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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, BUILDING D, PALM DESERT, CALIFORNIA 92211
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (760) 772-9080
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
PAR VALUE $.01
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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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 $21,203,291 as of October 11, 2002. The last reported sale
price of the Registrant's Common Stock was $2.25 per share as reported on the
Nasdaq SmallCap Market on October 11, 2002.
The number of shares of Common Stock, par value $.01 per share, outstanding
on October 11, 2002 was 14,870,977.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement relating to the
2002 Annual Meeting of Stockholder's (to be filed subsequently) are incorporated
by reference into Part III.
TABLE OF CONTENTS
ITEM PAGE NO.
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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 20
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
7A. Quantitative and Qualitative Disclosures About Market Risks 36
8. Financial Statements and Supplementary Data 37
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 75
Part III 10. Directors and Executive Officers of the Registrant 76
11. Executive Compensation 76
12. Security Ownership of Certain Beneficial Owners and Management 76
13. Certain Relationships and Related Transactions 76
Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 77
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, 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
ExxonMobil Corporation's ("Exxon") King Ranch Gas Plant in Kleberg County, Texas
and Duke Energy's La Gloria Gas Plant in Jim Wells County, Texas, to the
Company's Brownsville Terminal Facility. In addition, the Company has access to
a twelve-inch pipeline (the "ECCPL"), which connects from Exxon's Viola valve
station in Nueces County, Texas to the inlet of the King Ranch Gas Plant as well
as existing and other potential propane pipeline suppliers which have the
ability to access the ECCPL. In connection with the Company's lease agreement
for the Leased Pipeline, the Company may access up to 21.0 million gallons of
storage, located in Markham, Texas ("Markham"), as well as other potential
propane pipeline suppliers, via approximately 155 miles of pipeline located
between Markham and the Exxon King Ranch Gas Plant.
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 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.
The Company's principal executive offices are located at 77-530 Enfield
Lane, Building D, Palm Desert, California 92211, and its telephone number is
(760) 772-9080.
LIQUEFIED PETROLEUM GAS
OVERVIEW. Since operations commenced, the primary business of the Company
has been the purchase, transportation and sale of LPG. LPG is a mixture of
propane and butane principally used for residential and commercial heating and
cooking. The demand for propane is also growing as a motor fuel substitute for
motor gasoline.
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 407.6 million gallons per month in 2000
to an average of 416.6 million gallons per month from January 1, 2002 to August
31, 2002, an estimated annual increase of 2.2%. 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
shortfall 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 (in the
future as described 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 tanks, five mixed
product truck loading racks, two racks capable of receiving LPG delivered by
truck and three railcar loading racks which permit the loading and unloading of
LPG by railcar. The truck loading racks and railcar loading racks are linked to
a computer-controlled loading and remote accounting system.
The Company leases the land on which the Brownsville Terminal Facility is
located from the Brownsville Navigation District (the "District") under a lease
agreement (the "Brownsville Lease") that expires on November 30, 2006. The
Company has an option to renew for five additional five year terms. Currently,
substantially all of the Company's LPG supply is received by the Leased
Pipeline, which flows through pumping and metering equipment located at the
Brownsville Terminal Facility and then flows through the US - Mexico Pipelines
to the Matamoros Terminal Facility for offloading to trucks. Currently LPG sold
by the Company to PMI which is intended to be delivered to the Matamoros
Terminal Facility, may be delivered to the Brownsville Terminal Facility in the
event that the Matamoros Terminal Facility temporarily cannot be used. The
Brownsville Lease contains a pipeline easement to the District's water dock
facility at the Brownsville Ship Channel. The 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 have been 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 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"].
5
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.
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 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 L 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 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. The Company had previously completed construction
of an additional LPG terminal facility in Saltillo, Mexico (the "Saltillo
Terminal"). The Company was unable to receive all the necessary approvals to
operate the facility at that location. The Company has identified an alternate
site in Hipolito, Mexico, a town located in the proximity of Saltillo to
relocate the Satillo Terminal. The cost of such relocation is expected to be
between $250,000 and $500,000.
Once completed, the Company expects the newly-constructed terminal facility
to be capable of off-loading LPG from railcars to trucks. The newly-constructed
terminal facility will have three truck loading racks and storage to
accommodate approximately 390,000 gallons of LPG.
6
Once operational, the Company can directly transport LPG via railcar from
the Brownsville Terminal Facility to the Saltillo area. The Company believes
that by having the capability to deliver LPG to the Saltillo area, the Company
will be able to further penetrate the Mexican market for the sale of LPG.
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 November 30, 2006. The Company has an option to renew for five
additional five year terms. 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. In addition the Company intends to
upgrade its computer and information systems at a total estimated cost of
$350,000.
THE LEASED PIPELINE. The Company has a lease agreement (the "Pipeline
Lease") with Seadrift, a subsidiary of Dow Hydrocarbons and Resources, Inc.
("Dow"), for approximately 132 miles of pipeline which connects Exxon's King
Ranch Gas Plant in Kleberg County, Texas and Duke Energy Corporation's La Gloria
Gas Plant in Jim Wells County, Texas, to the Company's Brownsville Terminal
Facility (the "Leased Pipeline"). As provided for in the Pipeline Lease, the
Company has the right to use the Leased Pipeline solely for the transportation
of LPG and refined products belonging only to the Company and not to any third
party.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (the "Pipeline Lease Amendment") entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999 (the
"Effective Date"). The Pipeline Lease Amendment provides, among other things,
access up to 21.0 million gallons of storage located in Markham as well as other
potential propane pipeline suppliers via approximately 155 miles of pipeline
located between Markham and the Exxon King Ranch Gas Plant (see note K to the
consolidated financial statements). The Company's ability to utilize the
storage at Markham is subject to the hydraulic and logistic capabilities of that
system. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers. The Company has made all payments required under
the Pipeline Lease Amendment.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million gallons
per year and 360 million gallons per year.
THE ECCPL PIPELINE. In connection with the Company's supply agreement with
Exxon, the Company was granted access to Exxon's twelve-inch pipeline which
connects from Exxon's Viola valve station in Nueces County, Texas (near Corpus
Christi, Texas) to the inlet of the King Ranch Gas Plant (the "ECCPL Pipeline")
as well as existing and other potential propane pipeline suppliers which have
the ability to access the ECCPL. Under the terms of the agreement, Exxon has
agreed to make available space in the ECCPL for a minimum of 420,000 gallons per
day for the Company's use.
7
DISTRIBUTION. Until March 2000, all of the LPG from the Leased Pipeline
had been delivered to the Company's customers at the Brownsville Terminal
Facility and then transported by truck to the United States Rio Grande Valley
and northeastern Mexico by the customers or by railcar to customers in the
United States and Canada. From April 2000 through February 2001, the Company
began operating the Matamoros Terminal Facility, whereby a portion of the LPG
sold to PMI was delivered through the US - Mexico Pipelines to the Matamoros
Terminal Facility for further distribution by truck in northeastern Mexico.
Since March 2001, PMI uses the Matamoros Terminal Facility to load LPG
purchased from the Company for distribution by truck in Mexico. The Company
continues to use the Brownsville Terminal Facility in connection with LPG
delivered by railcar to other customers, storage and as an alternative terminal
in the event the Matamoros Terminal Facility cannot be used temporarily.
LPG SALES TO PMI. The Company entered into sales agreements with PMI for
the period from April 1, 2000 through March 31, 2001 (the "Old Agreements"), for
the annual sale of a combined minimum of 151.2 million gallons of LPG, mixed to
PMI specifications, subject to seasonal variability, to be delivered to PMI at
the Company's terminal facilities in Matamoros, Tamaulipas, Mexico 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.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (the "Confirmation") on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of 19.0
million gallons at indexed variable posted prices plus premiums that provided
the Company with annual fixed margins, which were to increase annually over a
three-year period. The Company was also entitled to receive additional fees for
any volumes which were undelivered. From April 1, 2001 through December 31,
2001, the Company and PMI operated under the terms provided for in the
Confirmation. During January 1, 2002 through February 28, 2002, PMI purchased
monthly volumes of approximately 17.0 million gallons per month at slightly
higher premiums than those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39.6 million gallons (the "Sold LPG") for which PMI had not taken
delivery. The Company received the posted price plus other fees on the sold LPG
but did not receive the fixed margin referred to in the Confirmation (see note
B9. to the consolidated financial statements). At July 31, 2001, the obligation
to deliver LPG totaled approximately $11.5 million related to such sales
(approximately 26.6 million gallons). During the period from December 1, 2001
through March 31, 2002, the Company delivered to PMI the Sold LPG.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17.0 million gallons of LPG, subject to monthly
adjustments based on seasonality (the "Contract"). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party on or after
May 31, 2003 upon 90 days written notice, or upon a change of circumstances as
defined under the Contract.
In connection with the Contract, the parties also executed a settlement
agreement (the "Settlement Agreement"), whereby the parties released each other
in connection with all disputes between the parties arising during the period
April 1, 2001 through February 28, 2002, and previous claims related to the
contract for the period April 1, 2000 through March 31, 2001.
Revenues from PMI totaled approximately $110.8 million for the year ended
July 31, 2002, representing approximately 77.9% of total revenues for the
period.
8
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 and 2002. 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, the Matamoros Terminal Facility and the Saltillo Terminal.
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.
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.
9
In connection with the above, in August 2001, Tergas received a one year
permit from the Mexican government to import LPG. During September 2001, the
Mexican government asked Tergas to defer use of the permit and, as a result, the
Company did not sell LPG to distributors other than PMI. In March 2002, the
Mexican government again announced its intention to issue permits for free
importation of LPG into Mexico by distributors and others beginning August 2002,
which was again delayed until February 2003. Tergas' permit to import LPG
expired during August 2002. Tergas intends to obtain a new permit when the
Mexican government begins to accept applications once more. As a result of the
foregoing, it is uncertain as to when, if ever, Deregulation will actually occur
and the effect, if any, it will have on the Company. However, should
Deregulation occur, it is the Company's intention to sell LPG directly to
distributors in Mexico as well as PMI. Tergas also received authorization from
Mexican Customs authorities regarding the use of the US-Mexico Pipelines for the
importation of LPG.
The point of sale for LPG sold to PMI which flows through the US - Mexico
Pipelines for delivery to the Matamoros Terminal Facility is the United States -
Mexico border. For LPG delivered into Mexico, PMI is the importer of record.
LPG SUPPLY. Effective October 1, 1999, the Company and Exxon entered into a
ten year LPG supply contract, as amended (the "Exxon Supply Contract"), whereby
Exxon has agreed to supply and the Company has agreed to take, 100% of Exxon's
owned or controlled volume of propane and butane available at Exxon's King Ranch
Gas Plant (the "Plant") up to 13.9 million gallons per month blended in
accordance with required specifications (the "Plant Commitment"). For the year
ending July 31, 2002, under the Exxon Supply Contract, Exxon has supplied an
average of approximately 14.3 million gallons of LPG per month. The purchase
price is indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (the "ECCPL") operational in September 2000. The
ability to utilize the ECCPL allows the Company to acquire an additional supply
of propane from other propane suppliers located near Corpus Christi, Texas (the
"Additional Propane Supply"), and bring the Additional Propane Supply to the
Plant (the "ECCPL Supply") for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122.0 million gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay minimum utilization fees
associated with the use of the ECCPL until September 2004. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso 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 expiring at September 30, 2002. The El Paso Supply
Agreement was not renewed. The purchase price was indexed to variable posted
prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. For the year ending July 31, 2002,
under the Koch Supply Contract, Koch has supplied an average of approximately
5.3 million gallons of propane per month. The purchase price is indexed to
variable posted prices. Furthermore, the Company was required to pay additional
charges associated with the construction of a new pipeline interconnection which
was paid through additional adjustments to the purchase price (totaling
approximately $1.0 million) which allows deliveries of the Koch Supply into the
ECCPL.
Under the terms of the Koch Supply Contract, the Koch Supply is delivered
into the ECCPL and blended to the required specifications.
10
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 24.0 million gallons per month adjusted
for El Paso (actual deliveries have been approximately 21.7 gallons per month
during fiscal 2002 adjusted for El Paso), although the Contract provides for
lesser quantities.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver 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, 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.
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 transportation rates charged to levels lower
than those charged by the Company. In addition, other suppliers of LPG may
reduce their sales prices to encourage additional sales. The Company believes
that such reductions are limited in both duration and volumes and that on an
annualized basis the ECCPL, the Leased Pipeline and the US - Mexico Pipelines
provide a transportation cost advantage over the Company's competitors.
The Company believes that its ECCLP, Leased Pipeline, the US-Mexico
Pipelines and the geographic location of the Brownsville Terminal Facility, the
Matamoros Terminal Facility and the Saltillo Terminal, 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 including its Mexico operations are subject
to certain federal, state and local laws and regulations relating to the
protection of the environment, and future regulations may impose additional
requirements. Although the Company believes that its operations are in
compliance with applicable environmental laws and regulations, because the
requirements imposed by environmental laws and regulations are frequently
changed, the Company is unable to predict with certainty the ultimate cost of
compliance with such requirements and its effect on the Company's operations and
business prospects.
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.
11
EMPLOYEES
As of July 31, 2002, the Company has 21 employees, including two in
finance, five in sales, seven in administration and seven in production. The
Company retains subcontractors and three full time consultants in connection
with its Mexico related operations. The Company also funds salaries related to
its affiliate, Tergas in connection with the operation of the Matamoros Terminal
Facility.
The Company has not experienced any work stoppages and considers relations
with its employees to be satisfactory.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Property, plant and equipment, net of accumulated depreciation, located in
the U.S. and Mexico were as follows for the fiscal years ended July 31,:
2000 2001 2002
----------- ----------- -----------
U.S. $ 9,628,025 $11,521,638 $11,368,460
Mexico 7,128,791 6,738,746 6,782,557
----------- ----------- -----------
Total $16,756,816 $18,260,384 $18,151,017
=========== =========== ===========
12
ITEM 2. PROPERTIES.
As of July 31, 2002, the Company owned, leased or had access to the
following facilities:
APPROXIMATE LEASE, OWN
LOCATION TYPE OF FACILITY SIZE OR ACCESS(2)
- ----------------------- ------------------------------------------- ------------------------ ------------
Brownsville, Texas Pipeline interconnection and railcar and 16,071 bbls of storage Owned(1)(7)
truck loading facilities, LPG storage
facilities, on-site administrative offices
Land 31 acres Leased(1)
Brownsville, Texas Brownsville Terminal Facility building 19,200 square feet Owned(1)(7)
Extending from Kleberg Seadrift Pipeline 132 miles Leased(3)
County, Texas to
Cameron County, Texas
Markham, Texas Salt Dome Storage 500,000 bbls of storage Access(3)
Markham, Texas to King Seadrift Pipeline
Ranch Plant 155 mile pipeline Access(3)
Extending from Nueces ECCPL Pipeline 46 miles Access(6)
County, Texas to King
Ranch Plant
Extending from US-Mexico Pipelines 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 and the
land
Brownsville, Texas Pipeline interconnection, Refined 300,000 bbls of Owned(5)(7)
Products storage tanks storage Leased(5)
Land 12 acres
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 November 30, 2006.
(2) The Company's assets are pledged or committed to be pledged as collateral
(see notes to the consolidated financial statements).
(3) The Company's lease with Seadrift expires December 31, 2013.
(4) The Company's lease with respect to its headquarters offices expires
October 31, 2002. The Company expects to renew the lease for similar terms.
The monthly lease payments approximate $3,000 a month.
(5) The Company's lease with respect to the Tank Farm expires in November 30,
2006.
(6) The Company's use of the ECCPL is pursuant to the Exxon Supply Contract,
which expires on September 30, 2009.
(7) The facilities can be removed upon termination of the lease.
For information concerning the Company's operating lease commitments, see note K
to the consolidated financial statements.
14
ITEM 3. LEGAL PROCEEDINGS.
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, 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 L 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 and Penn Wilson, CNG have been dismissed
from the litigation pursuant to separate summary judgments. Omnitrans is
appealing the summary judgments in favor of the Company and Penn Wilson. 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 plaintiffs are seeking
damages in the amount of $750,000. The Company believes that the complaint is
without merit and intends to vigorously defend against the lawsuit.
On October 11, 2001, litigation was filed in the 197th Judicial District
court of Cameron County, Texas by the Company against Tanner Pipeline Services,
Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging negligence and aided breaches
of fiduciary duties on behalf of CPSC in connection with the construction of the
US Pipelines. The Company is seeking damages. Discovery is continuing in this
matter. After July 31, 2002, Tanner sent notice of its intent to seek its
attorneys fees as a sanction in the event it prevails in the action. Trial is
sent for February 24, 2003.
15
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including those
discussed above, should not materially affect its consolidated financial
statements.
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, 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
FISCAL YEAR ENDED JULY 31, 2002:
First Quarter . . . . . . . . . . . . . . $3.510 $4.500
Second Quarter. . . . . . . . . . . . . . 3.030 3.950
Third Quarter . . . . . . . . . . . . . . 2.180 3.700
Fourth Quarter. . . . . . . . . . . . . . 2.500 4.150
On October 11, 2002, the closing bid price of the common stock as reported
on the Nasdaq SmallCap Market was $2.25 per share. On October 11, 2002, the
Company had 14,870,977 shares of common stock outstanding and approximately 295
holders of record of the common stock.
The Company has not paid any common stock dividends to stockholders and
does not intend to pay any common stock dividends to stockholders in the
foreseeable future and intends to retain any future earnings for capital
expenditures and otherwise to fund the Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
In connection with the Board 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.
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 warrants, through reductions of debt obligations.
During September 2001, the Company issued 1,000 shares of common stock of
the Company to an employee of the Company as a bonus. In connection with the
issuance of the shares, the Company recorded an expense of $2,800 based on the
market value of the stock issued.
During November 2001, warrants to purchase a total of 78,750 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $137,813.
17
In connection with the Board Plan, during November 2001 the Board granted
warrants to purchase 30,000 shares of common stock of the Company at exercise
prices of $3.66 per share to a newly appointed outside director.
During December 2001, the Company entered into agreements (the
"Restructuring Agreements") with the holders of $3.1 million in principal amount
of the notes (the "Notes") providing for the restructuring of such Notes (the
"Restructuring") whereby the due date for $3.1 million of principal due on the
Notes was extended to June 15, 2002. In connection with the extension, the
Company agreed to (i) continue paying interest at a rate of 16.5% annually on
the Notes, payable quarterly, (ii) pay the holders of the Notes a fee equal to
1% on the principal amount of the Notes, (iii) modify the warrants held by the
holders of the Notes by extending the expiration date to December 14, 2004 and
(iv) remove the Company's repurchase rights with regard to the warrants.
During June 2002, the Company and certain holders of the Notes (the "New
Accepting Noteholders") reached an agreement whereby the due date for
approximately $3.0 million of principal due on the New Accepting Noteholders'
Notes were extended to December 15, 2002. The New Accepting Noteholders' Notes
will continue to bear interest at 16.5% per annum. Interest is payable on the
outstanding balance on specified dates through December 15, 2002. The Company
paid a fee of 1.5% on the principal amount of the New Accepting Noteholders'
Notes on July 1, 2002.
During June 2002, the Company issued a note for $100,000 (the "New Note")
to a holder of the Notes. The New Note provides for similar terms and conditions
as the New Accepting Noteholders' Notes.
During June 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of $62,500.
During July 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of $62,500.
In connection with the Board Plan, during August 2002 the Board granted
warrants to purchase 20,000 shares of common stock of the Company at exercise
price of $3.10 per share to outside directors.
18
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.
EQUITY COMPENSATION PLANS
- -------------------------
The following table provides information concerning the Company's equity
participation plans as of July 31, 2002.
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS WARRANTS AND RIGHTS EQUITY PARTICIPATION PLANS
(EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation
plans approved by 2,200,000 $4.80 1,500,000 (1)(2)
security holders
Equity participation
plans not approved by 1,711,555 2.69 -
security holders (3) --------- ----------
Total 3,911,555 $3.87 1,500,000
========= ==========
(1) Pursuant to the Company's Board Plan, the outside directors are entitled to
receive warrants to purchase 20,000 shares of common stock of the Company
upon their initial election as a director and warrants to purchase 10,000
shares of common stock of the Company for each year of service as a
director.
(2) Pursuant to the Company's 2001 Warrant Plan, the Company may issue warrants
to purchase up to 1.5 million shares of common stock of the Company.
(3) The Company was not required to obtain shareholder approval for these
securities.
19
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data for each of the years in
the five-year period ended July 31, 2002, 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,
------------------------------------------------------
1998 1999 2000 2001 2002
------------ ---------- ------- --------- --------
Revenues $ 30,801(1) $35,338(1) $98,515 $150,700 $142,156
Income (loss) from continuing operations ( 2,072) 1,125 1,461 ( 8,094) 4,123
Net income (loss) ( 3,744) 545 1,461 ( 8,094) 4,123
Net income (loss) from continuing ( .25) .11 .11 ( .57) .28
operations per common share
Net income (loss) per common share ( .43) .05 .11 ( .57) .28
Total assets 6,698 8,909 31,537 40,070 30,355
Long-term obligations 60 259 1,465 3,274 612
(1) The operations of PennWilson for the period from August 1, 1997 (date of
incorporation) through May 25, 1999, the date operations were discontinued,
are presented in the consolidated financial statements as discontinued
operations.
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 2002) refer to the Company's fiscal year ended July 31.
20
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 2002, the Company derived 77.9% 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, 2000, 2001 and 2002.
2000 2001 2002
--------- ---------- ----------
VOLUME SOLD
LPG (MILLIONS OF GALLONS) - PMI 140.2 167.2 243.5
LPG (MILLION OF GALLONS) - OTHER 47.2 71.4 76.1
--------- ---------- ----------
187.4 238.6 319.6
AVERAGE SALES PRICE
LPG (PER GALLON) - PMI 0.54 0.67 0.46
LPG (PER GALLON) - OTHER $ 0.47 $ 0.55 $ 0.47
21
RESULTS OF OPERATIONS
YEAR ENDED JULY 31, 2002 COMPARED WITH JULY 31, 2001
Revenues. Revenues for the year ended July 31, 2002, were $142.2 million,
including $22.0 million (39.6 million gallons) related to the delivery during
the period December 2001 through April 2002 of LPG associated with the
obligation to deliver, compared with $150.7 million for the year ended July 31,
2001, a decrease of $8.5 million or 5.7%. Of this decrease, $35.9 million was
attributable to decreases in average sales prices of LPG sold to PMI during the
year ended July 31, 2002, and $8.9 million was attributable to decreased average
sales prices of LPG sold to customers other than PMI during the year ended July
31, 2002, in connection with the Company's desire to reduce quantities of
inventory, partially offset by increases of $34.7 million attributable to
increased volumes of LPG sold to PMI and $1.6 million attributable to increased
volumes of LPG sold to customers other than PMI during the year ended July 31,
2002.
Cost of goods sold. Cost of goods sold for the year ended July 31, 2002,
was $131.1 million compared with $151.5 million for the year ended July 31,
2001, a decrease of $20.3 million or 13.4%. Of this decrease, $40.3 million was
attributable to decreases in the cost of LPG sold to PMI during the year ended
July 31, 2002, $11.2 million was attributable to the decreased costs of LPG sold
to customers other than PMI in connection with the Company's desire to reduce
quantities of inventory during the year ended July 31, 2002, partially offset by
increases of $28.6 million attributable to increased volume of LPG sold to PMI
during the year ended July 31, 2002, $1.7 million attributable to increased
volume of LPG sold to customers other than PMI during the year ended July 31,
2002, and $773,797 attributable to net increases in other operating costs
associated with LPG during the year ended July 31, 2002.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $4.3 million for the year ended July 31, 2002,
compared with $3.6 million for the year ended July 31, 2001, an increase of
$729,217 or 20.2%. The increase during the year ended July 31, 2002, was
principally due to legal, consulting fees and compensation related costs.
Other income (expense). Other income (expense) was $(2.5) million for the
year ended July 31, 2002, compared with $(3.7) million for the year ended July
31, 2001, a decrease of $1.2 million. The decrease in other expense was due
primarily to decreased interest costs and amortization of discounts on
outstanding debt during the year ended July 31, 2002.
Income tax. During the year ended July 31, 2002, the Company recorded a
provision for income taxes of $100,000 (which was partially offset by a refund
previously received), representing alternative minimum tax due. Due to the
availability of net operating loss carryforwards (approximately $6.7 million at
July 31, 2002), the Company did not incur any additional income tax expense.
The Company can receive a credit against, any future tax payments due to the
extent of any prior alternative minimum taxes paid.
22
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 the 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.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception,
has used cash in operations and continues to have a deficit in working capital.
In addition, significantly all of the Company's assets are pledged or committed
to be pledged as collateral on existing debt in connection with the New
Accepting Noteholders' notes, the RZB Credit Facility and the notes related to
the Settlement. The New Accepting Noteholders' notes total approximately $3.1
million at October 4, 2002 (see Private Placements and Other Transactions
below). The Company may need to increase its credit facility for increases in
quantities of LPG purchased and/or to finance future price increases of LPG.
The Company depends heavily on sales to one major customer. The Company's
sources of liquidity and capital resources historically have been provided by
sales of LPG, proceeds from the issuance of short-term and long-term debt,
revolving credit facilities and credit arrangements, sale or issuance of
preferred and common stock of the Company and proceeds from the exercise of
warrants to purchase shares of the Company's common stock.
The following summary table reflects comparative cash flows for fiscal
years ended July 31, 2000, 2001 and 2002. All information is in thousands.
2000 2001 2002
------------- ------------- --------------
Net cash provided by (used in) operating activities. . $( 2,562) $ 6,196 $ 2,394
Net cash used in investing activities . . . . . . . . ( 10,811) ( 2,572) ( 717)
Net cash provided by (used in) financing activities. . 12,366 ( 2,327) ( 2,839)
------------- ------------- --------------
Net increase (decrease) in cash . . . . . . . . . . . $( 1,007) $ 1,297 $ ( 1,162)
============= ============= ==============
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.
23
On October 11, 2000, the Old Agreements were amended to increase the
minimum amount of LPG to be purchased during the period from November 2000
through March 2001 by 7.5 million gallons resulting in a new annual combined
minimum commitment of 158.7 million gallons. Under the terms of the Old
Agreements, sales prices were indexed to variable posted prices.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (the "Confirmation") on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of 19.0
million gallons at indexed variable posted prices plus premiums that provide the
Company with annual fixed margins, which increase annually over a three-year
period. The Company was also entitled to receive additional fees for any volumes
which were undelivered. From April 1, 2001 through December 31, 2001, the
Company and PMI operated under the terms provided for in the Confirmation.
During January 1, 2002 through February 28, 2002, PMI purchased monthly volumes
of approximately 17.0 million gallons per month at slightly higher premiums then
those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39.6 million gallons (the "Sold LPG") for which PMI had not taken
delivery. The Company received the posted price plus other fees on the sold LPG
but did not receive the fixed margin referred to in the Confirmation (see note
B9. to the consolidated financial statements). At July 31, 2001, the obligation
to deliver LPG totaled approximately $11.5 million related to such sales
(approximately 26.6 million gallons). During the period from December 1, 2001
through March 31, 2002, the Company delivered to PMI the Sold LPG.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17.0 million gallons of LPG, subject to monthly
adjustments based on seasonality (the "Contract"). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party on or after
May 31, 2003 upon 90 days written notice, or upon a change of circumstances as
defined under the Contract.
In connection with the Contract, the parties also executed a settlement
agreement (the "Settlement Agreement"), whereby the parties released each other
in connection with all disputes between the parties arising during the period
April 1, 2001 through February 28, 2002, and previous claims related to the
contract for the period April 1, 2000 through March 31, 2001.
PMI uses the Matamoros Terminal Facility to load LPG purchased from the
Company for distribution by truck in Mexico. The Company continues to use the
Brownsville Terminal Facility in connection with LPG delivered by railcar to
other customers, storage and as an alternative terminal in the event the
Matamoros Terminal Facility cannot be used temporarily.
Revenues from PMI totaled approximately $110.8 million for the year ended
July 31, 2002, representing approximately 77.9% of total revenue for the period.
LPG Supply Agreements. Effective October 1, 1999, the Company and Exxon
entered into a ten year LPG supply contract, as amended (the "Exxon Supply
Contract"), whereby Exxon has agreed to supply and the Company has agreed to
take, 100% of Exxon's owned or controlled volume of propane and butane available
at Exxon's King Ranch Gas Plant (the "Plant") up to 13.9 million gallons per
month blended in accordance with required specifications (the "Plant
Commitment"). For the year ending July 31, 2002, under the Exxon Supply
Contract, Exxon has supplied an average of approximately 14.3 million gallons of
LPG per month. The purchase price is indexed to variable posted prices.
24
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 minimum utilization fees
associated with the use of the ECCPL until September 2004. Thereafter the
utilization fees will be based on the actual utilization of the ECCPL.
In September 1999, the Company and El Paso NGL Marketing Company, L.P. ("El
Paso") entered into a three year supply agreement (the "El Paso Supply
Agreement") whereby El Paso agreed to supply and the Company agreed to take, a
monthly average of 2.5 million gallons of propane (the "El Paso Supply")
beginning in October 1999 expiring at September 30, 2002. The El Paso Supply
Agreement was not renewed. The purchase price was indexed to variable posted
prices.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. For the year ending July 31, 2002,
under the Koch Supply Contract, Koch has supplied an average of approximately
5.3 million gallons of propane per month. The purchase price is indexed to
variable posted prices. Furthermore, the Company was required to pay additional
charges associated with the construction of a new pipeline interconnection which
was paid through additional adjustments to the purchase price (totaling
approximately $1.0 million) which allows deliveries of the Koch Supply into the
ECCPL.
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 24.0 million gallons per month adjusted
for El Paso (actual deliveries have been approximately 21.7 million gallons per
month during fiscal 2002 adjusted for El Paso), although the Contract provides
for lesser quantities.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver 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, 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.
25
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 may reserve up to 21.0
million gallons each year thereafter provided that the Company notifies Seadrift
in advance.
The Pipeline Lease Amendment provides for variable rental increases based
on monthly volumes purchased and flowing into the Leased Pipeline and storage
utilized. The Company believes that the Pipeline Lease Amendment provides the
Company increased flexibility in negotiating sales and supply agreements with
its customers and suppliers. The Company has made all payments required under
the Pipeline Lease Amendment.
The Company at its own expense, installed a mid-line pump station which
included the installation of additional piping, meters, valves, analyzers and
pumps along the Leased Pipeline to increase the capacity of the Leased Pipeline.
The Leased Pipeline's capacity is estimated to be between 300 million 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. In addition the Company intends to upgrade its
computer and information systems at a total estimated cost of $350,000.
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 Pipelines and Matamoros Terminal Facility.
During December 1999, the Company and CPSC amended the Lease Agreements
whereby the Company acquired a 50% interest for $3.0 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 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. 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.
26
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 H and K 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.
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 amount required to be paid by CPSC has been recorded as a mortgage
receivable (see note H 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 and 2002. 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.
27
Mexican Operations. Under current Mexican law, foreign ownership of Mexican
entities involved in the distribution of LPG or the operation of LPG terminal
facilities is prohibited. Foreign ownership is permitted in the transportation
and storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation permit
and the Mexican Subsidiaries own, lease, or are in the process of obtaining the
land or rights of way used in the construction of the Mexican portion of the
US-Mexico Pipelines, and own the Mexican portion of the assets comprising the
US-Mexico Pipelines, the Matamoros Terminal Facility and the Saltillo Terminal.
The Company's Mexican affiliate, Tergas, S.A. de C.V. ("Tergas"), has been
granted the permit to operate the Matamoros Terminal Facility and the Company
relies on Tergas' permit to continue its delivery of LPG at the Matamoros
Terminal Facility. Tergas is owned 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.
The Company had previously completed construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal"). The Company
was unable to receive all the necessary approvals to operate the facility at
that location. The Company has identified an alternate site in Hipolito,
Mexico, a town located in the proximity of Saltillo to relocate the Saltillo
Terminal. The cost of such relocation is expected to be between $250,000 and
$500,000.
Once completed, the Company expects the newly-constructed terminal facility
to be capable of off-loading LPG from railcars to trucks. The newly-constructed
terminal facility will have three truck loading racks and storage to accommodate
approximately 390,000 gallons of LPG.
Once operational, the Company can directly transport LPG via railcar from
the Brownsville Terminal Facility to the Saltillo area. The Company believes
that by having the capability to deliver LPG to the Saltillo area, the Company
will be able to further penetrate the Mexican market for the sale of LPG.
Through its operations in Mexico and the operations of the Mexican
Subsidiaries and Tergas, the Company is subject to the tax laws of Mexico which,
among other things, require that the Company comply with transfer pricing rules,
the payment of income, asset and ad valorem taxes, and possibly taxes on
distributions in excess of earnings. In addition, distributions to foreign
corporations, including dividends and interest payments may be subject to
Mexican withholding taxes.
Deregulation of the LPG Industry in Mexico. The Mexican petroleum industry
is governed by the Ley Reglarmentaria del Art culo 27 Constitutional en el Ramo
del Petr leo (the Regulatory Law to Article 27 of the Constitution of Mexico
concerning Petroleum Affairs (the "Regulatory Law")), and Ley Org nica del Petr
leos Mexicanos y Organismos Subsidiarios (the Organic Law of Petr leos Mexicanos
and Subsidiary Entities (the "Organic Law")). Under Mexican law and related
regulations, PEMEX is entrusted with the central planning and the strategic
management of Mexico's petroleum industry, including importation, sales and
transportation of LPG. In carrying out this role, PEMEX controls pricing and
distribution of various petrochemical products, including LPG.
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.
28
In connection with the above, in August 2001, Tergas received a one year
permit from the Mexican government to import LPG. During September 2001, the
Mexican government asked Tergas to defer use of the permit and as a result, the
Company did not sell LPG to distributors other than PMI. In March 2002, the
Mexican government again announced its intention to issue permits for free
importation of LPG into Mexico by distributors and others beginning August 2002,
which was again delayed until February 2003. Tergas' permit to import LPG
expired during August 2002. Tergas intends to obtain a new permit when the
Mexican government begins to accept applications once more. As a result of the
foregoing, it is uncertain as to when, if ever, Deregulation will actually occur
and the effect, if any, it will have on the Company. However, should
Deregulation occur, it is the Company's intention to sell LPG directly to
distributors in Mexico as well as PMI. Tergas also received authorization from
Mexican Customs authorities regarding the use of the US-Mexico Pipelines for the
importation of LPG.
The point of sale for LPG which flows through the US-Mexico Pipelines for
delivery to the Matamoros Terminal Facility is the United States-Mexico border.
For LPG delivered into Mexico, PMI is the importer of record.
Credit Arrangements. As of July 31, 2002, the Company has a $13.0 million
credit facility with RZB Finance L.L.C. ("RZB") through December 31, 2002 (will
be reduced to $10.0 million after December 31, 2002 unless RZB authorizes an
extension) for demand loans and standby letters of credit (the "RZB Credit
Facility") to finance the Company's purchases of LPG. Under the RZB Credit
Facility, the Company pays a fee with respect to each letter of credit
thereunder in an amount equal to the greater of (i) $500, (ii) 2.5% of the
maximum face amount of such letter of credit, or (iii) such higher amount as may
be agreed to between the Company and RZB. Any loan amounts outstanding under the
RZB Credit Facility shall accrue interest at a rate equal to the rate announced
by the Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to the RZB
Credit Facility, RZB has sole and absolute discretion to limit or terminate
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 H and L to the consolidated financial statements).
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
(until September 30, 2002), 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, 2002, the Company's borrowings
and commitments exceeded the amount of the Assets which included $29,701 in
cash, by approximately $2.4 million (the "Asset Deficit"). Subsequent to July
31, 2002, RZB has continued to fund and issue letters of credit to the Company
despite the Asset Deficit.
29
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 were
paid quarterly beginning March 15, 2001.
Under the terms of the Restructuring Agreements, the holders of the
Restructured Notes also received warrants to purchase up to 676,125 shares of
common stock of 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 agreed to
register the shares of common stock which may be acquired in connection with the
exercise of the New Warrants (the "Exercisable Shares") by March 31, 2001. In
connection with the Company's obligations under the Restructured Notes, the
Company's registration statement containing the Exercisable Shares was declared
effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral to
secure the Company's payment obligations under the Restructured Notes consisting
of a senior interest in substantially all of the Company's assets which are
located in the United States (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. The release of the
first 1.0 million shares will be transferred to the Company as collateral for
the President's Promissory Note. The Collateral is also being pledged in
connection with the issuance of other indebtedness by the Company (see note L to
the consolidated financial statements). Investec PMG Capital, formerly PMG
Capital Corp., ("Investec") has agreed to serve as the collateral agent.
30
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. As described above, the Company's payment obligations under the
New Notes are to be secured by the Collateral and the 2.0 million shares of the
Company which are owned by the Company's President.
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 accrued interest related to
the New Notes and the Restructured Notes.
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.
During September 2001, the Company issued 1,000 shares of common stock of
the Company to an employee of the Company as a bonus. In connection with the
issuance of the shares, the Company recorded an expense of $2,800 based on the
market value of the stock issued.
During November 2001, warrants to purchase a total of 78,750 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $137,813.
During November 2001, in connection with notes in the aggregate amount of
$1,042,603 issued to the Company by certain officers, directors and a related
party (Note Issuers), the Company and the Note Issuers agreed to exchange 36,717
shares of common stock of the Company owned by the Note Issuers, and which
shares were being held by the Company as collateral for the notes, for payment
of all unpaid interest owing to the Company through October 31, 2001 ($146,869).
In addition, the Company agreed to extend the date of the notes issued by the
Note Issuers to October 31, 2003 (see note R). The accrued interest has been
reserved in total by the Company. Therefore, the Company has accounted for the
receipt of the shares as a reduction of the principal amount due on the notes at
the quoted price of the shares at the date of the agreement.
During December 2001, the Company and certain holders of the Restructured
Notes and the New Notes (the "Accepting Noteholders") reached an agreement
whereby the due date for $3.1 million of principal due on the Accepting
Noteholders' notes was extended to June 15, 2002. In connection with the
extension, the Company agreed to (i) continue paying interest at a rate of 16.5%
annually on the Accepting Noteholders' notes, payable quarterly, (ii) pay the
Accepting Noteholders a fee equal to 1% on the principal amount of the Accepting
Noteholders' notes, (iii) modify the warrants held by the Accepting Noteholders
by extending the expiration date to December 14, 2004 and (iv) remove the
Company's repurchase rights with regard to the warrants.
During June 2002, the Company and certain holders of the Restructured Notes
and the New Notes (the "New Accepting Noteholders") reached an agreement whereby
the due date for approximately $3.0 million of principal due on the New
Accepting Noteholders' notes were extended to December 15, 2002. The New
Accepting Noteholders' notes will continue to bear interest at 16.5% per annum.
Interest is payable on the outstanding balances on specified dates through
December 15, 2002. The Company paid a fee of 1.5% on the principal amount of the
New Accepting Noteholders' notes on July 1, 2002. The principal amount and
unpaid interest of the Restructured Notes and/or New Notes which were not
extended were paid on June 15, 2002.
During June 2002 the Company issued a note for $100,000 to a holder of the
Restructured Notes and the New Notes. The $100,000 note provides for similar
terms and conditions as the New Accepting Noteholders' notes.
During June 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised resulting in cash proceeds to the Company of $62,500.
During July 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised resulting in cash proceeds to the Company of $62,500.
In January 2002, the Company loaned the President $200,000 due in one year.
The Company also had other advances to the President of approximately $82,000 as
of July 31, 2002, which were offset per the employment agreement against accrued
and unpaid bonuses due to the President (see note K to the consolidated
financial statements). The Company and the President have agreed that the
Company will not pay the portion of the remaining bonus due under his employment
contract totaling $237,436 at July 31, 2002, to the extent of the outstanding
amounts due under this loan.
During October 2002, the Company agreed to accept the assets,
collateralizing the $214,355 note (see note D to the consolidated financial
statement), having a fair value of approximately $800,000 owned by an officer
and a director of the Company and Buyer (the "Officer") as full satisfaction of
the Officer's stock note ($498,000) and promissory note ($214,355) owed to the
Company (see note D to the consolidated financial statements).
31
In connection with warrants previously issued by the Company, certain of
these warrants contain a call provision whereby the Company has the right to
purchase the warrants for a nominal price if the holder of the warrants does not
elect to exercise the warrants during the call provision period.
Settlement of Litigation. On 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 L 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. Omnitrans is appealing the summary
judgments in favor the Company and of Penn Wilson. 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 plaintiffs are seeking
damages in the amount of $750,000. The Company believes that the complaint is
without merit and intends to vigorously defend against the lawsuit.
On October 11, 2001, litigation was filed in the 197th Judicial District
Court of Cameron County, Texas by the Company against Tanner Pipeline Services,
Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging negligence and aided breaches
of fiduciary duties on behalf of CPSC in connection with the construction of the
US Pipelines. The Company is seeking damages. Discovery is continuing in this
matter. After July 31, 2002, Tanner sent notice of its intent to seek its
attorneys fees as a sanction in the event it prevails in the action. Trial is
set for February 24, 2003.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including those
discussed above, should not materially affect its consolidated financial
statements.
32
Award from Litigation. For the year ended July 31, 2000, the Company
recognized a gain of approximately $3.0 million which represents the amount 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 and continues to have a deficit in
working capital. In addition, significantly all of the Company's assets are
pledged or committed to be pledged as collateral on existing debt in connection
with the New Acccepting Noteholders' notes, the RZB Credit Facility and the
notes related to the Settlement. The New Accepting Noteholders' notes, which
total approximately $3.1 million at October 4, 2002, are due on December 15,
2002. 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 or to reduce
outstanding balances under its credit facility. In addition, the Company has
entered into supply agreements for quantities of LPG totaling approximately 24.0
million gallons per month adjusted for El Paso (actual deliveries have been
approximately 21.7 million gallons per month during fiscal 2002 adjusted for El
Paso) although the Contract provides for lesser quantities (see note Q 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 New Accepting Noteholders'
notes, to raise additional equity capital, resolve uncertainties related to the
Saltillo Terminal 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, (ii) increase the number of customers assuming Deregulation, (iii)
extend the terms of the Pipeline Lease, (iv) expand its product lines, (v)
obtain additional letters of credit financing, (vi) raise additional debt and/or
equity capital, (vii) increase the current credit facility and (viii) relocate
the Saltillo Terminal to another location near Satillo, Coahuila, Mexico.
At July 31, 2002, the Company had net operating loss carryforward for
federal income tax purposes of approximately $6.7 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.
33
The following is a summary of the Company's estimated minimum contractual
obligations and commercial obligations as of July 31, 2002. Where applicable
LPG prices are based on the July 2002 monthly average as published by Oil Price
Information Services.
PAYMENTS DUE BY PERIOD
(AMOUNTS IN MILLIONS)
---------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After
Contractual Obligations Total 1 Year Years Years 5 Years
- ----------------------------------- -------------- -------------- ---------------- -------------- ---------------
Debt $ 3.7 $ 3.1 $ 0.5 $ .1 $ -
Operating Leases 14.3 1.5 2.9 2.7 7.2
LPG Purchase Obligations 444.7 85.1 116.6 116.6 126.4
-------------- -------------- ---------------- -------------- ---------------
Total Contractual Cash Obligations $ 462.7 $ 89.7 $ 120.0 $ 119.4 $ 133.6
============== ============== ================ ============== ===============
AMOUNT OF COMMITMENT EXPIRATION
PER PERIOD
(AMOUNTS IN MILLIONS)
---------------------------------------------------------------------------------
Commercial Total Amounts Less than 1 - 3 4 - 5 Over
Commitments Committed 1 Year Years Years 5 Years
- ----------------------------------- -------------- -------------- ---------------- -------------- ---------------
Lines of Credit $ .2 $ .2 $ - $ - $ -
Standby Letters of Credit 8.5 8.5 - - -
Guarantees N/A N/A N/A N/A N/A
Standby Repurchase Obligations N/A N/A N/A N/A N/A
Other Commercial Commitments N/A N/A N/A N/A N/A
-------------- -------------- ---------------- -------------- ---------------
Total Commercial Commitments $ 8.7 $ 8.7 $ - $ - $ -
============== ============== ================ ============== ===============
FINANCIAL ACCOUNTING STANDARDS
In August 2001 Statement of Financial Accounting Standards ("SFAS") No. 144
("SFAS 144") "Accounting for the Impairment or Disposal of Long-Lived Assets"was
issued. SFAS 144 supersedes the provisions of Statement of Financial Accounting
Standards No. 121 ("SFAS 121") "Accounting for the Impairment of Long-lived
Assets and for Long-lived Assets to be Disposed Of". SFAS 144 requires the
Company to review long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If it is determined that an
impairment has occurred, the amount of the impairment is charged to operations.
No impairments were recognized for the years ended July 31, 2000, 2001 and 2002.
The Company has adopted Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
which requires that all derivative financial instruments be recognized in the
financial statements and measured at fair value regardless of the purpose or
intent for holding them. Changes in the fair value of derivative financial
instruments are either recognized periodically in income or stockholders' equity
(as a component of comprehensive income), depending on whether the derivative is
being used to hedge changes in fair value or cash flows. At July 31, 2000, 2001
and 2002 the Company had no derivative financial instruments.
34
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.
35
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, 2001 and 2002, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended July 31, 2002. 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, 2001 and 2002, and the consolidated results of their
operations and their consolidated cash flows for each of the three years in the
period ended July 31, 2002 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, 2002. In our opinion, this schedule presents fairly,
in all material respects, the information required to be set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note P to
the consolidated financial statements, conditions exist which raise substantial
doubt about the Company's ability to continue as a going concern including 1)
the Company has a deficit in working capital and 2) significantly all of the
Company's assets are pledged or committed to be pledged as collateral on
existing debt in connection with the New Accepting Noteholders' notes, the RZB
Credit Facility and the notes related to the Settlement. Management's plans in
regard to these matters are also described in note P. The consolidated
financial statements do not include any adjustments related to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
/s/ BURTON McCUMBER & CORTEZ, L.L.P.
Brownsville, Texas
October 4, 2002
36
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31
ASSETS
2001 2002
----------- -----------
Current Assets
Cash (including restricted cash of $971,875 and $29,701 at 2001 and
2002) $ 1,322,560 $ 160,655
Trade accounts receivable (less allowance for doubtful accounts of 4,802,897 7,653,986
$779,663 and $5,783 at 2001 and 2002)
Notes receivable - related parties 214,355 414,356
Inventories 12,384,847 1,138,440
Prepaid expenses and other current assets 298,828 254,654
----------- -----------
Total current assets 19,023,487 9,622,091
Property, plant and equipment - net 18,260,384 18,151,017
Lease rights (net of accumulated amortization of $615,945 and $661,740 at
2001 and 2002) 538,094 492,299
Mortgage receivable 1,934,872 1,935,723
Other non-current assets 312,808 154,209
----------- -----------
Total assets $40,069,645 $30,355,339
=========== ===========
The accompanying notes are an integral part of these statements.
37
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
JULY 31
LIABILITIES AND STOCKHOLDERS' EQUITY
2001 2002
--------------- ---------------
Current Liabilities
Current maturities of long-term debt $ 918,885 $ 3,055,708
Short-term debt 5,650,430 3,085,000
Revolving line of credit - 150,000
LPG trade accounts payable 9,537,825 8,744,432
Obligation to deliver LPG 11,495,333 -
Other accounts payable 2,899,778 3,584,848
Accrued liabilities 1,415,576 860,551
--------------- ---------------
Total current liabilities 31,917,827 19,480,539
Long-term debt, less current maturities 3,273,969 612,498
Commitments and contingencies - -
Stockholders' Equity
Series A - Preferred stock-$0.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at 2001 and 2002 - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; No shares issued and outstanding at 2001
and 2002 - -
Common stock - $.01 par value, 25,000,000 shares authorized; 14,427,011
and 14,870,977 shares issued and outstanding at 2001 and 2002 144,270 148,709
Additional paid-in capital 25,833,822 26,919,674
Notes receivable from officers of the Company, a related party and
another party for exercise of warrants, less reserve of $596,705 and
$754,175 at 2001 and 2002 ( 3,986,048) ( 3,814,481)
Accumulated deficit ( 17,114,195) ( 12,991,600)
--------------- ---------------
Total stockholders' equity 4,877,849 10,262,302
--------------- ---------------
Total liabilities and stockholders' equity $ 40,069,645 $ 30,355,339
=============== ===============
The accompanying notes are an integral part of these statements.
38
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31
2000 2001 2002
-------------- --------------- ---------------
Revenues $ 98,514,963 $ 150,699,999 $ 142,156,099
Cost of goods sold 94,936,405 151,475,598 131,129,110
-------------- --------------- ---------------
Gross profit (loss) 3,578,558 ( 775,599) 11,026,989
Selling, general and administrative expenses
Legal and professional fees 826,310 1,139,141 1,568,002
Salaries and payroll related expenses 1,219,581 1,230,456 1,646,308
Other 1,106,755 1,248,042 1,132,546
-------------- --------------- ---------------
3,152,646 3,617,639 4,346,856
-------------- --------------- ---------------
Operating income (loss) 425,912 ( 4,393,238) 6,680,133
Other income (expense)
Interest expense ( 1,857,057) ( 3,615,477) ( 2,538,395)
Interest income 34,080 39,576 27,550
Settlement of litigation ( 81,250) ( 115,030) -
Award from litigation 3,036,638 - -
-------------- --------------- ---------------
Income (loss) before taxes 1,558,323 ( 8,084,169) 4,169,288
Provision for income taxes 97,542 9,641 46,693
-------------- --------------- ---------------
Net income (loss) $ 1,460,781 $ ( 8,093,810) $ 4,122,595
============== =============== ===============
Net income (loss) per common share $ 0.11 $ ( 0.57) $ 0.28
============== =============== ===============
Net income (loss) per common share assuming dilution $ 0.10 $ ( 0.57) $ 0.27
============== =============== ===============
Weighted average common shares outstanding 12,970,052 $ 14,146,980 $ 14,766,115
============== =============== ===============
The accompanying notes are an integral part of these statements.
39
PENN OCTANE CORPORATION AND SUBSIDIARIES.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31
2000 2001 2002
---------------------- ----------------------- --------------------
Shares Amount Shares Amount Shares Amount
----------- --------- ----------- ---------- ---------- --------
PREFERRED STOCK
Beginning balance - $ - - $ - - $ -
=========== ========= =========== ========== ========== ========
Ending balance - $ - - $ - - $ -
=========== ========= =========== ========== ========== ========
SENIOR PREFERRED STOCK
Beginning balance 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 - $ - - $ - - $ -
=========== ========= =========== ========== ========== ========
COMMON STOCK
Beginning balance 11,845,497 $118,456 13,435,198 $ 134,352 14,427,011 $144,270
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 - -
The accompanying notes are an integral part of these statements.
40
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
2000 2001 2002
-------------------- -------------------- -----------------------------
Shares Amount Shares Amount Shares Amount
---------- -------- ---------- -------- ----------- ----------------
COMMON STOCK - CONTINUED
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 - -
Issuance of common stock upon exercise of warrants
in exchange for debt obligations owed to the holder
of the warrants - August 2001 - - - - 37,500 375
Issuance of common stock upon exercise of warrants
in exchange for debt obligations owed to the holder
of the warrants - September 2001 - - - - 275,933 2,759
Issuance of common stock in connection with bonus
- September 2001 - - - - 1,000 10
Issuance of common stock for services - September
2001 - - - - 37,500 375
Receipt of stock for payment of interest on
indebtedness - October 2001 - - - - ( 36,717) ( 367)
Issuance of common stock upon exercise of warrants
- November 2001 - - - - 78,750 787
Issuance of common stock upon exercise of warrants
- June 2002 - - - - 25,000 250
Issuance of common stock upon exercise of warrants
- July 2002 - - - - 25,000 250
---------- -------- ---------- -------- ----------- ----------------
Ending balance 13,435,198 $134,352 14,427,011 $144,270 14,870,977 $ 148,709
========== ======== ========== ======== =========== ================
The accompanying notes are an integral part of these statements.
41
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
FOR THE YEARS ENDED JULY 31
2000 2001 2002
--------------- --------------- -----------------
Amount Amount Amount
--------------- --------------- -----------------
ADDITIONAL PAID-IN CAPITAL
Beginning balance $ 17,133,222 $ 21,782,638 $ 25,833,822
Sale of common stock 998,182 - -
Conversion of preferred stock to common stock ( 3,600) - -
Issuance of warrants in connection with settlement - 300,000 -
Loan discount 1,305,031 1,620,403 207,283
Grant of stock for bonus - 43,355 2,790
Grant of stock for services - 87,595 149,625
Common stock distributed in connection with the
settlement of a lawsuit 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) -
Receipt of stock for payment of interest - - ( 146,502)
Exercise of warrants - 2,142,025 872,967
Cost of registering securities ( 104,069) ( 85,637) ( 311)
--------------- --------------- -----------------
Ending balance $ 21,782,638 $ 25,833,822 $ 26,919,674
=============== =============== =================
STOCKHOLDERS' NOTES
Beginning balance $ ( 2,765,350) $ ( 3,263,350) $ ( 3,986,048)
Note receivable from an officer of the Company and
another party for exercise of warrants ( 498,000) ( 698,000) -
Interest on another party note receivable - ( 24,698) -
Reserve of interest - - 24,698
Reduction in notes receivable - - 146,869
--------------- --------------- -----------------
Ending balance $ ( 3,263,350) $ ( 3,986,048) $ ( 3,814,481)
=============== =============== =================
ACCUMULATED DEFICIT
Beginning balance $( 10,435,796) $( 9,020,385) $ ( 17,114,195)
Net income (loss) for the year 1,460,781 ( 8,093,810) 4,122,595
Dividends on preferred stock ( 45,370) - -
--------------- --------------- -----------------
Ending balance $ ( 9,020,385) $( 17,114,195) $ ( 12,991,600)
=============== =============== =================
The accompanying notes are an integral part of these statements.
42
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31
2000 2001 2002
-------------- -------------- ---------------
Cash flows from operating activities:
Net income (loss) $ 1,460,781 $ (8,093,810) $ 4,122,595
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization 388,445 758,911 843,436
Amortization of lease rights 45,795 45,795 45,795
Non-employee stock based costs and other 58,333 222,988 374,870
Amortization of loan discount 1,478,406 1,887,442 956,853
Settlement of litigation for stock 81,250 - -
Gain on sale of land - - ( 17,001)
Other 123,137 106,570 33,281
Changes in current assets and liabilities:
Trade accounts receivable (1,352,652) (986,213) (2,856,873)
Notes receivable - related parties - - ( 200,000)
Inventories (6,708,053) ( 5,061,638) 11,246,407
Prepaid and other current assets (54,003) 22,562 ( 180,697)
Property held for sale (1,908,000) - -
LPG trade accounts payable 2,376,761 4,310,867 ( 793,393)
Obligation to deliver LPG - 11,495,333 ( 11,495,333)
Other assets and liabilities, net (3,150) (4,649) 158,599
Other accounts payable and accrued liabilities 1,450,788 1,491,810 155,671
-------------- -------------- ---------------
Net cash provided by (used in) operating activities (2,562,162) 6,195,968 2,394,210
Cash flows from investing activities:
Capital expenditures (7,811,111) (2,572,367) ( 789,069)
Sale of land - - 72,001
Purchase of lease interests (3,000,000) - -
-------------- -------------- ---------------
Net cash used in investing activities (10,811,111) (2,572,367) ( 717,068)
Cash flows from financing activities:
Revolving credit facilities 3,538,394 (3,538,394) 150,000
Issuance of debt 7,279,212 1,046,000 381,032
Debt issuance costs (370,530) ( 326,232) -
Issuance of common stock 2,398,882 1,453,249 287,511
Costs of registration - (85,637) ( 568)
Reduction in debt (474,089) (875,518) (3,632,324)
Preferred stock dividends (45,370) - -
Payments on note receivable 40,000 - -
Reserve of interest on note receivable from another party - - ( 24,698)
-------------- -------------- ---------------
Net cash provided by (used in) financing activities 12,366,499 (2,326,532) (2,839,047)
-------------- -------------- ---------------
Net increase (decrease) in cash (1,006,774) 1,297,069 (1,161,905)
Cash at beginning of period 1,032,265 25,491 1,322,560
-------------- -------------- ---------------
Cash at end of period $ 25,491 $ 1,322,560 $ 160,655
============== ============== ===============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (including capitalized interest of $120,000 in 2001) $ 772,296 $ 1,806,356 $ 1,756,998
============== ============== ===============
Taxes $ 80,042 $ 27,141 $ -
============== ============== ===============
Supplemental disclosures of noncash transactions:
Preferred stock, common stock and warrants issued $ 960,500 $ 3,575,382 $ 974,915
============== ============== ===============
Notes receivable exchanged for common stock $ - $ (555,661) $ (146,869)
============== ============== ===============
Capitalized lease obligations $ 3,162,500 $ - $ -
============== ============== ===============
Mortgage receivable $ - $ ( 1,934,872) $ (851)
============== ============== ===============
The accompanying notes are an integral part of these statements.
43
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 (Brownsville
Terminal Facility) and owns a LPG terminal facility in Matamoros,
Tamaulipas, Mexico (Matamoros Terminal Facility) and pipelines (US - Mexico
Pipelines) which connect the Brownsville Terminal Facility to the Matamoros
Terminal Facility. The Company has a long-term lease agreement for
approximately 132 miles of pipeline (Leased Pipeline) which connects
ExxonMobil Corporation's (Exxon) King Ranch Gas Plant in Kleberg County,
Texas and Duke Energy's La Gloria Gas Plant in Jim Wells County, Texas, to
the Company's Brownsville Terminal Facility. In addition, the Company has
access to a twelve-inch pipeline which connects Exxon's Viola valve station
in Nueces County, Texas to the inlet of the King Ranch Gas Plant (ECCPL)
(see note Q) as well as existing and other potential propane pipeline
suppliers which have the ability to access the ECCPL. In connection with
the Company's lease agreement for the Leased Pipeline, the Company may
access up to 21,000,000 gallons of storage located in Markham, Texas
(Markham Storage), as well as other potential propane pipeline suppliers,
via approximately 155 miles of pipeline located between Markham, Texas and
the Exxon King Ranch Gas Plant. The Company sells LPG primarily to P.M.I.
Trading Limited (PMI). PMI is the exclusive importer of LPG into Mexico.
PMI is a subsidiary of Petroleos Mexicanos, the state-owned Mexican oil
company (PEMEX). The LPG purchased from the Company by PMI is generally
destined for consumption in the northeastern region of Mexico.
The Company commenced operations during the fiscal year ended July 31,
1995, upon construction of the Brownsville Terminal Facility. Since the
Company began operations, the primary customer for LPG has been PMI. Sales
of LPG to PMI accounted for approximately 77%, 74% and 78% of the Company's
total revenues for the years ended July 31, 2000, 2001 and 2002,
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.
44
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows.
1. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
on the first-in, first-out method.
2. PROPERTY, PLANT AND EQUIPMENT AND LEASE RIGHTS
Property, plant and equipment are recorded at cost. After being placed into
service, assets are depreciated and amortized using the straight-line
method over their estimated useful lives as follows:
LPG terminals, building and leasehold improvements (a) 8 to 19 years
Automobiles 3-5 years
Furniture, fixtures and equipment 3-5 years
Trailers 8 years
Pipelines 30 years
(a) Brownsville Terminal related assets are depreciated over their
estimated useful lives, not to exceed the term of the Pipeline Lease
(see note K).
The lease rights are being amortized over 19 years.
Maintenance and repair costs are charged to expense as incurred.
In August 2001 Statement of Financial Accounting Standards (SFAS) No. 144
(SFAS 144) "Accounting for the Impairment or Disposal of Long-Lived
Assets"was issued. SFAS 144 supersedes the provisions of Statement of
Financial Accounting Standards No. 121 (SFAS 121) "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed
Of". SFAS 144 requires the Company to review long-lived assets and certain
identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment has occurred, the
amount of the impairment is charged to operations. No impairments were
recognized for the years ended July 31, 2000, 2001 and 2002.
3. INCOME TAXES
The Company will file a consolidated income tax return for the year ended
July 31, 2002.
The Company accounts for deferred taxes in accordance with SFAS 109,
"Accounting for Income Taxes". Under the liability method specified
therein, deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax bases of assets and
liabilities as measured by the enacted tax rates which will be in effect
when these differences reverse. Deferred tax expense is the result of
changes in deferred tax assets and liabilities. The principal types of
differences between assets and liabilities for financial statement and tax
return purposes are the allowance for doubtful accounts receivable,
amortization of deferred interest costs, accumulated depreciation and
deferred compensation expense.
The foreign subsidiaries are taxed on their income directly by the Mexican
Government. Such foreign subsidiaries are not included in the U.S.
consolidated income tax return of the Company. Consequently U.S. income tax
effect will occur only when dividend distributions of earnings and profits
of the foreign subsidiaries are received by the Company.
45
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
4. INCOME (LOSS) PER COMMON SHARE
Income (loss) per share of common stock is computed on the weighted average
number of shares outstanding in accordance with SFAS 128, "Earnings Per
Share". During periods in which the Company incurred losses, giving effect
to common stock equivalents is not presented as it would be antidilutive.
5. CASH EQUIVALENTS
For purposes of the cash flow statement, the Company considers cash in
banks and securities purchased with a maturity of three months or less to
be cash equivalents.
6. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
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.
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.
46
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
10. FOREIGN CURRENCY TRANSLATION
The Company follows FASB No. 52 "Foreign Currency Translation" in
consolidation of the Company's Mexican subsidiaries, whose functional
currency is the US dollar. Non monetary balance sheet items and related
revenue and expense are remeasured using historical rates. Monetary balance
sheet items and related revenue and expense are remeasured using exchange
rates in effect at the balance sheet dates.
11. FINANCIAL INSTRUMENTS
The Company has adopted Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133), which requires that all derivative financial instruments be
recognized in the financial statements and measured at fair value
regardless of the purpose or intent for holding them. Changes in the fair
value of derivative financial instruments are either recognized
periodically in income or stockholders' equity (as a component of
comprehensive income), depending on whether the derivative is being used to
hedge changes in fair value or cash flows. At July 31, 2000, 2001 and 2002
the Company had no derivative financial instruments.
12. RECLASSIFICATIONS
Certain reclassifications have been made to prior year balances to conform
to the current presentation.
47
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 J for
the warrants):
For the year ended July 31, 2000
-----------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------
Net income (loss) $ 1,460,781
Less: Dividends on preferred stock ( 45,370)
--------------
BASIC EPS
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
Net income (loss) available to common
stockholders $ 1,415,411 14,447,119 $ 0.10
============== ============= ==========
For the year ended July 31, 2001
-------------------------------- -----------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------- -----------
Net income (loss) $( 8,093,810)
BASIC EPS
Net income (loss) available to common
stockholders ( 8,093,810) 14,146,980 $( 0.57)
===========
EFFECT OF DILUTIVE SECURITIES
Warrants - -
DILUTED EPS
Net income (loss) available to common
stockholders N/A N/A N/A
48
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INCOME (LOSS) PER COMMON SHARE - Continued
For the year ended July 31, 2002
-----------------------------------------------
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
-------------- ------------- ----------------
Net income (loss) $ 4,122,595
Basic EPS
Net income (loss) available to common
stockholders 4,122,595 14,766,115 $ 0.28
================
Effect of Dilutive Securities
Warrants - 351,424
-------------- -------------
Diluted EPS
Net income (loss) available to common
stockholders $ 4,122,595 15,117,539 $ 0.27
============== ============= ================
NOTE D - NOTES FROM RELATED PARTIES
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 (President's
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. In November 2001 the Company extended the due
date to October 31, 2003 and the interest was adjusted to the prime rate on
November 7, 2001 (5.0%). 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. Those shares were subsequently pledged
to the holders of the Restructured Notes and New Notes (see note H) as
collateral. The President's 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.
49
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - 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 below). The
promissory note has been recorded as a reduction of stockholders' equity.
On September 10, 2000, the Board of Directors approved the repayment by a
company controlled by a director and officer of the Company (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
compressed natural gas refueling station assets and 60,809 shares of the
Company's common stock owned by the Buyer (see note R).
During November 2001, in connection with notes discussed in preceding
paragraphs, in the aggregate amount of $1,042,603 issued to the Company by
certain officers, directors and a related party (Note Issuers), the Company
and the Note Issuers agreed to exchange 36,717 shares of common stock of
the Company owned by the Note Issuers, and which shares were being held by
the Company as collateral for the notes, for payment of all unpaid interest
owing to the Company through October 31, 2001 ($146,869). In addition, the
Company agreed to extend the date of the notes issued by the Note Issuers
to October 31, 2003 (see note R). The accrued interest has been reserved in
total by the Company. Therefore, the Company has accounted for the receipt
of the shares as a reduction of the principal amount due on the notes at
the quoted price of the shares at the date of the agreement.
In January 2002, the Company loaned the President $200,000 due in one year.
The Company also had other advances to the President of approximately
$82,000 as of July 31, 2002, which were offset per the employment agreement
against accrued and unpaid bonuses due to the President (see note K). The
Company and the President have agreed that the Company will not pay the
portion of the remaining bonus due under his employment contract totaling
$237,436 at July 31, 2002, to the extent of the outstanding amounts due
under this loan.
50
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following as of July 31, :
2001 2002
------------ ------------
LPG:
Brownsville Terminal Facility:
Building $ 173,500 $ 173,500
Terminal facilities 3,631,207 3,631,207
Tank Farm 370,855 370,855
Midline pump station 2,293,121 2,449,628
Leasehold improvements 291,409 302,657
Capital construction in progress 67,002 96,212
Equipment 469,545 502,557
------------ ------------
7,296,639 7,526,616
------------ ------------
US - Mexico Pipelines and Matamoros Terminal
Facility:
U.S. Pipelines and Rights of Way 6,245,614 6,297,703
Mexico Pipelines and Rights of Way 993,300 993,300
Matamoros Terminal Facility 5,078,336 5,074,087
Saltillo Terminal 799,309 1,027,267
Land 644,526 856,358
------------ ------------
13,761,085 14,248,715
------------ ------------
Total LPG 21,057,724 21,775,331
------------ ------------
Other:
Automobile 10,800 10,800
Office equipment 56,266 72,728
------------ ------------
67,066 83,528
------------ ------------
21,124,790 21,858,859
Less: accumulated depreciation and amortization (2,864,406) (3,707,842)
------------ ------------
$18,260,384 $18,151,017
============ ============
The Company had previously completed construction of an additional LPG terminal
facility in Saltillo, Mexico (Saltillo Terminal). The Company was unable
to receive all the necessary approvals to operate the facility at that location.
The Company has identified an alternate site in Hipolito, Mexico, a town located
in the proximity of Saltillo to relocate the Satillo Terminal. The cost of such
relocation is expected to be between $250,000 and $500,000.
Depreciation and amortization expense of property, plant and equipment totaled
$388,445, $758,911 and $843,435 for the years ended July 31, 2000, 2001 and
2002, respectively.
Property, plant and equipment, net of accumulated depreciation, includes
$6,738,746 and $6,782,557 of costs, located in Mexico at July 31, 2001 and 2002,
respectively.
51
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - INVENTORIES
Inventories consist of the following as of July 31,:
2004 2002
----------------------- ---------------------
Gallons Cost Gallons Cost
---------- ----------- --------- ----------
LPG:
Leased Pipeline, US-Mexico
Pipelines, Brownsville
Terminal Facility, Matamoros
Terminal Facility and railcars
leased by the Company 2,473,962 $ 1,016,641 2,495,466 $ 972,102
Markham Storage and other 27,664,139 11,368,206 427,003 166,338
---------- ----------- --------- ----------
30,138,101 $12,384,847 2,922,469 $1,138,440
========== =========== ========= ==========
NOTE G - 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,:
2001 2002
------------------------ ------------------------
Assets Liabilities Assets Liabilities
---------- ------------ ---------- ------------
Depreciation $ - $ 145,000 $ - $ 133,000
Bad debt reserve 265,000 - 140,000 -
Receivable 12,000 - 12,000 -
Deferred compensation expense 203,000 - 256,000 -
Deferred interest cost 1,041,000 - 1,296,000 -
Deferred other cost 95,000 - 172,000 -
Net operating loss carryforward 3,986,000 - 2,277,000 -
---------- ------------ ---------- ------------
5,602,000 145,000 4,153,000 133,000
Less: valuation allowance 5,602,000 145,000 4,153,000 133,000
---------- ------------ ---------- ------------
$ - $ - $ - $ -
========== ============ ========== ============
There is no current or deferred U.S. or foreign income tax expense for the
years ended July 31, 2000, 2001, and 2002. The Company did incur U.S.
alternative minimum tax for the years ended July 31, 2000 and 2002 totaling
$44,333 and $100,000, respectively. The Company was in a loss position for
2001 and utilized net operating loss carryforwards in 2000 and 2002.
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.
52
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE G - INCOME TAXES - CONTINUED
At July 31, 2002, 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
----------- -------------
2013 $ 598,000
2019 11,000
2021 6,087,000
-------------
$ 6,696,000
=============
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 H - 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 were paid quarterly beginning March 15, 2001.
53
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
SHORT-TERM DEBT - CONTINUED
------------------------------
Restructuring of Notes - Continued
--------------------------------------
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.
In connection with the Restructuring Agreements, the Company agreed to
register the shares of common stock which may be acquired in connection
with the exercise of the New Warrants (Exercisable Shares) by March 31,
2001. In connection with the Company's obligations under the Restructured
Notes, the Company's registration statement containing the Exercisable
Shares was declared effective on March 14, 2001.
Under the terms of the Restructuring Agreements, the Company is also
required to provide the holders of the Restructured Notes with collateral
to secure the Company's payment obligations under the Restructured Notes
consisting of a senior interest in substantially all of the Company's
assets which are located in the United States (US Assets) and Mexico
(Mexican Assets), excluding inventory, accounts receivable and sales
contracts with respect to which the Company is required to grant a
subordinated security interest (collectively referred to as the
Collateral). 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 the shares are to be released when the
required security interests in all of the Collateral have been granted and
perfected). The granting and perfection of the security interests in the
Collateral, as prescribed under the Restructured Notes, have not been
finalized. Accordingly, the interest rate under the Restructured Notes
increased to 16.5% on March 16, 2001. The release of the first 1,000,000
shares will be transferred to the Company as collateral for the President's
Promissory Note. The Collateral is also being pledged in connection with
the issuance of other indebtedness by the Company (see note L). Investec
PMG Capital, formerly PMG Capital Corp., (Investec) has agreed to serve as
the collateral agent.
54
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
SHORT-TERM DEBT - CONTINUED
------------------------------
Restructuring of Notes - Continued
--------------------------------------
Investec acted as financial advisor for the restructuring of $4,384,000 in
principal amount of the Restructured Notes. Investec received fees
consisting of $131,520 in cash and warrants to purchase 50,000 shares of
common stock of 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 Investec in connection with the original issuance of
the Notes with the same terms as those which were modified in the Warrants
in connection with the Restructuring Agreements.
In connection with the Restructuring Agreements, the Company recorded a
discount of $1,597,140 related to the fair value of the New Warrants
issued, fair value related to the modifications of the Warrants, fees paid
to Investec (including cash, new warrants granted and modifications to
warrants previously granted to Investec in connection with the original
issuance of the Notes) and other costs associated with the Restructuring
Agreements, to be amortized over the life of the Restructured Notes. Total
amortization of discounts related to the Notes and the Restructured Notes
and included in the consolidated statements of operations was $1,002,470,
$1,670,794 and $599,475 for the years ended July 31, 2000, 2001 and 2002,
respectively.
Issuance of New Promissory Notes
------------------------------------
On January 31, 2001, the Company completed the placement of $991,000 in
principal amount of promissory notes (New Notes) due December 15, 2001. The
holders of the New Notes received warrants to purchase up to 123,875 shares
of common stock of 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 are to be secured by the Collateral and the
2,000,000 shares of the Company which are owned by the Company's President.
Net proceeds from the New Notes were used for working capital purposes.
In connection with the New Notes, Investec acted as placement agent for the
Company and received cash fees totaling $69,370 and reimbursement of out of
pocket expenses.
In connection with the issuance of the New Notes and New Note Warrants, the
Company recorded a discount of $349,494 related to the fair value of the
New Note Warrants issued, fees paid to Investec and other costs associated
with the private placement, to be amortized over the life of the New Notes.
Total amortization of discounts related to the New Notes and included in
the consolidated statements of operations was $199,398 and $150,096 for the
years ended July 31, 2001 and 2002, respectively.
During August 2001 and September 2001, warrants to purchase 313,433 shares
of common stock of 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 accrued interest
related to the New Notes and the Restructured Notes.
55
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
SHORT-TERM DEBT - CONTINUED
------------------------------
Extension of Restructured Notes and New Notes
---------------------------------------------------
During December 2001, the Company and certain holders of the Restructured
Notes and the New Notes (Accepting Noteholders) reached an agreement
whereby the due date for $3,135,000 of principal due on the Accepting
Noteholders' notes was extended to June 15, 2002. In connection with the
extension, the Company agreed to (i) continue paying interest at a rate of
16.5% annually on the Accepting Noteholders' notes, payable quarterly, (ii)
pay the Accepting Noteholders a fee equal to 1% on the principal amount of
the Accepting Noteholders' notes, (iii) modify the warrants held by the
Accepting Noteholders by extending the expiration date to December 14, 2004
and (iv) remove the Company's repurchase rights with regard to the
warrants.
In connection with the extension of the Accepting Noteholders' warrants,
the Company recorded a discount of $207,283, which has been amortized for
the year ended July 31, 2002.
During June 2002, the Company and certain holders of the Restructured Notes
and the New Notes (New Accepting Noteholders) reached an agreement whereby
the due date for approximately $2,985,000 of principal due on the New
Accepting Noteholders' notes were extended to December 15, 2002. The New
Accepting Noteholders' notes will continue to bear interest at 16.5% per
annum. Interest is payable on the outstanding balances on specified dates
through December 15, 2002. The Company paid a fee of 1.5% on the principal
amount of the New Accepting Noteholders' notes on July 1, 2002. The
principal amount and unpaid interest of the Restructured Notes and/or New
Notes which were not extended were paid on June 15, 2002.
During June 2002 the Company issued a note for $100,000 to a holder of the
Restructured Notes and the New Notes. The $100,000 note provides for
similar terms and conditions as the New Accepting Noteholders' notes.
LONG-TERM DEBT
---------------
Long-term debt consists of the following as of July 31,:
2001 2002
---------- ----------
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility (see note L). $1,263,634 $ 837,918
Promissory note issued in connection with the acquisition of the US - Mexico Pipelines
and the Matamoros Terminal Facility (see note L). 811,532 554,159
Promissory note issued in connection with the purchase of property (see note L). 1,934,872 1,935,723
Noninterest-bearing note payable, discounted at 7%, for legal services; due in February
2001. 147,500 137,500
Other debt 35,316 202,906
---------- ----------
4,192,854 3,668,206
Current maturities 918,885 3,055,708
---------- ----------
$3,273,969 $ 612,498
========== ==========
56
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - DEBT OBLIGATIONS - CONTINUED
LONG-TERM DEBT - CONTINUED
---------------------------
In connection with the note payable for legal services, the Company has not
made all of the required payments. The Company provided a "Stipulation of
Judgment" to the creditor at the time the note for legal services was
issued.
Scheduled maturities are as follows:
Year ending July 31,
--------------------
2004 $552,498
2005 20,000
2006 20,000
2007 20,000
--------
$612,498
========
NOTE I - STOCKHOLDERS' EQUITY
COMMON STOCK
------------
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 H).
During September 2001, the Company issued 1,000 shares of common stock of
the Company to an employee of the Company as a bonus. In connection with
the issuance of the shares, the Company recorded an expense of $2,800 based
on the market value of the stock issued.
During November 2001, warrants to purchase a total of 78,750 shares of
common stock of the Company were exercised, resulting in cash proceeds to
the Company of $137,813.
During June 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of
$62,500.
During July 2002, warrants to purchase 25,000 shares of common stock of the
Company were exercised, resulting in cash proceeds to the Company of
$62,500.
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.
57
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - STOCKHOLDERS' EQUITY - CONTINUED
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 69,970
shares were unissued as of July 31, 2002, 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.
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.
NOTE J - 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 (Board) meeting held on September 3, 1999,
the Board approved the implementation of a plan to compensate each outside
director serving on the Board (Plan). Under the Plan, all outside directors
upon election to the Board are entitled to receive warrants to purchase
20,000 shares of common stock of 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, 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.
In connection with the Board Plan, during November 2001 the Board granted
warrants to purchase 30,000 shares of common stock of the Company at
exercise prices of $3.66 per share to a newly appointed outside director.
Based on the provisions of APB 25, no compensation expense was recorded for
these warrants.
In connection with the Plan, during August 2002 the Board granted warrants
to purchase 20,000 shares of common stock of the Company at exercise price
of $3.10 per share to outside directors. Based on the provisions of APB25,
no compensation expense was recorded for these warrants.
58
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
2001 WARRANT PLAN
-------------------
The Board in November 2001 approved the 2001 warrant plan (2001 Warrant
Plan). The purpose of the 2001 Warrant Plan is to provide the Company with
a vehicle to attract, compensate, and motivate selected employees,
particulary executive officers, by issuing stock purchase warrants which
will afford recipients an opportunity to share in potential capital
appreciation in the Company's common stock.
The 2001 Warrant Plan provides for issuance of warrants to purchase up to a
maximum of 1,500,000 shares of common stock of the Company, subject to
adjustment in the event of adjustments to the Company's capitalization
(such as stock dividends, splits or reverse splits, mergers,
recapitalizations, consolidations, etc.). Any warrants which expire without
being exercised are added back to the number of shares for which warrants
may be issued. The 2001 Warrant Plan has a term of 10 years, and no
warrants may be granted after that time.
The warrants may be issued to any person who, at the time of the grant
under the 2001 Warrant Plan, is an employee or director of, and/or
consultant or advisor to, the Company, or to any person who is about to
enter into any such relationship with the Company.
The warrants will be issued in the discretion of the compensation committee
and/or the Board (Administrator), which will determine when and who will
receive grants, the number of shares purchasable under the warrants, the
manner, conditions and timing of vesting, the exercise price, antidilution
adjustments to be applied, and forfeiture and vesting acceleration terms.
The exercise price of the warrants are determined in the discretion of the
Administrator, but may not be less than 85% of the fair market value of the
common stock of the Company on the date of the grant, except that warrants
granted to non-employee directors may have an exercise price not less than
100% of the fair market value. The fair market value is the closing price
of the Company's common stock on the grant date. Warrants may be exercised
only for cash.
The term of the warrants may not exceed ten years from the date of grant
and may be exercised only during the term specified in the warrants. In the
discretion of the Administrator, warrants may continue in effect and
continue to vest even after termination of the holder's employment by the
Company.
59
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
OTHER
-----
In connection with a consulting agreement between the Company and a former
director of the Company, during August 2000, the former 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.
SFAS 123 DISCLOSURES
--------------------
Had compensation cost related to the warrants granted to employees been
determined based on the fair value at the grant dates, consistent with the
provisions of SFAS 123, the Company's pro forma net income (loss), and net
income (loss) per common share would have been as follows for the years
ended July 31,:
2000 2001 2002
----------- ------------- ----------
Net income (loss) as reported $1,460,781 $( 8,093,810) $4,122,595
Net income (loss) proforma (245,886) (10,855,577) 2,109,392
Net income (loss) per common share as reported .11 ( .57) .28
Net income (loss) per common share proforma (.02) ( .77) .14
Net income (loss) per common share assuming
dilution as reported .10 ( .57) .27
Net income (loss) per common share assuming
dilution proforma (.02) ( .77) .14
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.
The following assumptions were used for grants of warrants to employees in
the year ended July 31, 2002, to compute the fair value of the warrants
using the Black-Scholes option-pricing model; dividend yield of 0% expected
volatility of 87%; risk free interest rate of 3.59% and 4.72% depending on
expected lives; and expected lives of 5 years.
60
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
SFAS 123 DISCLOSURES - 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, 2000, 2001 and 2002, totaled $58,333, $222,988 and $374,870,
respectively. Warrants granted to non-employees simultaneously with the
issuance of debt are accounted for based on the guidance provided by APB
14, "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants".
A summary of the status of the Company's warrants as of July 31, 2000, 2001
and 2002, and changes during the years ending on those dates is presented
below:
2000 2001 2002
------------------------- --------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Warrants Shares Exercise Price Shares Exercise Price Shares Exercise Price
- --------------------------- ---------- --------------- ---------- --------------- ----------- ---------------
Outstanding at beginning of
year 2,591,136 $ 2.71 4,154,988 $ 3.82 4,377,488 $ 3.67
Granted 2,478,738 4.36 1,395,000 3.82 60,000 3.84
Exercised (914,886) 2.16 ( 922,500) 2.33 ( 442,183) 1.98
Expired - - (250,000) 6.00 ( 83,750) 3.69
---------- ---------- -----------
Outstanding at end of year 4,154,988 3.82 4,377,488 3.67 3,911,555 3.87
========== ========== ===========
Warrants exercisable at end
of year 2,946,653 3,451,251 3,574,027
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:
2000 2001 2002
---------------------------- --------------------------- -----------------------------
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 $ 2.69 $ 3.84
Exceeds market price 2.96 4.21 1.84 4.16 - -
Less than market price 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,
2000, 2001 and 2002, respectively: dividend yield of 0% for all three
years; expected volatility of 92%, 92% and 87%; risk-free interest rate of
6.02%, 6.02% and 3.59 to 4.72% depending on expected lives; and expected
lives of 3 to 5, 3 to 5 and 5 years.
61
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J - STOCK WARRANTS - CONTINUED
SFAS 123 DISCLOSURES - CONTINUED
---------------------
The following table summarizes information about the warrants outstanding
at July 31, 2002:
Warrants Outstanding Warrants Exercisable
-------------------------- ------------------------
Weighted
Number Number Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
at Contractual Exercise at Exercise
Range of Exercise Prices July 31, 2002 Life Price July 31, 2002 Price
------------------------- ------------- ----------- --------- ------------- ---------
2.50 to $3.00 1,685,917 1.89 years $ 2.51 1,685,917 $ 2.51
3.66 to $3.99 90,000 2.07 3.71 87,060 3.71
4.00 to $4.05 225,638 .93 4.00 225,308 4.00
4.60 to $6.69 1,660,000 2.51 4.78 1,399,897 4.75
6.94 to $7.00 250,000 3.14 6.99 175,845 6.98
------------- -------------
2.50 to $7.00 3,911,555 2.18 $ 3.87 3,574,027 $ 3.73
============= =============
NOTE K - COMMITMENTS AND CONTINGENCIES
LITIGATION
On March 16, 1999, the Company settled a lawsuit in mediation with its
former chairman of the board, Jorge V. Duran. The total settlement costs
recorded by the Company at July 31, 1999, was $456,300. The parties had
agreed to extend the date on which the payments were required in connection
with the settlement including the issuance of the common stock. On July 26,
2000, the parties executed final settlement agreements whereby the Company
paid the required cash payment of $150,000. During September 2000, the
Company issued the required stock.
On July 10, 2001, litigation was filed in the 164th Judicial District Court
of Harris County, Texas by Jorge V. Duran and Ware, Snow, Fogel & Jackson
L.L.P. against the Company alleging breach of contract, common law fraud
and statutory fraud in connection with the settlement agreement between the
parties dated July 26, 2000. Plaintiffs 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.
62
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
LITIGATION - CONTINUED
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 L).
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 and Penn Wilson have both
been dismissed from the litigation pursuant to a summary judgment.
Omnitrans is appealing the summary judgments in favor of the Company and
Penn Wilson. 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 plaintiffs are
seeking damages in the amount of $750,000. The Company believes that the
complaint is without merit and intends to vigorously defend against the
lawsuit.
On October 11, 2001, litigation was filed in the 197th Judicial District
Court of Cameron County, Texas by the Company against Tanner Pipeline
Services, Inc. ("Tanner"); Cause No. 2001-10-4448-C alleging negligence and
aided breaches of fiduciary duties on behalf of CPSC in connection with the
construction of the US Pipelines. The Company is seeking damages. Discovery
is continuing in this matter. After July 31, 2002, Tanner sent notice of
its intent to seek its attorneys fees as a sanction in the event it
prevails in the action. Trial is set for February 24, 2003.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company believes that the liabilities, if any,
ultimately resulting from such proceedings, lawsuits and claims, including
those discussed above, should not materially affect its consolidated
financial statements.
AWARD FROM LITIGATION
For the year ended July 31, 2000, the Company recognized a gain of
$3,036,638 which represents the amount of an Award from litigation from a
lawsuit that originated in 1994.
63
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
CREDIT FACILITY AND LETTERS OF CREDIT
As of July 31, 2002, the Company has a $13,000,000 credit facility with RZB
Finance L.L.C. (RZB) through December 31, 2002 (will be reduced to
$10,000,000 after December 31, 2002 unless RZB authorizes an extension) for
demand loans and standby letters of credit (RZB Credit Facility) to finance
the Company's purchases of LPG. Under the RZB Credit Facility, the Company
pays a fee with respect to each letter of credit thereunder in an amount
equal to the greater of (i) $500, (ii) 2.5% of the maximum face amount of
such letter of credit, or (iii) such higher amount as may be agreed to
between the Company and RZB. Any loan amounts outstanding under the RZB
Credit Facility shall accrue interest at a rate equal to the rate announced
by the Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to the
RZB Credit Facility, RZB has sole and absolute discretion to limit or
terminate 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 H and L).
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)(until September 30, 2002), 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, 2002, the Company's
borrowings and commitments exceeded the amount of the Assets which included
$29,701 in cash, by approximately $2,400,000 (Asset Deficit). Subsequent to
July 31, 2002, RZB has continued to fund and issue letters of credit to the
Company despite the Asset Deficit.
Interest costs associated with the RZB Credit Facility totaled $513,392,
$839,130, and $452,164 for the years ended July 31, 2000, 2001 and 2002.
64
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
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, and at any time
by giving twelve months notice. Upon termination by the lessor, the lessor
has the obligation to reimburse the Company the lesser of 1) net book value
of its liquid propane gas terminal at the time of such termination or 2)
$2,000,000.
The Pipeline Lease currently expires on December 31, 2013, pursuant to an
amendment (Pipeline Lease Amendment) entered into between the Company and
Seadrift on May 21, 1997, which became effective on January 1, 1999
(Effective Date). The Pipeline Lease Amendment provides, among other
things, for additional storage access and inter-connection with another
pipeline controlled by Seadrift, thereby providing greater access to and
from the Leased Pipeline. Pursuant to the Pipeline Lease Amendment, the
Company's fixed annual rent for the use of the Leased Pipeline 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) originally was due to expire in October
2003. During December 2001 the Company extended the Brownsville Lease until
November 30, 2006. The Company has an option to renew for five additional
five year terms. The rent may be adjusted in accordance with the terms of
the agreement. The annual rental amount is approximately $75,000.
The Brownsville Lease provides, among other things, that if the Company
complies with all the conditions and covenants therein, the leasehold
improvements made to the Brownsville Terminal Facility by the Company may
be removed from the premises or otherwise disposed of by the Company at the
termination of the Brownsville Lease. In the event of a breach by the
Company of any of the conditions or covenants, all improvements owned by
the Company and placed on the premises shall be considered part of the real
estate and shall become the property of the District.
The Company leases the land on which its Tank Farm is located. The lease
amount is approximately $27,000 annually. The lease was originally due to
expire on January 18, 2005. During December 2001 the Company extended the
lease until November 30, 2006. The Company has an option to renew for five
additional five year terms. The rent may be adjusted in accordance with the
terms of the agreement.
65
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED
OPERATING LEASE COMMITMENTS - CONTINUED
Rent expense was as follows for the years ended July 31,:
2000 2001 2002
------------ ------------ ------------
Minimum Rent Expense $ 1,495,326 $ 2,067,620 $ 2,020,129
Variable Rent Expense 708,213 783,297 1,218,843
------------ ------------ ------------
Total $ 2,203,539 $ 2,850,917 $ 3,238,972
============ ============ ============
As of July 31, 2002, 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,
--------------------
2003 $ 1,539,782
2004 1,449,887
2005 1,391,678
2006 1,382,462
2007 1,310,821
Thereafter 7,225,000
-----------
$14,299,630
===========
EMPLOYMENT CONTRACTS
During the period February 1, 2001 through July 28, 2002, the Company
continued the terms of the previous six year employment agreement with the
President which had expired on January 31, 2001. Effective July 29, 2002,
the Company entered into a new three year employment agreement with the
President (Agreement). Under the terms of the Agreement, the President is
entitled to receive a monthly salary equal to $25,000 and a minimum annual
bonus payment equal to $100,000 plus five percent (5%) of net income before
taxes of the Company. In addition, the President is entitled to receive a
warrant grant by December 31, 2002 in an amount and with terms comensurate
with prior practices.
In connection with the Agreement, the Company also agreed to forgive any
interest due from the President pursuant to the President's Promissory
Note, provided that the President guarantees at least $2,000,000 of the
Company's indebtedness during any period of that fiscal year of the
Company. Furthermore, the Company agreed to forgive the President's
Promissory Note in the event that either (a) the share price of the
Company's common stock trades for a period of 90 days at a blended average
price equal to $6.20, or (b) the Company is sold for a price per share (or
an asset sale realizes revenues per share) equal to $6.20.
Aggregate compensation under employment agreements totaled $338,500,
$300,000 and $619,436 for the years ended July 31, 2000, 2001 and 2002,
respectively, which included agreements with former executives.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
include cash balances at banks which at times exceed the federal deposit
insurance.
NOTE L - 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].
66
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On July 2, 1998, PennMex (see note M), 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. 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 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. 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.
67
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L - ACQUISITION OF PIPELINE INTERESTS - CONTINUED
In connection with the Settlement, the Company agreed to pay CPSC
$5,800,000 (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 (CPSC Note) (payable
in 36 monthly installments of approximately $46,000, including interest at
9% per annum) and $900,000 (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 H and K). 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 (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 H). 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 had been included as part of
the cost of the Acquired Assets in the consolidated financial statements as
of 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.
68
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M - ACQUISITION OF MEXICAN SUBSIDIARIES
Effective April 1, 2001, the Company completed the purchase of 100% of the
outstanding common stock of both Termatsal and PennMex (Mexican
Subsidiaries), previous affiliates of the Company which were principally
owned by 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 and 2002. 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.
NOTE N - MEXICAN OPERATIONS
Under current Mexican law, foreign ownership of Mexican entities involved
in the distribution of LPG or the operation of LPG terminal facilities is
prohibited. Foreign ownership is permitted in the transportation and
storage of LPG. Mexican law also provides that a single entity is not
permitted to participate in more than one of the defined LPG activities
(transportation, storage or distribution). PennMex has a transportation
permit and the Mexican Subsidiaries own, lease, or are in the process of
obtaining the land or rights of way used in the construction of the Mexican
portion of the US-Mexico Pipelines, and own the Mexican portion of the
assets comprising the US-Mexico Pipelines, the Matamoros Terminal Facility
and the Satillo Terminal. The Company's Mexican affiliate, Tergas, S.A. de
C.V. (Tergas), has been granted the permit to operate the Matamoros
Terminal Facility and the Company relies on Tergas' permit to continue its
delivery of LPG at the Matamoros Terminal Facility. Tergas is owned 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 Mexican withholding taxes.
NOTE O - FOURTH QUARTER ADJUSTMENTS - UNAUDITED
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 above amounts previously estimated, and (iii) an
adjustment to reduce sales of approximately $507,000.
The net income for the quarter ended July 31, 2002, included the following
material fourth quarter adjustments: (i) approximately $170,000 for reduced
through-put fees previously estimated in a prior quarter and (ii)
approximately $270,000 related to LPG costs incurred in a prior quarter
above amounts previously estimated.
69
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - 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 and continues to have a deficit in working capital.
In addition, significantly all of the Company's assets are pledged or
committed to be pledged as collateral on existing debt in connection with
the New Accepting Noteholders' notes, the RZB Credit Facility and the notes
related to the Settlement. The New Accepting Noteholders' notes, which
total approximately $3,085,000 at October 4, 2002, are due on December 15,
2002. In addition, the Company has entered into supply agreements for
quantities of LPG totaling approximately 24,000,000 gallons per month
adjusted for El Paso (actual deliveries have been approximately 21,700,000
gallons per month during the year ended July 31, 2002 adjusted for El Paso)
although the Contract provides for lesser quantities (see note Q). 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 New
Accepting Noteholders' notes, raise additional equity capital, resolve
uncertainties related to the Saltillo Terminal 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, (ii) increase the number of customers assuming
deregulation of the LPG industry in Mexico, (iii) extend the terms of the
Pipeline Lease, (iv) expand its product lines, (v) obtain additional
letters of credit financing, (vi) raise additional debt and/or equity
capital, (vii) increase the current credit facility and (viii) relocate the
Saltillo Terminal to another location near Satillo, Coahuila, Mexico.
At July 31, 2002, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $6,700,000. 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.
70
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - 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.
Upon the expiration of the Old Agreements, PMI confirmed to the Company in
writing (Confirmation) on April 26, 2001, the terms of a new agreement
effective April 1, 2001, subject to revisions to be provided by PMI's legal
department. The Confirmation provided for minimum monthly volumes of
19,000,000 gallons at indexed variable posted prices plus premiums that
provide the Company with annual fixed margins, which increase annually over
a three-year period. The Company was also entitled to receive additional
fees for any volumes which were undelivered. From April 1, 2001 through
December 31, 2001, the Company and PMI operated under the terms provided
for in the Confirmation. During January 1, 2002 through February 28, 2002,
PMI purchased monthly volumes of approximately 17,000,000 gallons per month
at slightly higher premiums then those specified in the Confirmation.
From April 1, 2001 through November 30, 2001, the Company sold to PMI
approximately 39,600,000 million gallons (Sold LPG) for which PMI had not
taken delivery. The Company received the posted price plus other fees on
the sold LPG but did not receive the fixed margin referred to in the
Confirmation (see note B9. At July 31, 2001, the obligation to deliver LPG
totaled approximately $11,500,000 million related to such sales
(approximately 26,600,000 million gallons). During the period from December
1, 2001 through March 31, 2002, the Company delivered to PMI the Sold LPG.
Effective March 1, 2002, the Company and PMI entered into a contract for
the minimum monthly sale of 17,000,000 gallons of LPG, subject to monthly
adjustments based on seasonality (Contract). The Contract expires on May
31, 2004, except that the Contract may be terminated by either party on or
after May 31, 2003 upon 90 days written notice, or upon a change of
circumstances as defined under the Contract.
In connection with the Contract, the parties also executed a settlement
agreement (Settlement Agreement), whereby the parties released each other
in connection with all disputes between the parties arising during the
period April 1, 2001 through February 28, 2002, and previous claims related
to the contract for the period April 1, 2000 through March 31, 2001.
PMI uses the Matamoros Terminal Facility to load LPG purchased from the
Company for distribution by truck in Mexico. The Company continues to use
the Brownsville Terminal Facility in connection with LPG delivered by
railcar to other customers, storage and as an alternative terminal in the
event the Matamoros Terminal Facility cannot be used temporarily.
71
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - CONTRACTS - CONTINUED
LPG SALES TO PMI - CONTINUED
Revenues from PMI totaled approximately $110,800,000 for the year ended
July 31, 2002, representing approximately 77.9% of total revenues for the
period.
LPG SUPPLY AGREEMENTS
Effective October 1, 1999, the Company and Exxon entered into a ten year
LPG supply contract, as amended (Exxon Supply Contract), whereby Exxon has
agreed to supply and the Company has agreed to take, 100% of Exxon's owned
or controlled volume of propane and butane available at Exxon's King Ranch
Gas Plant (Plant) up to 13,900,000 gallons per month blended in accordance
with required specifications (Plant Commitment). For the year ending July
31, 2002, under the Exxon Supply Contract, Exxon has supplied an average of
approximately 14,300,000 gallons of LPG per month. The purchase price is
indexed to variable posted prices.
In addition, under the terms of the Exxon Supply Contract, Exxon made its
Corpus Christi Pipeline (ECCPL) operational in September 2000. The ability
to utilize the ECCPL allows the Company to acquire an additional supply of
propane from other propane suppliers located near Corpus Christi, Texas
(Additional Propane Supply), and bring the Additional Propane Supply to the
Plant (ECCPL Supply) for blending to the required specifications and then
delivered into the Leased Pipeline. The Company agreed to flow a minimum of
122,000,000 gallons per year of Additional Propane Supply through the ECCPL
until September 2004. The Company is required to pay minimum utilization
fees associated with the use of the ECCPL until September 2004. Thereafter
the utilization fee will be based on the actual utilization 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 agreed to supply and
the Company agreed to take, a monthly average of 2,500,000 gallons of
propane (El Paso Supply) beginning in October 1999 expiring at September
30, 2002. The El Paso Supply Agreement was not renewed. The purchase price
was 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. For the year ending July 31, 2002, under the Koch
Supply Contract, Koch has supplied an average of approximately 5,300,000
gallons of propane per month. The purchase price is indexed to variable
posted prices. Furthermore, the Company was required to pay additional
charges associated with the construction of a new pipeline interconnection
which was paid through additional adjustments to the purchase price
(totaling approximately $1,000,000) which allows deliveries of the Koch
Supply into the ECCPL.
Under the terms of the Koch Supply Contract, the Koch Supply is delivered
into the ECCPL and blended to the required specifications.
72
Penn Octane Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q - 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 24,000,000 gallons per month
adjusted for El Paso (actual deliveries have been approximately 21,700,000
gallons per month during the year ended July 31, 2002 adjusted for El
Paso), although the Contract provides for lesser quantities.
In addition to the LPG costs charged by the Suppliers, the Company also
incurs additional costs to deliver LPG to the Company's facilities.
Furthermore, the Company may incur significant additional costs associated
with the storage, disposal and/or changes in LPG prices resulting from the
excess of the Plant Commitment, Koch Supply or Duke Supply over actual
sales volumes. Under the terms of the Supply Contracts, the Company must
provide letters of credit in amounts equal to the cost of the product to be
purchased. In addition, the cost of the product purchased is tied directly
to overall market conditions. As a result, the Company's existing letter of
credit facility may not be adequate to meet the letter of credit
requirements under the agreements with the Suppliers or other suppliers due
to increases in quantities of LPG purchased and/or to finance future price
increases of LPG.
NOTE R - SUBSEQUENT EVENTS - UNAUDITED
During October 2002, the Company agreed to accept the assets,
collateralizing the $214,355 note (see note D), having a fair value of
approximately $800,000 owned by an officer and a director of the Company
and Buyer (Officer) as full satisfaction of the Officer's stock note
($498,000) and promissory note ($214,355) owed to the Company (see note D).
73
Schedule II
PENN OCTANE CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 2002, 2001 AND 2000
Balance at Charged to
Beginning of Costs and Charged to Balance at End
Description Period Expenses Other Accounts Deductions of Period
- ---------------- ------------- ------------ --------------- ------------ ---------------
Year ended July
- ----------------
31, 2002
- --------
Allowance for
doubtful
accounts $ 779,663 $ 5,783 $ - $ (779,663) $ 5,783
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
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
74
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 2002
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 22, 2002.
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 2002
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 22, 2002.
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 2002
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 22, 2002.
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 2002
Annual Meeting of Stockholders, which Proxy Statement will be filed with
the Securities and Exchange Commission on or about November 22, 2002.
75
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, 2001 and 2002
Consolidated Statements of Operations for the years ended
July 31, 2000, 2001 and 2002
Consolidated Statement of Stockholders' Equity for the years
ended July 31, 2000, 2001 and 2002
Consolidated Statements of Cash Flows for the years ended
July 31, 2000, 2001 and 2002
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).
76
10.2 Promissory Note and Pledge and Security Agreement dated
March 26, 1997 between M.I. Garcia Cuesta and the
Registrant. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly
period ended April 30, 1997 filed on June 16, 1997, SEC
File No. 000-24394).
10.3 Promissory Note and Pledge and Security Agreement dated
April 11, 1997 between Jerome B. Richter and the
Registrant. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly
period ended April 30, 1997 filed on June 16, 1997, SEC
File No. 000-24394).
10.4 Lease dated October 20, 1993 between Brownsville
Navigation District of Cameron County, Texas and
Registrant with respect to the Company's land lease
rights, including related amendment to the Lease dated
as of February 11, 1994 and Purchase Agreement.
(Incorporated by reference to the Company's Quarterly
Report on Form 10-QSB filed for the quarterly period
ended April 30, 1994 on February 25, 1994, SEC File No.
000-24394).
10.5 Lease Amendment dated May 7, 1997 between Registrant
and Brownsville Navigation District of Cameron County,
Texas. (Incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarterly
period ended April 30, 1997 filed on June 16, 1997, SEC
File No. 000-24394).
10.6 Lease dated September 1, 1993 between Seadrift Pipeline
Corporation and Registrant with respect to the
Company's pipeline rights. (Incorporated by reference
to the Company's Quarterly Report on Form 10-QSB for
the quarterly period ended October 31, 1993 filed on
March 7, 1994, SEC File No. 000-24394).
10.7 Lease Amendment dated May 21, 1997 between Seadrift
Pipeline Corporation and the Registrant. (Incorporated
by reference to the Company's Quarterly Report on Form
10-QSB for the quarterly period ended April 30, 1997
filed on June 16, 1997, SEC File No. 000-24394).
10.8 Continuing Agreement for Private Letters of Credit
dated October 14, 1997 between RZB Finance LLC and the
Company. (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31,
1997 filed on November 13, 1997, SEC File No.
000-24394)
10.9 Promissory Note dated October 14, 1997 between RZB
Finance LLC and the Company. (Incorporated by reference
to the Company's Annual Report on Form 10-K for the
year ended July 31, 1997 filed on November 13, 1997,
SEC File No. 000-24394)
10.10 General Security Agreement dated October 14, 1997
between RZB Finance LLC and the Company. (Incorporated
by reference to the Company's Annual Report on Form
10-K for the year ended July 31, 1997 filed on November
13, 1997, SEC File No. 000-24394)
10.11 Guaranty and Agreement dated October 14, 1997 between
RZB Finance LLC and Jerome Richter. (Incorporated by
reference to the Company's Annual Report on Form 10-K
for the year ended July 31, 1997 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)
77
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).
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).
78
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).
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).
79
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).
10.40 Promissory Share Transfer Agreement to purchase shares
of Penn Octane de Mexico, S.A. de C.V. dated November
13, 2000, between Juan Jose Navarro Plascencia and Penn
Octane International, L.L.C. (Translation from
Spanish). (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended July 31,
2000, filed on November 14, 2000, SEC File No.
000-24394).
10.41 Promissory Note and Pledge and Security Agreement dated
November 30, 2000, between Western Wood Equipment
Corporation and the Registrant. (Incorporated by
reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 2000,
filed on December 12, 2000, SEC File No. 000-24394).
10.42 Form of Amendment to Promissory Note (the "Note") of
Penn Octane Corporation (the "Company") due December
15, 2001, and related agreements and instruments dated
November 28, 2001, between the Company and the holders
of the Notes. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the
quarterly period ended October 31, 2001 filed on
December 17, 2001, Sec File No. 000-24394).
10.43 LPG sales agreement entered into as of March 1, 2002 by
and between Penn Octane Corporation ("Seller") and
P.M.I. Trading Limited ("Buyer"). (Incorporated by
reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended April 30, 2002
filed on June 13, 2002, Sec File No. 000-24394).
10.44 Settlement agreement, dated as of March 1, 2002 by and
between P.M.I. Trading Limited and Penn Octane
Corporation. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 2002 filed on June 13,
2002, Sec File No. 000-24394).
10.45 Form of Amendment to Promissory Note (the "Note") of
Penn Octane Corporation (the "Company") due June 15,
2002, and related agreements and instruments dated June
5, 2002, between the Company and the holders of the
Notes. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period
ended April 30, 2002 filed on June 13, 2002, Sec File
No. 000-24394).
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:
21 Subsidiaries of the Registrant.
23 Consent of Independent Certified Public Accountant
99.1 Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes - Oxley
Act of 2002.
80
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 4, 2002
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 4, 2002
- ----------------------- Chairman, President and Chief
Executive Officer
/s/Jorge R. Bracamontes Jorge R. Bracamontes November 4, 2002
- ----------------------- Executive Vice President,
Secretary and Director
/s/Ian T. Bothwell Ian T. Bothwell November 4, 2002
- ----------------------- Vice President, Treasurer,
Assistant Secretary, Chief
Financial Officer, Principal
Accounting Officer and Director
/s/Stewart J. Paperin Stewart J. Paperin November 4, 2002
- ----------------------- Director
/s/Harvey L. Benenson Harvey L. Benenson November 4, 2002
- ----------------------- Director
/s/Emmett Murphy Emmett Murphy November 4, 2002
- ----------------------- Director
81
CERTIFICATIONS
I, Jerome B. Richter, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Penn Octane
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
/s/ Jerome B. Richter
-------------------------------
I, Ian T. Bothwell, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Penn Octane
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
/s/ Ian T. Bothwell
-------------------------------
82