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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------- -------
Commission file number: 000-24394
PENN OCTANE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1790357
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
77-530 ENFIELD LANE, BLDG. D, PALM DESERT, CALIFORNIA 92211
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (760) 772-9080
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 February 29, 2000 was 12,996,131.
<PAGE>
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<CAPTION>
PENN OCTANE CORPORATION
TABLE OF CONTENTS
ITEM PAGE NO.
---- --------
<S> <C>
Part I 1. Financial Statements
Consolidated Balance Sheets as of January 31, 2000 (unaudited)
and July 31, 1999 3-4
Consolidated Statements of Operations for the three and six months
ended January 31, 2000 and 1999 (unaudited) 5
Consolidated Statements of Cash Flows for the six months
ended January 31, 2000 and 1999 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7-24
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25-36
3. Quantitative and Qualitative Disclosures About Market Risk 36
Part II 1. Legal Proceedings 37
2. Changes in Securities 37
3. Defaults Upon Senior Securities 37
4. Submission of Matters to a Vote of Security Holders 37
5. Other Information 37
6. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 37
</TABLE>
2
<PAGE>
PART I
ITEM 1.
<TABLE>
<CAPTION>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
January 31,
2000 July 31,
(Unaudited) 1999
------------- ----------
<S> <C> <C>
Current Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,255,574 $1,032,265
Trade accounts receivable, less allowance for doubtful accounts
of $521,067 and $521,067 . . . . . . . . . . . . . . . . . . 5,608,801 2,505,915
Notes receivables (note F) . . . . . . . . . . . . . . . . . . 122,764 77,605
Receivable from IBC-Brownsville (note M) . . . . . . . . . . . 4,254,347 -
Inventories (note D) . . . . . . . . . . . . . . . . . . . . . 4,803,969 615,156
Prepaid expenses and other current assets. . . . . . . . . . . 60,748 42,517
------------- ----------
Total current assets . . . . . . . . . . . . . . . . . . . . 16,106,203 4,273,458
Property, plant and equipment - net (note C) . . . . . . . . . . 7,579,017 3,171,650
Lease rights (net of accumulated amortization
of $547,252 and $524,355). . . . . . . . . . . . . . . . . . . 606,787 629,684
Notes receivable (note F). . . . . . . . . . . . . . . . . . . . 737,038 822,196
Other non-current assets . . . . . . . . . . . . . . . . . . . . 14,870 11,720
------------- ----------
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . $ 25,043,915 $8,908,708
============= ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
<TABLE>
<CAPTION>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
LIABILITIES AND STOCKHOLDERS' EQUITY
January 31,
2000 July 31,
(Unaudited) 1999
-------------- ---------------
<S> <C> <C>
Current Liabilities
Current maturities of long-term debt (note G). . . . . . . . . . . . . . . $ 3,944,493 $ 365,859
Revolving line of credit (note I). . . . . . . . . . . . . . . . . . . . . 3,707,035 -
LPG trade accounts payable (note I). . . . . . . . . . . . . . . . . . . . 4,645,815 2,850,197
Other accounts payable and accrued liabilities . . . . . . . . . . . . . . 3,122,140 1,382,603
-------------- ---------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . 15,419,483 4,598,659
Long-term debt, less current maturities (note G) . . . . . . . . . . . . . . 128,034 258,617
Commitments and contingencies (note I) . . . . . . . . . . . . . . . . . . . - -
Stockholders' Equity (note H)
Series A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
No shares issued and outstanding at January 31, 2000 and July 31, 1999 . - -
Series B - Senior preferred stock-$.01 par value, $10 liquidation value,
5,000,000 shares authorized; 0 and 90,000 shares issued and
outstanding at January 31, 2000 and July 31, 1999. . . . . . . . . . . . - 900
Common stock-$.01 par value, 25,000,000 shares authorized;
12,901,131 and 11,845,497 shares issued and outstanding at
January 31, 2000 and July 31, 1999 . . . . . . . . . . . . . . . . . . . 129,011 118,456
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . 19,334,662 17,133,222
Notes receivable from the president of the Company and a related party
for exercise of warrants, less reserve of $563,806 and $451,141 at
January 31, 2000 and July 31, 1999 . . . . . . . . . . . . . . . . . . . (2,765,350) (2,765,350)
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,201,925) (10,435,796)
-------------- ---------------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . 9,496,398 4,051,432
-------------- ---------------
Total liabilities and stockholders' equity . . . . . . . . . . . . . . $ 25,043,915 $ 8,908,708
============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
<TABLE>
<CAPTION>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
---------------------------- ----------------------------
January 31, January 31, January 31, January 31,
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,006,831 $ 8,353,027 $ 34,977,731 $ 14,831,593
Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . . . 17,823,068 7,413,785 32,788,080 13,323,218
------------- ------------- ------------- -------------
Gross profit. . . . . . . . . . . . . . . . . . . . . . . . . . 1,183,763 939,242 2,189,651 1,508,375
------------- ------------- ------------- -------------
Selling, general and administrative expenses
Legal and professional fees . . . . . . . . . . . . . . . . . . 456,321 223,617 622,050 426,699
Salaries and payroll related expenses . . . . . . . . . . . . . 335,315 228,870 545,107 416,698
Travel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,963 43,740 87,983 80,105
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190,400 148,465 324,297 258,200
------------- ------------- ------------- -------------
1,011,999 644,692 1,579,437 1,181,702
------------- ------------- ------------- -------------
Operating income. . . . . . . . . . . . . . . . . . . . . . . . 171,764 294,550 610,214 326,673
Other income (expense)
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . (237,970) (200,681) (303,997) (293,074)
Interest income . . . . . . . . . . . . . . . . . . . . . . . . 2,858 879 6,386 1,297
Award from litigation, net (note M) . . . . . . . . . . . . . . 3,036,638 987,114 3,036,638 987,114
------------- ------------- ------------- -------------
Income (loss) from continuing operations before taxes . . . . 2,973,290 1,081,862 3,349,241 1,022,010
Provision for income taxes. . . . . . . . . . . . . . . . . . . . 70,000 - 70,000 -
------------- ------------- ------------- -------------
Income (loss) from continuing operations. . . . . . . . . . . . 2,903,290 1,081,862 3,279,241 1,022,010
Discontinued operations, net of taxes (note E)
Income (loss) from operations of CNG segment. . . . . . . . . . - (121,403) - (202,822)
------------- ------------- ------------- -------------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . $ 2,903,290 $ 960,459 $ 3,279,241 $ 819,188
============= ============= ============= =============
Income (loss) from continuing operations
per common share (note B) . . . . . . . . . . . . . . . . . . . $ 0.23 $ 0.10 $ 0.25 $ 0.10
============= ============= ============= =============
Net income (loss) per common share (note B) . . . . . . . . . . . $ 0.23 $ 0.09 $ 0.25 $ 0.08
============= ============= ============= =============
Income (loss) from continuing operations per
common share assuming dilution (note B) . . . . . . . . . . . . $ 0.21 $ 0.10 $ 0.24 $ 0.10
============= ============= ============= =============
Net income (loss) per common share assuming
dilution (note B) . . . . . . . . . . . . . . . . . . . . . . . $ 0.21 $ 0.09 $ 0.24 $ 0.08
============= ============= ============= =============
Weighted average common shares outstanding. . . . . . . . . . . . 12,894,078 10,479,319 12,685,225 10,215,996
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
<TABLE>
<CAPTION>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
------------------------------
January 31, January 31,
2000 1999
-------------- --------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net income. . . . . . . . . . . . . . . . . . . . . . . $ 3,279,241 $ 819,188
Adjustments to reconcile net income to net cash used in
(provided by) operating activities:
Depreciation and amortization . . . . . . . . . . . . 116,054 159,291
Amortization of lease rights. . . . . . . . . . . . . 22,898 22,897
Amortization of loan discount . . . . . . . . . . . . 119,729 94,255
Award from litigation . . . . . . . . . . . . . . . . (3,036,638) (987,114)
Changes in current assets and liabilities:
Trade accounts receivable . . . . . . . . . . . . . . (3,102,884) (388,874)
Inventories . . . . . . . . . . . . . . . . . . . . . (4,188,813) (48,092)
Prepaids and other current assets . . . . . . . . . . (18,231) 54,375
LPG trade accounts payable. . . . . . . . . . . . . . 1,795,618 593,698
Other assets and liabilities, net . . . . . . . . . . (3,150) (48,486)
Other accounts payable and accrued liabilities. . . . 521,788 (104,058)
-------------- --------------
Net cash provided by (used in) operating activities (4,494,388) 167,080
Cash flows from investing activities:
Capital expenditures. . . . . . . . . . . . . . . . . (1,523,421) (170,485)
Investment in leased interests. . . . . . . . . . . . (3,000,000) -
Payments on note receivable . . . . . . . . . . . . . 40,000
--------------
Net cash used in investing activities . . . . . . . (4,483,421) (170,485)
Cash flows from financing activities:
Revolving credit facilities . . . . . . . . . . . . . 3,707,035 (404,322)
Issuance of debt. . . . . . . . . . . . . . . . . . . 4,633,170 43,706
Preferred stock dividends . . . . . . . . . . . . . . (45,370) -
Issuance of common stock. . . . . . . . . . . . . . . 1,067,200 717,500
Reduction in debt . . . . . . . . . . . . . . . . . . (160,917) -
-------------- --------------
Net cash provided by financing activities . . . . . 9,201,118 356,884
-------------- --------------
Net increase in cash. . . . . . . . . . . . . . . 223,309 353,479
Cash at beginning of period . . . . . . . . . . . . . . 1,032,265 157,513
-------------- --------------
Cash at end of period . . . . . . . . . . . . . . . . . $ 1,255,574 $ 510,992
============== ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest. . . . . . . . . . . . . . . . . . . . . . $ 149,493 $ 125,800
============== ==============
Supplemental disclosures of non-cash transactions:
Common stock and warrants issued. . . . . . . . . . . $ - $ 144,883
============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(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 ("Company"). The Company is engaged primarily in the
business of purchasing, transporting and selling LPG. Prior to March 1999,
PennWilson CNG, Inc. ("PennWilson"), a subsidiary of the Company, provided
services and equipment to the compressed natural gas ("CNG") industry. The
Company owns and operates a terminal facility in Brownsville, Texas
("Brownsville Terminal Facility"). The Company has a long-term lease agreement
for approximately 132 miles of pipeline from certain gas plants in Texas to the
Brownsville Terminal Facility. The Company sells LPG primarily to P.M.I.
Trading Limited ("PMI"). PMI is the exclusive importer of LPG into Mexico. PMI
is also a subsidiary of Petroleos Mexicanos, the state-owned Mexican oil company
("PEMEX"). PMI distributes the LPG purchased from the Company 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. Prior to such time, the
Company was in the "development stage" until the business was established.
Since the Company began operations, the primary customer for LPG has been PMI.
Sales of LPG to PMI accounted for approximately all of the Company's total
revenues for the six months ended January 31, 2000.
BASIS OF PRESENTATION
- -----------------------
The accompanying financial statements include the Company and its subsidiaries
(hereinafter referred to as the "Company"). All significant intercompany
accounts and transactions are eliminated.
The unaudited consolidated balance sheet as of January 31, 2000, the unaudited
consolidated statements of operations for the three and six months ended January
31, 2000 and 1999, and the unaudited consolidated statements of cash flows for
the six months ended January 31, 2000 and 1999 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, 2000 and the unaudited consolidated results of operations for the
three and six months ended January 31, 2000 and 1999, and unaudited consolidated
cash flows for the six months ended January 31, 2000 and 1999.
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 fiscal year ended July 31, 1999.
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.
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 Financial Accounting Standards Board ("FASB") issued SFAS 128, "Earnings Per
Share", which supersedes Accounting Principles Board Opinion ("APB") 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.
7
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE - Continued
The following table presents reconciliation's from income (loss) per common
share to income (loss) per common share assuming dilution (see note H for the
convertible preferred stock and the warrants):
<TABLE>
<CAPTION>
For the three months ended January 31,2000 For the three months ended January 31,1999
------------------------------------------ ------------------------------------------
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 . . . . . . . . . . . $ 2,903,290 - - $ 1,081,862 - -
Income (loss) from discontinued
operations . . . . . . . . . . . - - - (121,403) - -
-------------- --------------
Net income (loss). . . . . . . . . 2,903,290 - - 960,459 - -
Less: Dividends on preferred
stock. . . . . . . . . . . . . . - - - - - -
BASIC EPS
Income (loss) from continuing
operations available to
common stockholders. . . . . . . 2,903,290 12,894,078 $ 0.23 1,081,862 10,479,319 $ 0.10
========== ===========
Income (loss) from
discontinued operations. . . . . - 12,894,078 $ 0.00 (121,403) 10,479,319 $ (0.01)
-------------- ========== -------------- ===========
Net income (loss) available to
common stockholders. . . . . . . 2,903,290 12,894,078 $ 0.23 960,459 10,479,319 $ 0.09
========== ===========
EFFECT OF DILUTIVE SECURITIES
Warrants . . . . . . . . . . . . . - 978,205 - - 19,396 -
Convertible Preferred Stock. . . . - - - - - -
DILUTED EPS
Income (loss) from continuing
operations available to
common stockholders. . . . . . . 2,903,290 13,872,283 $ 0.21 1,081,862 10,498,715 $ 0.10
========== ===========
Income (loss) from
discontinued operations. . . . . - 13,872,283 $ 0.00 (121,403) 10,498,715 $ (0.01)
-------------- ========== -------------- ===========
Net income (loss) available to
common stockholders. . . . . . . $ 2,903,290 13,872,783 $ 0.21 $ 960,459 10,498,715 $ 0.09
============== ============= ========== ============== ============= ===========
</TABLE>
8
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE B - INCOME (LOSS) PER COMMON SHARE - Continued
<TABLE>
<CAPTION>
For the six months ended January 31, 2000 For the six months ended January 31,1999
----------------------------------------- ------------------------------------------
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. . . . . . . . . . $ 3,279,241 - - $ 1,022,010 - -
Income (loss) from
discontinued operations . . . - - - (202,822) - -
-------------- --------------
Net income (loss) . . . . . . . 3,279,241 - - 819,188 - -
Less: Dividends on preferred
stock . . . . . . . . . . . . (45,370) - - - - -
BASIC EPS
Income (loss) from continuing
operations available to
common stockholders . . . . . 3,233,871 12,685,225 $ 0,25 1,022,010 10,215,996 $ 0.10
========== ===========
Income (loss) from
discontinued operations . . . - 12,685,225 $ 0.00 (202,822) 10,215,996 $ (0.02)
-------------- ========== -------------- ===========
Net income (loss) available to
common stockholders . . . . . 3,233,871 12,685,225 $ 0.25 819,188 10,215,996 $ 0.08
========== ===========
EFFECT OF DILUTIVE SECURITIES
Warrants. . . . . . . . . . . . - 813,534 - - 98,686 -
Convertible Preferred Stock . . - 83,152 - - - -
DILUTED EPS
Income (loss) from continuing
operations available to
common stockholders . . . . . 3,233,871 13,581,911 $ 0.24 1,022,010 10,314,682 $ 0.10
========== ===========
Income (loss) from
discontinued operations . . . - 13,581,911 $ 0.00 (202,822) 10,314,682 $ (0.02)
-------------- ========== -------------- ===========
Net income (loss) available to
common stockholders . . . . . $ 3,233,871 13,581,911 $ 0.24 $ 819,188 10,314,682 $ 0.08
============== ============= ========== ============== ============= ===========
</TABLE>
9
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE C - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
January 31, July 31,
2000 1999
-------------- --------------
<S> <C> <C>
LPG:
Brownsville Terminal Facilities:
Building. . . . . . . . . . . . . . . . . . . . . $ 173,500 $ 173,500
Terminal facilities . . . . . . . . . . . . . . . 3,719,008 3,426,440
Leasehold improvements. . . . . . . . . . . . . . 291,409 291,409
Capital construction in progress (see note J) . . 306,645 -
Equipment . . . . . . . . . . . . . . . . . . . . 383,011 378,039
-------------- --------------
4,873,573 4,269,388
-------------- --------------
US-Mexico Pipeline and Mexican Terminal Facilities
(see note J):
Purchase of 50% interest in the Lease Agreements. 3,000,000 -
Other costs paid by the Company . . . . . . . . . 1,490,525 572,774
-------------- --------------
4,490,525 572,774
-------------- --------------
Other:
Automobile. . . . . . . . . . . . . . . . . . . . . 10,800 10,800
Office Equipment. . . . . . . . . . . . . . . . . . 37,223 35,738
-------------- --------------
48,023 46,538
-------------- --------------
9,412,121 4,888,700
Less: accumulated depreciation and amortization. . (1,833,104) (1,717,050)
-------------- --------------
$ 7,579,017 $ 3,171,650
============== ==============
</TABLE>
The actual costs to complete the US-Mexico Pipeline and Mexican Terminal
Facilities (the "Costs") are the sole responsibility of CPSC. As of January 31,
2000 and July 31, 1999, the Company has spent approximately $683,000 and
$512,000, respectively, related to the Costs (see notes I and J).
10
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE D - INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
January 31, July 31,
2000 1999
------------ ---------
<S> <C> <C>
LPG:
Pipeline. . . . . . . . . . . . . . . . . $ 657,596 $ 434,987
LPG terminal. . . . . . . . . . . . . . . 288,046 180,169
Storage-Union Carbide (see notes I and L) 3,858,327 -
------------ ---------
$ 4,803,969 $ 615,156
============ =========
</TABLE>
NOTE E - DISCONTINUED OPERATIONS
RESULTS OF OPERATIONS
- -----------------------
In connection with the sale of assets related to the CNG business during May
1999, the Company has effectively disposed of its CNG segment and has
discontinued operations of that segment. In accordance with APB 30, the results
of operations related to the CNG segment have been recorded as discontinued
operations for all periods presented in the Company's financial statements (see
note F).
NOTE F - SALE OF CNG ASSETS
During May 1999, the Company sold its remaining CNG assets and business to a
company ("Buyer") controlled by a director and officer of the Company. Under
the terms of the sale, the Company received promissory notes aggregating
$1,200,000 to be paid over a period of 61 months. The notes are collateralized
by the CNG assets, the common stock of the Buyer owned by the director and
officer and warrants to purchase 200,000 shares of common stock of the Company
which had previously been issued to the director and officer by the Company.
The director and officer has personally guaranteed a portion of the balance of
the notes.
The notes contain a provision for prepayment at a discount and bear interest at
rates specified therein. The Company discounted the notes for the prepayment
discount, resulting in a discount of $260,000 and a discounted balance of the
notes of $940,000 at the date of issuance, which the Company believes is less
than the fair value of the collateral. The effective interest rate of the
notes after giving affect to the discount is 8.6%. Because the Buyer can pay the
notes at any time, the Company has determined that it will account for interest
income using the cost recovery method to account for collections on the notes.
Under this method, the amounts recorded as notes receivable will not exceed the
discounted cash payoff amounts.
The Stock Pledge and Security Agreement ("Security Agreement") executed in
connection with the sale provides that the Buyer may sell the collateral at fair
market value at any time during the term of the notes without the Company's
consent provided that all proceeds collected from the sale will be applied to
the note balances. In addition, the Company has agreed to subordinate its
secured interest in the collateral after the Buyer has paid $300,000 plus
interest at 10% as provided for in the Security Agreement.
11
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE G - LONG-TERM DEBT
ISSUANCE 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 (the "Notes") 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. Interest at 9% is due on June 15, 2000, and December 15, 2000 (or
the maturity date, if earlier). In connection with the Notes, the Company also
granted the holders of the Notes, warrants (the "Warrants") to purchase a total
of 279,559 shares of common stock of the Company at an exercise price of $4.00
per share, exercisable through December 15, 2002 and the Company agreed to issue
to the holders of the Notes, additional warrants (the "Additional Warrants") to
purchase a total of 213,066 shares of common stock of the Company at an exercise
price of $4.00 per share, exercisable through December 15, 2002 if the Notes are
not repurchased prior to 90 days from the original date of issuance of the
Notes. The Company is also required to register the shares issuable in
connection with exercise of the Warrants and the Additional Warrants on or
before April 15, 2000.
Net proceeds from the Notes were used for the purchase of the 50% interest in
the US-Mexico Pipeline and Mexican Terminal Facilities (see notes C and J) and
for working capital purposes.
Under the terms of the Notes, the Company has agreed to pledge the Company's
interests in the US-Mexico Pipeline and the Mexican Terminal Facilities.
In connection with the issuance of $3,869,000 and $710,000 of Notes from
December 10, 1999 through January 18, 2000 and February 2, 2000, respectively,
the Company paid a fee equal to a cash payment of $270,830 and $49,700 and
warrants to purchase a total of 96,725 shares and 17,750 shares, respectively,
of common stock of the Company at an exercise price of $4.00 per share,
exercisable for three years. The Company also granted piggy back registration
rights to the holders of the warrants issued for fees.
Upon the issuance of the Notes, the Company recorded a discount of $1,454,762
related to the fair value of the Warrants and the Additional Warrants issued and
other costs, to be amortized over the life of the Notes.
12
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE G - LONG-TERM DEBT - Continued
LONG-TERM DEBT CONSISTS OF THE FOLLOWING:
- ----------------------------------------------
<TABLE>
<CAPTION>
January 31, July 31,
2000 1999
------------ ---------
<S> <C> <C>
$4,944,000 in promissory notes, less unamortized discount of $1,345,128;
principal due December 15, 2000, or upon earlier receipt of proceeds from any
public offering of debt or equity of the Company resulting in net proceeds to
the Company in excess of $2,250,000; interest at 9.0% (effective interest rate of
approximately 45% after consideration of the discount and loan fees) on the
principal amount of the promissory notes is due June 15, 2000 and
December 15, 2000. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,598,872 _
Contract for Bill of Sale which was extended in April 1999; due in
monthly payments of $3,000, including interest at 10%; due in February 2001;
collateralized by a building.. . . . . . . . . . . . . . . . . . . . . . . . . . . 32,347 $ 50,347
Noninterest bearing note payable, discounted at 7%, for legal services, due in
monthly installments of $20,000 through January 2001 with a final payment
of $110,000 in February 2001.. . . . . . . . . . . . . . . . . . . . . . . . . . . 337,225 387,129
Note payable for legal services in connection with litigation; payable in
monthly installments of $11,092, including interest at 6.9% (see note I).. . . . . 74,083 127,000
Other long-term debt.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 60,000
4,072,527 624,476
Current maturities.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,944,493 365,859
------------ ---------
$ 128,034 $ 258,617
============ =========
</TABLE>
In connection with the notes to attorneys, the Company has agreed in the future
to provide a "Stipulation of Judgment" to the creditors in the event that the
Company defaults under the settlement agreements.
NOTE H - STOCKHOLDERS' EQUITY
SERIES B - SENIOR PREFERRED STOCK
- --------------------------------------
At the 1997 Annual Meeting of Stockholders of the Company held on May 29, 1997,
the stockholders authorized the amendment of the Company's Restated Certificate
of Incorporation to authorize 5,000,000 shares, $.01 par value per share, of a
new class of senior preferred stock (Series B Senior Preferred Stock) (the
"Convertible Stock")for possible future issuance in connection with acquisitions
and general corporate purposes, including public or private offerings of shares
for cash and stock dividends.
In connection with the Company's notice to repurchase 90,000 shares of the
Convertible Stock for $900,000 plus dividends of $45,370 on September 3, 1999,
the holder of the Convertible Stock elected to convert all of the Convertible
Stock into 450,000 shares of common stock of the Company. The Company paid the
$45,370 of dividends in cash.
13
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE H - STOCKHOLDERS' EQUITY - Continued
The Company has granted one demand registration right with respect to the common
stock referred to in the preceding paragraph. The Company and the holder of the
common stock have agreed to share the costs of the registration.
COMMON STOCK
- -------------
During August 1999, warrants to purchase a total of 425,000 shares of common
stock of the Company were exercised, resulting in cash proceeds to the Company
of $681,233. The proceeds of such exercises were used for working capital
purposes.
During October 1999, warrants to purchase a total of 163,636 shares of common
stock of the Company were exercised, resulting in cash proceeds to the Company
of $390,951. The proceeds of such exercises were used for working capital
purposes.
During February 2000, warrants to purchase a total of 95,000 shares of common
stock of the Company were exercised, resulting in cash proceeds to the Company
of $308,750. The proceeds of such exercises were used for working capital
purposes.
BOARD COMPENSATION PLAN
- -------------------------
During the Board of Directors (the "Board") meeting held on September 3, 1999,
the Board approved the implementation of a plan to compensate each outside
director serving on the Board (the "Plan"). Under the Plan, all outside
directors upon election to the Board will be entitled to receive warrants to
purchase 20,000 shares of common stock of the Company and 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 become
vested. The exercise price of the warrants issued under the Plan will be based
on the average trading price of the Company's common stock on the effective date
of the granting of the warrants, and the warrants will vest monthly over a one
year period.
In connection with the Plan, the Board granted warrants to purchase 40,000
shares of common stock at an exercise price of $2.50 for those outside directors
previously elected and serving on the Board at September 3, 1999. In addition,
the Board granted those directors warrants to purchase 20,000 shares of common
stock, at an exercise of $2.50 per share with the vesting period to commence on
August 1, 1999.
MANAGEMENT INCENTIVE PLAN
- ---------------------------
During December 2000, the Board authorized the implementation of a management
incentive program whereby officers and directors of the Company received
warrants to purchase 1,200,000 shares of common stock of the Company and
warrants to purchase 400,000 shares of common stock of the Company were received
by other members of management and consultants (the "Incentive Warrants"). The
Incentive Warrants have an exercise price equal to $4.60 per share and will vest
ratably on a monthly basis over three years or immediately upon a change in
control in the Company.
14
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE H - STOCKHOLDERS' EQUITY - Continued
REGISTRATION RIGHTS
- --------------------
In connection with the issuance of shares and warrants by the Company (the
"Shares"), the Company has on numerous instances granted registration rights to
the holders of the Shares, including those shares which result from the exercise
of warrants (the "Registrable Securities"). The obligations of the Company with
respect to the Registrable Securities include demand registration rights and/or
piggy-back registration rights and/or the Company is required to file an
effective registration by either September 19, 1999, December 1, 1999, January
31, 2000 or April 15, 2000 (the "Registration"). In connection with the
Registration of the Registrable Securities, the Company is required to provide
notice to the holder of the Registrable Securities, who may or may not elect to
be included in the Registration. The Company is obligated to register the
Registrable Securities even though the Registrable Securities may be tradable
under Rule 144. The Company did not file a registration statement for the
shares agreed to be registered by September 19, 1999, December 1, 1999 or
January 31, 2000. The Company has also received notice of a demand for
registration for certain of the Shares. The registration rights agreements do
not contain provisions for damages if the Registration is not completed except
for those Shares required to be registered on December 1, 1999, whereby for each
month after December 1999 if the Company fails to have an effective registration
statement, the Company will be required to pay a penalty of $80,000 to be paid
in cash and/or common stock of the Company based on the then current trading
price of the common stock of the Company. The Company has received an extension
of time to file the registration statement with respect to certain of the Shares
required to be registered on December 1, 1999.
The total amount of shares and warrants subject to registration at February 29,
2000, are as follows:
<TABLE>
<CAPTION>
Unexercised
Shares Warrants
----------- ---------
<S> <C> <C>
Demand Registration Rights . . 1,400,000 -
Piggy-Back Registration Rights 1,617,576 1,379,419
----------- ---------
Total Registrable Securities . 3,017,576 1,379,419
=========== =========
Registration Rights Subject To
Penalty* . . . . . . . . . . 400,000 200,000
<FN>
* Also entitled to piggy-back registration rights
</TABLE>
STOCK AWARD PLAN
- ------------------
Under the Company's 1997 Stock Award Plan (the "Stock Award Plan"), the Company
has reserved for issuance 150,000 shares of Common Stock, of which 124,686
shares were unissued as of January 31, 2000, to compensate consultants who have
rendered significant services to the Company. The Stock Award 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 Stock Award Plan for purposes of its administration
and make determinations relating to the 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 Stock Award Plan. Other eligibility
criteria may be established by the Compensation Committee as administrator of
the Stock Award Plan.
15
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES
LITIGATION
On March 16, 1999, the Company settled in mediation a lawsuit with its former
chairman of the board, Jorge V. Duran. In connection therewith and without
admitting or denying liability, the Company agreed to pay Mr. Duran $250,000 in
cash and the issuance of 100,000 shares of common stock of the Company of which
$100,000 is to be paid by the Company's insurance carrier. The total settlement
costs recorded by the Company at July 31, 1999 was $456,300. The Company has
agreed to register the common stock issuable in the future. The parties have
agreed to extend the date which the payments required in connection with the
settlement, including the issuance of the common stock, are to be made.
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 (Vendors). These amounts were previously recorded
in the Company's balance sheet at the time of the complaint. In addition,
Amwest was seeking pre-judgment for any amounts ultimately paid by Amwest
relating to claims presented to Amwest against the performance and payment
bonds, but have not yet been authorized or paid to date by Amwest. In May 1999,
the Company and PennWilson reached a settlement agreement with Amwest whereby
Amwest will be reimbursed $160,000 by PennWilson for the payments made to the
Vendors, with the Company acting as guarantor. Upon satisfactory payment,
Amwest will dismiss its pending claims related to the payment bond. On October
12, 1999, a Demand for Arbitration (the "Arbitration") of $780,767 was filed by
A.E. Schmidt Environmental ("Schmidt") against Amwest, PennWilson and the
Company on the performance bond pursuant to the NYDOT contract. The Company has
filed a response with the court opposing the petition by Schmidt to compel Penn
Octane Corporation to participate in the Arbitration. The Company is currently
considering its legal options and intends to vigorously defend against the
claims made against the performance bond but not yet paid by Amwest.
On January 28, 2000, a complaint was filed by WIN Capital Corporation ("WIN") in
the Supreme Court of the State of New York, County of New York, against the
Company for breach of contract seeking specific performance and declaratory
relief in connection with an investment banking agreement. In connection with
the lawsuit, WIN is seeking damages of no less than $1,500,000, issuance of
warrants to purchase 150,000 shares of common stock of the Company at an
exercise price of $1.75 per share exercisable for five years from November 10,
1998 and issuance of warrants to purchase 225,000 shares of common stock of the
Company at a exercise price of $3.25 per share exercisable for five years from
November 10, 1998. In addition, WIN is demanding that the warrants to be issued
be registered by the Company. The Company believes that the allegations are
without merit and intends to vigorously defend against the claims made by WIN.
On February 24, 2000, a complaint was filed in the 357th Judicial District Court
of Cameron County, Texas, by a landowner (the "Landowner") against Cowboy
Pipeline Service Company, Inc. ("Cowboy"), CPSC International, Inc. ("CPSC") and
the Company (collectively referred as the "Defendants") alleging that the
Defendants had illegally trespassed on the Landowner's property (the "Property")
in connection with the construction of the US-Mexico Pipeline and the Mexican
Terminal Facilities (the "Complaint"). On March 20, 2000, the Defendants
settled the Complaint (see note J).
On March 14, 2000 CPSC filed for protection under Chapter 11 of the United
States Bankruptcy Code. The Company is reviewing its legal options.
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.
16
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES - Continued
CREDIT FACILITY, LETTERS OF CREDIT AND OTHER
As of January 31, 2000, the Company has a $10.0 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) 2.5% of the
maximum face amount of such letter of credit, or (iii) such higher amount as may
be agreed to between the Company and RZB. Any amounts outstanding under the RZB
Credit Facility shall accrue interest at a rate equal to the rate announced by
the Chase Manhattan Bank as its prime rate plus 2.5%. Pursuant to the RZB
Credit Facility, RZB 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.
In connection with the Company's purchases of LPG from Exxon Mobil Corporation
("Exxon") PG&E NGL Marketing, L.P. ("PG&E") and/or Koch Hydrocarbon Company
("Koch"), the Company issues letters of credit on a monthly basis based on
anticipated purchases.
As of January 31, 2000, letters of credit established under the RZB Credit
Facility in favor of Exxon, PG&E and Koch for purchases of LPG totaled
$5,722,580 of which $4,645,815 was being used to secure unpaid purchases. In
addition, as of January 31, 2000, the Company had borrowed $3,707,035 from its
revolving line of credit under the RZB Credit Facility for purchases of LPG. In
connection with these purchases, at January 31, 2000, the Company had unpaid
invoices due from PMI totaling $5,342,925, cash balances maintained in the RZB
Credit Facility collateral account of $186,739 and inventory held in storage of
$3,858,327 (see note D).
OPERATING LEASE COMMITMENTS
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, which the Company believes will provide 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 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 also provides for variable rental increases based on
monthly volumes purchased and flowing into the Pipeline and storage utilized.
17
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE I - COMMITMENTS AND CONTINGENCIES - CONTINUED
CAPITALIZED LEASE COMMITMENT
- ------------------------------
The following is a schedule of the estimated future minimum lease payments under
the Lease Agreements for the US-Mexico Pipeline and Mexican Terminal Facilities
together with the present value of the net minimum lease payments net of the 50%
interest in Lease Agreements purchased during December 1999. The Company will
record the capitalized lease obligations upon the Substantial Completion Date
(see note J).
<TABLE>
<CAPTION>
<S> <C>
Total minimum lease payments. . . . . . . . . . . . . . . . . . . . $ 28,260,000
Less: Amount representing estimated executory costs for operations ( 3,600,000)
---------------
24,660,000
Less: Amounts related to the purchased interest - see note J . . . ( 11,304,000)
---------------
Net minimum lease payments. . . . . . . . . . . . . . . . . . . . . 13,356,000
Less: Amount representing interest . . . . . . . . . . . . . . . . ( 7,356,000)
---------------
Present value of net minimum lease payments . . . . . . . . . . . . $ 6,000,000
===============
</TABLE>
In connection with the Addendum and the Letter Agreement, the Company may
acquire the remaining 50% interest in the Lease Agreements. At the time that
the Company has purchased the remaining 50% interest in the Lease Agreements,
the Company will no longer record any capitalized lease obligations (see note
J).
NOTE J - LPG EXPANSION PROGRAM
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 Pipeline") crossing the international boundary line
between the United States and Mexico (from the Brownsville Terminal Facilities
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"].
Previously, on July 2, 1998, Penn Octane de Mexico, S.A. de C.V. ("PennMex")
(see below), 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 Pipeline"] between El Sabino (at the
point North of the Rio Bravo) and to a terminal facility in the City of
Matamoros, State of Tamaulipas, Mexico (the "Mexican Terminal Facilities"). The
construction and operation of the US-Mexico Pipeline and the Mexican Terminal
Facilities are referred to as the "Expansion."
In addition to the Expansion, the Company has begun construction of (i) a
midline pump station on the Pipeline (estimated cost of $1,500,000), (ii)
expansion of the Brownsville Terminal Facility to allow for the loading and
unloading of railcars, (iii) has begun construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal Facilities") at
an estimated cost of $500,000, and (iv) completed the purchase of a tank farm
for a purchase price of $195,000 (plus costs related to the clean up of the tank
farm), which after additional improvements will be capable of storing and
distributing refined products. The Saltillo Terminal Facilities, when complete,
will allow for the distribution of LPG by railcars, which will directly link the
Company's Brownsville Terminal Facility and the Saltillo Terminal Facilities.
The Saltillo Terminal Facilities will contain storage to accommodate
approximately 100,000 gallons of LPG. In connection with the purchase of the
tank farm, the Company entered into a lease agreement for rental of the land
which the tank farm occupies and for the use of a refined products pipeline
connecting the tank farm with public dock facilities.
18
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE J - LPG EXPANSION PROGRAM - Continued
In connection with the Expansion, the Company and CPSC entered into two separate
Lease / Installation Purchase Agreements, as amended, (the "Lease Agreements"),
whereby CPSC agreed to construct and maintain the US-Mexico Pipeline (including
an additional pipeline to accommodate refined products) and the Mexican Terminal
Facilities and agreed to lease these assets to the Company. Under the terms of
the Lease Agreements, the Company is required to make monthly rental payments of
approximately $157,000, beginning the date that the US-Mexico Pipeline and
Mexican Terminal Facilities reach substantial completion, as defined under the
Lease Agreements (the "Substantial Completion Date"). During January 2000, CPSC
notified the Company that the Substantial Completion Date had occurred. In
addition, the Company has agreed to provide a lien on certain assets, leases and
contracts which are currently pledged to RZB, and provide CPSC with a letter of
credit of approximately $1,000,000 (the "LOC"). The Company is currently in
negotiations with RZB and CPSC concerning RZB's subordination of RZB's lien on
certain assets, leases and contracts. The Company also has the option to
purchase the US-Mexico Pipeline and the Mexican Terminal Facilities at the end
of the 10th year anniversary and 15th year anniversary for $5,000,000 and
$100,000, respectively. Under the terms of the Lease Agreements, CPSC is
required to pay all costs associated with the design, construction and
maintenance of the US-Mexico Pipeline and Mexican Terminal Facilities (the
"Costs"). As of January 31, 2000, the Company has spent approximately $683,000
related to the Costs, which are included in other costs paid by the Company (see
note C).
On September 16, 1999, the Lease Agreements were amended whereby CPSC agreed to
accept 500,000 shares of common stock of the Company owned by the President of
the Company (the "Collateral") in place of the LOC originally required under the
Lease Agreements. The Collateral shall be replaced by a letter of credit or
cash collateral over a ten-month period beginning monthly after the Substantial
Completion Date. In addition, the Company has agreed to guarantee the value of
the Collateral based on the fair market value of the Collateral for up to
$1,000,000.
During December 1999, the Company and CPSC amended (the "Addendum") the Lease
Agreements, which modified certain terms of the Lease Agreements, including all
prior amendments, modifications, options, extensions and renewals, which were
entered into from the date of the Lease Agreements until the date of the
Addendum. In connection with the Addendum, the Company purchased 50% of the
US-Mexico Pipeline and Mexican Terminal Facilities, including a 50% interest in
the underlying Lease Agreements for $3,000,000 and the right to receive a
minimum per month of the greater of $62,800 or 40% of the monthly net income
from the Lease Agreements.
In addition, under the Addendum, the Company received an option until December
15, 2000 to acquire the remaining 50% of the US-Mexico Pipeline and Mexican
Terminal Facilities, including the remaining 50% interest in the Lease
Agreements for $6,000,000 and the issuance of (i) warrants to purchase 200,000
shares of common stock of the Company exercisable for three years at an exercise
price of $4.00 per share if the option is exercised by June 15, 2000 or (ii)
warrants to purchase 300,000 shares of common stock of the Company exercisable
for three years at an exercise price of $4.00 per share if the option is
exercised thereafter.
In connection with the Addendum, the Company is also entitled to offset any
amounts which have been paid by the Company on behalf of CPSC related to the
completion of CPSC's obligations under the Lease Agreements, except for the
$3,000,000 paid for the 50% interest, described herein, against the Company's
future rental obligations under the Lease Agreements and/or against the option
price of $6,000,000 to purchase the remaining 50% interest in the US-Mexico
Pipeline and Mexican Terminal Facilities, including a 50% interest in the
underlying Lease Agreements. The Company may also offset against its monthly
rent obligations under the Lease Agreements any amounts to be received from its
interests in the Lease Agreements so long as the Company is current on all of
the lease payments required under the Lease Agreements.
As a result of the purchase of the 50% interest in the US-Mexico Pipeline and
Mexican Terminal Facilities, including a 50% interest in the underlying Lease
Agreements, the Company is only required to provide 50% of the collateral
originally agreed to under the Lease Agreements.
19
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE J - LPG EXPANSION PROGRAM - Continued
On February 21, 2000, the Company and CPSC entered into a letter of agreement
(the "Letter Agreement") whereby the Company modified the terms associated with
acquiring the remaining 50% interest in the US-Mexico Pipeline and Mexican
Terminal Facilities, whereby the Company will only be required to make a cash
payment of $4,500,000 ($2,000,000 to be paid on or prior to March 3, 2000,
$1,000,000 payable on or before August 21, 2000 and $1,500,000 payable in twelve
equal monthly installments beginning March 31, 2000) and warrants to purchase
200,000 shares of common stock of the Company exercisable for three years at an
exercise price of $4.00 per share. In addition, the Company agreed to pay
Cowboy $150,000 on or before June 1, 2000 as full satisfaction of a disputed
claim arising from a previous consulting agreement entered into between Cowboy
and the Company. The Company also agreed that all payments made by the Company
on behalf of CPSC in connection with the Lease Agreements (see note C) be
assumed by the Company. The Company has yet to make any payments under the
Letter Agreement and is not obligated until CPSC provides the Company the among
other things, proof of ownership and lease rights (see following paragraph) in
connection with the US-Mexico Pipeline and Mexican Terminal Facilities. The
closing of the purchase is subject to satisfactory transfer of title to all
assets relating to the US-Mexico Pipeline and Mexican Terminal Facilities and
execution of formal agreements.
In connection with the lawsuit filed on February 24, 2000 (see note I), the
Company discovered that CPSC had not fulfilled all of its obligations under the
Lease Agreements and therefore the Substantial Completion Date has not occurred.
As a result, additional amounts may be required to reach the Substantial
Completion Date. If CPSC is not able to complete the US-Mexico Pipeline and
Mexican Terminal Facilities, the Company may incur additional costs to complete
the US-Mexico Pipeline and Mexican Terminal Facilities, the amount of which can
not presently be determined. As described earlier, any additional costs
incurred by the Company may be offset against future rental obligations under
the Lease Agreements or against amounts required to be paid to purchase the
remaining 50% interest in the US-Mexico Pipeline and Mexican Terminal
Facilities.
For financial accounting purposes, the Lease Agreements are capital leases.
Therefore, the assets and related liabilities will be recorded in the Company's
balance sheet on the Substantial Completion Date (see note I) for the portion of
the obligations under the Lease Agreements which have not been purchased by the
Company.
On May 31, 1999, Tergas, S.A. de C.V., a Mexican company ("Tergas") (see below),
was formed for the purpose of operating LPG terminal facilities in Mexico,
including the Mexican Terminal Facilities and the planned Saltillo Terminal
Facilities and future LPG terminal facilities in Mexico. Tergas has been issued
the permit to operate the Mexican Terminal Facilities and the Company
anticipates Tergas will be issued the permit to operate the Saltillo Terminal
Facilities.
In connection with the construction of the Mexico Pipelines and Mexican Terminal
Facilities, CPSC provided all payments and delivery of equipment through
Termatsal, S.A. de C.V., a Mexican company ("Termatsal") (see below).
PennMex, Tergas or Termatsal are currently the owners of the land which is being
utilized for the Mexican Pipeline and Mexican Terminal Facilities, have entered
into leases associated with the Saltillo Terminal Facilities, have been granted
the permit for the Mexican Pipeline, have been granted and/or are expected to be
granted permits to operate the Mexican Terminal Facilities and the Saltillo
Terminal Facilities, or have title to the assets paid for by CPSC to construct
the Mexican Pipeline and Mexican Terminal Facilities. In addition, the Company
has advanced funds (totaling approximately $790,000 at January 31, 2000) to
PennMex, Tergas or Termatsal in connection with the purchase of property, plant
and equipment associated with the construction of the Mexican Pipeline, Mexican
Terminal Facilities and the Saltillo Terminal Facilities, which are included in
other costs paid by the Company (see note C).
20
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE J - LPG EXPANSION PROGRAM - Continued
During the years ended July 31, 1998 and 1999 and for the six months ended
January 31, 2000, the Company paid PennMex $181,000, $125,000 and $121,312,
respectively, for Mexico related expenses incurred by that corporation on the
Company's behalf. Such amounts were expensed.
PennMex, Tergas and Termatsal are Mexican companies which are owned 90%, 90% and
98%, respectively, by Jorge R. Bracamontes ("Bracamontes"), an officer and
director of the Company and the balance by other citizens of Mexico.
Under current Mexican law, foreign ownership of Mexican entities involved in the
distribution of LPG and the operation of LPG terminal facilities are prohibited.
However, transportation and storage of LPG by foreigners is permitted.
In October 1999, the Company received a verbal opinion from the Foreign
Investment Section of the Department of Commerce and Industrial Development
("SECOFI") that the operation of the Mexican Pipeline and Mexican Terminal
Facilities would be considered a transportation rather than a distribution
activity, and therefore, could be performed by a foreign entity or through a
foreign-owned Mexican entity. The Company intends to request a ruling from
SECOFI confirming the verbal opinion. On November 4, 1999, the Company and
Bracamontes and the other shareholders entered into a purchase agreement to
acquire up to 75% of the common stock of PennMex for a nominal amount. The
purchase agreement is subject to among other things, the receipt of the
aforementioned ruling. The Company intends to formalize contracts among the
Company, PennMex, Tergas and Termatsal for services to be performed in
connection with the operations of the Mexican Pipeline, the Mexican Terminal
Facilities and the Saltillo Terminal Facilities.
The operations of PennMex, Tergas or Termatsal, are subject to the tax laws of
Mexico, which among other things, require that Mexican subsidiaries of foreign
entities or transactions between Mexican and foreign entities comply with
transfer pricing rules, the payment of income and/or asset taxes, and possibly
taxes on distributions in excess of earnings. In addition, distributions to
foreign corporations may be subject to withholding taxes, including dividends
and interest payments.
The transfer of any of the interests acquired by the Company or the
formalization of any contractual arrangements related to assets which are
located in Mexico are dependent upon the determination of the ultimate legal
structure of the ownership of such assets.
NOTE K - 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 had an accumulated deficit since
inception, has used cash in operations, and has had a deficit in working
capital. In addition, the Company is involved in litigation, the outcome of
which cannot be determined at the present time. Although the Company has
entered into the Lease Agreements, there exists significant uncertainties
related to the substantial completion of the US-Mexico Pipeline and Mexican
Terminal Facilities (see note J). In addition, the acquisition of the interests
in PennMex and the operating agreements among the Company, Tergas, PennMex or
Termatsal have yet to be consummated. 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 Company's ability to obtain
additional financing and to raise additional equity capital, the completion of
the transactions related to the US-Mexico Pipeline and Mexican Terminal
Facilities 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.
21
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE K - REALIZATION OF ASSETS - Continued
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 its customer base, (iii) extend the terms and capacity
of the Pipeline Lease and the Brownsville Terminal Facility, (iv) expand its
product lines, (v) increase its source of LPG supply and at more favorable
terms, (vi) obtain additional letters of credit financing, (vii) raise
additional debt and/or equity capital and (viii) resolve the issues related to
the US-Mexico Pipeline and Mexican Terminal Facilities.
At July 31, 1999, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $8,000,000. 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.
NOTE L - CONTRACTS
LPG BUSINESS
The Company has entered into a sales agreement, as amended (the "Agreement"),
with PMI, its major customer, to provide a minimum monthly volume of LPG to PMI
through March 31, 2000. Sales to PMI for the six months ended January 31, 2000
totaled $34,883,855, representing approximately 100% of total revenues for the
period. The Company is currently purchasing LPG from major suppliers to meet
the minimum monthly volumes required in the Agreement. The suppliers' prices
are below the sales price provided for in the Agreement.
Effective October 1, 1999, the Company and Exxon entered into a ten year LPG
supply contract (the "Exxon Supply Contract"), whereby Exxon has agreed to
supply and the Company has agreed to take, the supply of propane and butane
available at Exxon's King Ranch Gas Plant (the "Plant") which is estimated to be
between 10,100,000 gallons per month and 13,900,000 gallons per month blended in
accordance with the specifications as outlined under the PMI Sales Agreement
(the "Plant Commitment"), with a minimum of 10,100,000 gallons per month
guaranteed by Exxon to be provided to the Company.
In addition, under the terms of the Exxon Supply Contract, Exxon is required to
make operational its Corpus Christi Pipeline (the "CCPL") which will allow 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 "CCPL Supply") for blending to
the proper specifications outlined under the PMI Sales Agreement and then
delivered into the Pipeline. In connection with the CCPL Supply, the Company
has agreed to supply a minimum of 7,700,000 gallons into the CCPL during the
first quarter from the date that the CCPL is operational, approximately
92,000,000 gallons the following year and 122,000,000 gallons each year
thereafter and continuing for four years. The CCPL has yet to be completed.
The Exxon Supply Contract currently requires that the Company purchase a minimum
supply of LPG, which is significantly higher than committed sales volumes under
the PMI Sales Agreement. In addition, the Company is required to pay additional
fees associated with the Additional Propane Supply, which will increase its LPG
costs by a minimum of $.01 per gallon without considering the actual cost of the
propane charged to the Company from other suppliers.
In September 1999, the Company and PG&E entered into a three year supply
agreement (the "PG&E Supply Agreement") whereby PG&E has agreed to supply and
the Company has agreed to take, a monthly average of 2,500,000 gallons (the
"PG&E Supply") of propane beginning during October 1999.
Under the terms of the PG&E Supply Agreement, when the CCPL becomes operational,
the PG&E Supply will be delivered to the CCPL, as described above, and blended
to the proper specifications as outlined under the PMI Sales Agreement. Prior
to the completion of the CCPL, the Company will receive delivery of the PG&E
Supply through the facilities provided for under the Pipeline Lease Amendment.
22
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE L - CONTRACTS - Continued
In March 2000, the Company and 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 8,200,000 gallons (the "Koch Supply")
of propane beginning April 1, 2000, subject to the actual amounts of propane
purchased by Koch from the refinery owned by its affiliate, Koch Petroleum
Group, L.P. In connection with the Koch Supply Contract, the sales price charged
to the Company may be adjusted during each year of the contract (the "Contract
Year") if Koch receives a bona-fide third party offer prior to the Contract Year
for the Koch Supply and the Company agrees to accept such price adjustment for
the Contract Year at issue, otherwise the Koch Supply Contract shall be
terminated. Furthermore, the Company has agreed to pay additional charges
associated with the construction of a new pipeline interconnection which would
allow deliveries of the Koch Supply into the CCPL.
In connection with the delivery of the Koch Supply, Exxon has yet to make
operational the CCPL. Accordingly, the Company will not be able to accept the
Koch Supply until the completion of the CCPL. During the period April 1, 2000
to the date the CCPL is completed, the Company will arrange for the sale of the
Koch Supply to third parties (the "Unaccepted Koch Supply Sales"). The Company
anticipates that the net cost to the Company in connection with the Unaccepted
Koch Supply Sales will be between $0.00 per gallon and $.025 per gallon.
Under the terms of the Koch Supply Contract, when the CCPL becomes operational,
the Koch Supply will be delivered into the CCPL, as described above, and blended
to the proper specifications as outlined under the PMI Sales Agreement.
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 1,900,000 gallons (the "Duke Supply") of propane or propane/butane mix,
beginning April 1, 2000.
Under the terms of the Duke Supply Contract, the Company will be required to pay
for modifications related to the connections necessary to bring a portion of the
Duke Supply into the Pipeline facilities. These costs are expected to be
minimal. All other Duke Supply will be delivered through facilities provided
for under the Pipeline Lease Amendment, and blended to the proper specifications
as outlined under the PMI Sales Agreement.
In addition, upon completion of the CCPL, the delivery of the PG&E Supply or the
Koch Supply would satisfy a portion or all of the CCPL Supply requirements under
the Exxon Supply Contract.
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, PG&E Supply, Koch Supply or Duke Supply over actual sales volumes.
Furthermore, the Company's existing letter of credit facility may not be
adequate and the Company may require additional sources of financing to meet the
letter of credit requirements under the Exxon Supply Contract, the PG&E Supply
Agreement, the Koch Supply Contract or the Duke Supply Contract.
CONSULTING COMMISSION AGREEMENT
The Company has entered into an incentive arrangement with several consultants
(the "Arrangement") whereby the Company will pay a commission based on $.001
plus 5% of every $.01 of gross margin in excess of $.0425 earned by the Company
in connection with the LPG sales of the Company, so long as the volume is in
excess of 7.5 million gallons per month. The Arrangement became effective July
1, 1999 and is renewable annually. The amounts owed by the Company to the
Consultants for the period from August 1, 1999 through January 31, 2000, were
not material.
23
<PAGE>
PENN OCTANE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOTE M - AWARD FROM 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
(the "Petitioner") filed a petition for review with the Supreme Court of Texas.
On May 10, 1999 the Company responded to the Supreme Court of Texas' request for
response of the Petitioner's petition for review. On May 27, 1999, the
Petitioner filed a reply with the Supreme Court of Texas to the Company's
response of the Petitioner's petition for review. On June 10, 1999, the Supreme
Court of Texas denied the Petitioner's petition for review. During July 1999,
the Petitioner filed an appeal with the Supreme Court of Texas to rehear the
Petitioner's petition for review. On August 26, 1999, the Supreme Court of
Texas upheld its decision to deny the Petitioner's petition for review. During
November 1999, the Petitioner filed a petition for writ of certiorari with the
United States Supreme Court. On January 24, 2000, the United States Supreme
Court denied the Petitioner's request for review and the Judgment became final
and binding. During March 2000, the Company received a cash payment from
IBC-Brownsville of $4,254,347 of which approximately $1,200,000 is to be paid
for legal fees and for other expenses associated with the Judgment.
For the quarter ended January 31, 1999, the Company recorded a gain of
approximately $987,000, which represented the amount of the Judgment which was
recorded as a liability on the Company's balance sheet at December 31, 1998
(non-cash). The cash portion of the Judgment received by the Company, net of
all contingent expenses, has been recorded as a gain during the three months
ended January 31, 2000.
24
<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 and was discontinued during
fiscal 1999, have been presented separately in the Consolidated Financial
Statements of the Company as discontinued operations.
FORWARD-LOOKING STATEMENTS
Statements in this report regarding future events or conditions are
forward-looking statements. Actual results, performance or achievements could
differ materially due to, among other things, factors discussed in this report
and in Part I of the Company's Annual Report on Form 10-K for the fiscal year
ended July 31, 1999. These forward-looking statements include, but are not
limited to, statements regarding anticipated future revenues, sales, operations,
demand, competition, capital expenditures, the deregulation of the LPG market in
Mexico, the completion and operations of the US - Mexico Pipeline, the Mexican
Terminal Facilities and the Saltillo Terminal Facilities, foreign ownership of
LPG operations, credit arrangements and other statements regarding matters that
are not historical facts, and involves predictions which are based upon a number
of future conditions that ultimately may prove to be inaccurate. We caution
you, however, that this list of factors may not be complete.
OVERVIEW
The Company has been principally engaged in the purchase, transportation
and sale of LPG and, from 1997 to March 1999, the provision of equipment and
services to the CNG industry. Beginning in 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 of LPG to PMI, its primary customer. During the six months ended
January 31, 2000, the Company derived approximately all of its revenues from
sales of LPG.
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 cost 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 suppliers and resold to PMI could result in
unanticipated costs.
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, 2000 and 1999.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- --------------------------
January 31, January 31, January 31, January 31,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Volume Sold
LPG (millions of gallons) 36.6 31.5 70.4 54.0
Average sales price
LPG (per gallon). . . . . $ 0.52 $ 0.26 $ 0.50 $ 0.27
</TABLE>
25
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JANUARY 31, 2000 COMPARED WITH THE THREE MONTHS ENDED
JANUARY 31, 1999
Revenues. Revenues for the three months ended January 31, 2000 were $19.0
million compared with $8.4 million for the three months ended January 31, 1999,
an increase of $10.6 million or 127.5%. Of this increase $2.6 million was
attributable to increased volumes of LPG sold in the three months ended January
31, 2000 and $8.0 million was attributable to increased average sales prices of
LPG sold in the three months ended January 31, 2000.
Cost of sales. Cost of sales for the three months ended January 31, 2000
was $17.8 million compared with $7.4 million for the three months ended January
31, 1999, an increase of $10.4 million or 140.4%. Of this increase $2.4
million was attributable to an increased volumes of LPG purchased in the three
months ended January 31, 2000, $7.7 million was attributable to increased
average sales prices of LPG purchased in the three months ended January 31, 2000
and $370,612 was attributable to increased operating costs associated with LPG
during the three months ended January 31, 2000.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.0 million for the three months ended January 31,
2000 compared with $644,692 for the three months ended January 31, 1999, an
increase of $367,307 or 57.0%. This increase was primarily attributable to
additional professional fees incurred during the three months ended January 31,
2000.
Other income and expense, net. Other income (expense), net was $2.8
million for the three months ended January 31, 2000 compared with $787,312 for
the three months ended January 31, 1999, an increase of $2.0 million. The
increase in other income, net was due primarily to increased income from the
award from litigation of $2.1 million which was recorded during the three months
ended January 31, 2000 compared with the award from litigation recorded during
the three months ended January 31, 1999.
Income tax. During the three months ended January 31, 2000, the Company
recorded a provision for income taxes of $70,000, representing the alternative
minimum tax due. Due to the availability of net operating loss carryforwards
($8.0 million at July 31, 1999), the Company did not incur any additional income
tax expense during the three months ended January 31, 2000. Due to the
availability of net operating loss carryforwards at June 31, 1998 of $8.8
million, there was no income tax expense recorded during the three months ended
January 31, 1999. The ability to use such net operating loss carryforwards,
which expire in the years 2009 to 2018, 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 prior alternate minimum taxes paid.
SIX MONTHS ENDED JANUARY 31, 2000 COMPARED WITH THE SIX MONTHS ENDED
JANUARY 31, 1999
Revenues. Revenues for the six months ended January 31, 2000 were $35.0
million compared with $14.8 million for the six months ended January 31, 1999,
an increase of $20.2 million or 135.8%. Of this increase $8.2 million was
attributable to increased volumes of LPG sold in the six months ended January
31, 2000 and $12.1 million was attributable to increased average sales prices of
LPG sold in the six months ended January 31, 2000.
Cost of sales. Cost of sales for the six months ended January 31, 2000 was
$32.8 million compared with $13.3 million for the six months ended January 31,
1999, an increase of $19.5 million or 146.1%. Of this increase $7.4 million
was attributable to an increased volumes of LPG purchased in the six months
ended January 31, 2000, $11.8 million was attributable to increased average
sales prices of LPG purchased in the six months ended January 31, 2000 and
$339,596 was attributable to increased operating costs associated with LPG
during the six months ended January 31, 2000.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.6 million for the six months ended January 31,
2000 compared with $1.2 million for the six months ended January 31, 1999, an
increase of $397,735 or 33.7%. This increase was primarily attributable to
additional professional fees incurred during the six months ended January 31,
2000.
26
<PAGE>
Other income and expense, net. Other income (expense), net was $2.7
million for the six months ended January 31, 2000 compared with $695,337 for the
six months ended January 31, 1999, an increase of $2.0 million. The increase in
other income, net was due primarily to increased income from the award from
litigation of $2.1 million which was recorded during the six months ended
January 31, 2000 compared with the award from litigation recorded during the six
months ended January 31, 2000.
Income tax. During the six months ended January 31, 2000, the Company
recorded a provision for income taxes of $70,000, representing the alternative
minimum tax due. Due to the availability of net operating loss carryforwards
($8.0 million at July 31, 1999), the Company did not incur any additional income
tax expense during the six months ended January 31, 2000. Due to the
availability of net operating loss carryforwards at June 31, 1998 of $8.8
million, there was no income tax expense recorded during the six months ended
January 31, 1999. The ability to use such net operating loss carryforwards,
which expire in the years 2009 to 2018, 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 prior alternate minimum taxes paid.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has had an accumulated deficit since its inception in
1992, has used cash in operations and has had a deficit in working capital. In
addition, the Company is involved in litigation, the outcome of which cannot be
determined at the present time. Although the Company has entered into the Lease
Agreements, there exists significant uncertainties related to the substantial
completion of the US-Mexico Pipeline and Mexican Terminal Facilities (see note J
to the unaudited consolidated financial statements). 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.
The following summary table reflects comparative cash flows for the six
months ended January 31, 2000 and 1999. All information is in thousands.
<TABLE>
<CAPTION>
Six months Ended
----------------------------
January 31, January 31,
2000 1999
------------- -------------
<S> <C> <C>
Net cash provided by (used in) operating activities $ (4,494) $ 167
Net cash (used in) investing. . . . . . . . . . . . (4,484) (171)
Activities
Net cash provided by financing activities . . . . . 9,201 357
------------- -------------
Net increase in cash . . . . . . . . . . . . . . . $ 223 $ 353
============= =============
</TABLE>
PMI Sales Agreement. 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 June 1999, the PMI Sales Agreement was amended (the
"PMI Sales Agreement Amendment") to extend the expiration date until March 31,
2000 and to provide the Company with additional margins for any volume exceeding
7.0 million gallons per month during the summer period (April - September) and
9.0 million gallons per month during the winter period (October - March). Under
the PMI Sales Agreement Amendment, PMI is obligated to purchase a minimum volume
of 45.0 million gallons during October 1999 through March 2000.
LPG Supply Agreements. During October 1998, the Company entered into a
monthly supply agreement with Exxon Mobil Corporation ("Exxon") pursuant to
which Exxon agreed to supply minimum volumes of LPG to the Company. Effective
November 1, 1998, the Company entered into a supply agreement with Exxon to
purchase minimum monthly volumes of LPG through September 1999.
27
<PAGE>
Effective October 1, 1999, the Company and Exxon entered into a ten year
LPG supply contract (the "Exxon Supply Contract"), whereby Exxon has agreed to
supply and the Company has agreed to take, the supply of propane and butane
available at Exxon's King Ranch Gas Plant (the "Plant") which is estimated to be
between 10.1 million gallons per month and 13.9 million gallons per month
blended in accordance with the specifications as outlined under the PMI Sales
Agreement (the "Plant Commitment"), with a minimum of 10.1 million gallons per
month guaranteed by Exxon to be provided to the Company.
In addition, under the terms of the Exxon Supply Contract, Exxon is
required to make operational its Corpus Christi Pipeline (the "CCPL") which will
allow 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 "CCPL Supply") for
blending to the proper specifications outlined under the PMI Sales Agreement and
then delivered into the Pipeline. In connection with the CCPL Supply, the
Company has agreed to supply a minimum of 7.7 million gallons into the CCPL
during the first quarter from the date that the CCPL is operational,
approximately 92.0 million gallons the following year and 122.0 million gallons
each year thereafter and continuing for four years. The CCPL has yet to be
completed.
The Exxon Supply Contract currently requires that the Company purchase a
minimum supply of LPG, which is significantly higher than committed sales
volumes under the PMI Sales Agreement. In addition, the Company is required to
pay additional fees associated with the Additional Propane Supply, which will
increase its LPG costs by a minimum of $.01 per gallon without considering the
actual cost of the propane charged to the Company from other suppliers.
In September 1999, the Company and PG&E NGL Marketing, L.P. ("PG&E")
entered into a three year supply agreement (the "PG&E Supply Agreement") whereby
PG&E has agreed to supply and the Company has agreed to take, a monthly average
of 2.5 million gallons (the "PG&E Supply") of propane beginning during October
1999.
Under the terms of the PG&E Supply Agreement, when the CCPL becomes
operational, the PG&E Supply will be delivered to the CCPL, as described above,
and blended to the proper specifications as outlined under the PMI Sales
Agreement. Prior to the completion of the CCPL, the Company will receive
delivery of the PG&E Supply through the facilities provided for under the
Pipeline Lease Amendment.
In March 2000, the Company and Koch Hydrocarbon Company ("Koch") entered
into a three year supply agreement (the "Koch Supply Contract") whereby Koch has
agreed to supply and the Company has agreed to take, a monthly average of 8.2
million gallons (the "Koch Supply") of propane beginning April 1, 2000, subject
to the actual amounts of propane purchased by Koch from the refinery owned by
its affiliate, Koch Petroleum Group, L.P. In connection with the Koch Supply
Contract, the sales price charged to the Company may be adjusted during each
year of the contract (the "Contract Year") if Koch receives a bona-fide third
party offer prior to the Contract Year for the Koch Supply and the Company
agrees to accept such price adjustment for the Contract Year at issue, otherwise
the Koch Supply Contract shall be terminated. Furthermore, the Company has
agreed to pay additional charges associated with the construction of a new
pipeline interconnection which would allow deliveries of the Koch Supply into
the CCPL.
In connection with the delivery of the Koch Supply, Exxon has yet to make
operational the CCPL. Accordingly, the Company will not be able to accept the
Koch Supply until the completion of the CCPL. During the period April 1, 2000
to the date the CCPL is completed, the Company will arrange for the sale of the
Koch Supply to third parties (the "Unaccepted Koch Supply Sales"). The Company
anticipates that the net cost to the Company in connection with the Unaccepted
Koch Supply Sales will be between $0.00 per gallon and $.025 per gallon.
Under the terms of the Koch Supply Contract, when the CCPL becomes
operational, the Koch Supply will be delivered into the CCPL, as described
above, and blended to the proper specifications as outlined under the PMI Sales
Agreement.
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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.
Under the terms of the Duke Supply Contract, the Company will be required
to pay for modifications related to the connections necessary to bring a portion
of the Duke Supply into the Pipeline facilities. These costs are expected to be
minimal. All other Duke Supply will be delivered through facilities provided
for under the Pipeline Lease Amendment, and blended to the proper specifications
as outlined under the PMI Sales Agreement.
In addition, upon completion of the CCPL, the delivery of the PG&E Supply
or the Koch Supply would satisfy a portion or all of the CCPL Supply
requirements under the Exxon Supply Contract.
In connection with the Plant Commitment, the PG&E Supply, the Koch Supply
and the Duke Supply, the Company anticipates lower gross margins on its sales of
LPG under the PMI Sales Agreement of approximately 10% - 40% as a result of
increased LPG costs compared with the previous agreements to purchase LPG. The
Company may incur significant additional costs associated with storage, disposal
and/or changes in LPG prices resulting from the excess of the Plant Commitment,
PG&E Supply, Koch Supply or Duke Supply (the "Excess Supply") over actual sales
volumes.
The Company believes that the terms of the Exxon Supply Contract, the PG&E
Supply Agreement, the Koch Supply Contract and the Duke Supply Contract are
commensurate with the anticipated future demand for LPG in Mexico and that any
additional costs associated with the Excess Supply as well as the increase in
the costs for LPG over previous agreements will be offset by increased sales
margins on LPG sold to the Company's customers. The Company further believes
that any additional costs incurred in connection with the Plant Commitment, the
CCPL Supply, the PG&E Supply, the Koch Supply, and the Duke Supply, if any, will
be short-term in nature.
The ability of the Company to increase sales of LPG into Mexico in the
future is largely dependent on the Company's ability to negotiate future
contracts with PMI and/or with local Mexican distributors once Deregulation in
Mexico is implemented. In addition, there can be no assurance that the Company
will be able to obtain terms as favorable as the PMI Sales Agreement. In the
event that the Company is unable to meet its intended LPG sales objectives, then
the Company may incur significant losses as a result of not being able to meet
its minimum purchase requirements under the Exxon Supply Contract, the PG&E
Supply Agreement, the Koch Supply Contract and the Duke Supply Contract or the
costs of LPG may be in excess of prices received on sales of LPG.
Furthermore, until the US-Mexico Pipeline and Mexican Terminal Facilities
and Saltillo Terminal Facilities are completed and begin to be utilized, the
Company will be required to deliver the minimum monthly volumes from its
Brownsville terminal facility (see note J to the unaudited consolidated
financial statements). Historically, sales of LPG from the Brownsville terminal
facility have not exceeded 12.7 million gallons per month. In addition,
breakdowns along the planned distribution route for the LPG once purchased from
Exxon, PG&E, Koch or Duke or other suppliers, may limit the ability of the
Company to accept the Plant Commitment, the CCPL Supply, the PG&E Supply, the
Koch Supply, and the Duke Supply.
Under the terms of the Exxon Supply Contract, the PG&E Supply Agreement,
the Koch Supply Contract and the Duke Supply Contract, the Company must provide
letters of credit in amounts equal to the cost of the product purchased. The
amount of product to be purchased under the Exxon Supply Contract, the PG&E
Supply Agreement, the Koch Supply Contract and the Duke Supply Contract are
significantly higher than historical amounts. 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 and the
Company may require additional sources of financing to meet the letter of credit
requirements under the Exxon Supply Contract, the PG&E Supply Agreement, the
Koch Supply Contract and the Duke Supply Contract. Furthermore upon the
implementation of Deregulation the Company anticipates entering into contracts
with Mexican customers which require payments in pesos. In addition the Mexican
customers may be limited in their ability to provide adequate financing.
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As a result of the Exxon Supply Contract, the PG&E Supply Agreement, the Koch
Supply Contract and the Duke Supply Contract, the Company believes that its has
an adequate supply of LPG to satisfy the requirements of PMI under the PMI Sales
Agreement and to meet its future sales obligations, if any, upon the expiration
of the PMI Sales Agreement. Due to strategic location of the Company's
pipelines and terminal facilities, the Company believes that it will be able to
achieve higher margins on the sale of LPG in the future.
In determining whether any supplier will be utilized, the Company considers
the applicable prices charged as well as any additional fees that may be
required to be paid under the Pipeline Lease Amendment and other costs.
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 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, 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 the second year from the Effective Date. In
addition, the Pipeline Lease Amendment provides for variable rental increases
based on monthly volumes purchased and flowing into the 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.
Present Pipeline capacity is approximately 265 million gallons per year.
During the six months ended January 31, 2000, the Company sold 70.4 million
gallons of LPG which flowed through the Pipeline. The Company intends to
increase the Pipeline's capacity through the installation of additional pumping
equipment. (See "LPG Expansion Program" below).
LPG EXPANSION PROGRAM. 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 Pipeline") crossing the
international boundary line between the United States and Mexico (from the
Brownsville Terminal Facilities 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"].
Previously, on July 2, 1998, Penn Octane de Mexico, S.A. de C.V.
("PennMex") (see below), 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 Pipeline"] between El Sabino
(at the point North of the Rio Bravo) and to a terminal facility in the City of
Matamoros, State of Tamaulipas, Mexico (the "Mexican Terminal Facilities"). The
construction and operation of the US-Mexico Pipeline and the Mexican Terminal
Facilities are referred to as the "Expansion."
Management believes that as a result of the Expansion, the Company will
have additional strengths due to its ability to penetrate further into Mexico,
provide greater volumes of LPG as a result of reduced cross border trucking
delays and greater access to Mexican distribution resources and the potential to
achieve greater margins on its LPG sales.
In addition to the Expansion, the Company has begun construction of (i) a
midline pump station on the Pipeline (estimated cost of $1.5 million), (ii)
expansion of the Brownsville Terminal Facility to allow for the loading and
unloading of railcars, (iii) has begun construction of an additional LPG
terminal facility in Saltillo, Mexico (the "Saltillo Terminal Facilities") at
an estimated cost of $500,000, and (iv) completed the purchase of a tank farm
for a purchase price of $195,000 (plus costs related to the clean up of the tank
farm), which after additional improvements will be capable of storing and
distributing refined products. The Saltillo Terminal Facilities, when complete,
will allow for the distribution of LPG by railcars, which will directly link the
Company's Brownsville Terminal Facility and the Saltillo Terminal Facilities.
The Saltillo Terminal Facilities will contain storage to accommodate
approximately 100,000 gallons of LPG. In connection with the purchase of the
tank farm, the Company entered into a lease agreement for rental of the land
which the tank farm occupies and for the use of a refined products pipeline
connecting the tank farm with public dock facilities. The completion of the
midline pump station will increase the capacity of the Pipeline to 360 million
gallons per year.
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In connection with the Expansion, the Company and CPSC International, Inc.
("CPSC") entered into two separate Lease / Installation Purchase Agreements, as
amended, (the "Lease Agreements"), whereby CPSC agreed to construct and maintain
the US-Mexico Pipeline (including an additional pipeline to accommodate refined
products) and the Mexican Terminal Facilities and agreed to lease these assets
to the Company. Under the terms of the Lease Agreements, the Company is
required to make monthly rental payments of approximately $157,000, beginning
the date that the US-Mexico Pipeline and Mexican Terminal Facilities reach
substantial completion, as defined under the Lease Agreements (the "Substantial
Completion Date"). During January 2000, CPSC notified the Company that the
Substantial Completion Date had occurred. In addition, the Company has agreed
to provide a lien on certain assets, leases and contracts which are currently
pledged to RZB, and provide CPSC with a letter of credit of approximately $1.0
million (the "LOC"). The Company is currently in negotiations with RZB and CPSC
concerning RZB's subordination of RZB's lien on certain assets, leases and
contracts. The Company also has the option to purchase the US-Mexico Pipeline
and the Mexican Terminal Facilities at the end of the 10th year anniversary and
15th year anniversary for $5.0 million and $100,000, respectively. Under the
terms of the Lease Agreements, CPSC is required to pay all costs associated with
the design, construction and maintenance of the US-Mexico Pipeline and Mexican
Terminal Facilities (the "Costs"). As of January 31, 2000, the Company has
spent approximately $683,000 related to the Costs, which are included in other
costs paid by the Company (see note C to the unaudited consolidated financial
statements).
On September 16, 1999, the Lease Agreements were amended whereby CPSC
agreed to accept 500,000 shares of common stock of the Company owned by the
President of the Company (the "Collateral") in place of the LOC originally
required under the Lease Agreements. The Collateral shall be replaced by a
letter of credit or cash collateral over a ten-month period beginning monthly
after the Substantial Completion Date. In addition, the Company has agreed to
guarantee the value of the Collateral based on the fair market value of the
Collateral for up to $1.0 million.
During December 1999, the Company and CPSC amended (the "Addendum") the
Lease Agreements, which modified certain terms of the Lease Agreements,
including all prior amendments, modifications, options, extensions and renewals,
which were entered into from the date of the Lease Agreements until the date of
the Addendum. In connection with the Addendum, the Company purchased 50% of the
US-Mexico Pipeline and Mexican Terminal Facilities, including a 50% interest in
the underlying Lease Agreements for $3.0 million and the right to receive a
minimum per month of the greater of $62,800 or 40% of the monthly net income
from the Lease Agreements.
In addition, under the Addendum, the Company received an option until
December 15, 2000 to acquire the remaining 50% of the US-Mexico Pipeline and
Mexican Terminal Facilities, including the remaining 50% interest in the Lease
Agreements for $6.0 million and the issuance of (i) warrants to purchase 200,000
shares of common stock of the Company exercisable for three years at an exercise
price of $4.00 per share if the option is exercised by June 15, 2000 or (ii)
warrants to purchase 300,000 shares of common stock of the Company exercisable
for three years at an exercise price of $4.00 per share if the option is
exercised thereafter.
In connection with the Addendum, the Company is also entitled to offset any
amounts which have been paid by the Company on behalf of CPSC related to the
completion of CPSC's obligations under the Lease Agreements, except for the $3.0
million paid for the 50% interest, described herein, against the Company's
future rental obligations under the Lease Agreements and/or against the option
price of $6.0 million to purchase the remaining 50% interest in the US-Mexico
Pipeline and Mexican Terminal Facilities, including a 50% interest in the
underlying Lease Agreements. The Company may also offset against its monthly
rent obligations under the Lease Agreements any amounts to be received from its
interests in the Lease Agreements so long as the Company is current on all of
the lease payments required under the Lease Agreements.
As a result of the purchase of the 50% interest in the US-Mexico Pipeline
and Mexican Terminal Facilities, including a 50% interest in the underlying
Lease Agreements, the Company is only required to provide 50% of the collateral
originally agreed to under the Lease Agreements.
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On February 21, 2000, the Company and CPSC entered into a letter of
agreement (the "Letter Agreement") whereby the Company modified the terms
associated with acquiring the remaining 50% interest in the US-Mexico Pipeline
and Mexican Terminal Facilities, whereby the Company will only be required to
make a cash payment of $4.5 million ($2.0 million to be paid on or prior to
March 3, 2000, $1.0 million payable on or before August 21, 2000 and $1.5
million payable in twelve equal monthly installments beginning March 31, 2000)
and warrants to purchase 200,000 shares of common stock of the Company
exercisable for three years at an exercise price of $4.00 per share. In
addition, the Company agreed to pay Cowboy Pipeline Service Company, Inc.
("Cowboy") $150,000 on or before June 1, 2000 as full satisfaction of a disputed
claim arising from a previous consulting agreement entered into between Cowboy
and the Company. The Company also agreed that all payments made by the Company
on behalf of CPSC in connection with the Lease Agreements (see note C to the
unaudited consolidated financial statements) be assumed by the Company. The
Company has yet to make any payments under the Letter Agreement and is not
obligated until CPSC provides the Company the among other things, proof of
ownership and lease rights (see following paragraph) in connection with the
US-Mexico Pipeline and Mexican Terminal Facilities. The closing of the purchase
is subject to satisfactory transfer of title to all assets relating to the
US-Mexico Pipeline and Mexican Terminal Facilities and execution of formal
agreements.
In connection with the lawsuit filed on February 24, 2000 (see note I to
the unaudited consolidated financial statements), the Company discovered that
CPSC had not fulfilled all of its obligations under the Lease Agreements and
therefore the Substantial Completion Date has not occurred. As a result,
additional amounts may be required to reach the Substantial Completion Date. If
CPSC is not able to complete the US-Mexico Pipeline and Mexican Terminal
Facilities, the Company may incur additional costs to complete the US-Mexico
Pipeline and Mexican Terminal Facilities, the amount of which can not presently
be determined. As described earlier, any additional costs incurred by the
Company may be offset against future rental obligations under the Lease
Agreements or against amounts required to be paid to purchase the remaining 50%
interest in the US-Mexico Pipeline and Mexican Terminal Facilities.
For financial accounting purposes, the Lease Agreements are capital leases.
Therefore, the assets and related liabilities will be recorded in the Company's
balance sheet on the Substantial Completion Date for the portion of the
obligations under the Lease Agreements which have not been purchased by the
Company.
On May 31, 1999, Tergas, S.A. de C.V., a Mexican company ("Tergas") (see
below), was formed for the purpose of operating LPG terminal facilities in
Mexico, including the Mexican Terminal Facilities and the planned Saltillo
Terminal Facilities and future LPG terminal facilities in Mexico. Tergas has
been issued the permit to operate the Mexican Terminal Facilities and the
Company anticipates Tergas will be issued the permit to operate the Saltillo
Terminal Facilities.
In connection with the construction of the Mexico Pipelines and Mexican
Terminal Facilities, CPSC provided all payments and delivery of equipment
through Termatsal, S.A. de C.V., a Mexican company ("Termatsal") (see below).
PennMex, Tergas or Termatsal are currently the owners of the land which is
being utilized for the Mexican Pipeline and Mexican Terminal Facilities, have
entered into leases associated with the Saltillo Terminal Facilities, have been
granted the permit for the Mexican Pipeline, have been granted and/or are
expected to be granted permits to operate the Mexican Terminal Facilities and
the Saltillo Terminal Facilities, or have title to the assets paid for by CPSC
to construct the Mexican Pipeline and Mexican Terminal Facilities. In addition,
the Company has advanced funds (totaling approximately $790,000 at January 31,
2000) to PennMex, Tergas or Termatsal in connection with the purchase of
property, plant and equipment associated with the construction of the Mexican
Pipeline, Mexican Terminal Facilities and the Saltillo Terminal Facilities,
which are included in other costs paid by the Company (see note C to the
unaudited consolidated financial statements).
During the years ended July 31, 1998 and 1999 and for the six months ended
January 31, 2000, the Company paid PennMex $181,000, $125,000 and $121,312,
respectively, for Mexico related expenses incurred by that corporation on the
Company's behalf. Such amounts were expensed.
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Foreign Ownership of LPG Operations. PennMex, Tergas and Termatsal are
Mexican companies which are owned 90%, 90% and 98%, respectively, by Jorge R.
Bracamontes ("Bracamontes"), an officer and director of the Company and the
balance by other citizens of Mexico.
Under current Mexican law, foreign ownership of Mexican entities involved
in the distribution of LPG and the operation of LPG terminal facilities are
prohibited. However, transportation and storage of LPG by foreigners is
permitted.
In October 1999, the Company received a verbal opinion from the Foreign
Investment Section of the Department of Commerce and Industrial Development
("SECOFI") that the operation of the Mexican Pipeline and Mexican Terminal
Facilities would be considered a transportation rather than a distribution
activity, and therefore, could be performed by a foreign entity or through a
foreign-owned Mexican entity. The Company intends to request a ruling from
SECOFI confirming the verbal opinion. On November 4, 1999, the Company and
Bracamontes and the other shareholders entered into a purchase agreement to
acquire up to 75% of the common stock of PennMex for a nominal amount. The
purchase agreement is subject to among other things, the receipt of the
aforementioned ruling. The Company intends to formalize contracts among the
Company, PennMex, Tergas and Termatsal for services to be performed in
connection with the operations of the Mexican Pipeline, the Mexican Terminal
Facilities and the Saltillo Terminal Facilities.
The operations of PennMex, Tergas or Termatsal, are subject to the tax laws
of Mexico, which among other things, require that Mexican subsidiaries of
foreign entities or transactions between Mexican and foreign entities comply
with transfer pricing rules, the payment of income and/or asset taxes, and
possibly taxes on distributions in excess of earnings. In addition,
distributions to foreign corporations may be subject to withholding taxes,
including dividends and interest payments.
The transfer of any of the interests acquired by the Company or the
formalization of any contractual arrangements related to assets which are
located in Mexico are dependent upon the determination of the ultimate legal
structure of the ownership of such assets.
Deregulation of the LPG Market 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 LPG activities related to transportation and storage. Upon the completion of
Deregulation, Mexican entities will be able to import LPG into Mexico. However,
foreign entities will be prohibited from participating in the distribution of
LPG in Mexico. Accordingly, the Company expects to sell LPG directly to
independent Mexican distributors as well as PMI. Upon Deregulation, it is
anticipated that the independent Mexican distributors will be required to obtain
authorization from the Mexican government for the importation of LPG prior to
entering into contracts with the Company.
Pursuant to the PMI Sales Agreement upon Deregulation by the Mexican
government of the LPG market, the Company will have the right to renegotiate the
PMI Sales Agreement. Depending on the outcome of any such re-negotiation, the
Company expects to either (i) enter into contracts directly with independent
Mexican LPG distributors located in the northeast region of Mexico, or (ii)
modify the terms of the PMI Sales Agreement to account for the effects of
Deregulation.
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Currently the Company sells LPG to PMI at its Brownsville Terminal Facility.
Upon the completion of the US - Mexico Pipeline and Mexican Terminal Facilities,
the Company will sell LPG to PMI at the U.S. border and transport the LPG to the
Mexican Terminal Facilities through the US-Mexico Pipeline. Upon Deregulation,
the Company intends to sell to independent Mexican LPG distributors as well as
PMI.
Credit Arrangements. As of January 31, 2000, the Company has a $10.0
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) 2.5% of the maximum face amount of such letter of credit, or
(iii) such higher amount as may be agreed to between the Company and RZB. Any
amounts outstanding under the RZB Credit Facility shall accrue interest at a
rate equal to the rate announced by the Chase Manhattan Bank as its prime rate
plus 2.5%. Pursuant to the RZB Credit Facility, RZB 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.
In connection with the Company's purchases of LPG from Exxon, PG&E and/or
Koch, the Company issues letters of credit on a monthly basis based on
anticipated purchases.
As of January 31, 2000, letters of credit established under the RZB Credit
Facility in favor of Exxon, PG&E and Koch for purchases of LPG totaled $5.7
million of which $4.6 million was being used to secure unpaid purchases. In
addition, as of January 31, 2000, the Company had borrowed $3.7 million from its
revolving line of credit under the RZB Credit Facility for purchases of LPG. In
connection with these purchases, at January 31, 2000, the Company had unpaid
invoices due from PMI totaling $5.3 million, cash balances maintained in the RZB
Credit Facility collateral account of $186,739 and inventory held in storage of
$3.9 million.
Private Placements and Other Transactions. In connection with the
Company's notice to repurchase 90,000 shares of the Convertible Stock for
$900,000 plus dividends of $45,370 on September 3, 1999, the holder of the
Convertible Stock elected to convert all of the Convertible Stock into 450,000
shares of common stock of the Company. The Company paid the $45,370 of
dividends in cash.
The Company has granted one demand registration right with respect to the
common stock referred to in the preceding paragraph. The Company and the holder
of the common stock have agreed to share the costs of the registration.
During August 1999, warrants to purchase a total of 425,000 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $681,233. The proceeds of such exercises were used for working
capital purposes.
During October 1999, warrants to purchase a total of 163,636 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $390,951. The proceeds of such exercises were used for working
capital purposes.
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 $5.0 million and $710,000, respectively, of subordinated
notes (the "Notes") 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. Interest at 9% is due on June 15, 2000, and December 15, 2000 (or
the maturity date, if earlier). In connection with the Notes, the Company also
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granted the holders of the Notes, warrants (the "Warrants") to purchase a total
of 279,559 shares of common stock of the Company at an exercise price of $4.00
per share, exercisable through December 15, 2002 and the Company agreed to issue
to the holders of the Notes, additional warrants (the "Additional Warrants") to
purchase a total of 213,066 shares of common stock of the Company at an exercise
price of $4.00 per share, exercisable through December 15, 2002 if the Notes are
not repurchased prior to 90 days from the original date of issuance of the
Notes. The Company is also required to register the shares issuable in
connection with exercise of the Warrants and the Additional Warrants on or
before April 15, 2000.
Net proceeds from the Notes were used for the purchase of the 50% interest
in the US-Mexico Pipeline and Mexican Terminal Facilities (see notes C and J to
the unaudited consolidated financial statement) and for working capital
purposes.
Under the terms of the Notes, the Company has agreed to pledge the
Company's interests in the US-Mexico Pipeline and the Mexican Terminal
Facilities.
In connection with the issuance of $3.9 million and $710,000 of Notes from
December 10, 1999 through January 18, 2000 and February 2, 2000, respectively,
the Company paid a fee equal to a cash payment of $270,830 and $49,700 and
warrants to purchase a total of 96,725 shares and 17,750 shares, respectively,
of common stock of the Company at an exercise price of $4.00 per share,
exercisable for three years. The Company also granted piggy back registration
rights to the holders of the Warrants and the Additional Warrants issued for
fees.
During February 2000, warrants to purchase a total of 95,000 shares of
common stock of the Company were exercised, resulting in cash proceeds to the
Company of $308,750. The proceeds of such exercises were used for working
capital purposes.
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.
In connection with the issuance of shares and warrants by the Company (the
"Shares"), the Company has on numerous instances granted registration rights to
the holders of the Shares, including those shares which result from the exercise
of warrants (the "Registrable Securities"). The obligations of the Company with
respect to the Registrable Securities include demand registration rights and/or
piggy-back registration rights and/or the Company is required to file an
effective registration by either September 19, 1999, December 1, 1999, January
31, 2000 or April 15, 2000 (the "Registration"). In connection with the
Registration of the Registrable Securities, the Company is required to provide
notice to the holder of the Registrable Securities, who may or may not elect to
be included in the Registration. The Company is obligated to register the
Registrable Securities even though the Registrable Securities may be tradable
under Rule 144. The Company did not file a registration statement for the
shares agreed to be registered by September 19, 1999, December 1, 1999 or
January 31, 2000. The Company has also received notice of a demand for
registration for certain of the Shares. The registration rights agreements do
not contain provisions for damages if the Registration is not completed except
for those Shares required to be registered on December 1, 1999, whereby for each
month after December 1999 if the Company fails to have an effective registration
statement, the Company will be required to pay a penalty of $80,000 to be paid
in cash and/or common stock of the Company based on the then current trading
price of the common stock of the Company. The Company has received an extension
of time to file the registration statement with respect to certain of the Shares
required to be registered on December 1, 1999.
Judgment in favor of the Company. During March 2000, the Company received
the cash portion of the Judgement from IBC-Brownsville of $4.3 million of which
approximately $1.2 million is to be paid for legal fees and other expenses
associated with the Judgment.
35
<PAGE>
Settlement of Litigation. On March 16, 1999, the Company settled in
mediation a lawsuit with its former chairman of the board, Jorge V. Duran. In
connection therewith and without admitting or denying liability the Company
agreed to pay Mr. Duran $250,000 in cash and the issuance of 100,000 shares of
common stock of the Company of which $100,000 is to be paid by the Company's
insurance carrier. The Company has agreed to register the stock in the future.
The parties have agreed to extend the date which the payments required in
connection with the settlement, including the issuance of the common stock, are
to be made.
Realization of Assets. Recoverability of a major portion of the recorded
asset amounts as shown in the Company's consolidated balance sheet is dependent
upon (i) the Company's ability to obtain additional financing and raise
additional equity capital, (ii) the completion of the transactions related to
the US-Mexico Pipeline and Mexican Terminal Facilities, (iii) the success of the
Company's future operations and Expansion Program, and (iv) the consummation of
the acquisition of the interests in PennMex and the operating agreements among
the Company, Tergas, PennMex or Termatsal.
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 its customer base, (iii) extend the terms and capacity
of the Pipeline Lease and the Brownsville Terminal Facility, (iv) expand its
product lines, (v) increase its source of LPG supply and at more favorable
terms, (vi) obtain additional letters of credit financing, (vii) raise
additional debt and/or equity capital and (viii) resolve the issues related to
the US-Mexico Pipeline and Mexican Terminal Facilities. See note K to the
unaudited consolidated financial statements.
At July 31, 1999, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $8.0 million. The ability to
utilize such net operating loss carryforwards may be significantly limited by
the application of the "change of ownership" rules under Section 382 of the
Internal Revenue Code.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None.
36
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note I to the unaudited Consolidated Financial Statements and
Note N to the Company's Annual Report on Form 10-K for the fiscal
year ended July 31, 1999.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
See Notes G and H to the unaudited Consolidated Financial
Statements and Note L to the Company's Annual Report on Form 10-K
for the fiscal year ended July 31, 1999 for information concerning
certain sales of Securities.
The Notes, Warrants, Additional Warrants and other securities 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) and Section 4(6) and
Rule 506 of Regulation D promulgated thereunder.
Pennsylvania Merchant Group acted as placement agent for the
Company in connection with certain of the transactions.
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.
a. Exhibits and Financial Statement Schedules
The following Exhibits are incorporated herein by reference:
EXHIBIT NO.
- ------------
10.14 Transfer of Shares Agreement dated November 4, 1999 between Jorge
Bracamontes and the Company. (Incorporated by reference to the
Company's Quarterly report on Form 10-Q for the quarterly period
ended October 31, 1999, filed on December 14, 1999, SEC File No.
000-24394).
10.15 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).
The following Exhibits and Financial Statement Schedules are filed as part
of this report:
10.16 Addendum dated December 15, 1999 between CPSC International, Inc. and
the Company.
27.1 Financial Data Schedule.
b. Reports on Form 8-K.
None.
37
<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 21, 2000 By: /s/ Ian T. Bothwell
-------------------
Ian T. Bothwell
Vice President, Treasurer, Assistant Secretary,
Chief Financial Officer
38
<PAGE>
ADDENDUM
--------
THIS ADDENDUM is entered into between PENN OCTANE CORPORATION, a Delaware
corporation (hereinafter referred to as "POC") and CPSC INTERNATIONAL, INC., a
Texas corporation (hereinafter referred to as "CPSC") and is intended to set
forth additional understandings and agreements that have been reached between
the parties, as well as clarify that certain prior agreement entered into by the
parties in Houston on September 16, 1999 whereby POC obtained options to
purchase interests in two 15-mile pipelines in the County of Cameron, State of
Texas, and two 7-mile pipelines as well as a transfer terminal in Matamoros,
Tamaulipas, Mexico (hereinafter collectively referred to as the "Pipelines and
Transfer Terminal Assets"), as well as an interest in the underlying lease
documents relating to the Pipelines and Transfer Terminal Assets (including all
amendments, modifications, extensions, and renewals thereof) between CPSC and
POC (hereinafter referred to as the "CPSC Agreements" or the "Lease"). The
agreement entered into by the parties on 9/16/99 is hereinafter referred to as
the "Houston Agreement" and is attached hereto as Exhibit A and incorporated
---------
herein by reference.
1. Except as modified by this Addendum, the terms used in this Addendum
shall have the same meanings as those defined in the Houston Agreement.
2. Except as modified by this Addendum, all of the terms and conditions of
the Houston Agreement and the CPSC Agreements, including the POC purchase
options contained therein, shall remain in full force and effect and are hereby
incorporated by reference. A dispute has arisen between the parties as to
whether those certain agreements previously entered into by Cowboy Pipeline
=
Service Company and POC ( namely, the Consulting Services Agreement of May 29,
1998 and the Pipeline Project Management Services Agreement of July 20, 1998,
respectively), were superceded by the CPSC Agreements and is otherwise of no
further force or effect. In an effort to move forward with this Addendum, the
parties agree to try and mediate in good faith a resolution of this dispute,
even after this Addendum has been executed. To the extent that the parties are
not successful, the issue shall be resolved by binding arbitration pursuant to
Section 20 of this Addendum.
- -----------
3. CPSC hereby grants to POC the right, until December 15, 1999, to
purchase a fifty percent (50%) interest in the Pipelines and Transfer Terminal
Assets and the CPSC Agreements (hereinafter collectively referred to as the "POC
Interest") for a total purchase price of $3,000,000. To exercise this option,
POC must open an escrow account into which
$1,000,000 shall be deposited for the benefit of CPSC on or before December 15,
1999. Said escrow account shall require the joint signatures of representatives
of both POC and CPSC for all disbursements made therefrom. For purposes of the
escrow account joint signatories, the designated initial representative for POC
shall be Jerry Lockett. The designated initial representative of CPSC shall be
Eric B. Dubose. The remaining $2,000,000 option amount will be deposited on an
Page 1 of 9
<PAGE>
as needed basis for Substantial Completion (as defined under the CPSC
Agreements) , but in no event shall be deposited later than January 17, 2000,
subject to the provisions of Section 6 of this Addendum. CPSC agrees to
===============================================================
cooperate with POC in raising the additional $2,000,000, including the
subordination of a fifty percent (50%) interest in the Pipelines and Transfer
Terminal Assets and CPSC Agreements to the extent reasonably necessary for POC
to raise this additional sum. The parties agree that the $3,000,000 shall be
distributed from the escrow account solely for purposes of reaching Substantial
Completion (as that term is defined under the CPSC Agreements) of the Pipelines
and Transfer Terminal Assets, and that following POC's payment into escrow of
the $3,000,000, POC shall have no further obligation to contribute toward the
Substantial Completion of the Pipelines and Transfer Terminal Assets or to make
any further advancements or investments in same. Until such time as POC pays the
$3,000,000 purchase price for the POC Interest, or otherwise obtains an interest
in the Pipelines and Transfer Terminal Assets and CPSC Agreements under the
Houston Agreement or the CPSC Agreements, POC shall not be entitled to any
rental income under the CPSC Agreements. CPSC warrants and represents that the
$3,000,000 will be sufficient to reach Substantial Completion of the Pipelines
and Transfer Terminal Assets and to the extent additional monies prove
necessary, CPSC will immediately provide said funds without delaying Substantial
Completion. Once the purchase price has been paid, the parties agree that POC
shall be entitled to receive forty percent (40%) of the gross monthly income
generated by the Pipelines and Transfer Terminal Assets, which gross monthly
income shall not be subject to offset or deduction, consistent with Section 9 of
---------
this Addendum. In addition to the foregoing, and provided POC successfully and
timely raises the $3,000,000 purchase price for the POC Interest (subject to
===========
Section 6 of this Addendum), CPSC hereby also grants to POC a one (1) year
===============================
option, commencing on the date on which the above escrow is opened, to purchase
the remaining fifty percent (50%) of the Pipelines and Transfer Terminal Assets
and CPSC Agreements from CPSC for the sum of $6,000,000 (hereinafter referred to
as the "POC Option Interest") plus the following consideration: (i) to the
extent POC exercises the POC Option within six (6) months of the date on which
escrow is opened, CPSC or its assigns shall also be granted 200,000 warrants of
POC stock, with a three (3) year life from issuance and a strike price of $4.00
per share; or (ii) to the extent POC exercises the POC Option at any time
following six (6) months from the date on which escrow is opened until the
one-year anniversary date of the opening of escrow, CPSC shall be granted
300,000 warrants of POC stock, with a three (3) year life from issuance and a
strike price of $4.00 per share. POC shall have the option of requiring CPSC to
exercise the foregoing warrant, if it has not already done so, when and if POC's
shares reach $6.00 per share; provided, however, that POC shall refrain from
making the foregoing call for CPSC to exercise its warrants for a period of one
(1) year from the execution date of this Addendum. To the extent POC advances
additional funds over the $3,000,000 paid pursuant to this Addendum for
Substantial Completion after the date of this Addendum, including advances made
after Substantial Completion occurs, whether through the escrow account or not,
POC shall have the option to offset that amount against future rent payments or
the $6,000,000 POC Option Interest or against any other option granted by CPSC
to POC pursuant to the Houston Agreement and/or the CPSC Agreements or to demand
reimbursement from CPSC pursuant to Section 12 of this Addendum. In the event
Page 2 of 9
<PAGE>
POC does not pay its $3,000,000 option fee as set forth in this Section 3, it
---------
shall retain all other rights and options to purchase as set forth in the
Houston and the CPSC Agreements.
4. In the event of a default by POC under its obligations as a lessee in the
CPSC Agreements, and except as is otherwise in accordance with the rights and
remedies granted POC under those agreements, POC, pursuant to its rights under
the Houston Agreement, hereby agrees not to take any action, directly or
indirectly, as an owner of the POC Interest, to prevent CPSC from enforcing its
rights and remedies against POC in the event of a default by POC under the CPSC
Agreements. Nothing contained herein shall preclude POC, as a lessee, from
asserting any defenses or counter claims it may have in response to CPSC's claim
of default.
5. Except as otherwise specifically agreed to in writing between the
parties, CPSC hereby agrees that any and all sums paid by POC to CPSC in
exercising any of the options set forth in the Houston Agreement or CPSC's share
of any rent paid by POC pursuant to the CPSC Agreements, shall first be applied
by CPSC to reduce CPSC's outstanding obligations, if any, owed to any financial
institution providing financing or contractors or vendors providing services or
materials in connection with the construction of the Pipelines and Transfer
Terminal Assets which are the subject of the CPSC Agreements.
6. CPSC warrants, represents, and agrees that CPSC shall convey to POC
and/or its assigns clear, good, and marketable title to the Pipelines and
Transfer Terminal Assets and CPSC Agreements, which shall include all permits,
easements, and rights of entry required or necessary for the operation of the
Pipelines and Transfer Terminal Assets and POC's and/or its assigns' full
enjoyment of its share of the Pipelines and Transfer Assets and the CPSC
Agreements, free and clear of all liens, charges, and other encumbrances. To
the extent that CPSC cannot provide proof reasonably satisfactory to POC and POC
==========
's counsel that CPSC will be in a position to transfer these interests to POC
and/or its assigns in accordance with the foregoing, the parties agree that POC
shall be under no obligation to pay, and further, that all POC options under
this Addendum, the CPSC Agreements, and/or the Houston Agreement shall continue
in effect until forty five (45) days after such time as CPSC is in a position to
convey clear title to POC and/or its assigns in accordance with this Section 6.
---------
CPSC agrees to deliver no later than 12/31/99, in recordable form reasonably
========== ====================== ==========
satisfactory to POC and POC's counsel, a document of conveyance adequate to
===========
convey to POC and/or its assigns clear, good, and marketable title to the
================================================================================
Pipelines and Transfer Terminal Assets and CPSC Agreements pursuant to this
================================================================================
Section 6, free and clear of all liens, charges, and other encumbrances. Until
========================================================================= =====
such time as POC and/or its counsel receives an appropriate document of
================================================================================
conveyance consistent with the foregoing, POC shall be under no obligation to
================================================================================
advance the additional $2,000,000 to CPSC pursuant to Section 3 of this
================================================================================
Addendum. In addition to this document of conveyance, CPSC agrees to cooperate
========
with POC and/or its assigns in executing whatever additional documents may be
reasonably necessary to effectuate a legal transfer of the Pipelines and
Page 3 of 9
<PAGE>
Transfer Terminal Assets and the CPSC Agreements to POC and/or its assigns upon
POC's request. CPSC shall fully (100%) indemnify, defend, and hold POC, its
affiliates, shareholders, directors, officers, agents, and attorneys harmless
from and against any and all third party claims, demands, or liabilities
incurred or arising prior to Substantial Completion against the Pipelines and
Transfer Terminal Assets and the CPSC Agreements. In connection therewith, CPSC
shall reimburse POC for all expenses (including attorneys' fees and expenses)
incurred in connection with the investigation of, preparation for, or defense
of, any such claim, whether or not POC is actually made a party. Upon POC
obtaining a fifty percent (50%) interest in the Pipelines and Transfer Terminal
Assets, CPSC and POC shall jointly (50/50) indemnify, defend, and hold the
other, its affiliates, shareholders, directors, officers, agents, and
attorneys, harmless from and against any and all third party claims, demands, or
liabilities incurred or arising after Substantial Completion with respect to the
Pipelines and Transfer Terminal Assets and the CPSC Agreements. In connection
therewith, each party shall bear fifty percent (50%) of the other party's
expenses (including attorneys' fees and expenses) incurred in connection with
the investigation of, preparation for, or defense of, any such claim. Upon POC
========
obtaining a one hundred percent (100%) interest in the Pipelines and Transfer
================================================================================
Terminal Assets, POC shall fully (100%) indemnify, defend, and hold CPSC, its
================================================================================
affiliates, shareholders, directors, officers, agents, and attorneys, harmless
================================================================================
from and against any and all third party claims, demands, or liabilities based
================================================================================
upon events occurring after POC's acquisition of a one hundred percent (100%)
================================================================================
ownership interest in the Pipelines and Transfer Terminal Assets and the CPSC
================================================================================
Agreements. Notwithstanding the foregoing, however, neither CPSC nor POC shall
===========
be obligated to indemnify the other pursuant to this Section 6 for claims based
---------
upon the other party's breach of contract, mismanagement, intentional, wilful,
or reckless conduct, negligence, and/or omissions, nor shall POC be obligated to
=============================
indemnify CPSC for any claims based upon faulty, inadequate, or defective
================================================================================
construction of the Pipelines and/or Transfer Terminal Assets. Within ten (10)
===============================================================
days of the execution of this Addendum, CPSC shall deliver to POC and POC's
counsel, letters from all financial institutions providing financing to CPSC in
connection with the construction of the Pipelines and Transfer Terminal Assets,
including but not limited to Bank One, and all other entities to whom CPSC has
granted a security interest in the Pipelines and the Transfer Terminal Assets,
acknowledging that said financial institutions do not have as of the date of the
letter, any outstanding claims against the Pipelines and Transfer Terminal
Assets and the CPSC Agreements and further, that said financial institutions
waive any and all future claims in said assets pursuant to this Addendum, the
Houston Agreement, and/or the CPSC Agreements. CPSC agrees that it shall not
encumber the Pipelines and Transfer Terminal Assets and the CPSC Agreements
absent POC's prior written approval. In addition to the foregoing, in the event
POC and/or its assigns ever acquires 100% of the Pipelines and Transfer Terminal
Assets and CPSC Agreements , POC and/or its assigns shall have the option of
also requiring CPSC to transfer to POC and/or its assigns 100% of CPSC's
outstanding shares of stock in consideration of the POC's (and/or its assigns')
payment of $1.00, provided, however, that CPSC shall be entitled to make a third
party transfer of any warrants granted pursuant to Section 3 of this Addendum
---------
prior to the transfer of CPSC's outstanding shares.
Page 4 of 9
<PAGE>
7. The "Lease Effective Date" as defined under the CPSC Agreements, and as
used in the Operating Agreement which is Exhibit C to the CPSC Agreements, is
---------
hereby clarified to reflect that it commences on that day on which Substantial
Completion occurs, rather than that day which is twelve (12) months after the
------ ----
first day of the month that Substantial Completion occurs.
The parties acknowledge that pursuant to the CPSC Agreements, CPSC had a
Substantial Completion deadline of May 1, 1999, which deadline has not yet been
met as of the execution date of this Addendum. The parties hereby waive
compliance with the original May 1, 1999 Substantial Completion deadline
provided that Substantial Completion is obtained on or before February 1, 2000.
- -------- ----
CPSC also waives any and all current claims of breach it may have against POC
in connection with or arising under the CPSC Agreements up to the date of this
Addendum, including, without limitation, POC's inability to deliver to CPSC a
subordination agreement from RZB Bank consistent with the CPSC Agreements.
8. The "Lease Term" as defined under the CPSC Agreements, and as used in the
Operating Agreement which is Exhibit C to the CPSC Agreements, is hereby
----------
clarified to reflect that it shall terminate at the end of the fifteenth (15th)
lease year or such earlier date that POC timely exercises its options under this
Addendum, the Houston Agreement, and/or the CPSC Agreements and acquires a 100%
interest in the Pipelines and Transfer Terminal Assets from CPSC. In no event
shall the Lease Term expire earlier than the end of the 15th lease year absent
POC's exclusive ownership of the Pipelines and Transfer Terminal Assets.
9. CPSC shall continue to be the Initial Operator pursuant to the CPSC
Agreements and to perform all functions and responsibilities and bear all costs
and expenses, including insurance and taxes, associated with being the Initial
Operator until such time as POC owns a 100% interest in the Pipelines and
Transfer Terminal Assets. CPSC represents and warrants that the minimum
monthly income generated by the POC Interest (provided that the lessee is not in
monetary default in making the lease payments) shall be $62,800. The parties
further agree that such operating costs and expenses shall not be used to offset
POC's right to receive the greater of $62,800 or forty percent (40%) of the
monthly gross income generated from the Pipelines and Transfer Terminal Assets
pursuant to Section 3 of this Addendum .
----------
10. With regard to the two 7-mile pipelines and the LPG transfer terminal
being constructed by CPSC in Matamoros, Tamaulipas, Mexico (hereinafter
collectively referred to as the "Mexico Facilities"), the parties hereby confirm
and agree that CPSC's construction obligations for the Mexico facilities shall
be no greater and no less than those anticipated and specified in the CPSC
Agreements.
11. At POC's option, POC may elect to offset the monthly income guaranteed
to POC under Paragraph 1 of the Houston Agreement and Section 9 of this Addendum
----------- ---------
against its monthly rental obligations to CPSC under the CPSC Agreements,
remitting the difference where the monthly rental amount exceeds the monthly
Page 5 of 9
<PAGE>
guaranteed income to CPSC. As long as POC is not in monetary default under the
Lease, CPSC shall not have the option of withholding any monthly guaranteed
income payments owed to POC, as an owner of the Pipelines and Transfer Terminal
Assets and the CPSC Agreements, against POC's non-monetary obligations owing to
CPSC under the Lease.
12. To the extent that POC has advanced or will advance sums towards the
construction of the Pipelines, Transfer Terminal, and/or LPG transfer terminal
on either the U.S. or Mexico side in addition to the $3,000,000 required to be
provided under Section 3 of this Addendum, CPSC agrees to reimburse POC for such
---------
advancements within thirty (30) days of invoicing by POC, and that any
advancements not so timely reimbursed shall bear interest on the unpaid balance
at Bank of America's prime rate plus 1%. CPSC further agrees that, to the
extent that any such advancements remain unreimbursed and due and owing to POC
at the time that POC exercises any of its options pursuant to this Addendum, the
CPSC Agreements, and/or the Houston Agreement, then, consistent with Section 3
of this Addendum, POC, at POC's election, may apply such unpaid amounts to any
purchase or option exercise price. In the alternative, POC shall have the right
to apply any sums not timely reimbursed by CPSC pursuant to this Section 12 to
----------
any rental obligations then due and owing by POC to CPSC pursuant to the Lease.
These remedies are in addition to any other remedies POC may be entitled
pursuant to law. POC agrees to provide to CPSC upon request appropriate
reasonable documentation of all expenses for which reimbursement hereunder is
sought.
13. CPSC hereby agrees to partially release collateral POC has granted to
CPSC to secure its rental obligations under the CPSC Agreements in proportion to
POC's percentage ownership interest in the Pipelines and Transfer Terminal
Assets to the extent that POC timely exercises its options under this Addendum,
the Houston Agreement ,and/or the CPSC Agreements. Thus, for example, to the
extent that $1,000,000 worth of collateral has been pledged by POC to secure
its obligations to CPSC under the Lease, upon acquisition of a fifty percent
(50%) interest in the Pipelines and Transfer Terminal Assets and CPSC Agreement,
POC shall be entitled to have fifty percent (50%), or $500,000 worth of said
collateral, released by CPSC. In connection with any such release, POC agrees
that all of the remaining POC pledged collateral ($500,000 worth in the
preceding example), shall secure POC's remaining obligations to CPSC under the
Lease and that said collateral shall not be applied to secure POC's lessor
interest. The parties agree to work in good faith and in a prompt and timely
manner to mutually identify the collateral to be released and to effectively
consummate such releases.
14. The parties hereby agree that POC's post-closing indemnification
obligations (as the term "Closing" was redefined under the Houston Agreement)
pursuant to Section 8.1 of the CPSC Agreements, which shall arise only upon
------------
POC's acquisition of an ownership interest in the POC Interest, shall be in
proportion to POC's percentage ownership interest in the Pipelines and Transfer
Terminal Assets and CPSC Agreements. For example, to the extent that POC owns a
50% interest, then its indemnification obligations shall only be relative to the
50% interest it has acquired.
Page 6 of 9
<PAGE>
15. POC shall be under no obligation to assign or pledge its judgment in the
International Energy Development Corporation case, also known as Penn Octane
-----------
Corporation v. International Bank of Commerce Brownsville (197th District Court,
- ---------------------------------------------------------
Cameron County, Case No. 94-08-4008-C) to CPSC except as provided under this
Section 15, and then it shall only be obligated to assign that portion of the
- -----------
judgment necessary to meet the balance then owing toward the appropriate unpaid
option purchase price. It is the intention of the parties that, to the extent
that POC fails to timely exercise its option under Section 3 of this Addendum to
---------
acquire a fifty percent (50%) interest in the POC Interest or fails to come up
with the $3,000,000 purchase price on a timely basis, then POC shall still
retain an option to acquire a thirty percent (30%) interest in the Pipelines and
Transfer Terminal Assets and CPSC Agreements pursuant to the Houston Agreement.
To the extent, however, that POC does not pay the $3,000,000 option
consideration when due under the Houston Agreement, and provided that at that
time the judgment in favor of POC in International Energy Development
----------------------------------
Corporation v. International Bank of Commerce-Brownsville has not been
- --------------------------------------------------------------
satisfied, CPSC shall have the right to either: (i) accept from POC an
assignment of the unpaid purchase price portion of the judgment as payment in
full for the remainder of the purchase price and, upon collection of the
judgment, remitting any sums in excess of unpaid purchase price back to POC
,but retaining all interest on the unpaid purchase price pursuant to the
judgment interest rate accruing from the date of transfer of the judgment from
POC to CPSC until the judgment is collected; or (ii) treating the Houston
Agreement as null and void between POC and CPSC, thereby entitling CPSC to enter
into other agreements covering the same subject matter with third parties
interested in obtaining interests in the Pipelines and Transfer Terminal Assets
and CPSC Agreements. To the extent that POC is only able to raise a portion of
the $3,000,000 required for either the fifty percent (50%) interest under
Section 3 of this Addendum or the thirty percent (30%) interest under the
- ----------
Houston Agreement and is therefore unsuccessful in obtaining any interest in the
Pipelines and Transfer Terminal Assets and the CPSC Agreements, POC shall still
have the right to reimbursement from CPSC pursuant to Section 12 of this
----------
Addendum for all monies to-date advanced by POC to CPSC towards the purchase of
the fifty percent (50%) interest or the thirty percent (30%) interest, as the
case may be. Any sum advanced by POC towards the purchase of an interest in the
Pipelines and Transfer Terminal Assets and the CPSC Agreements that does not
result in POC obtaining an interest in same may also be applied by POC, at POC's
option, to the exercise of any other option or purchase right it may have under
the Houston and CPSC Agreements.
16. This Addendum may not be amended, altered, or modified except in
writing signed by the parties hereto.
17. This Addendum shall be binding upon and shall inure to the benefit of
permitted successors and assigns of the parties hereto.
Page 7 of 9
<PAGE>
18. In the event of the bringing of any action or suit by a party hereto by
reason of any breach of any of the covenants, agreements, or provisions arising
out of this Addendum, the prevailing party shall be entitled to recover all
costs and expenses of that action or suit, at trial or on appeal, and in
collection of judgment, including reasonable attorneys' fees, accounting, and
other professional fees resulting therefrom.
19. Except for POC's initial taking of title to the Pipelines and Transfer
Terminal Assets and the CPSC Agreements pursuant to Section 6, this Addendum
---------
shall not be assignable by either party hereto absent the prior written consent
of the other party.
20. Any controversy or claim (other than claims for preliminary injunctive
relief or other pre-judgment or equitable remedies) arising our of or relating
to this Addendum, including any controversy or claim as to the arbitrability of
any controversy or claim and any claim for rescission, shall be settled by
binding arbitration in Houston, Texas, in accordance with the then rules of the
American Arbitration Association, and judgment upon an award rendered in such
arbitration may be entered in any court having proper jurisdiction thereof.
BOTH PARTIES HAVE READ AND UNDERSTAND THIS SECTION 20, WHICH DISCUSSES
----------
ARBITRATION. THE PARTIES UNDERSTAND THAT BY SIGNING THIS ADDENDUM, THEY AGREE
TO SUBMIT ANY FUTURE CLAIMS ARISING OUT OF RELATING TO, OR IN CONNECTION WITH
THIS ADDENDUM, OR THE INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE,
BREACH, OR TERMINATION THEREOF TO BINDING ARBITRATION, AND THAT THIS ARBITRATION
CLAUSE CONSTITUTES A WAIVER OF EACH PARTIES' RIGHT TO A JURY TRIAL AND RELATES
TO THE RESOLUTION OF ALL DISPUTES RELATING TO ALL ASPECTS OF THE RELATIONSHIP
BETWEEN CPSC AND POC. IN THE EVENT ANY DISPUTE IS IN EXCESS OF $10,000, THEN
EACH OF THE PARTIES SHALL BE ENTITLED TO PURSUE FORMAL DISCOVERY TO THE EXTENT
THEY WOULD OTHERWISE BE ENTITLED IF THE DISPUTE WAS BEFORE THE FEDERAL UNITED
STATES DISTRICT COURT IN HOUSTON.
21. This Addendum may be executed in one or more counterparts, each of
which shall be deemed an original and all of which together shall constitute one
and the same instrument.
22. The parties hereby clarify that for purposes of notice under Section
-------
10.3 of the CPSC Agreements, and wherever notice is otherwise required by any
- ----
other agreement between POC and CPSC, notice to CPSC shall be sent to Eric B.
Dubose, President of CPSC, rather than to A.C. Dubose, at the address set forth
under Section 10.3, and that notice to POC shall be sent to Jerome Richter,
-------------
President of POC, at the following new California address: 77530 Enfield Lane,
Building D, Palm Desert, California 92211.
Page 8 of 9
<PAGE>
EFFECTIVE the ______ day of _________________, 1999.
"POC" "CPSC"
PENN OCTANE CORPORATION, CPSC INTERNATIONAL, INC.,
a Delaware corporation a Texas corporation
By: /s/ Jerome Richter By: /s/ Eric B. Dubose
------------------------- -----------------------
Jerome Richter Eric B. Dubose
Title: President Title: President
By:__________________________ By:_______________________
Title:_______________________ Title:____________________
Page 9 of 9
<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, 2000 and is qualified in its entirety by reference to such Financial
Statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUL-31-2000
<PERIOD-START> NOV-01-1999
<PERIOD-END> JAN-31-2000
<CASH> 1255574
<SECURITIES> 0
<RECEIVABLES> 9985912
<ALLOWANCES> 521067
<INVENTORY> 4803969
<CURRENT-ASSETS> 16106203
<PP&E> 9412121
<DEPRECIATION> 1833104
<TOTAL-ASSETS> 25043915
<CURRENT-LIABILITIES> 15419483
<BONDS> 128034
0
0
<COMMON> 129011
<OTHER-SE> 9367387
<TOTAL-LIABILITY-AND-EQUITY> 25043915
<SALES> 34977731
<TOTAL-REVENUES> 34977731
<CGS> 32788080
<TOTAL-COSTS> 32788080
<OTHER-EXPENSES> 1579437
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 303997
<INCOME-PRETAX> 3349241
<INCOME-TAX> 70000
<INCOME-CONTINUING> 3279241
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3279241
<EPS-BASIC> .25
<EPS-DILUTED> .24
</TABLE>
