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 March 31, 2005
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: 000-50394
RIO VISTA ENERGY PARTNERS L.P.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 20-0153267
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
820 GESSNER ROAD, SUITE 1285, HOUSTON, TEXAS 77024
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (713) 467-8235
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 common units outstanding on May 6, 2004 was 1,910,656.
1
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM PAGE NO.
---------- --------
Part I 1. Financial Statements
Independent Certified Public Accountants' Review Report 3
Consolidated Balance Sheets as of December 31, 2004 and
March 31, 2005 (unaudited) 4-5
Unaudited Consolidated Statements of Operations for the three months
ended March 31, 2004 and 2005 6
Unaudited Consolidated Statement of Partners' Capital as of
March 31, 2005 7
Unaudited Consolidated Statements of Cash Flows for the three months
ended March 31, 2004 and 2005 8
Notes to Consolidated Financial Statements (unaudited) 9-21
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 22-40
3. Quantitative and Qualitative Disclosures About Market Risk 41
4. Controls and Procedures 41
Part II 1. Legal Proceedings 42
2. Unregistered Sales of Equity Securities and Use of Proceeds 42
3. Defaults Upon Senior Securities 42
4. Submission of Matters to a Vote of Security Holders 42
5. Other Information 42
6. Exhibits 42
Signatures 43
2
PART I
ITEM 1.
Independent Certified Public Accountants' Review Report
-------------------------------------------------------
To the Board of Managers of Rio Vista GP LLC,
General Partner of Rio Vista Energy Partners L.P.
We have reviewed the consolidated balance sheet of Rio Vista Energy Partners
L.P. and subsidiaries (Rio Vista) as of March 31, 2005, the consolidated
statement of partners' capital for the three months ended March 31, 2005 and the
consolidated statements of operations and cash flows for the three months ended
March 31, 2004 and 2005. These consolidated financial statements are the
responsibility of Rio Vista's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 the
standards of the Public Company Accounting Oversight Board, 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 review, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for it to be
in conformity with United States generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Rio Vista Energy Partners L.P. and subsidiaries as of December 31, 2004
and the consolidated statements of operations, partners' capital and cash flows
for the year ended December 31, 2004 (not presented herein); and in our report
dated February 2, 2005, 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 December 31, 2004, is fairly
stated.
Our auditors' report on Rio Vista's financial statements as of December 31, 2004
included an explanatory paragraph referring to the matters discussed in Note N
of those financial statements which raised substantial doubt about Rio Vista's
ability to continue as a going concern. As indicated in Note K to the
accompanying unaudited interim consolidated financial statements, conditions
continue to exist which raise substantial doubt about Rio Vista's ability to
continue as a going concern.
/s/ BURTON McCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
April 25, 2005
3
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
March 31,
December 31, 2005
2004 (Unaudited)
------------- ------------
Current Assets
Cash $ 13,000 $ 26,000
Restricted cash 3,983,000 922,000
Trade accounts receivable (less allowance for doubtful accounts of $0 at
2003 and 2004) 5,785,000 6,664,000
Inventories 198,000 196,000
Prepaid expenses and other current assets 9,000 412,000
------------- ------------
Total current assets 9,988,000 8,220,000
Property, plant and equipment - net 14,244,000 14,046,000
Other non-current assets 12,000 13,000
------------- ------------
Total assets $ 24,244,000 $ 22,279,000
============= ============
The accompanying notes and accountants' report are an integral part of these
statements.
4
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND PARTNERS' CAPITAL
March 31,
December 31, 2005
2004 (Unaudited)
------------- ------------
Current Liabilities
Due to Penn Octane Corporation, net $ 8,632,000 $ 6,479,000
Accounts payable 290,000 372,000
Mexican taxes payable 27,000 29,000
Accrued liabilities 382,000 379,000
------------- ------------
Total current liabilities 9,331,000 7,259,000
Commitments and contingencies - -
Partners' Capital
Common units 14,615,000 14,720,000
General partner's equity 298,000 300,000
------------- ------------
Total partners' capital 14,913,000 15,020,000
------------- ------------
Total liabilities and partners' capital $ 24,244,000 $ 22,279,000
============= ============
The accompanying notes and accountants' report are an integral part of these
statements.
5
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
-------------------------
March 31, March 31,
2004 2005
----------- ------------
Revenues $ - $28,557,000
Cost of goods sold - 27,238,000
----------- ------------
Gross profit - 1,319,000
Selling, general and administrative expenses
Legal and professional fees - 242,000
Salaries and payroll related expenses - 394,000
Other - 391,000
----------- ------------
- 1,027,000
----------- ------------
Operating income - 292,000
Other income (expense)
Interest and LPG financing expense - ( 119,000)
----------- ------------
Income before taxes - 173,000
Provision (benefit) for Mexican income taxes - 1,000
----------- ------------
Net income $ - $ 172,000
=========== ============
Net income allocable to the partners $ - $ 172,000
Less general partner's interest in net income - 3,000
----------- ------------
Net income allocable to the common units $ - $ 169,000
=========== ============
Net income per common unit $ - $ 0.09
=========== ============
Net income per common unit assuming dilution $ - $ 0.08
=========== ============
Weighted average common units outstanding - 1,910,656
=========== ============
The accompanying notes and accountants' report are an integral part of these
statements.
6
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
COMMON UNITS
--------------------------
TOTAL
GENERAL PARTNERS'
UNITS AMOUNT PARTNER CAPITAL
--------- --------------- ------------- ---------------
BALANCE AS OF DECEMBER 31, 2004 1,910,656 14,615,000 298,000 14,913,000
Net income - 169,000 3,000 172,000
Cash distribution to partners - ( 477,000) ( 10,000) ( 487,000)
Loan discount on Penn Octane
Corporation's debt related to detachable
warrants - 413,000 9,000 422,000
--------- --------------- ------------- ---------------
BALANCE AS OF MARCH 31, 2005 (UNAUDITED) 1,910,656 $ 14,720,000 $ 300,000 $ 15,020,000
========= =============== ============= ===============
The accompanying notes and accountants' report are an integral part of these
statements.
7
RIO VISTA ENERGY PARTNERS L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
----------------------------
March 31, March 31,
2004 2005
------------ --------------
Cash flows from operating activities:
Net income $ - $ 172,000
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation - 205,000
Amortization of loan discount related to detachable warrants 57,000
Changes in current assets and liabilities:
Trade accounts receivable - ( 879,000)
Inventories - 2,000
Prepaid and other current assets - ( 38,000)
Trade accounts payable - 82,000
Due to Penn Octane Corporation, net - ( 2,152,000)
Other accounts payable and accrued liabilities - ( 3,000)
Mexican taxes payable - 1,000
------------ --------------
Net cash provided by (used in) operating activities - ( 2,553,000)
Cash flows from investing activities:
Capital expenditures - ( 7,000)
Other non-current assets - ( 1,000)
------------ --------------
Net cash used in investing activities - ( 8,000)
Cash flows from financing activities:
Increase (decrease) in restricted cash - 3,061,000
Initial capitalization - -
Cash distributions to partners - ( 487,000)
------------ --------------
Net cash provided by (used) in financing activities - 2,574,000
------------ --------------
Net increase in cash - 13,000
Cash at beginning of period 2,000 13,000
------------ --------------
Cash at end of period $ 2,000 $ 26,000
============ ==============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest and LPG financing expense $ - $ -
============ ==============
Supplemental disclosures of noncash transactions:
Units and warrants issued and other $ - $ 422,000
============ ==============
The accompanying notes and accountants' report are an integral part of these
statements.
8
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - ORGANIZATION
Rio Vista Energy Partners L.P. (Rio Vista), a Delaware limited partnership, was
formed by Penn Octane Corporation (Penn Octane) on July 10, 2003 and was a
wholly owned subsidiary of Penn Octane until September 30, 2004, the date that
Penn Octane completed a series of transactions involving (i) the transfer of
substantially all of its owned pipeline and terminal assets in Brownsville,
Texas and Matamoros, Mexico and certain immaterial liabilities (Assets) to Rio
Vista Operating Partnership L.P. (RVOP) (ii) the transfer of its 99.9% interest
in RVOP to Rio Vista and (iii) the distribution of all of its limited
partnership interests (Common Units) in Rio Vista to its common stockholders
(Spin-Off), resulting in Rio Vista becoming a separate public company. The
Common Units represented 98% of Rio Vista's outstanding capital and 100% of Rio
Vista's limited partnership interests. The remaining 2%, which is the general
partner interest, is owned and controlled by Rio Vista GP LLC (General Partner),
a wholly owned subsidiary of Penn Octane. The General Partner is responsible
for the management of Rio Vista. Rio Vista Energy Partners L.P. and its
consolidated subsidiaries are hereinafter referred to as "Rio Vista".
As a result of the Spin-Off, Rio Vista is engaged in the purchase,
transportation and sale of liquefied petroleum gas (LPG). Rio Vista owns and
operates LPG terminal facilities in Brownsville, Texas (Brownsville Terminal
Facility) and 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 primary
market for Rio Vista's LPG is the northeastern region of Mexico, which includes
the states of Coahuila, Nuevo Leon and Tamaulipas. Rio Vista's primary customer
for LPG is P.M.I. Trading Limited (PMI). PMI is a subsidiary of Petroleos
Mexicanos, the state-owned Mexican oil company, which is commonly known by its
trade name "PEMEX." PMI is the exclusive importer of LPG into Mexico. The LPG
purchased by PMI from Rio Vista is sold to PEMEX which distributes the LPG
purchased from PMI into the northeastern region of Mexico.
All of Rio Vista's LPG operations are conducted through, and Rio Vista's LPG
operating assets are owned by, RVOP. The General Partner is entitled to receive
distributions on its general partner interest as provided for in Rio Vista's
partnership agreement (Agreement). The General Partner has sole responsibility
for conducting Rio Vista's business and for managing Rio Vista's operations in
accordance with the Agreement. Other than the foregoing distributions, the
General Partner does not receive a management fee or other compensation in
connection with its management of Rio Vista's business, but is entitled to be
reimbursed for all direct and indirect expenses incurred on Rio Vista's behalf.
Rio Vista purchases LPG from Penn Octane under a long-term supply agreement (LPG
Supply Agreement). The purchase price of the LPG from Penn Octane is determined
based on the cost of LPG under Penn Octane's agreements with its LPG suppliers
for volumes sold to Rio Vista for sale to PMI or to other Rio Vista customers,
other direct costs related to PMI and other LPG sales of Rio Vista and a formula
that takes into consideration operating costs of Penn Octane and Rio Vista.
Historically, up until the date of the Spin-Off, Penn Octane has sold LPG
primarily to PMI. Penn Octane has a long-term lease agreement, expiring in
December 2013, for approximately 132 miles of 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 Rio Vista's
Brownsville Terminal Facility (Leased Pipeline). In addition, Penn Octane 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 Penn Octane's lease agreement for the
Leased Pipeline, Penn Octane 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. Penn Octane's long term
supply agreement in effect as of March 31, 2005 with Exxon requires Penn Octane
to purchase minimum quantities of LPG totaling up to 13,900,000 gallons of LPG
per month although actual quantities supplied under such agreement during the
three months ended March 31, 2005 were approximately 9,295,000 gallons per
month.
9
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - ORGANIZATION - CONTINUED
BASIS OF PRESENTATION
- -----------------------
The accompanying consolidated financial statements include Rio Vista and its
United States subsidiaries including RVOP, Rio Vista Operating GP LLC and Penn
Octane International, L.L.C., and its Mexican subsidiaries, Penn Octane de
Mexico, S. de R.L. de C.V. (PennMex) and Termatsal, S. de R.L. de C.V.
(Termatsal) and its consolidated affiliate, Tergas, S. de R.L. de C.V. (Tergas).
All significant intercompany accounts and transactions are eliminated.
The unaudited consolidated balance sheet as of March 31, 2005 and the unaudited
consolidated statements of operations and cash flows for the three months ended
March 31, 2004 and 2005 have been prepared by Rio Vista 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 Rio Vista as of
March 31, 2005, the unaudited consolidated results of operations and cash flows
for the three months ended March 31, 2004 and 2005. Rio Vista was inactive
until September 30, 2004, the date of the Spin-Off and operations did not
commence until October 1, 2004. Accordingly, there are no results of operations
during the three months ended March 31, 2004.
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 Rio
Vista's Fiscal Year 2004 Annual Report on Form 10-K filed with the Securities
and Exchange Commission.
NOTE B - UNIT BASED COMPENSATION
Under the guidance provided by SFAS 123, Rio Vista has elected to continue
to account for employee unit-based compensation using the intrinsic value
method prescribed in Accounting Principles Board (APB) 25, "Accounting for
Stock Issued to Employees", and related Interpretations.
10
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B - UNIT BASED COMPENSATION - CONTINUED
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, Rio Vista's pro forma net income (loss), and net
income (loss) per common unit would have been as follows for the three
months ended March 31,:
2004 2005
---------------- ----------------
Net income (loss) as reported $ - $ 172,000
Add: Unit-based employee compensation expense
included in reported net loss - -
Less: Total unit-based employee compensation
expense determined under fair value based method for
all awards - ( 285,000)
---------------- ----------------
Net income (loss) pro forma - ( 113,000)
Net income (loss) allocable to the common units pro forma - ( 111,000)
Net income (loss) per common unit, as reported - .09
Net income (loss) per common unit, pro forma - ( .06)
Net income (loss) per common unit assuming dilution,
as reported - .08
Net income (loss) per common unit assuming dilution,
pro forma - ( .06)
The following assumptions were used for grants of warrants to employees in
the three months ended March 31, 2005, to compute the fair value of the
warrants using the Black-Scholes option-pricing model; dividend yield of
7.7%; expected volatility of 48.4%; risk free interest rate of 3.05%; and
expected life of 3 years.
During December 2004, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standard No. 123 (revised 2004)
"Share-Based Payment" (SFAS 123R). SFAS 123R replaces SFAS 123, "Accounting
for Stock-Based Compensation", and supercedes APB Opinion 25, "Accounting
for Stock Issued to Employees" (APB 25). SFAS 123R requires that the cost
of share-based payment transactions (including those with employees and
non-employees) be recognized in the financial statements as compensation
cost. That cost will be measured based on the fair value of equity or
liability instrument issued. SFAS 123R is effective for Rio Vista beginning
January 1, 2006. Rio Vista will apply the modified prospective method as
provided for in SFAS 123R, and therefore the financial statements of Rio
Vista for interim and annual periods prior to the adoption of SFAS 123R
will not reflect any restatements.
11
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - INCOME (LOSS) PER COMMON UNIT
The following tables present reconciliations from income (loss) per common
unit to income (loss) per common unit assuming dilution (see note G for the
warrants):
For the three months ended March 31, 2005
-----------------------------------------
Income (Loss) Shares Per-Unit
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Net income (loss) available to the common units $ 169,000
BASIC EPS
Net income (loss) available to the common units 169,000 1,910,656 $ 0.09
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 85,686
-------------- -------------
DILUTED EPS
Net income (loss) available to the common units $ 169,000 1,996,342 $ 0.08
============== ============= ==========
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
December 31, March 31,
2004 2005
-------------- ------------
Brownsville Terminal Facility
Building $ 173,000 $ 173,000
Terminal facilities 3,631,000 3,631,000
Tank Farm 374,000 374,000
Leasehold improvements 319,000 319,000
Equipment 226,000 226,000
Truck 26,000 26,000
-------------- ------------
4,749,000 4,749,000
-------------- ------------
US - Mexico Pipelines and Matamoros Terminal
Facility: (a)
U.S. Pipelines and Rights of Way 6,775,000 6,782,000
Mexico Pipelines and Rights of Way 993,000 993,000
Matamoros Terminal Facility 5,876,000 5,876,000
Land 856,000 856,000
-------------- ------------
14,500,000 14,507,000
-------------- ------------
Total 19,249,000 19,256,000
-------------- ------------
Less: accumulated depreciation and amortization ( 5,005,000) ( 5,210,000)
-------------- ------------
$ 14,244,000 $14,046,000
============== ============
(a) Rio Vista owns, leases, or is in the process of obtaining the land or
rights of way used related to the US-Mexico Pipelines.
12
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE D - PROPERTY, PLANT AND EQUIPMENT - CONTINUED
Property, plant and equipment, net of accumulated depreciation, includes
$5,745,000 and $5,644,000 of costs, located in Mexico at December 31, 2004
and March 31, 2005, respectively.
NOTE E - INVENTORIES
Inventories are valued at the lower of FIFO cost or market (LCM) and
consist of the following:
December 31, 2004 March 31, 2005
------------------ ------------------
Gallons LCM Gallons LCM
------- --------- ------- ---------
LPG:
Brownsville Terminal Facility
and Matamoros Terminal Facility 239,000 $ 198,000 239,000 $ 196,000
======= ========= ======= =========
NOTE F - INCOME TAXES
Rio Vista is taxed as a Partnership under Code Section 701 of the Internal
Revenue Code. All of Rio Vista's income is taxed at the partner level,
therefore, Rio Vista has no U.S. income tax expense or liability. Rio
Vista's Mexican subsidiaries incur income tax expense in Mexico on their
taxable income. Mexican income tax expense for the three months ended March
31, 2005 was $1,000. No deferred Mexican income tax expense was recorded
for the three months ended March 31, 2005.
NOTE G - PARTNERS' CAPITAL
COMMON UNITS
-------------
In connection with the Spin-Off on September 30, 2004, Rio Vista issued
1,910,656 common units to the holders of Penn Octane common stock.
The common units represent limited partner interests in Rio Vista. The
holders of common units are entitled to participate in Rio Vista's
distributions and exercise the rights or privileges available to limited
partners under the Agreement. The holders of common units have only limited
voting rights on matters affecting Rio Vista. Holders of common units have
no right to elect the General Partner or its managers on an annual or other
continuing basis. Penn Octane elects the managers of the General Partner.
Although the General Partner has a fiduciary duty to manage Rio Vista in a
manner beneficial to Rio Vista and its unitholders, the managers of the
General Partner also have a fiduciary duty to manage the General Partner in
a manner beneficial to Penn Octane and its stockholders. The General
Partner generally may not be removed except upon the vote of the holders of
at least 80% of the outstanding common units; provided, however, if at any
time any person or group, other than the General Partner and its
affiliates, or a direct or subsequently approved transferee of the General
Partner or its affiliates, acquires, in the aggregate, beneficial ownership
of 20% or more of any class of units then outstanding, that person or group
will lose voting rights on all of its units and the units may not be voted
on any matter and will not be considered to be outstanding when sending
notices of a meeting of unitholders, calculating required votes,
determining the presence of a quorum or for other similar purposes.
13
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - PARTNERS' CAPITAL - CONTINUED
In addition, the Agreement contains provisions limiting the ability of
holders of common units to call meetings or to acquire information about
Rio Vista's operations, as well as other provisions limiting the holders of
common units ability to influence the manner or direction of management.
GENERAL PARTNER INTEREST
--------------------------
The General Partner of Rio Vista owns a 2% general partner interest in Rio
Vista. The General Partner is currently 100% owned by Penn Octane. Penn
Octane has granted options to Jerome B. Richter and to Shore Capital LLC
(Shore Capital), an affiliate of Richard Shore, Jr., to purchase 50% of its
general partner interest. Following the exercise of any of these options,
Penn Octane will retain voting control of the General Partner pursuant to a
voting agreement.
The General Partner generally has unlimited liability for the obligations
of Rio Vista, such as its debts and environmental liabilities, except for
those contractual obligations of Rio Vista that are expressly made without
recourse to the General Partner.
OPTIONS AND WARRANTS
----------------------
Rio Vista has no U.S. employees and is managed by its General Partner. Rio
Vista applies APB 25 for warrants granted to employees and managers of the
General Partner and SFAS 123 for warrants issued to acquire goods and
services from non-employees.
COMMON UNIT WARRANTS
In connection with an employment agreement with Mr. Shore, Shore Capital
received warrants to acquire 97,415 common units of Rio Vista with an
exercise price of $8.47 per common unit. On October 1, 2004, Rio Vista
recorded approximately $344,000 of compensation cost related to these
warrants. The warrants are exercisable beginning on October 1, 2004 and
expire on July 10, 2006.
LOAN DISCOUNT ON PENN OCTANE CORPORATION'S DEBT RELATED TO DETACHABLE
WARRANTS
During January 2004, in connection with $1,805,000 of debt obligations of
Penn Octane, Penn Octane agreed to issue, in the future, an aggregate of
110,250 warrants to purchase Rio Vista common units (Rio Vista Warrants).
The exercise price of the warrants was to be determined based on the amount
of the first quarterly distribution paid by Rio Vista. As a result of the
approval of the payment of Rio Vista's first cash distribution on January
14, 2005 (see below), Rio Vista granted the immediately exercisable
warrants having an exercise price of $5.00 and recorded a discount of
approximately $422,000 which is reflected as interest expense ratably
amortized from the grant date of January 14, 2005 to December 15, 2005, the
maturity date of the debt obligations. The Rio Vista Warrants will expire
on December 15, 2006.
14
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - PARTNERS' CAPITAL - CONTINUED
EQUITY INCENTIVE PLAN
On March 9, 2005, the board of managers of the General Partner approved the
Rio Vista 2005 Equity Incentive Plan (2005 Plan). The 2005 Plan permits the
grant of common unit options, common unit appreciation rights, restricted
common unit and phantom common units to any person who is an employee
(including to any executive officer) or consultant of Rio Vista or the
General Partner or any affiliate of Rio Vista or the General Partner. The
2005 Plan provides that each outside manager of the General Partner shall
be granted a common unit option once each fiscal year for not more than
5,000 common units, in an equal amount as determined by the board of
managers. The aggregate number of common units authorized for issuance as
awards under the 2005 Plan is 750,000. The 2005 Plan shall remain available
for the grant of awards until March 9, 2015, or such earlier date as the
board of managers may determine. The 2005 Plan is administered by the
compensation committee of the board of managers. Under the terms of the
Agreement and applicable rules of the Nasdaq Stock Market, no approval by
the common unitholders of Rio Vista was required.
On March 9, 2005, the board of managers of the General Partner
approved the grant of options to purchase a total of 108,750 common units
under the 2005 Plan. Of the total number of options granted, 93,750 were
granted to executive officers of the General Partner and Mr. Richter and
15,000 were issued to outside managers of the General Partner. The exercise
price for the options is $12.51 per common unit, which is the average of
the high and low sales prices for Rio Vista common units as reported by the
Nasdaq Stock Market on March 9, 2005. The options granted to executive
officers (including Mr. Richter) were fully vested on the date of grant.
The options granted to outside managers vest in equal monthly installments
over a period of 12 months from the date of grant. All options become fully
exercisable upon a change in control event and expire three years from the
date of grant.
DISTRIBUTIONS OF AVAILABLE CASH
----------------------------------
All unitholders have the right to receive distributions of "available cash"
as defined in the Agreement from Rio Vista in an amount equal to the
minimum distribution of $0.25 per quarter per unit, plus any arrearages in
the payment of the minimum quarterly distribution on the units from prior
quarters. The General Partner receives a distribution corresponding to its
2% General Partnership Interest. The distributions are to be paid 45 days
after the end of each calendar quarter. However, Rio Vista is prohibited
from making any distributions to unitholders if it would cause an event of
default, or an event of default is existing, under any obligation of Penn
Octane which Rio Vista has guaranteed (see note H).
Cash distributions from Rio Vista are shared by the holders of the common
units and the General Partner interest as described in the Agreement based
on a formula whereby the General Partner will receive disproportionately
more distributions per unit than the holders of the common units as annual
cash distributions exceed certain milestones.
On February 14, 2005, Rio Vista made a cash distribution of $487,000.
On April 21, 2005, the board of managers of Rio Vista approved the payment
of a $.025 cash distribution per unit to all Rio Vista common unitholders
and a corresponding distribution to the General Partner as of the record
date of May 9, 2005. The distribution is to be paid on May 13, 2005 (see
note L).
15
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - COMMITMENTS AND CONTINGENCIES
CREDIT FACILITY, LETTERS OF CREDIT AND OTHER
Rio Vista's LPG purchases are financed entirely by Penn Octane through its
credit facility with RZB Finance, LLC (RZB).
As of March 31, 2005, Penn Octane had a $20,000,000 credit facility with
RZB for demand loans and standby letters of credit (RZB Credit Facility) to
finance Penn Octane's purchases of LPG and gasoline and diesel fuel (Fuel
Products) in connection with Penn Octane's fuel sales business. The RZB
Credit facility is an uncommitted facility under which the letters of
credit have an expiration date of no more than 90 days and the facility is
reviewed annually at March 31. As a result of the financing provided to Rio
Vista by Penn Octane, Rio Vista has agreed to guarantee Penn Octane's
obligations with respect to the RZB Credit Facility. In connection with Rio
Vista's guaranty, Rio Vista granted RZB a security interest and assignment
in any and all of Rio Vista'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 Rio Vista's Brownsville
Terminal Facility is located, and has entered into leasehold deeds of
trust, security agreements, financing statements and assignments of rent.
Under the RZB Credit Facility, Rio Vista 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. In connection with the LPG Supply Agreement,
Penn Octane and Rio Vista have agreed to share the financing costs related
to Penn Octane's purchase of LPG under the RZB Credit Facility.
Under the RZB Credit Facility, Penn Octane is required to pay 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 Penn Octane
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 (5.75% at March 31, 2005) 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 at any time, and to
refrain from making any loans or issuing any letters 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. Jerome B. Richter has personally
guaranteed all of Penn Octane's and Rio Vista's payment obligations with
respect to the RZB Credit Facility.
Under the terms of the RZB Credit Facility, either Penn Octane or Rio Vista
is required to maintain net worth of a minimum of $10,000,000.
Under the terms of the RZB Credit Facility, all cash from Rio Vista's LPG
sales is deposited directly into a restricted cash account under the
direction of RZB to pay down all obligations of Penn Octane arising under
the RZB Credit Facility. Accordingly, Rio Vista only receives net proceeds
from the restricted cash account when the amounts of collateral provided by
Penn Octane and Rio Vista exceed all liabilities under outstanding letters
of credit issued on behalf of Penn Octane, at the sole discretion of RZB.
Historically RZB has not unduly withheld net proceeds from Penn Octane, and
Rio Vista does not expect that RZB will unduly withhold net proceeds from
Rio Vista. Upon the release of Rio Vista's net proceeds from Rio Vista's
restricted cash account, Rio Vista is then required to pay any remaining
amounts due Penn Octane, if any, for the supply of LPG and other allocated
or direct expenses.
16
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject Rio Vista to credit risk
include cash balances at banks which at times exceed the federal deposit
insurance.
TAX OBLIGATIONS OF PENN OCTANE RESULTING FROM THE SPIN-OFF
Rio Vista has agreed to indemnify Penn Octane 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. Penn Octane does not believe that it has a federal income tax
in connection with the Spin-Off in excess of $2,500,000. However, the
Internal Revenue Service (IRS) may review Penn Octane's federal income tax
returns and challenge positions that it may take with respect to the
Spin-Off.
PARTNERSHIP TAX TREATMENT
Rio Vista is not a taxable entity for U.S. tax purposes (see below) and
incurs no U.S. federal income tax liability. Rio Vista's Mexican
subsidiaries are taxed on their income directly by the Mexican government.
The income/loss of Rio Vista's Mexican subsidiaries are included in the
U.S. partnership income tax return of Rio Vista. The holders of the common
units and General Partner interest will be entitled to their proportionate
share of any tax credits resulting from any income taxes paid to the
Mexican government. Each unitholder of Rio Vista is required to take into
account that unitholder's share of items of income, gain, loss and
deduction of Rio Vista in computing that unitholder's federal income tax
liability, even if no cash distributions are made to the unitholder by Rio
Vista. Distributions by Rio Vista to a unitholder are generally not taxable
unless the amount of cash distributed is in excess of the unitholder's
adjusted tax basis in Rio Vista.
Section 7704 of the Internal Revenue Code (Code) provides that publicly
traded partnerships shall, as a general rule, be taxed as corporations
despite the fact that they are not classified as corporations under Section
7701 of the Code. Section 7704 of the Code provides an exception to this
general rule for a publicly traded partnership if 90% or more of its gross
income for every taxable year consists of "qualifying income" (Qualifying
Income Exception). For purposes of this exception, "qualifying income"
includes income and gains derived from the exploration, development, mining
or production, processing, refining, transportation (including pipelines)
or marketing of any mineral or natural resource. Other types of "qualifying
income" include interest (other than from a financial business or interest
based on profits of the borrower), dividends, real property rents, gains
from the sale of real property, including real property held by one
considered to be a "dealer" in such property, and gains from the sale or
other disposition of capital assets held for the production of income that
otherwise constitutes "qualifying income".
No ruling has been or will be sought from the IRS and the IRS has made no
determination as to Rio Vista's classification as a partnership for federal
income tax purposes or whether Rio Vista's operations generate a minimum of
90% of "qualifying income" under Section 7704 of the Code.
If Rio Vista was classified as a corporation in any taxable year, either as
a result of a failure to meet the Qualifying Income Exception or otherwise,
Rio Vista's items of income, gain, loss and deduction would be reflected
only on Rio Vista's tax return rather than being passed through to Rio
Vista's unitholders, and Rio Vista's net income would be taxed at corporate
rates.
17
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
PARTNERSHIP TAX TREATMENT - CONTINUED
If Rio Vista was treated as a corporation for federal income tax purposes,
Rio Vista would pay tax on income at corporate rates, which is currently a
maximum of 35%. Distributions to unitholders would generally be taxed again
as corporate distributions, and no income, gains, losses, or deductions
would flow through to the unitholders. Because a tax would be imposed upon
Rio Vista as a corporation, the cash available for distribution to
unitholders would be substantially reduced and Rio Vista's ability to make
minimum quarterly distributions would be impaired. Consequently, treatment
of Rio Vista as a corporation would result in a material reduction in the
anticipated cash flow and after-tax return to unitholders and therefore
would likely result in a substantial reduction in the value of Rio Vista's
common units.
Current law may change so as to cause Rio Vista to be taxable as a
corporation for federal income tax purposes or otherwise subject Rio Vista
to entity-level taxation. The Agreement provides that, if a law is enacted
or existing law is modified or interpreted in a manner that subject Rio
Vista to taxation as a corporation or otherwise subjects Rio Vista to
entity-level taxation for federal, state or local income tax purposes, then
the minimum quarterly distribution amount and the target distribution
amount will be adjusted downward to reflect the impact of that law on Rio
Vista.
OTHER
Rio Vista is a newly-created entity and is not currently a party to any
litigation. Pursuant to the Omnibus Agreement, Penn Octane has agreed to
indemnify Rio Vista for claims related to the Assets arising from events or
conditions occurring or existing before completion of the Spin-Off.
LONG-TERM DEBT
Long-term debt of Penn Octane guaranteed by Rio Vista and on which certain
of its assets are pledged totaled $1,805,000 at March 31, 2005. This debt
is due on December 15, 2005. Interest is payable quarterly at a rate of
16.5% per annum.
GUARANTEES AND ASSETS PLEDGED ON CERTAIN OF PENN OCTANE'S OBLIGATIONS
The dollar amounts of Penn Octane's obligations which Rio Vista guarantees
and/or for which Rio Vista's assets are pledged total $18,400,000 at March
31, 2005 based on Penn Octane's most recently filed Quarterly Report on
Form 10-Q and the unaudited amounts were as follows:
LPG and fuel products trade accounts payable $ 7,300,000
Total debt, net of discount $ 1,600,000
Lines of credit $ 5,800,000
Letters of credit in excess of LPG and fuel products
trade accounts payable $ 3,700,000
Consolidated current assets of Penn Octane, which includes assets of Rio
Vista, pledged in favor of Penn Octane's credit facility and certain other
debt total $33,700,000 at March 31, 2005 and the unaudited amounts were as
follows:
Accounts receivable $11,100,000
Restricted cash $ 4,700,000
Inventory $ 2,100,000
Property, plant and equipment, net $15,800,000
18
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
GUARANTEES AND ASSETS PLEDGED ON CERTAIN OF PENN OCTANE'S OBLIGATIONS -
CONTINUED
Rio Vista's assets that are included in the above amounts are as follows:
Accounts receivable $ 6,700,000
Restricted cash $ 900,000
Inventory $ 200,000
Property, plant and equipment, net $14,100,000
NOTE I - CONTRACTS
LPG SALES TO PMI
During December 2004, Rio Vista and PMI entered into a three month
agreement for the period January 1, 2005 to March 31, 2005 for the minimum
sale of 11,700,000 gallons of LPG for the months of January and February
and 11,050,000 gallons of LPG for the month of March (Quarterly Agreement)
at reduced margins compared with those in effect during 2004. Actual
volumes sold were 12,700,000 gallons, 9,900,000 gallons and 9,600,000
gallons for January, February and March 2005, respectively. In April 2005,
Rio Vista entered into a one month contract with PMI for the sale of a
minimum of 10,450,000 gallons at a further reduction in margin (see note
L).
The shortfall for the month of February 2005 was attributable to Penn
Octane not having a sufficient supply of LPG to meet the minimum contract
volume. The shortfall for the month of March 2005 was attributable to PMI
not purchasing the minimum contract volume. In accordance with the
Quarterly Agreement, PMI paid approximately $104,000 representing the total
amount due associated with the shortfall volumes for March 2005.
Rio Vista continues to negotiate a new long-term LPG contract with PMI.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from Penn Octane prior to the Spin-Off and from Rio Vista,
subsequent thereto, for distribution by truck in Mexico. Rio Vista will
continue 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.
NOTE J - RELATED PARTY TRANSACTIONS
The General Partner has a legal duty to manage Rio Vista in a manner
beneficial to Rio Vista's unitholders. This legal duty originates in
statutes and judicial decisions and is commonly referred to as a
"fiduciary" duty. Because the General Partner is currently owned by Penn
Octane, Penn Octane's officers and managers of the General Partner also
have fiduciary duties to manage the business of the General Partner in a
manner beneficial to Penn Octane and its stockholders.
The Agreement limits the liability and reduces the fiduciary duties of the
General Partner to the unitholders. The Agreement also restricts the
remedies available to unitholders for actions that might otherwise
constitute breaches of the General Partner's fiduciary duty.
Under the terms of the LPG Supply Agreement and Omnibus Agreement, Penn
Octane charged Rio Vista $27,280,230 for the three months ended March 31,
2005.
19
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE J - RELATED PARTY TRANSACTIONS - CONTINUED
INTERCOMPANY PURCHASE AGREEMENT FOR LPG
Penn Octane entered into the LPG Supply Agreement with Rio Vista pursuant
to which Rio Vista has agreed to purchase all of its LPG requirements for
sales which utilize the assets transferred to Rio Vista by Penn Octane to
the extent Penn Octane is able to supply such LPG requirements. The LPG
Supply Agreement further provides that Rio Vista has no obligation to
purchase LPG from Penn Octane to the extent the distribution of such LPG to
Rio Vista's customers would not require the use of any of the assets Penn
Octane contributed to Rio Vista or Penn Octane ceases to have the right to
access the Leased Pipeline.
Under the LPG Supply Agreement, Penn Octane supplies all of Rio Vista's LPG
requirements in connection with its LPG sales obligations to PMI. The
purchases of the LPG are at fluctuating prices and are determined based on
the cost of LPG under Penn Octane's agreements with its LPG suppliers for
volumes sold to Rio Vista for sale to PMI or to other Rio Vista customers,
other direct costs related to PMI and other LPG sales of Rio Vista and a
formula that takes into consideration operating costs of Penn Octane and
Rio Vista. Rio Vista expects the aggregate costs per gallon to purchase LPG
(less any applicable adjustments) to be below the aggregate sales prices
per gallon of LPG sold to PMI.
Under the terms of Penn Octane's Exxon Supply Contract, Penn Octane 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, Penn Octane's existing letter of
credit facility may not be adequate to meet the letter of credit
requirements under the Exxon Supply Contract or other suppliers if there
are increases in quantities of LPG purchased and/or to finance future price
increases of LPG.
The LPG Supply Agreement terminates on the earlier to occur of:
- Penn Octane ceases to have the right to access the Leased
Pipeline that connects to Rio Vista's Brownsville Terminal
Facility; and
- Rio Vista ceases to sell LPG using any of the assets contributed
by Penn Octane to Rio Vista pursuant to the Spin-Off.
OMNIBUS AGREEMENT
In connection with the Spin-Off, Penn Octane entered into an Omnibus
Agreement with Rio Vista that governs, among other things, indemnification
obligations among the parties to the agreement, related party transactions,
the provision of general administration and support services by Penn
Octane.
The Omnibus Agreement prohibits Rio Vista from entering into any material
agreement with Penn Octane without the prior approval of the conflicts
committee of the board of managers of the General Partner. For purposes of
the Omnibus Agreement, the term material agreements means any agreement
between Rio Vista and Penn Octane that requires aggregate annual payments
in excess of $100,000.
The Omnibus Agreement may be amended by written agreement of the parties;
provided, however that it may not be amended without the approval of the
conflicts committee of the General Partner if such amendment would
adversely affect the unitholders of Rio Vista. The Omnibus Agreement has an
initial term of five years that automatically renews for successive
five-year terms and, other than the indemnification provisions, will
terminate if Rio Vista is no longer an affiliate of Penn Octane.
20
RIO VISTA PARTNERS L.P. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE K - REALIZATION OF ASSETS
The accompanying consolidated balance sheet has been prepared in conformity
with accounting principles generally accepted in the United States of
America, which contemplate continuation of Rio Vista as a going concern.
Rio Vista is dependent on Penn Octane's ability to deliver adequate
quantities of LPG at an acceptable price for ultimate sale to PMI, to
provide credit to Rio Vista for such purchases and to provide management of
its operations. Currently, Rio Vista's only source of revenue is from sales
of LPG to PMI and it operates under short-term sales agreements with PMI.
Since April 1, 2004, through the date of the Spin-Off, Penn Octane had also
been operating under short-term sales agreements with PMI. The monthly
volumes of LPG sold by Penn Octane to PMI since April 1, 2004 up to the
date of the Spin-Off were materially less than historical levels (see note
L). Additionally, the monthly volumes of LPG sold by Rio Vista to PMI since
October 1, 2004 have also been materially less than Penn Octane's
historical levels and margins have declined in 2005. As a result, Penn
Octane's and Rio Vista's gross profit have been materially reduced and may
continue to decline and their cash flow and available credit may be
insufficient to absorb such additional reductions in gross profit.
Rio Vista has guaranteed certain of Penn Octane's obligations.
Substantially all of Rio Vista's and Penn Octane's assets are pledged or
committed to be pledged as collateral on $1,805,000 of Penn Octane's
existing debt and the RZB Credit Facility, and therefore, both Rio Vista
and Penn Octane may be unable to obtain additional financing collateralized
by those assets. Penn Octane's Report of Independent Certified Public
Accountants on the consolidated financial statements of Penn Octane at July
31, 2004 contains an explanatory paragraph which describes an uncertainty
about Penn Octane's ability to continue as a going concern. If Penn
Octane's and Rio Vista's cash flows are not adequate to pay their
obligations, Penn Octane and/or Rio Vista may be required to raise
additional funds to avoid foreclosure by Penn Octane's creditors. There can
be no assurance that such additional funding will be available on terms
attractive to either Penn Octane or Rio Vista or available at all. If
additional amounts cannot be raised and cash flow is inadequate, Penn
Octane and/or Rio Vista would likely be required to seek other alternatives
which could include the sale of assets, closure of operations up to and
including protection under the U.S. bankruptcy laws.
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
unaudited consolidated balance sheet is dependent upon the ability of Penn
Octane to continue as a going concern and continued sales of LPG to PMI at
acceptable volumes and margins to provide sufficient cash flow to pay Rio
Vista's expenses and guarantees of Penn Octane's obligations assuming Penn
Octane's inability to pay such obligations. The unaudited consolidated
balance sheet does 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 Rio Vista be
unable to continue in existence.
To provide Rio Vista with the ability it believes necessary to continue in
existence, management is negotiating with PMI to increase LPG sales at
acceptable monthly volumes and margins on a long-term basis. In addition,
management is taking steps to diversify Rio Vista's operations to reduce
dependency on sales of LPG.
NOTE L - SUBSEQUENT EVENT
On May 5, 2005, Rio Vista entered into a contract with PMI for the sale of
a minimum of 6,000,000 gallons of LPG for the period May 5, 2005 to May 31,
2005 at the reduced margin received in April 2005. For the period May 1,
2005 to May 4, 2005, PMI did not purchase any LPG from Rio Vista.
On May 13, 2005, Rio Vista made a cash distribution of $487,000 (see note
G).
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of Rio Vista's liquidity and capital resources
should be read in conjunction with the unaudited consolidated financial
statements of Rio Vista and related notes thereto appearing elsewhere herein.
References to specific years preceded by "fiscal" (e.g. fiscal 2004) refer to
Rio Vista's fiscal year ending December 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 and Section 21E of the Securities Exchange Act of 1934.
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 inherently involve risks and uncertainties.
From time to time, Rio Vista has made or may make forward-looking statements,
orally or in writing. These forward-looking statements include statements
regarding anticipated future revenues, sales, LPG supply, LPG pricing,
operations, demand, potential acquisitions, competition, capital expenditures,
future acquisitions, additional financing, the deregulation of the LPG market in
Mexico, the operations of the US - Mexico Pipelines, the Brownsville and
Matamoros Terminal Facilities, other upgrades to Rio Vista's facilities, foreign
ownership of LPG operations, short-term obligations and credit arrangements,
guarantees, cash distributions, Qualifying Income, Penn Octane, the 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 in Rio Vista's Form 10 filed with the
Securities and Exchange Commission, those discussed under "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Rio Vista's fiscal year 2004 Annual Report as well as those
discussed elsewhere in this Quarterly Report. These factors may not include all
material risks facing Rio Vista.
RIO VISTA ENERGY PARTNERS L.P. AND ITS CONSOLIDATED SUBSIDIARIES ARE HEREINAFTER
REFERRED TO AS "RIO VISTA".
RISK FACTORS
Business Factors. The expiration of the liquefied petroleum gas ("LPG")
sales contract between Penn Octane Corporation ("Penn Octane') and P.M.I.
Trading Limited ("PMI") effective March 31, 2004 and the resulting lower LPG
sales volumes since that date between Penn Octane and PMI through the date of
the Spin-Off and Rio Vista and PMI after the Spin-off have adversely affected
Rio Vista's results of operations. Rio Vista has only one customer for LPG in
Mexico, PMI. Rio Vista cannot be sure that PMI will continue to purchase LPG
from Rio Vista or in quantities or at prices that are profitable. There are a
limited number of suppliers of LPG that connect to Rio Vista's pipelines and a
limited supply of LPG. Rio Vista may lose its competitive advantage when Penn
Octane's Seadrift pipeline lease expires in 2013. Rio Vista may be unable to
successfully develop additional sources of revenue in order to reduce its
dependence on PMI. Rio Vista may not have sufficient cash to meet its
obligations. All of Rio Vista's assets are pledged as collateral for existing
debt of Penn Octane, and Rio Vista therefore may be unable to obtain additional
financing collateralized by such assets. Rio Vista is at risk of economic loss
due to fixed margin contracts. If Rio Vista does not have sufficient capital
resources for acquisitions or opportunities for expansion, Rio Vista's growth
will be limited. Future acquisitions and expansions may not be successful, may
substantially increase Rio Vista's indebtedness and contingent liabilities, and
may create integration difficulties. Rio Vista's business would be adversely
affected if operations at its transportation, terminal and distribution
facilities were interrupted. Rio Vista's business would also be adversely
affected if the operations of Rio Vista's customers and suppliers (including
Penn Octane) were interrupted.
Competitive Factors. The energy industry is highly competitive. There is
competition within the industries and also with other industries in supplying
the energy and fuel needs of the industry and individual consumers. Rio Vista
competes with other companies in the sale or purchase of LPG as well as the
transportation of these products in the U.S. and Mexican markets and employs all
methods of competition which are lawful and appropriate for such purposes. A
key component of Rio Vista's competitive position, particularly given the
commodity-based nature of many of its products, is its ability to manage its
expenses successfully, which requires continuous management focus on reducing
unit costs and improving efficiency and its ability to secure unique
opportunities for the purchase, sale and/or delivery methods of its products.
22
International Factors. Mexican economic, political and social conditions
may change and adversely affect Rio Vista's operations. Rio Vista may not be
able to continue operations in Mexico if Mexico restricts the existing ownership
structure of its Mexican operations, requiring Rio Vista to increase its
reliance on Mexican nationals to conduct its business. The LPG market in Mexico
is undergoing deregulation, the results of which may hinder Rio Vista's ability
to negotiate acceptable contracts with distributors.
Political Factors. The operations and earnings of Rio Vista in the U.S.
and Mexico have been, and may in the future be, affected from time to time in
varying degree by political instability and by other political developments and
laws and regulations, such as forced divestiture of assets; restrictions on
production, imports and exports; war or other international conflicts; civil
unrest and local security concerns that threaten the safe operation of Rio
Vista's facilities; price controls; tax increases and retroactive tax claims;
expropriation of property; cancellation of contract rights; and environmental
regulations. Both the likelihood of such occurrences and their overall effect
upon Rio Vista vary greatly and are not predictable.
Industry and Economic Factors. The operations and earnings of Rio Vista
throughout the U.S. and Mexico are affected by local, regional and global events
or conditions that affect supply and demand for Rio Vista's products. These
events or conditions are generally not predictable and include, among other
things, general economic growth rates and the occurrence of economic recessions;
the development of new supply sources for its products; supply disruptions;
weather, including seasonal patterns that affect energy demand and severe
weather events that can disrupt operations; technological advances, including
advances in exploration, production, refining and advances in technology
relating to energy usage; changes in demographics, including population growth
rates and consumer preferences; and the competitiveness of alternative
hydrocarbon or other energy sources or product substitutes.
Acquisition Factors. In additional to the factors cited above, the
advancement, cost and results of particular acquisitions sought by Rio Vista,
including acquisitions which do not specifically fall within the areas of Rio
Vista's current lines of businesses will depend on: the outcome of negotiations
for such acquisitions; the ability of the Rio Vista's management to manage such
acquisitions; the ability of Rio Vista to obtain financing for such
acquisitions; changes in operating conditions or costs; and the occurrence of
unforeseen technical difficulties.
Market Risk Factors. See "Notes to Consolidated Financial Statements,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Quantitative and Qualitative Disclosures About Market Risk" in
this report for discussion of the impact of market risks, inflation and other
uncertainties.
Internal Control Factors. Pursuant to Section 404 of the Sarbanes Oxley
Act of 2002, beginning with the year ended December 31, 2006, Rio Vista's
management will be required to complete an annual evaluation of its internal
control systems. In addition, Rio Vista's independent auditors are required to
provide an opinion regarding such evaluation and the adequacy of Rio Vista's
internal accounting controls. Rio Vista's internal controls may be found to be
inadequate, deficiencies or weaknesses may be discovered, and remediation may
not be successful. As Rio Vista grows, Rio Vista will need to strengthen its
internal control systems. If Rio Vista acquires an existing business, the
internal control systems of the acquired business may be inadequate and may
require additional strengthening.
Projections. Projections, estimates and descriptions of Rio Vista's plans
and objectives included herein are forward-looking statements. Actual future
results could differ materially due to, among other things, the factors
discussed above and elsewhere in this report.
23
OVERVIEW
Rio Vista Energy Partners L.P. ("Rio Vista"), a Delaware limited
partnership, was formed by Penn Octane Corporation ("Penn Octane") on July 10,
2003 and was a wholly owned subsidiary of Penn Octane until September 30, 2004,
the date that Penn Octane completed a series of transactions involving (i) the
transfer of substantially all of its owned pipeline and terminal assets in
Brownsville, Texas and Matamoros, Mexico and certain immaterial liabilities (the
"Assets") to Rio Vista Operating Partnership L.P. ("RVOP") (ii) the transfer of
its 99.9% interest in RVOP to Rio Vista and (iii) the distribution of all of its
limited partnership interests (the "Common Units") in Rio Vista to its common
stockholders (the "Spin-Off"), resulting in Rio Vista becoming a separate public
company. The Common Units represented 98% of Rio Vista's outstanding capital
and 100% of Rio Vista's limited partnership interests. The remaining 2%, which
is the general partner interest, is owned and controlled by Rio Vista GP LLC
(the "General Partner"), a wholly owned subsidiary of Penn Octane. The General
Partner is responsible for the management of Rio Vista. Rio Vista Energy
Partners L.P. and its consolidated subsidiaries are hereinafter referred to as
"Rio Vista".
As a result of the Spin-Off, Rio Vista is engaged in the purchase,
transportation and sale of liquefied petroleum gas ("LPG"). Rio Vista owns
and operates terminal facilities in Brownsville, Texas (the "Brownsville
Terminal Facility") and in Matamoros, Tamaulipas, Mexico (the "Matamoros
Terminal Facility") and approximately 23 miles of pipelines (the "US - Mexico
Pipelines") which connect the Brownsville Terminal Facility to the Matamoros
Terminal Facility. The primary market for Rio Vista's LPG is the northeastern
region of Mexico, which includes the states of Coahuila, Nuevo Leon and
Tamaulipas.
Rio Vista believes it has a competitive advantage in the supply of LPG for
the northeastern region of Mexico because of Rio Vista's pipeline and terminal
facilities and its long term LPG supply agreement with Penn Octane which allow
Rio Vista to bring supplies of LPG close to consumers of LPG in major cities in
that region at competitive prices. Rio Vista's primary customer for LPG is
P.M.I. Trading Limited ("PMI"). PMI is a subsidiary of Petroleos Mexicanos, the
state-owned Mexican oil company, which is commonly known by its trade name
"PEMEX." PMI is the exclusive importer of LPG into Mexico. The LPG purchased
by PMI from Rio Vista is sold to PEMEX which distributes the LPG purchased from
PMI into the northeastern region of Mexico.
All of Rio Vista's LPG operations are conducted through, and Rio Vista's
LPG operating assets are owned by, RVOP. The General Partner is entitled to
receive distributions on its general partner interest as provided for in Rio
Vista's partnership agreement (the "Agreement"). The General Partner has sole
responsibility for conducting Rio Vista's business and for managing Rio Vista's
operations in accordance with the Agreement. Other than the foregoing
distributions, the General Partner does not receive a management fee or other
compensation in connection with its management of Rio Vista's business, but is
entitled to be reimbursed for all direct and indirect expenses incurred on Rio
Vista's behalf.
Rio Vista purchases LPG from Penn Octane under a long-term supply agreement
(the "LPG Supply Agreement"). The purchase price of the LPG from Penn Octane is
determined based on the cost of LPG under Penn Octane's agreements with its LPG
suppliers for volumes sold to Rio Vista for sale to PMI or to other Rio Vista
customers, other direct costs related to PMI and other LPG sales of Rio Vista
and a formula that takes into consideration operating costs of Penn Octane and
Rio Vista.
Rio Vista 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.
24
Historically, up until the date of the Spin-Off, Penn Octane has sold LPG
primarily to PMI. Penn Octane has a long-term lease agreement, expiring in
December 2013, for approximately 132 miles of 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 Rio Vista's
Brownsville Terminal Facility (the "Leased Pipeline"). In addition, Penn Octane
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 (the "ECCPL"),
as well as existing and other potential propane pipeline suppliers which have
the ability to access the ECCPL. In connection with Penn Octane's lease
agreement for the Leased Pipeline, Penn Octane may access up to 21.0 million
gallons of storage located in Markham, Texas (the "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.
Penn Octane's long term supply agreements in effect as of March 31, 2005 with
Exxon requires Penn Octane to purchase minimum quantities of LPG totaling up to
13.9 million gallons of LPG per month although actual quantities supplied under
such agreements during the three months ended March 31, 2005 were approximately
9.2 million gallons per month.
LPG SALES
The following table shows Rio Vista's actual volumes sold to PMI in gallons
and average sales price for the three months ended March 31, 2005 and actual
sales to PMI by Penn Octane in gallons and average sales price for the three
months ended March 31, 2004.
2004 2005
------- -------
Volume Sold
LPG (millions of gallons) - PMI 57.4 32.3
Average sales price
LPG (per gallon) - PMI $ 0.76 $ 0.88
25
RECENT TRENDS. Since April 2004, PMI had contracted with Penn Octane and
Rio Vista (subsequent to the Spin-Off) for volumes which were significantly
lower than amounts purchased by PMI from Penn Octane in similar periods during
previous years. See Liquidity and Capital Resources - Sales to PMI below. Rio
Vista believes that the reduction of volume commitments is based on additional
LPG production by PEMEX being generated from the Burgos Basin field in Reynosa,
Mexico, an area within the proximity of Rio Vista's Matamoros Terminal Facility
and increased competition from U.S. suppliers (see below). Although Rio Vista
is not aware of the total amount of LPG actually being produced by PEMEX from
the Burgos Basin, it is aware that PEMEX has constructed and is operating two
new cryogenic facilities at the Burgos Basin which it believes may have a
capacity of producing up to 12 million gallons of LPG per month. Rio Vista also
believes that PEMEX intends to install two additional cryogenic facilities, with
similar capacity, to be operational in early 2006. Rio Vista is not aware of
the capacity at which the current cryogenic facilities are being operated.
Furthermore, Rio Vista is not aware of the actual gas reserves of the Burgos
Basin or the gas quality, each of which could significantly impact LPG
production amounts. Rio Vista still believes that its LPG supplies are
competitive with the necessary U.S. imports of LPG by PEMEX and that the LPG
volumes which are actually produced from the Burgos Basin would not eliminate
the need for U.S. LPG imports by PEMEX and that LPG volumes produced from the
Burgos Basin would be more economically suited for distribution to points
further south in Mexico rather than Rio Vista's strategic zone.
During June 2004, Valero L.P., a U.S. limited partnership ("Valero") began
operation of a newly constructed LPG terminal facility in Nuevo Laredo, Mexico
and a newly constructed pipeline connecting the terminal facility in Nuevo
Laredo, Mexico to existing pipelines which connect directly to Valero Energy
Corporation's Corpus Christi, Texas and Three Rivers, Texas refineries. Valero
has contracted with PMI under a five year agreement to deliver approximately 6.3
million gallons (of which 3.2 million gallons were previously delivered by truck
from Three Rivers, Texas) of LPG per month. Valero has also indicated that it
intends to increase capacity of its Nuevo Laredo terminal to 10.1 million
gallons per month. Rio Vista believes that if Valero intends to maximize
capacity of these facilities, then Valero would be required to obtain additional
LPG supplies from major LPG hubs located in Corpus Christi and Mont Belvieu,
Texas. Accordingly, Rio Vista believes that any additional supplies over
amounts currently available to the Mexican market through Valero's system could
be more expensive than Rio Vista's currently available supplies and delivery
systems.
During 2004, a pipeline operated by El Paso Energy between Corpus Christi,
Texas and Hidalgo County, Texas was closed. Historically these facilities had
supplied approximately 5.0 million gallons of LPG per month to Rio Vista's
strategic zone. Rio Vista is not aware of any future plans for these
facilities.
During 2003, PMI constructed and began operations of a refined products
cross border pipeline connecting a pipeline running from PEMEX's Cadereyta
Refinery in Monterey, Mexico to terminal facilities operated by Transmontagne,
Inc., in Brownsville, Texas. Transmontagne is a U.S. corporation. The
pipeline crosses the U.S.-Mexico border near the proximity of Rio Vista's U.S. -
Mexico Pipelines. In connection with the construction of the pipeline, PMI
utilizes an easement from Rio Vista for an approximate 21.67 acre portion of the
pipeline. Under the terms of the easement, PMI has warranted that it will not
transport LPG through October 15, 2017.
26
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 COMPARED WITH PENN OCTANE'S SALES TO PMI
FOR THE THREE MONTHS ENDED MARCH 31, 2004.
Revenues. Revenues for the three months ended March 31, 2005, were $28.6
million compared with $43.4 million for the comparative period one year earlier,
a decrease of $14.8 million or 34.2%. Of this decrease, $22.0 million was
attributable to decreased volumes of LPG sold to PMI during the three months
ended March 31, 2005, partially offset by $7.0 million attributable to increases
in average sales prices of LPG sold to PMI during the three months ended March
31, 2005.
Cost of goods sold. Cost of goods sold for the three months ended March
31, 2005 was $27.2 million. The cost of goods sold for LPG purchased from Penn
Octane was determined in accordance with the LPG Supply Agreement. Costs of
goods sold also included other direct costs related to Rio Vista's LPG
operations, including costs associated with operating the Brownsville and
Matamoros terminal facilities.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.0 million for the three months ended March 31,
2005. These costs were comprised of indirect selling general expenses directly
incurred by Rio Vista or allocated by Penn Octane to Rio Vista in accordance
with the Omnibus Agreement. Salary related costs allocated by Penn Octane were
based on the percentage of time spent by those employees (including executive
officers) in performing Rio Vista related matters compared with the overall time
spent working by those employees.
Other income (expense). Other income (expense) was $(119,000) for the
three months ended March 31, 2005 and is comprised of interest expense allocated
to Rio Vista by Penn Octane in connection with the RZB Credit Facility and
amortization of loan discount related to detachable warrants.
Mexican Income tax. Rio Vista incurred $1,000 of Mexican income tax
expense related to its Mexican subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
General. Rio Vista commenced operations on October 1, 2004 and only had
nominal cash at the time of the Spin-Off. Rio Vista pays all of its direct
costs and expenses, and Rio Vista reimburses Penn Octane for cost and expenses
paid by Penn Octane on behalf of Rio Vista. As discussed below, Rio Vista sells
LPG to PMI and purchases the LPG from Penn Octane. Rio Vista's LPG Supply
Agreement with Penn Octane provides that it pays Penn Octane for LPG purchased
upon receipt of the proceeds from sales to PMI. Rio Vista intends to distribute
any "available cash" as defined in the Agreement to its unitholders on a
quarterly basis.
Dependency on Penn Octane. Rio Vista is dependent on Penn Octane's ability
to deliver adequate quantities of LPG at an acceptable price for ultimate sale
to PMI, to provide credit to Rio Vista for such purchases and to provide
management of its operations. In addition, substantially all of Rio Vista's and
Penn Octane's assets are pledged or committed to be pledged as collateral on
$1.8 million of Penn Octane's existing debt and the RZB Credit Facility and
therefore, both Rio Vista and Penn Octane maybe unable to obtain additional
financing collateralized by those assets.
27
Guarantees and Assets Pledged on Certain of Penn Octane's Obligations. Rio
Vista has agreed to guarantee certain of Penn Octane's obligations to creditors
and all of Rio Vista's assets are pledged as collateral for those obligations of
Penn Octane to such creditors. In addition, Rio Vista has agreed to indemnify
Penn Octane 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. Consequently, Rio Vista may be unable
to obtain financing using these pledged assets as collateral and Rio Vista's
inability to borrow on these assets may adversely affect Rio Vista's results of
operations and ability to make distributions to its unitholders. Rio Vista may
also be prohibited from making any distributions to unitholders if it would
cause an event of default, or if an event of default is existing, under Penn
Octane's revolving credit facilities, or any other covenant which may exist
under any other credit arrangement or other regulatory requirement at the time.
The following table reflects cash flows for the three months ended March
31, 2004 and 2005. All information is in thousands.
2004 2005
------------ ------------
Net cash provided by (used in) operating
activities $ - $( 2,553)
Net cash used in investing activities - ( 8)
Net cash provided by (used in) in financing
activities - 2,574
------------ ------------
Net increase in cash $ - $ 13
============ ============
The following is a discussion of the guaranteed obligations:
RZB OBLIGATION
Rio Vista's LPG purchases are financed entirely by Penn Octane through its
credit facility with RZB Finance, LLC ("RZB"). As of March 31, 2005, Penn
Octane had a $20.0 million credit facility with RZB for demand loans and standby
letters of credit (the "RZB Credit Facility") to finance Penn Octane's purchases
of LPG and gasoline and diesel fuel ("Fuel Products") in connection with Penn
Octane's fuel sales business. The RZB Credit facility is an uncommitted
facility under which the letters of credit have an expiration date of no more
than 90 days and the facility is reviewed annually at March 31. As a result of
the financing provided to Rio Vista by Penn Octane, Rio Vista has agreed to
guarantee Penn Octane's obligations with respect to the RZB Credit Facility. In
connection with Rio Vista's guaranty, Rio Vista granted RZB a security interest
and assignment in any and all of Rio Vista'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 Rio Vista's Brownsville
Terminal Facility is located, and has entered into leasehold deeds of trust,
security agreements, financing statements and assignments of rent. Under the
RZB Credit Facility, Rio Vista 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.
In connection with the LPG Supply Agreement, Penn Octane and Rio Vista have
agreed to share the financing costs related to Penn Octane's purchase of LPG
under the RZB Credit Facility.
28
Under the RZB Credit Facility, Penn Octane is required to pay 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 Penn Octane 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
(5.75% at March 31, 2005) 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 at any time, and to refrain from making any loans or issuing
any letters 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.
Jerome B. Richter has personally guaranteed all of Penn Octane's and Rio Vista's
payment obligations with respect to the RZB Credit Facility.
Under the terms of the RZB Credit Facility, either Penn Octane or Rio Vista
is required to maintain net worth of a minimum of $10.0 million.
Under the terms of the RZB Credit Facility, all cash from Rio Vista's LPG
sales is deposited directly into a restricted cash account under the direction
of RZB to pay down all obligations of Penn Octane arising under the RZB Credit
Facility. Accordingly, Rio Vista only receives net proceeds from the restricted
cash account when the amounts of collateral provided by Penn Octane and Rio
Vista exceed all liabilities under outstanding letters of credit issued on
behalf of Penn Octane, at the sole discretion of RZB. Historically RZB has not
unduly withheld net proceeds from Penn Octane, and Rio Vista does not expect
that RZB will unduly withhold net proceeds from Rio Vista. Upon the release of
Rio Vista's net proceeds from Rio Vista's restricted cash account, Rio Vista is
then required to pay any remaining amounts due Penn Octane, if any, for the
supply of LPG and other allocated or direct expenses.
LPG financing expense allocated to Rio Vista from Penn Octane associated
with the RZB Credit Facility totaled $61,242 for the three months ended March
31, 2005.
Penn Octane may need to increase its credit facility for increases in
quantities of LPG and Fuel Products purchased and/or to finance future price
increases of LPG and Fuel Products. Rio Vista relies on Penn Octane's ability
to allocate credit limits under the RZB Credit Facility to purchase quantities
of LPG. However there can be no assurance that Penn Octane will have available
and/or continue to provide sufficient credit limits for Rio Vista's required
purchases of LPG.
LONG-TERM DEBT
Long-term debt of Penn Octane guaranteed by Rio Vista and on which certain
of its assets are pledged totaled $1.8 million at March 31, 2005. This debt is
due on December 15, 2005. Interest is payable quarterly at a rate of 16.5% per
annum.
OBLIGATIONS AND ASSETS PLEDGED
The dollar amounts of Penn Octane obligations which Rio Vista guarantees
and/or for which Rio Vista's assets are pledged total $18.4 million at March 31,
2005, based on Penn Octane's most recently filed Quarterly Report on Form 10-Q,
and the unaudited amounts were as follows (in millions):
LPG and fuel products trade payables $ 7.3
Total debt, net of discount $ 1.6
Lines of credit $ 5.8
Letters of credit in excess of LPG and fuel products
trade payables $ 3.7
Consolidated current assets of Penn Octane, which includes assets of Rio
Vista, pledged in favor of Penn Octane's credit facility and certain other debt
total $33.7 million at March 31, 2005 and the unaudited amounts were as follows
(in millions):
Accounts receivable $11.1
Restricted cash $ 4.7
Inventory $ 2.1
Property, plant and equipment, net $15.8
29
Rio Vista's assets that are included in the above amounts are as follows
(in millions):
Accounts receivable $ 6.7
Restricted cash $ .9
Inventory $ .2
Property, plant and equipment, net $14.1
The following is a summary of Rio Vista's estimated minimum contractual
obligations as of March 31, 2005.
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 .2 .1 .1 - -
LPG Purchase Obligations - - - - -
Other Long-Term Obligations - - - - -
------ ---------- --------- --------- ---------
Total Contractual Cash Obligations $ .2 $ .1 $ .1 $ - $ -
====== ========== ========= ========= =========
The following is a summary of Rio Vista's estimated minimum commercial
obligations as of March 31, 2005, based on Penn Octane's most recently filed
Quarterly Report on Form 10-Q as of March 31, 2005.
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 - - - - -
Guarantees 18.4 18.3 .1 - -
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 $ 18.4 $ 18.3 $ .1 $ - $ -
============== ========== ========== ========== ===========
If Penn Octane's cash flow from operations is not adequate to satisfy such
payment of liabilities and obligations and/or tax liabilities when due and Rio
Vista is unable to satisfy its guarantees and/or tax indemnification agreement,
Penn Octane and/or Rio Vista may be required to pursue additional debt and/or
equity financing. In such event, Penn Octane's management and the General
Partner do not believe that Penn Octane and/or Rio Vista 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 Penn Octane and/or Rio Vista or at all. If additional financing
is available through the sale of Penn Octane's and/or Rio Vista's equity and/or
other securities convertible into equity securities through public or private
financings, substantial and immediate dilution may occur. There is no assurance
that Rio Vista would be able to raise any additional capital if needed. If
additional financing cannot be accomplished and Rio Vista is unable to pay its
liabilities and obligations when due or to restructure certain of Penn Octane's
liabilities and obligations, Rio Vista may suffer material adverse consequences
to its business, financial condition and results of operations and Penn Octane
and/or Rio Vista would likely be required to seek other alternatives which
include the sale of assets, closure of operations up to and including protection
under the U.S. bankruptcy laws.
30
Income Taxes. Rio Vista has agreed to indemnify Penn Octane 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. Penn Octane does not believe that it has a federal income tax in
connection with the Spin-Off in excess of $2.5 million. However, the Internal
Revenue Service (the "IRS") may review Penn Octane's federal income tax returns
and challenge positions that it may take with respect to the Spin-Off.
Partnership Tax Treatment. Rio Vista is not a taxable entity for U.S. tax
purposes (see below) and incurs no U.S. federal income tax liability. Rio
Vista's Mexican subsidiaries are taxed on their income directly by the Mexican
government. The income/loss of Rio Vista's Mexican subsidiaries are included
in the U.S. partnership income tax return of Rio Vista. The holders of the
common units and General Partner interest will be entitled to their
proportionate share of any tax credits resulting from any income taxes paid to
the Mexican government. Each unitholder of Rio Vista is required to take into
account that unitholder's share of items of income, gain, loss and deduction of
Rio Vista in computing that unitholder's federal income tax liability, even if
no cash distributions are made to the unitholder by Rio Vista. Distributions
by Rio Vista to a unitholder are generally not taxable unless the amount of cash
distributed is in excess of the unitholder's adjusted tax basis in Rio Vista.
Section 7704 of the Internal Revenue Code (Code) provides that publicly
traded partnerships shall, as a general rule, be taxed as corporations despite
the fact that they are not classified as corporations under Section 7701 of the
Code. Section 7704 of the Code provides an exception to this general rule for a
publicly traded partnership if 90% or more of its gross income for every taxable
year consists of "qualifying income" (the "Qualifying Income Exception"). For
purposes of this exception, "qualifying income" includes income and gains
derived from the exploration, development, mining or production, processing,
refining, transportation (including pipelines) or marketing of any mineral or
natural resource. Other types of "qualifying income" include interest (other
than from a financial business or interest based on profits of the borrower),
dividends, real property rents, gains from the sale of real property, including
real property held by one considered to be a "dealer" in such property, and
gains from the sale or other disposition of capital assets held for the
production of income that otherwise constitutes "qualifying income".
No ruling has been or will be sought from the IRS and the IRS has made no
determination as to Rio Vista's classification as a partnership for federal
income tax purposes or whether Rio Vista's operations generate a minimum of 90%
of "qualifying income" under Section 7704 of the Code.
If Rio Vista was classified as a corporation in any taxable year, either as
a result of a failure to meet the Qualifying Income Exception or otherwise, Rio
Vista's items of income, gain, loss and deduction would be reflected only on Rio
Vista's tax return rather than being passed through to Rio Vista's unitholders,
and Rio Vista's net income would be taxed at corporate rates.
If Rio Vista was treated as a corporation for federal income tax purposes,
Rio Vista would pay tax on income at corporate rates, which is currently a
maximum of 35%. Distributions to unitholders would generally be taxed again as
corporate distributions, and no income, gains, losses, or deductions would flow
through to the unitholders. Because a tax would be imposed upon Rio Vista as a
corporation, the cash available for distribution to unitholders would be
substantially reduced and Rio Vista's ability to make minimum quarterly
distributions would be impaired. Consequently, treatment of Rio Vista as a
corporation would result in a material reduction in the anticipated cash flow
and after-tax return to unitholders and therefore would likely result in a
substantial reduction in the value of Rio Vista's common units.
Current law may change so as to cause Rio Vista to be taxable as a
corporation for federal income tax purposes or otherwise subject Rio Vista to
entity-level taxation. The Agreement provides that, if a law is enacted or
existing law is modified or interpreted in a manner that subjects Rio Vista to
taxation as a corporation or otherwise subjects Rio Vista to entity-level
taxation for federal, state or local income tax purposes, then the minimum
quarterly distribution amount and the target distribution amount will be
adjusted downward to reflect the impact of that law on Rio Vista.
31
Distributions of Available Cash. All unitholders have the right to receive
distributions of "available cash" as defined in the Agreement from Rio Vista in
an amount equal to the minimum distribution of $0.25 per quarter per unit, plus
any arrearages in the payment of the minimum quarterly distribution on the units
from prior quarters. The General Partner receives a distribution corresponding
to its 2% General Partnership Interest. The distributions are to be paid 45
days after the end of each calendar quarter. However, Rio Vista is prohibited
from making any distributions to unitholders if it would cause an event of
default, or an event of default is existing, under any obligation of Penn Octane
which Rio Vista has guaranteed (see note J to the consolidated financial
statements).
Cash distributions from Rio Vista are shared by the holders of the common
units and the General Partner interest as described in the Agreement based on a
formula whereby the General Partner will receive disproportionately more
distributions per unit than the holders of the common units as annual cash
distributions exceed certain milestones.
On February 14, 2005, Rio Vista made a cash distribution of $487,000.
On April 21, 2005, the board of managers of Rio Vista approved the payment
of a $0.25 cash distribution per unit to all Rio Vista common unitholders and a
corresponding distribution to the General Partner as of the record date of May
9, 2005. The distribution of $487,000 was paid on May 13, 2005 (see note L to
the unaudited consolidated financial statements).
Rio Vista's ability to make distributions may be impacted by sales to PMI
at acceptable volumes and margins, payments on its guarantees, costs and
expenses and the inability to obtain additional financing on its pledged assets.
Although Penn Octane is not required to do so, to the extent that Penn Octane
has sufficient cash to do so, it intends to lend amounts to Rio Vista to meet
the minimum distributions. If Rio Vista's revenues and other sources of
liquidity after its quarterly distributions are not adequate to satisfy such
payment obligations of Penn Octane and/or Penn Octane does not have the
necessary cash to loan to Rio Vista, Rio Vista may be required to reduce or
eliminate the quarterly distributions to unitholders and/or Penn Octane and/or
Rio Vista may be required to raise additional funds to avoid foreclosure against
its assets. However, there can be no assurance that such additional funding
will be available on terms attractive to either Penn Octane or Rio Vista or
available at all.
The following is a reconciliation of net income to distributable cash flow
for the three months ended December 31, 2004 and March 31, 2005.
Three Months Ended
--------------------------------------------
December 31,
2004 March 31, 2005
---------------------- --------------------
Net income (loss) $( 63,000) $ 172,000
Plus interest and other expense, net 101,000 119,000
Plus depreciation and amortization 178,000 205,000
Plus other non-cash expenses 344,000 -
---------------------- --------------------
EBITDA 560,000 496,000
Less cash interest, net ( 101,000) ( 61,000)
---------------------- --------------------
Distributable cash flow 459,000 435,000
Distributable cash flow applicable to general partner (9,000) ( 9,000)
---------------------- --------------------
Distributable cash flow applicable to limited partners $ 450,000 $ 426,000
====================== ====================
Rio Vista utilizes two financial measures, EBITDA and distributable cash
flow, which are not defined in GAAP. Management uses these financial measures
because they are widely accepted financial indicators used by investors to
compare partnership performance. In addition, management believes that these
measures provide investors an enhanced perspective of the operating performance
of Rio Vista's assets and the cash flow the business is generating. Neither
EBITDA nor distributable cash flow are intended to represent cash flows for the
period, nor are they presented as an alternative to net income. They should not
be considered in isolation or as substitutes for a measure of performance
prepared in accordance with GAAP.
Increased expenses. As a result of the Spin-Off, Rio Vista estimates that
operating expenses will increase by approximately $450,000 on an annual basis as
a result of additional public company and income tax preparation costs related
to Rio Vista.
32
Sales to PMI. Prior to the Spin-Off, during the period April 1, 2004
through September 30, 2004, Penn Octane entered into monthly agreements for the
sale of LPG. On March 31, 2004, Penn Octane's sales agreement with PMI (the
"Contract") expired. During the months of October 2004 through December 2004,
Rio Vista and PMI entered into monthly agreements for the sale of LPG ("Monthly
2004 Contracts").
During December 2004, Rio Vista and PMI entered into a three month
agreement for the period January 1, 2005 to March 31, 2005 ("Quarterly
Agreement") at margins lower than those in effect during 2004. For April 2005,
Rio Vista entered into a one month agreement with PMI at further reduced
margins. On May 5, 2005, Rio Vista entered into a contract with PMI for the
sale of a minimum of 6,000,000 gallons of LPG for the period May 5, 2005 to May
31, 2005 at the reduced margin received in April 2005. For the period May 1,
2005 to May 4, 2005, PMI did not purchase any LPG from Rio Vista.
The following table describes the minimum monthly volumes of LPG to be
purchased by PMI and the actual monthly volumes purchased by PMI under monthly
contracts from April 1, 2004 through December 31, 2004, the Quarterly Agreement
and contracts for April and May 2005:
MINIMUM ACTUAL
CONTRACT VOLUMES
VOLUMES SOLD
(IN MILLIONS (IN MILLIONS
MONTH (*) YEAR OF GALLONS) OF GALLONS)
- ---------- ---- -------------- -------------
April 2004 13.0 13.1
May 2004 13.0 13.4
June 2004 13.0 13.8
July 2004 11.7 12.3
August 2004 11.7 12.4
September 2004 11.7 11.8
October 2004 11.1 10.9
November 2004 11.1 12.4
December 2004 11.7 13.9
January 2005 11.7 12.7
February 2005 11.7 9.9
March 2005 11.1 9.6
April 2005 10.5 10.8
May 2005 6.0 *
* Not yet available
The shortfall for the month of February 2005 was attributable to Penn
Octane, not having a sufficient supply of LPG to meet minimum contract volume.
The shortfall for the month of March 2005 was attributable to PMI not purchasing
the minimum contract volume. In accordance with the Quarterly Agreement,
PMI paid approximately $104,000 representing the total amount due associated
with the shortfall volumes for March 2005.
If the actual volume sold in May 2005 approximates the minimum contract
volume, cash flows for May 2005 will be less than expected cash operating and
other expenses by approximately $150,000. Rio Vista intends to take certain
measures to reduce cash operating and other expenses immediately. There can be
no assurance that costs and expenses can be reduced sufficiently to mitigate
negative cash flows at such reduced volumes at current or lower margins.
Rio Vista continues to negotiate a new long-term LPG contract with PMI.
There is no assurance that a LPG contract with PMI will be obtained, and if so,
that the terms will be more or less favorable than prior agreements. Until the
terms of a new long-term contract are reached, Rio Vista expects to enter into
additional monthly agreements similar to the Quarterly Agreement.
33
Rio Vista's management believes that PMI's reduction of volume commitments
for April 2004 through May 2005 is based on additional LPG production by PEMEX
being generated from the Burgos Basin field in Reynosa, Mexico, an area within
the proximity of Rio Vista's Matamoros Terminal Facility and increased
competition from U.S. suppliers (see Recent Trends above). In the event the
volume of LPG purchased by PMI under future agreements decline below an average
of approximately 11 million gallons per month and/or margins are further
reduced, Rio Vista may suffer material adverse consequences to its business,
financial condition and results of operations. If Penn Octane is unsuccessful in
lowering its LPG costs and to offset a decline in volume and/or Rio Vista is
forced to accept similar or lower margins for sales to PMI, the results of
operations of Rio Vista may be adversely affected. Rio Vista may not have
sufficient cash flow or available credit to absorb such reductions in gross
profit.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from Penn Octane prior to the Spin-Off and from Rio Vista, subsequent
thereto, for distribution by truck in Mexico. Rio Vista will continue 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.
Seasonality. Rio Vista's gross profit will be dependent on sales volume of
LPG to PMI, which fluctuates in part based on the seasons. The demand for LPG
is strongest during the winter season.
LPG Supply Agreement. Penn Octane entered into the LPG Supply Agreement
with Rio Vista pursuant to which Rio Vista has agreed to purchase all of its LPG
requirements for sales which utilize the assets transferred to Rio Vista by Penn
Octane to the extent Penn Octane is able to supply such LPG requirements. The
LPG Supply Agreement further provides that Rio Vista has no obligation to
purchase LPG from Penn Octane to the extent the distribution of such LPG to Rio
Vista's customers would not require the use of any of the assets Penn Octane
contributed to Rio Vista or Penn Octane ceases to have the right to access the
Leased Pipeline.
Under the LPG Supply Agreement, Penn Octane supplies all of Rio Vista's LPG
requirements in connection with its LPG sales obligations to PMI. The purchases
of the LPG are at fluctuating prices and are determined based on the cost of LPG
under Penn Octane's agreements with its LPG suppliers for volumes sold to Rio
Vista for sale to PMI or to other Rio Vista customers, other direct costs
related to PMI and other LPG sales of Rio Vista and a formula that takes into
consideration operating costs of Penn Octane and Rio Vista. Rio Vista expects
the aggregate costs per gallon to purchase LPG (less any applicable adjustments)
to be below the aggregate sales prices per gallon of LPG sold to PMI. Rio Vista
believes that its LPG Supply Agreement with Penn Octane provides it with an
advantage over competitors in the supply of LPG to PMI based on Penn Octane's
adequate volumes and price provided for in its agreements with its LPG
suppliers, and Penn Octane's Leased Pipeline which takes the LPG directly to Rio
Vista's Brownsville Terminal Facility from those suppliers. The Leased
Pipeline's capacity is estimated to be between 25.0 million and 30.0 million
gallons per month.
Under the terms of the Exxon Supply Contract, Penn Octane 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, Penn Octane's existing letter of credit
facility may not be adequate to meet the letter of credit requirements under the
Exxon Supply Contract or other suppliers if there are increases in quantities of
LPG purchased and/or to finance future price increases of LPG.
The LPG Supply Agreement terminates on the earlier to occur of:
- Penn Octane ceases to have the right to access the Leased
Pipeline that connects to Rio Vista's Brownsville Terminal
Facility; and
- Rio Vista ceases to sell LPG using any of the assets contributed
by Penn Octane to Rio Vista pursuant to the Spin-Off.
34
Mexican Operations. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of
receiving, conveying, storing and delivering LPG to final users is prohibited.
Foreign ownership is permitted in the transportation and storage of LPG.
Mexican law also provides that an entity with a permit to transport LPG is not
permitted to obtain permits for the other defined LPG activities (storage or
distribution). PennMex has a transportation permit and Termatsal owns, leases,
or is 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 owns the
Mexican portion of the assets comprising the US-Mexico Pipelines and the
Matamoros Terminal Facility. Rio Vista's consolidated Mexican affiliate,
Tergas, S. de R.L. de C.V. ("Tergas"), has been granted the permit to operate
the Matamoros Terminal Facility and Rio Vista relies on Tergas' permit to
continue its delivery of LPG at the Matamoros Terminal Facility. Rio Vista pays
Tergas its actual cost for distribution services at the Matamoros Terminal
Facility plus a small profit.
Through Rio Vista's operations in Mexico and the operations of the Mexican
subsidiaries and Tergas, Rio Vista is subject to the tax laws of Mexico which,
among other things, require that Rio Vista 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
entities, including dividends and interest payments may be subject to Mexican
withholding taxes.
During July 2003, Penn Octane acquired an option to purchase Tergas, which
is 95% owned by Vicente Soriano, an employee of Penn Octane, and the remaining
balance owned by Abelardo Mier, a consultant of Penn Octane, for a nominal
price of approximately $5,000. The option was transferred to Rio Vista on
September 30, 2004.
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Articulo 27 Constitutional en el Ramo
del Petroleo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), Reglamento de Gas Licuado
de Petroleo (Regulation of LPG) and Ley Org nica del Petr leos Mexicanos y
Organismos Subsidiarios (the Organic Law of Petroleos Mexicanos and Subsidiary
Entities (the "Organic Law")). Under Mexican law and related regulations, PEMEX
is entrusted with the central planning and the strategic management of Mexico's
petroleum industry, including importation, sales and transportation of LPG. In
carrying out this role, PEMEX controls pricing and distribution of various
petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulation of LPG
was enacted 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, an entity with a permit to transport LPG is not permitted to
obtain permits for the other defined LPG activities (storage and distribution).
Rio Vista expects to sell LPG directly to independent Mexican distributors as
well as PMI upon Deregulation. Rio Vista 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 Rio Vista.
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 decided to delay the implementation of Deregulation and asked
Tergas to defer use of the permit and as a result, Penn Octane 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. To
date the Mexican government has continued to delay implementation of
Deregulation. Tergas' permit to import LPG expired during August 2002. Tergas
intends to obtain a new permit when the Mexican government again begins to
accept applications. 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 Rio Vista. However, should Deregulation occur, it is Rio Vista's intention
to sell LPG directly to distributors in Mexico as well as to PMI.
35
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.
Partners' Capital. Rio Vista's beginning capital was contributed by Penn
Octane to Rio Vista's operating partnership in the form of assets consisting
primarily of terminal assets located in Brownsville, Texas, and Matamoros,
Mexico, as well as the pipelines connecting these terminal facilities. The
contribution to Rio Vista was recorded at Penn Octane's historical cost of such
assets on the date of the Spin-Off ($14.6 million).
COMMON UNITS
In connection with the Spin-Off on September 30, 2004, Rio Vista issued
1,910,656 common units to the holders of Penn Octane common stock.
The common units represent limited partner interests in Rio Vista. The
holders of common units are entitled to participate in Rio Vista's distributions
and exercise the rights or privileges available to limited partners under the
Agreement. The holders of common units have only limited voting rights on
matters affecting Rio Vista. Holders of common units have no right to elect the
General Partner or its managers on an annual or other continuing basis. Penn
Octane elects the managers of the General Partner. Although the General Partner
has a fiduciary duty to manage Rio Vista in a manner beneficial to Rio Vista and
its unitholders, the managers of the General Partner also have a fiduciary duty
to manage the General Partner in a manner beneficial to Penn Octane and its
stockholders. The General Partner generally may not be removed except upon the
vote of the holders of at least 80% of the outstanding common units; provided,
however, if at any time any person or group, other than the General Partner and
its affiliates, or a direct or subsequently approved transferee of the General
Partner or its affiliates, acquires, in the aggregate, beneficial ownership of
20% or more of any class of units then outstanding, that person or group will
lose voting rights on all of its units and the units may not be voted on any
matter and will not be considered to be outstanding when sending notices of a
meeting of unitholders, calculating required votes, determining the presence of
a quorum or for other similar purposes.
In addition, the Agreement contains provisions limiting the ability of
holders of common units to call meetings or to acquire information about Rio
Vista's operations, as well as other provisions limiting the holders of common
units ability to influence the manner or direction of management.
GENERAL PARTNER INTEREST
The General Partner of Rio Vista owns a 2% general partner interest in Rio
Vista. The General Partner is currently 100% owned by Penn Octane. Penn Octane
has granted options to Jerome B. Richter and to Shore Capital LLC ("Shore
Capital"), an affiliate of Richard Shore, Jr., to purchase 50% of its general
partner interest. Following the exercise of any of these options, Penn Octane
will retain voting control of the General Partner pursuant to a voting
agreement.
The General Partner generally has unlimited liability for the obligations
of Rio Vista, such as its debts and environmental liabilities, except for those
contractual obligations of Rio Vista that are expressly made without recourse to
the General Partner.
OPTIONS AND WARRANTS
Rio Vista has no U.S. employees and is managed by its General Partner. Rio
Vista applies APB 25 for warrants granted to employees and managers of the
General Partner and SFAS 123 for warrants issued to acquire goods and services
from non-employees.
COMMON UNIT WARRANTS. In connection with an employment agreement with Penn
Octane's President, Richard Shore, Jr., Shore Capital LLC, an affiliate of Mr.
Shore, received warrants to acquire 97,415 common units of Rio Vista with an
exercise price of $8.47 per common unit. On October 1, 2004, Rio Vista recorded
approximately $344,000 of compensation cost related to these warrants. The
warrants are exercisable beginning on October 1, 2004 and expire on July 10,
2006.
36
On March 9, 2005, the board of managers of the General Partner approved the
Rio Vista 2005 Equity Incentive Plan (the "2005 Plan"). The 2005 Plan permits
the grant of common unit options, common unit appreciation rights, restricted
common unit and phantom common units to any person who is an employee (including
to any executive officer) or consultant of Rio Vista or the General Partner or
any affiliate of Rio Vista or the General Partner. The 2005 Plan provides that
each outside manager of the General Partner shall be granted a common unit
option once each fiscal year for not more than 5,000 common units, in an equal
amount as determined by the board of managers. The aggregate number of common
units authorized for issuance as awards under the 2005 Plan is 750,000. The 2005
Plan shall remain available for the grant of awards until March 9, 2015, or such
earlier date as the board of managers may determine. The 2005 Plan is
administered by the compensation committee of the board of managers. Under the
terms of the Agreement and applicable rules of the Nasdaq Stock Market, no
approval by the common unitholders of Rio Vista was required.
On March 9, 2005, the board of managers of the General Partner approved the
grant of options to purchase a total of 108,750 common units under the 2005
Plan. Of the total number of options granted, 93,750 were granted to executive
officers of the General Partner and Mr. Richter and 15,000 were issued to
outside managers of the General Partner. The exercise price for the options is
$12.51 per common unit, which is the average of the high and low sales prices
for Rio Vista common units as reported by the Nasdaq Stock Market on March 9,
2005. The options granted to executive officers (including Mr. Richter) were
fully vested on the date of grant. The options granted to outside managers vest
in equal monthly installments over a period of 12 months from the date of grant.
All options become fully exercisable upon a change in control event and expire
three years from the date of grant.
LOAN DISCOUNT ON PENN OCTANE'S DEBT RELATED TO DETACHABLE WARRANTS. During
January 2004, in connection with $1.8 million of debt obligations of Penn
Octane, Penn Octane agreed to issue, in the future, an aggregate of 110,250
warrants to purchase Rio Vista common units ("Rio Vista Warrants"). The
exercise price of the warrants was to be determined based on the amount of the
first quarterly distribution paid by Rio Vista. As a result of the approval of
the payment of Rio Vista's first cash distribution on January 14, 2005 (see
below), Rio Vista granted the immediately exercisable warrants having an
exercise price of $5.00 and recorded a discount of approximately $422,000 which
is reflected as interest expense ratably amortized from the grant date of
January 14, 2005 to December 15, 2005, the maturity date of the debt
obligations. The Rio Vista Warrants will expire on December 15, 2006.
The Spin-Off. During September 2003, Penn Octane's board of directors and
the independent committee of its board of directors formally approved the terms
of the Spin-Off and Rio Vista filed a Form 10 registration statement with the
Securities and Exchange Commission. On September 30, 2004, all of Penn Octane's
limited partnership interest in Rio Vista was distributed to Penn Octane's
stockholders. Each stockholder of Penn Octane on September 30, 2004, received
one common unit of the limited partnership interest of Rio Vista for every eight
shares of Penn Octane's common stock owned.
As a result of the Spin-Off, Rio Vista owns and operates the LPG,
distribution, transportation and marketing business previously conducted by Penn
Octane. All of the assets transferred to Rio Vista in connection with the
Spin-Off have been transferred at historical costs and related accumulated
depreciation of Penn Octane at the date of the Spin-Off. Rio Vista began
selling LPG to PMI upon the completion of the Spin-Off and at that time also
began purchasing LPG from Penn Octane under the LPG Supply Agreement.
The General Partner is responsible for managing the operations and
activities of Rio Vista. Common unitholders do not participate in the
management of Rio Vista. Penn Octane controls Rio Vista by virtue of its
current ownership, management and voting control of the General Partner.
Therefore, Rio Vista is accounted for as a consolidated subsidiary of Penn
Octane for financial accounting purposes.
INTERCOMPANY PURCHASE AGREEMENT FOR LPG
Penn Octane entered into the LPG Supply Agreement with Rio Vista pursuant
to which Rio Vista has agreed to purchase all of its LPG requirements for sales
which utilize the assets transferred to Rio Vista by Penn Octane to the extent
Penn Octane is able to supply such LPG requirements (see LPG Supply Agreement
above).
37
OMNIBUS AGREEMENT
In connection with the Spin-Off, Penn Octane entered into an Omnibus
Agreement with Rio Vista that governs, among other things, indemnification
obligations among the parties to the agreement, related party transactions, the
provision of general administration and support services by Penn Octane.
The Omnibus Agreement prohibits Rio Vista from entering into any material
agreement with Penn Octane without the prior approval of the conflicts committee
of the board of managers of the General Partner. For purposes of the Omnibus
Agreement, the term material agreements means any agreement between Rio Vista
and Penn Octane that requires aggregate annual payments in excess of $100,000.
The Omnibus Agreement may be amended by written agreement of the parties;
provided, however that it may not be amended without the approval of the
conflicts committee of the General Partner if such amendment would adversely
affect the unitholders of Rio Vista. The Omnibus Agreement has an initial term
of five years that automatically renews for successive five-year terms and,
other than the indemnification provisions, will terminate if Rio Vista is no
longer an affiliate of Penn Octane.
Realization of Assets. Rio Vista's unaudited consolidated balance sheet
included elsewhere herein has been prepared in conformity with accounting
principles generally accepted in the United States of America, which contemplate
continuation of Rio Vista as a going concern. Rio Vista is dependent on Penn
Octane's ability to deliver adequate quantities of LPG at an acceptable price
for ultimate sale to PMI, to provide credit to Rio Vista for such purchases and
to provide management of its operations. Currently, Rio Vista's only source of
revenue is from sales of LPG to PMI and it operates under short-term sales
agreements with PMI. Since April 1, 2004, through the date of the Spin-Off,
Penn Octane had also been operating under short-term sales agreements with PMI.
The monthly volumes of LPG sold by Penn Octane to PMI since April 1, 2004 up to
the date of the Spin-Off were materially less than historical levels.
Additionally the monthly volumes of LPG sold by Rio Vista to PMI since October
1, 2004 have also been materially less than Penn Octane's historical levels and
margins have declined in 2005. As a result, Penn Octane's and Rio Vista's gross
profit have been materially reduced and may continue to decline and their cash
flow and available credit may be insufficient to absorb such additional
reductions in gross profit.
Rio Vista has guaranteed certain of Penn Octane's obligations.
Substantially all of Rio Vista's and Penn Octane's assets are pledged or
committed to be pledged as collateral on $1.8 million of Penn Octane's existing
debt and the RZB Credit Facility, and therefore, both Rio Vista and Penn Octane
may be unable to obtain additional financing collateralized by those assets.
Penn Octane's Report of Independent Certified Public Accountants on the
consolidated financial statements of Penn Octane at July 31, 2004 contains an
explanatory paragraph which describes an uncertainty about Penn Octane's ability
to continue as a going concern. If Penn Octane's and Rio Vista's cash flows are
not adequate to pay their obligations, Penn Octane and/or Rio Vista may be
required to raise additional funds to avoid foreclosure by Penn Octane's
creditors. There can be no assurance that such additional funding will be
available on terms attractive to either Penn Octane or Rio Vista or available at
all. If additional amounts cannot be raised and cash flow is inadequate, Penn
Octane and/or Rio Vista would likely be required to seek other alternatives
which include the sale of assets, closure of operations up to and including
protection under the U.S. bankruptcy laws.
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in Rio Vista's unaudited
consolidated balance sheet including elsewhere herein, is dependent upon the
ability of Penn Octane to continue as a going concern and continued sales of LPG
to PMI at acceptable volumes and margins to provide sufficient cash flow to pay
Rio Vista's expenses and guarantees of Penn Octane's obligations assuming Penn
Octane's inability to pay such obligations. The unaudited consolidated balance
sheet included elsewhere herein, does 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 Rio Vista be unable
to continue in existence.
To provide Rio Vista with the ability it believes necessary to continue in
existence, management is negotiating with PMI to increase LPG sales at
acceptable monthly volumes and margins on a long-term basis. In addition,
management is taking steps to diversify Rio Vista's operations to reduce
dependency on sales of LPG.
38
IMPACT OF INFLATION
Inflation in the United States and Mexico has been relatively low in recent
years and did not have a material impact on the consolidated financial
statements of Rio Vista. However, inflation remains a factor in the United
States and Mexico economies and could increase Rio Vista's cost to acquire or
replace property, plant and equipment as well as our labor and supply costs.
Rio Vista may be adversely impacted as a result of increases in LPG prices,
which are related to oil and natural gas prices, because of limits on Penn
Octane's credit facility.
ENVIRONMENTAL MATTERS
Rio Vista's operations are subject to environmental laws and regulations
adopted by various governmental authorities in the jurisdictions in which these
operations are conducted. Under the Omnibus Agreement, Penn Octane will
indemnify Rio Vista for five years after the completion of the Spin-Off against
certain potential environmental liabilities associated with the assets it
contributed to Rio Vista relating to events or conditions that existed before
the completion of the Spin-Off.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
During 2004, Rio Vista adopted Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Entities" ("FIN 46"), which
was amended by FIN 46R. This interpretation of Accounting Research Bulletin No.
51, "Consolidated Financial Statements", addresses consolidation by business
enterprises of variable interest entities ("VIE") that do not have sufficient
equity investment at risk to permit the entity to finance its activities without
additional subordinated financial support. FIN 46R requires the beneficiary of
a VIE to consolidate in its financial statements the assets, liabilities and
results of operations of the VIE. Tergas, an affiliate of Rio Vista, is a VIE
and therefore, its assets, liabilities and results of operations have been
included in the accompanying consolidated financial statements of Rio Vista.
In November 2004, the FASB issued Statement of Financial Accounting
Standard No. 151, "Inventory Costs - An Amendment of ARB No. 43 Chapter 4"
("SFAS 151") which clarifies that abnormal amounts of idle facility expense,
freight, handling costs and spoilage should be expensed as incurred and not
included in overhead. Further, SFAS 151 requires that allocation of fixed
production overheads to conversion costs should be based on normal capacity of
the production facilities. The provisions in SFAS 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. Rio
Vista has determined that SFAS 151 will not have a material impact on their
consolidated results of operations, financial position or cash flows.
During December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 123 (revised 2004)
"Share-Based Payment" ("SFAS 123R"). SFAS 123R replaces SFAS 123, "Accounting
for Stock-Based Compensation", and supercedes APB Opinion 25, "Accounting for
Stock Issued to Employees" ("APB 25"). SFAS 123R requires that the cost of
share-based payment transactions (including those with employees and
non-employees) be recognized in the financial statements as compensation cost.
That cost will be measured based on the fair value of equity or liability
instrument issued. SFAS 123R is effective for Rio Vista beginning January 1,
2006. Rio Vista will apply the modified prospective method as provided for in
SFAS 123R, and therefore the financial statements of Rio Vista for interim and
annual periods prior to the adoption of SFAS 123R will not reflect any
restatements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard No. 153, "Exchanges of Nonmonetary Assets-An Amendment of APB Opinion
No. 29" ("SFAS 153"). The amendments made by SFAS 153 are based on the
principle that exchanges on nonmonetary assets should be measured based on the
fair value of the assets exchanged. The provisions in SFAS 153 are effective
for nonmonetary asset exchanges occurring in fiscal periods beginning after June
15, 2005. Early application is permitted and companies must apply the standard
prospectively. Rio Vista has determined that SFAS 153 will not have a material
impact on their consolidated results of operations, financial position or cash
flows.
39
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of Rio Vista reflect the selection
and application of accounting policies which require management to make
significant estimates and judgments. See note B to Rio Vista's consolidated
financial statements included in its Annual Report on Form 10-K for the fiscal
year ended December 31, 2004, "Summary of Significant Accounting Policies". Rio
Vista believes that the following reflect the more critical accounting policies
that affect the financial position and results of operations.
Revenue recognition - Rio Vista expects in the future to enter into sales
agreements to sell LPG for future delivery. Rio Vista will not record sales
until the LPG is delivered to the customer.
Impairment of long-lived assets - The determination of whether impairment
has occurred is based on an estimate of undiscounted cash flows
attributable to assets in future periods. If impairment has occurred, the
amount of the impairment loss recognized will be determined by estimating
the fair value of the assets and recording a loss if the fair value is less
than the carrying value. Assessments of impairment are subject to
management's judgments and based on estimates that management is required
to make.
Depreciation and amortization expenses - Property, plant and equipment are
carried at cost less accumulated depreciation and amortization.
Depreciation and amortization rates are based on management's estimate of
the future utilization and useful lives of the assets.
Unit-based compensation - Rio Vista accounts for unit-based compensation
using the provisions of APB 25 (intrinsic value method), which is permitted
by SFAS 123. The difference in net income, if any, between the intrinsic
value method and the method provided for by SFAS 123 (fair value method) is
required to be disclosed in the financial statements on an annual and
interim basis as a result of the issuance of SFAS 148.
Allowance for doubtful accounts - The carrying value of trade accounts
receivable is based on estimated fair value. The determination of fair
value is subject to management's judgments and is based on estimates that
management is required to make.
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.
40
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
To the extent that Rio Vista 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, Rio Vista is exposed to
market risk related to the volatility of LPG prices. In the event that inventory
balances exceed commitments for undelivered LPG, during periods of falling LPG
prices, Rio Vista may sell excess inventory to customers to reduce the risk of
these price fluctuations. In the event that commitments for undelivered LPG
exceed inventory balances, Rio Vista may purchase contracts which protect it
against future price increases of LPG.
Rio Vista does not maintain quantities of LPG inventory in excess of
quantities actually ordered by PMI. Therefore, Rio Vista 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.
Rio Vista does not have any debt. Trade accounts receivable from PMI and
Rio Vista's trade and other accounts payable generally do not bear interest.
Penn Octane's credit facility with RZB for which Rio Vista is responsible for
some of the costs does not bear interest since generally no cash advances are
made to Rio Vista or Penn Octane by RZB. Fees paid to RZB for letters of credit
are based on a fixed schedule as provided in Penn Octane's agreement with RZB.
Therefore, Rio Vista currently has limited, if any, interest rate risk.
Rio Vista routinely converts U.S. dollars into Mexican pesos to pay
terminal operating costs and income taxes. Such costs are expected to be less
than $1 million per year and Rio Vista expects such costs will remain at less
than $1 million in any year. Rio Vista does not maintain Mexican peso bank
accounts with other than nominal balances. Therefore, Rio Vista has limited, if
any, risk related to foreign currency exchange rates.
ITEM 4. CONTROLS AND PROCEDURES.
The General Partner's management, including the principal executive officer
and principal financial officer, conducted an evaluation of Rio Vista'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, as of the end
of the period. Based on their evaluation, the General Partner's principal
executive officer and principal accounting officer concluded that Rio Vista'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 Rio Vista's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referenced in paragraph above.
41
PART II
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
See note G to the accompanying unaudited consolidated financial
statements, for information concerning certain sales of securities.
The above transactions were exempt from registration under the
Securities Act of 1933 pursuant to Section 4(2) thereof because the
issuance did not involve any public offering of securities.
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
THE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE TO PREVIOUSLY FILED
REPORTS, AS NOTED.
Exhibit No.
------------
10.1* Rio Vista Energy Partners L.P. 2005 Equity Incentive Plan
(incorporated by reference to Rio Vista's Annual Report on
Form 10-K for the year ended December 31, 2004 filed on
April 12, 2005, SEC File No. 000-50394)
* indicates management contract or compensatory plan or
arrangement.
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:
Exhibit No.
------------
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
42
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.
RIO VISTA ENERGY PARTNERS L.P.
May 20, 2005 By: /s/Ian T. Bothwell
------------------------------------
Ian T. Bothwell
Treasurer (principal accounting and
financial officer) of Rio Vista GP
LLC, general partner of Rio Vista
Energy Partners L.P.
43