##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended September 30, 2006
 OR
 o
    
    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
  Delaware
(State or Other Jurisdiction of Incorporation or Organization)
    
    52-1790357
(I.R.S. Employer Identification No.)77-530 Enfield Lane, Bldg. D, Palm Desert, California
(Address of Principal Executive Offices)
    
    92211
(Zip Code)
 (760) 772-9080
 þ o
  Large Accelerated Filer o
    
    Accelerated Filer o
    
    Non-Accelerated Filer þ
 o þ
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##### 



PENN OCTANE CORPORATION
TABLE OF CONTENTS
 ITEM
    
    
    
    PAGE NO.Part I
    
    1.
    
    Financial StatementsReport of Independent Registered Public Accounting Firm
    
    
    3Consolidated Balance Sheets as of December 31, 2005 and September 30, 2006 (unaudited)
    
    
    4 - 5Unaudited Consolidated Statements of Operations for the three months and nine months ended September 30, 2005 and 2006
    
    
    6Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2006
    
    
    7Notes to Consolidated Financial Statements (unaudited)
    
    
    8 - 242.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25 - 423.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    434.
    
    Controls and Procedures
    
    
    43Part II
    
    1.
    
    Legal Proceedings
    
    
    441A.
    
    Risk Factors
    
    
    44 - 452.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    453.
    
    Defaults Upon Senior Securities
    
    
    454.
    
    Submission of Matters to a Vote of Security Holders
    
    
    455.
    
    Other Information
    
    
    456.
    
    Exhibits
    
    
    46 - 47Signatures
    
    
    48Exhibit Index
    
    
    49Exhibit 10.12Exhibit 10.13Exhibit 15Exhibit 31.1Exhibit 31.2Exhibit 32
   2




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##### Table of Contents



Part I
 
 Item 1.
 
 Report of Independent Registered Public Accounting Firm
 
       
  3




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 CONSOLIDATED BALANCE SHEETS
 ASSETS
 December 31,
    
    
    September 30,2005
    
    
    2006Current Assets
    
    
    
    
    (Unaudited)Cash
    
    $
    299,597
    
    
    $
    9,934,945Restricted cash
    
    
    5,657,623
    
    
    
    3,079,145Trade accounts receivable (less allowance for
doubtful accounts of $0 and $254,729 at
December 31, 2005 and September 30, 2006)
    
    
    12,470,891
    
    
    
    5,606,999Inventories
    
    
    1,199,782
    
    
    
    3, 333,699Prepaid expenses and other current assets
    
    
    100,272
    
    
    
    162,405Deferred tax asset
    
    
    
    
    
    
    634,100Net current assets from discontinued operations
    
    
    5,520,386
    
    
    
    Total current assets
    
    
    25,248,551
    
    
    
    22,751,293Property, plant and equipment  net
    
    
    11,477,180
    
    
    
    10,904,597Other non-current assets
    
    
    31,089
    
    
    
    26,605Total assets
    
    $
    36,756,820
    
    
    $
    33,682,495
   4




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 CONSOLIDATED BALANCE SHEETS  CONTINUED
 LIABILITIES AND STOCKHOLDERS EQUITY
 December 31,
    
    
    September 30,2005
    
    
    2006Current Liabilities
    
    
    
    
    (Unaudited)Current maturities of debt obligations
    
    $
    3,009,861
    
    
    $
    1,150,553Revolving line of credit
    
    
    560,283
    
    
    
    1,286,329LPG and Fuel Products trade accounts payable
    
    
    16,305,320
    
    
    
    6,236,108Other accounts payable
    
    
    1,770,656
    
    
    
    804,228U.S. and foreign taxes payable
    
    
    21,045
    
    
    
    1,270,195Accrued liabilities
    
    
    2,184,168
    
    
    
    1,192,441Net current liabilities from discontinued operations
    
    
    598,581
    
    
    
    Total current liabilities
    
    
    24,449,914
    
    
    
    11,939,854Long-term debt, less current maturities
    
    
    
    
    
    
    Minority interest in Rio Vista Energy Partners L.P.
    
    
    11,955,005
    
    
    
    16,125,473Commitments and contingencies
    
    
    
    
    
    
    Stockholders EquitySeries A  Preferred stock-$.01 par value, 5,000,000 shares
authorized; no shares issued and outstanding at December 31,
2005 and September 30, 2006
    
    
    
    
    
    
    Series B  Senior preferred stock-$.01 par value, $10
liquidation value, 5,000,000 shares authorized; no shares
issued and outstanding at December 31, 2005 and September 30,
2006
    
    
    
    
    
    
    Common stock  $.01 par value, 25,000,000 shares authorized;
15,522,745 and 15,386,187 shares issued and outstanding at
December 31, 2005 and September 30, 2006
    
    
    155,227
    
    
    
    153,862Additional paid-in capital
    
    
    28,741,122
    
    
    
    28,949,373Note receivable from a former officer of the Company for
exercise of warrants, less reserve of $1,500,000 and
$1,615,730 at December 31, 2005 and September 30, 2006
    
    
    (1,696,693
    )
    
    
    (1,696,693
    )Accumulated deficit
    
    
    (26,847,755
    )
    
    
    (21,789,374
    )Total stockholders equity
    
    
    351,901
    
    
    
    5,617,168Total liabilities and stockholders equity
    
    $
    36,756,820
    
    
    $
    33,682,495
   5




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 Three Months Ended
    
    

Nine Months EndedSeptember 30,
    
    
    September 30,
    
    
    September 30,
    
    
    September 30,2005
    
    
    2006
    
    
    2005
    
    
    2006Revenues
    
    $
    37,388,710
    
    
    $
    42,882,739
    
    
    $
    93,172,771
    
    
    $
    108,342,679Cost of goods sold
    
    
    37,033,133
    
    
    
    43,436,559
    
    
    
    92,824,551
    
    
    
    109,037,944Gross profit
    
    
    355,577
    
    
    
    (553,820
    )
    
    
    348,220
    
    
    
    (695,265
    )Selling, general and administrative expensesLegal and professional fees
    
    
    335,784
    
    
    
    120,511
    
    
    
    1,294,967
    
    
    
    894,885Salaries and payroll related expenses
    
    
    544,450
    
    
    
    393,912
    
    
    
    2,767,049
    
    
    
    1,311,166Other
    
    
    510,891
    
    
    
    613,320
    
    
    
    1,483,480
    
    
    
    1,611,8191,391,125
    
    
    
    1,127,743
    
    
    
    5,545,496
    
    
    
    3,817,870Operating income (loss) from continuing operations
    
    
    (1,035,548
    )
    
    
    (1,681,563
    )
    
    
    (5,197,276
    )
    
    
    (4,513,135
    )Other income (expense)Interest and Fuel Products financing expense
    
    
    (496,403
    )
    
    
    (211,541
    )
    
    
    (1,110,519
    )
    
    
    (607,266
    )Interest income
    
    
    9,234
    
    
    
    22,683
    
    
    
    18,887
    
    
    
    45,668Minority interest in (earnings) loss of Rio Vista Energy
Partners L.P.
    
    
    1,740,669
    
    
    
    789,250
    
    
    
    4,832,274
    
    
    
    3,210,081Income (loss) from continuing operations before taxes
    
    
    217,952
    
    
    
    (1,081,171
    )
    
    
    (1,456,634
    )
    
    
    (1,864,652
    )Provision for income tax
    
    
    (31,099
    )
    
    
    (23,283
    )
    
    
    (64,946
    )
    
    
    (51,871
    )Net income (loss) s from continuing operations
    
    $
    186,853
    
    
    $
    (1,104,454
    )
    
    $
    (1,521,580
    )
    
    $
    (1,916,523
    )Discontinued operations:Net income (loss) from operations of the LPG Assets Sold,
net of minority interest of $687,938, $277,352, $3,235,536 and $2,026,436
    
    
    (22,119
    )
    
    
    (66,409
    )
    
    
    (340,369
    )
    
    
    108,765Net gain on sale of the LPG Assets, net of minority interest
of $5,161,717 and income tax expense of $576,687
    
    
    
    
    
    
    6,866,139
    
    
    
    
    
    
    
    6,866,139Net income from discontinued operations
    
    
    (22,119
    )
    
    
    6,799,730
    
    
    
    (340,369
    )
    
    
    6,974,904Net income (loss)
    
    $
    164,734
    
    
    $
    5,695,276
    
    
    $
    (1,861,949
    )
    
    $
    5,058,381Basic and Diluted EPS:Net loss from continuing operations per common share
    
    $
    0.01
    
    
    $
    (0.07
    )
    
    $
    (0.10
    )
    
    $
    (0.12
    )Net income from discontinued operations per common share
    
    
    0.00
    
    
    
    0.44
    
    
    
    (0.02
    )
    
    
    0.45Net income (loss) per common share
    
    $
    0.01
    
    
    $
    0.37
    
    
    $
    (0.12
    )
    
    $
    0.33Weighted average common shares outstanding
    
    
    15,522,745
    
    
    
    15,386,187
    
    
    
    15,489,572
    
    
    
    15,476,725
   6




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2006Cash flows from operating activities:Net loss from continuing operations
    
    $
    (1,521,580
    )
    
    $
    (1,916,523
    )Adjustments to reconcile net income from continuing operations to
net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    461,501
    
    
    
    448,495Amortization of loan discount related to detachable warrants
    
    
    398,955
    
    
    
    22,104Provision for doubtful accounts
    
    
    
    
    
    
    190,771Share-based payment expense
    
    
    
    
    
    
    295,925Minority interest in loss of Rio Vista Energy Partners L.P.
    
    
    (4,832,274
    )
    
    
    (3,210,081
    )Discount of note receivable from former officer
    
    
    1,031,307
    
    
    
    (Gain) loss on sale of assets
    
    
    (24,000
    )
    
    
    74,520Changes in current assets and liabilities:Trade accounts receivable
    
    
    (1,758,184
    )
    
    
    6,673,121Inventories
    
    
    1,364,511
    
    
    
    (2,133,917
    )Prepaid expenses and other current assets
    
    
    (105,199
    )
    
    
    (62,133
    )Deferred tax asset
    
    
    
    
    
    
    (634,100
    )LPG and Fuel Products trade accounts payable
    
    
    (156,773
    )
    
    
    (10,069,212
    )Other accounts payable and accrued liabilities
    
    
    2,052,471
    
    
    
    (1,958,154
    )U.S. and Foreign taxes payable
    
    
    (36,099
    )
    
    
    1,249,150Net cash used in continuing operating activities
    
    
    (3,125,364
    )
    
    
    (11,030,034
    )Net cash provided by discontinued operating activities
    
    
    2,894,985
    
    
    
    2,135,201Net cash used in operating activities
    
    
    (230,379
    )
    
    
    (8,894,833
    )Cash flows from investing activities:Capital expenditures
    
    
    (104,507
    )
    
    
    (81,208
    )Proceeds from sale of assets
    
    
    175,000
    
    
    
    212,333Proceeds from sale of discontinued operations
    
    
    
    
    
    
    16,949,356Net assets held for sale
    
    
    429,960
    
    
    
    Decrease in other non-current assets
    
    
    5,024
    
    
    
    4,484Net cash provided by investing activities
    
    
    505,477
    
    
    
    17,084,965Cash flows from financing activities:Decrease (increase) in restricted cash
    
    
    (1,956,181
    )
    
    
    2,578,478Revolving credit facilities
    
    
    1,230,770
    
    
    
    726,046Issuance of common stock
    
    
    97,750
    
    
    
    Distributions paid by Rio Vista Energy Partners L.P. to
limited partners
    
    
    (955,328
    )
    
    
    Issuance of debt
    
    
    1,300,000
    
    
    
    Reduction in debt
    
    
    (77,042
    )
    
    
    (1,859,308
    )Net cash (used in) provided by financing activities
    
    
    (360,031
    )
    
    
    1,445,216Net change in cash
    
    
    (84,933
    )
    
    
    9,635,348Cash at beginning of period
    
    
    374,567
    
    
    
    299,597Cash at end of period
    
    $
    289,634
    
    
    $
    9,934,945Supplemental disclosures of cash flow information:Cash paid during the period for:Interest and LPG and Fuel Products financing expense
    
    $
    625,931
    
    
    $
    1,337,942Supplemental disclosures of noncash transactions:Equity-common stock and warrants issued and other
    
    $
    530,450
    
    
    $
    369,694Note issued for software
    
    $
    55,463
    
    
    $
    Transfer of line fill to inventory
    
    $
    91,941
    
    
    $
    
   7




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE A  ORGANIZATION
       8




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE A  ORGANIZATION  Continued
  Basis of Presentation
      9




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE B  INCOME (LOSS) PER COMMON SHARE
   For the three months ended September 30, 2005Income (Loss)
    
    
    Shares
    
    
    Per-Share(Numerator)
    
    
    (Denominator)
    
    
    AmountNet income (loss) from continuing
operations
    
    $
    186,853Basic EPSIncome (loss) available to common
stockholders
    
    
    186,853
    
    
    
    15,522,745
    
    
    $
    0.01Effect of Dilutive SecuritiesWarrants
    
    
    
    
    
    
    Diluted EPSIncome (loss) available to common
stockholders
    
    $
    186,853
    
    
    
    15,522,745
    
    
    $
    0.01
 For the three months ended September 30, 2006Income (Loss)
    
    
    Shares
    
    
    Per-Share(Numerator)
    
    
    (Denominator)
    
    
    AmountNet income (loss) from continuing
operations
    
    $
    (1,104,454
    )Basic EPSIncome (loss) available to common
stockholders
    
    
    (1,104,454
    )
    
    
    15,386,187
    
    
    $
    (0.07
    )Effect of Dilutive SecuritiesWarrants
    
    
    
    
    
    
    Diluted EPSIncome (loss) available to common
stockholders
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
  10




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE B  INCOME (LOSS) PER COMMON SHARE  Continued
 For the nine months ended September 30, 2005Income (Loss)
    
    
    Shares
    
    
    Per-Share(Numerator)
    
    
    (Denominator)
    
    
    AmountNet income (loss) from continuing
operations
    
    $
    (1,521,580
    )Basic EPSIncome (loss) available to common
stockholders
    
    
    (1,521,580
    )
    
    
    15,489,572
    
    
    $
    (0.10
    )Effect of Dilutive SecuritiesWarrants
    
    
    
    
    
    
    Diluted EPSIncome (loss) available to common
stockholders
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
 For the nine months ended September 30, 2006Income (Loss)
    
    
    Shares
    
    
    Per-Share(Numerator)
    
    
    (Denominator)
    
    
    AmountNet income (loss) from continuing
operations
    
    $
    (1,916,523
    )Basic EPSIncome (loss) available to common
stockholders
    
    
    (1,916,523
    )
    
    
    15,476,725
    
    
    $
    (0.12
    )Effect of Dilutive SecuritiesWarrants
    
    
    
    
    
    
    Diluted EPSIncome (loss) available to common
stockholders
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
  11




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE C  SHARE-BASED PAYMENT
   Three Months
    
    
    Nine MonthsEnded
    
    
    EndedSeptember 30, 2005
    
    
    September 30, 2005Net income (loss), as reported
    
    $
    164,734
    
    
    $
    (1,861,949
    )Add: Stock-based employee compensation cost
expense included in reported net income
(loss), net of related tax effects
    
    
    
    
    
    
    Less: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects
    
    
    (117,772
    )
    
    
    (272,237
    )Net income (loss), pro forma
    
    $
    46,962
    
    
    $
    (2,134,186
    )Basic and Diluted EPS:Net income (loss) per common share, as reported
    
    $
    0.01
    
    
    $
    (0.12
    )Net income (loss) per common share, pro forma
    
    $
    0.00
    
    
    $
    (0.14
    )
   12




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE D  SALE OF LPG ASSETS / DISCONTINUED OPERATIONS
       13




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE
D  SALE OF LPG ASSETS / DISCONTINUED OPERATIONS  Continued
   December 31,
    
    
    September 30,2005
    
    
    2006Net Current Assets:Property, plant and equipmentMidline pump station (b)
    
    $
    2,326,985
    
    
    $
    Brownsville Terminal Facility: (a)Building
    
    
    173,500
    
    
    
    Terminal facilities
    
    
    3,631,207
    
    
    
    Tank Farm
    
    
    373,945
    
    
    
    Leasehold improvements
    
    
    318,807
    
    
    
    Equipment
    
    
    226,285
    
    
    
    Truck
    
    
    25,968
    
    
    
    Static Inventory
    
    
    167,379
    
    
    
    7,244,076
    
    
    
    Less: Accumulated depreciation
    
    
    (3,738,008
    )
    
    
    3,506,068
    
    
    
    Inventories (a)(b)
    
    
    1,678,486
    
    
    
    Lease rights, net (b)
    
    
    335,832
    
    
    
    $
    5,520,386
    
    
    $
    Net Current Liabilities:Note payable (a)
    
    $
    (15,581
    )
    
    
    Accounts payable  Exxon (b)
    
    
    (583,000
    )
    
    
    $
    (598,581
    )
    
    $
    
 (a)
    
    Rio Vista.(b)
    
    Penn Octane and subsidiaries other than Rio Vista.
  14




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE E  PROPERTY, PLANT AND EQUIPMENT
  December 31,
    
    
    September 30,2005
    
    
    2006US  Mexico Pipelines and Matamoros Terminal
Facility: (a)(c)U.S. Pipelines and Rights of Way
    
    $
    6,747,391
    
    
    $
    6,751,667Mexico Pipelines and Rights of Way
    
    
    993,300
    
    
    
    1,038,300Matamoros Terminal Facility
    
    
    5,874,781
    
    
    
    5,646,822Land
    
    
    705,358
    
    
    
    705,358Total LPG
    
    
    14,320,830
    
    
    
    14,142,147Other:Office equipment (b)
    
    
    108,487
    
    
    
    117,802Software (b)
    
    
    57,163
    
    
    
    79,779165,650
    
    
    
    197,58114,486,480
    
    
    
    14,339,728Less: accumulated depreciation and amortization
    
    
    (3,009,300
    )
    
    
    (3,435,131
    )$
    11,477,180
    
    
    $
    10,904,597
 (a)
    
    Rio Vista assets(b)
    
    Penn Octane and Subsidiaries other than Rio Vista(c)
    
    Rio Vista owns, leases, or is in the process of obtaining the land or rights of way used related to the US-Mexico Pipelines
   15




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Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE F  INVENTORIES
 December 31, 2005
    
    
    September 30, 2006Gallons
    
    
    LCM
    
    
    Gallons
    
    
    LCMFuel Products
    
    
    687,115
    
    
    $
    1,199,782
    
    
    
    1,802,993
    
    
    $
    3,333,699
 NOTE G  DEBT OBLIGATIONS
  December 31,
    
    
    September 30,2005
    
    
    2006Noninterest-bearing note payable,
discounted at 7%, for legal services;
due in February 2001
    
    $
    137,500
    
    
    $
    137,500Restructured Notes and $280,000 Notes
    
    
    1,550,000
    
    
    
    TransMontaigne Note
    
    
    1,300,000
    
    
    
    1,000,000Other debt
    
    
    22,361
    
    
    
    13,053Total debt
    
    
    3,009,861
    
    
    
    1,150,553Less: Current maturities
    
    
    3,009,861
    
    
    
    1,150,553Long-term debt
    
    $
    
    
    
    $
    
 Restructured Notes and $280,000 Notes (Notes)
        16




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE G  DEBT OBLIGATIONS  Continued
 TransMontaigne Note
  NOTE H  STOCKHOLDERS EQUITY
 Penn Octane 2001 Warrant Plan
  Note Receivable from a Former Officer of the Company
   17




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE I  OPTIONS AND WARRANTS OF RIO VISTA
 General Partner Options
  Common Unit Warrants
    18




---



##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES
 Credit Facility, Letters of Credit and Other
        19




---



##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES  Continued
 Credit Facility, Letters of Credit and Other  Continued
    Amended Leased Pipeline Lease Agreement
  Distributions of Available Cash
    20




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES  Continued
 Distributions of Available Cash  Continued
   Partnership Tax Treatment
      21




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES  Continued
 Partnership Tax Treatment  Continued
   Litigation
   Lesly Camacho by Her Mother Dora Adame as Next Friend, et al. vs. Penn Octane
International LLC th
  22




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES  Continued
 Litigation  Continued
  Faustino Izaguirre Gonzalez, et al. vs. Penn Octane Corporation, et
al. th
  Rio Vista
Operating Partnership L.P. vs. Guajardo, Jr. Farms, Inc.
  23




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##### Table of Contents



Penn Octane Corporation and Subsidiaries
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 NOTE J  COMMITMENTS AND CONTINGENCIES  Continued
 Litigation  Continued
  Consulting Agreement
    Concentrations of Credit Risk
   24




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##### Table of Contents



Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
 Penn Octane Corporation (Penn Octane) and its consolidated subsidiaries which includes Rio
Vista Energy Partners L.P. (Rio Vista) and its subsidiaries are collectively hereinafter referred
to as the Company.
 The following discussion of the Companys results of operations and liquidity and capital
resources should be read in conjunction with the unaudited consolidated financial statements of the
Company and related notes thereto appearing elsewhere herein. References to specific years
proceeded by fiscal (e.g. fiscal 2006) refer to the Companys fiscal year ended December 31.
 Forward-Looking Statements
 The statements contained in this Quarterly Report that are not historical facts are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. These forward-looking statements may be identified by the use of
forward-looking terms such as believes, expects, may, will, should, estimates,
projects or anticipates or by discussions of strategy that inherently involve risks and
uncertainties. From time to time, the Company has made or may make forward-looking statements,
orally or in writing. These forward-looking statements include statements regarding anticipated
future revenues, sales, LPG supply, LPG Transportation Agreement, LPG pricing, operations, demand,
competition, capital expenditures, future acquisitions, additional financing, the deregulation of
the LPG market in Mexico, the operations of the US  Mexico Pipelines, the Matamoros Terminal
Facility, other upgrades to facilities, foreign ownership of LPG operations, short-term obligations
and credit arrangements, Fuel Sales Business, LPG Transportation Business, LPG Asset Sale
,TransMontaigne Note, cash distributions, Qualifying Income, partnership tax treatment, risk
factors and other statements regarding matters that are not historical facts, and involve
predictions which are based upon a number of future conditions that ultimately may prove to be
inaccurate. Actual results, performance or achievements could differ materially from the results
expressed in, or implied by, these forward-looking statements. Factors that may cause or
contribute to such differences include those discussed under Risk Factors and Managements
Discussion and Analysis of Financial Condition and Results of Operations, as well as those
discussed elsewhere in this Report on Form 10-Q . We caution you, however, that the risks contained
in this report may not include all material risks facing the Company.
 Overview
     25




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##### Table of Contents



LPG Transportation Agreement
   26




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##### Table of Contents



Month
    
    Minimum Volumes(gallons)October 2006
    
    
    8,100,000November 2006
    
    
    8,100,000December 2006
    
    
    9,000,000January 2007
    
    
    8,100,000February 2007
    
    
    8,100,000March 2007
    
    
    8,100,000
   Potential Factors Affecting Future Demand Of The Retained Assets:
 Recent Trends.
     27




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##### Table of Contents



Dependence on TransMontaigne.
 Fuel Sales Business
        28




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##### Table of Contents



Three months ended
    
    Three months ended
    
    Nine months ended
    
    Nine months endedSeptember 30, 2005
    
    September 30, 2006
    
    September 30, 2005
    
    September 30, 2006Volume SoldFuel Products
    
    
    18.8
    
    
    
    18.9
    
    
    
    53.5
    
    
    
    49.2(millions of gallons)Average sales priceFuel Products (per gallon)
    
    $
    1.99
    
    
    $
    2.24
    
    
    $
    1.74
    
    
    $
    2.20
 Results of Operations
  For the three months ended September 30, 2005
 Continuing OperationsLPG
    
    
    FuelTransportation
    
    
    Sales
    
    
    Other
    
    
    TotalRevenues
    
    $
    
    (a)
    
    $
    37,389
    
    
    $
    
    
    
    $
    37,389Cost Of Sales
    
    
    774
    (b)
    
    
    36,259
    
    
    
    
    
    
    
    37,033Gross Profit (Loss)
    
    $
    (774
    )
    
    $
    1,130
    
    
    $
    
    
    
    $
    356
 For the three months ended September 30, 2006
 Continuing OperationsLPG
    
    
    FuelTransportation
    
    
    Sales
    
    
    Other
    
    
    TotalRevenues
    
    $
    191
    (a)
    
    $
    42,502
    
    
    $
    189
    
    
    $
    42,882Cost Of Sales
    
    
    397
    (b)
    
    
    43,039
    
    
    
    
    
    
    
    43,436Gross Profit (Loss)
    
    $
    (206
    )
    
    $
    (537
    )
    
    $
    189
    
    
    $
    (554
    )
  29




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##### Table of Contents



For the nine months ended September 30, 2005
 Continuing OperationsLPG
    
    
    FuelTransportation
    
    
    Sales
    
    
    Other
    
    
    TotalRevenues
    
    $
    
    (a)
    
    $
    93,170
    
    
    $
    2
    
    
    $
    93,172Cost Of Sales
    
    
    1,650
    (b)
    
    
    91,174
    
    
    
    
    
    
    
    92,824Gross Profit (Loss)
    
    $
    (1,650
    )
    
    $
    1,996
    
    
    $
    2
    
    
    $
    348
 For the nine months ended September 30, 2006
 Continuing OperationsLPG
    
    
    FuelTransportation
    
    
    Sales
    
    
    Other
    
    
    TotalRevenues
    
    $
    191
    (a)
    
    $
    107,963
    
    
    $
    189
    
    
    $
    108,343Cost Of Sales
    
    
    1,384
    (b)
    
    
    107,654
    
    
    
    
    
    
    
    109,038Gross Profit (Loss)
    
    $
    (1,193
    )
    
    $
    309
    
    
    $
    189
    
    
    $
    (695
    )
 (a)
    
    LPG Transportation revenue began August 22, 2006.(b)
    
    Consists of depreciation on Retained Assets and expenses related to the US-Mexico
Pipelines and the Matamoros Terminal Facility.
 Continuing Operations:
 The following discussion of the Companys results of operations from continuing operations for all
periods presented excludes the results of operations related to the Sold Assets, including
revenues, direct costs, associated interest expenses, minority interest and income taxes, which
have been reclassified as discontinued operations (see below). As a result, the results of
operations from continuing operations reflects only the results associated with the LPG
Transportation Business, including all costs associated with operation of the US-Mexico Pipelines
and Matamoros Terminal Facility, the Companys Fuel Sales business and all indirect income and
expenses of the Company.
  30




---



##### Table of Contents



Three Months Ended September 30, 2006 Compared With Three Months Ended September 30, 2005
 Revenues.
 Cost of goods sold.
 Selling, general and administrative expenses.
 Other income (expense).
 Nine Months Ended September 30, 2006 Compared With Nine Months Ended September 30, 2005
 Revenues.
 Cost of goods sold.
 Selling, general and administrative expenses.
  31




---



##### Table of Contents



Other income (expense).
 Discontinued Operations:
 The following is a discussion of the Companys results of operations from discontinued operations
of its LPG sales business for all periods presented through the date of the LPG Asset Sale and
includes all related revenues, direct costs, associated interest expenses, minority interest and
income taxes.
  Three months ended
    
    
    Three months ended
    
    
    Nine months ended
    
    
    Nine months endedSeptember 30, 2005
    
    
    September 30, 2006 (a)
    
    
    September 30, 2005
    
    
    September 30, 2006 (a)Volume SoldLPG (millions of gallons)
 PMI
    
    
    21.0
    
    
    
    9.0
    
    
    
    73.7
    
    
    
    66.2LPG (millions of gallons)
 Other
    
    
    7.8
    
    
    
    6.2
    
    
    
    19.9
    
    
    
    16.228.8
    
    
    
    15.2
    
    
    
    93.6
    
    
    
    82.4Average sales priceLPG (per gallon)  PMI
    
    $
    1.08
    
    
    $
    1.23
    
    
    $
    0.94
    
    
    $
    1.08LPG (per gallon)  Other
    
    
    0.79
    
    
    
    1.13
    
    
    
    0.81
    
    
    
    1.07
 (a)
    
    Sales of LPG ceased on August 21, 2006, immediately prior to the date of the LPG Asset
Sale
  32




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##### Table of Contents



Three Months Ended September 30, 2006 Compared With Three Months Ended September 30, 2005
 Revenues.
 Cost of goods sold.
 Minority interest on earnings of Rio Vista.
 Nine Months Ended September 30, 2006 Compared With Nine Months Ended September 30, 2005
 Revenues.
 Cost
of goods sold.
 Minority interest on earnings of Rio Vista.
  33




---



##### Table of Contents



Liquidity and Capital Resources
 General.
 The Companys Consolidated Pro Forma
    
    
    Rio Vistas Consolidated Pro FormaWorking Capital
    
    
    Working CapitalSeptember 30, 2006
    
    
    September 30, 2006As Reported
    
    
    
    
    
    
    Adjusted
    
    
    As Reported
    
    
    
    
    
    
    Adjusted9/30/2006
    
    
    Pro Forma
    
    
    9/30/2006
    
    
    9/30/2006
    
    
    Pro Forma
    
    
    9/30/2006Current AssetsCash
    
    $
    9,934,945
    
    
    $
    (487,412
    )(a)
    
    $
    9,447,533
    
    
    $
    3,930,980
    
    
    $
    (487,412
    )(a)
    
    $
    6,731,3013,287,733
    (b)Restricted Cash
    
    
    3,079,145
    
    
    
    
    
    
    
    3,079,145
    
    
    
    26,181
    
    
    
    
    
    
    
    26,181Trade Accounts Receivable
    
    
    5,606,999
    
    
    
    
    
    
    
    5,606,999
    
    
    
    286,632
    
    
    
    
    
    
    
    286,632Inventories
    
    
    3,333,699
    
    
    
    
    
    
    
    3,333,699
    
    
    
    
    
    
    
    
    
    
    
    Due From Affiliates
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,287,733
    
    
    
    (3,287,733
    )(b)
    
    
    Deferred Tax Asset
    
    
    634,100
    
    
    
    
    
    
    
    634,100
    
    
    
    
    
    
    
    
    
    
    
    Prepaid Expenses
    
    
    162,405
    
    
    
    
    
    
    
    162,405
    
    
    
    6,931
    
    
    
    
    
    
    
    6,931Total Current Assets
    
    
    22,751,293
    
    
    
    (487,412
    )
    
    
    22,263,881
    
    
    
    7,538,457
    
    
    
    (487,412
    )
    
    
    7,051,045Current LiabilitiesCurrent Maturities Of Long-Term
Debt
    
    $
    1,150,553
    
    
    
    
    
    
    $
    1,150,553
    
    
    $
    1,000,000
    
    
    
    
    
    
    $
    1,000,000Revolving Line Of Credit
    
    
    1,286,329
    
    
    
    
    
    
    
    1,286,329
    
    
    
    
    
    
    
    
    
    
    
    Fuel Products Payables
    
    
    6,236,108
    
    
    
    
    
    
    
    6,236,108
    
    
    
    
    
    
    
    
    
    
    
    US and Foreign Taxes Payable
    
    
    1,270,195
    
    
    
    
    
    
    
    1,270,195
    
    
    
    73,398
    
    
    
    
    
    
    
    73,398Accounts Payables
    
    
    804,228
    
    
    
    
    
    
    
    804,228
    
    
    
    325,671
    
    
    
    
    
    
    
    325,671Accrued Liabilities
    
    
    1,192,441
    
    
    
    
    
    
    
    1,192,441
    
    
    
    724,362
    
    
    
    
    
    
    
    724,362Total Current Liabilities
    
    
    11,939,854
    
    
    
    
    
    
    
    11,939,854
    
    
    
    2,123,431
    
    
    
    
    
    
    
    2,123,431Working Capital
    
    $
    10,811,439
    
    
    $
    (487,412
    )
    
    $
    10,324,027
    
    
    $
    5,415,026
    
    
    $
    (487,412
    )
    
    $
    4,927,614
    34




---



##### Table of Contents



35




---



##### Table of Contents



Credit Arrangements
        36




---



##### Table of Contents



Payments due by Period(Amounts in Millions)Less than
    
    
    1  3
    
    
    4  5
    
    
    AfterContractual Obligations
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 YearsLong-Term Debt
Obligations and Note Payable
    
    $
    1.0
    
    
    $
    1.0
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating Leases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other Long-Term Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Contractual Cash Obligations
    
    $
    1.0
    
    
    $
    1.0
    
    
    $
    
    
    
    $
    
    
    
    $
    
 Amount of Commitment ExpirationPer Period(Amounts in Millions)Total Amounts
    
    
    Less than
    
    
    1  3
    
    
    4  5
    
    
    OverCommercial Commitments
    
    Committed
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 YearsLines of Credit
    
    $
    1.3
    
    
    $
    1.3
    
    
    $
    
    
    
    $
    
    
    
    $
    Standby Letters of Credit
    
    
    8.8
    
    
    
    8.8
    
    
    
    
    
    
    
    
    
    
    
    Guarantees
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AStandby Repurchase Obligations
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AOther Commercial Commitments
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ATotal Commercial Commitments
    
    $
    10.1
    
    
    $
    10.1
    
    
    $
    
    
    
    $
    
    
    
    $
    
 Distributions of Available Cash.
   37




---



##### Table of Contents



Partnership Tax Treatment.
 Litigation.
 Consulting Agreement.
 Other.
 Mexican Operations.
  Deregulation of the LPG Industry in Mexico. Ley Reglarmentaria del Artículo 27 Constitutional en el Ramo del Petróleo Ley Orgánica del Petróleos Mexicanos
y Organismos Subsidiarios
  38




---



##### Table of Contents



Private Placements and Other Transactions
 Penn Octane 2001 Warrant Plan
  Note Receivable from a Former Officer of the Company
  Restructured Notes and $280,000 Notes (Notes).
    39




---



##### Table of Contents



TransMontaigne Note
  Options and Warrants of Rio Vista
 General Partner Options.
 Common Unit Warrants.
  40




---



##### Table of Contents



Intercompany Agreement
 Omnibus Agreement.
   Rio Vistas Guarantees
 Debt Guarantee .
 Tax Guarantee .
 Impact of Inflation
    41




---



##### Table of Contents



Environmental Matters
   Recently Issued Financial Accounting Standards
 Accounting for Certain Hybrid
Instruments. Accounting for
Derivative Instruments and Hedging Activities, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities.
  Statement by Management Concerning Review of Interim Information by An Independent Registered
Public Accounting Firm.
   42




---



##### Table of Contents



Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk.
     
 Item 4.
    
    Controls and Procedures.
    43




---



##### Table of Contents



PART II
 
 Item 1.
    
    Legal Proceedings
  
 Item 1A.
    
    Risk Factors
 Business Factors.
 Acquisition Factors.
 Market Listing
 Competitive Factors.
 International Factors.
  44




---



##### Table of Contents



Political Factors.
 Industry and Economic Factors.
 Market Risk Factors.
 Internal Control Factors.
 Projections
 
 Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds 
None.
 
 Item 3.
    
    Defaults Upon Senior Securities 
None.
 
 Item 4.
    
    Submission of Matters to a Vote of Security Holders 
None.
 
 Item 5.
    
    Other Information 
None.
  45




---



##### Table of Contents



Item 6.
    
    Exhibits The following exhibits are incorporated by reference to previously filed reports, as noted.
 Exhibit No.
 2.1
    
    
    Purchase and Sale Agreement dated August 15, 2006 as amended and restated on August 15, 2006
entered into by and between Penn Octane Corporation and TransMontaigne Product Services Inc.
(Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter
ended June 30, 2006 filed on August 14, 2006, SEC File No. 000-24394).2.2
    
    
    Purchase and Sale Agreement dated August 15, 2006 as amended and restated on August 15, 2006
entered into by and between Rio Vista Operating Partnership L.P. and TransMontaigne Product
Services Inc. (Incorporated by reference to the Companys Quarterly Report on Form 10-Q for
the quarter ended June 30, 2006 filed on August 14, 2006, SEC File No. 000-24394).10.1
    
    
    Matamoros LPG Mix Purchase and Sales Agreement made and entered into as of June 4, 2005, by
and between Rio Vista Energy Partners L.P. and P.M.I. Trading Limited (Incorporated by
reference to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30,
2005 filed on August 19, 2005, SEC File No. 000-24394).10.2
    
    
    Purchase and Sale Agreement dated as of August 15, 2005 between Penn Octane Corporation and
TransMontaigne Product Services Inc. (Incorporated by reference to the Companys Quarterly
Report on Form 10-Q for the quarter ended September 30, 2005 filed on August 19, 2005, SEC
File No. 000-24394).10.3
    
    
    Form of Amendment of Promissory Note(s) of Penn Octane Corporation due December 15, 2005 and
Related Agreements dated September 30, 2005. (Incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 filed on August 14,
2006, SEC File No. 000-24394).10.4
    
    
    Form of Escrow Agreement dated as of September 30, 2005 by and between Jerome B. Richter,
Penn Octane Corporation and the Noteholders of Promissory Notes of Penn Octane due on December
15, 2005. (Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarter ended September 30, 2005 filed on August 14, 2006, SEC File No. 000-24394).10.5
    
    
    Fourth Amendment to Purchase, Sale and Service Agreement for Propane/Butane Mix made and
extended into effective March 1, 2006 by and between Exxon Mobil Gas and Power Marketing
Company and Penn Octane Corporation. (Incorporated by reference to the Companys Annual Report
on Form 10-K for the year ended December 31, 2005 filed on April 6, 2006, SEC File No.
000-24394).10.6
    
    
    Amendment No. 1 to Purchase and Sale Agreement between Penn Octane Corporation and
TransMontaigne Product Services Inc., dated January 26, 2006. (Incorporated by reference to
the Companys Annual Report on Form 10-K for the year ended December 31, 2005 filed on April
6, 2006, SEC File No. 000-24394).10.7
    
    
    Amended and Restated Consulting Agreement dated November 15, 2005 between Penn Octane
Corporation, Rio Vista Energy Partners L.P. and Jerome B. Richter. (Incorporated by reference
to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 filed
on November 21, 2005, SEC File No. 000-24394).10.8
    
    
    Amended and Restated Promissory Note by Jerome B. Richter to the Company dated November 15,
2005. (Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarter ended September 30, 2005 filed on November 21, 2005, SEC File No. 000-24394).10.9
    
    
    Agreement dated as of November 15, 2005 by and between Penn Octane Corporation and Jerome B.
Richter. (Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarter ended September 30, 2005 filed on November 21, 2005, SEC File No. 000-24394).
  46




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##### Table of Contents



10.10
    
    
    Ella-Brownsville Pipeline Lease Agreement effective as of August 1, 2006 between Seadrift
Pipeline Corporation and Penn Octane Corporation. (Incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 filed on August 14, 2006,
SEC File No. 000-24394).10.11
    
    
    Matamoros LPG Mix Purchase and Sales Agreement made and entered into as of April 28, 2006,
by and between Rio Vista Operating Partnership L.P. and P.M.I. Trading Limited. (Incorporated
by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30,
2006 filed on August 14, 2006, SEC File No. 000-24394).
 The following Exhibits are filed as part of this report:
 10.12
    
    
    Amendment to Pledge and Security Agreement between the Penn Octane Corporation and Jerome B.
Richter dated October 13, 2006.10.13
    
    
    First Amendment to Amended and Restated Limited Liability Company Agreement of Rio Vista GP
LLC dated October 6, 2006.15
    
    
    Accountants Acknowledgment.31.1
    
    
    Certification Pursuant to Rule 13a  14(a) / 15d  14(a) of the Exchange Act.31.2
    
    
    Certification Pursuant to Rule 13a  14(a) / 15d  14(a) of the Exchange Act.32
    
    
    Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 www.sec.gov
  47




---



##### Table of Contents



SIGNATURES
  PENN OCTANE CORPORATIONNovember 20, 2006
    By:
    /s/ Ian T. BothwellIan T. BothwellActing Chief Executive Officer, Acting
President, Vice President, Chief Financial
Officer, Treasurer and Assistant Secretary
(Principal Executive, Financial and
Accounting Officer) 
  48




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNo.
    
    Description10.12
    
    
    Amendment to Pledge and Security Agreement between the Penn Octane Corporation and Jerome B.
Richter dated October 13, 2006.10.13
    
    
    First Amendment to Amended and Restated Limited Liability Company Agreement of Rio Vista GP
LLC dated October 6, 2006.15
    
    
    Accountants Acknowledgment.31.1
    
    
    Certification Pursuant to Rule 13a  14(a) / 15d  14(a) of the Exchange Act.31.2
    
    
    Certification Pursuant to Rule 13a  14(a) / 15d  14(a) of the Exchange Act.32
    
    
    Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
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