UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended July 31, 2003
OR
[ ] 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: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, BUILDING D, PALM DESERT, CALIFORNIA 92211
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (760) 772-9080
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE $.01
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---- ----
Indicate by check mark 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 or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
---- ----
1
The aggregate market value of the voting stock held by non-affiliates of
the Registrant was $28,941,042 as of January 31, 2003. The last reported sale
price of the Registrant's Common Stock was $3.01 per share as reported on the
Nasdaq SmallCap Market on January 31, 2003.
The number of shares of Common Stock, par value $.01 per share, outstanding
on October 10, 2003 was 15,328,817.
TABLE OF CONTENTS
ITEM PAGE NO.
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Part I 1. Business 3
2. Properties 15
3. Legal Proceedings 17
4. Submission of Matters to a Vote of Security Holders 18
Part II 5. Market for Registrant's Common Equity and Related
Stockholder Matters 19
6. Selected Financial Data 23
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
7A. Quantitative and Qualitative Disclosures About Market
Risks 43
8. Financial Statements and Supplementary Data 44
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
90
9A. Controls and Procedures 90
Part III 10. Directors and Executive Officers of the Registrant 91
11. Executive Compensation 93
12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 99
13. Certain Relationships and Related Transactions 102
14. Principal Accountant Fees and Services 104
Part IV 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 105
2
PART I
The statements contained in this Annual Report that are not historical facts are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933. These forward-looking statements may be identified by the use of
forward-looking terms such as "believes," "expects," "may," "will", "should" or
anticipates" or by discussions of strategy that involve risks and uncertainties.
From time to time, we have made or may make forward-looking statements, orally
or in writing. These forward-looking statements include statements regarding
anticipated future revenues, sales, LPG supply, operations, demand, competition,
capital expenditures, the deregulation of the LPG market in Mexico, the
operations of the US - Mexico Pipelines, the Matamoros Terminal Facility and the
Saltillo Terminal, other upgrades to our facilities, foreign ownership of LPG
operations, short-term obligations and credit arrangements, outcome of
litigation, the proposed spin-off and other statements regarding matters that
are not historical facts, and involve predictions which are based upon a number
of future conditions that ultimately may prove to be inaccurate. Actual
results, performance or achievements could differ materially from the results
expressed in, or implied by, these forward-looking statements. Factors that may
cause or contribute to such differences include those discussed under "Business"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as those discussed elsewhere in this Annual Report. We
caution you, however, that this list of factors may not be complete.
ITEM 1. BUSINESS.
INTRODUCTION
Penn Octane Corporation (the "Company"), formerly known as International
Energy Development Corporation ("International Energy"), was incorporated in
Delaware in August 1992. The Company has been principally engaged in the
purchase, transportation and sale of liquefied petroleum gas ("LPG"). From 1997
until March 1999, the Company was also involved in the provision of equipment
and services to the compressed natural gas ("CNG") industry. The Company owns
and operates a terminal facility in Brownsville, Texas (the "Brownsville
Terminal Facility") and owns a LPG terminal facility in Matamoros, Tamaulipas,
Mexico (the "Matamoros Terminal Facility") and approximately 23 miles of
pipelines (the "US - Mexico Pipelines") which connect the Brownsville Terminal
Facility to the Matamoros Terminal Facility. The Company has a long-term lease
agreement for approximately 132 miles of pipeline (the "Leased Pipeline") which
connects ExxonMobil Corporation's ("Exxon") King Ranch Gas Plant in Kleberg
County, Texas and Duke Energy's La Gloria Gas Plant in Jim Wells County, Texas,
to the Company's Brownsville Terminal Facility. In addition, the Company has
access to a twelve-inch pipeline (the "ECCPL"), which connects from Exxon's
Viola valve station in Nueces County, Texas to the inlet of the King Ranch Gas
Plant as well as existing and other potential propane pipeline suppliers which
have the ability to access the ECCPL. In connection with the Company's lease
agreement for the Leased Pipeline, the Company may access up to 21.0 million
gallons of storage, located in Markham, Texas ("Markham"), as well as other
potential propane pipeline suppliers, via approximately 155 miles of pipeline
located between Markham and the Exxon King Ranch Gas Plant.
3
The Company commenced commercial operations for the purchase, transport and
sale of LPG in the fiscal year ended July 31, 1995, upon construction of the
Brownsville Terminal Facility. The primary market for the Company's LPG is the
northeastern region of Mexico, which includes the states of Coahuila, Nuevo Leon
and Tamaulipas. The Company believes it has a competitive advantage in the
supply of LPG for the northeastern region of Mexico because of the Company's
access to pipelines and terminal facilities which allow the Company to bring
supplies of LPG close to consumers of LPG in major cities in that region. The
Company sells LPG primarily to P.M.I. Trading Limited ("PMI"). PMI is a
subsidiary of Petroleos Mexicanos, the state-owned Mexican oil company, which is
commonly known by its trade name "PEMEX." PMI is the exclusive importer of LPG
into Mexico. The LPG purchased by PMI from the Company is sold to PEMEX which
distributes the LPG purchased from PMI into the northeastern region of Mexico.
Since operations commenced, the Company's primary customer for LPG has been PMI.
In March 1997, the Company, through its wholly-owned subsidiary PennWilson
CNG, Inc., a Delaware corporation ("PennWilson"), acquired certain assets,
including inventory, equipment and intangibles, from Wilson Technologies
Incorporated ("WTI"), a company formerly engaged in the design, construction,
installation and maintenance of turnkey CNG fueling stations, hired certain of
WTI's former employees and commenced operations for the provision of equipment
and services used in the CNG industry. In May 1999, the Company discontinued
operation of its CNG business and most of the Company's CNG assets were sold.
The Company's principal executive offices are located at 77-530 Enfield
Lane, Building D, Palm Desert, California 92211, and its telephone number is
(760) 772-9080.
LIQUEFIED PETROLEUM GAS
OVERVIEW. Since operations commenced, the primary business of the Company
has been the purchase, transportation and sale of LPG. LPG is a mixture of
propane and butane principally used for residential and commercial heating and
cooking. The demand for propane is also growing as a motor fuel substitute for
motor gasoline.
The primary market for the Company's LPG is the northeastern region of
Mexico, which includes the states of Coahuila, Nuevo Leon and Tamaulipas.
Mexico is one of the largest markets for LPG consumption in the world. LPG is
the most widely used domestic fuel in Mexico and is the primary energy source
for Mexican households using such domestic fuels. Domestic consumption of LPG
in Mexico decreased from an average of 416.6 million gallons per month in 2002
to an average of 409.5 million gallons per month from January 1, 2003 to August
31, 2003, an estimated annual decrease of 1.67%. The future of LPG in Mexico
continues to favor the Company for the following reasons: (i) Mexico's domestic
consumption of LPG exceeds current domestic production capacity and such
shortfall is expected to increase (ii) limited sources of competitive LPG supply
for importation into Mexico which is destined for consumption in northeastern
Mexico, (iii) the Mexican government's current plans to deregulate the LPG
industry, (iv) the expanding use of propane as an automotive fuel, and (v) the
location of Mexico's major domestic LPG production, which is in the southeastern
region of Mexico, combined with the lack of pipeline infrastructure within
Mexico from those production centers, resulting in higher distribution costs to
transport the LPG to areas where consumption is heaviest including the central,
northern and Pacific coast regions of Mexico.
4
The Company is able to successfully compete with other LPG suppliers in the
provision of LPG to customers in northeastern Mexico primarily as a result of
the Leased Pipeline, the US - Mexico Pipelines and the geographic proximity of
its Matamoros Terminal Facility to consumers of LPG in such major cities in
Mexico as Matamoros, Reynosa and Monterrey. With the commencement of operations
of the Matamoros Terminal Facility in April 2000, the Company reduced its
exposure to the previous logistical inefficiencies and sales limitations of its
Brownsville Terminal Facility resulting from trucking delays at the United
States-Mexico border crossings or the ability of PMI to provide United States
certified trucks or trailers capable of receiving LPG at the Brownsville
Terminal Facility. Current alternatives for delivery of LPG exports to
northeastern Mexico from the United States are by truck primarily through Eagle
Pass and Hidalgo, Texas, which are northwest of Brownsville and rail. The
Company believes that the Matamoros Terminal Facility provides PMI with a less
costly alternative than other LPG supply centers used by it for the importation
of LPG. The Company believes that the Matamoros Terminal Facility and the
Saltillo Terminal (in the future as described below) enhances its strategic
position for the sale of LPG in northeastern Mexico.
THE BROWNSVILLE TERMINAL FACILITY. The Company's Brownsville Terminal
Facility occupies approximately 31 acres of land located adjacent to the
Brownsville Ship Channel, a major deep-water port serving northeastern Mexico,
including the city of Monterrey, and southeastern Texas. The Brownsville
Terminal Facility also contains a railroad spur. Total rated storage capacity
of the Brownsville Terminal Facility is approximately 675,000 gallons of LPG.
The Brownsville Terminal Facility includes eleven storage tanks, five mixed
product truck loading racks, two racks capable of receiving LPG delivered by
truck and three railcar loading racks which permit the loading and unloading of
LPG by railcar. The truck loading racks and railcar loading racks are linked to
a computer-controlled loading and remote accounting system.
The Company leases the land on which the Brownsville Terminal Facility is
located from the Brownsville Navigation District (the "District") under a lease
agreement (the "Brownsville Lease") that expires on November 30, 2006. The
Company has an option to renew for five additional five year terms. Currently,
substantially all of the Company's LPG supply is received by the Leased
Pipeline, which flows through pumping and metering equipment located at the
Brownsville Terminal Facility and then flows through the US - Mexico Pipelines
to the Matamoros Terminal Facility for offloading to trucks. Currently LPG sold
by the Company to PMI which is intended to be delivered to the Matamoros
Terminal Facility, may be delivered to the Brownsville Terminal Facility in the
event that the Matamoros Terminal Facility temporarily cannot be used. The
Brownsville Lease contains a pipeline easement to the District's water dock
facility at the Brownsville Ship Channel. The Company intends to complete
upgrades (see below) which would allow the Company to utilize the water dock
facility for the loading or offloading of barges of LPG or other products. The
railroad loading facilities are being used by the Company for sales of LPG to
other US or Canadian customers and to provide the Company with increased
flexibility in managing its LPG supplies and sales.
The Brownsville Lease provides, among other things, that if the Company
complies with all the conditions and covenants therein, the leasehold
improvements made to the Brownsville Terminal Facility by the Company may be
removed from the premises or otherwise disposed of by the Company at the
termination of the Brownsville Lease. In the event of a breach by the Company
of any of the conditions or covenants of the Brownsville Lease, all improvements
owned by the Company and placed on the premises shall be considered part of the
real estate and shall become the property of the District.
THE US - MEXICO PIPELINES AND MATAMOROS TERMINAL FACILITY. On July 26,
1999, the Company was granted a permit by the United States Department of State
authorizing the Company to construct, maintain and operate two pipelines (the
"US Pipelines") crossing the international boundary line between the United
States and Mexico (from the Brownsville Terminal Facility near the Port of
Brownsville, Texas and El Sabino, Mexico) for the transport of LPG and refined
products (motor gasoline and diesel fuel) [the "Refined Products"].
5
On July 2, 1998, Penn Octane de Mexico, S.A. de C.V. ("PennMex") (see
Mexican Operations), received a permit from the Comision Reguladora de Energia
(the "Mexican Energy Commission") to build and operate one pipeline to transport
LPG (the "Mexican Pipeline") [collectively, the US Pipelines and the Mexican
Pipeline are referred to as the "US - Mexico Pipelines"] from El Sabino (at the
point north of the Rio Bravo) to the Matamoros Terminal Facility.
The Company's Mexican subsidiaries, PennMex and Termatsal, S.A. de C.V
("Termatsal"), own all of the assets related to the Mexican portion of the US -
Mexico Pipelines and Matamoros Terminal Facility and the Company's affiliate
Tergas, S.A. de C.V. ("Tergas") has been granted the permit to operate the
Matamoros Terminal Facility (see Mexican Operations).
US - Mexico Pipelines. The Company's US-Mexico Pipelines consist of two
parallel pipelines, one of approximately six inch diameter and the other of
approximately eight inch diameter, running approximately 23 miles and connecting
the Brownsville Terminal Facility to the Matamoros Terminal Facility. The
capacity of the six inch pipeline and eight inch pipeline is approximately
840,000 gallons per day and 1.7 million gallons per day, respectively. Each of
the pipelines can accommodate LPG or Refined Products.
The Matamoros Terminal Facility. The Company's Matamoros Terminal Facility
occupies approximately 35 acres of land located approximately seven miles from
the United States-Mexico border and is linked to the Brownsville Terminal
Facility via the US - Mexico Pipelines. The Matamoros Terminal Facility is
located in an industrial zone west of the city of Matamoros, and the Company
believes that it is strategically positioned to be a centralized distribution
center of LPG for the northeastern region of Mexico. Total rated storage
capacity of the Matamoros Terminal Facility is approximately 270,000 gallons of
LPG and there are plans to install additional storage capacity totaling
approximately 630,000 gallons. The Matamoros Terminal Facility includes three
storage tanks and ten specification product truck loading racks for LPG product.
The truck loading racks are linked to a computer-controlled loading and remote
accounting system and to the Company's Brownsville Terminal Facility. The
Matamoros Terminal Facility receives its LPG supply directly from the US -
Mexico Pipelines which connect to the Leased Pipelines at the Brownsville
Terminal Facility.
OTHER. The Company's other facilities and pending projects which may
expand the Company's business activities are as follows:
The Saltillo Terminal. The Company had previously completed construction
of an additional LPG terminal facility in Saltillo, Mexico (the "Saltillo
Terminal"). The Company was unable to receive all the necessary approvals to
operate the facility at that location. The Company has identified an alternate
site in Hipolito, Mexico, a town located in the proximity of Saltillo to
relocate the Saltillo Terminal. The relocation of the Saltillo terminal is very
important to the Company's growth strategy in Mexico. The expense of such
relocation is estimated to be $500,000.
Once completed, the Company expects the newly-constructed terminal facility
to be capable of off-loading LPG from railcars to trucks. The newly-constructed
terminal facility will have three truck loading racks and storage to accommodate
approximately 390,000 gallons of LPG.
Once operational, the Company can directly transport LPG via railcar from
the Brownsville Terminal Facility to the Saltillo area. The Company believes
that by having the capability to deliver LPG to the Saltillo area, the Company
will be able to further penetrate the Mexican market for the sale of LPG.
The Tank Farm. The Company owns four storage tanks capable of storing
approximately 12.6 million gallons of Refined Products. The Company leases the
land on which the Tank Farm is located from the District under a lease agreement
that expires November 30, 2006. The Company has an option to renew for five
additional five year terms. The Company intends to construct additional piping
to the Tank Farm which would connect the Brownsville Terminal Facility, the Tank
Farm and the water dock facilities at the Brownsville Ship Channel.
6
Upgrades. The Company also intends to contract for the design,
installation and construction of pipelines which will connect the Brownsville
Terminal Facility to the District's water dock facilities at the Brownsville
Ship Channel and install additional storage capacity. The cost of this project
is expected to approximate $2.0 million. In addition the Company intends to
upgrade its computer and information systems at a total estimated cost of
$350,000.
THE LEASED PIPELINE. The Company has a lease agreement (the "Pipeline
Lease") with Seadrift, a subsidiary of Dow Hydrocarbons and Resources, Inc.
("Dow"), for approximately 132 miles of pipeline which connects Exxon's King
Ranch Gas Plant in Kleberg County, Texas and Duke Energy Corporation's La Gloria
Gas Plant in Jim Wells County, Texas, to the Company's Brownsville Terminal
Facility (the "Leased Pipeline"). As provided for in the Pipeline Lease, the
Company has the right to use the Leased Pipeline solely for the transportation
of LPG and refined products belonging only to the Company and not to any third
party.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (the "Pipeline Lease Amendment") entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999 (the
"Effective Date"). The Pipeline Lease Amendment provides, among other things,
access up to 21.0 million gallons of storage located in Markham as well as other
potential propane pipeline suppliers via approximately 155 miles of pipeline
located between Markham and the Exxon King Ranch Gas Plant (see note K to the
consolidated financial statements). The Company's ability to utilize the
storage at Markham is subject to the hydraulic and logistic capabilities of that
system. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million and 360
million gallons per year.
THE ECCPL PIPELINE. In connection with the Company's supply agreement with
Exxon, the Company was granted access to Exxon's twelve-inch pipeline which
connects from Exxon's Viola valve station in Nueces County, Texas (near Corpus
Christi, Texas) to the inlet of the King Ranch Gas Plant (the "ECCPL Pipeline")
as well as existing and other potential propane pipeline suppliers which have
the ability to access the ECCPL. Under the terms of the agreement, Exxon has
agreed to make available space in the ECCPL for a minimum of 420,000 gallons per
day for the Company's use.
DISTRIBUTION. Until March 2000, all of the LPG from the Leased Pipeline
had been delivered to the Company's customers at the Brownsville Terminal
Facility and then transported by truck to the United States Rio Grande Valley
and northeastern Mexico by the customers or by railcar to customers in the
United States and Canada. From April 2000 through February 2001, the Company
began operating the Matamoros Terminal Facility, whereby a portion of the LPG
sold to PMI was delivered through the US - Mexico Pipelines to the Matamoros
Terminal Facility for further distribution by truck in northeastern Mexico.
Since March 2001, PMI has primarily used the Matamoros Terminal Facility to
load LPG purchased from the Company for distribution by truck in Mexico. The
Company continues to use the Brownsville Terminal Facility in connection with
LPG delivered by railcar to other customers, storage and as an alternative
terminal in the event the Matamoros Terminal Facility cannot be used.
LPG SALES TO PMI. The Company entered into sales agreements with PMI for
the period from April 1, 2000 through March 31, 2001 (the "Old Agreements"), for
the annual sale of a combined minimum of 151.2 million gallons of LPG, mixed to
PMI specifications, subject to seasonal variability, to be delivered to PMI at
the Company's terminal facilities in Matamoros, Tamaulipas, Mexico or alternate
delivery points as prescribed under the Old Agreements.
7
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7.5 million gallons resulting in a new annual combined
minimum commitment of 158.7 million gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (the "Confirmation") on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of 19.0
million gallons at indexed variable posted prices plus premiums that provided
the Company with annual fixed margins, which were to increase annually over a
three-year period. The Company was also entitled to receive additional fees
for any volumes which were undelivered. From April 1, 2001 through December 31,
2001, the Company and PMI operated under the terms provided for in the
Confirmation. During January 1, 2002 through February 28, 2002, PMI purchased
monthly volumes of approximately 17.0 million gallons per month at slightly
higher premiums than those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39.6 million gallons (the "Sold LPG") for which PMI had not taken
delivery. The Company received the posted price plus other fees on the Sold LPG
but did not receive the fixed margin referred to in the Confirmation (see note
B9 to the consolidated financial statements). At July 31, 2001, the obligation
to deliver LPG totaled approximately $11.5 million related to such sales
(approximately 26.6 million gallons). During the period from December 1, 2001
through March 31, 2002, the Company delivered the Sold LPG to PMI and collected
the fixed margin referred to in the Confirmation.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17.0 million gallons of LPG, subject to monthly
adjustments based on seasonality (the "Contract"). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party upon 90
days written notice, or upon a change of circumstances as defined under the
Contract.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative terminal
in the event the Matamoros Terminal Facility cannot be used.
In connection with the Contract, the parties also executed a settlement
agreement, whereby the parties released each other in connection with all
disputes between the parties arising during the period April 1, 2001 through
February 28, 2002, and previous claims related to the contract for the period
April 1, 2000 through March 31, 2001.
Revenues from PMI totaled approximately $132.8 million for the year ended
July 31, 2003, representing approximately 82.0% of total revenues for the
period.
ACQUISITION OF MEXICAN SUBSIDIARIES. Effective April 1, 2001, the
Company completed the purchase of 100% of the outstanding common stock of both
Termatsal and PennMex (the "Mexican Subsidiaries"), previous affiliates of the
Company which were principally owned by a former officer and director (see note
D to the consolidated financial statements). The Company paid a nominal
purchase price. As a result of the acquisition, the Company has included the
results of the Mexican Subsidiaries in its consolidated financial statements at
July 31, 2001, 2002 and 2003. Since inception, the operations of the Mexican
Subsidiaries had been funded by the Company and such amounts funded were
included in the Company's consolidated financial statements prior to the
acquisition date. Therefore, there were no material differences between the
amounts previously reported by the Company and the amounts that would have been
reported by the Company had the Mexican Subsidiaries been consolidated since
inception.
During July 2003, the Company acquired an option to purchase Tergas for a
nominal price from an officer and consultant of the Company (see note D to the
consolidated financial statements).
MEXICAN OPERATIONS. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of LPG
terminal facilities is prohibited. Foreign ownership is permitted in the
transportation and storage of LPG. Mexican law also provides that a single
8
entity is not permitted to participate in more than one of the defined LPG
activities (transportation, storage or distribution). PennMex has a
transportation permit and the Mexican Subsidiaries own, lease, or are in the
process of obtaining the land or rights of way used in the construction of the
Mexican portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines, the Matamoros Terminal Facility and
the Saltillo Terminal. Tergas has been granted the permit to operate the
Matamoros Terminal Facility and the Company relies on Tergas' permit to continue
its delivery of LPG at the Matamoros Terminal Facility. Tergas is owned 95% by
an officer of the Company and the remaining balance is owned by a consultant of
the Company (see above). The Company pays Tergas its actual cost for
distribution services at the Matamoros Terminal Facility plus a small profit.
DEREGULATION OF THE LPG INDUSTRY IN MEXICO. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Articulo 27 Constitutional en el Ramo
del Petroleo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Organica del
Petroleos Mexicanos y Organismos Subsidiarios (the Organic Law of Petroleos
Mexicanos and Subsidiary Entities (the "Organic Law")). Under Mexican law and
related regulations, PEMEX is entrusted with the central planning and the
strategic management of Mexico's petroleum industry, including importation,
sales and transportation of LPG. In carrying out this role, PEMEX controls
pricing and distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law for
LPG was changed to permit foreign entities to participate without limitation in
the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its affiliates expect to sell LPG directly to
independent Mexican distributors as well as PMI upon Deregulation. The Company
anticipates that the independent Mexican distributors will be required to obtain
authorization from the Mexican government for the importation of LPG upon
Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
In connection with the above, in August 2001, Tergas received a one year
permit from the Mexican government to import LPG. During September 2001, the
Mexican government asked Tergas to defer use of the permit and, as a result, the
Company did not sell LPG to distributors other than PMI. In March 2002, the
Mexican government again announced its intention to issue permits for free
importation of LPG into Mexico by distributors and others beginning August 2002,
which was again delayed until February 2003. Tergas' permit to import LPG
expired during August 2002. Tergas intends to obtain a new permit when the
Mexican government begins to accept applications once more. As a result of the
foregoing, it is uncertain as to when, if ever, Deregulation will actually occur
and the effect, if any, it will have on the Company. However, should
Deregulation occur, it is the Company's intention to sell LPG directly to
distributors in Mexico as well as PMI. Tergas previously received authorization
from Mexican Customs authorities regarding the use of the US-Mexico Pipelines
for the importation of LPG.
The point of sale for LPG sold to PMI which flows through the US - Mexico
Pipelines for delivery to the Matamoros Terminal Facility is the United States -
Mexico border. For LPG delivered into Mexico, PMI is the importer of record.
LPG SUPPLY. Effective October 1, 1999, the Company and Exxon entered into a
ten year LPG supply contract, as amended (the "Exxon Supply Contract"), whereby
Exxon has agreed to supply and the Company has agreed to take, 100% of Exxon's
owned or controlled volume of propane and butane available at Exxon's King Ranch
Gas Plant (the "Plant") up to 13.9 million gallons per month blended in
accordance with required specifications (the "Plant Commitment"). For the year
ending July 31, 2003, under the Exxon Supply Contract, Exxon has supplied an
average of approximately 13.8 million gallons of LPG per month. The purchase
price is indexed to variable posted prices.
9
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The ability
to utilize the ECCPL allows the Company to acquire an additional supply of
propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay minimum utilization fees
associated with the use of the ECCPL until September 2004. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso agreed to supply and the Company agreed to take, a
monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999 and expiring on September 30, 2002. The El Paso
Supply Agreement was not renewed. The purchase price was indexed to variable
posted prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. In March 2003 the Company extended
the Koch Supply Contract for an additional year pursuant to the Koch Supply
Contract which provides for automatic annual renewals unless terminated in
writing by either party. For the year ending July 31, 2003, under the Koch
Supply Contract, Koch has supplied an average of approximately 5.8 million
gallons of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, prior to April 2002, the Company paid additional charges
associated with the construction of a new pipeline interconnection which was
paid through additional adjustments to the purchase price (totaling
approximately $1.0 million) which allows deliveries of the Koch Supply into the
ECCPL.
During March 2000, the Company and Duke Energy NGL Services, Inc. ("Duke")
entered into a three year supply agreement (the "Duke Supply Contract") whereby
Duke has agreed to supply and the Company has agreed to take, a monthly average
of 1.9 million gallons (the "Duke Supply") of propane or propane/butane mix
beginning April 1, 2000. In March 2003 the Company extended the Duke Supply
Contract for an additional year pursuant to the Duke Supply Contract which
provides for automatic annual renewals unless terminated in writing by either
party. The purchase price is indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
As described above, the Company has entered into supply agreements for
quantities of LPG totaling approximately 24.0 million gallons per month
excluding El Paso (actual deliveries have been approximately 21.3 million
gallons per month during fiscal 2003 excluding El Paso), although the Contract
provides for lesser quantities.
10
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver the LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated with
the storage, disposal and/or changes in LPG prices resulting from the excess of
the Plant Commitment, Koch Supply or Duke Supply over actual sales volumes.
Under the terms of the Supply Contracts, the Company must provide letters of
credit in amounts equal to the cost of the product to be purchased. In addition,
the cost of the product purchased is tied directly to overall market conditions.
As a result, the Company's existing letter of credit facility may not be
adequate to meet the letter of credit requirements under agreements with the
Suppliers or other suppliers due to increases in quantities of LPG purchased
and/or to finance future price increases of LPG.
COMPETITION
LPG. LPG production within Mexico could impact the quantity of LPG
imported into Mexico. The Company competes with several major oil and gas and
trucking companies and other foreign suppliers of LPG for the export of LPG to
Mexico. In many cases, these companies own or control their LPG supply and have
significantly greater financial and human resources than the Company. The
Company is aware of several cross border pipeline permits which have been
granted to others for transportation of LPG and/or refined products. However,
the Company is not aware of any such pipelines currently operating.
The Company competes in the supply of LPG on the basis of service, price
and volume. As such, LPG providers who own or control their LPG supply may have
a competitive advantage over their competitors. As a result of the Supply
Contracts, the Company believes that it has committed to purchase a significant
amount of the LPG supply available in south Texas which could be delivered
competitively to northeastern Mexico.
Pipelines generally provide a relatively low-cost alternative for the
transportation of petroleum products; however, at certain times of the year,
trucking companies may reduce their transportation rates charged to levels lower
than those charged by the Company. In addition, other suppliers of LPG may
reduce their sales prices to encourage additional sales. The Company believes
that such reductions are limited in both duration and volumes and that on an
annualized basis the ECCPL, the Leased Pipeline and the US - Mexico Pipelines
provide a transportation cost advantage over the Company's competitors.
The Company believes that its ECCLP, Leased Pipeline, the US-Mexico
Pipelines and the geographic location of the Brownsville Terminal Facility, the
Matamoros Terminal Facility and the Saltillo Terminal (in the future as
described above) leave it well positioned to successfully compete for LPG supply
contracts with PMI and, upon Deregulation, if ever, with local distributors in
northeastern Mexico.
ENVIRONMENTAL AND OTHER REGULATIONS
The operations of the Company including its Mexico operations are subject
to certain federal, state and local laws and regulations relating to the
protection of the environment, and future regulations may impose additional
requirements. Although the Company believes that its operations are in
compliance with applicable environmental laws and regulations, because the
requirements imposed by environmental laws and regulations are frequently
changed, the Company is unable to predict with certainty the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects.
Certain of the Company's United States operations are subject to regulation
by the Texas Railroad Commission and/or the United States Department of
Transportation. The Company believes it is in compliance with all applicable
regulations. However, there can be no assurance that these laws will not change
in the future, or if such a change were to occur, that the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects would not be significant.
11
EMPLOYEES
As of July 31, 2003, the Company has 22 employees, including two in
finance, six in sales, seven in administration and seven in production. The
Company retains subcontractors and three full time consultants in connection
with its Mexico related operations. The Company also funds salaries related to
its affiliate, Tergas in connection with the operation of the Matamoros Terminal
Facility.
The Company has not experienced any work stoppages and considers relations
with its employees to be satisfactory.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Property, plant and equipment, net of accumulated depreciation, located in
the U.S. and Mexico were as follows for the fiscal years ended July 31,:
2001 2002 2003
----------- ----------- -----------
U.S. $11,521,638 $11,568,228 $11,250,443
Mexico 6,738,746 6,782,557 6,427,387
----------- ----------- -----------
Total $18,260,384 $18,350,785 $17,677,830
=========== =========== ===========
RIO VISTA ENERGY PARTNERS L.P.
On July 10, 2003, the Company formed Rio Vista Energy Partners L.P. (the
"Partnership"), a Delaware partnership. The Partnership is a wholly owned
subsidiary of the Company. The Partnership has invested in two subsidiaries,
Rio Vista Operating Partnership L.P. (.1% owned by the Partnership and 99.9%
owned by the Company) and Rio Vista Operating GP LLC (wholly owned by the
Partnership). The above subsidiaries are newly formed and are currently
inactive.
The Company formed the Partnership for the purpose of transferring a 99.9%
interest in Rio Vista Operating Partnership L.P., which will own substantially
all of the Company's owned pipeline and terminal assets in Brownsville and
Matamoros, (the "Asset Transfer") in exchange for a 2% general partner interest
and a 98% limited partnership interest in the Partnership. The Company intends
to spin off 100% of the limited partner units to its common stockholders (the
"Spin-Off"), resulting in the Partnership becoming an independent public
company. The remaining 2% general partner interest will be initially owned and
controlled by the Company and the Company will be responsible for the management
of the Partnership. The Company will account for the Spin-Off at historical
cost.
During September 2003, the Company's Board of Directors and the Independent
Committee of its Board of Directors formally approved the terms of the Spin-Off
and the Partnership filed a Form 10 registration statement with the Securities
and Exchange Commission. The Board of Directors anticipates that the Spin-Off
will occur in late 2003 or in 2004, subject to a number of conditions, including
the receipt of an independent appraisal of the assets to be transferred by the
Company to the Partnership in connection with the Spin-Off that supports an
acceptable level of federal income taxes to the Company as a result of the
Spin-Off; the absence of any contractual and regulatory restraints or
prohibitions preventing the consummation of the Spin-Off; and final action by
the Board of Directors to set the record date and distribution date for the
Spin-Off and the effectiveness of the registration statement.
Each shareholder of the Company will receive one common unit of the limited
partnership interest in the Partnership for every eight shares of the Company's
common stock owned as of the record date.
Warrants issued to holders of the existing unexercised warrants of the
Company will be exchanged in connection with the Spin-Off whereby the holder
will receive options to acquire unissued units in the Partnership and unissued
12
common shares of the Company in exchange for the existing warrants. The number
of units and shares subject to exercise and the exercise price will be set to
equalize each option's value before and after the Spin-Off.
Ninety-eight percent of the cash distributions from the Partnership will be
distributed to the limited unit holders and the remaining 2% will be distributed
to the general partner for distributions up to $1.25 per unit annually
(approximately $2.5 million per year). Distributions in excess of that amount
will be shared by the limited unit holders and the general partner based on a
formula whereby the general partner will receive disproportionately more
distributions per unit than the limited unit holders as annual cash
distributions exceed certain milestones.
Subsequent to the Asset Transfer, the Partnership will sell LPG directly to
PMI and will purchase LPG from the Company under a long-term supply agreement.
The purchase price of the LPG from the Company will be determined based on the
Company's cost to acquire LPG and a formula that takes into consideration
operating costs of both the Company and the Partnership.
In connection with the Spin-Off, the Company will grant to Mr. Richter and
Shore Capital LLC ("Shore"), a company owned by Mr. Shore, options to each
purchase 25% of the ownership interests in the Company's general partner
interest in the Partnership. It is anticipated that Mr. Richter and Shore will
exercise these options immediately after the Spin-Off occurs. The exercise price
for each option will be the pro rata share (.5%) of the Partnership's tax basis
capital immediately after the Spin-Off. The Company will retain voting control
of the Partnership pursuant to a voting agreement. In addition, Shore will also
receive an option to acquire 5% of the common stock of the Company and 5% of the
limited partnership interest in the Partnership at a combined equivalent
exercise price of $2.20 per share.
The Partnership will be liable as guarantor for the Company's
collateralized debt (see note P to the consolidated financial statements) and
will continue to pledge all of its assets as collateral. The Partnership may
also be prohibited from making any distributions to unit holders if it would
cause an event of default, or if an event of default is existing, under the
Company's revolving credit facilities, or any other covenant which may exist
under any other credit arrangement or other regulatory requirement at the time.
The Spin-Off will be a taxable transaction for federal income tax purposes
(and may also be taxable under applicable state, local and foreign tax laws) to
both the Company and its stockholders. The Company intends to treat the
Spin-Off as a "partial liquidation" for federal income tax purposes. A "partial
liquidation" is defined under Section 302(e) of the Code as a distribution that
(i) is "not essentially equivalent to a dividend," as determined at the
corporate level, which generally requires a genuine contraction of the business
of the corporation, (ii) constitutes a redemption of stock and (iii) is made
pursuant to a plan of partial liquidation and within the taxable year in which
the plan is adopted or within the succeeding taxable year.
The Company may have a federal income tax liability in connection with the
Spin-Off. If the income tax liability resulting from the Spin-Off is greater
than $2.5 million, the Partnership has agreed to indemnify the Company for any
tax liability resulting from the transaction which is in excess of that amount.
13
The Company believes that the Spin-Off, which effectively separates the
Partnership, as a limited partnership, from the Company will provide greater
growth opportunities for each company and the following overall benefits to the
Company's shareholders:
- Tax Efficiency. As a limited partnership, the Partnership will be able
to operate in a more tax efficient manner by eliminating corporate
federal income taxes on a portion of future taxable income which would
have been fully subject to corporate federal income taxes.
- Raising Capital. As a limited partnership, the Company believes that
the Partnership will have an improved ability to raise capital for
expansion. This expansion will benefit the Company directly though
anticipated contractual arrangements between the parties and
indirectly, through the Company's general partner interest.
- Acquisitions. Due to industry preference and familiarity with the
limited partnership structure, the Company anticipates that the
Company will improve its competitiveness in making acquisitions of
assets that generate "qualifying income," as this term is defined in
Section 7704 of the Internal Revenue Code.
- Recognition. As a limited partnership, the Company anticipates that
both the Company and the Partnership will receive increased analyst
coverage and acceptance in the marketplace.
14
ITEM 2. PROPERTIES.
As of July 31, 2003, the Company owned, leased or had access to the
following facilities:
APPROXIMATE LEASE, OWN
LOCATION TYPE OF FACILITY SIZE OR ACCESS(2)
- ----------------------- ------------------------------------------- ------------------------ ------------
Brownsville, Texas Pipeline interconnection and railcar and 16,071 bbls of storage Owned(1)(7)
truck loading facilities, LPG storage
facilities, on-site administrative offices
Land 31 acres Leased(1)
Brownsville, Texas Brownsville Terminal Facility building 19,200 square feet Owned(1)(7)
Extending from Kleberg Seadrift Pipeline 132 miles Leased(3)
County, Texas to
Cameron County, Texas
Markham, Texas Salt Dome Storage 500,000 bbls of storage Access(3)
Markham, Texas to King Seadrift Pipeline
Ranch Plant 155 mile pipeline Access(3)
Extending from Nueces ECCPL Pipeline 46 miles Access(6)
County, Texas to King
Ranch Plant
Extending from US-Mexico Pipelines 23 miles Owned
Brownsville, Texas to
Matamoros, Mexico
Matamoros, Mexico Pipeline interconnection, LPG truck 35 acres Owned
loading facilities, LPG storage facilities,
on-site administration office and the
land
Brownsville, Texas Pipeline interconnection, Refined 300,000 bbls of Owned(5) (7)
Products storage tanks storage
Land 12 acres Leased(5)
Palm Desert, California Penn Octane Corporation Headquarters 3,400 square feet Leased(4)
15
_____________
(1) The Company's lease with respect to the Brownsville Terminal Facility
expires on November 30, 2006.
(2) The Company's assets are pledged or committed to be pledged as collateral
(see notes to the consolidated financial statements).
(3) The Company's lease with Seadrift expires December 31, 2013. The Company
has reserved for the calendar year ending December 31, 2003, 200,000 bbls
of storage.
(4) The Company's lease with respect to its headquarters offices expires
October 31, 2003. The Company expects to renew the lease. The monthly lease
payments approximate $3,400 a month.
(5) The Company's lease with respect to the Tank Farm expires in November 30,
2006.
(6) The Company's use of the ECCPL is pursuant to the Exxon Supply Contract,
which expires on September 30, 2009.
(7) The facilities can be removed upon termination of the lease.
For information concerning the Company's operating lease commitments, see note K
to the consolidated financial statements.
16
ITEM 3. LEGAL PROCEEDINGS.
On March 16, 1999, the Company settled a lawsuit in mediation with its
former chairman of the board, Jorge V. Duran. The total settlement costs
recorded by the Company at July 31, 1999, was $456,300. The parties had agreed
to extend the date on which the payments were required in connection with the
settlement including the issuance of the common stock. On July 26, 2000, the
parties executed final settlement agreements whereby the Company paid the
required cash payment of $150,000. During September 2000, the Company issued
the required stock.
On July 10, 2001, litigation was filed in the 164th Judicial District Court
of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel & Jackson L.L.P.
against the Company alleging breach of contract, common law fraud and statutory
fraud in connection with the settlement agreement between the parties dated July
26, 2000. Plaintiffs were seeking actual and punitive damages. During July
2003 the lawsuit was settled whereby the Company agreed to pay the plaintiffs
$45,000.
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,000 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation (WIN) settled
litigation whereby the Company issued WIN 12,500 shares of common stock of the
Company. The value of the stock, totaling approximately $82,000 at the time of
settlement, was recorded in the Company's consolidated financial statements at
July 31, 2000.
On March 2, 2000, litigation was filed in the Superior Court of California,
County of San Bernardino by Omnitrans against Penn Octane Corporation, Penn
Wilson and several other third parties alleging breach of contract, fraud and
other causes of action related to the construction of a refueling station by a
third party. Penn Octane Corporation and Penn Wilson, have both been dismissed
from the litigation pursuant to a summary judgment. Omnitrans appealed the
summary judgment in favor of the Company and Penn Wilson. During August 2003,
the Appellate Court issued a preliminary decision denying Omnitran's appeal of
the summary judgment in favor of the Company and Penn Wilson. Oral argument on
Omnitran's appeal is set for November 2003.
On August 7, 2001, a Mexican company, Intertek Testing Services de Mexico,
S.A. de C.V. (the "Plaintiff'), which contracts with PMI for LPG testing
services required to be performed under the Contract, filed suit in the Superior
Court of California, County of San Mateo against the Company alleging breach of
contract. During April 2003 the case proceeded to a jury trial. The Plaintiff
demanded from the judge and jury approximately $850,000 in damages and interest.
During May 2003, the jury found substantially in favor of the Company and
awarded damages to Intertek of only approximately $228,000 and said sum was
recorded as a judgment on June 5, 2003 and during August 2003 the Court awarded
the Plaintiff interest and costs totaling approximately $50,000. In connection
with the judgment, and the additional interest and costs, the Company recorded
an additional expense of approximately $106,000 as of July 31, 2003 representing
the additional expense over amounts previously accrued.
On October 11, 2001, litigation was filed in the 197th Judicial District
court of Cameron County, Texas by the Company against Tanner Pipeline Services,
Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging negligence and aided breaches
of fiduciary duties on behalf of CPSC in connection with the construction of the
US Pipelines. During September 2003, the Company entered into a settlement
agreement with Tanner whereby Tanner was required to reimburse the Company for
$50,000 to be paid through the reduction of the final payments on Tanner's note
(see note H to consolidated financial statements).
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including those
discussed above, should not materially affect its consolidated financial
statements.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The 2002 Annual Meeting of Stockholders of the Company (the "Meeting") was
held at the Company's executive offices on July 31, 2003. The record date
for the Meeting was July 14, 2003. Proxies for the meeting were solicited
pursuant to Regulation 14A under the Exchange Act. There was no
solicitation in opposition to management's two proposals, and all of the
nominees for election as director were elected. The results of the voting
by the stockholders for each proposal are presented below.
Proposal #1 Election of Directors
Name of Director Elected Votes For Votes Withheld
- ------------------------ --------- --------------
Jerome B. Richter 8,476,104 18,764
Richard "Beau" Shore, Jr. 8,476,104 18,764
Charles Handly 8,476,104 18,764
Ian T. Bothwell 8,476,104 18,764
Jerry L. Lockett 8,476,104 18,764
Stewart J. Paperin 8,476,104 18,764
Harvey L. Benenson 8,476,104 18,764
Emmett M. Murphy 8,476,104 18,764
Proposal #2 Ratification of the appointment of Burton McCumber & Cortez,
L.L.P. as the independent auditors of the Company for the fiscal
year ending July 31, 2003.
For Against Abstain
--- ------- -------
8,493,368 1,100 400
18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock began trading in the over-the-counter ("OTC")
market on the Nasdaq SmallCap Market under the symbol "POCC" in December 1995.
The following table sets forth the reported high ask and low bid quotations
of the common stock for the periods indicated. Such quotations reflect
inter-dealer prices, without retail mark-ups, mark-downs or commissions and may
not necessarily represent actual transactions.
LOW HIGH
--- ----
FISCAL YEAR ENDED JULY 31, 2002:
First Quarter . . . . . . . . . . . . $3.51 $4.50
Second Quarter. . . . . . . . . . . . 3.03 3.95
Third Quarter . . . . . . . . . . . . 2.18 3.70
Fourth Quarter. . . . . . . . . . . . 2.50 4.15
FISCAL YEAR ENDED JULY 31, 2003:
First Quarter . . . . . . . . . . . . $1.90 $3.14
Second Quarter. . . . . . . . . . . . 2.02 3.30
Third Quarter . . . . . . . . . . . . 2.26 3.05
Fourth Quarter. . . . . . . . . . . . 2.51 3.75
On October 10, 2003, the closing bid price of the common stock as reported
on the Nasdaq SmallCap Market was $3.05 per share. On October 10, 2003, the
Company had 15,328,817 shares of common stock outstanding and approximately 300
holders of record of the common stock.
The Company has not paid any common stock dividends to stockholders and
does not intend to pay any common stock dividends to stockholders in the
foreseeable future and intends to retain any future earnings for capital
expenditures and otherwise to fund the Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
In connection with the Board Plan, during August 2001, the Board granted
warrants to purchase 10,000 and 20,000 shares of common stock of the Company at
exercise prices of $3.99 and $4.05 per share to outside directors.
During August and September 2001, warrants to purchase 37,500 and 275,933
shares, respectively, of common stock of the Company were exercised by certain
holders of warrants, through reductions of debt obligations.
During September 2001, the Company issued 1,000 shares of common stock of
the Company to an employee of the Company as a bonus. In connection with the
issuance of the shares, the Company recorded an expense of $2,800 based on the
market value of the stock issued.
During November 2001, warrants to purchase a total of 78,750 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $137,813.
19
In connection with the Board Plan, during November 2001 the Board granted
warrants to purchase 30,000 shares of common stock of the Company at exercise
prices of $3.66 per share to a newly appointed outside director.
During December 2001, the Company entered into agreements (the
"Restructuring Agreements") with the holders of $3.1 million in principal amount
of the notes (the "Notes") providing for the restructuring of such Notes (the
"Restructuring") whereby the due date for $3.1 million of principal due on the
Notes was extended to June 15, 2002. In connection with the extension, the
Company agreed to (i) continue paying interest at a rate of 16.5% annually on
the Notes, payable quarterly, (ii) pay the holders of the Notes a fee equal to
1% on the principal amount of the Notes, (iii) modify the warrants held by the
holders of the Notes by extending the expiration date to December 14, 2004 and
(iv) remove the Company's repurchase rights with regard to the warrants.
During June 2002, the Company and certain holders of the Notes (the "New
Accepting Noteholders") reached an agreement whereby the due date for
approximately $3.0 million of principal due on the New Accepting Noteholders'
Notes were extended to December 15, 2002. The New Accepting Noteholders' Notes
will continue to bear interest at 16.5% per annum. Interest is payable on the
outstanding balance on specified dates through December 15, 2002. The Company
paid a fee of 1.5% on the principal amount of the New Accepting Noteholders'
Notes on July 1, 2002.
During June 2002, the Company issued a note for $100,000 (the "New Note")
to a holder of the Notes. The New Note provides for similar terms and
conditions as the New Accepting Noteholders' Notes.
During June 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of $62,500.
During July 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of $62,500.
In connection with the Board Plan, during August 2002 the Board granted
warrants to purchase 20,000 shares of common stock of the Company at exercise
price of $3.10 per share to outside directors.
In connection with the Board Plan, during November 2002 the Board granted
warrants to purchase 10,000 shares of common stock of the Company at exercise
prices of $2.27 per share to an outside director. Based on the provisions of
APB 25, no compensation expense was recorded for these warrants.
During December 2002, the Company and certain holders of New Accepting
Noteholders' notes and holder of the Additional Note (the "Extending
Noteholders") reached an agreement whereby the due date for $2.7 million of
principal due on the Extending Noteholders' notes were extended to December 15,
2003. Under the terms of the agreement, the Extending Noteholders' notes will
continue to bear interest at 16.5% per annum. Interest is payable quarterly on
the outstanding balances beginning on March 15, 2003 (the December 15, 2002
interest was paid on January 1, 2003). In addition, the Company is required to
pay principal in equal monthly installments beginning March 2003 (approximately
$1.2 million of principal was paid through the period ended April 30, 2003 of
which $1.0 million was reduced in connection with the exercise of warrants and
purchase of common stock - see below). The Company may prepay the Extending
Noteholders' notes at any time. The Company is also required to pay a fee of
1.5% on the principal amount of the Extending Noteholders' notes which are
outstanding on December 15, 2002, March 15, 2003, June 15, 2003 and September
15, 2003. The Company also agreed to extend the expiration date on the warrants
held by the Extending Noteholders in connection with the issuance of the
Extending Noteholders' notes to December 15, 2006. In connection with the
extension of the warrants, the Company recorded a discount of $316,665 related
to the additional value of the modified warrants of which $240,043 has been
amortized for the year ended July 31, 2003.
20
During December 2002, the Company issued a note for $250,000 (the "$250,000
Note") to a holder of the Extending Noteholders' notes. The note provides for
similar terms and conditions as the Extending Noteholders' notes.
During March 2003, warrants to purchase 250,000 shares of common stock of
the Company were exercised by a certain holder of the Warrants and New Warrants,
through reductions of debt obligations (see note H to the consolidated financial
statements).
During March 2003, a holder of the Extending Noteholders' notes agreed to
acquire 161,392 shares of common stock of the Company at a price of $2.50 per
share. The purchase price was paid through the cancellation of outstanding debt
and accrued interest owed to the holder totaling $403,480 (see note H to the
consolidated financial statements).
In connection with the Board Plan, during August 2003 the Board granted
warrants to purchase 20,000 shares of common stock of the Company at exercise
prices of $3.22 and $3.28 per share to outside directors. Based on the
provisions of APB 25, no compensation expense was recorded for these warrants.
During September 2003, warrants to purchase 32,250 shares of common stock
of the Company were exercised resulting in cash proceeds to the Company of
$80,625.
During September 2003, the Company issued 21,818 shares of common stock of
the Company to Mr. Bracamontes, a former officer and director of the Company as
severance compensation (see note D to the consolidated financial statements).
In connection with the issuance of the shares, the Company recorded an expense
of approximately $75,000 based on the market value of the stock issued.
The above transactions were issued without registration under the
Securities Act of 1933, as amended, in reliance upon the exemptions from the
registration provisions thereof, contained in Section 4(2) thereof and Rule 506
of Regulation D promulgated thereunder.
21
EQUITY COMPENSATION PLANS
- -------------------------
The following table provides information concerning the Company's equity
compensation plans as of July 31, 2003.
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS WARRANTS AND RIGHTS EQUITY COMPENSATION
PLANS (EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation
plans approved by 2,180,000 $ 4.79 1,500,000 (1)(2)
security holders
Equity compensation
plans not approved by 1,412,179 $ 2.69 -
security holders (3)
--------- ----------
Total 3,592,179 $ 3.97 1,500,000
========= ==========
(1) Pursuant to the Company's Board Plan, the outside directors are entitled to
receive warrants to purchase 20,000 shares of common stock of the Company
upon their initial election as a director and warrants to purchase 10,000
shares of common stock of the Company for each year of service as a
director.
(2) Pursuant to the Company's 2001 Warrant Plan, the Company may issue warrants
to purchase up to 1.5 million shares of common stock of the Company.
(3) The Company was not required to obtain shareholder approval for these
securities.
22
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data for each of the years in
the five-year period ended July 31, 2003, have been derived from the
consolidated financial statements of the Company. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements of the Company and related notes included elsewhere herein. All
information is in thousands, except per-share data.
Year Ended July 31,
--------------------------------------------------
1999 2000 2001 2002 2003
---------- ------- --------- -------- --------
Revenues $35,338(1) $98,515 $150,700 $142,156 $162,490
Income (loss) from continuing operations 1,125 1,461 (8,094) 4,123 1,958
Net income (loss) 545 1,461 (8,094) 4,123 1,958
Net income (loss) from continuing
operations per common share .11 .11 (.57) .28 .13
Net income (loss) per common share .05 .11 (.57) .28 .13
Total assets 8,909 31,537 40,070 30,155 27,838
Long-term obligations 259 1,465 3,274 612 60
(1) The operations of PennWilson for the period from August 1, 1997 (date of
incorporation) through May 25, 1999, the date operations were discontinued,
are presented in the consolidated financial statements as discontinued
operations.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Company's results of operations and
liquidity and capital resources should be read in conjunction with the
consolidated financial statements of the Company and related notes thereto
appearing elsewhere herein. References to specific years preceded by "fiscal"
(e.g. fiscal 2003) refer to the Company's fiscal year ended July 31.
OVERVIEW
The Company has been principally engaged in the purchase, transportation
and sale of LPG for distribution into northeast Mexico. In connection with the
Company's desire to reduce quantities of inventory, the Company also sells LPG
to U.S. and Canadian customers.
During fiscal 2003, the Company derived 82% of its revenues from sales of
LPG to PMI, its primary customer.
The Company provides products and services through a combination of
fixed-margin and fixed-price contracts. Costs included in cost of goods sold,
other than the purchase price of LPG, may affect actual profits from sales,
including costs relating to transportation, storage, leases and maintenance.
Mismatches in volumes of LPG purchased from suppliers and volumes sold to PMI or
others could result in gains during periods of rising LPG prices or losses
during periods of declining LPG prices as a result of holding inventories or
disposing of excess inventories.
LPG SALES
The following table shows the Company's volume sold in gallons and average
sales price for fiscal years ended July 31, 2001, 2002 and 2003.
2001 2002 2003
------ ------ ------
Volume Sold
LPG (millions of gallons) - PMI 167.2 243.5 211.1
LPG (million of gallons) - Other 71.4 76.1 56.4
------ ------ ------
238.6 319.6 267.5
Average sales price
LPG (per gallon) - PMI $ 0.67 $ 0.46 $ 0.63
LPG (per gallon) - Other 0.55 0.47 0.52
24
RESULTS OF OPERATIONS
YEAR ENDED JULY 31, 2003 COMPARED WITH JULY 31, 2002
Revenues. Revenues for the year ended July 31, 2003, were $162.5 million
compared with $142.2 million for the year ended July 31, 2002, an increase of
$20.3 million or 14.3%. Of this increase, $42.4 million was attributable to
increases in average sales prices of LPG sold to PMI during the year ended July
31, 2003 and $8.4 million was attributable to increased average sales prices of
LPG sold to customers other than PMI during the year ended July 31, 2003,
partially offset by $20.4 million attributable to decreased volumes of LPG sold
to PMI during the year ended July 31, 2003 and $10.2 million attributable to
decreased volumes of LPG sold to customers other than PMI during the year ended
July 31, 2003.
Cost of goods sold. Cost of goods sold for the year ended July 31, 2003
was $152.4 million compared with $131.1 million for the year ended July 31,
2002, an increase of $21.2 million or 16.2%. Of this increase, $43.3 million
was attributable to increases in the cost of LPG sold to PMI during the year
ended July 31, 2003 and $6.6 million was attributable to increased costs of LPG
sold to customers other than PMI during the year ended July 31, 2003, partially
offset by $10.5 million attributable to decreased volume of LPG sold to
customers other than PMI during the year ended July 31, 2003 and $17.9 million
attributable to decreased volume of LPG sold to PMI during the year ended July
31, 2003.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $6.4 million for the year ended July 31, 2003,
compared with $4.3 million for the year ended July 31, 2002, an increase of $2.0
million or 47%. The increase during the year ended July 31, 2003, was
principally due to legal and professional fees associated with the Spin-Off and
litigation, consulting fees and compensation related costs.
Other income (expense). Other income (expense) was $(1.8) million for the
year ended July 31, 2003, compared with $(2.5) million for the year ended July
31, 2002. The decrease in other expense was due primarily to decreased
amortization of discounts on outstanding debt, partially offset by settlements
of litigation during the year ended July 31, 2003.
Income tax. Due to the availability of net operating loss carryforwards
(approximately $5.3 million at July 31, 2003), the Company did not incur any
additional U.S. income tax expense during the year ended July 31, 2003. The
Company did incur $60,000 of Mexican income tax expense related to its Mexican
subsidiaries. The Mexican subsidiaries file their income tax returns on a
calendar year basis. The Company can receive a credit against any future tax
payments due to the extent of any prior alternative minimum taxes paid ($54,375
at July, 31, 2003).
25
YEAR ENDED JULY 31, 2002 COMPARED WITH JULY 31, 2001
Revenues. Revenues for the year ended July 31, 2002, were $142.2 million,
including $22.0 million (39.6 million gallons) related to the delivery during
the period December 2001 through April 2002 of LPG associated with the
obligation to deliver, compared with $150.7 million for the year ended July 31,
2001, a decrease of $8.5 million or 5.7%. Of this decrease, $35.9 million was
attributable to decreases in average sales prices of LPG sold to PMI during the
year ended July 31, 2002, and $8.9 million was attributable to decreased average
sales prices of LPG sold to customers other than PMI during the year ended July
31, 2002, in connection with the Company's desire to reduce quantities of
inventory, partially offset by increases of $34.7 million attributable to
increased volumes of LPG sold to PMI and $1.6 million attributable to increased
volumes of LPG sold to customers other than PMI during the year ended July 31,
2002.
Cost of goods sold. Cost of goods sold for the year ended July 31, 2002,
was $131.1 million compared with $151.5 million for the year ended July 31,
2001, a decrease of $20.3 million or 13.4%. Of this decrease, $40.3 million was
attributable to decreases in the cost of LPG sold to PMI during the year ended
July 31, 2002, $11.2 million was attributable to the decreased costs of LPG sold
to customers other than PMI in connection with the Company's desire to reduce
quantities of inventory during the year ended July 31, 2002, partially offset by
increases of $28.6 million attributable to increased volume of LPG sold to PMI
during the year ended July 31, 2002, $1.7 million attributable to increased
volume of LPG sold to customers other than PMI during the year ended July 31,
2002, and $773,797 attributable to net increases in other operating costs
associated with LPG during the year ended July 31, 2002.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $4.3 million for the year ended July 31, 2002,
compared with $3.6 million for the year ended July 31, 2001, an increase of
$729,217 or 20.2%. The increase during the year ended July 31, 2002, was
principally due to legal, consulting fees and compensation related costs.
Other income (expense). Other income (expense) was $(2.5) million for the
year ended July 31, 2002, compared with $(3.7) million for the year ended July
31, 2001, a decrease of $1.2 million. The decrease in other expense was due
primarily to decreased interest costs and amortization of discounts on
outstanding debt during the year ended July 31, 2002.
Income tax. During the year ended July 31, 2002, the Company recorded a
provision for income taxes of $100,000 (which was partially offset by a refund
previously received), representing alternative minimum tax due. Due to the
availability of net operating loss carryforwards (approximately $6.7 million at
July 31, 2002), the Company did not incur any additional income tax expense.
The Company can receive a credit against, any future tax payments due to the
extent of any prior alternative minimum taxes paid.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception
and has a deficit in working capital. In addition, significantly all of the
Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the Extending Noteholders' notes, the $250,000
Note, the RZB Credit Facility and the notes related to the settlement. Unless
RZB authorizes an extension, the RZB Credit Facility will be reduced to $12.0
million after January 31, 2004. The Extending Noteholders' notes and the
$250,000 Note, which total approximately $1.8 million at July 31, 2003 are due
on December 15, 2003 (see Private Placements and Other Transactions below). The
Company may need to increase its credit facility for increases in quantities of
LPG purchased and/or to finance future price increases of LPG. The Company
depends heavily on sales to one major customer. The Company's sources of
liquidity and capital resources historically have been provided by sales of LPG,
proceeds from the issuance of short-term and long-term debt, revolving credit
facilities and credit arrangements, sale or issuance of preferred and common
stock of the Company and proceeds from the exercise of warrants to purchase
shares of the Company's common stock.
26
In additional to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note R in the consolidated financial
statement). As a result of the Spin-Off, the Company's stockholders' equity
will be reduced by the amount of the Spin-Off which may result in a deficit in
stockholders' equity and a portion of the Company's current cash flow from
operations will be shifted to the Partnership. Therefore, the Company's
remaining cash flow may not be sufficient to allow the Company to pay its
federal income tax liability resulting from the Spin-Off, if any, and other
liabilities and obligations when due. The Partnership will be liable as
guarantor on the Company's collateralized debt discussed in the preceding
paragraph and will continue to pledge all of its assets as collateral. In
addition, the Partnership has agreed to indemnify the Company for a period of
three years from the fiscal year end that includes the date of the Spin-Off for
any federal income tax liabilities resulting from the Spin-Off in excess of $2.5
million (see Rio Vista Energy Partners L.P. below).
The following summary table reflects comparative cash flows for fiscal
years ended July 31, 2001, 2002 and 2003. All information is in thousands.
2001 2002 2003
-------- -------------- --------
Net cash provided by operating activities . . . $ 6,196 $ 2,394 $ 4,735
Net cash used in investing activities . . . . . (2,572) ( 717) (167)
Net cash used in financing activities . . . . . (2,327) (2,839) (1,253)
-------- -------------- --------
Net increase (decrease) in cash . . . . . . . . $ 1,297 $ (1,162) $ 3,315
-------- -------------- --------
Less net decrease (increase) in restricted cash (940) 942 (3,375)
-------- -------------- --------
Net increase (decrease) in non-restricted cash. $ 357 $ ( 220) $ ( 60)
======== ============== ========
Sales to PMI. The Company entered into sales agreements with PMI for the
period from April 1, 2000 through March 31, 2001 (the "Old Agreements"), for the
annual sale of a combined minimum of 151.2 million gallons of LPG, mixed to PMI
specifications, subject to seasonal variability, which was delivered to PMI at
the Company's terminal facilities in Matamoros, Tamaulipas, Mexico or
alternative delivery points as prescribed under the Old Agreements.
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7.5 million gallons resulting in a new annual combined
minimum commitment of 158.7 million gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (the "Confirmation") on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of 19.0
million gallons at indexed variable posted prices plus premiums that provide the
Company with annual fixed margins, which increase annually over a three-year
period. The Company was also entitled to receive additional fees for any
volumes which were undelivered. From April 1, 2001 through December 31, 2001,
the Company and PMI operated under the terms provided for in the Confirmation.
During January 1, 2002 through February 28, 2002, PMI purchased monthly volumes
of approximately 17.0 million gallons per month at slightly higher premiums then
those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39.6 million gallons (the "Sold LPG") for which PMI had not taken
delivery. The Company received the posted price plus other fees on the Sold LPG
but did not receive the fixed margin referred to in the Confirmation (see note
B9 to the consolidated financial statements). At July 31, 2001, the obligation
to deliver LPG totaled approximately $11.5 million related to such sales
(approximately 26.6 million gallons). During the period from December 1, 2001
through March 31, 2002, the Company delivered the Sold LPG to PMI and collected
the fixed margin referred to in the Confirmation.
27
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17.0 million gallons of LPG, subject to monthly
adjustments based on seasonality (the "Contract"). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party upon 90
days written notice, or upon a change of circumstances as defined under the
Contract.
In connection with the Contract, the parties also executed a settlement
agreement, whereby the parties released each other in connection with all
disputes between the parties arising during the period April 1, 2001 through
February 28, 2002, and previous claims related to the contract for the period
April 1, 2000 through March 31, 2001.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative terminal
in the event the Matamoros Terminal Facility cannot be used.
Revenues from PMI totaled approximately $132.8 million for the year ended
July 31, 2003, representing approximately 82% of total revenue for the period.
LPG Supply Agreements. Effective October 1, 1999, the Company and Exxon
entered into a ten year LPG supply contract, as amended (the "Exxon Supply
Contract"), whereby Exxon has agreed to supply and the Company has agreed to
take, 100% of Exxon's owned or controlled volume of propane and butane available
at Exxon's King Ranch Gas Plant (the "Plant") up to 13.9 million gallons per
month blended in accordance with required specifications (the "Plant
Commitment"). For the year ending July 31, 2003, under the Exxon Supply
Contract, Exxon has supplied an average of approximately 13.8 million gallons of
LPG per month. The purchase price is indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The
ability to utilize the ECCPL allows the Company to acquire an additional supply
of propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay minimum utilization fees
associated with the use of the ECCPL until September 2004. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso agreed to supply and the Company agreed to take, a
monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999 and expiring on September 30, 2002. The El Paso
Supply Agreement was not renewed. The purchase price was indexed to variable
posted prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. In March 2003 the Company extended
the Koch Supply Contract for an additional year pursuant to the Koch Supply
Contract which provides for automatic annual renewals unless terminated in
writing by either party. For the year ending July 31, 2003, under the Koch
Supply Contract, Koch has supplied an average of approximately 5.8 million
gallons of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, prior to April 2002, the Company paid additional charges
associated with the construction of a new pipeline interconnection which was
paid through additional adjustments to the purchase price (totaling
approximately $1.0 million) which allows deliveries of the Koch Supply into the
ECCPL.
28
During March 2000, the Company and Duke Energy NGL Services, Inc. ("Duke")
entered into a three year supply agreement (the "Duke Supply Contract") whereby
Duke has agreed to supply and the Company has agreed to take, a monthly average
of 1.9 million gallons (the "Duke Supply") of propane or propane/butane mix
beginning April 1, 2000. In March 2003 the Company extended the Duke Supply
Contract for an additional year pursuant to the Duke Supply Contract which
provides for automatic annual renewals unless terminated in writing by either
party. The purchase price is indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
As described above, the Company has entered into supply agreements for
quantities of LPG totaling approximately 24.0 million gallons per month
excluding El Paso (actual deliveries have been approximately 21.3 million
gallons per month during fiscal 2003 excluding El Paso), although the Contract
provides for lesser quantities.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver the LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated with
the storage, disposal and/or changes in LPG prices resulting from the excess of
the Plant Commitment, Koch Supply or Duke Supply over actual sales volumes.
Under the terms of the Supply Contracts, the Company must provide letters of
credit in amounts equal to the cost of the product to be purchased. In
addition, the cost of the product purchased is tied directly to overall market
conditions. As a result, the Company's existing letter of credit facility may
not be adequate to meet the letter of credit requirements under the agreements
with the Suppliers or other suppliers due to increases in quantities of LPG
purchased and/or to finance future price increases of LPG.
Pipeline Lease. The Pipeline Lease currently expires on December 31, 2013,
pursuant to an amendment (the "Pipeline Lease Amendment") entered into between
the Company and Seadrift on May 21, 1997, which became effective on January 1,
1999 (the "Effective Date"). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another pipeline
controlled by Seadrift, thereby providing greater access to and from the Leased
Pipeline. Pursuant to the Pipeline Lease Amendment, the Company's fixed annual
rent for the use of the Leased Pipeline is $1.0 million including monthly
service payments of $8,000 through March 2004. The service payments are subject
to an annual adjustment based on a labor cost index and an electric power cost
index. The Company is also required to pay for a minimum volume of storage of
$300,000 per year (based on reserved storage of 8.4 million gallons) beginning
January 1, 2000. In connection with the Pipeline Lease, the Company may
reserve up to 21.0 million gallons each year thereafter provided that the
Company notifies Seadrift in advance.
The Pipeline Lease Amendment provides for variable rental increases based
on monthly volumes purchased and flowing into the Leased Pipeline and storage
utilized. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million and 360
millions gallons per year.
Upgrades. The Company also intends to contract for the design,
installation and construction of pipelines which will connect the Brownsville
Terminal Facility to the water dock facilities at the Brownsville Ship Channel
and install additional storage capacity. The cost of this project is expected
to approximate $2.0 million. In addition the Company intends to upgrade its
computer and information systems at a total estimated cost of $350,000.
29
Acquisition of Pipeline Interests. On March 30, 2001, the Company
completed a settlement with CPSC and Cowboy, which provided the Company with the
remaining 50% interest in the US-Mexico Pipelines, Matamoros Terminal Facility
and related land, permits or easements (the "Acquired Assets") previously
constructed and/or owned by CPSC and leased to the Company. Until the
settlement was completed (see below), the Company had recorded the remaining 50%
portion of the US-Mexico Pipelines and Matamoros Terminal Facility as a capital
lease. In addition, as part of the settlement, the Company conveyed to CPSC all
of its rights to a certain property (the "Sold Asset"). The foregoing is more
fully discussed below. The terms of the settlement did not deviate in any
material respect from the terms previously reported except that the fair value
of the warrants issued in connection with the settlement (see below) was reduced
from $600,000 to $300,000 as a result of a decrease in the market value of the
Company's common stock.
In connection with the settlement, the Company agreed to pay CPSC $5.8
million (the "Purchase Price") for the Acquired Assets, less agreed upon credits
and offsets in favor of the Company totaling $3.2 million. The remaining $2.6
million was paid at the closing of the settlement by a cash payment of $200,000
to CPSC and the issuance to or for the benefit of CPSC of two promissory notes
in the amounts of $1.5 million (the "CPSC Note") (payable in 36 monthly
installments of approximately $46,000 (reduced to payments of approximately
$42,000 beginning April 2003), including interest at 9% per annum) and $900,000
(the "Other Note") (payable in 36 equal monthly installments of approximately
$29,000 (see note H to consolidated financial statements), including interest at
9% per annum). The Other Note is collateralized by a first priority security
interest in the U.S. portion of the pipelines comprising the Acquired Assets.
The CPSC Note is also collateralized by a security interest in the Acquired
Assets, which security interest is subordinated to the security interest which
secures the Other Note. In addition, the security interest granted under the
CPSC Note is shared on a pari passu basis with certain other creditors of the
Company (see notes H and K to the consolidated financial statements). Under the
terms of the CPSC Note, the Company is entitled to certain offsets related to
future costs which may be incurred by the Company in connection with the
Acquired Assets. In addition to the payments described above, the Company
agreed to assume certain liabilities which were previously owed by CPSC in
connection with construction of the Acquired Assets. CPSC also transferred to
the Company any right that it held to any amounts owing from Termatsal for cash
and/or equipment provided by CPSC to Termatsal, including approximately $2.6
million of cash advanced to Termatsal, in connection with construction of the
Mexican portion of the Acquired Assets.
The Sold Asset transferred to CPSC in connection with the settlement
consisted of real estate of the Company with an original cost to the Company of
$3.8 million and with a remaining book value totaling approximately $1.9 million
(after giving effect to credits provided to the Company included in the
financial terms described above). CPSC agreed to be responsible for payments
required in connection with the Debt related to the original purchase by the
Company of the Sold Asset totaling approximately $1.9 million. Through March
2003, CPSC's obligations under the Debt were paid by the Company through direct
offsets by the Company against the CPSC Note. During April 2003, CPSC paid the
remaining amount due under the Debt. CPSC also granted the Company a pipeline
related easement on the Sold Asset. Until the Debt was fully paid the principal
of $1.9 million plus accrued and unpaid interest was included in long-term debt
and the corresponding amount required to be paid by CPSC was recorded as a
mortgage receivable (see note H to the consolidated financial statements). In
addition to the Purchase Price above, CPSC received from the Company warrants to
purchase 175,000 shares of common stock of the Company at an exercise price of
$4.00 per share exercisable through March 30, 2004, such shares having a fair
value totaling approximately $300,000. This amount has been included as part of
the cost of the Acquired Assets in the accompanying consolidated financial
statements at July 31, 2001.
Until the security interests as described above are perfected, Mr. Richter
is providing a personal guarantee for the punctual payment and performance under
the CPSC Note.
30
Acquisition of Mexican Subsidiaries. Effective April 1, 2001, the Company
completed the purchase of 100% of the outstanding common stock of both Termatsal
and PennMex (the "Mexican Subsidiaries"), previous affiliates of the Company
which were principally owned by a former officer and director (see note D to the
consolidated financial statements). The Company paid a nominal purchase price.
As a result of the acquisition, the Company has included the results of the
Mexican Subsidiaries in its consolidated financial statements at July 31, 2001,
2002 and 2003. Since inception, the operations of the Mexican Subsidiaries had
been funded by the Company and such amounts funded were included in the
Company's consolidated financial statements prior to the acquisition date.
Therefore there were no material differences between the amounts previously
reported by the Company and the amounts that would have been reported by the
Company had the Mexican Subsidiaries been consolidated since inception.
During July 2003, the Company acquired an option to purchase Tergas for a
nominal price from an officer and consultant of the Company (see note D to the
consolidated financial statements).
Mexican Operations. Under current Mexican law, foreign ownership of Mexican
entities involved in the distribution of LPG or the operation of LPG terminal
facilities is prohibited. Foreign ownership is permitted in the transportation
and storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation permit
and the Mexican Subsidiaries own, lease, or are in the process of obtaining the
land or rights of way used in the construction of the Mexican portion of the
US-Mexico Pipelines, and own the Mexican portion of the assets comprising the
US-Mexico Pipelines, the Matamoros Terminal Facility and the Saltillo Terminal.
The Company's Mexican affiliate, Tergas, S.A. de C.V. ("Tergas"), has been
granted the permit to operate the Matamoros Terminal Facility and the Company
relies on Tergas' permit to continue its delivery of LPG at the Matamoros
Terminal Facility. Tergas is owned 95% by an officer of the Company and the
remaining balance is owned by a consultant of the Company (see above). The
Company pays Tergas its actual cost for distribution services at the Matamoros
Terminal Facility plus a small profit.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal"). The Company
was unable to receive all the necessary approvals to operate the facility at
that location. The Company has identified an alternate site in Hipolito,
Mexico, a town located in the proximity of Saltillo to relocate the Saltillo
Terminal. The relocation of the Saltillo terminal is very important to the
Company's growth strategy in Mexico. The expense of such relocation is
estimated to be $500,000.
Once completed, the Company expects the newly-constructed terminal facility
to be capable of off-loading LPG from railcars to trucks. The newly-constructed
terminal facility will have three truck loading racks and storage to accommodate
approximately 390,000 gallons of LPG.
Once operational, the Company can directly transport LPG via railcar from
the Brownsville Terminal Facility to the Saltillo area. The Company believes
that by having the capability to deliver LPG to the Saltillo area, the Company
will be able to further penetrate the Mexican market for the sale of LPG.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, the Company is subject to the tax laws of Mexico which,
among other things, require that the Company comply with transfer pricing rules,
the payment of income, asset and ad valorem taxes, and possibly taxes on
distributions in excess of earnings. In addition, distributions to foreign
corporations, including dividends and interest payments may be subject to
Mexican withholding taxes.
31
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law
for LPG was changed to permit foreign entities to participate without limitation
in the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its affiliates expect to sell LPG directly to
independent Mexican distributors as well as PMI upon Deregulation. The Company
anticipates that the independent Mexican distributors will be required to obtain
authorization from the Mexican government for the importation of LPG upon
Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
In connection with the above, in August 2001, Tergas received a one year
permit from the Mexican government to import LPG. During September 2001, the
Mexican government asked Tergas to defer use of the permit and as a result, the
Company did not sell LPG to distributors other than PMI. In March 2002, the
Mexican government again announced its intention to issue permits for free
importation of LPG into Mexico by distributors and others beginning August 2002,
which was again delayed until February 2003. Tergas' permit to import LPG
expired during August 2002. Tergas intends to obtain a new permit when the
Mexican government begins to accept applications once more. As a result of the
foregoing, it is uncertain as to when, if ever, Deregulation will actually occur
and the effect, if any, it will have on the Company. However, should
Deregulation occur, it is the Company's intention to sell LPG directly to
distributors in Mexico as well as PMI. Tergas previously received authorization
from Mexican Customs authorities regarding the use of the US-Mexico Pipelines
for the importation of LPG.
The point of sale for LPG which flows through the US-Mexico Pipelines for
delivery to the Matamoros Terminal Facility is the United States-Mexico border.
For LPG delivered into Mexico, PMI is the importer of record.
Credit Arrangements. As of July 31, 2003, the Company has a $15.0 million
credit facility with RZB Finance L.L.C. ("RZB") through January 31, 2004 for
demand loans and standby letters of credit (the "RZB Credit Facility") to
finance the Company's purchases of LPG. Under the RZB Credit Facility, the
Company pays a fee with respect to each letter of credit thereunder in an amount
equal to the greater of (i) $500, (ii) 2.5% of the maximum face amount of such
letter of credit, or (iii) such higher amount as may be agreed to between the
Company and RZB. Any loan amounts outstanding under the RZB Credit Facility
shall accrue interest at a rate equal to the rate announced by the JPMorgan
Chase Bank as its prime rate plus 2.5%. Pursuant to the RZB Credit Facility,
RZB has sole and absolute discretion to limit or terminate their participation
in the RZB Credit Facility and to make any loan or issue any letter of credit
thereunder. RZB also has the right to demand payment of any and all amounts
outstanding under the RZB Credit Facility at any time. In connection with the
RZB Credit Facility, the Company granted a security interest and assignment in
any and all of the Company's accounts, inventory, real property, buildings,
pipelines, fixtures and interests therein or relating thereto, including,
without limitation, the lease with the Brownsville Navigation District of
Cameron County for the land on which the Company's Brownsville Terminal Facility
is located, the Pipeline Lease, and in connection therewith agreed to enter into
leasehold deeds of trust, security agreements, financing statements and
assignments of rent, in forms satisfactory to RZB. Under the RZB Credit
Facility, the Company may not permit to exist any subsequent lien, security
interest, mortgage, charge or other encumbrance of any nature on any of its
32
properties or assets, except in favor of RZB, without the consent of RZB (see
notes H and L to the consolidated financial statements).
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, Duke and/or
Koch, letters of credit are issued on a monthly basis based on anticipated
purchases.
In connection with the Company's purchase of LPG, under the RZB Credit
Facility, assets related to product sales (the "Assets") are required to be in
excess of borrowings and commitments (including restricted cash of $3.4 million
at July 31, 2003). At July 31, 2003, the Company's borrowings and commitments
were less than the amount of the Assets. Outstanding letters of credit at July
31, 2003 totaled approximately $7.2 million.
Under the terms of the RZB Credit Facility, the Company is required to
maintain net worth of a minimum of $9.0 million and is not allowed to make cash
dividends to shareholders without the consent of RZB. The $15.0 million is
effective until January 31, 2004 when it will be automatically reduced to $12.0
million.
Interest costs associated with the RZB Credit Facility totaled $839,130,
$452,164, and $732,718 for the years ended July 31, 2001, 2002 and 2003.
Private Placements and Other Transactions. From December 10, 1999 through
January 18, 2000, and on February 2, 2000, the Company completed a series of
related transactions in connection with the private placement of $4.9 million
and $710,000, respectively, of subordinated notes (the "Notes") which were due
the earlier of December 15, 2000, or upon the receipt of proceeds by the Company
from any future debt or equity financing in excess of $2.3 million (see below).
Interest at 9% was due and paid on June 15, 2000 and December 15, 2000. In
connection with the Notes, the Company granted the holders of the Notes,
warrants (the "Warrants") to purchase a total of 706,763 shares of common stock
of the Company at an exercise price of $4.00 per share, exercisable through
December 15, 2002.
During December 2000, the Company also entered into agreements (the
"Restructuring Agreements") with the holders of $5.4 million in principal amount
of the Notes providing for the restructuring of such remaining Notes (the
"Restructuring"). The remaining $245,000 balance of the Notes was paid.
Under the terms of the Restructuring Agreements, the due dates for the
restructured Notes (the "Restructured Notes") were extended to December 15,
2001, subject to earlier repayment upon the occurrence of certain specified
events provided for in the Restructured Notes. Additionally, beginning December
16, 2000, the annual interest rate on the Restructured Notes was increased to
13.5% (subject to the adjustments referred to below). Interest payments were
paid quarterly beginning March 15, 2001.
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares of
common stock of the Company at an exercise price of $3.00 per share and
exercisable until December 15, 2003 (the "New Warrants"). The Company also
agreed to modify the exercise prices of the Warrants to purchase up to 676,137
shares of common stock of the Company previously issued to the holders of the
Restructured Notes in connection with their original issuance from $4.00 per
share to $3.00 per share and extend the exercise dates of the Warrants from
December 15, 2002 to December 15, 2003. In addition, the Company was required
to reduce the exercise price of the Warrants and the New Warrants issued to the
holders of the Restructured Notes from $3.00 per share to $2.50 per share
because the Restructured Notes were not fully repaid by June 15, 2001.
33
In connection with the Restructuring Agreements, the Company agreed to
register the shares of common stock which may be acquired in connection with the
exercise of the New Warrants (the "Exercisable Shares") by March 31, 2001. In
connection with the Company's obligations under the Restructured Notes, the
Company's registration statement containing the Exercisable Shares was declared
effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral to
secure the Company's payment obligations under the Restructured Notes consisting
of a senior interest in substantially all of the Company's assets which are
located in the United States (the "US Assets") and Mexico (the "Mexican
Assets"), excluding inventory, accounts receivable and sales contracts with
respect to which the Company is required to grant a subordinated security
interest (collectively referred to as the "Collateral"). Mr. Richter has also
pledged 2.0 million shares of common stock of the Company owned by Mr. Richter
(1.0 million shares to be released when the required security interests in the
US Assets have been granted and perfected and all of the shares are to be
released when the required security interests in all of the Collateral have been
granted and perfected). The granting and perfection of the security interests in
the Collateral, as prescribed under the Restructured Notes, have not been
finalized. Accordingly, the interest rate under the Restructured Notes increased
to 16.5% on March 16, 2001. The release of the first 1.0 million shares will be
transferred to the Company as collateral for Mr. Richter's Promissory Note. The
Collateral is also being pledged in connection with the issuance of other
indebtedness by the Company (see note L to the consolidated financial
statements). Investec PMG Capital, formerly PMG Capital Corp., ("Investec") has
agreed to serve as the collateral agent.
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (the "New Notes") due December 15, 2001.
The holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of the Company (the "New Note Warrants"). The terms of the New
Notes and New Note Warrants are substantially the same as those contained in the
Restructured Notes and New Warrants issued in connection with the Restructuring
described above. As described above, the Company's payment obligations under
the New Notes are to be secured by the Collateral and the 2.0 million shares of
the Company which are owned by Mr. Richter.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of the Company were exercised by certain holders of the New
Warrants and New Note Warrants for which the exercise price totaling $614,833
was paid by reduction of the outstanding debt and accrued interest related to
the New Notes and the Restructured Notes.
During September 2001, the Company issued 37,500 shares of common stock of
the Company to a consultant in payment for services rendered to the Company
valued at $150,000.
During September 2001, the Company issued 1,000 shares of common stock of
the Company to an employee of the Company as a bonus. In connection with the
issuance of the shares, the Company recorded an expense of $2,800 based on the
market value of the stock issued.
During November 2001, warrants to purchase a total of 78,750 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $137,813.
During November 2001, in connection with notes, in the aggregate amount of
$1,042,603 issued to the Company by certain officers, directors and a related
party (the "Note Issuers"), the Company and the Note Issuers agreed to exchange
36,717 shares of common stock of the Company owned by the Note Issuers, and
which shares were being held by the Company as collateral for the notes, for
payment of all unpaid interest owing to the Company through October 31, 2001
($146,869). In addition, the Company agreed to extend the date of the notes
issued by the Note Issuers to October 31, 2003. The accrued interest has been
reserved in total by the Company. Therefore, the Company has accounted for the
receipt of the shares as a reduction of the principal amount due on the notes at
the quoted price of the shares at the date of the agreement.
34
During December 2001, the Company and certain holders of the Restructured
Notes and the New Notes (the "Accepting Noteholders") reached an agreement
whereby the due date for $3.1 million of principal due on the Accepting
Noteholders' notes was extended to June 15, 2002. In connection with the
extension, the Company agreed to (i) continue paying interest at a rate of 16.5%
annually on the Accepting Noteholders' notes, payable quarterly, (ii) pay the
Accepting Noteholders a fee equal to 1% on the principal amount of the Accepting
Noteholders' notes, (iii) modify the warrants held by the Accepting Noteholders
by extending the expiration date to December 14, 2004 and (iv) remove the
Company's repurchase rights with regard to the warrants.
In January 2002, the Company loaned Mr. Richter, the Company's Chief
Executive Officer, Chairman of the Board and former President, $200,000 due in
one year. The Company also had other advances to Mr. Richter of approximately
$82,000 as of July 31, 2002, which were offset per the employment agreement
against accrued and unpaid bonuses due to Mr. Richter. The note due from Mr.
Richter in the amount of $200,000 plus accrued interest as of January 31, 2003,
was paid through an offset against previously accrued bonus and profit sharing
amounts due to Mr. Richter in January 2003.
During June 2002, the Company and certain holders of the Restructured Notes
and the New Notes (the "New Accepting Noteholders") reached an agreement whereby
the due date for approximately $3.0 million of principal due on the New
Accepting Noteholders' notes were extended to December 15, 2002. The New
Accepting Noteholders' notes will continue to bear interest at 16.5% per annum.
Interest is payable on the outstanding balances on specified dates through
December 15, 2002. The Company paid a fee of 1.5% on the principal amount of
the New Accepting Noteholders' notes on July 1, 2002. The principal amount and
unpaid interest of the Restructured Notes and/or New Notes which were not
extended were paid on June 15, 2002.
During June 2002 the Company issued a note for $100,000 to a holder of the
Restructured Notes and the New Notes. The $100,000 note provides for similar
terms and conditions as the New Accepting Noteholders' notes.
During June 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised resulting in cash proceeds to the Company of $62,500.
During July 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised resulting in cash proceeds to the Company of $62,500.
During October 2002, the Company agreed to accept the assets,
collateralizing the $214,355 note (see note D to the consolidated financial
statements), having a fair value of approximately $800,000 owned by Mr. Ian
Bothwell, an executive officer and a director of the Company, (the "Officer") as
full satisfaction of the Officer's stock note ($498,000) and promissory note
($214,355) owed to the Company (see note D to the consolidated financial
statements).
During December 2002, the Company and certain holders of New Accepting
Noteholders' notes and holder of the Additional Note (the "Extending
Noteholders") reached an agreement whereby the due date for $2.7 million of
principal due on the Extending Noteholders' notes were extended to December 15,
2003. Under the terms of the agreement, the Extending Noteholders' notes will
continue to bear interest at 16.5% per annum. Interest is payable quarterly on
the outstanding balances beginning on March 15, 2003 (the December 15, 2002
interest was paid on January 1, 2003). In addition, the Company is required to
pay principal in equal monthly installments beginning March 2003 (approximately
$1.2 million of principal was paid through the period ended April 30, 2003 of
which $1.0 million was reduced in connection with the exercise of warrants and
purchase of common stock - see below). The Company may prepay the Extending
Noteholders' notes at any time. The Company is also required to pay a fee of
1.5% on the principal amount of the Extending Noteholders' notes which are
outstanding on December 15, 2002, March 15, 2003, June 15, 2003 and September
15, 2003. The Company also agreed to extend the expiration date on the warrants
held by the Extending Noteholders in connection with the issuance of the
Extending Noteholders' notes to December 15, 2006. In connection with the
extension of the warrants, the Company recorded a discount of $316,665 related
to the additional value of the modified warrants of which $240,043 has been
amortized for the year ended July 31, 2003.
During December 2002, the Company issued a note for $250,000 (the "$250,000
Note") to a holder of the Extending Noteholders' notes. The note provides for
similar terms and conditions as the Extending Noteholders' notes.
35
During March 2003, warrants to purchase 250,000 shares of common stock of
the Company were exercised by a holder of the Warrants and New Warrants for
which the exercise price totaling $625,000 was paid by reduction of a portion of
the outstanding debt and accrued interest owed to the holder related to the
Extending Noteholders' Notes. In addition, during March 2003, the holder
acquired 161,392 shares of common stock of the Company at a price of $2.50 per
share. The purchase price was paid through the cancellation of the remaining
outstanding debt and accrued interest owed to the holder totaling $403,480. In
connection with this transaction the Company recorded additional interest
expense of approximately $68,000 representing the difference between the market
value and sales price on the day of the transaction.
During July 2003, Mr. Bracamontes resigned from his position as a director
and officer of the Company. In connection with his resignation the Company
agreed to (i) forgive the remaining balance of his $498,000 promissory note,
(ii) forgive the remaining balance of his affiliate's $46,603 promissory note,
(iii) issue 21,818 shares of the Company's common stock (valued at approximately
$75,000) and (iv) agreed to make certain payments of up to $500,000 based on the
success of future projects (the Company's Chief Executive Officer agreed to
guarantee these payments with 100,000 of his shares of the common stock of the
Company). Mr. Bracamontes will continue to provide services and the Company will
continue to make payments to Mr. Bracamontes of $15,000 a month until March 31,
2004. All of the above amounts totaling approximately $520,000 have been
reflected in the consolidated financial statements as of July 31, 2003 as
salaries and payroll related expenses. Simultaneously, Mr. Bracamontes sold his
interest in Tergas, S.A. de C.V. (an affiliate of the Company) to another
officer of the Company. The Company has an option to acquire Tergas, S.A. de
C.V. ("Tergas") for a nominal price.
During September 2003, warrants to purchase 32,250 shares of common stock
of the Company were exercised resulting in cash proceeds to the Company of
$80,625.
During September 2003, the Company issued 21,818 shares of common stock of
the Company to Mr. Bracamontes as severance compensation (see above). In
connection with the issuance of the shares, the Company recorded an expense of
approximately $75,000 based on the market value of the stock issued.
In connection with warrants previously issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right to
purchase the warrants for a nominal price if the holder of the warrants does not
elect to exercise the warrants during the call provision period.
Settlement of Litigation. On March 16, 1999, the Company settled a lawsuit
in mediation with its former chairman of the board, Jorge V. Duran. The total
settlement costs recorded by the Company at July 31, 1999, was $456,300. The
parties had agreed to extend the date on which the payments were required in
connection with the settlement including the issuance of the common stock. On
July 26, 2000, the parties executed final settlement agreements whereby the
Company paid the required cash payment of $150,000. During September 2000, the
Company issued the required stock.
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,00 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation ("WIN") settled
litigation whereby the Company issued WIN 12,500 shares of common stock of the
Company. The value of the stock, totaling approximately $82,000 at the time of
settlement, was recorded in the Company's consolidated financial statements at
July 31, 2000.
36
On July 10, 2001, litigation was filed in the 164th Judicial District Court
of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel & Jackson L.L.P.
against the Company alleging breach of contract, common law fraud and statutory
fraud in connection with the settlement agreement between the parties dated July
26, 2000 (see above). Plaintiffs were seeking actual and punitive damages.
During July 2003 the lawsuit was settled whereby the Company agreed to pay the
plaintiffs $45,000.
On August 7, 2001, a Mexican company, Intertek Testing Services de Mexico,
S.A. de C.V. (the "Plaintiff"), which contracts with PMI for LPG testing
services required to be performed under the Contract, filed suit in the Superior
Court of California, County of San Mateo against the Company alleging breach of
contract. During April 2003 the case proceeded to a jury trial. The Plaintiff
demanded from the judge and jury approximately $850,000 in damages and interest.
During May 2003, the jury found substantially in favor of the Company and
awarded damages to Intertek of only approximately $228,000 said sum was recorded
as a judgment on June 5, 2003 and during August 2003 the Court awarded the
Plaintiff interest and costs totaling approximately $50,000. In connection with
the judgment, and the additional interest and costs, the Company recorded an
additional expense of approximately $106,000 as of July 31, 2003 representing
the additional expense over amounts previously accrued.
On October 11, 2001, litigation was filed in the 197th Judicial District
Court of Cameron County, Texas by the Company against Tanner Pipeline Services,
Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging negligence and aided breaches
of fiduciary duties on behalf of CPSC in connection with the construction of the
US Pipelines. During September 2003, the Company entered into a settlement
agreement with Tanner whereby Tanner was required to reimburse the Company for
$50,000 to be paid through the reduction of the final payments on Tanner's note
(see note H to the consolidated financial statements).
Litigation. On March 2, 2000, litigation was filed in the Superior Court
of California, County of San Bernardino by Omnitrans against Penn Octane
Corporation, Penn Wilson and several other third parties alleging breach of
contract, fraud and other causes of action related to the construction of a
refueling station by a third party. Penn Octane Corporation and Penn Wilson
have both recently been dismissed from the litigation pursuant to a summary
judgment. Omnitrans appealed the summary judgments in favor of the Company and
Penn Wilson. During August 2003, the Appellate Court issued a preliminary
decision denying Omnitran's appeal of the summary judgment in favor of the
Company and Penn Wilson. Oral argument on Omnitran's appeal is set for November
2003.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including those
discussed above, should not materially affect its consolidated financial
statements.
Realization of Assets. The accompanying consolidated financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America, which contemplate continuation of the Company
as a going concern. The Company has had an accumulated deficit since inception
and has a deficit in working capital. In addition, significantly all of the
Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the Extending Noteholders' notes, the $250,000
Note, the RZB Credit Facility and the notes related to the settlement. Unless
RZB authorizes an extension, the RZB Credit Facility will be reduced to $12.0
million after January 31, 2004. The Extending Noteholders' notes and the
$250,000 Note, which total approximately $1.8 million at July 31, 2003 are due
on December 15, 2003 (see note H to the consolidated financial statements).
37
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note R to the consolidated financial
statements). As a result of the Spin-Off, the Company's stockholders' equity
will be reduced by the amount of the Spin-Off which may result in a deficit in
stockholders' equity and a portion of the Company's current cash flow from
operations will be shifted to the Partnership. Therefore, the Company's
remaining cash flow may not be sufficient to allow the Company to pay its
federal income tax liability resulting from the Spin-Off, if any, and other
liabilities and obligations when due. The Partnership will be liable as
guarantor on the Company's collateralized debt discussed in the preceding
paragraph and will continue to pledge all of its assets as collateral. In
addition, the Partnership has agreed to indemnify the Company for a period of
three years from the fiscal year end that includes the date of the Spin-Off for
any federal income tax liabilities resulting from the Spin-Off in excess of $2.5
million.
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon the ability of the Company to (1)
restructure certain of the obligations discussed in the first paragraph and/or
generate sufficient cash flow through operations or additional debt or equity
financing to pay its liabilities and obligations when due, or (2) the ability of
the Partnership to meet its obligations related to its guarantees and tax
agreement in the event the Spin-Off occurs if the Company does not accomplish
the restructuring or generate sufficient cash flow. The consolidated financial
statements do not include any adjustments related to the recoverability and
classification of recorded asset amounts or amounts and classification of
liabilities that might be necessary should the Company be unable to continue in
existence.
To provide the Company with the ability it believes necessary to continue
in existence, management is negotiating with PMI to extend the contract (see
note Q) and increase the minimum monthly sales volume. In addition, management
is taking steps to (i) obtain additional sale contracts commensurate with supply
agreements (ii) increase the number of customers assuming deregulation of the
LPG industry in Mexico, (iii) raise additional debt and/or equity capital, (iv)
increase and extend the RZB Credit Facility and (v) restructure certain of its
liabilities and obligations.
At July 31, 2003, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $5.3 million. If the net operating
loss carryforwards are utilized in the future, the Company will begin to pay
federal income tax at the corporate income tax rate.
Rio Vista Energy Partners L.P. On July 10, 2003, the Company formed Rio
Vista Energy Partners L.P. (the "Partnership"), a Delaware partnership. The
Partnership is a wholly owned subsidiary of the Company. The Partnership has
invested in two subsidiaries, Rio Vista Operating Partnership L.P. (.1% owned by
the Partnership and 99.9% owned by the Company) and Rio Vista Operating GP LLC
(wholly owned by the Partnership). The above subsidiaries are newly formed and
are currently inactive.
The Company formed the Partnership for the purpose of transferring a 99.9%
interest in Rio Vista Operating Partnership L.P., which will own substantially
all of the Company's owned pipeline and terminal assets in Brownsville and
Matamoros, (the "Asset Transfer") in exchange for a 2% general partner interest
and a 98% limited partnership interest in the Partnership. The Company intends
to spin off 100% of the limited partner units to its common stockholders (the
"Spin-Off"), resulting in the Partnership becoming an independent public
company. The remaining 2% general partner interest will be initially owned and
controlled by the Company and the Company will be responsible for the management
of the Partnership. The Company will account for the Spin-Off at historical
cost.
During September 2003, the Company's Board of Directors and the Independent
Committee of its Board of Directors formally approved the terms of the Spin-Off
and the Partnership filed a Form 10 registration statement with the Securities
and Exchange Commission. The Board of Directors anticipates that the Spin-Off
will occur in late 2003 or in 2004, subject to a number of conditions, including
the receipt of an independent appraisal of the assets to be transferred by the
Company to the Partnership in connection with the Spin-Off that supports an
acceptable level of federal income taxes to the Company as a result of the
Spin-Off; the absence of any contractual and regulatory restraints or
prohibitions preventing the consummation of the Spin-Off; and final action by
the Board of Directors to set the record date and distribution date for the
Spin-Off and the effectiveness of the registration statement.
38
Each shareholder of the Company will receive one common unit of the limited
partnership interest in the Partnership for every eight shares of the Company's
common stock owned as of the record date.
Warrants issued to holders of the existing unexercised warrants of the
Company will be exchanged in connection with the Spin-Off whereby the holder
will receive options to acquire unissued units in the Partnership and unissued
common shares of the Company in exchange for the existing warrants. The number
of units and shares subject to exercise and the exercise price will be set to
equalize each option's value before and after the Spin-Off.
Ninety-eight percent of the cash distributions from the Partnership will be
distributed to the limited unit holders and the remaining 2% will be distributed
to the general partner for distributions up to $1.25 per unit annually
(approximately $2.5 million per year). Distributions in excess of that amount
will be shared by the limited unit holders and the general partner based on a
formula whereby the general partner will receive disproportionately more
distributions per unit than the limited unit holders as annual cash
distributions exceed certain milestones.
Subsequent to the Asset Transfer, the Partnership will sell LPG directly to
PMI and will purchase LPG from the Company under a long-term supply agreement.
The purchase price of the LPG from the Company will be determined based on the
Company's cost to acquire LPG and a formula that takes into consideration
operating costs of both the Company and the Partnership.
In connection with the Spin-Off, the Company will grant to Mr. Richter and
Shore Capital LLC ("Shore"), a company owned by Mr. Shore, options to each
purchase 25% of the ownership interests in the Company's general partner
interest in the Partnership. It is anticipated that Mr. Richter and Shore will
exercise these options immediately after the Spin-Off occurs. The exercise
price for each option will be the pro rata share (.5%) of the Partnership's tax
basis capital immediately after the Spin-Off. The Company will retain voting
control of the Partnership pursuant to a voting agreement. In addition, Shore
will also receive an option to acquire 5% of the common stock of the Company and
5% of the limited partnership interest in the Partnership at a combined
equivalent exercise price of $2.20 per share.
The Partnership will be liable as guarantor for the Company's
collateralized debt (see note P to the consolidated financial statements) and
will continue to pledge all of its assets as collateral. The Partnership may
also be prohibited from making any distributions to unit holders if it would
cause an event of default, or if an event of default is existing, under the
Company's revolving credit facilities, or any other covenant which may exist
under any other credit arrangement or other regulatory requirement at the time.
The Spin-Off will be a taxable transaction for federal income tax purposes
(and may also be taxable under applicable state, local and foreign tax laws) to
both the Company and its stockholders. The Company intends to treat the
Spin-Off as a "partial liquidation" for federal income tax purposes. A "partial
liquidation" is defined under Section 302(e) of the Code as a distribution that
(i) is "not essentially equivalent to a dividend," as determined at the
corporate level, which generally requires a genuine contraction of the business
of the corporation, (ii) constitutes a redemption of stock and (iii) is made
pursuant to a plan of partial liquidation and within the taxable year in which
the plan is adopted or within the succeeding taxable year.
The Company may have a federal income tax liability in connection with the
Spin-Off. If the income tax liability resulting from the Spin-Off is greater
than $2.5 million, the Partnership has agreed to indemnify the Company for any
tax liability resulting from the transaction which is in excess of that amount.
39
The Company believes that the Spin-Off, which effectively separates the
Partnership, as a limited partnership, from the Company will provide greater
growth opportunities for each company and the following overall benefits to the
Company's shareholders:
- Tax Efficiency. As a limited partnership, the Partnership will be able
to operate in a more tax efficient manner by eliminating corporate
federal income taxes on a portion of future taxable income which would
have been fully subject to corporate federal income taxes.
- Raising Capital. As a limited partnership, the Company believes that
the Partnership will have an improved ability to raise capital for
expansion. This expansion will benefit the Company directly though
anticipated contractual arrangements between the parties and
indirectly, through the Company's general partner interest.
- Acquisitions. Due to industry preference and familiarity with the
limited partnership structure, the Company anticipates that the
Company will improve its competitiveness in making acquisitions of
assets that generate "qualifying income," as this term is defined in
Section 7704 of the Internal Revenue Code.
- Recognition. As a limited partnership, the Company anticipates that
both the Company and the Partnership will receive increased analyst
coverage and acceptance in the marketplace.
Liquidity:
---------
The Partnership expects that once the period for minimum distributions
commences it will distribute to the holders of common units on a quarterly basis
at least the minimum quarterly distribution of $0.25 per common unit, or $1.00
per year, to the extent that the Partnership has sufficient cash from operations
after establishment of cash reserves and payment of expenses, including the
reimbursement of our general partner fees and the guarantees and tax agreement
discussed below. The Company intends to restructure certain of its liabilities
and obligations to the extent possible, but there can be no assurance that such
restructuring can be accomplished or that it will be adequate to allow the
Company to pay such liabilities and obligations when due.
A portion of the Company's current cash flow from operations will be
shifted to the Partnership as a result of Spin-Off. As a result, the Company's
remaining cash flow from operations may not be sufficient to allow the Company
to pay its federal income tax liability resulting from the Spin-Off, if any, and
other liabilities and obligations when due. The Partnership will be liable as
guarantor and will continue to pledge all of its assets as collateral on the
Company's existing debt obligations. In addition, the Partnership has agreed to
indemnify the Company for a period of three years from the fiscal year end that
includes the date of the Spin-Off for any federal income tax liabilities
resulting from the Spin-Off in excess of $2.5 million. However as a result of
the distributions, the Partnership may not have sufficient cash flow to pay any
obligations related to its guarantees and tax agreement.
If the Company's cash flow from operations is not adequate to satisfy such
payment of liabilities and obligations and/or tax liabilities when due and the
Partnership is unable to satisfy its guarantees and /or tax agreement, the
Company may be required to pursue additional debt and/or equity financing. In
such event, the Company's management does not believe that the Company would be
able to obtain such financing from traditional commercial lenders. In addition,
there can be no assurance that such additional financing will be available on
terms attractive to the Company or at all. If additional financing is available
through the sale of the Company's equity and/or other securities convertible
into equity securities through public or private financings, substantial and
immediate dilution to existing stockholders may occur. There is no assurance
that the Company would be able to raise any additional capital if needed. If
additional financing can not be accomplished and the Company is unable to pay
its liabilities and obligations when due or to restructure certain of its
liabilities and obligations, the Company may suffer material adverse
consequences to its business, financial condition and results of operations.
40
Contractual Obligations and Commercial Commitments. The following is a
summary of the Company's estimated minimum contractual obligations and
commercial obligations as of July 31, 2003. Where applicable LPG prices are
based on the July 2003 monthly average as published by Oil Price Information
Services.
PAYMENTS DUE BY PERIOD
(AMOUNTS IN MILLIONS)
---------------------------------------------------
Less than 1 - 3 4 - 5 After
Contractual Obligations Total 1 Year Years Years 5 Years
- ---------------------------------- -------- ---------- -------- --------- --------
Long-Term Debt Obligations $ - $ - $ - $ - $ -
Operating Leases 12.8 1.4 2.8 2.6 6.0
LPG Purchase Obligations 540.9 117.4 163.9 163.9 95.7
Other Long-Term Obligations .1 - .1 - -
-------- ---------- -------- --------- --------
Total Contractual Cash Obligations $ 553.8 $ 118.8 $ 166.8 $ 166.5 $ 101.7
======== ========== ======== ========= ========
AMOUNT OF COMMITMENT EXPIRATION
PER PERIOD
(AMOUNTS IN MILLIONS)
----------------------------------------------------
Commercial Total Amounts Less than 1 - 3 4 - 5 Over
Commitments Committed 1 Year Years Years 5 Years
- ------------------------------ -------------- ---------- ------ ------ --------
Lines of Credit $ - $ - $ - $ - $ -
Standby Letters of Credit 7.2 7.2 - - -
Guarantees N/A N/A N/A N/A N/A
Standby Repurchase Obligations N/A N/A N/A N/A N/A
Other Commercial Commitments N/A N/A N/A N/A N/A
-------------- ---------- ------ ------ --------
Total Commercial Commitments $ 7.2 $ 7.2 $ - $ - $ -
============== ========== ====== ====== ========
41
FINANCIAL ACCOUNTING STANDARDS
In August 2001 Statement of Financial Accounting Standards ("SFAS") No. 144
("SFAS 144") "Accounting for the Impairment or Disposal of Long-Lived Assets"
was issued. SFAS 144 supersedes the provisions of Statement of Financial
Accounting Standards No. 121 ("SFAS 121") "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to be Disposed Of". SFAS 144
requires the Company to review long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If it is
determined that an impairment has occurred, the amount of the impairment is
charged to operations. No impairments were recognized for the years ended July
31, 2001, 2002 and 2003.
The Company has adopted Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
which requires that all derivative financial instruments be recognized in the
financial statements and measured at fair value regardless of the purpose or
intent for holding them. Changes in the fair value of derivative financial
instruments are either recognized periodically in income or stockholders' equity
(as a component of comprehensive income), depending on whether the derivative is
being used to hedge changes in fair value or cash flows. At July 31, 2001, 2002
and 2003 the Company had no derivative financial instruments.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation - Transition and Disclosure", an amendment of FASB Statement No.
123. This statement provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. Additionally, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123, "Accounting for Stock-based Compensation", to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The transition guidance and annual disclosure
provisions are effective for financial statements issued for fiscal years ending
after December 15, 2002. The interim disclosure provisions are effective for
financial reports containing financial statements for interim periods beginning
after December 15, 2002. The Company adopted the interim disclosure provisions
of SFAS No. 148 during the third quarter of fiscal 2003.
42
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
To the extent that the Company maintains quantities of LPG inventory in
excess of commitments for quantities of undelivered LPG and/or has commitments
for undelivered LPG in excess of inventory balances, the Company is exposed to
market risk related to the volatility of LPG prices. In the event that
inventory balances exceed commitments for undelivered LPG, during periods of
falling LPG prices, the Company may sell excess inventory to customers to reduce
the risk of these price fluctuations. In the event that commitments for
undelivered LPG exceed inventory balances, the Company may purchase contracts
which protect the Company against future price increases of LPG.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Certified Public Accountants
--------------------------------------------------
To the Board of Directors
Penn Octane Corporation
We have audited the accompanying consolidated balance sheets of Penn Octane
Corporation and its subsidiaries (Company) as of July 31, 2002 and 2003, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended July 31, 2003. These
financial statements 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of July 31, 2002 and 2003, and the consolidated results of their
operations and their consolidated cash flows for each of the three years in the
period ended July 31, 2003 in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II of the Company for each of the three years in
the period ended July 31, 2003. In our opinion, this schedule presents fairly,
in all material respects, the information required to be set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note P to
the consolidated financial statements, conditions exist which raise substantial
doubt about the Company's ability to continue as a going concern including 1)
the Company has a deficit in working capital and 2) significantly all of the
Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the Extending Noteholders' notes and the
$250,000 Note, the RZB Credit Facility and the notes related to the Settlement.
In addition, if the Spin-Off discussed in note R occurs, the Company's
stockholders' equity will be reduced by the amount of the Spin-Off which may
result in a deficit in stockholders' equity and the Company's ability to obtain
cash from operations or additional debt or equity financing may be limited.
Management's plans in regard to these matters are also described in note P. The
consolidated financial statements do not include any adjustments related to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
/s/ BURTON McCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
September 19, 2003
44
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31
ASSETS
2002 2003
----------- -----------
Current Assets
Cash (including restricted cash of $29,701 and $3,404,782 at 2002 and
2003) $ 160,655 $ 3,475,846
Trade accounts receivable (less allowance for doubtful accounts of
$5,783 at 2002 and 2003) 7,653,986 4,143,458
Notes receivable - related parties 214,356 -
Inventories 938,672 878,082
Assets held for sale - 720,000
Mortgage receivable 1,935,723 -
Prepaid expenses and other current assets 254,654 476,109
----------- -----------
Total current assets 11,158,046 9,693,495
Property, plant and equipment - net 18,350,785 17,677,830
Lease rights (net of accumulated amortization of $661,740 and $707,535 at
2002 and 2003) 492,299 446,504
Other non-current assets 154,209 19,913
----------- -----------
Total assets $30,155,339 $27,837,742
=========== ===========
The accompanying notes are an integral part of these statements.
45
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
JULY 31
LIABILITIES AND STOCKHOLDERS' EQUITY
2002 2003
------------- -------------
Current Liabilities
Current maturities of long-term debt $ 3,055,708 $ 746,933
Short-term debt 3,085,000 1,744,128
Revolving line of credit 150,000 -
LPG trade accounts payable 8,744,432 7,152,098
Other accounts payable 3,584,848 2,470,880
Foreign taxes payable - 60,000
Accrued liabilities 860,551 1,083,966
------------- -------------
Total current liabilities 19,480,539 13,258,005
Long-term debt, less current maturities 612,498 60,000
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at 2002 and 2003 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; No shares issued and outstanding at 2002
and 2003 - -
Common stock - $.01 par value, 25,000,000 shares authorized;
14,870,977 and 15,274,749 shares issued and outstanding at 2002 and
2003 148,709 152,747
Additional paid-in capital 26,919,674 28,298,301
Notes receivable from an officer of the Company and another party for
exercise of warrants, net of reserves of $754,175 and $535,736 at 2002
and 2003 (4,014,481) (2,897,520)
Accumulated deficit (12,991,600) (11,033,791)
------------- -------------
Total stockholders' equity 10,062,302 14,519,737
------------- -------------
Total liabilities and stockholders' equity $ 30,155,339 $ 27,837,742
============= =============
The accompanying notes are an integral part of these statements.
46
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31
2001 2002 2003
--------------- --------------- ------------------
Revenues $ 150,699,999 $ 142,156,099 $ 162,489,565
Cost of goods sold 151,475,598 131,129,110 152,375,349
--------------- --------------- ------------------
Gross profit (loss) (775,599) 11,026,989 10,114,216
Selling, general and administrative expenses
Legal and professional fees 1,139,141 1,568,002 2,597,065
Salaries and payroll related expenses 1,230,456 1,646,308 2,411,843
Other 1,248,042 1,132,546 1,380,009
--------------- --------------- ------------------
3,617,639 4,346,856 6,388,917
--------------- --------------- ------------------
Operating income (loss) (4,393,238) 6,680,133 3,725,299
Other income (expense)
Interest expense ( 3,615,477) ( 2,538,395) ( 1,757,664)
Interest income 39,576 27,550 95,327
Settlement of litigation (115,030) - ( 145,153)
--------------- --------------- ------------------
Income (loss) before taxes (8,084,169) 4,169,288 1,917,809
Provision (benefit) for income taxes 9,641 46,693 ( 40,000)
--------------- --------------- ------------------
Net income (loss) $ (8,093,810) $ 4,122,595 $ 1,957,809
=============== =============== ==================
Net income (loss) per common share $ (0.57) $ 0.28 $ 0.13
=============== =============== ==================
Net income (loss) per common share assuming dilution $ (0.57) $ 0.27 $ 0.13
=============== =============== ==================
Weighted average common shares outstanding 14,146,980 14,766,115 15,035,220
=============== =============== ==================
The accompanying notes are an integral part of these statements.
47
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31
2001 2002 2003
---------------------- -------------------- --------------------
Shares Amount Shares Amount Shares Amount
----------- --------- ---------- -------- ---------- --------
PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
=========== ========= ========== ======== ========== ========
Ending balance - $ - - $ - - $ -
=========== ========= ========== ======== ========== ========
SENIOR PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
=========== ========= ========== ======== ========== ========
Ending balance - $ - - $ - - $ -
=========== ========= ========== ======== ========== ========
COMMON STOCK
Beginning balance 13,435,198 $134,352 14,427,011 $144,270 14,870,977 $148,709
Issuance of common stock in connection with
registration rights penalty 3,480 35 - - - -
Issuance of common stock for services - August
2000 6,500 65 - - - -
Issuance of common stock in connection with
settlement of litigation - August 2000 12,500 125 - - - -
Issuance of common stock in connection with
settlement of litigation - September 2000 100,000 1,000 - - - -
Issuance of common stock upon exercise of
warrants - September 2000 200,000 2,000 - - - -
Receipt of stock for cancellation of indebtedness (78,383) (784) - - - -
Issuance of common stock upon exercise of
warrants - October 2000 7,500 75 - - - -
Issuance of common stock for services -
November 2000 4,716 47 - - - -
Issuance of common stock upon exercise of
warrants - November 2000 700,000 7,000 - - - -
Issuance of common stock in connection with
bonus - December 2000 14,500 145 - - - -
Issuance of common stock for services -
December 2000 - January 2001 6,000 60 - - - -
Issuance of common stock upon exercise of
warrants - July 2001 15,000 150 - - - -
Issuance of common stock upon exercise of
warrants in exchange for debt obligations owed
to the holder of the warrants - August 2001 - - 37,500 375 - -
Issuance of common stock upon exercise of
warrants in exchange for debt obligations owed
to the holder of the warrants - September 2001 - - 275,933 2,759 - -
Issuance of common stock in connection with
bonus - September 2001 - - 1,000 10 - -
Issuance of common stock for services -
September 2001 - - 37,500 375 - -
The accompanying notes are an integral part of these statements.
48
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
2001 2002 2003
-------------------- ---------------------- ------------------------
Shares Amount Shares Amount Shares Amount
---------- -------- ----------- --------- ----------- -----------
COMMON STOCK - CONTINUED
Receipt of stock for payment of indebtedness -
October 2001 - - ( 36,717) (367) - -
Issuance of common stock upon exercise of
warrants - November 2001 - - 78,750 787 - -
Issuance of common stock upon exercise of
warrants - June 2002 - - 25,000 250 - -
Issuance of common stock upon exercise of
warrants - July 2002 - - 25,000 250 - -
Receipt of stock for payment of indebtedness - - - - ( 7,620) (76)
Issuance of common stock upon exercise of
warrants in exchange for debt obligations owed
to the holder of the warrants - March 2003 - - - - 250,000 2,500
Issuance of common stock in exchange for debt
obligations - March 2003 - - - - 161,392 1,614
---------- -------- ----------- --------- ----------- -----------
Ending balance 14,427,011 $144,270 14,870,977 $148,709 15,274,749 $ 152,747
========== ======== =========== ========= =========== ===========
The accompanying notes are an integral part of these statements.
49
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
2001 2002 2003
--------------- ----------------- -----------------
Amount Amount Amount
--------------- ----------------- -----------------
ADDITIONAL PAID-IN CAPITAL
Beginning balance $ 21,782,638 $ 25,833,822 $ 26,919,674
Sale of common stock - - 401,866
Issuance of warrants in connection with settlement 300,000 - -
Loan discount 1,620,403 207,283 384,665
Grant of stock for bonus 43,355 2,790 -
Grant of stock for services 87,595 149,625 -
Common stock distributed in connection with the
settlement of a lawsuit (1,125) - -
Grant of warrants for services 499,480 - -
Grant of warrants in connection with registration
rights agreement (35) - -
Receipt of common stock for cancellation of debt (554,877) - -
Receipt of stock for payment of indebtedness - (146,502) (30,404)
Exercise of warrants 2,142,025 872,967 622,500
Cost of registering securities (85,637) (311) -
--------------- ----------------- -----------------
Ending balance $ 25,833,822 $ 26,919,674 $ 28,298,301
=============== ================= =================
STOCKHOLDERS' NOTES
Beginning balance $ (3,263,350) $ (3,986,048) $ (4,014,481)
Note receivable from an officer of the Company
and another party for exercise of warrants (698,000) - -
Note receivable from an officer and director of the
Company - (200,000) 200,000
Interest on another party note receivable (24,698) - -
Reserve of interest - 24,698 -
Reduction in notes receivable - 146,869 30,480
Forgiveness of note receivable in connection with
severance pay - - 448,077
Receipt of assets for cancellation of note receivable - - 438,404
--------------- ----------------- -----------------
Ending balance $ (3,986,048) $ (4,014,481) $ (2,897,520)
=============== ================= =================
ACCUMULATED DEFICIT
Beginning balance $ (9,020,385) $ (17,114,195) $ (12,991,600)
Net income (loss) for the year (8,093,810) 4,122,595 1,957,809
--------------- ----------------- -----------------
Ending balance $ (17,114,195) $ (12,991,600) $ (11,033,791)
=============== ================= =================
The accompanying notes are an integral part of these statements.
50
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31
2001 2002 2003
-------------- ------------- ------------
Cash flows from operating activities:
Net income (loss) $ (8,093,810) $ 4,122,595 $ 1,957,809
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization 758,911 843,436 976,054
Amortization of lease rights 45,795 45,795 45,795
Non-employee stock based costs and other 222,988 374,870 166,537
Amortization of loan discount 1,887,442 956,853 240,043
Gain on sale of land - (17,001) -
Gain on sale of equipment - - (231,925)
Gain on settlement of litigation - - (50,000)
Interest expense associated with exchange of debt - - 68,000
Interest income - officer note - - (67,241)
Salaries and payroll related expenses - - 523,349
Other 106,570 33,281 58,834
Changes in current assets and liabilities:
Trade accounts receivable (986,213) (2,856,873) 3,510,529
Notes receivable - related parties - (200,000) -
Inventories (5,061,638) 11,246,407 60,590
Prepaid and other current assets 22,562 (180,697) (387,992)
LPG trade accounts payable 4,310,867 (793,393) (1,592,334)
Obligation to deliver LPG 11,495,333 (11,495,333) -
Other assets and liabilities, net (4,649) 158,599 134,296
Other accounts payable and accrued liabilities 1,491,810 155,671 (737,343)
Foreign taxes payable - - 60,000
-------------- ------------- ------------
Net cash provided by (used in) operating activities 6,195,968 2,394,210 4,735,001
Cash flows from investing activities:
Capital expenditures (2,572,367) (789,069) (534,883)
Sale of land - 72,001 -
Proceeds from sale of equipment - - 368,303
-------------- ------------- ------------
Net cash used in investing activities (2,572,367) (717,068) (166,580)
Cash flows from financing activities:
Revolving credit facilities (3,538,394) 150,000 (150,000)
Issuance of debt 1,046,000 381,032 584,711
Debt issuance costs (326,232) - -
Issuance of common stock 1,453,249 287,511 -
Costs of registration (85,637) (568) -
Reduction in debt (875,518) (3,632,324) (1,687,941)
Reserve of interest on note receivable from another party - (24,698) -
-------------- ------------- ------------
Net cash provided by (used in) financing activities (2,326,532) (2,839,047) (1,253,230)
-------------- ------------- ------------
Net increase (decrease) in cash 1,297,069 (1,161,905) 3,315,191
Cash at beginning of period 25,491 1,322,560 160,655
-------------- ------------- ------------
Cash at end of period $ 1,322,560 $ 160,655 $ 3,475,846
============== ============= ============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (including capitalized interest of $120,000 in 2001) $ 1,806,356 $ 1,756,998 $ 1,522,960
============== ============= ============
Taxes $ 27,141 $ - $ -
============== ============= ============
Supplemental disclosures of noncash transactions:
Equity - common stock and warrants issued and other $ 3,575,382 $ 974,915 $ 1,345,145
============== ============= ============
Notes receivable exchanged for common stock $ (555,661) $ (146,869) $ (30,480)
============== ============= ============
Mortgage receivable $ (1,934,872) $ (851) $ 1,935,723
============== ============= ============
Equipment exchange for notes receivable $ - $ - $ 720,000
============== ============= ============
The accompanying notes are an integral part of these statements.
51
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION
Penn Octane Corporation was incorporated in Delaware in August 1992. The
Company has been principally engaged in the purchase, transportation and
sale of liquefied petroleum gas (LPG). The Company owns and operates a
terminal facility on leased property in Brownsville, Texas (Brownsville
Terminal Facility) and owns a LPG terminal facility in Matamoros,
Tamaulipas, Mexico (Matamoros Terminal Facility) and approximately 23 miles
of pipelines (US - Mexico Pipelines) which connect the Brownsville Terminal
Facility to the Matamoros Terminal Facility. The Company has a long-term
lease agreement for approximately 132 miles of pipeline (Leased Pipeline)
which connects ExxonMobil Corporation's (Exxon) King Ranch Gas Plant in
Kleberg County, Texas and Duke Energy's La Gloria Gas Plant in Jim Wells
County, Texas, to the Company's Brownsville Terminal Facility. In addition,
the Company has access to a twelve-inch pipeline which connects Exxon's
Viola valve station in Nueces County, Texas to the inlet of the King Ranch
Gas Plant (ECCPL) (see note Q) as well as existing and other potential
propane pipeline suppliers which have the ability to access the ECCPL. In
connection with the Company's lease agreement for the Leased Pipeline, the
Company may access up to 21,000,000 gallons of storage located in Markham,
Texas (Markham Storage), as well as other potential propane pipeline
suppliers, via approximately 155 miles of pipeline located between Markham,
Texas and the Exxon King Ranch Gas Plant. The Company sells LPG primarily
to P.M.I. Trading Limited (PMI). PMI is the exclusive importer of LPG into
Mexico. PMI is a subsidiary of Petroleos Mexicanos, the state-owned Mexican
oil company (PEMEX). The LPG purchased from the Company by PMI is generally
destined for consumption in the northeastern region of Mexico.
The Company commenced operations during the fiscal year ended July 31,
1995, upon construction of the Brownsville Terminal Facility. Since the
Company began operations, the primary customer for LPG has been PMI. Sales
of LPG to PMI accounted for approximately 74%, 78% and 82% of the Company's
total revenues for the years ended July 31, 2001, 2002 and 2003,
respectively.
BASIS OF PRESENTATION
-----------------------
The accompanying consolidated financial statements include the Company and
its United States subsidiaries including its recently formed Rio Vista
Energy Partners, LP and its subsidiaries, all inactive (see note R), Penn
Octane International, L.L.C., PennWilson CNG, Inc. (PennWilson) and Penn
CNG Holdings, Inc. and subsidiaries, its Mexican subsidiaries, Penn Octane
de Mexico, S.A. de C.V. (PennMex) and Termatsal, S.A. de C.V. (Termatsal)
and its other inactive Mexican subsidiaries, (collectively the Company).
All significant intercompany accounts and transactions are eliminated.
52
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows.
1. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
on the first-in, first-out method.
2. PROPERTY, PLANT AND EQUIPMENT AND LEASE RIGHTS
Property, plant and equipment are recorded at cost. After being placed into
service, assets are depreciated and amortized using the straight-line
method over their estimated useful lives as follows:
LPG terminals, building and leasehold improvements (a) 8 to 19 years
Automobiles 3-5 years
Furniture, fixtures and equipment 3-5 years
Trailers 8 years
Pipelines 30 years
(a) Brownsville Terminal related assets are depreciated over their
estimated useful lives, not to exceed the term of the Pipeline Lease
(see note K).
The lease rights are being amortized over 19 years.
Maintenance and repair costs are charged to expense as incurred.
In August 2001 Statement of Financial Accounting Standards (SFAS) No. 144
(SFAS 144) "Accounting for the Impairment or Disposal of Long-Lived Assets"
was issued. SFAS 144 supersedes the provisions of Statement of Financial
Accounting Standards No. 121 (SFAS 121) "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to be Disposed Of". SFAS 144
requires the Company to review long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If it
is determined that an impairment has occurred, the amount of the impairment
is charged to operations. No impairments were recognized for the years
ended July 31, 2001, 2002 and 2003.
3. INCOME TAXES
The Company will file a consolidated income tax return for the year ended
July 31, 2003.
The Company accounts for deferred taxes in accordance with SFAS 109,
"Accounting for Income Taxes". Under the liability method specified
therein, deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax bases of assets and
liabilities as measured by the enacted tax rates which will be in effect
when these differences reverse. Deferred tax expense is the result of
changes in deferred tax assets and liabilities. The principal types of
differences between assets and liabilities for financial statement and tax
return purposes are the allowance for doubtful accounts receivable,
amortization of deferred interest costs, accumulated depreciation and
deferred compensation expense.
The foreign subsidiaries are taxed on their income directly by the Mexican
Government. Such foreign subsidiaries are not included in the U.S.
consolidated income tax return of the Company. Consequently U.S. income tax
effect will occur only when dividend distributions of earnings and profits
of the foreign subsidiaries are received by the Company.
53
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
4. INCOME (LOSS) PER COMMON SHARE
Income (loss) per share of common stock is computed on the weighted average
number of shares outstanding in accordance with SFAS 128, "Earnings Per
Share". During periods in which the Company incurred losses, giving effect
to common stock equivalents is not presented as it would be antidilutive.
5. CASH EQUIVALENTS
For purposes of the cash flow statement, the Company considers cash in
banks and securities purchased with a maturity of three months or less to
be cash equivalents.
6. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments", requires
the disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable
to estimate the value. SFAS 107 excludes certain financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
are not intended to represent the underlying value of the Company. The
carrying amounts of cash and cash equivalents, current receivables and
payables and long-term liabilities approximate fair value because of the
short-term nature of these instruments.
8. STOCK-BASED COMPENSATION
SFAS 123 and SFAS 148, "Accounting for Stock-Based Compensation" and
"Accounting for Stock-Based Compensation-Transition and Disclosure",
establishes financial accounting and reporting standards for stock-based
employee compensation plans and for transactions in which an entity issues
its equity instruments to acquire goods and services from non-employees.
Under the guidance provided by SFAS 123, the Company has elected to
continue to account for employee stock-based compensation using the
intrinsic value method prescribed in APB 25, "Accounting for Stock Issued
to Employees", and related Interpretations.
9. REVENUE RECOGNITION ON SALES OF LPG
Revenues are not recorded from sales of LPG to be delivered in the future
until final delivery. Any amounts collected from such sales are recorded as
obligation to deliver LPG in the consolidated balance sheet. Losses, if
any, resulting from inventory imbalances from such sales are recognized
currently, and gains, if any, are recognized at final delivery.
54
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
10. FOREIGN CURRENCY TRANSLATION
The Company follows FASB No. 52 "Foreign Currency Translation" in
consolidation of the Company's Mexican subsidiaries, whose functional
currency is the US dollar. Non monetary balance sheet items and related
revenue and expense are remeasured using historical rates. Monetary balance
sheet items and related revenue and expense are remeasured using exchange
rates in effect at the balance sheet dates.
11. FINANCIAL INSTRUMENTS
The Company has adopted Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133), which requires that all derivative financial instruments be
recognized in the financial statements and measured at fair value
regardless of the purpose or intent for holding them. Changes in the fair
value of derivative financial instruments are either recognized
periodically in income or stockholders' equity (as a component of
comprehensive income), depending on whether the derivative is being used to
hedge changes in fair value or cash flows. At July 31, 2001, 2002 and 2003
the Company had no derivative financial instruments.
12. RECLASSIFICATIONS
Certain reclassifications have been made to prior year balances to conform
to the current presentation.
55
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE
The following tables present reconciliations from income (loss) per common
share to income (loss) per common share assuming dilution (see note J for
the warrants):
For the year ended July 31, 2001
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -----------
Net income (loss) $ (8,093,810)
BASIC EPS
Net income (loss) available to common
stockholders (8,093,810) 14,146,980 $( 0.57 )
===========
EFFECT OF DILUTIVE SECURITIES
Warrants - -
DILUTED EPS
Net income (loss) available to common N/A N/A N/A
stockholders
For the year ended July 31, 2002
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -----------
Net income (loss) $ 4,122,595
BASIC EPS
Net income (loss) available to common
stockholders 4,122,595 14,766,115 $ 0.28
===========
EFFECT OF DILUTIVE SECURITIES
Warrants - 351,424
--------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 4,122,595 15,117,539 $ 0.27
=============== ============= ===========
56
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE - CONTINUED
For the year ended July 31, 2003
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -----------
Net income (loss) $ 1,957,809
BASIC EPS
Net income (loss) available to common 1,957,809 15,035,220 $ 0.13
Stockholders ============
EFFECT OF DILUTIVE SECURITIES
Warrants - 80,610
Convertible Preferred Stock - -
-------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,957,809 15,115,830 $ 0.13
============== ============= ==========
NOTE D - NOTES FROM RELATED PARTIES
During April 1997, Mr. Jerome B. Richter, the Company's Chief Executive
Officer, Chairman of the Board and former President, exercised warrants to
purchase 2,200,000 shares of common stock of the Company, at an exercise
price of $1.25 per share. The consideration for the exercise of the
warrants included $22,000 in cash and a $2,728,000 promissory note. The
note was due on April 11, 2000. On April 11, 2000, Mr. Richter's issued a
new promissory note totaling $3,196,693 (Mr. Richter's Promissory Note),
representing the total unpaid principal and unpaid accrued interest at the
expiration of the original promissory note. During September 1999, the
Board of Directors of the Company agreed to offset interest due on Mr.
Richter's Promissory Note in consideration for providing collateral and
personal guarantees of Company debt. The principal amount of the note plus
accrued interest at an annual rate of 10.0%, except as adjusted for above,
was due on April 30, 2001. In November 2001 the Company extended the due
date to October 31, 2003 and the interest was adjusted to the prime rate on
November 7, 2001 (5.0%). In July 2002 the Company extended the due date to
July 29, 2005. In connection with the extension, the Company agreed in Mr.
Richter's employment agreement (see note K) to continue to forgive any
interest due from Mr. Richter pursuant to Mr. Richter's Promissory Note,
provided that Mr. Richter guarantees at least $2,000,000 of the Company's
indebtedness during any period of that fiscal year of the Company.
Furthermore, the Company agreed to forgive Mr. Richter's Promissory Note in
the event that either (a) the share price of the Company's common stock
trades for a period of 90 days at a blended average price equal to at least
$6.20, or (b) the Company is sold for a price per share (or an asset sale
realizes revenues per share) equal to at least $6.20. Mr. Richter is
personally liable with full recourse to the Company and has provided
1,000,000 shares of common stock of the Company as collateral. Those shares
were subsequently pledged as collateral to the holders of certain of the
Company's debt obligations (see note H). Mr. Richter's Promissory Note has
been recorded as a reduction of stockholders' equity.
57
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - NOTES FROM RELATED PARTIES - CONTINUED
On March 26, 2000, an affiliate of Mr. Jorge Bracamontes, a director and
executive officer of the Company, issued the Company a new promissory note
totaling $46,603, representing the total unpaid principal and interest due
under a prior promissory note due to the Company which matured March 26,
2000. The principal amount of the note plus accrued interest at an annual
rate of 10.0% was due in April 2001. During November 2001, the Company and
the affiliate of Mr. Bracamontes agreed to exchange 1,864 shares of common
stock of the Company held by the affiliate of Mr. Bracamontes for payment
of all unpaid interest owing to the Company through October 2001. In
addition, the Company agreed to extend the maturity date of the note held
by the affiliate of Mr. Bracamontes to October 31, 2003. The affiliate of
Mr. Bracamontes was personally liable with full recourse under such
promissory note and had provided the remaining 13,136 shares of common
stock of the Company as collateral.
During March 2000, Mr. Bracamontes exercised warrants to purchase 200,000
shares of common stock of the Company, at an exercise price of $2.50 per
share. The consideration for the exercise of the warrants included $2,000
in cash and a $498,000 promissory note. The principal amount of the note
plus accrued interest at an annual rate of 10.0% was due in April 2001.
During November 2001, the Company and Mr. Bracamontes agreed to exchange
19,954 shares of common stock of the Company held by Mr. Bracamontes for
payment of all unpaid interest owing to the Company through October 2001.
In addition, the Company agreed to extend the maturity date of the note
held by Mr. Bracamontes to October 31, 2003. Mr. Bracamontes was personally
liable with full recourse under such promissory note and had provided the
remaining 180,036 shares of common stock of the Company as collateral.
During July 2003, Mr. Bracamontes resigned from his position as a director
and officer of the Company. In connection with his resignation the Company
agreed to (i) forgive the remaining balance of his $498,000 promissory
note, (ii) forgive the remaining balance of his affiliate's $46,603
promissory note, (iii) issue 21,818 shares of the Company's common stock
(valued at approximately $75,000) and (iv) agreed to make certain payments
of up to $500,000 based on the success of future projects (the Company's
Chief Executive Officer agreed to guarantee these payments with 100,000 of
his shares of the common stock of the Company). Mr. Bracamontes will
continue to provide services and the Company will continue to make payments
to Mr. Bracamontes of $15,000 a month until March 31, 2004. All of the
above amounts totaling approximately $520,000 have been reflected in the
consolidated financial statements as of July 31, 2003 as salaries and
payroll related expenses. Simultaneously, Mr. Bracamontes sold his interest
in Tergas, S.A. de C.V. (an affiliate of the Company) to another officer of
the Company. The Company has an option to acquire Tergas, S.A. de C.V.
(Tergas) for a nominal price.
During September 2000, Mr. Ian Bothwell, a director and executive officer
of the Company, exercised warrants to purchase 200,000 shares of common
stock of the Company, at an exercise price of $2.50 per share. The
consideration for the exercise of the warrants included $2,000 in cash and
a $498,000 promissory note. The principal amount of the note plus accrued
interest at an annual rate of 10.5% was due in April 2001. During November
2001, the Company and Mr. Bothwell agreed to exchange 14,899 shares of
common stock of the Company held by Mr. Bothwell for payment of all unpaid
interest owing to the Company through October 2001. In addition, the
Company agreed to extend the maturity date of the note held by Mr. Bothwell
to October 31, 2003.
58
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - NOTES FROM RELATED PARTIES - CONTINUED
On September 10, 2000, the Board of Directors approved the repayment by a
company controlled by Mr. Bothwell (Buyer) of the $900,000 promissory note
to the Company through the exchange of 78,373 shares of common stock of the
Company owned by the Buyer, which were previously pledged to the Company in
connection with the promissory note. The exchanged shares had a fair market
value of approximately $556,000 at the time of the transaction resulting in
an additional loss of $84,000 which was included in the consolidated
statement of operations at July 31, 2000. The remaining note had a balance
of $214,355 and was collateralized by compressed natural gas refueling
station assets and 60,809 shares of the Company's common stock owned by the
Buyer.
During October 2002, the Company agreed to accept the compressed natural
gas refueling station assets with an appraised fair value of approximately
$800,000 as payment for all notes outstanding at the time (with total
principal amount of $652,759 plus accrued interest) owed to the Company by
Mr. Bothwell. In connection with the transaction, the Company adjusted the
fair value of the assets to $720,000 to reflect additional costs estimated
to be incurred in disposing of the assets. The Company also recorded
interest income as of July 31, 2003 on the notes of approximately $67,241,
which has been previously been reserved, representing the difference
between the adjusted fair value of the assets and the book value of the
notes.
In January 2002, the Company loaned Mr. Richter, $200,000 due in one year.
The Company had also made other advances to Mr. Richter of approximately
$82,000 as of July 31, 2002, which were offset per his employment agreement
against accrued and unpaid bonuses due to Mr. Richter. The note due from
Mr. Richter in the amount of $200,000 plus accrued interest as of January
31, 2003, was paid through an offset against previously accrued bonus and
profit sharing amounts due to Mr. Richter in January 2003.
59
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following as of July 31, :
2002 2003
------------ ------------
LPG:
Midline pump station $ 2,449,628 $ 2,443,988
Brownsville Terminal Facility: (a)
Building 173,500 173,500
Terminal facilities 3,631,207 3,631,207
Tank Farm 370,855 373,945
Leasehold improvements 302,657 302,657
Capital construction in progress 96,212 96,212
Equipment 502,557 226,285
------------ ------------
7,526,616 7,247,794
------------ ------------
US - Mexico Pipelines and Matamoros Terminal
Facility: (a)
U.S. Pipelines and Rights of Way 6,497,471 6,680,242
Mexico Pipelines and Rights of Way 993,300 993,300
Matamoros Terminal Facility 5,074,087 5,107,514
Saltillo Terminal 1,027,267 1,027,267
Land 856,358 856,358
------------ ------------
14,448,483 14,664,681
------------ ------------
Total LPG 21,975,099 21,912,475
------------ ------------
Other:
Automobile 10,800 -
Office equipment 72,728 93,201
Software - 75,890
------------ ------------
83,528 169,091
------------ ------------
22,058,627 22,081,566
Less: accumulated depreciation and amortization (3,707,842) (4,403,736)
------------ ------------
$18,350,785 $17,677,830
============ ============
(a) See note R.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (Saltillo Terminal). The Company was
unable to receive all the necessary approvals to operate the facility at
that location. The Company has identified an alternate site in Hipolito,
Mexico, a town located in the proximity of Saltillo to relocate the
Saltillo Terminal. The expense of such relocation is estimated to be
$500,000.
Depreciation and amortization expense of property, plant and equipment
totaled $758,911, $843,435 and $976,055 for the years ended July 31, 2001,
2002 and 2003, respectively.
Property, plant and equipment, net of accumulated depreciation, includes
$6,782,557 and $6,427,387 of costs, located in Mexico at July 31, 2002 and
2003, respectively.
60
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - INVENTORIES
Inventories consist of the following as of July 31,:
2002 2003
------------------- -------------------
Gallons Cost Gallons Cost
--------- -------- --------- --------
LPG:
Leased Pipeline 1,175,958 $458,091 1,175,958 $638,623
Brownsville Terminal Facility
Matamoros Terminal Facility
and railcars leased by the
Company 806,688 314,243 440,771 239,368
Markham Storage and other 427,003 166,338 168 91
--------- -------- --------- --------
2,409,649 $938,672 1,616,897 $878,082
========= ======== ========= ========
NOTE G - INCOME TAXES
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets and liabilities were as follows at July 31,:
2002 2003
---------------------------------------- ----------------------------------------
Assets Liabilities Assets Liabilities
------------------- ------------------- ------------------- -------------------
Depreciation
Bad debt reserve $ - $ 133,000 $ - $ 193,000
Receivable 140,000 - 2,000 -
Alternative minimum tax credits 12,000 - - -
Deferred interest cost - - 84,000 -
Deferred other cost 1,552,000 - 1,346,000 -
Rio Vista Registration costs 172,000 - 228,000 -
Net operating loss carryforward - - 156,000 -
2,277,000 - 1,797,000 -
------------------- ------------------- ------------------- -------------------
4,153,000 133,000 3,613,000 193,000
Less: valuation allowance
4,153,000 133,000 3,613,000 193,000
------------------- ------------------- ------------------- -------------------
$ - $ - $ - $ -
=================== =================== =================== ===================
There is no current or deferred U.S. income tax expense for the years ended
July 31, 2001, 2002 and 2003. The Company did incur U.S. alternative
minimum tax for the years ended July 31, 2003 totaling $29,000. The Company
was in a loss position for 2001 and utilized net operating loss
carryforwards in 2002 and 2003. The Company has estimated a Mexican income
tax of $60,000 for the year ended July 31, 2003. The Mexican subsidiaries
file their income tax returns on a calendar year basis.
Management believes that the valuation allowance reflected above is
appropriate because of the uncertainty that sufficient taxable income will
be generated in future taxable years by the Company to absorb the entire
amount of such net operating losses.
61
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE G - INCOME TAXES - CONTINUED
At July 31, 2003, the approximate amount of net operating loss
carryforwards and expiration dates for U.S. income tax purposes were as
follows:
Year ending Tax Loss
July 31, Carryforward
------------ -------------
2021 $ 5,285,000
-------------
5,285,000
============
Future changes in ownership, as defined by section 382 of the Internal
Revenue Code, could limit the amount of net operating loss carryforwards
used in any one year.
NOTE H - DEBT OBLIGATIONS
Restructuring of Notes
------------------------
From December 10, 1999 through January 18, 2000, and on February 2, 2000,
the Company completed a series of related transactions in connection with
the private placement of $4,944,000 and $710,000, respectively, of
subordinated notes (Notes) which were due the earlier of December 15, 2000,
or upon the receipt of proceeds by the Company from any future debt or
equity financing in excess of $2,250,000 (see below). Interest at 9% was
due and paid on June 15, 2000 and December 15, 2000. In connection with the
Notes, the Company granted the holders of the Notes, warrants (Warrants) to
purchase a total of 706,763 shares of common stock of the Company at an
exercise price of $4.00 per share, exercisable through December 15, 2002.
During December 2000, the Company entered into agreements (Restructuring
Agreements) with the holders of $5,409,000 in principal amount of the Notes
providing for the restructuring of such Notes (Restructuring). The
remaining $245,000 balance of the Notes was paid.
Under the terms of the Restructuring Agreements, the due dates for the
restructured Notes (Restructured Notes) were extended to December 15, 2001,
subject to earlier repayment upon the occurrence of certain specified
events provided for in the Restructured Notes. Additionally, beginning
December 16, 2000, the annual interest rate on the Restructured Notes was
increased to 13.5% (subject to the adjustments referred to below). Interest
payments were paid quarterly beginning March 15, 2001.
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares
of common stock of the Company at an exercise price of $3.00 per share and
exercisable until December 15, 2003 (New Warrants). The Company also agreed
to modify the exercise prices of the Warrants to purchase up to 676,137
shares of common stock of the Company previously issued to the holders of
the Restructured Notes in connection with their original issuance from
$4.00 per share to $3.00 per share and extend the exercise dates of the
Warrants from December 15, 2002 to December 15, 2003. In addition, the
Company was required to reduce the exercise price of the Warrants and the
New Warrants issued to the holders of the Restructured Notes from $3.00 per
share to $2.50 per share because the Restructured Notes were not fully
repaid by June 15, 2001.
62
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
Restructuring of Notes - Continued
--------------------------------------
In connection with the Restructuring Agreements, the Company agreed to
register the shares of common stock which may be acquired in connection
with the exercise of the New Warrants (Exercisable Shares) by March 31,
2001. In connection with the Company's obligations under the Restructured
Notes, the Company's registration statement containing the Exercisable
Shares was declared effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral
to secure the Company's payment obligations under the Restructured Notes
consisting of a senior interest in substantially all of the Company's
assets which are located in the United States (US Assets) and Mexico
(Mexican Assets), excluding inventory, accounts receivable and sales
contracts with respect to which the Company is required to grant a
subordinated security interest (collectively referred to as the
Collateral). Mr. Richter has also pledged 2,000,000 shares of common stock
of the Company owned by Mr. Richter (1,000,000 shares to be released when
the required security interests in the US Assets have been granted and
perfected and all the shares are to be released when the required security
interests in all of the Collateral have been granted and perfected). The
granting and perfection of the security interests in the Collateral, as
prescribed under the Restructured Notes, have not been finalized.
Accordingly, the interest rate under the Restructured Notes increased to
16.5% on March 16, 2001. The release of the first 1,000,000 shares will be
transferred to the Company as collateral for Mr. Richter's Promissory Note.
The Collateral is also being pledged in connection with the issuance of
other indebtedness by the Company (see note L). Investec PMG Capital,
formerly PMG Capital Corp., (Investec) has agreed to serve as the
collateral agent.
Investec acted as financial advisor for the restructuring of $4,384,000 in
principal amount of the Restructured Notes. Investec received fees
consisting of $131,520 in cash and warrants to purchase 50,000 shares of
common stock of the Company with terms similar to the terms of the New
Warrants. The Company also agreed to modify and extend the exercise date of
warrants to purchase 114,375 shares of common stock of the Company
originally issued to Investec in connection with the original issuance of
the Notes with the same terms as those which were modified in the Warrants
in connection with the Restructuring Agreements.
In connection with the Restructuring Agreements, the Company recorded a
discount of $1,597,140 related to the fair value of the New Warrants
issued, fair value related to the modifications of the Warrants, fees paid
to Investec (including cash, new warrants granted and modifications to
warrants previously granted to Investec in connection with the original
issuance of the Notes) and other costs associated with the Restructuring
Agreements, to be amortized over the life of the Restructured Notes. Total
amortization of discounts related to the Notes and the Restructured Notes
and included in the consolidated statements of operations was $1,670,794,
and $599,475 for the years ended July 31, 2001 and 2002.
63
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
Issuance of New Promissory Notes
------------------------------------
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (New Notes) due December 15, 2001. The
holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of the Company (New Note Warrants). The terms of the New
Notes and New Note Warrants are substantially the same as those contained
in the Restructured Notes and New Warrants issued in connection with the
Restructuring described above. As described above, the Company's payment
obligations under the New Notes are to be secured by the Collateral and the
2,000,000 shares of the Company which are owned by Mr. Richter.
Net proceeds from the New Notes were used for working capital purposes.
In connection with the New Notes, Investec acted as placement agent for the
Company and received cash fees totaling $69,370 and reimbursement of out of
pocket expenses.
In connection with the issuance of the New Notes and New Note Warrants, the
Company recorded a discount of $349,494 related to the fair value of the
New Note Warrants issued, fees paid to Investec and other costs associated
with the private placement, to be amortized over the life of the New Notes.
Total amortization of discounts related to the New Notes and included in
the consolidated statements of operations was $199,398 and $150,096 for the
years ended July 31, 2001 and 2002, respectively.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of the Company were exercised by certain holders of the New
Warrants and New Note Warrants for which the exercise price totaling
$614,833 was paid by reduction of the outstanding debt and accrued interest
related to the New Notes and the Restructured Notes.
Extension of Restructured Notes and New Notes
---------------------------------------------------
During December 2001, the Company and certain holders of the Restructured
Notes and the New Notes (Accepting Noteholders) reached an agreement
whereby the due date for $3,135,000 of principal due on the Accepting
Noteholders' notes was extended to June 15, 2002. In connection with the
extension, the Company agreed to (i) continue paying interest at a rate of
16.5% annually on the Accepting Noteholders' notes, payable quarterly, (ii)
pay the Accepting Noteholders a fee equal to 1% on the principal amount of
the Accepting Noteholders' notes, (iii) modify the warrants held by the
Accepting Noteholders by extending the expiration date to December 14, 2004
and (iv) remove the Company's repurchase rights with regard to the
warrants.
In connection with the extension of the Accepting Noteholders' warrants,
the Company recorded a discount of $207,283, which has been amortized for
the year ended July 31, 2002.
During June 2002, the Company and certain holders of the Restructured Notes
and the New Notes (New Accepting Noteholders) reached an agreement whereby
the due date for approximately $2,985,000 of principal due on the New
Accepting Noteholders' notes were extended to December 15, 2002 (see
below). The New Accepting Noteholders' notes will continue to bear interest
at 16.5% per annum. Interest is payable on the outstanding balances on
specified dates through December 15, 2002. The Company paid a fee of 1.5%
on the principal amount of the New Accepting Noteholders' notes on July 1,
2002. The principal amount and unpaid interest of the Restructured Notes
and/or New Notes which were not extended were paid on June 15, 2002.
64
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
Extension of Restructured Notes and New Notes - Continued
---------------------------------------------------
During June 2002 the Company issued a note for $100,000 (Additional Note)
to a holder of the Restructured Notes and the New Notes. The $100,000 note
provides for similar terms and conditions as the New Accepting Noteholders'
notes (see below).
Extension of New Accepting Noteholders' Notes and Additional Note
-------------------------------------------------------------------------
During December 2002, the Company and certain holders of New Accepting
Noteholders' notes and holder of the Additional Note (Extending
Noteholders) reached an agreement whereby the due date for $2,730,000 of
principal due on the Extending Noteholders' notes were extended to December
15, 2003. Under the terms of the agreement, the Extending Noteholders'
notes will continue to bear interest at 16.5% per annum. Interest is
payable quarterly on the outstanding balances beginning on March 15, 2003
(the December 15, 2002 interest was paid on January 1, 2003). In addition,
the Company is required to pay principal in equal monthly installments
beginning March 2003 (approximately $1,152,000 of principal was paid
through the period ended April 30, 2003 of which $1,000,000 was reduced in
connection with the exercise of warrants and purchase of common stock - see
below). The Company may prepay the Extending Noteholders' notes at any
time. The Company is also required to pay a fee of 1.5% on the principal
amount of the Extending Noteholders' notes which are outstanding on
December 15, 2002, March 15, 2003, June 15, 2003 and September 15, 2003.
The Company also agreed to extend the expiration date on the warrants held
by the Extending Noteholders in connection with the issuance of the
Extending Noteholders' notes to December 15, 2006. In connection with the
extension of the warrants, the Company recorded a discount of $316,665
related to the additional value of the modified warrants of which $240,043
has been amortized for the year ended July 31, 2003.
The Company paid the portion of the New Accepting Noteholders' notes which
were not extended, $355,000 plus accrued interest, on December 15, 2002.
During March 2003, warrants to purchase 250,000 shares of common stock of
the Company were exercised by a holder of the Warrants and New Warrants for
which the exercise price totaling $625,000 was paid by reduction of a
portion of the outstanding debt and accrued interest owed to the holder
related to the Extending Noteholders' Notes. In addition, during March
2003, the holder acquired 161,392 shares of common stock of the Company at
a price of $2.50 per share. The purchase price was paid through the
cancellation of the remaining outstanding debt and accrued interest owed to
the holder totaling $403,480. In connection with this transaction the
Company recorded additional interest expense of approximately $68,000
representing the difference between the market value and sales price on the
day of the transaction.
Issuance of Promissory Note
------------------------------
During December 2002, the Company issued a note for $250,000 ($250,000
Note) to a holder of the Extending Noteholders' notes. The note provides
for similar terms and conditions as the Extending Noteholders' notes.
65
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
Debt consists of the following as of July 31,:
2002 2003
---------- ----------
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines $ 837,918 $ 284,731
and the Matamoros Terminal Facility (see note L).
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines 554,159 198,178
and the Matamoros Terminal Facility (see note L).
Promissory note issued in connection with the purchase of property (see note L). 1,935,723 -
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February 2001. 137,500 137,500
Extending Noteholders' notes and $250,000 Note 3,085,000 1,744,128
Other debt 202,906 186,524
---------- ----------
Total debt 6,753,206 2,551,061
Less: Current maturities 3,055,708 746,933
Short-term debt 3,085,000 1,744,128
---------- ----------
Long-term debt $ 612,498 $ 60,000
========== ==========
In connection with the note payable for legal services, the Company has not
made all of the required payments. The Company provided a "Stipulation of
Judgment" to the creditor at the time the note for legal services was
issued.
CPSC International, Inc. (CPSC) agreed to be responsible for payments
required by the Mortgage Note in connection with a settlement in March 2001
between CPSC and the Company. During April 2003, CPSC paid the mortgage
receivable by direct payment of the Mortgage Note.
In accordance with provisions of the settlement, during April 2003, $92,000
of amounts previously paid under the CPSC note were refunded to the
Company. In addition, the Company reduced its CPSC Note by approximately
$32,000. The total amount of the CPSC note reductions of approximately
$124,000 was recorded as a reduction to the costs related to the CPSC
acquisition.
During September 2003, the Company entered into a settlement agreement with
one of the holders of a promissory note issued in connection with the
acquisition of the US-Mexico Pipelines and the Matamoros Terminal Facility
whereby the noteholder was required to reimburse the Company for $50,000 to
be paid through the reduction of the final payments of the noteholder's
note (see note K).
Mr. Richter is providing a personal guarantee for the punctual payment and
performance under the CPSC Note until collateral pledged in connection with
the note is perfected.
Scheduled maturities are as follows:
Year ending July 31,
--------------------
2005 $20,000
2006 20,000
2007 20,000
-------
60,000
=======
66
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - STOCKHOLDERS' EQUITY
COMMON STOCK
-------------
The Company routinely issues shares of its common stock for cash, as a
result of the exercise of warrants, in payment of notes and other
obligations and to settle lawsuits.
During March 2003, warrants to purchase 250,000 shares of common stock of
the Company were exercised by a certain holder of the Warrants and New
Warrants, through reductions of debt obligations (see note H).
During March 2003, a holder of the Extending Noteholders' notes agreed to
acquire 161,392 shares of common stock of the Company at a price of $2.50
per share. The purchase price was paid through the cancellation of
outstanding debt and accrued interest owed to the holder totaling $403,480
(see note H).
During September 2003, warrants to purchase 32,250 shares of common stock
of the Company were exercised resulting in cash proceeds to the Company of
$80,625.
During September 2003, the Company issued 21,818 shares of common stock of
the Company to Mr. Bracamontes as severance compensation (see note D). In
connection with the issuance of the shares, the Company recorded an expense
of approximately $75,000 based on the market value of the stock issued.
In connection with previous warrants issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right
to purchase the warrants for a nominal price if the holder of the warrants
does not elect to exercise the warrants within the call provision.
STOCK AWARD PLAN
------------------
Under the Company's 1997 Stock Award Plan (Plan), the Company has reserved
for issuance 150,000 shares of common stock of the Company, of which 69,970
shares were unissued as of July 31, 2003, to compensate consultants who
have rendered significant services to the Company. The Plan is administered
by the Compensation Committee of the Board of Directors of the Company
which has complete authority to select participants, determine the awards
of common stock of the Company to be granted and the times such awards will
be granted, interpret and construe the Plan for purposes of its
administration and make determinations relating to the Plan, subject to its
provisions, which are in the best interests of the Company and its
stockholders. Only consultants who have rendered significant advisory
services to the Company are eligible to be participants under the Plan.
Other eligibility criteria may be established by the Compensation Committee
as administrator of the Plan.
During September 2001, the Company issued 37,500 shares of common stock of
the Company to a consultant in payment for services rendered to the Company
valued at $150,000.
67
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS
In December 2002, the FASB issued SFAS No. 148, an amendment of FASB
Statement No. 123. This statement provides alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, SFAS No.
148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. The transition guidance and annual
disclosure provisions are effective for financial statements issued for
fiscal years ending after December 15, 2002. The interim disclosure
provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. The
Company adopted the interim disclosure provisions of SFAS No. 148 during
the third quarter of fiscal 2003.
The Company applies APB 25 for warrants granted to the Company's employees
and to the Company's Board of Directors and SFAS 123 for warrants issued to
acquire goods and services from non-employees.
BOARD COMPENSATION PLAN
-------------------------
During the Board of Directors (Board) meeting held on September 3, 1999,
the Board approved the implementation of a plan to compensate each outside
director serving on the Board (Plan). Under the Plan, all outside directors
upon election to the Board are entitled to receive warrants to purchase
20,000 shares of common stock of the Company and are to be granted warrants
to purchase 10,000 shares of common stock of the Company for each year of
service as a director. Such warrants will expire five years after the
warrants are granted. The exercise price of the warrants issued under the
Plan are based on the average trading price of the Company's common stock
on the effective date the warrants are granted, and the warrants vest
monthly over a one year period.
In connection with the Board Plan, during August 2002 the Board granted
warrants to purchase 20,000 shares of common stock of the Company at
exercise prices of $3.10 per share to outside directors. Based on the
provisions of APB25, no compensation expense was recorded for these
warrants.
In connection with the Board Plan, during November 2002 the Board granted
warrants to purchase 10,000 shares of common stock of the Company at
exercise prices of $2.27 per share to an outside director. Based on the
provisions of APB 25, no compensation expense was recorded for these
warrants.
In connection with the Board Plan, during August 2003 the Board granted
warrants to purchase 20,000 shares of common stock of the Company at
exercise prices of $3.22 and $3.28 per share to outside directors. Based on
the provisions of APB 25, no compensation expense was recorded for these
warrants.
68
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
2001 WARRANT PLAN
-------------------
The Board in November 2001 approved the 2001 warrant plan (2001 Warrant
Plan). The purpose of the 2001 Warrant Plan is to provide the Company with
a vehicle to attract, compensate, and motivate selected employees,
particularly executive officers, by issuing stock purchase warrants which
will afford recipients an opportunity to share in potential capital
appreciation in the Company's common stock.
The 2001 Warrant Plan provides for issuance of warrants to purchase up to a
maximum of 1,500,000 shares of common stock of the Company, subject to
adjustment in the event of adjustments to the Company's capitalization
(such as stock dividends, splits or reverse splits, mergers,
recapitalizations, consolidations, etc.). Any warrants which expire without
being exercised are added back to the number of shares for which warrants
may be issued. The 2001 Warrant Plan has a term of 10 years, and no
warrants may be granted after that time.
The warrants may be issued to any person who, at the time of the grant
under the 2001 Warrant Plan, is an employee or director of, and/or
consultant or advisor to, the Company, or to any person who is about to
enter into any such relationship with the Company.
The warrants will be issued in the discretion of the compensation committee
and/or the Board (Administrator), which will determine when and who will
receive grants, the number of shares purchasable under the warrants, the
manner, conditions and timing of vesting, the exercise price, antidilution
adjustments to be applied, and forfeiture and vesting acceleration terms.
The exercise price of the warrants are determined in the discretion of the
Administrator, but may not be less than 85% of the fair market value of the
common stock of the Company on the date of the grant, except that warrants
granted to non-employee directors may have an exercise price not less than
100% of the fair market value. The fair market value is the closing price
of the Company's common stock on the grant date. Warrants may be exercised
only for cash.
The term of the warrants may not exceed ten years from the date of grant
and may be exercised only during the term specified in the warrants. In the
discretion of the Administrator, warrants may continue in effect and
continue to vest even after termination of the holder's employment by the
Company.
69
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
OTHER
-----
In connection with a consulting agreement between the Company and a
director of the Company, during August 2000, the director received warrants
to purchase 100,000 shares of common stock of the Company at an exercise
price of $6.38 per share exercisable through August 6, 2005. The warrants
will vest ratably on a quarterly basis over four years. The warrants were
accounted for under the provisions of SFAS 123 and the resulting expense is
being amortized over the vesting period.
SFAS 148 AND 123 DISCLOSURES
--------------------------------
Had compensation cost related to the warrants granted to employees been
determined based on the fair value at the grant dates, consistent with the
provisions of SFAS 123, the Company's pro forma net income (loss), and net
income (loss) per common share would have been as follows for the years
ended July 31,:
2001 2002 2003
------------------- -------------- --------------
Net income (loss) as reported $ (8,093,810) $ 4,122,595 $ 1,957,809
Less: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (2,761,767) (2,013,203) (1,317,073)
------------------- -------------- --------------
Net income (loss) pro forma (10,855,577) 2,109,392 640,736
Net income (loss) per common share, as reported (.57) .28 .13
Net income (loss) per common share, pro forma (.77) .14 .04
Net income (loss) per common share assuming (.57) .27 .13
dilution, as reported
Net income (loss) per common share assuming (.77) .14 .04
dilution, pro forma
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2001, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 90% to 92%; risk free interest rate of 6.02%; and
expected lives of 5 years.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2002, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0% expected
volatility of 87%; risk free interest rate of 3.59% and 4.72% depending on
expected lives; and expected lives of 5 years.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2003, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 80%; risk free interest rate of 1.75 and 1.81%
depending on expected lives; and expected lives of 5 years.
70
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
SFAS 148 AND 123 DISCLOSURES - CONTINUED
--------------------------------
For warrants granted to non-employees, the Company applies the provisions
of SFAS 123 to determine the fair value of the warrants issued. Costs
associated with warrants granted to non-employees for the years ended July
31, 2001, 2002 and 2003, totaled $222,988, $374,870 and $166,537,
respectively. Warrants granted to non-employees simultaneously with the
issuance of debt are accounted for based on the guidance provided by APB
14, "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants".
A summary of the status of the Company's warrants as of July 31, 2001, 2002
and 2003, and changes during the years ending on those dates is presented
below:
2001 2002 2003
--------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Warrants Shares Exercise Price Shares Exercise Price Shares Exercise Price
------------------------------ ---------- --------------- ---------- --------------- ---------- ---------------
Outstanding at beginning of
year 4,154,988 $ 3.82 4,377,488 $ 3.67 3,911,555 $ 3.87
Granted 1,395,000 3.82 60,000 3.84 30,000 2.82
Exercised ( 922,500) 2.33 (442,183) 1.98 ( 250,000) 2.50
Expired (250,000) 6.00 ( 83,750) 3.69 (99,376) 3.66
---------- ---------- ----------
Outstanding at end of year 4,377,488 3.67 3,911,555 3.87 3,592,179 3.97
========== ========== ==========
Warrants exercisable at end of
year 3,451,251 3,574,027 3,556,189
The following table depicts the weighted-average exercise price and
weighted average fair value of warrants granted during the years ended July
31, 2001, 2002 and 2003, by the relationship of the exercise price of the
warrants granted to the market price on the grant date:
2001 2002 2003
---------------------------- ---------------------------- ----------------------------
For warrants granted For warrants granted For warrants granted
Weighted Weighted Weighted Weighted Weighted Weighted
Exercise price compared to average average average average average average
market price on grant date fair value exercise price fair value exercise price fair value exercise price
- -------------------------- ----------- --------------- ----------- --------------- ----------- ---------------
Equals market price $ 5.06 $ 6.77 $ 2.69 $ 3.84 $ 1.82 $ 2.82
Exceeds market price 1.84 4.16 - - - -
Less than market price 2.30 2.50 - - - -
The fair value of each warrant grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in the years ended July 31,
2001, 2002 and 2003, respectively: dividend yield of 0% for all three
years; expected volatility of 92%, 87% and 80%; risk-free interest rate of
6.02%, 3.59 to 4.72% and 1.75 to 1.81% depending on expected lives; and
expected lives of 3 to 5, 5 and 5 years.
71
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
SFAS 148 AND 123 DISCLOSURES - CONTINUED
--------------------------------
The following table summarizes information about the warrants outstanding
at July 31, 2003:
Warrants Outstanding Warrants Exercisable
-------------------------- ------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
at Contractual Exercise at Exercise
Range of Exercise Prices July 31, 2003 Life Price July 31, 2003 Price
- ------------------------- ------------- ----------- --------- ------------- ---------
2.27 to $3.66 1,477,179 1.40 years $ 2.53 1,474,208 $ 2.53
3.99 to $4.60 1,705,000 1.39 4.53 1,705,000 4.53
6.37 to $7.00 410,000 2.09 6.79 376,981 6.82
------------- -------------
2.27 to $7.00 3,592,179 1.47 $ 3.97 3,556,189 $ 3.94
============= =============
NOTE K - COMMITMENTS AND CONTINGENCIES
LITIGATION
On March 16, 1999, the Company settled a lawsuit in mediation with its
former chairman of the board, Jorge V. Duran. The total settlement costs
recorded by the Company at July 31, 1999, was $456,300. The parties had
agreed to extend the date on which the payments were required in connection
with the settlement including the issuance of the common stock. On July 26,
2000, the parties executed final settlement agreements whereby the Company
paid the required cash payment of $150,000. During September 2000, the
Company issued the required stock.
On July 10, 2001, litigation was filed in the 164th Judicial District Court
of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel & Jackson
L.L.P. against the Company alleging breach of contract, common law fraud
and statutory fraud in connection with the settlement agreement between the
parties dated July 26, 2000. Plaintiffs were seeking actual and punitive
damages. During July 2003 the lawsuit was settled whereby the Company
agreed to pay the plaintiffs $45,000.
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,000 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation (WIN) settled
litigation whereby the Company issued WIN 12,500 shares of common stock of
the Company. The value of the stock, totaling approximately $82,000 at the
time of settlement, was recorded in the Company's consolidated financial
statements at July 31, 2000.
72
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
LITIGATION - CONTINUED
On March 2, 2000, litigation was filed in the Superior Court of California,
County of San Bernardino by Omnitrans against Penn Octane Corporation, Penn
Wilson and several other third parties alleging breach of contract, fraud
and other causes of action related to the construction of a refueling
station by a third party. Penn Octane Corporation and Penn Wilson have both
been dismissed from the litigation pursuant to a summary judgment.
Omnitrans appealed the summary judgment in favor of the Company and Penn
Wilson. During August 2003, the Appellate Court issued a preliminary
decision denying Omnitran's appeal of the summary judgment in favor of the
Company and Penn Wilson. Oral argument on Omnitran's appeal is set for
November 2003.
On August 7, 2001, a Mexican company, Intertek Testing Services de Mexico,
S.A. de C.V. (Plaintiff), which contracts with PMI for LPG testing services
required to be performed under the Contract, filed suit in the Superior
Court of California, County of San Mateo against the Company alleging
breach of contract. During April 2003 the case proceeded to a jury trial.
The Plaintiff demanded from the judge and jury approximately $850,000 in
damages and interest. During May 2003, the jury found substantially in
favor of the Company and awarded damages to Intertek of only approximately
$228,000 and said sum was recorded as a judgment on June 5, 2003 and during
August 2003 the Court awarded the Plaintiff interest and costs totaling
approximately $50,000. In connection with the judgment, and the additional
interest and costs, the Company recorded an additional expense of
approximately $106,000 as of July 31, 2003 representing the additional
expense over amounts previously accrued.
On October 11, 2001, litigation was filed in the 197th Judicial District
Court of Cameron County, Texas by the Company against Tanner Pipeline
Services, Inc. (Tanner); Cause No. 2001-10-4448-C alleging negligence and
aided breaches of fiduciary duties on behalf of CPSC in connection with the
construction of the US Pipelines. During September 2003, the Company
entered into a settlement agreement with Tanner whereby Tanner was required
to reimburse the Company for $50,000 to be paid through the reduction of
the final payments on Tanner's note (see note H).
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including
those discussed above, should not materially affect its consolidated
financial statements.
73
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
CREDIT FACILITY AND LETTERS OF CREDIT
As of July 31, 2003, the Company has a $15,000,000 credit facility (see
below) with RZB Finance L.L.C. (RZB) through January 31, 2004 for demand
loans and standby letters of credit (RZB Credit Facility) to finance the
Company's purchases of LPG. Under the RZB Credit Facility, the Company pays
a fee with respect to each letter of credit thereunder in an amount equal
to the greater of (i) $500, (ii) 2.5% of the maximum face amount of such
letter of credit, or (iii) such higher amount as may be agreed to between
the Company and RZB. Any loan amounts outstanding under the RZB Credit
Facility shall accrue interest at a rate equal to the rate announced by the
JPMorgan Chase Bank as its prime rate plus 2.5%. Pursuant to the RZB Credit
Facility, RZB has sole and absolute discretion to limit or terminate their
participation in the RZB Credit Facility and to make any loan or issue any
letter of credit thereunder. RZB also has the right to demand payment of
any and all amounts outstanding under the RZB Credit Facility at any time.
In connection with the RZB Credit Facility, the Company granted a security
interest and assignment in any and all of the Company's accounts,
inventory, real property, buildings, pipelines, fixtures and interests
therein or relating thereto, including, without limitation, the lease with
the Brownsville Navigation District of Cameron County (District) for the
land on which the Company's Brownsville Terminal Facility is located, the
Pipeline Lease, and in connection therewith agreed to enter into leasehold
deeds of trust, security agreements, financing statements and assignments
of rent, in forms satisfactory to RZB. Under the RZB Credit Facility, the
Company may not permit to exist any subsequent lien, security interest,
mortgage, charge or other encumbrance of any nature on any of its
properties or assets, except in favor of RZB, without the consent of RZB
(see notes H and L).
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, Duke Energy
NGL Services, Inc. (Duke) and/or Koch Hydrocarbon Company (Koch), letters
of credit are issued on a monthly basis based on anticipated purchases.
Outstanding letters of credit at July 31, 2003 totaled approximately
$7,200,000.
In connection with the Company's purchase of LPG, under the RZB Credit
Facility, assets related to product sales (Assets) are required to be in
excess of borrowings and commitments (including restricted cash of
$3,404,782 at July 31, 2003). At July 31, 2003, the Company's borrowings
and commitments were less than the amount of the Assets.
Under the terms of the RZB Credit Facility, the Company is required to
maintain net worth of a minimum of $9,000,000 and is not allowed to make
cash dividends to shareholders without the consent of RZB. The $15,000,000
is effective until January 31, 2004 when it will be automatically reduced
to $12,000,000.
Interest costs associated with the RZB Credit Facility totaled $839,130,
$452,164 and $732,718 for the years ended July 31, 2001, 2002 and 2003.
74
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
OPERATING LEASE COMMITMENTS
The Company has lease commitments for its pipeline, land, office space and
office equipment.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (Pipeline Lease Amendment) entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999
(Effective Date). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another
pipeline controlled by Seadrift, thereby providing greater access to and
from the Leased Pipeline. Pursuant to the Pipeline Lease Amendment, the
Company's fixed annual rent for the use of the Leased Pipeline is
$1,000,000 including monthly service payments of $8,000 through March 2004.
The service payments are subject to an annual adjustment based on a labor
cost index and an electric power cost index. The Company is also required
to pay for a minimum volume of storage of $300,000 per year beginning
January 1, 2000. In addition, the Pipeline Lease Amendment provides for
variable rental increases based on monthly volumes purchased and flowing
into the Leased Pipeline and storage utilized. As provided in the Pipeline
Lease, the Company has the right to use the Pipeline solely for the
transportation of LPG belonging only to the Company and not to any third
party. The lessor has the right to terminate the lease agreement under
certain limited circumstances, which management currently believes are
remote, as provided for in the lease agreement at specific times in the
future by giving twelve months written notice. The Company can also
terminate the lease at any time by giving thirty days notice only if its
sales agreement with its main customer is terminated, and at any time by
giving twelve months notice. Upon termination by the lessor, the lessor has
the obligation to reimburse the Company the lesser of 1) net book value of
its liquid propane gas terminal at the time of such termination or 2)
$2,000,000.
The operating lease for the land on which the Brownsville Terminal Facility
is located (Brownsville Lease) originally was due to expire in October
2003. During December 2001 the Company extended the Brownsville Lease until
November 30, 2006. The Company has an option to renew for five additional
five year terms. The rent may be adjusted in accordance with the terms of
the agreement. The annual rental amount is approximately $75,000.
The Brownsville Lease provides, among other things, that if the Company
complies with all the conditions and covenants therein, the leasehold
improvements made to the Brownsville Terminal Facility by the Company may
be removed from the premises or otherwise disposed of by the Company at the
termination of the Brownsville Lease. In the event of a breach by the
Company of any of the conditions or covenants, all improvements owned by
the Company and placed on the premises shall be considered part of the real
estate and shall become the property of the District.
The Company leases the land on which its Tank Farm is located. The lease
amount is approximately $27,000 annually. The lease was originally due to
expire on January 18, 2005. During December 2001 the Company extended the
lease until November 30, 2006. The Company has an option to renew for five
additional five year terms. The rent may be adjusted in accordance with the
terms of the agreement.
75
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
OPERATING LEASE COMMITMENTS - CONTINUED
Rent expense was as follows for the years ended July 31,:
2001 2002 2003
----------- ----------- -----------
Brownsville Lease and $ 113,056 $ 108,744 $ 96,760
Other (a)
Minimum Rent Expense 1,954,564 1,911,385 1,396,431
Variable Rent Expense 783,297 1,218,843 1,202,893
----------- ----------- -----------
Total $ 2,850,917 $ 3,238,972 $ 2,696,084
=========== =========== ===========
(a) See note R
As of July 31, 2003, the minimum lease payments for operating leases having
initial or remaining noncancellable lease terms in excess of one year are
as follows:
Year ending July 31,
--------------------
2004 $1,434,805
2005 1,425,368
2006 1,407,779
2007 1,310,822
2008 1,275,000
Thereafter 5,950,000
----------
12,803,774
==========
EMPLOYMENT CONTRACTS
During the period February 1, 2001 through July 28, 2002, the Company
continued the terms of the previous six year employment agreement with Mr.
Richter which had expired on January 31, 2001. Effective July 29, 2002, the
Company entered into a new three year employment agreement with Mr. Richter
(Agreement). Under the terms of the Agreement, Mr. Richter is entitled to
receive a monthly salary equal to $25,000 and a minimum annual bonus
payment equal to $100,000 plus five percent (5%) of net income before taxes
of the Company. In addition, Mr. Richter was entitled to receive a warrant
grant by December 31, 2002 in an amount and with terms commensurate with
prior practices. As of July 31, 2003, the Company has not made the warrant
grant. Pursuant to the Agreement, Mr. Richter was granted a term life
insurance policy in the amount of $5,000,000.
In connection with the Agreement, the Company also agreed to forgive any
interest due from Mr. Richter pursuant to Mr. Richter's Promissory Note,
provided that Mr. Richter guarantees at least $2,000,000 of the Company's
indebtedness during any period of that fiscal year of the Company.
Furthermore, the Company agreed to forgive Mr. Richter's Promissory Note in
the event that either (a) the share price of the Company's common stock
trades for a period of 90 days at a blended average price equal to $6.20,
or (b) the Company is sold for a price per share (or an asset sale realizes
revenues per share) equal to $6.20.
Aggregate compensation under employment agreements totaled $300,000,
$619,436 and $508,832 for the years ended July 31, 2001, 2002 and 2003,
respectively, which included agreements with former executives.
76
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
CONSULTING AGREEMENT
Effective November 2002, the Company and Mr. Richard Shore, an outside
consultant, entered into a consulting contract whereby the Company agreed
to pay Mr. Shore $30,000 a month for a period of six months.
During May 2003, Mr. Shore was appointed President of the Company. The
Company currently continues to make payments of $30,000 per month and an
employment contract is currently being negotiated.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
include cash balances at banks which at times exceed the federal deposit
insurance.
NOTE L - ACQUISITION OF PIPELINE INTERESTS
On March 30, 2001, the Company completed a settlement with CPSC and Cowboy,
which provided the Company with the remaining 50% interest in the US-Mexico
Pipelines, Matamoros Terminal Facility and related land, permits or
easements (Acquired Assets) previously constructed and/or owned by CPSC and
leased to the Company. Until the settlement was completed (see below), the
Company had recorded the remaining 50% portion of the US-Mexico Pipelines
and Matamoros Terminal Facility as a capital lease. In addition, as part of
the Settlement, the Company conveyed to CPSC all of its rights to a certain
property (Sold Asset). The foregoing is more fully discussed below. The
terms of the settlement did not deviate in any material respect from the
terms previously reported except that the fair value of the warrants issued
in connection with the settlement (see below) was reduced from $600,000 to
$300,000 as a result of a decrease in the market value of the Company's
common stock.
In connection with the settlement, the Company agreed to pay CPSC
$5,800,000 (Purchase Price) for the Acquired Assets, less agreed upon
credits and offsets in favor of the Company totaling $3,237,500. The
remaining $2,562,500 was paid at the closing of the settlement by a cash
payment of $200,000 to CPSC and the issuance to or for the benefit of CPSC
of two promissory notes in the amounts of $1,462,500 (CPSC Note) (payable
in 36 monthly installments of approximately $46,000 (reduced to payments of
approximately $42,000 beginning April 2003), including interest at 9% per
annum) and $900,000 (Other Note) (payable in 36 equal monthly installments
of approximately $29,000 (see note H), including interest at 9% per annum).
The Other Note is collateralized by a first priority security interest in
the U.S. portion of the pipelines comprising the Acquired Assets. The CPSC
Note is also collateralized by a security interest in the Acquired Assets,
which security interest is subordinated to the security interest which
secures the Other Note. In addition, the security interest granted under
the CPSC Note is shared on a pari passu basis with certain other creditors
of the Company (see notes H and K). Under the terms of the CPSC Note, the
Company is entitled to certain offsets related to future costs which may be
incurred by the Company in connection with the Acquired Assets. In addition
to the payments described above, the Company agreed to assume certain
liabilities which were previously owed by CPSC in connection with
construction of the Acquired Assets. CPSC also transferred to the Company
any right that it held to any amounts owing from Termatsal for cash and/or
equipment provided by CPSC to Termatsal, including approximately $2,600,000
of cash advanced to Termatsal, in connection with construction of the
Mexican portion of the Acquired Assets.
77
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - ACQUISITION OF PIPELINE INTERESTS - CONTINUED
The Sold Asset transferred to CPSC in connection with the settlement
consisted of real estate of the Company with an original cost to the
Company of $3,800,000 and with a remaining book value totaling
approximately $1,908,000 (after giving effect to credits provided to the
Company included in the financial terms described above). CPSC agreed to be
responsible for payments required in connection with the Debt related to
the original purchase by the Company of the Sold Asset totaling
approximately $1,908,000. Through March 2003, CPSC's obligations under the
Debt were paid by the Company through direct offsets by the Company against
the CPSC Note. During April 2003, CPSC paid the remaining amount due under
the Debt. CPSC also granted the Company a pipeline related easement on the
Sold Asset. Until the Debt was fully paid, the principal of $1,908,000 plus
accrued and unpaid interest was included in long-term debt and the
corresponding amount required to be paid by CPSC was recorded as a mortgage
receivable (see note H). In addition to the Purchase Price above, CPSC
received from the Company warrants to purchase 175,000 shares of common
stock of the Company at an exercise price of $4.00 per share exercisable
through March 30, 2004, such shares having a fair value totaling
approximately $300,000. This amount had been included as part of the cost
of the Acquired Assets in the consolidated financial statements as of July
31, 2001.
Until the security interests as described above are perfected, Mr. Richter
is providing a personal guarantee for the punctual payment and performance
under the CPSC Note.
NOTE M - ACQUISITION OF MEXICAN SUBSIDIARIES
Effective April 1, 2001, the Company completed the purchase of 100% of the
outstanding common stock of both Termatsal and PennMex (Mexican
Subsidiaries), previous affiliates of the Company which were principally
owned by Mr. Bracamontes (see note D). The Company paid a nominal purchase
price. As a result of the acquisition, the Company has included the results
of the Mexican Subsidiaries in its consolidated financial statements at
July 31, 2001, 2002 and 2003. Since inception, the operations of the
Mexican Subsidiaries had been funded by the Company and such amounts funded
were included in the Company's consolidated financial statements prior to
the acquisition date. Therefore, there were no material differences between
the amounts previously reported by the Company and the amounts that would
have been reported by the Company had the Mexican Subsidiaries been
consolidated since inception.
During July 2003 the Company acquired an option to purchase Tergas for a
nominal price from an officer and consultant of the Company (see note D).
NOTE N - MEXICAN OPERATIONS
Under current Mexican law, foreign ownership of Mexican entities involved
in the distribution of LPG or the operation of LPG terminal facilities is
prohibited. Foreign ownership is permitted in the transportation and
storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation
permit and the Mexican Subsidiaries own, lease, or are in the process of
obtaining the land or rights of way used in the construction of the Mexican
portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines, the Matamoros Terminal Facility
and the Saltillo Terminal. The Company's Mexican affiliate, Tergas, S.A. de
C.V. (Tergas), has been granted the permit to operate the Matamoros
Terminal Facility and the Company relies on Tergas' permit to continue its
delivery of LPG at the Matamoros Terminal Facility. Tergas is owned 95% by
an officer of the Company, and the remaining balance is owned by a
consultant of the Company (see note M). The Company pays Tergas its actual
cost for distribution services at the Matamoros Terminal Facility plus a
small profit.
78
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE N - MEXICAN OPERATIONS - CONTINUED
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, the Company is subject to the tax laws of Mexico
which, among other things, require that the Company comply with transfer
pricing rules, the payment of income, asset and ad valorem taxes, and
possibly taxes on distributions in excess of earnings. In addition,
distributions to foreign corporations, including dividends and interest
payments may be subject to Mexican withholding taxes.
NOTE O - FOURTH QUARTER ADJUSTMENTS - UNAUDITED
The net loss for the quarter ended July 31, 2001, included the following
material fourth quarter adjustments: (i) an allowance for uncollectible
receivables of approximately $200,000, (ii) through-put deficiency fees of
approximately $660,000 above amounts previously estimated, and (iii) an
adjustment to reduce sales of approximately $507,000.
The net income for the quarter ended July 31, 2002, included the following
material fourth quarter adjustments: (i) approximately $170,000 for reduced
through-put fees previously estimated in a prior quarter and (ii)
approximately $270,000 related to LPG costs incurred in a prior quarter
above amounts previously estimated.
The net loss for the quarter ended July 31, 2003, included the following
material fourth quarter adjustments: (i) approximately $800,000 for the
formation of a registered limited partnership (see note R) which did not
result in the raising of capital, (ii) approximately $520,000 of salaries
and payroll related expenses (see note D) and (iii) approximately $200,000
related to the settlement of litigation including legal fees of
approximately $153,000 (see note K).
NOTE P - REALIZATION OF ASSETS
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States of America, which contemplate continuation of the Company as a going
concern. The Company has had an accumulated deficit since inception and has
a deficit in working capital. In addition, significantly all of the
Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the Extending Noteholders' notes, the
$250,000 Note, the RZB Credit Facility and the notes related to the
settlement. Unless RZB authorizes an extension, the RZB Credit Facility
will be reduced to $12,000,000 after January 31, 2004. The Extending
Noteholders' notes and the $250,000 Note, which total $1,820,750 at July
31, 2003 are due on December 15, 2003 (see note H).
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note R). As a result of the
Spin-Off, the Company's stockholders' equity will be reduced by the amount
of the Spin-Off which may result in a deficit in stockholders' equity and a
portion of the Company's current cash flow from operations will be shifted
to the Partnership. Therefore, the Company's remaining cash flow may not be
sufficient to allow the Company to pay its federal income tax liability
resulting from the Spin-Off, if any, and other liabilities and obligations
when due. The Partnership will be liable as guarantor on the Company's
collateralized debt discussed in the preceding paragraph and will continue
to pledge all of its assets as collateral. In addition, the Partnership has
agreed to indemnify the Company for a period of three years from the fiscal
year end that includes the date of the Spin-Off for any federal income tax
liabilities resulting from the Spin-Off in excess of $2,500,000.
79
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - REALIZATION OF ASSETS - CONTINUED
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon the ability of the Company to
(1) restructure certain of the obligations discussed in the first paragraph
and/or generate sufficient cash flow through operations or additional debt
or equity financing to pay its liabilities and obligations when due, or (2)
the ability of the Partnership to meet its obligations related to its
guarantees and tax agreement in the event the Spin-Off occurs if the
Company does not accomplish the restructuring or generate sufficient cash
flow. The consolidated financial statements do not include any adjustments
related to the recoverability and classification of recorded asset amounts
or amounts and classification of liabilities that might be necessary should
the Company be unable to continue in existence.
To provide the Company with the ability it believes necessary to continue
in existence, management is negotiating with PMI to extend the contract
(see note Q) and increase the minimum monthly sales volume. In addition,
management is taking steps to (i) obtain additional sale contracts
commensurate with supply agreements (ii) increase the number of customers
assuming deregulation of the LPG industry in Mexico, (iii) raise additional
debt and/or equity capital, (iv) increase and extend the RZB Credit
Facility and (v) restructure certain of its liabilities and obligations.
At July 31, 2003, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $5,300,000.
NOTE Q - CONTRACTS
LPG SALES TO PMI
The Company entered into sales agreements with PMI for the period from
April 1, 2000 through March 31, 2001 (Old Agreements), for the annual sale
of a combined minimum of 151,200,000 gallons of LPG, mixed to PMI
specifications, subject to seasonal variability, which was delivered to PMI
at the Company's terminal facilities in Matamoros, Tamaulipas, Mexico, or
alternative delivery points as prescribed under the Old Agreements.
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7,500,000 gallons resulting in a new annual combined
minimum commitment of 158,700,000 gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (Confirmation) on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of
19,000,000 gallons at indexed variable posted prices plus premiums that
provide the Company with annual fixed margins, which increase annually over
a three-year period. The Company was also entitled to receive additional
fees for any volumes which were undelivered. From April 1, 2001 through
December 31, 2001, the Company and PMI operated under the terms provided
for in the Confirmation. During January 1, 2002 through February 28, 2002,
PMI purchased monthly volumes of approximately 17,000,000 gallons per month
at slightly higher premiums then those specified in the Confirmation.
80
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - CONTRACTS - CONTINUED
LPG SALES TO PMI - CONTINUED
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39,600,000 gallons (Sold LPG) for which PMI had not taken
delivery. The Company received the posted price plus other fees on the Sold
LPG but did not receive the fixed margin referred to in the Confirmation
(see note B9. At July 31, 2001, the obligation to deliver LPG totaled
approximately $11,500,000 related to such sales (approximately 26,600,000
gallons). During the period from December 1, 2001 through March 31, 2002,
the Company delivered the Sold LPG to PMI and collected the fixed margin
referred to in the Confirmation.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17,000,000 gallons of LPG, subject to monthly
adjustments based on seasonality (Contract). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party upon
90 days written notice, or upon a change of circumstances as defined under
the Contract.
In connection with the Contract, the parties also executed a settlement
agreement, whereby the parties released each other in connection with all
disputes between the parties arising during the period April 1, 2001
through February 28, 2002, and previous claims related to the contract for
the period April 1, 2000 through March 31, 2001.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative
terminal in the event the Matamoros Terminal Facility cannot be used.
Revenues from PMI totaled approximately $132,800,000 for the year ended
July 31, 2003, representing approximately 82% of total revenues for the
period.
LPG SUPPLY AGREEMENTS
Effective October 1, 1999, the Company and Exxon entered into a ten year
LPG supply contract, as amended (Exxon Supply Contract), whereby Exxon has
agreed to supply and the Company has agreed to take, 100% of Exxon's owned
or controlled volume of propane and butane available at Exxon's King Ranch
Gas Plant (Plant) up to 13,900,000 gallons per month blended in accordance
with required specifications (Plant Commitment). For the year ending July
31, 2003, under the Exxon Supply Contract, Exxon has supplied an average of
approximately 13,800,000 gallons of LPG per month. The purchase price is
indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (ECCPL) operational in September 2000. The ability
to utilize the ECCPL allows the Company to acquire an additional supply of
propane from other propane suppliers located near Corpus Christi, Texas
(Additional Propane Supply), and bring the Additional Propane Supply to the
Plant (ECCPL Supply) for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122,000,000 gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay minimum utilization
fees associated with the use of the ECCPL until September 2004. Thereafter
the utilization fee will be based on the actual utilization of the ECCPL.
81
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - CONTRACTS - CONTINUED
LPG SUPPLY AGREEMENTS - CONTINUED
In September 1999, the Company and El Paso entered into a three year supply
agreement (El Paso Supply Agreement) whereby El Paso agreed to supply and
the Company agreed to take, a monthly average of 2,500,000 gallons of
propane (El Paso Supply) beginning in October 1999 and expiring on
September 30, 2002. The El Paso Supply Agreement was not renewed. The
purchase price was indexed to variable posted prices.
In March 2000, the Company and Koch entered into a three year supply
agreement (Koch Supply Contract) whereby Koch has agreed to supply and the
Company has agreed to take, a monthly average of 8,200,000 gallons (Koch
Supply) of propane beginning April 1, 2000, subject to the actual amounts
of propane purchased by Koch from the refinery owned by its affiliate, Koch
Petroleum Group, L.P. In March 2003 the Company extended the Koch Supply
Contract for an additional year pursuant to the Koch Supply Contract which
provides for automatic annual renewals unless terminated in writing by
either party. For the year ending July 31, 2003, under the Koch Supply
Contract, Koch has supplied an average of approximately 5,800,000 gallons
of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, prior to April 2002 the Company paid additional
charges associated with the construction of a new pipeline interconnection
which was paid through additional adjustments to the purchase price
(totaling approximately $1,000,000) which allows deliveries of the Koch
Supply into the ECCPL.
During March 2000, the Company and Duke entered into a three year supply
agreement (Duke Supply Contract) whereby Duke has agreed to supply and the
Company has agreed to take, a monthly average of 1,900,000 gallons (Duke
Supply) of propane or propane/butane mix beginning April 1, 2000. In March
2003 the Company extended the Duke Supply Contract for an additional year
pursuant to the Duke Supply Contract which provides for automatic annual
renewals unless terminated in writing by either party. The purchase price
is indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(Suppliers). The Company's aggregate costs per gallon to purchase LPG (less
any applicable adjustments) are below the aggregate sales prices per gallon
of LPG sold to its customers.
As described above, the Company has entered into supply agreements for
quantities of LPG totaling approximately 24,000,000 gallons per month
excluding El Paso (actual deliveries have been approximately 21,300,000
gallons per month during the year ended July 31, 2003 excluding El Paso),
although the Contract provides for lesser quantities.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated
with the storage, disposal and/or changes in LPG prices resulting from the
excess of the Plant Commitment, Koch Supply or Duke Supply over actual
sales volumes. Under the terms of the Supply Contracts, the Company must
provide letters of credit in amounts equal to the cost of the product to be
purchased. In addition, the cost of the product purchased is tied directly
to overall market conditions. As a result, the Company's existing letter of
credit facility may not be adequate to meet the letter of credit
requirements under the agreements with the Suppliers or other suppliers due
to increases in quantities of LPG purchased and/or to finance future price
increases of LPG.
82
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY
On July 10, 2003, the Company formed Rio Vista Energy Partners L.P.
(Partnership), a Delaware partnership. The Partnership is a wholly owned
subsidiary of the Company. The Partnership has invested in two
subsidiaries, Rio Vista Operating Partnership L.P. (.1% owned by the
Partnership and 99.9% owned by the Company) and Rio Vista Operating GP LLC
(wholly owned by the Partnership). The above subsidiaries are newly formed
and are currently inactive.
The Company formed the Partnership for the purpose of transferring a 99.9%
interest in Rio Vista Operating Partnership L.P., which will own
substantially all of the Company's owned pipeline and terminal assets in
Brownsville and Matamoros, (Asset Transfer) in exchange for a 2% general
partner interest and a 98% limited partnership interest in the Partnership.
The Company intends to spin off 100% of the limited partner units to its
common stockholders (Spin-Off), resulting in the Partnership becoming an
independent public company. The remaining 2% general partner interest will
be initially owned and controlled by the Company and the Company will be
responsible for the management of the Partnership. The Company will account
for the Spin-Off at historical cost.
During September 2003, the Company's Board of Directors and the Independent
Committee of its Board of Directors formally approved the terms of the
Spin-Off and the Partnership filed a Form 10 registration statement with
the Securities and Exchange Commission. The Board of Directors anticipates
that the Spin-Off will occur in late 2003 or in 2004, subject to a number
of conditions, including the receipt of an independent appraisal of the
assets to be transferred by the Company to the Partnership in connection
with the Spin-Off that supports an acceptable level of federal income taxes
to the Company as a result of the Spin-Off; the absence of any contractual
and regulatory restraints or prohibitions preventing the consummation of
the Spin-Off; and final action by the Board of Directors to set the record
date and distribution date for the Spin-Off and the effectiveness of the
registration statement.
Each shareholder of the Company will receive one common unit of the limited
partnership interest in the Partnership for every eight shares of the
Company's common stock owned as of the record date.
Warrants issued to holders of the existing unexercised warrants of the
Company will be exchanged in connection with the Spin-Off whereby the
holder will receive options to acquire unissued units in the Partnership
and unissued common shares of the Company in exchange for the existing
warrants. The number of units and shares subject to exercise and the
exercise price will be set to equalize each option's value before and after
the Spin-Off.
Ninety-eight percent of the cash distributions from the Partnership will be
distributed to the limited unit holders and the remaining 2% will be
distributed to the general partner for distributions up to $1.25 per unit
annually (approximately $2,500,000 per year). Distributions in excess of
that amount will be shared by the limited unit holders and the general
partner based on a formula whereby the general partner will receive
disproportionately more distributions per unit than the limited unit
holders as annual cash distributions exceed certain milestones.
Subsequent to the Asset Transfer, the Partnership will sell LPG directly to
PMI and will purchase LPG from the Company under a long-term supply
agreement. The purchase price of the LPG from the Company will be
determined based on the Company's cost to acquire LPG and a formula that
takes into consideration operating costs of both the Company and the
Partnership.
83
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
In connection with the Spin-Off, the Company will grant to Mr. Richter and
Shore Capital LLC (Shore), a company owned by Mr. Shore, options to each
purchase 25% of the ownership interests in the Company's general partner
interest in the Partnership. It is anticipated that Mr. Richter and Shore
will exercise these options immediately after the Spin-Off occurs. The
exercise price for each option will be the pro rata share (.5%) of the
Partnership's tax basis capital immediately after the Spin-Off. The Company
will retain voting control of the Partnership pursuant to a voting
agreement. In addition, Shore will also receive an option to acquire 5% of
the common stock of the Company and 5% of the limited partnership interest
in the Partnership at a combined equivalent exercise price of $2.20 per
share.
The Partnership will be liable as guarantor for the Company's
collateralized debt (see note P) and will continue to pledge all of its
assets as collateral. The Partnership may also be prohibited from making
any distributions to unit holders if it would cause an event of default, or
if an event of default is existing, under the Company's revolving credit
facilities, or any other covenant which may exist under any other credit
arrangement or other regulatory requirement at the time.
The Spin-Off will be a taxable transaction for federal income tax purposes
(and may also be taxable under applicable state, local and foreign tax
laws) to both the Company and its stockholders. The Company intends to
treat the Spin-Off as a "partial liquidation" for federal income tax
purposes. A "partial liquidation" is defined under Section 302(e) of the
Code as a distribution that (i) is "not essentially equivalent to a
dividend," as determined at the corporate level, which generally requires a
genuine contraction of the business of the corporation, (ii) constitutes a
redemption of stock and (iii) is made pursuant to a plan of partial
liquidation and within the taxable year in which the plan is adopted or
within the succeeding taxable year.
The Company may have a federal income tax liability in connection with the
Spin-Off. If the income tax liability resulting from the Spin-Off is
greater than $2,500,000, the Partnership has agreed to indemnify the
Company for any tax liability resulting from the transaction which is in
excess of that amount.
The following unaudited pro forma condensed consolidated financial
information for the Company give effect to the Asset Transfer and the
resulting allocation of sales, cost of goods sold and expenses, and to
certain pro forma adjustments. The unaudited pro forma condensed
consolidated statement of income for the year ended July 31, 2003 assumes
that the above transaction was consummated as of August 1, 2002. The
unaudited pro forma condensed consolidated balance sheet assumes that the
transaction was consummated on July 31, 2003. Because the Company has
control of the Partnership by virtue of its ownership and related voting
control of the general partner, the Partnership has been consolidated with
the Company and the interests of the limited partners have been classified
as minority interests in the unaudited pro forma condensed consolidated
financial information.
84
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET
JULY 31, 2003
(UNAUDITED)
AS REPORTED PRO FORMA PRO FORMA
JULY 31, 2003 ADJUSTMENTS JULY 31, 2003
---------------- ------------------- --------------
ASSETS:
Current Assets
Cash (restricted cash of $3,404,782) $ 3,475,846 $ 154,669 (1) $ 3,630,515
Trade accounts receivable, net 4,143,458 - 4,143,458
Inventories 878,082 - 878,082
Assets held for sale 720,000 - 720,000
Prepaid expenses and other current assets 476,109 476,109
---------------- ------------------- --------------
Total Current Assets 9,693,495 154,669 9,848,164
Investment in Subsidiary - 15,466,943 (2) -
- (154,669) (1)
(15,033,939) (3)
(216,502) (5)
(61,833) (6)
Property Plant And Equipment - net 17,677,830 (15,466,943) (2) 17,677,830
15,466,943 (5)
Lease rights (net of accumulated amortization of
$707,535) 446,504 - 446,504
Other non-current assets 19,913 - 19,913
---------------- ------------------- --------------
Total Assets $ 27,837,742 $ 154,669 $ 27,992,411
================ =================== ==============
85
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET-CONTINUED
JULY 31, 2003
(UNAUDITED)
AS REPORTED PRO FORMA PRO FORMA
JULY 31, 2003 ADJUSTMENTS JULY 31, 2003
---------------- ----------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities
Current maturities of long-term debt $ 746,933 $ - $ 746,933
Short-term debt 1,744,128 - 1,744,128
Revolving line of credit - - -
LPG trade accounts payable 7,152,098 - 7,152,098
Other accounts payable 2,470,880 - (10) 2,470,880
Foreign taxes payable 60,000 - 60,000
Accrued liabilities 1,083,966 - 1,083,966
---------------- ----------------- ----------------
Total Current Liabilities 13,258,005 - 13,258,005
---------------- ----------------- ----------------
Long-term debt, less current maturities 60,000 - 60,000
Commitments and contingencies - - -
Minority interest in equity earnings of subsidiary - 15,250,441 (4) 15,250,441
Stockholders Equity:
Common stock - $.01 par value, 25,000,000 shares
authorized; 15,274,749 shares issued and outstanding 152,747 - - 152,747
Additional paid-in-capital 28,298,301 (15,250,441) (4) 28,985,643
15,250,441 (5)
687,342 (6)
Notes receivable from an officer and another party for
exercise of warrants, net of reserves of $535,736 (2,897,520) - - (2,897,520)
Accumulated deficit (11,033,791) (749,175) (6) (26,816,905)
(15,033,939) (3)
- (10)
---------------- ----------------- ----------------
Total Stockholders' equity 14,519,737 (15,095,772) (576,035)
---------------- ----------------- ----------------
Total Liabilities and Stockholders' equity $ 27,837,742 $ 154,669 $ 27,992,411
================ ================= ================
86
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED JULY 31, 2003
(UNAUDITED)
AS REPORTED PRO FORMA
AUGUST 1, 2002 - PRO FORMA AUGUST 1, 2002-
JULY 31, 2003 ADJUSTMENTS JULY 31, 2003
------------------ ---------------- -----------------
Revenues $ 162,489,565 $ - $ 162,489,565
Cost of goods sold 152,375,349 - 152,375,349
------------------ ---------------- -----------------
Gross Profit 10,114,216 - 10,114,216
------------------ ---------------- -----------------
Selling, general and administrative expenses
Legal and professional fees 2,597,065 300,000 (7) 2,897,065
Salaries and payroll related expenses 2,411,843 749,175 (6) 3,161,018
Other 1,380,009 150,000 (7) 1,530,009
------------------ ---------------- -----------------
6,388,917 1,199,175 7,588,092
------------------ ---------------- -----------------
Operating income (loss) 3,725,299 (1,199,175) 2,526,124
Other income (expense)
Interest expense (1,757,664) - (1,757,664)
Interest income 95,327 - 95,327
Settlement of litigation (145,153) - (145,153)
Minority interest in equity earnings of subsidiary - ( 1,997,499)(8) (1,997,499)
------------------ ---------------- -----------------
Income (loss) before taxes 1,917,809 (3,196,674) (1,278,865)
Provision (benefit) for income taxes (40,000) -(10) (40,000)
------------------ ---------------- -----------------
Net income (loss) $ 1,957,809 $ (3,196,674) $ (1,238,865)
------------------ ================ -----------------
Net income (loss) per common share $ 0.13 $ (.08)
================== ================
Net income (loss) per common share assuming dilution $ 0.13 $ (.08)
================== ================
Weighted average common shares outstanding 15,035,220 15,035,220
================== ================
87
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
YEAR ENDED JULY 31, 2003
------------------------
(UNAUDITED)
The following unaudited pro forma condensed consolidated financial information
(Pro Forma Statements) for the Company give effect to the Spin-off. The Pro
Forma Statements are based on the available information and contain certain
assumptions that the Company deems appropriate. The Pro Forma Statements do not
purport to be indicative of the financial position or results of operations of
the Company had the Spin-Off occurred on the dates indicated, nor are the Pro
Forma Statements necessarily indicative of the future financial position or
results of operations of the Company. The Pro Forma Statements should be read
in conjunction with the consolidated balance sheet of the Company.
BALANCE SHEET:
The unaudited pro forma condensed consolidated balance sheets assume that such
transactions were consummated on July 31, 2003.
(1) To record the exercise of the options granted to Shore and Mr. Richter
to each acquire a 25% general partner interest in the Partnership.
(2) To reflect the transfer of assets from the Company to the Partnership
in exchange for limited and general partnership interests.
(3) To record the Spin-Off of the Company's limited partnership interests
in the Partnership to its stockholders.
(4) To reflect minority interest in the equity of the Partnership.
(5) To eliminate intercompany transactions between the Company and the
Partnership.
(6) Represents the estimated intrinsic value associated with the (i)
options granted to Shore and Mr. Richter to acquire a 50% interest in
the general partner and (ii) options granted to Shore Capital LLC to
acquire a 5% limited partnership interest in the Partnership and 5%
interest in the common shares of the Company.
(10) Taxable income, if any, resulting from the Spin-Off is assumed to be
offset at July 31, 2003 by existing net operating loss carryforwards.
INCOME STATEMENT:
The unaudited pro forma condensed consolidated statements of income for the year
ended July 31, 2003 assume that the Spin-Off was consummated as of August 1,
2002.
(6) Represents the estimated intrinsic value associated with the (i)
options granted to Shore and Mr. Richter to acquire a 50% interest in
the general partner and (ii) options granted to Shore Capital LLC to
acquire a 5% limited partnership interest in the Partnership and 5%
interest in the common shares of the Company.
(7) Represents estimated additional direct costs, including tax related
services, public listing fees and transfer agent fees, resulting from
the Partnership becoming publicly traded.
(8) To record minority interest in earnings of the Partnership.
(9) Proforma earnings per share has been calculated based on pro forma
weighted average shares outstanding for the year ended July 31, 2003.
(10) Taxable income, if any, resulting from the Spin-Off is assumed to be
offset at July 31, 2003 by existing net operating loss carryforwards.
88
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE S - SUBSEQUENT EVENTS - UNAUDITED
In connection with a contract to upgrade its computer and information
systems, the Company entered into an agreement with a vendor during the
year ended July 31, 2003. On October 1, 2003, the vendor agreed to pay the
Company $210,000 for cancellation of the contract. This amount will be
included in earnings during the quarter ending October 31, 2003.
89
SCHEDULE II
PENN OCTANE CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 2003, 2002 AND 2001
Balance at Charged to
Beginning of Costs and Charged to Balance at End
Description Period Expenses Other Accounts Deductions of Period
- ---------------------------------------- ------------- ----------- --------------- ---------------- ----------
Year ended July
- ----------------
31, 2003
- --------
Allowance for
doubtful
accounts $ 5,783 $ - $ - $ - $ 5,783
Year ended July
- ----------------
31, 2002
- --------
Allowance for
doubtful
accounts $ 779,663 $ 5,783 $ - $ ( 779,663) $ 5,783
Year ended July
- ----------------
31, 2001
- --------
Allowance for
doubtful
accounts $ 562,950 $ 216,713 $ - $ - $ 779,663
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
The Company's management, including the principal executive officer and
principal financial officer, conducted an evaluation of the Company's
disclosure controls and procedures, as such term is defined under Rule
13a-14(c) promulgated under the Securities Exchange Act of 1934, as
amended, within 90 days of the filing date of this report. Based on their
evaluation, the Company's principal executive officer and principal
accounting officer concluded that the Company's disclosure controls and
procedures are effective.
There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referenced in paragraph
above.
90
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The directors and executive officers of the Company are as follows:
DIRECTOR
NAME OF DIRECTOR AGE POSITION WITH COMPANY SINCE
- ------------------------- -------- -------------------------------------------------------------------------- -----
Jerome B. Richter 67 Chairman of the Board of Directors and Chief Executive Officer 1992
Richard "Beau" Shore, Jr. 37 Director and President 2003
Charles Handly 66 Director, Chief Operating Officer and Executive Vice President 2003
Ian T. Bothwell 43 Director, Vice President, Treasurer, Chief Financial Officer and Assistant 1997
Secretary
Jerry L. Lockett 62 Director and Vice President 1999
Stewart J. Paperin 55 Director 1996
Harvey L. Benenson 55 Director 2000
Emmett M. Murphy 52 Director 2001
All directors were elected at the 2002 Annual Meeting of Stockholders of the
Company held on July 31, 2003. All directors hold office until the next annual
meeting of shareholders and until their successors are duly elected and
qualified or until their earlier resignation or removal.
JEROME B. RICHTER founded the Company and served as its Chairman of the Board
and Chief Executive Officer from the date of its organization in August 1992 to
December 1994, when he resigned from such positions and became Secretary and
Treasurer of the Company. He resigned from such positions in August 1996.
Effective October 1996, Mr. Richter was elected Chairman of the Board, President
and Chief Executive Officer of the Company. During May 2003, Mr. Richter,
resigned form his position as President of the Company upon the election of Mr.
Shore to such position.
RICHARD "BEAU" SHORE, JR. was elected President of the Company in May 2003. Mr.
Shore was elected to the board of directors in July 2003. Since 2001, Mr. Shore
has served as founder, President and CEO of Shore Capital LLC, a company
involved in investing in small, energy related ventures. From November 1998
through January 2001, Mr. Shore was the founder, President and CEO of Shore
Terminals, LLC, a company engaged in managing marine petroleum storage and
pipeline facilities. From 1994 through 1998, Mr. Shore was Vice President of
Wickland Oil Company. During the period November 2002 through April 2003, Shore
Capital LLC provided consulting services to the Company.
CHARLES HANDLY Mr. Handly was appointed Chief Operating Officer and Executive
Vice President of the Company in May 2002. From August 2002 through April 2003,
Mr. Handly served as Vice President of the Company. From August 2000 through
July 2002, Mr. Handly provided consulting services to the Company. Mr. Handly
was elected to the board of directors in July 2003. Mr. Handly retired from
Exxon Corporation on February 1, 2000 after 38 years of service. From 1997
until January 2000, Mr. Handly was Business Development Coordinator for gas
liquids in Exxon's Natural Gas Department. From 1987 until 1997, Mr. Handly was
supply coordinator for two Exxon refineries and 57 gas plants in Exxon's Supply
Department.
IAN T. BOTHWELL was elected Vice President, Treasurer, Assistant Secretary and
Chief Financial Officer of the Company in October 1996 and a director of the
Company in March 1997. Since July 1993, Mr. Bothwell has been a principal of
Bothwell & Asociados, S.A. de C.V., a Mexican management consulting and
financial
91
advisory company that was founded by Mr. Bothwell in 1993 and specializes in
financing infrastructure projects in Mexico. From February 1993 through November
1993, Mr. Bothwell was a senior manager with Ruiz, Urquiza y Cia., S.C., the
affiliate in Mexico of Arthur Andersen L.L.P., an accounting firm. Mr. Bothwell
also serves as Chief Executive Officer of B & A Eco-Holdings, Inc., the company
formed to purchase the Company's CNG assets.
JERRY L. LOCKETT joined the Company as a Vice President in November 1998. Prior
to joining the Company, Mr. Lockett held a variety of positions during a
thirty-one year career with Union Carbide Corporation in sales management,
hydrocarbon supply and trading, and strategic planning. He also served in a
management position with Union Carbide's wholly-owned pipeline subsidiaries.
STEWART J. PAPERIN was elected a director of the Company in February 1996.
Since July 1996, Mr. Paperin has served as Executive Vice President of the Soros
Foundations Open Society Institute, which encompasses the charitable operations
of forty foundations in Central and Eastern Europe, the United States, Africa,
and Latin America. From January 1994 to July 1996, Mr. Paperin was President of
Capital Resources East Ltd., a diversified consulting and investment firm in New
York. He served as president of Brooke Group International, a United States
based leveraged buy-out firm operating in the former Soviet Union. Brooke Group
International is a corporation controlled by Brooke Group. From 1989 to 1990,
he served as Chief Financial Officer of the Western Union Corporation.
HARVEY L. BENENSON was elected a director of the Company in August 2000. Mr.
Benenson has been Managing Director, Chairman and Chief Executive Officer of
Lyons, Benenson & Company Inc., a management consulting firm, since 1988, and
Chairman of the Benenson Strategy Group, a strategic research, polling and
consulting firm affiliated with Lyons, Benenson & Company Inc., since July 2000.
Earlier, Mr. Benenson was a partner in the management consulting firm of Cresap,
McCormick and Paget from 1974 to 1983, and Ayers, Whitmore & Company from 1983
to 1988.
EMMETT M. MURPHY was elected a director of the Company in November 2001. In
April 1996, Mr. Murphy founded Paradigm Capital Corp., Fort Worth, Texas, an
investment firm, and he has been the President and Chief Executive Officer of
Paradigm Capital since that time. From March 1981 to April 1996, Mr. Murphy was
a Partner in Luther King Capital Management, Fort Worth, Texas, a registered
investment advisor. Mr. Murphy has been a Chartered Financial Analyst since
1979. He received a Bachelor of Science degree from the University of
California at Berkeley in 1973 and a Master of Business Administration degree
from Columbia University in 1975.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act, requires the Company's directors and
officers, and persons who own more than 10% of a registered class of the
Company's equity securities, to file initial reports of ownership and reports of
changes in ownership with the SEC. Such persons are required by the SEC to
furnish the Company with copies of all Section 16(a) forms they file. Based
solely on its review of the copies of Forms 3, 4 and 5 received by it, the
Company believes that all directors, officers and 10% stockholders complied with
such filing requirements.
92
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Company's compensation to executive management was administered by the
Compensation Committee of the Board of Directors. As of July 31, 2003, the
Compensation Committee was comprised of four directors, of which all but
one are outside directors, who report to the Board of Directors on all
compensation matters concerning the Company's executive officers (the
"Executive Officers"), including the Company's Chief Executive Officer and
the Company's other Executive Officers (collectively, with the Chief
Executive Officer, the "Named Executive Officers") (see below). In
determining annual compensation, including bonus, and other incentive
compensation to be paid to the Named Executive Officers, the Compensation
Committee considers several factors including overall performance of the
Named Executive Officer (measured in terms of financial performance of the
Company, opportunities provided to the Company, responsibilities, quality
of work and/or tenure with the Company), and considers other factors
including retention and motivation of the Named Executive Officers and the
overall financial condition of the Company. The Compensation Committee
provides compensation to the Named Executive Officers in the form of cash,
equity instruments and forgiveness of interest incurred on indebtedness to
the Company.
The overall compensation provided to the Named Executive Officers
consisting of base salary and the issuance of equity instruments is
intended to be competitive with the compensation provided to other
executives at other companies after adjusting for factors described above,
including the Company's financial condition during the term of employment
of the Executive Officers.
BASE SALARY: The base salary is approved based on the Named Executive
Officer's position, level of responsibility and tenure with the Company.
CHIEF EXECUTIVE OFFICER'S COMPENSATION: During fiscal year 2003, Mr.
Richter was paid in accordance with the terms of his employment agreement
which was in effect during the period. The Board of Directors continued to
ratify prior elections not to accrue any future interest payable by Mr.
Richter on his note to acquire shares of common stock of the Company to the
Company so long as Mr. Richter continued to provide guarantees to certain
of the Company's creditors. The Compensation Committee determined that Mr.
Richter's compensation under the employment agreement is fair to the
Company, especially considering the position of Mr. Richter with the
Company.
COMPENSATION COMMITTEE
STEWART J. PAPERIN
HARVEY L. BENENSON
EMMETT M. MURPHY
JEROME B. RICHTER
93
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Jerome B. Richter, Stewart J. Paperin, Emmett M. Murphy and Harvey L.
Benenson served as the members of the Compensation Committee during fiscal year
2003. Mr. Richter is the Chief Executive Officer of the Company, so his
compensation is subject to ratification by the Board of Directors.
EXECUTIVE COMPENSATION
During December 1999, the Board authorized the implementation of a management
incentive program whereby officers and directors of the Company received
warrants to purchase 1,400,000 shares of common stock of the Company and
warrants to purchase 100,000 shares of common stock of the Company were received
by consultants (the "Incentive Warrants"). The Incentive Warrants have an
exercise price equal to $4.60 per share and will vest ratably on a monthly basis
over three years or immediately upon a change in control of the Company. The
exercise price per share of the warrants was equal to or greater than the quoted
market price per share at the measurement date.
As bonuses to four of its executive officers for the year ended July 31, 2000,
the Company granted each executive officer warrants to purchase 10,000 shares of
common stock at an exercise price of $6.94 per share exercisable through July
31, 2005. The exercise price per share of the warrants was equal to or greater
than the quoted market price per share at the measurement date.
As a bonus to a director and executive officer of the Company, during November,
2000, the Company granted warrants to purchase 200,000 shares of Common Stock of
the Company at an exercise price of $7.00 per share exercisable for five years.
The exercise price per share of the warrants was equal to or greater than the
quoted market price per share at the measurement date.
94
The following table sets forth annual and all other compensation to the Named
Executive Officers, for services rendered in all capacities to the Company and
its subsidiaries during each of the fiscal years indicated. This information
includes the dollar values of base salaries, bonus awards, the number of
warrants granted and certain other compensation, if any, whether paid or
deferred. The Company does not grant stock appreciation rights or other
long-term compensation plans for employees.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
------------------------------------------ ------------------------------------
AWARDS PAYOUTS
------------ ---------
ALL OTHER SECURITIES
ANNUAL RESTRICTED UNDERLYING
NAME AND PRINCIPAL COMPEN- STOCK OPTIONS/ LTIP
POSITION YEAR SALARY ($) BONUS ($) SATION ($) AWARDS ($) SARS (#) PAYOUTS ($)
Jerome B. Richter, 2003 300,000 208,832(3) - - - -
Chairman of the 2002 300,000 319,436(3) - - - -
Board and Chief 2001 300,000 - - - - -
Executive Officer
Richard Shore, Jr., 2003 78,462 - - - - -
President 2002 - - - - - -
2001 - - - - - -
Charles Handly, 2003 138,461 - - - - -
Chief Operating Officer 2002 6,923 - - - - -
and Executive Vice 2001 - - - - - -
President
Ian T. Bothwell, 2003 180,000 - - - - -
Vice President, Treasurer, 2002 168,000 - - - - -
Assistant Secretary and 2001 168,000 1,026,351(2) - - - -
Chief Financial Officer
Jorge R. Bracamontes 2003 - - - - - -
2002 - - - - - -
2001 - - - - - -
Jerry L. Lockett, 2003 132,000 - - - - -
Vice President 2002 132,000 - - - - -
2001 132,000 - - - - -
ALL OTHER
NAME AND PRINCIPAL COMPENSATION
POSITION ($)
Jerome B. Richter, 54,733(4)
Chairman of the -
Board and Chief -
Executive Officer
Richard Shore, Jr., -
President -
Charles Handly, -
Chief Operating Officer -
and Executive Vice
President
Ian T. Bothwell, -
Vice President, Treasurer, -
Assistant Secretary and -
Chief Financial Officer
Jorge R. Bracamontes 703,349(1)
180,000(1)
180,000(1)
Jerry L. Lockett, -
Vice President -
_____________________________________________
(1) Mr. Bracamontes received consulting fees totaling $180,000, $180,000
and $180,000 for services performed on behalf of the Company in Mexico
for the years ended July 31, 2001, 2002 and 2003. Mr. Bracamontes also
received $523,349 in severance costs for the year ended July 31, 2003.
(2) The fair market value of non-cash bonuses issued in the form of stock
warrants are determined by using the Black-Scholes Option Pricing
Model.
(3) Includes amounts to be paid in cash.
(4) In connection with Mr. Richter's employment contract, the Company paid
$54,733 in life insurance premiums on behalf of Mr. Richter.
95
AGGREGATED WARRANT EXERCISES DURING FISCAL 2003
AND WARRANT VALUES ON JULY 31, 2003
NUMBER OF SECURITIES VALUE OF UNEXERCISED
NUMBER OF SHARES UNDERLYING UNEXERCISED IN-THE-MONEY
ACQUIRED UPON VALUE REALIZED WARRANTS AT JULY 31, 2003 WARRANTS AT JULY 31, 2003
EXERCISE OF WARRANTS UPON EXERCISE (#) EXERCISABLE/ EXERCISABLE/UNEXERCISABLE
NAME (#) ($) UNEXERCISABLE ($)(1)
- -------------------- --------------------- --------------- ------------------------- --------------------------
Jerome B. Richter 0 0 540,000/0 24,300/0
Richard Shore, Jr. 0 0 0/0 0/0
Charles Handly 0 0 114,470/25,530 0/0
Ian T. Bothwell 0 0 332,511/7,489 24,300/0
Jorge R. Bracamontes 0 0 340,000/0 24,300/0
Jerry L. Lockett 0 0 240,000/0 24,300/0
(1) Based on a closing price of $3.31 per share of Common Stock on July 31, 2003.
EMPLOYMENT CONTRACTS
From February 2001 through July 2002, the Company continued the terms of
the previous six year employment agreement with Mr. Richter, the Chief
Executive Officer of the Company, which had expired in January 2001 (the
"Old Agreement"). Under the Old Agreement, Mr. Richter was entitled to
receive $300,000 in annual compensation until earnings exceed a gross
profit of $500,000 per month for an annual period (Minimum Gross Profit),
whereupon Mr. Richter was entitled to an increase in his salary to $40,000
per month for the first year of the agreement increasing to $50,000 per
month during the second year of the agreement. Mr. Richter was entitled to
an increase in his salary to $480,000 for the first year following the
period in which the Minimum Gross Profit is met, increasing to $600,000 per
year during the second year following the period in which the Minimum Gross
Profit is met. He was also entitled to an annual bonus of 5% of all pre-tax
profits of the Company. He was also entitled to receive warrants to
purchase 200,000 shares of Common Stock of the Company at an exercise price
of $5.00 per share upon the Company achieving the Minimum Gross Profit. Mr.
Richter's employment agreement also entitled him to a right of first
refusal to participate in joint venture opportunities in which the Company
may invest, contained a covenant not to compete for a period of one year
from his termination of the agreement and had restrictions on use of
confidential information.
Effective July 29, 2002, the Company entered into a new three year
employment agreement with Mr. Richter (the "Agreement"). Under the terms of
the Agreement, Mr. Richter is entitled to receive a monthly salary equal to
$25,000 and a minimum annual bonus payment equal to $100,000 plus five
percent (5%) of net income before taxes of the Company. In addition, Mr.
Richter was entitled to receive a warrant grant by December 31, 2002 in an
amount and with terms commensurate with prior practices. The Company has
yet to issue Mr. Richter his warrant grant in connection with the
Agreement.
In connection with the Agreement, the Company also agreed to forgive any
interest due from Mr. Richter pursuant to Mr. Richter's Promissory Note,
provided that Mr. Richter guarantees at least $2,000,000 of the Company's
indebtedness during any period of that fiscal year of the Company.
Furthermore, the Company agreed to forgive Mr. Richter's Promissory Note in
the event that either (a) the share price of the Company's common stock
trades for a period of 90 days at a blended average price equal to $6.20,
or (b) the Company is sold for a price per share (or an asset sale realizes
revenues per share) equal to $6.20.
96
Effective November 2002, the Company and Shore Capital LLC ("Shore
Capital"), a company owned by Mr. Shore, entered into a consulting contract
whereby the Company agreed to pay Shore Capital $30,000 a month for a
period of six months. Under the terms of the consulting contract, Shore
Capital received an exclusive right in the event the Company effectively
converts its current structure into a publicly traded limited partnership
(the "MLP"), to purchase up to a 50% voting interest in the general partner
of the MLP at a price not to exceed $330,000. In addition, in the event
that the conversion of the Company into an MLP was successful, Shore
Capital was also entitled to receive an option to acquire up to 5% interest
in the MLP at an exercise price not to exceed $1,650,000. The contract also
provided for the Company to offer Mr. Shore a two-year employment agreement
at the same rate provided for under the contract. The Company did not
convert to an MLP but is contemplating the Spin-Off referred to in note R
to the consolidated financial statements. Pursuant thereto, the Company
intends to grant to Shore Capital and Mr. Richter options to each purchase
25% of the Company's General Partners' interest. In addition the Company
intends to grant to Shore Capital an option to purchase up to 5% of the
outstanding common stock of the Company at a price per share of $1.14 if
the Spin-Off is consummated.
During May 2003, Mr. Shore was appointed President of the Company. The
Company has continued to make payments of $30,000 per month, and the
Company is currently negotiating an employment agreement with Mr. Shore.
COMPENSATION OF DIRECTORS
During the Board of Directors (the "Board") meeting held on September 3,
1999, the Board approved the implementation of a plan to compensate each
outside director serving on the Board (the "Plan"). Under the Plan, all
outside directors upon election to the Board are entitled to receive
warrants to purchase 20,000 shares of common stock of the Company and are
to be granted additional warrants to purchase 10,000 shares of common stock
of the Company for each year of service as a director. All such warrants
will expire five years after the warrants are granted. The exercise price
of the warrants issued under the Plan are equal to the average trading
price of the Company's common stock on the effective date the warrants are
granted, and the warrants vest monthly over a one year period.
97
STOCK PERFORMANCE GRAPH
The following graph compares the yearly percentage change in the Company's
cumulative, five-year total stockholder return with the Russell 2000 Index
and the NASD Index. The graph assumes that $100 was invested on August 1,
1998 in each of the Company's Common Stock, the Russell 2000 Index and the
NASD Index, and that all dividends were reinvested. The graph is not, nor
is it intended to be, indicative of future performance of the Company's
Common Stock.
The Company is not aware of a published industry or line of business index
with which to compare the Company's performance. Nor is the Company aware
of any other companies with a line of business and market capitalization
similar to that of the Company with which to construct a peer group index.
Therefore, the Company has elected to compare its performance with the
NASDAQ Index and Russell 2000 Index, an index of companies with small
capitalization.
PENN OCTANE CORPORATION
STOCK PERFORMANCE GRAPH
JULY 31, 2003
[GRAPHIC OMITTED]
- --------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
- ----------------------- ----- ------- ------- ------- ------ -------
Penn Octane Corporation $ 100 $ 60.00 $180.00 $100.00 $77.00 $ 83.00
- ----------------------- ----- ------- ------- ------- ------ -------
Russell 2000 Index $ 100 $105.96 $119.27 $115.49 $93.49 $113.41
- ----------------------- ----- ------- ------- ------- ------ -------
NASDAQ Index $ 100 $140.92 $201.19 $108.26 $70.94 $ 92.66
- --------------------------------------------------------------------------
98
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the amount of stock of the Company
beneficially owned as of October 10, 2003 by each person known by the
Company to own beneficially more than 5% of the outstanding shares of the
Company's outstanding common stock ("Common Stock").
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP OF PERCENT OF CLASS OF
NAME OF BENEFICIAL OWNER COMMON STOCK(1) COMMON STOCK
- --------------------------------------------------- ------------------------ --------------------
Jerome B. Richter (2) . . . . . . . . . . . . . . . 4,453,750 28.07%
CEC, Inc. (3) . . . . . . . . . . . . . . . . . . . 1,417,667 9.20%
The Apogee Fund, Paradigm Capital Corporation, and
Emmett M. Murphy (4) . . . . . . . . . . . . . . . 1,155,500 7.52%
Trellus Management Company, LLC(5). . . . . . . . . 836,392 5.46%
.. . . . . . . . . . . . .
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock
which are purchasable under warrants which are currently exercisable,
or which will become exercisable no later than 60 days after October
10, 2003, are deemed outstanding for computing the percentage of the
person holding such warrants but are not deemed outstanding for
computing the percentage of any other person. Except as indicated by
footnote and subject to community property laws where applicable, the
persons named in the table have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by
them.
(2) Includes 37,850 shares of Common Stock owned by Mrs. Richter and
540,000 shares of Common Stock issuable upon exercise of Common Stock
purchase warrants.
(3) One Radnor Corporate Center, 100 Matsonford Road, Suite 250, Radnor,
PA. Includes 74,067 shares of Common Stock issuable upon exercise of
Common Stock purchase warrants.
(4) 201 Main Street, Suite 1555, Fort Worth, Texas. Mr. Murphy, who became
a director of the Company in November, 2001, is the president of
Paradigm Capital Corporation, a Texas corporation, which in turn, is
the sole general partner of The Apogee Fund, L.P., a Delaware limited
partnership. All of the referenced stock and warrants are actually
owned by The Apogee Fund, and beneficial ownership of such securities
is attributable to Mr. Murphy and Paradigm Capital Corporation by
reason of their shared voting and disposition power with respect The
Apogee Fund assets. Includes 40,000 shares of Common Stock issuable
upon exercise of Common Stock purchase warrants.
(5) 350 Madison Avenue, 9th Floor, New York, New York.
99
The following table sets forth the amount of Common Stock of the Company
beneficially owned as of October 10, 2003 by each director of the Company, each
Named Executive Officer, and all directors and Named Executive Officers as a
group. Except as noted, the address of each person is Penn Octane Corporation,
77-530 Enfield Lane, Bldg. D, Palm Desert, CA.
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP OF PERCENT OF CLASS OF
NAME OF BENEFICIAL OWNER COMMON STOCK(1) COMMON STOCK
- ------------------------------------------------------ ------------------------ --------------------
Jerome B. Richter (2). . . . . . . . . . . . . . . . . 4,453,750 28.07%
Emmett M. Murphy (3) . . . . . . . . . . . . . . . . . 1,155,500 7.52%
Jorge R. Bracamontes (4) . . . . . . . . . . . . . . . 555,500 3.55%
Ian T. Bothwell (5). . . . . . . . . . . . . . . . . . 446,718 2.85%
Jerry L. Lockett (6) . . . . . . . . . . . . . . . . . 266,225 1.71%
Stewart J. Paperin (7) . . . . . . . . . . . . . . . . 213,762 1.38%
Charles Handly(8). . . . . . . . . . . . . . . . . . . 143,436 *
Harvey L. Benenson (9) . . . . . . . . . . . . . . . . 53,562 *
Richard "Beau" Shore, Jr . . . . . . . . . . . . . . . 16,000 *
All Directors and Named Executive Officers as a group
(9 people) (10 . . . . . . . . . . . . . . . . . . . . 7,304,453 42.54%
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock which
are purchasable under warrants which are currently exercisable, or which
will become exercisable no later than 60 days after October 10, 2003, are
deemed outstanding for computing the percentage of the person holding such
warrants but are not deemed outstanding for computing the percentage of any
other person. Except as indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them.
(2) Includes 37,850 shares of Common Stock owned by Mrs. Richter and 540,000
shares of Common Stock issuable upon exercise of Common Stock purchase
warrants.
(3) 201 Main Street, Suite 1555, Fort Worth, Texas. Mr. Murphy, who became a
director of the Company in November, 2001, is the president of Paradigm
Capital Corporation, a Texas corporation, which, in turn, is the sole
general partner of The Apogee Fund, L.P., a Delaware limited partnership.
All of the referenced stock is actually owned by The Apogee Fund;
beneficial ownership of such securities is attributed to Mr. Murphy by
reason of his voting and disposition power with respect to The Apogee Fund
assets. Includes 40,000 shares of Common Stock issuable upon exercise of
Common Stock purchase warrants.
(4) Includes 340,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants owned by Mr. Bracamontes and 15,000 shares of
Common Stock owned by Mrs. Bracamontes.
(5) Includes 340,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(6) Includes 240,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(7) Includes 163,562 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(8) Includes 123,436 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(9) Includes 53,562 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(10) Includes 1,840,559 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
100
EQUITY COMPENSATION PLANS
The following table provides information concerning the Company's equity
compensation plans as of July 31, 2003.
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS WARRANTS AND RIGHTS EQUITY COMPENSATION
PLANS (EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation
plans approved by 2,180,000 $ 4.79 1,500,000 (1)(2)
security holders
Equity compensation
plans not approved by 1,412,179 $ 2.69 -
security holders (3) __________ __________
Total 3,592,179 $ 3.97 1,500,000
========== ==========
(1) Pursuant to the Company's Board Plan, the outside directors are entitled to
receive warrants to purchase 20,000 shares of common stock of the Company
upon their initial election as a director and warrants to purchase 10,000
shares of common stock of the Company for each year of service as a
director.
(2) Pursuant to the Company's 2001 Warrant Plan, the Company may issue warrants
to purchase up to 1.5 million shares of common stock of the Company.
(3) The Company was not required to obtain shareholder approval for these
securities.
101
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During April 1997, Mr. Jerome B. Richter, the Company's Chief Executive
Officer, Chairman of the Board and former President, exercised warrants to
purchase 2.2 million shares of common stock of the Company, at an exercise
price of $1.25 per share. The consideration for the exercise of the
warrants included $22,000 in cash and a $2.7 million promissory note. The
note was due on April 11, 2000. On April 11, 2000, Mr. Richter's issued a
new promissory note totaling $3.2 million ("Mr. Richter's Promissory
Note"), representing the total unpaid principal and unpaid accrued interest
at the expiration of the original promissory note. During September 1999,
the Board of Directors of the Company agreed to offset interest due on Mr.
Richter's Promissory Note in consideration for providing collateral and
personal guarantees of Company debt. The principal amount of the note plus
accrued interest at an annual rate of 10.0%, except as adjusted for above,
was due on April 30, 2001. In November 2001 the Company extended the due
date to October 31, 2003 and the interest was adjusted to the prime rate on
November 7, 2001 (5.0%). In July 2002 the Company extended the due date to
July 29, 2005. In connection with the extension, the Company agreed in Mr.
Richter's employment agreement (see note K to the consolidated financial
statements) to continue to forgive any interest due from Mr. Richter
pursuant to Mr. Richter's Promissory Note, provided that Mr. Richter
guarantees at least $2.0 million of the Company's indebtedness during any
period of that fiscal year of the Company. Furthermore, the Company agreed
to forgive Mr. Richter's Promissory Note in the event that either (a) the
share price of the Company's common stock trades for a period of 90 days at
a blended average price equal to at least $6.20, or (b) the Company is sold
for a price per share (or an asset sale realizes revenues per share) equal
to at least $6.20. Mr. Richter is personally liable with full recourse to
the Company and has provided 1.0 million shares of common stock of the
Company as collateral. Those shares were subsequently pledged to the
holders of certain of the Company's debt obligations (see note H). Mr.
Richter's Promissory Note has been recorded as a reduction of stockholders'
equity.
On March 26, 2000, an affiliate of Mr. Jorge Bracamontes, a director and
executive officer of the Company, issued the Company a new promissory note
totaling $46,603, representing the total unpaid principal and interest due
under a prior promissory note due to the Company which matured March 26,
2000. The principal amount of the note plus accrued interest at an annual
rate of 10.0% was due in April 2001. During November 2001, the Company and
the affiliate of Mr. Bracamontes agreed to exchange 1,864 shares of Common
Stock of the Company held by the affiliate of Mr. Bracamontes for payment
of all unpaid interest owing to the Company through October 2001. In
addition, the Company agreed to extend the maturity date of the note held
by the affiliate of Mr. Bracamontes to October 31, 2003. The affiliate of
Mr. Bracamontes was personally liable with full recourse under such
promissory note and had provided the remaining 13,136 shares of Common
Stock of the Company as collateral.
During March 2000, Mr. Bracamontes exercised warrants to purchase 200,000
shares of Common Stock of the Company, at an exercise price of $2.50 per
share. The consideration for the exercise of the warrants included $2,000
in cash and a $498,000 promissory note. The principal amount of the note
plus accrued interest at an annual rate of 10.0% was due in April 2001.
During November 2001, the Company and Mr. Bracamontes agreed to exchange
19,954 shares of Common Stock of the Company held by Mr. Bracamontes for
payment of all unpaid interest owing to the Company through October 2001.
In addition, the Company agreed to extend the maturity date of the note
held by Mr. Bracamontes to October 31, 2003. Mr. Bracamontes was personally
liable with full recourse under such promissory note and had provided the
remaining 180,036 shares of Common Stock of the Company as collateral.
102
During July 2003, Mr. Bracamontes resigned from his position as a director
and officer of the Company. In connection with his resignation the Company
agreed to (i) forgive the remaining balance of his $498,000 promissory
note, (ii) forgive the remaining balance of his affiliate's $46,603
promissory note, (iii) issue 21,818 shares of the Company's common stock
(valued at approximately $75,000 and (iv) agreed to make certain payments
of up to $500,000 based on the success of future projects (the Company's
Chief Executive Officer agreed to guarantee these payments with 100,000 of
his shares of the common stock of the Company). Mr. Bracamontes will
continue to provide services and the Company will continue to make payments
to Mr. Bracamontes of $15,000 a month until March 31, 2004. All of the
above amounts totaling approximately $520,000 have been reflected in the
consolidated financial statements as of July 31, 2003 as salaries and
payroll related expenses. Simultaneously, Mr. Bracamontes sold his interest
in Tergas, S.A. de C.V. (an affiliate of the Company) to another officer of
the Company. The Company has an option to acquire Tergas, S.A. de C.V.
("Tergas") for a nominal price.
During September 2000, Mr. Ian Bothwell, a director and executive officer
of the Company, exercised warrants to purchase 200,000 shares of Common
Stock of the Company, at an exercise price of $2.50 per share. The
consideration for the exercise of the warrants included $2,000 in cash and
a $498,000 promissory note. The principal amount of the note plus accrued
interest at an annual rate of 10.5% was due in April 2001. During November
2001, the Company and Mr. Bothwell agreed to exchange 14,899 shares of
common stock of the Company held by Mr. Bothwell for payment of all unpaid
interest owing to the Company through October 2001. In addition, the
Company agreed to extend the maturity date of the note held by Mr. Bothwell
to October 31, 2003.
On September 10, 2000, the Board of Directors approved the repayment by a
company controlled by Mr. Bothwell (the "Buyer") of the $900,000 promissory
note to the Company through the exchange of 78,373 shares of common stock
of the Company owned by the Buyer, which were previously pledged to the
Company in connection with the promissory note. The exchanged shares had a
fair market value of approximately $556,000 at the time of the transaction
resulting in an additional loss of $84,000 which was included in the
consolidated statement of operations at July 31, 2000. The remaining note
had a balance of $214,355 and was collateralized by compressed natural gas
refueling station assets and 60,809 shares of the Company's common stock
owned by the Buyer.
During October 2002, the Company agreed to accept the compressed natural
gas refueling station assets with an appraised fair value of approximately
$800,000 as payment for all notes outstanding at the time (with total
principal amount of $652,759 plus accrued interest) owed to the Company by
Mr. Bothwell. In connection with the transaction, the Company adjusted the
fair value of the assets to $720,000 to reflect additional costs estimated
to be incurred in disposing of the assets. The Company also recorded
interest income as of July 31, 2003 on the notes of approximately $67,241,
which has been previously been reserved, representing the difference
between the adjusted fair value of the assets and the book value of the
notes.
In January 2002, the Company loaned Mr. Richter, $200,000 due in one year.
The Company had also made other advances to Mr. Richter of approximately
$82,000 as of July 31, 2002, which were offset per his employment agreement
against accrued and unpaid bonuses due to Mr. Richter. The note due from
Mr. Richter in the amount of $200,000 plus accrued interest as of January
31, 2003, was paid through an offset against previously accrued bonus and
profit sharing amounts due to Mr. Richter in January 2003.
During March 2003, warrants to purchase 250,000 shares of common stock of
the Company were exercised by Trellus Partners, L.P. for which the exercise
price totaling $625,000 was paid by reduction of a portion of the
outstanding debt and accrued interest owed to Trellus Partners, L.P. by the
Company. In addition, during March 2003, Trellus Partners, L.P. acquired
161,392 shares of Common Stock from the Company at a price of $2.50 per
share in exchange for cancellation of the remaining outstanding debt and
accrued interest owed to Trellus Partners, L.P. totaling $403,480.
103
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The Company has been billed as follows for the professional services of
Burton McCumber & Cortez, L.L.P. rendered during fiscal years 2002 and 2003:
2002 2003
---------- -----------
Audit Fees $ 245,304 $ 263,229
Audit - Related Fees $ - $ -
Tax Fees (1) $ 17,139 $ 12,420
All Other Fees $ 16,587(2) $ 165,746 (3)
(1) Represents fees billed for tax compliance, tax advice and tax planning
services.
(2) Represents fees billed for accounting and tax issues related to Mexico and
U.S.
(3) Represents fees billed for accounting and tax issues related to Mexico and
U.S. and $162,458 represents fees billed related to the Spin-Off.
The Company's audit committee approves the engagement of its independent auditor
to perform audit related services. The audit committee does not formally approve
specific amounts to be spent on non-audit related services which in the
aggregate do not exceed amounts to be spent on audit related services. In
determining the reasonableness of audit fees, the audit committee considers
historical amounts paid and the scope of services to be performed.
104
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
a. Financial Statements and Financial Statement Schedules.
The following documents are filed as part of this report:
(1) Consolidated Financial Statements:
Penn Octane Corporation
Independent Auditor's Report
Consolidated Balance Sheet as of July 31, 2002 and 2003
Consolidated Statements of Operations for the years ended July
31, 2001, 2002 and 2003
Consolidated Statement of Stockholders' Equity for the years
ended July 31, 2001, 2002 and 2003
Consolidated Statements of Cash Flows for the years ended July
31, 2001, 2002 and 2003
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
b. Reports on Form 8-K.
The following Report on Form 8-K is incorporated herein by reference:
Company's Current Report on Form 8-K filed on September 18,
2003 regarding the Company's Spin Off of Penn Octane's 100%
limited partner interest in Rio Vista Energy Partners L.P.
c. Exhibits.
THE FOLLOWING EXHIBITS ARE INCORPORATED HEREIN BY REFERENCE:
Exhibit No.
------------
3.1 Restated Certificate of Incorporation, as amended.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-QSB for the quarterly period ended April 30, 1997
filed on June 16, 1997, SEC File No. 000-24394).
3.2 Amended and Restated By-Laws of the Company. (Incorporated
by reference to the Company's Quarterly Report on Form
10-QSB for the quarterly period ended April 30, 1997 filed
on June 16, 1997, SEC File No. 000-24394).
3.3 The Company's Certificate of the Designation, Powers,
Preferences and Rights of the Series B. Class A Senior
Cumulative Preferred Stock, filed with the State of
Delaware.
10.1 Employment Agreement dated July 12, 1993 between the
Registrant and Jerome B. Richter. (Incorporated by reference
to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended October 31, 1993 filed on March 7,
1994, SEC File No. 000-24394).
105
10.2 Promissory Note and Pledge and Security Agreement dated
March 26, 1997 between M.I. Garcia Cuesta and the
Registrant. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly period
ended April 30, 1997 filed on June 16, 1997, SEC File No.
000-24394).
10.3 Promissory Note and Pledge and Security Agreement dated
April 11, 1997 between Jerome B. Richter and the Registrant.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-QSB for the quarterly period ended April 30, 1997
filed on June 16, 1997, SEC File No. 000-24394).
10.4 Lease dated October 20, 1993 between Brownsville Navigation
District of Cameron County, Texas and Registrant with
respect to the Company's land lease rights, including
related amendment to the Lease dated as of February 11, 1994
and Purchase Agreement. (Incorporated by reference to the
Company's Quarterly Report on Form 10-QSB filed for the
quarterly period ended April 30, 1994 on February 25, 1994,
SEC File No. 000-24394).
10.5 Lease Amendment dated May 7, 1997 between Registrant and
Brownsville Navigation District of Cameron County, Texas.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-QSB for the quarterly period ended April 30, 1997
filed on June 16, 1997, SEC File No. 000-24394).
10.6 Lease dated September 1, 1993 between Seadrift Pipeline
Corporation and Registrant with respect to the Company's
pipeline rights. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly period
ended October 31, 1993 filed on March 7, 1994, SEC File No.
000-24394).
10.7 Lease Amendment dated May 21, 1997 between Seadrift Pipeline
Corporation and the Registrant. (Incorporated by reference
to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended April 30, 1997 filed on June 16,
1997, SEC File No. 000-24394).
10.8 Continuing Agreement for Private Letters of Credit dated
October 14, 1997 between RZB Finance LLC and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1997 filed on November
13, 1997, SEC File No. 000-24394)
10.9 Promissory Note dated October 14, 1997 between RZB Finance
LLC and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July
31, 1997 filed on November 13, 1997, SEC File No. 000-24394)
10.10 General Security Agreement dated October 14, 1997 between
RZB Finance LLC and the Company. (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year
ended July 31, 1997 filed on November 13, 1997, SEC File No.
000-24394)
10.11 Guaranty and Agreement dated October 14, 1997 between RZB
Finance LLC and Jerome Richter. (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year
ended July 31, 1997 filed on November 13, 1997, SEC File No.
000-24394)
10.12 Amendment letter dated April 22, 1998 between RZB Finance
LLC and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the three months
ended April 30, 1998 filed on June 15, 1998, SEC File No.
000-24394)
10.13 Employment Agreement dated November 17, 1997 between the
Company and Jerry L. Lockett. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the three
months ended April 30, 1998 filed on June 15, 1998, SEC File
No. 000-24394)
106
10.14 Lease/Installment Purchase Agreement dated November 24,
1998 by and between CPSC International and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.15 Amendment No. 1, to the Lease/Installment Purchase
Agreement dated November 24, 1999, dated January 7, 1999 by
and between CPSC International and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.16 Amendment, to Lease/Installment Purchase Agreement dated
February 16, 1999 dated January 25, 1999 by and between CPSC
International and the Company. (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended
July 31, 1999 filed on November 9, 1999, SEC File No.
000-24394).
10.17 Lease/Installment Purchase Agreement dated February 16,
1999 by and between CPSC International and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.18 Amendment No. 2, to Lease/Installment Purchase Agreement
dated November 24, 1998 and to Lease/Installment Purchase
Agreement dated January 7, 1999 dated September 16, 1999 by
and between CPSC International and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.19 Agreement dated September 16, 1999 by and between CPSC
International and the Company. (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended
July 31, 1999 filed on November 9, 1999, SEC File No.
000-24394).
10.20 Purchase, Sale and Service Agreement for Propane/Butane Mix
entered into effective as of October 1, 1999 by and between
Exxon Company, U.S.A. and the Company. (Incorporated by
reference to the Company's Annual Report on Form 10-K for
the year ended July 31, 1999 filed on November 9, 1999, SEC
File No. 000-24394).
10.21 Sales/Purchase Agreement of Propane Stream dated October 1,
1999 between PG&E NGL Marketing, L.P. and the Company.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.22 Permit issued on July 26, 1999 by the United States
Department of State authorizing the Company to construct two
pipelines crossing the international boundary line between
the United States and Mexico for the transport of liquefied
petroleum gas (LPG) and refined product (motor gasoline and
diesel fuel). (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 1999
filed on November 9, 1999, SEC File No. 000-24394).
10.23 Amendment to the LPG Purchase Agreement dated June 18, 1999
between P.M.I. Trading Ltd. and the Company. (Incorporated
by reference to the Company's Annual Report on Form 10-K for
the year ended July 31, 1999 filed on November 9, 1999, SEC
File No. 000-24394).
10.24 Transfer of Shares Agreement dated November 4, 1999 between
Jorge Bracamontes and the Company. (Incorporated by
reference to the Company's Quarterly report on Form 10-Q for
the quarterly period ended October 31, 1999, filed on
December 14, 1999, SEC File No. 000-24394).
107
10.25 Transfer of Shares Agreement dated November 4, 1999 between
Juan Jose Navarro Plascencia and the Company. (Incorporated
by reference to the Company's Quarterly report on Form 10-Q
for the quarterly period ended October 31, 1999, filed on
December 14, 1999, SEC File No. 000-24394).
10.26 Addendum dated December 15, 1999 between CPSC
International, Inc. and the Company. (Incorporated by
reference to the Company's Quarterly report on Form 10-Q for
the quarterly period ended January 31, 2000, filed on March
21, 2000, SEC File No. 000-24394).
10.27 LPG Mix Purchase Contract (DTIR-010-00) dated March 31,
2000 between P.M.I. Trading Limited and the Company.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended April 30, 2000
filed on June 19, 2000, SEC File No. 000-24394).
10.28 LPG Mix Purchase Contract (DTIR-011-00) dated March 31,
2000 between P.M.I. Trading Limited and the Company.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended April 30, 2000
filed on June 19, 2000, SEC File No. 000-24394).
10.29 Product Sales Agreement dated February 23, 2000 between
Koch Hydrocarbon Company and the Company. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended April 30, 2000 filed on June 19,
2000, SEC File No. 000-24394).
10.30 First Amendment Line Letter dated May 2000 between RZB
Finance LLC and the Company. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 2000 filed on June 19,
2000, SEC File No. 000-24394).
10.31 Promissory Note and Pledge and Security Agreement dated
April 11, 2000 between Jerome B. Richter and the Registrant.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on
November 14, 2000, SEC File No. 000-24394).
10.32 Promissory Note and Pledge and Security Agreement dated
March 25, 2000 between Jorge Bracamontes A. and the
Registrant. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 2000,
filed on November 14, 2000, SEC File No. 000-24394).
10.33 Promissory Note and Pledge and Security Agreement dated
March 26, 2000 between M.I. Garcia Cuesta and the
Registrant. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 2000,
filed on November 14, 2000, SEC File No. 000-24394).
10.34 Promissory Note and Pledge and Security Agreement dated
September 10, 2000, between Ian Bothwell and the Registrant.
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on
November 14, 2000, SEC File No. 000-24394).
10.35 Promissory Share Transfer Agreement to purchase shares of
Termatsal, S.A. de C.V. dated November 13, 2000, between
Jorge Bracamontes and the Company (Translation from
Spanish). (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 2000, filed
on November 14, 2000, SEC File No. 000-24394).
10.36 Promissory Share Transfer Agreement to purchase shares of
Termatsal, S.A. de C.V. dated November 13, 2000, between
Pedro Prado and the Company (Translation from Spanish).
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on
November 14, 2000, SEC File No. 000-24394).
108
10.37 Promissory Share Transfer Agreement to purchase shares of
Termatsal, S.A. de C.V. dated November 13, 2000, between
Pedro Prado and Penn Octane International, L.L.C.
(Translation from Spanish). (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended
July 31, 2000, filed on November 14, 2000, SEC File No.
000-24394).
10.38 Promissory Share Transfer Agreement to purchase shares of
Penn Octane de Mexico, S.A. de C.V. dated November 13, 2000,
between Jorge Bracamontes and the Company (Translation from
Spanish). (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 2000, filed
on November 14, 2000, SEC File No. 000-24394).
10.39 Promissory Share Transfer Agreement to purchase shares of
Penn Octane de Mexico, S.A. de C.V. dated November 13, 2000,
between Juan Jose Navarro Plascencia and the Company
(Translation from Spanish). (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended
July 31, 2000, filed on November 14, 2000, SEC File No.
000-24394).
10.40 Promissory Share Transfer Agreement to purchase shares of
Penn Octane de Mexico, S.A. de C.V. dated November 13, 2000,
between Juan Jose Navarro Plascencia and Penn Octane
International, L.L.C. (Translation from Spanish).
(Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on
November 14, 2000, SEC File No. 000-24394).
10.41 Promissory Note and Pledge and Security Agreement dated
November 30, 2000, between Western Wood Equipment
Corporation and the Registrant. (Incorporated by reference
to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended October 31, 2000, filed on December
12, 2000, SEC File No. 000-24394).
10.42 Form of Amendment to Promissory Note (the "Note") of Penn
Octane Corporation (the "Company") due December 15, 2001,
and related agreements and instruments dated November 28,
2001, between the Company and the holders of the Notes.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended October 31, 2001
filed on December 17, 2001, SEC File No. 000-24394).
10.43 LPG sales agreement entered into as of March 1, 2002 by and
between Penn Octane Corporation ("Seller") and P.M.I.
Trading Limited ("Buyer"). (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended April 30, 2002 filed on June 13, 2002, SEC File
No. 000-24394).
10.44 Settlement agreement, dated as of March 1, 2002 by and
between P.M.I. Trading Limited and Penn Octane Corporation.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended April 30, 2002
filed on June 13, 2002, SEC File No. 000-24394).
10.45 Form of Amendment to Promissory Note (the "Note") of Penn
Octane Corporation (the "Company") due June 15, 2002, and
related agreements and instruments dated June 5, 2002,
between the Company and the holders of the Notes.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended April 30, 2002
filed on June 13, 2002, SEC File No. 000-24394).
10.46 Form of Amendment to Promissory Note (the "Note") of Penn
Octane Corporation (the "Company") due December 15, 2002,
and related agreements and instruments dated December 9,
2002 between the Company and the holders of the Notes.
(Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended January 31, 2003
filed on March 20, 2003, SEC File No. 000-24394).
10.47 Employee contract entered into and effective July 29, 2002,
between the Company and Jerome B. Richter. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended January 31, 2003 filed on March
20, 2003, SEC File NO. 000-24394).
10.48 Equipment Acquisition Agreement effective October 18, 2002
by and between Penn Octane Corporation and Penn Wilson CNG,
Inc., on the one hand, and B&A Eco-Holdings, Inc. and Ian T.
Bothwell, on the other hand. (Incorporated by reference to
the Company's Quarterly Report on
109
Form 10-Q for the quarterly period ended January 31, 2003
filed on March 20, 2003, SEC File No. 000-24394).
10.49 Bill of Sale dated October 18, 2002 between B&A
Eco-Holdings, Inc. and the Company. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended January 31, 2003 filed on March
20, 2003, SEC File NO. 000-24394).
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:
10.50 Stock Purchase and Separation Agreement dated July 22, 2003
between Jorge Bracamontes and the Company.
10.51 Supplement and Amendment to Stock Purchase of Separation
Agreement dated September 12, 2003 between Jorge Bracamontes
and the Company.
10.52 Amended Supplement and Amendment to Stock Purchase and
Separation Agreement dated October 2, 2003 between Jorge
Bracamontes and the Company.
21 Subsidiaries of the Registrant
23 Consent of Independent Certified Public Accountant
31.1 Certification Pursuant to Rule 13a-14(a) / 15d - 14(a) of
the Exchange Act.
31.2 Certification Pursuant to Rule 13a-14(a) / 15d - 14(a) of
the Exchange Act.
32 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002.
110
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENN OCTANE CORPORATION
By: /s/Ian T. Bothwell
----------------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
October 31, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ---------------------------------- -------------------------------- ----------------
/s/Jerome B. Richter Jerome B. Richter October 31, 2003
- ---------------------------------- Chairman and Chief Executive
Officer
/s/Richard "Beau" Shore, Jr. Richard "Beau" Shore, Jr. October 31, 2003
- ---------------------------------- President
/s/Charles Handly Charles Handly October 31, 2003
- ---------------------------------- Chief Operating Officer and
Executive Vice President
/s/Ian T. Bothwell Ian T. Bothwell October 31, 2003
- ---------------------------------- Vice President, Treasurer,
Assistant Secretary, Chief
Financial Officer, Principal
Accounting Officer and Director
/s/Jerry Lockett Jerry Lockett October 31, 2003
- ---------------------------------- Vice President
/s/Stewart J. Paperin Stewart J. Paperin October 31, 2003
- ---------------------------------- Director
/s/Harvey L. Benenson Harvey L. Benenson October 31, 2003
- ---------------------------------- Director
/s/Emmett Murphy Emmett Murphy October 31, 2003
- ---------------------------------- Director
111