Alto Ingredients, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This discussion contains forward-looking statements, reflecting our plans and objectives that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors” and elsewhere in this report. Overview We are a leading producer and marketer of specialty alcohols and essential ingredients, and the largest producer of specialty alcohols in the United States. We operate five alcohol production facilities. Three of our production facilities are located in the Midwestern state of Illinois and two of our facilities are located in the Western states of Oregon and Idaho. We have an annual alcohol production capacity of 350 million gallons. We market all of the alcohols produced at our facilities as well as fuel-grade ethanol produced by third parties. In 2021, we marketed approximately 480 million gallons combined of our own alcohols as well as fuel-grade ethanol produced by third parties, and over 1.2 million tons of essential ingredients on a dry matter basis. We report our financial and operating performance in three segments: (1) marketing and distribution, which includes marketing and merchant trading for Company-produced alcohols and essential ingredients on an aggregated basis, and third party fuel-grade ethanol, (2) Pekin production, which includes the production and sale of alcohols and essential ingredients produced at our Pekin, Illinois campus, or Pekin Campus, and (3) Other production, which includes the production and sale of renewable fuel and essential ingredients produced at all of our other production facilities on an aggregated basis, none of which are individually so significant as to be considered a reportable segment. Our mission is to expand our business as a leading producer and marketer of specialty alcohols and essential ingredients. We intend to accomplish this goal in part by investing in our specialized and higher value specialty alcohol production and distribution infrastructure, expanding production in high-demand essential ingredients, expanding and extending the sale of our products into new regional and international markets, building efficiencies and economies of scale and by capturing a greater portion of the value stream. On January 14, 2022, we acquired Eagle Alcohol Company LLC, or Eagle Alcohol, for $14.0 million in cash plus an estimated net working capital adjustment of $1.3 million in cash. The members of Eagle Alcohol are eligible to receive up to an additional $14.0 million of contingent consideration, payable through a combination of cash and our common stock over the next five years, subject to the satisfaction of certain conditions. Eagle Alcohol specializes in break bulk distribution of specialty alcohols. The company purchases bulk alcohol from suppliers, including us. Then it stores, denatures, packages, and resells alcohol products in smaller sizes, including tank trucks, totes, and drums, that garner a premium to bulk alcohols. Eagle Alcohol delivers products to customers in the beverage, food, pharma, and related-process industries via its own dedicated trucking fleet and common carrier. Eagle Alcohol generated over $35 million in revenues in 2021. Eagle Alcohol is now one of our wholly-owned subsidiaries, and its former president, Dan Croghan, who has many years of experience and expertise in the chemical and alcohol distribution industry, continues on as our employee. - 24 - Production Segments We produce specialty alcohols, fuel-grade ethanol and essential ingredients, focusing on four key markets: Health, Home & Beauty ; Food & Beverage ; Essential Ingredients ; and Renewable Fuels . Products for the Health, Home & Beauty market include specialty alcohols used in mouthwash, cosmetics, pharmaceuticals, hand sanitizers, disinfectants and cleaners. Products for the Food & Beverage markets include grain neutral spirits used in alcoholic beverages and vinegar as well as corn germ used for corn oils. Products for Essential Ingredients markets include yeast, corn gluten and distillers grains used in commercial animal feed and pet foods. Our Renewable Fuels products include fuel-grade ethanol and distillers corn oil used as a feedstock for renewable diesel fuel. We produce our alcohols and essential ingredients at our production facilities described below. Our production facilities located in the Midwest are in the heart of the Corn Belt, benefit from low-cost and abundant feedstock and enjoy logistical advantages that enable us to provide our products to both domestic and international markets via truck, rail or barge. Our production facilities located on the West Coast are near their respective fuel and feed customers, offering significant timing, transportation cost and logistical advantages. We restarted our Magic Valley facility in November 2021 and we are now operating all of our production facilities. As market conditions change, we may increase, decrease or idle production at one or more operating facilities or resume operations at any idled facility. Annual Production Capacity (estimated, in gallons) Production Facility Location Fuel-Grade Ethanol Specialty Alcohol Pekin Campus Pekin, IL 110,000,000 140,000,000 Magic Valley Burley, ID 60,000,000 — Columbia Boardman, OR 40,000,000 — Marketing Segment We market all of the alcohols and essential ingredients we produce at our facilities. We also market fuel-grade ethanol produced by third parties. We have extensive and long-standing customer relationships, both domestic and international, for our specialty alcohols and essential ingredients. These customers include producers and distributors of ingredients for cosmetics, sanitizers and related products, distilled spirits producers, food products manufacturers, producers of personal health/consumer health and personal care hygiene products, and global trading firms. Our fuel-grade ethanol customers are located throughout the Western and Midwestern United States and consist of integrated oil companies and gasoline marketers who blend fuel-grade ethanol into gasoline. Our customers depend on us to provide a reliable supply of fuel-grade ethanol and manage the logistics and timing of delivery with very little effort on their part. Our customers collectively require fuel-grade ethanol volumes in excess of the supplies we produce at our facilities. We secure additional fuel-grade ethanol supplies from third-party fuel-grade ethanol producers. We arrange for transportation, storage and delivery of fuel-grade ethanol purchased by our customers through our agreements with third-party service providers in the Western United States as well as in the Midwest from a variety of sources. We market our essential ingredient feed products to dairies and feedlots, in many cases located near our production facilities. These customers use our feed products for livestock as a substitute for corn and other sources of starch and protein. We sell our corn oil to poultry and biodiesel customers. We do not market essential ingredients from other producers. - 25 - See “Note 4 – Segments” to our Notes to Consolidated Financial Statements included elsewhere in this report for financial information about our business segments. Current Initiatives and Outlook We further advanced our strategic initiatives in the fourth quarter. During the quarter, we sold our Stockton, California fuel-grade ethanol production facility, which completed our efforts to optimize our asset base by divesting non-core assets in Nebraska and California. Shortly prior to the fourth quarter, we launched our first project to produce enhanced protein at our dry mill in Magic Valley, Idaho by installing Harvesting Technology’s patented CoPromax TM system. We chose this facility because of its location near cattle, poultry, pork and acquaculture markets to serve the growing demand for high protein feed. We restarted production at this facility in November and expect to commence expanded corn oil production in mid-2022. We expect full corn oil and protein feed production by year end. Once completed, we expect the CoPromax system to produce over 33,000 tons of feed annually with a protein content greater than 50%. The system will also increase corn oil yields by 50%, or nearly 9.0 million pounds annually. We expect the combination of additional sales of corn oil and premium prices from high protein feed to contribute over $9.0 million annually in earnings before interest, taxes, depreciation and amortization, or EBITDA, based on current market prices. We plan to roll out the CoPromax system at our three other dry mills following its successful installation at our Magic Valley facility with the goal of having them fully operational by 2024. The total investment for all four facilities is $70.0 million. Assuming similar economics across all four dry mills, we estimate that the systems will contribute $34.0 million in EBITDA annually based on current market values. This initiative is one example of our efforts to grow and diversify our revenues and bolster the quantity and quality of our earnings. We continue to work with new and existing customers to act as their certified producer of a growing variety of specialty alcohols used in common, everyday consumer goods, such as vinegars, spirits, mouthwash, cosmetics and cleaning supplies. To proactively address our customers’ growing needs, we extended to our Pekin wet mill in February 2022 the certifications we obtained for our ICP facility, thus creating full redundancy across our entire Pekin Campus. These certifications appeal to customers using high grade alcohols in Health, Home & Beauty products as well as distilled spirits. We believe the certifications help deepen existing customer relationships and enable new opportunities in domestic and export markets. In January 2022, we completed the acquisition of Eagle Alcohol, an established leader in premium alcohol distribution. Eagle Alcohol expands the scope of our product offerings, our customer base and our commercial opportunities. We also expect the acquisition to accelerate our penetration into new markets and to lower our exposure to bulk alcohol price volatility, increasing our margins and creating new opportunities for organic growth. Eagle Alcohol fits perfectly into our strategic roadmap as we continue to raise the quality of our production to the highest grades of grain neutral spirits by further enhancing our distillation process, optimizing our production capabilities and integrating Eagle Alcohol’s strong distribution and sales services. We plan to invest $5.0 million in 2022 to further optimize specialty alcohol distribution and expect Eagle Alcohol to contribute $4.0 million in EBITDA for 2022 and between $8.0 million and $9.0 million in EBITDA annually starting in 2023, including synergies. We plan to reinvest further in sustainable and profitable business segments, strengthening our core operations and further diversifying our product offerings in specialty alcohols and essential ingredients. We intend to expand corn storage at our Pekin Campus, which will increase our corn-buying flexibility and reduce our need to purchase product at premium prices when farmers and elevators are not shipping corn during holidays or unfavorable weather conditions. This capital improvement project represents an investment of approximately $6.0 million and is expected to yield over $2.0 million in EBITDA annually with a payback in less than three years beginning in the fourth quarter of 2022. We are also evaluating an investment to bypass the local natural gas utility at our Pekin Campus, which we estimate would reduce natural gas prices by 11% based on 2021 values. This investment would also create an opportunity to sell renewable natural gas produced at our Pekin Campus directly into the pipeline in the future. The investment would be approximately $9.0 million in 2023 and yield a return of approximately $5.0 million in EBITDA annually beginning in 2024. In addition, we remain actively engaged with third parties to evaluate a carbon capture and sequestration program at our Pekin Campus. Various alternatives are available, including development of the project as a standalone system sized to our facilities or interconnecting with other viable gathering and sequestration systems under development in proximity to our Pekin Campus. Currently, we have contracted for sales of over 90 million gallons in specialty alcohols for 2022. This represents a 28% year-over-year increase in longer-term contracted sales volumes as compared to shorter-term sales arrangements, including spot sales, and excludes Eagle Alcohol’s contracted sales volumes. This increase is approximately equivalent to the increase in fixed-price specialty alcohol sales we contracted in 2021 compared to 2020. These sales, while still priced at a premium to fuel-grade ethanol, reflect tighter spreads to ethanol than we experienced in 2021 due to higher commodity prices as well as unusual swings in demand due to the pandemic. As demand and supply rebalance over time, we expect specialty alcohol margins to return to more stable and normalized levels. - 26 - Although our contracted volumes provide greater visibility into our anticipated results for 2022, extreme volatility in commodity prices, ongoing logistical constraints and the potential impact the war in Ukraine may have on corn supplies and other commodities prevent us from providing any specific 2022 revenue or gross profit guidance at this time. Nevertheless, we expect positive results throughout the year and anticipate that our cost-savings and other initiatives and our capital improvement projects completed in 2021 will contribute an additional $18 million in EBITDA for 2022, excluding our renewable fuels business. We also expect that the capital improvement projects outlined above will contribute an additional $45 million in EBITDA annually by the end of 2024, not including any additional benefits we may generate from carbon capture and sequestration or other projects that are under evaluation and development. 2021 Financial Performance Summary Summary Our consolidated net sales increased by $0.3 billion to $1.2 billion for 2021 from $0.9 billion for 2020. Our net income (loss) available to common stockholders increased by $60.6 million from a loss of $16.4 million for 2020 to income of $44.2 million for 2021. Factors that contributed to our results of operations for 2021 include: ● Net sales. Our net sales for 2021 increased by $0.3 billion, or 35%, to $1.2 billion for 2021 from $0.9 billion for 2020 as a result of an increase in our average sales price per gallon, partially offset by a decrease in total alcohol gallons sold. o Our average sales price per gallon increased by $0.83, or 51%, to $2.46 for 2021 from $1.63 for 2020. The increase was driven primarily by higher fuel-grade ethanol prices in the fourth quarter of 2021 due to supply constraints and higher prices for oil and gasoline. We expect fuel-grade ethanol prices to normalize as additional production moderates the supply and demand imbalance. o Our total gallons sold declined by 56 million gallons, or 10%, to 480 million gallons for 2021 from 536 million gallons for 2020. ● Our fuel-grade ethanol production sales volume declined by 20 million gallons, or 11%, to 161 million gallons for 2021 from 181 million gallons for 2020, primarily from reduced production at our California facilities. Our California production facilities were sold in 2021. ● Our specialty alcohol production sales volume declined by 1 million gallons, or 1%, to 90 million gallons for 2021 from 91 million gallons for 2020, as volumes declined slightly due to higher than normal spot sales in 2020 due to the pandemic. Although spot sales declined in 2021, our contracted sales increased significantly during the year as compared to 2020. ● Our third-party sales volume declined by 35 million gallons, or 13%, to 229 million gallons for 2021 from 264 million gallons for 2020. We intentionally reduced sales of third-party fuel-grade ethanol to focus on sales of inventory from our own production. ● Gross Profit . Our gross profit improved by $14.9 million to a gross profit of $67.8 million for 2021 from $52.9 million for 2020 as a result of substantially higher margins, particularly in the fourth quarter for fuel-grade ethanol, and due to strong demand for our specialty alcohols. In addition, we sold unprofitable fuel-grade ethanol production facilities, substantially reducing carrying costs. Sales and Margins We generate sales by marketing all of the alcohols produced by our production facilities, all of the fuel-grade ethanol produced by two other production facilities in the Western United States and fuel-grade ethanol purchased from other third-party suppliers throughout the United States. We also market essential ingredients produced by our production facilities, including dried yeast, corn gluten meal, corn gluten feed, and distillers grains and liquid feed used in commercial animal feed and pet foods. - 27 - Our profitability is highly dependent on various commodity prices, including the market prices of corn, natural gas and fuel-grade ethanol. Our consolidated average alcohol sales price increased by 51% to $2.46 per gallon for 2021 compared to $1.63 per gallon for 2020. The average price of fuel-grade ethanol as reported by the Chicago Board of Options Trade, or CBOT, increased 69% to $2.11 per gallon for 2021 compared to $1.25 per gallon for 2020. Our average delivered cost of corn increased 62% to $6.22 per bushel for 2021 from $3.84 per bushel for 2020. The average price of corn as reported by the CBOT increased 56% to $5.67 per bushel for 2021 from $3.63 per bushel for 2020. We believe that our gross profit margins depend primarily on six key factors: ● the prices of our specialty alcohols and the market price of fuel-grade ethanol, the latter of which is impacted by the price of gasoline and related petroleum products, and government regulation, including government ethanol mandates; ● the market price of key production input commodities, including corn and natural gas; ● the prices of our essential ingredients; ● our ability to anticipate trends in the prices of our alcohols, essential ingredients, and key input commodities, and our ability to implement appropriate risk management and opportunistic pricing strategies; ● the proportion of our sales of specialty alcohols to our sales of fuel-grade ethanol produced at our facilities; and ● the proportion of our sales of fuel-grade ethanol produced at our facilities to our sales of fuel-grade ethanol produced by unrelated third-parties. We seek to optimize our gross profit margins by anticipating the factors above and, when resources are available, implementing hedging transactions and taking other actions designed to limit risk and address these factors. For example, we may seek to reduce inventory levels in anticipation of declining alcohol or essential ingredient prices and increase production and inventory levels in anticipation of rising alcohol or essential ingredient prices. We may also seek to alter our proportion or timing, or both, of purchase and sales commitments. Our inability to anticipate the factors described above or their relative importance, and adverse movements in the factors themselves, could result in declining or even negative gross profit margins over certain periods of time. Our ability to anticipate these factors or favorable movements in these factors may enable us to generate above-average gross profit margins. However, given the difficulty associated with successfully forecasting any of these factors, we are unable to estimate our future gross profit margins. - 28 - Results of Operations Selected Financial Information The following selected financial information should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report. Certain performance metrics that we believe are important indicators of our results of operations include: Years Ended December 31, Percentage Change 2021 2020 2019 2021 vs 2020 2020 vs 2019 Renewable fuel production gallons sold (in millions) 161.1 181.0 421.3 (11.0 )% (57.0 )% Specialty alcohol production gallons sold (in millions) 89.5 90.9 69.7 (1.5 )% 30.4 % Third-party renewable fuel gallons sold (in millions) 229.0 264.4 328.4 (13.4 )% (19.5 )% Total gallons sold (in millions) 479.6 536.3 819.4 (10.6 )% (34.5 )% Total gallons produced (in millions) 251.7 262.1 494.6 (4.0 )% (47.0 )% Production capacity utilization 60 % 53 % 82 % 13.2 % (35.4 )% Average sales price per gallon $ 2.46 $ 1.63 $ 1.61 50.9 % 1.2 % Corn cost per bushel—CBOT equivalent $ 5.70 $ 3.56 $ 3.83 60.1 % (7.0 )% Average basis (1) $ 0.52 $ 0.28 $ 0.43 85.7 % (34.9 )% Delivered cost of corn $ 6.22 $ 3.84 $ 4.26 62.0 % (9.9 )% Total essential ingredients tons sold (in thousands) 1,236.2 1,447.5 2,821.7 (14.6 )% (48.7 )% Essential ingredient revenues as % of delivered cost of corn (2) 33.7 % 44.1 % 35.1 % (23.6 )% 25.6 % Average CBOT ethanol price per gallon $ 2.11 $ 1.25 $ 1.39 68.8 % (10.1 )% Average CBOT corn price per bushel $ 5.67 $ 3.63 $ 3.83 56.2 % (5.2 )% (1) Corn basis represents the difference between the immediate cash price of delivered corn and the future price of corn for Chicago delivery. (2) Essential ingredient revenues as a percentage of delivered cost of corn shows our yield based on sales of essential ingredients, including WDG and corn oil, generated from ethanol we produced. - 29 - Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020 Years Ended Dollar Change Percentage Change Results as a Percentage of Net Sales for the Years Ended December 31, Favorable Favorable December 31, 2021 2020 (Unfavorable) (Unfavorable) 2021 2020 (dollars in thousands) Net sales $ 1,207,892 $ 897,023 $ 310,869 34.7 % 100.0 % 100.0 % Cost of goods sold 1,140,108 844,164 (295,944 ) (35.1 )% 94.4 % 94.1 % Gross profit 67,784 52,859 14,925 28.2 % 5.6 % 5.9 % Selling, general and administrative expenses (29,185 ) (31,980 ) 2,795 8.7 % (2.4 )% (3.6 )% Gain on litigation settlement — 11,750 (11,750 ) (100.0 )% 0.0 % 1.3 % Gain on sale of assets 4,571 1,580 2,991 189.3 % 0.4 % 0.2 % Asset impairments (3,100 ) (24,356 ) 21,256 87.3 % (0.3 )% (2.7 )% Income from operations 40,070 9,853 30,217 306.7 % 3.3 % 1.1 % Income from loan forgiveness 9,860 — 9,860 NM 0.8 % 0.0 % Interest expense (3,587 ) (17,943 ) 14,356 80.0 % (0.3 )% (2.0 )% Fair value adjustments — (9,959 ) 9,959 100.0 % 0.0 % (1.1 )% Other income, net 1,208 750 458 61.1 % 0.1 % 0.1 % Income (loss) before income taxes 47,551 (17,299 ) 64,850 NM 3.9 % (1.9 )% Provision (benefit) for income taxes 1,469 (17 ) (1,486 ) NM 0.1 % (0.0 )% Consolidated net income (loss) 46,082 (17,282 ) 63,364 NM 3.8 % (1.9 )% Net loss attributed to noncontrolling interests — 2,166 (2,166 ) (100.0 )% 0.0 % 0.2 % Net income (loss) attributed to Alto Ingredients, Inc. $ 46,082 $ (15,116 ) $ 61,198 NM 3.8 % (1.7 )% Preferred stock dividends (1,265 ) (1,268 ) 3 0.2 % (0.1 )% (0.1 )% Income allocated to participating securities (600 ) — (600 ) NM (0.0 )% 0.0 % Income (loss) available to common stockholders $ 44,217 $ (16,384 ) $ 60,601 NM 3.7 % (1.8 )% Net Sales The increase in our consolidated net sales for 2021 as compared to 2020 was primarily due to an increase in our average sales price per gallon for our alcohols and sales price per ton for our essential ingredients, partially offset by a decrease in our total gallons sold and volume of essential ingredients sold. Our average sales price per gallon increased predominately due to higher fuel-grade ethanol prices, particularly in the fourth quarter, from supply constraints and higher oil and gasoline prices. Our average sales price for our essential ingredients increased predominately due to the higher corn prices. Pekin Campus Production Segment Net sales of alcohol from our Pekin Campus production segment increased by $167.8 million, or 51%, to $498.2 million for 2021 as compared to $330.4 million for 2020. Our total volume of production gallons sold increased 19.1 million gallons, or 10%, to 213.0 million gallons for 2021 as compared to 193.9 million gallons for 2020. At our Pekin Campus production segment’s average sales price per gallon of $2.34 for 2021, we generated $44.7 million in additional net sales from our Pekin Campus production segment from the additional 19.1 million gallons of alcohol sold in 2021 as compared to 2020. The increase of $0.63, or 37%, in our Pekin Campus production segment’s average sales price per gallon in 2021 as compared to 2020 improved our net sales from our Pekin Campus production segment by $123.1 million. Net sales of essential ingredients increased $59.2 million, or 45%, to $189.5 million for 2021 as compared to $130.3 million for 2020. Our total volume of essential ingredients sold increased by 46,000 tons, or 6%, to 875,000 tons for 2021 from 829,000 tons for 2020. At our average sales price per ton of $216.59 for 2021, we generated an additional $10.0 million in net sales from the 46,000 additional tons of essential ingredients sold in 2021 as compared to 2020. The increase of $59.40, or 38%, in our average sales price per ton in 2021 as compared to 2020 increased our net sales from our Pekin Campus production segment by $49.2 million. - 30 - Marketing Segment Net sales of fuel-grade ethanol from our marketing segment, excluding intersegment sales, increased by $123.5 million, or 48%, to $381.2 million for 2021 as compared to $257.7 million for 2020. Our volume of third-party fuel-grade ethanol gallons sold reported gross by our marketing segment decreased by 23.0 million gallons, or 14%, to 140.9 million gallons for 2021 as compared to 163.9 million gallons for 2020. At our marketing segment’s average sales price per gallon of $2.69 for 2021, net sales were $61.9 million lower as a result of the 23.0 million fewer gallons sold in 2021 as compared to 2020. This decline was more than offset by the $1.13 increase in our sales price per gallon for 2021. The increase of $1.13, or 72%, in our average sales price per gallon in 2021 as compared to 2020 increased our net sales from our third party fuel-grade ethanol gallons sold by $185.4 million. Our volume of third-party fuel-grade ethanol gallons sold reported net by our marketing segment decreased by 12.4 million gallons, or 12%, to 88.1 million gallons for 2021 as compared to 100.5 million gallons for 2020. Other Production Segment Net sales of alcohol from our other production segment decreased by $29.8 million, or 22%, to $107.9 million for 2021 as compared to $137.7 million for 2020. Our total volume of gallons sold decreased by 40.4 million gallons, or 52%, to 37.6 million gallons for 2021 as compared to 78.0 million gallons for 2020. At our other production segment’s average sales price per gallon of $2.87 for 2021, net sales were $115.9 million lower as a result of the 40.4 million fewer gallons sold in 2021 as compared to 2020. This decline was more than offset by the $1.10 increase in our sales price per gallon for 2021. The increase of $1.10, or 63%, in our average sales price per gallon in 2021 as compared to 2020 increased our net sales of alcohol from our other production segment by $86.1 million. Net sales of essential ingredients decreased $9.8 million, or 24%, to $31.1 million for 2021 as compared to $40.9 million for 2020. Our total volume of essential ingredients sold decreased by 258,000 tons, or 42%, to 361,000 tons for 2021 from 619,000 tons for 2020. At our average sales price per ton of $86.00 for 2021, net sales were $22.2 million lower as a result of the 258,000 fewer tons sold in 2021 as compared to 2020. This decline was more than offset by the $19.96 increase in our sales price per ton for 2021. The increase of $19.96, or 30%, in our average sales price per ton in 2021 as compared to 2020 increased our net sales of essential ingredients from our other production segment by $12.4 million. Cost of Goods Sold and Gross Profit Our consolidated gross profit improved to a gross profit of $67.8 million for 2021 from a gross profit of $52.9 million for 2020, representing a gross profit margin of 5.6% for 2021 compared to 5.9% for 2020. Our consolidated gross profit improved due to significantly higher margin sales for fuel-grade ethanol as we successfully managed our profitable production facilities, partially offset by modest declines in specialty alcohol sales volumes and compared to unusually high spot margins in 2020. Pekin Campus Production Segment Our Pekin Campus production segment’s gross profit declined by $20.5 million to a gross profit of $54.0 million for 2021 as compared to $74.5 million for 2020. Of this decline, $25.3 million is attributable to lower margins from our specialty alcohols, partially offset by $4.8 million in increased gross profit attributable to increased sales volumes in 2021 as compared to 2020. Margins in 2020 were unusually high due to strong spot price demand for sanitizers and disinfectants due to the coronavirus pandemic. - 31 - Marketing Segment Our marketing segment’s gross profit increased by $5.2 million to $10.8 million for 2021 as compared to $5.6 million for 2020. Of this increase, $7.0 million is attributable to higher margins from sales of third-party fuel-grade ethanol, partially offset by $1.8 million attributable to lower marketing volumes of third-party fuel-grade ethanol in 2021 as compared to 2020. Other Production Segment Our other production segment’s gross profit improved by $30.2 million to a gross profit of $3.0 million for 2021 as compared to a gross loss of $27.2 million for 2020. Of this improvement, $33.4 million is attributable to an improved margin environment for fuel-grade ethanol, partially offset by a $3.2 million reduction in gross profit attributable to lower sales volumes in 2021 as compared to 2020. Selling, General and Administrative Expenses Our selling, general and administrative, or SG&A, expenses decreased $2.8 million to $29.2 million for 2021 as compared to $32.0 million for the same period in 2020. SG&A expenses declined primarily due to reduced legal and consulting expenses as we completed many of our strategic realignment initiatives in 2020. We expect SG&A expenses of under $30 million for 2022. Gain on Sale of Assets Gain on sale of assets increased $3.0 million to $4.6 million for 2021 as compared to $1.6 million for the same period in 2020. The gains in 2021 reflect the sale of our Madera and Stockton facilities. The gains in 2020 reflect the sale of certain land at our Magic Valley facility. These gains are not expected to recur in future periods. Asset Impairments We assess the impairment of long-lived assets, including property and equipment, when events or changes in circumstances indicate that the fair value of an asset could be less than the net book value of the asset. In addition, prior to our sales of our Madera and Stockton, California production facilities, we reviewed quarterly their fair values compared to their estimated sales prices, less estimated selling costs. As a result, we recorded an aggregate impairment charge of $3.1 million for 2021. Income from Loan Forgiveness In 2020, we received loan proceeds of $9.9 million under the Coronavirus Aid, Relief, and Economic Security Act through the Paycheck Protection Program administered by the U.S. Small Business Administration, or SBA. In 2021, we requested and were granted forgiveness for the full amount, and accordingly, we recognized income from loan forgiveness in 2021. Income from loan forgiveness is not expected to recur in future periods. Interest Expense Interest expense decreased $14.3 million to $3.6 million for 2021 from $17.9 million for 2020. The decrease in interest expense is primarily due to substantial principal payments on our outstanding indebtedness during the year, resulting in significantly lower average debt balances for 2021. Year Ended December 31, 2020, Compared to the Year Ended December 31, 2019 An analysis of our financial results comparing 2020 to 2019 can be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the Securities and Exchange Commission on March 26, 2021, which is available free of charge on the Securities and Exchange Commission’s website at www.sec.gov. - 32 - Liquidity and Capital Resources During the year ended December 31, 2021, we funded our operations primarily from cash flow from operations, cash proceeds from the sales of our Madera and Stockton facilities, proceeds from lines of credit and cash on hand. A portion of these funds was also used to repay in full our term debt and our other credit facilities and for capital expenditures. As of December 31, 2021, we had $50.6 million in cash and cash equivalents and $25.4 million available for borrowing under Kinergy’s operating line of credit. We anticipate capital expenditures to range between $22 million and $28 million in 2022. We believe we have sufficient liquidity to meet our anticipated working capital, debt service, capital expenditure and other liquidity needs for at least the next twelve months from the date of this report. Quantitative Year-End Liquidity Status We believe that the following amounts provide insight into our liquidity and capital resources. The following selected financial information should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report, and the other sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this report (dollars in thousands). December 31, 2021 December 31, 2020 Change Cash and cash equivalents $ 50,612 $ 47,667 6.2 % Current assets $ 229,526 $ 214,046 7.2 % Property and equipment, net $ 222,550 $ 229,486 (3.0 )% Current liabilities $ 69,602 $ 86,927 (19.9 )% Long-term debt, noncurrent portion $ 50,361 $ 71,807 (29.9 )% Working capital $ 159,924 $ 127,119 25.8 % Working capital ratio 3.30 2.46 34.1 % Restricted Net Assets At December 31, 2021, we had approximately $69.4 million of net assets at our subsidiaries that were not available to be transferred to Alto Ingredients, Inc. in the form of dividends, distributions, loans or advances due to restrictions contained in the credit facilities of the subsidiaries. Changes in Working Capital and Cash Flows Working capital improved to $159.9 million at December 31, 2021, from $127.1 million at December 31, 2020, as a result of an increase of $15.5 million in current assets and a decrease of $17.3 million in current liabilities. Current assets increased primarily due to an increase in accounts receivable and higher inventory values due to increased commodity prices for both alcohol and corn from the prior period, partially offset by a reduction in assets held-for-sale as we completed the sales of our Madera and Stockton facilities. Our current liabilities decreased primarily due to a reduction in liabilities held-for-sale as we completed the sales of our Madera and Stockton facilities and a reduction in the current portion of our long-term debt, partially offset by an increase in accounts payable and accrued liabilities due to the timing of payments and an increase in derivative instruments. - 33 - Our cash, cash equivalents and restricted cash increased by $13.9 million due to $26.8 million in cash provided by our operating activities and $27.1 million in cash provided by our investing activities, partially offset by $40.0 million in cash used in our financing activities. Cash provided by our Operating Activities We generated $26.8 million in cash from our operating activities during 2021, as compared to $71.7 million in 2020. Specific factors that contributed significantly to the change in cash from our operating activities include: ● an increase of $74.1 million related to higher accounts receivable balances primarily due to the timing of payments and higher commodity sales prices; ● an increase of $35.5 million related to higher inventories primarily due to increased commodity prices; ● a reduction in the impact of noncash asset impairments on operating cash flows of $21.3 million; ● income from debt forgiveness of $9.9 million; and ● an increase in fair value adjustments of derivative instruments of $6.8 million. These amounts were partially offset by: ● an improvement in net income of $63.4 million; ● an increase of $33.0 million in accounts payable and accrued expenses as commodity prices rose at the end of the year; ● a reduction of $7.0 million in depreciation expense as we reduced the amount of fixed assets held-for-use; and ● a decrease of $37.5 million in other assets due to position changes in derivative instruments. Cash provided by our Investing Activities We generated $27.1 million of cash from our investing activities for 2021, of which $24.0 million and $19.5 million in cash were generated from the sales of our Stockton and Madera facilities, respectively, partially offset by $16.4 million for additions to property and equipment resulting from our capital expenditure projects. Cash used in our Financing Activities Cash used in our financing activities was $40.0 million for 2021, which reflected payments on plant borrowings of $30.0 million, payments on our senior notes of $25.5 million and payments of preferred stock dividends of $2.9 million, partially offset by net proceeds of $17.9 million from Kinergy’s operating line of credit. Kinergy’s Operating Line of Credit Kinergy maintains an operating line of credit for an aggregate amount of up to $100.0 million. The credit facility matures on August 8, 2023. Interest accrues under the credit facility at a rate equal to (i) the daily Secured Overnight Financing Rate, plus (ii) a specified applicable margin ranging from 1.75% to 2.25%. The credit facility’s monthly unused line fee is 0.25% to 0.375% of the amount by which the maximum credit under the facility exceeds the average daily principal balance during the immediately preceding month. Payments that may be made by Kinergy to Alto Ingredients, Inc. as reimbursement for management and other services provided by Alto Ingredients, Inc. to Kinergy are limited under the terms of the credit facility to $1.5 million per fiscal quarter. The credit facility also includes the accounts receivable of our indirect wholly-owned subsidiary, Alto Nutrients, LLC, or Alto Nutrients, as additional collateral. Payments that may be made by Alto Nutrients to Alto Ingredients, Inc. as reimbursement for management and other services provided by Alto Ingredients, Inc. to Alto Nutrients are limited under the terms of the credit facility to $0.5 million per fiscal quarter. Alto Nutrients markets our essential ingredients and also provides raw material procurement services to our subsidiaries. - 34 - For all monthly periods in which excess borrowing availability falls below a specified level, Kinergy and Alto Nutrients must collectively maintain a fixed-charge coverage ratio (calculated as a twelve-month rolling earnings before interest, taxes, depreciation and amortization divided by the sum of interest expense, capital expenditures, principal payments of indebtedness, indebtedness from capital leases and taxes paid during such twelve-month rolling period) of at least 2.0 and are prohibited from incurring certain additional indebtedness (other than specific intercompany indebtedness). The obligations of Kinergy and Alto Nutrients under the credit facility are secured by a first-priority security interest in all of their respective assets in favor of the lender. We believe Kinergy and Alto Nutrients are in compliance with the fixed-charge coverage ratio covenant as of the filing of this report. The following table sets forth the fixed-charge coverage ratio financial covenant and the actual results for the periods presented: Years Ended December 31, 2021 2020 Fixed Charge Coverage Ratio Requirement 2.00 2.00 Actual 13.32 5.35 Excess 11.32 3.35 Alto Ingredients, Inc. has guaranteed all of Kinergy’s obligations under the credit facility. As of December 31, 2021, Kinergy had an outstanding balance of $50.4 million and $25.4 million of unused borrowing availability under the credit facility. Alto Pekin Credit Facilities On December 15, 2016, Alto Pekin, LLC, or Alto Pekin, one of our indirect wholly-owned subsidiaries and the entity that holds two of our production facilities in Pekin, Illinois, entered into a Credit Agreement, or the Pekin Credit Agreement, with 1 st Farm Credit Services, PCA and CoBank, ACB, or CoBank. Under the terms of the Pekin Credit Agreement, Alto Pekin borrowed from 1 st Farm Credit Services $64.0 million under a term loan facility that matured on August 20, 2021, or the Pekin Term Loan, and up to $32.0 million under a revolving term loan facility that was to mature on February 1, 2022, or the Pekin Revolving Loan, and together with the Pekin Term Loan, the Pekin Credit Facility. On November 5, 2021, we closed the sale of our Stockton, California facility and, using net proceeds from the sale, repaid the Pekin Credit Facility in full. ICP Credit Facilities On September 15, 2017, ICP, Compeer Financial, PCA, or Compeer, and CoBank as agent, entered into a Credit Agreement, or the ICP Credit Agreement. Under the terms of the ICP Credit Agreement, ICP borrowed from Compeer $24.0 million under a term loan facility that matured on September 20, 2021, or the ICP Term Loan, and up to $18.0 million under a revolving term loan facility that was to mature on September 1, 2022, or the ICP Revolving Loan, and together with the ICP Term Loan, the ICP Credit Facility. - 35 - On November 5, 2021, we closed the sale of our Stockton, California facility and, using net proceeds from the sale, repaid the ICP Credit Facility in full. Senior Secured Notes On December 12, 2016, we entered into a Note Purchase Agreement with five accredited investors and sold $55.0 million in aggregate principal amount of senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold. On June 26, 2017, we entered into a second Note Purchase Agreement with five accredited investors and sold an additional $13.9 million in aggregate principal amount of senior secured notes to the investors in a private offering for aggregate gross proceeds of 97% of the principal amount of the notes sold, and collectively with the notes previously sold, the Notes. On May 14, 2021, in connection with the sale of our Madera, California fuel-grade ethanol production facility, we repaid $19.3 million in principal on these Notes. On November 5, 2021, we closed the sale of our Stockton, California facility and, using net proceeds from the sale, repaid the Notes in full. CARES Act Loans On May 4, 2020, Alto Ingredients, Inc. and Alto Pekin, received loan proceeds from Bank of America, NA under the Coronavirus Aid, Relief, and Economic Security Act through the Paycheck Protection Program administered by the SBA. Alto Ingredients, Inc. received $6.0 million and Alto Pekin received $3.9 million in loan proceeds. In June 2021, the SBA approved Alto Pekin’s forgiveness application for the full amount of $3.9 million, and accordingly, we recognized income from loan forgiveness for the three months ended June 30, 2021. In September 2021, the SBA approved Alto Ingredients, Inc.’s forgiveness application for the full amount of $6.0 million, and accordingly, we recognized income from loan forgiveness for the three months ended September 30, 2021. The SBA may audit the loan forgiveness applications and further examine eligibility for forgiveness, including the facts and circumstances existing at the time the loans were made. We can provide no assurances that any loan forgiven will not require repayment following an audit by the SBA. Other Cash Obligations As of December 31, 2021, we had future commitments for certain capital projects totaling $19.4 million. These commitments are scheduled to be satisfied through mid-2022. In connection with our acquisition of Eagle Alcohol, we committed to payments of contingent consideration of up to $9.0 million in cash over the next three years if certain targets are met. - 36 - Effects of Inflation The impact of inflation was not significant to our financial condition or results of operations for 2021, 2020 or 2019. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of net sales and expenses for each period. The following represents a summary of our critical accounting policies and related estimates, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain. Revenue Recognition We recognize revenue primarily from sales of alcohols and essential ingredients. We have five alcohol production facilities from which we produce and sell alcohols to our customers through our subsidiary Kinergy. Kinergy enters into sales contracts with customers under exclusive intercompany sales agreements with each of our five production facilities. Kinergy also acts as a principal when it purchases third party fuel-grade ethanol which it resells to its customers. Finally, Kinergy has exclusive sales agreements with other third-party owned fuel-grade ethanol plants under which it sells their fuel-grade ethanol production for a fee plus the costs to deliver the ethanol to Kinergy’s customers. These sales are referred to as third-party agent sales. Revenue from these third-party agent sales is recorded on a net basis, with Kinergy recognizing its predetermined fees and any associated delivery costs. We have five production facilities from which we produce and sell essential ingredients to our customers through our subsidiary Alto Nutrients. Alto Nutrients enters into sales contracts with essential ingredient customers under exclusive intercompany sales agreements with each of our five production facilities. We recognize revenue from sales of alcohols and essential ingredients at the point in time when the customer obtains control of the products, which typically occurs upon delivery depending on the terms of the underlying contracts. In some instances, we enter into contracts with customers that contain multiple performance obligations to deliver volumes of alcohols or essential ingredients over a contractual period of less than 12 months. We allocate the transaction price to each performance obligation identified in the contract based on relative standalone selling prices and recognize the related revenue as control of each individual product is transferred to the customer in satisfaction of the corresponding performance obligations. When we are the agent, the supplier controls the products before they are transferred to the customer because the supplier is primarily responsible for fulfilling the promise to provide the product, has inventory risk before the product has been transferred to a customer and has discretion in establishing the price for the product. When we are the principal, we control the products before they are transferred to the customer because we are primarily responsible for fulfilling the promise to provide the products, we have inventory risk before the product has been transferred to a customer and we have discretion in establishing the price for the product. - 37 - See “Note 4 – Segments” of the Notes to Consolidated Financial Statements for our revenue-breakdown by type of contract. Impairment of Long-Lived Assets and Held-for-Sale Classification Our long-lived assets have been primarily associated with our production facilities, reflecting their original cost, adjusted for depreciation and any subsequent impairment. We assess the impairment of long-lived assets, including property and equipment, when events or changes in circumstances indicate that the fair value of an asset could be less than the net book value of the asset. Generally, we assess long-lived assets for impairment by first determining the forecasted, undiscounted cash flows each asset is expected to generate plus the net proceeds expected from the sale of the asset. If the total amount of the undiscounted cash flows is less than the carrying value of the asset, we then determine the fair value of the asset. An impairment loss would be recognized when the fair value is less than the related net book value, and an impairment expense would be recorded in the amount of the difference. Forecasts of future cash flows are estimates based on our experience and knowledge of our operations and the industry in which we operate. These estimates could be significantly affected by future changes in market conditions, the economic environment, including inflation, and the purchasing decisions of our customers. We review our intangible assets with indefinite lives at least annually or more frequently if impairment indicators arise. In our review, we determine the fair value of these assets using market multiples and discounted cash flow modeling and compare it to the net book value of the acquired assets. Assets held-for-sale are assessed for impairment by comparing the carrying value to their expected net sales proceeds. In 2019, we entered into a term sheet with Aurora Cooperative Elevator Company for the sale of our interest in two fuel-grade ethanol production facilities in Nebraska. We reviewed the criteria for held-for-sale classification of the long-lived assets associated with the pending transaction. Our analysis concluded that these long-lived assets should be classified as held-for-sale with a related impairment of $29.3 million to fair value. We did not recognize any other asset impairment charges in 2019. In 2020, our Board of Directors approved a plan to sell our fuel-grade ethanol production facilities in Madera and Stockton, California, which were ultimately sold in 2021. We reviewed the criteria for held-for-sale classification of the long-lived assets associated with these asset groups. Our analysis concluded that these assets should be classified as held-for-sale as of December 31, 2020, and as such estimated the aggregate asset impairment of $22.3 million for 2020. We further evaluated the original estimate and recorded an additional asset impairment of $1.2 million for 2021. In 2021, we decided to sell our property and equipment located in Canton, Illinois. We reviewed the criteria for held-for-sale classification of the long-lived assets for this asset group. We concluded that these assets should be classified as held-for-sale as of December 31, 2021, and as such estimated the impairment of $1.9 million for 2021. Valuation Allowance for Deferred Taxes We account for income taxes under the asset and liability approach, where deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. We evaluate our deferred tax asset balance for realizability. To the extent we believe it is more likely than not that some portion or all of our deferred tax assets will not be realized, we will establish a valuation allowance against the deferred tax assets. Realization of our deferred tax assets is dependent upon future taxable income during the periods in which the associated temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made. We had pre-tax consolidated income of $47.6 million for the year ended December 31, 2021. We had pre-tax consolidated losses of $17.3 million and $101.3 million for the years ended December 31, 2020 and 2019, respectively. Based on our current and prior results, we do not have significant evidence to support a conclusion that we will more likely than not be able to benefit from our remaining deferred tax assets. As such, we have recorded a valuation allowance against our net deferred tax assets. - 38 - Derivative Instruments We evaluate our contracts to determine whether the contracts are derivative instruments. Management may elect to exempt certain forward contracts that meet the definition of a derivative from derivative accounting as normal purchases or normal sales. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from the fair value accounting and reporting requirements of derivative accounting. We enter into short-term cash, option and futures contracts as a means of securing purchases of corn, natural gas and sales of fuel-grade ethanol and managing exposure to changes in commodity prices. All of our exchange-traded derivatives are designated as non-hedge derivatives for accounting purposes, with changes in fair value recognized in net income. Although the contracts are economic hedges of specified risks, they are not designated or accounted for as hedging instruments. Realized and unrealized gains and losses related to exchange-traded derivative contracts are included as a component of cost of goods sold in the accompanying financial statements. The fair values of contracts entered through commodity exchanges are presented on the accompanying balance sheet as derivative assets or liabilities. The selection of normal purchase or sales contracts, and use of hedge accounting, are accounting policies that can change the timing of recognition of gains and losses in the statement of operations.