e10vkza

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A

Amendment No. 2

(Mark One)


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

For the Fiscal Year Ended December 31, 2006


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

For the transition period from to

Commission File Number 000-50282

PANDA ETHANOL, INC.

(Exact name of registrant as specified in its charter)


Nevada		33-0986282
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

4100 Spring Valley, Suite 1002
Dallas, Texas		75244
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (972) 361-1200

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, $.001 par value
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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

The aggregate market value of Common Stock, $0.001 par value per share (the “Common Stock”), held by nonaffiliates of the registrant, based on the last sale price of the Common Stock on the last business day of Panda Ethanol’s most recently completed second fiscal quarter, was $8,162.

As of October 9, 2007, 31,066,659 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

None

PANDA ETHANOL, INC.

FORM 10-K/A

AMENDMENT NO. 2

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

INDEX


		Page
PART II

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		1
Item 8.	Financial Statements and Supplementary Data		5
Item 9A.	Controls and Procedures		5

PART IV

Item 15.	Exhibits and Financial Statement Schedules		6
Consent of Deloitte & Touche LLP
Certification of Principal Executive Officer
Certification of Principal Financial Officer
Certification of Chief Executive Officer Pursuant to Section 906
Certification of Chief Financial Officer Pursuant to Section 906

EXPLANATORY NOTE

Panda Ethanol, Inc. (the “Company”) is filing this Amendment No. 2 (“Amendment No. 2”) to its Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as previously amended (the “Form 10-K”) to reflect the restatement of the Company’s consolidated balance sheet as of December 31, 2006, and the consolidated statements of cash flows for the year ended December 31, 2006 and for the period from inception through December 31, 2006 as discussed in Note 8 “Restatement of Previously Issued Financial Statements” of the Notes to Consolidated Financial Statements included in Item 8 of this Amendment No. 2. The restatement did not impact the Company’s total assets, shareholders’ equity, net loss, net loss per share, cash used in operating activities or cash provided by financing activities.

On October 9, 2007, management and the Audit Committee (the “Audit Committee”) of the Board of Directors of the Company concluded that the correction of errors related to the classification of certain assets on the Company’s consolidated balance sheet and the related presentation in the consolidated statements of cash flows was appropriate. Specifically, it was determined that investments in auction rate securities (“ARS”) should have been classified as investments available for sale, rather than as cash equivalents as previously reported. ARS are investments with interest rates that are reset through a “dutch auction” process that generally occurs every 28 days for the ARS held by the Company. At each auction date, the Company may elect to reset the interest rate on these securities at the rate determined by a market auction or to sell the securities. At the balance sheet date, there is the potential for a failed auction at the next reset date, in which case the Company would be unable to immediately liquidate its position in these securities. Additionally, the amounts of restricted cash and cash equivalents and restricted short-term investments at December 31, 2006 were reclassified as noncurrent assets, rather than current assets as originally reported, because their use is restricted to construction of the Hereford facility, which is a noncurrent asset.

Except as set forth herein, no changes are made to our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as amended. This Amendment No. 2 contains only the amended items. Items 7 and 8 include an updated discussion of the Company’s liquidity, the current status of the Hereford facility and the new organizational plan for the Company. Item 9A includes a discussion of the material weakness related to the classification errors. This Amendment No. 2 does not purport to fully reflect or describe other events occurring after the date of the Form 10-K or modify or update those disclosures affected by subsequent events.

In addition, we are also including as exhibits to this Amendment No. 2 the certifications required under Section 302 of the Sarbanes-Oxley Act of 2002 and are also furnishing, but not filing, certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

In this Amendment No. 2, the words “Panda Ethanol” refer to Panda Ethanol, Inc. and its subsidiaries, unless otherwise stated or the context otherwise requires. Panda Ethanol is a Nevada corporation. On November 6, 2006, Panda Ethanol, Inc. (a Delaware corporation), which is referred to in this annual report as Panda Ethanol-Delaware, merged with and into Cirracor, Inc., which we refer to as Cirracor, a Nevada corporation. The surviving Nevada corporation after the merger changed its name to “Panda Ethanol, Inc.” In Amendment No. 2, the words “company,” “we,” “our,” “ours” and “us” refer to the surviving company after the merger and its subsidiaries, unless otherwise stated or the context otherwise requires.

PART II

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 financial statements and the related notes to those statements included elsewhere in this Amendment No. 2. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results and timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Item 1A—Risk Factors” on page 16 and the factors listed under “Item 1—Business—Forward-Looking Statements” on page 14 of our annual report on Form 10-K filed on April 2, 2007.

Restatement — As discussed in the Explanatory Note, the Company has restated certain previously reported financial statements to reflect the correction of errors regarding the balance sheet classification of certain assets and the related presentation in the consolidated statements of cash flows. The amounts under “Liquidity and Capital Resources” below reflect such restatement.

Overview

The following discussion should be read in conjunction with our audited consolidated financial statements for the period from inception (November 1, 2004) through December 31, 2004 and for the years ended December 31, 2005 and 2006 and for the period from inception through December 31, 2006 and the related notes included in this Amendment No. 2.

We are in the development stage and were formed to develop ethanol production plants and other related assets. We do not expect to operate at a profit before our first ethanol plant is completely constructed and operational. Until June 7, 2006, Panda Ethanol—Delaware was a wholly-owned subsidiary of Panda Energy, a privately-held company. On June 7, 2006, Panda Ethanol—Delaware closed a private placement of approximately 14.9 million shares of its common stock for a total gross proceeds of approximately $90 million. On July 28, 2006, a wholly-owned subsidiary of Panda Ethanol—Delaware, Panda Hereford Ethanol, L.P., entered into project level debt facilities aggregating approximately $188.1 million. On December 1, 2006, we closed a private placement of 1,066,667 shares of our common stock for gross proceeds of $8 million.

On November 6, 2006, Panda Ethanol-Delaware merged with and into Cirracor pursuant to a merger agreement dated May 18, 2006. The surviving company of the merger changed its name to “Panda Ethanol, Inc.” Pursuant to the merger, each outstanding share of common stock of Panda Ethanol—Delaware was converted into the right to receive one share of Cirracor common stock with a total of 28,800,000 shares of Cirracor common stock issued for 28,800,000 shares of Panda Ethanol—Delaware common stock. The merger was accounted for as a reverse acquisition whereby Panda Ethanol was deemed to be the acquirer for accounting purposes.

We began construction of our 115 million gallon, manure-fueled ethanol production facility in Hereford, Texas in August 2006. While we currently do not produce ethanol, we currently estimate that the Hereford facility will begin producing ethanol in the first quarter of 2008 and will be fully operational by the end of the first quarter of 2008.

Through our wholly-owned subsidiaries, Panda Yuma Ethanol, L.P. and Panda Haskell Ethanol, L.P., we are also currently developing additional ethanol production facilities in Yuma, Colorado and Haskell, Kansas. We have received an air permit and entered into an EPC contract for the Yuma project, which would become fully effective upon issuance of a notice to proceed following the completion of the debt and equity financing required to commence construction of the Yuma facility. We have received both an air permit and waste water discharge permit for the Haskell facility.

To finance our ongoing development and capital needs, we will need to incur additional indebtedness, issue additional securities and/or sell interests in or form partnerships or joint ventures to develop our specific projects. Any such transactions may be consummated by Panda Ethanol or by the particular subsidiaries of Panda Ethanol that own and are developing the specific ethanol projects. Any such dispositions of interests in the specific projects may result in a deconsolidation of these project subsidiaries from our consolidated financial results and may result in a material decrease our interest in, and control over, such projects.

From the date of our inception (November 1, 2004) through December 31, 2006, we incurred an accumulated net loss of $18.5 million. We believe we will incur significant losses primarily related to development and administrative expenses and interest expense on debt from this time forward until we are able to successfully complete construction and commence operations of our initial ethanol production facility. There is no assurance that existing financing will be adequate for completion of the Hereford facility, that we will be able to secure additional financing for other projects, or that we will be successful in our efforts to develop, construct and operate one or more ethanol plants. Even if we successfully meet all of these objectives and begin operations, there is no assurance that we will be able to operate profitably.

Summary of Critical Accounting Policies and Estimates

This discussion and analysis of financial condition and results of operations are based on the financial statements of Panda Ethanol, which have been prepared in accordance with accounting principles generally accepted in the United States. Note 2 to our audited consolidated financial statements included in this Amendment No. 2 contain summaries of our significant accounting policies, many of which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to accrued expenses, financing operations, and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant accounting estimates inherent in the preparation of our consolidated financial statements include allocation of expenses from the parent (discussed below), estimates as to the appropriate carrying value of certain assets which are not readily apparent from other sources (primarily development costs), and valuation of financial derivatives. The valuation of financial derivatives is based upon discounted estimated future payments under these derivative instruments, which in turn are based upon forward market data obtained from independent sources.

Allocation of Expenses from the Former Parent

We are in the development stage and were a wholly-owned subsidiary of Panda Energy until June 7, 2006. Until October 1, 2006, we had no employees nor offices. Prior to that date, our activities were conducted by Panda Energy employees in the offices of Panda Energy. Accordingly, our financial statements include development and administrative expenses allocated from Panda Energy, our former parent. Such allocated expenses include both salary and nonsalary costs. Allocation of salary costs from the former parent is performed on an individual employee basis and is based upon the proportionate share of each employee’s time dedicated to ethanol projects. Nonsalary costs which are not specifically identifiable to projects (such as employee benefits, office rent, information technology and other office expenses) are allocated from the former parent in proportion to allocated salary costs. Our management believes the allocation methodology is reasonable and represents management’s best available estimate of actual costs incurred for the ethanol development activities; however, such allocations may not necessarily be representative of the actual costs that would have been incurred by us as a stand-alone company.

Results of Operations

For the year ended December 31, 2005 as compared to the year ended December 31, 2006

We are in the development stage and had no operating revenues for the years ended December 31, 2005 and 2006. Our activities consist solely of developing and constructing projects for ethanol manufacturing facilities.

Development and administrative expenses allocated from the former parent increased from $5,488,683 for the year ended December 31, 2005 to $6,411,285 for the year ended December 31, 2006. The increase was caused by the significant growth in development activity during 2006. Development activity accelerated during 2005 and 2006 as additional employees became involved in ethanol project development activities. Expenses allocated from the former parent included allocated salary costs of $3.5 million and $3.8 million, and allocated non-salary costs of $2.0 million and $2.6 million, for the years ended December 31, 2005 and 2006, respectively.

Other development and administrative expenses increased from $1,110,408 in the year ended December 31, 2005 to $7,014,657 in the year ended December 31, 2006. As with the expenses allocated from the former parent discussed above, the increase was primarily attributable to the growth in development activity during 2006. Effective October 1, 2006, all of the Panda Energy’s employees dedicated to ethanol-related activities on a full-time basis became our employees, and we began paying substantially all of our own overhead costs. As a result, salaries and general overhead costs incurred in the fourth quarter of 2006 which would previously have been reflected in expenses allocated from the former parent were instead reflected in other development and administrative expenses. In addition to salaries and general overhead costs for the fourth quarter of 2006 of $3.2 million, this expense category included legal fees and other expenses of $1.6 million attributable to the merger transaction in the 2006 period.

Other income and expenses for the year ended December 31, 2006 included interest income of $3.7 million, interest expense of $3.1 million, amortization of debt issuance costs of $0.3 million, and income from the decrease in fair value of financial derivative of $1.5 million. There were no other income or expense items for the year ended December 31, 2005. The other income and expense items in the 2006 period resulted from our equity and debt financing transactions and investment of the related cash balances.

For the two months ended December 31, 2004 as compared to the year ended December 31, 2005

We are in the development stage and had no operating revenues for the two months ended December 31, 2004 or the year ended December 31, 2005. Our activities consist solely of developing projects for ethanol manufacturing facilities.

Development and administrative expenses allocated from our former parent, Panda Energy, increased from $269,775 for the two months ended December 31, 2004 to $5,488,683 for the year ended December 31, 2005. The increase was caused by the significant growth in development activity during 2005. Development activity commenced in November 2004 and accelerated throughout 2005 as additional employees became involved in ethanol project development activities. Expenses allocated from the former parent include allocated salary costs of $0.2 million and $3.5 million, and allocated nonsalary costs of $0.1 million and $2.0 million, for the two months ended December 31, 2004 and the year ended December 31, 2005, respectively.

Other development and administrative expenses increased from $22,635 in the 2004 period to $1,110,408 in 2005. As with the expenses allocated from the former parent discussed above, the increase was attributable to the growth in development activity in 2005. The major expenses in this category include contract labor and travel, both of which increased significantly in 2005 as development activity increased.

Liquidity and Capital Resources

We are in the development stage and do not expect to operate at a profit before our first ethanol plant is completely constructed and operational. While we currently do not produce ethanol, we currently estimate that the Hereford facility will begin producing ethanol in the first quarter of 2008 and will be fully operational by the end of the first quarter of 2008.

We had cash of $25,043 and restricted cash of $247,000 at December 31, 2005, and cash of $0.7 million, restricted cash of $135.6 million, investments available for sale of $14.7 million, and restricted short-term investments of $12.5 million at December 31, 2006. The restricted cash and restricted short-term investments at December 31, 2006 are restricted for use in connection with the construction of the Hereford facility. In connection with the financing of the Hereford facility, we paid $5.5 million to Panda Energy in the third quarter of 2006, including $2.0 million of reimbursement for costs incurred on the Hereford facility in excess of a $13.0 million capital commitment that we were not required to repay, and a $3.5 million development fee.

On June 7, 2006, we closed a private placement of approximately 14.9 million shares of our common stock to accredited investors for total net proceeds of approximately $86.1 million, after deducting offering costs of approximately $3.9 million. On July 28, 2006, our wholly-owned subsidiary, Panda Hereford Ethanol, L.P., entered into project level debt facilities aggregating $188.1 million, which are described below. We did not guarantee and are not obligated on these project level debt facilities. On December 1, 2006, we closed a private placement of 1,066,667 shares of our common stock for net proceeds of approximately $7.6 million, after deducting offering costs of approximately $0.4 million.

Our Hereford facility commenced site preparation in February 2006 and construction in August 2006. Lurgi PSI, Inc. (“Lurgi”), the construction contractor, designed, engineered and is constructing the Hereford facility. The total commitment under the contract with Lurgi is currently approximately $162 million. Energy Products of Idaho (“EPI”) has agreed to design and supply the biomass handling and conversion equipment for the Hereford facility. The total commitment under the contract with EPI is approximately $25 million. The total estimated cost of the Hereford facility, including interest during construction, initial inventories, working capital and debt service reserves, has been estimated at approximately $271 million.

On July 10, 2007, the Company announced that it had withdrawn its private offering of $140 million aggregate principal amount of 6% convertible, redeemable senior notes which was previously announced on June 5, 2007. The offering was withdrawn because management believed that current market conditions were not conducive to achieving a per-share valuation which reflected the long-term value of the Company’s common stock. The funds from the proposed offering had been slated for construction of our ethanol facility in Yuma, Colorado and for general corporate purposes, including working capital. Due to the withdrawal of the private offering, management determined that the Company would not have sufficient working capital to continue its development activities to the extent originally planned. On August 9, 2007, in response to the withdrawal of the private offering, expenditures in connection with the private offering effort and with the cancellation of a construction-related contract for the Yuma facility, and the impact of tightening credit markets, our Board of Directors approved a new organizational plan designed to reduce costs and enable the Company to focus on the construction and subsequent operation of the Hereford facility. As a part of the new organizational plan, five executive officers and a number of additional

development and administrative employees left the Company and joined Panda Energy effective September 1, 2007. It is anticipated that these departing officers and employees will be available to provide services to us on an as-needed basis under the terms of a confidentiality and services arrangement to be entered into by us and Panda Energy, or their subsidiaries. It is expected that Panda Energy will be compensated for these services through deferred arrangements, which could include common stock. Other than administrative costs associated with the new organizational plan, there are no costs (including severance or retention payments) associated with the departures of these officers and employees or the organizational plan in general. Altogether, the repositioning is projected to reduce our cash outlay for operating expenses by approximately $4.8 million between September 1, 2007 and the time the facility achieves substantial completion.

Although the Company’s operating expenses will be significantly reduced under the new organizational plan, management anticipates that the Company will need to secure additional financing in the range of $1 million to $5 million to finance working capital requirements until the Company begins to receive cash distributions from the Hereford facility. The Company is currently seeking such additional financing. Management believes, but can offer no assurance, that such financing can be obtained. This uncertainty raises substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary in the event that the Company is not able to obtain such additional financing.

Additionally, to finance our development activities, we will need to incur additional indebtedness, issue additional securities and/or sell interests in or form partnerships or joint ventures to develop our specific projects. Any such transactions may be consummated by Panda Ethanol or by the particular subsidiaries of Panda Ethanol that own and are developing the specific ethanol projects. Any such dispositions of interests in the specific projects may result in a deconsolidation of these project subsidiaries from our consolidated financial results and may result in a material decrease in our interest in, and control over, such projects.

In addition to funds raised through the issuance of additional securities of Panda Ethanol, amounts necessary to finance other projects may be obtained through other transactions such as the sale of interests in the particular projects or the formation of partnerships or joint ventures to finance any remaining development costs for these projects. It is currently contemplated that these co-investors, partners or venture partners would generally be industry participants that have an interest in developing ethanol or have had prior involvement in the production and development of ethanol-related projects. Any sale of ownership interests in a project could have an adverse effect on our consolidated financial results and on our ability to control the operations relating to these projects.

No assurance can be given that any such financings, sales of interests or securities, or formations of strategic partnerships may be consummated or that we will be able to obtain the necessary amounts to fund these development costs and capital needs. Additionally, these transactions may have an adverse impact on our ongoing business operations and consolidated financial results. There is no assurance that we will be successful in our efforts to develop, construct and operate one or more ethanol plants. Even if we successfully meet all of these objectives and begin operations, there is no assurance that we will be able to operate profitably.

Hereford Facility Project Financing

On July 28, 2006, Panda Hereford Ethanol, L.P. closed three debt financing transactions, the proceeds of which are being used to finance the construction of the Hereford facility and provide certain working capital for the project. The debt transactions include a $158.1 million senior secured credit facility, or senior debt, a $30.0 million subordinated secured credit facility, or subordinated debt, and $50.0 million of tax-exempt bonds. The senior debt includes a letter of credit facility which supports the tax-exempt bonds; accordingly, the total borrowing capacity under the three debt transactions is $188.1 million. The debt financing transactions are more fully discussed in Note 5 to the audited financial statements contained in this Amendment No. 2.

Contractual Obligations

The table below presents our contractual obligations as of December 31, 2006, in millions of dollars. We had no capital lease obligations or operating lease obligations as of December 31, 2006.


	Payments due by period
			Less						More
			than		1-3		3-5		than
Contractual obligations	Total		1 year		years		years		5 years
Long-Term Debt Obligations (1)	$	217.3	$	7.4	$	49.0	$	51.1	$	109.8
Construction-Related Obligations (2)		135.1		135.1		—		—		—

Total (3)	$	352.4	$	142.5	$	49.0	$	51.1	$	109.8


(1)		The table includes scheduled interest, principal and fee payments related to the our long-term debt outstanding as of December 31, 2006. Our long-term debt obligations are all related to the construction financing for the Hereford facility. As more fully discussed in Note 5 to our audited financial statements included in this Amendment No. 2, the amount and timing of payments may be affected by cash sweep provisions in the debt agreements which are based on the future operating cash flow of the Hereford facility. These cash sweep provisions, if applicable, would generally have the effect of accelerating principal payments on the debt as operating cash flow increases. Acceleration of principal payments under these provisions would generally reduce future interest cost since the amount of principal outstanding in future periods would be reduced. Also, we anticipate additional future borrowings under our debt facilities beyond those outstanding at December 31, 2006, which will increase the future payment obligations accordingly.

(2)		We are obligated under construction-related contracts as more fully discussed in Note 3 to our audited financial statements included in this Amendment No. 2. The total obligations at inception of these contracts was $188.6 million. Payments on these contracts through December 31, 2006 totaled $53.5 million, resulting in future obligations totaling $135.1 million. Payments generally become due under the contracts based on achievement of specified construction milestones. At December 31, 2006, $5.9 million of the future obligations were included on the balance sheet in “accounts payable and accrued liabilities—property, plant and equipment.”

(3)		The Company has financial derivative obligations consisting of a royalty interest embedded in the subordinated debt obligation which is valued at $7.1 million, and an interest rate swap agreement which is valued at $0.5 million. These obligations are more fully discussed in Notes 2 and 5 to our audited financial statements included in this Amendment No. 2. The value of the royalty interest is based on expected future operating cash flow of the Hereford facility. If the Hereford facility’s expected future operating cash flow increases, the value of the royalty interest liability would also increase. The value of the interest rate swap is based on expectations of future interest rates. If expectations of future interest rates increase, the value of the interest rate swap liability would decrease. We cannot reliably predict the timing of the derivative payments on a year-by-year basis and, accordingly, the derivative obligations are not included in the table above.

Off-balance sheet arrangements

There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Item 8. Financial Statements and Supplementary Data

See Index to Financial Statements on page F-1.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired control objectives and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.

Our management, together with our disclosure committee, evaluated, under the supervision and with the participation of our CEO, CFO and Chief Accounting Officer (CAO), together with our disclosure committee, the effectiveness of the

design and operation of our disclosure controls and procedures as of December 31, 2006 in connection with the filing of our original Form 10-K in April 2007. In connection with this Amendment No. 2, management re-evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of the Company’s CEO and CFO. A material weakness is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the company’s financial statements will not be prevented or detected on a timely basis. Based on this re-evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were not effective as of December 31, 2006, due to the following material weakness:

Management has determined that a material weakness in internal control over financial reporting existed as of December 31, 2006, which resulted in errors and the subsequent restatement of the 2006 financial statements and financial statement schedule included in this Amendment No. 2. Specifically, management determined that the Company’s controls over the accounting for cash and cash equivalents and investments available for sale were not designed and did not operate effectively to appropriately identify certain auction-rate securities and determine that such auction-rate securities were presented in accordance with generally accepted accounting principles in the Company’s consolidated financial statements and financial statement schedule.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting during our last fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

At the end of the 2007 fiscal year, Section 404 of the Sarbanes-Oxley Act will require our management to provide an assessment of the effectiveness of our internal control over financial reporting. We are in the process of performing the system and process documentation, evaluation and testing required for management to make this assessment. We have not completed this process or our assessment, and this process will require significant amounts of management time and resources. In the course of evaluation and testing, management may identify deficiencies that will need to be addressed and remediated.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)

Documents filed as part of Report.

	1.		Report of Independent Registered Public Accounting Firm

			Consolidated Balance Sheets as of December 31, 2005 and 2006 (Restated)

			Consolidated Statements of Operations for the period from inception (November 1, 2004) through December 31, 2004, for the years ended December 31, 2005 and 2006 and for the period from inception through December 31, 2006

			Consolidated Statements of Shareholders’ Equity for the period from inception (November 1, 2004) through December 31, 2004, for the years ended December 31, 2005 and 2006 and for the period from inception through December 31, 2006

			Consolidated Statements of Cash Flows for the period from inception (November 1, 2004) through December 31, 2004, for the years ended December 31, 2005 and 2006 (Restated) and for the period from inception through December 31, 2006 (Restated)

			Notes to Consolidated Financial Statements

	2.		Financial Statement Schedule: Schedule I, Condensed Financial Information of Registrant (Restated)

	3.		Exhibits required to be filed by Item 601 of Regulation S-K

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Panda Ethanol, Inc.

Dallas, Texas

We have audited the accompanying consolidated balance sheets of Panda Ethanol, Inc. and subsidiaries (a development stage company) as of December 31, 2005 and 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the two-month period ended December 31, 2004, the years ended December 31, 2005 and 2006, and for the period from November 1, 2004 (date of inception) to December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of Panda Ethanol, Inc. and subsidiaries (a development stage company) as of December 31, 2005 and 2006, and the results of its operations and its cash flows for the two-month period ended December 31, 2004, the years ended December 31, 2005 and 2006, and the period from November 1, 2004 (date of inception) to December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 8 to the financial statements, Panda Ethanol, Inc. has restated its previously issued financial statements and financial statement schedule as of and for the year ended December 31, 2006 to properly account for its auction rate securities as investments available for sale and to reclassify restricted cash and restricted short-term investments to noncurrent assets.

We have not audited any financial statements of the Company for any period subsequent to December 31, 2006. However, as discussed in Note 1 to the financial statements, the Company will need to secure additional financing to meet its working capital requirements. This matter raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ DELOITTE & TOUCHE LLP

Dallas, Texas

March 30, 2007

(October 9, 2007 as to Notes 1, 2, 3, and 8)

F-2

PANDA ETHANOL, INC.
AND SUBSIDIARIES
(A Development Stage Enterprise)

CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2006


	2005			2006
				As Restated —
				See Note 8

ASSETS
Current assets:
Cash and cash equivalents	$	25,043		$	713,529
Restricted cash		247,000			—
Accounts receivable from former parent		—			32,265
Investments available for sale		—			14,700,000
Prepaid expenses and other assets		—			932,214

Total current assets		272,043			16,378,008
Restricted cash and cash equivalents		—			135,607,427
Restricted short-term investments		—			12,495,335
Property, plant and equipment:
Construction in progress		—			66,087,367
Development costs		4,587,921			2,084,463
Furniture and fixtures		—			76,693
Accumulated depreciation		—			(3,079	)

Total property, plant and equipment, net		4,587,921			68,245,444
Debt issuance costs, net of accumulated amortization of $520,393 at December 31, 2006		—			8,902,699

Total assets	$	4,859,964		$	241,628,913


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities — property, plant and equipment	$	1,986,508		$	6,309,361
Accounts payable and accrued liabilities — operating expenses		56,465			1,051,919
Accrued interest		—			491,497

Total current liabilities		2,042,973			7,852,777
Financial derivatives		—			7,659,400
Long-term debt, net		—			136,369,890
Commitments and contingencies (Notes 3 and 5)
Temporary equity — payable to former parent		—			4,301,558
Shareholders’ equity:
Preferred stock, par value $.001; 100,000,000 shares authorized; none issued and outstanding		—			—
Common stock, par value $.001; 250,000,000 shares authorized; 13,817,341 and 31,066,667 shares issued and outstanding at December 31, 2005 and 2006, respectively		13,817			31,067
Additional contributed capital		9,694,675			104,405,191
Accumulated other comprehensive losses		—			(513,400	)
Deficit accumulated during the development stage		(6,891,501	)		(18,477,570	)

Total shareholders’ equity		2,816,991			85,445,288

Total liabilities and shareholders’ equity	$	4,859,964		$	241,628,913

See notes to consolidated financial statements.

F-3

PANDA ETHANOL, INC.
AND SUBSIDIARIES
(A Development Stage Enterprise)

CONSOLIDATED STATEMENTS OF OPERATIONS

For the period from inception (November 1, 2004) through December 31, 2004,
for the years ended December 31, 2005 and 2006, and for the period
from inception through December 31, 2006


	Inception							Inception
	through		Year Ended December 31,					through
	December 31, 2004		2005		2006			December 31, 2006

Development and administrative expenses:
Development and administrative expenses allocated from former parent	$	269,775	$	5,488,683	$	6,411,285		$	12,169,743
Other development and administrative expenses		22,635		1,110,408		7,014,657			8,147,700

Total development and administrative expenses		292,410		6,599,091		13,425,942			20,317,443
Other expense (income):
Interest income		—		—		(3,730,833	)		(3,730,833	)
Interest expense and letter of credit fees		—		—		3,137,889			3,137,889
Amortization of debt issuance costs		—		—		271,992			271,992
Depreciation		—		—		3,079			3,079
Decrease in fair value of financial derivative		—		—		(1,522,000	)		(1,522,000	)

Total other expense (income)		—		—		(1,839,873	)		(1,839,873	)

Net loss	$	292,410	$	6,599,091	$	11,586,069		$	18,477,570

Net loss per common share — basic and dilutive:
Net loss per common share	$	0.02	$	0.48	$	0.51

Weighted average common shares outstanding — basic and dilutive		13,817,341		13,817,341		22,630,107

See notes to consolidated financial statements.

F-4

PANDA ETHANOL, INC.
AND SUBSIDIARIES
(A Development Stage Enterprise)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the period from inception (November 1, 2004) through December 31, 2004,
for the years ended December 31, 2005 and 2006, and for the period
from inception through December 31, 2006


															Deficit
												Accumulated			Accumulated
					Common Stock				Additional			Other			During the			Total
			Amount				Total Par		Contributed			Comprehensive			Development			Shareholders’
	Date		per Share		Shares		Value		Capital			Losses			Stage			Equity

Balance at inception		11/1/2004	$	—		13,817,341	$	13,817	$	(13,817	)	$	—		$	—		$	—
Capital contributions from former parent						—		—		292,410			—			—			292,410
Net loss						—		—		—			—			(292,410	)		(292,410	)

Balance, December 31, 2004						13,817,341		13,817		278,593			—			(292,410	)		—
Capital contributions from former parent						—		—		9,416,082			—			—			9,416,082
Net loss						—		—		—			—			(6,599,091	)		(6,599,091	)

Balance, December 31, 2005						13,817,341		13,817		9,694,675			—			(6,891,501	)		2,816,991
Capital contributions from former parent						—		—		6,424,972			—			—			6,424,972
Capital distributions to former parent						—		—		(5,480,712	)		—			—			(5,480,712	)
Issuance of common stock to non-affiliates		6/7/2006	$	6.01		14,982,659		14,983		86,143,580			—			—			86,158,563
Issuance of common stock in reverse merger transaction		11/6/2006	$	—		1,200,000		1,200		(1,200	)		—			—			—
Issuance of common stock to former parent		12/1/2006	$	7.50		400,000		400		2,858,954			—			—			2,859,354
Issuance of common stock to non-affiliates		12/1/2006	$	7.50		666,667		667		4,764,922			—			—			4,765,589
Unrealized loss on interest rate swap						—		—		—			(483,128	)		—			(483,128	)
Reclassification adjustments for earnings realized in net loss						—		—		—			(30,272	)		—			(30,272	)
Net loss						—		—		—			—			(11,586,069	)		(11,586,069	)

Balance, December 31, 2006						31,066,667	$	31,067	$	104,405,191		$	(513,400	)	$	(18,477,570	)	$	85,445,288

See notes to consolidated financial statements.

F-5

PANDA ETHANOL, INC.
AND SUBSIDIARIES
(A Development Stage Enterprise)

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the period from inception (November 1, 2004) through December 31, 2004,
for the years ended December 31, 2005 and 2006, and for the period
from inception through December 31, 2006


	Inception through			Year Ended December 31,						Inception through
	December 31, 2004			2005			2006			December 31, 2006
							As Restated —			As Restated —
							See Note 8			See Note 8

Operating activities:
Net loss	$	(292,410	)	$	(6,599,091	)	$	(11,586,069	)	$	(18,477,570	)
Adjustments to reconcile net loss to net cash used by operating activities:
Interest expense added to debt principal		—			—			1,937,890			1,937,890
Amortization of debt issuance costs		—			—			271,992			271,992
Decrease in fair value of financial derivative		—			—			(1,522,000	)		(1,522,000	)
Increase in accounts receivable from former parent		—			—			(32,265	)		(32,265	)
Increase in prepaid expenses		—			—			(932,214	)		(932,214	)
Increase in accounts payable and accrued liabilities — operating expenses		—			56,465			995,454			1,051,919
Increase in accrued interest		—			—			491,497			491,497

Net cash used in operating activities		(292,410	)		(6,542,626	)		(10,375,715	)		(17,210,751	)

Investing activities:
Purchases of investments available for sale		—			—			(83,025,000	)		(83,025,000	)
Sales of investments available for sale		—			—			68,325,000			68,325,000
Increase in restricted cash and cash equivalents		—			(247,000	)		(135,360,427	)		(135,607,427	)
Increase in restricted short-term investments		—			—			(12,495,335	)		(12,495,335	)
Additions to property, plant and equipment		—			(2,601,413	)		(59,086,269	)		(61,687,682	)

Net cash used in investing activities		—			(2,848,413	)		(221,642,031	)		(224,490,444	)

Financing activities:
Capital contributions from former parent		292,410			9,416,082			6,424,972			16,133,464
Capital distributions to former parent		—			—			(5,480,712	)		(5,480,712	)
Temporary equity advanced from former parent		—			—			4,301,558			4,301,558
Issuance of common stock to former parent		—			—			2,859,354			2,859,354
Issuance of common stock to non-affiliates		—			—			90,924,152			90,924,152
Issuance of long-term debt and financial derivative		—			—			143,100,000			143,100,000
Debt issuance costs		—			—			(9,423,092	)		(9,423,092	)

Net cash provided by financing activities		292,410			9,416,082			232,706,232			242,414,724

Increase in cash and cash equivalents		—			25,043			688,486			713,529
Cash and cash equivalents, beginning of period		—			—			25,043			—

Cash and cash equivalents, end of period	$	—		$	25,043		$	713,529		$	713,529

Noncash investing and financing activities:
Property, plant and equipment costs accrued	$	—		$	1,986,508		$	6,309,361		$	6,309,361
Interest cost accrued to long-term debt	$	—		$	—		$	1,937,890		$	1,937,890
Supplemental cash flow information:
Interest paid, net of amounts capitalized	$	—		$	—		$	708,502		$	708,502

See notes to consolidated financial statements.

F-6

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2005 and 2006
And For the Period from Inception (November 1, 2004) through December 31, 2004,
For The Years Ended December 31, 2005 and 2006,
And For the Period from Inception through December 31, 2006


1.	ORGANIZATION AND BASIS OF PRESENTATION

Panda Ethanol, Inc. (“Panda Ethanol” or collectively with its subsidiaries the “Company”)(a Nevada corporation), through various subsidiaries, holds a 100% interest in an ethanol manufacturing facility currently under construction in Hereford, Texas (“Hereford Facility”) and also holds 100% interests in ethanol projects under development in various states (see Note 3).

Until June 7, 2006, the Company was a wholly owned subsidiary of Panda Energy International, Inc. (“PEII”). PEII currently holds a 45.8% interest in the Company (see Note 4). PEII commenced development activities with respect to ethanol manufacturing facilities on November 1, 2004, which is the inception date of the accompanying financial statements. The financial statements are presented on a “carved out” basis and reflect the ethanol project development activities as if Panda Ethanol had been incorporated, with 13,817,341 common shares (par value $.001) initially outstanding and held by PEII, for all periods presented, until June 7, 2006 (see Note 4). The retrospective presentation under the current capital structure had no impact on net loss, any asset or liability, or net shareholders’ equity.

Development Stage Enterprise — The Company is in the development stage and has no operating revenues. The Company does not currently produce ethanol, as its projects are under construction or development as discussed in Note 3. Financial support initially was provided in the form of equity contributions and temporary equity advances from PEII. Additionally, the Company completed private equity transactions in June and December 2006, and debt financing for the Hereford Facility in July 2006.

Liquidity and Going Concern Considerations — On July 10, 2007, the Company announced that it had withdrawn its private offering of $140 million aggregate principal amount of 6% convertible, redeemable senior notes which was previously announced on June 5, 2007. The offering was withdrawn because management believed that current market conditions were not conducive to achieving a per-share valuation which reflects the long-term value of the Company’s common stock. The funds from the proposed offering had been slated for construction of the Company’s ethanol facility in Yuma, Colorado and for general corporate purposes, including working capital. Due to the withdrawal of the private offering, management determined that the Company would not have sufficient working capital to continue its development activities to the extent originally planned. On August 9, 2007, in response to the withdrawal of the private offering, expenditures in connection with the private offering effort and with the cancellation of a construction-related contract for the Yuma facility, and the impact of tightening credit markets, the Company’s Board of Directors approved a new organizational plan designed to reduce costs and enable the Company to focus on the construction and subsequent operation of the Hereford Facility. As a part of the new organizational plan, five executive officers and a number of additional development and administrative employees left the Company and joined PEII effective September 1, 2007. It is anticipated that these departing officers and employees will be available to provide services to the Company on an as-needed basis under the terms of a confidentiality and services arrangement to be entered into by the Company and PEII, or their subsidiaries. It is expected that PEII will be compensated for these services through deferred arrangements, which could include common stock. Other than administrative costs associated with the new organizational plan, there are no costs (including severance or retention payments) associated with the departures of these officers and employees or the organizational plan in general.

F-7

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Hereford Facility. The Company is currently seeking such additional financing. Management believes, but can offer no assurance, that such financing can be obtained. This uncertainty raises substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary in the event that the Company is not able to obtain such additional financing.

The consolidated financial statements include the accounts of all subsidiaries or projects in which the Company has a controlling financial interest or is the primary beneficiary. All intercompany accounts and transactions are eliminated in consolidation.


2.	SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Any differences from those estimates are recorded in the period in which they are identified.

Cash and Cash Equivalents — Included in cash and cash equivalents are highly liquid investments with original maturities of three months or less at date of purchase.

Restricted cash and cash equivalents — Restricted cash and cash equivalents at December 31, 2006 are highly liquid investments with original maturities of three months or less at date of purchase, the use of which is contractually restricted to construction of the Hereford Facility. At December 31, 2005, restricted cash was escrowed cash which collateralized a letter of credit issued by a financial institution. The letter of credit, which was issued in connection with a vendor agreement, expired in May 2006 and the restricted cash balance was released to the Company.

Investments available for sale — Investments available for sale consist of auction-rate securities (“ARS”), which are securities with variable interest rates that are reset through a “dutch auction” process that generally occurs every 28 days for the securities held by the Company. The securities are priced and traded as short-term instruments due to the interest rate reset mechanism. In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, ARS are classified as “available for sale” and are stated at cost which approximates fair value. As of December 31, 2006, the Company has experienced no realized or unrealized gains or losses related to these securities, as they have been traded at par value.

Restricted short-term investments — Restricted short-term investments are highly liquid investments with original maturities of more than three months at date of purchase, the use of which is contractually restricted to construction of the Hereford Facility. The Company expects to hold such investments to maturity. The investments, which are carried at amortized cost, will mature before March 31, 2007.

Property, Plant and Equipment — Costs related to the projects under construction, including interest on funds borrowed to finance the construction of facilities, are capitalized as construction in progress. Construction in progress balances are transferred to ethanol manufacturing facilities when the assets are ready for their intended use. Such costs will be depreciated using the straight-line method over the expected useful lives of the related equipment, generally twenty-five years. Depreciation will begin when commercial operations commence.

Development Costs — The Company capitalizes the external costs of construction-related development activities. Such costs include direct incremental amounts incurred for professional services (primarily legal,

F-8

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

engineering and consulting services), permits, options and deposits on land and equipment purchase commitments, capitalized interest and other related costs. The continued capitalization is subject to on-going risks related to successful completion, including legal, political, siting, financing, construction, permitting and contract compliance. Capitalized costs are transferred to construction in progress when financing has been obtained and construction activity has commenced. In accordance with Statement of Position (“SOP”) 98-5, “Reporting on the Costs of Start-up Activities,” start-up costs and organization costs are expensed as incurred.

Capitalization of interest — The Company capitalizes interest cost on construction in progress and capitalized development costs in accordance with the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 34, Capitalization of Interest Cost, and SFAS No. 62, Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants. These standards require that a certain portion of interest cost be capitalized as part of the historical cost of developing or constructing an asset. For assets financed with restricted tax-exempt borrowings, SFAS No. 62 requires the capitalization of all interest cost incurred on such borrowings, less any interest earned on temporary investment of the proceeds of those borrowings, from the date of borrowing until the specified qualifying assets acquired with those borrowings are ready for their intended use.

Environmental Matters — The operations of the Company are subject to federal, state and local laws and regulations relating to protection of the environment. Although the Company believes that it is in compliance with applicable environmental regulations, risk of costs and liabilities are inherent in ethanol manufacturing operations, and there can be no assurances that significant costs and liabilities will not be incurred by the Company. Management is not aware of any contingent liabilities that currently exist with respect to environmental matters.

Environmental expenditures are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded if environmental assessments and/or remedial efforts become probable, and the costs reasonably estimable. No such liabilities have been recorded as of December 31, 2006.

Income Taxes — Deferred tax liabilities or assets are required to be recognized for the anticipated future tax effects of temporary differences that arise as a result of the differences in the carrying amounts and the tax bases of assets and liabilities. A valuation allowance is required for deferred tax assets in certain circumstances.

The Company was included in the consolidated federal income tax return of PEII for 2005, and will be so included for the portion of 2006 for which it was a wholly-owned subsidiary of PEII. PEII’s policy is to allocate income tax expense or benefits to the Company as if it filed a separate tax return. The Company will file a separate tax return for the portion of 2006 for which it was not a wholly-owned subsidiary of PEII. See Note 6.

Asset Impairment — The Company evaluates the impairment of long-lived assets if circumstances indicate that the carrying value of those assets may not be recoverable. No provision for impairment has been required since the inception of the Company.

Derivative Financial Instruments and Hedging Activities — Derivative financial instruments are currently utilized by the Company to reduce its exposure to market risks from changes in interest rates. These derivative financial instruments consist of interest rate swaps. Additionally, the subordinated debt issued in connection with the Hereford Facility contains an embedded derivative financial instrument which is based upon certain future cash flows of the project (see Note 5). Periodically, the Company may enter into derivative financial instruments to hedge the price of ethanol or the cost of corn used in the production of ethanol. The Company does not currently hold or issue derivative financial instruments for speculative or trading purposes. Derivative financial instruments are recorded on the balance sheet as either an asset or a liability measured at fair value. If the derivative does not qualify as a hedge or is not designated as a hedge, the change in fair value of the derivative is recognized currently in earnings. If the derivative qualifies for hedge accounting, the change in fair value of the derivative is recognized either currently in earnings or deferred in other comprehensive income depending on the type of hedge and to what extent the hedge is effective.

F-9

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company has designated, documented and assessed hedging relationships, which resulted in cash-flow hedges that require the Company to record the derivative instruments at fair value on its balance sheet with a corresponding charge or credit to other comprehensive loss. Any hedge ineffectiveness is recorded currently in earnings. Amounts are reclassified from other comprehensive losses into earnings as the underlying forecasted transactions occur.

Allocation of Administrative Costs — As discussed in Notes 1 and 4, the Company is in the development stage and was a wholly-owned subsidiary of PEII until June 7, 2006. Until October 1, 2006, the Company had no employees nor offices. Prior to that date, its activities were conducted by PEII employees in the offices of PEII. Accordingly, the Company’s financial statements include development and administrative expenses allocated from PEII, its former parent. Such allocated expenses include both salary and nonsalary costs. Allocation of salary costs from the former parent is performed on an individual employee basis and is based upon the proportionate share of each employee’s time dedicated to ethanol projects. Nonsalary costs which are not specifically identifiable to projects (such as employee benefits, office rent, information technology and other office expenses) are allocated from the former parent in proportion to allocated salary costs. Management believes the allocation methodology is reasonable and represents management’s best available estimate of actual costs incurred for the ethanol development activities; however, such allocations may not necessarily be representative of the actual costs that would have been incurred by the Company as a stand-alone company.

Net loss per share — Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the period. There were no common stock equivalents outstanding during the periods presented; accordingly, for all periods presented, the Company’s basic and diluted net loss per share are the same.

Financial instruments — Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value of Financial Instruments”, requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. This statement defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The estimated fair value of the Company’s financial instruments was determined using market information and valuation methodologies. As of December 31, 2005 and 2006, the fair value of all financial instruments approximated carrying value. The carrying amounts of cash and cash equivalents, restricted cash and cash equivalents, restricted short-term investments and accounts payable are reasonable estimates of their fair value because of the short maturity of these items. The carrying amount of investments available for sale reasonably approximates fair value because the securities are priced and traded as short-term instruments due to the interest rate reset mechanism. The Company’s long-term debt includes borrowings under both fixed and floating interest rates. At December 31, 2006, approximately 17% of the debt accrues interest at a fixed rate, whereas the remaining 83% accrues interest at a floating rate. The fixed rate debt was issued in July 2006. Accordingly, the carrying values for both the fixed rate and floating rate debt approximate fair value.

Share-Based Payment — SFAS No. 123R, “Share-Based Payment”, requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. FASB Statement No. 123R was adopted by the Company effective January 1, 2005. Although the Company has adopted a long-term incentive plan as discussed in Note 4, no awards have been granted under the plan. Accordingly, the adoption of FASB Statement No. 123R had no impact on the Company’s results of operations or financial position.

Recent Accounting Pronouncements — In February 2006, the FASB issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). SFAS 155 establishes, among other things, the accounting for certain derivatives embedded in other financial

F-10

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

instruments. This combination is referred to as a hybrid financial instrument. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not believe the adoption of SFAS 155 will have a significant impact on the Company’s financial position, cash flows or results of operations.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The Company is required to adopt FIN 48 effective January 1, 2007. The cumulative effect of initially adopting FIN 48 will be recorded as an adjustment to opening retained earnings in the year of adoption and will be presented separately. Only tax positions that meet the more likely than not recognition threshold at the effective date may be recognized upon adoption of FIN 48. The adoption of FIN 48 should not have a significant impact on the Company’s financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has not yet determined the impact that the implementation of SFAS 157 will have on its financial position or results of operations.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB 108 does not amend or change the SEC staff’s previous positions in Staff Accounting Bulletin No. 99, Materiality, regarding qualitative considerations in assessing the materiality of misstatements. SAB 108 is effective for fiscal years beginning after November 15, 2006. The Company does not expect the adoption of SAB 108 to have a material impact on its financial position, results of operations or cash flows.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new Statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS 157. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has not yet determined the impact, if any, of this standard on its financial position, results of operations or cash flows.


3.	ETHANOL PROJECTS

The Hereford Facility is an ethanol manufacturing facility with an expected annual capacity of 115 million gallons of denatured ethanol which is currently under construction in Hereford, Texas. The Hereford Facility is being constructed under a fixed-price, turnkey engineering, procurement, and construction (“EPC”) contract with Lurgi PSI, Inc. (“Lurgi”). Lurgi will install a biomass conversion system to be manufactured by Energy Products of Idaho, Inc. (“EPI”), which will use cattle manure and cotton gin waste to generate process steam used in the production of ethanol. At December 31, 2006, the total commitments under the Lurgi and EPI contracts, which

F-11

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

became effective upon completion of financing for the Hereford Facility on July 28, 2006 as discussed in Note 5, are approximately $186 million. Total commitments under ancillary construction-related contracts are approximately $2 million. The total cost of the Hereford Facility, including interest during construction, initial inventories, working capital and debt service reserves, is currently expected to be approximately $271 million. Construction of the Hereford Facility, which commenced in August 2006, is currently expected to be completed in the first quarter of 2008.

Under the terms of the debt financing for the Hereford Facility (see Note 5), the assets related to the Hereford Facility are restricted for use in connection with the construction of that facility and are not available for general corporate purposes. Restricted net assets related to the Hereford Facility amounted to approximately $73 million at December 31, 2006.

The Company has other ethanol manufacturing facilities under development. Projects to be located in Yuma County, Colorado; Haskell County, Kansas; Sherman County, Texas; Muleshoe, Texas; and Lincoln County, Nebraska have been announced.

The Yuma and Haskell facilities are also designed to each produce approximately 115 million gallons of denatured ethanol per year. The Company has received an air permit for the Yuma facility and is seeking debt and equity financing required to construct that facility. On March 1, 2007, the Company entered into an EPC contract with Lurgi for construction of the Yuma facility (the “Yuma EPC Contract”). The Yuma EPC Contract would become fully effective upon issuance of a notice to proceed following completion of financing. In the first quarter of 2007, the Company also entered into an ancillary construction-related contract of approximately $9 million for the Yuma facility. This ancillary contract was later cancelled. See Note 1. The Company has received an air permit and a waste water discharge permit for the Haskell facility. The Company has filed applications for air permits for all of its other announced projects.


4.	CAPITAL STRUCTURE AND EQUITY

Capital Structure and Equity Contributions from Parent

The initial capitalization of Panda Ethanol at formation in May 2006 was 1,000 shares of common stock with a par value of $.01 per share. In June 2006, in anticipation of the private equity transaction discussed below, the number of shares of common stock issued and outstanding was increased by a stock dividend to 13,817,341 shares, and the par value was decreased to $.001 per share. The financial statements are presented as if the 13,817,341 shares of common stock, par value $.001 per share, had been issued initially and outstanding from inception through June 7, 2006, when additional shares were issued as discussed below. The retrospective presentation under the current capital structure had no impact on net loss, any asset or liability, or net equity. Amounts per share have also been retrospectively adjusted.

Until June 2006, PEII funded all project development and administrative activities for the Projects. In connection with the private equity transaction in June 2006 discussed below, PEII agreed to a total equity commitment of $13 million to Panda Ethanol which was reached in the first quarter of 2006. Accordingly, amounts funded by PEII in excess of the $13 million commitment which relate to specific projects are reflected on the balance sheet as temporary equity payable to former parent. The amounts payable to former parent do not bear interest and have no specific repayment terms. Panda Ethanol repaid $2.0 million to PEII in the third quarter of 2006 in connection with the Hereford Facility financing (see Note 5). The remaining amounts of temporary equity are expected to be repaid in the future, in amounts and at times not presently determinable, in connection with equity and debt financing transactions.

Through July 2006, the Company’s project development and administrative costs funded by PEII were treated as equity contributions, a portion of which are considered temporary equity as discussed above. Effective with August 2006, the Company was required to pay PEII on a monthly basis for the allocated costs under a Transition

F-12

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Services Agreement (“TSA”). Total charges under the TSA payable by the Company to PEII amounted to $1.9 million for the two months ended September 30, 2006. Effective October 1, 2006, all of the PEII employees dedicated to ethanol-related activities on a full-time basis became employees of the Company, and the Company began paying substantially all of its own overhead costs. Accordingly, charges under the TSA payable by the Company to PEII for the fourth quarter of 2006 decreased substantially from the August-September period and amounted to approximately $216,000 for the quarter. Additionally, certain of the Company’s employees provided transition assistance to PEII during the fourth quarter of 2006, and charges under the TSA payable by PEII to the Company amounted to approximately $205,000 for the quarter. As of December 31, 2006, PEII owed approximately $32,000 to the Company, which is included in accounts receivable from former parent in the Company’s consolidated balance sheet.

Additionally, effective October 1, 2006, the Company rents office space from PEII on a month to month basis for approximately $35,000 per month. Such amount represents a prorata allocation of PEII’s actual rent, based upon the proportion of PEII’s total office space occupied by the Company.

In connection with the Hereford Facility debt financing (see Note 5), the Company paid a $3.5 million development fee to PEII in July 2006. The payment was treated as an equity distribution for accounting purposes.

Merger Transaction

On May 18, 2006 Panda Ethanol entered into an Agreement and Plan of Merger (“Merger Agreement”) with Cirracor, Inc. (“Cirracor”) and Grove Panda Investments, LLC (“Grove”). Grove was the owner of 71% of the common stock of Cirracor. The merger transaction became effective on November 6, 2006. Pursuant to the terms of the Merger Agreement, prior to the effective time of the merger, Cirracor was required to effect a reverse stock split whereby each share of Cirracor was converted into 0.340885 of a share of Cirracor stock amounting in the aggregate to 1,200,000 shares which represented 4% of the issued and outstanding stock of the surviving corporation at the merger effective date. The merger was structured so that Panda Ethanol merged into Cirracor with Cirracor as the surviving corporation. At the effective date of the merger, Cirracor changed its name to Panda Ethanol, Inc. Pursuant to the Merger Agreement, the surviving corporation granted certain piggyback registration rights to Grove.

In connection with the merger, the Company assumed the liabilities of Cirracor for merger-related costs. In addition, Cirracor divested itself of its operations, such that it did not have any ongoing business operations effective with the closing of the merger. Because Cirracor had no operations, and only net monetary liabilities, the merger transaction was treated for accounting purposes as a capital transaction, whereby the Company assumed the net monetary liabilities of Cirracor. As such, no fair value adjustments were necessary for any of the liabilities assumed. The merger transaction was accounted for as a reverse acquisition whereby the Company was deemed to be the acquirer for accounting purposes. Since no cash was exchanged in the merger, the Company recorded expenses of approximately $212,000 related to the assumption of Cirracor’s liabilities, including $190,000 related to the merger transaction. Additionally, the Company incurred legal fees and other expenses of approximately $1.4 million related to the merger transaction.

Equity Transactions

On June 7, 2006, the Company issued to accredited investors in a private offering an aggregate of 14,982,659 shares of common stock at a purchase price of $6.01 per share, for total gross proceeds of approximately $90.0 million. The Company incurred placement agent fees and expenses of approximately $3.9 million. Additional costs related to the financing included legal fees which totaled approximately $0.4 million.

On December 1, 2006, the Company issued to accredited investors (including PEII) in a private offering an aggregate of 1,066,667 shares of common stock at a purchase price of $7.50 per share, for total gross proceeds of $8.0 million. PEII purchased 400,000 shares for $3.0 million and unaffiliated investors purchased 666,667 shares

F-13

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for $5.0 million. The Company incurred placement agent fees, legal fees and expenses of approximately $0.4 million. After the transaction, PEII beneficially owns 45.8% of the Company’s outstanding common stock.

In connection with the private offerings discussed above, the Company entered into Registration Rights Agreements with the investors which required the Company to file a registration statement with the Securities and Exchange Commission within 75 days after the effective date of the merger with Cirracor. The Company filed the registration statement on January 10, 2007, which complied with the 75-day requirement. Under the agreements, 75% of the Panda Ethanol shares held by PEII will be subject to a six-month lockup period from the effective date of the registration statement.

Long Term Incentive Plan

In May 2006, as amended and restated on June 7, 2006, the Company adopted the Panda Ethanol, Inc. 2006 Long Term Incentive Plan (the “Plan”). The Plan authorizes the issuance of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights and other awards to employees, consultants and outside directors. A maximum of 3,333,333 shares of common stock may be delivered pursuant to awards under the plan. No awards have been granted under the plan.


5.	LONG-TERM DEBT

On July 28, 2006, the Company closed three debt financing transactions, the proceeds of which will be used to finance the construction of the Hereford Facility and provide certain working capital for the project. The debt transactions include a $158.1 million senior secured credit facility (“Senior Debt”), a $30.0 million subordinated secured credit facility (“Subordinated Debt”), and $50.0 million of tax-exempt bonds (“Tax-Exempt Bonds”). As described below, the Senior Debt includes a letter of credit facility which supports the Tax-Exempt Bonds; accordingly, the total borrowing capacity under the three debt transactions is $188.1 million.

The Senior Debt is comprised of a $101.6 million term loan facility, a $5.0 million working capital facility, and a $51.5 million letter of credit facility. The Senior Debt is secured by substantially all of the assets of Panda Hereford Ethanol, L.P. The term loan facility has a seven-year maturity and generally bears interest at a variable annual rate equal to LIBOR plus a margin of 3.75% pre-completion and 3.50% post-completion. The working capital facility has a five-year maturity and generally bears interest at the same rate as the term loan. The letter of credit facility has a seven-year maturity and an annual fee of 3.75% pre-completion and 3.50% post-completion. The letter of credit facility supports the $50.0 million of Tax-Exempt Bonds which are discussed separately below. In addition to scheduled amortization during the applicable terms of the Senior Debt, a cash flow sweep provision requires between 30% and 100% of excess cash flow after scheduled debt service and capital expenditures to be applied quarterly to reduce the term loan principal. After the term loan has been fully repaid, 30% of the excess cash flow will be applied to a sinking fund account to cash collateralize the letter of credit facility supporting the Tax-Exempt Bonds. An additional cash flow sweep provision requires 25% of excess cash flow (after debt service on both the senior and subordinated debt) to be applied to reduce the Senior Debt principal until the Senior Debt balance is below $100 million.

At December 31, 2006, the Company had $63.1 million outstanding under the Senior Debt, which bore interest at a rate of 9.1% per annum (before impact of the interest rate swap agreement discussed below).

On August 28, 2006, the Company entered into an interest rate swap agreement to hedge its interest rate exposure on approximately 100% of the projected term loan balance outstanding during the construction period and lesser amounts after commercial operations commence. The Company has designated, documented and assessed hedging relationships in connection with the swap agreement, which results in no hedge ineffectiveness. Under the swap agreement, on a quarterly basis the Company pays a fixed rate of approximately 5.2% and receives a variable rate based upon LIBOR. Including the pre-completion margin of 3.75%, the Company’s total interest rate on the

F-14

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

term loan is effectively fixed at approximately 9.0% during construction via the swap agreement. At December 31, 2006, the notional amount of the swap agreement was $63.1 million. The term of the swap agreement runs through 2011. The fair value of the swap agreement at December 31, 2006 was a liability of approximately $513,000, which is included in financial derivatives on the balance sheet with a corresponding charge to accumulated other comprehensive losses.

The Subordinated Debt has a term of up to seven years and bears interest at 12% per year. The Subordinated Debt is secured by a second lien on a portion of the collateral for the Senior Debt and, after commencement of commercial operations, a first lien on any funds available under a subordinated debt service reserve. Interest will be added to the principal of the loan until the first scheduled payment date for the term loan, with payment in cash thereafter. Beginning six months following completion of the Hereford Facility, a cash flow sweep provision requires 100% of excess cash flow after Senior Debt service requirements and Subordinated Debt interest to be applied to reduce the Subordinated Debt principal up to targeted amortization amounts of $1 million to $2 million per quarter. In addition, the Subordinated Debt lender is entitled to a royalty of 8.5% of distributable cash flows as defined. The royalty will be payable for the longer of (a) four years from substantial completion of the Hereford Facility or (b) the remaining term of the Subordinated Debt. A further cash flow sweep provision requires prepayment of Subordinated Debt principal equal to 15% of distributable cash flows, as defined, after Senior Debt service, Subordinated Debt service and royalty payments.

The 8.5% royalty interest in the Subordinated Debt discussed above is considered to be an embedded derivative financial instrument. The fair value of the royalty interest at inception, which is estimated to be approximately $8,668,000, has been accounted for as a financial derivative liability separate from the loan. Accordingly, the carrying value of the loan was reduced by a discount of that amount at inception. The discount will be amortized over the life of the Subordinated Debt, resulting in a scheduled effective annual interest rate of 20.5% on the Subordinated Debt. The effective annual interest rate may be affected by accelerated principal payments under the cash flow sweep provisions. The fair value of the royalty interest at December 31, 2006 was estimated to be a liability of approximately $7,146,000, which is included in financial derivatives on the balance sheet. The decrease in fair value from inception of $1,522,000 has been recognized in the statement of operations.

At December 31, 2006, the Company had $30.0 million original principal amount outstanding under the Subordinated Debt, plus approximately $1,580,000 in accrued pay-in-kind interest which was added to the principal balance, which bore interest at a rate of 12% per annum. The unamortized discount related to the royalty interest amounted to approximately $8,310,000, resulting in a net carrying value of approximately $23,270,000 for the Subordinated Debt at December 31, 2006.

The Tax-Exempt Bonds are industrial revenue bonds issued by the Red River Authority, a governmental agency of the State of Texas. The Tax-Exempt Bonds are supported solely by the Senior Debt letter of credit facility and do not constitute indebtedness of the Red River Authority, the State of Texas or any political subdivision thereof. The economic substance of the Tax-Exempt Bonds is analogous to a direct borrowing by Panda Hereford Ethanol, L.P. The Tax-Exempt Bonds bear interest at a variable rate which is reset on a weekly basis by the remarketing agent (the initial rate was 3.7%). Although the Tax-Exempt Bonds have a stated maturity of 24 years, the supporting letter of credit facility has a seven-year maturity as stated above; thus the Tax-Exempt Bonds effectively also have a seven-year maturity unless the letter of credit facility is refinanced at maturity.

At December 31, 2006, the Company had $50.0 million outstanding under the Tax-Exempt Bonds, which bore interest at a rate of 4.0% per annum.

From July 28, 2006 (the closing date for the debt transactions) through December 31, 2006, the net amount of capitalized interest cost was approximately $2.3 million. See Note 2 for a discussion of the Company’s accounting policy for capitalization of interest.

F-15

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The scheduled principal maturities of net long-term debt for each of the five years succeeding December 31, 2006 and thereafter are as follows:


2007	$	—
2008		8,414,157
2009		14,293,876
2010		15,388,876
2011		15,493,876
Thereafter		91,088,842

Subtotal		144,679,627
Less unamortized discount on subordinated debt		(8,309,737	)

Total	$	136,369,890


6.	INCOME TAXES

For 2005, the Company filed a consolidated federal income tax return with PEII. For the period from January 1, 2006 to June 7, 2006, the Company will also file a consolidated federal income tax return with PEII. For the period from June 7, 2006 through December 31, 2006 and for future years, the Company will file a separate federal tax return since PEII will own less than 80% of the Company for those periods as a result of the equity financing transactions discussed in Note 4.

The Company accounts for deferred income taxes using the asset and liability method. The approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred income tax assets and liabilities are computed annually for the differences between the book value and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. For financial statement purposes, income tax benefit or expense is computed as if the Company filed separate federal and state income tax returns.

All costs incurred were capitalized for tax purposes from inception to June 7, 2006. Accordingly, the Company had no federal or state net operating loss carryforwards (“NOLs”) as of December 31, 2005. At December 31, 2006, the Company had federal NOLs of approximately $5.2 million which will expire in 2026.

The Company recorded no current income tax provision or benefit from inception through December 31, 2006 as it had no taxable income. At December 31, 2005 and 2006, the Company had deferred tax assets of $2.4 million and $6.1 million, respectively, resulting from temporary differences in the book and tax basis of assets and liabilities as shown below. The deferred tax assets were fully offset by valuation allowances of $2.4 million and $6.1 million at December 31, 2005 and 2006, respectively. Accordingly, no deferred tax benefit was recorded in either period.

F-16

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The tax effects of temporary differences that give rise to significant portions of deferred tax assets as of December 31, 2005 and 2006 were as follows (in thousands):


	2005			2006

Net operating loss carry forward	$	—		$	1,809
Start-up costs		2,412			3,906
Property, plant and equipment		—			1,013
Long-term liabilities		—			(785	)
Accumulated other comprehensive losses		—			179

Total deferred tax assets		2,412			6,122
Valuation allowance		(2,412	)		(6,122	)

Net deferred tax assets	$	—		$	—

The income tax expense (benefit) differs from the statutory federal income tax rate of 35% applied to pretax income (loss) as follows (in thousands):


	2004			2005			2006

Income tax expense (benefit) at U.S. federal statutory rate	$	(102	)	$	(2,310	)	$	(4,055	)
Permanent differences and other		—			—			345
Change in valuation allowance		102			2,310			3,710

Income tax expense (benefit)	$	—		$	—		$	—

In evaluating the reasonableness of the valuation allowance, management assesses whether it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. Ultimately, the realization of deferred tax assets is dependent upon generation of future taxable income during those periods in which temporary differences become deductible. To this end, management considers the level of historical taxable income, the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income. Although the Company anticipates future profitability, the losses for 2005 and 2006 and anticipated losses for 2007 during the construction of the Hereford Facility are the primary factors considered for management’s assessment at December 31, 2006. Based on these considerations, management does not believe it is more likely than not that the Company will realize the benefit of the deferred tax assets.

On May 18, 2006, the Texas Governor signed into law a Texas margin tax (“H.B. No. 3”) which restructures the state business tax by replacing the taxable capital and earned surplus components of the current franchise tax with a new “taxable margin” component. Because the tax base on the Texas margin tax is derived from an income-based measure, the Company believes the margin tax is an income tax and, therefore, the provisions of Statement of Financial Accounting Standards No. 109 (“SFAS No. 109”) regarding the recognition of deferred taxes apply to the new margin tax. In accordance with SFAS No. 109, the effect on deferred tax assets of a change in tax law should be included in tax expense attributable to continuing operations in the period that includes the enactment date. Although the effective date of H.B. No. 3 is January 1, 2008, certain effects of the change should be reflected in the financial statements of the first interim or annual reporting period that includes May 18, 2006. The Company has considered any impact of this new tax law in the computation of its deferred tax assets.

F-17

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


7.	QUARTERLY INFORMATION (UNAUDITED)

Results of operations by quarter for the years ended December 31, 2005 and 2006 are summarized below and reflect all adjustments, consisting only of normal recurring adjustments, needed to present fairly the results of operations for the quarterly periods:


	2005		2006

Quarter ended March 31:
Net loss	$	1,179,310	$	2,445,487
Net loss per common share	$	.09	$	.18
Quarter ended June 30:
Net loss	$	1,504,162	$	2,726,963
Net loss per common share	$	.10	$	.15
Quarter ended September 30:
Net loss	$	1,919,920	$	3,164,945
Net loss per common share	$	.14	$	.11
Quarter ended December 31:
Net loss	$	1,995,699	$	3,248,674
Net loss per common share	$	.15	$	.11


8.	RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

On October 9, 2007, management and the Audit Committee (the “Audit Committee”) of the Board of Directors of the Company concluded that the correction of errors related to the classification of certain assets on the Company’s consolidated balance sheet and the related presentation in the consolidated statements of cash flows was appropriate. Specifically, it was determined that investments in auction rate securities (“ARS”) should have been classified as investments available for sale, rather than as cash equivalents as previously reported. ARS are investments with interest rates that are reset through a “dutch auction” process that generally occurs every 28 days for the securities held by the Company. At each auction date, the Company may elect to reset the interest rate on these securities at the rate determined by a market auction or to sell the securities. At the balance sheet date, there is the potential for a failed auction at the next reset date in which case the Company would be unable to immediately liquidate its position in these securities. Additionally, the amounts of restricted cash and cash equivalents and restricted short-term investments at December 31, 2006 were reclassified as noncurrent assets, rather than current assets as originally reported, because their use was restricted to construction of the Hereford facility, which is a noncurrent asset.

The correction of these errors does not have any impact on the Company’s reported total assets, shareholders’ equity, net loss, net loss per share, net cash used in operating activities, or net cash provided by financing activities in the periods affected.

The effect of correcting the errors on the consolidated financial statements is indicated below. The Company did not invest in ARS prior to 2006; accordingly, previously reported prior periods are not affected.

F-18

PANDA ETHANOL, INC. AND SUBSIDIARIES
(A Development Stage Enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The impact of the restatement on the consolidated balance sheet and the related financial statement schedule is as follows:


	As
	Previously
	Reported		As Restated

As of December 31, 2006:
Cash and cash equivalents	$	15,413,529	$	713,529
Investments available for sale		—		14,700,000
Total current assets		164,480,770		16,378,008

The impact of the restatement on the consolidated statements of cash flows is as follows:


	As Previously
	Reported			As Restated

For the year ended December 31, 2006:
Cash flows from investing activities:
Purchases of investments available for sale	$	—		$	(83,025,000	)
Sales of investments available for sale		—			68,325,000
Net cash used in investing activities		(206,942,031	)		(221,642,031	)
Increase in cash and cash equivalents		15,388,486			688,486
Cash and cash equivalents, end of period		15,413,529			713,529
From inception through December 31, 2006:
Cash flows from investing activities:
Purchases of investments available for sale	$	—		$	(83,025,000	)
Sales of investments available for sale		—			68,325,000
Net cash used in investing activities		(209,790,444	)		(224,490,444	)
Increase in cash and cash equivalents		15,413,529			713,529
Cash and cash equivalents, end of period		15,413,529			713,529

F-19

Schedule I — Condensed financial information of registrant.

Presented below is condensed balance sheet information of the registrant as of December 31, 2006, reflecting separately the assets that are restricted for use in connection with construction of the Hereford Facility under the project financing agreements (as discussed in Notes 3 and 5 to the consolidated financial statements) and the related liabilities, and the unrestricted assets and liabilities of the Company. The project financing agreements were executed in July 2006; accordingly, the restrictions were not applicable prior to 2006. The amounts reflect the restatement discussed in Note 8 of the consolidated financial statements.


							Consolidated
	Restricted			Unrestricted			Total
	As Restated —			As Restated —			As Restated —
	See Note 8			See Note 8			See Note 8

ASSETS
Current assets:
Cash and cash equivalents	$	261,048		$	452,481		$	713,529
Accounts receivable from former parent		—			32,265			32,265
Investments available for sale		—			14,700,000			14,700,000
Prepaid expenses and other assets		52,140			880,074			932,214

Total current assets		313,188			16,064,820			16,378,008
Restricted cash and cash equivalents		135,607,427			—			135,607,427
Restricted short-term investments		12,495,335			—			12,495,335
Property, plant and equipment:
Construction in progress		66,087,367			—			66,087,367
Development costs		—			2,084,463			2,084,463
Furniture and fixtures		64,642			12,051			76,693
Accumulated depreciation		(2,701	)		(378	)		(3,079	)

Total property, plant and equipment, net		66,149,308			2,096,136			68,245,444
Debt issuance costs, net of accumulated amortization of $520,393 at December 31, 2006		8,902,699			—			8,902,699

Total assets	$	223,467,957		$	18,160,956		$	241,628,913


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities — property, plant and equipment	$	6,003,229		$	306,132			6,309,361
Accounts payable and accrued liabilities — operating expenses		52,781			999,138			1,051,919
Accrued interest		491,497			—			491,497

Total current liabilities		6,547,507			1,305,270			7,852,777
Financial derivatives		7,659,400			—			7,659,400
Long-term debt, net		136,369,890			—			136,369,890
Commitments and contingencies (Notes 3 and 5) Temporary equity — payable to former parent		—			4,301,558			4,301,558
Shareholders’ equity		72,891,160			12,554,128			85,445,288

Total liabilities and shareholders’ equity	$	223,467,957		$	18,160,956		$	241,628,913

S-1

Schedule I — Condensed financial information of registrant.

Presented below is condensed results of operations information of the registrant for the year ended December 31, 2006, reflecting separately the results of operations related to the Hereford facility, which are restricted under the project financing agreements (as discussed in Notes 3 and 5 to the consolidated financial statements), and the unrestricted operations of the Company. The project financing agreements were executed in July 2006; accordingly, the restrictions were not applicable prior to 2006.


	Year Ended December 31, 2006
							Consolidated
	Restricted			Unrestricted			Total

Development and administrative expenses:
Development and administrative expenses allocated from former parent	$	3,388,590		$	3,022,695		$	6,411,285
Other development and administrative expenses		1,550,485			5,464,172			7,014,657

Total development and administrative expenses		4,939,075			8,486,867			13,425,942
Other expense (income):
Interest income		(2,943,620	)		(787,213	)		(3,730,833	)
Interest expense and letter of credit fees		3,130,681			7,208			3,137,889
Amortization of debt issuance costs		271,992			—			271,992
Depreciation		2,701			378			3,079
Decrease in fair value of financial derivative		(1,522,000	)		—			(1,522,000	)

Total other expense (income)		(1,060,246	)		(779,627	)		(1,839,873	)

Net loss	$	3,878,829		$	7,707,240		$	11,586,069

S-2

Schedule I — Condensed financial information of registrant.

Presented below is condensed cash flow information of the registrant for the year ended December 31, 2006, reflecting separately the cash flows related to the Hereford facility, which are restricted under the project financing agreements (as discussed in Notes 3 and 5 to the consolidated financial statements), and the unrestricted cash flows of the Company. The project financing agreements were executed in July 2006; accordingly, the restrictions were not applicable prior to 2006. The amounts reflect the restatement discussed in Note 8 of the consolidated financial statements.


	Year Ended December 31, 2006
							Consolidated
	Restricted			Unrestricted			Total

Operating activities:
Net loss	$	(3,878,829	)	$	(7,707,240	)	$	(11,586,069	)
Adjustments to reconcile net loss to net cash used by operating activities:
Interest expense added to debt principal		1,937,890			—			1,937,890
Amortization of debt issuance costs		271,992			—			271,992
Decrease in fair value of financial derivative		(1,522,000	)		—			(1,522,000	)
Increase in accounts receivable from former parent		—			(32,265	)		(32,265	)
Increase in prepaid expenses		(52,140	)		(880,074	)		(932,214	)
Increase (decrease) in accounts payable and accrued liabilities — operating expenses		(3,684	)		999,138			995,454
Increase in accrued interest		491,497			—			491,497

Net cash used in operating activities		(2,755,274	)		(7,620,441	)		(10,375,715	)

Investing activities:
Purchases of investments available for sale		—			(83,025,000	)		(83,025,000	)
Sales of investments available for sale		—			68,325,000			68,325,000
Increase in restricted cash and cash equivalents		(135,360,427	)		—			(135,360,427	)
Increase in restricted short-term investments		(12,495,335	)		—			(12,495,335	)
Additions to property, plant and equipment		(57,562,462	)		(1,523,807	)		(59,086,269	)

Net cash used in investing activities		(205,418,224	)		(16,223,807	)		(221,642,031	)

Financing activities:
Capital contributions (investments) within consolidated group, net		74,732,595			(74,732,595	)		—
Capital contributions from former parent		—			6,424,972			6,424,972
Capital distributions to former parent		—			(5,480,712	)		(5,480,712	)
Temporary equity advanced from former parent		—			4,301,558			4,301,558
Issuance of common stock to former parent		—			2,859,354			2,859,354
Issuance of common stock to non-affiliates		—			90,924,152			90,924,152
Issuance of long-term debt and financial derivative		143,100,000			—			143,100,000
Debt issuance costs		(9,423,092	)		—			(9,423,092	)

Net cash provided by financing activities		208,409,503			24,296,729			232,706,232

Increase in cash and cash equivalents		236,005			452,481			688,486
Cash and cash equivalents, beginning of period		25,043			—			25,043

Cash and cash equivalents, end of period	$	261,048		$	452,481		$	713,529

Noncash investing and financing activities:
Property, plant and equipment costs accrued	$	6,003,229		$	306,132		$	6,309,361
Interest cost accrued to long-term debt	$	1,937,890		$	—		$	1,937,890
Supplemental cash flow information:
Interest paid, net of amounts capitalized	$	701,294		$	7,208		$	708,502

S-3


Exhibit
Number		Description
23.1⁽¹⁾		Consent of Deloitte & Touche LLP.

31.1⁽¹⁾		Certification of Principal Executive Officer.

31.2⁽¹⁾		Certification of Principal Financial Officer.

32.1⁽¹⁾		Certification of Chief Executive Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2⁽¹⁾		Certification of Chief Financial Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	PANDA ETHANOL, INC.
	/s/ Darol Lindloff
	Darol Lindloff,
	Chief Executive Officer and President


Exhibit
Number		Description
23.1⁽¹⁾		Consent of Deloitte & Touche LLP.

31.1⁽¹⁾		Certification of Principal Executive Officer.

31.2⁽¹⁾		Certification of Principal Financial Officer.

32.1⁽¹⁾		Certification of Chief Executive Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2⁽¹⁾		Certification of Chief Financial Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents


(1)		Filed herewith.


(1)		Filed herewith.