UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended July 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ___________________
Commission file number: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, BUILDING D, PALM DESERT, CALIFORNIA 92211
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (760) 772-9080
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K or any amendment to this Form 10-K
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
--- ---
1
The aggregate market value of the voting stock held by non-affiliates of
the Registrant was $24,326,290 as of January 31, 2004. The last reported sale
price of the Registrant's Common Stock was $2.39 per share as reported on the
Nasdaq SmallCap Market on January 30, 2004.
The number of shares of Common Stock, par value $0.01 per share,
outstanding on October 15, 2004 was 15,285,245.
DOCUMENTS INCORPORATED BY REFERENCE
The follow documents are incorporated by reference into Parts I and II of
this report on Form 10-K: the Company's Current Report on Form 8-K filed on
September 21, 2004 regarding the amendment of the RZB Credit Facility and the
Company's Current Report on Form 8-K filed on September 22, 2004 regarding the
execution of material contracts with Rio Vista in connection with the Spin-Off.
TABLE OF CONTENTS
ITEM PAGE NO.
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Part I 1. Business 3
2. Properties 20
3. Legal Proceedings 22
4. Submission of Matters to a Vote of Security Holders 22
Part II 5. Market for Registrant's Common Equity and Related
Stockholder Matters and Issuer Purchases of Equity
Securities 23
6. Selected Financial Data 26
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
7A. Quantitative and Qualitative Disclosures About
Market Risks 48
8. Financial Statements and Supplementary Data 49
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 97
9A. Controls and Procedures 97
9B. Other Information 97
Part III 10. Directors and Executive Officers of the Registrant 98
11. Executive Compensation 101
12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 106
13. Certain Relationships and Related Transactions 109
14. Principal Accountant Fees and Services 111
Part IV 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 112
2
PART I
The statements contained in this Annual Report that are not historical facts are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933. These forward-looking statements may be identified by the use of
forward-looking terms such as "believes," "expects," "may," "will", "should" or
anticipates" or by discussions of strategy that inherently involve risks and
uncertainties. From time to time, we have made or may make forward-looking
statements, orally or in writing. These forward-looking statements include
statements regarding anticipated future revenues, sales, LPG supply, operations,
demand, competition, capital expenditures, the deregulation of the LPG market in
Mexico, the operations of the US - Mexico Pipelines, the Matamoros Terminal
Facility, the remaining Saltillo Terminal assets, other upgrades to our
facilities, foreign ownership of LPG operations, short-term obligations and
credit arrangements, outcome of litigation, Fuel Sales Business, 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 under "Business" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations," as
well as those discussed elsewhere in this Annual Report. We caution you,
however, that the following list of factors may not include all material risks
facing the Company.
PENN OCTANE CORPORATION AND ITS CONSOLIDATED SUBSIDIARIES WHICH INCLUDES RIO
VISTA ENERGY PARTNERS L.P. AND ITS SUBSIDIARIES ARE HEREINAFTER REFERRED TO AS
THE "COMPANY".
RISK FACTORS
Business Factors. The expiration of the LPG sales contract with PMI and
the resulting lower LPG sales volumes may adversely affect the Company's results
of operations. The Company has only one customer for LPG in Mexico, PMI. The
Company just recently commenced its Fuel Sales Business. The Company cannot be
sure that PMI will continue to purchase LPG from the Company or in quantities or
prices that are profitable. There are a limited number of suppliers of LPG
that connect to the Company's pipelines and a limited supply of LPG. The
Company may lose its competitive advantage when then Company's Seadrift pipeline
lease expires in 2013. The Company may be unable to successfully develop
additional sources of revenue in order to reduce its dependence on PMI. The
Company may not have sufficient cash to meet its obligations. All of the
Company's assets are pledged as collateral for existing debt, and the Company
therefore may be unable to obtain additional financing collateralized by such
assets. The Company is at risk of economic loss due to fixed margin contracts.
If the Company does not have sufficient capital resources for acquisitions or
opportunities for expansion, the Company's growth will be limited. The
Company's ability to grow the Fuel Sales Business is largely dependent on
available financing which may be limited. Future acquisitions and expansions
may not be successful, may substantially increase the Company's indebtedness and
contingent liabilities, and may create integration difficulties. The Company's
business would be adversely affected if operations at the Company's
transportation, terminal and distributions facilities were interrupted. The
Company's business would also be adversely affected if the operations of the
Company's customers and suppliers 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. The Company
competes with other firms in the sale or purchase of LPG and Fuel Products as
well as the transportation of these products in the US and Mexican markets and
employs all methods of competition which are lawful and appropriate for such
purposes. A key component of the Company'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.
See Liquefied Petroleum Gas and Fuel Sales Business for further discussion.
3
International Factors. Mexican economic, political and social conditions
may change and adversely affect the Company's operations. The Company may not
be able to continue operations in Mexico if Mexico restricts the existing
ownership structure of its Mexican operations, requiring the Company 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 the Company's
ability to negotiate acceptable contracts with distributors. The Company's
contracts and Mexican business operations are subject to volatility in currency
exchange rates which could negatively impact its earnings.
Political Factors. The operations and earnings of the Company and its
consolidated affiliate in the US 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 the Company'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 the Company vary greatly and are not
predictable.
Industry and Economic Factors. The operations and earnings of the Company
and its consolidated affiliate throughout the US and Mexico are affected by
local, regional and global events or conditions that affect supply and demand
for the Company'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.
Project Acquisition Factors. In additional to the factors cited above,
the advancement, cost and results of particular projects sought by the Company,
including projects which do not specifically fall within the areas of the
Company's current lines of businesses will depend on the outcome of negotiations
for such acquisitions; the ability of the Company's management to manage such
businesses; the ability of the Company to obtain financing for such
acquisitions; changes in operating conditions or costs; and the occurrence of
unforeseen technical difficulties.
Market Risk Factors. See page 48 of the Financial Section of this report
for discussion of the impact of market risks and other uncertainties.
Projections, estimates and descriptions of the Company's plans and
objectives included or incorporated in Items 1, 7 and 7A of this report are
forward-looking statements. Actual future results could differ materially due
to, among other things, the factors discussed above and elsewhere in this
report.
ITEM 1. BUSINESS.
INTRODUCTION
Before the Spin-Off on September 30, 2004
Penn Octane Corporation, formerly known as International Energy Development
Corporation ("International Energy"), was incorporated in Delaware in August
1992. Penn Octane Corporation and its consolidated subsidiaries are hereinafter
referred to as the "Company". The Company has been principally engaged in the
purchase, transportation and sale of liquefied petroleum gas ("LPG"). The
Company owns and operates a terminal facility in Brownsville, Texas (the
"Brownsville Terminal Facility") and owns a LPG terminal facility in Matamoros,
Tamaulipas, Mexico (the "Matamoros Terminal Facility") and approximately 23
miles of pipelines (the "US - Mexico Pipelines") which connect the Brownsville
Terminal Facility to the Matamoros Terminal Facility. The Company has a
long-term lease agreement for approximately 132 miles of pipeline (the "Leased
Pipeline") which connects ExxonMobil Corporation's ("Exxon") King Ranch Gas
Plant in Kleberg County, Texas and Duke Energy's La Gloria Gas Plant in Jim
Wells County, Texas, to the Company's Brownsville Terminal Facility. In
addition, the Company has access to a twelve-inch pipeline (the "ECCPL"), which
connects from Exxon's Viola valve station in Nueces County, Texas to the inlet
of the King Ranch Gas Plant as well as existing and other potential propane
pipeline suppliers which have the ability to access the ECCPL. In
4
connection with the Company's lease agreement for the Leased Pipeline, the
Company may access up to 21.0 million gallons of storage, located in Markham,
Texas ("Markham"), as well as other potential propane pipeline suppliers, via
approximately 155 miles of pipeline located between Markham and the Exxon King
Ranch Gas Plant.
The Company commenced commercial operations for the purchase, transport and
sale of LPG in the fiscal year ended July 31, 1995, upon construction of the
Brownsville Terminal Facility. The primary market for the Company's LPG is the
northeastern region of Mexico, which includes the states of Coahuila, Nuevo Leon
and Tamaulipas. The Company believes it has a competitive advantage in the
supply of LPG for the northeastern region of Mexico because of the Company's
access to pipelines and terminal facilities which allow the Company to bring
supplies of LPG close to consumers of LPG in major cities in that region. Since
operations commenced, the Company's primary customer for LPG has been P.M.I.
Trading Limited ("PMI"). PMI is a subsidiary of Petroleos Mexicanos, the
state-owned Mexican oil company, which is commonly known by its trade name
"PEMEX." PMI is the exclusive importer of LPG into Mexico. The LPG purchased
by PMI from the Company is sold to PEMEX which distributes the LPG purchased
from PMI into the northeastern region of Mexico.
During June 2004, the Company began operations as a reseller of gasoline
and diesel fuel (the "Fuel Products") with the ability to access certain
pipeline and terminal systems located in California, Arizona, Nevada and Texas
("Fuel Sales Business").
Spin-Off
On September 30, 2004, Penn Octane Corporation ("Penn Octane")
completed a series of transactions involving (i) the transfer of substantially
all of its owned pipeline and terminal assets in Brownsville and Matamoros to
its wholly owned subsidiary, Rio Vista Operating Partnership L.P. and its
subsidiaries ("RVOP") (ii) transferred its 99.9% interest in RVOP to its wholly
owned subsidiary Rio Vista Energy Partners L.P. and its subsidiaries ("Rio
Vista") and (iii) distributed all of its limited partnership interest (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 units. The remaining 2% of such
units, 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,
and the General Partner will be responsible for the management of Rio Vista.
Accordingly the Company will have control of Rio Vista by virtue of its
ownership and related voting control of the General Partner and Rio Vista will
be consolidated with the Company and the interests of the limited partners will
be classified as minority interests in the Company's consolidated financial
statements. Subsequent to the Spin-Off, Rio Vista will sell LPG directly to
PMI and will purchase LPG from Penn Octane under a long-term supply agreement.
The purchase price of the LPG from Penn Octane will be determined based on the
cost of LPG under Penn Octane's LPG supply agreements and a formula that takes
into consideration LPG operating costs of Penn Octane and Rio Vista. The
transfer of such assets and the distribution of the Rio Vista Common Units were
conducted in accordance with the terms of the Distribution Agreement, the
Omnibus Agreement, the Purchase Agreement for LPG, the Contribution, Conveyance
and Assumption Agreement and the Conveyance Agreement, copies of which are
attached as exhibits to this report. These agreements are described in Penn
Octane's Current Report on Form 8-K filed by Penn Octane with the SEC on
September 22, 2004, and incorporated by reference.
The Company's principal executive offices are located at 77-530 Enfield
Lane, Building D, Palm Desert, California 92211, and its telephone number is
(760) 772-9080.
LIQUEFIED PETROLEUM GAS
OVERVIEW. Since operations commenced, the primary business of the Company
has been the purchase, transportation and sale of LPG. LPG is a mixture of
propane and butane principally used for residential and commercial heating and
cooking. The demand for propane is also growing as a motor fuel substitute for
motor gasoline.
5
The primary market for the Company's LPG is the northeastern region of
Mexico, which includes the states of Coahuila, Nuevo Leon and Tamaulipas.
Mexico is one of the largest markets for LPG consumption in the world. LPG is
the most widely used domestic fuel in Mexico and is the primary energy source
for Mexican households using such domestic fuels. Domestic consumption of LPG
in Mexico increased from an average of 408.2 million gallons per month during
the period January 1, 2003 through September 30, 2003 to an average of 413.4
million gallons per month during the period January 1, 2004 through September
30, 2004, an estimated annual increase of 1.3%. The future of LPG in Mexico may
continue to favor the Company for the following reasons: (i) Mexico's domestic
consumption of LPG exceeds current domestic production capacity, and such
shortfall is expected to continue (ii) limited sources of competitive LPG supply
for importation into Mexico which is destined for consumption in northeastern
Mexico, (iii) the Mexican government's current plans to deregulate the LPG
industry, (iv) the expanding use of propane as an automotive fuel, and (v) the
location of Mexico's major domestic LPG production, which is in the southeastern
region of Mexico, combined with the lack of pipeline infrastructure within
Mexico from those production centers, resulting in higher distribution costs to
transport the LPG to areas where consumption is heaviest including the central,
northern and Pacific coast regions of Mexico.
The Company has been able to successfully compete with other LPG suppliers
in the provision of LPG to customers in northeastern Mexico primarily as a
result of the Leased Pipeline, the US - Mexico Pipelines, the Company's supply
agreements for LPG and the geographic proximity of its Matamoros Terminal
Facility to consumers of LPG in such major cities in Mexico as Matamoros,
Reynosa and Monterrey. With the commencement of operations of the Matamoros
Terminal Facility in April 2000, the Company reduced its exposure to the
previous logistical inefficiencies and sales limitations of the Brownsville
Terminal Facility resulting from trucking delays at the United States-Mexico
border crossings or the ability of PMI to provide United States certified trucks
or trailers capable of receiving LPG at the Brownsville Terminal Facility.
Current alternatives for delivery of LPG exports to northeastern Mexico from the
United States are by truck primarily through Eagle Pass and Hidalgo, Texas,
which are northwest of Brownsville and rail. The Company believes that the
Matamoros Terminal Facility provides PMI with a less costly alternative than
other LPG supply centers used by it for the importation of LPG to the strategic
areas the Company serves.
RECENT TRENDS. Since April 2004, PMI has contracted with the Company for
volumes which are significantly lower than amounts purchased by PMI in similar
periods during previous years. The Company 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 the Company's Mexican terminal facilities. Although the Company 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. The Company also
believes that PEMEX is intending to install two additional cryogenic facilities,
with similar capacity, to be operational in early 2006. The Company is also not
aware of the capacity at which the current cryogenic facilities are being
operated. Furthermore, the Company 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. The Company still believes that its LPG supplies are
competitive with the necessary US imports of LPG by PEMEX and that the LPG
volumes which are actually produced from the Burgos Basin would not eliminate
the need for US 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 in the Company'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 in Juarez, Texas 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. The Company believes that if
Valero intends to maximize capacity of these facilities, then it would be
required to obtain additional LPG supplies from major LPG hubs located in Corpus
Christi and Mont Belvieu, Texas. Accordingly, the Company believes that any
additional supplies over amounts currently available to the Mexican market
through Valero's system could be more expensive than the Company's currently
available supplies and delivery systems.
6
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 the Company's
strategic zone. The Company 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 US-Mexico border near the proximity of the Company's
pipelines. In connection with the construction of the pipeline, PMI was
required to obtain an easement from the Company 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.
THE BROWNSVILLE TERMINAL FACILITY. The Company's Brownsville Terminal
Facility occupies approximately 31 acres of land located adjacent to the
Brownsville Ship Channel, a major deep-water port serving northeastern Mexico,
including the city of Monterrey, and southeastern Texas. The Brownsville
Terminal Facility also contains a railroad spur. Total rated storage capacity
of the Brownsville Terminal Facility is approximately 675,000 gallons of LPG.
The Brownsville Terminal Facility includes eleven storage tanks, five mixed
product truck loading racks, two racks capable of receiving LPG delivered by
truck and three railcar loading racks which permit the loading and unloading of
LPG by railcar. The truck loading racks and railcar loading racks are linked to
a computer-controlled loading and remote accounting system.
The Company leases the land on which the Brownsville Terminal Facility is
located from the Brownsville Navigation District (the "District") under a lease
agreement (the "Brownsville Lease") that expires on November 30, 2006. The
Company has an option to renew for five additional five year terms. Currently,
substantially all of the Company's LPG supply is received by the Leased
Pipeline, which flows through pumping and metering equipment located at the
Brownsville Terminal Facility and then flows through the US - Mexico Pipelines
to the Matamoros Terminal Facility for offloading to trucks. Currently LPG sold
by the Company to PMI which is intended to be delivered to the Matamoros
Terminal Facility, may be delivered to the Brownsville Terminal Facility in the
event that the Matamoros Terminal Facility temporarily cannot be used. The
Brownsville Lease contains a pipeline easement to the District's water dock
facility at the Brownsville Ship Channel. The railroad loading facilities are
being used by the Company for sales of LPG to other customers and to provide the
Company with increased flexibility in managing its LPG supplies and sales.
The Brownsville Lease provides, among other things, that if the Company
complies with all the conditions and covenants therein, the leasehold
improvements made to the Brownsville Terminal Facility by the Company may be
removed from the premises or otherwise disposed of by the Company at the
termination of the Brownsville Lease. In the event of a breach by the Company
of any of the conditions or covenants of the Brownsville Lease, all improvements
owned by the Company and placed on the premises shall be considered part of the
real estate and shall become the property of the District.
THE US - MEXICO PIPELINES AND MATAMOROS TERMINAL FACILITY. On July 26,
1999, the Company was granted a permit by the United States Department of State
authorizing the Company to construct, maintain and operate two pipelines (the
"US Pipelines") crossing the international boundary line between the United
States and Mexico (from the Brownsville Terminal Facility near the Port of
Brownsville, Texas and El Sabino, Mexico) for the transport of LPG and refined
products (motor gasoline and diesel fuel) [the "Refined Products"].
On July 2, 1998, Penn Octane de Mexico, S. de R.L. de C.V. (formerly Penn
Octane de Mexico, S.A. de C.V.) ("PennMex") (see Mexican Operations), received a
permit from the Comision Reguladora de Energia (the "Mexican Energy Commission")
to build and operate one pipeline to transport LPG (the "Mexican Pipeline")
(collectively, the US Pipelines and the Mexican Pipeline are referred to as the
"US - Mexico Pipelines") from El Sabino (at the point north of the Rio Bravo) to
the Matamoros Terminal Facility.
The Company's Mexican subsidiaries, PennMex and Termatsal, S.de R.L. de C.V
(formerly Termatsal, S.A. de C.V. "Termatsal"), own all of the assets related to
the Mexican portion of the US - Mexico Pipelines and Matamoros Terminal Facility
and the Company's consolidated affiliate Tergas, S.A. de C.V. ("Tergas") has
been granted the permit to operate the Matamoros Terminal Facility (see Mexican
Operations).
7
US - Mexico Pipelines. The Company's US-Mexico Pipelines consist of two
parallel pipelines, one of approximately six inch diameter and the other of
approximately eight inch diameter, running approximately 23 miles and connecting
the Brownsville Terminal Facility to the Matamoros Terminal Facility. The
capacity of the six inch pipeline and eight inch pipeline is approximately
840,000 gallons per day and 1.7 million gallons per day, respectively. Each of
the pipelines can accommodate LPG or Refined Products.
The Matamoros Terminal Facility. The Company's Matamoros Terminal Facility
occupies approximately 35 acres of land located approximately seven miles from
the United States-Mexico border and is linked to the Brownsville Terminal
Facility via the US - Mexico Pipelines. The Matamoros Terminal Facility is
located in an industrial zone west of the city of Matamoros, and the Company
believes that it is strategically positioned to be a centralized distribution
center of LPG for the northeastern region of Mexico. Total rated storage
capacity of the Matamoros Terminal Facility is approximately 270,000 gallons of
LPG and there are plans to install additional storage capacity totaling
approximately 630,000 gallons. The Matamoros Terminal Facility includes three
storage tanks and ten specification product truck loading racks for LPG product.
The truck loading racks are linked to a computer-controlled loading and remote
accounting system and to the Company's Brownsville Terminal Facility. The
Matamoros Terminal Facility receives its LPG supply directly from the US -
Mexico Pipelines which connect to the Leased Pipelines at the Brownsville
Terminal Facility.
The Saltillo Terminal. The Company had previously completed construction
of an additional LPG terminal facility in Saltillo, Mexico (the "Saltillo
Terminal"). The Company was unable to receive all the necessary approvals to
operate the facility at that location. The terminal was subsequently
dismantled.
The Company has accounted for the Saltillo Terminal at cost. The cost
included in the balance sheet is comprised primarily of dismantled pipe,
dismantled steel structures, steel storage tanks, pumps and compressors and
capitalized engineering costs related to the design of the terminal. The cost
of dismantling the terminal at the Saltillo location was expensed and on-going
storage fees have also been expensed.
As a result of the reduced volumes of LPG being sold to PMI and the
short-term nature of the agreements (see LPG Sales to PMI below), the Company
has determined that construction of a new Saltillo Terminal is currently not
feasible. Accordingly, as of July 31, 2004, the Company has written off
$227,829 related to the capitalized engineering costs and other costs associated
with the design of the Saltillo Terminal and expensed $32,171 of costs related
to pipes, pumps and values which were used as replacement parts in the Matamoros
Terminal Facility. The Company anticipates utilizing the remaining Saltillo
Terminal assets in its existing operations.
OTHER. The Company intends to upgrade its computer and information systems
at a total estimated cost of approximately $350,000.
THE LEASED PIPELINE. The Company has a lease agreement (the "Pipeline
Lease") with Seadrift, a subsidiary of Dow Hydrocarbons and Resources, Inc.
("Dow"), for approximately 132 miles of pipeline which connects Exxon's King
Ranch Gas Plant in Kleberg County, Texas and Duke Energy Corporation's La Gloria
Gas Plant in Jim Wells County, Texas, to the Company's Brownsville Terminal
Facility (the "Leased Pipeline"). As provided for in the Pipeline Lease, the
Company has the right to use the Leased Pipeline solely for the transportation
of LPG and refined petroleum products belonging only to the Company and not to
any third party.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (the "Pipeline Lease Amendment") entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999 (the
"Effective Date"). The Pipeline Lease Amendment provides, among other things,
access up to 21.0 million gallons of storage located in Markham as well as other
potential propane pipeline suppliers via approximately 155 miles of pipeline
located between Markham and the Exxon King Ranch Gas Plant (see note K to the
consolidated financial statements). The Company's ability to utilize the
storage at Markham is subject to the hydraulic and logistic capabilities of that
system. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million and 360
million gallons per year.
8
THE ECCPL PIPELINE. In connection with the Company's supply agreement with
Exxon, the Company was granted access to Exxon's twelve-inch pipeline which
connects from Exxon's Viola valve station in Nueces County, Texas (near Corpus
Christi, Texas) to the inlet of the King Ranch Gas Plant (the "ECCPL Pipeline")
as well as existing and other potential propane pipeline suppliers which have
the ability to access the ECCPL. Under the terms of the agreement, Exxon has
agreed to make available space in the ECCPL for a minimum of 420,000 gallons per
day for the Company's use.
DISTRIBUTION. Until March 2000, all of the LPG from the Leased Pipeline
had been delivered to the Company's customers at the Brownsville Terminal
Facility and then transported by truck to the United States Rio Grande Valley
and northeastern Mexico by the customers or by railcar to customers in the
United States and Canada. From April 2000 through February 2001, the Company
began operating the Matamoros Terminal Facility, whereby a portion of the LPG
sold to PMI was delivered through the US - Mexico Pipelines to the Matamoros
Terminal Facility for further distribution by truck in northeastern Mexico.
Since March 2001, PMI has primarily used the Matamoros Terminal Facility to
load LPG purchased from the Company for distribution by truck in Mexico. The
Company continues to use the Brownsville Terminal Facility in connection with
LPG delivered by railcar to other customers, storage and as an alternative
terminal in the event the Matamoros Terminal Facility cannot be used.
LPG SALES TO PMI. The Company entered into sales agreements with PMI for
the period from April 1, 2000 through March 31, 2001 (the "Old Agreements"), for
the annual sale of a combined minimum of 151.2 million gallons of LPG, mixed to
PMI specifications, subject to seasonal variability, to be delivered to PMI at
the Company's terminal facilities in Matamoros, Tamaulipas, Mexico or alternate
delivery points as prescribed under the Old Agreements.
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7.5 million gallons resulting in a new annual combined
minimum commitment of 158.7 million gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (the "Confirmation") on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of 19.0
million gallons at indexed variable posted prices plus premiums that provided
the Company with annual fixed margins, which were to increase annually over a
three-year period. The Company was also entitled to receive additional fees
for any volumes which were undelivered. From April 1, 2001 through December 31,
2001, the Company and PMI operated under the terms provided for in the
Confirmation. From January 1, 2002 through February 28, 2002, PMI purchased
monthly volumes of approximately 17.0 million gallons per month at slightly
higher premiums than those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39.6 million gallons (the "Sold LPG") for which PMI had not taken
delivery. The Company received the posted price plus other fees on the Sold LPG
but did not receive the fixed margin referred to in the Confirmation (see note
B9 to the consolidated financial statements). At July 31, 2001, the obligation
to deliver LPG totaled approximately $11.5 million related to such sales
(approximately 26.6 million gallons). During the period from December 1, 2001
through March 31, 2002, the Company delivered the Sold LPG to PMI and collected
the fixed margin referred to in the Confirmation.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17.0 million gallons of LPG, subject to monthly
adjustments based on seasonality (the "Contract"). In connection with the
Contract, the parties also executed a settlement agreement, whereby the parties
released each other in connection with all disputes between the parties arising
during the period April 1, 2001 through February 28, 2002, and previous claims
related to the contract for the period April 1, 2000 through March 31, 2001.
The Contract was originally to expire on May 31, 2004. On December 29, 2003,
the Company received a notice from PMI requesting the termination of the
Contract effective March 31, 2004, the end of the winter period as defined under
the Contract.
9
During the months of April 2004 through October 2004, the Company and PMI
have entered into monthly agreements for the sale of LPG (the "Monthly 2004
Contracts"). Under the terms of the Monthly 2004 Contracts for April, May and
June, the minimum amount of LPG to be purchased per month by PMI was 13.0
million gallons. Under the terms of the Monthly 2004 Contracts for July, August
and September, the minimum amount of LPG to be purchased per month by PMI was
11.7 million gallons. Under the terms of the Monthly 2004 Contracts for October
and November, the minimum amount of LPG to be purchased per month by PMI is 11.1
million gallons. During the months of April 2004, May 2004, June 2004, July
2004, August 2004, September 2004 and October 2004, the actual amount of LPG
purchased by PMI was approximately 13.1 million gallons, 13.4 million gallons,
13.8 million gallons, 12.3 million gallons, 12.4 million gallons, 11.8 million
gallons and 10.9 million gallons, respectively. The expiration of the Contract
has caused a reduction in the Company's gross revenue due to the reduction in
LPG volumes sold to PMI from approximately 17 million gallons per month under
the Contract to approximately 13 million gallons per month under the Monthly
2004 Contracts. The change in volume from 17 million gallons to an average of
approximately 13 million gallons for the months of April 2004 through September
2004 had the impact of reducing gross profit by approximately $340,000 per month
on average. The Company was able to offset a portion of the reduction in gross
profit by reducing its monthly variable costs by approximately $100,000. In
addition, the Company has also been able to offset further the reduction in
gross profit by negotiating more favorable terms under its LPG supply contracts,
resulting in savings of approximately $115,000 per month and will receive
additional savings of approximately $40,000 per month beginning in October 2004.
As a result of the Company's cost reduction efforts, the net effect of the
reduction in volumes from 17 million gallons per month to 13 million gallons per
month is a monthly decrease in gross profit of approximately $125,000. To
further reduce costs, the Company previously terminated El Paso and Duke supply
agreements totaling approximately 4.4 million gallons per month, which
terminations allowed the Company to reduce losses from the disposal of excess
inventory.
The Company continues to negotiate for the extension and/or renewal of the
LPG contract with PMI. There is no assurance that the LPG contract with PMI
will be extended and/or renewed, and if so, that the terms will be more or less
favorable than those of the Monthly 2004 Contracts. Until the terms of a new
long-term contract are reached, the Company expects to enter into additional
monthly agreements similar to the Monthly 2004 Contracts.
The Company's management believes that PMI's reduction of volume
commitments for April 2004 through October 2004 is based on additional LPG
production by PEMEX being generated from the Burgos Basin field in Reynosa,
Mexico, an area within the proximity of the Company's Mexican terminal
facilities. In the event the volume of LPG purchased by PMI under the
month-to-month agreements declines below the current level of approximately 13
million gallons, assuming margins remain unchanged, the Company would suffer
material adverse consequences to its business, financial condition and results
of operations to the extent that the Company is unable to obtain additional
favorable price and/or volume concessions from LPG suppliers. The Company is
attempting to obtain additional price and/or volume concessions from its LPG
suppliers to lower costs. If the Company is unsuccessful in lowering its costs
to offset a decline in volumes below 13 million gallons per month and/or the
Company is forced to accept similar or lower prices for sales to PMI, the
results of operations of the Company may be adversely affected. The Company
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 the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative terminal
in the event the Matamoros Terminal Facility cannot be used.
Revenues from PMI totaled approximately $142 million for the year ended
July 31, 2004, representing approximately 80.0% of total revenues for the
period.
10
ACQUISITION OF MEXICAN SUBSIDIARIES. Effective April 1, 2001, the
Company completed the purchase of 100% of the outstanding common stock of both
Termatsal and PennMex (the "Mexican Subsidiaries"), previous affiliates of the
Company which were principally owned by a former officer and director (see note
D to the consolidated financial statements). The Company paid a nominal
purchase price of approximately $5,000 for each Mexican subsidiary. As a result
of the acquisition, the Company has included the results of the Mexican
Subsidiaries in its consolidated financial statements at July 31, 2002, 2003 and
2004. Since inception through the acquisition date, the operations of the
Mexican Subsidiaries had been funded by the Company and such amounts funded were
included in the Company's consolidated financial statements. Therefore, there
are no material differences between the amounts previously reported by the
Company and the amounts that would have been reported by the Company had the
Mexican Subsidiaries been consolidated since inception.
During July 2003, the Company acquired an option to purchase Tergas, an
affiliate 95% owned by Vicente Soriano and the remaining balance owned by
Abelardo Mier, a consultant of the Company, for a nominal price of approximately
$5,000. Since inception the operations of Tergas have been funded by the
Company and the assets, liabilities and results of operations of Tergas are
included in the Company's consolidated financial statements.
MEXICAN OPERATIONS. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of LPG
terminal facilities is prohibited. Foreign ownership is permitted in the
transportation and storage of LPG. Mexican law also provides that a single
entity is not permitted to participate in more than one of the defined LPG
activities (transportation, storage or distribution). PennMex has a
transportation permit and 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. The
Company's consolidated Mexican affiliate, Tergas, has been granted the permit to
operate the Matamoros Terminal Facility and the Company relies on Tergas' permit
to continue its delivery of LPG at the Matamoros Terminal Facility. The Company
pays Tergas its actual cost for distribution services at the Matamoros Terminal
Facility plus a small profit.
DEREGULATION OF THE LPG INDUSTRY IN MEXICO. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law
for LPG was changed to permit foreign entities to participate without limitation
in the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its consolidated affiliate expect to sell LPG
directly to independent Mexican distributors as well as PMI upon Deregulation.
The Company anticipates that the independent Mexican distributors will be
required to obtain authorization from the Mexican government for the importation
of LPG upon Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
11
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, the Company did not sell LPG
to distributors other than PMI. In March 2002, the Mexican government again
announced its intention to issue permits for free importation of LPG into Mexico
by distributors and others beginning August 2002, which was again delayed. 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 the Company. However, should Deregulation occur, it is the Company's
intention to sell LPG directly to distributors in Mexico as well as to PMI.
The point of sale for LPG sold to PMI which flows through the US - Mexico
Pipelines for delivery to the Matamoros Terminal Facility is the United States -
Mexico border. For LPG delivered into Mexico, PMI is the importer of record.
LPG SUPPLY. Effective October 1, 1999, the Company and Exxon entered into
a ten year LPG supply contract, as amended (the "Exxon Supply Contract"),
whereby Exxon has agreed to supply and the Company has agreed to take, 100% of
Exxon's owned or controlled volume of propane and butane available at Exxon's
King Ranch Gas Plant (the "Plant") up to 13.9 million gallons per month blended
in accordance with required specifications (the "Plant Commitment"). For the
year ending July 31, 2004, under the Exxon Supply Contract, Exxon has supplied
an average of approximately 12.3 million gallons of LPG per month. The purchase
price is indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The
ability to utilize the ECCPL allows the Company to acquire an additional supply
of propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until December 2005. The Company is required to pay minimum utilization fees
associated with the use of the ECCPL until December 2005. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso agreed to supply and the Company agreed to take, a
monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999 and expiring on September 30, 2002. The El Paso
Supply Agreement was not renewed upon expiration. The purchase price was indexed
to variable posted prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch
agreed to supply and the Company agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. In March 2003, the Company extended
the Koch Supply Contract for an additional year pursuant to the Koch Supply
Contract which provides for automatic annual renewals unless terminated in
writing by either party. During December 2003, the Company and Koch entered
into a new three year supply agreement. The terms of the new agreement are
similar to the agreement previously in effect between the parties.
For the year ending July 31, 2004, under the Koch Supply Contract, Koch has
supplied an average of approximately 6.4 million gallons of propane per month.
The purchase price is indexed to variable posted prices. Prior to April 2002,
the Company paid additional charges associated with the construction of a new
pipeline interconnection which allows deliveries of the Koch Supply into the
ECCPL, which was paid through additional adjustments to the purchase price
(totaling approximately $1.0 million).
12
During March 2000, the Company and Duke Energy NGL Services, Inc. ("Duke")
entered into a three year supply agreement (the "Duke Supply Contract") whereby
Duke agreed to supply and the Company agreed to take, a monthly average of 1.9
million gallons (the "Duke Supply") of propane or propane/butane mix beginning
April 1, 2000. In March 2003 the Company extended the Duke Supply Contract for
an additional year pursuant to the Duke Supply Contract which provided for
automatic annual renewals unless terminated in writing by either party. The
Duke Supply Contract, which expired in March 2004 was not renewed. The purchase
price was indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
The Company's current long-term supply agreements in effect as of July 31,
2004 ("Supply Contracts") require the Company to purchase minimum quantities of
LPG totaling up to approximately 22.1 million gallons per month although the
Monthly 2004 Contracts require PMI to purchase lesser quantities. The actual
amounts supplied under the Supply Contracts averaged approximately 18.7 million
gallons per month for the year ended July 31, 2004.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver the LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated with
the storage, disposal and/or changes in LPG prices resulting from the excess of
the Plant Commitment or Koch Supply over actual sales volumes to PMI. Under the
terms of the Supply Contracts, the Company must provide letters of credit in
amounts equal to the cost of the product to be purchased. In addition, the cost
of the product purchased is tied directly to overall market conditions. As a
result, the Company's existing letter of credit facility may not be adequate to
meet the letter of credit requirements under agreements with the Suppliers or
other suppliers due to increases in quantities of LPG purchased and/or to
finance future price increases of LPG.
COMPETITION. LPG production within Mexico could impact the quantity of LPG
imported into Mexico (see Recent Trends above). The Company competes with
several major oil and gas and trucking companies and other foreign suppliers of
LPG for the export of LPG into Mexico. In many cases, these companies own or
control their LPG supply and have significantly greater financial and human
resources than the Company. The Company is aware of several cross border
pipelines which are currently operating within the Company's strategic zone for
transportation of LPG and/or refined products.
The Company competes in the supply of LPG on the basis of service, price
and volume. As such, LPG providers who own or control their LPG supply may have
a competitive advantage over their competitors. As a result of the Supply
Contracts, the Company believes that it has committed to purchase a significant
amount of the LPG supply available in south Texas which could be delivered
competitively to northeastern Mexico.
Pipelines generally provide a relatively low-cost alternative for the
transportation of petroleum products; however, at certain times of the year,
trucking companies may reduce their transportation rates charged to levels lower
than those charged by the Company. In addition, other suppliers of LPG may
reduce their sales prices to encourage additional sales. The Company believes
that such reductions are limited in both duration and volumes and that on an
annualized basis the ECCPL, the Leased Pipeline and the US - Mexico Pipelines
provide a transportation cost advantage over the Company's competitors.
The Company believes that its ECCPL, Leased Pipeline, the US-Mexico
Pipelines and the geographic location of the Brownsville Terminal Facility and
the Matamoros Terminal Facility leave it well positioned to successfully compete
for LPG supply contracts with PMI and, upon Deregulation, if ever, with local
distributors in northeastern Mexico.
Certain of the Company's United States LPG operations are subject to
regulation by the Texas Railroad Commission and/or the United States Department
of Transportation. The Company believes it is in compliance with all applicable
regulations. However, there can be no assurance that these laws will not change
in the future, or if such a change were to occur, that the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects would not be significant.
13
FUEL SALES BUSINESS
During June 2004, the Company began operations as a reseller of Fuel
Products. The Company sells Fuel Products (the "Fuel Sales Business") through
transactional, bulk and/or rack transactions. Typical transactional and bulk
sales are made based on a predetermined net spread between the purchase and
sales price over posted monthly variable prices and/or daily spot prices. Rack
sales transactions are based on variable sale prices charged by the Company
which are tied to posted daily spot prices and purchase costs which are based on
a monthly average or 3 day average based on posted prices. The Company pays
pipeline and terminal fees based on regulated rates.
The Fuel Sales business on the west coast of the United States is
characterized by limited pipeline and terminal space to move sufficient Fuel
Products to locations where demand for Fuel Products exists. The Company has the
ability to access to certain pipeline and terminal systems located in
California, Arizona, Nevada and Texas, where it is able to deliver its Fuel
Products. The markets where the Company has targeted its products are generally
in areas where the Fuel Products are difficult to deliver due to the
infrastructure limitations and accordingly, the Company's access provides an
advantage over other potential competitors who may not have access to these
pipelines or terminals. In addition, the Company's supply contracts provide it
with greater flexibility to manage changes in the prices of the Fuel Products.
The Company believes it has an advantage over other competitors based on its
favorable supply contracts and existing access to certain pipelines and
terminals.
For bulk and transactional sales, the Company enters into individual sales
contracts for each sale. Rack sales are subject to credit limitations imposed on
each individual buyer by the Company. The Company has several supply contracts
for each of the Fuel Products it sells. The supply contracts are for annual
periods with flexible volumes but they may be terminated sooner by the supplier
if the Company consistently fails to purchase minimum volumes of Fuel Products.
The ability of the Company to participate in the Fuel Sales Business is
largely dependent on the Company's ability to finance its supplies. Currently,
the Company utilizes the RZB Credit Facility to finance the purchases of Fuel
Products. Based on the Company's LPG purchase commitments, increases in the
costs of LPG and/or the increases in the costs of Fuel Products, the amount of
financing available for the Fuel Sales Business may be reduced.
Federal and State agencies require the Company to obtain the necessary
regulatory and other approvals for its Fuel Sales Business.
THE SPIN-OFF
On July 10, 2003, Penn Octane formed Rio Vista, a Delaware limited
partnership, the General Partner, a Delaware limited liability company, RVOP, a
Delaware limited partnership (0.1% owned by Rio Vista Operating GP LLC and 99.9%
owned by Rio Vista) and Rio Vista Operating GP LLC, a Delaware limited liability
company (wholly owned by Rio Vista) for the purpose of completing the Spin-Off.
During September 2003, the Company's Board of Directors and the Independent
Committee of its Board of Directors formally approved the terms of the Spin-Off
(see below) and Rio Vista filed a Form 10 registration statement with the
Securities and Exchange Commission ("SEC").
14
On September 30, 2004, Penn Octane completed a series of transactions
involving (i) the transfer of substantially all of its owned pipeline and
terminal assets in Brownsville and Matamoros to RVOP (ii) transferred its 99.9%
interest in RVOP to Rio Vista and (iii) the Spin-Off, resulting in Rio Vista
becoming a separate public company. The Common Units represented 98% of Rio
Vista's outstanding units. The remaining 2% of such units, which is the general
partner interest, is owned and controlled by the General Partner, and the
General Partner will be responsible for the management of Rio Vista. Accordingly
the Company will have control of Rio Vista by virtue of its ownership and
related voting control of the General Partner and Rio Vista will be consolidated
with the Company and the interests of the limited partners will be classified as
minority interests in the Company's consolidated financial statements.
Subsequent to the Spin-Off, Rio Vista will sell LPG directly to PMI and will
purchase LPG from Penn Octane under a long-term supply agreement. The purchase
price of the LPG from Penn Octane will be determined based on the proportionate
share of the costs associated with LPG business of Penn Octane and Rio Vista.
The transfer of such assets and the distribution of the Rio Vista Common Units
were conducted in accordance with the terms of the Distribution Agreement, the
Omnibus Agreement, the Purchase Agreement for LPG, the Contribution, Conveyance
and Assumption Agreement and the Conveyance Agreement, copies of which are
attached as exhibits to this report. These agreements are described in Penn
Octane's Current Report on Form 8-K filed by Penn Octane with the SEC on
September 22, 2004, and incorporated herein by reference.
As a result of the Spin-Off, Rio Vista will own and operate the LPG,
distribution, transportation and marketing business previously conducted by Penn
Octane. Rio Vista will sell LPG directly to PMI and will purchase LPG from Penn
Octane under a long-term supply agreement.
INTERCOMPANY PURCHASE AGREEMENT FOR LPG
Penn Octane entered into a Purchase Agreement with RVOP pursuant to which
RVOP agrees to purchase all of its LPG requirements for sales which utilize the
assets transferred to RVOP by Penn Octane to the extent Penn Octane is able to
supply such LPG requirements. This agreement further provides that RVOP will
have 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 contributes to RVOP under the Contribution,
Conveyance and Assumption Agreement. The Purchase Agreement terminates on the
earlier to occur of:
- Penn Octane ceases to have the right to access the Seadrift pipeline
that connects to Rio Vista's Brownsville terminal facilities; and
- RVOP ceases to sell LPG using any of the assets contributed by Penn
Octane to RVOP pursuant to the Contribution, Conveyance and Assumption
Agreement.
The price Rio Vista will pay for LPG under this contract is indexed to the
price quoted by the Oil Price Information Service for Mt. Belvieu non-tet
propane and non-tet normal butane, plus other costs and amounts based on a
formula that takes into consideration operating costs to both Penn Octane and to
Rio Vista.
OMNIBUS AGREEMENT
In connection with the Spin-Off, Penn Octane entered into an Omnibus
Agreement with Rio Vista and its subsidiaries 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.
15
INDEMNIFICATION PROVISIONS. Under the Omnibus Agreement, Penn Octane will
indemnify Rio Vista against certain potential environmental liabilities
associated with the operation of the assets contributed to Rio Vista, and assets
retained, by Penn Octane that relate to events or conditions occurring or
existing before the completion of the distribution. Penn Octane will also
indemnify Rio Vista for liabilities relating to:
- legal actions against Penn Octane;
- events and conditions associated with any assets retained by Penn
Octane;
- certain defects in the title to the assets contributed to Rio Vista by
Penn Octane that arise within three years after the completion of the
distribution to the extent such defects materially and adversely
affect Rio Vista's ownership and operation of such assets;
- Rio Vista's failure to obtain certain and consents and permits
necessary to conduct Rio Vista's business to the extent such
liabilities arise within three years after the completion of the
distribution; and
- certain income tax liabilities attributable to the operation of the
assets contributed to Rio Vista prior to the time that they were
contributed.
Rio Vista will indemnify Penn Octane for certain potential environmental
liabilities associated with the operation of the assets contributed to Rio Vista
that relate to events or conditions occurring or existing after the completion
of the distribution and for federal income tax liabilities in excess of $2.5
million incurred by Penn Octane as a result of the distribution.
SERVICES. Under the Omnibus Agreement, Penn Octane will provide Rio Vista
with corporate staff and support services that are substantially identical in
nature and quality to the services previously provided by Penn Octane in
connection with its management and operation of the assets of Rio Vista during
the one-year period prior to the completion of the distribution. These services
will include centralized corporate functions, such as accounting, treasury,
engineering, information technology, insurance, administration of employee
benefit and incentive compensation plans and other corporate services. Penn
Octane will be reimbursed for the costs and expenses it incurs in rendering
these services, including an overhead allocation to Rio Vista of Penn Octane's
indirect general and administrative expenses from its corporate allocation pool.
The General Partner will determine the general and administrative expenses that
will be allocated to Rio Vista. Administrative and general expenses directly
associated with providing services to Rio Vista (such as legal and accounting
services) are not included in the overhead allocation pool.
RELATED PARTY TRANSACTIONS. 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.
AMENDMENT AND TERMINATION. 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.
GENERAL PARTNER OPTIONS
Penn Octane's 2% general partnership interest in Rio Vista is expected to
be decreased to 1% as a result of the exercise by Shore Capital LLC ("Shore
Capital"), designee of Richard Shore, Jr., President of Penn Octane, and Jerome
B. Richter, Chief Executive Officer of Penn Octane, of options to each acquire
25% of the General Partner (the "General Partner Options") causing Penn Octane's
ownership in the General Partner to be decreased from 100% to 50%. Mr. Shore
and Mr. Richter are each members of the board of directors of Penn Octane and
the board of managers of Rio Vista.
16
TRANSFERRED ASSETS
The following assets of Penn Octane were transferred to the operating
subsidiary of Rio Vista on September 30, 2004:
Brownsville Terminal Facilities
US Mexico Pipelines, including various rights of way and land obtained in
connection with operation of US Pipelines between Brownsville Terminal
Facility and the US Border
Inventory located in storage tanks and pipelines located in Brownsville
(and extending to storage and pipelines located in assets held by the
Mexican subsidiaries)
Contracts and Leases (assumed and/or assigned):
Lease Agreements:
Port of Brownsville:
LPG Terminal Facility
Tank Farm Lease
US State Department Permit
Other licenses and permits in connection with ownership and operation of
the US pipelines between Brownsville and US border
Investment in Subsidiaries:
Penn Octane de Mexico, S. de R.L. de C.V., consisting primarily of a
permit to transport LPG from the Mexican Border to the Matamoros
Terminal Facility
Termatsal, S. de R.L. de C.V., consisting primarily of land, LPG
terminal facilities, Mexican pipelines and rights of way, and
equipment used in the transportation of LPG from the Mexican
border to the Matamoros terminal facility and various LPG
terminal equipment
Penn Octane International LLC
Option to acquire Tergas, S.A. de C.V.
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.
Holders of unexercised warrants of Penn Octane as of the date of the Spin-Off
received an adjustment to reduce the exercise price of their existing Penn
Octane warrant and new warrants to purchase Common Units of Rio Vista to reflect
the transfer of assets from Penn Octane into Rio Vista. As of the date of the
Spin-Off, Penn Octane had 2,542,500 warrants to purchase common stock
outstanding. The adjustment to the exercise price of Penn Octane warrants was
determined by multiplying the original exercise price of Penn Octane warrants by
0.369. The number of Rio Vista warrants given to the holder of Penn Octane
warrants as of the date of the Spin-Off was determined by dividing the existing
number of warrants of Penn Octane by eight. The exercise price of the Rio Vista
warrants was determined by multiplying the original exercise price of the
existing Penn Octane warrants by 5.05. The expiration date of the Rio Vista
warrants is the same as the existing Penn Octane warrants.
Under the terms of Rio Vista's partnership agreement, the General Partner is
entitled to receive cash distributions from Rio Vista in accordance with 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.
It is anticipated that Mr. Richter and Shore Capital will exercise their General
Partner Options in the near future. The exercise price for each option will be
the pro rata share (0.5%) of Rio Vista's tax basis capital immediately after the
Spin-Off. Penn Octane will retain voting control of Rio Vista pursuant to a
voting agreement. In addition, Shore Capital received warrants to acquire
763,737 shares of the common stock of Penn Octane at $1.14 per common share and
97,415 Common Units of Rio Vista at $8.47 per Common Unit. The warrants are
exercisable beginning on October 1, 2004 and expire on July 10, 2006.
17
Rio Vista is liable as guarantor for Penn Octane's collateralized debt and will
continue to pledge all of its assets as collateral. Rio Vista may also be
prohibited from making any distributions to unit holders if it would cause an
event of default, or if an event of default is existing, under 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 Spin-Off is a taxable transaction for federal income tax purposes (and may
also be taxable under applicable state, local and foreign tax laws) to both the
Company and its stockholders. Penn Octane intends to treat the Spin-Off as a
"partial liquidation" for federal income tax purposes. A "partial liquidation"
is defined under Section 302(e) of the Internal Revenue Code as a distribution
that (i) is "not essentially equivalent to a dividend," as determined at the
corporate level, which generally requires a genuine contraction of the business
of the corporation, (ii) constitutes a redemption of stock and (iii) is made
pursuant to a plan of partial liquidation and within the taxable year in which
the plan is adopted or within the succeeding taxable year.
Penn Octane does not believe that it has a federal income tax in connection with
the Spin-Off due to utilization of existing net operating loss carryforwards.
The Company estimates alternative minimum tax and state franchise tax of
approximately $238,000. However, the Internal Revenue Service (the "IRS") may
review Penn Octane's federal income tax returns and challenge positions that
Penn Octane may take when preparing those income tax returns, including
positions that it may take with respect to the Spin-Off. If the IRS challenges
any of the Company's positions, Penn Octane will vigorously defend the positions
that it takes in preparing its federal income tax, including positions that it
may take with respect to the Spin-Off. If there is determined to be an income
tax liability resulting from the Spin-Off, to the extent such liability is
greater than $2.5 million, Rio Vista has agreed to indemnify Penn Octane for any
tax liability resulting from the transaction which is in excess of that amount.
PENN OCTANE'S FUTURE OPERATIONS
Penn Octane will continue to sell LPG to PMI through its supply contract with
Rio Vista, and it will shift certain costs of operations related to the
Brownsville and Matamoros terminals and pipelines, and certain administrative
costs to Rio Vista. In addition, it will continue to manage Rio Vista through
the General Partner and to explore opportunities to acquire and grow other lines
of business such as the Fuel Sales Business described above. Penn Octane will
benefit from the Spin-Off indirectly based on the success of Rio Vista through
Penn Octane's ownership of the General Partner. As a limited partnership, Rio
Vista is expected to have the following benefits not available to Penn Octane.
- Tax Efficiency. As a limited partnership, Rio Vista will be able to
operate in a more tax efficient manner by eliminating corporate
federal income taxes on a portion of future taxable income which would
have been fully subject to corporate federal income taxes.
- Raising Capital. As a limited partnership, Rio Vista will have an
improved ability to raise capital for expansion.
- Acquisitions. Due to industry preference and familiarity with the
limited partnership structure, Rio Vista will have a competitive
advantage over a company taxed as a corporation in making acquisitions
of assets that generate "qualifying income," as this term is defined
in Section 7704 of the Internal Revenue Code.
- Recognition. As a limited partnership, Penn Octane anticipates that
both Penn Octane and Rio Vista will receive increased analyst coverage
and acceptance in the marketplace.
18
ENVIRONMENTAL AND OTHER REGULATIONS
The operations of the Company including its Mexico operations are subject
to certain federal, state and local laws and regulations relating to the
protection of the environment, and future regulations may impose additional
requirements. Although the Company believes that its operations are in
compliance with applicable environmental laws and regulations, because the
requirements imposed by environmental laws and regulations are frequently
changed, the Company is unable to predict with certainty the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects.
EMPLOYEES
As of July 31, 2004, the Company had 34 employees, including three in
finance, seven in sales, nine in administration and 15 in production. The
Company retains subcontractors and two full time consultants in connection with
its Mexico related operations.
The Company has not experienced any work stoppages and considers relations
with its employees to be satisfactory.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Property, plant and equipment, net of accumulated depreciation, located in
the U.S. and Mexico were as follows for the fiscal years ended July 31,:
2002 2003 2004
----------- ----------- -----------
U.S. $11,568,228 $11,250,443 $10,527,530
Mexico 6,782,557 6,427,387 5,870,750
----------- ----------- -----------
Total $18,350,785 $17,677,830 $16,398,280
=========== =========== ===========
19
ITEM 2. PROPERTIES.
As of July 31, 2004, the Company owned, leased or had access to the
following facilities:
APPROXIMATE LEASE, OWN
LOCATION TYPE OF FACILITY SIZE OR ACCESS(2)
- -------- ---------------- ---- ------------
Brownsville, Texas Pipeline interconnection and railcar and 16,071 bbls of storage Owned(1)(7)
truck loading facilities, LPG storage
facilities, on-site administrative offices
Land 31 acres Leased(1)
Brownsville, Texas Brownsville Terminal Facility building 19,200 square feet Owned(1)(7)
Extending from Kleberg Seadrift Pipeline 132 miles Leased(3)
County, Texas to
Cameron County, Texas
Markham, Texas Salt Dome Storage 500,000 bbls of storage Access(3)
Markham, Texas to King Seadrift Pipeline
Ranch Plant 155 mile pipeline Access(3)
Extending from Nueces ECCPL Pipeline 46 miles Access(6)
County, Texas to King
Ranch Plant
Extending from US-Mexico Pipelines, associated land 23 miles Owned
Brownsville, Texas to and rights of way Access(8)
Matamoros, Mexico
Matamoros, Mexico Pipeline interconnection, LPG truck 35 acres Owned
loading facilities, LPG storage facilities,
on-site administration office and the
land
Brownsville, Texas Pipeline interconnection, Refined 300,000 bbls of Owned(5) (7)
Products storage tanks storage
Land 12 acres Leased(5)
Palm Desert, California Penn Octane Corporation Headquarters 1,700 square feet Leased(4)
20
_______________
(1) The Company's lease with respect to the Brownsville Terminal Facility
expires on November 30, 2006.
(2) The Company's assets are pledged or committed to be pledged as
collateral (see notes to the consolidated financial statements).
(3) The Company's lease with Seadrift expires December 31, 2013.
(4) The Company's lease with respect to its headquarters offices expires
October 31, 2005. The monthly lease payments approximate $1,950 a
month.
(5) The Company's lease with respect to the Tank Farm expires in November
30, 2006.
(6) The Company's use of the ECCPL is pursuant to the Exxon Supply
Contract, which expires on September 30, 2009.
(7) The facilities can be removed upon termination of the lease.
(8) The Company's right to use land for its pipelines.
For information concerning the Company's operating lease commitments, see note L
to the consolidated financial statements.
21
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The fiscal 2003 Annual Meeting of Stockholders of the Company (the
"Meeting") was held at The Hyatt Newporter Hotel Ocean Room, 1107 Jamboree
Road, Newport Beach, California, 92660 on July 30, 2004. The record date
for the Meeting was July 13, 2004. Proxies for the meeting were solicited
pursuant to Regulation 14A under the Exchange Act. There was no
solicitation in opposition to management's two proposals, and all of the
nominees for election as director were elected. The results of the voting
by the stockholders for each proposal are presented below.
Proposal #1 Election of Directors
Name of Director Elected Votes For Votes Withheld
------------------------- --------- --------------
Jerome B. Richter 8,208,209 87,218
Richard "Beau" Shore, Jr. 8,217,709 77,628
Stewart J. Paperin 8,236,437 58,900
Harvey L. Benenson 8,222,673 72,664
Emmett M. Murphy 8,236,537 58,800
Proposal #2 Ratification of the appointment of Burton McCumber &
Cortez, L.L.P. as the independent auditors of the Company
and its subsidiaries for the fiscal year ending July 31,
2004.
For Against Abstain
--------- ------- -------
8,057,687 237,500 150
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
Penn Octane's common stock began trading in the over-the-counter ("OTC")
market on the Nasdaq SmallCap Market under the symbol "POCC" in December 1995.
The following table sets forth the reported high ask and low bid quotations
of the common stock for the periods indicated. Such quotations reflect
inter-dealer prices, without retail mark-ups, mark-downs or commissions and may
not necessarily represent actual transactions.
LOW HIGH
----- -----
FISCAL YEAR ENDED JULY 31, 2003:
First Quarter . . . . . . . . . . . . . . . $1.90 $3.14
Second Quarter. . . . . . . . . . . . . . . 2.02 3.30
Third Quarter . . . . . . . . . . . . . . . 2.26 3.05
Fourth Quarter. . . . . . . . . . . . . . . 2.51 3.75
FISCAL YEAR ENDED JULY 31, 2004:
First Quarter . . . . . . . . . . . . . . . $2.53 $3.45
Second Quarter. . . . . . . . . . . . . . . 2.10 3.00
Third Quarter . . . . . . . . . . . . . . . 2.07 2.64
Fourth Quarter. . . . . . . . . . . . . . . 1.70 2.42
On October 15, 2004, the closing bid price of the common stock as reported
on the Nasdaq SmallCap Market was $1.01 per share. On October 15, 2004, Penn
Octane had 15,285,245 shares of common stock outstanding and approximately 230
holders of record of the common stock.
On September 30, 2004, Penn Octane made a distribution to all holders of
Penn Octane's common stock on that date of 100% of its limited partnership
interests of Rio Vista at a rate of 1 unit for each 8 shares of common stock
held. Penn Octane has not paid any common stock dividends to stockholders and
does not intend to pay any common stock dividends to stockholders in the
foreseeable future and intends to retain any future earnings for capital
expenditures and otherwise to fund the Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
In connection with the Penn Octane Board Plan, during August 2003 the Board
granted warrants to purchase 20,000 shares of common stock of Penn Octane at
exercise prices of $3.22 and $3.28 per share to outside directors. The warrants
expire in August 2008. Based on the provisions of APB 25, no compensation
expense was recorded for these warrants.
During September 2003, the Company issued 21,818 shares of common stock of
Penn Octane to Jorge Bracamontes, a former officer and director of the Company
as severance compensation (see note D to the consolidated financial statements).
In connection with the issuance of the shares, the Company recorded an expense
of approximately $75,000 based on the market value of the stock issued.
In connection with the Penn Octane Board Plan, during November 2003 the
Board granted warrants to purchase 10,000 shares of common stock of Penn Octane
at exercise prices of $2.61 per share to an outside director. The warrants
expire in November 2008. Based on the provisions of APB 25, no compensation
expense was recorded for these warrants.
23
On January 16, 2004, the Restructured Notes which were due on December 15,
2003 were renewed and extended (the "Restructuring"). In connection with the
Restructuring, the due date of the Restructured Notes was extended to December
15, 2005. The Restructured Notes can be repaid at any time without penalty.
Annual interest on the Restructured Notes is 16.5% and the Company also agreed
to pay a fee of 1.5% on any principal balance of the Restructured Notes
outstanding at the end of each quarterly period, beginning December 15, 2003.
Interest and fees are payable quarterly beginning March 15, 2004.
In addition, the Company agreed to extend the expiration date on
outstanding warrants to purchase common stock of Penn Octane held by holders of
the Restructured Notes until December 15, 2008 and agreed to issue new warrants
to purchase Rio Vista Common Units in an amount equal to 2,500 warrants for each
$100,000 of Restructured Notes and an additional 2,500 warrants in Rio Vista for
each $100,000 of Restructured Notes outstanding at December 15, 2004 (the "Rio
Vista Warrants"). The Rio Vista Warrants will expire three years from the date
of the Spin-Off (see note R to the consolidated financial statements) and the
exercise price will be determined based on a formula whereby the annualization
of the first quarterly distribution will represent a 20% yield on the exercise
price. In addition, the Company agreed to issue an additional 37,500 warrants
to purchase shares of common stock of Penn Octane to certain holders of the
Restructured Notes.
Certain holders of promissory notes totaling approximately $280,000 of
principal due December 15, 2003 which did not agree to the Restructuring (the
"Declining Noteholders") were paid by the Company. In connection with amounts
due to the Declining Noteholders, the Company issued $280,000 of promissory
notes ($280,000 Notes). The terms of the $280,000 Notes are substantially
similar to the Restructured Notes, except that the holders of the $280,000 Notes
were not entitled to receive any warrants to purchase shares of common stock of
Penn Octane.
In addition, holders of the Restructured Notes and $280,000 Notes consented
to the Spin-Off of Rio Vista provided that the assets of Penn Octane to be
transferred to Rio Vista will continue to be pledged as collateral for payment
of the Restructured Notes and $280,000 Notes, Rio Vista guarantees Penn Octane's
obligations under the Restructured Notes and $280,000 Notes and that Rio Vista
is prohibited against making any distributions in the event that the Company is
in default under the Restructured Notes and $280,000 Notes.
In connection with the Restructured Notes and $280,000 Notes, Philadelphia
Brokerage Corporation acted as placement agent and will receive a fee equal to
1.5% of the Restructured Notes and $280,000 Notes and after the date of the
Spin-Off warrants to purchase 10,000 units in Rio Vista and an additional 10,000
warrants to purchase 10,000 units in Rio Vista if the Restructured Notes and
$280,000 Notes are not paid by December 15, 2004. The terms of the warrants are
the same as the Rio Vista Warrants.
In connection with the issuance of the new warrants of Penn Octane and the
extension of the warrants of Penn Octane, the Company recorded a discount of
$194,245 related to the fair value of the newly issued, modified warrants and
including fees of $27,075. The Company will record an additional discount
related to the Rio Vista warrants issued to the holders of the Restructured
Notes and $280,000 Notes when the Company is able to determine the fair value,
if any.
In connection with the Penn Octane Board Plan, during August 2004 the Board
granted warrants to purchase 20,000 shares of common stock of Penn Octane at
exercise prices of $1.93 and $1.94 per share to outside directors. The warrants
expire in August 2009. Based on the provisions of APB 25, no compensation
expense was recorded for these warrants.
On September 30, 2004, pursuant to the terms of an employment agreement
dated as of May 13, 2003 with Mr. Shore, the Company issued warrants to purchase
763,737 shares of Penn Octane's common stock at an exercise price of $1.14 per
share. The warrants are exercisable beginning on October 1, 2004 and expire on
July 10, 2006.
24
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.
EQUITY COMPENSATION PLANS
- -------------------------
The following table provides information concerning Penn Octane's equity
compensation plans as of July 31, 2004.
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS WARRANTS AND RIGHTS EQUITY COMPENSATION
PLANS (EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation
plans approved by 2,090,000 $ 4.90 1,500,000 (1)(2)
security holders
Equity compensation
plans not approved by 492,500 $ 2.50 -
security holders (3) __________ ____________
Total 2,582,500 $ 4.44 1,500,000
========== ============
<FN>
(1) Pursuant to Penn Octane's Board Plan, the outside directors are entitled to receive warrants
to purchase 20,000 shares of common stock of Penn Octane upon their initial election as a director
and warrants to purchase 10,000 shares of common stock of Penn Octane for each year of service as a
director.
(2) Pursuant to Penn Octane's 2001 Warrant Plan, Penn Octane may issue warrants to purchase up to
1.5 million shares of common stock of Penn Octane.
(3) Penn Octane was not required to obtain shareholder approval for these securities.
25
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data for each of the years in
the five-year period ended July 31, 2004, have been derived from the
consolidated financial statements of the Company. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements of the Company and related notes included elsewhere herein. All
information is in thousands, except per-share data.
Year Ended July 31,
-------------------------------------------------
2000 2001 2002 2003 2004
------- ---------- -------- -------- --------
Revenues $98,515 $ 150,700 $142,156 $162,490 $177,664
Income (loss) from continuing operations 1,461 ( 8,094) 4,123 1,958 1,798
Net income (loss) 1,461 ( 8,094) 4,123 1,958 1,798
Income (loss) from continuing operations .11 ( .57) .28 .13 .12
per common share
Net income (loss) per common share .11 ( .57) .28 .13 .12
Total assets 31,537 40,070 30,155 27,838 31,577
Long-term obligations 1,465 3,274 612 60 1,729
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Company's results of operations and
liquidity and capital resources should be read in conjunction with the
consolidated financial statements of the Company and related notes thereto
appearing elsewhere herein. References to specific years preceded by "fiscal"
(e.g. fiscal 2004) refer to the Company's fiscal year ended July 31.
OVERVIEW
The Company has been principally engaged in the purchase, transportation
and sale of LPG for distribution into northeast Mexico. In connection with the
Company's desire to reduce quantities of inventory, the Company also sells LPG
to U.S. and Canadian customers.
During fiscal 2004, the Company derived 80% of its revenues from sales of
LPG to PMI, its primary customer.
The Company provides products and services through a combination of
fixed-margin and fixed-price contracts. Costs included in cost of goods sold,
other than the purchase price of LPG, may affect actual profits from sales,
including costs relating to transportation, storage, leases and maintenance.
Mismatches in volumes of LPG purchased from suppliers and volumes sold to PMI or
others could result in gains during periods of rising LPG prices or losses
during periods of declining LPG prices as a result of holding inventories or
disposing of excess inventories.
During June 2004, the Company began the Fuel Sales Business with the
ability to access certain pipeline and terminal systems located in California,
Arizona, Nevada and Texas. Fuel Sales approximated $5.1 million for the year
ended July 31, 2004 which represents approximately 2.8% of total revenues.
On September 30, 2004, Penn Octane completed a series of transactions
involving (i) the transfer of substantially all of its owned pipeline and
terminal assets in Brownsville and Matamoros to RVOP (ii) transferred its 99.9%
interest in RVOP to Rio Vista and (iii) the Spin-Off, resulting in Rio Vista
becoming a separate public company. The Common Units represented 98% of Rio
Vista's outstanding units. The remaining 2% of such units, which is the general
partner interest, is owned and controlled by the General Partner, and the
General Partner will be responsible for the management of Rio Vista. Accordingly
the Company will have control of Rio Vista by virtue of its ownership and
related voting control of the General Partner and Rio Vista will be consolidated
with the Company and the interests of the limited partners will be classified as
minority interests in the Company's consolidated financial statements.
Subsequent to the Spin-Off, Rio Vista will sell LPG directly to PMI and will
purchase LPG from Penn Octane under a long-term supply agreement. The purchase
price of the LPG from Penn Octane will be determined based on the proportionate
share of the costs associated with LPG business of Penn Octane and Rio Vista.
The transfer of such assets and the distribution of the Rio Vista Common Units
were conducted in accordance with the terms of the Distribution Agreement, the
Omnibus Agreement, the Purchase Agreement for LPG, the Contribution, Conveyance
and Assumption Agreement and the Conveyance Agreement, copies of which are
attached as exhibits to this report. These agreements are described in Penn
Octane's Current Report on Form 8-K filed by Penn Octane with the SEC on
September 22, 2004, and incorporated herein by reference. Penn Octane
Corporation and its consolidated subsidiaries which includes Rio Vista and its
consolidated subsidiaries are hereinafter referred to as the "Company".
27
Penn Octane will continue to sell LPG to PMI through its supply contract
with Rio Vista, and it will shift certain costs of operations related to the
Brownsville and Matamoros terminals and pipelines, and certain administrative
costs to Rio Vista. In addition, it will continue to manage Rio Vista through
the General Partner and to explore opportunities to acquire and grow other lines
of business such as the Fuel Sales Business described below. Penn Octane will
benefit from the Spin-Off indirectly based on the success of Rio Vista through
Penn Octane's ownership of the General Partner. As a limited partnership, Rio
Vista is expected to have the following benefits not available to Penn Octane.
- Tax Efficiency. As a limited partnership, Rio Vista will be able to
operate in a more tax efficient manner by eliminating corporate
federal income taxes on a portion of future taxable income which would
have been fully subject to corporate federal income taxes.
- Raising Capital. As a limited partnership, Rio Vista will have an
improved ability to raise capital for expansion.
- Acquisitions. Due to industry preference and familiarity with the
limited partnership structure, Rio Vista will have a competitive
advantage over a company taxed as a corporation in making acquisitions
of assets that generate "qualifying income," as this term is defined
in Section 7704 of the Internal Revenue Code.
- Recognition. As a limited partnership, Penn Octane anticipates that
both Penn Octane and Rio Vista will receive increased analyst coverage
and acceptance in the marketplace.
LPG SALES
The following table shows the Company's volume sold in gallons and average
sales price for fiscal years ended July 31, 2002, 2003 and 2004.
2002 2003 2004
------ ------ ------
Volume Sold
LPG (millions of gallons) - PMI 243.5 211.1 197.9
LPG (millions of gallons) - Other 76.1 56.4 49.6
------ ------ ------
319.6 267.5 247.5
Average sales price
LPG (per gallon) - PMI $ 0.46 $ 0.63 $ 0.72
LPG (per gallon) - Other 0.47 0.52 0.62
28
RECENT TRENDS. Since April 2004, PMI has contracted with the Company for
volumes which are significantly lower than amounts purchased by PMI in similar
periods during previous years. See Liquidity and Capital Resources - Sales to
PMI below. The Company 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 the Company's
Mexican terminal facilities. Although the Company 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. The Company also believes that PEMEX is
intending to install two additional cryogenic facilities, with similar capacity,
to be operational in early 2006. The Company is also not aware of the capacity
at which the current cryogenic facilities are being operated. Furthermore, the
Company 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. The
Company still believes that its LPG supplies are competitive with the necessary
US imports of LPG by PEMEX and that the LPG volumes which are actually produced
from the Burgos Basin would not eliminate the need for US 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 in the
Company'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 in Juarez, Texas 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. The Company believes that if
Valero intends to maximize capacity of these facilities, then it would be
required to obtain additional LPG supplies from major LPG hubs located in Corpus
Christi and Mont Belvieu, Texas. Accordingly, the Company believes that any
additional supplies over amounts currently available to the Mexican market
through Valero's system could be more expensive than the Company'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 the Company's
strategic zone. The Company 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 US-Mexico border near the proximity of the Company's
pipelines. In connection with the construction of the pipeline, PMI was
required to obtain an easement from the Company 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.
29
RESULTS OF OPERATIONS
YEAR ENDED JULY 31, 2004 COMPARED WITH JULY 31, 2003
Revenues. Revenues for the year ended July 31, 2004, were $177.7 million
compared with $162.5 million for the year ended July 31, 2003, an increase of
$15.2 million or 9.3%. Of this increase, $18.5 million was attributable to
increases in average sales prices of LPG sold to PMI during the year ended July
31, 2004, $5.5 million was attributable to increased average sales prices of LPG
sold to customers other than PMI during the year ended July 31, 2004 and $5.1
million was attributable to new revenues generated for the Company's Fuel Sales
Business which commenced during the fiscal 2004, partially offset by $9.5
million attributable to decreased volumes of LPG sold to PMI during the year
ended July 31, 2004 and $4.2 million attributable to decreased volumes of LPG
sold to customers other than PMI during the year ended July 31, 2004.
Cost of goods sold. Cost of goods sold for the year ended July 31, 2004
was $168.1 million compared with $152.4 million for the year ended July 31,
2003, an increase of $15.7 million or 10.3%. Of this increase, $16.8 million
was attributable to increases in the cost of LPG sold to PMI during the year
ended July 31, 2004, $6.3 million was attributable to increased costs of LPG
sold to customers other than PMI during the year ended July 31, 2004 and $5.0
million was attributable to new costs of goods sold arising from the Company's
Fuel Sales Business which commenced operations during fiscal 2004, partially
offset by $4.4 million attributable to decreased volume of LPG sold to customers
other than PMI during the year ended July 31, 2004 and $8.3 million attributable
to decreased volume of LPG sold to PMI during the year ended July 31, 2004.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $5.8 million for the year ended July 31, 2004,
compared with $6.4 million for the year ended July 31, 2003, a decrease of
$576,412 or 9.0%. The decrease during the year ended July 31, 2004, was
principally due to reduced litigation fees, consulting fees and compensation
related costs partially offset by increased accounting fees.
Loss on sale of CNG assets and asset impairment charge. During fiscal 2004,
the Company recorded a loss on the sale of CNG assets of $500,000 and the
Company recorded an asset impairment charge of $324,041.
Other income (expense). Other income (expense) was $(1.2) million for the
year ended July 31, 2004, compared with $(1.8) million for the year ended July
31, 2003. The decrease in other expense was due primarily to reduced interest
costs resulting from reduced debt, decreased amortization of iscounts on
outstanding debt incurred, reduction in the settlement of litigation costs and
$210,000 of other income related to the cancellation of a contract during the
year ended July 31, 2004.
Income tax. Due to the availability of net operating loss carryforwards
(approximately $4.7 million at July 31, 2004), the Company did not incur U.S.
income tax expense during the year ended July 31, 2004. However, the Company
did incur alternative minimum income tax expense of $53,084 during the year
ended July 31, 2004. The Company also recorded $56,076 of Mexican income tax
benefits related to its Mexican subsidiaries. The Mexican subsidiaries file
their income tax returns on a calendar year basis. The Company can receive a
credit against any future tax payments due to the extent of any prior
alternative minimum taxes paid ($114,103 at July, 31, 2004).
30
YEAR ENDED JULY 31, 2003 COMPARED WITH JULY 31, 2002
Revenues. Revenues for the year ended July 31, 2003, were $162.5 million
compared with $142.2 million for the year ended July 31, 2002, an increase of
$20.3 million or 14.3%. Of this increase, $42.4 million was attributable to
increases in average sales prices of LPG sold to PMI during the year ended July
31, 2003 and $8.4 million was attributable to increased average sales prices of
LPG sold to customers other than PMI during the year ended July 31, 2003,
partially offset by $20.4 million attributable to decreased volumes of LPG sold
to PMI during the year ended July 31, 2003 and $10.2 million attributable to
decreased volumes of LPG sold to customers other than PMI during the year ended
July 31, 2003.
Cost of goods sold. Cost of goods sold for the year ended July 31, 2003
was $152.4 million compared with $131.1 million for the year ended July 31,
2002, an increase of $21.2 million or 16.2%. Of this increase, $43.3 million
was attributable to increases in the cost of LPG sold to PMI during the year
ended July 31, 2003 and $6.6 million was attributable to increased costs of LPG
sold to customers other than PMI during the year ended July 31, 2003, partially
offset by $10.5 million attributable to decreased volume of LPG sold to
customers other than PMI during the year ended July 31, 2003 and $17.9 million
attributable to decreased volume of LPG sold to PMI during the year ended July
31, 2003.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $6.4 million for the year ended July 31, 2003,
compared with $4.3 million for the year ended July 31, 2002, an increase of $2.0
million or 47%. The increase during the year ended July 31, 2003, was
principally due to legal and professional fees associated with the Spin-Off and
litigation, consulting fees and compensation related costs.
Other income (expense). Other income (expense) was $(1.8) million for the
year ended July 31, 2003, compared with $(2.5) million for the year ended July
31, 2002. The decrease in other expense was due primarily to decreased
amortization of discounts on outstanding debt, partially offset by settlements
of litigation during the year ended July 31, 2003.
Income tax. Due to the availability of net operating loss carryforwards
(approximately $5.3 million at July 31, 2003), the Company did not incur any
additional U.S. income tax expense during the year ended July 31, 2003. The
Company did incur $60,000 of Mexican income tax expense related to its Mexican
subsidiaries. The Mexican subsidiaries file their income tax returns on a
calendar year basis. The Company can receive a credit against any future tax
payments due to the extent of any prior alternative minimum taxes paid ($54,375
at July, 31, 2003).
31
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception
and has historically had a deficit in working capital. In addition,
substantially all of the Company's assets are pledged or committed to be pledged
as collateral on existing debt in connection with the Restructured Notes, the
$280,000 Notes and the RZB Credit Facility. The RZB Credit Facility is an
uncommitted facility which is authorized every ninety days and is reviewed
annually at March 31. The Company 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. The Company depends heavily on
sales to one major customer, PMI. Since April 1, 2004 the Company has been
operating on month-to-month contracts with PMI (see below). The Company's
sources of liquidity and capital resources historically have been provided by
sales of LPG, proceeds from the issuance of short-term and long-term debt,
revolving credit facilities and credit arrangements, sale or issuance of
preferred and common stock of the Company and proceeds from the exercise of
warrants to purchase shares of the Company's common stock.
Penn Octane has recently completed the transfer of a major portion of its
assets to Rio Vista and the Spin-Off of Rio Vista to its stockholders. As a
result of the Spin-Off, the Company's stockholders' equity has been materially
reduced by the amount of the Spin-Off and a portion of Penn Octane's current
cash flow from operations will be shifted to Rio Vista as of the date of the
Spin-Off. Therefore, Penn Octane's remaining cash flow may not be sufficient
to allow Penn Octane to pay its liabilities and obligations when due. Rio Vista
will be liable as guarantor on Penn Octane's collateralized debt discussed in
the preceding paragraph and will continue to pledge all of its assets as
collateral. Penn Octane does not believe that it has a federal income tax in
connection with the Spin-Off due to utilization of existing net operating loss
carryforwards. The Company estimates alternative minimum tax and state
franchise tax of approximately $238,000. However, the Internal Revenue Service
(IRS) may review Penn Octane's federal income tax returns and challenge
positions that Penn Octane may take when preparing those income tax returns,
including positions that it may take with respect to the Spin-Off. If the IRS
challenges any of the Company's positions, Penn Octane will vigorously defend
the positions that it takes in preparing its federal income tax, including
positions that it may take with respect to the Spin-Off. 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 (see
Spin-Off below).
The volume of LPG sold to PMI has been materially reduced over historical
levels resulting in a reduction of the Company's cash flow (see discussion
below). In addition, Rio Vista intends to make distributions on a quarterly
basis to its unitholders beginning in February 2005. Initially, those
distributions are expected to be approximately $500,000 per quarter. Also,
during the years ended July 31, 2003 and 2004, professional fees and related
costs associated with the Spin-Off totaled approximately $802,000 and $931,000,
respectively. The Company expects to eliminate these costs in future periods.
However, as a result of the Spin-Off, the Company estimates that consolidated
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.
As a result of the reduced cash flow and the intention of Rio Vista to make
distributions, there may not be sufficient cash flow to make such
distributions and to pay Penn Octane's obligations when due. In the event Penn
Octane is unable to pay its liabilities and obligations when due, Rio Vista's
payment obligations may be triggered under its guarantees to Penn Octane and
Penn Octane's creditors and Rio Vista may be required to pay such liabilities
and obligations of Penn Octane to avoid foreclosure of its assets by Penn
Octane's creditors. Although Rio Vista is not required to do so, if Penn Octane
is unable to pay its obligations when they become due, Rio Vista may lend the
necessary funds to Penn Octane. Conversely, if Rio Vista does not have the
funds necessary to make its distributions, to the extent that Penn Octane has
sufficient cash to do so, it intends to lend such amounts to Rio Vista. 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. 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.
32
In the event Penn Octane is required to raise additional funds, management
does not believe that it would be able to obtain such financing from traditional
commercial lenders. Rather, Penn Octane would likely have to conduct sales of
its equity and/or debt securities through public or private financings,
collaborative relationships or other arrangements.
If additional amounts cannot be raised and Penn Octane is unable to
restructure its obligations, material adverse consequences to its business,
financial condition, results of operations would likely occur. Further, if Penn
Octane is determined to have a federal income tax liability as a result of the
Spin-Off and if Penn Octane is unable to pay such liabilities, the Internal
Revenue Service may assert that the Penn Octane stockholders who receive common
units in the Spin-Off are liable for unpaid federal income taxes of Penn Octane,
including interest and any penalties, up to the value of the Rio Vista Common
Units received by each stockholder.
The following summary table reflects comparative cash flows for fiscal
years ended July 31, 2002, 2003 and 2004. All information is in thousands.
2002 2003 2004
---------------- ---------------- ---------------
Net cash provided by operating activities . . . . . $ 2,436 $ 4,601 $ 850
Net cash (used in) provided by investing activities (783) (32) 191
Net cash used in financing activities . . . . . . . (1,872) ( 4,628) (728)
---------------- ---------------- ---------------
Net (decrease) increase in cash . . . . . . . . . . $ (219) $ (59) $ 313
---------------- ---------------- ---------------
Sales to PMI. On March 31, 2004, the Company's sales agreement with PMI
("the Contract") expired. During the months of April 2004 through October
2004, the Company and PMI have entered into monthly agreements for the sale of
LPG (the "Monthly 2004 Contracts"). Under the terms of the Monthly 2004
Contracts for April, May and June, the minimum amount of LPG to be purchased per
month by PMI was 13.0 million gallons. Under the terms of the Monthly 2004
Contracts for July, August and September, the minimum amount of LPG to be
purchased per month by PMI was 11.7 million gallons. Under the terms of the
Monthly 2004 Contracts for October and November, the minimum amount of LPG to be
purchased per month by PMI is 11.1 million gallons. During the months of April
2004, May 2004, June 2004, July 2004, August 2004, September 2004 and October
2004, the actual amount of LPG purchased by PMI was approximately 13.1 million
gallons, 13.4 million gallons, 13.8 million gallons, 12.3 million gallons, 12.4
million gallons, 11.8 million gallons and 10.9 million gallons, respectively.
The expiration of the Contract has caused a reduction in the Company's gross
revenue due to the reduction in LPG volumes sold to PMI from approximately 17
million gallons per month under the Contract to approximately 13 million gallons
per month under the Monthly 2004 Contracts. The change in volume from 17
million gallons to an average of approximately 13 million gallons for the months
of April 2004 through September 2004 had the impact of reducing gross profit by
approximately $340,000 per month on average. The Company was able to offset a
portion of the reduction in gross profit by reducing its monthly variable costs
by approximately $100,000. In addition, the Company has also been able to
offset further the reduction in gross profit by negotiating more favorable terms
under its LPG supply contracts, resulting in savings of approximately $115,000
per month and will receive additional savings of approximately $40,000 per month
beginning in October 2004. As a result of the Company's cost reduction efforts,
the net effect of the reduction in volumes from 17 million gallons per month to
13 million gallons per month is a monthly decrease in gross profit of
approximately $125,000. To further reduce costs, the Company terminated El Paso
and Duke supply agreements totaling approximately 4.4 million gallons per month,
which terminations allowed the Company to reduce losses from the disposal of
excess inventory.
The Company continues to negotiate for the extension and/or renewal of the
LPG contract with PMI. There is no assurance that the LPG contract with PMI
will be extended and/or renewed, and if so, that the terms will be more or less
favorable than those of the Monthly 2004 Contracts. Until the terms of a new
long-term contract are reached, the Company expects to enter into additional
monthly agreements similar to the Monthly 2004 Contracts.
33
The Company's management believes that PMI's reduction of volume
commitments for April 2004 through October 2004 is based on additional LPG
production by PEMEX being generated from the Burgos Basin field in Reynosa,
Mexico, an area within the proximity of the Company's Mexican terminal
facilities. In the event the volume of LPG purchased by PMI under the
month-to-month agreements declines below the current level of approximately 13
million gallons, assuming margins remain unchanged, the Company would suffer
material adverse consequences to its business, financial condition and results
of operations to the extent that the Company is unable to obtain additional
favorable price and/or volume concessions from LPG suppliers. The Company is
attempting to obtain additional price and/or volume concessions from its LPG
suppliers to lower costs. If the Company is unsuccessful in lowering its costs
to offset a decline in volumes below 13 million gallons per month and/or the
Company is forced to accept similar or lower prices for sales to PMI, the
results of operations of the Company may be adversely affected. The Company
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 the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative terminal
in the event the Matamoros Terminal Facility cannot be used.
Revenues from PMI totaled approximately $142 million for the year ended
July 31, 2004, representing approximately 80% of total revenue for the period.
LPG Supply Agreements. Effective October 1, 1999, the Company and Exxon
entered into a ten year LPG supply contract, as amended (the "Exxon Supply
Contract"), whereby Exxon has agreed to supply and the Company has agreed to
take, 100% of Exxon's owned or controlled volume of propane and butane available
at Exxon's King Ranch Gas Plant (the "Plant") up to 13.9 million gallons per
month blended in accordance with required specifications (the "Plant
Commitment"). For the year ending July 31, 2003, under the Exxon Supply
Contract, Exxon has supplied an average of approximately 12.3 million gallons of
LPG per month. The purchase price is indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The
ability to utilize the ECCPL allows the Company to acquire an additional supply
of propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until December 2005. The Company is required to pay minimum utilization fees
associated with the use of the ECCPL until December 2005. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso agreed to supply and the Company agreed to take, a
monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999 and expiring on September 30, 2002. The El Paso
Supply Agreement was not renewed upon expiration. The purchase price was indexed
to variable posted prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. In March 2003 the Company extended
the Koch Supply Contract for an additional year pursuant to the Koch Supply
Contract which provides for automatic annual renewals unless terminated in
writing by either party. During December 2003, the Company and Koch entered
into a new three year supply agreement. The terms of the new agreement are
similar to the agreement previously in effect between the parties.
For the year ending July 31, 2004, under the Koch Supply Contract, Koch has
supplied an average of approximately 6.4 million gallons of propane per month.
The purchase price is indexed to variable posted prices. Prior to April 2002,
the Company paid additional charges associated with the construction of a new
pipeline interconnection which allows deliveries of the Koch Supply into the
ECCPL, which was paid through additional adjustments to the purchase price
(totaling approximately $1.0 million).
34
During March 2000, the Company and Duke Energy NGL Services, Inc. ("Duke")
entered into a three year supply agreement (the "Duke Supply Contract") whereby
Duke has agreed to supply and the Company has agreed to take, a monthly average
of 1.9 million gallons (the "Duke Supply") of propane or propane/butane mix
beginning April 1, 2000. In March 2003 the Company extended the Duke Supply
Contract for an additional year pursuant to the Duke Supply Contract which
provided for automatic annual renewals unless terminated in writing by either
party. The Duke Supply contract, which expired in March 2004 was not renewed.
The purchase price was indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
The Company's current long-term supply agreements in effect as of July 31,
2004 ("Supply Contracts") require the Company to purchase minimum quantities of
LPG totaling up to approximately 22.1 million gallons per month although the
Monthly 2004 Contracts require PMI to purchase lesser quantities. The actual
amounts supplied under Supply Contracts averaged approximately 18.7 million
gallons per month for the year ended July 31, 2004.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver the LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated with
the storage, disposal and/or changes in LPG prices resulting from the excess of
the Plant Commitment or Koch Supply over actual sales volumes to PMI. Under the
terms of the Supply Contracts, the Company must provide letters of credit in
amounts equal to the cost of the product to be purchased. In addition, the cost
of the product purchased is tied directly to overall market conditions. As a
result, the Company's existing letter of credit facility may not be adequate to
meet the letter of credit requirements under the agreements with the Suppliers
or other suppliers due to increases in quantities of LPG purchased and/or to
finance future price increases of LPG.
Credit Arrangements. Pursuant to an amendment (see below), as of July 31,
2004 the Company had a $15.0 million credit facility with RZB Finance LLC
("RZB") for demand loans and standby letters of credit (the "RZB Credit
Facility") to finance the Company's purchases of LPG and Fuel Products in
connection with the 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 reviewed annually at March 31. Under
the RZB Credit Facility, the Company pays a fee with respect to each letter of
credit thereunder in an amount equal to the greater of (i) $500, (ii) 2.5% of
the maximum face amount of such letter of credit, or (iii) such higher amount as
may be agreed to between the Company and RZB. Any loan amounts outstanding
under the RZB Credit Facility shall accrue interest at a rate equal to the rate
announced by the JPMorgan Chase Bank as its prime rate (4.25% at July 31, 2004)
plus 2.5%. Pursuant to the RZB Credit Facility, RZB has sole and absolute
discretion to limit or terminate its participation in the RZB Credit Facility
and to 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. In connection with the
RZB Credit Facility, the Company granted a security interest and assignment in
any and all of the Company's accounts, inventory, real property, buildings,
pipelines, fixtures and interests therein or relating thereto, including,
without limitation, the lease with the Brownsville Navigation District of
Cameron County (the "District") for the land on which the Company's Brownsville
Terminal Facility is located, the Pipeline Lease, and in connection therewith
agreed to enter into leasehold deeds of trust, security agreements, financing
statements and assignments of rent, in forms satisfactory to RZB. Under the RZB
Credit Facility, the Company may not permit to exist any subsequent lien,
security interest, mortgage, charge or other encumbrance of any nature on any of
its properties or assets, except in favor of RZB, without the consent of RZB.
After the Spin-Off and transfer of assets to RVOP, RZB continues to retain a
security interest in the transferred assets.
35
Effective April 30, 2004, the RZB Credit Facility was informally amended to
provide for a credit limit of $15.0 million through March 31, 2005, although the
facility may be terminated any time. In addition, RZB also approved the
Company's use of the RZB Credit Facility to purchase Fuel Products in addition
to LPG, including a $3.0 million limit for purchase of Fuel Products inventory
for a maximum of 30 days. Based on current minimum purchase commitments under
the Company's LPG supply agreements and current LPG prices, the amount available
to finance Fuel Products and LPG purchases in excess of current minimum purchase
commitments is limited to current volumes and therefore the ability of the
Company to grow the Fuel Sales Business is dependent on future increases in its
RZB Credit Facility or other sources of financing, the reduction of LPG supply
commitments and/or the reduction in LPG or Fuel Products prices. In connection
with the amendment, the Company is required to pay RZB annual fees of $50,000 in
addition to the fees described above.
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG and Fuel Products,
letters of credit are issued based on anticipated purchases. Outstanding letters
of credit for purchases of LPG and Fuel Products at July 31, 2004 totaled
approximately $12.7 million of which approximately $9.4 million represents July
2004 purchases and approximately $3.3 million represents August 2004 purchases.
In connection with the Company's purchase of LPG and Fuel Products, under
the RZB Credit Facility, assets related to product sales (the "Assets") are
required to be in excess of borrowings and commitments (including restricted
cash of $5.9 million at July 31, 2004). At July 31, 2004, the Company's
borrowings and commitments were less than the amount of the Assets.
Under the terms of the RZB Credit Facility, Penn Octane or Rio Vista are
required to maintain net worth of a minimum of $9.0 million.
In connection with the Company's Fuel Sales Business, the Company has
issued bonds totaling $662,000 to the states of California, Nevada, Arizona and
Texas (the "Bonds") to secure payments of excise and other taxes collected from
customers in connection with sales of Fuel Products. The Bonds are partially
secured by letters of credit totaling $452,600. At July 31, 2004, such taxes of
approximately $90,000 were due. In addition, in connection with the Fuel Sales
Business, the Company issued a letter of credit of $284,000 in connection with
the Company's use of pipeline and terminal systems from a third party. The
letters of credit issued have all been secured by cash in the amount of $736,600
which is included in restricted cash in the Company's balance sheet at July 31,
2004.
LPG and Fuel Products financing expense associated with the RZB Credit
Facility totaled $452,164, $732,718 and $832,787 for the years ended July 31,
2002, 2003 and 2004.
36
The following is a summary of the Company's estimated minimum contractual
obligations and commercial obligations as of July 31, 2004. Where applicable,
LPG prices are based on the July 2004 monthly average as published by Oil Price
Information Services.
PAYMENTS DUE BY PERIOD
(AMOUNTS IN MILLIONS)
-------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After
Contractual Obligations Total 1 Year Years Years 5 Years
- --------------------------------------- ------------- -------------- ---------------- -------------- --------------
Long-Term Debt Obligations $ 1.7 $ - $ 1.7 $ - $ -
Operating Leases 12.3 1.4 2.7 2.6 5.6
LPG Purchase Obligations 727.9 173.6 303.8 231.5 19.0
Other Long-Term Obligations .1 - .1 - -
------------- -------------- ---------------- -------------- --------------
Total Contractual Cash Obligations $ 742.0 $ 175.0 $ 308.3 $ 234.1 $ 24.6
============= ============== ================ ============== ==============
AMOUNT OF COMMITMENT EXPIRATION
PER PERIOD
(AMOUNTS IN MILLIONS)
------------------------------------------------------------
Total Amounts Less than 1 - 3 4 - 5 Over
Commercial Commitments Committed 1 Year Years Years 5 Years
- ------------------------------ -------------- ---------- -------- --------- -----------
Lines of Credit $ 2.7 $ 2.7 $ - $ - $ -
Standby Letters of Credit 13.4 13.4 - - -
Guarantees N/A N/A N/A N/A N/A
Standby Repurchase Obligations N/A N/A N/A N/A N/A
Other Commercial Commitments N/A N/A N/A N/A N/A
-------------- ---------- -------- --------- -----------
Total Commercial Commitments $ 16.1 $ 16.1 $ - $ - $ -
============== ========== ======== ========= ===========
Pipeline Lease. The Pipeline Lease currently expires on December 31, 2013,
pursuant to an amendment (the "Pipeline Lease Amendment") entered into between
the Company and Seadrift on May 21, 1997, which became effective on January 1,
1999 (the "Effective Date"). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another pipeline
controlled by Seadrift, thereby providing greater access to and from the Leased
Pipeline. Pursuant to the Pipeline Lease Amendment, the Company's fixed annual
rent for the use of the Leased Pipeline is $1.0 million including monthly
service payments of $8,000 through March 2004. The service payments are subject
to an annual adjustment based on a labor cost index and an electric power cost
index. The Company is also required to pay for a minimum volume of storage of
$300,000 per year (based on reserved storage of 8.4 million gallons) beginning
January 1, 2000. In connection with the Pipeline Lease, the Company may
reserve up to 21.0 million gallons each year thereafter provided that the
Company notifies Seadrift in advance.
The Pipeline Lease Amendment provides for variable rental increases based
on monthly volumes purchased and flowing into the Leased Pipeline and storage
utilized. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million and 360
million gallons per year.
Other. The Company intends to upgrade its computer and information systems
at a total estimated cost of approximately $350,000.
37
Acquisition of Mexican Subsidiaries. Effective April 1, 2001, the Company
completed the purchase of 100% of the outstanding common stock of both Termatsal
and PennMex (the "Mexican Subsidiaries"), previous affiliates of the Company
which were principally owned by a former officer and director (see note D to the
consolidated financial statements). The Company paid a nominal purchase price
of approximately $5,000 for each Mexican subsidiary. As a result of the
acquisition, the Company has included the results of the Mexican Subsidiaries in
its consolidated financial statements at July 31, 2002, 2003 and 2004. Since
inception through the acquisition date, the operations of the Mexican
Subsidiaries had been funded by the Company and such amounts funded were
included in the Company's consolidated financial statements. Therefore there
are no material differences between the amounts previously reported by the
Company and the amounts that would have been reported by the Company had the
Mexican Subsidiaries been consolidated since inception.
During July 2003, the Company acquired an option to purchase Tergas, an
affiliate 95% owned by Mr. Soriano and the remaining balance owned by Mr.
Abelardo Mier, a consultant of the Company, for a nominal price of approximately
$5,000. Since inception the operations of Tergas have been funded by the
Company and the assets, liabilities and results of operations of Tergas are
included in the Company's consolidated financial statements.
Mexican Operations. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of LPG
terminal facilities is prohibited. Foreign ownership is permitted in the
transportation and storage of LPG. Mexican law also provides that a single
entity is not permitted to participate in more than one of the defined LPG
activities (transportation, storage or distribution). PennMex has a
transportation permit and 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. The
Company's consolidated Mexican affiliate, Tergas, S.A. de C.V. ("Tergas"), has
been granted the permit to operate the Matamoros Terminal Facility and the
Company relies on Tergas' permit to continue its delivery of LPG at the
Matamoros Terminal Facility. The Company pays Tergas its actual cost for
distribution services at the Matamoros Terminal Facility plus a small profit.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal"). The Company
was unable to receive all the necessary approvals to operate the facility at
that location. The terminal was subsequently dismantled.
The Company has accounted for the Saltillo Terminal at cost. The cost
included in the balance sheet is comprised primarily of dismantled pipe,
dismantled steel structures, steel storage tanks, pumps and compressors and
capitalized engineering costs related to the design of the terminal. The cost
of dismantling the terminal at the Saltillo location was expensed and on-going
storage fees have also been expensed.
As a result of the reduced volumes of LPG being sold to PMI and the
short-term nature of the agreements (see Sales to PMI above), the Company has
determined that construction of a new Saltillo Terminal is currently not
feasible. Accordingly, as of July 31, 2004, the Company has written off
$227,829 relating to the capitalized engineering costs and other costs
associated with the design of the Saltillo Terminal and expensed $32,171 of
costs related to pipes, pumps and valves which were used as replacement parts in
the Matamoros Terminal Facility. The Company anticipates utilizing the
remaining Saltillo Terminal assets in its existing operations.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, a consolidated affiliate, the Company is subject to the
tax laws of Mexico which, among other things, require that the Company comply
with transfer pricing rules, the payment of income, asset and ad valorem taxes,
and possibly taxes on distributions in excess of earnings. In addition,
distributions to foreign corporations, including dividends and interest payments
may be subject to Mexican withholding taxes.
38
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law
for LPG was changed to permit foreign entities to participate without limitation
in the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its consolidated affiliate expect to sell LPG
directly to independent Mexican distributors as well as PMI upon Deregulation.
The Company anticipates that the independent Mexican distributors will be
required to obtain authorization from the Mexican government for the importation
of LPG upon Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
In connection with the above, in August 2001, Tergas received a one year
permit from the Mexican government to import LPG. During September 2001, the
Mexican government decided to delay the implementation of Deregulation and asked
Tergas to defer use of the permit and as a result, the Company did not sell LPG
to distributors other than PMI. In March 2002, the Mexican government again
announced its intention to issue permits for free importation of LPG into Mexico
by distributors and others beginning August 2002, which was again delayed. 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 the Company. However, should Deregulation occur, it is the Company's
intention to sell LPG directly to distributors in Mexico as well as to PMI.
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.
Private Placements and Other Transactions. In connection with the Penn
Octane Board Plan, during August 2003 the Board granted warrants to purchase
20,000 shares of common stock of Penn Octane at exercise prices of $3.22 and
$3.28 per share to outside directors. The warrants expire in August 2008. Based
on the provisions of APB 25, no compensation expense was recorded for these
warrants.
During September 2003, warrants to purchase 32,250 shares of common stock
of Penn Octane were exercised resulting in cash proceeds to the Company of
$80,625.
During September 2003, the Company issued 21,818 shares of common stock of
Penn Octane to Mr. Bracamontes as severance compensation (see above). In
connection with the issuance of the shares, the Company recorded an expense of
approximately $75,000 based on the market value of the stock issued.
In connection with the Penn Octane Board Plan, during November 2003 the
Board granted warrants to purchase 10,000 shares of common stock of Penn Octane
at exercise prices of $2.61 per share to an outside director. The warrants
expire in November 2008. Based on the provisions of APB 25, no compensation
expense was recorded for these warrants.
39
During October 2003, cashless warrants to purchase 103,685 shares of common
stock of Penn Octane were exercised. The exercise price of the warrants was
$2.50 per share and the market price of Penn Octane's common stock on the date
of exercise was $3.01 per share, resulting in the net issuance of 17,568 shares
of common stock of Penn Octane. The Company had previously expensed the cost
associated with the warrants when the warrants were originally granted.
During November 2003, warrants to purchase 16,625 shares of common stock of
Penn Octane were exercised resulting in cash proceeds to the Company of $41,563.
During January 2004, the Company agreed to accept 77,765 shares of common
stock of Penn Octane as full satisfaction of indebtedness owed to the Company by
a related party. As a result, the Company recorded previously reserved interest
income of $32,334.
On January 16, 2004, the Restructured Notes which were due on December 15,
2003 were renewed and extended (the "Restructuring"). In connection with the
Restructuring, the due date of the Restructured Notes was extended to December
15, 2005. The Restructured Notes can be repaid at any time without penalty.
Annual interest on the Restructured Notes is 16.5% and the Company also agreed
to pay a fee of 1.5% on any principal balance of the Restructured Notes
outstanding at the end of each quarterly period, beginning December 15, 2003.
Interest and fees are payable quarterly beginning March 15, 2004.
In addition, the Company agreed to extend the expiration date on
outstanding warrants to purchase common stock of Penn Octane held by holders of
the Restructured Notes until December 15, 2008 and agreed to issue new warrants
to purchase Rio Vista Common Units in an amount equal to 2,500 warrants for each
$100,000 of Restructured Notes and an additional 2,500 warrants in Rio Vista for
each $100,000 of Restructured Notes outstanding at December 15, 2004 (the "Rio
Vista Warrants"). The Rio Vista Warrants will expire three years from the date
of the Spin-Off (see note M to the consolidated financial statements) and the
exercise price will be determined based on a formula whereby the annualization
of the first quarterly distribution will represent a 20% yield on the exercise
price. In addition, the Company agreed to issue an additional 37,500 warrants
to purchase shares of common stock of Penn Octane to certain holders of the
Restructured Notes.
Certain holders of promissory notes totaling approximately $280,000 of
principal due December 15, 2003 which did not agree to the Restructuring (the
"Declining Noteholders") were paid by the Company. In connection with amounts
due to the Declining Noteholders, the Company issued $280,000 of promissory
notes ($280,000 Notes). The terms of the $280,000 Notes are substantially
similar to the Restructured Notes, except that the holders of the $280,000 Notes
were not entitled to receive any warrants to purchase shares of common stock of
Penn Octane.
In addition, holders of the Restructured Notes and $280,000 Notes consented
to the Spin-Off of Rio Vista provided that the assets of Penn Octane to be
transferred to Rio Vista will continue to be pledged as collateral for payment
of the Restructured Notes and $280,000 Notes, Rio Vista guarantees Penn Octane's
obligations under the Restructured Notes and $280,000 Notes and that Rio Vista
is prohibited against making any distributions in the event that the Company is
in default under the Restructured Notes and $280,000 Notes.
In connection with the Restructured Notes and $280,000 Notes, Philadelphia
Brokerage Corporation acted as placement agent and will receive a fee equal to
1.5% of the Restructured Notes and $280,000 Notes and after the date of the
Spin-Off warrants to purchase 10,000 units in Rio Vista and an additional 10,000
warrants to purchase 10,000 units in Rio Vista if the Restructured Notes and
$280,000 Notes are not paid by December 15, 2004. The terms of the warrants are
the same as the Rio Vista Warrants.
In connection with the issuance of the new warrants of Penn Octane and the
extension of the warrants of Penn Octane, the Company recorded a discount of
$194,245 related to the fair value of the newly issued, modified warrants and
including fees of $27,075. The Company will record an additional discount
related to the Rio Vista warrants issued to the holders of the Restructured
Notes and $280,000 Notes when the Company is able to determine the fair value,
if any.
40
In connection with the Penn Octane Board Plan, during August 2004 the Board
granted warrants to purchase 20,000 shares of common stock of Penn Octane at
exercise prices of $1.93 and $1.94 per share to outside directors. The warrants
expire in August 2009. Based on the provisions of APB 25, no compensation
expense was recorded for these warrants.
On September 30, 2004, pursuant to the terms of an employment agreement
dated as of May 13, 2003 with Mr. Shore, the Company issued warrants to purchase
763,737 shares of Penn Octane's common stock at an exercise price of $1.14 per
share. The warrants are exercisable beginning on October 1, 2004 and expire on
July 10, 2006.
In connection with warrants previously issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right to
purchase the warrants for a nominal price if the holder of the warrants does not
elect to exercise the warrants during the call provision period.
Settlement of Litigation. On October 11, 2001, litigation was filed in the
197th Judicial District Court of Cameron County, Texas by the Company against
Tanner Pipeline Services, Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging
negligence and aided breaches of fiduciary duties on behalf of CPSC
International, Inc. ("CPSC") in connection with the construction of the US
Pipelines. During September 2003, the Company entered into a settlement
agreement with Tanner whereby Tanner was required to reimburse the Company for
$50,000 to be paid through the reduction of the final payments on Tanner's note
(see note H to the consolidated financial statements).
On March 2, 2000, litigation was filed in the Superior Court of California,
County of San Bernardino by Omnitrans against Penn Octane Corporation, Penn
Wilson and several other third parties alleging breach of contract, fraud and
other causes of action related to the construction of a refueling station by a
third party. Penn Octane Corporation and Penn Wilson have both been dismissed
from the litigation pursuant to a summary judgment. Omnitrans appealed the
summary judgment in favor of the Company and Penn Wilson. During August 2003,
the Appellate Court issued a preliminary decision denying Omnitran's appeal of
the summary judgment in favor of the Company and Penn Wilson. Oral arguments on
the appeal were heard in November 2003 and the Company prevailed on its summary
judgment.
Fuel Sales Business. During June 2004, the Company began the Fuel Sales
Business. The Company sells Fuel Products through transactional, bulk and/or
rack transactions. Typical transactional and bulk sales are made based on a
predetermined net spread between the purchase and sales price over posted
monthly variable prices and/or daily spot prices. Rack sales transactions are
based on variable sale prices charged by the Company which are tied to posted
daily spot prices and purchase costs which are based on a monthly average or 3
day average based on posted prices. The Company pays pipeline and terminal fees
based on regulated rates.
The Fuel Sales Business on the west coast of the United States is
characterized by limited pipeline and terminal space to move sufficient Fuel
Products to locations where demand for Fuel Products exists. The Company has
the ability to access to certain pipeline and terminal systems located in
California, Arizona, Nevada and Texas, where it is able to deliver its Fuel
Products. The markets where the Company has targeted its products are generally
in areas where the Fuel Products are difficult to deliver due to the
infrastructure limitations and accordingly, the Company's access provides an
advantage over other potential competitors who may not have access to these
pipelines or terminals. In addition, the Company's supply contracts provide it
with greater flexibility to manage changes in the prices of the Fuel Products.
The Company believes it has an advantage over other competitors based on its
favorable supply contracts and existing access to certain pipelines and
terminals.
41
For bulk and transactional sales, the Company enters into individual sales
contracts for each sale. Rack sales are subject to credit limitations imposed
on each individual buyer by the Company. The Company has several supply
contracts for each of the Fuel Products it sells. The supply contracts are
for annual periods with flexible volumes but they may be terminated sooner by
the supplier if the Company consistently fails to purchase minimum volumes of
Fuel Products.
The ability of the Company to participate in the Fuel Sales Business is
largely dependent on the Company's ability to finance its supplies. Currently,
the Company utilizes the RZB Credit Facility to finance the purchases of Fuel
Products. Based on the Company's LPG purchase commitments, increases in the
costs of LPG and/or the increases in the costs of Fuel Products, the amount of
financing available for the Fuel Sales Business may be reduced.
Federal and State agencies require the Company to obtain the necessary
regulatory and other approvals for its Fuel Sales Business.
The Spin-Off. On July 10, 2003, Penn Octane formed Rio Vista, a Delaware
limited partnership, the General Partner, a Delaware limited liability company,
RVOP, a Delaware limited partnership (0.1% owned by Rio Vista Operating GP LLC
and 99.9% owned by Rio Vista) and Rio Vista Operating GP LLC, a Delaware limited
liability company (wholly owned by Rio Vista) for the purpose of completing the
Spin-Off. During September 2003, the Company's Board of Directors and the
Independent Committee of its Board of Directors formally approved the terms of
the Spin-Off (see below) and Rio Vista filed a Form 10 registration statement
with the Securities and Exchange Commission ("SEC"). On September 30, 2004 the
Common Units of Rio Vista were distributed to Penn Octane's stockholders.
As a result of the Spin-Off, Rio Vista will own and operate the LPG,
distribution, transportation and marketing business previously conducted by Penn
Octane. Rio Vista will sell LPG directly to PMI and will purchase LPG from Penn
Octane under a long-term supply agreement.
INTERCOMPANY PURCHASE AGREEMENT FOR LPG
Penn Octane entered into a Purchase Agreement with RVOP pursuant to which
RVOP agrees to purchase all of its LPG requirements for sales which utilize the
assets transferred to RVOP by Penn Octane to the extent Penn Octane is able to
supply such LPG requirements. This agreement further provides that RVOP will
have 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 contributes to RVOP under the Contribution,
Conveyance and Assumption Agreement. The Purchase Agreement terminates on the
earlier to occur of:
- Penn Octane ceases to have the right to access the Seadrift
pipeline that connects to Rio Vista's Brownsville terminal
facilities; and
- RVOP ceases to sell LPG using any of the assets contributed by
Penn Octane to RVOP pursuant to the Contribution, Conveyance and
Assumption Agreement.
The price Rio Vista will pay for LPG under this contract is indexed to the
price quoted by the Oil Price Information Service for Mt. Belvieu non-tet
propane and non-tet normal butane, plus other costs and amounts based on a
formula that takes into consideration operating costs to both Penn Octane and to
Rio Vista.
OMNIBUS AGREEMENT
In connection with the Spin-Off, Penn Octane entered into an Omnibus
Agreement with Rio Vista and its subsidiaries 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.
42
INDEMNIFICATION PROVISIONS. Under the Omnibus Agreement, Penn Octane will
indemnify Rio Vista against certain potential environmental liabilities
associated with the operation of the assets contributed to Rio Vista, and assets
retained, by Penn Octane that relate to events or conditions occurring or
existing before the completion of the distribution. Penn Octane will also
indemnify Rio Vista for liabilities relating to:
- legal actions against Penn Octane;
- events and conditions associated with any assets retained by Penn
Octane;
- certain defects in the title to the assets contributed to Rio
Vista by Penn Octane that arise within three years after the
completion of the distribution to the extent such defects
materially and adversely affect Rio Vista's ownership and
operation of such assets;
- Rio Vista's failure to obtain certain and consents and permits
necessary to conduct Rio Vista's business to the extent such
liabilities arise within three years after the completion of the
distribution; and
- certain income tax liabilities attributable to the operation of
the assets contributed to Rio Vista prior to the time that they
were contributed.
Rio Vista will indemnify Penn Octane for certain potential environmental
liabilities associated with the operation of the assets contributed to Rio Vista
that relate to events or conditions occurring or existing after the completion
of the distribution and for federal income tax liabilities in excess of $2.5
million incurred by Penn Octane as a result of the distribution.
SERVICES. Under the Omnibus Agreement, Penn Octane will provide Rio Vista
with corporate staff and support services that are substantially identical in
nature and quality to the services previously provided by Penn Octane in
connection with its management and operation of the assets of Rio Vista during
the one-year period prior to the completion of the distribution. These services
will include centralized corporate functions, such as accounting, treasury,
engineering, information technology, insurance, administration of employee
benefit and incentive compensation plans and other corporate services. Penn
Octane will be reimbursed for the costs and expenses it incurs in rendering
these services, including an overhead allocation to Rio Vista of Penn Octane's
indirect general and administrative expenses from its corporate allocation pool.
The General Partner will determine the general and administrative expenses that
will be allocated to Rio Vista. Administrative and general expenses directly
associated with providing services to Rio Vista (such as legal and accounting
services) are not included in the overhead allocation pool.
RELATED PARTY TRANSACTIONS. 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.
AMENDMENT AND TERMINATION. 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.
GENERAL PARTNER OPTIONS
Penn Octane's 2% general partnership interest in Rio Vista is expected to
be decreased to 1% as a result of the exercise by Shore Capital and Mr. Richter
of options to each acquire 25% of the General Partner (the "General Partner
Options") causing Penn Octane's ownership in the General Partner to be decreased
from 100% to 50%. Mr. Shore and Mr. Richter are each members of the board of
directors of Penn Octane and the board of managers of Rio Vista. Penn Octane
and Rio Vista are parties to the Distribution Agreement, the Omnibus Agreement,
the Purchase Agreement for LPG, the Contribution, Conveyance and Assumption
Agreement and the Conveyance Agreement, copies of which are attached as exhibits
to this report. These agreements are described in Penn Octane's Current Report
on Form 8-K filed by Penn Octane with the SEC on September 22, 2004, and
incorporated herein by reference.
43
TRANSFERRED ASSETS
The following assets of Penn Octane were transferred to the operating
subsidiary of Rio Vista on September 30, 2004:
Brownsville Terminal Facilities
US Mexico Pipelines, including various rights of way and land obtained in
connection with operation of US Pipelines between Brownsville Terminal
Facility and the US Border
Inventory located in storage tanks and pipelines located in Brownsville
(and extending to storage and pipelines located in assets held by the
Mexican subsidiaries)
Contracts and Leases (assumed and/or assigned):
Lease Agreements:
Port of Brownsville:
LPG Terminal Facility
Tank Farm Lease
US State Department Permit
Other licenses and permits in connection with ownership and operation of
the US pipelines between Brownsville and US border
Investment in Subsidiaries:
Penn Octane de Mexico, S. de R.L. de C.V., consisting primarily of a
permit to transport LPG from the Mexican Border to the Matamoros
Terminal Facility
Termatsal, S. de R.L. de C.V., consisting primarily of land, LPG
terminal facilities, Mexican pipelines and rights of way, and
equipment used in the transportation of LPG from the Mexican
border to the Matamoros terminal facility and various LPG
terminal equipment
Penn Octane International LLC
Option to acquire Tergas, S.A. de C.V.
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.
Holders of unexercised warrants of Penn Octane as of the date of the Spin-Off
received an adjustment to reduce the exercise price of their existing Penn
Octane warrant and new warrants to purchase Common Units of Rio Vista to reflect
the transfer of assets from Penn Octane into Rio Vista. As of the date of the
Spin-Off, Penn Octane had 2,542,500 warrants to purchase common stock
outstanding. The adjustment to the exercise price of Penn Octane warrants was
determined by multiplying the original exercise price of Penn Octane warrants by
0.369. The number of Rio Vista warrants given to the holder of Penn Octane
warrants as of the date of the Spin-Off was determined by dividing the existing
number of warrants of Penn Octane by eight. The exercise price of the Rio Vista
warrants was determined by multiplying the original exercise price of the
existing Penn Octane warrants by 5.05. The expiration date of the Rio Vista
warrants is the same as the existing Penn Octane warrants.
Under the terms of Rio Vista's partnership, the General Partner is entitled to
receive cash distributions from Rio Vista in accordance with 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.
It is anticipated that Mr. Richter and Shore Capital will exercise their General
Partner Options in the near future. The exercise price for each option will be
the pro rata share (.5%) of Rio Vista's tax basis capital immediately after the
Spin-Off. Penn Octane will retain voting control of Rio Vista pursuant to a
voting agreement. In addition, Shore Capital received warrants to acquire
763,737 shares of the common stock of Penn Octane at $1.14 per common share and
97,415 Common Units of Rio Vista at $8.47 per Common Unit. The warrants are
exercisable beginning on October 1, 2004 and expire on July 10, 2006.
44
Rio Vista is liable as guarantor for Penn Octane's collateralized debt and will
continue to pledge all of its assets as collateral. Rio Vista may also be
prohibited from making any distributions to unit holders if it would cause an
event of default, or if an event of default is existing, under 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 Spin-Off is a taxable transaction for federal income tax purposes (and may
also be taxable under applicable state, local and foreign tax laws) to both the
Company and its stockholders. Penn Octane intends to treat the Spin-Off as a
"partial liquidation" for federal income tax purposes. A "partial liquidation"
is defined under Section 302(e) of the Internal Revenue Code as a distribution
that (i) is "not essentially equivalent to a dividend," as determined at the
corporate level, which generally requires a genuine contraction of the business
of the corporation, (ii) constitutes a redemption of stock and (iii) is made
pursuant to a plan of partial liquidation and within the taxable year in which
the plan is adopted or within the succeeding taxable year.
Penn Octane does not believe that it has a federal income tax in connection with
the Spin-Off due to utilization of existing net operating loss carryforwards.
The Company estimates alternative minimum taxes and state franchise tax of
approximately $238,000. However, the Internal Revenue Service (the "IRS") may
review Penn Octane's federal income tax returns and challenge positions that
Penn Octane may take when preparing those income tax returns, including
positions that it may take with respect to the Spin-Off. If the IRS challenges
any of the Company's positions, Penn Octane will vigorously defend the positions
that it takes in preparing its federal income tax, including positions that it
may take with respect to the Spin-Off. If there is determined to be an income
tax liability resulting from the Spin-Off, to the extent such liability is
greater than $2.5 million, Rio Vista has agreed to indemnify Penn Octane for any
tax liability resulting from the transaction which is in excess of that amount.
Realization of Assets. The accompanying consolidated financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America, which contemplate continuation of the Company
as a going concern. The Company has had an accumulated deficit since inception
and has historically had a deficit in working capital. In addition,
substantially all of the Company's assets are pledged or committed to be pledged
as collateral on existing debt in connection with the Restructured Notes, the
$280,000 Notes and the RZB Credit Facility and therefore, the Company maybe
unable to obtain additional financing collateralized by those assets. The RZB
Credit Facility may be insufficient to finance the Company's LPG sales and/or
Fuel Products sales, assuming increases in product costs per gallon, or
volumetric growth in product sales, and maybe terminated by RZB with 90 days
notice.
Since April 1, 2004, the Company has been operating under the Monthly 2004
Contracts with PMI (see note P to the consolidated financial statements). The
monthly volumes of LPG sold to PMI since April 1, 2004 have been materially less
than historical levels. As discussed in note P to the consolidated financial
statements, the Company has LPG supply contracts which require it to purchase
volumes of LPG materially in excess of monthly volumes under the Monthly 2004
Contracts (the "Mismatched LPG"). The volume of the Mismatched LPG was
materially lower prior to April 1, 2004 than subsequent to April 1, 2004, and
the Company was able to dispose of the Mismatched LPG prior to April 1, 2004 at
acceptable margins. The Company may incur additional reductions of gross
profits on sales of LPG in disposing of the Mismatched LPG if (i) the volume of
LPG sold under the Monthly 2004 Contracts declines below the current levels of
approximately 13.0 million gallons per month and/or the margins are materially
reduced and/or (ii) the Company cannot successfully reduce the minimum volumes
and/or purchase costs required under the LPG supply agreements. The Company may
not have sufficient cash flow or available credit to absorb such reductions in
gross profit.
The Company's cash flow has been reduced as a result of lower volumes of
sales to PMI. Additionally, the Company will also incur the additional public
company and income tax preparation costs for Rio Vista. As a result, the Company
may not have sufficient cash flow to make distributions to Rio Vista's
unitholders and to pay Penn Octane's obligations when due. In the event Penn
Octane does not pay its obligations when due, Rio Vista's guarantees to Penn
Octane and Penn Octane's creditors may be triggered. Accordingly, Rio Vista may
be required to pay such obligations of Penn Octane to avoid foreclosure of its
assets by Penn Octane's creditors. If the Company's revenues and other sources
of liquidity are not adequate to pay Penn Octane's obligations, 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. 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.
45
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon the ability of the Company to
generate sufficient cash flow through operations or additional debt or equity
financing to pay its liabilities and obligations when due. The ability for the
Company to generate sufficient cash flows is significantly dependent on the
continued sale of LPG to PMI at acceptable monthly sales volumes and margins,
the success of the Fuel Sales Business and the adequacy of the RZB Credit
Facility to finance such sales. The consolidated financial statements do not
include any adjustments related to the recoverability and classification of
recorded asset amounts or amounts and classification of liabilities that might
be necessary should the Company be unable to continue in existence.
To provide the Company with the ability it believes necessary to continue
in existence, management is negotiating with PMI to increase LPG sales at
acceptable monthly volumes and margins. In addition, management is taking steps
to (i) expand its Fuel Sales Business, (ii) further diversify its operations to
reduce dependency on sales of LPG, (iii) increase the amount of financing for
its products and operations, and (iv) raise additional debt and/or equity
capital.
At July 31, 2004, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $4.7 million. If the net operating
loss carryforwards are utilized in the future, the Company will begin to pay
federal income tax at the corporate income tax rate.
46
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
During 2004, the Company 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 the Company, is a VIE
and therefore, its assets, liabilities and results of operations have been
included in the accompanying consolidated financial statements of the Company.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of the Company reflect the selection and
application of accounting policies which require management to make significant
estimates and judgments. See note B to those consolidated financial statements,
"Summary of Significant Accounting Policies". The Company believes that the
following reflect the more critical accounting policies that affect the
financial position and results of operations.
Revenues recognition - The Company expects in the future to enter into
sales agreements to sell LPG and Fuel Products for future delivery. The
Company will not record sales until the LPG and Fuel Products are 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.
Stock-based compensation - The Company accounts for stock-based
compensation using the provisions of ABP 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.
47
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
To the extent that the Company maintains quantities of LPG inventory in
excess of commitments for quantities of undelivered LPG and/or has commitments
for undelivered LPG in excess of inventory balances, the Company is exposed to
market risk related to the volatility of LPG prices. In the event that
inventory balances exceed commitments for undelivered LPG, during periods of
falling LPG prices, the Company may sell excess inventory to customers to reduce
the risk of these price fluctuations. In the event that commitments for
undelivered LPG exceed inventory balances, the Company may purchase contracts
which protect the Company against future price increases of LPG.
The Company does not maintain quantities of LPG inventory in excess of
quantities actually ordered by PMI. Therefore, the Company has not currently
entered into and does not currently expect to enter into any arrangements in the
future to mitigate the impact of commodity price risk.
To the extent the Company maintains quantities of Fuel Products inventory
in excess of commitments for quantities of undelivered Fuel Products, the
Company is exposed to market risk related to the volatility of Fuel Product
prices. In the event that inventory balances exceed commitments for undelivered
Fuel Products, during periods of falling Fuel Products prices, the Company may
sell excess inventory to customers to reduce the risk of these price
fluctuations.
The Company has historically borrowed only at fixed interest rates. All
current interest bearing debt is at a fixed rate. Trade accounts receivable
from the Company's limited number of customers and the Company's trade and other
accounts payable do not bear interest. The Company's credit facility with RZB
does not bear interest since generally no cash advances are made to the Company
by RZB. Fees paid to RZB for letters of credit are based on a fixed schedule as
provided in the Company's agreement with RZB. Therefore, the Company currently
has limited, if any, interest rate risk.
The Company routinely converts U.S. dollars into Mexican pesos to pay
terminal operating costs and income taxes. Such costs have historically been
less than $1 million per year and the Company expects such costs will remain at
less than $1 million in any year. The Company does not maintain Mexican peso
bank accounts with other than nominal balances. Therefore, the Company has
limited, if any, risk related to foreign currency exchange rates.
48
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Certified Public Accountants
--------------------------------------------------
To the Board of Directors
Penn Octane Corporation
We have audited the accompanying consolidated balance sheets of Penn Octane
Corporation and its subsidiaries (Company) as of July 31, 2003 and 2004, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended July 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of July 31, 2003 and 2004, and the consolidated results of their
operations and their consolidated cash flows for each of the three years in the
period ended July 31, 2004 in conformity with United States generally accepted
accounting principles.
We have also audited Schedule II of the Company for each of the three years in
the period ended July 31, 2004. In our opinion, this schedule presents fairly,
in all material respects, the information required to be set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note S to
the consolidated financial statements, conditions exist which raise substantial
doubt about the Company's ability to continue as a going concern including 1)
as a result of the termination of the Company's sales agreement with its primary
customer, sales volume to that customer has been materially reduced to the
extent that the Company may have insufficient cash flow to pay its obligations
when due, 2) substantially all of the Company's assets are pledged or committed
to be pledged as collateral on existing debt and therefore, the Company may be
unable to obtain additional financing collateralized by those assets and (3) the
Company's existing credit facility may be insufficient to finance its LPG and
Fuel Sales Business. Management's plans in regard to these matters are also
described in note S. The consolidated financial statements do not include any
adjustments related to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue in existence.
/s/ BURTON McCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
October 5, 2004
49
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31
ASSETS
2003 2004
----------- -----------
Current Assets
Cash $ 71,064 $ 384,074
Restricted cash 3,404,782 6,314,071
Trade accounts receivable (less allowance for doubtful accounts of 4,143,458 6,207,067
$5,783 and $0 at 2003 and 2004)
Inventories 878,082 1,632,992
Assets held for sale 720,000 -
Prepaid expenses and other current assets 476,109 210,520
----------- -----------
Total current assets 9,693,495 14,748,724
Property, plant and equipment - net 17,677,830 16,398,280
Lease rights (net of accumulated amortization of $707,535 and $753,330 at 446,504 400,709
2003 and 2004)
Other non-current assets 19,913 29,639
----------- -----------
Total assets $27,837,742 $31,577,352
=========== ===========
The accompanying notes are an integral part of these statements.
50
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
JULY 31
LIABILITIES AND STOCKHOLDERS' EQUITY
2003 2004
--------------- ----------------------
Current Liabilities
Current maturities of long-term debt $ 746,933 $ 162,694
Short-term debt 1,744,128 -
Revolving line of credit - 2,688,553
LPG trade accounts payable 7,152,098 7,432,728
Other accounts payable 2,470,880 1,784,643
Foreign taxes payable 60,000 5,194
Accrued liabilities 1,083,966 1,123,979
--------------- ----------------------
Total current liabilities 13,258,005 13,197,791
Long-term debt, less current maturities 60,000 1,729,202
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at 2003 and 2004 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; No shares issued and outstanding at 2003
and 2004 - -
Common stock - $.01 par value, 25,000,000 shares authorized; 152,747 152,852
15,274,749 and 15,285,245 shares issued and outstanding at 2003 and
2004
Additional paid-in capital 28,298,301 28,460,972
Notes receivable from an officer of the Company and another party for ( 2,897,520) ( 2,728,000)
exercise of warrants, net of reserves of $516,653 and $468,693 at 2003
and 2004
Accumulated deficit ( 11,033,791) ( 9,235,465)
--------------- ----------------------
Total stockholders' equity 14,519,737 16,650,359
--------------- ----------------------
Total liabilities and stockholders' equity $ 27,837,742 $ 31,577,352
=============== ======================
The accompanying notes are an integral part of these statements.
51
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31
2002 2003 2004
---------------- ---------------------- ---------------------
Revenues $ 142,156,099 $ 162,489,565 $ 177,663,524
Cost of goods sold 131,129,110 152,375,349 168,059,905
---------------- ---------------------- ---------------------
Gross profit 11,026,989 10,114,216 9,603,619
Selling, general and administrative expenses
Legal and professional fees 1,568,002 2,597,065 1,917,562
Salaries and payroll related expenses 1,646,308 2,466,576 2,439,333
Other 1,132,546 1,325,276 1,455,610
---------------- ---------------------- ---------------------
4,346,856 6,388,917 5,812,505
Loss on sale of CNG assets - - ( 500,000)
Asset impairment charge - - ( 324,041)
---------------- ---------------------- ---------------------
Operating income 6,680,133 3,725,299 2,967,073
Other income (expense)
Interest and LPG and Fuel Products financing expense ( 2,538,395) ( 1,757,664) ( 1,445,188)
Interest income 27,550 95,327 63,449
Settlement of litigation - ( 145,153) -
Other income - - 210,000
---------------- ---------------------- ---------------------
Income before taxes 4,169,288 1,917,809 1,795,334
Provision (benefit) for income taxes 46,693 ( 40,000) ( 2,992)
---------------- ---------------------- ---------------------
Net income $ 4,122,595 $ 1,957,809 $ 1,798,326
================ ====================== =====================
Net income per common share $ 0.28 $ 0.13 $ 0.12
================ ====================== =====================
Net income per common share assuming dilution $ 0.27 $ 0.13 $ 0.12
================ ====================== =====================
Weighted average common shares outstanding 14,766,115 15,035,220 15,305,500
================ ====================== =====================
The accompanying notes are an integral part of these statements.
52
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31
2002 2003 2004
---------------------- ------------------------- ----------------------
Shares Amount Shares Amount Shares Amount
----------- --------- ----------- ------------ ----------- ---------
PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
=========== ========= =========== ============ =========== =========
Ending balance - $ - - $ - - $ -
=========== ========= =========== ============ =========== =========
SENIOR PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
=========== ========= =========== ============ =========== =========
Ending balance - $ - - $ - - $ -
=========== ========= =========== ============ =========== =========
COMMON STOCK
Beginning balance 14,427,011 $144,270 14,870,977 $ 148,709 15,274,749 $152,747
Issuance of common stock upon exercise of warrants
in exchange for debt obligations owed to the holder
of the warrants - August 2001 37,500 375 - - - -
Issuance of common stock upon exercise of warrants
in exchange for debt obligations owed to the holder
of the warrants - September 2001 275,933 2,759 - - - -
Issuance of common stock in connection with bonus
- September 2001 1,000 10 - - - -
Issuance of common stock for services - September
2001 37,500 375 - - - -
Receipt of stock for payment of indebtedness -
October 2001 ( 36,717) ( 367) - - - -
Issuance of common stock upon exercise of warrants
- November 2001 78,750 787 - - - -
Issuance of common stock upon exercise of warrants
- June 2002 25,000 250 - - - -
Issuance of common stock upon exercise of warrants
- July 2002 25,000 250 - - - -
Receipt of stock for payment of indebtedness -
December 2002 - - ( 7,620) ( 76) - -
Issuance of common stock upon exercise of warrants
in exchange for debt obligations owed to the holder
of the warrants - March 2003 - - 250,000 2,500 - -
Issuance of common stock in exchange for debt
obligations - March 2003 - - 161,392 1,614 - -
Issuance of common stock as part of severance
package - August 2003 - - - - 21,818 218
Issuance of common stock upon exercise of warrants -
September 2003 - - - - 6,250 63
Issuance of common stock upon exercise of warrants -
October 2003 - - - - 26,000 260
Issuance of common stock upon exercise of cashless
warrants - October 2003 - - - - 17,568 176
Issuance of common stock upon exercise of warrants
- November 2003 - - - - 16,625 166
Receipt of stock in payment of note receivable -
January 2004 - - - - ( 77,765) ( 778)
----------- --------- ----------- ------------ ----------- ---------
Ending balance 14,870,977 $148,709 15,274,749 $ 152,747 15,285,245 $152,852
=========== ========= =========== ============ =========== =========
The accompanying notes are an integral part of these statements.
53
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
2002 2003 2004
----------------- ----------------- -------------------
Amount Amount Amount
----------------- ----------------- -------------------
ADDITIONAL PAID-IN CAPITAL
Beginning balance $ 25,833,822 $ 26,919,674 $ 28,298,301
Sale of common stock - 401,866 -
Loan discount related to detachable warrants 207,283 384,665 167,170
Grant of stock for bonus 2,790 - -
Grant of stock for services 149,625 - -
Receipt of stock for payment of indebtedness ( 146,502) ( 30,404) -
Exercise of warrants 872,967 622,500 121,699
Cost of registering securities ( 311) - -
Grant of stock for severance - - 75,054
Exercise of cashless warrants - - ( 176)
Receipt of stock in payment of note receivable - - ( 201,076)
----------------- ----------------- -------------------
Ending balance $ 26,919,674 $ 28,298,301 $ 28,460,972
================= ================= ===================
STOCKHOLDERS' NOTES
Beginning balance $ ( 3,986,048) $ ( 4,014,481) $ ( 2,897,520)
Note receivable from an officer and director of the
Company ( 200,000) 200,000 -
Reserve of interest 24,698 - -
Reduction in notes receivable 146,869 30,480 169,520
Forgiveness of note receivable in connection with
severance pay - 448,077 -
Receipt of assets for cancellation of note receivable - 438,404 -
----------------- ----------------- -------------------
Ending balance $ ( 4,014,481) $ ( 2,897,520) $ ( 2,728,000)
================= ================= ===================
ACCUMULATED DEFICIT
Beginning balance $ ( 17,114,195) $ ( 12,991,600) $ ( 11,033,791)
Net income for the year 4,122,595 1,957,809 1,798,326
----------------- ----------------- -------------------
Ending balance $ ( 12,991,600) $ ( 11,033,791) $ ( 9,235,465)
================= ================= ===================
The accompanying notes are an integral part of these statements.
54
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31
2002 2003 2004
---------------- ---------------- ----------------
Cash flows from operating activities:
Net income $ 4,122,595 $ 1,957,809 $ 1,798,326
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 843,436 976,054 942,754
Amortization of lease rights 45,795 45,795 45,795
Non-employee stock based costs and other 374,870 166,537 124,870
Amortization of loan discount related to detachable warrants 956,853 240,043 137,323
Gain on sale of land ( 17,001) - -
Gain on sale of equipment - ( 231,925) -
Gain on settlement of litigation - ( 50,000) -
Interest expense associated with exchange of debt - 68,000 -
Interest income - officer note - ( 67,241) -
Salaries and payroll related expenses - 523,349 -
Loss on sale of CNG assets - - 500,000
Asset impairment charge - - 324,041
Other 33,281 58,834 ( 163)
Changes in current assets and liabilities:
Trade accounts receivable ( 2,856,873) 3,510,529 ( 2,063,609)
Inventories 11,246,407 60,590 ( 754,910)
Prepaid and other current assets ( 180,697) ( 387,992) 140,719
LPG trade accounts payable ( 793,393) ( 1,592,334) 280,630
Obligation to deliver LPG ( 11,495,333) - -
Other accounts payable and accrued liabilities 155,671 ( 737,343) ( 570,952)
Foreign taxes payable - 60,000 ( 54,806)
---------------- ---------------- ----------------
Net cash provided by operating activities 2,435,611 4,600,705 850,018
Cash flows from investing activities:
Capital expenditures ( 789,069) ( 534,883) ( 19,416)
Sale of land 72,001 - -
Proceeds from sale of equipment - 368,303 -
Property held for sale - - 220,000
Decrease in other non-current assets 158,599 134,296 ( 9,726)
Reduction in note receivable ( 224,698) - -
---------------- ---------------- ----------------
Net cash (used in) provided by investing activities ( 783,167) ( 32,284) 190,858
Cash flows from financing activities:
Decrease (increase) in restricted cash 942,174 ( 3,375,081) ( 2,909,289)
Revolving credit facilities 150,000 ( 150,000) 2,688,553
Issuance of debt 381,032 584,711 365,969
Issuance of common stock 287,511 - 122,188
Costs of registration ( 568) - -
Reduction in debt ( 3,632,324) ( 1,687,941) ( 995,287)
---------------- ---------------- ----------------
Net cash used in financing activities ( 1,872,175) ( 4,628,311) ( 727,866)
---------------- ---------------- ----------------
Net (decrease) increase in cash ( 219,731) ( 59,890) 313,010
Cash at beginning of period 350,685 130,954 71,064
---------------- ---------------- ----------------
Cash at end of period $ 130,954 $ 71,064 $ 384,074
================ ================ ================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 1,756,998 $ 1,522,960 $ 1,285,052
================ ================ ================
Taxes $ - $ - $ 72,500
================ ================ ================
Supplemental disclosures of noncash transactions:
Equity - common stock and warrants issued and other $ 974,915 $ 1,345,145 $ 501,655
================ ================ ================
Common stock exchange for note receivable $ (146,869) $ (30,480) $ (169,520)
================ ================ ================
Mortgage receivable $( 851) $ 1,935,723 $ -
================ ================ ================
Equipment exchanged for notes receivable $ - $ 720,000 $ -
================ ================ ================
The accompanying notes are an integral part of these statements.
55
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION
Penn Octane Corporation, formerly known as International Energy Development
Corporation (International Energy), was incorporated in Delaware in August
1992. Penn Octane Corporation and its consolidated subsidiaries are
hereinafter referred to as the Company. The Company has been principally
engaged in the purchase, transportation and sale of liquefied petroleum gas
(LPG). The Company owns and operates a terminal facility in Brownsville,
Texas (Brownsville Terminal Facility) and owns a LPG terminal facility in
Matamoros, Tamaulipas, Mexico (Matamoros Terminal Facility) and
approximately 23 miles of pipelines (US - Mexico Pipelines) which connect
the Brownsville Terminal Facility to the Matamoros Terminal Facility. The
Company has a long-term lease agreement for approximately 132 miles of
pipeline (Leased Pipeline) which connects ExxonMobil Corporation's (Exxon)
King Ranch Gas Plant in Kleberg County, Texas and Duke Energy's La Gloria
Gas Plant in Jim Wells County, Texas, to the Company's Brownsville Terminal
Facility. In addition, the Company has access to a twelve-inch pipeline
(ECCPL), which connects from Exxon's Viola valve station in Nueces County,
Texas to the inlet of the King Ranch Gas Plant as well as existing and
other potential propane pipeline suppliers which have the ability to access
the ECCPL. In connection with the Company's lease agreement for the Leased
Pipeline, the Company may access up to 21,000,000 gallons of storage,
located in Markham, Texas (Markham), as well as other potential propane
pipeline suppliers, via approximately 155 miles of pipeline located between
Markham and the Exxon King Ranch Gas Plant.
The Company commenced commercial operations for the purchase, transport and
sale of LPG in the fiscal year ended July 31, 1995, upon construction of
the Brownsville Terminal Facility. The primary market for the Company's LPG
is the northeastern region of Mexico, which includes the states of
Coahuila, Nuevo Leon and Tamaulipas. Since operations commenced, the
Company's primary customer for LPG has been P.M.I. Trading Limited (PMI).
PMI is a subsidiary of Petroleos Mexicanos, the state-owned Mexican oil
company, which is commonly known by its trade name "PEMEX." PMI is the
exclusive importer of LPG into Mexico. The LPG purchased by PMI from the
Company is sold to PEMEX which distributes the LPG purchased from PMI into
the northeastern region of Mexico. Sales of LPG to PMI accounted for
approximately 78%, 82% and 80% of the Company's total revenues for the
years ended July 31, 2002, 2003 and 2004, respectively.
During June 2004, the Company began operations as a reseller of gasoline
and diesel fuel (Fuel Products). The Company sells Fuel Products (Fuel
Sales Business) through transactional, bulk and/or rack transactions.
Typical transactional and bulk sales are made based on a predetermined net
spread between the purchase and sales price over posted monthly variable
prices and/or daily spot prices. Rack sales transactions are based on
variable sale prices charged by the Company which are tied to posted daily
spot prices and purchase costs which are based on a monthly average or 3
day average based on posted prices. The Company pays pipeline and terminal
fees based on regulated rates.
The Company has the ability to access to certain pipeline and terminal
systems located in California, Arizona, Nevada and Texas, where it is able
to deliver its Fuel Products.
For bulk and transactional sales, the Company enters into individual sales
contracts for each sale. Rack sales are subject to credit limitations
imposed on each individual buyer by the Company. The Company has several
supply contracts for each of the Fuel Products it sells. The supply
contracts are for annual periods with flexible volumes but they may be
terminated sooner by the supplier if the Company consistently fails to
purchase minimum volumes of Fuel Products.
56
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION - CONTINUED
On September 30, 2004, Penn Octane Corporation (Penn Octane) completed a
series of transactions involving (i) the transfer of substantially all of
its owned pipeline and terminal assets in Brownsville and Matamoros to its
wholly owned subsidiary Rio Vista Operating Partnership L.P. and its
subsidiaries (RVOP) (ii) transferred its 99.9% interest in RVOP to its
wholly owned subsidiary Rio Vista Energy Partners L.P. and its subsidiaries
(Rio Vista) and (iii) distributed all of its limited partnership interest
(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 units. The remaining 2% of such
units, which is the general partner interest, is owned and controlled by
Rio Vista GP LLC (General Partner), a wholly owned subsidiary of Penn
Octane, and the General Partner will be responsible for the management of
Rio Vista. Accordingly the Company will have control of Rio Vista by virtue
of its ownership and related voting control of the General Partner and Rio
Vista will be consolidated with the Company and the interests of the
limited partners will be classified as minority interests in the Company's
consolidated financial statements. Subsequent to the Spin-Off, Rio Vista
will sell LPG directly to PMI and will purchase LPG from Penn Octane under
a long-term supply agreement. The purchase price of the LPG from Penn
Octane will be determined based on the cost of LPG under Penn Octane's LPG
supply agreements and a formula that takes into consideration LPG operating
costs of Penn Octane and Rio Vista.
BASIS OF PRESENTATION
-----------------------
The accompanying consolidated financial statements include the Company and
its United States subsidiaries including Rio Vista, Penn Octane
International, L.L.C., PennWilson CNG, Inc. (PennWilson) and Penn CNG
Holdings, Inc. and subsidiaries, its Mexican subsidiaries, Penn Octane de
Mexico, S. de R.L. de C.V. (PennMex), Termatsal, S. de R.L. de C.V.
(Termatsal) and Tergas, S.A. de C.V. (Tergas), a consolidated affiliate,
and its other inactive Mexican subsidiaries, (collectively the Company).
All significant intercompany accounts and transactions are eliminated.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows.
1. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
on the first-in, first-out method.
2. PROPERTY, PLANT AND EQUIPMENT AND LEASE RIGHTS
Property, plant and equipment are recorded at cost. After being placed into
service, assets are depreciated and amortized using the straight-line
method over their estimated useful lives as follows:
LPG terminals, building and leasehold improvements (a) 8 to 19 years
Automobiles 3-5 years
Furniture, fixtures and equipment 3-5 years
Pipelines 30 years
(a) Brownsville Terminal related assets are depreciated over their
estimated useful lives, not to exceed the term of the Pipeline Lease
(see note L).
The lease rights of $1,154,039 are being amortized over 19 years which
corresponds with the life of lease of the Leased Pipeline. Annual
amortization expense is $45,795 ($228,975 for five years).
Maintenance and repair costs are charged to expense as incurred.
57
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
2. PROPERTY, PLANT AND EQUIPMENT AND LEASE RIGHTS - CONTINUED
In August 2001 Statement of Financial Accounting Standards (SFAS) No. 144
(SFAS 144) "Accounting for the Impairment or Disposal of Long-Lived Assets"
was issued. SFAS 144 supersedes the provisions of Statement of Financial
Accounting Standards No. 121 (SFAS 121) "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to be Disposed Of". SFAS 144
requires the Company to review long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If it
is determined that an impairment has occurred, the amount of the impairment
is charged to operations. No impairments were recognized for the years
ended July 31, 2002 and 2003. For the year ended July 31, 2004 impairments
recognized totaled $324,041 and are included in the consolidated statements
of operations under asset impairment charge (see note F).
3. INCOME TAXES
The Company will file a consolidated income tax return for the year ended
July 31, 2004.
The Company accounts for deferred taxes in accordance with SFAS 109,
"Accounting for Income Taxes". Under the liability method specified
therein, deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax bases of assets and
liabilities as measured by the enacted tax rates which will be in effect
when these differences reverse. Deferred tax expense is the result of
changes in deferred tax assets and liabilities. The principal types of
differences between assets and liabilities for financial statement and tax
return purposes are the allowance for doubtful accounts receivable,
amortization of deferred interest costs, accumulated depreciation and
deferred compensation expense.
The foreign subsidiaries are taxed on their income directly by the Mexican
Government. Such foreign subsidiaries are not included in the U.S.
consolidated income tax return of the Company. Consequently U.S. income tax
effect will occur only when dividend distributions of earnings and profits
of the foreign subsidiaries are received by the Company.
4. INCOME (LOSS) PER COMMON SHARE
Income (loss) per share of common stock is computed on the weighted average
number of shares outstanding in accordance with SFAS 128, "Earnings Per
Share". During periods in which the Company incurred losses, giving effect
to common stock equivalents is not presented as it would be antidilutive.
5. CASH EQUIVALENTS
For purposes of the cash flow statement, the Company considers cash in
banks and securities purchased with a maturity of three months or less to
be cash equivalents.
6. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
58
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments", requires
the disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable
to estimate the value. SFAS 107 excludes certain financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
are not intended to represent the underlying value of the Company. The
carrying amounts of cash and cash equivalents, current receivables and
payables approximate fair value because of the short-term nature of these
instruments. Note receivable and long-term liabilities approximate fair
value because they bear market rates of interest.
8. STOCK-BASED COMPENSATION
SFAS 123 and SFAS 148, "Accounting for Stock-Based Compensation" and
"Accounting for Stock-Based Compensation-Transition and Disclosure",
establishes financial accounting and reporting standards for stock-based
employee compensation plans and for transactions in which an entity issues
its equity instruments to acquire goods and services from non-employees.
Under the guidance provided by SFAS 123, the Company has elected to
continue to account for employee stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board (APB) 25,
"Accounting for Stock Issued to Employees", and related Interpretations.
Had compensation cost related to the warrants granted to employees been
determined based on the fair value at the grant dates, consistent with the
provisions of SFAS 123, the Company's pro forma net income (loss), and net
income (loss) per common share would have been as follows for the years
ended July 31,:
2002 2003 2004
-------------- -------------- ----------------
Net income (loss) as reported $ 4,122,595 $ 1,957,809 $ 1,798,326
Less: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects ( 2,013,203) ( 1,317,073) ( 97,267)
-------------- -------------- ----------------
Net income (loss) pro forma 2,109,392 640,736 1,701,059
Net income (loss) per common share, as reported .28 .13 .12
Net income (loss) per common share, pro forma .14 .04 .11
Net income (loss) per common share assuming
dilution, as reported .27 .13 .12
Net income (loss) per common share assuming
dilution, pro forma .14 .04 .11
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2002, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0% expected
volatility of 87%; risk free interest rate of 3.59% and 4.72% depending on
expected lives; and expected lives of 5 years.
59
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
8. STOCK-BASED COMPENSATION - CONTINUED
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2003, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 80%; risk free interest rate of 1.75% and 1.81%
depending on expected lives; and expected lives of 5 years.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2004, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 72% to 81%; risk free interest rate of 3.22% and
3.27%; and expected lives of 5 years.
9. REVENUE RECOGNITION ON SALES OF LPG AND FUEL PRODUCTS
Revenues are recorded based on the following criteria:
(1) Persuasive evidence of an arrangement exists and the price is
determined
(2) Delivery has occurred
(3) Collectibility is reasonably assured
Any amounts collected from customers for which the delivery has not
occurred are recorded as an obligation to deliver LPG or Fuel Products in
the consolidated balance sheet. Losses, if any, resulting from inventory
imbalances from such sales are recognized currently, and gains, if any, are
recognized at final delivery.
10. FOREIGN CURRENCY TRANSLATION
The Company follows FASB No. 52 "Foreign Currency Translation" in
consolidation of the Company's Mexican subsidiaries, whose functional
currency is the US dollar. Non monetary balance sheet items and related
revenue and expense are remeasured using historical rates. Monetary balance
sheet items and related revenue and expense are remeasured using exchange
rates in effect at the balance sheet dates.
11. FINANCIAL INSTRUMENTS
The Company has adopted SFAS 133, "Accounting for Derivative Instruments
and Hedging Activities", which requires that all derivative financial
instruments be recognized in the financial statements and measured at fair
value regardless of the purpose or intent for holding them. Changes in the
fair value of derivative financial instruments are either recognized
periodically in income or stockholders' equity (as a component of
comprehensive income), depending on whether the derivative is being used to
hedge changes in fair value or cash flows. In April 2003, the FASB issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities". SFAS No. 149 amends and clarifies financial accounting
and reporting for derivative instruments and hedging activities. SFAS No.
149 is effective for contracts entered into or modified after June 30, 2003
and is effective for hedging relationships designed after June 30, 2003. At
July 31, 2002, 2003 and 2004 the Company had no derivative financial
instruments.
60
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
12. RECLASSIFICATIONS
Certain reclassifications have been made to prior year balances to conform
to the current presentation.
13. NON-EMPLOYEE STOCK-BASED COMPENSATION
The Company routinely issues warrants to purchase common stock to
non-employees for goods and services and to acquire or extend debt. The
Company applies the provisions of SFAS 123 and APB 14 to account for such
transactions. SFAS 123 requires that such transactions be accounted for at
fair value. If the fair value of the goods and services or debt related
transactions are not readily measurable, the fair value of the warrants is
used to account for such transactions.
14. TRADE ACCOUNTS AND NOTES RECEIVABLE AND ALLOWANCE FOR DOUBTFUL
ACCOUNTS
Trade accounts and notes receivable are accounted for at fair value. Trade
accounts receivable do not bear interest and are short-term in nature.
Notes receivable bear interest at prevailing market rates at the time of
issuance. An allowance for doubtful accounts for trade accounts receivable
and notes receivable is established when the fair value is less than the
carrying value. Trade accounts receivable and notes receivable are charged
to the allowance when management determines that collection is remote. An
allowance for uncollected interest income is established for interest
income on notes receivable when the notes receivable are contractually past
due.
15. CONSOLIDATION OF VARIABLE INTEREST ENTITIES
During 2004, the Company 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 the Company, is a VIE and therefore, its assets,
liabilities and results of operations have been included in the
accompanying consolidated financial statements of the Company.
61
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE
The following tables present reconciliations from income (loss) per common
share to income (loss) per common share assuming dilution (see note K for
the warrants):
For the year ended July 31, 2002
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Net income (loss) $ 4,122,595
BASIC EPS
Net income (loss) available to common
stockholders 4,122,595 14,766,115 $ 0.28
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 351,424
-------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 4,122,595 15,117,539 $ 0.27
============== ============= ==========
For the year ended July 31, 2003
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Net income (loss) $ 1,957,809
BASIC EPS
Net income (loss) available to common
stockholders 1,957,809 15,035,220 $ 0.13
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 80,610
-------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,957,809 15,115,830 $ 0.13
============== ============= ==========
For the year ended July 31, 2004
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Net income (loss) $ 1,798,326
BASIC EPS
Net income (loss) available to common
stockholders 1,798,326 15,305,500 $ 0.12
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 6,141
-------------- -------------
DILUTED EPS
Net income (loss) available to common
stockholders $ 1,798,326 15,311,641 $ 0.12
============== ============= ==========
62
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - NOTES FROM RELATED PARTIES
During April 1997, Mr. Jerome B. Richter, the Company's Chief Executive
Officer, Chairman of the Board and former President, exercised warrants to
purchase 2,200,000 shares of common stock of Penn Octane, at an exercise
price of $1.25 per share. The consideration for the exercise of the
warrants included $22,000 in cash and a $2,728,000 promissory note. The
note was due on April 11, 2000. On April 11, 2000, Mr. Richter's issued a
new promissory note totaling $3,196,693 (Mr. Richter's Promissory Note),
representing the total unpaid principal and unpaid accrued interest at the
expiration of the original promissory note. During September 1999, the
Board of Directors of the Company agreed to offset interest due on Mr.
Richter's Promissory Note in consideration for providing collateral and
personal guarantees of Company debt. The principal amount of the note plus
accrued interest at an annual rate of 10.0%, except as adjusted for above,
was due on April 30, 2001. In November 2001 the Company extended the due
date to October 31, 2003 and the interest was adjusted to the prime rate on
November 7, 2001 (5.0%). In July 2002 the Company extended the due date to
July 29, 2005 and the interest rate was adjusted to the prime rate plus 1%
on July 24, 2002 (5.75%). In connection with the extension, the Company
agreed in Mr. Richter's employment agreement (see note L) to continue to
forgive any interest due from Mr. Richter pursuant to Mr. Richter's
Promissory Note, provided that Mr. Richter guarantees at least $2,000,000
of the Company's indebtedness during any period of that fiscal year of the
Company. Furthermore, the Company agreed to forgive Mr. Richter's
Promissory Note in the event that either (a) the share price of Penn
Octane's common stock trades for a period of 90 days at a blended average
price equal to at least $6.20, or (b) the Company is sold for a price per
share (or an asset sale realizes revenues per share) equal to at least
$6.20. Mr. Richter is personally liable with full recourse to the Company
and has provided 1,000,000 shares of common stock of Penn Octane as
collateral. As a result of the Spin-Off he is also required to provide
125,000 Common Units of Rio Vista owned by him (see note S). Those shares
were subsequently pledged as collateral to the holders of certain of the
Company's debt obligations (see note I). Mr. Richter's Promissory Note has
been recorded as a reduction of stockholders' equity.
On March 26, 2000, the wife of Jorge Bracamontes, a director and executive
officer of the Company, issued the Company a new promissory note totaling
$46,603, representing the total unpaid principal and interest due under a
prior promissory note due to the Company which matured March 26, 2000. The
principal amount of the note plus accrued interest at an annual rate of
10.0% was due in April 2001. During November 2001, the Company and the wife
of Mr. Bracamontes agreed to exchange 1,864 shares of common stock of Penn
Octane held by the wife of Mr. Bracamontes for payment of all unpaid
interest owing to the Company through October 2001. In addition, the
Company agreed to extend the maturity date of the note held by the wife of
Mr. Bracamontes to October 31, 2003. The wife of Mr. Bracamontes was
personally liable with full recourse under such promissory note and had
provided the remaining 13,136 shares of common stock of Penn Octane as
collateral.
During March 2000, Mr. Bracamontes exercised warrants to purchase 200,000
shares of common stock of Penn Octane, at an exercise price of $2.50 per
share. The consideration for the exercise of the warrants included $2,000
in cash and a $498,000 promissory note. The principal amount of the note
plus accrued interest at an annual rate of 10.0% was due in April 2001.
During November 2001, the Company and Mr. Bracamontes agreed to exchange
19,954 shares of common stock of Penn Octane held by Mr. Bracamontes for
payment of all unpaid interest owing to the Company through October 2001.
In addition, the Company agreed to extend the maturity date of the note
held by Mr. Bracamontes to October 31, 2003. Mr. Bracamontes was personally
liable with full recourse under such promissory note and had provided the
remaining 180,036 shares of common stock of Penn Octane as collateral.
63
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - NOTES FROM RELATED PARTIES - CONTINUED
During July 2003, Mr. Bracamontes resigned from his position as a director
and officer of the Company. In connection with his resignation the Company
agreed to (i) forgive the remaining balance of his $498,000 promissory
note, (ii) forgive the remaining balance of his wife's $46,603 promissory
note, (iii) issue 21,818 shares of Penn Octane's common stock (valued at
approximately $75,000), and (iv) make certain payments of up to $500,000
based on the success of future projects (Mr. Richter agreed to guarantee
these payments with 100,000 of his shares of the common stock of Penn
Octane). Mr. Bracamontes continued to provide services and the Company paid
Mr. Bracamontes $15,000 a month through March 31, 2004. All of the above
amounts totaling approximately $520,000 and $120,000 were reflected in the
consolidated financial statements as of July 31, 2003 and 2004,
respectively as salaries and payroll related expenses. Simultaneously, Mr.
Bracamontes sold his interest in Tergas, S.A. de C.V. (a consolidated
affiliate of the Company) to another officer of the Company, Vicente
Soriano. The Company has an option to acquire Tergas, S.A. de C.V. (Tergas)
for a nominal price of approximately $5,000.
During September 2000, Mr. Ian Bothwell, a director and executive officer
of the Company, exercised warrants to purchase 200,000 shares of common
stock of Penn Octane's, at an exercise price of $2.50 per share. The
consideration for the exercise of the warrants included $2,000 in cash and
a $498,000 promissory note. The principal amount of the note plus accrued
interest at an annual rate of 10.5% was due in April 2001. During November
2001, the Company and Mr. Bothwell agreed to exchange 14,899 shares of
common stock of Penn Octane held by Mr. Bothwell for payment of all unpaid
interest owing to the Company through October 2001. In addition, the
Company agreed to extend the maturity date of the note held by Mr. Bothwell
to October 31, 2003.
On September 10, 2000, the Board of Directors approved the repayment by a
company controlled by Mr. Bothwell (Buyer) of the $900,000 promissory note
to the Company through the exchange of 78,373 shares of common stock of
Penn Octane owned by the Buyer, which were previously pledged to the
Company in connection with the promissory note. The exchanged shares had a
fair market value of approximately $556,000 at the time of the transaction
resulting in an additional loss of $84,000 which was included in the
consolidated statement of operations at July 31, 2000. The remaining note
had a balance of $214,355 and was collateralized by compressed natural gas
refueling station assets and 60,809 shares of Penn Octane's common stock
owned by the Buyer.
During October 2002, the Company agreed to accept the compressed natural
gas refueling station assets with an appraised fair value of approximately
$800,000 as payment for all notes outstanding at the time (with total
principal amount of $652,759 plus accrued interest) owed to the Company by
Mr. Bothwell. In connection with the transaction, the Company adjusted the
fair value of the assets to $720,000 to reflect additional costs estimated
to be incurred in disposing of the assets. The Company also recorded
interest income as of July 31, 2003 on the notes of approximately $67,241,
which has been previously been reserved, representing the difference
between the adjusted fair value of the assets and the book value of the
notes.
In January 2002, the Company loaned Mr. Richter, $200,000 due in one year.
The Company had also made other advances to Mr. Richter of approximately
$82,000 as of July 31, 2002, which were offset per his employment agreement
against accrued and unpaid bonuses due to Mr. Richter. The note due from
Mr. Richter in the amount of $200,000 plus accrued interest as of January
31, 2003, was paid through an offset against previously accrued bonus and
profit sharing amounts due to Mr. Richter in January 2003.
64
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE E - ASSETS HELD FOR SALE
During February 2004, the Company sold all of its compressed natural gas
(CNG) equipment to a third party for $220,000. The purchase price was paid
in cash. Under the terms of the sales agreement, the equipment was sold "as
is". During the year ended July 31, 2004, a loss of $500,000 was recognized
and is included in the accompanying consolidated statements of operations
under loss on sale of CNG assets.
NOTE F - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following as of July 31, :
2003 2004
-------------- --------------
LPG:
Midline pump station $ 2,443,988 $ 2,326,985
Brownsville Terminal Facility: (a)
Building 173,500 173,500
Terminal facilities 3,631,207 3,631,207
Tank Farm 373,945 373,945
Leasehold improvements 302,657 302,657
Capital construction in progress 96,212 -
Equipment 226,285 226,285
Truck - 25,968
-------------- --------------
7,247,794 7,060,547
-------------- --------------
US - Mexico Pipelines and Matamoros Terminal
Facility: (a)
U.S. Pipelines and Rights of Way 6,680,242 6,775,242
Mexico Pipelines and Rights of Way 993,300 993,300
Matamoros Terminal Facility 5,318,925 5,874,781
Saltillo Terminal 815,856 -
Land 856,358 856,358
-------------- --------------
14,664,681 14,499,681
-------------- --------------
Total LPG 21,912,475 21,560,228
-------------- --------------
Other:
Office equipment 93,201 106,953
Software 75,890 77,590
-------------- --------------
169,091 184,543
-------------- --------------
22,081,566 21,744,771
Less: accumulated depreciation and amortization ( 4,403,736) ( 5,346,491)
-------------- --------------
$ 17,677,830 $ 16,398,280
============== ==============
(a) See note S.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (Saltillo Terminal). The Company was
unable to receive all the necessary approvals to operate the facility at
that location. The terminal was subsequently dismantled.
The Company has accounted for the Saltillo Terminal at cost. The cost
included in the balance sheet is comprised primarily of dismantled pipe,
dismantled steel structures, steel storage tanks, pumps and compressors and
capitalized engineering costs related to the design of the terminal. The
cost of dismantling the terminal at the Saltillo location was expensed and
on-going storage fees have also been expensed.
65
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - PROPERTY, PLANT AND EQUIPMENT - CONTINUED
As a result of the reduced volumes of LPG being sold to PMI and the
short-term nature of the agreements, (see note P), the Company has
determined that construction of a new Saltillo Terminal is currently not
feasible. Accordingly, as of July 31, 2004, the Company has written off
$227,829 related to the capitalized engineering costs and other costs
associated with the design of the Saltillo Terminal and expensed $32,171 of
costs related to pipes, pumps and values which were used as replacement
parts in the Matamoros Terminal Facility. The Company anticipates utilizing
the remaining Saltillo Terminal assets in its existing operations.
Depreciation and amortization expense of property, plant and equipment
totaled $843,435, $976,055 and $942,754 for the years ended July 31, 2002,
2003 and 2004, respectively.
Property, plant and equipment, net of accumulated depreciation, includes
$6,427,387 and $5,870,750 of costs, located in Mexico at July 31, 2003 and
2004, respectively.
NOTE G - INVENTORIES
Inventories consist of the following as of July 31,:
2003 2004
------------------- ---------------------
Gallons LCM Gallons LCM
--------- -------- --------- ----------
LPG:
Leased Pipeline 1,175,958 $638,623 1,175,958 $ 887,815
Brownsville Terminal Facility,
Matamoros Terminal Facility
and railcars 440,771 239,368 257,665 194,530
Markham Storage and other 168 91 - -
--------- -------- --------- ----------
1,616,897 878,082 1,433,623 1,082,345
========= =========
Fuel Products - - 433,566 550,647
========= -------- ========= ----------
$878,082 $1,632,992
======== ==========
66
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - INCOME TAXES
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets and liabilities were as follows at July 31,:
2003 2004
---------------------------------------- ----------------------------------------
Assets Liabilities Assets Liabilities
------------------- ------------------- ------------------- -------------------
Depreciation $ - $ 321,000 $ - $ 376,000
Bad debt reserve 2,000 - - -
Asset basis differences - - 33,000 -
Alternative minimum tax credits 84,000 - 114,000 -
Deferred interest cost 990,000 - 537,000 -
Deferred other cost 229,000 - 272,000 -
Rio Vista Registration costs 110,000 - 110,000 -
Net operating loss carryforward 2,197,000 - 1,599,000 -
------------------- ------------------- ------------------- -------------------
3,612,000 321,000 2,665,000 376,000
Less: valuation allowance 3,612,000 321,000 2,665,000 376,000
------------------- ------------------- ------------------- -------------------
$ - $ - $ - $ -
=================== =================== =================== ===================
There was no current U.S. income tax expense for the years ended July 31,
2002, 2003 and 2004 due to the utilization of net operating loss
carryforwards. There was no deferred U.S. income tax expense for the years
ended July 31, 2002, 2003 and 2004. The Company did incur U.S. alternative
minimum tax for the year ended July 31, 2004 totaling $53,084. The Company
has estimated a Mexican income tax benefit of approximately $56,000 for the
year ended July 31, 2004. The Mexican subsidiaries file their income tax
returns on a calendar year basis.
Management believes that the valuation allowance reflected above is
appropriate because of the uncertainty that sufficient taxable income will
be generated in future taxable years by the Company to absorb the entire
amount of such net operating losses. However, should taxable income arise
as a result of the Spin-Off discussed in note R, the net operating losses
are available to reduce this taxable income.
At July 31, 2004, the approximate amount of net operating loss
carryforwards and expiration dates for U.S. income tax purposes were as
follows:
Year ending Tax Loss
July 31, Carryforward
----------- -------------
2021 $ 4,705,000
-------------
$ 4,705,000
=============
Future changes in ownership, as defined by section 382 of the Internal
Revenue Code, could limit the amount of net operating loss carryforwards
used in any one year.
67
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS
Restructuring of Notes
------------------------
From December 10, 1999 through January 18, 2000, and on February 2, 2000,
the Company completed a series of related transactions in connection with
the private placement of $4,944,000 and $710,000, respectively, of
subordinated notes (Notes) which were due the earlier of December 15, 2000,
or upon the receipt of proceeds by the Company from any future debt or
equity financing in excess of $2,250,000 (see below). Interest at 9% was
due and paid on June 15, 2000 and December 15, 2000. In connection with the
Notes, the Company granted the holders of the Notes, warrants (Warrants) to
purchase a total of 706,763 shares of common stock of Penn Octane at an
exercise price of $4.00 per share, exercisable through December 15, 2002.
During December 2000, the Company entered into agreements (Restructuring
Agreements) with the holders of $5,409,000 in principal amount of the Notes
providing for the restructuring of such Notes (Restructuring). The
remaining $245,000 balance of the Notes was paid.
Under the terms of the Restructuring Agreements, the due dates for the
restructured Notes (Restructured Notes) were extended to December 15, 2001,
subject to earlier repayment upon the occurrence of certain specified
events provided for in the Restructured Notes. Additionally, beginning
December 16, 2000, the annual interest rate on the Restructured Notes was
increased to 13.5% (subject to the adjustments referred to below). Interest
payments were paid quarterly beginning March 15, 2001.
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares
of common stock of Penn Octane at an exercise price of $3.00 per share and
exercisable until December 15, 2003 (New Warrants). The Company also agreed
to modify the exercise prices of the Warrants to purchase up to 676,137
shares of common stock of Penn Octane previously issued to the holders of
the Restructured Notes in connection with their original issuance from
$4.00 per share to $3.00 per share and extend the exercise dates of the
Warrants from December 15, 2002 to December 15, 2003. In addition, the
Company was required to reduce the exercise price of the Warrants and the
New Warrants issued to the holders of the Restructured Notes from $3.00 per
share to $2.50 per share because the Restructured Notes were not fully
repaid by June 15, 2001.
In connection with the Restructuring Agreements, the Company agreed to
register the shares of common stock which may be acquired in connection
with the exercise of the New Warrants (Exercisable Shares) by March 31,
2001. In connection with the Company's obligations under the Restructured
Notes, the Company's registration statement containing the Exercisable
Shares was declared effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral
to secure the Company's payment obligations under the Restructured Notes
consisting of a senior interest in substantially all of the Company's
assets which are located in the United States (US Assets) and Mexico
(Mexican Assets), excluding inventory, accounts receivable and sales
contracts with respect to which the Company is required to grant a
subordinated security interest (collectively referred to as the
Collateral). Mr. Richter has also pledged 2,000,000 shares of common stock
of Penn Octane owned by Mr. Richter (1,000,000 shares to be released when
the required security interests in the US Assets have been granted and
perfected and all the shares are to be released when the required security
interests in all of the Collateral have been granted and perfected). The
granting and perfection of the security interests in the Collateral, as
prescribed under the Restructured Notes, have not been finalized.
Accordingly, the interest rate under the Restructured Notes increased to
16.5% on March 16, 2001. The release of the first 1,000,000 shares will be
transferred to the Company as collateral for Mr. Richter's Promissory Note.
Investec PMG Capital, formerly PMG Capital Corp., (Investec) has agreed to
serve as the collateral agent.
68
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Restructuring of Notes - Continued
--------------------------------------
Investec acted as financial advisor for the restructuring of $4,384,000 in
principal amount of the Restructured Notes. Investec received fees
consisting of $131,520 in cash and warrants to purchase 50,000 shares of
common stock of Penn Octane with terms similar to the terms of the New
Warrants. The Company also agreed to modify and extend the exercise date of
warrants to purchase 114,375 shares of common stock of Penn Octane
originally issued to Investec in connection with the original issuance of
the Notes with the same terms as those which were modified in the Warrants
in connection with the Restructuring Agreements.
In connection with the Restructuring Agreements, the Company recorded a
discount of $1,597,140 related to the fair value of the New Warrants
issued, fair value related to the modifications of the Warrants, fees paid
to Investec (including cash, new warrants granted and modifications to
warrants previously granted to Investec in connection with the original
issuance of the Notes) and other costs associated with the Restructuring
Agreements, to be amortized over the life of the Restructured Notes. Total
amortization of discounts related to the Notes and the Restructured Notes
and included in the consolidated statements of operations was $1,670,794,
and $599,475 for the years ended July 31, 2001 and 2002, respectively.
Issuance of New Promissory Notes
------------------------------------
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (New Notes) due December 15, 2001. The
holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of Penn Octane (New Note Warrants). The terms of the New
Notes and New Note Warrants are substantially the same as those contained
in the Restructured Notes and New Warrants issued in connection with the
Restructuring described above. As described above, the Company's payment
obligations under the New Notes are to be secured by the Collateral and the
2,000,000 shares of Penn Octane which are owned by Mr. Richter.
Net proceeds from the New Notes were used for working capital purposes.
In connection with the New Notes, Investec acted as placement agent for the
Company and received cash fees totaling $69,370 and reimbursement of out of
pocket expenses.
In connection with the issuance of the New Notes and New Note Warrants, the
Company recorded a discount of $349,494 related to the fair value of the
New Note Warrants issued, fees paid to Investec and other costs associated
with the private placement, to be amortized over the life of the New Notes.
Total amortization of discounts related to the New Notes and included in
the consolidated statements of operations was $199,398 and $150,096 for the
years ended July 31, 2001 and 2002, respectively.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of Penn Octane were exercised by certain holders of the New
Warrants and New Note Warrants for which the exercise price totaling
$614,833 was paid by reduction of the outstanding debt and accrued interest
related to the New Notes and the Restructured Notes.
69
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Extension of Restructured Notes and New Notes
---------------------------------------------------
During December 2001, the Company and certain holders of the Restructured
Notes and the New Notes (Accepting Noteholders) reached an agreement
whereby the due date for $3,135,000 of principal due on the Accepting
Noteholders' notes was extended to June 15, 2002. In connection with the
extension, the Company agreed to (i) continue paying interest at a rate of
16.5% annually on the Accepting Noteholders' notes, payable quarterly, (ii)
pay the Accepting Noteholders a fee equal to 1% on the principal amount of
the Accepting Noteholders' notes, (iii) modify the warrants held by the
Accepting Noteholders by extending the expiration date to December 14, 2004
and (iv) remove the Company's repurchase rights with regard to the
warrants.
In connection with the extension of the Accepting Noteholders' warrants,
the Company recorded a discount of $207,283, which has been amortized for
the year ended July 31, 2002.
During June 2002, the Company and certain holders of the Restructured Notes
and the New Notes (New Accepting Noteholders) reached an agreement whereby
the due date for approximately $2,985,000 of principal due on the New
Accepting Noteholders' notes were extended to December 15, 2002 (see
below). The New Accepting Noteholders' notes will continue to bear interest
at 16.5% per annum. Interest is payable on the outstanding balances on
specified dates through December 15, 2002. The Company paid a fee of 1.5%
on the principal amount of the New Accepting Noteholders' notes on July 1,
2002. The principal amount and unpaid interest of the Restructured Notes
and/or New Notes which were not extended were paid on June 15, 2002.
During June 2002 the Company issued a note for $100,000 (Additional Note)
to a holder of the Restructured Notes and the New Notes. The $100,000 note
provides for similar terms and conditions as the New Accepting Noteholders'
notes (see below).
Extension of New Accepting Noteholders' Notes and Additional Note
-------------------------------------------------------------------------
During December 2002, the Company and certain holders of New Accepting
Noteholders' notes and holder of the Additional Note (Extending
Noteholders) reached an agreement whereby the due date for $2,730,000 of
principal due on the Extending Noteholders' notes were extended to December
15, 2003. Under the terms of the agreement, the Extending Noteholders'
notes will continue to bear interest at 16.5% per annum. Interest is
payable quarterly on the outstanding balances beginning on March 15, 2003
(the December 15, 2002 interest was paid on January 1, 2003). In addition,
the Company is required to pay principal in equal monthly installments
beginning March 2003 (approximately $1,152,000 of principal was paid
through the period ended April 30, 2003 of which $1,000,000 was reduced in
connection with the exercise of warrants and purchase of common stock - see
below). The Company may prepay the Extending Noteholders' notes at any
time. The Company is also required to pay a fee of 1.5% on the principal
amount of the Extending Noteholders' notes which are outstanding on
December 15, 2002, March 15, 2003, June 15, 2003 and September 15, 2003.
The Company also agreed to extend the expiration date on the warrants held
by the Extending Noteholders in connection with the issuance of the
Extending Noteholders' notes to December 15, 2006. In connection with the
extension of the warrants, the Company recorded a discount of $316,665
related to the additional value of the modified warrants of which $240,043
and $76,622 has been amortized for the years ended July 31, 2003 and 2004,
respectively.
The Company paid the portion of the New Accepting Noteholders' notes which
were not extended, $355,000 plus accrued interest, on December 15, 2002.
70
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Extension of New Accepting Noteholders' Notes and Additional Note -
-------------------------------------------------------------------
Continued
---------
During March 2003, warrants to purchase 250,000 shares of common stock of
Penn Octane were exercised by a holder of the Warrants and New Warrants for
which the exercise price totaling $625,000 was paid by reduction of a
portion of the outstanding debt and accrued interest owed to the holder
related to the Extending Noteholders' notes. In addition, during March
2003, the holder acquired 161,392 shares of common stock of Penn Octane at
a price of $2.50 per share. The purchase price was paid through the
cancellation of the remaining outstanding debt and accrued interest owed to
the holder totaling $403,480. In connection with this transaction the
Company recorded additional interest expense of approximately $68,000
representing the difference between the market value and sales price on the
day of the transaction.
Issuance of Promissory Note
------------------------------
During December 2002, the Company issued a note for $250,000 ($250,000
Note) to a holder of the Extending Noteholders' notes. The note provides
for similar terms and conditions as the Extending Noteholders' notes.
Extension of Certain of the New Accepting Noteholders' Notes, Additional
---------------------------------------------------------------------------
Note and $250,000 Note Totaling $1,525,000 (collectively the Restructured
---------------------------------------------------------------------------
Notes)
------
On January 16, 2004, the Restructured Notes which were due on December 15,
2003 were renewed and extended (Restructuring). In connection with the
Restructuring, the due date of the Restructured Notes was extended to
December 15, 2005. The Restructured Notes can be repaid at any time without
penalty. Annual interest on the Restructured Notes is 16.5% and the Company
also agreed to pay a fee of 1.5% on any principal balance of the
Restructured Notes outstanding at the end of each quarterly period,
beginning December 15, 2003. Interest and fees are payable quarterly
beginning March 15, 2004.
In addition, the Company agreed to extend the expiration date on
outstanding warrants to purchase common stock of Penn Octane held by
holders of the Restructured Notes until December 15, 2008 and agreed to
issue new warrants to purchase Rio Vista Common Units in an amount equal to
2,500 warrants for each $100,000 of Restructured Notes and an additional
2,500 warrants in Rio Vista for each $100,000 of Restructured Notes
outstanding at December 15, 2004 (Rio Vista Warrants). The Rio Vista
Warrants will expire three years from the date of the Spin-Off (see note R)
and the exercise price will be determined based on a formula whereby the
annualization of the first quarterly distribution will represent a 20%
yield on the exercise price. In addition, the Company agreed to issue an
additional 37,500 warrants to purchase shares of common stock of Penn
Octane to certain holders of the Restructured Notes.
Certain holders of promissory notes totaling approximately $280,000 of
principal due December 15, 2003 which did not agree to the Restructuring
(Declining Noteholders) were paid by the Company. In connection with
amounts due to the Declining Noteholders, the Company issued $280,000 of
promissory notes ($280,000 Notes). The terms of the $280,000 Notes are
substantially similar to the Restructured Notes, except that the holders of
the $280,000 Notes were not entitled to receive any warrants to purchase
shares of common stock of Penn Octane.
In addition, holders of the Restructured Notes and $280,000 Notes consented
to the Spin-Off of Rio Vista provided that the assets of Penn Octane to be
transferred to Rio Vista will continue to be pledged as collateral for
payment of the Restructured Notes and $280,000 Notes, Rio Vista guarantees
Penn Octane's obligations under the Restructured Notes and $280,000 Notes
and that Rio Vista is prohibited against making any distributions in the
event that the Company is in default under the Restructured Notes and
$280,000 Notes.
71
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Extension of Certain of the New Accepting Noteholders' Notes, Additional
---------------------------------------------------------------------------
Note and $250,000 Note Totaling $1,525,000 (collectively the Restructured
---------------------------------------------------------------------------
Notes) - Continued
--------------------
In connection with the Restructured Notes and $280,000 Notes, Philadelphia
Brokerage Corporation acted as placement agent and will receive a fee equal
to 1.5% of the Restructured Notes and $280,000 Notes and after the date of
the Spin-Off warrants to purchase 10,000 units in Rio Vista and an
additional 10,000 warrants to purchase 10,000 units in Rio Vista if the
Restructured Notes and $280,000 Notes are not paid by December 15, 2004.
The terms of the warrants are the same as the Rio Vista Warrants.
In connection with the issuance of the new warrants of Penn Octane and the
extension of the warrants of Penn Octane, the Company recorded a discount
of $194,245 related to the fair value of the newly issued, modified
warrants and including fees of $27,075 of which $60,701 has been amortized
through July 31, 2004. The Company will record an additional discount
related to the Rio Vista warrants issued to the holders of the Restructured
Notes and $280,000 Notes when the Company is able to determine the fair
value, if any (see above).
Mr. Richter continues to provide collateral to the Restructured Notes and
the $280,000 Notes noteholders with 2,000,000 shares of common stock of
Penn Octane owed by him. As a result of the Spin-Off he is also required to
provide 250,000 Common Units of Rio Vista owned by him (see note S).
OTHER
During September 2003, the Company entered into a settlement agreement with
one of the holders of a promissory note issued in connection with the
acquisition of the US-Mexico Pipelines and the Matamoros Terminal Facility
whereby the noteholder was required to reimburse the Company for $50,000 to
be paid through the reduction of the final payments of the noteholder's
note (see note L).
Debt consists of the following as of July 31,:
2003 2004
---------- ----------
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility $ 284,731 $ -
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility 198,178 -
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February 2001. 137,500 137,500
Restructured Notes and $280,000 Notes 1,744,128 1,671,456
Other debt 186,524 82,939
---------- ----------
Total debt 2,551,061 1,891,895
Less: Current maturities 746,933 162,694
Short-term debt 1,744,128 -
---------- ----------
Long-term debt $ 60,000 $1,729,201
========== ==========
In connection with the note payable for legal services, the Company has not made
all of the required payments. The Company provided a "Stipulation of Judgment"
to the creditor at the time the note for legal services was issued.
72
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Scheduled maturities are as follows:
Year ending July 31,
---------------------
2005 $ 162,694
2006 1,696,650
2007 25,194
2008 5,194
2009 2,163
----------
1,891,895
==========
NOTE J - STOCKHOLDERS' EQUITY
COMMON STOCK
-------------
The Company routinely issues shares of its common stock for cash, as a
result of the exercise of warrants, in payment of notes and other
obligations and to settle lawsuits.
During September 2003, warrants to purchase 32,250 shares of common stock
of Penn Octane were exercised resulting in cash proceeds to the Company of
$80,625.
During September 2003, the Company issued 21,818 shares of common stock of
Penn Octane to Mr. Bracamontes as severance compensation (see note D). In
connection with the issuance of the shares, the Company recorded an expense
of approximately $75,000 based on the market value of the stock issued.
During October 2003, cashless warrants to purchase 103,685 shares of common
stock of Penn Octane were exercised. The exercise price of the warrants was
$2.50 per share and the market price of Penn Octane's common stock on the
date of exercise was $3.01 per share, resulting in the net issuance of
17,568 shares of common stock of Penn Octane. The Company had previously
expensed the cost associated with the warrants when the warrants were
originally granted.
During November 2003, warrants to purchase 16,625 shares of common stock of
Penn Octane were exercised resulting in cash proceeds to the Company of
$41,563.
During January 2004, the Company agreed to accept 77,765 shares of common
stock of Penn Octane as full satisfaction of indebtedness owed to the
Company by a related party. As a result, the Company recorded previously
reserved interest income of $32,334.
In connection with previous warrants issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right
to purchase the warrants for a nominal price if the holder of the warrants
does not elect to exercise the warrants within the call provision.
STOCK AWARD PLAN
------------------
Under Penn Octane's 1997 Stock Award Plan (Plan), the Company has reserved
for issuance 150,000 shares of common stock of Penn Octane, of which 69,970
shares were unissued as of July 31, 2004, to compensate consultants who
have rendered significant services to the Company. The Plan is administered
by the Compensation Committee of the Board of Directors of the Company
which has complete authority to select participants, determine the awards
of common stock of Penn Octane to be granted and the times such awards will
be granted, interpret and construe the Plan for purposes of its
administration and make determinations relating to the Plan, subject to its
provisions, which are in the best interests of the Company and its
stockholders. Only consultants who have rendered significant advisory
services to the Company are eligible to be participants under the Plan.
Other eligibility criteria may be established by the Compensation Committee
as administrator of the Plan.
73
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS
In December 2002, the FASB issued SFAS No. 148, an amendment of FASB
Statement No. 123. This statement provides alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, SFAS No.
148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. The transition guidance and annual
disclosure provisions are effective for financial statements issued for
fiscal years ending after December 15, 2002. The interim disclosure
provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. The
Company adopted the interim disclosure provisions of SFAS No. 148 during
the third quarter of fiscal 2003.
The Company applies APB 25 for warrants granted to the Company's employees
and to the Company's Board of Directors and SFAS 123 for warrants issued to
acquire goods and services from non-employees.
BOARD COMPENSATION PLAN
-------------------------
During the Board of Directors (Board) meeting held on September 3, 1999,
the Board approved the implementation of a plan to compensate each outside
director serving on the Board (Plan). Under the Plan, all outside directors
upon election to the Board are entitled to receive warrants to purchase
20,000 shares of common stock of Penn Octane and are to be granted warrants
to purchase 10,000 shares of common stock of Penn Octane for each year of
service as a director. Such warrants will expire five years after the
warrants are granted. The exercise price of the warrants issued under the
Plan are based on the average trading price of Penn Octane's common stock
on the effective date the warrants are granted, and the warrants vest
monthly over a one year period.
In connection with the Penn Octane Board Plan, during August 2003 the Board
granted warrants to purchase 20,000 shares of common stock of Penn Octane
at exercise prices of $3.22 and $3.28 per share to outside directors. Based
on the provisions of APB 25, no compensation expense was recorded for these
warrants.
In connection with the Penn Octane Board Plan, during November 2003 the
Board granted warrants to purchase 10,000 shares of common stock of Penn
Octane at exercise price of $2.61 per share to an outside director. Based
on the provisions of APB 25, no compensation expense was recorded for these
warrants.
In connection with the Penn Octane Board Plan, during August 2004 the Board
granted warrants to purchase 20,000 shares of common stock of Penn Octane
at exercise prices of $1.93 and $1.94 per share to outside directors. Based
on the provisions of APB 25, no compensation expense was recorded for these
warrants.
2001 WARRANT PLAN
-------------------
The Penn Octane Board in November 2001 approved the 2001 warrant plan (2001
Warrant Plan). The purpose of the 2001 Warrant Plan is to provide the
Company with a vehicle to attract, compensate, and motivate selected
employees, particularly executive officers, by issuing stock purchase
warrants which will afford recipients an opportunity to share in potential
capital appreciation in Penn Octane's common stock.
The 2001 Warrant Plan provides for issuance of warrants to purchase up to a
maximum of 1,500,000 shares of common stock of Penn Octane, subject to
adjustment in the event of adjustments to the Company's capitalization
(such as stock dividends, splits or reverse splits, mergers,
recapitalizations, consolidations, etc.). Any warrants which expire without
being exercised are added back to the number of shares for which warrants
may be issued. The 2001 Warrant Plan has a term of 10 years, and no
warrants may be granted after that time.
74
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS - CONTINUED
2001 WARRANT PLAN - CONTINUED
-------------------
The warrants may be issued to any person who, at the time of the grant
under the 2001 Warrant Plan, is an employee or director of, and/or
consultant or advisor to, the Company, or to any person who is about to
enter into any such relationship with the Company.
The warrants will be issued in the discretion of the compensation committee
and/or the Board (Administrator), which will determine when and who will
receive grants, the number of shares purchasable under the warrants, the
manner, conditions and timing of vesting, the exercise price, antidilution
adjustments to be applied, and forfeiture and vesting acceleration terms.
The exercise price of the warrants are determined in the discretion of the
Administrator, but may not be less than 85% of the fair market value of the
common stock of Penn Octane on the date of the grant, except that warrants
granted to non-employee directors may have an exercise price not less than
100% of the fair market value. The fair market value is the closing price
of Penn Octane's common stock on the grant date. Warrants may be exercised
only for cash.
The term of the warrants may not exceed ten years from the date of grant
and may be exercised only during the term specified in the warrants. In the
discretion of the Administrator, warrants may continue in effect and
continue to vest even after termination of the holder's employment by the
Company.
OTHER
-----
In connection with a consulting agreement between the Company and a
director of the Company, during August 2000, the director received warrants
to purchase 100,000 shares of common stock of Penn Octane at an exercise
price of $6.38 per share exercisable through August 6, 2005. The warrants
will vest ratably on a quarterly basis over four years. The warrants were
accounted for under the provisions of SFAS 123 and the resulting expense is
being amortized over the vesting period.
In connection with the restructuring of certain debt obligations (see Note
I), during January 2004 the Company issued warrants to purchase 37,500
shares of common stock of Penn Octane at an exercise price of $2.50 per
share, exercisable until December 15, 2008.
On September 30, 2004, pursuant to the terms of an employment agreement
dated as of May 13, 2003 with Richard Shore, Jr., President of Penn Octane,
the Company issued warrants to purchase 763,737 shares of Penn Octane's
common stock at an exercise price of $1.14 per share. The warrant is
exercisable beginning on October 1, 2004, and expires on July 10, 2006.
75
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS
SFAS 148 AND 123 DISCLOSURES
--------------------------------
For warrants granted to non-employees, the Company applies the provisions
of SFAS 123 to determine the fair value of the warrants issued. Costs
associated with warrants granted to non-employees for the years ended July
31, 2002, 2003 and 2004, totaled $374,870, $166,537 and $ 124,870,
respectively. Warrants granted to non-employees simultaneously with the
issuance of debt are accounted for based on the guidance provided by APB
14, "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants".
A summary of the status of the Company's warrants as of July 31, 2002, 2003
and 2004, and changes during the years ending on those dates is presented
below:
2002 2003 2004
---------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Warrants Shares Exercise Price Shares Exercise Price Shares Exercise Price
------------------------------ ----------- --------------- ------------ --------------- ------------ ---------------
Outstanding at beginning of
year 4,377,488 $ 3.67 3,911,555 $ 3.87 3,592,179 $ 3.97
Granted 60,000 3.84 30,000 2.82 67,500 2.74
Exercised ( 442,183) 1.98 ( 250,000) 2.50 ( 152,560) 2.50
Expired ( 83,750) 3.69 ( 99,376) 3.66 ( 924,619) 2.78
----------- ------------ ------------
Outstanding at end of year 3,911,555 3.87 3,592,179 3.97 2,582,500 4.44
=========== ============ ============
Warrants exercisable at end of
year 3,574,027 3,556,189 2,579,070
The following table depicts the weighted-average exercise price and
weighted average fair value of warrants granted during the years ended July
31, 2002, 2003 and 2004, by the relationship of the exercise price of the
warrants granted to the market price on the grant date:
2002 2003 2004
---------------------------- ---------------------------- ----------------------------
For warrants granted For warrants granted For warrants granted
Weighted Weighted Weighted Weighted Weighted Weighted
Exercise price compared to average average average average average average
market price on grant date fair value exercise price fair value exercise price fair value exercise price
-------------------------- ----------- --------------- ----------- --------------- ----------- ---------------
Equals market price $ 2.69 $ 3.84 $ 1.82 $ 2.82 $ 1.97 $ 3.04
Exceeds market price - - - - 1.43 2.50
Less than market price - - - - - -
The fair value of each warrant grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in the years ended July 31,
2002, 2003 and 2004, respectively: dividend yield of 0% for all three
years; expected volatility of 87%, 80% and 72% to 81%; risk-free interest
rate of 3.59% to 4.72%, 1.75% to 1.81% and 3.22% to 3.27% depending on
expected lives; and expected lives of 5, 5 and 5 years.
76
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS - CONTINUED
SFAS 148 AND 123 DISCLOSURES - CONTINUED
--------------------------------
The following table summarizes information about the warrants outstanding
at July 31, 2004:
Warrants Outstanding Warrants Exercisable
-------------------------- ------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
at Contractual Exercise at Exercise
Range of Exercise Prices July 31, 2004 Life Price July 31, 2004 Price
- ------------------------- ------------- ----------- --------- ------------- ---------
2.27 to $3.66 642,500 2.91 years $ 2.59 639,549 $ 2.59
3.99 to $4.60 1,530,000 0.46 4.59 1,530,000 4.59
6.37 to $7.00 410,000 1.08 6.79 409,521 6.79
------------- -------------
2.27 to $7.00 2,582,500 1.17 $ 4.44 2,579,070 $ 4.44
============= =============
NOTE L - COMMITMENTS AND CONTINGENCIES
LITIGATION
On March 16, 1999, the Company settled a lawsuit in mediation with its
former chairman of the board, Jorge V. Duran. The total settlement costs
recorded by the Company at July 31, 1999, was $456,300. The parties had
agreed to extend the date on which the payments were required in connection
with the settlement including the issuance of the common stock. On July 26,
2000, the parties executed final settlement agreements whereby the Company
paid the required cash payment of $150,000. During September 2000, the
Company issued the required stock.
On July 10, 2001, litigation was filed in the 164th Judicial District Court
of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel & Jackson
L.L.P. against the Company alleging breach of contract, common law fraud
and statutory fraud in connection with the settlement agreement between the
parties dated July 26, 2000. Plaintiffs were seeking actual and punitive
damages. During July 2003 the lawsuit was settled whereby the Company
agreed to pay the plaintiffs $45,000.
On March 2, 2000, litigation was filed in the Superior Court of California,
County of San Bernardino by Omnitrans against Penn Octane Corporation, Penn
Wilson and several other third parties alleging breach of contract, fraud
and other causes of action related to the construction of a refueling
station by a third party. Penn Octane Corporation and Penn Wilson have both
been dismissed from the litigation pursuant to a summary judgment.
Omnitrans appealed the summary judgment in favor of the Company and Penn
Wilson. During August 2003, the Appellate Court issued a preliminary
decision denying Omnitran's appeal of the summary judgment in favor of the
Company and Penn Wilson. Oral arguments on the appeal were heard in
November 2003 and the Company prevailed on its summary judgment.
On August 7, 2001, a Mexican company, Intertek Testing Services de Mexico,
S.A. de C.V. (Plaintiff), which contracts with PMI for LPG testing services
required to be performed under the Contract, filed suit in the Superior
Court of California, County of San Mateo against the Company alleging
breach of contract. During April 2003 the case proceeded to a jury trial.
The Plaintiff demanded from the judge and jury approximately $850,000 in
damages and interest. During May 2003, the jury found substantially in
favor of the Company and awarded damages to Intertek of only approximately
$228,000 and said sum was recorded as a judgment on June 5, 2003 and during
August 2003 the Court awarded the Plaintiff interest and costs totaling
approximately $50,000. In connection with the judgment, and the additional
interest and costs, the Company recorded an additional expense of
approximately $106,000 as of July 31, 2003 representing the additional
expense over amounts previously accrued.
77
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
LITIGATION - CONTINUED
On October 11, 2001, litigation was filed in the 197th Judicial District
Court of Cameron County, Texas by the Company against Tanner Pipeline
Services, Inc. (Tanner); Cause No. 2001-10-4448-C alleging negligence and
aided breaches of fiduciary duties on behalf of CPSC International, Inc.
(CPSC) in connection with the construction of the US Pipelines. During
September 2003, the Company entered into a settlement agreement with Tanner
whereby Tanner was required to reimburse the Company for $50,000 to be paid
through the reduction of the final payments on Tanner's note (see note I).
CREDIT FACILITY AND LETTERS OF CREDIT
Pursuant to an amendment (see below), as of July 31, 2004 the Company had a
$15,000,000 credit facility with RZB Finance LLC (RZB) for demand loans and
standby letters of credit (RZB Credit Facility) to finance the Company's
purchases of LPG and Fuel Products in connection with the 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. Under the RZB Credit
Facility, the Company pays a fee with respect to each letter of credit
thereunder in an amount equal to the greater of (i) $500, (ii) 2.5% of the
maximum face amount of such letter of credit, or (iii) such higher amount
as may be agreed to between the Company and RZB. Any loan amounts
outstanding under the RZB Credit Facility shall accrue interest at a rate
equal to the rate announced by the JPMorgan Chase Bank as its prime rate
(4.25% at July 31, 2004) plus 2.5%. Pursuant to the RZB Credit Facility,
RZB has sole and absolute discretion to limit or terminate its
participation in the RZB Credit Facility and to 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. In connection with the RZB Credit Facility, the
Company granted a security interest and assignment in any and all of the
Company's accounts, inventory, real property, buildings, pipelines,
fixtures and interests therein or relating thereto, including, without
limitation, the lease with the Brownsville Navigation District of Cameron
County (the District) for the land on which the Company's Brownsville
Terminal Facility is located, the Pipeline Lease, and in connection
therewith agreed to enter into leasehold deeds of trust, security
agreements, financing statements and assignments of rent, in forms
satisfactory to RZB. Under the RZB Credit Facility, the Company may not
permit to exist any subsequent lien, security interest, mortgage, charge or
other encumbrance of any nature on any of its properties or assets, except
in favor of RZB, without the consent of RZB. After the Spin-Off and
transfer of assets to RVOP, RZB continues to retain a security interest in
the transferred assets.
Effective April 30, 2004, the RZB Credit Facility was informally amended to
provide for a credit limit of $15,000,000 through March 31, 2005, although
the facility may be terminated any time. In addition, RZB also approved the
Company's use of the RZB Credit Facility to purchase Fuel Products in
addition to LPG, including a $3,000,000 limit for purchase of Fuel Products
inventory for a maximum of 30 days. Based on current minimum purchase
commitments under the Company's LPG supply agreements and current LPG
prices, the amount available to finance Fuel Products and LPG purchases in
excess of current minimum purchase commitments is limited to current
volumes and therefore the ability of the Company to grow the Fuel Sales
Business is dependent on future increases in its RZB Credit Facility or
other sources of financing, the reduction of LPG supply commitments and/or
the reduction in LPG or Fuel Products prices. In connection with the
amendment, the Company is required to pay RZB annual fees of $50,000 in
addition to the fees described above.
Mr. Richter has personally guaranteed all of the Company's payment
obligations with respect to the RZB Credit Facility.
In connection with the Company's purchases of LPG and Fuel Products,
letters of credit are issued based on anticipated purchases. Outstanding
letters of credit for purchases of LPG and Fuel Products at July 31, 2004
totaled approximately $12,700,000 of which approximately $9,400,000
represents July 2004 purchases and approximately $3,300,000 represents
August 2004 purchases.
78
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
CREDIT FACILITY AND LETTERS OF CREDIT - CONTINUED
In connection with the Company's purchase of LPG and Fuel Products, under
the RZB Credit Facility, assets related to product sales (Assets) are
required to be in excess of borrowings and commitments (including
restricted cash of $5,859,857 at July 31, 2004). At July 31, 2004, the
Company's borrowings and commitments were less than the amount of the
Assets.
Under the terms of the RZB Credit Facility, Penn Octane or Rio Vista are
required to maintain net worth of a minimum of $9,000,000.
In connection with the Company's Fuel Sales Business, the Company has
issued bonds totaling $662,000 to the states of California, Nevada, Arizona
and Texas (Bonds) to secure payments of excise and other taxes collected
from customers in connection with sales of Fuel Products. The Bonds are
partially secured by letters of credit totaling $452,600. At July 31, 2004,
such taxes of approximately $90,000 were due. In addition, in connection
with the Fuel Sales Business, the Company issued a letter of credit of
$284,000 in connection with the Company's use of pipeline and terminal
systems from a third party. The letters of credit issued have all been
secured by cash in the amount of $736,600 which is included in restricted
cash in the Company's balance sheet at July 31, 2004.
LPG and Fuel Products financing expense associated with the RZB Credit
Facility totaled $452,164, $732,718 and $832,787 for the years ended July
31, 2002, 2003 and 2004.
OPERATING LEASE COMMITMENTS
The Company has lease commitments for its pipeline, land, office space and
office equipment.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (Pipeline Lease Amendment) entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999
(Effective Date). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another
pipeline controlled by Seadrift, thereby providing greater access to and
from the Leased Pipeline. Pursuant to the Pipeline Lease Amendment, the
Company's fixed annual rent for the use of the Leased Pipeline is
$1,000,000 including monthly service payments of $8,000 through March 2004.
The service payments are subject to an annual adjustment based on a labor
cost index and an electric power cost index. The Company is also required
to pay for a minimum volume of storage of $300,000 per year beginning
January 1, 2000. In addition, the Pipeline Lease Amendment provides for
variable rental increases based on monthly volumes purchased and flowing
into the Leased Pipeline and storage utilized. As provided in the Pipeline
Lease, the Company has the right to use the Pipeline solely for the
transportation of LPG belonging only to the Company and not to any third
party. The lessor has the right to terminate the lease agreement under
certain limited circumstances, which management currently believes are
remote, as provided for in the lease agreement at specific times in the
future by giving twelve months written notice. The Company can also
terminate the lease at any time by giving thirty days notice only if its
sales agreement with its main customer is terminated, and at any time by
giving twelve months notice. Upon termination by the lessor, the lessor has
the obligation to reimburse the Company the lesser of 1) net book value of
its liquid propane gas terminal at the time of such termination or 2)
$2,000,000.
The operating lease for the land on which the Brownsville Terminal Facility
is located (Brownsville Lease) originally was due to expire in October
2003. During December 2001 the Company extended the Brownsville Lease until
November 30, 2006. The Company has an option to renew for five additional
five year terms. The rent may be adjusted in accordance with the terms of
the agreement. The annual rental amount is approximately $75,000.
79
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
OPERATING LEASE COMMITMENTS - CONTINUED
The Brownsville Lease provides, among other things, that if the Company
complies with all the conditions and covenants therein, the leasehold
improvements made to the Brownsville Terminal Facility by the Company may
be removed from the premises or otherwise disposed of by the Company at the
termination of the Brownsville Lease. In the event of a breach by the
Company of any of the conditions or covenants, all improvements owned by
the Company and placed on the premises shall be considered part of the real
estate and shall become the property of the District.
The Company leases the land on which its Tank Farm is located. The lease
amount is approximately $27,000 annually. The lease was originally due to
expire on January 18, 2005. During December 2001 the Company extended the
lease until November 30, 2006. The Company has an option to renew for five
additional five year terms. The rent may be adjusted in accordance with the
terms of the agreement.
Rent expense was as follows for the years ended July 31,:
2002 2003 2004
----------- ----------- -----------
Brownsville Lease and $ 108,744 $ 96,760 $ 107,542
Other (a)
Minimum Rent Expense 1,911,385 1,396,431 1,282,539
Variable Rent Expense 1,218,843 1,202,893 1,057,120
----------- ----------- -----------
Total $ 3,238,972 $ 2,696,084 $ 2,447,201
=========== =========== ===========
<FN>
(a) See note S
As of July 31, 2004, the minimum lease payments for operating leases having
initial or remaining noncancellable lease terms in excess of one year are as
follows:
Year ending July 31,
---------------------
2005 $ 1,447,984
2006 1,412,861
2007 1,310,821
2008 1,275,000
2009 1,275,000
Thereafter 5,631,250
-----------
$12,352,916
===========
EMPLOYMENT CONTRACTS
During the period February 1, 2001 through July 28, 2002, the Company
continued the terms of the previous six year employment agreement with Mr.
Richter which had expired on January 31, 2001. Effective July 29, 2002, the
Company entered into a new three year employment agreement with Mr. Richter
(Agreement). Under the terms of the Agreement, Mr. Richter is entitled to
receive a monthly salary equal to $25,000 and a minimum annual bonus
payment equal to $100,000 plus five percent (5%) of net income before taxes
of the Company. In addition, Mr. Richter was entitled to receive a warrant
grant by December 31, 2002 in an amount and with terms commensurate with
prior practices. As of July 31, 2004, the Company has not made the warrant
grant. Pursuant to the Agreement, Mr. Richter was granted a term life
insurance policy in the amount of $5,000,000.
80
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
EMPLOYMENT CONTRACTS - CONTINUED
In connection with the Agreement, the Company also agreed to forgive any
interest due from Mr. Richter pursuant to Mr. Richter's Promissory Note,
provided that Mr. Richter guarantees at least $2,000,000 of the Company's
indebtedness during any period of that fiscal year of the Company.
Furthermore, the Company agreed to forgive Mr. Richter's Promissory Note in
the event that either (a) the share price of Penn Octane's common stock
trades for a period of 90 days at a blended average price equal to $6.20,
or (b) the Company is sold for a price per share (or an asset sale realizes
revenues per share) equal to $6.20.
Effective November 2002, the Company and Shore Capital LLC (Shore Capital),
a company owned by Mr. Shore, entered into a consulting contract whereby
the Company agreed to pay Shore Capital $30,000 a month for a period of six
months. Under the terms of the consulting contract, Shore Capital received
an exclusive right in the event the Company effectively converted its
structure into a publicly traded limited partnership (MLP), to purchase up
to a 50% voting interest in the general partner of the MLP at a price not
to exceed $330,000. In addition, in the event that the conversion of the
Company into an MLP was successful, Shore Capital was also entitled to
receive an option to acquire up to 5% interest in the MLP at an exercise
price not to exceed $1,650,000. The contract also provided for the Company
to offer Mr. Shore a two-year employment agreement at the same rate
provided for under the contract. The Company did not convert to an MLP as
originally structured.
In May 2003, Mr. Shore was appointed President of the Company. Effective
May 13, 2003, the Company and Mr. Shore entered into a two-year employment
agreement. Under the terms of the agreement, Mr. Shore is entitled to
receive a monthly salary of $30,000 per month and in connection with the
Company's revised structure to form an MLP, Shore Capital received options
exercisable after the date of the distribution of the Common Units of Rio
Vista to the stockholders of Penn Octane, to purchase 97,415 Common Units
of Rio Vista at a per Common Unit exercise price of $8.47, to purchase
763,737 shares of common stock of Penn Octane at a per common share
exercise price of $1.14 and to purchase 25% of the General Partner of Rio
Vista, at an exercise price equal to .5% of the tax basis capital of Rio
Vista immediately after the distribution of Common Units of Rio Vista to
the stockholders of Penn Octane. Under the terms of his employment
agreement, Mr. Shore may make monetary investments in other businesses so
long as the business does not directly compete with the Company.
Aggregate compensation under employment agreements totaled $619,436,
$642,027 and $1,008,627 for the years ended July 31, 2002, 2003 and 2004,
respectively, which included agreements with former executives.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
include cash balances at banks which at times exceed the federal deposit
insurance.
81
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M - ACQUISITION OF MEXICAN SUBSIDIARIES
Effective April 1, 2001, the Company completed the purchase of 100% of the
outstanding common stock of both Termatsal and PennMex (Mexican
Subsidiaries), previous affiliates of the Company which were principally
owned by Mr. Bracamontes (see note D). The Company paid a nominal purchase
price of approximately $5,000 for each Mexican subsidiary. As a result of
the acquisition, the Company has included the results of the Mexican
Subsidiaries in its consolidated financial statements at July 31, 2002,
2003 and 2004. Since inception through the acquisition date, the operations
of the Mexican Subsidiaries had been funded by the Company and such amounts
funded were included in the Company's consolidated financial statements.
Therefore, there were no material differences between the amounts
previously reported by the Company and the amounts that would have been
reported by the Company had the Mexican Subsidiaries been consolidated
since inception.
During July 2003, the Company acquired an option to purchase Tergas, an
affiliate 95% owned by Mr. Soriano and the remaining balance owned by
Abelardo Mier, a consultant of the Company, for a nominal price of
approximately $5,000. Since inception the operations of Tergas have been
funded by the Company and the assets, liabilities and results of operations
of Tergas are included in the Company's consolidated financial statements.
NOTE N - MEXICAN OPERATIONS
Under current Mexican law, foreign ownership of Mexican entities involved
in the distribution of LPG or the operation of LPG terminal facilities is
prohibited. Foreign ownership is permitted in the transportation and
storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation
permit and 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. The
Company's consolidated Mexican affiliate, Tergas, S.A. de C.V. (Tergas),
has been granted the permit to operate the Matamoros Terminal Facility and
the Company relies on Tergas' permit to continue its delivery of LPG at the
Matamoros Terminal Facility. Tergas is owned 95% by Mr. Soriano, and the
remaining balance is owned by Mr. Mier (see note M). The Company pays
Tergas its actual cost for distribution services at the Matamoros Terminal
Facility plus a small profit.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, a consolidated affiliate, the Company is subject
to the tax laws of Mexico which, among other things, require that the
Company comply with transfer pricing rules, the payment of income, asset
and ad valorem taxes, and possibly taxes on distributions in excess of
earnings. In addition, distributions to foreign corporations, including
dividends and interest payments may be subject to Mexican withholding
taxes.
82
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE O - SELECTED QUARTERLY DATA - (UNAUDITED)
Penn Octane Corporation and Subsidiaries
Selected Quarterly Data
(Unaudited)
October 31, January 31, April 30, July 31,
Year ended July 31, 2004:
Revenues $ 38,549,107 $ 50,609,858 $42,798,287 $ 45,706,272
Gross profit 2,065,930 3,292,279 2,220,905 2,024,505
Net income (loss) ( 158,516) 1,450,873 675,004 ( 169,035)
Net income (loss) per common share ( .01) .09 .04 ( .00)
Net income (loss) per common share
assuming dilution ( .01) .09 .04 ( .00)
Year ended July 31, 2003:
Revenues $ 37,440,658 $ 43,621,932 $45,454,607 $ 35,972,368
Gross profit 2,514,419 3,384,371 2,076,831 2,138,595
Net income (loss) 1,206,767 1,549,865 336,842 ( 1,135,665)
Net income (loss) per common share .08 .10 .02 ( .07)
Net income (loss) per common share
assuming dilution .08 .10 .02 ( .07)
The net loss for the quarter ended July 31, 2003, included the following
material fourth quarter adjustments: (i) approximately $800,000 for the
formation of and Spin-Off of Rio Vista (see note R) which did not result in
the raising of capital, (ii) approximately $520,000 of salaries and payroll
related expenses (see note D) and (iii) approximately $200,000 related to
the settlement of litigation, including legal fees of approximately
$153,000 (see note L).
The net loss for the quarter ended July 31, 2004, included the following
material fourth quarter adjustment: (i) an asset impairment charge of
$324,041.
83
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - CONTRACTS
LPG SALES TO PMI
The Company entered into sales agreements with PMI for the period from
April 1, 2000 through March 31, 2001 (Old Agreements), for the annual sale
of a combined minimum of 151,200,000 gallons of LPG, mixed to PMI
specifications, subject to seasonal variability, which was delivered to PMI
at the Company's terminal facilities in Matamoros, Tamaulipas, Mexico, or
alternative delivery points as prescribed under the Old Agreements.
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7,500,000 gallons resulting in a new annual combined
minimum commitment of 158,700,000 gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (Confirmation) on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of
19,000,000 gallons at indexed variable posted prices plus premiums that
provide the Company with annual fixed margins, which increase annually over
a three-year period. The Company was also entitled to receive additional
fees for any volumes which were undelivered. From April 1, 2001 through
December 31, 2001, the Company and PMI operated under the terms provided
for in the Confirmation. From January 1, 2002 through February 28, 2002,
PMI purchased monthly volumes of approximately 17,000,000 gallons per month
at slightly higher premiums then those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39,600,000 gallons (Sold LPG) for which PMI had not taken
delivery. The Company received the posted price plus other fees on the Sold
LPG but did not receive the fixed margin referred to in the Confirmation
(see note B9). At July 31, 2001, the obligation to deliver LPG totaled
approximately $11,500,000 related to such sales (approximately 26,600,000
gallons). During the period from December 1, 2001 through March 31, 2002,
the Company delivered the Sold LPG to PMI and collected the fixed margin
referred to in the Confirmation.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17,000,000 gallons of LPG, subject to monthly
adjustments based on seasonality (Contract). In connection with the
Contract, the parties also executed a settlement agreement, whereby the
parties released each other in connection with all disputes between the
parties arising during the period April 1, 2001 through February 28, 2002,
and previous claims related to the contract for the period April 1, 2000
through March 31, 2001. The Contract was originally to expire on May 31,
2004. On December 29, 2003, the Company received a notice from PMI
requesting the termination of the Contract effective March 31, 2004, the
end of the winter period as defined under the Contract.
84
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - CONTRACTS - CONTINUED
LPG SALES TO PMI - CONTINUED
During the months of April 2004 through October 2004, the Company and PMI
have entered into monthly agreements for the sale of LPG (Monthly 2004
Contracts) for volumes materially less than the volumes provided in the
Contract.
PMI has primarily used the Matamoros Terminal Facility to load LPG
purchased from the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative
terminal in the event the Matamoros Terminal Facility cannot be used.
Revenues from PMI totaled approximately $142,000,000 for the year ended
July 31, 2004, representing approximately 80% of total revenues for the
period.
LPG SUPPLY AGREEMENTS
Effective October 1, 1999, the Company and Exxon entered into a ten year
LPG supply contract, as amended (Exxon Supply Contract), whereby Exxon has
agreed to supply and the Company has agreed to take, 100% of Exxon's owned
or controlled volume of propane and butane available at Exxon's King Ranch
Gas Plant (Plant) up to 13,900,000 gallons per month blended in accordance
with required specifications (Plant Commitment). For the year ending July
31, 2004, under the Exxon Supply Contract, Exxon has supplied an average of
approximately 12,300,000 gallons of LPG per month. The purchase price is
indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (ECCPL) operational in September 2000. The ability
to utilize the ECCPL allows the Company to acquire an additional supply of
propane from other propane suppliers located near Corpus Christi, Texas
(Additional Propane Supply), and bring the Additional Propane Supply to the
Plant (ECCPL Supply) for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122,000,000 gallons per year of Additional Propane Supply through the ECCPL
until December 2005. The Company is required to pay minimum utilization
fees associated with the use of the ECCPL until December 2005. Thereafter
the utilization fee will be based on the actual utilization of the ECCPL.
In March 2000, the Company and Koch entered into a three year supply
agreement (Koch Supply Contract) whereby Koch has agreed to supply and the
Company has agreed to take, a monthly average of 8,200,000 gallons (Koch
Supply) of propane beginning April 1, 2000, subject to the actual amounts
of propane purchased by Koch from the refinery owned by its affiliate, Koch
Petroleum Group, L.P. In March 2003 the Company extended the Koch Supply
Contract for an additional year pursuant to the Koch Supply Contract which
provides for automatic annual renewals unless terminated in writing by
either party. During December 2003, the Company and Koch entered into a new
three year supply agreement. The terms of the new agreement are similar to
the agreement previously in effect between the parties.
For the year ending July 31, 2004, under the Koch Supply Contract, Koch has
supplied an average of approximately 6,400,000 gallons of propane per
month. The purchase price is indexed to variable posted prices. Prior to
April 2002 the Company paid additional charges associated with the
construction of a new pipeline interconnection which allows deliveries of
the Koch Supply into the ECCPL, which was paid through additional
adjustments to the purchase price (totaling approximately $1,000,000).
85
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - CONTRACTS - CONTINUED
LPG SUPPLY AGREEMENTS - CONTINUED
During March 2000, the Company and Duke entered into a three year supply
agreement (Duke Supply Contract) whereby Duke has agreed to supply and the
Company has agreed to take, a monthly average of 1,900,000 gallons (Duke
Supply) of propane or propane/butane mix beginning April 1, 2000. In March
2003 the Company extended the Duke Supply Contract for an additional year
pursuant to the Duke Supply Contract which provided for automatic annual
renewals unless terminated in writing by either party. The Duke Supply
Contract, which expired in March 2004 was not renewed. The purchase price
was indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(Suppliers). The Company's aggregate costs per gallon to purchase LPG (less
any applicable adjustments) are below the aggregate sales prices per gallon
of LPG sold to its customers.
The Company's current long-term supply agreements in effect as of July 31,
2004 (Supply Contracts) provide for minimum quantities of LPG totaling up
to approximately 22,100,000 gallons per month although the Monthly 2004
Contracts provide for lesser quantities. The actual amounts supplied under
Supply Contracts averaged approximately 18,700,000 gallons per month for
the year ended July 31, 2004.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated
with the storage, disposal and/or changes in LPG prices resulting from the
excess of the Plant Commitment or Koch Supply over actual sales volumes to
PMI. Under the terms of the Supply Contracts, the Company must provide
letters of credit in amounts equal to the cost of the product to be
purchased. In addition, the cost of the product purchased is tied directly
to overall market conditions. As a result, the Company's existing letter of
credit facility may not be adequate to meet the letter of credit
requirements under the agreements with the Suppliers or other suppliers due
to increases in quantities of LPG purchased and/or to finance future price
increases of LPG.
NOTE Q - OTHER INCOME
In connection with a contract to upgrade its computer and information
systems, the Company entered into an agreement with a vendor during the
year ended July 31, 2003. On October 1, 2003, the vendor agreed to pay the
Company $210,000 for cancellation of the contract. This amount was included
in earnings during the year ended July 31, 2004.
NOTE R - SPIN-OFF
During September 2003, the Company's Board of Directors and the Independent
Committee of its Board of Directors formally approved the terms of the
Spin-Off (see below) and Rio Vista filed a Form 10 registration statement
with the Securities and Exchange Commission. On September 30, 2004 the
Common Units of Rio Vista were distributed to Penn Octane's stockholders.
86
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
As a result of the Spin-Off, Rio Vista will own and operate the LPG,
distribution, transportation and marketing business previously conducted by
Penn Octane. Rio Vista will sell LPG directly to PMI and will purchase LPG
from Penn Octane under a long-term supply agreement.
INTERCOMPANY PURCHASE AGREEMENT FOR LPG
Penn Octane entered into a Purchase Agreement with RVOP pursuant to which
RVOP agrees to purchase all of its LPG requirements for sales which utilize
the assets transferred to RVOP by Penn Octane to the extent Penn Octane is
able to supply such LPG requirements. This agreement further provides that
RVOP will have 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 contributes to RVOP under the
Contribution, Conveyance and Assumption Agreement. The Purchase Agreement
terminates on the earlier to occur of:
- Penn Octane ceases to have the right to access the Seadrift
pipeline that connects to Rio Vista's Brownsville terminal
facilities; and
- RVOP ceases to sell LPG using any of the assets contributed by
Penn Octane to RVOP pursuant to the Contribution, Conveyance and
Assumption Agreement.
The price Rio Vista will pay for LPG under this contract is indexed to the
price quoted by the Oil Price Information Service for Mt. Belvieu non-tet
propane and non-tet normal butane, plus other costs and amounts based on a
formula that takes into consideration operating costs to both Penn Octane
and to Rio Vista.
OMNIBUS AGREEMENT
In connection with the Spin-Off, Penn Octane entered into an Omnibus
Agreement with Rio Vista and its subsidiaries 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.
INDEMNIFICATION PROVISIONS. Under the Omnibus Agreement, Penn Octane will
indemnify Rio Vista against certain potential environmental liabilities
associated with the operation of the assets contributed to Rio Vista, and
assets retained, by Penn Octane that relate to events or conditions
occurring or existing before the completion of the distribution. Penn
Octane will also indemnify Rio Vista for liabilities relating to:
- legal actions against Penn Octane;
- events and conditions associated with any assets retained by Penn
Octane;
- certain defects in the title to the assets contributed to Rio
Vista by Penn Octane that arise within three years after the
completion of the distribution to the extent such defects
materially and adversely affect Rio Vista's ownership and
operation of such assets;
- Rio Vista's failure to obtain certain and consents and permits
necessary to conduct Rio Vista's business to the extent such
liabilities arise within three years after the completion of the
distribution; and
- certain income tax liabilities attributable to the operation of
the assets contributed to Rio Vista prior to the time that they
were contributed.
87
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
Rio Vista will indemnify Penn Octane for certain potential environmental
liabilities associated with the operation of the assets contributed to Rio
Vista that relate to events or conditions occurring or existing after the
completion of the distribution and for federal income tax liabilities in
excess of $2,500,000 incurred by Penn Octane as a result of the
distribution.
SERVICES. Under the Omnibus Agreement, Penn Octane will provide Rio Vista
with corporate staff and support services that are substantially identical
in nature and quality to the services previously provided by Penn Octane in
connection with its management and operation of the assets of Rio Vista
during the one-year period prior to the completion of the distribution.
These services will include centralized corporate functions, such as
accounting, treasury, engineering, information technology, insurance,
administration of employee benefit and incentive compensation plans and
other corporate services. Penn Octane will be reimbursed for the costs and
expenses it incurs in rendering these services, including an overhead
allocation to Rio Vista of Penn Octane's indirect general and
administrative expenses from its corporate allocation pool. The General
Partner will determine the general and administrative expenses that will be
allocated to Rio Vista. Administrative and general expenses directly
associated with providing services to Rio Vista (such as legal and
accounting services) are not included in the overhead allocation pool.
RELATED PARTY TRANSACTIONS. 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.
AMENDMENT AND TERMINATION. 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.
GENERAL PARTNER OPTIONS
Penn Octane's 2% general partnership interest in Rio Vista is expected to
be decreased to 1% as a result of the exercise by Shore Capital and Mr.
Richter of the options to each acquire 25% of the General Partner (General
Partner Options) causing Penn Octane's ownership in the General Partner to
be decreased from 100% to 50%. Mr. Shore and Mr. Richter are each members
of the board of directors of Penn Octane and the board of managers of Rio
Vista.
88
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
TRANSFERRED ASSETS
The following assets of Penn Octane were transferred to the operating
subsidiary of Rio Vista on September 30, 2004:
Brownsville Terminal Facilities
US Mexico Pipelines, including various rights of way and land
obtained in connection with operation of US Pipelines between
Brownsville Terminal Facility and the US Border
Inventory located in storage tanks and pipelines located in
Brownsville (and extending to storage and pipelines located in
assets held by the Mexican subsidiaries)
Contracts and Leases (assumed and/or assigned):
Lease Agreements:
Port of Brownsville:
LPG Terminal Facility
Tank Farm Lease
US State Department Permit
Other licenses and permits in connection with ownership and operation
of the US pipelines between Brownsville and US border
Investment in Subsidiaries:
Penn Octane de Mexico, S. de R.L. de C.V., consisting primarily
of a permit to transport LPG from the Mexican Border to the
Matamoros Terminal Facility
Termatsal, S. de R.L. de C.V., consisting primarily of land, LPG
terminal facilities, Mexican pipelines and rights of way,
and equipment used in the transportation of LPG from the
Mexican border to the Matamoros terminal facility and
various LPG terminal equipment
Penn Octane International LLC
Option to acquire Tergas, S.A. de C.V.
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.
Holders of unexercised warrants of Penn Octane as of the date of the
Spin-Off received an adjustment to reduce the exercise price of their
existing Penn Octane warrant and new warrants to purchase Common Units of
Rio Vista to reflect the transfer of assets from Penn Octane into Rio
Vista. As of the date of the Spin-Off, Penn Octane had 2,542,500 warrants
to purchase common stock outstanding. The adjustment to the exercise price
of Penn Octane warrants was determined by multiplying the original exercise
price of Penn Octane warrants by 0.369. The number of Rio Vista warrants
given to the holder of Penn Octane warrants as of the date of the Spin-Off
was determined by dividing the existing number of warrants of Penn Octane
by eight. The exercise price of the Rio Vista warrants was determined by
multiplying the original exercise price of the existing Penn Octane
warrants by 5.05. The expiration date of the Rio Vista warrants is the same
as the existing Penn Octane warrants.
Under the terms of Rio Vista's partnership agreement, the General Partner
is entitled to receive cash distributions from Rio Vista in accordance with
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.
It is anticipated that Mr. Richter and Shore Capital will exercise their
General Partner Options in the near future. The exercise price for each
option will be the pro rata share (.5%) of Rio Vista's tax basis capital
immediately after the Spin-Off. Penn Octane will retain voting control of
Rio Vista pursuant to a voting agreement. In addition, Shore Capital
received warrants to acquire 763,737 shares of the common stock of Penn
Octane at $1.14 per common share and 97,415 Common Units of Rio Vista at
$8.47 per Common Unit. The warrants are exercisable beginning on October 1,
2004 and expire on July 10, 2006.
89
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
Rio Vista is liable as guarantor for Penn Octane's collateralized debt and
will continue to pledge all of its assets as collateral. Rio Vista may also
be prohibited from making any distributions to unit holders if it would
cause an event of default, or if an event of default is existing, under
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 Spin-Off is a taxable transaction for federal income tax purposes (and
may also be taxable under applicable state, local and foreign tax laws) to
both the Company and its stockholders. Penn Octane intends to treat the
Spin-Off as a "partial liquidation" for federal income tax purposes. A
"partial liquidation" is defined under Section 302(e) of the Internal
Revenue Code as a distribution that (i) is "not essentially equivalent to a
dividend," as determined at the corporate level, which generally requires a
genuine contraction of the business of the corporation, (ii) constitutes a
redemption of stock and (iii) is made pursuant to a plan of partial
liquidation and within the taxable year in which the plan is adopted or
within the succeeding taxable year.
Penn Octane does not believe that it has a federal income tax in connection
with the Spin-Off due to utilization of existing net operating loss
carryforwards. The Company estimates alternative minimum tax and state
franchise tax of approximately $238,000. However, the Internal Revenue
Service (IRS) may review Penn Octane's federal income tax returns and
challenge positions that Penn Octane may take when preparing those income
tax returns, including positions that it may take with respect to the
Spin-Off. If the IRS challenges any of the Company's positions, Penn Octane
will vigorously defend the positions that it takes in preparing its federal
income tax, including positions that it may take with respect to the
Spin-Off. If there is determined to be an income tax liability resulting
from the Spin-Off, to the extent such liability is greater than $2,500,000,
Rio Vista has agreed to indemnify Penn Octane for any tax liability
resulting from the transaction which is in excess of that amount.
90
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
The following unaudited pro forma condensed consolidated financial
information for the Company give effect to the Asset Transfer and the
resulting allocation of sales, cost of goods sold and expenses, and to
certain pro forma adjustments. The unaudited pro forma condensed
consolidated statement of income for the year ended July 31, 2004 assumes
that the above transaction was consummated as of August 1, 2003. The
unaudited pro forma condensed consolidated balance sheet at July 31, 2004
assumes that the transaction was consummated on July 31, 2004. Because the
Company has control of Rio Vista by virtue of its ownership and related
voting control of the General Partner, Rio Vista has been consolidated with
the Company and the interests of the limited partners have been classified
as minority interests in the unaudited pro forma condensed consolidated
financial information.
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET
JULY 31, 2004
(UNAUDITED)
AS REPORTED PRO FORMA PRO FORMA
JULY 31, 2004 ADJUSTMENTS JULY 31, 2004
--------------- -------------- --------------
ASSETS:
- ------
Current Assets
Cash $ 384,074 $ 162,515 (1) $ 546,589
Restricted cash 6,314,071 - 6,314,071
Trade accounts receivable, net 6,207,067 - 6,207,067
Inventories 1,632,992 ( 383,268) (2) 1,632,992
383,268 (5)
Prepaid expenses and other current assets 210,520 210,520
--------------- -------------- --------------
Total current assets 14,748,724 162,515 14,911,239
Investment in subsidiary - 14,908,192 (2) -
( 162,515) (1)
( 14,538,734) (3)
( 184,729) (5)
( 22,214) (6)
Property, plant and equipment - net 16,398,280 ( 14,524,924) (2) 16,398,280
14,524,924 (5)
Lease rights (net of accumulated amortization of
$ 753,330) 400,709 - 400,709
Other non-current assets 29,639 - 29,639
--------------- -------------- --------------
Total assets $ 31,577,352 $ 162,515 $ 31,739,867
=============== ============== ==============
91
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET-CONTINUED
JULY 31, 2004
(UNAUDITED)
AS REPORTED PRO FORMA PRO FORMA
JULY 31, 2004 ADJUSTMENTS JULY 31, 2004
--------------- --------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities
Current maturities of long-term debt $ 162,694 $ - $ 162,694
Short-term debt - - -
Revolving line of credit 2,688,553 - 2,688,553
LPG trade accounts payable 7,432,728 - 7,432,728
Other accounts payable 1,784,643 - 1,784,643
United States and foreign taxes payable 5,194 55,011 (7) 60,205
Accrued liabilities 1,123,979 183,005 (7) 1,306,984
--------------- --------------- ---------------
Total current liabilities 13,197,791 238,016 13,435,807
--------------- --------------- ---------------
Long-term debt, less current maturities 1,729,202 - 1,729,202
Commitments and contingencies - - -
Minority interest - 14,723,463 (4) 14,723,463
Stockholders' Equity:
Common stock - $.01 par value, 25,000,000 shares
Authorized; 15,285,245 shares issued and outstanding 152,852 - 152,852
Additional paid-in-capital 28,460,972 ( 14,723,463) (4) 28,479,457
14,723,463 (5)
18,485 (6)
Note receivable from an officer for exercise of warrants,
net of reserves of $468,693 ( 2,728,000) - ( 2,728,000)
Accumulated deficit ( 9,235,465) ( 40,699) (6) ( 24,052,914)
( 14,538,734) (3)
( 238,016) (7)
--------------- --------------- ---------------
Total stockholders' equity 16,650,359 ( 14,798,964) 1,851,395
--------------- --------------- ---------------
Total liabilities and stockholders' equity $ 31,577,352 $ 162,515 $ 31,739,867
=============== =============== ===============
92
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED JULY 31, 2004
(UNAUDITED)
AS REPORTED PRO FORMA
AUGUST 1, 2003 - PRO FORMA AUGUST 1, 2003-
JULY 31, 2004 ADJUSTMENTS JULY 31, 2004
------------------ --------------- -----------------
Revenues $ 177,663,524 $ - $ 177,663,524
Cost of goods sold 168,059,905 - 168,059,905
------------------ --------------- -----------------
Gross profit 9,603,619 - 9,603,619
------------------ --------------- -----------------
Selling, general and administrative expenses (11)
Legal and professional fees 1,917,562 - 1,917,562
Salaries and payroll related expenses 2,439,333 850,058 (8) 3,289,391
Other 1,455,610 183,005 (10) 1,638,615
------------------ --------------- -----------------
5,812,505 1,033,063 6,845,568
Loss on sale of CNG assets ( 500,000) - ( 500,000)
Asset impairment charge ( 324,041) - ( 324,041)
------------------ --------------- -----------------
Operating income (loss) 2,967,073 ( 1,033,063) 1,934,010
Other income (expense)
Interest and LPG and Fuel Products financing expense ( 1,445,188) - ( 1,445,188)
Interest income 63,449 - 63,449
Other income 210,000 - 210,000
Minority interest in equity of earnings of subsidiary - ( 2,612,399) (9) ( 2,612,399)
------------------ --------------- -----------------
Income (loss) before taxes 1,795,334 ( 3,645,462) ( 1,850,128)
Provision (benefit) for income taxes ( 2,992) 55,011 (10) 52,019
------------------ --------------- -----------------
Net income (loss) $ 1,798,326 $ ( 3,700,473) $ ( 1,902,147)
================== =============== =================
Net income (loss) per common share $ 0.12 $ ( .12)
================== =================
Net income (loss) per common share assuming dilution $ 0.12 $ ( .12)
================== =================
Weighted average common shares outstanding 15,305,500 15,305,500
================== =================
93
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - SPIN-OFF OF SUBSIDIARY - CONTINUED
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
YEAR ENDED JULY 31, 2004
------------------------
(UNAUDITED)
The following unaudited pro forma condensed consolidated financial information
(Pro Forma Statements) for the Company give effect to the Spin-off. The Pro
Forma Statements are based on the available information and contain certain
assumptions that the Company deems appropriate. The Pro Forma Statements do not
purport to be indicative of the financial position or results of operations of
the Company had the Spin-Off occurred on the dates indicated, nor are the Pro
Forma Statements necessarily indicative of the future financial position or
results of operations of the Company. The Pro Forma Statements should be read
in conjunction with the consolidated balance sheet of the Company.
BALANCE SHEET:
The unaudited pro forma condensed consolidated balance sheets assume that such
transactions were consummated on July 31, 2004.
(1) To record the exercise of the options granted to Shore Capital and Mr.
Richter to each acquire 25% of the limited liability company interests
of the General partner of Rio Vista.
(2) To reflect the transfer of assets from Penn Octane to Rio Vista in
exchange for limited and general partnership interests.
(3) To record the Spin-Off of Penn Octane's limited partnership interests
in Rio Vista to its stockholders.
(4) To reflect minority interest in the equity of Rio Vista.
(5) To eliminate intercompany transactions between Penn Octane and Rio
Vista.
(6) Represents the estimated intrinsic value associated with the (i)
options granted to Shore Capital and Mr. Richter to acquire a 50%
interest in the General Partner and (ii) options granted to Shore
Capital to acquire a 5% limited partnership interest in Rio Vista and
5% interest in the common shares of Penn Octane.
(7) To record estimated alternative minimum tax and state taxes resulting
from the Spin-Off .
INCOME STATEMENT:
The unaudited pro forma condensed consolidated statements of income for the year
ended July 31, 2004 assume that the Spin-Off was consummated as of August 1,
2003.
(8) Represents the estimated intrinsic value associated with the (i)
options granted to Shore Capital and Mr. Richter to acquire a 50%
interest in the General Partner and (ii) options granted to Shore
Capital to acquire a 5% limited partnership interest in Rio Vista and
5% interest in the common shares of Penn Octane.
(9) To record minority interest in earnings of Rio Vista.
(10) To record estimated alternative minimum tax and state taxes resulting
from the Spin-Off.
(11) The Company anticipates that it will incur additional direct costs,
including tax related services, public listing fees and transfer fees
resulting from Rio Vista becoming publicly traded.
94
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE S - REALIZATION OF ASSETS
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States of America, which contemplate continuation of the Company as a going
concern. The Company has had an accumulated deficit since inception and has
historically had a deficit in working capital. In addition, substantially
all of the Company's assets are pledged or committed to be pledged as
collateral on existing debt in connection with the Restructured Notes, the
$280,000 Notes and the RZB Credit Facility and therefore, the Company maybe
unable to obtain additional financing collateralized by those assets. The
RZB Credit Facility may be insufficient to finance the Company's LPG sales
and/or Fuel Products sales, assuming increases in product costs per gallon,
or volumetric growth in product sales, and maybe terminated by RZB with 90
days notice.
Since April 1, 2004, the Company has been operating under the Monthly 2004
Contracts with PMI (see note P). The monthly volumes of LPG sold to PMI
since April 1, 2004 have been materially less than historical levels. As
discussed in note P, the Company has LPG supply contracts which require it
to purchase volumes of LPG materially in excess of monthly volumes under
the Monthly 2004 Contracts (Mismatched LPG). The volume of the Mismatched
LPG was materially lower prior to April 1, 2004 than subsequent to April 1,
2004, and the Company was able to dispose of the Mismatched LPG prior to
April 1, 2004 at acceptable margins. The Company may incur additional
reductions of gross profits on sales of LPG in disposing of the Mismatched
LPG if (i) the volume of LPG sold under the Monthly 2004 Contracts declines
below the current levels of approximately 13,000,000 gallons per month
and/or the margins are materially reduced and/or (ii) the Company cannot
successfully reduce the minimum volumes and/or purchase costs required
under the LPG supply agreements. The Company may not have sufficient cash
flow or available credit to absorb such reductions in gross profit.
The Company's cash flow has been reduced as a result of lower volumes of
sales to PMI. Additionally, the Company will also incur the additional
public company and income tax preparation costs for Rio Vista. As a result,
the Company may not have sufficient cash flow to make distributions to Rio
Vista's unitholders and to pay Penn Octane's obligations when due. In the
event Penn Octane does not pay its obligations when due, Rio Vista's
guarantees to Penn Octane and Penn Octane's creditors may be triggered.
Accordingly, Rio Vista may be required to pay such obligations of Penn
Octane to avoid foreclosure of its assets by Penn Octane's creditors. If
the Company's revenues and other sources of liquidity are not adequate to
pay Penn Octane's obligations, 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. 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.
In view of the matters described in the preceding paragraphs,
recoverability of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon the ability of the Company to
generate sufficient cash flow through operations or additional debt or
equity financing to pay its liabilities and obligations when due. The
ability for the Company to generate sufficient cash flows is significantly
dependent on the continued sale of LPG to PMI at acceptable monthly sales
volumes and margins, the success of the Fuel Sales Business and the
adequacy of the RZB Credit Facility to finance such sales. The consolidated
financial statements do not include any adjustments related to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
95
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE S - REALIZATION OF ASSETS - CONTINUED
To provide the Company 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. In addition, management is taking
steps to (i) expand its Fuel Sales Business, (ii) further diversify its
operations to reduce dependency on sales of LPG, (iii) increase the amount
of financing for its products and operations, and (iv) raise additional
debt and/or equity capital.
At July 31, 2004, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $4,700,000. If the net
operating loss carryforwards are utilized in the future, the Company will
begin to pay federal income tax at the corporate income tax rate.
96
SCHEDULE II
PENN OCTANE CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 2004, 2003 AND 2002
Balance at Charged to Balance
Beginning of Costs and Charged to at End
Description Period Expenses Other Accounts Deductions (a) of Period
- ---------------- ------------- ----------- --------------- ---------------- ----------
Year ended July
- ----------------
31, 2004
- --------
Allowance for
doubtful
accounts $ 5,783 $ - $ - $ ( 5,783) $ 0
Year ended July
- ----------------
31, 2003
- --------
Allowance for
doubtful
accounts $ 5,783 $ - $ - $ - $ 5,783
Year ended July
- ----------------
31, 2002
- --------
Allowance for
doubtful
accounts $ 779,663 $ 5,783 $ - $ ( 779,663) $ 5,783
<FN>
(a) Trade accounts receivable written off against allowance.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
The Company's management, including the principal executive officer and
principal financial officer, conducted an evaluation of the Company's disclosure
controls and procedures, as such term is defined under Rule 13a-14(c)
promulgated under the Securities Exchange Act of 1934, as amended, as of the end
of the period. Based on their evaluation, the Company's principal executive
officer and principal accounting officer concluded that the Company's disclosure
controls and procedures are effective.
There have been no significant changes (including corrective actions with regard
to significant deficiencies or material weaknesses) in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph above.
ITEM 9B. OTHER INFORMATION.
Inapplicable.
97
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS OF THE COMPANY
The names of the Company's directors and certain information about them are set
forth below:
DIRECTOR
NAME OF DIRECTOR AGE POSITION WITH COMPANY SINCE
- ------------------------- --- ------------------------------------------------------------------------ --------
Jerome B. Richter . . . . 68 Chairman of the Board of Directors, Chief Executive Officer and Director 1992
Richard "Beau" Shore, Jr. 38 President and Director 2003
Stewart J. Paperin. . . . 56 Director 1996
Harvey L. Benenson. . . . 56 Director 2000
Emmett M. Murphy. . . . . 53 Director 2001
All directors were elected at the fiscal 2003 Annual Meeting of
Stockholders of the Company held on July 30, 2004. All directors hold office
until the next annual meeting of shareholders and until their successors are
duly elected and qualified or until their earlier resignation or removal.
JEROME B. RICHTER founded the Company and served as its Chairman of the
Board and Chief Executive Officer from the date of its organization in August
1992 to December 1994, when he resigned from such positions and became Secretary
and Treasurer of the Company. He resigned from such positions in August 1996.
Effective October 1996, Mr. Richter was elected Chairman of the Board, President
and Chief Executive Officer of the Company. During May 2003, Mr. Richter
resigned from his position as President of the Company upon the election of Mr.
Shore to such position.
RICHARD "BEAU" SHORE, JR. was elected President of the Company in May 2003.
Mr. Shore was elected to the board of directors in July 2003. Since 2001, Mr.
Shore has served as founder, President and CEO of Shore Capital LLC, a company
involved in investing in small, energy related ventures. From November 1998
through January 2001, Mr. Shore was the founder, President and CEO of Shore
Terminals, LLC, a company engaged in managing marine petroleum storage and
pipeline facilities. From 1994 through 1998, Mr. Shore was Vice President of
Wickland Oil Company. During the period November 2002 through April 2003, Shore
Capital LLC provided consulting services to the Company.
STEWART J. PAPERIN was elected a director of the Company in February 1996.
Since July 1996, Mr. Paperin has served as Executive Vice President of the Soros
Foundations Open Society Institute, which encompasses the charitable operations
of 40 foundations in Central and Eastern Europe, the United States, Africa, and
Latin America, and as a portfolio manager of Soros Fund Management.
HARVEY L. BENENSON was elected a director of the Company in August 2000.
Mr. Benenson has been Managing Director, Chairman and Chief Executive Officer of
Lyons, Benenson & Company Inc., a management consulting firm, since 1988, and
Chairman of the Benenson Strategy Group, a strategic research, polling and
consulting firm affiliated with Lyons, Benenson & Company Inc., since July 2000.
Earlier, Mr. Benenson was a partner in the management consulting firm of Cresap,
McCormick and Paget from 1974 to 1983, and Ayers, Whitmore & Company from 1983
to 1988.
98
EMMETT M. MURPHY was elected a director of the Company in November 2001.
In April 1996, Mr. Murphy founded Paradigm Capital Corp., Fort Worth, Texas, an
investment firm, and he has been the President and Chief Executive Officer of
Paradigm Capital since that time. From March 1981 to April 1996, Mr. Murphy was
a Partner in Luther King Capital Management, Fort Worth, Texas, a registered
investment advisor. Mr. Murphy has been a Chartered Financial Analyst since
1979. He received a Bachelor of Science degree from the University of
California at Berkeley in 1973 and a Master of Business Administration degree
from Columbia University in 1975.
The following directors are considered "independent" under applicable
rules of the Nasdaq Stock Market: Messrs. Benenson, Murphy, and Paperin. As a
result, the majority of the Board of Directors is comprised of independent
directors.
The Company's audit committee (the "Audit Committee") consists of Stewart
J. Paperin, Harvey L. Benenson, and Emmett M. Murphy. All of the members of the
Audit Committee are "independent" under applicable rules of the Nasdaq Stock
Market. Mr. Paperin and Mr. Murphy are considered "audit committee financial
experts" as defined in applicable rules of the Securities and Exchange
Commission.
EXECUTIVE OFFICERS OF THE COMPANY
The names of the Company's executive officers, and certain information
about them are set forth below:
OFFICER
NAME OF EXECUTIVE OFFICER AGE POSITION WITH COMPANY SINCE
- ------------------------- --- -------------------------------------------------------------------------- -------
Jerome B. Richter 68 Chairman of the Board of Directors, Chief Executive Officer and Director 1992
Richard "Beau" Shore, Jr. 38 President and Director 2003
Charles Handly 68 Chief Operating Officer and Executive Vice President 2003
Ian T. Bothwell 44 Vice President, Treasurer, Chief Financial Officer and Assistant Secretary 1996
Jerry L. Lockett 63 Vice President and Secretary 1998
JEROME B. RICHTER - see biographical information above.
RICHARD "BEAU" SHORE, JR. - see biographical information above.
CHARLES HANDLY was appointed Chief Operating Officer and Executive Vice
President of the Company in May 2003. From August 2002 through April 2003, Mr.
Handly served as Vice President of the Company. From August 2000 through July
2002, Mr. Handly provided consulting services to the Company. Mr. Handly
previously served as a director of the Company from August 2000 until August
2002 and from July 2003 through July 2004. Mr. Handly's term as a director
ended on July 30, 2004 with the fiscal 2003 Annual Meeting. Mr. Handly was not
able to stand for reelection to the Board of Directors at the fiscal 2003 Annual
Meeting in order to satisfy new requirements of the Nasdaq Stock Market
regarding independence of the board. Mr. Handly retired from Exxon Corporation
on February 1, 2000 after 38 years of service. From 1997 until January 2000,
Mr. Handly was Business Development Coordinator for gas liquids in Exxon's
Natural Gas Department. From 1987 until 1997, Mr. Handly was supply coordinator
for two Exxon refineries and 57 gas plants in Exxon's Supply Department.
99
IAN T. BOTHWELL was elected Vice President, Treasurer, Assistant Secretary and
Chief Financial Officer of the Company in October 1996. He also served as a
director of the Company from March 1997 until July 2004. Mr. Bothwell's term as
a director ended on July 30, 2004 with the fiscal 2003 Annual Meeting. Mr.
Bothwell was not able tot stand for reelection to the Board of Directors at the
fiscal 2003 Annual Meeting in order to satisfy new requirements of the Nasdaq
Stock Market regarding independence of the board. Since July 1993, Mr. Bothwell
has been a principal of Bothwell & Asociados, S.A. de C.V., a Mexican management
consulting and financial advisory company that was founded by Mr. Bothwell in
1993 and specializes in financing infrastructure projects in Mexico. From
February 1993 through November 1993, Mr. Bothwell was a senior manager with
Ruiz, Urquiza y Cia., S.C., the affiliate in Mexico of Arthur Andersen L.L.P.,
an accounting firm. Mr. Bothwell also serves as Chief Executive Officer of B &
A Eco-Holdings, Inc., the company formed to purchase the Company's CNG assets.
JERRY L. LOCKETT joined the Company as a Vice President in November 1998. In
January 2004, Mr. Lockett was elected Secretary of the Company. He also served
as a director of the Company from 1999 until July 2004. Mr. Lockett's term as a
director ended on July 30, 2004 with the fiscal 2003 Annual Meeting. Mr.
Lockett was not able to stand for reelection to the Board of Directors at the
fiscal 2003 Annual Meeting in order to satisfy new requirements of the Nasdaq
Stock Market regarding independence of the board. Prior to joining the Company,
Mr. Lockett held a variety of positions during a 31 year career with Union
Carbide Corporation in sales management, hydrocarbon supply and trading, and
strategic planning. He also served in a management position with Union
Carbide's wholly-owned pipeline subsidiaries.
In 2004 the Company adopted a code of conduct applicable to its principal
executive officer, principal accounting officer and principal financial officer,
a copy of which is attached hereto as an exhibit.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act, requires the Company's directors and
executive officers, and persons who own more than 10% of a registered class of
the Company's equity securities, to file initial reports of ownership and
reports of changes in ownership with the SEC. Such persons are required by the
SEC to furnish the Company with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of Forms 3, 4 and 5 received by it, the
Company believes that all directors, officers and 10% stockholders complied with
such filing requirements, except as follows: Mr. Benenson filed a late report
on Form 3 in August 2003 and a Form 5 in September 2004 containing a late report
of certain warrant transactions; Mr. Bothwell filed a corrected Form 5 in
February 2004 in order to report his warrant holdings in Table II; Mr. Lockett
filed a late Form 4 in January 2004 to report a change in form of ownership of
shares held by his children and to report his warrant holdings in Table II; Mr.
Murphy filed a late report on Form 3 in July 2004, a Form 5 in September 2004
containing a late report of certain purchase and sale transactions and certain
warrant transactions, and a late report on Form 4 in November 2004 to report
certain purchases during the pervious month; Mr. Paperin filed a Form 5 in
September 2004 containing a late report of his warrant transactions; and Mr.
Richter filed a corrected Form 4 in January 2004 to report his warrant holdings
in Table II.
100
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Company's compensation to executive management was administered by the
Compensation Committee of the Board of Directors. As of July 31, 2004, the
Compensation Committee was comprised of three directors (Mr. Richter
resigned effective July 30, 2004), of which all are outside directors, who
report to the Board of Directors on all compensation matters concerning the
Company's executive officers (the "Executive Officers"), including the
Company's Chief Executive Officer and the Company's other Executive
Officers (collectively, with the Chief Executive Officer, the "Named
Executive Officers") (see below). In determining annual compensation,
including bonus, and other incentive compensation to be paid to the Named
Executive Officers, the Compensation Committee considers several factors
including overall performance of the Named Executive Officer (measured in
terms of financial performance of the Company, opportunities provided to
the Company, responsibilities, quality of work and/or tenure with the
Company), and considers other factors including retention and motivation of
the Named Executive Officers and the overall financial condition of the
Company. The Compensation Committee provides compensation to the Named
Executive Officers in the form of cash, equity instruments and forgiveness
of interest incurred on indebtedness to the Company.
The overall compensation provided to the Named Executive Officers
consisting of base salary and the issuance of equity instruments is
intended to be competitive with the compensation provided to other
executives at other companies after adjusting for factors described above,
including the Company's financial condition during the term of employment
of the Executive Officers.
BASE SALARY: The base salary is approved based on the Named Executive
Officer's position, level of responsibility and tenure with the Company.
CHIEF EXECUTIVE OFFICER'S COMPENSATION: During fiscal year 2004, Mr.
Richter was paid in accordance with the terms of his employment agreement
which was in effect during the period. The Board of Directors continued to
ratify prior elections not to accrue any future interest payable by Mr.
Richter on his note to acquire shares of common stock of the Company to the
Company so long as Mr. Richter continued to provide guarantees to certain
of the Company's creditors. In connection with the Spin-Off , the Company
granted Mr. Richter an option to purchase 25% of the General Partner of Rio
Vista (the "Option"). The Compensation Committee determined that Mr.
Richter's compensation under the employment agreement and the Option are
fair to the Company, especially considering the position of Mr. Richter
with the Company.
COMPENSATION COMMITTEE
STEWART J. PAPERIN
HARVEY L. BENENSON
EMMETT M. MURPHY
JEROME B. RICHTER (through July 30, 2004)
101
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Stewart J. Paperin, Emmett M. Murphy and Harvey L. Benenson served as
the members of the Compensation Committee during fiscal year 2004. Messr.
Jerome Richter also served as a member of the Compensation committee in fiscal
year 2004 until his resignation on July 30, 2004. Mr. Richter is the Chief
Executive Officer of the Company, so his compensation during his term on the
Compensation Committee was subject to ratification by the Board of Directors.
The following table sets forth annual and all other compensation to the Named
Executive Officers, for services rendered in all capacities to the Company and
its subsidiaries during each of the fiscal years indicated. This information
includes the dollar values of base salaries, bonus awards, the number of
warrants granted and certain other compensation, if any, whether paid or
deferred. The Company does not grant stock appreciation rights or other
long-term compensation plans for employees.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------------- ------------------------------------
AWARDS PAYOUTS
------------- -----------
ALL OTHER SECURITIES
ANNUAL RESTRICTED UNDERLYING ALL OTHER
NAME AND PRINCIPAL COMPEN- STOCK OPTIONS/ LTIP COMPENSATION
POSITION YEAR SALARY ($) BONUS ($) SATION ($) AWARDS ($) SARS (#) PAYOUTS ($) ($)
Jerome B. Richter,
Chairman of the 2004 300,000 189,695 - - - - 158,932(1)
Board and Chief 2003 300,000 208,832 - - - - 54,733(1)
Executive Officer 2002 300,000 319,436 - - - - -
Richard Shore, Jr.,
President 2004 360,000 - - - - - -
2003 78,462 - - - - - -
2002 - - - - - - -
Charles Handly,
Chief Operating Officer 2004 180,000 - - - - - -
and Executive Vice 2003 138,461 - - - - - -
President 2002 6,923 - - - - - -
Ian T. Bothwell,
Vice President, Treasurer, 2004 180,000 - - - - - -
Assistant Secretary and 2003 180,000 - - - - - -
Chief Financial Officer 2002 168,000 - - - - - -
Jerry L. Lockett, 2004 132,000 - - - - - -
Vice President and Secretary 2003 132,000 - - - - - -
2002 132,000 - - - - - -
_______________________________
<FN>
(1) In connection with Mr. Richter's employment contract, the Company paid
these amounts for life insurance premiums on behalf of Mr. Richter.
102
AGGREGATED WARRANT EXERCISES DURING FISCAL 2004
AND WARRANT VALUES ON JULY 31, 2004
NUMBER OF SECURITIES VALUE OF UNEXERCISED
NUMBER OF SHARES UNDERLYING UNEXERCISED IN-THE-MONEY
ACQUIRED UPON VALUE REALIZED WARRANTS AT JULY 31, 2004 WARRANTS AT JULY 31, 2004
EXERCISE OF WARRANTS UPON EXERCISE (#) EXERCISABLE/ EXERCISABLE/UNEXERCISABLE
NAME (#) ($) UNEXERCISABLE ($)(1)
- ------------------ --------------------- --------------- ------------------------- --------------------------
Jerome B. Richter 0 0 510,000 / 0 0/0
Richard Shore, Jr. 0 0 0 / 0 0/0
Charles Handly 0 0 139,521 / 479 0/0
Ian T. Bothwell 0 0 310,000 / 0 0/0
Jerry L. Lockett 0 0 210,000 / 0 0/0
<FN>
(1) Based on a closing price of $2.05 per share of Common Stock on July 31, 2004.
EMPLOYMENT CONTRACTS
From February 2001 through July 2002, the Company continued the terms of
the previous six year employment agreement with Mr. Richter, the Chief
Executive Officer of the Company, which had expired in January 2001 (the
"Old Agreement"). Under the Old Agreement, Mr. Richter was entitled to
receive $300,000 in annual compensation until earnings exceed a gross
profit of $500,000 per month for an annual period (Minimum Gross Profit),
whereupon Mr. Richter was entitled to an increase in his salary to $40,000
per month for the first year of the agreement increasing to $50,000 per
month during the second year of the agreement. Mr. Richter was entitled to
an increase in his salary to $480,000 for the first year following the
period in which the Minimum Gross Profit is met, increasing to $600,000 per
year during the second year following the period in which the Minimum Gross
Profit is met. He was also entitled to an annual bonus of 5% of all pre-tax
profits of the Company. He was also entitled to receive warrants to
purchase 200,000 shares of Common Stock of Penn Octane at an exercise price
of $5.00 per share upon the Company achieving the Minimum Gross Profit. Mr.
Richter's employment agreement also entitled him to a right of first
refusal to participate in joint venture opportunities in which the Company
may invest, contained a covenant not to compete for a period of one year
from his termination of the agreement and had restrictions on use of
confidential information.
Effective July 2002, the Company entered into a new three year employment
agreement with Mr. Richter (the "New Agreement"). Under the terms of the
New Agreement, Mr. Richter is entitled to receive a monthly salary equal to
$25,000 and a minimum annual bonus payment equal to $100,000 plus 5% of net
income before taxes of the Company. In addition, Mr. Richter was entitled
to receive a warrant grant by December 31, 2002 in an amount and with terms
commensurate with prior practices. The Company has yet to issue Mr. Richter
his warrant grant in connection with the New Agreement. In connection with
the New Agreement, Mr. Richter also is the beneficiary of a term life
insurance policy which is paid for by the Company.
In connection with the New Agreement, the Company also agreed to forgive
any interest due from Mr. Richter pursuant to Mr. Richter's promissory
note, provided that Mr. Richter guarantees at least $2,000,000 of the
Company's indebtedness during any period of that fiscal year of the
Company. Furthermore, the Company agreed to forgive Mr. Richter's
promissory note in the event that either (a) the share price of Penn
Octane's common stock trades for a period of 90 days at a blended average
price equal to at least $6.20, or (b) the Company is sold for a price per
share (or an asset sale realizes revenues per share) equal to at least
$6.20.
103
Effective November 2002, the Company and Shore Capital entered into a
consulting contract whereby the Company agreed to pay Shore Capital $30,000
a month for a period of six months. Under the terms of the consulting
contract, Shore Capital received an exclusive right in the event the
Company effectively converted its structure into a publicly traded limited
partnership (the "MLP"), to purchase up to a 50% voting interest in the
general partner of the MLP at a price not to exceed $330,000. In addition,
in the event that the conversion of the Company into an MLP was successful,
Shore Capital was also entitled to receive an option to acquire up to 5%
interest in the MLP at an exercise price not to exceed $1,650,000. The
contract also provided for the Company to offer Mr. Shore a two-year
employment agreement at the same rate provided for under the contract. The
Company did not convert to an MLP as originally structured.
In May 2003, Mr. Shore was appointed President of the Company. Effective
May 13, 2003, the Company and Mr. Shore entered into a two-year employment
agreement. Under the terms of the agreement, Mr. Shore is entitled to
receive a monthly salary of $30,000 per month and in connection with the
Company's revised structure to form an MLP, Shore Capital received options
exercisable after the date of the distribution of the Common Units of Rio
Vista to the stockholders of Penn Octane, to purchase 97,415 Common Units
of Rio Vista at a per Common Unit exercise price of $8.47, to purchase
763,737 shares of common stock of Penn Octane at a per common share
exercise price of $1.14 and to purchase 25% of the General Partner of Rio
Vista, at an exercise price equal to .5% of the tax basis capital of Rio
Vista immediately after the distribution of Common Units of Rio Vista to
the stockholders of Penn Octane. Under the terms of his employment
agreement, Mr. Shore may make monetary investments in other businesses so
long as the business does not directly compete with the Company.
COMPENSATION OF DIRECTORS
At a meeting of the Board of Directors (the "Board") held in September
1999, the Board approved the implementation of a plan to compensate each
outside director serving on the Board (the "Plan"). Under the Plan, all
outside directors upon election to the Board are entitled to receive
warrants to purchase 20,000 shares of common stock of Penn Octane and are
to be granted additional warrants to purchase 10,000 shares of common stock
of Penn Octane for each year of service as a director. All such warrants
will expire five years after the warrants are granted. The exercise price
of the warrants issued under the Plan are equal to the average trading
price of Penn Octane's common stock on the effective date the warrants are
granted, and the warrants vest monthly over a one year period. The Company
does not pay cash compensation to outside directors but does reimburse
expenses incurred by directors in connection with board and committee
meetings.
104
STOCK PERFORMANCE GRAPH
The following graph compares the yearly percentage change in the Company's
cumulative, five-year total stockholder return with the Russell 2000 Index
and the NASDAQ Index. The graph assumes that $100 was invested on August 1,
1999 in each of Penn Octane's Common Stock, the Russell 2000 Index and the
NASDAQ Index, and that all dividends were reinvested. The graph is not, nor
is it intended to be, indicative of future performance of Penn Octane's
Common Stock.
The Company is not aware of a published industry or line of business index
with which to compare the Company's performance. Nor is the Company aware
of any other companies with a line of business and market capitalization
similar to that of the Company with which to construct a peer group index.
Therefore, the Company has elected to compare its performance with the
NASDAQ Index and Russell 2000 Index, an index of companies with small
capitalization.
PENN OCTANE CORPORATION
STOCK PERFORMANCE GRAPH
JULY 31, 2004
[GRAPHIC OMITED]
- -----------------------------------------------------------------
1999 2000 2001 2002 2003 2004
- ----------------------- ----- ----- ----- ----- ----- -----
Penn Octane Corporation $ 100 $ 302 $ 168 $ 130 $ 139 $ 86
- ----------------------- ----- ----- ----- ----- ----- -----
Russell 2000 Index $ 100 $ 113 $ 109 $ 88 $ 107 $ 124
- ----------------------- ----- ----- ----- ----- ----- -----
NASDAQ Index $ 100 $ 143 $ 77 $ 50 $ 66 $ 71
- -----------------------------------------------------------------
105
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the amount of stock of the Company
beneficially owned as of October 19, 2004 by each person known by the
Company to own beneficially more than 5% of the outstanding shares of Penn
Octane's outstanding common stock ("Common Stock").
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP OF PERCENT OF CLASS OF
NAME OF BENEFICIAL OWNER COMMON STOCK(1) COMMON STOCK
- --------------------------------------------------- ------------------------ --------------------
Jerome B. Richter (2) . . . . . . . . . . . . . . . 4,398,750 27.85%
The Apogee Fund, Paradigm Capital Corporation, and
Emmett M. Murphy (3) . . . . . . . . . . . . . . . 1,227,700 8.01%
Trellus Management Company, LLC (4).. . . . . . . . 836,392 5.47%
Kayne Anderson Capital Advisors, L.P. (5) . . . . . 800,765 5.24%
<FN>
_______________
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock which
are purchasable under warrants which are currently exercisable, or which
will become exercisable no later than 60 days after October 19, 2004, are
deemed outstanding for computing the percentage of the person holding such
warrants but are not deemed outstanding for computing the percentage of any
other person. Except as indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them.
(2) Includes 37,850 shares of Common Stock owned by Mr. Richter's spouse and
510,000 shares of Common Stock issuable upon exercise of Common Stock
purchase warrants.
(3) 201 Main Street, Suite 1555, Fort Worth, Texas. Mr. Murphy, who became a
director of the Company in November 2001, is the president of Paradigm
Capital Corporation, a Texas corporation, which in turn, is the sole
general partner of The Apogee Fund, L.P., a Delaware limited partnership.
All of the referenced stock is owned of record by The Apogee Fund, and
beneficial ownership of such securities is attributable to Mr. Murphy and
Paradigm Capital Corporation by reason of their shared voting and
disposition power with respect The Apogee Fund assets. Includes 50,000
shares of Common Stock issuable upon exercise of Common Stock purchase
warrants granted to Mr. Murphy.
(4) 350 Madison Avenue, 9th Floor, New York, New York.
(5) 1800 Avenue of the Stars, Second Floor, Los Angeles, California. All of the
shares are owned by limited partnerships controlled by Kayne Anderson
Capital Advisors, L.P. Kayne Anderson Capital Advisors, L.P. disclaims
beneficial ownership of the shares reported, except those shares
attributable to it by virtue of its general partner interests in the
limited partnerships.
106
The following table sets forth the amount of Common Stock of the Company
beneficially owned as of October 15, 2004 by each director of the Company,
each Named Executive Officer, and all directors and Named Executive
Officers as a group. Except as noted, the address of each person is c/o
Penn Octane Corporation, 77-530 Enfield Lane, Bldg. D, Palm Desert,
California.
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP OF PERCENT OF CLASS OF
NAME OF BENEFICIAL OWNER COMMON STOCK(1) COMMON STOCK
- --------------------------------------------------------- ------------------------ --------------------
Jerome B. Richter (2) . . . . . . . . . . . . . . . . . . 4,398,750 27.85%
Emmett M. Murphy (3). . . . . . . . . . . . . . . . . . . 1,227,700 8.01%
Richard "Beau" Shore, Jr. (4) . . . . . . . . . . . . . . 779,737 4.86%
Ian T. Bothwell (5) . . . . . . . . . . . . . . . . . . . 310,000 1.99%
Jerry L. Lockett (6). . . . . . . . . . . . . . . . . . . 236,225 1.52%
Stewart J. Paperin (7). . . . . . . . . . . . . . . . . . 194,019 1.26%
Charles Handly (8). . . . . . . . . . . . . . . . . . . . 160,000 1.04%
Harvey L. Benenson (9). . . . . . . . . . . . . . . . . . 63,819 *
All Directors and Named Executive Officers as a group (8
persons) (10) . . . . . . . . . . . . . . . . . . . . . . 7,370,250 42.17%
<FN>
_______________
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock which
are purchasable under warrants which are currently exercisable, or which
will become exercisable no later than 60 days after October 19, 2004, are
deemed outstanding for computing the percentage of the person holding such
warrants but are not deemed outstanding for computing the percentage of any
other person. Except as indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them.
(2) Includes 37,850 shares of Common Stock owned by Mr. Richter's spouse and
510,000 shares of Common Stock issuable upon exercise of Common Stock
purchase warrants.
(3) 201 Main Street, Suite 1555, Fort Worth, Texas. Mr. Murphy, who became a
director of the Company in November 2001, is the president of Paradigm
Capital Corporation, a Texas corporation, which, in turn, is the sole
general partner of The Apogee Fund, L.P., a Delaware limited partnership.
All of the referenced common stock is owned of record by The Apogee Fund;
beneficial ownership of such securities is attributed to Mr. Murphy by
reason of his voting and disposition power with respect to The Apogee Fund
assets. Includes 50,000 shares of common stock issuable upon exercise of
common stock purchase warrants granted to Mr. Murphy.
(4) Includes 763,737 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(5) Includes 310,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(6) Includes 210,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(7) Includes 143,819 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(8) Includes 140,000 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(9) Includes 63,819 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
(10) Includes 2,191,374 shares of Common Stock issuable upon exercise of Common
Stock purchase warrants.
107
EQUITY COMPENSATION PLANS
The following table provides information concerning Penn Octane's equity
compensation plans as of July 31, 2004.
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
BE ISSUED UPON EXERCISE EXERCISE PRICE OF EQUITY COMPENSATION
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, PLANS (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation
plans approved by 2,090,000 $ 4.90 1,500,000 (1)(2)
security holders
Equity compensation
plans not approved by 492,500 $ 2.50 -
security holders (3) --------- ----------
Total 2,582,500 $ 4.44 1,500,000
========= ==========
<FN>
(1) Pursuant to Penn Octane's Board Plan, the outside directors are entitled to
receive warrants to purchase 20,000 shares of common stock of Penn Octane
upon their initial election as a director and warrants to purchase 10,000
shares of common stock of Penn Octane for each year of service as a
director.
(2) Pursuant to Penn Octane's 2001 Warrant Plan, Penn Octane may issue warrants
to purchase up to 1.5 million shares of common stock of Penn Octane.
(3) Penn Octane was not required to obtain shareholder approval for these
securities.
108
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During April 1997, Mr. Richter exercised warrants to purchase 2,200,000
shares of common stock of Penn Octane, at an exercise price of $1.25 per share.
The consideration for the exercise of the warrants included $22,000 in cash and
a $2,728,000 promissory note. The note was due on April 11, 2000. On April 11,
2000, Mr. Richter issued a new promissory note totaling $3,196,693 ("Mr.
Richter's Promissory Note"), representing the total unpaid principal and unpaid
accrued interest at the expiration of the original promissory note. During
September 1999, the Board of Directors of the Company agreed to offset interest
due on Mr. Richter's Promissory Note in consideration for providing collateral
and personal guarantees of Company debt. The principal amount of the note plus
accrued interest at an annual rate of 10.0%, except as adjusted for above, was
due on April 30, 2001. In November 2001 the Company extended the due date to
October 31, 2003 and the interest was adjusted to the prime rate on November 7,
2001 (5.0%). In July 2002 the Company extended the due date to July 29, 2005
and the interest rate was adjusted to the prime rate plus 1% on July 24, 2002
(5.75%). In connection with the extension, the Company agreed in Mr. Richter's
employment agreement to continue to forgive any interest due from Mr. Richter
pursuant to Mr. Richter's Promissory Note, provided that Mr. Richter guarantees
at least $2,000,000 of the Company's indebtedness during any period of that
fiscal year of the Company. Furthermore, the Company agreed to forgive Mr.
Richter's Promissory Note in the event that either (a) the share price of Penn
Octane's common stock trades for a period of 90 days at a blended average price
equal to at least $6.20, or (b) the Company is sold for a price per share (or an
asset sale realizes revenues per share) equal to at least $6.20. Mr. Richter is
personally liable with full recourse to the Company and has provided 1,000,000
shares of common stock of Penn Octane as collateral. As a result of the
Spin-Off he is also required to provide 125,000 Common Units of Rio Vista owned
by him (see note S to the consolidated financial statements). Those shares were
subsequently pledged to the holders of certain of the Company's debt
obligations.
Beginning in August 2002, the Company has employed Lon Richter, son of
Jerome B. Richter. Lon Richter is currently employed as the director of
information systems at an annual salary of approximately $96,000.
On March 26, 2000, the wife of Mr. Jorge Bracamontes, a former director and
executive officer of the Company, issued the Company a new promissory note
totaling $46,603, representing the total unpaid principal and interest due under
a prior promissory note due to the Company which matured March 26, 2000. The
principal amount of the note plus accrued interest at an annual rate of 10.0%
was due in April 2001. During November 2001, the Company and the wife of Mr.
Bracamontes agreed to exchange 1,864 shares of common stock of Penn Octane held
by the wife of Mr. Bracamontes for payment of all unpaid interest owing to the
Company through October 2001. In addition, the Company agreed to extend the
maturity date of the note held by the wife of Mr. Bracamontes to October 31,
2003. The wife of Mr. Bracamontes was personally liable with full recourse
under such promissory note and had provided the remaining 13,136 shares of
common stock of Penn Octane as collateral.
During March 2000, Mr. Bracamontes, a former director and executive officer
of the Company, exercised warrants to purchase 200,000 shares of common stock of
Penn Octane, at an exercise price of $2.50 per share. The consideration for the
exercise of the warrants included $2,000 in cash and a $498,000 promissory note.
The principal amount of the note plus accrued interest at an annual rate of
10.0% was due in April 2001. During November 2001, the Company and Mr.
Bracamontes agreed to exchange 19,954 shares of common stock of Penn Octane held
by Mr. Bracamontes for payment of all unpaid interest owing to the Company
through October 2001. In addition, the Company agreed to extend the maturity
date of the note held by Mr. Bracamontes to October 31, 2003. Mr. Bracamontes
was personally liable with full recourse under such promissory note and had
provided the remaining 180,036 shares of common stock of Penn Octane as
collateral.
109
During July 2003, Mr. Bracamontes resigned from his position as a director
and officer of the Company. In connection with his resignation the Company
agreed to (i) forgive the remaining balance of his $498,000 promissory note,
(ii) forgive the remaining balance of his wife's $46,603 promissory note, (iii)
issue 21,818 shares of Penn Octane's common stock (valued at approximately
$75,000), and (iv) make certain payments of up to $500,000 based on the success
of future projects (Mr. Richter agreed to guarantee these payments with 100,000
of his shares of the common stock of Penn Octane). Mr. Bracamontes continued to
provide services and the Company paid Mr. Bracamontes $15,000 a month through
March 31, 2004. All of the above amounts totaling approximately $520,000 and
$120,000 were reflected in the consolidated financial statements as of July 31,
2003 and 2004 respectively, as salaries and payroll related expenses.
Simultaneously, Mr. Bracamontes sold his 90% interest in Tergas, S.A. de C.V.
("Tergas"), a consolidated affiliate of the Company, to another officer of the
Company, Mr. Vicente Soriano, who collectively owns a 95% interest in Tergas.
The remaining balance is owned by Mr. Abelardo Mire, a consultant of the
Company. The Company has an option to acquire Tergas for a nominal price of
approximately $5,000. The Company pays Tergas its actual cost for distribution
services at the Matamoros Terminal Facility plus a small profit.
During September 2000, Mr. Ian Bothwell, a director and executive officer
of the Company, exercised warrants to purchase 200,000 shares of common stock of
Penn Octane, at an exercise price of $2.50 per share. The consideration for the
exercise of the warrants included $2,000 in cash and a $498,000 promissory note.
The principal amount of the note plus accrued interest at an annual rate of
10.5% was due in April 2001. During November 2001, the Company and Mr. Bothwell
agreed to exchange 14,899 shares of common stock of Penn Octane held by Mr.
Bothwell for payment of all unpaid interest owing to the Company through October
2001. In addition, the Company agreed to extend the maturity date of the note
held by Mr. Bothwell to October 31, 2003.
On September 10, 2000, the Board of Directors approved the repayment by a
company controlled by Mr. Bothwell (the "Buyer"), a director and executive
officer of the Company, of the $900,000 promissory note to the Company through
the exchange of 78,373 shares of common stock of Penn Octane owned by the Buyer,
which were previously pledged to the Company in connection with the promissory
note. The exchanged shares had a fair market value of approximately $556,000 at
the time of the transaction resulting in an additional loss of $84,000. The
remaining note had a balance of $214,355 and was collateralized by compressed
natural gas refueling station assets and 60,809 shares of Penn Octane's common
stock owned by the Buyer.
During October 2002, the Company agreed to accept the compressed natural
gas refueling station assets with an appraised fair value of approximately
$800,000 as payment for all notes outstanding at the time (with total principal
amount of $652,759 plus accrued interest) owed to the Company by Mr. Bothwell,
an executive officer and director of the Company. In connection with the
transaction, the Company adjusted the fair value of the assets to $720,000 to
reflect additional costs estimated to be incurred in disposing of the assets.
The Company also recorded interest income as of July 31, 2003 on the notes of
approximately $67,241, which had previously been reserved, representing the
difference between the adjusted fair value of the assets and the book value of
the notes.
In January 2002, the Company loaned Mr. Richter, the Company's Chief
Executive Officer, Chairman of the Board and former President, $200,000 due in
one year. The Company had also made other advances to Mr. Richter of
approximately $82,000 as of July 31, 2002, which were offset per his employment
agreement against accrued and unpaid bonuses due to Mr. Richter. The note due
from Mr. Richter in the amount of $200,000 plus accrued interest as of January
31, 2003, was paid through an offset against previously accrued bonus and profit
sharing amounts due to Mr. Richter in January 2003.
During March 2003, warrants to purchase 250,000 shares of common stock of
Penn Octane were exercised by Trellus Partners, L.P. for which the exercise
price totaling $625,000 was paid by reduction of a portion of the outstanding
debt and accrued interest owed to Trellus Partners, L.P. by the Company. In
addition, during March 2003, Trellus Partners, L.P. acquired 161,392 shares of
common stock of Penn Octane from the Company at a price of $2.50 per share in
exchange for cancellation of the remaining outstanding debt and accrued interest
owed to Trellus Partners, L.P. totaling $403,480.
It is anticipated that Mr. Richter and Shore Capital will exercise their
General Partners Options in the near future. The exercise price for each option
will be the pro rata share (0.5%) of Rio Vista's tax basis capital immediately
after the Spin-Off. Penn Octane will retain voting control of Rio Vista
pursuant to a voting agreement between Penn Octane, Mr. Richter and Shore
Capital. In addition, Shore Capital received warrants to acquire 763,737 shares
of the common stock of Penn Octane at $1.14 per common share and 97,415 Common
Units of Rio Vista at $8.47 per Common Unit. The warrants are exercisable
beginning on October 1, 2004 and expire on July 10, 2006.
110
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The Company has been billed as follows for the professional services of
Burton McCumber & Cortez, L.L.P. rendered during fiscal years 2003 and 2004:
2003 2004
----------- ------------
Audit Fees $ 263,229 $ 317,897
Audit - Related Fees $ - $ -
Tax Fees (1) $ 12,420 $ 13,867
All Other Fees $165,746(2) $240,083 (2)
<FN>
(1) Represents fees billed for tax compliance, tax advice and tax planning
services.
(2) Represents fees billed for accounting and tax issues related to Mexico and
U.S. with $162,458 and $227,570 representing fees billed related to the
Spin-Off for the years ended July 31, 2003 and 2004, respectively.
The Company's audit committee approves the engagement of its independent
auditor to perform audit related services. The audit committee does not
formally approve specific amounts to be spent on non-audit related services
which in the aggregate do not exceed amounts to be spent on audit related
services. In determining the reasonableness of audit fees, the audit
committee considers historical amounts paid and the scope of services to be
performed.
111
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
a. Financial Statements and Financial Statement Schedules.
The following documents are filed as part of this report:
(1) Consolidated Financial Statements:
Penn Octane Corporation
Independent Auditor's Report
Consolidated Balance Sheet as of July 31, 2003 and 2004
Consolidated Statements of Operations for the years ended
July 31, 2002, 2003 and 2004
Consolidated Statement of Stockholders' Equity for the years
ended July 31, 2002, 2003 and 2004
Consolidated Statements of Cash Flows for the years ended
July 31, 2002, 2003 and 2004
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
b. Reports on Form 8-K.
The following Reports on Form 8-K were filed during the period May 1
through July 31, 2004:
the Company's Current Report on Form 8-K filed on May 7, 2004
regarding the expiration of the contract with PMI and
commencement of monthly sales agreements with PMI.
c. Exhibits.
THE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE TO PREVIOUSLY
FILED REPORTS, AS NOTED:
Exhibit No.
- -----------
3.1 Restated Certificate of Incorporation, as amended. (Incorporated by reference to the Company's Quarterly
Report on Form 10-QSB for the quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File No. 000-24394).
3.2 Amended and Restated By-Laws of the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-QSB for the quarterly period ended April
30, 1997 filed on June 16, 1997, SEC File No. 000-24394).
3.3 The Company's Certificate of the Designation, Powers, Preferences and Rights of the Series B. Class A Senior
Cumulative Preferred Stock, filed with the State of Delaware.
10.1* Employment Agreement dated July 12, 1993 between the Registrant and Jerome B. Richter. (Incorporated
by reference to the Company's Quarterly Report on Form 10-QSB for the quarterly period ended October
31, 1993 filed on March 7, 1994, SEC File No. 000-24394).
112
10.2* Promissory Note and Pledge and Security Agreement dated March 26, 1997 between M.I.
Garcia Cuesta and the Registrant. (Incorporated by reference to the Company's Quarterly
Report on Form 10-QSB for the quarterly period ended April 30, 1997 filed on June 16, 1997,
SEC File No. 000-24394).
10.3* Promissory Note and Pledge and Security Agreement dated April 11, 1997 between Jerome B.
Richter and the Registrant. (Incorporated by reference to the Company's Quarterly Report on
Form 10-QSB for the quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
10.4 Lease dated October 20, 1993 between Brownsville Navigation District of Cameron County,
Texas and Registrant with respect to the Company's land lease rights, including related
amendment to the Lease dated as of February 11, 1994 and Purchase Agreement.
(Incorporated by reference to the Company's Quarterly Report on Form 10-QSB filed for the
quarterly period ended April 30, 1994 on February 25, 1994, SEC File No. 000-24394).
10.5 Lease Amendment dated May 7, 1997 between Registrant and Brownsville Navigation District
of Cameron County, Texas. (Incorporated by reference to the Company's Quarterly Report on
Form 10-QSB for the quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
10.6 Lease dated September 1, 1993 between Seadrift Pipeline Corporation and Registrant with
respect to the Company's pipeline rights. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly period ended October 31, 1993 filed on
March 7, 1994, SEC File No. 000-24394).
10.7 Lease Amendment dated May 21, 1997 between Seadrift Pipeline Corporation and the
Registrant. (Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File No. 000-24394).
10.8 Continuing Agreement for Private Letters of Credit dated October 14, 1997 between RZB
Finance LLC and the Company. (Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended July 31, 1997 filed on November 13, 1997, SEC File No.
000-24394).
10.9 Promissory Note dated October 14, 1997 between RZB Finance LLC and the Company.
(Incorporated by reference to the Company's Annual Report on Form 10-K for the year
ended July 31, 1997 filed on November 13, 1997, SEC File No. 000-24394).
10.10 General Security Agreement dated October 14, 1997 between RZB Finance LLC and the
Company. (Incorporated by reference to the Company's Annual Report on Form 10-K for the
year ended July 31, 1997 filed on November 13, 1997, SEC File No. 000-24394).
10.11 Guaranty and Agreement dated October 14, 1997 between RZB Finance LLC and Jerome
Richter. (Incorporated by reference to the Company's Annual Report on Form 10-K for the
year ended July 31, 1997 file don November 13, 1997, SEC File No. 000-24394).
10.12 Amendment letter dated April 22, 1998 between RZB Finance LLC and the Company.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the three
months ended April 30, 1998 filed on June 15, 1998, SEC File No. 000-24394).
10.13* Employment Agreement dated November 17, 1997 between the Company and Jerry L. Lockett.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the three
months ended April 30, 1998 filed on June 15, 1998, SEC File No. 000-24394).
10.14 Lease/Installment Purchase Agreement dated November 24, 1998 by and between CPSC
International and the Company. (Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended July 31, 1999 filed on November 9, 1999, SEC File No. 000-
24394).
113
10.15 Amendment No. 1, to the Lease/Installment Purchase Agreement dated November 25, 1999,
dated January 7, 1999 by and between CPSC International and the Company. (Incorporated by
reference to the Company's Annual Report on Form 10-K for the year ended July 31, 1999 filed
on November 9, 1999, SEC File No. 000-24394).
10.16 Amendment, to Lease/Installment Purchase Agreement dated February 16, 1999 dated January
25, 1999 by and between CPSC International and the Company. (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended July 31, 1999 filed on
November 9, 1999, SEC File No. 000-24394).
10.17 Lease/Installment Purchase Agreement dated February 16, 1999 by and between CPSC
International and the Company. (Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended July 31, 1999 filed on November 9, 1999, SEC File No. 000-
24394).
10.18 Amendment No. 2, to Lease/Installment Purchase Agreement dated November 24, 1998 and to
Lease/Installment Purchase Agreement dated January 7, 1999 dated September 16, 1999 by and
between CPSC International and the Company. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 1999 filed on November 9, 1999,
SEC File No. 000-24394).
10.19 Agreement dated September 16, 1999 by and between CPSC International and the Company.
(Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended
July 31, 1999 filed on November 9, 1999, SEC File No. 000-24394).
10.20 Purchase, Sale and Service Agreement for Propane/Butane Mix entered into effective as of
October 1, 1999 by and between Exxon Company, U.S.A. and the Company. (Incorporated by
reference to the Company's Annual Report on Form 10-K for the year ended July 31, 1999 filed
on November 9, 1999, SEC File No. 000-24394).
10.21 Sales/Purchase Agreement of Propane Stream dated October 1, 1999 between PG&E NGL
Marketing, L.P. and the Company. (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 1999 filed on November 9, 1999, SEC File
No. 000-24394).
10.22 Permit issued on July 26, 1999 by the United States Department of State authorizing the
Company to construct two pipelines crossing the international boundary line between the
United States and Mexico for the transport of liquefied petroleum gas (LPG) and refined
product (motor gasoline and diesel fuel). (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 1999 filed on November 9, 1999, SEC File
No. 000-24394).
10.23 Amendment to the LPG Purchase Agreement dated June 18, 1999 between P.M.I. Trading Ltd.
and the Company. (Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended July 31, 1999 filed on November 9, 1999, SEC File No. 000-24394).
10.24* Transfer of Shares Agreement dated November 4, 1999 between Jorge Bracamontes and the
Company. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended October 31, 1999 filed on December 14, 1999, SEC File No. 000-
24394).
10.25* Transfer of Shares Agreement dated November 4, 1999 between Juan Jose Navarro Plascencia
and the Company. (Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 1999 filed on December 14, 1999, SEC File
No. 000-24394).
114
10.26 Addendum dated December 15, 1999 between CPSC International, Inc. and the Company.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended January 31, 2000, filed on March 21, 2000, SEC File No. 000-24394).
10.27 LPG Mix Purchase Contract (DTIR-010-00) dated March 31, 2000 between P.M.I. Trading
Limited and the Company. (Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended April 30, 2000, filed on June 19, 2000, SEC File No.
000-24394).
10.28 LPG Mix Purchase Contract (DTIR-011-00) dated March 31, 2000 between P.M.I. Trading
Limited and the Company. (Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended April 30, 2000, filed on June 19, 2000, SEC File No.
000-24394).
10.29 Product Sales Agreement dated February 23, 2000 between Koch Hydrocarbon Company and
the Company. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended April 30, 2000, filed on June 19, 2000, SEC File No. 000-
24394).
10.30 First Amendment Line Letter dated May 2000 between RZB Finance LLC and the Company.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended April 30, 2000, filed on June 19, 2000, SEC File No. 000-24394).
10.31* Promissory Note and Pledge and Security Agreement dated April 11, 2000 between Jerome B.
Richter and the Registrant. (Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on November 14, 2000, SEC File No. 000-
24394).
10.32* Promissory Note and Pledge and Security Agreement dated March 25, 2000 between Jorge
Bracamontes A. and the Registrant. (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 2000, filed on November 14, 2000, SEC File
No. 000-24394).
10.33* Promissory Note and Pledge and Security Agreement dated March 26, 2000 between M.I.
Garcia Cuesta and the Registrant. (Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended July 31, 2000, filed on November 14, 2000, SEC File No.
000-24394).
10.34* Promissory Note and Pledge and Security Agreement dated September 10, 2000, between Ian
Bothwell and the Registrant. (Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on November 14, 2000, SEC File No. 000-
24394).
10.35* Promissory Share Transfer Agreement to purchase shares of Termatsal, S.A. de C.V. dated
November 13, 2000, between Jorge Bracamontes and the Company (Translation from Spanish).
(Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended
July 31, 2000, filed on November 14, 2000, SEC File No. 000-24394).
10.36* Promissory Share Transfer Agreement to purchase shares of Termatsal, S.A. de C.V. dated
November 13, 2000, between Pedro Prado and the Company (Translation from Spanish).
(Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended
July 31, 2000, filed on November 14, 2000, SEC File No. 000-24394).
115
10.37* Promissory Share Transfer Agreement to purchase shares of Termatsal, S.A. de C.V. dated
November 13, 2000, between Pedro Prado and Penn Octane International, L.L.C. (Translation
form Spanish). (Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended July 31, 2000, filed on November 14, 2000, SEC File No. 000-24394).
10.38* Promissory Share Transfer Agreement to purchase shares of Penn Octane de Mexico, S.A. de
C.V. dated November 13, 2000, between Jorge Bracamontes and the Company. (Translation
from Spanish). (Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended July 31, 2000, filed on November 14, 2000, SEC File No. 000-24394).
10.39 Promissory Share Transfer Agreement to purchase shares of Penn Octane de Mexico, S.A. de
C.V. dated November 13, 2000, between Juan Jose Navarro Plascencia and the Company.
(Translation from Spanish). (Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, filed on November 14, 2000, SEC File No. 000-
24394).
10.40 Promissory Share Transfer Agreement to purchase shares of Penn Octane de Mexico, S.A. de
C.V. dated November 13, 2000, between Juan Jose Navarro Plascencia and Penn Octane
International, L.L.C. (Translation from Spanish). (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 2000, filed on November 14, 2000,
SEC File No. 000-24394).
10.41* Promissory Note and Pledge and Security Agreement dated November 30, 2000, between
Western Wood Equipment Corporation and the Registrant. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2000,
filed on December 12, 2000, SEC File No. 000-24394).
10.42 Form of Amendment to Promissory Note (the "Note") of Penn Octane Corporation (the
"Company") due December 15, 2001, and related agreements and instruments dated November
28, 2001, between the Company and the holders of the Notes. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2001,
filed on December 17, 2001, SEC File No. 000-24394).
10.43 LPG sales agreement entered into as of March 1, 2002 by and between Penn Octane
Corporation ("Seller") and P.M.I. Trading Limited ("Buyer"). (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2002 filed
on June 13, 2002, SEC File No. 000-24394).
10.44 Settlement agreement, dated as of March 1, 2002 by and between P.M.I. Trading Limited and
Penn Octane Corporation. (Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended April 30, 2002 filed on June 13, 2002, SEC File No.
000-24394).
10.45 Form of Amendment to Promissory Note (the "Note") of Penn Octane Corporation (the
"Company") due June 15, 2002, and related agreements and instruments dated June 5, 2002,
between the Company and the holders of the Notes. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2002 filed
on June 13, 2002, SEC File No. 000-24394).
10.46 Form of Amendment to Promissory Note (the "Note") of Penn Octane Corporation (the
"Company") due December 15, 2002, and related agreements and instruments dated December
9, 2002 between the Company and the holders of the Notes. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended January 31, 2003
filed on March 20, 2003, SEC File No. 000-24394).
10.47* Employee contract entered into and effective July 29, 2002, between the Company and Jerome
B. Richter. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended January 31, 2003 filed on March 20, 2003, SEC File No. 000-
24394).
116
10.48* Equipment Acquisition Agreement effective October 18, 2002 by and between Penn Octane
Corporation and Penn Wilson CNG, Inc., on the one hand, and B&A Eco-Holdings, Inc. and
Ian T. Bothwell, on the other hand. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended January 31, 2003 filed on March 20, 2003,
SEC File No. 000-24394).
10.49* Bill of Sale dated October 18, 2002 between B&A Eco-Holdings, Inc. and the Company.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended January 31, 2003 filed on March 20, 2003, SEC File No. 000-24394).
10.50* Stock Purchase and Separation Agreement dated July 22, 2003 between Jorge Bracamontes and
the Company. (Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended July 31, 2003 filed on October 31, 2003, SEC File No. 000-24394).
10.51* Supplement and Amendment to Stock Purchase of Separation Agreement dated September
12, 2003 between Jorge Bracamontes and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 2003 filed on
November 3, 2003, SEC File No. 000-24394).
10.52* Amended Supplement and Amendment to Stock Purchase of Separation Agreement dated
October 2, 2003 between Jorge Bracamontes and the Company. (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended July 31, 2003 filed on
November 3, 2003, SEC File No. 000-24394).
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:
10.53* Employee contract entered into and effective May 13, 2003 between the Company and
Richard Shore, Jr.
10.54 Form of Amendment to Promissory Note (the "Note") of Penn Octane Corporation (the
"Company") due December 15, 2003, and related agreements and instruments dated January
13, 2004, between the Company and the holders of the Notes.
10.55 Contribution, Conveyance and Assumption Agreement entered into as of September 16,
2004 by and among Penn Octane Corporation, Rio Vista GP LLC, Rio Vista Energy Partners
L.P., Rio Vista Operating GP LLC and Rio Vista Operating Partnership L.P.
10.56 Conveyance Agreement effective September 30, 2004 from Penn Octane Corporation in favor
of Rio Vista Operating Partnership L.P.
10.57 Distribution Agreement dated September 16, 2004 by and among Penn Octane Corporation,
Rio Vista Energy Partners L.P. and Subsidiaries.
10.58 Omnibus Agreement entered into as of September 16, 2004 by and among Penn Octane
Corporation, Rio Vista GP LLC , Rio Vista Energy Partners, L.P. and Rio Vista Operating
Partnership L.P.
10.59 Amendment No. 1 to Omnibus Agreement entered into as of September 16, 2004 by and
among Penn Octane Corporation, Rio Vista GP LLC, Rio Vista Energy Partners L.P. and Rio
Vista Operating Partnership L.P.
10.60 Purchase Contract made and entered into effective as of October 1, 2004 by and between Penn
Octane Corporation and Rio Vista Operating Partnership L.P.
10.61* Rio Vista GP LLC Unit Purchase Option dated July 10, 2003 granted by Penn Octane
Corporation to Shore Capital LLC.
117
10.62* Rio Vista GP LLC Unit Purchase Option dated July 10, 2003 granted by Penn Octane
Corporation to Jerome B. Richter.
10.63* Rio Vista Energy Partners L.P. Unit option Agreement dated July 10, 2003 granted to Shore
Capital LLC.
10.64* Penn Octane Corporation Common Stock Purchase Warrant dated October 1, 2004 granted to
Shore Capital LLC.
10.65 First Amended and Restated Agreement of Limited Partnership of Rio Vista Energy Partners
L.P. dated as of September 16, 2004.
10.66 Rio Vista GP LLC Amended and Restated Limited Liability Company Agreement dated as of
September 16, 2004.
10.67* Form of RVGP Voting Agreement by and among Rio Vista GP LLC, Penn Octane Corporation
and the members of Rio Vista GP LLC.
10.68 First Amended and Restated Agreement of Limited Partnership of Rio Vista Operating
Partnership L.P. dated as of September 16, 2004.
10.69 Amended and Restated Line Letter dated September 15, 2004 between RZB Finance LLC and
Penn Octane Corporation.
10.70 Replacement Promissory Note dated September 15, 2004 by Penn Octane Corporation to RZB
Finance LLC.
10.71 Consent Letter dated September 15, 2004 between RZB Finance LLC and Penn Octane
Corporation.
10.72 Assignment of Easements from Penn Octane to Rio Vista Operating Partnership L.P. dated
September 15, 2004.
10.73 Guaranty & Agreement between Rio Vista Energy Partners L.P. and RZB Finance LLC dated
as of September 15, 2004.
10.74 Guaranty & Agreement between Rio Vista Operating Partnership L.P. and RZB Finance LLC
dated as of September 15, 2004.
10.75 General Security Agreement between Rio Vista Energy Partners L.P. and RZB Finance LLC
dated as of September 15, 2004.
10.76 General Security Agreement between Rio Vista Operating Partnership L.P. and RZB Finance
LLC dated as of September 15, 2004.
10.77 Assignment of lease No. "2823" dated September 15, 2004 between Penn Octane Corporation
and Rio Vista Operating Partnership L.P.
10.78 Assignment of lease No. "3165" dated September 15, 2004 between Penn Octane Corporation
and Rio Vista Operating Partnership L.P.
10.79 Assignment of lease No. "3154" dated September 15, 2004 between Penn Octane Corporation
and Rio Vista Operating Partnership L.P.
118
14.1 Code of Conduct of the Registrant
21 Subsidiaries of the Registrant
23 Consent of Independent Certified Public Accountant
31.1 Certification Pursuant to Rule 13a-14(a) / 15d - 14(a) of the Exchange Act
31.2 Certification Pursuant to Rule 13a-14(a) / 15d - 14(a) of the Exchange Act
32 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes - Oxley Act of 2002
<FN>
* indicates management contract or compensatory plan or arrangement.
119
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENN OCTANE CORPORATION
By: /s/Ian T. Bothwell
--------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
November 9, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/Jerome B. Richter Jerome B. Richter November 9, 2004
- ----------------------
Chairman and Chief Executive
Officer (Principal Executive Officer)
/s/Richard Shore, Jr. Richard Shore, Jr. November 9, 2004
- ---------------------- President
/s/Charles Handly Charles Handly November 9, 2004
- ---------------------- Executive Vice President, Chief
Operations Officer
/s/Ian T. Bothwell Ian T. Bothwell November 9, 2004
- ---------------------- Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary
(Principal Financial and Accounting
Officer)
/s/Jerry Lockett Jerry Lockett November 9, 2004
- ---------------------- Vice President and Secretary
/s/Stewart J. Paperin Stewart J. Paperin November 9, 2004
- ---------------------- Director
/s/Harvey L. Benenson Harvey L. Benenson November 9, 2004
- ---------------------- Director
/s/Emmett M. Murphy Emmett M. Murphy November 9, 2004
- ---------------------- Director
120