows (in thousands):

Years Ended December 31,	Amount
2008	$	2,247
2009		2,434
2010		2,424
2011		2,267
2012		1,965
Total	$	11,337

Total rent expense during the years ended December 31, 2007, 2006 and 2005 was $1,102,000, $254,000 and $84,000, respectively.

Purchase Commitments – At December 31, 2007, the Company had purchase contracts with its suppliers to purchase certain quantities of ethanol, corn, natural gas and denaturant. The volumes indicated in the indexed price table are at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

	Fixed-Price Contracts
Ethanol (gallons)	$	70,565
Corn (bushels)		4,369
Natural gas (decatherms)		1,846
Total	$	76,780

	Indexed-Price Contracts (Volume)
Ethanol (gallons)		4,144
Corn (bushels)		2,400

Sales Commitments – At December 31, 2007, the Company had entered into sales contracts with its major customers to sell certain quantities of ethanol and corn. The volumes indicated in the indexed price contracts table will be sold at publicly-indexed sales prices determined by market prices in effect on their respective transaction dates (in thousands):

F-48

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Fixed-Price Contracts
Ethanol (gallons)	$	57,794
WDG		14,756
Total	$	72,550

		Indexed-Price Contracts (Volume)
Ethanol (gallons)			40,572

Carbon Dioxide Plant – On April 4, 2007, the Company entered into a long-term agreement to sell substantially all the carbon dioxide gas (“CO2”) produced by the Company’s Madera facility to a third party. Under this agreement the Company will modify its Madera plant, at a cost of approximately $1,500,000, to capture and further process CO2 for delivery to the third party. The agreement calls for the third party to reimburse the Company for its capital investment through a recovery fee included in the agreed upon sales price and has a take-or-pay component which requires the third party to purchase, or if it does not purchase, pay for a minimum quantity of raw CO2. The agreement has a fifteen-year term and will automatically renew for successive five year periods unless terminated by either party. In February 2008, the Company terminated this agreement.

Capital Commitments – Construction commitments for in-progress and contracted ethanol processing facilities are approximately $118,357,000 for the year ended December 31, 2008.

Contingencies – The following is a description of significant contingencies at December 31, 2007:

Litigation – General – The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect the Company’s quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not adversely affect the Company’s financial position, results of operations or cash flows.

Litigation – Barry Spiegel – State Court Action – On December 23, 2005, Barry J. Spiegel, a former shareholder and director of Accessity, filed a complaint in the Circuit Court of the 17th Judicial District in and for Broward County, Florida (Case No. 05018512) (the “State Court Action”) against Barry Siegel, Philip Kart, Kenneth Friedman and Bruce Udell (collectively, the “Individual Defendants”). Messrs. Siegel, Udell and Friedman are former directors of Accessity and Pacific Ethanol. Mr. Kart is a former executive officer of Accessity and the Company.

The State Court Action relates to the Share Exchange Transaction and purports to state the following five counts against the Individual Defendants: (i) breach of fiduciary duty, (ii) violation of the Florida Deceptive and Unfair Trade Practices Act, (iii) conspiracy to defraud, (iv) fraud, and (v) violation of Florida’s Securities and Investor Protection Act. Mr. Spiegel based his claims on allegations that the actions of the Individual Defendants in approving the Share Exchange Transaction caused the value of his Accessity common stock to diminish and is seeking $22.0 million in damages. On March 8, 2006, the Individual Defendants filed a motion to dismiss the State Court Action. Mr. Spiegel filed his response in opposition on May 30, 2006. The Court granted the motion to dismiss by Order dated December 1, 2006 (the “Order”), on the grounds that, among other things, Mr. Spiegel failed to bring his claims as a derivative action.

F-49

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On February 9, 2007, Mr. Spiegel filed an amended complaint which purported to state the following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The amended complaint includes the Company as a defendant. The breach of fiduciary duty counts are alleged solely against the Individual Defendants and not the Company. On June 19, 2007, the Company filed a motion to dismiss the amended complaint. The Court denied the motion to dismiss the amended complaint by order dated July 31, 2007. Mr. Spiegel, however, voluntarily dismissed without prejudice the case against the Company on August 27, 2007, and therefore the Company is no longer a party to the state action.

Litigation – Barry Spiegel – Federal Court Action – On December 22, 2006, Barry J. Spiegel, filed a complaint in the United States District Court, Southern District of Florida (Case No. 06-61848) (the “Federal Court Action”) against the Individual Defendants and the Company. The Federal Court Action relates to the Share Exchange Transaction and purports to state the following three counts: (i) violations of Section 14(a) of the Exchange Act and SEC Rule 14a-9 promulgated thereunder, (ii) violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (iii) violation of Section 20(A) of the Exchange Act. The first two counts are alleged against the Individual Defendants and the Company and the third count is alleged solely against the Individual Defendants. Mr. Spiegel bases his claims on, among other things, allegations that the actions of the Individual Defendants and the Company in connection with the Share Exchange Transaction resulted in a share exchange ratio that was unfair and resulted in the preparation of a proxy statement seeking shareholder approval of the Share Exchange Transaction that contained material misrepresentations and omissions. Mr. Spiegel is seeking in excess of $15.0 million in damages. Mr. Spiegel amended the Federal Court Action on February 9, 2007 and then sought to stay his own federal case, but the Motion was denied on July 17, 2007. Mr. Spiegel filed his reply to the Company’s Motion to Dismiss and that Motion remains pending. The Company intends to vigorously defend the Federal Court Action.

Litigation – Mercator – In 2003, Accessity filed a lawsuit seeking damages in excess of $100 million against: (i) Presidion Corporation, f/k/a MediaBus Networks, Inc., the parent corporation of Presidion Solutions, Inc. (“Presidion”), (ii) Presidion’s investment bankers, Mercator Group, LLC (“Mercator”), and various related and affiliated parties, and (iii) Taurus Global LLC (“Taurus”), (collectively referred to as the “Mercator Action”), alleging that these parties committed a number of wrongful acts, including, but not limited to tortiously interfering in a transaction between Accessity and Presidion. In 2004, Accessity dismissed this lawsuit without prejudice, which was filed in Florida state court. In January 2005, Accessity refiled this action in the State of California, for a similar amount, as Accessity believed that this was the proper jurisdiction. On August 18, 2005, the court stayed the action and ordered the parties to arbitration. The parties agreed to mediate the matter. Mediation took place on December 9, 2005 and was not successful. On December 5, 2005, the Company filed a Demand for Arbitration with the American Arbitration Association. On April 6, 2006, a single arbitrator was appointed. Arbitration hearings had been scheduled to commence in July 2007. In April 2007, the arbitration proceedings were suspended due to non-payment of arbitration fees by Presidion and Taurus. As a result of non-payment of arbitration fees, a default order was entered against Taurus by the Los Angeles Superior Court. In July 2007, the Company entered into a confidential settlement agreement with Presidion and its former officers. On July 23, 2007, the Company dismissed Presidion from the arbitration. On July 23, 2007, Taurus filed a Voluntary Petition for Chapter 7 Bankruptcy in the United States District Court, Central District of California, Case Number SV07-12547 GM. The arbitration hearings against Mercator begun on February 11, 2008 and concluded on February 19, 2008. After the hearings concluded but prior to an award being issued, the parties engaged in a two day mediation. As a result of the mediation, the parties entered into a confidential settlement agreement. The share exchange agreement relating to the Share Exchange Transaction provides that following full and final settlement or other final resolution of the Mercator Action, after deduction of all fees and expenses incurred by the law firm representing the Company in this action and payment of the 25% contingency fee to the law firm, shareholders of record of Accessity on the date immediately preceding the closing date of the Share Exchange Transaction will receive two-thirds and the Company will retain the remaining one-third of the net proceeds from any Mercator Action recovery.

F-50

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.	DERIVATIVES/HEDGES.

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. The Company accounts for its use of derivatives related to its hedging activities pursuant to SFAS No. 133, under which the Company recognizes all of its derivative instruments in its statement of financial position as either assets or liabilities, depending on the rights or obligations under the contracts, unless the contracts qualify as a normal purchase or normal sale as further discussed below. The Company has designated and documented contracts for the physical delivery of commodity products to and from counterparties as normal purchases and normal sales. Derivative instruments are measured at fair value. Changes in the derivative’s fair value are recognized currently in income unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s effective gains and losses to be deferred in accumulated other comprehensive income and later recorded together with the gains and losses to offset related results on the hedged item in income. Companies must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. Contracts designated and documented as normal purchases or normal sales are not recorded at fair value.

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 are designated and documented as SFAS No. 133 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 income.

For the year ended December 31, 2007, a gain from ineffectiveness in the amount of $2,832,000 and an effective loss in the amount of $1,680,000 were recorded in cost of goods sold. For the year ended December 31, 2006, losses of ineffectiveness in the amount of $239,000 and an effective loss in the amount of $438,000 was recorded in cost of goods sold. For the year ended December 31, 2006, an effective gain in the amount of $1,281,000 was recorded in net sales. Amounts remaining in accumulated other comprehensive income will be reclassified to income upon the recognition of the related purchase or sale. Accumulated other comprehensive loss in the amount of $455,000 associated with commodity cash flow hedges is expected to be recognized in income over the next twelve months. The notional balances remaining on these derivatives as of December 31, 2007 and 2006 was $2,427,000 and $11,588,000, respectively.

F-51

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Commodity Risk – Non-Designated Hedges – As part of the Company’s risk management strategy, it uses forward contracts on corn, crude oil and reformulated blendstock for oxygenate blending gasoline to lock in prices for certain amounts of corn, denaturant and ethanol, respectively. These derivatives are not designated under SFAS No. 133 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 Company recognized a loss of $6,484,000 (of which $3,532,000 is related to settled non-designated hedges) and $0 as the change in the fair value of these contracts for the year ended December 31, 2007 and 2006, respectively. The notional balances remaining on these contracts as of December 31, 2007 and 2006 were $29,999,000 and $0, respectively.

Interest Rate Risk – As part of the Company’s interest rate risk management strategy, the Company uses derivative instruments to minimize significant unanticipated income fluctuations that may arise from rising variable interest rate costs associated with existing and anticipated borrowings. To meet these objectives the Company purchased interest rate caps and swaps. The rate for notional balances of interest rate caps ranging from $0 to $21,588,000 is 5.50%-6.00% per annum. The rate for notional balances of interest rate swaps ranging from $0 to $63,219,000 is 5.01%-8.16% per annum. These derivatives are designated and documented as SFAS No. 133 cash flow hedges and effectiveness is evaluated by assessing the probability of anticipated interest expense and regressing the historical value of the rates against the historical value in the existing and anticipated debt. Ineffectiveness, reflecting the degree to which the derivative does not offset the underlying exposure, is recognized immediately in income. For the year ended December 31, 2007, losses from ineffectiveness in the amount of $4,836,000, losses from effectiveness in the amount of $147,000 and losses from undesignated hedges in the amount of $606,000 were recorded in other income (expense). These losses resulted primarilty from the Company’s deferral of constructing its Imperial Valley facility. (See Note 9.) During the year ended December 31, 2006, ineffectiveness in the amount of $24,000 was recorded in other income (expense). There was no ineffectiveness for the year ended December 31, 2005. Amounts remaining in accumulated other comprehensive income will be reclassified to income upon the recognition of the hedged interest expense. For the year ending December 31, 2008, the Company anticipates reclassifying $595,000 to income in connection with its cash flow interest rate caps and swaps.

The Company marked its derivative instruments to fair value at each period end, except for those derivative contracts that qualified for the normal purchase and sale exemption under SFAS No. 133. According to the Company’s designation of the derivative, changes in the fair value of derivatives are reflected in income or accumulated other comprehensive income.

Accumulated Other Comprehensive Income – Accumulated other comprehensive income relative to derivatives is as follows (in thousands):

	Commodity Derivatives			Interest Rate Derivatives
	Gain/(Loss)*			Gain/(Loss)*
Beginning balance, January 1, 2007	$	461		$	(265	)
Net changes		(2,596	)		(1,810	)
Less: Amount reclassified to cost of goods sold		(1,680	)		—
Less: Amount reclassified to other income (expense)		—			(147	)
Ending balance, December 31, 2007	$	(455	)	$	(1,928	)

—————

*Calculated on a pretax basis

F-52

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18.	RELATED PARTY TRANSACTIONS.

Related Customers – On August 10, 2005, the Company entered into a six-month sales contract with Southern Counties Oil Co., an entity owned by a former director and stockholder of the Company. The contract period was from October 1, 2005 through March 31, 2006 for 5,544,000 gallons of fuel grade ethanol to be delivered ratably at approximately 924,000 gallons per month at varying prices based on delivery destinations in California, Nevada and Arizona. On January 14, 2006, the Company entered into a second six-month sales contract with Southern Counties Oil Co. The contract period was from April 1, 2006 through September 30, 2006 for 2,100,000 gallons of fuel-grade ethanol to be delivered ratably at approximately 350,000 gallons per month at varying prices based on delivery destinations in California. On June 13, 2006, the Company entered into a third six-month sales contract with a contract period from October 1, 2006 through March 31, 2007 for 6,300,000 gallons of fuel-grade ethanol to be delivered ratably at approximately 1,050,000 gallons per month at varying prices based on delivery destinations in California, Nevada and Arizona. Sales to Southern Counties Oil Co. under these contracts totaled $6,039,000, $16,985,000 and $9,060,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Accounts receivable from Southern Counties Oil Co. related to these contracts totaled $0 and $1,188,000 at December 31, 2007 and 2006, respectively.

During 2007, the Company started selling corn to Tri J Land and Cattle (“Tri J”), an entity owned by a director of the Company. The Company is not under contract with Tri J, but currently sells Tri J rolled corn on a spot basis as needed. Sales to Tri J totaled $166,000 for the year ended December 31, 2007 and $0 for each of the years ended December 31, 2006 and 2005. Accounts receivable from Tri J totaled $7,000 at December 31, 2007.

Related Vendors – The Company purchased 18,628 bushels of corn from Jones Villere Farms (“JVF”), a company owned by a director of the Company. Purchases from JVF totaled $95,000 for the years ended December 31, 2007 and $0 for each of the years ended December 31, 2006 and 2005. There were no accounts payable due to JVF at December 31, 2007.

The Company purchased 35,219 bushels of corn from Llanada Farms (“Llanada”), an affiliate of a director of the Company for the year ended December 31, 2006. Purchases from Llanada under this contract totaled $112,000 for the year ended December 31, 2006. There were no additional purchases during the years ended December 31, 2007 and 2005.

The Company purchased 45,708 gallons of fuel grade ethanol from Southern Counties Oil Co., an entity owned by a former director and stockholder of the Company for the year ended December 31, 2005. Purchases from Southern Counties Oil Co. under this contract totaled $74,000 for the year ended December 31, 2005. There were no additional purchases during the years ended December 31, 2007 and 2006. Accounts payable to Southern Counties Oil Co. totaled $0 at December 31, 2007 and 2006.

Plant Development and Construction – In 2006, the Company entered into an agreement with a construction company to build an ethanol production facility in Madera, California. An officer of the construction company was a former member of the board of directors of PEI California. The Company had outstanding liabilities to the construction company in the amount of $900,000 as of December 31, 2007.

The Company entered into a consulting agreement with a shareholder of the Company for consulting services related to the development of an ethanol plant. Compensation payable under the agreement was $6,000 per month. The Company paid a total of $21,000 for the year ended December 31, 2005. There were no additional payments for the years ended December 31, 2007 and 2006.

F-53

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Consulting Agreement – Environmental – The Company entered into a consulting agreement with a company owned by a member of ReEnergy, LLC for consulting services related to environmental regulations and permitting. Compensation payable under the agreement was $3,000 per month. The Company paid a total of $8,000 for the year ended December 31, 2005. There were no additional payments for the years ended December 31, 2007 and 2006.

19.	QUARTERLY FINANCIAL DATA.

The Company’s unaudited quarterly results of operations for the years ended December 31, 2007 and 2006 are as follows (in thousands):

	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
December 31, 2007:
Net sales	$	99,242		$	113,763		$	118,118		$	130,390
Gross profit	$	15,341		$	11,121		$	4,759		$	1,678
Income (loss) from operations	$	5,839		$	2,801		$	(1,161	)	$	(5,402	)
Net income (loss)	$	2,975		$	2,156		$	(4,842	)	$	(14,689	)
Preferred stock dividend	$	(1,050	)	$	(1,050	)	$	(1,050	)	$	(1,050	)
Deemed dividend on preferred stock	$	—		$	—		$	—		$	(28	)
Income (loss) available to common stockholders	$	1,925		$	1,106		$	(5,892	)	$	(15,767	)
Income (loss) per common share:
Basic and diluted	$	0.05		$	0.03		$	(0.15	)	$	(0.39	)

	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
December 31, 2006:
Net sales	$	38,239		$	46,461		$	61,102		$	80,554
Gross profit	$	2,325		$	3,308		$	7,448		$	11,748
Income (loss) from operations	$	(659	)	$	(1,451	)	$	1,900		$	398
Net income (loss)	$	(612	)	$	(182	)	$	3,755		$	(3,103	)
Preferred stock dividend	$	—		$	(898	)	$	(1,050	)	$	(1,050	)
Deemed dividend on preferred stock	$	—		$	(84,000	)	$	—		$	—
Income (loss) available to common stockholders	$	(612	)	$	(85,080	)	$	2,705		$	(4,153	)
Income (loss) per common share:
Basic and diluted	$	(0.02	)	$	(2.56	)	$	0.07		$	(0.11	)

20.	SUBSEQUENT EVENTS.

Note Extension – On February 25, 2008, the Company elected to extend the term of its $15,000,000 note payable and in connection with the terms of the extension, issued a warrant to purchase the Company’s common stock for $8.00 per share. (See Note 9.)

Settlement of Mercator Litigation – In February 2008, the Company entered into a confidential settlement agreement with Mercator. (See Note 16.)

Waiver of Defaults under Credit Agreement – In March 2008, the Company became aware of various events or circumstances which constituted defaults under its Credit Agreement. (See Note 9.) These events or circumstances included the existence of material weaknesses in the Company’s internal control over financial reporting as of December 31, 2007, cash management activities that violated covenants in its Credit Agreement, failure to maintain adequate amounts in a designated debt service reserve account, the existence of a number of Eurodollar loans in excess of the maximum number permitted under the Company’s Credit Agreement, and the Company’s failure to pay all remaining project costs on its Madera and Boardman facilities by certain stipulated deadlines. On March 26, 2008, the Company obtained waivers from its lenders as to these defaults and was required to pay the lenders a consent fee in an aggregate amount of up to approximately $600,000. In addition to the waivers, the Company’s lenders agreed to amend the Credit Agreement. These amendments include an increase in the frequency with which the Company is to deposit certain revenues into a restricted account each month, an increase the allowable Eurodollar loans from a maximum of seven to a maximum of ten, and the Company is required to pay all remaining project costs on its Madera and Boardman facilities by May 16, 2008.

F-54

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Series B Financing Transaction

Securities Purchase Agreement and Warrant

On March 18, 2008, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Lyles United, LLC (the “Purchaser”). The Purchase Agreement provides for the sale by the Company and the purchase by the Purchaser of (i) 2,051,282 shares of the Company’s Series B Cumulative Convertible Preferred Stock (the “Series B Preferred Stock”), all of which would initially be convertible into an aggregate of 6,153,846 shares of the Company’s common stock based on an initial three-for-one conversion ratio, and (ii) a warrant (the “Warrant”) to purchase an aggregate of 3,076,923 shares of the Company’s common stock at an exercise price of $7.00 per share, for an aggregate purchase price of $40 million. On March 27, 2008, the Company consummated the purchase and sale of the Series B Preferred Stock. The Series B Preferred Stock was created under the Certificate of Designations described below. The Purchase Agreement includes customary representations and warranties on the part of both the Company and the Purchaser and other customary terms and conditions.

The Warrant is exercisable at any time during the period commencing on the date that is six months and one day from the date of the Warrant and ending ten years from the date of the Warrant. The Warrant contains customary anti-dilution provisions for stock splits, stock dividends and the like and other customary terms and conditions.

Certificate of Designations

The Certificate of Designations, Powers, Preferences and Rights of the Series B Cumulative Convertible Preferred Stock (the “Certificate of Designations”) provides for 3,000,000 shares of preferred stock to be designated as Series B Cumulative Convertible Preferred Stock. The Series B Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s common stock and on parity with respect to dividend and liquidation rights with the Company’s Series A Preferred Stock. Holders of Series B Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in cash in an amount equal to 7.00% of the purchase price per share of the Series B Preferred Stock on a pari passu basis with the holders of Series A Preferred Stock; however, subject to the provisions of the Letter Agreement described below, such dividends may, at the option of the Company, be paid in additional shares of Series B Preferred Stock based initially on liquidation value of the Series B Preferred Stock. The holders of Series B Preferred Stock have a liquidation preference over the holders of the Company’s common stock initially equivalent to $19.50 per share of the Series B Preferred Stock plus any accrued and unpaid dividends on the Series B Preferred Stock but on a pro rata and pari passu basis with the holders of Series A Preferred Stock. A liquidation will be deemed to occur upon the happening of customary events, including transfer of all or substantially all of the capital stock or assets of the Company or a merger, consolidation, share exchange, reorganization or other transaction or series of related transaction, unless holders of 66 2/3% of the Series B Preferred Stock vote affirmatively in favor of or otherwise consent that such transaction shall not be treated as a liquidation.

F-55

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The holders of the Series B Preferred Stock have conversion rights initially equivalent to three shares of common stock for each share of Series B Preferred Stock. The conversion ratio is subject to customary antidilution adjustments. In addition, antidilution adjustments are to occur in the event that the Company issues equity securities at a price equivalent to less than $6.50 per share, including derivative securities convertible into equity securities (on an as-converted or as-exercised basis). The shares of Series B Preferred Stock are also subject to forced conversion upon the occurrence of a transaction that would result in an internal rate of return to the holders of the Series B Preferred Stock of 25% or more. The forced conversion is to be based upon the conversion ratio as last adjusted. Accrued but unpaid dividends on the Series B Preferred Stock are to be paid in cash upon any conversion of the Series B Preferred Stock.

The holders of Series B Preferred Stock vote together as a single class with the holders of the Company’s Series A Preferred Stock and common stock on all actions to be taken by the Company’s stockholders. Each share of Series B Preferred Stock entitles the holder to the number of votes equal to the number of shares of common stock into which each share of Series B Preferred Stock is convertible on all matters to be voted on by the stockholders of the Company. Notwithstanding the foregoing, the holders of Series B Preferred Stock are afforded numerous customary protective provisions with respect to certain actions that may only be approved by holders of a majority of the shares of Series B Preferred Stock.

As long as 50% of the shares of Series B Preferred Stock remain outstanding, the holders of the Series B Preferred Stock are afforded preemptive rights with respect to certain securities offered by the Company. The preemptive rights of the holders of the Series B Preferred Stock are subordinate to the preemptive rights of, and prior exercise thereof by, the holders of the Series A Preferred Stock.

Registration Rights Agreement

In connection with the closing of the sale of its Series B Preferred Stock, the Company entered into a Registration Rights Agreement with the Purchaser. The Registration Rights Agreement is to be effective until the holders of the Series B Preferred Stock, and their affiliates, as a group, own less than 10% of the Series B Preferred Stock issued under the Purchase Agreement, including common stock into which such Series B Preferred Stock has been converted (the “Termination Date”). The Registration Rights Agreement provides that holders of a majority of the Series B Preferred Stock, including common stock into which such Series B Preferred Stock has been converted, may demand and cause the Company, at any time after the first anniversary of the Closing, to register on their behalf the shares of common stock issued, issuable or that may be issuable upon conversion of the Series B Preferred Stock and as payment of dividends thereon, and upon exercise of the Warrant as well as upon exercise of a warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $8.00 per share and issued in connection with the extension of the maturity date of a loan, as discussed above (collectively, the “Registrable Securities”). The Company is required to keep such registration statement effective until such time as all of the Registrable Securities are sold or until such holders may avail themselves of Rule 144 for sales of Registrable Securities without registration under the Securities Act of 1933, as amended. The holders are entitled to two demand registrations on Form S-1 and unlimited demand registrations on Form S-3; provided, however, that the Company is not obligated to effect more than one demand registration on Form S-3 in any calendar year. In addition to the demand registration rights afforded the holders under the Registration Rights Agreement, the holders are entitled to unlimited “piggyback” registration rights. These rights entitle the holders who so elect to be included in registration statements to be filed by the Company with respect to other registrations of equity securities. The Company is responsible for all costs of registration, plus reasonable fees of one legal counsel for the holders, which fees are not to exceed $25,000 per registration. The Registration Rights Agreement includes customary representations and warranties on the part of both the Company and the Purchaser and other customary terms and conditions.

F-56

PACIFIC ETHANOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Ancillary Agreements

In connection with the closing of the sale of its Series B Preferred Stock, the Company entered into a Letter Agreement with the Purchaser under which the Company expressly waived its rights under the Certificate of Designation to make dividend payments in additional shares of Series B Preferred Stock in lieu of cash dividend payments without the prior written consent of the Purchaser.

In connection with the closing of the sale of its Series B Preferred Stock, the Company entered into a Series A Preferred Stockholder Consent and Waiver (the “Consent and Waiver”) with Cascade Investment, L.L.C. (“Cascade”), the sole holder of the Company’s issued and outstanding shares of Series A Preferred Stock. Pursuant to the Consent and Waiver, Cascade waived its preemptive rights as to the issuance and sale of the Series B Preferred Stock, consented to the authorization, creation, issuance and sale of the Series B Preferred Stock, and consented to the registration rights granted under the aforementioned Registration Rights Agreement. In addition, each of the Company and Cascade waived the right to adjust the conversion price of the Series A Preferred Stock with respect to the sale and issuance of the Series B Preferred Stock and any shares of common stock issuable on conversion thereof or shares of Series B Preferred Stock payable as a dividend thereon. Under the Consent and Waiver, the Company expressly waived its rights under the Certificate of Designations, Powers, Preferences and Rights of the Series A Preferred Stock to make dividend payments in additional shares of Series A Preferred Stock in lieu of cash dividend payments without the prior written consent of Cascade.

F-57

INDEX TO EXHIBITS

Exhibit Number	Description
2.1	Agreement and Plan of Merger dated March 23, 2005 between the Registrant and Accessity Corp. (1)
2.2	Share Exchange Agreement dated as of May 14, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.3	Amendment No. 1 to Share Exchange Agreement dated as of July 29, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.4	Amendment No. 2 to Share Exchange Agreement dated as of October 1, 2004 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.5	Amendment No. 3 to Share Exchange Agreement dated as of January 7, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.6	Amendment No. 4 to Share Exchange Agreement dated as of February 16, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
2.7	Amendment No. 5 to Share Exchange Agreement dated as of March 3, 2005 by and among Accessity Corp., Pacific Ethanol, Inc., Kinergy Marketing, LLC, ReEnergy, LLC and the other parties named therein (1)
3.1	Certificate of Incorporation of the Registrant (1)
3.2	Certificate of Designations, Powers, Preferences and Rights of the Series A Cumulative Redeemable Convertible Preferred Stock (14)
3.3	Certificate of Designations, Powers, Preferences and Rights of the Series B Cumulative Convertible Preferred Stock (29)
3.4	Bylaws of the Registrant (1)
10.1	Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (7)
10.2	Form of Placement Warrant dated effective of various dates issued by Pacific Ethanol, Inc., a California corporation, to certain placement agents (7)
10.3	Form of Registration Rights Agreement dated effective May 14, 2004 between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (6)
10.4	Form of Placement Warrant dated effective May 14, 2004 issued by Pacific Ethanol, Inc., a California corporation, to certain placement agents (7)
10.5	Form of Registration Rights Agreement of various dates between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (6)
10.6	Form of Warrant of various dates issued to subscribers to a private placement of securities of Pacific Ethanol, Inc., a California corporation (7)
10.7	Form of Registration Rights Agreement dated effective March 23, 2005 between Pacific Ethanol, Inc., a California corporation and the investors who are parties thereto (1)
10.8	Form of Warrant dated March 23, 2005 issued by the Registrant to subscribers to a private placement of securities by Pacific Ethanol, Inc., a California corporation (1)
10.9	Form of Placement Warrant dated March 23, 2005 issued by the Registrant to certain placement agents (1)

Exhibit

Number

Description

10.10	Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March 23, 2005 between the Registrant and Barry Siegel (1)
10.11	Confidentiality, Non-Competition, Non-Solicitation and Consulting Agreement dated March 23, 2005 between the Registrant and Philip B. Kart (1)
10.12	Form of Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23, 2005 between the Registrant and each of Neil M. Koehler, Tom Koehler, William L. Jones, Andrea Jones and Ryan W. Turner (1)
10.13	Confidentiality, Non-Competition and Non-Solicitation Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (1)
10.14	Form of Indemnification Agreement between the Registrant and each of its Executive Officers and Directors (#) (14)
10.15	Executive Employment Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (#)(1)
10.16	Executive Employment Agreement dated March 23, 2005 between the Registrant and Ryan W. Turner (#)(1)
10.17	Stock Purchase Agreement and Assignment and Assumption Agreement dated March 23, 2005 between the Registrant and Barry Siegel (1)
10.18	Letter Agreement dated March 23, 2005 between the Registrant and Neil M. Koehler (1)
10.19	Ethanol Purchase and Marketing Agreement dated March 4, 2005 between Kinergy Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific Ethanol, Inc. and Western Milling, LLC (2)
10.20	Pacific Ethanol Inc. 2004 Stock Option Plan (3)
10.21	First Amendment to Pacific Ethanol, Inc. 2004 Stock Option Plan (13)
10.22	Amended 1995 Stock Option Plan (4)
10.23	Warrant dated March 23, 2005 issued by the Registrant to Liviakis Financial Communications, Inc. (1)
10.24	Executive Employment Agreement dated August 10, 2005 between the Registrant and William G. Langley (#)(5)
10.25	Ethanol Marketing Agreement dated as of August 31, 2005 by and between Kinergy Marketing, LLC and Front Range Energy, LLC (8)
10.26	Master Revolving Note dated September 24, 2004 of Kinergy Marketing, LLC in favor of Comerica Bank (9)
10.27	Loan Revision/Extension Agreement dated October 4, 2005 and effective as of June 20, 2005 between Kinergy Marketing, LLC and Comerica Bank (9)
10.28	Letter Agreement dated as of October 4, 2005 between Kinergy Marketing, LLC and Comerica Bank (9)
10.29	Guaranty dated October 4, 2005 by Pacific Ethanol, Inc. in favor of Comerica Bank (9)
10.30	Security Agreement dated as of September 24, 2004 executed by Kinergy Marketing, LLC in favor of Comerica Bank (12)
10.31	Amended and Restated Phase 1 Design-Build Agreement dated November 2, 2005 by and between Pacific Ethanol Madera LLC and W.M. Lyles Co. (10)
10.32	Phase 2 Design-Build Agreement dated November 2, 2005 by and between Pacific Ethanol Madera LLC and W.M. Lyles Co. (10)
10.33	Letter Agreement dated November 2, 2005 by and between Pacific Ethanol California, Inc. and W.M. Lyles Co. (10)

Exhibit

Number

Description

10.34	Continuing Guaranty dated as of November 3, 2005 by William L. Jones in favor of W.M. Lyles Co. (10)
10.35	Continuing Guaranty dated as of November 3, 2005 by Neil M. Koehler in favor of W.M. Lyles Co. (10)
10.36	Description of Non-Employee Director Compensation (11)
10.37	Purchase Agreement dated November 14, 2005 between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (11)
10.38	Deposit Agreement dated April 13, 2006 by and between Pacific Ethanol, Inc. and Comerica Bank (14)
10.39	Registration Rights and Stockholders Agreement dated as of April 13, 2006 by and between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (14)
10.40	Amendment No. 1 to Ethanol Purchase and Marketing Agreement dated effective as of March 4, 2005 between Kinergy Marketing, LLC, Phoenix Bio-Industries, LLC, Pacific Ethanol, Inc. and Western Milling, LLC (14)
10.41	Construction and Term Loan Agreement dated April 10, 2006 by and among Pacific Ethanol Madera LLC, Comerica Bank and Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.42	Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Comerica Bank (14)
10.43	Construction Loan Note dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.44	Assignment and Security Agreement dated April 13, 2006 by and between Pacific Ethanol Madera LLC and Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.45	Member Interest Pledge Agreement dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (14)
10.46	Disbursement Agreement dated April 13, 2006 by and among Pacific Ethanol Madera LLC, Hudson United Capital, a division of TD Banknorth, N.A., Comerica Bank and Wealth Management Group of TD Banknorth, N.A. (14)
10.47	Amended and Restated Term Loan Agreement effective as of April 13, 2006 by and between Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
10.48	Letter Agreement dated as of April 13, 2006 by and among Pacific Ethanol California, Inc., Lyles Diversified, Inc. and Pacific Ethanol Madera LLC (14)
10.49	Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Hudson United Capital, a division of TD Banknorth, N.A. (15)
10.50	Deed of Trust (Non-Construction) Security Agreement and Fixture Filing with Assignment of Rents dated April 13, 2006 by Pacific Ethanol Madera LLC in favor of Lyles Diversified, Inc. (15)
10.51	Securities Purchase Agreement dated as of May 25, 2006 by and among Pacific Ethanol, Inc. and the investors listed on the Schedule of Investors attached thereto as Exhibit A (16)
10.52	Form of Warrant dated May 31, 2006 (16)
10.53	Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol, Inc. and John T. Miller (17)
10.54	Executive Employment Agreement dated as of June 26, 2006 by and between Pacific Ethanol, Inc. and Christopher W. Wright (17)

Exhibit

Number

Description

10.55	Amended and Restated Ethanol Purchase and Sale Agreement dated as of August 9, 2006 by and between Kinergy Marketing, LLC and Front Range Energy, LLC (18)
10.56	Construction Agreement for the Boardman Project between Pacific Ethanol Columbia, LLC and Parsons RCIE Inc. dated as of August 28, 2006 (19)
10.57	Engineering, Procurement and Technology License Agreement dated September 6, 2006 by and between Delta-T Corporation and PEI Columbia, LLC (*)(21)
10.58	Engineering, Procurement and Technology License Agreement (Plant No. 3) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.59	Engineering, Procurement and Technology License Agreement (Plant No. 4) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.60	Engineering, Procurement and Technology License Agreement (Plant No. 5) dated September 6, 2006 by and between Delta-T Corporation and Pacific Ethanol, Inc. (*)(21)
10.61	Pacific Ethanol, Inc. 2006 Stock Incentive Plan (#)(20)
10.62	Form of Employee Restricted Stock Agreement (#)(22)
10.63	Form of Non-Employee Director Restricted Stock Agreement (#)(22)
10.64	Amendment No. 1 to Construction and Term Loan Agreement and Agreement as to Future Financing Transactions dated September 29, 2006 by and among Pacific Ethanol Madera LLC, TD Banknorth, N.A., Comerica Bank and Pacific Ethanol, Inc. (23)
10.65	Membership Interest Purchase Agreement dated as of October 17, 2006 by and among Eagle Energy, LLC, Pacific Ethanol California, Inc. and Pacific Ethanol, Inc. (24)
10.66	Warrant to Purchase Common Stock dated October 17, 2006 issued to Eagle Energy, LLC by Pacific Ethanol, Inc. (24)
10.67	Registration Rights Agreement dated as of October 17, 2006 by and between Pacific Ethanol, Inc. and Eagle Energy, LLC (24)
10.68	Second Amended and Restated Operating Agreement of Front Range Energy, LLC among the members identified therein (as amended by Amendment No. 1 described below) (24)
10.69	Amendment No. 1, dated as of October 17, 2006, of the Second Amended and Restated Operating Agreement of Front Range Energy, LLC to Add a Substitute Member and for Certain Other Purposes (24)
10.70	Form of Non-Competition Agreement dated as of October 17, 2006 by and among Pacific Ethanol, Inc., Front Range Energy, LLC and each of the members of Eagle Energy, LLC (24)
10.71	Amendment to Amended and Restated Ethanol Purchase and Sale Agreement dated October 17, 2006 between Kinergy Marketing, LLC and Front Range Energy, LLC (24)
10.72	Separation and Consulting Agreement dated December 14, 2006 between Pacific Ethanol, Inc. and William G. Langley (25)

Exhibit Number	Description

10.73	Credit Agreement, dated as of February 27, 2007, by and among Pacific Ethanol Holding Co. LLC, Pacific Ethanol Madera LLC, Pacific Ethanol Columbia, LLC, Pacific Ethanol Stockton, LLC, Pacific Ethanol Imperial, LLC, and Pacific Ethanol Magic Valley, LLC, as borrowers, the lenders party thereto, WestLB AG, New York Branch, as administrative agent, lead arranger and sole book runner, WestLB AG, New York Branch, as collateral agent, Union Bank of California, N.A., as accounts bank, Mizuho Corporate Bank, Ltd., as lead arranger and co-syndication agent, CIT Capital Securities LLC, as lead arranger and co-syndication agent, Cooperative Centrale Raiffeisen-Boerenleenbank BA., “Rabobank Nederland”, New York Branch, and Banco Santander Central Hispano S.A., New York Branch (26)
10.74	Sponsor Support Agreement, dated as of February 27, 2007, by and among Pacific Ethanol, Inc., Pacific Ethanol Holding Co. LLC and WestLB AG, New York Branch, as administrative agent (26)
10.75	Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Joseph W. Hansen (#) (27)
10.76	Indemnification Agreement as of January 2, 2008 by and between Pacific Ethanol, Inc. and Joseph W. Hansen (#) (27)
10.77	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Neil M. Koehler (#) (27)
10.78	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and John T. Miller (#) (27)
10.79	Amended and Restated Executive Employment Agreement dated December 11, 2007 by and between Pacific Ethanol, Inc. and Christopher W. Wright (#) (27)
10.80	Securities Purchase Agreement dated March 18, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (28)
10.81	Warrant dated March 27, 2008 issued by Pacific Ethanol, Inc. to Lyles United, LLC (29)
10.82	Registration Rights Agreement dated as of March 27, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (29)
10.83	Letter Agreement dated March 27, 2008 by and between Pacific Ethanol, Inc. and Lyles United, LLC (29)
10.84	Series A Preferred Stockholder Consent and Waiver dated March 27, 2008 by and between Pacific Ethanol, Inc. and Cascade Investment, L.L.C. (29)
10.85	Form of Waiver and Third Amendment to Credit Agreement dated March 25, 2008 by and among Pacific Ethanol, Inc. and the parties thereto (29)
21.1	Subsidiaries of the Registrant
23.1	Consent of Independent Registered Public Accounting Firm
31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

_______________

(#)	Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit.

(*)	Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission.

(1)	Filed as an exhibit to the Registrant’s current report on Form 8-K for March 23, 2005 filed with the Securities and Exchange Commission on March 29, 2005 and incorporated herein by reference.

(2)	Filed as an exhibit to the Registrant’s quarterly report on Form 10-QSB for March 31, 2005 (File No. 0-21467) filed with the Securities and Exchange Commission on May 23, 2005 and incorporated herein by reference.

(3)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-123538) filed with the Securities and Exchange Commission on March 24, 2005 and incorporated herein by reference.

(4)	Filed as an exhibit to the Registrant’s annual report Form 10-KSB for December 31, 2002 (File No. 0-21467) filed with the Securities and Exchange Commission on March 31, 2003 and incorporated herein by reference.

(5)	Filed as an exhibit to the Registrant’s current report on Form 8-K for August 10, 2005 filed with the Securities and Exchange Commission on August 16, 2005 and incorporated herein by reference.

(6)	The Form of the Registration Rights Agreement was filed as Exhibit 4.4 to the Registrant’s Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on August 19, 2005 and incorporated herein by reference.

(7)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on August 19, 2005 and incorporated herein by reference.

(8)	Filed as an exhibit to the Registrant’s current report on Form 8-K for August 31, 2005 filed with the Securities and Exchange Commission on September 7, 2005 and incorporated herein by reference.

(9)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 1, 2005 filed with the Securities and Exchange Commission on November 7, 2005 and incorporated herein by reference.

(10)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 2, 2005 filed with the Securities and Exchange Commission on November 8, 2005 and incorporated herein by reference.

(11)	Filed as an exhibit to the Registrant’s current report on Form 8-K for November 10, 2005 filed with the Securities and Exchange Commission on November 15, 2005 and incorporated herein by reference.

(12)	Filed as an exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (Reg. No. 333-127714) filed with the Securities and Exchange Commission on November 22, 2005 and incorporated herein by reference.

(13)	Filed as an exhibit to the Registrant’s current report on Form 8-K for January 26, 2006 filed with the Securities and Exchange Commission on February 1, 2006 and incorporated herein by reference.

(14)	Filed as an exhibit to the Registrant’s annual report on Form 10-KSB for December 31, 2005 filed with the Securities and Exchange Commission on April 14, 2006 and incorporated herein by reference.

(15)	Filed as an exhibit to the Registrant’s current report on Form 8-K for April 13, 2006 filed with the Securities and Exchange Commission on April 19, 2006 and incorporated herein by reference.

(16)	Filed as an exhibit to the Registrant’s current report on Form 8-K for May 25, 2006 filed with the Securities and Exchange Commission on May 31, 2006 and incorporated herein by reference.

(17)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for June 26, 2006 filed with the Securities and Exchange Commission on June 27, 2006.

(18)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 9, 2006 filed with the Securities and Exchange Commission on August 15, 2006.

(19)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for August 23, 2006 filed with the Securities and Exchange Commission on August 29, 2006.

(20)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-137663) filed with the Securities and Exchange Commission on September 29, 2006.

(21)	Filed as an exhibit to the Registrant’s quarterly report on Form 10-Q for September 30, 2006 filed with the Securities and Exchange Commission on November 20, 2006 and incorporated herein by reference.

(22)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 4, 2006 filed with the Securities and Exchange Commission on October 10, 2006.

(23)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 2, 2006 filed with the Securities and Exchange Commission on October 12, 2006.

(24)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for October 17, 2006 filed with the Securities and Exchange Commission on October 23, 2006.

(25)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 14, 2006 filed with the Securities and Exchange Commission on December 15, 2006.

(26)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for February 27, 2007 filed with the Securities and Exchange Commission on March 5, 2007.

(27)	Filed as an exhibit to the Registrant’s Current Report on Form 8-K for December 11, 2007 filed with the Securities and Exchange Commission on December 17, 2007.
(28)	Filed as an exhibit to the Registrant's Current Report on Form 8-K for March 18, 2008 filed within the Securities and Exchange Commission on March 18, 2008.
(29)	Filed as an exhibit to the Registrant's Current Report on Form 8-K for March 26, 2008 filed with the Securities and Exchange Commission on March 27, 2008.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 27th day of March, 2008.

PACIFIC ETHANOL, INC.

/s/ NEIL M. KOEHLER

Neil M. Koehler

President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date

/s/ WILLIAM L. JONES William L. Jones	Chairman of the Board and Director	March 27, 2008

/s/ NEIL M. KOEHLER Neil M. Koehler	President, Chief Executive Officer (Principal Executive Officer) and Director	March 27, 2008

/s/ JOSEPH W. HANSEN Joseph W. Hansen	Chief Financial Officer (Principal Financial and Accounting Officer)	March 27, 2008

/s/ TERRY L. STONE Terry L. Stone	Director	March 27, 2008

/s/ JOHN L. PRINCE John L. Prince	Director	March 27, 2008

/s/ DOUGLAS L. KIETA Douglas L. Kieta	Director	March 27, 2008

/s/ LARRY D. LAYNE Larry D. Layne	Director	March 27, 2008

EXHIBITS FILED WITH THIS REPORT

Exhibit Number	Description

21.1	Subsidiaries of the Registrant
23.1	Consent of Independent Registered Public Accounting Firm
31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Delaware	41-2170618
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

400 Capitol Mall, Suite 2060, Sacramento, California	95814
(Address of principal executive offices)	(Zip Code)

Large accelerated filer ¨	Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

		Page
PART I

Item 1.	Business	1
Item 1A.	Risk Factors.	13
Item 1B.	Unresolved Staff Comments.	23
Item 2.	Properties.	24
Item 3.	Legal Proceedings.	24
Item 4.	Submission of Matters to a Vote of Security Holders.	26

PART II

Item 5.	Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	26
Item 6.	Selected Financial Data.	29
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	30
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	34
Item 8.	Financial Statements and Supplementary Data.	51
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	51
Item 9A.	Controls and Procedures	51
Item 9A(T)	Controls and Procedures	57
Item 9B.	Other Information.	38

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	57
Item 11.	Executive Compensation	57
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	57
Item 13.	Certain Relationships and Related Transactions, and Director Independence	57
Item 14.	Principal Accounting Fees and Services	57

PART IV

Item 15.	Exhibits, Financial Statement Schedules	57

Index to Financial Statements		F-1
Index to Exhibits
Signatures
Exhibits Filed With This Report

	Madera Facility	Front Range Facility(1)	Boardman Facility	Magic Valley Facility(2)	Stockton Facility(2)
Location	Madera, CA	Windsor, CO	Boardman, OR	Burley, ID	Stockton, CA
Quarter/Year completed or scheduled to be completed	4th Qtr., 2006	2nd Qtr., 2006	3rd Qtr., 2007	2nd Qtr., 2008	3rd Qtr., 2008
Annual design basis ethanol production capacity (in millions of gallons)	35	40	35	50	50
Approximate maximum annual ethanol production capacity (in millions of gallons)	40	50	40	60	60
Ownership	100%	42%	100%	100%	100%
Primary energy source	Natural Gas	Natural Gas	Natural Gas	Natural Gas	Natural Gas
Estimated annual WDG production capacity (in thousands of tons)	293	335	293	418	418

	Price Range
	High		Low
Year Ended December 31, 2007:
First Quarter (January 1 – March 31)	$	17.85	$	14.22
Second Quarter (April 1 – June 30)	$	16.50	$	12.25
Third Quarter (July 1 – September 30)	$	14.86	$	8.58
Fourth Quarter (October 1 – December 31)	$	9.46	$	4.22

Year Ended December 31, 2006:
First Quarter	$	22.34	$	9.99
Second Quarter	$	42.39	$	20.14
Third Quarter	$	25.45	$	13.76
Fourth Quarter	$	19.08	$	12.58

	Cumulative Total Return ($)
	12/02	12/03	12/04	3/23/05	12/05	12/06	12/07
PACIFIC ETHANOL, INC.	100.00	151.61	382.58	583.87	698.06	992.90	529.68
THE NASDAQ STOCK MARKET (U.S.) INDEX	100.00	149.75	164.64	155.75	168.60	187.83	205.22
SIC 2860—INDUSTRIAL ORGANIC CHEMICALS	100.00	117.59	148.52	139.73	123.21	180.97	144.37

	Years Ended December 31,								Percentage Variance From Prior Year
	2007			2006			2005		2007			2006
Gallons sold (in millions)		190.6			101.7			52.3		87.4	%		94.4	%
Average sales price per gallon	$	2.15		$	2.28		$	1.67		(5.7	)%		36.5	%
Corn cost per bushel—CBOT equivalent(1)	$	3.61		$	2.44			N/A		48.0	%		N/A
Co-product revenues as % of delivered cost of corn(2)		24.8	%		33.4	%		N/A		(8.6	)%		N/A

Average CBOT ethanol price per gallon	$	1.98		$	2.52		$	1.70		(21.4	)%		48.2	%
Average CBOT corn price per bushel	$	3.74		$	2.60		$	1.77		43.9	%		46.9	%
_____________

	Years Ended						Dollar Variance			Percentage Variance			Results as a Percentage of Net Sales for the Years Ended
	December 31,						Favorable			Favorable			December 31,
	2007			2006			(Unfavorable)			(Unfavorable)			2007			2006
	(dollars in thousands)
Net sales	$	461,513		$	226,356		$	235,157			103.9	%		100.0	%		100.0	%
Cost of goods sold		428,614			201,527			(227,087	)		(112.7	)		92.9			89.0
Gross profit		32,899			24,829			8,070			32.5			7.1			11.0
Selling, general and administrative expenses		30,822			24,641			(6,181	)		(25.1	)		6.6			10.9
Income from operations		2,077			188			1,889			1,004.8			0.5			0.1
Other income (expense), net		(6,801	)		3,426			(10,227	)		(298.5	)		(1.5	)		1.5
Income (loss) before provision for income taxes and noncontrolling interest in variable interest entity		(4,724	)		3,614			(8,338	)		(230.7	)		(1.0	)		1.6
Provision for income taxes		—			—			—			—			—			—
Noncontrolling interest in variable interest entity		(9,676	)		(3,756	)		(5,920	)		(157.6	)		(2.1	)		(1.7	)
Net loss	$	(14,400	)	$	(142	)	$	(14,258	)		(10,040.9	)%		(3.1	)%		(0.1	)%
Preferred stock dividends		(4,200	)		(2,998	)		(1,202	)		(40.1	)		(0.9	)		(1.3	)
Deemed dividend on preferred stock		(28	)		(84,000	)		83,972			100.0			(0.0	)		(37.1	)
Loss available to common stockholders	$	(18,628	)	$	(87,140	)	$	68,512			78.6	%		(4.0	)%		(38.5	)%

	As of and for the Year Ended
	December 31, 2007			December 31, 2006			Variance
Current assets	$	82,193		$	127,045			(35.3	)%
Current liabilities	$	120,079		$	30,951			288.0	%
Property and equipment, net	$	468,704		$	196,156			138.9	%
Notes payable, net of current portion	$	151,188		$	28,970			421.9	%
Cash provided by (used in) operating activities	$	16,718		$	(8,144	)		305.3	%
Working capital	$	(37,886	)	$	96,094			(139.4	)%
Working capital ratio		0.68			4.10			(83.4	)%

Contractual Obligations At December 31, 2007	2008		2009		2010		2011		2012		Thereafter		Total
Sourcing commitments(1)	$	76,780	$	—	$	—	$	—	$	—	$	—	$	76,780
Debt principal		13,637		53,465		7,260		17,546		5,661		70,717		168,286
Debt interest		14,787		13,898		9,416		8,749		7,243		18,396		72,489
Operating leases(2)		2,247		2,434		2,425		2,267		1,965		10,282		21,620
Firm capital commitments(3)		118,357		—		—		—		—		—		118,357
Preferred dividends(4)		4,253		4,253		4,253		4,253		4,253		4,253		25,518

Total commitments	$	230,061	$	74,050	$	23,354	$	32,815	$	19,122	$	103,648	$	483,050

Report of Independent Registered Public Accounting Firm	F-2

Consolidated Balance Sheets as of December 31, 2007 and 2006	F-3

Consolidated Statements of Operations for the Years Ended
December 31, 2007, 2006 and 2005	F-5

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
December 31, 2007, 2006 and 2005	F-6

Consolidated Statement of Stockholders’ Equity for the Years Ended
December 31, 2007, 2006 and 2005	F-7

Consolidated Statements of Cash Flows for the Years Ended
December 31, 2007, 2006 and 2005	F-10

Notes to Consolidated Financial Statements	F-12

	December 31,
ASSETS	2007		2006

Current Assets:
Cash and cash equivalents	$	5,707	$	44,053
Investments in marketable securities		19,353		39,119
Accounts receivable, net (including $7 and $1,195 as of December 31, 2007 and 2006, respectively, from a related party)		28,034		29,322
Restricted cash		780		1,567
Inventories		18,540		7,595
Prepaid expenses		1,498		1,053
Prepaid inventory		3,038		2,029
Derivative instruments		1,613		551
Other current assets		3,630		1,756
Total current assets		82,193		127,045
Property and equipment, net		468,704		196,156
Other Assets:
Restricted cash		—		24,851
Deposits and advances		81		9,040
Goodwill		88,168		85,307
Intangible assets, net		6,324		10,155
Other assets		6,130		1,266
Total other assets		100,703		130,619
Total Assets	$	651,600	$	453,820

	December 31,
LIABILITIES AND STOCKHOLDERS’ EQUITY	2007			2006
Current Liabilities:
Accounts payable – trade	$	22,641		$	8,958
Accrued liabilities		5,570			3,130
Accounts payable and accrued liabilities – construction-related		55,203			3,031
Contract retentions		5,358			357
Other liabilities – related parties		900			9,422
Current portion – long-term notes payable		11,098			4,125
Short-term note payable		6,000			—
Derivative instruments		10,353			97
Other current liabilities		2,956			1,831
Total current liabilities		120,079			30,951

Notes payable, net of current portion		151,188			28,970
Other liabilities		1,965			1,091
Total Liabilities		273,232			61,012
Commitments and contingencies (Notes 9, 16 and 17)
Noncontrolling interest in variable interest entity		96,082			94,363
Stockholders’ Equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized; 5,315,625 and 5,250,000 shares issued and outstanding as of December 31, 2007 and 2006, respectively		5			5
Common stock, $0.001 par value; 100,000,000 shares authorized; 40,606,214 and 40,269,627 shares issued and outstanding as of December 31, 2007 and 2006, respectively		41			40
Additional paid-in capital		402,932			397,536
Accumulated other comprehensive income (loss)		(2,383	)		545
Accumulated deficit		(118,309	)		(99,681	)
Total stockholders’ equity		282,286			298,445
Total Liabilities and Stockholders’ Equity	$	651,600		$	453,820

	For the Years Ended December 31,
	2007			2006			2005
Net loss	$	(14,400	)	$	(142	)	$	(9,923	)
Other comprehensive income (loss), net of tax:
Cash flow hedges:
Net change in the fair value of derivatives, net of tax		(2,579	)		196			—
Unrealized gain on restricted available-for-sale securities		(349	)		349			—
Comprehensive income (loss)	$	(17,328	)	$	403		$	(9,923	)

	Preferred Stock				Common Stock				Additional Paid-In			Accumulated Other Comprehensive		Accumulated
	Shares		Amount		Shares		Amount		Capital			Income (Loss)		Deficit			Total
Balances, January 1, 2005		—		—		13,446	$	13	$	5,004		$	—	$	(3,661	)	$	1,356
Amounts received from shareholder		—		—		—		—		67			—		—			67
Issuance of shares in private placement, net of offering costs of $2,125		—		—		7,000		7		18,868			—		—			18,875
Share exchange		—		—		7,090		7		13,577			—		—			13,584
Acquisition costs in excess of cash acquired		—		—		—		—		481			—		—			481
Compensation expense related to issuance of warrants for consulting services		—		—		—		—		927			—		—			927
Stock issued for exercise of warrants for cash		—		—		237		—		490			—		—			490
Stock issued for cashless exercise of warrants		—		—		34		—		—			—		—			—
Compensation expense for options issued to employees		—		—		—		—		80			—		—			80
Compensation expense for employee option converted into a warrant		—		—		—		—		233			—		—			233
Stock issued for exercise of stock options for cash		—		—		78		—		450			—		—			450
Stock issued for cashless exercise of stock options		—		—		89		1		(1	)		—		—			—
Issuance of stock to employees		—		—		70		—		651			—		—			651
Conversion of LDI debt		—		—		830		1		1,244			—		—			1,245
Comprehensive loss		—		—		—		—		—			—		(9,923	)		(9,923	)
Balances, December 31, 2005		—	$	—		28,874	$	29	$	42,071		$	—	$	(13,584	)	$	28,516

Buildings	40 years
Site improvements and utilities	25 years
Facilities and plant equipment	10 – 25 years
Other equipment and vehicles	7 – 10 years
Office furniture, fixtures and equipment	5 – 10 years
Water rights	99 years