UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended October 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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, BLDG. D, PALM DESERT, CALIFORNIA 92211
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (760) 772-9080
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The number of shares of Common Stock, par value $.01 per share, outstanding
on December 5, 2003 was 15,363,010.
1
PENN OCTANE CORPORATION
TABLE OF CONTENTS
ITEM PAGE NO.
---- --------
Part I 1. Financial Statements
Independent Certified Public Accountants' Review Report 3
Consolidated Balance Sheets as of October 31, 2003 4-5
(unaudited) and July 31, 2003
Unaudited Consolidated Statements of Operations for the
three months ended October 31, 2003 and 2002 6
Unaudited Consolidated Statements of Cash Flows for
the three months ended October 31, 2003 and 2002 7
Notes to Consolidated Financial Statements
(Unaudited) 8-21
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22-35
3. Quantitative and Qualitative Disclosures About
Market Risk 35
4. Controls and Procedures 35
Part II 1. Legal Proceedings 36
2. Changes in Securities and Use of Proceeds 36
3. Defaults Upon Senior Securities 36
4. Submission of Matters to a Vote of Security Holders 36
5. Other Information 36
6. Exhibits and Reports on Form 8-K 36-37
Signatures 38
2
Independent Certified Public Accountants' Review Report
Board of Directors and Shareholders
Penn Octane Corporation
We have reviewed the accompanying consolidated balance sheet of Penn Octane
Corporation and subsidiaries (Company) as of October 31, 2003, and the related
consolidated statements of operations for the three months ended October 31,
2003 and 2002 and the consolidated statements of cash flows for the three months
ended October 31, 2003 and 2002. These consolidated financial statements are
the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
consolidated financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet as of
July 31, 2003, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended (not presented
herein) and in our report dated September 19, 2003, we expressed an unqualified
opinion on those consolidated financial statements. Our report letter
contained a paragraph stating that conditions existed which raised substantial
doubt about the Company's ability to continue as a going concern. In our
opinion, the information set forth in the accompanying consolidated balance
sheet as of July 31, 2003, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ BURTON MCCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
December 4, 2003
3
PART I
ITEM 1.
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
October 31,
2003 July 31,
(Unaudited) 2003
------------ -----------
Current Assets
Cash (including restricted cash of $2,552,308 and $3,404,782 at $ 2,644,334 $ 3,475,846
October 31, 2003 and July 31, 2003)
Trade accounts receivable (less allowance for doubtful accounts of
$5,783 at October 31, 2003 and July 31, 2003) 8,067,619 4,143,458
Inventories 864,510 878,082
Assets held for sale 220,000 720,000
Prepaid expenses and other current assets 418,534 476,109
------------ -----------
Total current assets 12,214,997 9,693,495
Property, plant and equipment - net 17,550,770 17,677,830
Lease rights (net of accumulated amortization of $718,984 and $707,535 at
October 31, 2003 and July 31, 2003) 435,055 446,504
Other non-current assets 17,380 19,913
------------ -----------
Total assets $ 30,218,202 $27,837,742
============ ===========
The accompanying notes and accountants' report are an integral part of these statements.
4
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
LIABILITIES AND STOCKHOLDERS' EQUITY
October 31,
2003 July 31,
(Unaudited) 2003
--------------- ---------------
Current Liabilities
Current maturities of long-term debt $ 491,432 $ 746,933
Short-term debt 1,790,484 1,744,128
LPG trade accounts payable 9,868,586 7,152,098
Other accounts payable 2,498,821 2,470,880
Foreign taxes payable 85,000 60,000
Accrued liabilities 906,763 1,083,966
--------------- ---------------
Total current liabilities 15,641,086 13,258,005
Long-term debt, less current maturities 60,000 60,000
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at October 31, 2003 and July 31, 2003 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; No shares issued and outstanding at
October 31, 2003 and July 31, 2003 - -
Common stock - $.01 par value, 25,000,000 shares authorized;
15,346,385 and 15,274,749 shares issued and outstanding at October
31, 2003 and July 31, 2003 153,464 152,747
Additional paid-in capital 28,453,481 28,298,301
Notes receivable from an officer of the Company and another party for
exercise of warrants, less reserve of $519,174 and $516,653 at October
31, 2003 and July 31, 2003 ( 2,897,520) ( 2,897,520)
Accumulated deficit ( 11,192,309) ( 11,033,791)
--------------- ---------------
Total stockholders' equity 14,517,116 14,519,737
--------------- ---------------
Total liabilities and stockholders' equity $ 30,218,202 $ 27,837,742
=============== ===============
The accompanying notes and accountants' report are an integral part of these statements.
5
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months Ended
----------------------------
October 31, October 31,
2003 2002
------------- -------------
Revenues $ 38,549,107 $ 37,440,658
Cost of goods sold 36,483,177 34,926,239
------------- -------------
Gross profit 2,065,930 2,514,419
Selling, general and administrative expenses
Legal and professional fees 761,869 320,114
Salaries and payroll related expenses 501,415 458,737
Other 275,915 326,005
------------- -------------
1,539,199 1,104,856
------------- -------------
Operating income 526,731 1,409,563
Other income (expense)
Interest expense ( 375,586) ( 371,665)
Interest income 5,339 68,869
Estimated reduction in value of assets held for sale ( 500,000) -
Other income 210,000 -
------------- -------------
Income (loss) before taxes ( 133,516) 1,106,767
Benefit (provision) for income tax ( 25,000) 100,000
------------- -------------
Net income (loss) $ ( 158,516) $ 1,206,767
============= =============
Net income (loss) per common share $ ( 0.01) $ 0.08
============= =============
Net income (loss) per common share assuming
dilution $ ( 0.01) $ 0.08
============= =============
Weighted average common shares outstanding 15,298,261 14,870,977
============= =============
The accompanying notes and accountants' report are an integral part of these statements.
6
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three months Ended
------------------------------------
October 31, October 31,
2003 2002
----------------- -----------------
Cash flows from operating activities:
Net income (loss) $ ( 158,516) $ 1,206,767
Adjustments to reconcile net income (loss) to net cash (used in) provided
by operating activities:
Depreciation and amortization 222,060 244,001
Amortization of lease rights 11,449 11,449
Non-employee stock based costs and other 31,217 56,217
Amortization of loan discount 51,081 -
Interest income - officer note - ( 67,241)
Estimated reduction in value of assets held for sale 500,000 -
Changes in current assets and liabilities:
Trade accounts receivable ( 3,924,161) 1,569,658
Inventories 13,572 ( 354,949)
Prepaid and other current assets 26,358 ( 23,977)
Other assets 2,531 42,726
LPG trade accounts payable 2,716,488 ( 2,081,994)
Other accounts payable and accrued liabilities ( 73,991) ( 1,570,040)
Foreign taxes payable 25,000 -
----------------- -----------------
Net cash (used in) provided by operating activities ( 556,912) ( 967,383)
Cash flows from investing activities:
Capital expenditures ( 94,999) ( 134,306)
----------------- -----------------
Net cash used in investing activities ( 94,999) ( 134,306)
Cash flows from financing activities:
Revolving credit facilities - 3,669,599
Issuance of common stock 80,625 -
Issuance of debt 60,000 -
Reduction in debt ( 320,226) ( 302,388)
----------------- -----------------
Net cash provided by (used in) financing activities ( 179,601) 3,367,211
----------------- -----------------
Net (decrease) increase in cash ( 831,512) 2,265,522
Cash at beginning of period 3,475,846 160,655
----------------- -----------------
Cash at end of period $ 2,644,334 $ 2,426,177
================= =================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 325,915 $ 371,635
================= =================
Supplemental disclosures of noncash transactions:
Mortgage receivable/ note payable $ - $ 2,382
================= =================
Equipment exchanged for note receivable $ - $ 720,000
================= =================
The accompanying notes and accountants' report are an integral part of these statements.
7
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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) 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 80% of the Company's total
revenues for the three months ended October 31, 2003.
BASIS OF PRESENTATION
-----------------------
The accompanying consolidated financial statements include the Company and
its United States subsidiaries including its recently formed Rio Vista
Energy Partners L.P. and its subsidiaries, all inactive (see note M), 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.
The unaudited consolidated balance sheet as of October 31, 2003, the
unaudited consolidated statements of operations for the three months ended
October 31, 2003 and 2002 and the unaudited consolidated statements of cash
flows for the three months ended October 31, 2003 and 2002, have been
prepared by the Company without audit. In the opinion of management, the
unaudited consolidated financial statements include all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
unaudited consolidated financial position of the Company as of October 31,
2003, the unaudited consolidated results of operations for the three months
ended October 31, 2003 and 2002 and the unaudited consolidated statements
of cash flows for the three months ended October 31, 2003 and 2002.
Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
omitted. These unaudited consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year
ended July 31, 2003.
Certain reclassifications have been made to prior period balances to
conform to the current presentation. All reclassifications have been
consistently applied to the periods presented.
8
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE
Income (loss) per share of common stock is computed on the weighted average
number of shares outstanding. During periods in which the Company incurs
losses, giving effect to common stock equivalents is not presented as it
would be antidilutive.
The following tables present reconciliations from income (loss) per common
share to income (loss) per common share assuming dilution:
For the three months ended October 31, 2003
---------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -------------
Net income (loss) $ ( 158,516)
BASIC EPS
Net income (loss) available to common
stockholders ( 158,516) 15,298,261 $( 0.01)
=============
EFFECT OF DILUTIVE SECURITIES
Warrants - -
DILUTED EPS
Net income (loss) available to common
stockholders N/A N/A N/A
For the three months ended October 31, 2002
---------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -------------
Net income (loss) $ 1,206,767
BASIC EPS
Net income (loss) available to common
stockholders 1,206,767 14,880,977 $ 0.08
=============
EFFECT OF DILUTIVE SECURITIES
Warrants - -
--------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,206,767 14,870,977 $ 0.08
=============== ============= =============
9
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - STOCK-BASED COMPENSATION
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 accounts for stock option plans in accordance with the
provisions of APB No. 25, "Accounting for Stock Issued to Employees", and
related interpretations which recognizes compensation expense on the grant
date if the current market price of the stock exceeds the exercise price.
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:
Three months Ended
-----------------------------------
October 31, October 31,
2003 2002
---------------- -----------------
Net income (loss), as reported $( 158,516) $ 1,206,767
Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax
effects ( 52,914) ( 654,567)
---------------- -----------------
Net income (loss), pro forma $( 211,430) $ 552,200
================ =================
Net income (loss) per common share, as reported $( 0.01) $ 0.08
================ =================
Net income (loss) per common share, pro forma $( 0.01) $ 0.04
================ =================
Net income (loss) per common share assuming dilution, as reported $( 0.01) $ 0.08
================ =================
Net income (loss) per common share assuming dilution, pro forma $( 0.01) $ 0.04
================ =================
The following assumptions were used for grants of warrants to employees in
the three months ended October 31, 2003, to compute the fair value of the
warrants using the Black-Scholes option-pricing model; dividend yield of
0%; expected volatility of 81%; risk free interest rate of 3.27% and
expected lives of 5 years.
The following assumptions were used for grants of warrants to employees in
the three months ended October 31, 2002, to compute the fair value of the
warrants using the Black-Scholes option-pricing model; dividend yield of
0%; expected volatility of 79%; risk free interest rate of 1.81% and
expected lives of 5 years.
10
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE D - ESTIMATED REDUCTION IN VALUE OF ASSETS HELD FOR SALE
During November 2003, the Company granted a third party the option to
purchase its compressed natural gas (CNG) equipment for $220,000. The
proposed buyer paid the Company $3,000 for the option and the parties
agreed to execute definitive documents no later than January 26, 2004. The
Company is not obligated to complete the sale beyond the expiration date of
the option and under terms which cannot be mutually agreed upon among the
parties including warranty terms, indemnifications and form of payment.
Although the consummation of the sale is not certain, the Company has
reduced the carrying value of the assets to the value agreed to above and
accordingly has recorded a charge of $500,000 for the three months ended
October 31, 2003. The Company will record a gain to the extent that the
Company ultimately realizes any amounts in excess of $220,000.
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
October 31, July 31,
2003 2003
------------- ------------
LPG:
Midline pump station $ 2,443,988 $ 2,443,988
Brownsville Terminal Facility: (a)
Building 173,500 173,500
Terminal facilities 3,631,207 3,631,207
Tank Farm 373,945 373,945
Leasehold improvements 302,657 302,657
Capital construction in progress 96,212 96,212
Equipment 226,285 226,285
------------- ------------
7,247,794 7,247,794
------------- ------------
US - Mexico Pipelines and Matamoros Terminal
Facility: (a)
U.S. Pipelines and Rights of Way 6,775,242 6,680,242
Mexico Pipelines and Rights of Way 993,300 993,300
Matamoros Terminal Facility 5,107,514 5,107,514
Saltillo Terminal 1,027,267 1,027,267
Land 856,358 856,358
------------- ------------
14,759,681 14,664,681
------------- ------------
Total LPG 22,007,475 21,912,475
------------- ------------
Other:
Office equipment 93,201 93,201
Software 75,890 75,890
------------- ------------
169,091 169,091
------------- ------------
22,176,566 22,081,566
Less: accumulated depreciation and amortization (4,625,796) (4,403,736)
------------- ------------
17,550,770 17,677,830
============= ============
(a) See note M.
11
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE E - PROPERTY, PLANT AND EQUIPMENT - CONTINUED
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 cost of such relocation is estimated to be $500,000.
Property, plant and equipment, net of accumulated depreciation, includes
$6,355,672 and $6,427,387 of costs, located in Mexico at October 31, 2003
and July 31, 2003, respectively.
NOTE F - INVENTORIES
Inventories consist of the following:
October 31, 2003 July 31, 2003
------------------- -------------------
Gallons Cost Gallons Cost
--------- -------- --------- --------
LPG:
Leased Pipeline 1,175,958 $672,817 1,175,958 $638,623
Brownsville Terminal Facility,
Matamoros Terminal Facility
and railcars leased by the
Company 335,044 191,693 440,771 239,368
Markham Storage and other - - 168 91
--------- -------- --------- --------
1,511,002 $864,510 1,616,897 $878,082
========= ======== ========= ========
NOTE G - DEBT OBLIGATIONS
Debt consists of the following:
October 31, July 31,
2003 2003
------------ ----------
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility. $ 163,858 $ 284,731
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility. 117,300 198,178
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February
2002. 137,500 137,500
Extending Noteholders' notes and $250,000 Note. 1,790,484 1,744,128
Other debt. 132,774 186,524
------------ ----------
Total debt 2,341,916 2,551,061
Less: Current maturities 491,432 746,933
Short term debt 1,790,484 1,744,128
------------ ----------
Long-term debt $ 60,000 $ 60,000
============ ==========
12
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - DEBT OBLIGATIONS - CONTINUED
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 (see note O). Under the terms of the agreement, the Extending
Noteholders' notes bear interest at 16.5% per annum. Interest has been paid
quarterly on the outstanding balances since March 15, 2003 (the December
15, 2002 interest was paid on January 1, 2003) through September 15, 2003.
In addition, the Company was required to pay certain amounts of principal
beginning March 2003 (approximately $1,114,000 of principal was paid
through the period ended October 31, 2003 of which $1,000,000 was reduced
in connection with the exercise of warrants and purchase of common stock -
see below). The Company was allowed to prepay the Extending Noteholders'
notes at any time. The Company also paid a fee of 1.5% on the principal
amount of the Extending Noteholders' notes which was 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 $291,124
has been amortized through October 31, 2003 ($51,081 has been amortized for
the three months ended October 31, 2003).
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 Restructured 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. As of
October 31, 2003 the Company repaid $50,000 of principal.
OTHER
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.
13
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - DEBT OBLIGATIONS - CONTINUED
OTHER - CONTINUED
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 I).
The Company's Chairman and Chief Executive Officer 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.
NOTE H - STOCKHOLDERS' EQUITY
COMMON STOCK
-------------
The Company routinely issues shares of its common stock for cash, the
exercise of warrants, in payment of notes and other obligations and to
settle lawsuits.
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 which had been previously accrued but unissued at July 31, 2003.
During October 2003, cashless warrants to purchase 103,685 shares of common
stock of the Company were exercised. The exercise price of the warrants was
$2.50 per share and the market price of the Company's common stock on the
date of exercise was $3.01 per share, resulting in the net issuance of
17,568 shares of common stock of the Company. The Company had previously
expensed the cost associated with the warrants when the warrants were
originally granted.
STOCK WARRANTS
---------------
The Company applies APB 25 for warrants granted to the Company's employees
and to the Company's Board of Directors serving in the capacity as
directors and SFAS 123 for warrants issued to acquire goods and services
from non-employees.
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.
BOARD COMPENSATION PLAN (BOARD PLAN)
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.
In connection with the Board Plan, during November 2003 the Board granted
warrants to purchase 10,000 shares of common stock of the Company at
exercise price of $2.61 per share to an outside director. Based on the
provisions of APB 25, no compensation expense was recorded for these
warrants.
14
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES
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 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 arguments on the appeal were heard in
November 2003 and the Company prevailed on its summary judgment.
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 G).
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.
15
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES - CONTINUED
CREDIT FACILITY, LETTERS OF CREDIT AND OTHER
As of October 31, 2003, the Company had 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
Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to the RZB
Credit Facility, RZB has sole and absolute discretion to limit or terminate
its 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.
The Company's Chairman and Chief Executive Officer 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), Koch Hydrocarbon Company (Koch) and/or other
suppliers, letters of credit are issued on a monthly basis based on
anticipated purchases. Outstanding letters of credit at October 31, 2003
totaled approximately $10,640,000.
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
$2,552,308 at October 31, 2003). At October 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
credit facility is effective until January 31, 2004 when it will be
automatically reduced to $12,000,000.
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.
16
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE J - 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 $1,816,025 at October
31, 2003, including accrued interest, are due on December 15, 2003 (see
notes G and O).
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note M). 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, if
any, resulting from the Spin-Off 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.
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 K) 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.
17
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE K - CONTRACTS
LPG SALES TO PMI
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17,000,000 gallons of LPG (see supply
agreements below), 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 on or after May 31, 2003 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.
LPG SUPPLY AGREEMENTS
The Company has entered into minimum long-term supply agreements for
quantities of LPG totaling approximately 24,000,000 gallons per month
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.
NOTE L - INCOME TAX
During the three months ended October 31, 2003, the Company recorded an
income tax expense of $25,000 related to Mexican income taxes. 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 October 31, 2003).
18
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE M - 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 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 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.
19
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE M - SPIN-OFF OF SUBSIDIARY - CONTINUED
In connection with the Spin-Off, the Company will grant to Mr. Jerome
Richter, the Company's Chairman and Chief Executive Officer, and Shore
Capital LLC (Shore), a company owned by Mr. Richard Shore the Company's
President, 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 G) 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.
Because the Company will have control of the Partnership by virtue of its
ownership and related voting control of the general partner, the
Partnership will continue to be consolidated with the Company and the
interests of the limited partners will be classified as minority interests.
Had the transaction been consummated on October 31, 2003 the amount of
stockholders' equity reflected in the Company's pro forma consolidated
balance sheet would have been reduced by approximately $15,000,000 with a
corresponding credit to minority interest. This would have resulted in a
deficit in stockholders' equity of approximately $500,000.
Had the transaction been consummated as of August 1, 2003, the Company's
pro forma consolidated net loss for the three months ended October 31, 2003
would have been approximately $(1,500,000) after giving effect to minority
interest related to the Spin-Off and estimated expenses related to the
estimated intrinsic value associated with the options granted to Shore and
Mr. Richter. As a result of the foregoing, loss per share would have
increased to approximately $(.10).
20
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE N - OTHER INCOME
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 was included
in earnings during the quarter ending October 31, 2003.
NOTE O - SUBSEQUENT EVENT
The Extending Noteholders' notes and the $250,000 Note (Notes) matured on
December 15, 2003. The Company did not pay the Notes at maturity. The
Company is negotiating with the holders of the Notes to renew and extend
the Notes.
21
ITEM 2. 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.
FORWARD-LOOKING STATEMENTS
The statements contained in this Quarterly 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
Part I of the Company's Annual Report on Form 10-K for the fiscal year ended
July 31, 2003 as well as those discussed elsewhere in this Report. We caution
you, however, that this list of factors may not be complete.
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 may also sell
LPG to U.S. and Canadian customers.
During the three months ended October 31, 2003, the Company derived 80% 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 and delivered in
gallons and average sales price for the three months ended October 31, 2003 and
2002;
2003 2002
----- -----
Volume Sold
LPG (millions of gallons) - PMI 48.6 49.6
LPG (millions of gallons) - Other 14.3 22.6
----- -----
62.9 72.2
===== =====
Average sales price
LPG (per gallon) - PMI $0.64 $0.55
LPG (per gallon) - Other 0.53 0.45
22
RESULTS OF OPERATIONS
THREE MONTHS ENDED OCTOBER 31, 2003 COMPARED WITH THREE MONTHS ENDED OCTOBER 31,
2002
Revenues. Revenues for the three months ended October 31, 2003 were $38.5
million compared with $37.4 million for the three months ended October 31, 2002,
an increase of $1.1 million or 3.0%. Of this increase, $4.3 million was
attributable to increases in average sales prices of LPG sold to PMI during the
three months ended October 31, 2003, and $1.9 million was attributable to
increased average sales prices of LPG sold to customers other than PMI during
the three months ended October 31, 2003, partially offset by $664,614
attributable to decreased volumes of LPG sold to PMI during the three months
ended October 31, 2003 and $4.4 million attributable to decreased volumes of LPG
sold to customers other than PMI during the three months ended October 31, 2003.
Cost of goods sold. Cost of goods sold for the three months ended October
31, 2003 was $36.5 million compared with $34.9 million for the three months
ended October 31, 2002, an increase of $1.6 million or 4.5%. Of this increase,
$4.3 million was attributable to increases in the cost of LPG sold to PMI during
the three months ended October 31, 2003 and $2.6 million was attributable to
increased costs of LPG sold to customers other than PMI during the three months
ended October 31, 2003, partially offset by $4.7 million attributable to
decreased volume of LPG sold to customers other than PMI during the three months
ended October 31, 2003 and $581,650 attributable to decreased volume of LPG sold
to PMI during the three months ended October 31, 2003.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.5 million for the three months ended October 31,
2003 compared with $1.1 million for the three months ended October 31, 2002, an
increase of $434,343 or 39.3%. The increase during the three months ended
October 31, 2003 was principally due to legal and other professional fees
related to the Spin-Off.
Other income (expense). Other income (expense) was $(660,247) for the
three months ended October 31, 2003, compared with $(302,796) for the three
months ended October 31, 2002. The increase in other expenses was due primarily
to increased amortization of discounts on outstanding debt incurred and the
estimated reduction in value of the assets held for sale of $500,000 during the
three months ended October 31, 2003, partially offset by $210,000 of other
income related to the cancellation of a contract.
Income tax. The Company incurred $25,000 of Mexican income tax expense
during the three months ended October 31, 2003.
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 October 31, 2003 were
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.
23
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders. 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 three
months ended October 31, 2003, and 2002. All information is in thousands.
2003 2002
-------------- --------------
Net cash (used in) operating activities . . . . . . $( 557) $( 967)
Net cash (used in) investing activities . . . . . . ( 95) ( 134)
Net cash provided by (used in) financing activities ( 180) 3,367
-------------- --------------
Net (decrease) increase in cash . . . . . . . . . . $ ( 832) $ 2,266
-------------- --------------
Less net decrease (increase) in restricted cash . . 853 ( 2,378)
-------------- --------------
Net increase (decrease) in non-restricted
cash. . . . . . . . . . . . . . . . . . . . . . . . $ 21 $ 112
============== ==============
24
Sales to PMI. 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.
LPG Supply Agreements. The Company has entered into minimum long-term
supply agreements for quantities of LPG totaling approximately 24.0 million
gallons per month 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.
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.
25
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.
Sales of Assets. Based on the Company's recognition that the sale of the
CNG assets may require considerable additional time and expense to dispose of,
managements' desire to focus on the LPG business, and the Company's need for
cash, during November 2003, the Company granted a third party the option to
purchase its CNG equipment for $220,000. The proposed buyer paid the Company
$3,000 for the option and the parties agreed to execute definitive documents no
later than January 26, 2004. The Company is not obligated to complete the sale
beyond the expiration date of the option and under terms which cannot be
mutually agreed upon among the parties including warranty terms,
indemnifications and form of payment. Although the consummation of the sale is
not certain, the Company has reduced the carrying value of the assets to the
value agreed to above and accordingly has recorded a charge of $500,000 for the
three months ended October 31, 2003.
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. The Company paid
a nominal purchase price. As a result, since the acquisition, the Company has
included the results of the Mexican Subsidiaries in its consolidated financial
statements. 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.
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
26
distributions in excess of earnings. In addition, distributions to foreign
corporations, including dividends and interest payments may be subject to
Mexican withholding taxes.
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 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.
27
Credit Arrangements. As of October 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
properties or assets, except in favor of RZB, without the consent of RZB.
The Company's Chairman and Chief Executive Officer 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, Koch
and/or other suppliers, letters of credit are issued on a monthly basis based on
anticipated purchases. Outstanding letters of credit at October 31, 2003 totaled
approximately $10.6 million.
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 $2.6 million
at October 31, 2003). At October 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 $9.0 million and is not allowed to make cash
dividends to shareholders without the consent of RZB. The $15.0 million credit
facility is effective until January 31, 2004 when it will be automatically
reduced to $12.0 million.
Private Placements and Other Transactions. 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.
28
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 (see below). Under the terms of the agreement, the Extending Noteholders'
notes bear interest at 16.5% per annum. Interest has been paid quarterly on the
outstanding balances since March 15, 2003 (the December 15, 2002 interest was
paid on January 1, 2003) through September 15, 2003. In addition, the Company
was required to pay certain amounts of principal beginning March 2003
(approximately $1.1 million of principal was paid through the period ended
October 31, 2003 of which $1.0 million was reduced in connection with the
exercise of warrants and purchase of common stock - see below). The Company was
allowed to prepay the Extending Noteholders' notes at any time. The Company also
paid a fee of 1.5% on the principal amount of the Extending Noteholders' notes
which was 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 $291,124 has been
amortized through October 31, 2003 ($51,081 has been amortized for the three
months ended October 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. As of
October 31, 2003 the Company repaid $50,000 of principal.
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.
The Extending Noteholders' notes and $250,000 Note (Notes) matured on
December 15, 2003. The Company did not pay the Notes at maturity. The Company
is negotiating with the holders of the Notes to renew and extend the Notes.
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 the former officer and director as severance compensation (see
above). In connection with the issuance of the shares, the Company recorded an
expense of approximately $75,000 during the year ended July 31, 2003 based on
the market value of the stock.
During October 2003, cashless warrants to purchase 103,685 shares of common
stock of the Company were exercised. The exercise price of the warrants was
$2.50 per share and the market price of the Company's common stock on the date
of exercise was $3.01 per share, resulting in the net issuance of 17,568 shares
of common stock of the Company.
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.
29
Settlement of Litigation. 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.
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 arguments on the appeal were heard in November
2003 and the Company prevailed on its summary judgment.
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.
Other Income. 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 was included in
earnings during the quarter ending October 31, 2003.
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 October 31, 2003,
including accrued interest, are due on December 15, 2003 (see notes G and O).
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note M). 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, if any, resulting from the
Spin-Off 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.
30
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 K) 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.
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 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 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 $2.5 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. Jerome
Richter, the Company's Chairman and Chief Executive Officer, and Shore Capital
LLC ("Shore"), a company owned by Mr. Richard Shore the Company's President,
options to each purchase 25% of the ownership interests in the Company's
31
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 G) 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.
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.
32
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 the 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 the 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 cannot 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.
33
Contractual Obligations and Commercial Commitments. The following is a
summary of the Company's estimated minimum contractual obligations and
commercial obligations as of October 31, 2003. Where applicable, LPG prices are
based on the October 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 12.5 1.5 2.8 2.6 5.6
LPG Purchase Obligations 538.1 110.3 174.1 174.1 79.6
Other Long-Term Obligations - - - - -
-------------- ---------- ---------- --------- --------
Total Contractual Cash Obligations $ 550.6 $ 111.8 $ 176.9 $ 176.7 $ 85.2
============== ========== ========== ========= ========
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 10.6 10.6 - - -
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 $ 10.6 $ 10.6 $ - $ - $ -
============== ========== ========== ========= ========
34
STATEMENT BY MANAGEMENT CONCERNING REVIEW OF INTERIM INFORMATION BY INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS.
The unaudited consolidated financial statements included in this filing on
Form 10-Q have been reviewed by Burton McCumber & Cortez, L.L.P., independent
certified public accountants, in accordance with established professional
standards and procedures for such review. The report of Burton McCumber &
Cortez, L.L.P. commenting on their review, accompanies the unaudited
consolidated financial statements included in Item 1 of Part I.
ITEM 3. 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.
ITEM 4. 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.
35
PART II
ITEM 1. LEGAL PROCEEDINGS
See note I to the accompanying unaudited consolidated financial
statements and note K to the Company's Annual Report on Form 10-K for
the fiscal year ended July 31, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
See note H to the accompanying unaudited consolidated financial
statements and notes I and J to the Company's Annual Report on Form
10-K for the fiscal year ended July 31, 2003, for information
concerning certain sales of Securities.
In connection with the issuances of securities discussed in note I to
the accompanying unaudited consolidated financial statements, the
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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
THE FOLLOWING EXHIBITS ARE INCORPORATED HEREIN BY REFERENCE:
Exhibit No.
------------
10.01 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 October 31, 2002
filed on June 13, 2002, SEC File No. 000-24394).
10.02 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 October 31, 2002 filed on June 13, 2002, SEC
File No. 000-24394).
10.03 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).
10.04 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).
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:
23 Accountant's Acknowledgment
36
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.
b. Reports on Form 8-K
None.
37
SIGNATURES
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.
PENN OCTANE CORPORATION
December 17, 2003 By: /s/Ian T. Bothwell
-----------------------------------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
38