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, 2001
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 Identification No.)
of Incorporation or Organization)
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. [ ]
1
The aggregate market value of the voting stock held by non-affiliates of
the Registrant was $43,240,518 as of October 12, 2001. The last reported sale
price of the Registrant's Common Stock was $4.15 per share as reported on the
Nasdaq SmallCap Market on October 12, 2001.
The number of shares of Common Stock, par value $.01 per share, outstanding
on October 12, 2001 was 14,778,944.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement relating to the
2001 Annual Meeting of Stockholder's (to be filed subsequently) are incorporated
by reference into Part III.
TABLE OF CONTENTS
ITEM PAGE NO.
---- --------
Part I 1. Business 3
2. Properties 13
3. Legal Proceedings 15
4. Submission of Matters to a Vote of Security Holders 16
Part II 5. Market for Registrant's Common Equity and Related
Stockholder Matters 17
6. Selected Financial Data 19
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
7A. Quantitative and Qualitative Disclosures About Market Risks 32
8. Financial Statements and Supplementary Data 33
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 72
Part III 10. Directors and Executive Officers of the Registrant 73
11. Executive Compensation 73
12. Security Ownership of Certain Beneficial Owners and Management 73
13. Certain Relationships and Related Transactions 73
Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 74
2
PART I
The statements contained in this Annual Report that are not historical facts are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933. These forward-looking statements may be identified by the use of
forward-looking terms such as "believes," "expects," "may," "will", "should" or
anticipates" or by discussions of strategy that involve risks and uncertainties.
From time to time, we have made or may make forward-looking statements, orally
or in writing. These forward-looking statements include statements regarding
anticipated future revenues, sales, LPG supply, operations, demand, competition,
capital expenditures, the deregulation of the LPG market in Mexico, the
operations of the US - Mexico Pipelines, the Matamoros Terminal Facility and the
Saltillo Terminal Facility, other upgrades to our facilities, foreign ownership
of LPG operations, short-term obligations and credit arrangements, outcome of
litigation and other statements regarding matters that are not historical facts,
and involve predictions which are based upon a number of future conditions that
ultimately may prove to be inaccurate. Actual results, performance or
achievements could differ materially from the results expressed in, or implied
by, these forward-looking statements. Factors that may cause or contribute to
such differences include those discussed under "Business" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations", as
well as those discussed elsewhere in this Annual Report. We caution you,
however, that this list of factors may not be complete.
ITEM 1. BUSINESS.
INTRODUCTION
Penn Octane Corporation (the "Company"), formerly known as International
Energy Development Corporation ("International Energy"), was incorporated in
Delaware in August 1992. The Company has been principally engaged in the
purchase, transportation and sale of liquefied petroleum gas ("LPG"). From 1997
until March 1999, the Company was also involved in the provision of equipment
and services to the compressed natural gas ("CNG") industry. The Company owns
and operates a terminal facility in Brownsville, Texas (the "Brownsville
Terminal Facility") and owns a LPG terminal facility in Matamoros, Tamaulipas,
Mexico (the "Matamoros Terminal Facility") and 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 Exxon
Mobil Corporation's ("Exxon") King Ranch Gas Plant in Kleberg County, Texas and
Duke Energy's La Gloria Gas Plant in Jim Wells County, Texas, to the Company's
Brownsville Terminal Facility. In addition, the Company has access to a
twelve-inch pipeline (the "ECCPL"), which connects from Exxon's Viola valve
station in Nueces County, Texas to the inlet of the King Ranch Gas Plant as well
as existing and other potential propane pipeline suppliers which have the
ability to access the ECCPL. In connection with the Company's lease agreement
for the Leased Pipeline, the Company may access up to 21.0 million gallons of
storage, located in Markham, Texas ("Markham"), as well as other potential
propane pipeline exchange suppliers, via approximately 155 miles of pipeline
located between Markham and the Exxon King Ranch Gas Plant. The Company also
has up to 8.4 million gallons of available storage at Mont Belvieu.
On October 21, 1993, International Energy purchased 100% of the common
stock of Penn Octane Corporation, a Texas corporation, and merged it into
International Energy as a division. As a result of the merger, the Company
assumed the lease agreement with Seadrift Pipeline Corporation ("Seadrift") for
the use of the Leased Pipeline. In January 1995, the Board of Directors
approved the change of the Company's name to Penn Octane Corporation.
3
The Company commenced commercial operations for the purchase, transport and
sale of LPG in the fiscal year ended July 31, 1995, upon construction of the
Brownsville Terminal Facility. The primary market for the Company's LPG is the
northeastern region of Mexico, which includes the states of Coahuila, Nuevo Leon
and Tamaulipas. The Company believes it has a competitive advantage in the
supply of LPG for the northeastern region of Mexico because of the Company's
access to pipelines and terminal facilities which allow the Company to bring
supplies of LPG close to consumers of LPG in major cities in that region. The
Company sells LPG primarily to P.M.I. Trading Limited ("PMI"). PMI is also a
subsidiary of Petroleos Mexicanos, the state-owned Mexican oil company, which is
commonly known by its trade name "PEMEX." PMI is the exclusive importer of LPG
into Mexico. The LPG purchased by PMI from the Company is sold to PEMEX which
distributes the LPG purchased from PMI into the northeastern region of Mexico.
Since operations commenced, the Company's primary customer for LPG has been PMI.
In March 1997, the Company, through its wholly-owned subsidiary PennWilson
CNG, Inc., a Delaware corporation ("PennWilson"), acquired certain assets,
including inventory, equipment and intangibles, from Wilson Technologies
Incorporated ("WTI"), a company formerly engaged in the design, construction,
installation and maintenance of turnkey CNG fueling stations, hired certain of
WTI's former employees and commenced operations for the provision of equipment
and services used in the CNG industry. In May 1999, the Company discontinued
operation of its CNG business and most of the Company's CNG assets were sold
(see note D to the consolidated financial statements).
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. The offices of PennWilson are located at 12631 Imperial
Highway, Bldg. A, Suite 120A, Santa Fe Springs, California 90670, and its
telephone number is (562) 929-1984.
LIQUEFIED PETROLEUM GAS
OVERVIEW. Since operations commenced, the primary business of the Company
has been the purchase, transportation and sale of LPG. LPG is a mixture of
propane and butane principally used for residential and commercial heating and
cooking. The demand for propane is also growing as a motor fuel substitute for
motor gasoline.
The primary market for the Company's LPG is the northeastern region of
Mexico, which includes the states of Coahuila, Nuevo Leon and Tamaulipas.
Mexico is one of the largest markets for LPG consumption in the world. LPG is
the most widely used domestic fuel in Mexico and is the primary energy source
for Mexican households using such domestic fuels. Domestic consumption of LPG
in Mexico increased from an average of 385.7 million gallons per month in 2000
to an average of 407.6 million gallons per month from January 1, 2001 to August
31, 2001, an estimated annual increase of 5.7%. The future of LPG in Mexico
continues to favor the Company for the following reasons: (i) Mexico's domestic
consumption of LPG exceeds current domestic production capacity and such short
fall is expected to increase (ii) limited sources of competitive LPG supply for
importation into Mexico which is destined for consumption in northeastern
Mexico, (iii) the Mexican government's current plans to deregulate the LPG
industry, (iv) the expanding use of propane as an automotive fuel, and (v) the
location of Mexico's major domestic LPG production, which is in the southeastern
region of Mexico, combined with the lack of pipeline infrastructure within
Mexico from those production centers, resulting in higher distribution costs to
transport the LPG to areas where consumption is heaviest including the central,
northern and Pacific coast regions of Mexico.
4
The Company is able to successfully compete with other LPG suppliers in the
provision of LPG to customers in northeastern Mexico primarily as a result of
the Leased Pipeline, the US - Mexico Pipelines and the geographic proximity of
its Matamoros Terminal Facility to consumers of LPG in such major cities in
Mexico as Matamoros, Reynosa and Monterrey. With the commencement of operations
of the Matamoros Terminal Facility in April 2000, the Company reduced its
exposure to the previous logistical inefficiencies and sales limitations of its
Brownsville Terminal Facility resulting from trucking delays at the United
States-Mexico border crossings or the ability of PMI to provide United States
certified trucks or trailers capable of receiving LPG at the Brownsville
Terminal Facility. 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. The Company believes that
the Matamoros Terminal Facility provides PMI with a less costly alternative than
other LPG supply centers used by it for the importation of LPG. The Company
believes that the Matamoros Terminal Facility and the Saltillo Terminal Facility
(in the future as defined below) enhances its strategic position for the sale
of LPG in northeastern Mexico.
THE BROWNSVILLE TERMINAL FACILITY. The Company's Brownsville Terminal
Facility occupies approximately 31 acres of land located adjacent to the
Brownsville Ship Channel, a major deep-water port serving northeastern Mexico,
including the city of Monterrey, and southeastern Texas. The Brownsville
Terminal Facility also contains a railroad spur. Total rated storage capacity
of the Brownsville Terminal Facility is approximately 675,000 gallons of LPG.
The Brownsville Terminal Facility includes eleven storage and mixing tanks, four
mixed product truck loading racks, one specification product propane loading
rack and 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 October 15, 2003.
Currently, substantially all of the Company's LPG supply is received by the
Leased Pipeline, flows through pipelines, 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 cannot be used. The
Brownsville Lease contains a pipeline easement to the District's water dock
facility at the Brownsville Ship Channel. The Company intends to complete
upgrades (see below) which would allow the Company to utilize the water dock
facility for the loading or offloading of barges of LPG or other products. The
railroad loading facilities are currently being used by the Company for sales of
LPG to other US or Canadian customers and to provide the Company with increased
flexibility in managing its LPG supplies and sales.
The Company anticipates renewing the Brownsville Lease prior to its
expiration. 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.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.
5
The principal construction of the US - Mexico Pipelines and the Matamoros
Terminal Facility was performed by CPSC International, Inc. ("CPSC") under two
separate Lease / Installation Purchase Agreements, as amended (the "Lease
Agreements") between CPSC and the Company. During December 1999, the Company
and CPSC amended the Lease Agreements whereby the Company acquired a 50%
interest for $3.0 million and had the option to acquire the remaining 50%
interest in the Lease Agreements. During February 2000, the Company determined
that CPSC did not comply with certain obligations under the Lease Agreements.
In March 2000, CPSC filed for protection under Chapter 11 of the United States
Bankruptcy Code.
On March 30, 2001, the Company completed a settlement with CPSC and Cowboy
Pipeline Service Company, Inc. ("Cowboy"), an affiliate of CPSC, which provided
the Company with the remaining 50% interest in the portion of the US - Mexico
Pipelines, Matamoros Terminal Facility and related land, permits or easements
(the "Acquired Assets") previously constructed and/or owned by CPSC and leased
to the Company (see note M to the consolidated financial statements).
The Company's Mexican subsidiaries, PennMex and Termatsal, S.A. de C.V
("Termatsal"), own all of the assets related to the Mexican portion of the US -
Mexico Pipelines and Matamoros Terminal Facility and the Company's affiliate
Tergas, S.A. de C.V. ("Tergas") has been granted the permit to operate the
Matamoros Terminal Facility (see Mexican Operations).
US - Mexico Pipelines. The Company's US-Mexico Pipelines consist of two
parallel pipelines, one of approximately six inch diameter and the other of
approximately eight inch diameter, running approximately 25 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 flow product bi-directionally and can accommodate LPG or
Refined Products.
The Matamoros Terminal Facility. The Company's Matamoros Terminal Facility
occupies approximately 35 acres of land located approximately seven miles from
the United States-Mexico border and is linked to the Brownsville Terminal
Facility via the US - Mexico Pipelines. The Matamoros Terminal Facility is
located in an industrial zone west of the city of Matamoros, and the Company
believes that it is strategically positioned to be a centralized distribution
center of LPG for the northeastern region of Mexico. Total rated storage
capacity of the Matamoros Terminal Facility is approximately 270,000 gallons of
LPG and there are plans to install additional storage capacity totaling
approximately 630,000 gallons. The Matamoros Terminal Facility includes three
storage tanks and ten specification product truck loading racks for LPG product.
The truck loading racks are linked to a computer-controlled loading and remote
accounting system and to the Company's Brownsville Terminal Facility. The
Matamoros Terminal Facility receives its LPG supply directly from the US -
Mexico Pipelines which connect to the Leased Pipelines at the Brownsville
Terminal Facility.
OTHER. The Company's other facilities and pending projects which may expand
the Company's business activities are as follows:
The Saltillo Terminal Facility. Termatsal has completed construction of an
additional LPG terminal facility in Saltillo, Mexico (the "Saltillo Terminal
Facility"). The Saltillo Terminal Facility is capable of off loading LPG from
railcars to trucks. The Saltillo Terminal Facility contains storage to
accommodate approximately 90,000 gallons of LPG with additional storage planned
for 180,000 gallons. The Saltillo Terminal Facility has three railcar off
loading racks and three truck loading racks. As a result of the Saltillo
Terminal Facility, the Company can directly transport LPG via railcar from the
Brownsville Terminal Facility to the Saltillo Terminal Facility. The Company
believes that by having the capability to deliver LPG to the Saltillo Terminal
Facility, the Company will be able to further penetrate the Mexican market for
the sale of LPG. The Saltillo Terminal Facility has not begun operations due to
concerns by local residents in Saltillo. If such concerns cannot be resolved,
the Company may relocate the tangible assets comprising the Saltillo Terminal
Facility to a remote location. The cost of such relocation is not expected to
be material to the Company's consolidated financial statements.
6
The Tank Farm. The Company owns four storage tanks capable of storing
approximately 12.6 million gallons of Refined Products. The Company leases the
land on which the Tank Farm is located from the District under a lease agreement
that expires in January 2005. The Company intends to construct additional piping
to the Tank Farm which would connect the Brownsville Terminal Facility, the Tank
Farm and the water dock facilities at the Brownsville Ship Channel.
Upgrades. The Company also intends to contract for the design,
installation and construction of pipelines which will connect the Brownsville
Terminal Facility to the District's water dock facilities at the Brownsville
Ship Channel and install additional storage capacity. The cost of this project
is expected to approximate $2.0 million. The Company had employed a firm to
provide the design and engineering for this project.
THE LEASED PIPELINE. The Company has a lease agreement (the "Pipeline
Lease") with Seadrift, a subsidiary of Dow Hydrocarbons and Resources, Inc.
("Dow"), for approximately 132 miles of pipeline which connects Exxon's King
Ranch Gas Plant in Kleberg County, Texas and Duke Energy Corporation's La Gloria
Gas Plant in Jim Wells County, Texas, to the Company's Brownsville Terminal
Facility (the "Leased Pipeline"). As provided for in the Pipeline Lease, the
Company has the right to use the Leased Pipeline solely for the transportation
of LPG and refined products belonging only to the Company and not to any third
party.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (the "Pipeline Lease Amendment") entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999 (the
"Effective Date"). The Pipeline Lease Amendment provides, among other things,
access up to 21.0 million gallons of storage located in Markham as well as other
potential propane pipeline exchange suppliers via approximately 155 miles of
pipeline located between Markham and the Exxon King Ranch Gas Plant (see note L
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 has made all payments required
under the Pipeline Lease Amendment.
The Company has recently completed 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
Company anticipates the mid-line pump station will be utilized in the near
future. The Leased Pipeline's capacity is estimated to be between 300 million
gallons per year and 360 million gallons per year.
The Company intends to obtain additional lease extensions for the Leased
Pipeline, which would enable the Company to maintain its LPG business beyond the
term of the Pipeline Lease Amendment.
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 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 up to 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.
7
Since March 2001, PMI has used the Matamoros Terminal Facility to load a
portion of LPG purchased from the Company for distribution in Mexico. The
Company continues to use the Brownsville Terminal Facility in connection with
LPG delivered by railcar to other customers or 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 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 and Saltillo,
Coahuila, 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.
The Old Agreements expired March 31, 2001. On April 26, 2001, PMI
confirmed to the Company in writing (the "Confirmation") the following terms of
a new agreement (the "Proposed Agreement") effective April 1, 2001, subject to
revisions to be provided by PMI's legal department. The Confirmation provides
for minimum monthly volumes of 19.0 million gallons at indexed variable posted
prices plus premiums that provide the Company with annual fixed margins, which
increase annually over a three year period. Since April 1, 2001, the Company
and PMI have operated under the terms provided for in the Confirmation. From
April 1, 2001 through July 31, 2001, the Company sold to PMI approximately 26.6
million gallons (the "Sold LPG") for which PMI has not taken delivery. The
Company received the posted price plus other fees on the sold LPG but has not
received 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 totals approximately $11.5 million related to such sales. The
Company and PMI are negotiating the revisions of the Proposed Agreement.
Revenues from PMI totaled approximately $112.0 million for the year ended
July 31, 2001, representing approximately 74% of total revenues for the period.
ACQUISITION OF MEXICAN SUBSIDIARIES. Effective April 1, 2001, the
Company completed the purchase of 100% of the outstanding common stock of both
Termatsal and PennMex (the "Mexican Subsidiaries"), previous affiliates of the
Company which were principally owned by an officer and director. The Company
paid a nominal purchase price. As a result of the acquisition, the Company has
included the results of the Mexican Subsidiaries in its consolidated financial
statements at July 31, 2001. Since inception the operations of the Mexican
Subsidiaries have been funded by the Company and such amounts funded were
included in the Company's consolidated financial statements prior to the
acquisition date. Therefore, there were no material differences between the
amounts previously reported by the Company and the amounts that would have been
reported by the Company had the Mexican Subsidiaries been consolidated since
inception.
MEXICAN OPERATIONS. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of LPG
terminal facilities is prohibited. Foreign ownership is permitted in the
transportation and storage of LPG. Mexican law also provides that a single
entity is not permitted to participate in more than one of the defined LPG
activities (transportation, storage or distribution). PennMex has a
transportation permit and the Mexican Subsidiaries own, lease, or are in the
process of obtaining the land or rights of way used in the construction of the
Mexican portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines and Matamoros Terminal Facility.
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 90% by Jorge Bracamontes, an
officer and director of the Company and the remaining balance is owned by
another officer and a consultant of the Company. The Company pays Tergas its
actual cost for distribution services at the Matamoros Terminal Facility plus a
small profit.
8
DEREGULATION OF THE LPG INDUSTRY IN MEXICO. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Articulo 27 Constitutional en el Ramo
del Petroleos (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Organica del
Petroleos Mexicanos y Organismos Subsidiarios (the Organic Law of Petroleos
Mexicanos and Subsidiary Entities (the "Organic Law")). Under Mexican law and
related regulations, PEMEX is entrusted with the central planning and the
strategic management of Mexico's petroleum industry, including importation,
sales and transportation of LPG. In carrying out this role, PEMEX controls
pricing and distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law
for LPG was changed to permit foreign entities to participate without limitation
in the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its affiliates expect to sell LPG directly to
independent Mexican distributors as well as PMI upon Deregulation. The Company
anticipates that the independent Mexican distributors will be required to obtain
authorization from the Mexican government for the importation of LPG upon
Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
In connection with the above, in August 2001, Tergas received a permit from
the Mexican government to import LPG. Tergas also received authorization from
Mexican custom authorities regarding the use of the US-Mexico Pipelines for the
importation of LPG.
Although by virtue of the permit, Tergas is currently able to import LPG
into Mexico, the Mexican government has asked Tergas to defer use of the permit
and as a result the Company has not sold LPG to distributors other than PMI. 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.
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"). Through
July 31, 2001, under the Exxon Supply Contract, Exxon has supplied an average of
approximately 11.5 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 has agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay additional costs
associated with the use 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 has agreed to supply and the Company has agreed to
take, a monthly average of 2.5 million gallons of propane (the "El Paso")
beginning in October 1999. The purchase price is indexed to variable posted
prices.
9
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. Through July 31, 2001, under the Koch
Supply Contract, Koch has supplied an average of approximately 6.0 million
gallons of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, the Company is required to pay additional charges
associated with the construction of a new pipeline interconnection to be paid
through additional adjustments to the purchase price (totaling approximately
$1.0 million) which allows deliveries of the Koch Supply into the ECCPL
(approximately $600,000 has been paid through July 31, 2001).
Under the terms of the Koch Supply Contract, the Koch Supply is delivered
into the ECCPL and blended to the required specifications.
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. The purchase price is indexed to variable posted
prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
As described above the Company has entered into supply agreements for
quantities of LPG totaling approximately 26.5 million gallons per month (actual
deliveries have been approximately 23.0 gallons per month) although a new sales
agreement with PMI has not been consummated.
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, El Paso Supply, Koch Supply or Duke Supply over actual
sales volumes. Under the terms of the Supply Contracts, the Company must
provide letters of credit in amounts equal to the cost of the product to be
purchased. In addition, the cost of the product purchased is tied directly to
overall market conditions. As a result, the Company's existing letter of credit
facility may not be adequate to meet the letter of credit requirements under
agreements with the Suppliers or other suppliers due to increases in quantities
of LPG purchased and/or to finance future price increases of LPG.
10
COMPETITION
LPG. The Company competes with several major oil and gas and trucking
companies and other foreign suppliers of LPG for the export of LPG to Mexico.
In many cases, these companies own or control their LPG supply and have
significantly greater financial and human resources than the Company.
The Company 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 rates to levels lower than those charged by
the Company. In addition, other suppliers of LPG may reduce their sales
prices to encourage additional sales. The Company believes that such reductions
are limited in both duration and volumes and that on an annualized basis the
ECCPL, the Leased Pipeline and the US - Mexico Pipelines provide a
transportation cost advantage over the Company's competitors.
The Company believes that its ECCLP, Leased Pipeline, the US-Mexico
Pipelines and the geographic location of the Brownsville Terminal Facility, the
Matamoros Terminal Facility and the Saltillo Terminal 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.
ENVIRONMENTAL AND OTHER REGULATIONS
The operations of the Company are subject to certain federal, state and
local laws and regulations relating to the protection of the environment, and
future regulations may impose additional requirements. Although the Company
believes that its operations are in compliance with applicable environmental
laws and regulations, because the requirements imposed by environmental laws and
regulations are frequently changed, the Company is unable to predict with
certainty the ultimate cost of compliance with such requirements and its effect
on the Company's operations and business prospects.
Certain of the Company's United States operations are subject to regulation
by the Texas Railroad Commission and/or the United States Department of
Transportation. The Company believes it is in compliance with all applicable
regulations. However, there can be no assurance that these laws will not change
in the future, or if such a change were to occur, that the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects would not be significant.
EMPLOYEES
As of July 31, 2001, the Company has 20 employees, including two in
finance, four in sales, seven in administration and seven in production. In
addition, the Company's Mexican affiliate has employees which provide services
in Mexico to the Company. The Company retains subcontractors and consultants in
connection with its operations.
The Company has not experienced any work stoppages and considers relations
with its employees to be satisfactory.
11
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,:
1999 2000 2001
---------- ----------- -----------
U.S. $2,598,875 $ 9,628,025 $11,521,638
Mexico 572,775 7,128,791 6,738,746
---------- ----------- -----------
Total $3,171,650 $16,756,816 $18,260,384
========== =========== ===========
12
ITEM 2. PROPERTIES.
As of July 31, 2001, 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)(8)
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)(8)
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 155 mile pipeline Access(3)
Ranch Plant
Extending from Nueces ECCPL Pipeline 46 miles Access(6)
County, Texas to King
Ranch Plant
Saltillo, Mexico Railcar and truck loading facilities, 53,820 square feet Owned(7)
LPG storage facilities, on-site
administration offices
Extending from US-Mexico Pipelines 25 miles Owned
Brownsville, Texas to
Matamoros, Mexico
Matamoros, Mexico Pipeline interconnection, LPG truck 35 acres Owned
loading facilities, LPG storage
facilities, on-site administration office
Brownsville, Texas Land 12 acres Leased(5)
Pipeline interconnection, Refined 300,000 bbls of Owned(5) (9)
Products storage tanks storage
Palm Desert, California Penn Octane Corporation Headquarters 3,400 square feet Leased(4)
13
_____________
(1) The Company's lease with respect to the Brownsville Terminal Facility expires on October 15, 2003.
(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, 2002. The monthly
lease payments approximate $3,000 a month.
(5) The Company's lease with respect to the Tank Farm expires in January 2005.
(6) The Company's use of the ECCPL is pursuant to the Exxon Supply Contract, which expires on September
30, 2009.
(7) These assets are located on land leased by Tergas. The lease agreement expires on January 31,
2003, with an option to renew annually thereafter.
(8) The facilities can be removed upon termination of the lease.
(9) The storage tanks can be removed upon termination of the lease.
For information concerning the Company's operating lease commitments, see note L
to the consolidated financial statements.
14
ITEM 3. LEGAL PROCEEDINGS.
LITIGATION - CPSC
On March 14, 2000, CPSC filed for protection under Chapter 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court (the
"Court"), Southern District of Texas, Corpus Christi Division.
On April 27, 2000, the Company filed a complaint in the 107th Judicial
District Court of Cameron County, Texas, against Cowboy and the sole
shareholder of Cowboy ("Owner") alleging (i) fraud, (ii) aiding and
abetting a breach of fiduciary duty, (iii) negligent misrepresentation, and
(iv) conspiracy to defraud in connection with the construction of the
US-Mexico Pipelines and Matamoros Terminal Facility and the underlying
agreements thereto. The Company also alleges that Cowboy was negligent in
performing its duties. The Company was seeking actual and exemplary damages
and other relief. On June 9, 2000, Cowboy removed the case to the Court.
On May 8, 2000, CPSC filed an adversary proceeding against the Company
in the Court seeking (i) prevention of the Company's use of the US-Mexico
Pipelines and escrow of all income related to use of the US-Mexico
Pipelines, (ii) sequestering all proceeds related to the sale from any
collateral originally pledged to CPSC, (iii) the avoidance of the addendum
agreement between the Company and CPSC, and (iv) damages arising from the
Company's breach of the Lease Agreements (see note M to the consolidated
financial statements) and the September 1999 agreements.
During May 2000, the Company filed a motion with the Court seeking to
appoint a Chapter 11 Trustee and the Company also filed a complaint with
the Court seeking a declaratory judgment stating that the US Pipelines be
held in trust for the benefit of the Company and that the US Pipelines are
no longer the assets of the bankruptcy estate.
On June 2, 2000, additional litigation was filed in the 138th Judicial
District Court of Cameron County, Texas, against Cowboy and the Company
alleging that Cowboy and the Company had illegally trespassed in connection
with the construction of the US Pipelines and seeking declaratory relief,
including damages, exemplary damages and injunctive relief preventing
Cowboy and the Company from utilizing the US Pipelines. On June 9, 2000,
CPSC intervened and removed the case to the Court. During August 2000, the
litigation was settled through a court ordered mediation by the Company
agreeing to acquire land for $342,305, substantially all of which was
provided through offsets against the purchase price in connection with the
Settlement (see below).
During March 2001, the Company, Cowboy and the Owner reached a
settlement (the "Settlement") whereby the Company purchased the remaining
50% interest owned by CPSC in the Lease Agreements and related assets
resulting in 100% ownership of the US-Mexico Pipelines and the Matamoros
Terminal Facility by the Company. Under the terms of the Settlement, the
parties provided mutual general releases with respect to previous disputes
and claims among the parties (see note M to the consolidated financial
statements).
LITIGATION - OTHER
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 seek actual and
punitive damages. The Company believes the claims are without merit and
intends to vigorously defend against the lawsuit.
15
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,000 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation ("WIN")
settled litigation whereby the Company issued WIN 12,500 shares of common
stock of the Company. The value of the stock, totaling approximately
$82,000 at the time of settlement, was recorded in the Company's
consolidated financial statements at July 31, 2000.
On February 24, 2000, litigation was filed in the 357th Judicial
District Court of Cameron County, Texas, against Cowboy, CPSC and the
Company (collectively referred to as the "Defendants") alleging that the
Defendants had illegally trespassed in connection with the construction of
the US Pipelines and seeking a temporary restraining order against the
Defendants from future use of the US Pipelines. On March 20, 2000, the
Company acquired the portion of the property which surrounds the area where
the US Pipelines were constructed for cash of $1.9 million, which was paid
during April 2000, and debt in the amount of $1.9 million. As a result, the
litigation was dismissed. The debt bears interest at 10.0% per annum,
payable monthly in minimum installments of $15,000 or $.001 for each gallon
that flows through the US Pipelines with a balloon payment due in April
2003 (see note M 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, CNG 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 has recently been dismissed from the litigation pursuant to a
summary judgment. Based on proceedings to date, the Company believes that
the claims are without merit and intends to vigorously defend against the
lawsuit.
On August 7, 2001, a Mexican company, Intertek Testing Services de
Mexico, S.A. de C.V., (the "Plaintiff') which contracts with PMI for LPG
testing services filed suit in the Superior Court of California, County of
San Mateo against the Company alleging breach of contract. The Company has
no contract with the Plaintiff and, therefore, believes that the complaint
is without merit and intends to vigorously defend against the lawsuit.
The Company and its subsidiaries are also involved with other
proceedings, lawsuits and claims. The Company believes that the
liabilities, if any, ultimately resulting from such proceedings, lawsuits
and claims should not materially affect its consolidated financial
statements.
AWARD FROM LITIGATION
For the years ended July 31, 1999 and 2000, the Company recognized
gains of $987,114, and approximately $3.0 million, respectively, which
represent the amounts of an Award from litigation from a lawsuit that
originated in 1994.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock began trading in the over-the-counter ("OTC")
market on the Nasdaq SmallCap Market under the symbol "POCC" in December 1995.
The following table sets forth the reported high ask and low bid quotations
of the common stock for the periods indicated. Such quotations reflect
inter-dealer prices, without retail mark-ups, mark-downs or commissions and may
not necessarily represent actual transactions.
LOW HIGH
------ --------
FISCAL YEAR ENDED JULY 31, 2000:
First Quarter . . . . . . . . . . . . . . $2.375 $ 4.281
Second Quarter. . . . . . . . . . . . . . 3.375 7.875
Third Quarter . . . . . . . . . . . . . . 6.500 10.938
Fourth Quarter. . . . . . . . . . . . . . 6.375 8.875
FISCAL YEAR ENDED JULY 31, 2001:
First Quarter . . . . . . . . . . . . . . $3.500 $ 7.375
Second Quarter. . . . . . . . . . . . . . 2.250 5.250
Third Quarter . . . . . . . . . . . . . . 2.437 4.500
Fourth Quarter. . . . . . . . . . . . . . 2.650 3.990
On October 12, 2001, the closing bid price of the common stock as reported
on the Nasdaq SmallCap Market was $4.15 per share. On October 12, 2001, the
Company had 14,778,944 shares of common stock outstanding and approximately 307
holders of record of the common stock.
The Company has not paid 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
The Board granted warrants to purchase 10,000 shares of common stock of the
Company at an exercise price of $6.94 per share to an outside director on August
1, 2000. In addition, the Board granted to newly elected directors warrants to
purchase 60,000 shares of common stock of the Company, at an exercise price of
$6.69 per share, with the vesting period to commence on August 7, 2000.
In connection with a consulting agreement between the Company and a
director of the Company, during August 2000, the director received warrants to
purchase 100,000 shares of common stock of the Company at an exercise price of
$6.38 per share exercisable through August 6, 2005. The warrants will vest
ratably on a quarterly basis over four years.
During August 2000 and September 2000, the Company issued 12,500 and
100,000 shares, respectively, of common stock of the Company in connection with
settlement of litigation.
During September 2000, the Company issued 3,480 shares of common stock of
the Company in satisfaction of registration rights penalties.
17
During September 2000, a director and officer of the Company exercised
warrants to purchase 200,000 shares of common stock of the Company at an
exercise price of $2.50 per share. The consideration for the exercise of the
warrants included $2,000 in cash and a $498,000 promissory note. The principal
amount of the note plus accrued interest at an annual rate of 10.5% was due on
April 30, 2001. The director and officer of the Company is personally liable
with full recourse to the Company and has provided 60,809 shares of common stock
of the Company as collateral. The promissory note has been recorded as a
reduction of stockholders' equity. Interest on the promissory note will be
recorded when the cash is received.
During October 2000, warrants to purchase a total of 7,500 shares of common
stock of the Company were exercised, resulting in cash proceeds to the Company
of $11,250.
During November 2000, warrants to purchase a total of 200,000 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $602,500.
During November 2000, the Company agreed to reduce the exercise price from
$2.50 to $2.00 per share for warrants to purchase 500,000 shares of common stock
of the Company as an inducement for the holder of the warrants (the "Holder") to
exercise the warrants. The consideration for the exercise of the warrants
included $5,000 in cash and a $995,000 promissory note. The principal amount of
the note plus accrued interest at an annual rate of 10.5% was due on April 30,
2001. During January 2001, the Company received $795,000 as partial payment of
the promissory note. The remaining balance of $200,000 on this note has not
been paid by the Holder. The Holder is liable with full recourse to the
Company and is required to provide 500,000 shares of common stock of the Company
as collateral. The Company agreed to allow the Holder to pledge the 500,000
shares in connection with a bank loan of $795,000 which was used by the Holder
to partially repay the Company.
As a bonus to a director and officer of the Company, during November 2000,
the Company granted warrants to purchase 200,000 shares of common stock of the
Company at an exercise price of $7.00 per share exercisable for five years. The
exercise price per share of the warrants was equal to or greater than the quoted
market price per share at the measurement date.
During December 2000, the Company entered into agreements (the
"Restructuring Agreements") with the holders of $5.4 million in principal amount
of the notes (the "Notes") providing for the restructuring of such Notes (the
"Restructuring") (see note I to the consolidated financial statements). Under
the terms of the Restructuring Agreements, the holders of the Restructured Notes
also received warrants to purchase up to 676,125 shares of common stock of the
Company at an exercise price of $3.00 per share and exercisable until December
15, 2003 (the "New Warrants"). The Company also agreed to modify the exercise
prices of up to 676,137 warrants (the "Warrants") to purchase shares of common
stock of the Company previously issued to the holders of the Restructured Notes
in connection with their original issuance from $4.00 per share to $3.00 per
share and extend the exercise dates of the Warrants from December 15, 2002 to
December 15, 2003. In addition, the Company was required to reduce the exercise
price of the Warrants and the New Warrants issued to the holders of the
Restructured Notes from $3.00 per share to $2.50 per share because the
Restructured Notes were not fully repaid by June 15, 2001 (see note I to the
consolidated financial statements).
PMG Capital Corp. ("PMG") acted as financial advisor for the restructuring
of $4.4 million in principal amount of the Restructured Notes. PMG received
fees consisting of $131,520 in cash and warrants to purchase 50,000 shares of
common stock of the Company with terms similar to the terms of the New Warrants.
The Company also agreed to modify and extend the exercise date of warrants to
purchase 114,375 shares of common stock of the Company originally issued to PMG
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.
During December 2000, the Company issued 15,500 shares of common stock of
the Company to certain employees of the Company as a bonus. In connection with
the issuance of the shares, the Company recorded an expense of $47,500 based on
the market value of the stock issued.
18
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (the "New Notes") due December 15, 2001.
The holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of the Company (the "New Note Warrants"). The terms of the New
Notes and New Note Warrants are substantially the same as those contained in the
Restructured Notes and New Warrants issued in connection with the Restructuring
described above.
In connection with the Settlement, CPSC received from the Company warrants
to purchase 175,000 shares of common stock of the Company at an exercise price
of $4.00 per share exercisable through March 30, 2004, such shares having a fair
value totaling approximately $300,000. This amount has been included as part of
the cost of the Acquired Assets in the accompanying consolidated financial
statements at July 31, 2001 (see note M to the consolidated financial
statements).
During July 2001, warrants to purchase a total of 15,000 shares of common
stock of the Company were exercised resulting in cash proceeds to the Company of
$37,500.
During August 2001, the Board granted warrants to purchase 10,000 and
20,000 shares of common stock of the Company at exercise prices of $3.99 and
$4.05 per share to outside directors.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of the Company were exercised by certain holders of the New
Warrants and New Note Warrants for which the exercise price totaling $614,833
was paid by reduction of the outstanding debt and interest relating to the New
Notes and the Restructured Notes.
The above transactions were issued without registration under the
Securities Act of 1933, as amended, in reliance upon the exemptions from the
registration provisions thereof, contained in Section 4(2) thereof and Rule 506
of Regulation D promulgated thereunder.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data for each of the years in
the five-year period ended July 31, 2001, 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,
-----------------------------------------------------------
1997 1998 1999 2000 2001
------------ ------------ ---------- ------- ----------
Revenues $ 29,699(1) $ 30,801(1) $35,338(1) $98,515 $ 150,700
Income (loss) from continuing operations (2,886) (2,072) 1,125 1,461 (8,094)
Net income (loss) (2,923) (3,744) 545 1,461 (8,094)
Net income (loss) from continuing operations per common share (.48) (.25) .11 .11 (.57)
Net income (loss) per common share (.48) (.43) .05 .11 (.57)
Total assets 5,496 6,698 8,909 31,537 $ 40,294
Long-term obligations 1,113 60 259 1,465 3,274
(1) The operations of PennWilson for the period from February 12, 1997 (date of incorporation) through May 25, 1999, the
date operations were discontinued, are presented in the consolidated financial statements as discontinued operations.
19
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 2001) refer to the Company's fiscal year ended July 31. The
results of operations related to the Company's CNG segment, primarily consisting
of PennWilson, which began operations in March 1997 and was discontinued during
fiscal 1999, have been presented separately in the consolidated financial
statements of the Company as discontinued operations.
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 2001, the Company derived 74% of its revenues from sales of
LPG to PMI, its primary customer.
The Company provides products and services through a combination of
fixed-margin and fixed-price contracts. Costs included in cost of goods sold,
other than the purchase price of LPG, may affect actual profits from sales,
including costs relating to transportation, storage, leases and maintenance.
Mismatches in volumes of LPG purchased from suppliers and volumes sold to PMI or
others could result in gains during periods of rising LPG prices or losses
during periods of declining LPG prices as a result of holding inventories or
disposing of excess inventories.
LPG SALES
The following table shows the Company's volume sold in gallons and average
sales price for fiscal years ended July 31, 1999, 2000 and 2001.
1999 2000 2001
------ ------ ------
Volume Sold
LPG (millions of gallons) - PMI 117.0 140.2 167.2
LPG (million of gallons) - Other - 47.2 71.4
------ ------ ------
117.0 187.4 238.6
Average sales price
LPG (per gallon) - PMI $ 0.30 $ 0.54 $ 0.67
LPG (per gallon) - Other - 0.47 0.55
20
RESULTS OF OPERATIONS
YEAR ENDED JULY 31, 2001 COMPARED WITH JULY 31, 2000
Revenues. Revenues for fiscal 2001 were $150.7 million compared with $98.5
million for fiscal 2000, an increase of $52.2 million or 53.0%. Of this
increase, $18.1 million was attributable to increased volumes of LPG sold to PMI
in fiscal 2001, $17.9 million was attributable to increased average sales prices
of LPG sold to PMI in fiscal 2001, and $16.2 million was attributable to
increased sales of LPG to customers other then PMI during fiscal 2001 in
connection with the Company's desire to reduce quantities of inventory.
Cost of goods sold. Cost of goods sold for fiscal 2001, was $151.5 million
compared with $94.9 million for fiscal 2000, an increase of $56.5 million or
59.6%. Of this increase, $16.6 million was attributable to increased volumes of
LPG sold to PMI in fiscal 2001, $17.5 million was attributable to the increase
in the cost of LPG sold to PMI for fiscal 2001, $20.6 million was attributable
to increased costs of LPG sold to customers other than PMI in connection with
the Company's desire to reduce quantities of inventory during fiscal 2001, and
$1.8 million was attributable to increased operating costs associated with LPG
during fiscal 2001.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $3.6 million for fiscal 2001 compared with $3.2
million for fiscal 2000, an increase of $464,993 or 14.8%. The increase during
fiscal 2001 was principally due to additional costs associated with the
operations of the US-Mexico Pipelines and Matamoros Terminal Facility.
Other income (expense). Other income (expense) was $(3.7) million for
fiscal 2001 compared with $1.1 million for fiscal 2000, a decrease of $4.8
million. The decrease in other income was due primarily to increased interest
costs and amortization of discounts of $1.8 million associated with the issuance
of debt during fiscal 2001 and a decrease of $3.0 million related to the award
from litigation, which was recorded during fiscal 2000.
Income tax. The Company had a net operating loss carryforward of
approximately $12.0 million at July 31, 2001, which expires in the years 2010 to
2021, and may be significantly limited by the application of the "change in
ownership" rules under Section 382 of the Internal Revenue Code. The Company
can receive a credit against any future tax payments due to the extent of any
prior alternative minimum taxes paid.
YEAR ENDED JULY 31, 2000 COMPARED WITH JULY 31, 1999
Revenues. Revenues for fiscal 2000 were $98.5 million compared with $35.3
million for fiscal 1999, an increase of $63.2 million or 178.8%. Of this
increase, $12.6 million was attributable to increased volumes of LPG sold to PMI
in fiscal 2000, $28.2 million was attributable to increased average sales prices
of LPG sold to PMI in fiscal 2000 and $22.4 million was attributable to sales of
LPG to customers other then PMI in connection with the Company's desire to
reduce outstanding inventory balances during fiscal 2000.
Cost of goods sold. Cost of goods sold for fiscal 2000 was $94.9 million
compared with $32.0 million for fiscal 1999, an increase of $62.9 million or
196.2%. Of this increase, $11.4 million was attributable to increased volumes
of LPG purchased for sales to PMI in fiscal 2000, $27.4 million was
attributable to increased average sales prices of LPG purchased for sales to PMI
in fiscal 2000, $23.0 million was attributable to sales of LPG to customers
other then PMI in connection with the Company's desire to reduce outstanding
inventory balances during fiscal 2000 and $1.1 million was attributable to
increased operating costs associated with LPG during fiscal 2000.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $3.2 million for fiscal 2000 compared with $2.1
million for fiscal 1999, an increase of $1.1 million or 52.0%. This increase
was primarily attributable to additional professional fees and payroll related
expenses incurred during fiscal 2000.
21
Other income and expense, net. Other income (expense), net was $1.1
million for fiscal 2000 compared with $(0.1) million for fiscal 1999, an
increase of $1.2 million. The increase in other income, net was due primarily
to a gain on the award from litigation of $2.0 million and reduced costs from
the settlement of litigation of $0.5 million, partially offset by increased
interest costs and amortization of discounts associated with the issuance of
debt of $(1.3) million, which was recorded during fiscal 2000.
Income tax. During fiscal 2000, the Company recorded a provision for
income taxes of $0.1 million, representing the alternative minimum tax due. Due
to the availability of net operating loss carryforwards (approximately $5.6
million at July 31, 2000), the Company did not incur any additional income tax
expense during fiscal 2000. Due to the availability of net operating loss
carryforwards of approximately $8.0 million at July 31, 1999, no income tax
expense was recorded during fiscal 1999.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception,
has used cash in operations, continues to have a deficit in working capital and
has exposure related to financing of and/or losses associated with LPG price
fluctuations for imbalances on undelivered LPG. In addition, significantly all
of the Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the Restructured Notes, the New Notes, the RZB
Credit Facility and the notes related to the Settlement. The Company is
currently negotiating with the creditors for the required security agreements.
The Restructured Notes and the New Notes, which total approximately $5.8 million
at October 12, 2001, are due on December 15, 2001. The Company may need to
increase its credit facility for increases in quantities of LPG purchased and/or
to finance future price increases of LPG. Further, the Company may find it
necessary to liquidate inventories at a loss to provide working capital, to
reduce outstanding balances under its credit facility and/or due to storage
limitations at Markham Storage. The Company depends heavily on sales to one
major customer for which a new sales agreement has not been consummated. 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.
The following summary table reflects comparative cash flows for fiscal
years ended July 31, 1999, 2000 and 2001. All information is in thousands.
1999 2000 2001
-------- ----------- ----------
Net cash provided by (used in) operating activities $ 562 $( 2,562) $ 6,196
Net cash used in investing activities . . . . . . . ( 383) ( 10,771) ( 2,572)
Net cash provided by (used in) financing activities 696 12,326 ( 2,327)
-------- ----------- ----------
Net increase (decrease) in cash . . . . . . . . . . $ 875 $( 1,007) $ 1,297
======== =========== ==========
Sales to PMI. The Company entered into sales agreements with PMI for the
period from April 1, 2000 through March 31, 2001 (the "Old Agreements"), for the
annual sale of a combined minimum of 151.2 million gallons of LPG, mixed to PMI
specifications, subject to seasonal variability, which was delivered to PMI at
the Company's terminal facilities in Matamoros, Tamaulipas, Mexico and Saltillo,
Coahuila, Mexico or alternative delivery points as prescribed under the Old
Agreements.
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7.5 million gallons resulting in a new annual combined
minimum commitment of 158.7 million gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
22
The Old Agreements expired March 31, 2001. On April 26, 2001, PMI
confirmed to the Company in writing (the "Confirmation") the following terms of
a new agreement (the "Proposed Agreement") effective April 1, 2001, subject to
revisions to be provided by PMI's legal department. The Confirmation provides
for minimum monthly volumes of 19.0 million gallons at indexed variable posted
prices plus premiums that provide the Company with annual fixed margins, which
increase annually over a three year period. Since April 1, 2001, the Company
and PMI have operated under the terms provided for in the Confirmation. From
April 1, 2001 through July 31, 2001, the Company sold to PMI approximately 26.6
million gallons (the "Sold LPG") for which PMI has not taken delivery. The
Company received the posted price plus other fees on the Sold LPG but has not
received 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 totals approximately $11.5 million related to such sales. The Company and
PMI are negotiating the revisions of the Proposed Agreement.
Since March 2001, PMI has used the Matamoros Terminal Facility to load a
portion of LPG purchased from the Company for distribution in Mexico. The
Company continues to use the Brownsville Terminal Facility in connection with
LPG delivered by railcar to other customers or as an alternative terminal in the
event the Matamoros Terminal Facility cannot be used.
Based on the Company's interpretation of certain of the provisions of the
Old Agreements, additional amounts are due from PMI totaling approximately $5.9
million as of July 31, 2001, resulting principally from shortfalls in the
minimum volume requirements (approximately 15.1 million gallons) and other price
adjustments as provided for under those agreements. In addition, the Company's
interpretation of the Confirmation results in amounts due from PMI totaling
approximately $2.0 million as of July 31, 2001, related to the fixed margin on
undelivered LPG regardless of where the LPG is ultimately delivered. The
Company will not record revenues, if any, in its consolidated financial
statements related to the above-mentioned amounts until they are paid by PMI or
the validity of the Company's interpretations can be otherwise determined.
Revenues from PMI totaled approximately $112.0 million for the year ended
July 31, 2001, representing approximately 74% of total revenue for the period.
Sales Agreement - Other. Beginning May 1, 2001, the Company entered into
an agreement which provides for the sale of approximately 3.7 - 5.0 million
gallons of propane per month during the period from May 2001 through September
2001, and approximately 1.3 - 2.6 million gallons per month from October 2001
through March 2002. The sales price is based on indexed variable posted prices.
LPG Supply Agreements. During October 1998, the Company entered into a
monthly supply agreement with Exxon Mobil Corporation ("Exxon") pursuant to
which Exxon agreed to supply minimum volumes of LPG to the Company. Effective
November 1, 1998, the Company entered into a supply agreement with Exxon to
purchase minimum monthly volumes of LPG through September 1999.
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"). Through July 31, 2001,
under the Exxon Supply Contract, Exxon has supplied an average of approximately
11.5 million gallons of LPG per month. The purchase price is indexed to
variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The
ability to utilize the ECCPL allows the Company to acquire an additional supply
of propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay additional costs
associated with the use 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 has agreed to supply and the Company has agreed to
take, a monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999. The purchase price is indexed to variable posted
prices.
23
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. Through of July 31, 2001, under the
Koch Supply Contract, Koch has supplied an average of approximately 6.0 million
gallons of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, the Company is required to pay additional charges
associated with the construction of a new pipeline interconnection to be paid
through additional adjustments to the purchase price (totaling approximately
$1.0 million) which allows deliveries of the Koch Supply into the ECCPL
(approximately $600,000 has been paid through July 31, 2001).
Under the terms of the Koch Supply Contract, the Koch Supply is delivered
into the ECCPL and blended to the required specifications.
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. The purchase price is indexed to variable posted
prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(the "Suppliers"). The Company's aggregate costs per gallon to purchase LPG
(less any applicable adjustments) are below the aggregate sales prices per
gallon of LPG sold to its customers.
As described above, the Company has entered into supply agreements for
quantities of LPG totaling approximately 26.5 million gallons per month (actual
deliveries have been approximately 23.0 million gallons per month) although a
new sales agreement with PMI has not been consummated.
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, El Paso Supply, Koch Supply or Duke Supply over actual
sales volumes. Under the terms of the Supply Contracts, the Company must
provide letters of credit in amounts equal to the cost of the product to be
purchased. In addition, the cost of the product purchased is tied directly to
overall market conditions. As a result, the Company's existing letter of credit
facility may not be adequate to meet the letter of credit requirements under the
agreements with the Suppliers or other suppliers due to increases in quantities
of LPG purchased and/or to finance future price increases of LPG.
Pipeline Lease. The Pipeline Lease currently expires on December 31, 2013,
pursuant to an amendment (the "Pipeline Lease Amendment") entered into between
the Company and Seadrift on May 21, 1997, which became effective on January 1,
1999 (the "Effective Date"). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another pipeline
controlled by Seadrift, thereby providing greater access to and from the Leased
Pipeline. Pursuant to the Pipeline Lease Amendment, the Company's fixed annual
rent for the use of the Leased Pipeline beginning January 1, 2001 until its
expiration is $1.0 million. The Company is required to pay a minimum charge for
storage of $300,000 per year (based on reserved storage of 8.4 million gallons).
In connection with the Pipeline Lease, the Company reserved up to 12.6 million
gallons of storage through December 31, 2001 and may reserve up to 21.0 million
gallons each year thereafter provided that the Company notifies Seadrift in
advance. As of October 31, 2001, the Company's inventory balances at Markham
exceeded the amount the Company had reserved for storage at Markham.
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 has made all payments required under
the Pipeline Lease Amendment.
24
The Company has recently completed 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
Company anticipates the mid-line pump station will be utilized in the near
future. The Leased Pipeline's capacity is estimated to be between 300 million
gallons per year and 360 millions gallons per year.
Upgrades. The Company also intends to contract for the design,
installation and construction of pipelines which will connect the Brownsville
Terminal Facility to the water dock facilities at the Brownsville Ship Channel
and install additional storage capacity. The cost of this project is expected
to approximate $2.0 million. The Company had employed a firm to provide the
design and engineering for this project.
Acquisition of Pipeline Interests. In connection with the construction of
the US-Mexico Pipelines and the Matamoros Terminal Facility, the Company and
CPSC entered into two separate Lease / Installation Purchase Agreements, as
amended, (the "Lease Agreements"), whereby CPSC was required to construct and
operate the US - Mexico Pipelines (including an additional pipeline to
accommodate Refined Products) and the Matamoros Terminal Facility and lease
these assets to the Company. Under the terms of the Lease Agreements, CPSC was
required to pay all costs associated with the design, construction and
maintenance of the US - Mexico Pipeline and Matamoros Terminal Facility.
During December 1999, the Company and CPSC amended the Lease Agreements
whereby the Company acquired a 50% interest for $3.0 million and had the
option to acquire the remaining 50% interest in the Lease Agreements. During
February 2000, the Company determined that CPSC did not comply with certain
obligations under the Lease Agreements. In March 2000, CPSC filed for
protection under Chapter 11 of the United States Bankruptcy Code.
On March 30, 2001, the Company completed a settlement with CPSC and Cowboy,
which provided the Company with the remaining 50% interest in the portion of the
US-Mexico Pipelines, Matamoros Terminal Facility and related land, permits or
easements (the "Acquired Assets") previously constructed and/or owned by CPSC
and leased to the Company. Until the Settlement was completed (see below), the
Company had recorded the remaining 50% portion of the US-Mexico Pipelines and
Matamoros Terminal Facility as a capital lease. The Court entered an order
approving the Settlement. In addition, as part of the Settlement, the Company
conveyed to CPSC all of its rights to a certain property (the "Sold Asset").
The foregoing is more fully discussed below. The terms of the Settlement did
not deviate in any material respect from the terms previously reported except
that the fair value of the warrants issued in connection with the Settlement
(see below) was reduced from $600,000 to $300,000 as a result of a decrease in
the market value of the Company's common stock.
In connection with the Settlement, the Company agreed to pay CPSC $5.8
million (the "Purchase Price") for the Acquired Assets, less agreed upon credits
and offsets in favor of the Company totaling $3.2 million. The remaining $2.6
million was paid at the closing of the Settlement by a cash payment of $200,000
to CPSC and the issuance to or for the benefit of CPSC of two promissory notes
in the amounts of $1.5 million (the "CPSC Note") (payable in 36 monthly
installments of approximately $46,000, including interest at 9% per annum) and
$900,000 (the "Other Note") (payable in 36 equal monthly installments of
approximately $29,000, including interest at 9% per annum). The Other Note is
collateralized by a first priority security interest in the U.S. portion of the
pipelines comprising the Acquired Assets. The CPSC Note is also collateralized
by a security interest in the Acquired Assets, which security interest is
subordinated to the security interest which secures the Other Note. In
addition, the security interest granted under the CPSC Note is shared on a pari
passu basis with certain other creditors of the Company (see notes I and L to
the consolidated financial statements). Under the terms of the CPSC Note, the
Company is entitled to certain offsets related to future costs which may be
incurred by the Company in connection with the Acquired Assets. In addition to
the payments described above, the Company agreed to assume certain liabilities
which were previously owed by CPSC in connection with construction of the
Acquired Assets. CPSC also transferred to the Company any right that it held to
any amounts owing from Termatsal for cash and/or equipment provided by CPSC to
Termatsal, including approximately $2.6 million of cash advanced to Termatsal,
in connection with construction of the Mexican portion of the Acquired Assets.
25
The Sold Asset transferred to CPSC in connection with the Settlement
consisted of real estate of the Company with an original cost to the Company of
$3.8 million and with a remaining book value totaling approximately $1.9 million
(after giving effect to credits provided to the Company included in the
financial terms described above). CPSC agreed to be responsible for payments
required in connection with the Debt related to the original purchase by the
Company of the Sold Asset totaling approximately $1.9 million. CPSC's
obligations under the Debt are to be paid by the Company to the extent that
there are amounts owed by the Company under the CPSC Note, through direct
offsets by the Company against the CPSC Note. After the CPSC Note is fully
paid, the Company will no longer have any payment obligation to CPSC in
connection with the Debt and therefore, CPSC will then be fully responsible to
the Company for any remaining obligations in connection with the Debt (the
"Remaining Obligations"). CPSC's obligations to the Company in respect of the
Remaining Obligations are collateralized by a deed of trust lien granted by CPSC
in favor of the Company against the Sold Asset. CPSC also granted the Company a
pipeline related easement on the Sold Asset. The principal of $1.9 million
plus accrued and unpaid interest is included in long-term debt and the
corresponding amounts required to be paid by CPSC has been recorded as a
mortgage receivable (see note I to the consolidated financial statements). In
addition to the Purchase Price above, CPSC received from the Company warrants to
purchase 175,000 shares of common stock of the Company at an exercise price of
$4.00 per share exercisable through March 30, 2004, such shares having a fair
value totaling approximately $300,000. This amount has been included as part of
the cost of the Acquired Assets in the accompanying consolidated financial
statements at July 31, 2001.
Until the security interests as described above are perfected, the
Company's President is providing a personal guarantee for the punctual payment
and performance under the CPSC Note.
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 an officer and director. The Company paid a
nominal purchase price. As a result of the acquisition, the Company has
included the results of the Mexican Subsidiaries in its consolidated financial
statements at July 31, 2001. Since inception the operations of the Mexican
Subsidiaries have been funded by the Company and such amounts funded were
included in the Company's consolidated financial statements prior to the
acquisition date. Therefore there were no material differences between the
amounts previously reported by the Company and the amounts that would have been
reported by the Company had the Mexican Subsidiaries been consolidated since
inception.
Mexican Operations. Under current Mexican law, foreign ownership of
Mexican entities involved in the distribution of LPG or the operation of LPG
terminal facilities is prohibited. Foreign ownership is permitted in the
transportation and storage of LPG. Mexican law also provides that a single
entity is not permitted to participate in more than one of the defined LPG
activities (transportation, storage or distribution). PennMex has a
transportation permit and the Mexican Subsidiaries own, lease, or are in the
process of obtaining the land or rights of way used in the construction of the
Mexican portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines and Matamoros Terminal Facility. The
Company's Mexican affiliate, Tergas, S.A. de C.V. ("Tergas"), has been granted
the permit to operate the Matamoros Terminal Facility and the Company relies on
Tergas' permit to continue its delivery of LPG at the Matamoros Terminal
Facility. Tergas is owned 90% by Jorge Bracamontes, an officer and director of
the Company and the remaining balance is owned by another officer and a
consultant of the Company. The Company pays Tergas its actual cost for
distribution services at the Matamoros Terminal Facility plus a small profit.
Termatsal has completed construction of an additional LPG terminal facility
in Saltillo, Mexico (the "Saltillo Terminal Facility") for approximately
$800,000. The Saltillo Terminal Facility is capable of off loading LPG from
railcars to trucks. The Saltillo Terminal Facility contains storage to
accommodate approximately 90,000 gallons of LPG with additional storage planned
for 180,000 gallons. The Saltillo Terminal Facility has three railcar off
loading racks and three truck loading racks. As a result of the Saltillo
Terminal Facility, the Company can transport LPG directly via railcar from the
Brownsville Terminal Facility to the Saltillo Terminal Facility. The Saltillo
Terminal Facility has not begun operations due to concerns by local residents in
Saltillo. If such concerns cannot be resolved, the Company may relocate the
tangible assets comprising the Saltillo Terminal Facility to a remote location.
The cost of such relocation is not expected to be material to the Company's
consolidated financial statements.
26
Tergas leases the land on which the Saltillo Terminal Facility is located
and has been granted the permit to operate the Saltillo Terminal Facility. The
land is leased through January 2003 for $69,000 annually. Under the terms of
the land lease agreement, any leasehold improvements at the termination of the
lease may be removed.
In connection with the planned operations of the Saltillo Terminal
Facility, Termatsal has leased approximately 50 railcars to transport LPG
between the Brownsville Terminal Facility and the Saltillo Terminal Facility.
The Company is leasing the railcars on a month to month basis. The Saltillo
Terminal Facility is not operational. The Company has utilized some of the
railcars in connection with sales of LPG to U.S. and Canadian customers.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, the Company is subject to the tax laws of Mexico which,
among other things, require that the Company comply with transfer pricing rules,
the payment of income, asset and ad valorem taxes, and possibly taxes on
distributions in excess of earnings. In addition, distributions to foreign
corporations, including dividends and interest payments may be subject to
withholding taxes.
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
Beginning in 1995, as part of a national privatization program, the
Regulatory Law was amended to permit private entities to transport, store and
distribute natural gas with the approval of the Ministry of Energy. As part of
this national privatization program, the Mexican Government is expected to
deregulate the LPG market ("Deregulation"). In June 1999, the Regulatory Law
for LPG was changed to permit foreign entities to participate without limitation
in the defined LPG activities related to transportation and storage. However,
foreign entities are prohibited from participating in the distribution of LPG in
Mexico. Upon Deregulation, Mexican entities will be able to import LPG into
Mexico. Under Mexican law, a single entity is not permitted to participate in
more than one of the defined LPG activities (transportation, storage and
distribution). The Company or its affiliates expect to sell LPG directly to
independent Mexican distributors as well as PMI upon Deregulation. The Company
anticipates that the independent Mexican distributors will be required to obtain
authorization from the Mexican government for the importation of LPG upon
Deregulation prior to entering into contracts with the Company.
During July 2001, the Mexican government announced that it would begin to
accept applications from Mexican companies for permits to allow for the
importation of LPG pursuant to provisions already provided for under existing
Mexican law.
In connection with the above, in August 2001, Tergas received a permit from
the Mexican government to import LPG. Tergas also received authorization from
Mexican custom authorities regarding the use of the US-Mexico Pipelines for the
importation of LPG.
Although by virtue of the permit, Tergas is currently able to import LPG
into Mexico, the Mexican government has asked Tergas to defer use of the permit
and as a result the Company has not sold LPG to distributors other than PMI. 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.
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.
27
Credit Arrangements. As of July 31, 2001, the Company has a $20.0 million
credit facility with RZB Finance L.L.C. ("RZB") and Bayerische Hypo-und
Vereinsbank Aktiengeselischaft, New York Branch ("HVB"), whereby RZB and HVB
will each participate up to $10.0 million toward the total credit facility for
demand loans and standby letters of credit (RZB Credit Facility) to finance the
Company's purchases of LPG. Under the RZB Credit Facility, the Company pays a
fee with respect to each letter of credit thereunder in an amount equal to the
greater of (i) $500, (ii) 2.5% of the maximum face amount of such letter of
credit, or (iii) such higher amount as may be agreed to between the Company and
RZB. Any amounts outstanding under the RZB Credit Facility shall accrue interest
at a rate equal to the rate announced by the Chase Manhattan Bank as its prime
rate plus 2.5%. Pursuant to the RZB Credit Facility, RZB and HVB each have sole
and absolute discretion to limit or terminate their participation in the RZB
Credit Facility and to make any loan or issue any letter of credit thereunder.
RZB also has the right to demand payment of any and all amounts outstanding
under the RZB Credit Facility at any time. In connection with the RZB Credit
Facility, the Company granted a security interest and assignment in any and all
of the Company's accounts, inventory, real property, buildings, pipelines,
fixtures and interests therein or relating thereto, including, without
limitation, the lease with the Brownsville Navigation District of Cameron County
for the land on which the Company's Brownsville Terminal Facility is located,
the Pipeline Lease, and in connection therewith agreed to enter into leasehold
deeds of trust, security agreements, financing statements and assignments of
rent, in forms satisfactory to RZB. Under the RZB Credit Facility, the Company
may not permit to exist any subsequent lien, security interest, mortgage, charge
or other encumbrance of any nature on any of its properties or assets, except in
favor of RZB, without the consent of RZB (see notes I and M to the consolidated
financial statements). For the month of September 2001, HVB did not participate
in the RZB Credit Facility.
The Company's President, Chairman and Chief Executive Officer has
personally guaranteed all of the Company's payment obligations with respect to
the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, El Paso, Duke
and/or Koch, letters of credit are issued on a monthly basis based on
anticipated purchases.
In connection with the Company's purchase of LPG, under the RZB Credit
Facility, assets related to product sales (the "Assets") are required to be in
excess of borrowings and commitments. At July 31, 2001, the Company's
borrowings and commitments exceeded the amount of the Assets which included
$971,875 in cash, by approximately $4.0 million. As of September 30, 2001, the
Assets exceeded the borrowings and commitments.
Private Placements and Other Transactions. From December 10, 1999 through
January 18, 2000, and on February 2, 2000, the Company completed a series of
related transactions in connection with the private placement of $4.9 million
and $710,000, respectively, of subordinated notes (the "Notes") which were due
the earlier of December 15, 2000, or upon the receipt of proceeds by the Company
from any future debt or equity financing in excess of $2.3 million (see below).
Interest at 9% was due and paid on June 15, 2000, and December 15, 2000. In
connection with the Notes, the Company granted the holders of the Notes,
warrants (the "Warrants") to purchase a total of 706,763 shares of common stock
of the Company at an exercise price of $4.00 per share, exercisable through
December 15, 2002.
During December 2000, the Company also entered into agreements (the
"Restructuring Agreements") with the holders of $5.4 million in principal amount
of the Notes providing for the restructuring of such remaining Notes (the
"Restructuring"). The remaining $245,000 balance of the Notes was paid.
Under the terms of the Restructuring Agreements, the due dates for the
restructured notes (the "Restructured Notes") were extended to December 15,
2001, subject to earlier repayment upon the occurrence of certain specified
events provided for in the Restructured Notes. Additionally, beginning December
16, 2000, the annual interest rate on the Restructured Notes was increased to
13.5% (subject to the adjustments referred to below). Interest payments are due
quarterly beginning March 15, 2001.
28
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares of
common stock of the Company at an exercise price of $3.00 per share and
exercisable until December 15, 2003 (the "New Warrants"). The Company also
agreed to modify the exercise prices of the Warrants to purchase up to 676,137
shares of common stock of the Company previously issued to the holders of the
Restructured Notes in connection with their original issuance from $4.00 per
share to $3.00 per share and extend the exercise dates of the Warrants from
December 15, 2002 to December 15, 2003. In addition, the Company was required
to reduce the exercise price of the Warrants and the New Warrants issued to the
holders of the Restructured Notes from $3.00 per share to $2.50 per share
because the Restructured Notes were not fully repaid by June 15, 2001.
In connection with the Restructuring Agreements, the Company has also
agreed to register the shares of common stock which may be acquired in
connection with the exercise of the New Warrants (the "Exercisable Shares"). In
the event that the Company did not have an effective registration statement
under the Securities Act of 1933, as amended, covering the Exercisable Shares by
March 31, 2001 (or April 30, 2001, if, at the time, the Company was ineligible
to utilize Form S-3 for purposes of such registration), or if any effective
registration statement ceases to be effective during any period in which such
effectiveness is required, the Company will be required to pay additional
interest on the Restructured Notes at the rate of 4% per annum for the period in
which the deficiency continues to exist. In connection with the Company's
obligations under the Restructured Notes, the Company's registration statement
containing the Exercisable Shares was declared effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral to
secure the Company's payment obligations under the Restructured Notes consisting
of a senior interest in substantially all of the Company's assets which are
located in the United States (the "US Assets") and Mexico (the "Mexican
Assets"), excluding inventory, accounts receivable and sales contracts with
respect to which the Company is required to grant a subordinated security
interest (collectively referred to as the "Collateral"). The Company's
President has also pledged 2.0 million shares of common stock of the Company
owned by the President (1.0 million shares to be released when the required
security interests in the US Assets have been granted and perfected and all of
the shares are to be released when the required security interests in all of the
Collateral have been granted and perfected). The granting and perfection of the
security interests in the Collateral, as prescribed under the Restructured
Notes, have not been finalized. Accordingly, the interest rate under the
Restructured Notes increased to 16.5% on March 16, 2001, and will continue at
such rate until the required security interest in all of the Collateral has been
granted and perfected. In connection with the granting and perfection of the
security interests in the Collateral, the Company is currently negotiating with
the holders of the Restructured Notes and New Notes (see below) an additional
amendment which would provide for modifications to the Collateral. The
Collateral is also being pledged in connection with the issuance of other
indebtedness by the Company (see note M to the consolidated financial
statements). PMG has agreed to serve as the collateral agent.
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (the "New Notes") due December 15, 2001.
The holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of the Company (the "New Note Warrants"). The terms of the New
Notes and New Note Warrants are substantially the same as those contained in the
Restructured Notes and New Warrants issued in connection with the Restructuring
described above. The Company's payment obligations under the New Notes will
also be secured by the Collateral and the shares of the Company which, as
described above, are being pledged by the Company's President.
During September 2001, warrants to purchase 313,433 shares of common stock
of the Company were exercised by certain holders of the New Warrants and New
Note Warrants for which the exercise price totaling $614,833 was paid by
reduction of the outstanding debt and interest relating to the New Notes and the
Restructured Notes.
During August 2000 and September 2000, the Company issued 12,500 and
100,000 shares, respectively, of common stock of the Company in connection with
the settlement of litigation.
In August 2000, the Company issued 6,500 shares of Common Stock to a
consultant in payment for services rendered to the Company valued at $41,438.
29
During September 2000, the Company issued 3,480 shares of common stock of
the Company in satisfaction of registration rights penalties.
During September 2000, a director and officer of the Company exercised
warrants to purchase 200,000 shares of common stock of the Company at an
exercise price of $2.50 per share. The consideration for the exercise of the
warrants included $2,000 in cash and a $498,000 promissory note. The principal
amount of the note plus accrued interest at an annual rate of 10.5% was due on
April 30, 2001. The director and officer of the Company is personally liable
with full recourse to the Company and has provided 60,809 shares of common stock
of the Company as collateral. The promissory note has been recorded as a
reduction of stockholders' equity.
During September 2000, a promissory note to the Company was paid through
the exchange of 78,373 shares of common stock of the Company (see note D to the
consolidated financial statements).
During October 2000, warrants to purchase a total of 7,500 shares of common
stock of the Company were exercised, resulting in cash proceeds to the Company
of $11,250.
During November 2000, warrants to purchase a total of 200,000 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $602,500.
In November 2000, the Company issued 4,716 shares of common stock of the
Company to a consultant in payment for services rendered to the Company valued
at $23,583.
During November 2000, the Company agreed to reduce the exercise price from
$2.50 to $2.00 per share for warrants to purchase 500,000 shares of common stock
of the Company as an inducement for the holder of the warrants (the "Holder") to
exercise the warrants. The consideration for the exercise of the warrants
included $5,000 in cash and a $995,000 promissory note. The principal amount of
the note plus accrued interest at an annual rate of 10.5% was due on April 30,
2001. During January 2001, the Company received $795,000 as partial payment of
the promissory note. The remaining balance of $200,000 on this note has not
been paid by the Holder. The Holder is liable with full recourse to the
Company and is required to provide 500,000 shares of common stock of the Company
as collateral. The Company agreed to allow the Holder to pledge the 500,000
shares in connection with a bank loan of $795,000 which was used by the Holder
to partially repay the Company.
During December 2000, the Company issued 15,500 shares of common stock of
the Company to certain employees of the Company as a bonus. In connection with
the issuance of the shares, the Company recorded an expense of $47,500 based on
the market value of the stock issued.
In December 2000, the Company entered into an agreement with a consultant
whereby the Company agreed to issue 2,000 shares of Common Stock pursuant to the
Plan for each month of service for a minimum of three months. At January 31,
2001, the Company issued 2,000 shares of common stock in connection with this
agreement. In February 2001, the agreement was terminated and the Company
issued the remaining 4,000 shares of common stock due to the consultant.
During July 2001, warrants to purchase a total of 15,000 shares of common
stock of the Company were exercised resulting in cash proceeds to the Company of
$37,500.
During September 2001, the Company issued 37,500 shares of common stock of
the Company to a consultant in payment for services rendered to the Company
valued at $150,000.
The amounts due from notes issued by officers, directors and a related
party for the exercise of warrants totaling $4,239,296 plus interest have not
been paid as required by the terms of the notes to the Company. All accrued but
unpaid interest from officers, directors and a related party has been reserved
(see note S to the consolidated financial statements).
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.
30
Settlement of Litigation. On June 2, 2000, additional litigation was
filed in the 138th Judicial District Court of Cameron County, Texas, against
Cowboy and the Company alleging that Cowboy and the Company had illegally
trespassed in connection with the construction of the US Pipelines and seeking
declaratory relief, including damages, exemplary damages and injunctive relief
preventing Cowboy and the Company from utilizing the US Pipelines. On June 9,
2000, CPSC intervened and removed the case to the Court. During August 2000,
the litigation was settled through a court ordered mediation by the Company
agreeing to acquire land for $342,305, substantially all of which was provided
through offsets against the purchase price in connection with the Settlement
(see below).
During March 2001, the Company, Cowboy and the Owner reached a settlement
(the "Settlement") whereby the Company purchased the remaining 50% interest
owned by CPSC in the Lease Agreements and related assets resulting in 100%
ownership of the US-Mexico Pipelines and the Matamoros Terminal Facility by the
Company. Under the terms of the Settlement, the parties provided mutual general
releases with respect to previous disputes and claims among the parties (see
note M to the consolidated financial statements).
On March 16, 1999, the Company settled a lawsuit in mediation with its
former chairman of the board, Jorge V. Duran. The total settlement costs
recorded by the Company at July 31, 1999, was $456,300. The parties had agreed
to extend the date on which the payments were required in connection with the
settlement including the issuance of the common stock. On July 26, 2000, the
parties executed final settlement agreements whereby the Company paid the
required cash payment of $150,000. During September 2000, the Company issued
the required stock.
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,00 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation ("WIN") settled
litigation whereby the Company issued WIN 12,500 shares of common stock of the
Company. The value of the stock, totaling approximately $82,000 at the time of
settlement, was recorded in the Company's consolidated financial statements at
July 31, 2000.
On February 24, 2000, litigation was filed in the 357th Judicial District
Court of Cameron County, Texas, against Cowboy, CPSC and the Company
(collectively referred to as the "Defendants") alleging that the Defendants had
illegally trespassed in connection with the construction of the US Pipelines and
seeking a temporary restraining order against the Defendants from future use of
the US Pipelines. On March 20, 2000, the Company acquired the portion of the
property which surrounds the area where the US Pipelines were constructed for
cash of $1.9 million, which was paid during April 2000, and debt in the amount
of $1.9 million. As a result, the litigation was dismissed. The debt bears
interest at 10.0% per annum, payable monthly in minimum installments of $15,000
or $.001 for each gallon that flows through the US Pipelines with a balloon
payment due in April 2003 (see note M to the consolidated financial statements).
Litigation. On July 10, 2001, litigation was filed in the 164th Judicial
District Court of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel &
Jackson L.L.P. against the Company alleging breach of contract, common law fraud
and statutory fraud in connection with the settlement agreement between the
parties dated July 26, 2000 (see above). Plaintiffs seek actual and punitive
damages. The Company believes the claims are without merit and intends to
vigorously defend against the lawsuit.
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, CNG 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 has recently been dismissed from the
litigation pursuant to a summary judgment. Based on proceedings to date, the
Company believes that the claims are without merit and intends to vigorously
defend against the lawsuit.
31
On August 7, 2001, a Mexican company, Intertek Testing Services de Mexico,
S.A. de C.V., (the "Plaintiff") which contracts with PMI for LPG testing
services filed suit in the Superior Court of California, County of San Mateo
against the Company alleging breach of contract. The Company has no contract
with the Plaintiff and, therefore, believes that the complaint is without merit
and intends to vigorously defend against the lawsuit.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims should not
materially affect its consolidated financial statements.
Award from Litigation. For the years ended July 31, 1999 and 2000, the
Company recognized gains of $987,114, and approximately $3.0 million,
respectively, which represent the amounts of an Award from litigation from a
lawsuit that originated in 1994.
Realization of Assets. The Company has had an accumulated deficit since
inception, has used cash in operations, continues to have a deficit in working
capital and has exposure related to financing of and/or losses associated with
LPG price fluctuations for imbalances on undelivered LPG. In addition,
significantly all of the Company's assets are pledged or committed to be pledged
as collateral on existing debt in connection with the Restructured Notes, the
New Notes, the RZB Credit Facility and the notes related to the Settlement. The
Company is currently negotiating with the creditors for the required security
agreements. The Restructured Notes and the New Notes, which total approximately
$5.8 million at October 12, 2001, are due on December 15, 2001. The Company may
need to increase its credit facility for the purchase of quantities of LPG in
excess of current quantities sold and/or to finance future price increases of
LPG, if any. Further, the Company may find it necessary to liquidate inventories
at a loss to provide working capital, to reduce outstanding balances under its
credit facility or due to storage limitations at Markham storage. In addition,
the Company entered into supply agreements for quantities of LPG totaling
approximately 26.5 million gallons per month (actual deliveries have been
approximately 23.0 million gallons per month) although a new sales agreement
with PMI has not been consummated (see note R to the consolidated financial
statements). As discussed in note A to the consolidated financial statements,
the Company has historically depended heavily on sales to PMI.
In view of the matters described in the preceding paragraph, recoverability
of a major portion of the recorded asset amounts as shown in the accompanying
consolidated balance sheets is dependent upon the Company's ability to obtain
additional financing, repay, renew or extend the Restructured Notes and the New
Notes referred to in the preceding paragraph and to raise additional equity
capital, resolve uncertainties related to the Saltillo Terminal Facility and the
success of the Company's future operations. 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 taking steps to (i) increase sales to its current
customers including consummation of the Proposed Agreement (see note R to the
consolidated financial statements), (ii) increase its customers assuming
Deregulation, (iii) extend the terms of the Pipeline Lease and the Brownsville
Lease, (iv) expand its product lines, (v) obtain additional letters of credit
financing and (vi) raise additional debt and/or equity capital.
At July 31, 2001, the Company had net operating loss carryforward for
federal income tax purposes of approximately $12.0 million. The ability to
utilize such net operating loss carryforwards may be significantly limited by
the application of the "change of ownership" rules under Section 382 of the
Internal Revenue Code.
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.
32
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, 2000 and 2001, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended July 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of July 31, 2000 and 2001, and the consolidated results of their
operations and their consolidated cash flows for each of the three years in the
period ended July 31, 2001 in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II of the Company for each of the three years in
the period ended July 31, 2001. In our opinion, this schedule presents fairly,
in all material respects, the information required to be set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note Q, conditions
exist which raise substantial doubt about the Company's ability to continue as a
going concern including 1) the Company has not sustained profitable operations,
2) the Company has a deficit in working capital, 3) the Company has exposure
related to financing of and/or losses associated with LPG price fluctuations for
Imbalances on undelivered LPG, and 4) significantly all of the Company's assets
are pledged or committed to be pledged as collateral on existing debt in
connection with the Restructured Notes, the New Notes, the RZB Credit Facility
and the notes related to the Settlement. Management's plans regarding these
matters are described in note Q. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
/s/ BURTON McCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
October 12, 2001
33
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31
ASSETS
2000 2001
----------- -----------
Current Assets
Cash (including restricted cash of $32,372 and $971,875) $ 25,491 $ 1,322,560
Trade accounts receivable (less allowance for doubtful accounts of
$562,950 and $779,663) 3,816,685 4,802,897
Notes receivable 770,016 439,053
Inventories 7,323,209 12,384,847
Prepaid expenses and other current assets 196,520 298,828
Property held for sale 1,908,000 -
----------- -----------
Total current assets 14,039,921 19,248,185
Property, plant and equipment - net 16,756,816 18,260,384
Lease rights (net of accumulated amortization of $570,150 and $615,945) 583,889 538,094
Mortgage receivable - 1,934,872
Other non-current assets 156,537 312,808
----------- -----------
Total assets $31,537,163 $40,294,343
=========== ===========
The accompanying notes are an integral part of these statements.
34
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
JULY 31
LIABILITIES AND STOCKHOLDERS' EQUITY
2000 2001
-------------- ---------------
Current Liabilities
Current maturities of long-term debt $ 3,859,266 $ 918,885
Short-term debt 4,980,872 5,650,430
Revolving line of credit 3,538,394 -
LPG trade accounts payable 5,226,958 9,537,825
Obligation to deliver LPG - 11,495,333
Other accounts payable and accrued liabilities 2,833,434 4,315,354
-------------- ---------------
Total current liabilities 20,438,924 31,917,827
Long-term debt, less current maturities 1,464,984 3,273,969
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$.01 par value, 5,000,000 shares
authorized; No shares issued and outstanding at July 31, 2000 and
2001 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation
value, 5,000,000 shares authorized; No shares issued and outstanding
at July 31, 2000 and 2001 - -
Common stock - $.01 par value, 25,000,000 shares authorized;
13,435,198 and 14,427,011 shares issued and outstanding at July 31,
2000 and 2001 134,352 144,270
Additional paid-in capital 21,782,638 25,833,822
Notes receivable from officers of the Company and a related party for
exercise of warrants, less reserve of $496,077 and $596,705 at July
31, 2000 and 2001 ( 3,263,350) ( 3,761,350)
Accumulated deficit ( 9,020,385) ( 17,114,195)
-------------- ---------------
Total stockholders' equity 9,633,255 5,102,547
-------------- ---------------
Total liabilities and stockholders' equity $ 31,537,163 $ 40,294,343
============== ===============
The accompanying notes are an integral part of these statements.
35
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31
1999 2000 2001
-------------- -------------- -----------------
Revenues $ 35,337,935 $ 98,514,963 $ 150,699,999
Cost of goods sold 32,044,194 94,936,405 151,475,598
-------------- -------------- -----------------
Gross profit (loss) 3,293,741 3,578,558 ( 775,599)
Selling, general and administrative expenses
Legal and professional fees 350,558 826,310 1,139,141
Salaries and payroll related expenses 904,076 1,219,581 1,230,456
Travel 151,362 176,225 230,492
Other 668,173 930,530 1,017,550
-------------- -------------- -----------------
2,074,169 3,152,646 3,617,639
-------------- -------------- -----------------
Operating income (loss) 1,219,572 425,912 ( 4,393,238)
Other income (expense)
Interest expense ( 521,418) ( 1,857,057) ( 3,615,477)
Interest income 16,981 34,080 39,576
Settlement of litigation ( 577,691) ( 81,250) ( 115,030)
Award from litigation 987,114 3,036,638 -
-------------- -------------- -----------------
Income (loss) from continuing operations before taxes 1,124,558 1,558,323 ( 8,084,169)
Provision for income taxes - 97,542 9,641
-------------- -------------- -----------------
Income (loss) from continuing operations 1,124,558 1,460,781 ( 8,093,810)
Discontinued operations, net of taxes
Loss from operations of CNG segment ( 290,625) - -
Loss on disposal of CNG segment ( 288,488) - -
-------------- -------------- -----------------
Total loss from discontinued operations ( 579,113) - -
-------------- -------------- -----------------
Net income (loss) $ 545,445 $ 1,460,781 $ ( 8,093,810)
============== ============== =================
Income (loss) from continuing operations
per common share $ 0.11 $ 0.11 $ ( 0.57)
============== ============== =================
Net income (loss) per common share $ 0.05 $ 0.11 $ ( 0.57)
============== ============== =================
Income (loss) from continuing operations per common share assuming dilution $ 0.10 $ 0.10 $ ( 0.57)
============== ============== =================
Net income (loss) per common share assuming dilution $ 0.05 $ 0.10 $ ( 0.57)
============== ============== =================
Weighted average common shares outstanding 10,659,100 12,970,052 $ 14,146,980
============== ============== =================
36
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31
1999 2000 2001
------------------ ---------------------- --------------------
Shares Amount Shares Amount Shares Amount
--------- ------- ----------- --------- ---------- --------
PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
========= ======= =========== ========= ========== ========
Ending balance - $ - - $ - - $ -
========= ======= =========== ========= ========== ========
SENIOR PREFERRED STOCK
Beginning balance - $ - 90,000 $ 900 - $ -
Issuance of 90,000 shares of Senior Preferred
Stock during March 1999 in exchange for
cancellation of $900,000 of promissory notes 90,000 900 - - - -
Conversion of 90,000 shares of preferred stock
to 450,000 shares of common stock on
September 3, 1999 - - ( 90,000) ( 900) - -
--------- ------- ----------- --------- ---------- --------
Ending balance 90,000 $ 900 - $ - - $ -
========= ======= =========== ========= ========== ========
COMMON STOCK
Beginning balance 9,952,673 $99,527 11,845,497 $118,456 13,435,198 $134,352
Sale of common stock - November 1998 250,000 2,500 - - - -
Issuance of common stock in exchange for
settlement of $22,500 of outstanding obligations
- December 1998 15,000 150 - - - -
Issuance of common stock in exchange for
settlement of $118,607 of debt obligations -
December 1998 53,884 539 - - - -
Sale of common stock - December 1998 500,000 5,000 - - - -
Sale of common stock, including related fees of
35,000 shares of common stock - March 1999 362,273 3,623 - - - -
Issuance of common stock in connection with
conversion of debt to Senior Preferred Stock of
the Company 50,000 500 - - - -
Issuance of common stock in exchange for
consulting services 5,000 50 - - - -
Sale of common stock - July 1999 490,000 4,900 - - - -
Issuance of common stock in exchange for
cancellation of $300,000 of debt obligations -
July 1999 166,667 1,667 - - - -
The accompanying notes are an integral part of these statements.
37
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
1999 2000 2001
-------------------- -------------------- -----------------------
Shares Amount Shares Amount Shares Amount
---------- -------- ---------- -------- ----------- ----------
COMMON STOCK - CONTINUED
Issuance of common stock upon exercise of
warrants - August 1999 - - 425,000 4,250 - -
Issuance of common stock in connection with
conversion of Senior Preferred Stock -
September 1999 - - 450,000 4,500 - -
Issuance of common stock upon exercise of
warrants - October 1999 - - 163,636 1,636 - -
Issuance of common stock in connection with
bonus - January 2000 - - 10,000 100 - -
Issuance of common stock upon exercise of
warrants - February 2000 - - 95,000 950 - -
Issuance of common stock for services -
February 2000 - - 7,000 70 - -
Issuance of common stock upon exercise of
warrants in exchange for promissory note -
March 2000 - - 200,000 2,000 - -
Sale of common stock - April 2000 - - 181,818 1,818 - -
Issuance of common stock upon exercise of
warrants - May 2000 - - 48,750 488 - -
Issuance of common stock in connection with
registration rights penalty - - 8,497 84 - -
Issuance of common stock in connection with
registration rights penalty - - - - 3,480 35
Issuance of common stock for services - August
2000 - - - - 6,500 65
Issuance of common stock in connection with
settlement of litigation - August 2000 - - - - 12,500 125
Issuance of common stock in connection with
settlement of litigation - September 2000 - - - - 100,000 1,000
Issuance of common stock upon exercise of
warrants - September 2000 - - - - 200,000 2,000
Receipt of stock for cancellation of indebtedness - - - - ( 78,383) ( 784)
Issuance of common stock upon exercise of
warrants - October 2000 - - - - 7,500 75
Issuance of common stock for services -
November 2000 - - - - 4,716 47
Issuance of common stock upon exercise of
warrants - November 2000 - - - - 700,000 7,000
Issuance of common stock in connection with
bonus - December 2000 - - - - 14,500 145
Issuance of common stock for services -
December 2000 - January 2001 - - - - 6,000 60
Issuance of common stock upon exercise of
warrants - July 2001 - - - - 15,000 150
---------- -------- ---------- -------- ----------- ----------
Ending balance 11,845,497 $118,456 13,435,198 $134,352 14,427,011 $ 144,270
========== ======== ========== ======== =========== ==========
The accompanying notes are an integral part of these statements.
38
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
1999 2000 2001
--------------- --------------- ---------------
Amount Amount Amount
--------------- --------------- ---------------
ADDITIONAL PAID-IN CAPITAL
Beginning balance $ 13,318,592 $ 17,133,222 $ 21,782,638
Sale of common stock 2,288,477 998,182 -
Issuance of common stock for notes,
cancellation of commission agreements,
services and payment on promissory note 140,418 - -
Conversion of preferred stock to common
stock - ( 3,600) -
Exchange of debt for senior preferred stock and
common stock 997,933 - -
Issuance of warrants in connection with
settlement - - 300,000
Loan discount 172,802 1,305,031 1,620,403
Grant of stock for bonus - - 43,355
Grant of stock for services 8,700 - 87,595
Common stock distributed in connection with the settlement of a lawsuit 206,300 81,250 ( 1,125)
Grant of warrants for services - 381,080 499,480
Grant of warrants in connection with registration
rights agreement - ( 85) ( 35)
Receipt of common stock for cancellation of debt - 1,991,627 ( 554,877)
Exercise of warrants - - 2,142,025
Cost of registering securities - ( 104,069) ( 85,637)
--------------- --------------- ---------------
Ending balance $ 17,133,222 $ 21,782,638 $ 25,833,822
=============== =============== ===============
STOCKHOLDERS' NOTES
Beginning balance $ ( 2,763,006) $ ( 2,765,350) $ ( 3,263,350)
Note receivable from an officer of the Company
for exercise of warrants - ( 498,000) ( 498,000)
Other ( 2,344) - -
--------------- --------------- ---------------
Ending balance $ ( 2,765,350) $ ( 3,263,350) $ ( 3,761,350)
=============== =============== ===============
ACCUMULATED DEFICIT
Beginning balance $( 10,981,241) $ ( 10,435,796) $ ( 9,020,385)
Net income (loss) for the year 545,445 1,460,781 ( 8,093,810)
Dividends on preferred stock - ( 45,370) -
--------------- --------------- ---------------
Ending balance $( 10,435,796) $ ( 9,020,385) $( 17,114,195)
=============== =============== ===============
The accompanying notes are an integral part of these statements.
39
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31
1999 2000 2001
---------------- ---------------- -------------------------
Cash flows from operating activities:
Net income (loss) $ 545,445 $ 1,460,781 $ ( 8,093,810)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 230,078 388,445 758,911
Amortization of lease rights 45,795 45,795 45,795
Non-employee stock based costs and other - 58,333 222,988
Loan discount 134,741 1,478,406 1,887,442
Award from litigation ( 987,114) - -
Settlement of litigation 206,300 81,250 -
Loss on sale of assets 288,488 - -
Other 3,256 123,137 106,570
Changes in current assets and liabilities:
Trade accounts receivable ( 1,310,262) ( 1,352,652) ( 986,213)
Inventories ( 238,059) ( 6,708,053) ( 5,061,638)
Prepaid and other current assets 48,334 ( 54,003) 22,562
Property held for sale - ( 1,908,000) -
LPG trade accounts payable 1,918,835 2,376,761 4,310,867
Obligation to deliver LPG - - 11,495,333
Other assets and liabilities, net ( 11,270) ( 3,150) ( 4,649)
Other accounts payable and accrued liabilities ( 312,754) 1,450,788 1,491,810
---------------- ---------------- -------------------
Net cash provided by (used in) operating activities 561,813 ( 2,562,162) 6,195,968
Cash flows from investing activities:
Capital expenditures ( 432,988) ( 7,811,111) ( 2,572,367)
Purchase of lease interests - ( 3,000,000) -
Payments on note receivable 49,548 40,000 -
---------------- ---------------- -------------------
Net cash used in investing activities ( 383,440) ( 10,771,111) ( 2,572,367)
Cash flows from financing activities:
Revolving credit facilities ( 991,823) 3,538,394 ( 3,538,394)
Issuance of debt - 7,279,212 1,046,000
Debt issuance costs - ( 370,530) ( 326,232)
Issuance of common stock 2,105,500 2,398,882 1,453,249
Costs of registration - - ( 85,637)
Reduction in debt ( 417,298) ( 474,089) ( 875,518)
Preferred stock dividends - ( 45,370) -
---------------- ---------------- --------------------
Net cash provided by (used in) financing activities 696,379 12,326,499 ( 2,326,532)
---------------- ---------------- --------------------
Net increase (decrease) in cash 874,752 ( 1,006,774) 1,297,069
Cash at beginning of period 157,513 1,032,265 25,491
---------------- ---------------- --------------------
Cash at end of period $ 1,032,265 $ 25,491 $ 1,322,560
================ ================ ====================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (including capitalized interest of $120,000 in 2001) $ 338,659 $ 772,296 $ 1,806,356
================ ================ === ================
Taxes $ - $ 80,042 $ 27,141
================ ================ ====================
Supplemental disclosures of noncash transactions:
Preferred stock, common stock and warrants issued $ 1,556,507 $ 960,500 $ 3,575,382
================ ================ ====================
Notes receivable exchanged for common stock $ - $ - $ ( 555,661)
================ ================ ====================
Capitalized lease obligations $ - $ 3,162,500 $ -
================ ================ ====================
Mortgage receivable $ - $ - $ 1,934,872
================ ================ ====================
The accompanying notes are an integral part of these statements.
40
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION
Penn Octane Corporation was incorporated in Delaware in August 1992. The
Company has been principally engaged in the purchase, transportation and
sale of liquefied petroleum gas (LPG). The Company owns and operates a
terminal facility on leased property in Brownsville, Texas (the Brownsville
Terminal Facility) and owns a LPG terminal facility in Matamoros,
Tamaulipas, Mexico (the Matamoros Terminal Facility) and 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 Exxon Mobil 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
Exxon's Viola valve station in Nueces County, Texas to the inlet of the
King Ranch Gas Plant (see note R) as well as existing and other potential
propane pipeline suppliers which have the ability to access the ECCPL. In
connection with the Company's lease agreement for the Leased Pipeline, the
Company may access up to 21,000,000 gallons of storage located in Markham,
Texas (Markham Storage), as well as other potential propane pipeline
exchange suppliers, via approximately 155 miles of pipeline located between
Markham, Texas and the Exxon King Ranch Gas Plant. The Company also has up
to 8,400,000 gallons of available storage at Mont Belvieu. The Company
sells LPG primarily to P.M.I. Trading Limited (PMI). PMI is the exclusive
importer of LPG into Mexico. PMI is also a subsidiary of Petroleos
Mexicanos, the state-owned Mexican oil company (PEMEX). The LPG purchased
from the Company by PMI is destined for consumption in the northeastern
region of Mexico.
The Company commenced operations during the fiscal year ended July 31,
1995, upon construction of the Brownsville Terminal Facility. Since the
Company began operations, the primary customer for LPG has been PMI. Sales
of LPG to PMI accounted for approximately 100%, 77% and 74% of the
Company's total revenues for the years ended July 31, 1999, 2000 and 2001,
respectively.
BASIS OF PRESENTATION
-----------------------
The accompanying consolidated financial statements include the Company and
its United States subsidiaries, Penn Octane International, L.L.C.,
PennWilson CNG, Inc. (PennWilson) and Penn CNG Holdings, Inc. and
subsidiaries, its Mexican subsidiaries, Penn Octane de Mexico, S.A. de C.V.
(PennMex) and Termatsal, S.A. de C.V. (Termatsal) and its other inactive
Mexican subsidiaries, (collectively the Company). All significant
intercompany accounts and transactions are eliminated.
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 19 years
Automobiles 3-5 years
Furniture, fixtures and equipment 3-5 years
Trailers 8 years
Pipelines 30 years
41
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The lease rights are being amortized over 19 years.
Maintenance and repair costs are charged to expense as incurred, and
renewals and improvements that extend the useful life of the assets are
added to the property, plant and equipment accounts.
The provisions of Statement of Financial Accounting Standards (SFAS) No.
121 (SFAS 121) "Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed Of", require 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,
1999, 2000 and 2001.
3. INCOME TAXES
The Company will file a consolidated income tax return for the year ended
July 31, 2001.
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.
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", which supersedes Accounting Principles Board Opinion (APB) Opinion
No. 15 (APB 15), "Earnings Per Share". During periods in which the Company
incurred losses, giving effect to common stock equivalents is not presented
as it would be antidilutive.
5. CASH EQUIVALENTS
For purposes of the cash flow statement, the Company considers cash in
banks and securities purchased with a maturity of three months or less to
be cash equivalents.
6. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments", requires
the disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable
to estimate the value. SFAS 107 excludes certain financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
are not intended to represent the underlying value of the Company. The
carrying amounts of cash and cash equivalents, current receivables and
payables and long-term liabilities approximate fair value because of the
short-term nature of these instruments.
42
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
8. STOCK-BASED COMPENSATION
SFAS 123, "Accounting for Stock-Based Compensation", establishes financial
accounting and reporting standards for stock-based employee compensation
plans and for transactions in which an entity issues its equity instruments
to acquire goods and services from non-employees.
Under the guidance provided by SFAS 123, the Company has elected to
continue to account for employee stock-based compensation using the
intrinsic value method prescribed in APB 25, "Accounting for Stock Issued
to Employees", and related Interpretations.
9. REVENUE RECOGNITION ON SALES OF LPG
Revenues are not recorded from sales of LPG to be delivered in the future
until final delivery. Any amounts collected from such sales are recorded as
obligation to deliver LPG in the consolidated balance sheet. Losses, if
any, resulting from inventory imbalances from such sales are recognized
currently, and gains, if any, are recognized at final delivery.
10. RECLASSIFICATIONS
Certain reclassifications have been made to prior year balances to conform
to the current presentation.
43
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, 1999
------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- -----------
Income (loss) from continuing operations $ 1,124,558 - -
Income (loss) from discontinued operations ( 579,113) - -
--------------
Net income (loss) 545,445 - -
Less: Dividends on preferred stock - - -
BASIC EPS
Income (loss) from continuing operations
available to common stockholders 1,124,558 10,659,100 $ 0.11
===========
Income (loss) from discontinued operations ( 579,113) 10,659,100 $( 0.06)
-------------- ===========
Net income (loss) available to common
stockholders 545,445 10,659,100 $ 0.05
===========
EFFECT OF DILUTIVE SECURITIES
Warrants - 89,437 -
Convertible Preferred Stock - 185,440 -
DILUTED EPS
Income (loss) from continuing operations
available to common stockholders 1,124,558 10,933,977 $ 0.10
===========
Income (loss) from discontinued operations ( 579,113) 10,933,977 $ ( 0.05)
-------------- ===========
Net income (loss) available to common
stockholders $ 545,445 10,933,977 $ 0.05
============== ============= ===========
44
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE - Continued
For the year ended July 31, 2000
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Income (loss) from continuing operations $ 1,460,781 - -
Income (loss) from discontinued operations - - -
--------------
Net income (loss) 1,460,781 - -
Less: Dividends on preferred stock ( 45,370) - -
BASIC EPS
Income (loss) from continuing operations
available to common stockholders 1,415,411 12,970,052 $ 0.11
==========
Income (loss) from discontinued operations - - $ -
-------------- ==========
Net income (loss) available to common
stockholders 1,415,411 12,970,052 $ 0.11
==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 1,435,264 -
Convertible Preferred Stock - 41,803 -
DILUTED EPS
Income (loss) from continuing operations
available to common stockholders 1,415,411 14,447,119 $ 0.10
==========
Income (loss) from discontinued operations - - $ -
-------------- ==========
Net income (loss) available to common
stockholders $ 1,415,411 14,447,119 $ 0.10
============== ============= ==========
45
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE - Continued
For the year ended July 31, 2001
-------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -----------
Income (loss) from continuing operations $( 8,093,810) - -
Income (loss) from discontinued operations - - -
---------------
Net income (loss) ( 8,093,810) - -
Less: Dividends on preferred stock - - -
BASIC EPS
Income (loss) from continuing operations
available to common stockholders ( 8,093,810) 14,146,980 $( 0.57 )
===========
Income (loss) from discontinued operations - - $ -
--------------- ===========
Net income (loss) available to common
stockholders ( 8,093,810) 14,146,980 $( 0.57 )
===========
EFFECT OF DILUTIVE SECURITIES
Warrants - - -
Convertible Preferred Stock - - -
DILUTED EPS
Income (loss) from continuing operations
available to common stockholders N/A N/A N/A
Income (loss) from discontinued operations N/A N/A N/A
Net income (loss) available to common
stockholders N/A N/A N/A
NOTE D - DISCONTINUED OPERATIONS AND SALE OF CNG ASSETS
In connection with the sale of assets related to the CNG business during
May 1999, the Company disposed of its CNG segment and discontinued
operations of that segment. In accordance with APB 30, the results of
operations related to the CNG segment were recorded as discontinued
operations for all periods presented in the Company's consolidated
financial statements. The Company sold its remaining CNG assets and
business to a company controlled by a director and officer of the Company
(referred to collectively as the Buyer) for promissory notes of $300,000
and $900,000.
46
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - DISCONTINUED OPERATIONS AND SALE OF CNG ASSETS - CONTINUED
The notes contained a provision for prepayment at a discount and bore
interest at rates specified therein. The Company discounted the notes for
the prepayment discount, resulting in a discount of $260,000 which is
included in the statement of operations for the year ended July 31, 1999.
On September 10, 2000, the Board of Directors approved the repayment by the
Buyer of the $900,000 promissory note to the Company through the exchange
of 78,373 shares of common stock of the Company owned by 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 has a balance of $214,355 and is collateralized by
the CNG assets and 60,809 shares of the Company's common stock owned by the
Buyer. As of July 31, 2001, the Buyer has not made all of the payments as
required under the note.
NOTE E - NOTES FROM RELATED PARTIES
DIRECTORS, OFFICERS AND SHAREHOLDERS
---------------------------------------
During April 1997, the Company's President exercised warrants to purchase
2,200,000 shares of common stock of the Company, at an exercise price of
$1.25 per share. The consideration for the exercise of the warrants
included $22,000 in cash and a $2,728,000 promissory note. The note was due
on April 11, 2000. On April 11, 2000, the Company's President issued a new
promissory note totaling $3,196,693, 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 the President's promissory notes
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. The Company's President is personally liable with full recourse to
the Company and has provided 1,000,000 shares of common stock of the
Company as collateral. The promissory note has been recorded as a reduction
of stockholders' equity.
On March 26, 2000, an affiliate of a director and 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 expired on March 26, 2000. The principal amount of the
note plus accrued interest at an annual rate of 10.0% was due on April 30,
2001. The affiliate of a director and officer of the Company is personally
liable with full recourse to the Company and has provided 15,000 shares of
common stock of the Company as collateral. The promissory note has been
recorded as a reduction of stockholders' equity.
47
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE E - NOTES FROM RELATED PARTIES - CONTINUED
During March 2000, a director and officer of the Company exercised warrants
to purchase 200,000 shares of common stock of the Company at an exercise
price of $2.50 per share. The consideration for the exercise of the
warrants included $2,000 in cash and a $498,000 promissory note. The
principal amount of the note plus accrued interest at an annual rate of
10.0% was due on April 30, 2001. The director and officer of the Company is
personally liable with full recourse to the Company and has provided
200,000 shares of common stock of the Company as collateral. The promissory
note has been recorded as a reduction of stockholders' equity.
During September 2000, a director and officer of the Company exercised
warrants to purchase 200,000 shares of common stock of the Company at an
exercise price of $2.50 per share. The consideration for the exercise of
the warrants included $2,000 in cash and a $498,000 promissory note. The
principal amount of the note plus accrued interest at an annual rate of
10.5% was due on April 30, 2001. The director and officer of the Company is
personally liable with full recourse to the Company and has provided 60,809
shares of common stock of the Company as collateral (see note D). The
promissory note has been recorded as a reduction of stockholders' equity.
The amounts due from notes issued to the Company by officers, directors and
a related party for the exercise of warrants totaling $4,239,296 plus
interest have not been paid as required by the terms of the notes to the
Company. All accrued but unpaid interest from officers, directors and a
related party has been reserved (see note S).
48
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following as of July 31, :
LPG: 2000 2001
-------------- --------------
Brownsville Terminal Facility:
Building $ 173,500 $ 173,500
Terminal facilities 3,426,440 3,631,207
Tank Farm 370,845 370,855
Midline pump station - 2,293,121
Leasehold improvements 291,409 291,409
Capital construction in progress 1,295,825 67,002
Equipment 393,462 469,545
-------------- --------------
5,951,481 7,296,639
US - Mexico Pipelines and Matamoros Terminal
Facility:
U.S. Pipelines and Rights of Way 5,626,054 6,245,614
Mexico Pipelines and Rights of Way 1,042,039 993,300
Matamoros Terminal Facility 5,104,402 5,078,336
Saltillo Terminal Facility 785,699 799,309
Land 302,221 644,526
-------------- --------------
Total LPG 18,811,896 21,057,724
-------------- --------------
Other:
Automobile 10,800 10,800
Office equipment 39,615 56,266
-------------- --------------
50,415 67,066
-------------- --------------
18,862,311 21,124,790
Less: accumulated depreciation and amortization ( 2,105,495) ( 2,864,406)
-------------- --------------
$ 16,756,816 $ 18,260,384
============== ==============
Depreciation and amortization expense of property, plant and equipment
totaled $230,078, $388,445 and $758,911 for the years ended July 31, 1999,
2000 and 2001, respectively. These amounts include CNG related depreciation
of $10,105, $0 and $0, respectively, which is included in discontinued
operations in the consolidated statements of operations.
Property, plant and equipment, net of accumulated depreciation, includes
$7,128,791 and $6,738,746 of costs, located in Mexico at July 31, 2000 and
2001, respectively.
49
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE G - INVENTORIES
Inventories consist of the following as of July 31,:
2000 2001
---------------------- -----------------------
Gallons Cost Gallons Cost
---------- ---------- ---------- -----------
LPG:
Leased Pipeline and US-
Mexico Pipelines 1,361,850 $ 736,485 1,688,778 $ 693,981
Storage:
Brownsville Terminal Facility,
Matamoros Terminal Facility
and railcars leased by the
Company 1,037,290 560,964 785,184 322,660
Markham Storage and other 11,176,125 6,025,760 27,664,139 11,368,206
---------- ---------- ---------- -----------
13,575,265 $7,323,209 30,138,101 $12,384,847
========== ========== ========== ===========
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,:
2000 2001
------------------------------- ----------------------------------------
Assets Liabilities Assets Liabilities
---------- ------------------- ------------------- -------------------
Depreciation
Bad debt reserve $ - $ 135,000 $ - $ 145,000
Receivable 191,000 - - 265,000 -
Deferred compensation expense 31,000 - 12,000 -
Deferred interest cost 311,000 - 203,000 -
Deferred other cost 400,000 - 1,041,000 -
Net operating loss carryforward 19,000 - 95,000 -
1,915,000 - 3,986,000 -
---------- ------------------- ------------------- -------------------
2,867,000 135,000 5,602,000 145,000
Less: valuation allowance
2,867,000 135,000 5,602,000 145,000
---------- ------------------- ------------------- -------------------
$ - $ - $ - $ -
========== =================== =================== ===================
There is no current or deferred federal income tax expense for the years
ended July 31, 2000 and 2001. Alternative minimum tax for the year ended
July 31, 2000, totaled $44,333 (originally estimated at $97,542). The
Company was in a loss position for 2001 and utilized net operating loss
carryforwards in 1999 and 2000.
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.
50
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - INCOME TAXES - CONTINUED
At July 31, 2001, 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
------------ -------------
2010
2012 $ 19,000
2018 2,279,000
2019 3,326,000
2021 11,000
6,087,000
-------------
$ 11,722,000
=============
Future changes in ownership, as defined by section 382 of the Internal
Revenue Code, could limit the amount of net operating loss carryforwards
used in any one year.
NOTE I - DEBT OBLIGATIONS
SHORT-TERM DEBT
----------------
Restructuring of Notes
------------------------
From December 10, 1999 through January 18, 2000, and on February 2, 2000,
the Company completed a series of related transactions in connection with
the private placement of $4,944,000 and $710,000, respectively, of
subordinated notes (Notes) which were due the earlier of December 15, 2000,
or upon the receipt of proceeds by the Company from any future debt or
equity financing in excess of $2,250,000 (see below). Interest at 9% was
due and paid on June 15, 2000, and December 15, 2000. In connection with
the Notes, the Company granted the holders of the Notes, warrants
(Warrants) to purchase a total of 706,763 shares of common stock of the
Company at an exercise price of $4.00 per share, exercisable through
December 15, 2002.
During December 2000, the Company entered into agreements (Restructuring
Agreements) with the holders of $5,409,000 in principal amount of the Notes
providing for the restructuring of such Notes (Restructuring). The
remaining $245,000 balance of the Notes was paid.
Under the terms of the Restructuring Agreements, the due dates for the
restructured notes (Restructured Notes) were extended to December 15, 2001,
subject to earlier repayment upon the occurrence of certain specified
events provided for in the Restructured Notes. Additionally, beginning
December 16, 2000, the annual interest rate on the Restructured Notes was
increased to 13.5% (subject to the adjustments referred to below). Interest
payments are due quarterly beginning March 15, 2001.
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares
of common stock of the Company at an exercise price of $3.00 per share and
exercisable until December 15, 2003 (New Warrants). The Company also agreed
to modify the exercise prices of the Warrants to purchase up to 676,137
shares of common stock of the Company previously issued to the holders of
the Restructured Notes in connection with their original issuance from
$4.00 per share to $3.00 per share and extend the exercise dates of the
Warrants from December 15, 2002 to December 15, 2003. In addition, the
Company was required to reduce the exercise price of the Warrants and the
New Warrants issued to the holders of the Restructured Notes from $3.00 per
share to $2.50 per share because the Restructured Notes were not fully
repaid by June 15, 2001.
51
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
In connection with the Restructuring Agreements, the Company has also
agreed to register the shares of common stock which may be acquired in
connection with the exercise of the New Warrants (Exercisable Shares). In
the event that the Company did not have an effective registration statement
under the Securities Act of 1933, as amended, covering the Exercisable
Shares by March 31, 2001 (or April 30, 2001, if, at the time, the Company
was ineligible to utilize Form S-3 for purposes of such registration), or
if any effective registration statement ceases to be effective during any
period in which such effectiveness is required, the Company will be
required to pay additional interest on the Restructured Notes at the rate
of 4% per annum for the period in which the deficiency continues to exist.
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). The Company's President has also pledged 2,000,000 shares of
common stock of the Company owned by the President (1,000,000 shares to be
released when the required security interests in the US Assets have been
granted and perfected and all of the shares are to be released when the
required security interests in all of the Collateral have been granted and
perfected). The granting and perfection of the security interests in the
Collateral, as prescribed under the Restructured Notes, have not been
finalized. Accordingly, the interest rate under the Restructured Notes
increased to 16.5% on March 16, 2001, and will continue at such rate until
the required security interest in all of the Collateral has been granted
and perfected. In connection with the granting and perfection of the
security interests in the Collateral, the Company is currently negotiating
with the holders of the Restructured Notes and New Notes (see below) an
additional amendment which would provide for modifications to the
Collateral. The Collateral is also being pledged in connection with the
issuance of other indebtedness by the Company (see note M). PMG Capital
Corp. (PMG) has agreed to serve as the collateral agent.
PMG acted as financial advisor for the restructuring of $4,384,000 in
principal amount of the Restructured Notes. PMG received fees consisting of
$131,520 in cash and warrants to purchase 50,000 shares of common stock of
the Company with terms similar to the terms of the New Warrants. The
Company also agreed to modify and extend the exercise date of warrants to
purchase 114,375 shares of common stock of the Company originally issued to
PMG 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 PMG (including cash, new warrants granted and modifications to warrants
previously granted to PMG 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. The remaining portion of
the unamortized discount was $599,475 at July 31, 2001. Total amortization
of discounts related to the Notes and the Restructured Notes and included
in the consolidated statements of operations was $1,002,470 and $1,670,794
for the years ended July 31, 2000 and 2001, respectively.
52
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
Issuance of New Promissory Notes
- ------------------------------------
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (New Notes) due December 15, 2001. The
holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of the Company (New Note Warrants). The terms of the New
Notes and New Note Warrants are substantially the same as those contained
in the Restructured Notes and New Warrants issued in connection with the
Restructuring described above. As described above, the Company's payment
obligations under the New Notes will also be secured by the Collateral and
the shares of the Company which, are being pledged by the Company's
President.
Net proceeds from the New Notes were used for working capital purposes.
In connection with the New Notes, PMG 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 PMG and other costs associated with
the private placement, to be amortized over the life of the New Notes. The
remaining portion of the unamortized discount was $150,096 at July 31,
2001. Total amortization of discounts related to the New Notes and included
in the consolidated statements of operations was $199,398 for the year
ended July 31, 2001.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of the Company were exercised by certain holders of the New
Warrants and New Note Warrants for which the exercise price totaling
$614,833 was paid by reduction of the outstanding debt and interest
relating to the New Notes and the Restructured Notes.
53
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - DEBT OBLIGATIONS - CONTINUED
LONG-TERM DEBT
- ---------------
Long-term debt consists of the following as of July 31,:
2000 2001
---------- ----------
Capitalized lease obligations in connection with the US - Mexico Pipelines and the
Matamoros Terminal Facility (see note M). $5,070,500 $ -
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility (see note M). - 1,263,634
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility (see note M). - 811,532
Promissory note issued in connection with the purchase of property (see note M). - 1,934,872
Contract for Bill of Sale which was extended in April 1999; due in monthly payments of
3,000, including interest at 10%; due in February 2001; collateralized by a building.
Paid during November 2000. 14,347 -
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February
2001. 202,750 147,500
Other long-term debt 36,653 35,316
---------- ----------
5,324,250 4,192,854
Current maturities 3,859,266 918,885
---------- ----------
$1,464,984 $3,273,969
========== ==========
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 in the event that the Company defaulted under the
settlement agreement.
Scheduled maturities are as follows:
Year ending July 31,
---------------------
2002 $ 918,885
2003 805,117
2004 2,468,852
----------
$4,192,854
==========
54
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 August 2000 and September 2000, the Company issued 12,500 and
100,000 shares, respectively, of common stock of the Company in connection
with the settlement of litigation.
During September 2000, the Company issued 3,480 shares of common stock of
the Company in satisfaction of registration rights penalties.
During September 2000, a director and officer of the Company exercised
warrants to purchase 200,000 shares of common stock of the Company, at an
exercise price of $2.50 per share. The consideration for the exercise of
the warrants included $2,000 in cash and a $498,000 promissory note (see
note E).
During September 2000, a promissory note to the Company was paid through
the exchange of 78,373 shares of common stock of the Company (see note D).
During October 2000, warrants to purchase a total of 7,500 shares of common
stock of the Company were exercised, resulting in cash proceeds to the
Company of $11,250.
During November 2000, warrants to purchase a total of 200,000 shares of
common stock of the Company were exercised, resulting in cash proceeds to
the Company of $602,500.
During November 2000, the Company agreed to reduce the exercise price from
$2.50 to $2.00 per share for warrants to purchase 500,000 shares of common
stock of the Company as an inducement for the holder of the warrants
(Holder) to exercise the warrants. The consideration for the exercise of
the warrants included $5,000 in cash and a $995,000 promissory note. The
principal amount of the note plus accrued interest at an annual rate of
10.5% was due on April 30, 2001. During January 2001, the Company received
$795,000 as partial payment of the promissory note. The remaining balance
of $200,000 on this note has not been paid by the Holder. The Holder is
liable with full recourse to the Company and is required to provide 500,000
shares of common stock of the Company as collateral. The Company agreed to
allow the Holder to pledge the 500,000 shares in connection with a bank
loan of $795,000 which was used by the Holder to partially repay the
Company.
55
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCKHOLDERS' EQUITY - CONTINUED
COMMON STOCK - CONTINUED
-------------
During December 2000, the Company issued 15,500 shares of common stock of
the Company to certain employees of the Company as a bonus. In connection
with the issuance of the shares, the Company recorded an expense of $47,500
based on the market value of the stock issued.
During July 2001, warrants to purchase a total of 15,000 shares of common
stock of the Company were exercised resulting in cash proceeds to the
Company of $37,500.
During August and September 2001, warrants to purchase 37,500 and 275,933
shares, respectively, of common stock of the Company were exercised by
certain holders of the New Warrants and New Note Warrants, through
reductions of debt obligations (see note I).
In connection with previous warrants issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right
to purchase the warrants for a nominal price if the holder of the warrants
does not elect to exercise the warrants within the call provision.
STOCK AWARD PLAN
------------------
Under the Company's 1997 Stock Award Plan (Plan), the Company has reserved
for issuance 150,000 shares of common stock of the Company, of which
107,470 shares were unissued as of July 31, 2001, to compensate consultants
who have rendered significant services to the Company. The Plan is
administered by the Compensation Committee of the Board of Directors of the
Company which has complete authority to select participants, determine the
awards of common stock of the Company to be granted and the times such
awards will be granted, interpret and construe the Plan for purposes of its
administration and make determinations relating to the Plan, subject to its
provisions, which are in the best interests of the Company and its
stockholders. Only consultants who have rendered significant advisory
services to the Company are eligible to be participants under the Plan.
Other eligibility criteria may be established by the Compensation Committee
as administrator of the Plan.
Transactions subsequent to July 31, 2000, are as follows:
In August 2000, the Company issued 6,500 shares of Common Stock to a
consultant in payment for services rendered to the Company valued at
$41,438.
In November 2000, the Company issued 4,716 shares of common stock of the
Company to a consultant in payment for services rendered to the Company
valued at $23,583.
In December 2000, the Company entered into an agreement with a consultant
whereby the Company agreed to issue 2,000 shares of common stock of the
Company pursuant to the Plan for each month of service for a minimum of
three months. At January 31, 2001, the Company issued 2,000 shares of its
common stock in connection with this agreement. In February 2001, the
agreement was terminated and the Company issued the remaining 4,000 shares
of common stock of the Company due to the consultant.
During September 2001, the Company issued 37,500 shares of common stock of
the Company to a consultant in payment for services rendered to the Company
valued at $150,000.
56
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS
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 (the Board) meeting held on September 3,
1999, the Board approved the implementation of a plan to compensate each
outside director serving on the Board (the Plan). Under the Plan, all
outside directors upon election to the Board are entitled to receive
warrants to purchase 20,000 shares of common stock of the Company and are
to be granted warrants to purchase 10,000 shares of common stock of the
Company for each year of service as a director. Such warrants will expire
five years after the warrants are granted. The exercise price of the
warrants issued under the Plan are based on the average trading price of
the Company's common stock on the effective date the warrants are granted,
and the warrants vest monthly over a one year period.
In connection with the Plan, the Board granted warrants to purchase 10,000
shares of common stock of the Company at an exercise price of $6.94 per
share to an outside director on August 1, 2000. In addition, the Board
granted to newly elected directors warrants to purchase 60,000 shares of
common stock of the Company, at an exercise price of $6.69 per share, with
the vesting period to commence on August 7, 2000. The exercise prices per
share of the warrants issued were equal to or greater than the quoted
market prices per share at the measurement dates. Based on the provisions
of APB 25, no compensation expense was recorded for these warrants.
In connection with the Plan, during August 2001 the Board granted warrants
to purchase 10,000 and 20,000 shares of common stock of the Company at
exercise prices of $3.99 and $4.05 per share to outside directors. Based on
the provisions of APB 25, no compensation expense was recorded for these
warrants.
OTHER
-----
In connection with a consulting agreement between the Company and a
director of the Company, during August 2000, the director received warrants
to purchase 100,000 shares of common stock of the Company at an exercise
price of $6.38 per share exercisable through August 6, 2005. The warrants
will vest ratably on a quarterly basis over four years. The warrants were
accounted for under the provisions of SFAS 123 and the resulting expense is
being amortized over the vesting period.
As a bonus to a director and officer of the Company, during November 2000,
the Company granted warrants to purchase 200,000 shares of common stock of
the Company at an exercise price of $7.00 per share exercisable for five
years. The exercise price per share of the warrants was equal to or greater
than the quoted market price per share at the measurement date. Based on
the provisions of APB 25, no compensation expense was recorded for these
bonus warrants.
57
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS - CONTINUED
OTHER - CONTINUED
-----
Had compensation cost related to the warrants granted to employees been
determined based on the fair value at the grant dates, consistent with the
provisions of SFAS 123, the Company's pro forma income (loss) from
continuing operations, net income (loss), income (loss) from continuing
operations per common share and net income (loss) per common share would
have been as follows for the years ended July 31,:
1999 2000 2001
---------- ------------ -------------------
Income (loss) from continuing operations as reported $1,124,558 $ 1,460,781 $( 8,093,810)
Income (loss) from continuing operations proforma 896,958 ( 245,886) ( 10,855,577)
Net income (loss) as reported 545,445 1,460,781 ( 8,093,810)
Net income (loss) proforma 317,845 ( 245,886) ( 10,855,577)
Income (loss) from continuing operations per common
share as reported .11 .11 ( .57)
Income (loss) from continuing operations per common
share proforma .08 ( .02) ( .77)
Net income (loss) per common share as reported .05 .11 ( .57)
Net income (loss) per common share proforma .03 ( .02) ( .77)
Income (loss) from continuing operations per common
share assuming dilution as reported .10 .10 ( .57)
Income (loss) from continuing operations per common
share assuming dilution proforma .08 ( .02) ( .77)
Net income (loss) per common share assuming
dilution as reported .05 .10 ( .57)
Net income (loss) per common share assuming
dilution proforma .03 ( .02) ( .77)
The following assumptions were used for two grants of warrants to employees
in the year ended July 31, 1999, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0% for both
grants; expected volatility of 92% and 94%; risk free interest rate of 7%
for both grants; and expected lives of 3 and 5 years.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2000, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 92% and 93%; risk free interest rate of 6.02%; and
expected lives of 3 and 5 years.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2001, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0%;
expected volatility of 90% to 92%; risk free interest rate of 6.02%; and
expected lives of 5 years.
58
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS - CONTINUED
OTHER - CONTINUED
-----
For warrants granted to non-employees, the Company applies the provisions
of SFAS 123 to determine the fair value of the warrants issued. Costs
associated with warrants granted to non-employees for the years ended July
31, 1999, 2000 and 2001, totaled $0, $58,333 and $222,988, 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, 1999, 2000
and 2001, and changes during the years ending on those dates is presented
below:
1999 2000 2001
---------------------------- ---------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Warrants Shares Exercise Price Shares Exercise Price Shares Exercise Price
- ------------------------------ ----------- --------------- ----------- --------------- ---------- ---------------
Outstanding at beginning of
year 1,430,000 $ 3.15 2,591,136 $ 2.71 4,154,988 $ 3.82
Granted 1,451,136 2.27 2,478,738 4.36 1,395,000 3.82
Exercised - - ( 914,886) 2.16 ( 922,500) 2.33
Expired ( 290,000) 2.67 - - ( 250,000) 6.00
----------- ----------- ----------
Outstanding at end of year 2,591,136 2.71 4,154,988 3.82 4,377,488 3.67
=========== =========== ==========
Warrants exercisable at end of
year 2,591,136 2,946,653 3,451,251
The following table depicts the weighted-average exercise price and
weighted average fair value of warrants granted during the years ended July
31, 1999, 2000 and 2001, by the relationship of the exercise price of the
warrants granted to the market price on the grant date:
1999 2000 2001
---------------------------- ---------------------------- ----------------------------
For warrants granted For warrants granted For warrants granted
Weighted Weighted Weighted Weighted Weighted Weighted
Exercise price compared to average average average average average average
market price on grant date fair value exercise price fair value exercise price fair value exercise price
- -------------------------- ----------- --------------- ----------- --------------- ----------- ---------------
Equals market price $ - $ - $ - $ - $ 5.06 $ 6.77
Exceeds market price 1.03 2.27 2.96 4.21 1.84 4.16
Less than market price 1.98 2.50 1.85 2.50 2.30 2.50
The fair value of each warrant grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in the years ended July 31,
1999, 2000 and 2001, respectively: dividend yield of 0% for all three
years, expected volatility of 92%, 92% and 92%, risk-free interest rate of
7%, 6.02% and 6.02% and expected lives of 3.5, 3 to 5 and 3 to 5 years.
59
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - STOCK WARRANTS - CONTINUED
The following table summarizes information about the warrants outstanding
at July 31, 2001:
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, 2001 Life Price July 31, 2001 Price
- --------------------------- ------------- ----------- --------- ------------- ---------
1.75 to $2.50 2,173,738 2.14 years $ 2.38 2,173,738 $ 2.38
3.00 to $3.25 18,750 2.02 3.00 18,750 3.00
3.69 to $4.60 1,725,000 3.33 4.51 1,015,411 4.45
5.00 to $6.94 260,000 3.35 6.29 184,174 6.26
6.95 to $7.00 200,000 4.17 7.00 59,178 7.00
------------- -------------
$1.75 to $7.00 4,377,488 2.74 $ 3.67 3,451,251 $ 3.28
============= =============
NOTE L - COMMITMENTS AND CONTINGENCIES
LITIGATION - OTHER
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 seek actual and punitive damages.
The Company believes the claims are without merit and intends to vigorously
defend against the lawsuit.
In November 2000, the litigation between the Company and A.E. Schmidt
Environmental was settled in mediation for $100,000 without admission as to
fault.
During August 2000, the Company and WIN Capital Corporation (WIN) settled
litigation whereby the Company issued WIN 12,500 shares of common stock of
the Company. The value of the stock, totaling approximately $82,000 at the
time of settlement, was recorded in the Company's consolidated financial
statements at July 31, 2000.
On February 24, 2000, litigation was filed in the 357th Judicial District
Court of Cameron County, Texas, against Cowboy Pipeline Service Company,
Inc. (Cowboy), an affiliate of CPSC, CPSC International, Inc. (CPSC) and
the Company (collectively referred to as the "Defendants") alleging that
the Defendants had illegally trespassed in connection with the construction
of the US Pipelines and seeking a temporary restraining order against the
Defendants from future use of the US Pipelines. On March 20, 2000, the
Company acquired the portion of the property which surrounds the area where
the US Pipelines were constructed for cash of $1,908,000, which was paid
during April 2000, and debt in the amount of $1,908,000. As a result, the
litigation was dismissed. The debt bears interest at 10.0% per annum,
payable monthly in minimum installments of $15,000 or $.001 for each gallon
that flows through the US Pipelines with a balloon payment due in April
2003 (see note M).
60
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
LITIGATION - OTHER - CONTINUED
On March 2, 2000, litigation was filed in the Superior Court of California,
County of San Bernardino by Omnitrans against Penn Octane Corporation, Penn
Wilson, CNG 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 has recently been
dismissed from the litigation pursuant to a summary judgment. Based on
proceedings to date, the Company believes that the claims are without merit
and intends to vigorously defend against the lawsuit.
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
filed suit in the Superior Court of California, County of San Mateo against
the Company alleging breach of contract. The Company has no contract with
the Plaintiff and, therefore, believes that the complaint is without merit
and intends to vigorously defend against the lawsuit.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims should not
materially affect its consolidated financial statements.
AWARD FROM LITIGATION
For the years ended July 31, 1999 and 2000, the Company recognized gains of
$987,114, and $3,036,638, respectively, which represent the amounts of an
Award from litigation from a lawsuit that originated in 1994.
LITIGATION - CPSC
On March 14, 2000, CPSC filed for protection under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court (Court),
Southern District of Texas, Corpus Christi Division.
On April 27, 2000, the Company filed a complaint in the 107th Judicial
District Court of Cameron County, Texas, against Cowboy and the sole
shareholder of Cowboy (Owner) alleging (i) fraud, (ii) aiding and abetting
a breach of fiduciary duty, (iii) negligent misrepresentation, and (iv)
conspiracy to defraud in connection with the construction of the US-Mexico
Pipelines and Matamoros Terminal Facility and the underlying agreements
thereto. The Company also alleges that Cowboy was negligent in performing
its duties. The Company was seeking actual and exemplary damages and other
relief. On June 9, 2000, Cowboy removed the case to the Court.
On May 8, 2000, CPSC filed an adversary proceeding against the Company in
the Court seeking (i) prevention of the Company's use of the US-Mexico
Pipelines and escrow of all income related to use of the US-Mexico
Pipelines, (ii) sequestering all proceeds related to the sale from any
collateral originally pledged to CPSC, (iii) the avoidance of the addendum
agreement between the Company and CPSC, and (iv) damages arising from the
Company's breach of the Lease Agreements (see note M) and the September
1999 agreements.
During May 2000, the Company filed a motion with the Court seeking to
appoint a Chapter 11 Trustee and the Company also filed a complaint with
the Court seeking a declaratory judgment stating that the US Pipelines be
held in trust for the benefit of the Company and that the US Pipelines are
no longer the assets of the bankruptcy estate.
61
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
LITIGATION - CPSC - CONTINUED
On June 2, 2000, additional litigation was filed in the 138th Judicial
District Court of Cameron County, Texas, against Cowboy and the Company
alleging that Cowboy and the Company had illegally trespassed in connection
with the construction of the US Pipelines and seeking declaratory relief,
including damages, exemplary damages and injunctive relief preventing
Cowboy and the Company from utilizing the US Pipelines. On June 9, 2000,
CPSC intervened and removed the case to the Court. During August 2000, the
litigation was settled through a court ordered mediation by the Company
agreeing to acquire land for $342,305, substantially all of which was
provided through offsets against the purchase price in connection with the
Settlement (see below).
During March 2001, the Company, Cowboy and the Owner reached a settlement
(Settlement) whereby the Company purchased the remaining 50% interest owned
by CPSC in the Lease Agreements and related assets resulting in 100%
ownership of the US-Mexico Pipelines and the Matamoros Terminal Facility by
the Company. Under the terms of the Settlement, the parties provided mutual
general releases with respect to previous disputes and claims among the
parties (see note M).
CREDIT FACILITY AND LETTERS OF CREDIT
As of July 31, 2001, the Company has a $20,000,000 credit facility with RZB
Finance L.L.C. (RZB) and Bayerische Hypo-und Vereinsbank
Aktiengeselischaft, New York Branch (HVB), whereby RZB and HVB will each
participate up to $10,000,000 toward the total credit facility for demand
loans and standby letters of credit (RZB Credit Facility) to finance the
Company's purchases of LPG. Under the RZB Credit Facility, the Company pays
a fee with respect to each letter of credit thereunder in an amount equal
to the greater of (i) $500, (ii) 2.5% of the maximum face amount of such
letter of credit, or (iii) such higher amount as may be agreed to between
the Company and RZB. Any amounts outstanding under the RZB Credit Facility
shall accrue interest at a rate equal to the rate announced by the Chase
Manhattan Bank as its prime rate plus 2.5%. Pursuant to the RZB Credit
Facility, RZB and HVB each have sole and absolute discretion to limit or
terminate their participation in the RZB Credit Facility and to make any
loan or issue any letter of credit thereunder. RZB also has the right to
demand payment of any and all amounts outstanding under the RZB Credit
Facility at any time. In connection with the RZB Credit Facility, the
Company granted a security interest and assignment in any and all of the
Company's accounts, inventory, real property, buildings, pipelines,
fixtures and interests therein or relating thereto, including, without
limitation, the lease with the Brownsville Navigation District of Cameron
County (District) for the land on which the Company's Brownsville Terminal
Facility is located, the Pipeline Lease, and in connection therewith agreed
to enter into leasehold deeds of trust, security agreements, financing
statements and assignments of rent, in forms satisfactory to RZB. Under the
RZB Credit Facility, the Company may not permit to exist any subsequent
lien, security interest, mortgage, charge or other encumbrance of any
nature on any of its properties or assets, except in favor of RZB, without
the consent of RZB (see notes I and M). For the month of September 2001,
HVB did not participate in the RZB Credit Facility.
62
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
CREDIT FACILITY AND LETTERS OF CREDIT - CONTINUED
The Company's President, Chairman and Chief Executive Officer has
personally guaranteed all of the Company's payment obligations with respect
to the RZB Credit Facility.
In connection with the Company's purchases of LPG from Exxon, El Paso NGL
Marketing Company, L.P. (El Paso), Duke Energy NGL Services, Inc. (Duke)
and/or Koch Hydrocarbon Company (Koch), letters of credit are issued on a
monthly basis based on anticipated purchases.
In connection with the Company's purchase of LPG, under the RZB Credit
Facility, assets related to product sales (Assets) are required to be in
excess of borrowings and commitments. At July 31, the Company's borrowings
and commitments exceeded the amount of the Assets which included $971,875
in cash, by approximately $4,000,000. As of September 30, 2001, the Assets
exceeded the borrowings and commitments.
Interest costs associated with the RZB Credit Facility totaled $217,179,
$513,392, and $839,130 for the years ended July 31, 1999, 2000 and 2001.
OTHER
Subsequent to July 31, 2001, the obligation to deliver LPG exceeds
inventory quantities (Imbalances). As a result the Company is exposed to
price risk on the Imbalances.
OPERATING LEASE COMMITMENTS
The Company has lease commitments for its pipeline, land, office space and
office equipment. The Pipeline Lease originally required fixed monthly
payments of $45,834 ($550,000 annually) and 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. 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. The Company can
also terminate the lease at any time after the fifth anniversary date of
the lease 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 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 was
increased by $350,000, less certain adjustments during the first two years
from the Effective Date, and the Company is 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. The Company has made all payments required
under the Pipeline Lease Amendment.
The operating lease for the land on which the Brownsville Terminal Facility
is located (Brownsville Lease) expires in October 2003 and the annual
rental amount is approximately $75,000.
63
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - COMMITMENTS AND CONTINGENCIES - CONTINUED
OPERATING LEASE COMMITMENTS - CONTINUED
The Company anticipates renewing the Brownsville Lease prior to its
expiration. 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.
Tergas leases the land on which the Saltillo Terminal Facility is located.
The land is leased through January 2003 for $69,000 annually. Under the
terms of the land lease agreement, any leasehold improvements at the
termination of the lease may be removed.
The Company leases the land on which its Tank Farm is located. The lease
amount is approximately $27,000 annually and expires on January 18, 2005.
Rent expense was as follows for the years ended July 31,:
1999 2000 2001
----------- ----------- -----------
Minimum Rent Expense $ 1,152,153 $ 1,495,326 $ 2,067,620
Variable Rent Expense - 708,213 783,297
----------- ----------- -----------
Total $ 1,152,153 $ 2,203,539 $ 2,850,917
=========== =========== ===========
As of July 31, 2001, 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,
--------------------
2002 $ 1,442,246
2003 1,399,712
2004 1,335,974
2005 1,287,414
2006 1,275,000
Thereafter 8,525,000
-----------
$15,265,346
===========
EMPLOYMENT CONTRACTS
Effective February 1, 2001, the Company entered into a new six year
employment agreement with the President of the Company under terms similar
to the previous six year employment agreement with the President which
expired on January 31, 2001. Under the terms of the new agreement, he is
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 he is 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 is also entitled to
an annual bonus of 5% of all pre-tax profits of the Company. The employment
agreement also entitles him to a right of first refusal to participate in
joint venture opportunities in which the Company may invest, contains a
covenant not to compete for a period of one year from his termination and
has restrictions on use of confidential information.
Aggregate compensation under employment agreements totaled $432,000,
$338,500 and $300,000 for the years ended July 31, 1999, 2000 and 2001,
respectively, which included agreements with former executives.
64
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M - ACQUISITION OF PIPELINE INTERESTS
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 (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)
[Refined Products].
On July 2, 1998, PennMex (see note N), received a permit from the Comision
Reguladora de Energia (Mexican Energy Commission) to build and operate one
pipeline to transport LPG (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.
In connection with the construction of the US-Mexico Pipelines and the
Matamoros Terminal Facility, the Company and CPSC entered into two separate
Lease / Installation Purchase Agreements, as amended, (Lease Agreements),
whereby CPSC was required to construct and operate the US - Mexico
Pipelines (including an additional pipeline to accommodate Refined
Products) and the Matamoros Terminal Facility and lease these assets to the
Company. The Company had the option to purchase the US - Mexico Pipelines
and the Matamoros Terminal Facility at the end of the 10th year anniversary
and 15th year anniversary. Under the terms of the Lease Agreements, CPSC
was required to pay all costs associated with the design, construction and
maintenance of the US - Mexico Pipelines and Matamoros Terminal Facility.
During December 1999, the Company and CPSC amended the Lease Agreements
whereby the Company acquired a 50% interest for $3,000,000 and had the
option to acquire the remaining 50% interest in the Lease Agreements.
During February 2000, the Company determined that CPSC did not comply with
certain obligations under the Lease Agreements. In March 2000, CPSC filed
for protection under Chapter 11 of the United States Bankruptcy Code.
On March 30, 2001, the Company completed a settlement with CPSC and Cowboy,
which provided the Company with the remaining 50% interest in the portion
of the US-Mexico Pipelines, Matamoros Terminal Facility and related land,
permits or easements (Acquired Assets) previously constructed and/or owned
by CPSC and leased to the Company. Until the Settlement was completed (see
below), the Company had recorded the remaining 50% portion of the US-Mexico
Pipelines and Matamoros Terminal Facility as a capital lease. The Court
entered an order approving the Settlement. In addition, as part of the
Settlement, the Company conveyed to CPSC all of its rights to a certain
property (Sold Asset). The foregoing is more fully discussed below. The
terms of the Settlement did not deviate in any material respect from the
terms previously reported except that the fair value of the warrants issued
in connection with the Settlement (see below) was reduced from $600,000 to
$300,000 as a result of a decrease in the market value of the Company's
common stock.
65
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M - ACQUISITION OF PIPELINE INTERESTS - CONTINUED
In connection with the Settlement, the Company agreed to pay CPSC
$5,800,000 (the Purchase Price) for the Acquired Assets, less agreed upon
credits and offsets in favor of the Company totaling $3,237,500. The
remaining $2,562,500 was paid at the closing of the Settlement by a cash
payment of $200,000 to CPSC and the issuance to or for the benefit of CPSC
of two promissory notes in the amounts of $1,462,500 (the CPSC Note)
(payable in 36 monthly installments of approximately $46,000, including
interest at 9% per annum) and $900,000 (the Other Note) (payable in 36
equal monthly installments of approximately $29,000, including interest at
9% per annum). The Other Note is collateralized by a first priority
security interest in the U.S. portion of the pipelines comprising the
Acquired Assets. The CPSC Note is also collateralized by a security
interest in the Acquired Assets, which security interest is subordinated to
the security interest which secures the Other Note. In addition, the
security interest granted under the CPSC Note is shared on a pari passu
basis with certain other creditors of the Company (see notes I and L).
Under the terms of the CPSC Note, the Company is entitled to certain
offsets related to future costs which may be incurred by the Company in
connection with the Acquired Assets. In addition to the payments described
above, the Company agreed to assume certain liabilities which were
previously owed by CPSC in connection with construction of the Acquired
Assets. CPSC also transferred to the Company any right that it held to any
amounts owing from Termatsal for cash and/or equipment provided by CPSC to
Termatsal, including approximately $2,600,000 of cash advanced to
Termatsal, in connection with construction of the Mexican portion of the
Acquired Assets.
The Sold Asset transferred to CPSC in connection with the Settlement
consisted of real estate of the Company with an original cost to the
Company of $3,800,000 and with a remaining book value totaling
approximately $1,908,000 (after giving effect to credits provided to the
Company included in the financial terms described above). CPSC agreed to be
responsible for payments required in connection with the Debt related to
the original purchase by the Company of the Sold Asset totaling
approximately $1,908,000. CPSC's obligations under the Debt are to be paid
by the Company to the extent that there are amounts owed by the Company
under the CPSC Note, through direct offsets by the Company against the CPSC
Note. After the CPSC Note is fully paid, the Company will no longer have
any payment obligation to CPSC in connection with the Debt and therefore,
CPSC will then be fully responsible to the Company for any remaining
obligations in connection with the Debt (the Remaining Obligations). CPSC's
obligations to the Company in respect of the Remaining Obligations are
collateralized by a deed of trust lien granted by CPSC in favor of the
Company against the Sold Asset. CPSC also granted the Company a pipeline
related easement on the Sold Asset. The principal of $1,908,000 plus
accrued and unpaid interest is included in long-term debt and the
corresponding amount required to be paid by CPSC has been recorded as a
mortgage receivable (see note I). In addition to the Purchase Price above,
CPSC received from the Company warrants to purchase 175,000 shares of
common stock of the Company at an exercise price of $4.00 per share
exercisable through March 30, 2004, such shares having a fair value
totaling approximately $300,000. This amount has been included as part of
the cost of the Acquired Assets in the accompanying consolidated financial
statements at July 31, 2001.
Until the security interests as described above are perfected, the
Company's President is providing a personal guarantee for the punctual
payment and performance under the CPSC Note.
NOTE N - 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 an officer and director. The Company paid a nominal purchase
price. As a result of the acquisition, the Company has included the results
of the Mexican Subsidiaries in its consolidated financial statements at
July 31, 2001. Since inception the operations of the Mexican Subsidiaries
have been funded by the Company and such amounts funded were included in
the Company's consolidated financial statements prior to the acquisition
date. Therefore, there were no material differences between the amounts
previously reported by the Company and the amounts that would have been
reported by the Company had the Mexican Subsidiaries been consolidated
since inception.
66
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE O - MEXICAN OPERATIONS
Under current Mexican law, foreign ownership of Mexican entities involved
in the distribution of LPG or the operation of LPG terminal facilities is
prohibited. Foreign ownership is permitted in the transportation and
storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation
permit and the Mexican Subsidiaries own, lease, or are in the process of
obtaining the land or rights of way used in the construction of the Mexican
portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines and Matamoros Terminal Facility.
The Company's Mexican affiliate, Tergas, S.A. de C.V. (Tergas), has been
granted the permit to operate the Matamoros Terminal Facility and the
Company relies on Tergas' permit to continue its delivery of LPG at the
Matamoros Terminal Facility. Tergas is owned 90% by Jorge Bracamontes, an
officer and director of the Company and the remaining balance is owned by
another officer and consultant of the Company. 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, 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 withholding taxes.
NOTE P - FOURTH QUARTER ADJUSTMENTS - UNAUDITED
The net loss for the quarter ended July 31, 1999, included the following
material fourth quarter adjustments: (i) settlement of litigation of
$501,416, (ii) the discount of $260,000 on the note receivable in
connection with the sale of the CNG assets, and (iii) an increase in the
allowance for uncollectible receivables of $111,431.
The net loss for the quarter ended July 31, 2001, included the following
material fourth quarter adjustments: (i) an allowance for uncollectible
receivables of approximately $200,000, (ii) through-put deficiency fees of
approximately $660,000, and (iii) an adjustment to sales of approximately
$507,000.
67
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - 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, has
used cash in operations, continues to have a deficit in working capital,
and has exposure related to financing of and/or losses associated with LPG
price fluctuations for Imbalances on undelivered LPG. In addition,
significantly all of the Company's assets are pledged or committed to be
pledged as collateral on existing debt in connection with the Restructured
Notes, the New Notes, the RZB Credit Facility and the notes related to the
Settlement. The Company is currently negotiating with the creditors for the
required security agreements. The Restructured Notes and the New Notes,
which total approximately $5,800,000 at October 12, 2001, are due on
December 15, 2001. In addition, the Company entered into supply agreements
for quantities of LPG totaling approximately 26,500,000 gallons per month
(actual deliveries have been approximately 23,000,000 gallons per month)
although a new sales agreement with PMI has not been consummated (see note
R). As discussed in note A, the Company has historically depended heavily
on sales to PMI.
In view of the matters described in the preceding paragraph, recoverability
of a major portion of the recorded asset amounts as shown in the
accompanying consolidated balance sheets is dependent upon the Company's
ability to obtain additional financing, repay, renew or extend the
Restructured Notes and the New Notes referred to in the preceding paragraph
and to raise additional equity capital, resolve uncertainties related to
the Saltillo Terminal Facility and the success of the Company's future
operations. 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 taking steps to (i) increase sales to its
current customers including consummation of the Proposed Agreement (see
note R), (ii) increase its customers assuming deregulation of the LPG
industry in Mexico, (iii) extend the terms of the Pipeline Lease and the
Brownsville Lease, (iv) expand its product lines, (v) obtain additional
letters of credit financing, and (vi) raise additional debt and/or equity
capital.
At July 31, 2001, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $11,722,000. The ability to
utilize such net operating loss carryforwards may be significantly limited
by the application of the "change of ownership" rules under Section 382 of
the Internal Revenue Code.
68
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - 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,
Saltillo, Coahuila, 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.
The Old Agreements expired March 31, 2001. On April 26, 2001, PMI confirmed
to the Company in writing (Confirmation) the following terms of a new
agreement (Proposed Agreement) effective April 1, 2001, subject to
revisions to be provided by PMI's legal department. The Confirmation
provides 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. Since
April 1, 2001, the Company and PMI have operated under the terms provided
for in the Confirmation. From April 1, 2001 through July 31, 2001, the
Company sold to PMI approximately 26,600,000 gallons (Sold LPG) for which
PMI has not taken delivery. The Company received the posted price plus
other fees but has not received the fixed margin referred to in the
Confirmation (see note B9.). At July 31, 2001, the obligation to deliver
LPG totals approximately $11,495,000 related to such sales. The Company and
PMI are negotiating the revisions of the Proposed Agreement.
Since March 2001, PMI has used the Matamoros Terminal Facility to load a
portion of LPG purchased from the Company for distribution in Mexico. The
Company continues to use the Brownsville Terminal Facility in connection
with LPG delivered by railcar to other customers or as an alternative
terminal in the event the Matamoros Terminal Facility cannot be used.
Based on the Company's interpretation of certain of the provisions of the
Old Agreements, additional amounts are due from PMI totaling approximately
$5,900,000 as of July 31, 2001, resulting principally from shortfalls in
the minimum volume requirements (approximately 15,100,000 gallons) and
other price adjustments as provided for under those agreements. In
addition, the Company's interpretation of the Confirmation results in
amounts due from PMI totaling approximately $2,000,000 as of July 31, 2001,
related to the fixed margin on undelivered LGP regardless of where the LPG
is ultimately delivered. The Company will not record revenues, if any, in
its consolidated financial statements related to the above-mentioned
amounts until they are paid by PMI or the validity of the Company's
interpretations can be otherwise determined.
Revenues from PMI totaled approximately $112,000,000 for the year ended
July 31, 2001, representing approximately 74% of total revenues for the
period.
LPG BUSINESS - SALES AGREEMENT - OTHER
Beginning May 1, 2001, the Company entered into an agreement which provides
for the sale of approximately 3,700,000 - 5,000,000 gallons of propane per
month during the period from May 2001 through September 2001, and
approximately 1,300,000 - 2,600,000 gallons per month from October 2001
through March 2002. The sales price is based on indexed variable posted
prices.
69
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - CONTRACTS - CONTINUED
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). Through July 31, 2001,
under the Exxon Supply Contract, Exxon has supplied an average of
approximately 11,500,000 gallons of LPG per month. The purchase price is
indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (ECCPL) operational in September 2000. The ability
to utilize the ECCPL allows the Company to acquire an additional supply of
propane from other propane suppliers located near Corpus Christi, Texas
(Additional Propane Supply), and bring the Additional Propane Supply to the
Plant (ECCPL Supply) for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122,000,000 gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay additional costs
associated with the use of the ECCPL.
In September 1999, the Company and El Paso entered into a three year supply
agreement (El Paso Supply Agreement) whereby El Paso has agreed to supply
and the Company has agreed to take, a monthly average of 2,500,000 gallons
of propane (El Paso Supply) beginning in October 1999. The purchase price
is indexed to variable posted prices.
In March 2000, the Company and Koch entered into a three year supply
agreement (Koch Supply Contract) whereby Koch has agreed to supply and the
Company has agreed to take, a monthly average of 8,200,000 gallons (Koch
Supply) of propane beginning April 1, 2000, subject to the actual amounts
of propane purchased by Koch from the refinery owned by its affiliate, Koch
Petroleum Group, L.P. Through July 31, 2001, under the Koch Supply
Contract, Koch has supplied an average of approximately 6,000,000 gallons
of propane per month. The purchase price is indexed to variable posted
prices. Furthermore, the Company is required to pay additional charges
associated with the construction of a new pipeline interconnection to be
paid through additional adjustments to the purchase price (totaling
approximately $1,000,000) which allows deliveries of the Koch Supply into
the ECCPL (approximately $600,000 has been paid through July 31, 2001).
Under the terms of the Koch Supply Contract, the Koch Supply is delivered
into the ECCPL and blended to the required specifications.
70
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE R - 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. The
purchase price is indexed to variable posted prices.
The Company is currently purchasing LPG from the above-mentioned suppliers
(Suppliers). The Company's aggregate costs per gallon to purchase LPG (less
any applicable adjustments) are below the aggregate sales prices per gallon
of LPG sold to its customers.
As described above, the Company has entered into supply agreements for
quantities of LPG totaling approximately 26,500,000 gallons per month
(actual deliveries have been approximately 23,000,000 gallons per month)
although a new sales agreement with PMI has not been consummated.
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, El Paso Supply, Koch Supply or Duke Supply
over actual sales volumes. Under the terms of the Supply Contracts, the
Company must provide letters of credit in amounts equal to the cost of the
product to be purchased. In addition, the cost of the product purchased is
tied directly to overall market conditions. As a result, the Company's
existing letter of credit facility may not be adequate to meet the letter
of credit requirements under the agreements with the Suppliers or other
suppliers due to increases in quantities of LPG purchased and/or to finance
future price increases of LPG.
NOTE S - SUBSEQUENT EVENTS - UNAUDITED
During November 2001, in connection with notes issued to the Company by
certain officers, directors, a related party and an unrelated party (Note
Issuers), the Company and the Note Issuers agreed to exchange 43,014 shares
of common stock of the Company held by the Note Issuers for payment of all
unpaid interest owing to the Company through October 31, 2001 ($172,056).
In addition, the Company agreed to extend the date of the notes held by the
Note Issuers to October 31, 2003.
71
Schedule II - Valuation and Qualifying Accounts
Balance at Charged to
Beginning of Costs and Charged to Balance at End
Description Period Expenses(1) Other Accounts Deductions of Period
- -------------- ------------- -------------- -------------- ---------- --------------
Year ended
- ----------
July 31, 2001
- --------------
Allowance for
doubtful
accounts $ 562,950 $ 216,713 $ - $ - $ 779,663
Year ended
- ----------
July 31, 2000
- -------------
Allowance for
doubtful
accounts $ 521,067 $ 41,883 $ - $ - $ 562,950
Year ended
- ----------
July 31, 1999
- -------------
Doubtful
Accounts $ 418,796 $ 116,432 $ - $ 14,161 $ 521,067
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
72
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 2001
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 23, 2001.
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 2001
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 23, 2001.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 2001
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 23, 2001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 2001
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 23, 2001.
73
PART IV
ITEM 14. 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, 2000 and 2001
Consolidated Statements of Operations for the years ended
July 31, 1999, 2000 and 2001
Consolidated Statement of Stockholders' Equity for the years
ended July 31, 1999, 2000 and 2001
Consolidated Statements of Cash Flows for the years ended
July 31, 1999, 2000 and 2001
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
b. Reports on Form 8-K.
None.
c. Exhibits.
The following Exhibits are incorporated herein by reference:
Exhibit No.
------------
3.1 Restated Certificate of Incorporation, as amended. (Incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
3.2 Amended and Restated By-Laws of the Company. (Incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
3.3 The Company's Certificate of the Designation, Powers, Preferences and
Rights of the Series B. Class A Senior Cumulative Preferred Stock,
filed with the State of Delaware.
10.1 Employment Agreement dated July 12, 1993 between the Registrant and
Jerome B. Richter. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly period ended October
31, 1993 filed on March 7, 1994, SEC File No. 000-24394).
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).
74
10.3 Promissory Note and Pledge and Security Agreement dated April 11, 1997
between Jerome B. Richter and the Registrant. (Incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
10.4 Lease dated October 20, 1993 between Brownsville Navigation District
of Cameron County, Texas and Registrant with respect to the Company's
land lease rights, including related amendment to the Lease dated as
of February 11, 1994 and Purchase Agreement. (Incorporated by
reference to the Company's Quarterly Report on Form 10-QSB filed for
the quarterly period ended April 30, 1994 on February 25, 1994, SEC
File No. 000-24394).
10.5 Lease Amendment dated May 7, 1997 between Registrant and Brownsville
Navigation District of Cameron County, Texas. (Incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarterly period ended April 30, 1997 filed on June 16, 1997, SEC File
No. 000-24394).
10.6 Lease dated September 1, 1993 between Seadrift Pipeline Corporation
and Registrant with respect to the Company's pipeline rights.
(Incorporated by reference to the Company's Quarterly Report on Form
10-QSB for the quarterly period ended October 31, 1993 filed on March
7, 1994, SEC File No. 000-24394).
10.7 Lease Amendment dated May 21, 1997 between Seadrift Pipeline
Corporation and the Registrant. (Incorporated by reference to the
Company's Quarterly Report on Form 10-QSB for the quarterly period
ended April 30, 1997 filed on June 16, 1997, SEC File No. 000-24394).
10.8 Continuing Agreement for Private Letters of Credit dated October 14,
1997 between RZB Finance LLC and the Company. (Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended July 31, 1997 filed on November 13, 1997, SEC File No.
000-24394)
10.9 Promissory Note dated October 14, 1997 between RZB Finance LLC and the
Company. (Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1997 filed on November 13, 1997,
SEC File No. 000-24394)
10.10 General Security Agreement dated October 14, 1997 between RZB Finance
LLC and the Company. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 1997 filed on
November 13, 1997, SEC File No. 000-24394)
10.11 Guaranty and Agreement dated October 14, 1997 between RZB Finance LLC
and Jerome Richter. (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 1997 filed on November
13, 1997, SEC File No. 000-24394)
10.12 Amendment letter dated April 22, 1998 between RZB Finance LLC and the
Company. (Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the three months ended April 30, 1998 filed on June
15, 1998, SEC File No. 000-24394)
10.13 Employment Agreement dated November 17, 1997 between the Company and
Jerry L. Lockett. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the three months ended April 30,
1998 filed on June 15, 1998, SEC File No. 000-24394)
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).
75
10.15 Amendment No. 1, to the Lease/Installment Purchase Agreement dated
November 24, 1999, dated January 7, 1999 by and between CPSC
International and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 1999
filed on November 9, 1999, SEC File No. 000-24394).
10.16 Amendment, to Lease/Installment Purchase Agreement dated February 16,
1999 dated January 25, 1999 by and between CPSC International and the
Company. (Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended July 31, 1999 filed on November 9, 1999,
SEC File No. 000-24394).
10.17 Lease/Installment Purchase Agreement dated February 16, 1999 by and
between CPSC International and the Company. (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended July
31, 1999 filed on November 9, 1999, SEC File No. 000-24394).
10.18 Amendment No. 2, to Lease/Installment Purchase Agreement dated
November 24, 1998 and to Lease/Installment Purchase Agreement dated
January 7, 1999 dated September 16, 1999 by and between CPSC
International and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 1999
filed on November 9, 1999, SEC File No. 000-24394).
10.19 Agreement dated September 16, 1999 by and between CPSC International
and the Company. (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended July 31, 1999 filed on November
9, 1999, SEC File No. 000-24394).
10.20 Purchase, Sale and Service Agreement for Propane/Butane Mix entered
into effective as of October 1, 1999 by and between Exxon Company,
U.S.A. and the Company. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31, 1999 filed on
November 9, 1999, SEC File No. 000-24394).
10.21 Sales/Purchase Agreement of Propane Stream dated October 1, 1999
between PG&E NGL Marketing, L.P. and the Company. (Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended July 31, 1999 filed on November 9, 1999, SEC File No.
000-24394).
10.22 Permit issued on July 26, 1999 by the United States Department of
State authorizing the Company to construct two pipelines crossing the
international boundary line between the United States and Mexico for
the transport of liquefied petroleum gas (LPG) and refined product
(motor gasoline and diesel fuel). (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 1999
filed on November 9, 1999, SEC File No. 000-24394).
10.23 Amendment to the LPG Purchase Agreement dated June 18, 1999 between
P.M.I. Trading Ltd. and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 1999
filed on November 9, 1999, SEC File No. 000-24394).
10.24 Transfer of Shares Agreement dated November 4, 1999 between Jorge
Bracamontes and the Company. (Incorporated by reference to the
Company's Quarterly report on Form 10-Q for the quarterly period ended
October 31, 1999, filed on December 14, 1999, SEC File No. 000-24394).
10.25 Transfer of Shares Agreement dated November 4, 1999 between Juan Jose
Navarro Plascencia and the Company. (Incorporated by reference to the
Company's Quarterly report on Form 10-Q for the quarterly period ended
October 31, 1999, filed on December 14, 1999, SEC File No. 000-24394).
10.26 Addendum dated December 15, 1999 between CPSC International, Inc. and
the Company. (Incorporated by reference to the Company's Quarterly
report on Form 10-Q for the quarterly period ended January 31, 2000,
filed on March 21, 2000, SEC File No. 000-24394).
10.27 LPG Mix Purchase Contract (DTIR-010-00) dated March 31, 2000 between
P.M.I. Trading Limited and the Company. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended April 30, 2000 filed on June 19, 2000, SEC File No. 000-24394).
76
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).
10.37 Promissory Share Transfer Agreement to purchase shares of Termatsal,
S.A. de C.V. dated November 13, 2000, between Pedro Prado and Penn
Octane International, L.L.C. (Translation from Spanish). (Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended July 31, 2000, filed on November 14, 2000, SEC File No.
000-24394).
10.38 Promissory Share Transfer Agreement to purchase shares of Penn Octane
de Mexico, S.A. de C.V. dated November 13, 2000, between Jorge
Bracamontes and the Company (Translation from Spanish). (Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended July 31, 2000, filed on November 14, 2000, SEC File No.
000-24394).
10.39 Promissory Share Transfer Agreement to purchase shares of Penn Octane
de Mexico, S.A. de C.V. dated November 13, 2000, between Juan Jose
Navarro Plascencia and the Company (Translation from Spanish).
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended July 31, 2000, filed on November 14, 2000, SEC File
No. 000-24394).
77
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).
21.1 Subsidiaries of the Registrant.
78
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 13, 2001
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 13, 2001
- ----------------------- Chairman, President and Chief
Executive Officer
/s/Jorge R. Bracamontes Jorge R. Bracamontes November 13, 2001
- ----------------------- Executive Vice President,
Secretary and Director
/s/Ian T. Bothwell Ian T. Bothwell November 13, 2001
- ----------------------- Vice President, Treasurer,
Assistant Secretary, Chief
Financial Officer, Principal
Accounting Officer and Director
/s/Jerry L. Lockett Jerry L. Lockett November 13, 2001
- ----------------------- Vice President and Director
/s/Stewart J. Paperin Stewart J. Paperin November 13, 2001
- ----------------------- Director
/s/Harvey L. Benenson Harvey L. Benenson November 13, 2001
- ----------------------- Director
/s/Charles Handly Charles Handly November 13, 2001
- ----------------------- Director
79