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 January 31, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, 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 March 3, 2003 was 15,285,245.
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
January 31, 2004 (unaudited) and July 31, 2003 4-5
Unaudited Consolidated Statements of Operations for the three
Months and six months ended January 31, 2004 and 2003 6
Unaudited Consolidated Statements of Cash Flows for the six
months ended January 31, 2004 and 2003 7
Notes to Consolidated Financial Statements (Unaudited) 8-21
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 22-34
3. Quantitative and Qualitative Disclosures
About Market Risk 34
4. Controls and Procedures 34
Part II 1. Legal Proceedings 35
2. Changes in Securities, Use of Proceeds
and Issuer Purchases of Equity Securities 35
3. Defaults Upon Senior Securities 35
4. Submission of Matters to a Vote of Security Holders 35
5. Other Information 35
6. Exhibits and Reports on Form 8-K 35-36
Signatures 37
2
Independent Certified Public Accountants' Review Report
Board of Directors and Shareholders
Penn Octane Corporation
We have reviewed the consolidated balance sheet of Penn Octane Corporation and
subsidiaries (Company) as of January 31, 2004, and the related consolidated
statements of operations for the three months and six months ended January 31,
2004 and 2003 and the consolidated statements of cash flows for the six months
ended January 31, 2004 and 2003. These 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 and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the financial statements referred to above 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 of Penn
Octane Corporation and Subsidiaries 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. In our opinion, the information set forth in the accompanying
consolidated balance sheet as of July 31, 2003, is fairly stated.
Our auditor's report on the Company's financial statements as of July 31, 2003
included an explanatory paragraph referring to the matters discussed in Note P
of those financial statements which raised substantial doubt about the Company's
ability to continue as a going concern. As indicated in Note J of the
accompanying unaudited interim financial statements, conditions continue to
exist which raise substantial doubt about the Company's ability to continue as a
going concern.
/s/ BURTON MCCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
March 5, 2004
3
PART I
ITEM 1.
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
January 31,
2004 July 31,
(Unaudited) 2003
------------- -----------
Current Assets
Cash $ 84,306 $ 71,064
Restricted cash 4,133,465 3,404,782
Trade accounts receivable (less allowance for doubtful accounts of $0 at
January 31, 2004 and $5,783 at July 31, 2003) 13,434,280 4,143,458
Inventories 1,175,714 878,082
Assets held for sale 220,000 720,000
Prepaid expenses and other current assets 120,530 476,109
------------- -----------
Total current assets 19,168,295 9,693,495
Property, plant and equipment - net 17,244,512 17,677,830
Lease rights (net of accumulated amortization of $730,433 and $707,535 at
January 31, 2004 and July 31, 2003) 423,606 446,504
Other non-current assets 20,030 19,913
------------- -----------
Total assets $ 36,856,443 $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
January 31,
2004 July 31,
(Unaudited) 2003
------------- -------------
Current Liabilities
Current maturities of long-term debt $ 247,527 $ 746,933
Short-term debt - 1,744,128
LPG trade accounts payable 15,969,399 7,152,098
Other accounts payable 1,645,639 2,470,880
Foreign taxes payable 18,928 60,000
Accrued liabilities 1,125,677 1,083,966
------------- -------------
Total current liabilities 19,007,170 13,258,005
Long-term debt, less current maturities 1,678,516 60,000
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at January 31, 2004 and July 31, 2003 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; No shares issued and outstanding at
January 31, 2004 and July 31, 2003 - -
Common stock - $.01 par value, 25,000,000 shares authorized;
15,285,245 and 15,274,749 shares issued and outstanding at January 31,
2004 and July 31, 2003 152,852 152,747
Additional paid-in capital 28,487,341 28,298,301
Notes receivable from an officer of the Company and another party for
exercise of warrants, less reserve of $468,693 and $516,653 at January
31, 2004 and July 31, 2003 (2,728,000) (2,897,520)
Accumulated deficit ( 9,741,436) (11,033,791)
------------- -------------
Total stockholders' equity 16,170,757 14,519,737
------------- -------------
Total liabilities and stockholders' equity $ 36,856,443 $ 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 Six Months Ended
------------------ ----------------
January 31, January 31, January 31, January 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues $ 50,609,858 $ 43,621,932 $ 89,158,965 $ 81,062,590
Cost of goods sold 47,317,579 40,237,561 83,800,756 75,163,800
------------- ------------- ------------- -------------
Gross profit 3,292,279 3,384,371 5,358,209 5,898,790
Selling, general and administrative expenses
Legal and professional fees 416,526 731,677 1,178,395 1,051,791
Salaries and payroll related expenses 632,925 511,096 1,134,340 969,833
Other 506,365 182,937 782,280 508,942
------------- ------------- ------------- -------------
1,555,816 1,425,710 3,095,015 2,530,566
Estimated reduction in value of assets held for sale - - (500,000) -
------------- ------------- ------------- -------------
Operating income 1,736,463 1,958,661 1,763,194 3,368,224
Other income (expense)
Interest and LPG financing expense ( 338,998) ( 422,370) ( 714,584) ( 794,035)
Interest income 39,836 13,574 45,175 82,443
Other income - - 210,000 -
------------- ------------- ------------- -------------
Income before taxes 1,437,301 1,549,865 1,303,785 2,656,632
Benefit (provision) for income tax 13,572 - ( 11,428) 100,000
------------- ------------- ------------- -------------
Net income $ 1,450,873 $ 1,549,865 $ 1,292,357 $ 2,756,632
============= ============= ============= =============
Net income per common share $ 0.09 $ 0.10 $ 0.08 $ 0.19
============= ============= ============= =============
Net income per common share assuming
dilution $ 0.09 $ 0.10 $ 0.08 $ 0.18
============= ============= ============= =============
Weighted average common shares outstanding 15,352,808 14,866,836 15,325,535 14,868,906
============= ============= ============= =============
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)
Six Months Ended
----------------------------
January 31, January 31,
2004 2003
------------- -------------
Cash flows from operating activities:
Net income $ 1,292,357 $ 2,756,632
Adjustments to reconcile net income to net cash (used in) provided
by operating activities:
Depreciation and amortization 455,637 506,969
Amortization of lease rights 22,898 22,898
Non-employee stock based costs 62,434 104,101
Amortization of loan discount related to detachable warrants 63,335 39,583
Interest income - officer note and related party (32,334) (67,241)
Estimated reduction in value of assets held for sale 500,000 -
Gain on sale of equipment - (83,406)
Changes in current assets and liabilities:
Trade accounts receivable (9,290,822) (410,531)
Inventories (297,632) (1,594,619)
Prepaid and other current assets 293,145 (161,549)
LPG trade accounts payable 8,817,301 3,611,918
Other accounts payable and accrued liabilities (708,259) (1,371,082)
Foreign taxes payable (41,072) -
------------- -------------
Net cash provided by operating activities 1,136,988 3,353,673
Cash flows from investing activities:
Proceeds from the sale of equipment - 96,000
Capital expenditures (22,320) (367,354)
(Increase) decrease in other non-current assets (117) 71,995
------------- -------------
Net cash used in investing activities (22,437) (199,359)
Cash flows from financing activities:
Increase in restricted cash (728,683) (2,824,080)
Revolving credit facilities - (150,000)
Issuance of common stock 122,188 -
Issuance of debt 367,536 584,711
Reduction in debt (862,350) (866,045)
------------- -------------
Net cash used in financing activities (1,101,309) (3,255,414)
------------- -------------
Net increase (decrease) in cash 13,242 (101,100)
Cash at beginning of period 71,064 130,954
------------- -------------
Cash at end of period $ 84,306 $ 29,854
============= =============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest and LPG financing $ 631,785 $ 753,924
============= =============
Supplemental disclosures of noncash transactions:
Equity-common stock and warrants issued $ 528,024 $ 316,665
============= =============
Mortgage receivable/ note payable $ - $ 108,785
============= =============
Equipment exchanged for note receivable $ - $ 720,000
============= =============
Stock exchanged for note receivable $ 169,520 $ 30,480
============= =============
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 86% and 84% of the Company's
total revenues for the three and six months ended January 31, 2004,
respectively. See notes J, K and M.
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 January 31, 2004, the
unaudited consolidated statements of operations for the three months and
six months ended January 31, 2004 and 2003 and the unaudited consolidated
statements of cash flows for the six months ended January 31, 2004 and
2003, 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 January 31, 2004, the unaudited consolidated results of operations
for the three months and six months ended January 31, 2004 and 2003 and the
unaudited consolidated statements of cash flows for the three months and
six months ended January 31, 2004 and 2003.
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 January 31, 2004
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- -------------- ----------
Net income (loss) $ 1,450,873
BASIC EPS
Net income (loss) available to common
stockholders 1,450,873 15,352,808 $ 0.09
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 21,298
-------------- --------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,450,873 15,374,106 $ 0.09
============== ============== ==========
For the three months ended January 31, 2003
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- -------------- ----------
Net income (loss) $ 1,549,865
BASIC EPS
Net income (loss) available to common
stockholders 1,549,865 14,866,836 $ 0.10
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 169,926
-------------- --------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,549,865 15,036,762 $ 0.10
============== ============== ==========
9
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE - CONTINUED
For the six months ended January 31, 2004
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- -------------- ----------
Net income (loss) $ 1,292,357
BASIC EPS
Net income (loss) available to common
stockholders 1,292,357 15,325,535 $ 0.08
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 10,649
-------------- --------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,292,357 15,336,184 $ 0.08
============== ============== ==========
For the six months ended January 31, 2003
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- -------------- ----------
Net income (loss) $ 2,756,632
BASIC EPS
Net income (loss) available to common
stockholders 2,756,632 14,868,906 $ 0.19
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 85,065
-------------- --------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 2,756,632 14,953,971 $ 0.18
============== ============== ==========
10
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - STOCK-BASED COMPENSATION
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 Six Months Ended
---------------------------- ----------------------------
January 31, January 31, January 31, January 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net income, as reported $ 1,450,873 $ 1,549,865 $ 1,292,357 $ 2,756,632
Less: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (14,859) (465,753) (67,773) (1,120,309)
------------- ------------- ------------- -------------
Net income, pro forma $ 1,436,014 $ 1,084,112 $ 1,224,584 $ 1,636,323
============= ============= ============= =============
Net income per common share, as reported $ 0.09 $ 0.10 $ 0.08 $ 0.19
============= ============= ============= =============
Net income per common share, pro forma $ 0.09 $ 0.07 $ 0.08 $ 0.11
============= ============= ============= =============
Net income per common share assuming dilution, as
reported $ 0.09 $ 0.10 $ 0.08 $ 0.18
============= ============= ============= =============
Net income per common share assuming dilution,
pro forma $ 0.09 $ 0.07 $ 0.08 $ 0.11
============= ============= ============= =============
The following assumptions were used for grants of warrants to employees in
the six months ended January 31, 2004, to compute the fair value of the
warrants using the Black-Scholes option-pricing model; dividend yield of
0%; expected volatility of 72% and 81%; risk free interest rate of 3.22%
and 3.27% and expected lives of 5 years.
The following assumptions were used for grants of warrants to employees in
the six months ended January 31, 2003, to compute the fair value of the
warrants using the Black-Scholes option-pricing model; dividend yield of
0%; expected volatility of 80%; risk free interest rate of 1.75% and 1.81%
and expected lives of 5 years.
11
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE D - ESTIMATED REDUCTION IN VALUE OF ASSETS HELD FOR SALE
During February 2004, the Company sold all of its compressed natural gas
(CNG) equipment to a third party for $220,000. The purchase price was paid
in cash. Under the terms of the sales agreement, the equipment was sold "as
is".
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
January 31, July 31,
LPG: 2004 2003
-------------- --------------
Midline pump station $ 2,343,988 $ 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
Terminal vehicle 25,968 -
-------------- --------------
7,173,762 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 21,933,443 21,912,475
-------------- --------------
Other:
Office equipment 94,553 93,201
Software 75,890 75,890
-------------- --------------
170,443 169,091
-------------- --------------
22,103,886 22,081,566
Less: accumulated depreciation and amortization ( 4,859,374) ( 4,403,736)
-------------- --------------
$ 17,244,512 $ 17,677,830
============== ==============
(a) See note M.
12
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
$6,280,698 and $6,427,387 of costs, located in Mexico at January 31, 2004
and July 31, 2003, respectively.
NOTE F - INVENTORIES
Inventories are valued at the lower of cost or market (LCM) and consist of
the following:
January 31, 2004 July 31, 2004
--------------------- -------------------
Gallons LCM Gallons LCM
--------- ---------- --------- --------
LPG:
Leased Pipeline 1,175,958 $ 866,375 1,175,958 $638,623
Brownsville Terminal Facility,
Matamoros Terminal Facility
and railcars 419,875 309,339 440,771 239,368
Markham Storage and other - - 168 91
--------- ---------- --------- --------
1,595,833 $1,175,714 1,616,897 $878,082
========= ========== ========= ========
NOTE G - DEBT OBLIGATIONS
Debt consists of the following:
January 31, July 3,
2004 2003
------------ ----------
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility. (a) $ 40,246 $ 284,731
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility. (a) 34,587 198,178
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February
2002. 137,500 137,500
Restructured Notes and $280,000 Notes 1,598,174 1,744,128
Other debt. 115,536 186,524
------------ ----------
Total debt 1,926,043 2,551,061
Less: Current maturities 247,527 746,933
Short term debt - 1,744,128
------------ ----------
Long-term debt $ 1,678,516 $ 60,000
============ ==========
(a) Paid subsequent to January 31, 2004
13
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - DEBT OBLIGATIONS - CONTINUED
EXTENSION OF CERTAIN OF THE NEW ACCEPTING NOTEHOLDERS' NOTES, ADDITIONAL
NOTE AND $250,000 NOTE TOTALING $1,525,000 (COLLECTIVELY THE RESTRUCTURED
NOTES)
On January 16, 2004, the Restructured Notes which were due on December 15,
2003 were renewed and extended (Restructuring). In connection with the
Restructuring, the due date of the Restructured Notes was extended to
December 15, 2005. The Restructured Notes can be repaid at any time without
penalty. Annual interest on the Restructured Notes is 16.5% and the Company
also agreed to pay a fee of 1.5% on any principal balance of the
Restructured Notes outstanding at the end of each quarterly period,
beginning December 15, 2003. Interest and fees are payable quarterly
beginning March 15, 2004.
In addition, the Company agreed to extend the expiration date on
outstanding warrants to purchase common stock of the Company held by
holders of the Restructured Notes until December 15, 2008 and agreed to
issue new warrants to purchase units of Rio Vista Energy Partners L.P. (Rio
Vista) in an amount equal to 2,500 warrants for each $100,000 of
Restructured Notes and an additional 2,500 warrants in Rio Vista for each
$100,000 of Restructured Notes outstanding at December 15, 2004 (Rio Vista
Warrants). The Rio Vista Warrants will expire three years from the date of
the Spin-Off (see note M) and the exercise price will be determined based
on a formula whereby the annualization of the first quarterly distribution
will represent a 20% yield on the exercise price. In addition, the Company
agreed to issue an additional 37,500 warrants to purchase shares of common
stock of the Company to certain holders of the Restructured Notes.
Certain holders of promissory notes totaling approximately $280,000 of
principal due December 15, 2003 which did not agree to the Restructuring
(Declining Noteholders) were paid by the Company. In connection with
amounts due to the Declining Noteholders, the Company issued $280,000 of
promissory notes ($280,000 Notes). The terms of the $280,000 Notes are
substantially similar to the Restructured Notes, except that the holders of
the $280,000 Notes were not entitled to receive any warrants to purchase
shares of common stock of the Company.
In addition, holders of the Restructured Notes and $280,000 Notes consented
to the Spin-Off of Rio Vista provided that the assets of the Company to be
transferred to Rio Vista will continue to be pledged as collateral for
payment of the Restructured Notes and $280,000 Notes, Rio Vista guarantees
the Company's obligations under the Restructured Notes and $280,000 Notes
and that Rio Vista is prohibited against making any distributions in the
event that the Company is in default under the Restructured Notes and
$280,000 Notes.
In connection with the Restructured Notes and $280,000 Notes, Philadelphia
Brokerage Corporation acted as placement agent and will receive a fee equal
to 1.5% of the Restructured Notes and $280,000 Notes and after the date of
the Spin-Off warrants to purchase 10,000 units in Rio Vista and an
additional 10,000 warrants to purchase 10,000 units in Rio Vista if the
Restructured Notes and $280,000 Notes are not paid by December 15, 2004.
The terms of the warrants are the same as the Rio Vista Warrants.
In connection with the issuance of the new warrants of the Company and the
extension of the warrants of the Company, the Company recorded a discount
of $220,615 related to the fair value of the newly issued, modified
warrants and fees of which $13,788 has been amortized through January 31,
2004. In addition, $75,622 of discount was amortized which related to the
New Accepting Noteholders' Notes, Additional Note and $250,000 note during
the six months ended January 31, 2004. The Company will record an
additional discount related to the obligation to issue Rio Vista warrants
to the holders of the Restructured Notes and $280,000 Notes after the date
of the Spin-off and after the Company is able to determine the fair value,
if any.
OTHER
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
14
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - DEBT OBLIGATIONS - CONTINUED
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).
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. Jorge 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.
During November 2003, warrants to purchase 16,625 shares of common stock of
the Company were exercised resulting in cash proceeds to the Company of
$41,563.
During January 2004, the Company agreed to accept 77,765 shares of common
stock of the Company as full satisfaction of indebtedness owed to the
Company by a related party. As a result, the Company recorded previously
unrecorded interest income of $32,334.
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 the restructuring of certain debt obligations (see Note
G), during January 2004 the Company issued warrants to purchase 37,500
shares of common stock of the Company at an exercise price of $2.50 per
share, exercisable until December 15, 2008.
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.
15
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.
16
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 January 31, 2004, the Company had a $15,000,000 credit facility (see
below) with RZB Finance L.L.C. (RZB) for demand loans and standby letters
of credit (RZB Credit Facility) to finance the Company's purchases of LPG.
Under the RZB Credit Facility, the Company pays a fee with respect to each
letter of credit thereunder in an amount equal to the greater of (i) $500,
(ii) 2.5% of the maximum face amount of such letter of credit, or (iii)
such higher amount as may be agreed to between the Company and RZB. Any
loan amounts outstanding under the RZB Credit Facility shall accrue
interest at a rate equal to the rate announced by the JPMorgan Chase Bank
as its prime rate plus 2.5%. Pursuant to the RZB Credit Facility, RZB has
sole and absolute discretion to limit or terminate 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.
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, Duke Energy
NGL Services, Inc. (Duke), 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 January 31, 2004
totaled approximately $15,300,000.
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
$4,133,465 at January 31, 2004). At January 31, 2004, the Company's
borrowings and commitments were less than the amount of the Assets.
The RZB Credit Facility was to be reduced from $15,000,000 to $12,000,000
after January 31, 2004. However, the RZB Credit Facility has remained at
$15,000,000 pursuant to month-to-month extensions. The Company and RZB are
currently in negotiations to maintain the credit facility at $15,000,000
for a longer term than month-to-month.
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.
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.
17
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
historically had 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 Restructured Notes, the
$280,000 Note and the RZB Credit Facility. The RZB Credit Facility was to
be reduced from $15,000,000 to $12,000,000 after January 31, 2004. However,
the RZB Credit Facility has remained at $15,000,000 pursuant to
month-to-month extensions. The Company and RZB are currently in
negotiations to maintain the credit facility at $15,000,000 for a longer
term than month-to-month. On December 29, 2003, the Company received notice
from PMI that it was terminating the Contract effective March 31, 2004 (see
note K).
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 materially reduced by
the amount of the Spin-Off which may result in a deficit in stockholders'
equity and a portion of the Company's current cash flow from operations
will be shifted to the Partnership. Therefore, the Company's remaining cash
flow may not be sufficient to allow the Company to pay its federal income
tax liability resulting from the Spin-Off, if any, and other liabilities
and obligations when due. The Partnership will be liable as guarantor on
the Company's collateralized debt discussed in the preceding paragraph and
will continue to pledge all of its assets as collateral. In addition, the
Partnership has agreed to indemnify the Company for a period of three years
from the fiscal year end that includes the date of the Spin-Off for any
federal income tax liabilities resulting from the Spin-Off in excess of
$2,500,000.
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 (1) the ability of the Company
to 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 indemnification in the event the Spin-Off occurs if the
Company does not generate sufficient cash flow. The ability for the Company
and the Partnership to generate sufficient cash flows is significantly
dependant on the continued sales of LPG to PMI at acceptable monthly sales
volumes and margins. 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 renew and extend the
Contract at acceptable monthly sales volumes and margins. In addition,
management is taking steps to (i) consummate the Spin-Off (ii) diversify
its operations to reduce dependency on sales to PMI, (iii) increase and
extend the RZB Credit Facility and (iv) raise additional debt and/or equity
capital.
18
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 was originally to expire on May 31, 2004. On
December 29, 2003, the Company received a notice from PMI requesting the
termination of the Contract effective March 31, 2004, the end of the winter
period as defined under the Contract. The Company and PMI are currently
negotiating the renewal of 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.
During December 2003, the Company and Koch Hydrocarbon Company (Koch)
entered into a new three year supply agreement. The terms of the agreement
are similar to the agreement previously in effect between the parties.
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 - 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.
19
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 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 (SEC). The Form 10 has subsequently
been amended for clarification based on comments from the SEC staff. The
amended Form 10 was filed on March 5, 2004. Rio Vista is awaiting further
comments, if any, from the SEC staff. The Board of Directors anticipates
that the Spin-Off will occur in 2004, subject to a number of conditions
including 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.
20
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. Richter and
Shore Capital LLC (Shore), a company owned by Mr. Richard Shore, the
Company's President, options to each purchase 25% of the limited liability
company interests in the general partner of 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 January 31, 2004 the amount of
stockholders' equity reflected in the Company's pro forma consolidated
balance sheet would have been reduced by approximately $14,500,000 with a
corresponding credit to minority interest. This would have resulted in
stockholders' equity of approximately $1,700,000.
Had the transaction been consummated as of August 1, 2003, the Company's
pro forma consolidated net income for the six months ended January 31, 2004
would have decreased to a net loss of approximately $(800,000) 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, income per
share would have decreased to a net loss per share of approximately $(.05).
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 and six months ended January 31, 2004, the Company derived
86% and 84%, respectively 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 January 31, 2004 and
2003;
2004 2003
----- -----
Volume Sold
LPG (millions of gallons) - PMI 59.1 61.7
LPG (millions of gallons) - Other 10.9 9.3
------ -----
70.0 71.0
======= ======
Average sales price
LPG (per gallon) - PMI $ 0.74 $ 0.63
LPG (per gallon) - Other 0.65 0.52
22
RESULTS OF OPERATIONS
THREE MONTHS ENDED JANUARY 31, 2004 COMPARED WITH THREE MONTHS ENDED JANUARY 31,
2003
Revenues. Revenues for the three months ended January 31, 2004 were $50.6
million compared with $43.6 million for the three months ended January 31, 2003,
an increase of $6.9 million or 16.0%. Of this increase, $6.8 million was
attributable to increases in average sales prices of LPG sold to PMI during the
three months ended January 31, 2004, $1.2 million was attributable to increased
average sales prices of LPG sold to customers other than PMI during the three
months ended January 31, 2004 and $1.0 million was attributable to increased
volumes of LPG sold to customers other than PMI during the three months ended
January 31, 2004, partially offset by $1.9 million attributable to decreased
volumes of LPG sold to PMI during the three months ended January 31, 2004.
Cost of goods sold. Cost of goods sold for the three months ended January
31, 2004 was $47.3 million compared with $40.2 million for the three months
ended January 31, 2003, an increase of $7.1 million or 17.6%. Of this increase,
$6.6 million was attributable to increases in the cost of LPG sold to PMI during
the three months ended January 31, 2004, $1.1 million was attributable to
increased costs of LPG sold to customers other than PMI during the three months
ended January 31, 2004, and $1.0 million was attributable to increased volume of
LPG sold to customers other than PMI during the three months ended January 31,
2004, partially offset by $1.7 million attributable to decreased volume of LPG
sold to PMI during the three months ended January 31, 2004.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.5 million for the three months ended January 31,
2004 compared with $1.4 million for the three months ended January 31, 2003, an
increase of $130,106 or 9.1%. The increase during the three months ended January
31, 2004 was principally due to legal and other professional fees related to the
Spin-Off, salary related costs, insurance costs, foreign ad valorem and asset
taxes and domestic real estate taxes partially offset by a reduction in
professional fees related to litigation.
Other income (expense). Other income (expense) was $(299,162) for the
three months ended January 31, 2004, compared with $(408,796) for the three
months ended January 31, 2003. The decrease in other expenses was due primarily
to reduced interest and LPG financing costs resulting from reduced debt and
lower LPG purchases.
Income tax. The Company reduced its estimate of Mexican income tax by
$66,072 and recorded U.S. federal income taxes of $52,500 related to
alternative minimum taxes for the three months ended January 31, 2004.
SIX MONTHS ENDED JANUARY 31, 2004 COMPARED WITH SIX MONTHS ENDED JANUARY 31,
2003
Revenues. Revenues for the six months ended January 31, 2004 were $89.1
million compared with $81.0 million for the six months ended January 31, 2003,
an increase of $8.1 million or 10.0%. Of this increase, $11.0 million was
attributable to increases in average sales prices of LPG sold to PMI during the
six months ended January 31, 2004, and $3.6 million was attributable to
increased average sales prices of LPG sold to customers other than PMI during
the six months ended January 31, 2004, partially offset by $2.5 million
attributable to decreased volumes of LPG sold to PMI during the six months ended
January 31, 2004 and $3.9 million attributable to decreased volumes of LPG sold
to customers other than PMI during the six months ended January 31, 2004.
Cost of goods sold. Cost of goods sold for the six months ended January
31, 2004 was $83.8 million compared with $75.2 million for the six months ended
January 31, 2003, an increase of $8.6 million or 11.5%. Of this increase, $10.8
million was attributable to increases in the cost of LPG sold to PMI during the
six months ended January 31, 2004 and $3.9 million was attributable to increased
costs of LPG sold to customers other than PMI during the six months ended
January 31, 2004, partially offset by $4.0 million attributable to decreased
volume of LPG sold to customers other than PMI during the six months ended
January 31, 2004 and $2.2 million attributable to decreased volume of LPG sold
to PMI during the six months ended January 31, 2004.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $3.1 million for the six months ended January 31,
2004 compared with $2.5 million for the six months ended January 31, 2003, an
increase of $564,449 or 22.3%. The increase during the six months ended January
31, 2004 was principally due to legal and other professional fees related to the
Spin-Off, salary related costs, insurance costs, foreign ad valorem and asset
taxes and domestic real estate taxes partially offset by a reduction in
professional fees related to litigation.
23
Other income (expense) and estimated reduction in value of assets held for
sale. Other income (expense) was $(959,409) for the six months ended January 31,
2004, compared with $(711,592) for the six months ended January 31, 2003. The
increase in other expenses was due primarily to increased amortization of
discounts on outstanding debt incurred and the estimated reduction in value of
assets held for sale of $500,000 during the six months ended January 31, 2004,
partially offset by reduced interest costs resulting from reduced debt and
$210,000 of other income related to the cancellation of a contract.
Income tax. The Company reduced the estimate for Mexican income tax
expense by $41,072 and recorded U.S. federal income taxes of $52,500 related to
alternative minimum taxes for the six months ended January 31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception
and has historically had 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 Restructured Notes, the
$280,000 Note and the RZB Credit Facility. The RZB Credit Facility was to be
reduced from $15.0 million to $12.0 million after January 31, 2004. However,
the RZB Credit Facility has remained at $15.0 million pursuant to month-to-month
extensions. The Company and RZB are currently in negotiations to maintain the
credit facility at $15.0 million for a longer term than month-to-month. 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. On December 29, 2003, the
Company received notice from PMI that it was terminating the Contract effective
March 31, 2004 (see below). 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.
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 six months
ended January 31, 2004, and 2003. All information is in thousands.
2004 2003
--------- --------
Net cash provided by operating activities $ 1,137 $ 3,354
Net cash (used in) investing activities . (23) ( 199)
Net cash (used in) financing activities . ( 1,101) (3,256)
--------- --------
Net increase (decrease) in cash. . . . . $ 13 $ (101)
--------- --------
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.
On December 29, 2003, the Company received a notice from PMI requesting the
termination of the Contract effective March 31, 2004, the end of the winter
period as defined under the Contract. The Company believes that the termination
was based on PMI's desire to have the new contract fall within PMI's traditional
period of arranging for LPG supplies. The Company and PMI are currently
negotiating the renewal of the Contract, however, there can be no assurance that
such an agreement or any agreement will be reached with PMI or, if so, that the
terms of such agreement will be more or less beneficial to the Company than
those of 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 24.0 million
gallons per month although the Contract provides for lesser quantities.
During December 2003, the Company and Koch Hydrocarbon Company ("Koch")
entered into a new three year supply agreement. The terms of the agreement are
similar to the agreement previously in effect between the parties.
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.
25
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million and 360
millions gallons per year.
Upgrades. The Company also intends to contract for the design,
installation and construction of pipelines which will connect the Brownsville
Terminal Facility to the water dock facilities at the Brownsville Ship Channel
and install additional storage capacity. The cost of this project is expected
to approximate $2.0 million. In addition the Company intends to upgrade its
computer and information systems at a total estimated cost of $350,000.
Sales of Assets. During February 2004, the Company sold all of its
compressed natural gas ("CNG") equipment to a third party for $220,000. The
purchase price was paid in cash. Under the terms of the sales agreement, the
equipment was sold "as is".
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. During July 2003, the
Company acquired an option to purchase Tergas for a nominal price (estimated to
be $5,000) from an officer and consultant of the Company.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal"). The Company
was unable to receive all the necessary approvals to operate the facility at
that location. The Company has identified an alternate site in Hipolito,
Mexico, a town located in the proximity of Saltillo to relocate the Saltillo
Terminal. The relocation of the Saltillo terminal is very important to the
Company's growth strategy in Mexico. The expense of such relocation is
estimated to be $500,000.
Once completed, the Company expects the newly-constructed terminal facility
to be capable of off-loading LPG from railcars to trucks. The newly-constructed
terminal facility will have three truck loading racks and storage to accommodate
approximately 390,000 gallons of LPG.
Once operational, the Company can directly transport LPG via railcar from
the Brownsville Terminal Facility to the Saltillo area. The Company believes
that by having the capability to deliver LPG to the Saltillo area, the Company
will be able to further penetrate the Mexican market for the sale of LPG.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, the Company is subject to the tax laws of Mexico which,
among other things, require that the Company comply with transfer pricing rules,
the payment of income, asset and ad valorem taxes, and possibly taxes on
distributions in excess of earnings. In addition, distributions to foreign
corporations, including dividends and interest payments may be subject to
Mexican withholding taxes.
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
26
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.
Sales of Refined Products. During January 2004, the Company initiated its
plans to become involved in the bulk and rack sales of refined petroleum
products consisting of gasoline and diesel. The Company expects that the sale
of refined products will commence during April 2004, subject to the Company
obtaining the necessary trade financing required. The Company anticipates that
based on adequate financing, the sale of refined products will approximate $70.0
million on an annual basis and operating profits of approximately $1.0 million.
27
Credit Arrangements. As of January 31, 2004, the Company had a $15.0
million credit facility (see below) with RZB Finance L.L.C. ("RZB") 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.
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, Duke, Koch
and/or other suppliers, letters of credit are issued on a monthly basis based on
anticipated purchases. Outstanding letters of credit at January 31, 2004
totaled approximately $15.3 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 $4.1 million
at January 31, 2004). At January 31, 2004, the Company's borrowings and
commitments were less than the amount of the Assets.
The RZB Credit Facility was to be reduced from $15.0 million to $12.0
million after January 31, 2004. However, the RZB Credit Facility has remained
at $15.0 million pursuant to month-to-month extensions. The Company and RZB are
currently in negotiations to maintain the credit facility at $15.0 million for a
longer term than month-to-month.
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.
Private Placements and Other Transactions. On January 16, 2004, certain of
the Extending Noteholders' notes and $250,000 Note totaling $1.5 million
(collectively the "Restructured Notes") which were due on December 15, 2003 were
renewed and extended (the "Restructuring"). In connection with the
Restructuring, the due date of the Restructured Notes was extended to December
15, 2005. The Restructured Notes can be repaid at any time without penalty.
Annual interest on the Restructured Notes is 16.5% and the Company also agreed
to pay a fee of 1.5% on any principal balance of the Restructured Notes
outstanding at the end of each quarterly period, beginning December 15, 2003.
Interest and fees are payable quarterly beginning March 15, 2004.
Certain holders of promissory notes totaling approximately $280,000 of
principal due December 15, 2003 which did not agree to the Restructuring (the
"Declining Noteholders") were paid by the Company. In connection with amounts
due to the Declining Noteholders, the Company issued $280,000 of promissory
notes (the "$280,000 Notes"). The terms of the $280,000 Notes are substantially
similar to the Restructured Notes, except that the holders of the $280,000 Notes
were not entitled to receive any warrants to purchase shares of common stock of
the Company.
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.
28
During September 2003, the Company issued 21,818 shares of common stock of
the Company to the former officer and director as severance compensation 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.
During November 2003, warrants to purchase 16,625 shares of common stock of
the Company were exercised resulting in cash proceeds to the Company of $41,563.
During January 2004, the Company agreed to accept 77,765 shares of common
stock of the Company as full satisfaction of indebtedness owed to the Company by
a related party. As a result, the Company recorded previously unrecorded
interest income of $32,334.
In connection with warrants previously issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right to
purchase the warrants for a nominal price if the holder of the warrants does not
elect to exercise the warrants during the call provision period.
Settlement of Litigation. On 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.
29
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 historically had 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 Restructured Notes, the
$280,000 Note and the RZB Credit Facility. The RZB Credit Facility was to be
reduced from $15.0 million to $12.0 million after January 31, 2004. However,
the RZB Credit Facility has remained at $15.0 million pursuant to month-to-month
extensions. The Company and RZB are currently in negotiations to maintain the
credit facility at $15.0 million for a longer term than month-to-month. On
December 29, 2003, the Company received notice from PMI that it was terminating
the Contract effective March 31, 2004 (see note K to the unaudited consolidated
financial statements).
In addition to the above, the Company intends to Spin-Off a major portion
of its assets to its stockholders (see note M to the unaudited consolidated
financial statements). As a result of the Spin-Off, the Company's stockholders'
equity will be materially reduced by the amount of the Spin-Off which may result
in a deficit in stockholders' equity and a portion of the Company's current cash
flow from operations will be shifted to the Partnership. Therefore, the
Company's remaining cash flow may not be sufficient to allow the Company to pay
its federal income tax liability resulting from the Spin-Off, if any, and other
liabilities and obligations when due. The Partnership will be liable as
guarantor on the Company's collateralized debt discussed in the preceding
paragraph and will continue to pledge all of its assets as collateral. In
addition, the Partnership has agreed to indemnify the Company for a period of
three years from the fiscal year end that includes the date of the Spin-Off for
any federal income tax liabilities resulting from the Spin-Off in excess of $2.5
million.
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon (1) the ability of the Company to
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
indemnification in the event the Spin-Off occurs if the Company does not
generate sufficient cash flow. The ability for the Company and the Partnership
to generate sufficient cash flows is significantly dependant on the continued
sales of LPG to PMI at acceptable monthly sales volumes and margins. 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 renew and extend the
Contract at acceptable monthly sales volumes and margins. In addition,
management is taking steps to (i) consummate the Spin-Off (ii) diversify its
operations to reduce dependency on sales to PMI, (iii) increase and extend the
RZB Credit Facility and (iv) raise additional debt and/or equity capital.
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 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.
30
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 "SEC"). The Form 10 has subsequently been amended
for clarification based on comments from the SEC staff. The amended Form 10 was
filed on March 5, 2004. Rio Vista is awaiting further comments, if any, from
the SEC staff. The Board of Directors anticipates that the Spin-Off will occur
in 2004, subject to a number of conditions including 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. Richter and
Shore Capital LLC (Shore), a company owned by Mr. Richard Shore, the Company's
President, options to each purchase 25% of the limited liability company
interests in the general partner of 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.
31
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 January 31, 2004 the amount of
stockholders' equity reflected in the Company's pro forma consolidated balance
sheet would have been reduced by approximately $14.5 million with a
corresponding credit to minority interest. This would have resulted in
stockholders' equity of approximately $1.7 million.
Had the transaction been consummated as of August 1, 2003, the Company's
pro forma consolidated net income for the six months ended January 31, 2004
would have decreased to a net loss of approximately $(800,000) 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, income per share would
have decreased to a net loss per share of approximately $(.05).
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.
32
Contractual Obligations and Commercial Commitments. The following is a
summary of the Company's estimated minimum contractual obligations and
commercial obligations as of January 31, 2004. Where applicable, LPG prices are
based on the January 2004 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 12.1 1.4 2.8 2.6 5.3
LPG Purchase Obligations 810.1 174.9 329.9 229.3 76.0
Other Long-Term Obligations - - - - -
-------------- ---------- ------- ------ --------
Total Contractual Cash Obligations $ 822.2 $ 176.3 $ 332.7 $231.9 $ 81.3
============== ========== ======= ====== ========
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 15.3 15.3 - - -
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 $ 15.3 $ 15.3 $ - $ - $ -
============== ========== ======= ====== ========
33
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.
Market risk is the risk of loss arising from adverse changes in market
rates and prices. Because the Company primarily sells LPG on a fixed margin
basis and does not expect to hold inventory of LPG, the Company is not expected
to be exposed to market risk for fluctuations in the price of LPG. To the extent
the Company ever 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 would be exposed to market risk
related to the volatility of LPG prices. In the event that such inventory
balances were to 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 were to exceed such inventory balances, the Company may purchase
contracts which protect us against future price increases of LPG.
The Company does not maintain quantities of LPG inventory in excess of
quantities actually ordered by PMI. Therefore, the Company has not currently
entered into and does not currently expect to enter into any arrangements in the
future to mitigate the impact of commodity price risk.
The Company has historically borrowed only at fixed interest rates. All
current interest bearing debt is at a fixed rate. Trade accounts receivable
from the Company's limited number of customers and the Company's trade and other
accounts payable do not bear interest. The Company's credit facility with RZB
does not bear interest since generally no cash advances are made to the Company
by RZB. Fees paid to RZB for letters of credit are based on a fixed schedule
provided in the Company's agreement with RZB. Therefore, the Company currently
has limited, if any, interest rate risk.
The Company routinely converts U.S. dollars into Mexican pesos to pay
terminal operating costs and income taxes. Such costs have historically been
less than $1 million per year and the Company expects such costs will remain at
less than $1 million dollars in any year. The Company does not maintain Mexican
peso bank accounts with other than nominal balances. Therefore, the Company has
limited, if any, risk related to foreign currency exchange rates.
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.
34
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, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
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
January 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 January 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:
15 Accountant's Acknowledgment
35
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.
36
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
March 18, 2004 By: /s/Ian T. Bothwell
--------------------------------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
37