UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended January 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _________________
Commission file number: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction (I.R.S.
of Incorporation or Organization) Employer Identification No.)
900 VETERANS BOULEVARD, SUITE 240, REDWOOD CITY, CALIFORNIA 94063
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (415) 368-1501
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
----
The number of shares of Common Stock, par value $.01 per share, outstanding
on March 12, 1999 was 10,821,557.
1
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PENN OCTANE CORPORATION
TABLE OF CONTENTS
ITEM PAGE NO.
---- --------
<S> <C> <C> <C>
Part I 1.
Consolidated Balance Sheets as of January 31, 1999 (unaudited) 3-4
and July 31, 1998
Consolidated Statements of Operations for the three and six months
ended January 31, 1999 and 1998 (unaudited) 5
Consolidated Statements of Cash Flows for the six months
ended January 31, 1999 and 1998 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7-17
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 18-24
Part II 1. Legal Proceedings 25
2. Changes in Securities 25
3. Defaults Upon Senior Securities 25
4. Submission of Matters to a Vote of Security Holders 25
5. Other Information 25
6. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 25-27
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2
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PART I
ITEM 1.
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PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
January 31,
1999 July 31,
(Unaudited) 1998
------------- ----------
<S> <C> <C>
Current Assets
Cash $ 510,992 $ 157,513
Trade accounts receivable, less allowance for doubtful accounts of $418,796 and $418,796 1,584,444 1,195,653
Inventories (note D) 425,189 377,097
Prepaid expenses and other current assets 314,276 95,775
------------- ----------
Total current assets 2,834,901 1,826,038
Property, plant and equipment - net (note C) 3,052,899 3,001,387
Lease rights (net of accumulated amortization of $501,457 and $478,560) 652,582 675,479
CNG assets held for sale (note E) 1,100,000 1,100,000
Other noncurrent assets 140,050 95,077
------------- ----------
Total assets $ 7,780,432 $6,697,981
============= ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
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PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
LIABILITIES AND STOCKHOLDERS' EQUITY
January 31,
1999 July 31,
(Unaudited) 1998
--------------- ---------------
<S> <C> <C>
Current Liabilities
Current maturities of long-term debt (notes G, H and M) $ 1,697,603 $ 1,693,897
Revolving line of credit (note I) 587,501 991,823
Trade accounts payable 2,438,090 2,050,575
Borrowings from IBC-Brownsville (note L) - 672,552
1,301,716 1,555,262
--------------- ---------------
Accrued liabilities
Total current liabilities 6,024,910 6,964,109
Long-term debt, less current maturities (note G) - 60,000
Commitments and contingencies (note I) - -
Stockholders' Equity (note H)
Senior Preferred stock-$.01 par value, 5,000,000 shares authorized; 0
shares issued and outstanding at January 31, 1999 and July 31, 1998 - -
Preferred stock-$.01 par value, 5,000,000 shares authorized; 0
convertible shares issued and outstanding at January 31, 1999 and July 31,
1998 - -
Common stock-$.01 par value, 25,000,000 shares authorized;
10,771,557 and 9,952,673 shares issued and outstanding at January 31, 1999
and July 31, 1998 107,716 99,527
Additional paid-in capital 14,572,865 13,318,592
Notes receivable from the president of the Company and a related party
for exercise of warrants, less reserve of $223,000 at January 31, 1999 and
July 31, 1998 ( 2,763,006) ( 2,763,006)
Accumulated deficit ( 10,162,053) ( 10,981,241)
--------------- ---------------
Total stockholders' equity 1,755,522 ( 326,128)
--------------- ---------------
Total liabilities and stockholders' equity $ 7,780,432 $ 6,697,981
=============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
4
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PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
---------------------------- ----------------------------
January 31, January 31, January 31, January 31,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 8,353,027 $ 9,813,766 $ 14,831,593 $ 16,356,247
Cost of goods sold 7,413,785 8,805,890 13,323,218 15,055,308
------------- ------------- ------------- -------------
Gross profit 939,242 1,007,876 1,508,375 1,300,939
------------- ------------- ------------- -------------
Selling, general and administrative expenses
Legal and professional fees 223,617 223,926 426,699 348,019
Salaries and payroll related expenses 228,870 203,317 416,698 332,407
Travel 43,740 22,306 80,105 81,099
Other 148,465 154,752 258,200 179,219
------------- ------------- ------------- -------------
644,692 604,301 1,181,702 940,744
------------- ------------- ------------- -------------
Operating income 294,550 403,575 326,673 360,195
Other income (expense)
Interest expense ( 200,681) ( 100,510) ( 293,074) ( 159,609)
Interest income 879 59,356 1,297 116,860
Award from litigation (note L) 987,114 - 987,114 -
------------- ------------- ------------- -------------
Income from continuing operations
before taxes 1,081,862 362,421 1,022,010 317,446
Provision for income taxes - - - -
------------- ------------- ------------- -------------
Income from continuing
operations 1,081,862 362,421 1,022,010 317,446
Discontinued operations, net of taxes (note E)
(Loss) from operations of CNG segment ( 121,403) ( 103,744) ( 202,822) ( 183,217)
------------- ------------- ------------- -------------
Net income $ 960,459 $ 258,677 $ 819,188 $ 134,229
============= ============= ============= =============
Income from continuing operations
per common share (note B) $ 0.10 $ 0.02 $ 0.10 $ 0.01
============= ============= ============= =============
Net income (loss) per
common share (note B) $ 0.09 $ 0.00 $ 0.08 $ ( 0.01)
============= ============= ============= =============
Income from continuing
operations per common share
assuming dilution (note B) $ 0.10 $ 0.01 $ 0.10 $ 0.01
============= ============= ============= =============
Net income (loss) per
common share assuming
dilution (note B) $ 0.09 $ 0.00 $ 0.08 $ ( 0.01)
============= ============= ============= =============
Weighted average common shares outstanding 10,479,319 8,716,337 10,215,996 8,620,819
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
5
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PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
-----------------------------
January 31, January 31,
1999 1998
------------- --------------
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INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net income $ 819,188 $ 134,229
Adjustments to reconcile net income to net cash used in (provided by) operating
Activities:
Depreciation and amortization 159,291 142,946
Amortization of lease rights 22,897 22,897
Amortization of loan discount 94,255 28,125
Interest income from related party notes receivables - ( 115,008)
Award from litigation ( 987,114) -
Changes in current assets and liabilities:
Trade accounts receivable ( 388,874) ( 1,957,631)
Related party receivable 82 47,809
Costs and estimated earnings in excess of billing on uncompleted contracts - 133,218
Inventories ( 48,092) ( 118,937)
Prepaids and other current assets 54,375 ( 85,155)
Deferred registration costs - ( 473,132)
Construction and trade accounts payable 413,793 2,274,019
Billings in excess of costs and estimated earnings on uncompleted contracts - ( 7,596)
Other assets and liabilities ( 48,568) ( 99,514)
Accrued liabilities 75,847 269,819
------------- --------------
Net cash provided by operating activities 167,080 196,089
Cash flows from investing activities:
Capital expenditures ( 170,485) ( 75,449)
CNG assets held for sale - ( 664,405)
------------- --------------
Net cash used in investing activities ( 170,485) ( 739,854)
Cash flows from financing activities:
Revolving credit facilities ( 404,332) ( 140,000)
Issuance of debt 43,706 1,500,000
Issuance of Common Stock 717,500 1,131,250
Reduction in debt - ( 923,395)
------------- --------------
Net cash provided by financing activities 356,884 1,567,855
------------- --------------
Net increase in cash 353,479 1,024,090
Cash at beginning of period 157,513 31,142
------------- --------------
Cash at end of period $ 510,992 $ 1,055,232
============= ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 125,800 $ 129,007
============= ==============
Supplemental disclosures of noncash transactions:
Common stock and warrants issued $ 144,883 $ 263,000
============= ==============
</TABLE>
The accompanying notes are an integral part of these statements.
6
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - ORGANIZATION
Penn Octane Corporation, formerly International Energy Development Corporation
(IEDC) and The Russian Fund, a Delaware corporation, was incorporated on August
27, 1992. On October 21, 1993, IEDC acquired Penn Octane Corporation, a Texas
corporation, whose primary asset was a liquid petroleum gas (LPG) pipeline lease
agreement (Pipeline Lease) with Seadrift Pipeline Corporation (Seadrift), a
subsidiary of Union Carbide Corporation (Union Carbide). On January 6, 1995,
the Board of Directors approved the change of IEDC's name to Penn Octane
Corporation. The Company is engaged primarily in the business of purchasing,
transporting and selling LPG and has provided services and equipment to the
compressed natural gas (CNG) industry. Substantially all of the LPG sales
volume since inception has been to PMI Trading Limited (PMI), a subsidiary of
Petroleos Mexicanos (PEMEX), the Mexican state owned oil company.
In February 1997, the Company formed Wilson Acquisition Corporation, a Delaware
corporation and a wholly-owned subsidiary, for the purpose of engaging in the
business of designing, constructing, installing and servicing equipment for CNG
fueling stations and related products for use in the CNG industry throughout the
world. The subsidiary's name was changed to PennWilson CNG, Inc. (PennWilson)
in August 1997.
In October 1997, the Company formed Penn CNG Holdings, Inc. (Holdings), a
Delaware corporation and a wholly-owned subsidiary. In February 1998, the
Company formed PennWill, S.A. de C.V., Camiones Ecologicos, S.A. de C.V., Grupo
Ecologico Industrial, S.A. de C.V., Estacion Ambiental, S.A. de C.V., Estacion
Ambiental II, S.A. de C.V., and Serinc, S.A. de C.V. (collectively Estacion),
all Mexican corporations. To date there has not been significant operations for
any of these entities.
In March 1999, the Company approved the sale of certain CNG related assets
to a director and officer of the Company (see note E). As a result of the sale,
the Company will no longer be in the CNG business and has reflected the
historical results of the CNG segment as a discontinued operation. All prior
periods have been restated.
BASIS OF PRESENTATION
-----------------------
The accompanying financial statements include the Company and its
subsidiaries, PennWilson and Holdings (Company). All significant intercompany
accounts and transactions are eliminated.
The unaudited consolidated balance sheet as of January 31, 1999, the unaudited
consolidated statements of operations for the three and six months ended January
31, 1999 and 1998, and the unaudited consolidated statements of cash flows for
the six months ended January 31, 1999 and 1998 have been prepared by the Company
without audit. In the opinion of management, the financial statements include
all adjustments (which include only normal recurring adjustments) necessary to
present fairly the unaudited consolidated financial position of the Company as
of January 31, 1999 and the unaudited consolidated results of operations for the
three and six months ended January 31, 1999 and 1998, and unaudited consolidated
cash flows for the six months ended January 31, 1999 and 1998.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. These financial statements should be read in conjunction
with the financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the year ended July 31, 1998.
Certain reclassifications have been made to prior period balances to conform to
the current presentation. All reclassifications have been applied consistently
to the periods presented.
7
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE
Income (loss) per share of common stock is computed on the weighted average
number of shares outstanding. During periods in which the Company incurred
losses, giving effect to common stock equivalents is not presented as it would
be antidilutive.
The FASB issued Statement of Financial Accounting Standards No. 128 (SFAS 128),
"Earnings Per Share", which supersedes Accounting Principles Board Opinion No.
15 (APB 15), "Earnings Per Share". The statement became effective for financial
statements issued for periods ending after December 15, 1997, including interim
periods. Early adoption was not permitted.
The following table presents reconciliations from income (loss) per common share
to income (loss) per common share assuming dilution (see note H for the warrants
and convertible preferred stock):
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For the six months ended January 31, 1999 For the six months ended January 31, 1998
----------------------------------------- ------------------------------------------
Income (Loss) Shares Per-Share Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------- ------------- ---------- -------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Income (loss) from continuing
operations $ 1,022,010 - - $ 317,446 - -
--------------
Net income (loss) 819,188 - - 134,229 - -
--------------
Less: Dividends on preferred
stock - - - ( 225,000) - -
BASIC EPS
Income (loss) from continuing
operations available to
common stockholders 1,022,010 10,215,966 $ 0.10 92,446 8,620,819 $ 0.01
========== ===========
Net income (loss) available to
common stockholders 819,188 10,215,966 $ 0.08 ( 90,771) 8,620,819 $ ( 0.01)
========== ===========
EFFECT OF DILUTIVE SECURITIES
Warrants - 98,686 - - 916,962 -
Convertible Preferred Stock - - - - 989,041 -
DILUTED EPS
Income (loss) from continuing
operations available to
common stockholders 1,022,010 10,314,682 $ 0.10 92,446 10,526,822 $ 0.01
========== ===========
Net income (loss) available to
common stockholders $ 819,188 10,314,682 $ 0.08 n/a n/a n/a
============== ============= ========== ============== ============= ===========
</TABLE>
8
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE (CONTINUED)
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For the three months ended January 31, 1999 For the three months ended January 31, 1998
----------------------------------------- -----------------------------------------
Income (Loss) Shares Per-Share Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------- ------------- ---------- -------------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Income (loss) from continuing
operations $ 1,081,862 - - $ 362,421 - -
--------------
Net income (loss) 960,459 - - 258,677 - -
--------------
Less: Dividends on preferred
stock - - - ( 225,000) - -
BASIC EPS
Income (loss) from continuing
operations available to
common stockholders 1,081,862 10,479,319 $ 0.10 137,421 8,716,337 $ 0.02
========== ==========
Net income (loss) available to
common stockholders 960,459 10,479,319 $ 0.09 33,677 8,716,337 $ 0.00
========== ==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 19,396 - - 846,047 -
Convertible Preferred Stock - - - - 978,173 -
DILUTED EPS
Income (loss) from continuing
operations available to
common stockholders 1,081,862 10,498,715 $ 0.10 137,421 10,540,557 $ 0.01
========== ==========
Net income (loss) available to
common stockholders $ 960,459 10,498,715 $ 0.09 $ 33,677 10,540,557 $ 0.00
============== ============= ========== ============== ============= ==========
</TABLE>
9
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
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January 31, July 31,
1999 1998
-------------- --------------
<S> <C> <C>
LPG:
Building $ 173,500 $ 173,500
LPG terminal 3,426,440 3,426,440
Automobile and equipment 388,839 391,138
Office equipment 35,738 35,738
Capital construction in progress 329,347 75,389
Leasehold improvements 291,409 291,409
CNG:
Furniture, fixtures and equipment - 35,575
Automobiles - 3,500
Capital construction in progress - 45,485
8,575 8,575
Leasehold improvements -------------- --------------
4,653,848 4,486,749
Less: accumulated depreciation and
Amortization ( 1,600,949) ( 1,485,362)
-------------- --------------
$ 3,052,899 $ 3,001,387
============== ==============
NOTE D - INVENTORIES
Inventories consist of the following:
January 31, July 31,
1999 1998
-------------- --------------
LPG:
Pipeline $ 294,732 $ 276,938
LPG terminal 130,457 100,159
-------------- --------------
$ 425,189 $ 377,097
============== ==============
</TABLE>
10
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE E - DISCONTINUED OPERATIONS
In March 1999, the Company approved the sale of certain CNG related assets to a
company (Buyer) controlled by a director and officer of the Company. Under the
terms of the sale, Buyer will purchase approximately $1,100,000 of CNG assets
and the Company will receive promissory notes totaling $1,100,000. The
promissory notes are secured by certain assets to be acquired by Buyer and the
director and officer has pledged his stock in Buyer as well as 200,000 warrants
to purchase 200,000 shares of common stock of the Company, as additional
collateral. As a result of the sale, the Company has effectively disposed of
its CNG segment and discontinued operations. In accordance with APB 30, the
results of the CNG segment have been recorded as a discontinued operation for
all periods presented. The assets of the CNG segment to be sold are presented
separately at January 31, 1999 and July 31, 1998.
NOTE F - NYDOT CNG FUELING STATION
During the year ended July 31, 1998, the Company recorded additional revenues of
approximately $821,994 related to change-orders for additional work performed by
the Company in connection with the construction of equipment for a CNG fueling
station for the New York City Department of Transportation (NYDOT). The
change-orders have been submitted to the customer for approval. During March
1998, the Company was requested to furnish additional documentation with respect
to the submitted change-orders which was subsequently provided on May 15, 1998.
On April 30, 1998, the Company received notification from the general
contractor, A.E. Schmidt Environment ("AES"), that the Company was in default
under the agreement between AES and the Company relating to the NYDOT CNG
fueling station. The Company has responded to AES indicating that AES is in
default with the terms of the agreement and that the Company is awaiting
satisfactory resolution of these matters prior to completion of the remaining
work outlined under the agreement. The Company is currently exploring legal
remedies available. As of July 31, 1998, the Company revised its estimate
related to the work preformed in connection with the change-orders. As a result
of this revision the Company reduced revenues associated with the change-orders
by $500,000 and recorded an allowance for doubtful accounts of $321,994. In
connection with this contract, the Company does not anticipate a material amount
of additional costs associated with either completion of the contract or
subsequent warranties provided for in the contract.
For the three months and six months ended January 31, 1998, the Company had
recorded additional revenues of approximately $221,994 and $821,994,
respectively, related to change-orders in connection with the NYDOT CNG fueling
station.
11
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PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - LONG-TERM DEBT
Long-term debt consists of the following:
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January 31, July 31,
1999 1998
------------ ----------
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Contract for Bill of Sale; due in semi-annual payments of $22,469, including interest
at 11.8%; due in October 1998; collateralized by a building. $ 91,197 $ 91,197
Unsecured note with principal due in equal annual installments of $20,000
beginning June 5, 1998, plus interest at the prime rate due June 5, 2002 (note H). - 100,000
Note issued in connection with settlement of vendor obligation. Principal due in
monthly installments. 62,700 62,700
Promissory note to Seadrift, due February 1999 (paid February 1999). 43,706 -
1,500,000 in promissory notes, with warrants to purchase up to 250,000 shares of
common stock at an exercise price of $6.00 per share expiring October 21, 2000 and
warrants to purchase up to 337,500 shares of common stock at an exercise price of
1.75 per share expiring November 30, 2001; principal due June 30, 1999, or from
proceeds received by the Company from any public offering of debt or equity of the
Company in excess of $2,250,000. Promissory notes are secured by an assignment
of net proceeds received by the Company in connection with the Judgment; interest
at 10.0% on the principal amount of the promissory notes is due quarterly on March
31, June 30, September 30 and December 31. The effective interest rate after
consideration of the discount, is 18.0% per annum. Purchasers of the promissory
notes were granted one demand registration right with respect to the shares issuable
upon exercise of the warrants (note M). 1,500,000 1,500,000
------------ ----------
1,697,603 1,753,897
Current maturities. 1,697,603 1,693,897
------------ ----------
$ - $ 60,000
============ ==========
</TABLE>
NOTE H - STOCKHOLDERS' EQUITY
PREFERRED STOCK
----------------
On September 18, 1993, in a private placement, the Company issued 150,000 shares
of its $.01 par value, 11% convertible, cumulative non-voting preferred stock at
a purchase price of $10.00 per share. On June 10, 1994 the Company declared a
2-for-1 stock split. The preferred stock was convertible into voting shares of
common stock of the Company at a conversion ratio of one share of preferred
stock for 3.333 shares of common stock. On September 10, 1997, the Board of
Directors of the Company approved the issuance of an additional 100,000 shares
of common stock as an inducement for the preferred stockholders to convert the
shares of preferred stock and release all rights with respect to the preferred
stock. In January 1998, all 270,000 shares of the preferred stock were converted
into an aggregate of 999,910 shares of common stock of the Company. The
issuance of the additional 100,000 common shares was recorded as a preferred
stock dividend in the amount of $225,000 at January 30, 1998.
12
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - STOCKHOLDERS' EQUITY - Continued
COMMON STOCK
-------------
On November 13, 1998, the Company issued 250,000 shares of common
stock of the Company and warrants to purchase 125,000 shares of common stock
with an exercise price of $1.25 per warrant and an expiration date of November
12, 2000 for an amount of $250,000. Net proceeds from the sale were used for
working capital purposes.
On December 14, 1998, the Company issued 500,000 shares of common
stock of the Company and warrants to purchase 300,000 shares of common stock
with an exercise price of $1.75 per warrant and an expiration date of December
13, 2003 for an amount of $500,000. Net proceeds from the sale were used for
working capital purposes.
During December 1998, the Company issued 53,884 shares of common stock
of the Company to Zimmerman Holdings Inc. (ZHI), as payment for and full
cancellation of a note payable of $100,000 and related interest and other
obligations totaling $18,000 and the cancellation of any further obligation to
pay any future royalties in connection with Company's purchase of certain CNG
assets from Wilson Technologies Inc., a wholly owned subsidiary of ZHI.
During December, 1998, the Company issued 15,000 shares of common
stock of the Company and warrants to purchase 10,000 shares of common stock with
an exercise price of $3.25 per warrant and an expiration date of December 31,
2000 in exchange for cancellation of all outstanding obligations totaling
approximately $26,000 and other obligations as outlined in an agreement between
the parties.
STOCK AWARD PLAN
------------------
Under the Company's 1997 Stock Award Plan, the Company has reserved for issuance
150,000 shares of Common Stock, of which 129,686 shares were unissued as of
October 31, 1998, 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 to be granted and the times
such awards will be granted, interpret and construe the 1997 Stock Award Plan
for purposes of its administration and make determinations relating to the 1997
Stock Award 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.
In October 1997, the Company issued 20,314 shares of Common Stock to a
Mexican consultant in payment for services rendered to the Company valued at
$113,000 pursuant to the plan.
13
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES
LITIGATION
On August 24, 1994, the Company filed an Original Petition and Application for
Injunctive Relief against the International Bank of Commerce-Brownsville
("IBC-Brownsville"), a Texas state banking association, seeking (i) either
enforcement of a credit facility between the Company and IBC-Brownsville or a
release of the Company's property granted as collateral thereunder consisting of
significantly all of the Company's business and assets; (ii) declaratory relief
with respect to the credit facility; and (iii) an award for damages and
attorneys' fees. After completion of an arbitration proceeding, on February 28,
1996, the 197th District Court in and for Cameron County, Texas entered judgment
(the "Judgment") confirming the arbitral award for $3,246,754 to the Company by
IBC-Brownsville.
In connection with the lawsuit, IBC-Brownsville filed an appeal with the Texas
Court of Appeals on January 21, 1997. The Company responded on February 14,
1997. On September 18, 1997, the appeal was heard by the Texas Court of Appeals
and on June 18, 1998, the Texas Court of Appeals issued its opinion in the case,
ruling essentially in favor of the Company. IBC-Brownsville sought a rehearing
of the case on August 3, 1998. On December 30, 1998, The Court denied the
IBC-Brownsville request for rehearing. On February 16, 1999, IBC-Brownsville
filed a petition for review with the Supreme Court of Texas. As of January 31,
1999, the net amount of the Judgment is approximately $3.5 million, which is
comprised of (i) the original judgment, including attorneys' fees, (ii)
post-award interest, (iii) cancellation of the note and accrued interest payable
to IBC-Brownsville, less attorneys' fees. The decision to actually review the
case is solely up to the Supreme Court of Texas. Management of the Company
believes that if the Supreme Court of Texas should elect to review the case, the
Company will prevail.
For the three months ended January 31, 1999, the Company has recorded a gain of
approximately $987,000, which represents the amount of the Judgment which was
recorded as a liability on the Company's balance sheet at December 31, 1998 (see
note L). The remaining net amount of the Judgment to be realized by the Company
is approximately $2.4 million. The Company will record the remaining amount of
the Judgment when it realizes the proceeds associated with the Judgment.
On April 18, 1996, the Company reached an agreement (the "IBC Settlement
Agreement") to accept $400,000 to settle a lawsuit it filed in October 1995
against International Bank of Commerce-San Antonio, a bank related to
IBC-Brownsville ("IBC-San Antonio"). As part of the settlement agreement, the
parties, including IBC-Brownsville and IBC-San Antonio, executed mutual releases
from future claims related to the IBC-Brownsville litigation. Additionally,
IBC-San Antonio agreed to indemnify the Company for any such claims made or
asserted.
On June 26, 1996, IBC-Brownsville filed a suit against the Company (Case No.
96-06-3502) in the 357th Judicial District Court of Cameron County alleging that
the Company, in filing the Judgment against IBC-Brownsville in order to clear
title to its assets, slandered the name of IBC-Brownsville. IBC-Brownsville
contends that the Judgment against it prevented it from selling certain
property. IBC-Brownsville has claimed actual damages of $600,000 and requested
punitive damages of $2,400,000. On September 23, 1996, the court entered the
Judgment on behalf of the Company indicated in a preliminary ruling that the
Company was privileged in filing the Judgment to clear title to its assets.
On July 30, 1996, the Company filed suit in the District Court of Harris County,
Texas against Jorge V. Duran, former Chairman of the Board of the Company,
regarding alleged conversion and fraud by Mr. Duran during
14
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES - Continued
his time as an employee of the Company. The Company has not yet quantified its
damages and is seeking a declaration that the termination of employment of Mr.
Duran was lawful and within the rights of the Company based on Mr. Duran's
status as an at-will employee of the Company. On December 12, 1996, Mr. Duran
filed a counterclaim in the District Court of Harris County, Texas asserting the
following claims: breach of contract against the Company and Mr. Richter;
wrongful discharge against the Company, Mr. Richter, and Mr. Mark Casaday, a
former officer and director of the Company; defamation against the Company, Mr.
Richter, Mr. Mark Casaday, and Mr. Jorge Bracamontes; and interference with
contract against Mr. Jorge Bracamontes. On February 27, 1997, the two actions
were consolidated into Case No. 96-37447, Penn Octane Corporation v. Jorge V.
Duran in the 164th District Court of Harris County, Texas and on September 30,
1998, Mr. Duran filed a Fourth Amended Original Petition. Mr. Duran is seeking
judgment against the Company and Messrs. Richter, Casaday and Bracamontes for
damages in excess of $12.0 million, including prejudgment interest as provided
for by law, and attorneys' fees and such further relief to which he may be
justly entitled. The Company intends to vigorously defend against Mr. Duran's
counterclaim.
On October 14, 1998, a complaint was filed by Amwest Surety Insurance Company
("Amwest") naming as defendants, among others, PennWilson and the Company
seeking reimbursement for payments made to date by Amwest of approximately
$160,000 on claims made against the performance and payment bonds in connection
with services provided by suppliers, laborers and other materials and work to
complete the NYDOT contract. In addition, Amwest is seeking reimbursement of
approximately $600,000 for claims presented to Amwest against the performance
and payment bonds, but have not yet been authorized or paid to date by
Amwest. The Company is currently considering its legal options and intends to
file an answer to Amwest's complaint.
The Company and its subsidiaries are also involved with other proceedings,
lawsuits and claims. The Company is of the opinion that the liabilities, if
any, ultimately resulting from such proceedings, lawsuits and claims should not
materially affect its consolidated financial position.
CREDIT FACILITY, LETTERS OF CREDIT AND OTHER
In connection with the PMI Sales Agreement, invoicing occurs weekly. From
November 1996 to early November 1997, the Company and PMI made an arrangement
under which PMI provided financing on the Company's behalf under the terms of
the Company's supply agreement with Exxon, the Company's main supplier. As a
result of this arrangement, invoicing occurred on a monthly, rather than a
weekly basis.
On October 22, 1997, the Company entered into a $6,000,000 credit facility with
RZB Finance L.L.C. (RZB) for demand loans and standby letters of credit (RZB
Credit Facility) to finance the Company's purchase of LPG and propylene (PPL).
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)
1.5% of the maximum face amount of such letter of credit, or (iii) such higher
amount as may be agreed between the Company and RZB. Any amounts outstanding
under the RZB Credit Facility shall accrue interest at a rate equal to the rate
announced by the Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to
the RZB Credit Facility, RZB has sole and absolute discretion to terminate 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 mortgage, security interest and
assignment in any and all of the Company's 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 entered into leasehold deeds of
trust, security agreements, financing statements and assignments of rent. Under
the RZB Credit Facility, the Company may not permit to exist any 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. 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. Upon establishment of the RZB Credit Facility, beginning
November
15
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES - Continued
11, 1997, PMI no longer provided any financing on behalf of the Company, and the
Company began invoicing PMI on a weekly basis.
Effective April 22, 1998, the aggregate amount available under the RZB Credit
Facility was increased to $7,000,000. In January 1999, the fee charged for
letters of credit issued was increased to 2.5%.
In connection with the Company's purchases of LPG from Exxon and/or PG&E NGL
Marketing, L.P., the Company issues letters of credit on a monthly basis based
on anticipated purchases.
As of January 31, 1999, letters of credit established under the RZB Credit
Facility in favor of Exxon for purchases of LPG totaled $6,000,000 of which
$1,499,020 was being used to secure unpaid purchases from Exxon as of January
31, 1999. In addition, as of January 31, 1999, the Company had $587,501 of
loans outstanding under the RZB Credit Facility. In connection with these
purchases, as of January 31, 1999, the Company had unpaid invoices due from PMI
totaling $1,265,966 and cash balances maintained in the RZB Credit Facility
collateral account of $507,094.
During June 1998, a letter of credit was established under the RZB Credit
Facility in favor of PG&E NGL Marketing, L.P. for purchases of LPG totaling
$360,000. The letter of credit expired in August 1998.
During November 1998, a letter of credit was established under the RZB Credit
Facility in favor of PG&E NGL Marketing, L.P. for purchases of LPG totaling
$176,000. The letter of credit expired in January 1999.
NOTE J - REALIZATION OF ASSETS
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplate continuation of the
Company as a going concern. The Company has incurred losses since inception,
has used cash in operations, has a deficit in working capital and is delinquent
under certain loan and lease agreements. In addition, the Company is involved
in litigation, the outcome of which cannot be determined at the present time.
As discussed in note A, the Company has historically depended heavily on sales
to one major customer.
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 sheet is dependent upon the collection of the Judgment, the
Company's ability to obtain additional financing and to raise additional equity
capital, and the success of the Company's future operations. The 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 1) collect the Judgment, 2) increase
sales to its current customers, 3) increase its customer base, 4) extend the
terms and capacity of the Pipeline Lease and the Brownsville Terminal Facility,
5) expand its product lines and 6) raise additional debt and/or equity capital.
At July 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $8,826,000. 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.
16
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE K - CONTRACTS
LPG BUSINESS
The Company has entered into a sales agreement (Agreement) with its major
customer, PMI, to provide a minimum monthly volume of LPG to PMI through
September 30, 1999. During October 1998, the Company was purchasing LPG on a
month-to-month basis from Exxon Company, U.S.A. (Exxon), its major supplier, to
meet the minimum monthly volumes required in the Agreement. Effective November
1, 1998, the Company entered into a supply contract with Exxon to purchase
minimum monthly volumes of LPG through September 1999 under payment terms
similar to those required in the Agreement. The supply price is below the sales
price provided for in the Agreement.
LPG SUPPLY CONTRACT
Effective November 1, 1998, the Company entered into a supply contract with a
major supplier to purchase minimum monthly volumes of LPG through September 1999
under payment terms similar to those required in the Agreement. The supply
price is below the sales price provided for in the Agreement.
NOTE L - AWARD FROM LITIGATION
On December 31, 1998, the Company received notification from the Texas
Court of Appeals that the request by IBC-Brownsville for a rehearing of the
previous appellate decision upholding the judgment of The State District Court
(the "Judgment") against IBC-Brownsville in favor of the Company, was denied
(see note I).
As a result of this latest decision, IBC-Brownsville has now exhausted all legal
remedies under the appeals process available to it. On February 16, 1999,
IBC-Brownsville petitioned the Supreme Court of Texas to hear its case.
However, the decision to actually review the case is solely up to the Supreme
Court of Texas. If the Supreme Court of Texas should elect to review the case,
there is no certainty that the outcome of the Judgment will change.
As a result of the above, the Company will record the gain when it realizes the
proceeds associated with the Judgment. Due to the fact that the Judgment
included an offset related to a liability, which the Company had recorded on its
balance sheet, the Company has realized a portion of the Judgment, which relates
to that liability. When the cash portion of the Judgment is collected, the
Company will record the remaining amount of the Judgment.
For the three and six months ended January 31, 1999, the Company has recorded a
gain to the extent of the amount which was recorded as a liability on the
Company's balance sheet at December 31, 1998 totaling approximately $987,114.
NOTE M - SUBSEQUENT EVENTS
EXCHANGE OF PROMISSORY NOTES
On March 3, 1999, the Company completed an exchange of $900,000 of
promissory notes for 90,000 shares of the Company's Senior Preferred Stock (the
Senior Preferred Stock) at a purchase price of $10.00 per share. The Senior
Preferred Stock is non-voting and dividends are payable at a rate of 12%
annually, payable in cash or in kind, semi-annually. The Preferred Stock may be
converted in whole or in part at any time at a conversion ratio of one share of
Senior Preferred Stock for 4.0 shares of common stock of the Company. In
connection with the exchange, the holder of the Senior Preferred Stock received
50,000 shares of common stock of the Company and may receive an additional
50,000 shares of common stock of the Company, if the Senior Preferred Stock is
not redeemed by the Company prior to September 3, 1999.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the Company's results of operations and
liquidity and capital resources should be read in conjunction with the
Consolidated Financial Statements of the Company and related Notes thereto
appearing elsewhere herein. References to specific years preceded by "fiscal"
(e.g. fiscal 1999) refer to the Company's fiscal year ended July 31. The
results of operations related to the Company's CNG segment, primarily consisting
of PennWilson, which began operations in March 1997, have been included in the
Company's results of operations for fiscal 1999 and 1998, have been presented
separately as a discontinued operation.
OVERVIEW
The Company has been principally engaged in the purchase, transportation
and sale of LPG and, since 1997, the provision of equipment and services to the
CNG industry. Beginning July 1994, the Company has bought and sold LPG for
distribution into northeast Mexico and the U.S. Rio Grande Valley.
Historically, the Company has derived substantially all of its revenues
from sales to PMI, its primary customer, of LPG purchased from Exxon. In fiscal
1998, the Company derived approximately 95% of its revenues from sales of LPG,
of which sales to PMI accounted for nearly 100% of total LPG sales.
As part of its business strategy, in March 1997 the Company acquired
certain assets and hired certain former employees from WTI, a company engaged in
the engineering, design and construction of equipment for turnkey CNG fueling
stations. In connection with this acquisition, the Company paid $394,000 and
was committed to pay up to $2.0 million in royalty payments based on future
sales, if any. The acquisition was accounted for as a purchase and has been
reflected as such in the Company's consolidated financial statements beginning
in fiscal 1997.
The Company's CNG revenues were previously derived from contracts awarded
on a fixed-price, as-completed basis. During March 1999, the company entered
into an agreement to sell certain of the CNG assets. The Company is no longer
pursuing business opportunities related to CNG (see note E) and is once again
focusing primarily on its LPG operations, including the expansion of its
pipeline facilities.
The Company provides products and services through a combination of
fixed-margin and fixed-price contracts. Under the Company's agreements with its
customers and suppliers, the buying and selling prices of LPG are based on
variable posted prices that provide the Company with a fixed margin. Costs
included in costs of goods sold other than the purchase price of LPG may affect
actual profits from sales, including costs relating to transportation, storage,
leases, maintenance and financing. The Company generally attempts to purchase
in volumes commensurate with projected sales. However, mismatches in volumes and
prices of LPG purchased from Exxon and resold to PMI could result in
unanticipated costs.
18
<PAGE>
LPG SALES
The following table shows the Company's volume sold in gallons and average
sales price of LPG for the three and six months ended January 31, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- --------------------------
January 31, January 31, January 31, January 31,
1999 1999 1998 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Volume Sold
LPG (millions of gallons) 31.5 26.1 54.0 41.2
Average sales price
LPG (per gallon) $ 0.26 $ 0.37 $ 0.27 $ 0.39
</TABLE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JANUARY 31, 1999, COMPARED THE THREE MONTHS ENDED
JANUARY 31, 1998
Revenues. Revenues for the three months ended January 31, 1999 were $8.4
million compared with $9.8 million for the three months ended January 31, 1998,
a decrease of $1.3 million or 13.8%. This decrease was attributable to a
decrease in average sales price for LPG during the three months ended January
31, 1999 of $2.8 million, partially offset by increased volumes of LPG sold
during the three months ended January 31, 1999, resulting in an increase in
sales of $1.5 million.
Cost of sales. Cost of sales for the three months ended January 31, 1999
was $7.4 million compared with $8.8 million for the three months ended January
31, 1998, a decrease of $1.4 million or 15.8%. This decrease was attributable
to a decrease in average purchase price for LPG purchased during the three
months ended January 31, 1999 of $2.7 million, offset by the increase in volume
of LPG sold during the three months ended January 31, 1999, resulting in an
increase in cost of goods sold of $1.2 million.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $644,692 for the three months ended January 31,
1999 compared with $604,301 for the three months ended January 31, 1998, an
increase of $40,391 or 6.7%. This increase was primarily attributable to
payroll and other related costs.
Other income and expenses, net. Other income (expense), net was $787,312
for the three months ended January 31, 1999 compared with ($41,154) for the
three months ended January 31, 1998. The increase in other income (expense),
net, during the three months ended January 31, 1999 was due primarily to the
award from litigation of $987,114, partially offset by increased interest costs
and lower interest income on a note from the president of the Company and a
related party which during fiscal 1999, will be recorded only when cash is
actually received.
Income tax. Due to the availability of net operating loss carryforwards
($8.8 million and $5.3 million at July 31, 1998 and 1997), net income for the
three months ended January 31, 1999 and 1998 did not result in any income tax
expense. The ability to utilize such net operating loss carryforwards, which
expire in the years 2009 to 2013, may be significantly limited by the
application of the "change of ownership" rules under Section 382 of the Internal
Revenue Code.
19
<PAGE>
SIX MONTHS ENDED JANUARY 31, 1999, COMPARED THE SIX MONTHS ENDED JANUARY 31,
1998
Revenues. Revenues for the six months ended January 31, 1999 were $14.8
million compared with $16.4 million for the six months ended January 31, 1998, a
decrease of $1.6 million or 9.3%. This decrease was attributable to a decrease
in average sales price for LPG during the three months ended January 31, 1999 of
$4.9 million, partially offset by increased volumes of LPG sold during the three
months ended January 31, 1999, resulting in an increase in sales of $3.5
million.
Cost of sales. Cost of sales for the six months ended January 31, 1999 was
$13.3 million compared with $15.1 million for the six months ended January 31,
1998, a decrease of $1.8 million or 11.5%. This decrease was attributable to a
decrease in average purchase price for LPG purchased during the six months ended
January 31, 1999 of $4.8 million, offset by the increase in volume of LPG sold
during the six months ended January 31, 1999, resulting in an increase in cost
of goods sold of $2.9 million.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.2 million for the six months ended January 31,
1999 compared with $940,744 for the six months ended January 31, 1998, an
increase of $240,958 or 25.6%. This increase was primarily attributable to
payroll and other related costs.
Other income and expenses, net. Other income (expense), net was $695,337
for the six months ended January 31, 1999 compared with ($42,749) for the six
months ended January 31, 1998. The increase in other income (expense), net,
during the six months ended January 31, 1999 was due primarily to the award from
litigation of $987,114, partially offset by increased interest costs and lower
interest income on a note from the president of the Company and a related party
which during fiscal 1999, will be recorded only when cash is actually received.
Income tax. Due to the availability of net operating loss carryforwards
($8.8 million and $5.3 million at July 31, 1998 and 1997), net income for the
six months ended January 31, 1999 and 1998 did not result in any income tax
expense. The ability to utilize such net operating loss carryforwards, which
expire in the years 2009 to 2013, may be significantly limited by the
application of the "change of ownership" rules under Section 382 of the Internal
Revenue Code.
Historically, the Company has received the majority of its total annual
revenues during the months of October through March. Such pattern is
attributable to the seasonal demand for LPG, which is typically greatest during
the winter months of the second and third quarters of the Company's fiscal year.
The Company's quarterly earnings may vary considerably due to the impact of such
seasonality.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception in
1992, has used cash in operations and has a deficit in working capital and is
delinquent under certain loan and lease agreements. In addition, the Company is
involved in litigation, the outcome of which cannot be determined at the present
time. 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 and CNG-related equipment, 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.
20
<PAGE>
The following summary table reflects comparative cash flows for the six
months ended January 31, 1999 and 1998. All information is in thousands.
<TABLE>
<CAPTION>
January 31, January 31,
1999 1998
------------- -------------
<S> <C> <C>
Net cash provided by operating activities $ 167 $ 196
Net cash provided by (used in) investing
Activities (171) (740)
Net cash provided by financing activities 357 1,568
------------- -------------
Net increase (decrease) in cash $ 353 $ 1,024
============= =============
</TABLE>
The PMI Sales Agreement is effective for the period from October 1, 1998
through September 30, 1999 and provides for the purchase by PMI of minimum
monthly volumes of LPG aggregating a minimum annual volume of 69.0 million
gallons, similar to minimum volume requirements under the previous sales
agreement with PMI effective during the period from October 1, 1997 to September
30, 1998. During October 1998, the Company entered into a monthly supply
agreement with Exxon pursuant to which Exxon agreed to supply minimum volumes of
LPG to the Company. Effective November 1, 1998, the Company entered into a
supply agreement with Exxon to purchase minimum monthly volumes of LPG through
September 1999. The Company believes it has access to an adequate supply of LPG
from Exxon and other suppliers to satisfy the requirements of PMI under the PMI
Sales Agreement. In determining whether any supplier will be utilized, the
Company will consider the applicable prices charged as well as any additional
fees that may be required to be paid under the Pipeline Lease. The Company
anticipates 10% - 15% lower gross margins on its LPG sales as a result of
increased LPG costs beginning October 1998 compared with the previous
agreements.
Pipeline Lease. The Pipeline Lease currently expires on March 31, 2013,
pursuant to an amendment entered into between the Company and Seadrift on May
21, 1997, effective on April 1, 1998 (the "Pipeline Lease Amendment"). 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 Pipeline. Pursuant to the
Pipeline Lease Amendment, the Company's fixed annual fee associated with the use
of the Pipeline was increased by $350,000. In addition, the Pipeline Lease
Amendment also provides for variable rental increases based on monthly volumes
purchased and flowing into the Pipeline. Beginning February 1, 1999, Seadrift
started invoicing the Company as prescribed under the Pipeline Lease Amendment.
The Company believes the extension of the Pipeline Lease gives the Company
increased flexibility in negotiating sales and supply agreements with its
customers and suppliers. During November 1998, the Company issued a promissory
note to Seadrift for $261,206, representing all outstanding rental obligations
owed to Seadrift through November 1998. The promissory note was payable in six
installments beginning November 25, 1998 and ending February 3, 1999. Interest
on the promissory note was 10% per annum. The Company made all payments
required under the promissory note.
Credit Arrangements. In connection with the PMI Sales Agreement, invoicing
is to occur weekly. From November 1996 to early November 1997, the Company and
PMI made an arrangement under which PMI provided financing on the Company's
behalf under the terms of the Company's supply agreement with Exxon, the
Company's main supplier. As a result of this arrangement, invoicing occurred on
a monthly, rather than a weekly basis.
21
<PAGE>
On October 22, 1997, the Company entered into a $6.0 million credit
facility with RZB Finance L.L.C. (RZB) for demand loans and standby letters of
credit (RZB Credit Facility) to finance the Company's purchase 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) 1.5% of
the maximum face amount of such letter of credit, or (iii) such higher amount as
may be agreed to between the Company and RZB. Any amounts outstanding under the
RZB Credit Facility shall accrue interest at a rate equal to the rate announced
by the Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to the RZB
Credit Facility, RZB has sole and absolute discretion to terminate 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 mortgage, security interest and assignment in
any and all of the Company's 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
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. 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. Upon establishment of the RZB Credit Facility,
beginning November 11, 1997, PMI no longer provided any financing on behalf of
the Company, and the Company began invoicing PMI on a weekly basis.
Effective April 22, 1998, the aggregate amount available under the RZB
Credit Facility was increased to $7.0 million. The Company believes that based
on current market prices of LPG and LPG volume requirements under the PMI Sales
Agreement, the RZB Credit Facility is adequate. In January 1999, the fee
charged for letters of credit issued under the RZB Credit Facility was increased
to 2.5%.
In connection with the Company's purchases of LPG from Exxon and/or PG&E
NGL Marketing, L.P., the Company issues letters of credit on a monthly basis
based on anticipated purchases.
As of January 31, 1999, letters of credit established under the
RZB Credit Facility in favor of Exxon for purchases of LPG totaled $6.0 million
of which $1.5 million was being used to secure unpaid purchases from Exxon as of
January 31, 1999. In addition, as of January 31, 1999, the Company had $587,501
of loans outstanding under the RZB Credit Facility. In connection with these
purchases, as of January 31, 1999, the Company had unpaid invoices due from PMI
totaling $1.3 million and cash balances maintained in the RZB Credit Facility
collateral account of $507,094.
During June 1998, a letter of credit was established under the RZB Credit
Facility in favor of PG&E NGL Marketing, L.P. for purchases of LPG totaling
$360,000. The letter of credit expired during August 1998.
During November 1998, a letter of credit was established under the RZB
Credit Facility in favor of PG&E NGL Marketing, L.P. for purchases of LPG
totaling $176,000. This letter of credit expired in January 1999.
Private Placements and Other Transactions. On October 21, 1997, the
Company completed a private placement pursuant to which it issued promissory
notes in the aggregate principal amount of $1.5 million and warrants to purchase
250,000 shares of common stock exercisable until October 21, 2000 at an exercise
price of $6.00 per share. The notes were unsecured. Proceeds raised from the
private placement totaled $1.5 million, which the Company used for working
capital requirements. Interest at 10% per annum was due quarterly on March 31,
June 30, September 30 and December 31. Payment of the principal and accrued
interest on the promissory notes was due on June 30, 1998. On December 1, 1998,
the Company completed a rollover and assignment agreement effectively extending
the due date of the promissory notes until June 30, 1999 (the "Rollover
Agreement"). In connection with the Rollover Agreement, the Company agreed to
assign its rights to any net cash collected from the Judgment towards any unpaid
principal and interest owing on the promissory notes. The Company also agreed
to use any net proceeds received by the Company from any public offering of debt
or equity of the Company in excess of than $2.3 million, towards the repayment
of any balances owing under the promissory notes. The promissory note holders
22
<PAGE>
also received additional warrants to purchase 337,500 shares of common stock,
exercisable until November 30, 2001, at an exercise price of $1.75 per share.
The purchasers in the private placement were granted one demand registration
right with respect to the shares issuable upon exercise of the warrants.
On March 3, 1999, the Company completed an exchange of $0.9 million of the
promissory notes for 90,000 shares of the Company's Senior Preferred Stock (the
Senior Preferred Stock) at a purchase price of $10.00 per share. The Senior
Preferred Stock is non-voting and dividends are payable at a rate of 12%
annually, payable in cash or in kind, semi-annually. The Preferred Stock may be
converted in whole or in part at any time at a conversion ratio of one share of
Senior Preferred Stock for 4.0 shares of common stock of the Company. In
connection with the exchange, the holder of the Senior Preferred Stock received
50,000 shares of common stock of the Company and may receive an additional
50,000 shares of common stock of the Company, if the Senior Preferred Stock is
not redeemed by the Company prior to September 3, 1999.
On November 13, 1998, the Company issued 250,000 shares of common stock of
the Company and warrants to purchase 75,000 shares of common stock with an
exercise price of $1.25 per warrant and an expiration date of November 12, 2000
for an amount of $250,000. Net proceeds from the sale were used for working
capital purposes.
On December 14, 1998, the Company issued 500,000 shares of common stock of
the Company and warrants to purchase 300,000 shares of common stock with an
exercise price of $1.75 per warrant and an expiration date of December 13, 2003
for an amount of $500,000. Net proceeds from the sale were used for working
capital purposes.
During December 1998, the Company issued 53,884 shares of common stock of
the Company to Zimmerman Holdings Inc. (ZHI), as payment for and full
cancellation of a note payable of $100,000 and related interest and other
obligations totaling $18,000 and the cancellation of any further obligation to
pay any future royalties in connection with Company's purchase of certain CNG
assets from Wilson Technologies Inc., a wholly owned subsidiary of ZHI.
During December, 1998, the Company issued 15,000 shares of common stock of
the Company and warrants to purchase 10,000 shares of common stock with an
exercise price of $3.25 per warrant and an expiration date of December 31, 2000
in exchange for cancellation of all outstanding obligations totaling
approximately $26,000 and other obligations as outlined in an agreement between
the parties.
Judgment in favor of the Company. Judgment has been rendered in favor of
the Company in connection with its litigation against IBC-Brownsville in the
amount of $3.2 million. As of January 31, 1999, the net amount of the award is
approximately $3.5 million, which is comprised of the sum of (i) the original
award, including attorney's fees, (ii) post-award interest, and (iii)
cancellation of the note and accrued interest payable, less attorneys' fees.
The Judgment is being reviewed by the Supreme Court of Texas. Although no
assurance can be made, management believes that the Company will ultimately
prevail, and will receive the proceeds from such Judgment. In addition, a former
officer of the Company is entitled to 5% of the net proceeds (after expenses and
legal fees). The remaining proceeds available from the Judgment have been
assigned to the promissory note holders to the extent of any amounts then owing
under the promissory notes. See notes G, I, L and M to the Consolidated
Financial Statements.
Realization of Assets. Recoverability of a major portion of the recorded
asset amounts on the Company's balance sheet is dependent upon the collection of
the Judgment, the Company's ability to obtain additional financing and to raise
additional equity capital, and the success of the Company's future operations.
To provide the Company with the ability it believes necessary to continue
in existence, management is taking steps to (i) collect the Judgment, (ii)
increase sales to its current customers, (iii) increase its customer base, (iv)
extend the terms and capacity of the Pipeline Lease and the Brownsville Terminal
Facility, (v) expand its product lines and (vi) raise additional debt and/or
equity capital. See note J to the Consolidated Financial Statements.
Year 2000 Date Conversion. Management has determined that the consequences
of its Year 2000 issues will not have a material effect on the Company's
business, results of operations, or financial condition.
23
<PAGE>
FINANCIAL ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 (SFAS 128), Earnings per Share. SFAS
128 supersedes APB Opinion No. 15 (Opinion No. 15), Earnings per Share, and
requires the calculation and dual presentation of basic and diluted earnings per
share (EPS), replacing the measures of primary and fully-diluted EPS as reported
under Opinion No. 15. SFAS 128 became effective for financial statements issued
for periods ending after December 15, 1997; earlier application was not
permitted. Accordingly, EPS for the periods presented in the accompanying
consolidated statements of operations are calculated under the guidance of SFAS
128.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income and Statement of Financial Accounting Standards No. 131 (SFAS 131),
Disclosure about Segments of an Enterprise and Related Information. Both are
effective for periods beginning after December 15, 1997, with earlier
application encouraged for SFAS 131. The Company adopted SFAS 131 in fiscal
1997.
24
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note I to the unaudited Consolidated Financial Statements and Note O to
the Company's Annual Report on Form 10-K for the year ended July 31, 1998.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
The following Exhibits are incorporated herein by reference:
EXHIBIT NO.
- ------------
10.71 LPG Mix Purchase Contract dated September 28, 1998 between P.M.I.
Trading Limited and the Company. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended July 31, 1998
filed on November 13, 1998, SEC File No. 000-24394).
10.72 LPG Sales Agreement dated November 16, 1998 between Exxon and the
Company. (Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended October 31, 1998 filed on
December 18, 1998, SEC File No. 000-24394).
10.73 Rollover and Assignment Agreement dated December 1, 1998 among Castle
Energy Corporation, Clint Norton, Southwest Concept, Inc., James F.
Meara, Jr., Donaldson Luftkin Jenrette Securities Corporation
Custodian SEP FBO James F. Meara IRA, Lincoln Trust Company FBO Perry
D. Snavely IRA and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.74 Registration Rights Agreement dated December 1, 1998 among Castle
Energy Corporation, Clint Norton, Southwest Concept, Inc., James F.
Meara, Jr., Donaldson Luftkin Jenrette Securities Corporation
Custodian SEP FBO James F. Meara IRA, Lincoln Trust Company FBO Perry
D. Snavely IRA and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.75 Collateral Agreement dated December 1, 1998 among Castle Energy
Corporation, Clint Norton, Southwest Concept, Inc., James F. Meara,
Jr., Donaldson Luftkin Jenrette Securities Corporation Custodian SEP
FBO James F. Meara IRA, Lincoln Trust Company FBO Perry D. Snavely IRA
and the Company. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended October 31, 1998
filed on December 18, 1998, SEC File No. 000-24394).
25
<PAGE>
10.76 Assignment of Judgment Agreement dated December 1, 1998 among Castle
Energy Corporation, Clint Norton, Southwest Concept, Inc., James F.
Meara, Jr., Donaldson Luftkin Jenrette Securities Corporation
Custodian SEP FBO James F. Meara IRA, Lincoln Trust Company FBO Perry
D. Snavely IRA and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.77 Amended Promissory Note dated December 1, 1998 between Castle Energy
Corporation and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.78 Common Stock Purchase Warrant dated December 1, 1998 issued to Castle
Energy Corporation by the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.79 Amended Promissory Note dated December 1, 1998 between Clint Norton
and the Company. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended October 31, 1998
filed on December 18, 1998, SEC File No. 000-24394).
10.80 Common Stock Purchase Warrant dated December 1, 1998 issued to Clint
Norton by the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.81 Amended Promissory Note dated December 1, 1998 between Southwest
Concept, Inc. and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.82 Common Stock Purchase Warrant dated December 1, 1998 issued to
Southwest Concept, Inc. by the Company. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended October 31, 1998 filed on December 18, 1998, SEC File No.
000-24394).
10.83 Amended Promissory Note dated December 1, 1998 between James F. Meara,
Jr. and the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.84 Common Stock Purchase Warrant dated December 1, 1998 issued to James
F. Meara, Jr. by the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.85 Amended Promissory Note dated December 1, 1998 between Donaldson
Luftkin Jenrette Securities Corporation Custodian SEP FBO James F.
Meara IRA and the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.86 Common Stock Purchase Warrant dated December 1, 1998 issued to
Donaldson Luftkin Jenrette Securities Corporation Custodian SEP FBO
James F. Meara IRA and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
26
<PAGE>
10.87 Amended Promissory Note dated December 1, 1998 between Lincoln Trust
Company FBO Perry D. Snavely IRA and the Company. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended October 31, 1998 filed on December 18, 1998,
SEC File No. 000-24394).
10.88 Common Stock Purchase Warrant dated December 1, 1998 issued to Lincoln
Trust Company FBO Perry D. Snavely IRA by the Company. (Incorporated
by reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended October 31, 1998 filed on December 18, 1998,
SEC File No. 000-24394).
10.89 Purchase Agreement dated November 13, 1998 between Van Moer Santerre &
Company and the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.90 Registration Rights Agreement dated November 13, 1998 among Van Moer
Santerre & Company and the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.91 Common Stock Purchase Warrant dated November 13, 1998 issued to Van
Moer Santerre & Company by the Company. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended October 31, 1998 filed on December 18, 1998, SEC File No.
000-24394).
10.92 Purchase Agreement dated December 14, 1998 between KFP Grand LTD. and
the Company. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended October 31, 1998
filed on December 18, 1998, SEC File No. 000-24394).
10.93 Registration Rights Agreement dated December 14, 1998 among KFP Grand
LTD. and the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.94 Common Stock Purchase Warrant dated December 14, 1998 issued to KFP
Grand LTD. by the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended October
31, 1998 filed on December 18, 1998, SEC File No. 000-24394).
10.95 Second Amendment of the Interim Operating Agreement dated December 15,
1998 among Wilson Technologies Inc., Zimmerman Holdings, Inc. and the
Company. (Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended October 31, 1998 filed on
December 18, 1998, SEC File No. 000-24394).
The following material contracts are filed as part of this report:
27.1 Financial Data Schedule. (Filed herewith.)
b. Reports on Form 8-K.
The following Reports on Form 8-K are incorporated herein by reference:
Company's Current Report on Form 8-K filed on February 9, 1999 regarding the
Company's realization of the IBC-Brownsville award.
Company's Current Report on Form 8-K filed on March 4, 1999 regarding the
Company's exchange of $.9 million of indebtedness for Senior Preferred Stock of
the Company.
27
<PAGE>
SIGNATURES
Pursuant to the requirements 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
March 17, 1999 By: /s/ Ian T. Bothwell
----------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
28
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from Penn Octane
Corporation's Quarterly Report on Form 10-Q for the quarterly period ended
January 31, 1999 and is qualified in its entirety by reference to such Financial
Statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-START> NOV-01-1998
<PERIOD-END> JAN-31-1999
<CASH> 510992
<SECURITIES> 0
<RECEIVABLES> 1584444
<ALLOWANCES> 418796
<INVENTORY> 425189
<CURRENT-ASSETS> 2834901
<PP&E> 4653848
<DEPRECIATION> 1600949
<TOTAL-ASSETS> 7780432
<CURRENT-LIABILITIES> 6024910
<BONDS> 0
<COMMON> 107716
0
0
<OTHER-SE> 1647806
<TOTAL-LIABILITY-AND-EQUITY> 7780432
<SALES> 14831593
<TOTAL-REVENUES> 14831593
<CGS> 13323218
<TOTAL-COSTS> 13323218
<OTHER-EXPENSES> 1181702
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 293074
<INCOME-PRETAX> 1022010
<INCOME-TAX> 0
<INCOME-CONTINUING> 1022010
<DISCONTINUED> (202822)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 819188
<EPS-PRIMARY> .08
<EPS-DILUTED> .08
</TABLE>
